Cash flow hedge - in a cash flow hedge, the effective portion of the gain or loss on the hedging instrument is recognised in other comprehensive income and the ineffective portion in profit or loss. When the forecast transaction results in the recognition of a financial asset or financial liability, the cumulative gain or loss is reclassified from equity to profit or loss in the same periods in which the hedged forecast cash flows affect profit or loss. Otherwise the cumulative gain or loss is removed from equity and recognised in profit or loss at the same time as the hedged transaction. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; if the hedging instrument expires or is sold, terminated or exercised; if the forecast transaction is no longer expected to occur; or if hedge designation is revoked. On the discontinuance of hedge accounting (except where a forecast transaction is no longer expected to occur), the cumulative unrealised gain or loss in equity is recognised in profit or loss when the hedged cash flows occur or, if the forecast transaction results in the recognition of a financial asset or financial liability, when the hedged forecast cash flows affect profit or loss. Where a forecast transaction is no longer expected to occur, the cumulative unrealised gain or loss in equity is recognised in profit or loss immediately.
The cost of employee services received in exchange for an award of shares or share options granted is measured by reference to the fair value of the shares or share options on the date the award is granted and takes into account non-vesting conditions and market performance conditions (conditions related to the market price of RBSG shares): an award is treated as vesting irrespective of whether any market performance condition or non-vesting condition is met. The fair value of options granted is estimated using valuation techniques which incorporate exercise price, term, risk-free interest rates, the current share price and its expected volatility. The cost is expensed on a straight-line basis over the vesting period (the period during which all the specified vesting conditions must be satisfied) with a corresponding increase in equity in an equity-settled award, or a corresponding liability in a cashsettled award. The cost is adjusted for vesting conditions (other than market performance conditions) so as to reflect the number of shares or share options that actually vest.
Pensions The Group operates a number of defined benefit pension schemes as described in Note 4 on the accounts. The assets of the schemes are measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. Any recognisable surplus or deficit of scheme assets over liabilities is recorded in the balance sheet as an asset (surplus) or liability (deficit).
A pension asset of £188 million and a liability of £2,239 million were recognised on the balance sheet at 31 December 2011 (2010 - asset £105 million, liability £2,288 million; 2009 - asset £58 million, liability £2,963 million).
Accounting developments International Financial Reporting Standards The IASB issued IFRS 9 ‘Financial Instruments’ in November 2009 simplifying the classification and measurement requirements in IAS 39 in respect of financial assets. The standard reduces the measurement categories for financial assets to two: fair value and amortised cost. A financial asset is classified on the basis of the entity's business model for managing the financial asset and the contractual cash flow characteristics of the financial asset. Only assets with contractual terms that give rise to cash flows on specified dates that are solely payments of principal and interest on principal and which are held within a business model whose objective is to hold assets in order to collect contractual cash flows are classified as amortised cost. All other financial assets are measured at fair value. Changes in the value of financial assets measured at fair value are generally taken to profit or loss.
In December 2010, the IASB issued amendments to IFRS 9 and to IFRS 7 ‘Financial Instruments: Disclosures’ delaying the effective date of IFRS 9 to annual periods beginning on or after 1 January 2015 and introducing revised transitional arrangements including additional transition disclosures. If an entity implements IFRS 9 in 2012 the amendments permit it either to restate comparative periods or to provide the additional disclosures. The additional transition disclosures must be given if implementation takes place after 2012.
IFRS 9 makes major changes to the framework for the classification and measurement of financial instruments and will have a significant effect on the Group's financial statements. The Group is assessing the effect of IFRS 9 which will depend on the outcome of the other phases of the IASB's IAS 39 replacement project and on the outcome the IASB’s tentative decision at its December 2011 meeting to reconsider the following topics: additional application guidance to clarify how the instrument characteristics test was intended to be applied.
bifurcation of financial assets, after considering any additional guidance for the instrument characteristics test.
‘Disclosures - Transfers of Financial Assets (Amendments to IFRS 7)’ was published by the IASB in October 2010. This replaces IFRS 7’s existing derecognition disclosure requirements with disclosures about (a) transferred assets that are not derecognised in their entirety and (b) transferred assets that are derecognised in their entirety but where an entity has continuing involvement in the transferred asset. The amendments are effective for annual periods beginning on or after 1 July 2011.
IAS 27 ‘Separate Financial Statements’ which comprises those parts of the existing IAS 27 that dealt with separate financial statements.
IFRS 11 ‘Joint Arrangements’, which supersedes IAS 31’ Interests in Joint Ventures’, distinguishes between joint operations and joint ventures. Joint operations are accounted for by the investor recognising its assets and liabilities including its share of any assets held and liabilities incurred jointly and its share of revenues and costs. Joint ventures are accounted for in the investor’s consolidated accounts using the equity method.
IAS 28 ‘Investments in Associates and Joint Ventures’ covers joint ventures as well as associates; both must be accounted for using the equity method. The mechanics of the equity method are unchanged.
The standards are effective for annual periods beginning on or after 1 January 2013. Earlier application is permitted. The Group is reviewing the standards to determine their effect on the Group’s financial reporting.
Fees and commissions receivable Payment services 1,498 1,638 1,776 Credit and debit card fees 1,093 2,432 2,389 Lending (credit facilities) 1,707 1,863 2,433 Brokerage 631 652 450 Trade finance 410 423 370 Investment management 525 568 627 Other 520 617 693 6,384 8,193 8,738
- debt securities in issue 1,259 284 25 - subordinated liabilities 362 (35) 26 Changes in the fair value of securities and other financial assets and liabilities 150 (180) 42 Changes in the fair value of investment properties (139) (405) (117) Profit on sale of securities 882 496 162 Profit on sale of property, plant and equipment 22 50 40 Loss on sale of subsidiaries and associates (28) (107) (144) Life business (losses)/profits (13) 90 156 Dividend income 62 69 78 Share of profits/(losses) of associated entities 26 70 (268)
Notes: (1) The analysis of income from trading activities is based on how the business is organised and the underlying risks managed. Income from trading activities comprises gains and losses on financial instruments held for trading, both realised and unrealised, interest income and dividends and the related funding costs. The types of instruments include: - Foreign exchange: spot foreign exchange contracts, currency swaps and options, emerging markets and related hedges and funding. - Interest rate: interest rate swaps, forward foreign exchange contracts, forward rate agreements, interest rate options, interest rate futures and related hedges and funding. - Credit: asset-backed securities, corporate bonds, credit derivatives and related hedges and funding. - Equities: equities, equity derivatives and related hedges and funding. - Commodities: commodities, commodity contracts and related hedges and funding. Includes £225 million (2010 - (£75) million; 2009 - £(193) million) in relation to changes in fair value in the credit risk premium payable by the Group on debt securities in issue classified as held-fortrading.
Wages, salaries and other staff costs 7,367 7,945 8,039 Bonus tax 27 99 208 Social security costs 640 661 675 Share-based compensation 197 397 329 Pension costs - defined benefit schemes (see Note 4) 349 519 638 - curtailment gains (see Note 4) — (78) (2,148) - defined contribution schemes 98 128 104 Staff costs 8,678 9,671 7,845
Premises and equipment 2,451 2,402 2,594 Other administrative expenses 4,931 3,995 4,449
Property, plant and equipment (see Note 18) 1,267 1,428 1,427 Intangible assets (see Note 17) 608 722 739 Depreciation and amortisation 1,875 2,150 2,166
The levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The first chargeable period for the Group was the year ended 31 December 2011. In determining the chargeable equity and liabilities the following amounts are excluded: adjusted Tier 1 capital; certain ‘protected deposits’ (for example those protected under the Financial Services Compensation Scheme); liabilities that arise from certain insurance business within banking groups; liabilities in respect of currency notes in circulation; Financial Services Compensation Scheme liabilities; liabilities representing segregated client money; and deferred tax liabilities, current tax liabilities, liabilities in respect of the levy, revaluation of property liabilities, liabilities representing the revaluation of business premises and defined benefit retirement liabilities. It is also permitted in specified circumstances to reduce certain liabilities: by netting them against certain assets; offsetting assets on the relevant balance sheets that would qualify as high quality liquid assets (in accordance with the FSA definition); and repo liabilities secured against sovereign and supranational debt.
3 Operating expenses continued Integration costs included in operating expenses comprise expenditure incurred in respect of cost reduction and revenue enhancement programmes connected with acquisitions made by the Group.
Divestment costs included in operating expenses comprise: 2011 2010 2009 £m £m £m
The average number of persons employed, rounded to the nearest hundred, in the continuing operations of the Group during the year, excluding temporary staff, was 144,300 (2010 - 157,000; 2009 - 170,000); on the same basis there were no people employed in discontinued operations (2010 - 12,400; 2009 - 27,600). The average number of temporary employees during 2011 was 12,000 (2010 - 11,400; 2009 - 10,000). The number of persons employed in the continuing operations of the Group at 31 December, excluding temporary staff, was as follows: Global Transaction Services 2,400 2,400 3,200
Options are exercisable within six months of vesting; 3 million were exercisable at 31 December 2011 (2010 - 23 million; 2009 - 26 million). The weighted average share price at the date of exercise of options was 42p (2010 - 45p; 2009 - not applicable). At 31 December 2011, exercise prices ranged from 23p to 393p and the average contractual life was 3.7 years (2010 - 38p to 393p and 3.3 years; 2009 - 38p to 393p and 3.2 years). The fair value of options granted in 2011 was £43 million (2010 - £48 million; 2009 - £220 million).
The awards granted in 2011 vest evenly over the following three anniversaries.
The market value of awards exercised in 2011 was £11 million (2010 - £6 million; 2009 - £2 million).
At 31 December 2011, a provision of £3 million had been made in respect of 4 million share awards and 14 million options over shares that may be cash-settled (2010 - £6 million in respect of 3 million share awards and 16 million options over shares; 2009 - £6 million in respect of 3 million share awards and 16 million options over shares).
The fair value of options granted in 2011 was determined using a pricing model that included: expected volatility of shares determined at the grant date based on historic volatility over a period of up to seven years; expected option lives that equal the vesting period; no dividends on equity shares; and a risk-free interest rate determined from the UK gilt rates with terms matching the expected lives of the options.
Variable compensation as a % of core operating profit (2) 11% 16% 18% 22% Proportion of variable compensation that is deferred 86% 90% 92% 93%
Reconciliation of variable compensation awards to income statement charge 2011 £m
Variable compensation awarded for 2011 785 1,375 Less: deferral of charge for amounts awarded for current year (302) (512) Add: current year charge for amounts deferred from prior years 502 383 Income statement charge for variable compensation 985 1,246
Discount rate 5.0 5.5 5.9 5.2 5.4 5.7 Expected return on plan assets 5.7 6.7 6.8 5.6 6.3 6.1 Rate of increase in salaries 1.8 1.8 1.8 2.0 2.0 2.0 Rate of increase in pensions in payment 3.0 3.3 3.5 2.9 3.0 3.0 Inflation assumption 3.0 3.3 3.5 3.0 3.2 3.0
Notional amounts Assets Liabilities £m £m £m £m £m £m £m £m £m
Credit default swaps 238 6 — — — — — — —
Equity and bond call options 814 67 4 — — — — — — Equity and bond put options 665 11 — — — — — — —
Collateral is required on all swap transactions with those between the banks and the Main scheme on terms that do not allow the banks to rehypothecate. The banks had delivered £375 million of collateral at 31 December 2011 (2010 - delivered £210 million; 2009 - held £6 million).
Ordinary shares of the company with a fair value of £3 million (2010 - £9 million; 2009 - £4 million) are held by the Group's Main scheme which also holds other financial instruments issued by the Group with a value of £424 million (2010 - £264 million; 2009 - £192 million).
Longevity at age 60 for current pensioners (years) Males 27.3 27.2 27.1
At 1 January 2010 16,603 18,675 2,072 27,925 30,830 2,905 Currency translation and other adjustments — — — (206) (206) — Income statement
The Group and the Trustees of the Main scheme agreed the funding valuation as at 31 March 2010 during the year. It showed that the value of liabilities exceed the value of assets by £3.5 billion as at 31 March 2010, a ratio of assets to liabilities of 84%. In order to eliminate this deficit, the
The Group expects to contribute a total of £843 million to its defined benefit pension schemes in 2012. Of the net liabilities of schemes in deficit, £163 million (2010 - £161 million; 2009 - £198 million) relates to unfunded schemes.
Cumulative net actuarial losses of £4,805 million (2010 - £4,224 million; 2009 - £4,382 million) have been recognised in the statement of comprehensive income, of which £3,589 million losses (2010 - £3,252 million losses; 2009 - £3,296 million gains) relate to the Main scheme.
Fair value of plan assets 21,111 19,110 16,603 14,804 18,575 25,086 22,816 27,925 25,756 27,662 Present value of defined benefit obligations 22,955 21,092 18,675 15,594 18,099 27,137 24,999 30,830 27,752 27,547 Net deficit/(surplus) 1,844 1,982 2,072 790 (476) 2,051 2,183 2,905 1,996 (115)
The table below sets out the sensitivities of the pension cost for the year and the present value of defined benefit obligations at 31 December to a change in the principal actuarial assumptions: Main scheme All schemes Increase/(decrease) Increase/(decrease)
in pension cost for year in obligation at 31 December in pension cost for year in obligation at 31 December 0.25% increase in the discount rate (13) (17) (21) (1,019) (925) (790) (34) (42) (41) (1,360) (1,245) (1,261) 0.25% increase in inflation 60 59 49 911 799 654 88 89 93 1,244 1,106 1,143 0.25% additional rate of increase in pensions in payment 39 37 33 618 527 442 45 43 47 691 599 596 0.25% additional rate of increase in deferred pensions 20 21 16 285 265 214 40 44 25 526 497 366 0.25% additional rate of increase in salaries 6 6 8 56 56 66 26 30 17 283 270 125 Longevity increase of 1 year 33 34 29 566 519 416 58 59 50 875 781 734 5 Auditor’s remuneration Amounts paid to the Group's auditors for statutory audit and other services are set out below. All audit related and other services are approved by the Audit Committee and are subject to strict controls to ensure the external auditor’s independence is unaffected by the provision of other services. The Audit Committee recognise that for certain assignments the auditors are best placed to perform the work economically; for other work the Group selects the supplier best placed to meet its requirements. The Group’s auditors are permitted to tender for such work in competition with other firms where the work is permissible under audit independence rules.
Fees payable to the auditor and its associates in respect of audits of associated pension schemes 0.4 0.2
The actual tax (charge)/credit differs from the expected tax credit computed by applying the standard rate of UK corporation tax of 26.5% (2010 and 2009 - 28%) as follows: Expected tax credit 203 112 741 Sovereign debt impairment where no deferred tax asset recognised (275) — — Other losses in year where no deferred tax asset recognised (530) (450) (780) Foreign profits taxed at other rates (417) (517) (276) UK tax rate change - deferred tax impact (1) (110) (82) — Unrecognised timing differences (20) 11 274 Non-deductible goodwill impairment (24) (3) (102) Items not allowed for tax - losses on strategic disposals and write-downs (72) (311) (152) - UK bank levy (80) — —
(2) Prior year tax adjustments include releases of tax provisions in respect of structured transactions and investment disposals, and adjustments to reflect submitted tax computations in the UK and overseas.
Preference shareholders Non-cumulative preference shares of US$0.01 — 105 342 Non-cumulative preference shares of €0.01 — — 201 Non-cumulative preference shares of £1 - issued to UK Financial Investments Limited (1) — — 274 - other — — 61
Note: (1) Includes £50 million redemption premium on repayment of preference shares.
Weighted average number of shares (millions) Ordinary shares in issue during the year 57,219 56,245 51,494 B shares in issue during the year 51,000 51,000 1,397 Weighted average number of ordinary and B shares in issue during the year 108,219 107,245 52,891
Liabilities Deposits by banks - repos 20,585 — 12,154 32,739 - other (3) 28,216 — 37,835 66,051 Customer accounts - repos 53,031 — 29,063 82,094 - other (4) 14,357 4,824 409,418 428,599 Debt securities in issue (5) 7,730 43,488 167,154 218,372 Settlement balances — — 10,991 10,991 Short positions 43,118 — 43,118 Derivatives 419,103 4,864 423,967 Accruals, deferred income and other liabilities — — 1,793 458 20,838 23,089 Retirement benefit liabilities 2,288 2,288 Deferred tax 2,142 2,142 Insurance liabilities 6,794 6,794 Subordinated liabilities — 1,129 25,924 27,053 Liabilities of disposal groups 9,428 9,428 586,140 49,441 4,864 694,332 458 41,490 1,376,725 Equity 76,851
Gains on financial assets/liabilities designated as at fair value through profit or loss 1,761 279 1,441 Gains/(losses) on disposal or settlement of loans and receivables 59 267 (573)
(5) Comprises bonds and medium term notes of £129,780 million (2010 - £154,282 million; 2009 - £164,900 million) and certificates of deposit and other commercial paper of £32,841 million (2010 - £64,090 million; 2009 - £102,668 million).
(6) During 2009, the Group reclassified financial assets from the held-for-trading category into the loans and receivables category, and during 2008 from the held-for-trading and available-for-sale categories into the loans and receivables category and from the held-for-trading category into the available-for-sale category (see below).
Reclassified from HFT to LAR Loans 4,128 3,305 156 18 296 122 Debt securities 2,645 1,930 32 (7) (284) (309)
Reclassified from HFT to AFS (1) Debt securities 4,176 4,176 (84) (61) (20) 125 Equity securities — — — — 1 1 4,176 4,176 (84) (61) (19) 126
Reclassified from HFT to AFS (1) Debt securities 7,601 7,601 442 (428) 1,293 1,279 Equity securities 28 28 (1) — — 1
During 2011, the Group made a significant and ongoing investment into enhancing its already robust control environment. This included continuing investment into a new global IPV and reserving tool, which partly automates the process of carrying out IPV and consolidation of reserves into a single central portal.
The Group Executive Valuation Committee discusses the issues escalated by the Modelled Product Review Committee, GBM and NonCore senior management Valuations Control Committee and other relevant issues, including the APS credit derivative valuation. This committee covers key material and subjective valuation issues within the trading business and provides a ratification to the appropriateness of areas with high levels of residual valuation uncertainty. Committee members include the Group Finance Director, the Group Chief Accountant, Global Head of Market and Insurance Risk, GBM Chief Financial Officer and Non-Core Chief Financial Officer, and representation from front office trading and finance.
Valuation issues, adjustments and reserves are reported to GBM, NonCore and Group Audit Committees. Key judgmental issues are described in reports submitted to these Audit Committees.
Valuation hierarchy There is a process to review and control the classification of financial instruments into the three level hierarchy established by IFRS 7. Some instruments may not easily fall into a level of the fair value hierarchy per IFRS 7 (see page 350) and judgment may be required as to which level the instrument is classified.
11 Financial instruments - valuation continued Valuation techniques The Group derives fair value of its instruments differently depending on whether the instrument is a non-modelled or a modelled product.
Recovery rates/loss given default - these are used as an input to valuation models and reserves for asset-backed securities and other credit products as an indicator of severity of losses on default. Recovery rates are primarily sourced from market data providers or inferred from observable credit spreads.
Credit valuation adjustments Monoline insurers 1,198 2,443 3,796 Credit derivative product companies 1,034 490 499 Other counterparties 2,254 1,714 1,588 4,486 4,647 5,883 Bid-offer, liquidity and other reserves 2,704 2,797 2,814 7,190 7,444 8,697
The exposure to credit derivative product companies has increased, primarily driven by wider credit spreads of the underlying reference loans and bonds. The credit valuation adjustments increased in line with the increase in exposure.
Monoline insurers The Group has purchased protection from monoline insurers (“monolines”), mainly against specific Asset-backed securities. Monolines specialise in providing credit protection against the principal and interest cash flows due to the holders of debt instruments in the event of default by the debt instrument counterparty. This protection is typically held in the form of derivatives such as credit default swaps (CDSs) referencing underlying exposures held directly or synthetically by the Group.
The gross mark-to-market of the monoline protection depends on the value of the instruments against which protection has been bought. A positive fair value, or a valuation gain, in the protection is recognised if the fair value of the instrument it references decreases. For the majority of trades the gross mark-to-market of the monoline protection is determined directly from the fair value price of the underlying reference instrument However, for the remainder of the trades the gross mark-tomarket is determined using industry standard models.
The gross mark-to-market of the CDPC protection is determined using industry standard models. The methodology employed to calculate the CDPC CVA is different to that outlined above for monolines, as there are no market observable credit spreads and recovery levels for these entities. The level of expected loss on CDPC exposures is estimated with reference to recent market events impacting CDPCs (including communication activity); risk mitigation strategies (including analysing the underlying trades and the cost of hedging expected default losses in excess of the available capital); and the total notional of trades transacted by each CDPC together with the level of resources available to settle default payments.
CVA is held against exposures to all counterparties with the exception of the CDS protection that the Group has purchased from HM Treasury, as part of its participation in the Asset Protection Scheme, due to the unique features of this derivative.
Netting is applied on a portfolio basis to reflect the level at which the Group believes it could exit the portfolio, rather than the sum of exit costs for each of the portfolio’s individual trades. For example, netting is applied where long and short risk in two different maturity buckets can be closed out in a single market transaction at less cost than by way of two separate transactions (calendar netting). This reflects the fact that to close down the portfolio, the net risk can be settled rather than each long and short trade individually.
Product related risks such as correlation risk, attract specific bid-offer reserves. Additional reserves are provided for exotic products to ensure overall reserves match market close-out costs. These market close-out costs inherently incorporate risk decay and cross-effects (taking into account how moves in one risk factor may affect other inputs rather than treating all risk factors independently) that are unlikely to be adequately reflected in a static hedge based on vanilla instruments. Where there is limited bid-offer information for a product, the pricing approach and risk management strategy are taken into account when assessing the reserve.
Equity shares 12.4 1.8 1.0 15.2 18.4 2.8 1.0 22.2 15.4 2.6 1.5 19.5 Derivatives Foreign exchange — 72.9 1.6 74.5 — 83.2 0.1 83.3 — 69.2 0.2 69.4 Interest rate 0.2 420.8 1.1 422.1 1.7 308.3 1.7 311.7 0.3 321.8 1.5 323.6 Equities and commodities — 5.9 0.2 6.1 0.1 4.9 0.2 5.2 0.4 6.1 0.3 6.8 Credit - APS — — — — — — 0.6 0.6 — — 1.4 1.4 Credit - other — 23.1 3.8 26.9 — 23.2 3.1 26.3 0.1 37.2 3.0 40.3
Of which AFS debt securities UK government 13.4 — — 13.4 8.4 — — 8.4 19.1 — — 19.1 US government 18.1 2.7 — 20.8 17.8 4.4 — 22.2 12.6 6.4 — 19.0 Other government 21.6 4.0 — 25.6 26.5 6.4 — 32.9 38.4 7.1 — 45.5 Corporate — 2.3 0.2 2.5 — 1.4 0.1 1.5 — 3.3 0.2 3.5 Financial institutions 0.2 39.3 5.5 45.0 0.4 41.4 4.3 46.1 0.2 54.9 1.1 56.2 53.3 48.3 5.7 107.3 53.1 53.6 4.4 111.1 70.3 71.7 1.3 143.3 Equity shares 0.3 1.3 0.4 2.0 0.3 1.4 0.3 2.0 0.5 1.7 0.7 2.9 Total AFS assets 53.6 49.6 6.1 109.3 53.4 55.0 4.7 113.1 70.8 73.4 2.0 146.2
Liabilities Deposits by banks Repos — 23.3 — 23.3 — 20.6 — 20.6 — 21.0 — 21.0 Collateral — 31.8 — 31.8 — 26.6 — 26.6 — 28.2 — 28.2 Other — 2.4 — 2.4 — 1.6 — 1.6 — 4.4 — 4.4
— 85.5 — 85.5 — 72.1 0.1 72.2 — 61.3 0.1 61.4 Debt securities in issue — 45.0 2.2 47.2 — 49.0 2.2 51.2 — 43.2 2.3 45.5 Short positions 34.4 6.3 0.3 41.0 35.0 7.3 0.8 43.1 27.1 13.2 0.2 40.5 Derivatives Foreign exchange — 80.6 0.4 81.0 0.1 89.3 — 89.4 — 63.9 — 63.9 Interest rate 0.4 405.2 1.1 406.7 0.2 298.0 1.0 299.2 0.1 310.5 0.8 311.4 Equities and commodities — 9.1 0.5 9.6 0.1 9.6 0.4 10.1 1.0 8.5 0.2 9.7 Credit - APS — — 0.2 0.2 — — — — — — — — Credit - other — 24.9 1.6 26.5 — 25.0 0.3 25.3 — 38.1 1.0 39.1
Level 2: valued using techniques based significantly on observable market data. Instruments in this category are valued using: (a) quoted prices for similar instruments or identical instruments in markets which are not considered to be active; or (b) valuation techniques where all the inputs that have a significant effect on the valuations are directly or indirectly based on observable market data.
The type of instruments that trade in markets that are not considered to be active, but are based on quoted market prices, banker dealer quotations, or alternative pricing sources with reasonable levels of price transparency and those instruments valued using techniques include non-G10 government securities, most government agency securities, investment-grade corporate bonds, certain mortgage products, including CLOs, most bank loans, repos and reverse repos, less liquid listed equities, state and municipal obligations, most notes issued, investment contracts issued by the Group's life assurance business (2009) and certain money market securities and loan commitments and most OTC derivatives.
Balance Favourable Unfavourable Balance Favourable Unfavourable Balance Favourable Unfavourable £bn £m £m £bn £m £m £bn £m £m Assumptions
Of which AFS debt securities Corporate 0.2 10 (10) 0.1 20 (20) 0.2 10 (10) Financial institutions 5.5 310 (50) 4.3 280 (40) 1.1 80 (40)
5.7 320 (60) 4.4 300 (60) 1.3 90 (50) Equity shares 0.4 70 (70) 0.3 60 (60) 0.7 100 (90) Total AFS assets 6.1 390 (130) 4.7 360 (120) 2.0 190 (140)
Key to assumptions: (a) Correlation; (b) counterparty credit risk; (c) credit spreads; (d) default rates; (e) discount rate recoveries; (f) dividends; (g) expected losses; (h) fund valuation; (i) housing prices; (j) implied collateral valuation; (k) indices; (l) loss credits; (m) prepayment rates; (n) probability of default; (o) loss severity and yield; (p) recovery rates; (q) volatility.
Key points Total assets carried at fair value increased by £96.1 billion in the year to £882.2 billion at 31 December 2011, principally reflecting increases in derivative assets (£102.5 billion), reverse repos (£9.0 billion) and derivative collateral (£2.2 billion), partially offset by decreases in debt securities (£7.4 billion) and equity shares (£7.0 billion).
Level 3 liabilities increased to £6.3 billion in the year from £4.8 billion, mainly in credit derivatives due to market liquidity and resultant transfers from level 2 to level 3.
The level 3 sensitivities above are calculated at a trade or low level portfolio basis. They are not calculated on an overall portfolio basis and therefore do not reflect the likely overall potential uncertainty on the whole portfolio. The figures are aggregated and do not reflect the correlated nature of some of the sensitivities. In particular, for some of the portfolios the sensitivities may be negatively correlated where a downwards movement in one asset would produce an upwards movement in another, but due to the additive presentation of the above figures this correlation cannot be observed. For example, with assets in the APS, the downwards sensitivity on the underlying asset would be partially offset by the consequent upward movement of the APS derivative, so whilst the net sensitivity of the two positions may be lower, it would be shown with the gross upside and downside sensitivity of the two assets inflating the overall sensitivity figures in the above table. The actual potential downside sensitivity of the total portfolio may be less than the non-correlated sum of the additive figures as shown in the above table.
Judgmental issues The diverse range of products traded by the Group results in a wide range of instruments that are classified into the three level hierarchy. Whilst the majority of these instruments naturally fall into a particular level, for some products an element of judgment is required. The majority of the Group’s financial instruments carried at fair value are classified as level 2: inputs are observable either directly (i.e. as a price) or indirectly (i.e. derived from prices).
As part of the Group’s IPV process, data is gathered at a trade level from market trading activity, trading systems, pricing services, consensus pricing providers, brokers and research material amongst other sources.
Non-modelled products Non-modelled products are generally quoted on a price basis and can therefore be considered for each of the 3 levels. This is determined by the liquidity and valuation uncertainty of the instruments which is in turn measured from the availability of independent data used by the IPV process.
Loans and advances to customers Loans in level 3 primarily comprise loans to emerging market counterparties, structured loans and legacy commercial mortgages.
A collateral net asset value methodology using dealer buy side marks is used to determine an upper bound for super senior CDO valuations. An ABS index implied collateral valuation is also used to provide a market calibrated valuation data point. Both the ABS index implied valuation and the collateral net asset value methodology apply an assumed immediate liquidation approach.
The model primarily uses the following inputs in relation to each individual non-triggered asset: notional, maturity, probability of default and expected recovery rate given default. Other key inputs include: the correlation between the underlying assets; the range of possible recovery rates on the underlying assets (“alpha”); the size of the first loss. The size of the first loss is adjusted to reflect both realised and expected losses on triggered assets as well as the level of expected losses on covered assets that have been sold, that can be treated as losses for the purpose of the APS (“loss credits”).
The APS protects a wide range of asset types, and hence, the correlation between the underlying assets cannot be observed from market data. In the absence of this, the Group determines a reasonable level for this input. The expected recovery rate given default is based on internally assessed levels. The probability of default is calculated with reference to data observable in the market. Where possible, data is obtained for each asset within the APS, but for most of the assets, such observable data does not exist. In these cases, this important input is determined from information available for similar entities by geography and rating. The approach for doing this was refined during the year in order to accurately reflect both changes in market conditions and the profile of the portfolio of covered assets.
Using the above reasonably possible alternative assumptions, the fair value of the APS derivative could be higher by approximately £295 million or lower by approximately £44 million as detailed in the table below.
Credit derivatives - other The Group's other credit derivatives include vanilla and bespoke portfolio tranches, gap risk products and certain other unique trades.
Valuation of single name credit derivatives is carried out using industry standard models. Where single name derivatives have been traded and there is a lack of independent data or the quality of the data is weak, these instruments are classified into level 3. These assets will be priced using the Group’s standard credit derivative model using a proxy curve based upon a suitable alternative single name curve, a cash based product or a sector based curve. Where the sector based curve is used, the proxy will be chosen taking maturity, rating, seniority, geography and internal credit review on recoveries into account. Sensitivities for these instruments will be based upon the selection of reasonable alternative assumptions which may include adjustments to the credit curve and recovery rate assumptions.
The bespoke portfolio tranches are synthetic tranches referenced to a bespoke portfolio of corporate names on which the Group purchases credit protection. Bespoke portfolio tranches are valued using Gaussian Copula, a standard method which uses observable market inputs (credit spreads, index tranche prices and recovery rates) to generate an output price for the tranche by way of a mapping methodology. In essence this method takes the expected loss of the tranche expressed as a fraction of the expected loss of the whole underlying portfolio and calculates which detachment point on the liquid index, and hence which correlation level, coincides with this expected loss fraction. Where the inputs to this valuation technique are observable in the market, bespoke tranches are considered to be level 2 assets. Where inputs are not observable, bespoke tranches are considered to be level 3 assets. However, all transactions executed with a CDPC counterparty are considered level 3 as the counterparty credit risk assessment is a significant component of these valuations.
Exotic options do not trade in active markets except in a small number of cases. Consequently, the Group uses models to determine fair value using valuation techniques typical for the industry. These techniques can be divided firstly, into modelling approaches and secondly, into methods of assessing appropriate levels for model inputs. The Group uses a variety of proprietary models for valuing exotic trades.
Assets FVTPL (2) Loans and advances 843 (15) — 145 — — 701 (856) (64) 6 760 (11)
Liabilities Deposits 103 — — 11 — — (32) — 2 84 — Debt securities in issue 2,345 336 — (212) 413 — (695) — 16 2,203 309 Short positions 184 (187) — 792 6 — (2) (16) (1) 776 (179)
Financial assets Cash and balances at central banks 79.3 79.3 57.0 57.0 52.3 52.3 Loans and advances to banks 28.3 28.2 36.2 36.1 46.3 46.0 Loans and advances to customers 436.2 406.3 493.1 468.8 684.1 650.9 Debt securities 6.1 5.5 7.1 6.4 9.9 9.0 Settlement balances 7.8 7.8 11.6 11.6 12.0 12.0
Loans and advances to banks and customers In estimating the fair value of loans and advances to banks and customers measured at amortised cost, the Group’s loans are segregated into appropriate portfolios reflecting the characteristics of the constituent loans. Two principal methods are used to estimate fair value: (a) contractual cash flows are discounted using a market discount rate that incorporates the current spread for the borrower or where this is not observable, the spread for borrowers of a similar credit standing. This method is used for the majority of GBM’s lending portfolios where most counterparties have external ratings.
(b) expected cash flows (unadjusted for credit losses) are discounted at the current offer rate for the same or similar products. This approach is adopted for lending portfolios in UK Retail, UK Corporate and Ulster Bank reflecting the more homogeneous nature of these portfolios.
The discount to amortised cost reflects current stressed markets for NonCore loans, real estate lending in Ireland and other commercial real estate loans, and in GBM, corporate downgrades.
Liabilities Deposits by banks 100,499 8,305 108,804 95,241 3,549 98,790 135,641 6,503 142,144 Customer accounts 487,428 15,527 502,955 492,609 18,084 510,693 586,628 27,574 614,202 Debt securities in issue 68,889 93,732 162,621 94,048 124,324 218,372 140,826 126,742 267,568 Settlement balances and short positions 15,248 33,268 48,516 16,981 37,128 54,109 17,952 32,924 50,876 Derivatives 61,734 462,249 523,983 71,306 352,661 423,967 71,625 352,516 424,141 Subordinated liabilities 624 25,695 26,319 964 26,089 27,053 2,144 35,508 37,652
0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2011 £m £m £m £m £m £m
Deposits by banks 39,139 5,104 5,513 461 1,121 364 Customer accounts 379,692 23,068 12,643 5,389 1,483 779 Debt securities in issue 66,253 15,756 25,099 17,627 18,833 4,190 Derivatives held for hedging 525 788 1,981 1,186 1,101 821 Subordinated liabilities 133 1,116 4,392 7,872 8,654 3,488 Settlement balances and other liabilities 9,015 37 36 62 16 15 494,757 45,869 49,664 32,597 31,208 9,657
Guarantees and commitments - notional amount Guarantees (1) 24,886 — — — — — Commitments (2) 239,963 — — — — — 264,849 — — — — —
2010 Deposits by banks 43,396 4,417 1,243 304 651 374 Customer accounts 402,457 18,580 8,360 4,651 4,393 2,384 Debt securities in issue 89,583 43,032 31,862 22,569 24,209 6,697 Derivatives held for hedging 608 936 2,103 969 681 253 Subordinated liabilities 2,485 2,611 6,570 8,691 8,672 4,607 Settlement balances and other liabilities 12,423 59 136 177 385 25 550,952 69,635 50,274 37,361 38,991 14,340
Guarantees and commitments - notional amount Guarantees (1) 31,026 — — — — — Commitments (2) 266,822 — — — — — 297,848 — — — — —
Guarantees and commitments - notional amount Guarantees (1) 39,952 — — — — — Commitments (2) 291,634 — — — — — 331,586 — — — — —
Recoveries of amounts previously written-off 275 252 — 527 411 399 Charged to income statement - continuing operations 5,195 2,591 (545) 7,241 9,144 13,090 - discontinued operations (8) — — (8) 42 1,044 Unwind of discount (recognised in interest income) (342) (142) — (484) (455) (408)
Note: (1) Includes £123 million relating to loans and advances to banks (2010 - £127 million; 2009 - £157 million).
Loans and advances to customers 7,241 9,157 13,056 Loans and advances to banks — (13) 34 7,241 9,144 13,090 Debt securities 1,433 81 601 Equity shares 35 31 208 1,468 112 809
Residential property 60 47 52 Other property 73 139 110 Cash 56 127 283 Other assets 2 28 42 191 341 487
In general, the Group seeks to dispose of property and other assets not readily convertible into cash, obtained by taking possession of collateral, as rapidly as the market for the individual asset permits.
For fair value hedge relationships of interest rate risk, the hedged items are typically government bonds, large corporate fixed-rate loans, fixed rate finance leases, fixed rate medium-term notes or preference shares classified as debt. At 31 December 2011, fixed rate financial assets of £33.1 billion and fixed rate financial liabilities of £41.4 billion were hedged by interest rate swaps in fair value hedge relationships.
Exchange rate contracts Spot, forwards and futures 2,127 30,249 28,868 2,807 39,859 41,424 2,004 26,744 24,898
Fair value hedging Exchange rate contracts — — — — 160 38 Interest rate contracts 3,550 4,288 2,496 3,767 2,672 3,292
Cash flow hedging Exchange rate contracts — — — — 2 7
Hedged forecast cash flows expected to occur Forecast receivable cash flows 280 254 219 161 120 169 30 — 1,233 Forecast payable cash flows (47) (41) (33) (30) (30) (137) (176) (54) (548)
Hedged forecast cash flows affect on profit or loss Forecast receivable cash flows 503 467 422 255 163 371 141 — 2,322 Forecast payable cash flows (554) (518) (409) (346) (296) (978) (818) (167) (4,086)
2010 Held-for-trading 5,097 15,648 42,828 5,486 23,711 6,099 98,869 21,988 Designated as at fair value through profit or loss 1 117 262 4 8 10 402 119 Available-for-sale 8,377 22,244 32,865 16,982 29,148 1,514 111,130 42,515 Loans and receivables 11 — — 1 6,686 381 7,079 6,203 13,486 38,009 75,955 22,473 59,553 8,004 217,480 70,825
2009 Held-for-trading (2) 8,128 9,175 49,967 5,856 31,708 6,648 111,482 28,820 Designated as at fair value through profit or loss 122 208 402 415 1,211 245 2,603 394 Available-for-sale 19,071 19,010 45,530 19,569 36,635 3,483 143,298 51,044 Loans and receivables (2) 1 — — — 6,899 2,971 9,871 7,924 27,322 28,393 95,899 25,840 76,453 13,347 267,254 88,182
Available-for-sale Gross unrealised gains 109 399 1,062 149 621 72 2,412 783 Gross unrealised losses (60) (98) (266) (289) (2,984) (213) (3,910) (3,314)
Gross gains of £751 million (2010 - £635 million; 2009 - £1,155 million) and gross losses of £19 million (2010 - £159 million; 2009 - £1,255 million) were realised on the sale of available-for-sale securities.
Central and local governments - UK 65 0.1 3,489 2.8 7,067 3.3 2,815 3.2 13,436 3.1 - US 1,471 1.2 8,026 2.1 9,865 2.8 1,486 3.2 20,848 2.5 - other 6,219 1.0 9,511 3.1 7,366 3.9 2,456 4.2 25,552 2.9 Banks 3,632 3.1 6,324 3.3 2,066 3.2 1,153 2.7 13,175 3.2 Other financial institutions 1,091 2.8 6,459 2.7 6,906 2.9 17,296 2.2 31,752 2.5 Corporate 145 4.5 1,425 4.6 776 4.4 189 3.6 2,535 4.5 12,623 1.9 35,234 2.9 34,046 3.2 25,395 2.6 107,298 2.8
Held-for-trading 12,366 67 12,433 19,110 76 19,186 14,394 49 14,443 Designated as at fair value through profit or loss 373 401 774 282 731 1,013 1,548 644 2,192 Available-for-sale 609 1,367 1,976 650 1,349 1,999 937 1,956 2,893 13,348 1,835 15,183 20,042 2,156 22,198 16,879 2,649 19,528
Available-for-sale Gross unrealised gains 69 317 386 67 232 299 293 312 605 Gross unrealised losses (19) (114) (133) (17) (145) (162) (14) (68) (82)
Dividend income from available-for-sale equity shares was £62 million (2010 - £69 million; 2009 - £78 million).
Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. They include capital stock (redeemable at cost) in the Federal Home Loan Bank and the Federal Reserve Bank of £0.7 billion (2010 - £0.8 billion; 2009 - £0.8 billion) that the Group's banking subsidiaries in the US are required to hold; and a number of individually small shareholdings in unlisted companies. Disposals in the year generated a gain of £2 million (2010 - £2 million loss; 2009 - £21 million loss).
Disposals and write-off of fully amortised assets — — — (417) (417)
Cost At 1 January 45,624 2,780 4,367 4,524 57,295 Transfers to disposal groups (238) — — — (238) Currency translation and other adjustments (2,743) (225) (281) (65) (3,314)
Net book value at 31 December 14,264 991 1,562 1,030 17,847
The CGUs of the Group, excluding RFS Holdings minority interest, where the goodwill is significant, principally arose on the acquisitions of NatWest, ABN AMRO, Charter One and Churchill and are as follows: Goodwill at 30 September Recoverable amount based on £m £m
UK Retail Value in use 2,697 2,697 2,697 UK Corporate Value in use 2,693 2,693 2,693 Wealth Value in use 611 611 611 Global Transaction Services Value in use 2,370 2,376 2,749 US Retail & Commercial Value in use 2,826 2,811 2,761 RBS Insurance Value in use 935 935 935
17 Intangible assets continued Impairment testing involves the comparison of the carrying value of a CGU or group of CGUs with its recoverable amount. The recoverable amount is the higher of the unit's fair value and its value in use. Value in use is the present value of expected future cash flows from the CGU or group of CGUs. Fair value is the amount obtainable from the sale of the CGU in an arm's length transaction between knowledgeable, willing parties.
The recoverable amounts for all CGUs at 30 September 2011 were based on the value in use test, using management's latest five-year forecasts. The long-term growth rates have been based on respective country GDP rates adjusted for inflation. The risk discount rates are based on observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
The recoverable amount of UK Retail, based on a 3% (2010 - 3%; 2009 - 4%) terminal growth rate and a 14.0% (2010 - 15.7%; 2009 - 14.6%) pre tax discount rate, exceeded the carrying amount by £5.5 billion (2010 - £6.9 billion; 2009 - £0.7 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.5 billion; 2009 - £0.9 billion) and £0.6 billion (2010 - £0.9 billion; 2009 - £0.5 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.8 billion (2010 - £0.9 billion; 2009 - £0.4 billion).
The recoverable amount of UK Corporate, based on a 3% (2010 - 3%; 2009 - 4%) terminal growth rate and a 14.1% (2010 - 15.6%; 2009 - 15.1%) pre tax discount rate, exceeded its carrying value by £2.1 billion (2010 - £5.3 billion; 2009 - £6.1 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.6 billion; 2009 - £1.4 billion) and £0.5 billion (2010 and 2009 - £0.9 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.8 billion (2010 - £1.0 billion; 2009 - £0.8 billion).
The recoverable amount of Wealth, based on a 3% (2010 - 3%; 2009 - 4%) terminal growth rate and an 11.0% (2010 - 12.0%; 2009 - 15.3%) pre tax discount rate, exceeded its carrying value by more than 100% and was insensitive to a reasonably possible change in key assumptions.
The recoverable amount of Global Transaction Services, based on a 3% (2010 and 2009 - 3%) terminal growth rate and an 11.4% (2010 - 12.8%; 2009 - 16.7%) pre tax discount rate, exceeded its carrying value by more than 100% (2010 and 2009 - 100%) and was insensitive to a reasonably possible change in key assumptions.
The recoverable amount of US Retail & Commercial, based on a 5% (2010 and 2009 - 5%) terminal growth rate and a 14.4% (2010 - 14.9%; 2009 - 14.8%) pre tax discount rate, exceeded its carrying value by £0.2 billion (2010 - £1.6 billion; 2009 - £2.1 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.6 billion; 2009 - £1.0 billion) and £0.5 billion (2010 and 2009 - £0.8 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.6 billion (2010 and 2009 - £0.7 billion).
The recoverable amount of RBS Insurance, based on a 3% (2010 and 2009 - 3%) terminal growth rate and a 12.3% (2010 - 13.1%; 2009 - 13.9%) pre tax discount rate, exceeded the carrying amount by £0.8 billion (2010 - £2.4 billion; 2009 - £3.0 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £0.5 billion and £0.2 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.3 billion.
Operating lease assets Total 2011 £m £m £m £m £m £m £m
Accumulated impairment, depreciation and amortisation At 1 January — 553 87 641 2,396 1,764 5,441 Currency translation and other adjustments — 62 1 75 199 17 354 Disposal of subsidiaries — (24) — (30) (197) (141) (392) Reclassifications — (17) 17 — — — — Write down of property, plant and equipment — 32 4 1 4 — 41 Disposals and write-off of fully depreciated assets — (10) (2) (48) (261) (435) (756) Charge for the year - continuing operations — 106 11 148 536 627 1,428 Charge for the year - discontinued operations — — — 6 23 17 46 At 31 December — 702 118 793 2,700 1,849 6,162
Cost or valuation At 1 January 3,868 4,032 224 1,867 4,168 9,334 23,493 Transfers to disposal groups — (32) — (62) (80) — (174) Currency translation and other adjustments (85) (134) — (65) (131) (561) (976) Disposal of subsidiaries — (15) — — (19) — (34) Reclassifications 1 18 1 (34) 14 — — Additions 1,634 304 8 153 750 2,241 5,090 Expenditure on investment properties 8 — — — — — 8 Change in fair value of investment properties (117) — — — — — (117) Disposals and write-off of fully depreciated assets (426) (75) (19) (56) (420) (1,456) (2,452)
There were no sales of freehold and long leasehold properties subject to operating leases during 2011 (2010 - net book value of £2 million; 2009 - net book value of £5 million).
19 Prepayments, accrued income and other assets 2011 2010 2009 £m £m £m
Discontinued operations Total income 42 1,433 5,664 Operating expenses (5) (803) (4,061) Insurance net claims — (161) (500)
Profit before tax 45 427 52 Gain on disposal before recycling of reserves — 113 — Recycled reserves — (1,076) — Operating profit/(loss) before tax 45 (536) 52 Tax (11) (92) (58) Profit/(loss) after tax 34 (628) (6)
Discontinued operations reflect the results of RFS Holdings attributable to the State of the Netherlands and Santander following the legal separation of ABN AMRO Bank N.V. on 1 April 2010.
UK branch based businesses Other Total 2010 2009 £m £m £m £m £m
Assets of disposal groups Cash and balances at central banks 100 27 127 184 129 Loans and advances to banks — 87 87 651 388 Loans and advances to customers 18,676 729 19,405 5,013 3,216 Debt securities and equity shares — 5 5 20 904 Derivatives 431 8 439 5,148 6,361 Intangible assets — 15 15 — 238 Settlement balances — 14 14 555 1,579 Property, plant and equipment 112 4,637 4,749 18 136 Other assets — 456 456 704 5,417 Discontinued operations and other disposal groups 19,319 5,978 25,297 12,293 18,368 Assets acquired exclusively with a view to disposal — 153 153 191 174 19,319 6,131 25,450 12,484 18,542
Liabilities of disposal groups Deposits by banks — 1 1 266 618 Customer accounts 21,784 826 22,610 2,267 8,907 Derivatives 117 9 126 5,042 6,683 Settlement balances — 8 8 907 950 Subordinated liabilities — — — — 6 Other liabilities — 1,233 1,233 925 1,675 Discontinued operations and other disposal groups 21,901 2,077 23,978 9,407 18,839 Liabilities acquired exclusively with a view to disposal — 17 17 21 51 21,901 2,094 23,995 9,428 18,890
Notes in circulation 1,683 1,793 1,889 Current tax 700 723 429 Accruals 4,941 6,773 7,429 Deferred income 3,481 4,766 5,818 Other liabilities (1) 12,320 9,034 14,762 23,125 23,089 30,327
Note: (1) Other liabilities include £15 million (2010 - £18 million; 2009 - £10 million) in respect of share-based compensation.
At 1 January 2011 — 624 624 Transfer from accruals and other liabilities 215 — 215 Currency translation and other movements — 22 22 Charge to income statement - continuing operations 850 166 1,016 Releases to income statement - continuing operations — (53) (53)
Notes: (1) The FSA published its final policy statement on Payment Protection Insurance (PPI) complaint handling and redress in August 2010. The new rules impose significant changes with respect to the handling of mis-selling PPI complaints. In October 2010, the British Bankers’ Association (BBA) filed an application for judicial review of the FSA’s policy statement and of related guidance issued by the Financial Ombudsman Service (FOS). In April 2011, the High Court issued judgment in favour of the FSA and the FOS and in May 2011, the BBA announced that it would not appeal that judgment. During 2011, the Group reached agreement with the FSA on a process for implementation of its policy statement and for the future handling of PPI complaints following which it recorded a provision of £850 million in respect of PPI.
Transfers to disposal groups — (120) (149) — — — 1 — — — — — (268)
Charge/(credit) to income statement 46 (91) (24) (21) 77 (20) (160) (12) 273 (12) 470 (102) 424 Charge/(credit) to other comprehensive income 73 — — (2) — — (434) — 133 (6) 397 6 167 Currency translation and other adjustments (1) 52 (96) (25) — 112 23 (36) (61) (5) (7) 42 (2)
Charge/(credit) to income statement 223 27 344 262 77 46 (13) (178) 22 (3) 394 (152) 1,049 (Credit)/charge to other comprehensive income (86) — — 1 — — 780 — 238 14 415 — 1,362 Currency translation and other adjustments 4 7 (4) 1 — (3) 22 2 — 3 12 (4) (48)
Insurance liabilities General insurance business 6,219 6,726 5,802 Life assurance business - disposed — — 4,397 - retained 93 68 82 6,312 6,794 10,281
General insurance business (i) Claims and loss adjustment expenses. Gross Reinsurance Net £m £m £m
Notified claims 4,101 (276) 3,825 Incurred but not reported 1,701 (10) 1,691 At 1 January 2010 5,802 (286) 5,516 Cash paid for claims settled in the year (3,843) 55 (3,788) Increase/(decrease) in liabilities - arising from current year claims 4,459 (24) 4,435 - arising from prior year claims 322 (56) 266 Net exchange differences (14) 1 (13)
At 1 January 68 82 9,526 Premiums received 46 49 234 Fees and expenses (8) (14) (15)
Account balances paid on surrender and other terminations in the year (23) (18) (575) Disposal of subsidiaries — — (9,147) Foreign exchange and other adjustments — — (208)
Reinsurance of risks above the Group's risk appetite is only effective if the reinsurance premium is economic and the counterparty is financially secure. Acceptable reinsurers are rated A- or better unless specifically authorised.
Estimate of ultimate claims costs: At end of accident year 3,013 3,658 3,710 4,265 4,269 4,621 4,080 4,383 4,459 3,318 39,776 One year later 91 (140) (186) (92) (275) (71) 29 120 (66) (590)
Estimate of ultimate claims costs: At end of accident year 2,584 3,215 3,514 4,168 4,215 4,572 4,034 4,360 4,435 3,218 38,315 One year later 59 (106) (168) (67) (261) (90) 24 99 (67) (577)
Six years later (5) (34) 45 — 6 Seven years later (11) 20 5 14 Eight years later 10 6 16 Nine years later (35) (35) Current estimate of cumulative claims 2,542 2,878 3,160 3,820 3,812 4,478 4,094 4,422 4,368 3,218 36,792 Cumulative payments to date (2,536) (2,805) (3,008) (3,647) (3,530) (4,030) (3,466) (3,428) (3,078) (1,572) (31,100) 6 73 152 173 282 448 628 994 1,290 1,646 5,692 Liability in respect of earlier years 41 Claims handling costs 157 Net general insurance claims liability 5,890
The Group’s focus is on high volume and relatively straightforward products, for example home and motor. This facilitates the generation of comprehensive underwriting and claims data, which are used to price and monitor the risks accepted.
24 Insurance business continued Loss ratios The following table shows loss ratios for each major class of business, gross and net of reinsurance.
The frequency and severity of claims and the sources of uncertainty for the key classes that the Group is exposed to are as follows: Motor insurance contracts (personal and commercial) Claims experience is quite variable, due to a wide range of factors, but the principal ones are age, sex and driving experience of the driver, type and nature of vehicle, use of vehicle and area.
Property insurance contracts (residential and commercial) The major causes of claims for property insurance are theft, flood, escape of water, fire, storm, subsidence and various types of accidental damage.
The major source of uncertainty in the Group’s property contracts is the volatility of weather. Over a longer period, the strength of the economy is also a factor.
The following table shows the expected maturity of undiscounted insurance liabilities up to 20 years, excluding those linked directly to the financial assets backing these contracts (2011 and 2010 - nil; 2009 - £4,175 million).
In a series of exchange and tender offers in April 2009 and May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. The exchanges involving instruments classified as liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability.
The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (excluding companies in the RBS Holdings N.V. Group, which are subject to different restrictions, see below) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter (“the Deferral Period”), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.
25 Subordinated liabilities continued The following tables analyse the remaining contractual maturity of subordinated liabilities by (1) the final redemption date; and (2) the next call date.
£m £m £m £m Thereafter £m Perpetual £m Total £m 2011 - call date Currently £m £m £m £m £m Thereafter £m Perpetual £m Total £m £m £m £m £m Thereafter £m Perpetual £m Total £m 2010 - call date Currently £m £m £m £m £m Thereafter £m Perpetual £m Total £m £m £m £m £m Thereafter £m Perpetual £m Total £m 2009 - call date Currently £m £m £m £m £m Thereafter £m Perpetual £m Total £m
The Royal Bank of Scotland Group plc US$300 million 6.375% subordinated notes 2011 (redeemed February 2011) (1) — 199 201
The Royal Bank of Scotland plc €1,000 million 6% subordinated notes 2013 921 989 1,014 US$50 million floating rate subordinated notes 2013 37 38 36
US$125.6 million floating rate subordinated notes 2020 81 81 78 €1,000 million 4.625% subordinated notes 2021 (callable September 2016) 948 949 962 €300 million CMS linked floating rate subordinated notes 2022 (callable June 2022) 271 280 292 €144.4 million floating rate subordinated notes 2023 157 153 143
National Westminster Bank Plc €600 million 6% subordinated notes 2010 — — 564 €500 million 5.125% subordinated notes 2011 (redeemed June 2011) — 442 455
Charter One Financial, Inc. US$400 million 6.375% subordinated notes 2012 261 265 255
RBS Holdings USA Inc. US$500 million subordinated loan capital floating rate notes 2010 — — 311
US$1,500 million floating rate Bermudan callable subordinated notes 2015 (callable March 2012) 930 927 887 US$100 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (3) — — 62 US$36 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (3) — — 22 US$1,000 million floating rate Bermudan callable subordinated lower tier 2 notes 2017 (3) — — 598 AUD575 million 6.50% Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013) 378 371 318 AUD175 million floating rate Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013) 111 111 93 £42 million amortising MTN subordinated lower tier 2 notes 2010 — — 7 £25 million amortising MTN subordinated lower tier 2 notes 2011 (redeemed January 2011) — 3 8 £750 million 5% fixed rate Bermudan callable subordinated upper tier 2 notes 2016 (3) — — 727 US$136 million (2010 and 2009 - US$250 million) 7.75% fixed rate subordinated notes 2023 90 163 155 US$150 million 7.13% fixed rate subordinated notes 2093 100 98 93
Notes: (1) On-lent to The Royal Bank of Scotland plc on a subordinated basis. (2) Unconditionally guaranteed by the company. (3) Transferred to the Dutch State on legal separation of ABN AMRO Holding N.V. in 2010. (4) In the event of certain changes in tax laws, dated loan capital issues may be redeemed in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (5) Except as stated above, claims in respect of the Group's dated loan capital are subordinated to the claims of other creditors. None of the Group's dated loan capital is secured. (6) Interest on all floating rate subordinated notes is calculated by reference to market rates.
The Royal Bank of Scotland Group plc US$106 million (2010 - US$106 million; 2009 - US$163 million) undated floating rate primary capital notes (callable on any interest payment date) (1,2) 69 69 101 US$762 million 7.648% perpetual regulatory tier one securities (callable September 2031) (1,3,4) 497 494 473
National Westminster Bank Plc US$193 million (2010 - US$193 million; 2009 - US$332 million) primary capital floating rate notes, Series A (callable on any interest payment date) (1,2) 124 124 205 US$229 million (2010 - US$229 million; 2009 - US$293 million) primary capital floating rate notes, Series B (callable on any interest payment date) (1,2) 148 148 182 US$285 million (2010 - US$285 million; 2009 - US$312 million) primary capital floating rate notes, Series C (callable on any interest payment date) (1,2) 184 184 192 €178 million (2010 - €178 million; 2009 - €400 million) 6.625% fixed/floating rate undated subordinated notes (callable on any interest payment date) (2) 150 154 358 €10 million (2010 - €10 million; 2009 - €100 million) floating rate undated step-up notes (callable on any interest payment date) (2) 9 9 90 £87 million (2010 - £87 million; 2009 - £162 million) floating undated subordinated step-up notes (callable January 2015) (1,2) 91 89 174 £53 million (2010 - £53 million; 2009 - £127 million) 7.125% undated subordinated step-up notes (callable October 2022) (1,2) 56 54 127 £35 million (2010 - £35 million; 2009 - £55 million) 11.5% undated subordinated notes (callable December 2022) (1,2,6) 42 42 79
Notes: (1) Partially repurchased following completion of the exchange and tender offers in April 2009. (2) Partially repurchased following completion of the exchange and tender offers in May 2010. (3) On-lent to The Royal Bank of Scotland plc on a subordinated basis. (4) The company can satisfy interest payment obligations by issuing sufficient ordinary shares to appointed Trustees to enable them, on selling these shares, to settle the interest payment. (5) Guaranteed by the company. (6) Exchangeable at the option of the issuer into 8.392% (gross) non-cumulative preference shares of £1 each of National Westminster Bank Plc at any time. (7) Transferred to the Dutch State on legal separation of ABN AMRO Holding N.V. in 2010. (8) Except as stated above, claims in respect of the Group's undated loan capital are subordinated to the claims of other creditors. None of the Group's undated loan capital is secured. (9) In the event of certain changes in tax laws, undated loan capital issues may be redeemed in whole, but not in part, at the option of the Group, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (10) Interest on all floating rate subordinated notes is calculated by reference to market rates.
Series F US$156 million (2010 - US$156 million; 2009 - US$200 million) 7.65% (redeemable at option of issuer) (2) 101 101 123 Series H US$242 million (2010 - US$242 million; 2009 - US$300 million) 7.25% (redeemable at option of issuer) (2) 157 156 185 Series L US$751 million (2010 - US$751 million; 2009 - US$850 million) 5.75% (redeemable at option of issuer) (2) 485 484 524
Non-cumulative convertible preference shares of US$0.01 Series 1 US$65 million (2010 - US$65 million; 2009 - US$1,000 million) 9.118% (redeemable at option of issuer) (3) 43 43 630
Series 1 £15 million (2010 - £15 million; 2009 - £200 million) 7.387% (redeemable at option of issuer) (3) 15 15 199
Cumulative preference shares of £1 £0.5 million 11% and £0.4 million 5.5% (non-redeemable) 1 1 1
Series C US$246 million (2010 - US$246 million; 2009 - US$300 million) 7.7628% (2,4) 169 168 193
(2) Partially repurchased following completion of the exchange and tender offers in April 2009. (3) Partially repurchased following completion of the exchange and tender offers in May 2010. (4) Dividends are non-cumulative. They cannot be declared if RBS Holdings N.V. has not paid dividends on any parity securities. Distributions must be made, subject to the restrictions described in (5)
Losses on available-for-sale financial assets, net of tax 2 — 2 Equity withdrawn and disposals (29) (392) (421)
ABN AMRO represents the other Consortium Members' interests in RFS Holdings B.V. The capital and income rights of shares issued by RFS Holdings B.V. are linked to the net assets and income of the ABN AMRO business units which the individual Consortium Members agreed to acquire. The distribution to other Consortium Members of their respective interests occurred in 2010. Equity withdrawn in respect of ABN AMRO in 2010 relates to distributions to Consortium Members.
(4) The trust preferred securities are subject to restrictions on dividend payments agreed with the European Commission (see page 383).
Ordinary shares of 25p 59,228,412 58,458,131 56,365,721 B shares of £0.01 51,000,000 51,000,000 51,000,000 Dividend access share of £0.01 (1) — — — Non-voting deferred shares of £0.01 — — 2,660,556 Non-cumulative preference shares of US$0.01 209,609 209,609 308,015 Non-cumulative convertible preference shares of US$0.01 65 65 1,000 Non-cumulative preference shares of €0.01 2,044 2,044 2,526 Non-cumulative convertible preference shares of £0.01 15 15 200 Non-cumulative preference shares of £1 54 54 750 Cumulative preference shares of £1 900 900 900
Ordinary shares During the year, the issued ordinary share capital was increased by 770 million ordinary shares in connection with employee share schemes.
The B shares do not generally carry voting rights at general meetings of ordinary shareholders. Each B share is entitled to the same cash dividend as an ordinary share (subject to anti-dilution adjustments). The B shares may be converted into ordinary shares at a fixed ratio of issue price (50p) divided by the conversion price (50p subject to antidilution adjustments) at the option of the holder at any time after issue. 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.
Non-cumulative preference shares Non-cumulative preference shares entitle the holders thereof (subject to the terms of issue) to receive periodic non-cumulative cash dividends at specified fixed rates for each Series payable out of distributable profits of the company.
Non-cumulative preference shares of £1 Series 1 54,442 8.162% 5 October 2012 £1,000 Equity
On a winding-up or liquidation of the company, the holders of the noncumulative preference shares will be entitled to receive, out of any surplus assets available for distribution to the company's shareholders (after payment of arrears of dividends on the cumulative preference shares up to the date of repayment) pari passu with the cumulative preference shares and all other shares of the company ranking pari passu with the non-cumulative preference shares as regards participation in the surplus assets of the company, a liquidation distribution per share equal to the applicable redemption price detailed in the table above, together with an amount equal to dividends for the then current dividend period accrued to the date of payment, before any distribution or payment may be made to holders of the ordinary shares as regards participation in the surplus assets of the company.
The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (excluding companies in the RBS Holdings N.V. Group, which are subject to different restrictions) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter ("the Deferral Period"), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.
Merger reserve - on 1 January 2009, the merger reserve comprised the premium on shares issued to acquire NatWest less goodwill amortisation charged under previous GAAP. No share premium was recorded in the company financial statements through the operation of the merger relief provisions of the Companies Act 1985.
Capital redemption reserve - under UK companies legislation, when shares are redeemed or purchased wholly or partly out of the company's profits, the amount by which the company's issued share capital is diminished must be transferred to the capital redemption reserve. The capital maintenance provisions of UK companies legislation apply to the capital redemption reserve as if it were part of the company’s paid up share capital.
UK law prescribes that only the reserves of the company are taken into account for the purpose of making distributions and in determining the permissible applications of the share premium account.
Nature of operating lease assets on the balance sheet Transportation 1,549 6,162 6,039 Cars and light commercial vehicles 995 1,016 1,352 Other 161 208 403 2,705 7,386 7,794
Finance lease contracts and hire purchase agreements Accumulated allowance for uncollectable minimum receivables 347 401 313
Residual value exposures The table below gives details of the unguaranteed residual values included in the carrying value of finance lease receivables (see pages 340 to 343) and operating lease assets (see pages 373 and 374).
(ii) any currently unencumbered assets that could be substituted into those portfolios or used to collateralise debt securities which may be retained by the Group for contingent liquidity purposes.
£m Total £m - UK (covered bonds) 15,441 9,107 — 9,107 8,046 4,100 — 4,100 — — — — - Irish 12,660 3,472 8,670 12,142 15,034 5,101 11,152 16,253 14,540 5,799 6,905 12,704 UK credit cards 4,037 500 110 610 3,993 34 1,500 1,534 2,975 1,592 1,500 3,092 UK personal loans 5,168 — 4,706 4,706 5,795 — 5,383 5,383 8,411 — 8,160 8,160 Other loans (4) 19,778 4 20,577 20,581 25,193 974 23,186 24,160 28,037 1,010 25,290 26,300 106,633 24,071 81,387 105,458 111,193 23,256 91,249 114,505 109,350 18,539 95,211 113,750 Cash deposits (5) 11,998 13,068 12,016
Continuing involvement In certain securitisations of US residential mortgages, substantially all the risks and rewards have been neither transferred nor retained, but the Group has retained control, as defined by IFRS, of the assets and continues to recognise the assets to the extent of its continuing involvement which takes the form of retaining certain subordinated bonds issued by the securitisation SPEs. These bonds have differing rights and, depending on their terms, they may expose the Group to interest rate risk where they carry a fixed coupon or to credit risk depending on the extent of their subordination. Certain bonds entitle the Group to additional interest if the portfolio performs better than expected and others give the Group the right to prepayment penalties received on the securitised mortgages. At 31 December 2011, securitised assets were £0.6 billion (2010 - £2.3 billion; 2009 - £3.1 billion); retained interest £72 million (2010 - £286 million; 2009 - £102 million); subordinated assets £3 million (2010 - £4 million; 2009 - £91 million); and related liabilities £3 million (2010 - £4 million; 2009 - £33 million).
Securities repurchase agreements and lending transactions The Group enters into securities repurchase agreements and securities lending transactions under which it transfers securities in accordance with normal market practice. Generally, the agreements require additional collateral to be provided if the value of the securities falls below a predetermined level. Under standard terms for repurchase transactions in the UK and US markets, the recipient of collateral has an unrestricted right to sell or repledge it, subject to returning equivalent securities on settlement of the transaction.
Assets pledged in securities repurchase agreements and lending transactions 2011 £m
Liabilities secured by assets Deposits by banks 6,369 10,565 12,724 Customer accounts 2,663 3,599 3,319 Debt securities in issue — — 1,237 Derivatives 82,356 93,570 65,225 91,388 107,734 82,505
31 Capital resources The Group's regulatory capital resources in accordance with Financial Services Authority (FSA) definitions were as follows: Shareholders’ equity (excluding non-controlling interests) 2011 £m
Shareholders’ equity per balance sheet 74,819 75,132 77,736 Preference shares - equity (4,313) (4,313) (7,281) Other equity instruments (431) (431) (565)
Non-controlling interests Non-controlling interests per balance sheet 1,234 1,719 16,895 Non-controlling preference shares (548) (548) (656) Other adjustments to non-controlling interests for regulatory purposes (259) (259) (497)
Regulatory adjustments and deductions Own credit (2,634) (1,182) (1,057) Unrealised losses on AFS debt securities 1,065 2,061 1,888 Unrealised gains on AFS equity shares (108) (25) (134) Cash flow hedging reserve (879) 140 252 Other adjustments for regulatory purposes 571 204 (193) Goodwill and other intangible assets (14,858) (14,448) (17,847) 50% excess of expected losses over impairment provisions (net of tax) (2,536) (1,900) (2,558)
Other Tier 1 capital Preference shares - equity 4,313 4,313 7,281 Preference shares - debt 1,094 1,097 3,984 Innovative/hybrid Tier 1 securities 4,667 4,662 5,213
Tier 1 deductions 50% of material holdings (340) (310) (601) Tax on excess of expected losses over impairment provisions 915 758 1,020
Undated subordinated debt 1,838 1,852 4,950 Dated subordinated debt - net of amortisation 14,527 16,745 20,063 Reserves arising on revaluation of property — — 73 Unrealised gains on AFS equity shares 108 25 134 Collectively assessed impairment provisions 635 778 796 Non-controlling Tier 2 capital 11 11 11
Tier 2 deductions 50% of securitisation positions (2,019) (2,321) (1,353) 50% excess of expected losses over impairment provisions (3,451) (2,658) (3,578)
More than 3 years but less than 5 years £m £m £m £m £m £m £m
Contingent liabilities Guarantees and assets pledged as collateral security 13,512 3,514 2,082 5,924 25,032 31,101 40,008
Commitments (1) Undrawn formal standby facilities, credit lines and other commitments to lend
Note: (1) Includes liquidity facilities provided to Group sponsored conduits as detailed on page 125.
Notes: (1) Predominantly property leases. (2) Of which due within 1 year: £486 million (2010 - £263 million; 2009 - £370 million). (3) At 31 December 2011, £2,607 million related to the RBS Aviation Capital business which is included in disposal groups. (4) Of which due within 1 year: £483 million (2010 - £440 million; 2009 - £579 million).
Trustee and other fiduciary activities In its capacity as trustee or other fiduciary role, the Group may hold or place assets on behalf of individuals, trusts, companies, pension schemes and others. The assets and their income are not included in the Group's financial statements. The Group earned fee income of £502 million (2010 - £629 million; 2009 - £1,355 million) from these activities.
The FSCS will receive funds from asset sales, surplus cash flow, or other recoveries in relation to these institutions which will be used to reduce the principal amount of the FSCS's borrowings. After the interest only period a schedule for repayment of any outstanding borrowings will be agreed between the FSCS and HM Treasury in the light of market conditions at that time and the FSCS will begin to raise compensation levies (principal repayments).
The Group has accrued £157 million for its share of FSCS levies for the 2011/12 and 2012/13 scheme years.
While the outcome of the legal proceedings, investigations and regulatory matters in which the Group is involved is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been made in respect of legal proceedings, investigations and regulatory matters as at 31 December 2011.
In each of the material legal proceedings and investigations, reviews and proceedings described below, unless specifically noted otherwise, it is not possible to reliably estimate with any certainty the liability, if any, or the effect these proceedings investigations and reviews, and any related developments, may have on the Group. However, in the event that any such matters were resolved against the Group, these matters could, individually or in the aggregate, have a material adverse effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
The Group has also received notification of similar prospective claims in the United Kingdom and elsewhere but no court proceedings have been commenced in relation to these claims.
To date, Group companies have been named as defendants in their various roles as issuer, depositor and/or underwriter in a number of claims in the United States that relate to the securitisation and securities underwriting businesses. These cases include actions by individual purchasers of securities and purported class action suits. Together, the individual and class action cases involve the issuance of more than US$83 billion of mortgage-backed securities (MBS) issued primarily from 2005 to 2007. Although the allegations vary by claim, in general, plaintiffs in these actions claim that certain disclosures made in connection with the relevant offerings contained materially false or misleading statements and/or omissions regarding the underwriting standards pursuant to which the mortgage loans underlying the securities were issued. Group companies have been named as defendants in more than 30 lawsuits brought by purchasers of MBS, including five purported class actions. Among the lawsuits are six cases filed on 2 September 2011 by the US Federal Housing Finance Agency (FHFA) as conservator for the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"). The primary FHFA lawsuit pending in the federal court in Connecticut relates to approximately US$32 billion of AAA rated MBS for which Group entities acted as sponsor/depositor and/or lead underwriter or co-lead underwriter.
FHFA has also filed five separate lawsuits (against Ally Financial Group, Countrywide Financial Corporation, JP Morgan, Morgan Stanley and Nomura respectively) in which RBS Securities Inc. is named as a defendant by virtue of the fact that it was an underwriter of some of the securities at issue.
Certain other institutional investors have threatened to bring claims against the Group in connection with various mortgage-related offerings. The Group cannot predict with any certainty whether any of these individual investors will pursue these threatened claims (or their outcome), but expects that several may. If such claims are asserted and were successful, the amounts involved may be material.
With respect to the current claims described above, the Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously.
Unarranged overdraft charges In the US, Citizens Financial Group, Inc (“Citizens”) in common with other US banks, has been named as a defendant in a class action asserting that Citizens charges excessive overdraft fees. The plaintiffs claim that overdraft fees resulting from point of sale and automated teller machine (ATM) transactions violate the duty of good faith implied in Citizens’ customer account agreement and constitute an unfair trade practice. The Group considers that it has substantial and credible legal and factual defences to these claims and will defend them vigorously.
London Interbank Offered Rate (LIBOR) Certain members of the Group have been named as defendants in a number of class actions and individual claims filed in the US with respect to the setting of LIBOR. The complaints are substantially similar and allege that certain members of the Group and other panel banks individually and collectively violated US commodities and antitrust laws and state common law by manipulating LIBOR and prices of LIBORbased derivatives in various markets through various means. The Group considers that it has substantial and credible legal and factual defences to these and prospective claims.
32 Memorandum items continued Litigation and Investigations continued Summary of other disputes, legal proceedings and litigation In addition to the matters described above, members of the Group are engaged in other legal proceedings in the United Kingdom and a number of overseas jurisdictions, including the United States, involving claims by and against them arising in the ordinary course of business. The Group has reviewed these other actual, threatened and known potential claims and proceedings and, after consulting with its legal advisers, does not expect that the outcome of any of these other claims and proceedings will have a significant effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
Investigations, reviews and proceedings The Group’s businesses and financial condition can be affected by the fiscal or other policies and actions of various governmental and regulatory authorities in the United Kingdom, the European Union, the United States and elsewhere. The Group has engaged, and will continue to engage, in discussions with relevant regulators, including in the United Kingdom and the United States, on an ongoing and regular basis regarding operational, systems and control evaluations and issues including those related to compliance with applicable anti-bribery, antimoney laundering and sanctions regimes. It is possible that any matters discussed or identified may result in investigatory or other action being taken by the regulators, increased costs being incurred by the Group, remediation of systems and controls, public or private censure, restriction of the Group’s business activities or fines. Any of these events or circumstances could have a significant effect on the Group, its business, authorisations and licences, reputation, results of operations or the price of securities issued by it.
The Group is cooperating fully with the investigations and proceedings described below.
Visa’s cross-border MIFs were exempted in 2002 by the EC for a period of five years up to 31 December 2007 subject to certain conditions. On 26 March 2008, the EC opened a formal inquiry into Visa’s current MIF arrangements for cross border payment card transactions with Visa branded debit and consumer credit cards in the European Union and on 6 April 2009 the EC announced that it had issued Visa with a formal Statement of Objections. At the same time Visa announced changes to its interchange levels and introduced some changes to enhance transparency. There is no deadline for the closure of the inquiry. However, on 26 April 2010 Visa announced it had reached an agreement with the EC as regards immediate cross border debit card MIF rates only and in December 2010 the commitments were finalised for a four year period commencing December 2010 under Article 9 of Regulation 1/2003. The EC is continuing its investigations into Visa’s cross border MIF arrangements for deferred debit and credit transactions.
In the UK, the Office of Fair Trading (OFT) has carried out investigations into Visa and MasterCard domestic credit card interchange rates. The decision by the OFT in the MasterCard interchange case was set aside by the Competition Appeal Tribunal (CAT) in June 2006. The OFT’s investigations in the Visa interchange case and a second MasterCard interchange case are ongoing. On 9 February 2007, the OFT announced that it was expanding its investigation into domestic interchange rates to include debit cards. In January 2010 the OFT advised that it did not anticipate issuing a Statement of Objections prior to the General Court’s judgment, although it has reserved the right to do so if it considers it appropriate.
On 22 December 2009, the OFT published a further report in which it stated that it continued to have significant concerns about the operation of the PCA market in the United Kingdom, in particular in relation to unarranged overdrafts, and that it believed that fundamental changes are required for the market to work in the best interests of bank customers. The OFT stated that it would discuss these issues intensively with banks, consumer groups and other organisations, with the aim of reporting on progress by the end of March 2010. On 16 March 2010, the OFT announced that it had secured agreement from the banks on four industry-wide initiatives, namely minimum standards on the operation of opt-outs from unarranged overdrafts, new working groups on information sharing with customers, best practice for PCA customers in financial difficulties and incurring charges, and PCA providers to publish their policies on dealing with PCA customers in financial difficulties. The OFT also announced its plan to conduct six-monthly ongoing reviews, fully to review the market again in 2012 and to undertake a brief analysis on barriers to entry.
The first six-monthly ongoing review was completed in September 2010. The OFT noted progress in the areas of switching, transparency and unarranged overdrafts for the period March to September 2010, as well as highlighting further changes the OFT expected to see in the market. On 29 March 2011, the OFT published its update report in relation to PCA. This noted further progress in improving consumer control over the use of unarranged overdrafts. In particular, the Lending Standards Board had led on producing standards and guidance to be included in a revised Lending Code. The OFT stated it would continue to monitor the market and would consider the need for, and appropriate timing of, further update reports in light of other developments, in particular the work of the UK Government’s Independent Commission on Banking (ICB). The OFT has indicated its intention to conduct a more comprehensive review of the market in 2012.
Independent Commission on Banking Following an interim report published on 11 April 2011, the ICB published its final report to the Cabinet Committee on Banking Reform on 12 September 2011 (the “Final Report”). The Final Report makes a number of recommendations, including in relation to (i) the implementation of a ring-fence of retail banking operations, (ii) loss-absorbency (including bail-in) and (iii) competition.
The UK Government has now embarked on an extensive consultation on how exactly the general principles outlined by the ICB should be implemented, and intends to bring forward a White Paper in the spring of 2012. Its intention is to complete primary and secondary legislation before the end of the current Parliamentary term in May 2015 and to implement the ring-fencing measures as soon as practicable thereafter and the loss absorbency measures by 2019. The Government also stated its determination that changes to the account switching process should be completed by September 2013, as already scheduled.
With regard to the competition aspects, the Government recommended a number of initiatives aimed at improving transparency and switching in the market and ensuring a level playing field for new entrants. In addition, the Government has recommended that HM Treasury should consult on regulating the UK Payments Council and has confirmed that the Financial Conduct Authority's remit will include competition.
By way of example, in September and October 2010, the SEC requested voluntary production of information concerning residential mortgagebacked securities underwritten by subsidiaries of RBSG during the period from September 2006 to July 2007 inclusive. In November 2010, the SEC commenced a formal investigation and requested testimony from a former Group employee. The investigation is in its preliminary stages and it is difficult to predict any potential exposure that may result.
In June 2009, in connection with an investigation into the role of investment banks in the origination and securitisation of sub-prime loans in Massachusetts, the Massachusetts Attorney General issued subpoenas to various banks, including an RBSG subsidiary, seeking information related to residential mortgage lending practices and sales and securitisation of residential mortgage loans. On 28 November 2011, an Assurance of Discontinuance between RBS Financial Products Inc. and the Massachusetts Attorney General was filed in Massachusetts State Court which resolves the Massachusetts Attorney General's investigation as to RBSG. The Assurance of Discontinuance required RBS Financial Products Inc. to make payments totalling approximately US$52 million.
In issuing RMBS, GBM N.A. generally assigned certain representations and warranties regarding the characteristics of the underlying loans made by the originator of the residential mortgages; however, in some circumstances, GBM N.A. made such representations and warranties itself. Where GBM N.A. has given those or other representations and warranties (whether relating to underlying loans or otherwise), GBM N.A. may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of such representations and warranties. In certain instances where it is required to repurchase loans or related securities, GBM N.A. may be able to assert claims against third parties who provided representations or warranties to GBM N.A. when selling loans to it; although the ability to recover against such parties is uncertain. Since January 2009, GBM N.A. has received approximately US$75 million in repurchase demands in respect of loans made primarily from 2005 to 2008 and related securities sold where obligations in respect of contractual representations or warranties were undertaken by GBM N.A.. However, repurchase demands presented to GBM N.A. are subject to challenge and, to date, GBM N.A. has rebutted a significant percentage of these claims.
Citizens has not been an issuer or underwriter of non-agency RMBS. However, Citizens is an originator and servicer of residential mortgages, and it routinely sells such mortgage loans in the secondary market and to GSEs. In the context of such sales, Citizens makes certain representations and warranties regarding the characteristics of the underlying loans and, as a result, may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of the representations and warranties concerning the underlying loans. Since January 2009, Citizens has received approximately US$41.2 million in repurchase demands in respect of loans originated primarily since 2003. However, repurchase demands presented to Citizens are subject to challenge and, to date, Citizens has rebutted a significant percentage of these claims.
The Group cannot estimate what the future level of repurchase demands or ultimate exposure of GBM N.A. or Citizens may be, and cannot give any assurance that the historical experience will continue in the future. It is possible that the volume of repurchase demands will increase in the future. Furthermore, the Group is unable to estimate the extent to which the matters described above will impact it and future developments may have an adverse impact on the Group’s consolidated net assets, operating results or cash flows in any particular period.
On 27 July 2011, the Group consented to the issuance of a Cease and Desist Order (“the Order”) setting forth measures required to address deficiencies related to governance, risk management and compliance systems and controls identified by the Federal Reserve and state banking supervisors during examinations of the RBS plc and RBS N.V. branches in 2010. The Order requires the Group to strengthen its US corporate governance structure, to develop an enterprise-wide risk management programme, and to develop and enhance its programmes to ensure compliance with US law, particularly the US Bank Secrecy Act and antimoney laundering laws, rules and regulations. The Group has established a strategic and remedial programme of change to address the identified concerns and is committed to working closely with the US bank regulators to implement the remedial measures required by the Order.
The Group’s operations include businesses outside the United States that are responsible for processing US dollar payments. The Group is conducting a review of its policies, procedures and practices in respect of such payments and has initiated discussions with UK and US authorities to discuss its historical compliance with applicable laws and regulations, including US economic sanctions regulations. Although the Group cannot currently determine when the review of its operations will be completed or what the outcome of its discussions with UK and US authorities will be, the investigation costs, remediation required or liability incurred could have a material adverse effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
The Group may become subject to formal and informal supervisory actions and may be required by its US banking supervisors to take further actions and implement additional remedial measures with respect to these and additional matters. Any limitations or conditions placed on the Group's activities in the United States, as well as the terms of any supervisory action applicable to RBSG and its subsidiaries, could have a material adverse effect on the Group's consolidated net assets, operating results or cash flows in any particular period.
On 18 January 2012, the FSA published its Final Notice having reached a settlement with UK Insurance Limited for breaches of Principle 2 by Direct Line and Churchill (the "Firms"), under which UK Insurance Limited agreed to pay a fine of £2.17 million. The Firms were found to have acted without due skill, care and diligence in the way that they responded to the FSA's request to provide it with a sample of their closed complaint files. The Firms' breaches of Principle 2 did not result in any customer detriment.
Operating loss before tax - continuing operations (766) (399) (2,647) Operating profit/(loss) before tax - discontinued operations 58 (541) (49) Decrease/(increase) in prepayments and accrued income 976 (67) 433 Interest on subordinated liabilities 740 500 1,490 Decrease in accruals and deferred income (2,897) (1,915) (1,538) Provisions for impairment losses 8,709 9,298 14,950 Loans and advances written-off net of recoveries (4,000) (5,631) (6,540) Unwind of discount on impairment losses (484) (455) (408) Profit on sale of property, plant and equipment (22) (50) (43) Loss on sale of subsidiaries and associates 28 107 135 Profit on sale of securities (882) (496) (294) Charge for defined benefit pension schemes 349 540 659 Pension schemes curtailment gains — (78) (2,148) Cash contribution to defined benefit pension schemes (1,059) (832) (1,153) Other provisions utilised (513) (211) (159) Depreciation and amortisation 1,875 2,220 2,809 Gain on redemption of own debt (255) (553) (3,790) Write-down of goodwill and other intangible assets 91 10 363 Elimination of foreign exchange differences 2,702 (691) 12,217 Other non-cash items 2,303 875 1,404 Net cash inflow from trading activities 6,953 1,631 15,691 Decrease in loans and advances to banks and customers 15,800 42,766 151,568 Decrease/(increase) in securities 10,418 8,723 (5,902) Decrease/(increase) in other assets 4,991 445 (1,839) (Increase)/decrease in derivative assets (102,972) 10,741 544,744 Changes in operating assets (71,763) 62,675 688,571 Increase/(decrease) in deposits by banks and customers 24,096 (24,794) (131,685) (Decrease)/increase in insurance liabilities (482) 494 429 Decrease in debt securities in issue (55,496) (28,493) (34,528) Increase in other liabilities 1,827 1,108 20 Increase/(decrease) in derivative liabilities 100,133 2,454 (540,540) (Decrease)/increase in settlement balances and short positions (1,759) 3,651 1,769 Changes in operating liabilities 68,319 (45,580) (704,535) Income taxes (paid)/received (184) 565 (719) Net cash inflow/(outflow) from operating activities 3,325 19,291 (992)
34 Analysis of the net investment in business interests and intangible assets Acquisitions and disposals £m
Share capital, share premium, paid-in equity and merger reserve Subordinated liabilities £m 2010 £m £m
Note: (1) The subordinated liabilities adjustment in 2010 includes £6.1 billion relating to the disposal of RFS Holdings minority interest.
Certain subsidiary undertakings are required to maintain balances with the Bank of England which, at 31 December 2011, amounted to £415 million (2010 - £424 million; 2009 - £450 million). Certain subsidiary undertakings are required by law to maintain reserve balances with the Federal Reserve Bank in the US. Such reserve balances were $1.2 billion at 31 December 2011 (2010 and 2009 - $1.0 billion). RBS NV had mandatory reserve deposits of €1 billion at 31 December 2011 (2010 - €1 billion; 2009 - €6 billion).
Global Transaction Services (GTS) ranks among the top tier of global transaction banks, offering payments, cash and liquidity management, trade finance and commercial card products and services. Through the network and extensive partner bank agreements, GTS are able to support and connect customers across 128 countries.
UK Retail 4,272 1,206 5,478 (2,699) — (788) 1,991 UK Corporate 2,585 1,275 3,860 (1,489) (172) (785) 1,414 Wealth 718 459 1,177 (820) (11) (25) 321 Global Transaction Services 1,076 1,175 2,251 (1,335) (7) (166) 743 Ulster Bank 696 211 907 (546) (1) (1,384) (1,024) US Retail & Commercial 1,896 1,004 2,900 (1,979) (117) (325) 479 Global Banking & Markets 665 5,276 5,941 (4,170) (161) (49) 1,561 RBS Insurance 343 3,729 4,072 (3,583) (35) — 454 Central items (228) 213 (15) 950 (781) 2 156 Core 12,023 14,548 26,571 (15,671) (1,285) (3,520) 6,095 Non-Core 666 540 1,206 (1,133) (357) (3,919) (4,203)
Gain on redemption of own debt — 255 255 — — — 255 Strategic disposals — (24) (24) (80) — — (104) Bank levy — — — (300) — — (300) Bonus tax — — — (27) — — (27) Interest rate hedge adjustments on impaired available-for-sale Greek government bonds — — — — — (169) (169) Write-down of goodwill and other intangible assets — — — (11) — — (11)
UK Retail 4,078 1,422 5,500 (2,967) (1) (1,160) 1,372 UK Corporate 2,572 1,323 3,895 (1,498) (173) (761) 1,463 Wealth 609 447 1,056 (723) (11) (18) 304 Global Transaction Services 974 1,587 2,561 (1,459) (5) (9) 1,088 Ulster Bank 761 214 975 (573) (2) (1,161) (761) US Retail & Commercial 1,917 1,029 2,946 (2,024) (99) (517) 306 Global Banking & Markets 1,215 6,697 7,912 (4,281) (116) (151) 3,364 RBS Insurance 381 4,135 4,516 (4,788) (23) — (295) Central items 10 327 337 1,095 (852) (3) 577 Core 12,517 17,181 29,698 (17,218) (1,282) (3,780) 7,418 Non-Core 1,683 1,281 2,964 (2,513) (480) (5,476) (5,505)
Reconciling items Fair value of own debt — (142) (142) — — — (142) Amortisation of purchased intangible assets — — — — (272) — (272) Integration and restructuring costs — — — (1,268) (18) — (1,286) Gain on redemption of own debt — 3,790 3,790 — — — 3,790 Strategic disposals — 132 132 — — — 132 Bonus tax — — — (208) — — (208) Gains on pensions curtailment — — — 2,148 — — 2,148 Write-down of goodwill and other intangible assets — — — (363) — — (363)
UK Retail 5,520 (42) 5,478 5,523 (23) 5,500 5,163 (76) 5,087 UK Corporate 4,368 (508) 3,860 4,345 (450) 3,895 4,422 (840) 3,582 Wealth 565 612 1,177 562 494 1,056 409 700 1,109 Global Transaction Services 2,041 210 2,251 2,428 133 2,561 2,438 49 2,487 Ulster Bank 928 (21) 907 865 110 975 1,003 31 1,034 US Retail & Commercial 2,710 190 2,900 2,672 274 2,946 2,380 344 2,724 Global Banking & Markets 5,970 (29) 5,941 7,817 95 7,912 10,174 884 11,058 RBS Insurance 4,133 (61) 4,072 4,565 (49) 4,516 4,629 (15) 4,614 Central items (935) 920 (15) (489) 826 337 (1,668) 1,910 242 Core 25,300 1,271 26,571 28,288 1,410 29,698 28,950 2,987 31,937 Non-Core 2,477 (1,271) 1,206 4,382 (1,418) 2,964 547 (2,917) (2,370)
Reconciling items Fair value of own debt 1,846 — 1,846 174 — 174 (142) — (142) Asset Protection Scheme (906) — (906) (1,550) — (1,550) — — — Integration and restructuring costs (5) — (5) — — — — — — Gain on redemption of own debt 255 — 255 553 — 553 3,790 — 3,790 Strategic disposals (24) — (24) 171 — 171 132 — 132 RFS Holdings minority interest (6) — (6) (150) 8 (142) (251) (70) (321)
RFS Holdings minority interest Total £m £m £m £m £m £m £m £m £m £m
At 1 January 2009 2,803 2,695 800 3,067 3,023 38 1,029 597 1,510 15,562 Transfers to disposal groups — — — — — — — (238) — (238) Currency translation and other adjustments — — (12) (233) (302) (1) (8) (34) (107) (697) Write-down of goodwill — — — — — — (66) (297) — (363) At 1 January 2010 2,803 2,695 788 2,834 2,721 37 955 28 1,403 14,264 Currency translation and other adjustments — — 25 24 122 4 — 1 (40) 136 Disposals (4) — — (481) — — — (14) (1,363) (1,862) Write-down of goodwill — — (1) — — — (9) — — (10) At 1 January 2011 2,799 2,695 812 2,377 2,843 41 946 15 — 12,528 Transfers to disposal groups — — — — — — — (15) — (15) Currency translation and other adjustments — — — (24) 9 — (1) — — (16) Acquisitions — — — — — 18 — — — 18 Write-down of goodwill (20) (60) — — — — (11) — — (91)
Net interest income 8,711 2,430 994 544 12,679 Net fees and commissions 2,925 1,365 215 419 4,924 Income from trading activities 661 1,318 508 214 2,701 Other operating income/(loss) 3,097 219 1,079 (18) 4,377 Insurance premium income (net of reinsurers' share) 3,894 — 362 — 4,256 Total income 19,288 5,332 3,158 1,159 28,937
Operating profit/(loss) before tax 862 2,091 (2,450) (902) (399) Total assets 932,917 341,770 102,756 76,133 1,453,576 Of which total assets held for sale 2,855 6,686 2,943 — 12,484 Total liabilities 860,932 323,529 119,946 72,318 1,376,725 Of which total liabilities held for sale 570 6,938 1,920 — 9,428 Net assets attributable to equity owners and non-controlling interests 71,985 18,241 (17,190) 3,815 76,851 Contingent liabilities and commitments 134,983 98,429 71,025 9,894 314,331 Cost to acquire property, plant and equipment and intangible assets 1,283 355 1,388 109 3,135
Non-executive directors - emoluments 1,137 1,093 Chairman and executive directors - emoluments 4,671 5,243 - contributions and allowances in respect of defined contribution pension schemes 403 321 6,211 6,657 - amounts receivable under long-term incentive plans 1,594 1,097 7,805 7,754
The executive directors may participate in the company's long term incentive plans, executive share option and sharesave schemes and details of their interests in the company's shares arising from their participation are given in the Directors' remuneration report. Details of the remuneration received by each director during the year and each director's pension arrangements are also given in the Directors' remuneration report.
HM Treasury may at any time elect to cease to exercise its step-in rights in whole or part when it is satisfied that the step-in triggers have been remedied.
At 31 December 2011, the Group had issued debt guaranteed by the Government totalling £21.3 billion (2010 - £41.5 billion; 2009 - £51.5 billion).
Other related parties (a) In their roles as providers of finance, Group companies provide development and other types of capital support to businesses. These investments are made in the normal course of business and on arm's length terms. In some instances, the investment may extend to ownership or control over 20% or more of the voting rights of the investee company. However, these investments are not considered to give rise to transactions of a materiality requiring disclosure under IAS 24.
Assets Loans and advances to banks 3 18,368 19,535 31,238 Loans and advances to customers 3 4,056 6,689 2,777 Debt securities 7 1,568 1,454 1,286 Investments in Group undertakings 8 53,871 49,125 64,766 Derivatives 6 1,502 1,475 1,169 Prepayments, accrued income and other assets 25 30 56 Total assets 79,390 78,308 101,292
Liabilities Deposits by banks 3 1,091 — 93 Customer accounts 3 977 1,029 13,264 Debt securities in issue 3 8,373 8,742 11,788 Derivatives 6 79 231 446 Accruals, deferred income and other liabilities 9 704 1,034 1,357 Subordinated liabilities 10 8,777 8,048 8,762 Total liabilities 20,001 19,084 35,710 Owners’ equity 59,389 59,224 65,582 Total liabilities and equity 79,390 78,308 101,292
The accompanying notes on pages 424 to 431 form an integral part of these financial statements.
The accounts were approved by the Board of directors on 22 February 2012 and signed on its behalf by: Philip Hampton Chairman
Share premium account At 1 January 23,922 23,523 27,471 Ordinary shares issued in respect of placing and open offer, net of £95 million expenses — — 1,047 Ordinary shares issued 79 281 — Redemption of preference shares classified as debt — 118 — Preference shares redeemed — — (4,995)
Merger reserve At 1 January 2,391 14,641 — Issue of B shares, net of £399 million expenses — — 24,591 Transfer to retained earnings (50) (12,250) (9,950)
Cash flow hedging reserve At 1 January — (1) (4) Amount transferred from equity to earnings — 1 3 At 31 December — — (1)
Capital redemption reserve At 1 January 198 170 170 Preference shares redeemed — 1 — Cancellation of non-voting deferred shares — 27 — At 31 December 198 198 170
Total comprehensive loss recognised in the statement of changes in equity is attributable to: Preference shareholders — 105 878 Paid-in equity holders — 19 57 Ordinary and B shareholders (107) (4,677) (2,435)
Operating activities Operating loss before tax (34) (4,471) (1,286) Adjustments for: Write-down of investment in subsidiaries 570 5,124 5,139 Interest on subordinated liabilities 419 462 537 Gain on redemption of own debt — (53) (238) Elimination of foreign exchange differences (4) 272 (753) Other non-cash items (5) (1) 20 Net cash flows from trading activities 946 1,333 3,419 Changes in operating assets and liabilities 2,964 (10,238) 12,537 Net cash flows from operating activities before tax 3,910 (8,905) 15,956 Income taxes (paid)/received (95) (133) 409 Net cash flows from operating activities 12 3,815 (9,038) 16,365
Financing activities Issue of ordinary shares 2 1 — Placing and open offer — — 5,274 Issue of B shares — — 12,801 Redemption of paid-in equity — (132) (308) Issue of subordinated liabilities 940 — — Redemption of preference shares — (2,352) (5,000) Repayment of subordinated liabilities (193) (98) (458) Dividends paid — (124) (935) Interest on subordinated liabilities (415) (475) (557) Net cash flows from financing activities 334 (3,180) 10,817 Effects of exchange rate changes on cash and cash equivalents (55) 5 (83)
1 Presentation of accounts The accounts are prepared on a going concern basis (see page 300 of the Report of the directors) and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the IFRS Interpretations Committee of the IASB as adopted by the European Union (EU) (together IFRS). The company's financial statements are prepared in accordance with IFRS as issued by the IASB and are presented in accordance with the Companies Act 2006.
The accounting policies that are applicable to the company are included in the Group accounting polices which are set out on pages 314 to 326 of the Group financial statements, except that it has no policy regarding ‘Basis of consolidation’ and that the company’s investment in its subsidiaries are stated at cost less any impairment.
- loans and receivables 18,368 19,535 31,238 Loans and advances to customers (1)
1,502 1,475 1,169 Prepayments, accrued income and other assets - loans and receivables — — 11 - non-financial assets 25 30 45 79,390 78,308 101,292
79 231 446 Accruals, deferred income and other liabilities - non-financial liabilities 704 1,034 1,357 Subordinated liabilities - amortised cost 8,777 8,048 8,762 20,001 19,084 35,710 Owners’ equity 59,389 59,224 65,582 79,390 78,308 101,292
4 Financial instruments - valuation Fair value of financial instruments not carried at fair value The fair values of the company’s financial assets and liabilities are not materially different from their carrying values apart from subordinated liabilities, 2011 carrying value £8.8 billion, fair value £5.6 billion (2010 - carrying value £8.0 billion, fair value £5.8 billion; 2009 - carrying value £8.8 billion, fair value £4.9 billion) and debt securities, 2011 carrying value £1.6 billion, fair value £1.5 billion (2010 - carrying value £1.5 billion, fair value £1.8 billion; 2009 - carrying value £1.3 billion, fair value £1.3 billion).
The Royal Bank of Scotland plc, Direct Line Insurance Group plc (formerly RBS Insurance Group Limited) and RFS Holdings B.V. are directly owned by the company, and all of the other subsidiary undertakings are owned directly, or indirectly through intermediate holding companies, by these companies. All of these subsidiaries are included in the Group's consolidated financial statements and have an accounting reference date of 31 December.
9 Accruals, deferred income and other liabilities 2011 2010 2009 £m £m £m
US$300 million 6.375% subordinated notes 2011 (redeemed February 2011) (1) — 198 190
US$550 million floating rate (callable September 2014) (1) 354 353 337 US$450 million floating rate (callable September 2014) (1) 291 290 277
Notes: (1) Partially repurchased following completion of the exchange and tender offers in May 2010. (2) The company can satisfy interest payment obligations by issuing sufficient ordinary shares to appointed Trustees to enable them, on selling these shares, to settle the interest payment.
Non-cumulative preference shares of US$0.01 Series F US$156 million (2010 - US$156 million; 2009 - US$200 million) 7.65%
(redeemable at option of issuer) (2) 101 101 123 Series H US$242 million (2010 - US$242 million; 2009 - US$300 million) 7.25% (redeemable at option of issuer) (2) 157 156 185 Series L US$751 million (2010 - US$751 million; 2009 - US$850 million) 5.75% (redeemable at option of issuer) (2) 485 484 524
11 Share capital Details of the company’s share capital are set out in Note 27 on the consolidated accounts.
Operating loss before tax - continuing operations (34) (4,471) (1,286) Interest on subordinated liabilities 419 462 537 Decrease in accruals and deferred income (5) (1) (1) Gain on redemption of own debt — (53) (238) Write-down of investment in subsidiaries 570 5,124 5,139 Elimination of foreign exchange differences (4) 272 (753) Other non-cash items — — 21 Net cash inflow from trading activities 946 1,333 3,419 Decrease/(increase) in loans and advances to banks and customers 3,596 (6,300) 4,121 Increase in securities (114) (168) (1,286) Decrease/(increase) in other assets 5 105 (10) Increase in derivative assets (27) (306) (1) Changes in operating assets 3,460 (6,669) 2,824 Increase/(decrease) in deposits by banks and customers 328 (78) 11,533 Decrease in debt securities in issue (369) (3,020) (1,828) Decrease in other liabilities (303) (267) (66) (Decrease)/increase in derivative liabilities (152) (215) 85 Increase/(decrease) in settlement balances and short positions — 11 (11) Changes in operating liabilities (496) (3,569) 9,713 Income taxes (paid)/received (95) (133) 409 Net cash inflow/(outflow) from operating activities 3,815 (9,038) 16,365 13 Interest received and paid £m £m £m 14 Analysis of changes in financing during the year
At 1 January 41,869 53,359 38,442 8,048 8,762 10,314 Issue of ordinary shares 2 1 — — — — Redemption of preference shares — 117 (5,000) — — — Placing and open offer — — 5,274 — — — Issue of B shares — — 12,801 — — — Redemption of paid-in equity — (132) (308) — — — Cancellation of non-voting deferred shares — (27) — — — — Issue of subordinated liabilities — — — 940 — — Repayment of subordinated liabilities — — — (193) (98) (458) Net cash inflow/(outflow) from financing 2 (41) 12,767 747 (98) (458) Investment in subsidiaries — — 12,300 — — — Transfer to retained earnings (50) (12,252) (10,150) — — — Other adjustments including foreign exchange 270 803 — (18) (616) (1,094)
Comprising: Loans and advances to banks 1,883 2,357 16,448 16 Directors’ and key management remuneration The directors’ and key management of the Group and company are the same. Note 39 on the consolidated accounts on page 417 provides detailed disclosures.
Financial summary The Group's financial statements are prepared in accordance with IFRS. Selected data under IFRS for each of the five years ended 31 December 2011 are presented below.
Net interest income 12,679 14,209 13,388 15,482 11,550 Non-interest income (1,2,3) 16,258 17,659 19,638 5,248 17,922 Total income 28,937 31,868 33,026 20,730 29,472 Operating expenses (4,5,6,7,8) (18,026) (18,228) (17,417) (35,065) (13,383) Profit/(loss) before insurance net claims and impairment losses 10,911 13,640 15,609 (14,335) 16,089 Insurance net claims (2,968) (4,783) (4,357) (3,917) (4,528)
Owners' equity 74,819 75,132 77,736 58,879 53,038 Non-controlling interests 1,234 1,719 16,895 21,619 38,388 Subordinated liabilities 26,319 27,053 37,652 49,154 38,043 Deposits 611,759 609,483 756,346 897,556 994,657 Derivatives, settlement balances and short positions 572,499 478,076 475,017 1,025,641 363,073 Other liabilities 220,237 262,113 332,840 348,803 353,630 Total liabilities and equity 1,506,867 1,453,576 1,696,486 2,401,652 1,840,829
(Loss)/earnings per ordinary and B share from continuing operations - pence (1) (1.8) (0.5) (6.3) (146.2) 64.0 Diluted (loss)/earnings per ordinary and B share from continuing operations - pence (1,2) (1.8) (0.5) (6.3) (146.2) 63.4 Adjusted earnings/(loss) per ordinary and B share - pence 0.2 0.5 (13.0) (48.7) 63.8 Dividends per ordinary share - pence (1) — — — 19.3 27.0 Dividend payout ratio (3) — — — — 43% Share price per ordinary share at year end - £ 0.20 0.39 0.29 0.49 3.72 Market capitalisation at year end - £bn 22.3 42.8 31.4 19.5 44.4 Net asset value per ordinary and B share - £ 0.64 0.64 0.65 1.15 3.74 Return on average total assets (4) (0.13%) (0.07%) (0.18%) (1.19%) 0.65% Return on average ordinary and B shareholders' equity (5) (2.9%) (0.7%) (7.2%) (50.1%) 18.7% Adjusted return on average ordinary and B shareholders' equity (6) 0.3% 0.8% (14.8%) (17.3%) 18.6% Average owners' equity as a percentage of average total assets 4.9% 4.6% 2.8% 2.9% 3.9% Risk asset ratio - Tier 1 13.0% 12.9% 14.1% 10.0% 7.3% Risk asset ratio - Total 13.8% 14.0% 16.1% 14.1% 11.2% Ratio of earnings to combined fixed charges and preference share dividends (7)
- including interest on deposits 0.91 0.95 0.80 0.05 1.47 - excluding interest on deposits 0.25 0.44 (0.46) (9.74) 6.53
(7) For this purpose, earnings consist of income before tax and non-controlling interests, plus fixed charges less the unremitted income of associated undertakings (share of profits less dividends received). Fixed charges consist of total interest expense, including or excluding interest on deposits and debt securities in issue, as appropriate, and the proportion of rental expense deemed representative of the interest factor (one third of total rental expenses).
Analysis of loans and advances to customers The following table analyses loans and advances to customers before impairment provisions by remaining maturity, geographical area and type of customer.
UK Central and local government 2,836 33 1,748 4,617 3,919 3,174 3,091 3,135 Finance 35,598 2,445 1,115 39,158 38,975 36,283 42,432 70,006 Residential mortgages 2,397 4,963 93,016 100,376 101,157 92,583 80,967 73,916 Personal lending 12,386 3,797 3,619 19,802 23,236 25,254 26,989 28,186 Property 12,218 13,527 9,909 35,654 41,957 48,895 52,127 50,051 Construction 2,911 1,319 774 5,004 6,340 7,780 10,171 10,202 Manufacturing 4,848 1,375 860 7,083 9,111 11,432 15,074 13,452 Service industries and business activities 14,752 9,437 11,175 35,364 45,685 51,855 58,638 53,965 Agriculture, forestry and fishing 987 325 1,193 2,505 2,758 2,913 2,972 2,473 Finance leases and instalment credit 2,789 4,846 3,581 11,216 13,374 16,186 17,363 15,632 Accrued interest 361 5 57 423 558 992 2,463 2,344 Total domestic 92,083 42,072 127,047 261,202 287,070 297,347 312,287 323,362 Overseas residents 49,565 26,880 13,498 89,943 87,750 89,891 119,656 98,845 Total UK offices 141,648 68,952 140,545 351,145 374,820 387,238 431,943 422,207
Provisions at the end of the year (2) Domestic 7,728 8,199 6,670 4,474 3,258 Foreign 12,155 9,983 10,613 6,542 3,194 19,883 18,182 17,283 11,016 6,452
Closing customer provisions as a % of gross loans and advances to customers (3) Domestic 2.96% 2.86% 2.24% 1.43% 1.01%
Customer charge to income statement as a % of gross loans and advances to customers (3) Domestic 1.05% 1.38% 1.81% 0.86% 0.44%
The following table shows additional information in respect of loan impairment provisions. 2011 £m £m £m £m £m
As a % of average loans and advances to customers during the year Total customer provisions charged to income statement 1.3% 1.5% 1.6% 0.7% 0.4% Amounts written-off (net of recoveries) - customers 0.7% 0.9% 0.8% 0.3% 0.3%
Domestic Central and local government — 0.9 — 0.7 — 0.4 — 0.3 — 0.4 Manufacturing 135 1.3 100 1.6 153 1.5 127 1.7 93 1.6 Construction 502 0.9 605 1.1 355 1.0 254 1.1 75 1.2 Finance 40 7.3 98 6.8 26 4.9 67 4.8 52 8.4 Service industries and business activities 1,218 6.6 1,073 8.0 962 7.0 778 6.6 562 6.5 Agriculture, forestry and fishing 36 0.5 27 0.5 20 0.4 19 0.3 21 0.3 Property 2,657 6.2 2,071 7.3 908 6.6 490 5.9 85 6.0 Residential mortgages 384 18.7 302 17.6 196 12.4 36 9.1 36 8.8 Personal lending 1,919 3.7 2,504 4.1 2,527 3.4 2,235 3.0 2,054 3.4 Finance leases and instalment credit 366 2.1 435 2.3 341 2.2 194 2.0 132 1.9 Accrued interest — 0.1 — 0.1 — 0.1 — 0.3 — 0.3 Total domestic 7,257 48.3 7,215 50.1 5,488 39.9 4,200 35.1 3,110 38.8 Foreign 10,517 51.7 8,190 49.9 8,562 60.1 4,745 64.9 2,289 61.2 Impaired book provisions 17,774 100.0 15,405 100.0 14,050 100.0 8,945 100.0 5,399 100.0
Renegotiated loans Renegotiated loans are those loans restructured in response to a borrower's financial difficulties where no impairment provision is required. Restructured loans where an impairment provision is required continue to be reported as impaired loans. Loans renegotiated during the year amounted to: Note: (1) Restructured loan data include only those arrangements above thresholds set individually by the divisions, ranging from nil to £10 million.
Impaired loans (2) Domestic 14,528 15,471 13,572 8,588 5,599 Foreign 24,219 20,230 21,453 10,891 4,763 Total 38,747 35,701 35,025 19,479 10,362 Accruing loans which are contractually overdue 90 days or more as to principal or interest Domestic 1,697 2,363 2,224 1,201 217 Foreign 401 534 1,000 581 152 Total 2,098 2,897 3,224 1,782 369 Total risk elements in lending 40,845 38,598 38,249 21,261 10,731
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 offices outside the UK and through those offices in the UK specifically organised to service international banking transactions. (2) The write-off of impaired loans affects the closing provisions for impairment as a % of total risk elements in lending (the coverage ratio). The coverage ratio reduces if the loan written off carries a higher than average provision and increases if the loan written off carries a lower than average provision. (3) Includes REIL and gross lending relating to disposal groups.
Gross income not recognised but which would have been recognised under the original terms of impaired loans Domestic 636 579 625 393 390 Foreign 964 830 1,032 338 64 1,600 1,409 1,657 731 454
Interest on impaired loans included in net interest income Domestic 220 214 226 150 165 Foreign 264 241 182 42 15 484 455 408 192 180
Financial summary continued Analysis of deposits - product analysis The following table analyses the Group's deposits by type and geographical area. 2011 £m 2009 £m
Total UK offices 400,646 395,875 392,718 Overseas Demand deposits - interest-free 30,780 29,919 36,458
UK based companies and branches Certificates of deposit 6,092 1,367 949 331 8,739 Other time deposits 23,082 4,080 3,070 10,816 41,048
Overseas based companies and branches Certificates of deposit 6,689 666 553 169 8,077 Other time deposits 15,413 3,671 2,930 5,439 27,453 51,276 9,784 7,502 16,755 85,317
Noon Buying Rate High 1.5754 1.5698 1.6076 1.6141 1.6190 1.6591 Low 1.5301 1.5386 1.5467 1.5398 1.5358 1.6169
Consolidation rate (2) Period end rate 1.5475 1.5524 1.6222 1.4604 2.0043 Average rate for the year 1.6039 1.5455 1.5657 1.8528 2.0015
Notes: (1) The average of the Noon Buying Rates on the last US business day of each month during the year. (2) The rates used by the Group for translating US dollars into sterling in the preparation of its financial statements. (3) On 21 February 2012, the Noon Buying Rate was £1.00 = US$1.5796.
In the UK, growth weakened. Total economic activity, as measured by gross domestic product (GDP), grew by 0.9% compared with 2.1% in 2010. At the start of the year, expectations had been more positive, the consensus forecast for growth having been 2.1%. Yet the year ended with the economy contracting.
Against this backdrop, the Bank of England continued its ultra-loose monetary policy stance. Despite persistently above-target inflation, interest rates remained unchanged at a record low of 0.5%, the Bank of England judging elevated inflation to be the result of temporary factors. In fact, its greater concern was that the weak economy would cause inflation to be too low and in October, the Monetary Policy Committee announced that it would increase its asset purchase programme by £75 billion.
Judging that the pace of recovery was too slow to reduce unemployment sufficiently, the Federal Reserve tried to stimulate the economy in the third quarter with unconventional measures designed to push down medium to long-term interest rates. It also said it expected to keep the Fed Funds rate, its main policy rate, at its current low level at least until mid-2013.
For Ireland, gross national product (GNP) is a better measure of people’s material well-being. It reflects the income residents receive rather than the value of the incomes generated in the country, an important distinction when there is a large foreign-owned sector that remits profits overseas. GNP fell by an estimated 0.8%.
Unemployment averaged more than 14%. House prices dropped to a point where they were close to 50% below their peak level at the year end.
Looming over 2011 and prospects for 2012 was the likelihood that some euro area governments will not be able to repay in full monies they have borrowed. Uncertainty about how this problem will be solved damaged confidence. The policy prescribed for highly indebted countries, fiscal austerity, made their growth prospects worse because there are no compensating interest or exchange rate gains in a currency union. By the end of the year, the euro area was in recession, exacerbating the debt problem.
Europe’s leaders avoided both a disorderly default and a break-up of the euro area. However, it will take political will and public support to manage the immediate risk of defaults and to tackle the root causes of the acute challenges that have accumulated since the establishment of the single currency in 1999.
Absent the worst outcome for the euro area - a default that cannot be contained in one country and its banking system - growth in our main economies in 2012 will be slow as households and governments continue to labour under substantial debt burdens.
Other jurisdictions The Group operates in over 30 countries through a network of branches, local banks and non-bank subsidiaries and these activities are subject to supervision in most cases by a local regulator or central bank.
Regulatory developments and reviews The Group works with domestic and international trade associations and proactively engages with regulators and other authorities such as the Basel Committee, the European Commission and governments, in order to understand the implications of proposed regulatory change and to contribute to the development of regulatory policy.
In 2011, regulatory changes which have been introduced to improve transparency for retail customers include the addition of interest rates on savings account statements and annual statements for personal current accounts.
UK regulated firms within the Group are members of the Financial Services Compensation Scheme (FSCS), which provides compensation to eligible customers of authorised financial services firms that are unable to meet their obligations. The FSCS is a contributor to depositor confidence and financial stability and the Group is supporting the FSCS in increasing awareness amongst UK consumers.
Also notable in 2011, was significant work by the European Commission and the new European Supervisory Authorities in such areas as financial sector taxation, corporate governance, crisis management, credit rating agencies and remuneration. The Group provided input in all these areas.
Other jurisdictions The Group is active in monitoring regulatory developments in each country in which it operates so that internal policies are sufficient to ensure the effective management of regulatory risk.
Description of property and equipment The Group operates from a number of locations worldwide, principally in the UK. At 31 December 2011, the Royal Bank and NatWest had 627 and 1,493 retail branches, respectively, in the UK. Ulster Bank has a foot print of 236 branches and an extensive network of business banking offices across Northern Ireland and the Republic of Ireland. US Retail & Commercial had 1,519 retail banking offices (including in-store branches) covering Connecticut, Delaware, Illinois, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island and Vermont. A substantial majority of the UK branches are owned by the Royal Bank, NatWest and their subsidiaries or are held under leases with unexpired terms of over 50 years. The Group's principal properties include its headquarters at Gogarburn, Edinburgh, its principal offices in London at 135 and 280 Bishopsgate and the Drummond House administration centre located at South Gyle, Edinburgh.
Total capital expenditure on premises (excluding investment properties), computers and other equipment in the year ended 31 December 2011 was £820 million (2010 - £656 million; 2009 - £1,215 million).
In December 2009, HM Treasury acquired 51 billion B shares in the company representing the entire issued B share capital. At 31 December 2011, HM Treasury’s holding in the company’s ordinary shares was 66.9%.
Other than detailed above, there have been no significant changes in the percentage ownership of major shareholders of the company's ordinary, B and preference shares during the three years ended 22 February 2012. All shareholders within a class of the company's shares have the same voting rights.
Second Placing and Open Offer Agreement Pursuant to a placing and open offer agreement dated 19 January 2009 entered into between the company, UBS, Merrill Lynch International and HM Treasury, (i) the company agreed to invite qualifying shareholders to apply to subscribe for new shares at the issue price of 31.75 pence per new share by way of the Second Open Offer, (ii) UBS and Merrill Lynch International were appointed as joint sponsors, joint bookrunners and joint placing agents and agreed to use reasonable endeavours to procure placees to subscribe for the new shares on such terms as may be agreed by the company and HM Treasury at not less than the issue price of 31.75 pence per new share on the basis that the new shares placed will be subject to clawback to the extent they are taken up under the Second Open Offer and (iii) HM Treasury agreed that, to the extent not placed or taken up under the Second Open Offer and subject to the terms and conditions set out in the Second Placing and Open Offer Agreement, HM Treasury would subscribe for such new shares itself at the issue price of 31.75 pence per new share.
Material contracts continued Pursuant to the terms of the Second Placing and Open Offer Agreement, the aggregate proceeds of the Second Placing and Open Offer (net of expenses) were used in full to fund the redemption on Admission (as defined in the Second Placing and Open Offer Agreement) of the preference shares held by HM Treasury at 101 per cent of their issue price (£5.05 billion) together with the accrued dividend on the preference shares (from and including 1 December 2008 to but excluding the Date of Admission (as defined in the Second Placing and Open Offer Agreement)) and the commissions payable to HM Treasury under the Second Placing and Open Offer Agreement.
Pre-accession Commitments Letter On 26 February 2009, the Royal Bank entered into a deed poll in favour of HM Treasury, pursuant to which the Royal Bank gave a series of undertakings on behalf of each member of the Group, with immediate effect unless otherwise agreed, in relation to the provision of information and the management of the assets, commitments and exposures (the "Proposed Assets") in the period prior to the Royal Bank's proposed accession to and participation in the UK Government's Asset Protection Scheme (APS).
Proposed Assets is in accordance with usual business practices and also without regard to the possible benefits under the APS; (vi) develop and, subject to market conditions, implement a liability management plan which is designed to enable the Group to meet certain Core Tier 1 capital targets for 2009; and
On 23 March 2010, the company agreed with the UK government certain adjustments to the above lending commitments for the 2010 commitment period (the 12 month period commencing 1 March 2010), to reflect expected economic circumstances over the period. As part of the amended lending commitments, the company committed, among other things, to make available gross new facilities, drawn or undrawn, of £50 billion to UK businesses in the period 1 March 2010 to 28 February 2011. In addition, the company agreed with the UK government to make available £8 billion of net mortgage lending in the 2010 commitment period. This was a decrease of £1 billion on the net mortgage lending target that previously applied to the 2010 commitment period which ended on 28 February 2011, to reflect that the mortgage lending commitment for the 2009 commitment period was increased from £9 billion to £10 billion. In the Budget of 23 March 2011, the Chancellor of the Exchequer confirmed that RBS had met these lending commitments, providing £30 billion of gross new facilities to SMEs and £26.9 billion to larger businesses (a total of £56.9 billion) and delivering £9.4 billion of net mortgage lending.
Accession Agreement and the UK Asset Protection Scheme Terms and Conditions The company acceded to the APS through an accession agreement (the "Accession Agreement") entered into with HM Treasury, which became effective on 22 December 2009. Supplemental agreements were signed on 27 August 2010, 20 December 2010, 25 January 2011, 10 February 2011, 30 June 2011, 22 July 2011 and 18 August 2011. The Accession Agreement incorporates by reference the terms and conditions of the APS set out in the document entitled ‘UK Asset Protection Scheme Terms and Conditions’ which is available on HM Treasury's website (the ‘Scheme Conditions’). The Accession Agreement which incorporates the Scheme Conditions is accounted for as a credit derivative and it tailors the APS to the company (by, amongst other things, setting applicable bank-specific thresholds and addressing various other bank-specific issues).
Protection under the APS is, subject to various requirements under the Scheme Conditions, provided in respect of the Covered Assets on the company's consolidated balance sheet as at 31 December 2008 with an aggregate covered amount of £282 billion (the covered pool has since reduced substantially). Protection under the APS may be lost or limited in certain specified circumstances, including the failure of a Covered Asset to satisfy certain asset eligibility criteria set out in the Scheme Conditions.
During the life of the APS, the company will pay HM Treasury a nonrefundable annual fee (payable in advance) of £700 million per annum for the first three years of the APS and £500 million per annum until the earlier of (i) the date of termination of the APS and (ii) 31 December 2099. The annual fee can, subject to HM Treasury's consent, be paid wholly or partly by means of the waiver of certain UK tax reliefs that are treated as deferred tax assets or funded by the issuance of additional B shares to HM Treasury.
HM Treasury has the right to appoint one or more step-in managers to exercise extensive step-in rights in relation to all or some of the Covered Assets upon the occurrence of certain specified trigger events.
The Tax Loss Waiver On 26 November 2009, the company entered into three agreements (together comprising the Tax Loss Waiver) which provide the right, at the company’s option, subject to HM Treasury consent, to satisfy all or part of the annual fee in respect of the APS or the Contingent Subscription arrangement, and the exit fee payable in connection with any termination of the Group’s participation in the APS (but not the refund of the net payments it has received from HM Treasury under the APS), by waiving the entitlement to certain UK tax reliefs that are treated as deferred tax assets. The Tax Loss Waiver contains undertakings designed to prevent the Group from engaging in arrangements which have a main purpose of reducing the net cost to the Group of any waiver of tax reliefs pursuant to the Tax Loss Waiver.
The State Aid Commitment Deed also provides for the Group's undertakings in respect of State Aid to be modified in certain limited circumstances. However, HM Treasury has undertaken that it will not, without the consent of the Group, agree modifications to the Group's undertakings with respect to State Aid which are significantly more onerous to the Group than those granted in order to obtain the State Aid approval.
Material contracts continued RBS Sempra Commodities JV sales On 16 February 2010, the Group announced that RBS Sempra Commodities JV, a joint venture owned by the Royal Bank and Sempra Energy, had agreed to sell to J.P. Morgan Ventures Energy Corporation (JPMorgan) its metals, oils and European energy business lines. The Group announced completion of the transaction on 2 July 2010, for a total cash consideration of US$1.6 billion, post interim distributions of which the company's share is approximately 47 per cent.
Risk factors Set out below are certain risk factors which could adversely affect the Group's future results and cause them to be materially different from expected results. The Group's results could also be affected by competition and other factors. The factors discussed in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.
By virtue of the Group’s global presence, the Group is also exposed to risks arising out of geopolitical events, such as the existence of trade barriers, the implementation of exchange controls and other measures taken by sovereign governments that can hinder economic or financial activity levels. Furthermore, unfavourable political, military or diplomatic events, armed conflict, pandemics and terrorist acts and threats, and the response to them by governments could also adversely affect levels of economic activity and have an adverse effect upon the Group’s business, financial condition and results of operations.
The Group’s liquidity management focuses, among other things, on maintaining a diverse and appropriate funding strategy for its assets in line with the Group’s wider strategic plan. At certain times during periods of liquidity stress, the Group has been required to rely on shorter-term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks. Such schemes require the pledging of assets as collateral, the eligibility and valuation of which is determined by the applicable central bank. Changes to these valuations or eligibility criteria can negatively impact the available assets and reduce available liquidity access particularly during periods of stress when such lines may be needed most. Further tightening of credit markets could have a materially adverse impact on the Group. There is also a risk that corporate and financial institution counterparties may seek to reduce their credit exposures to banks and other financial institutions, which may cause funding from these sources to no longer be available. There is also likely to be increased competition for funding due to the significant levels of refinancing expected to be required by financial institutions during 2012, which may also reduce the level of funding available from these sources. Under such circumstances, the Group may need to seek funds from alternative sources potentially at higher costs than has previously been the case or may be required to consider disposals of other assets not previously identified for disposal to reduce its funding commitments.
In the context of its liquidity management efforts, the Group has sought to increase the average maturity of its wholesale funding, which has had the effect of increasing the Group’s overall cost of funding. In addition, the Group expects to proportionately increase its reliance on longer-term secured funding, such as covered bonds.
The occurrence of any of the risks described above could have a material adverse impact on the Group’s financial conditions and results of operations and/or result in a loss of value in its securities.
The Independent Commission on Banking has published its final report on competition and possible structural reforms in the UK banking industry. The UK Government has indicated that it supports and intends to implement the recommendations substantially as proposed, which could have a material adverse effect on the Group The Independent Commission on Banking (ICB) was appointed by the UK Government in June 2010 to review possible structural measures to reform the UK banking system in order to promote, amongst other things, stability and competition. The ICB published its final report to the Cabinet Committee on Banking Reform on 12 September 2011, which set out the ICB’s views on possible reforms to improve stability and competition in UK banking. The final report made a number of recommendations, including in relation to (i) the implementation of a ring-fence of retail banking operations, (ii) increased loss absorbency (including bail-in i.e. the ability to write-down debt or convert it into an issuer’s ordinary shares in certain circumstances) and (iii) promotion of competition. On 19 December 2011 the UK Government published its response to the final report and indicated its support and intention to implement the recommendations set out in the final report substantially as proposed. The UK Government indicated that it will work towards putting in place the necessary legislation by May 2015, requiring compliance as soon as practicable thereafter and a final deadline for full implementation of 2019. The Group will continue to participate in the debate and to consult with the UK Government on the implementation of the recommendations set out in the final report and in the UK Government’s response, the effects of which could have a material adverse effect on the Group’s structure, results of operations, financial condition and prospects.
Because the ability to dispose of assets and the price achieved for such disposals will be dependent on prevailing economic and market conditions, which remain challenging, there is no assurance that the Group will be able to sell or run-down (as applicable) those remaining businesses it is seeking to exit either on favourable economic terms to the Group or at all. In addition, material tax liabilities could arise on the disposal of assets. Furthermore, there is no assurance that any conditions precedent agreed will be satisfied, or consents and approvals required will be 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.
The Group may be liable for any deterioration in businesses being sold between the announcement of the disposal and its completion, which period may be lengthy and may span many months. In addition, the Group may be exposed to certain risks until completion, including risks arising out of ongoing liabilities and obligations, breaches of covenants, representations and warranties, indemnity claims, transitional services arrangements and redundancy or other transaction related costs.
The planned reorganisation, exit and downsizing of business activities announced in January 2012 will be time intensive and costly, the extent to which is not fully ascertainable. The process of implementing these changes may result in further disruption to the Group and the businesses it is trying to exit or downsize.
The occurrence of a delay in the implementation of (or any failure to implement) the approved proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank may have a material adverse effect on the Group As part of the restructuring of its businesses, operations and assets, on 19 April 2011, the Group announced the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank. Subject to, among other matters, regulatory and other approvals, it is expected that the proposed transfers will be implemented on a phased basis over a period ending 31 December 2013. A large part of the proposed transfers is expected to have taken place by the end of 2012. On 17 October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of FSMA.
The occurrence of a delay in the implementation of (or any failure to implement) any of the proposed transfers may therefore have a material adverse effect on the Group’s business, results of operations, financial condition, and could result in a loss of value in its securities.
Risk factors continued The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan and is prohibited from making discretionary dividend or coupon payments on existing hybrid capital instruments (including preference shares and B Shares) which may impair the Group’s ability to raise new Tier 1 capital The Group was required to obtain State Aid approval for the aid given to the Group by HM Treasury as part of the placing and open offer undertaken by the Group in December 2008, the issuance to HM Treasury of £25.5 billion of B shares in the capital of the Group which are, subject to certain terms and conditions, convertible into ordinary shares in the share capital of the Group and a contingent commitment by HM Treasury to subscribe for up to an additional £8 billion of B Shares if certain conditions are met and the Group’s participation in the Asset Protection Scheme (APS). In that context, as part of the terms of the State Aid approval, the Group, together with HM Treasury, agreed the terms of a restructuring plan.
In implementing the State Aid restructuring plan, the Group has lost, and will continue to 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 employees and giving rise to separation costs which could be substantial.
If HM Treasury decides to take the Group into temporary public ownership pursuant to the powers granted under the Banking Act, it may take various actions in relation to any securities without the consent of holders of the securities. These could include: (i) transferring the securities free from any trust, liability or other encumbrance and free from any contractual, legislative or other restrictions on transfer; (ii) extinguishing any rights to acquire securities; (iii) delisting the securities; (iv) converting the securities into another form or class; or (v) disapplying any termination or acceleration rights or events of default under the terms of the securities which would be triggered by the transfer or certain related events.
Where HM Treasury makes a share transfer order in respect of securities issued by a holding company of a relevant entity, HM Treasury may make an order providing for the property, rights or liabilities of the holding company or of any relevant entity in the holding company group to be transferred and where such property is held on trust, removing or altering the terms of such trust.
Although the Banking Act includes provisions related to compensation in respect of transfer instruments and orders made under it (including securities that are transferred with respect to a relevant entity) there can be no assurance that compensation would be assessed to be payable or that any compensation would be recovered promptly and/or would equal any loss actually incurred. HM Treasury is also empowered by order to amend the law (including with retrospective effect) for the purpose of enabling the powers under the special resolution regime to be used effectively. In general, there is considerable uncertainty about the scope of the powers afforded to the Authorities under the Banking Act and how the Authorities may choose to exercise them. However, potential impacts may include full nationalisation of the Group, the total loss of value of securities and the inability of the Group to perform its obligations under its securities.
The Group may continue to see adverse changes in the credit quality of its borrowers and counterparties, for example as a result of their inability to refinance their debts, with increasing delinquencies, defaults and insolvencies across a range of sectors and in a number of geographic markets. Since the credit quality of the Group’s borrowers and counterparties is impacted by prevailing economic and market conditions and by the legal and regulatory landscape in their respective markets, a significant deterioration in economic and market conditions or changes to legal or regulatory landscapes could worsen borrower and counterparty credit quality and also impact the Group’s ability to enforce contractual security rights. In addition, the Group’s credit risk is exacerbated when the collateral it holds cannot be realised or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is due to the Group, which is most likely to occur during periods of illiquidity and depressed asset valuations, such as those experienced in recent years. Any such losses could have an adverse effect on the Group’s results of operations and financial condition or result in a loss of value in its securities.
In the US during recent years, there has been disruption in the ability of certain financial institutions to complete foreclosure proceedings in a timely manner (or at all), including as a result of interventions by certain states and local governments. This disruption has lengthened the time to complete foreclosures, increased the backlog of repossessed properties and, in certain cases, has resulted in the invalidation of purported foreclosures. In addition, a number of other financial institutions have experienced increased repurchase demands in respect of US mortgage loans or other related securities originated and sold. However, the Group has not experienced a significant volume of repurchase demands in respect of similar loans or related securities it originated or sold and has not ceased any of its US foreclosure activities.
The trends and risks affecting borrower and counterparty credit quality have caused, and in the future may cause, the Group to experience further and accelerated impairment charges, increased repurchase demands, higher costs, additional write-downs and losses for the Group and an inability to engage in routine funding transactions, and may result in a loss of value of its securities.
The Group’s earnings and financial condition have been, and its future earnings and financial condition may continue to be, materially affected by depressed asset valuations resulting from poor market conditions Financial markets continue to be subject to significant stress conditions, where steep falls in perceived or actual asset values have been accompanied by a severe reduction in market liquidity, as exemplified by losses arising out of asset-backed collateralised debt obligations, residential mortgage-backed securities and the leveraged loan market. In dislocated markets, hedging and other risk management strategies may not be as effective as they are in normal market conditions due in part to the decreasing credit quality of hedge counterparties. Severe market events have resulted in the Group recording large write-downs on its credit market exposures in recent years. Any deterioration in economic and financial market conditions could lead to further impairment charges and write-downs. Moreover, market volatility and illiquidity (and the assumptions, judgements and estimates in relation to such matters that may change over time and may ultimately not turn out to be accurate) make it difficult to value certain of the Group’s exposures. Valuations in future periods, reflecting, among other things, then prevailing market conditions and changes in the credit ratings of certain of the Group’s assets, may result in significant changes in the fair values of the Group’s exposures, even in respect of exposures, such as credit market exposures, for which the Group has previously recorded write-downs. In addition, the value ultimately realised by the Group may be materially different from the current or estimated fair value. Any of these factors could require the Group to recognise further significant write-downs in addition to those already recorded or realised or realise increased impairment charges, which may have a material adverse effect on its financial condition, results of operations and capital ratios or result in a loss of value of its securities.
The value or effectiveness of any credit protection that the Group has purchased depends on the value of the underlying assets and the financial condition of the insurers and counterparties The Group has credit exposure arising from over-the-counter derivative contracts, mainly credit default swaps (CDSs), and other credit derivatives, such as the APS, each of which are carried at fair value. The fair value of these CDSs, as well as the Group’s exposure to the risk of default by the underlying counterparties, depends on the valuation and the perceived credit risk of the instrument against which protection has been bought. Market counterparties have been adversely affected by their exposure to residential mortgage linked and corporate credit products, whether synthetic or otherwise, and their actual and perceived creditworthiness may deteriorate rapidly. If the financial condition of these counterparties or their actual or perceived creditworthiness deteriorates, the Group may record further credit valuation adjustments on the credit protection bought from these counterparties under the CDSs. The Group also recognises any fluctuations in the fair value of other credit derivatives, such as the APS. If market conditions improve and credit spreads for assets covered by the APS narrow, the value of the protection decreases and a loss is recognised. If credit spreads widen, the protection is more valuable, giving rise to a gain. Any such adjustments or fair value changes may have a material adverse impact on the Group’s financial condition and results of operations.
The performance of financial markets affects bond, equity and commodity prices, which has caused, and may in the future cause, changes in the value of the Group’s investment and trading portfolios. As part of its ongoing derivatives operations, the Group also faces significant basis, volatility and correlation risks, the occurrence of which are also impacted by the factors noted above. 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 package of reforms to the regulatory capital framework published by the Basel Committee on Banking Supervision in December 2010 and January 2011 includes materially increasing the minimum common equity requirement and the total Tier 1 capital requirement. In addition, banks will be required to maintain, in the form of common equity (after the application of deductions), a capital conservation buffer to withstand future periods of stress, bringing the total common equity requirements to 7%. If there is excess credit growth in any given country resulting in a system-wide build-up of risk, a countercyclical buffer within a range of 02. 5% of common equity is to be applied as an extension of the conservation buffer. In addition, a leverage ratio will be introduced, together with a liquidity coverage ratio and a net stable funding ratio. Further measures may include bail-in debt which could be introduced by statute, possibly impacting existing as well as future issues of debt and exposing them to the risk of conversion into equity and/or write-down of principal amount. Such measures would be in addition to proposals for the write-off of Tier 1 and Tier 2 debt (and its possible conversion into ordinary shares) if a bank becomes non-viable.
The Basel III rules have not yet been approved by the EU and their incorporation into European and national law has, accordingly, not yet taken place. On 20 July 2011, the European Commission published a legislative package of proposals (known as CRD IV) to implement the changes through the replacement of the existing Capital Requirements Directive with a new Directive and Regulation. As with Basel III, the proposals contemplate the entry into force of the new legislation from 1 January 2013, with full implementation by 1 January 2019; however the proposals allow the UK to implement the stricter definition and/or level of capital more quickly than is envisaged under Basel III.
The Basel Committee changes and other future changes to capital adequacy and liquidity requirements in the UK and in other jurisdictions in which the Group operates, including any application of increasingly stringent stress case scenarios by the regulators in the UK, the US and other jurisdictions in which the Group undertakes regulated activities, may require the Group to raise additional Tier 1 (including Core Tier 1) and Tier 2 capital by way of further issuances of securities, and will result in existing Tier 1 and Tier 2 securities issued by the Group ceasing to count towards the Group’s regulatory capital, either at the same level as present or at all. The requirement to raise additional Core Tier 1 capital could have a number of negative consequences for the Group and its shareholders, including impairing the Group’s ability to pay dividends on or make other distributions in respect of ordinary shares and diluting the ownership of existing shareholders of the Group. If the Group is unable to raise the requisite Tier 1 and Tier 2 capital, it may be required to further reduce the amount of its risk-weighted assets and engage in the disposal of core and other non-core businesses, which may not occur on a timely basis or achieve prices which would otherwise be attractive to the Group. In addition, pursuant to the State Aid approval, should the Group’s Core Tier 1 capital ratio decline to below 5% 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 is and may be subject to litigation and regulatory investigations that may have a material impact on its business 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 UK, the EU, the US and other jurisdictions, including class action litigation, LIBOR related litigation and investigations and anti-money laundering, sanctions and compliance related investigations. The Group may also incur the risk of civil suits, criminal liability or regulatory actions as a result of its disclosure obligations to HM Treasury under the APS. In addition, the Group, like many other financial institutions, has come under greater regulatory scrutiny in recent years 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 early 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 have a significant effect on the Group’s reputation or results of operations or result in a loss of value of its securities.
The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate Under International Financial Reporting Standards (IFRS), the Group recognises at fair value: (i) financial instruments classified as held-fortrading or designated as at fair value through profit or loss; (ii) financial assets classified as available-for-sale; and (iii) derivatives. 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 prevailing market conditions. In such circumstances, the Group’s internal valuation models require the Group to make assumptions, judgements and estimates to establish fair value, which are complex and often relate to matters that are inherently uncertain. These assumptions, judgements and estimates will 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 or result in a loss of value of its securities.
Risk factors continued In addition, certain of the Group’s employees in the UK, continental Europe and other jurisdictions in which the Group operates are represented by employee representative bodies, including trade unions. Engagement with its employees and such bodies is important to the Group and a breakdown of these relationships could adversely affect the Group’s business, reputation and results. As the Group implements cost saving initiatives and disposes of, or runs-down, certain assets or businesses (including as part of its restructuring plans), it faces increased risk in this regard and there can be no assurance that the Group will be able to maintain good relations with its employees or employee representative bodies in respect of all matters. As a result, the Group may experience strikes or other industrial action from time to time, which could have an adverse effect on its business and results of operations and could cause damage to its reputation.
Areas in which, and examples of where, governmental policies, regulatory changes and increased public and regulatory scrutiny could have an adverse impact on the Group include those set out above as well as the following: the transition in the UK of regulatory and supervisory powers from the FSA to the new Financial Conduct Authority for conduct of business supervision and the Prudential Regulatory Authority for capital and liquidity supervision in 2013; the monetary, fiscal, interest rate and other policies of central banks and other governmental or regulatory bodies; requirements to separate retail banking from investment banking, and restrictions on proprietary trading and similar activities within a commercial bank and/or a group which contains a commercial bank; the design and potential implementation of government mandated resolution or insolvency regimes; the imposition of government imposed requirements with respect to lending to the UK SME market and larger commercial and corporate entities and residential mortgage lending; requirements to operate in a way that prioritises objectives other than shareholder value creation; changes to financial reporting standards (including accounting standards), corporate governance requirements, corporate structures and conduct of business rules; the imposition of restrictions on the Group’s ability to compensate its senior management and other employees; regulations relating to, and enforcement of, anti-bribery, anti-money laundering, anti-terrorism or other similar sanctions regimes; rules relating to foreign ownership, expropriation, nationalisation and confiscation of assets; other requirements or policies affecting the Group’s profitability, such as the imposition of onerous compliance obligations, further restrictions on business growth or pricing; the introduction of, and changes to, taxes, levies or fees applicable to the Group’s operations (such as the imposition of financial activities taxes and changes in tax rates that reduce the value of deferred tax assets); and the regulation or endorsement of credit ratings used in the EU (whether issued by agencies in EU member states or in other countries, such as the US).
The Group’s results could be adversely affected in the event of goodwill impairment 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 when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of the value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. At 31 December 2011, the Group carried goodwill of £12.4 billion on its balance sheet. 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. Any significant write-down of goodwill could have a material adverse effect on the Group’s results of operations and the value of its securities.
In addition, UKFI manages HM Treasury’s shareholder relationship with the Group and, although HM Treasury has indicated that it intends to respect the commercial decisions of the Group and that the Group will continue to have its own independent board of directors and management team determining its own strategy, should its current intentions change, HM Treasury’s position as a majority shareholder (and UKFI’s position as manager of this shareholding) means that HM Treasury or UKFI may be able to exercise a significant degree of influence over, among other things, the election of directors and the appointment of senior management. In addition, as the provider of the APS, HM Treasury has a range of rights that other shareholders do not have. These include rights under the terms of the APS over the Group’s remuneration policy and practice. The manner in which HM Treasury or UKFI exercises HM Treasury’s rights as majority shareholder or in which HM Treasury exercises its rights under the APS could give rise to conflict between the interests of HM Treasury and the interests of other shareholders. The Board has a duty to promote the success of the Group for the benefit of its members as a whole.
The Group’s operations have inherent reputational risk Reputational risk, meaning the risk to earnings and capital from negative public opinion, is inherent in the Group’s business. Negative public opinion can result from the actual or perceived manner in which the Group conducts its business activities, from the Group’s financial performance, from the level of direct and indirect government support or from actual or perceived practices in the banking and financial industry. Negative public opinion may adversely affect the Group’s ability to keep and attract customers and, in particular, corporate and retail depositors. The Group cannot ensure that it will be successful in avoiding damage to its business from reputational risk.
In the UK 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 the UK, the Financial Services Compensation Scheme (FSCS) was established under the FSMA and is the UK’s statutory fund of last resort for customers of authorised financial services firms. The FSCS can pay compensation to customers if a firm is unable or likely to be unable, to pay claims against it and may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under the Banking Act. The FSCS is funded by levies on firms authorised by the FSA, including the Group. In the event that the FSCS raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the Group may have an adverse impact on its results of operations and financial condition. At 31 December 2011, the Group had accrued £157 million for its share of FSCS levies for the 2011/2012 and 2012/2013 FSCS years.
The APS is a unique form of credit protection over a complex range of diversified assets and exposures in a number of jurisdictions. Due to the complexity, scale and unique nature of the APS and the uncertainty resulting from the recent 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. Such risks may have a material adverse effect on the Group. The Group may also be subject to further tax liabilities in the UK and overseas in connection with the APS and the associated intra-group arrangements which would not otherwise have arisen.
Risk factors continued The extensive governance, asset management and information requirements under the Scheme Conditions may have an adverse impact on the Group and the expected benefits of the APS There are extensive governance, asset management and information requirements under the Scheme Conditions in relation to the Covered Assets, other assets and the operations of the Group and HM Treasury also has the right to require the appointment of one or more step-in managers to exercise certain step-in rights in certain circumstances. 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 participation in the APS and the issuance of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares are not sufficient to maintain the Group’s capital ratios as expected, this could cause the Group’s business, results of operations and financial condition to suffer, its credit ratings to drop, its ability to lend and access to funding to be further limited and its cost of funding to increase, and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act as described above. The occurrence of any or all of such events may cause the price of its securities to decline.
466 Financial calendar 466 Shareholder enquiries 467 Analyses of ordinary shareholders 468 Trading market 471 Dividend history 472 Taxation for US Holders 475 Exchange controls 475 Memorandum and Articles of Association 475 Incorporation and registration 476 Glossary of terms 484 Index 487 Important addresses 487 Principal offices
Share Fraud Warning Share fraud includes scams where investors are called out of the blue and offered shares that often turn out to be worthless or non-existent, or an inflated price for shares they own. These calls come from fraudsters operating in ‘boiler rooms’ that are mostly based abroad. While high profits are promised, those who buy or sell shares in this way usually lose their money. The Financial Services Authority (FSA) has found most share fraud victims are experienced investors who lose an average of £20,000, with around £200 million lost in the UK each year.
Protect yourself If you are offered unsolicited investment advice, discounted shares, a premium price for shares you own, or free company or research reports, you should take these steps before handing over any money; get the name of the person and organisation contacting you; check the FSA Register at www.fsa.gov.uk/fsaregister to ensure they are authorised; use the details on the FSA Register to contact the firm; call the FSA Consumer Helpline on 0845 606 1234 if there are no contact details on the Register or you are told they are out of date; search our list of unauthorised firms and individuals to avoid doing business with; and remember if it sounds too good to be true, it probably is.
Individuals 214,369 1,350.6 2.3 Banks and nominee companies 14,835 57,265.1 96.7 Investment trusts 144 38.5 0.1 Insurance companies 171 6.0 — Other companies 1,351 109.5 0.2 Pension trusts 36 23.5 — Other corporate bodies 94 435.2 0.7 231,000 59,228.4 100.0
Range of shareholdings: 1 - 1,000 74,654 32.1 0.1 1,001 - 10,000 125,097 466.2 0.8 10,001 - 100,000 29,372 677.1 1.1 100,001 - 1,000,000 1,212 332.7 0.5 1,000,001 - 10,000,000 448 1,528.1 2.6 10,000,001 and over 217 56,192.2 94.9 231,000 59,228.4 100.0
At 31 December 2011, there were 69 registered shareholders of Series F ADSs, 41 registered shareholders of Series H ADSs, 23 registered shareholders of Series L ADSs, 7 registered shareholders of Series M ADSs, 20 registered shareholders of Series N ADSs, 27 registered shareholders of Series P ADSs, 13 registered shareholders of Series Q ADSs, 3 registered shareholders of Series R ADSs, 1 registered shareholder of Series S ADSs, 16 registered shareholders of Series T ADSs and 1 registered shareholder of Series U ADSs.
PROs In August 2001, the company issued US$1.2 billion perpetual regulatory tier one securities (PROs) in connection with a public offering in the United States. The PROs are listed on the NYSE.
ADSs representing ordinary shares In October 2007, the company listed ADSs, each representing one ordinary share nominal value 25p each (or a right to receive one ordinary share), and evidenced by an ADR or uncertificated securities, on the NYSE. With effect from 7 November 2008, the ratio of one ADS representing one ordinary share changed to one ADS representing 20 ordinary shares. As at 31 December 2011, 14.8 million ADSs were outstanding. The ADSs were issued in connection with the company's bid for the outstanding share capital of ABN AMRO Holding N.V..
January 2012 High 0.2814 2011: Q4 High 0.2727 2011 High 0.4900 Low 0.2007 Low 0.1734 Low 0.1734
December 2011 High 0.2277 2011: Q3 High 0.3980 2010 High 0.5804 Low 0.1940 Low 0.1967 Low 0.3125 November 2011 High 0.2312 2011: Q2 High 0.4443 2009 High 0.5765 Low 0.1734 Low 0.3509 Low 0.1030 October 2011 High 0.2727 2011: Q1 High 0.4900 2008 High 3.7054 Low 0.2152 Low 0.3950 Low 0.4140 September 2011 High 0.2625 2010: Q4 High 0.4949 2007 High 6.0208 Low 0.2077 Low 0.3759 Low 3.3265 August 2011 High 0.3415 2010: Q3 High 0.5210 Low 0.1967 Low 0.3896 2010: Q2 High 0.5804 Low 0.4143 2010: Q1 High 0.4560 Low 0.3125
On 21 February 2012, the closing price of the ordinary shares on the London Stock Exchange was £0.28, equivalent to $0.44 per share translated at the Noon Buying Rate of $1.5796 per £1.00 on 21 February 2012.
ADSs The following table shows, for the periods indicated, the high and low sales prices for the company's ordinary ADSs, as reported on the NYSE composite tape. Prices for 2008 were restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.
On 21 February 2012, the closing price of the ordinary ADSs on the New York Stock Exchange was $8.85.
Ordinary dividends Ordinary dividends per share for 2007 in the table below were restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.
Amount per ordinary share and American Depository Share (1) 2011 pence pence 2009 pence pence pence
The statements and practices set forth below regarding US and UK tax laws, including the US/UK double taxation convention relating to income and capital gains which entered into force on 31 March 2003 (the “Treaty”), and the US/UK double taxation convention relating to estate and gift taxes (the “Estate Taxation Treaty”), are based on those laws and practices as in force and as applied in practice on the date of this report. This summary is not exhaustive of all possible tax considerations and holders are advised to satisfy themselves as to the overall tax consequences, including specifically the consequences under US federal, state, local and other laws, and possible changes in taxation law, of the acquisition, ownership and disposition of ordinary shares, ordinary ADSs, preference ADSs or PROs by consulting their own tax advisers.
Ordinary shares, ordinary ADSs and preference ADSs Taxation of dividends For the purposes of the Treaty, the Estate Taxation Treaty and the US Internal Revenue Code of 1986 as amended (the “Code”), US Holders of ordinary ADSs and preference ADSs should be treated as owners of the ordinary shares and the non-cumulative dollar preference shares underlying such ADSs.
Dividends will be included in a US Holder's income on the date of the US Holder's (or in the case of ADSs, the depositary's) receipt of the dividend. The amount of any dividend paid in pounds sterling to be included in income by a US Holder will be the US dollar amount calculated by reference to the relevant exchange rate in effect on the date of such receipt regardless of whether the payment is in fact converted into US dollars. If the dividend is converted into US dollars on the date of receipt, the US Holder generally should not be required to recognise foreign currency gain or loss in respect of the dividend income. If the amount of such dividend is not converted into US dollars on the date of receipt, the US Holder may have foreign currency gain or loss.
A US Holder will, upon the sale or other disposition of an ordinary share, an ordinary ADS or a preference ADS, or upon the redemption of preference ADS, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption of a preference ADS, such US Holder does not own, and is not deemed to own, any ordinary shares or ordinary ADSs of the company) in an amount equal to the difference between the amount realised (excluding in the case of a redemption any amount treated as a dividend for US federal income tax purposes, which will be taxed accordingly) and the US Holder's tax basis in such share or ADS. This capital gain or loss will be long-term capital gain or loss if the US Holder held the share or ADS so sold, disposed or redeemed for more than one year.
A US Holder who is liable for both UK and US tax on a gain recognised on the disposal of an ordinary share, an ordinary ADS or a preference ADS will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.
A US Holder who is liable for both UK and US tax on gain recognised on the disposal of PROs will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.
United Kingdom Taxation of payments on the PROs Payments on the PROs will constitute interest rather than dividends for UK withholding tax purposes. However, the PROs will constitute 'quoted eurobonds' within the meaning of section 987 of the Income Tax Act 2007 and therefore payments of interest will not be subject to withholding or deduction for or on account of UK tax as long as the PROs remain at all times listed on a 'recognised stock exchange' within the meaning of section 1005 of the Income Tax Act 2007, such as the main market of the New York Stock Exchange. In all other cases, an amount must be withheld on account of UK income tax at the basic rate (currently 20%) subject to any direction to the contrary by HM Revenue & Customs under the Treaty and except that the withholding obligation does not apply to payments to persons who the company reasonably believes are within the charge to corporation tax or fall within various categories enjoying a special tax status (including charities and pension funds), or are partnerships consisting of such persons (unless HM Revenue & Customs directs otherwise). Where interest has been paid under deduction of UK
Passive Foreign Investment Company (PFIC) considerations A foreign corporation will be a PFIC in any taxable year in which, after taking into account the income and assets of the corporation and certain subsidiaries pursuant to applicable 'look-through rules', either (i) at least 75% of its gross income is 'passive income' or (ii) at least 50% of the average value of its assets is attributable to assets which produce passive income or are held for the production of passive income. The company does not believe that it was a PFIC for its 2011 taxable year. Although interest income is generally passive income, a special rule allows banks to treat their banking business income as non-passive. To qualify for this rule, a bank must satisfy certain requirements regarding its licensing and activities. The company's possible status as a PFIC must be determined annually, however, and may be subject to change if the company fails to qualify under this special rule for any year in which a US Holder holds ordinary shares, ordinary ADSs, preference ADSs or PROs. If the company were to be treated as a PFIC in any year during which a US Holder holds ordinary shares, ordinary ADSs, preference ADSs or PROs, US Holders would generally be subject to adverse US federal income tax consequences. Holders should consult their own tax advisers as to the potential application of the PFIC rules to the ownership and disposition of the company's ordinary shares, ordinary ADSs, preference ADSs or PROs.
Foreign financial assets reporting For taxable years beginning after 18 March 2010, certain US Holders who are individuals may be required to report information relating to the company’s securities, subject to certain exceptions (including an exception for securities held in accounts maintained by US financial institutions). US Holders are urged to consult their tax advisers regarding the application of these rules in the US Holders’ particular circumstances.
Glossary of terms Adjustable rate mortgage (ARM) - in the US, a variable-rate mortgage. ARMs include: hybrid ARMs which typically have a fixed-rate period followed by an adjustable-rate period; interest-only ARMs where interest only is payable for a specified number of years, typically for three to ten years; and payment-option ARMs that allow the borrower to choose periodically between various payment options.
Alt-A (Alternative A-paper) - a US description for mortgage loans with a higher credit quality than sub-prime loans but with features that disqualify the borrower from a traditional prime loan. Alt-A lending characteristics include limited documentation; high loan-to-value ratio; secured on nonowner occupied properties; and debt-to-income ratio above normal limits.
Arrears - the aggregate of contractual payments due on a debt that have not been met by the borrower. A loan or other financial asset is said to be 'in arrears' when payments have not been made. When a customer is in arrears, the entire outstanding balance is said to be delinquent (see Delinquency).
Asset protection scheme credit default swap - in 2009, the Group became party to the Asset Protection Scheme under which it purchased credit protection over a portfolio of specified assets and exposures (“covered assets”) from Her Majesty’s Treasury acting on behalf of the UK Government. The contract is accounted for as a derivative financial instrument. It is recognised at fair value and included in Derivatives on the balance sheet. Changes in its fair value are recognised in profit or loss within Income from trading activities.
Assets under management - assets managed by the Group on behalf of clients.
Basel III - in December 2010, the Basel Committee on Banking Supervision issued final rules: ‘Basel III: A global regulatory framework for more resilient banks and banking systems’ and ‘Basel III: International framework for liquidity risk measurement, standards and monitoring’. These strengthened global regulatory standards on bank capital adequacy and liquidity and will be phased in from 2013 with full implementation by 1 January 2019.
Basis point - one hundredth of a per cent i.e. 0.01 per cent. 100 basis points is 1 per cent. Used when quoting movements in interest rates or yields on securities.
Collateralised debt obligation squared (CDO-squared) - a type of collateralised debt obligation where the underlying asset portfolio includes tranches of other CDOs.
Commercial paper (CP) - unsecured obligations issued by a corporate or a bank directly or secured obligations (asset-backed CP), often issued through a commercial paper conduit, to fund working capital. Maturities typically range from two to 270 days. However, the depth and reliability of some CP markets means that issuers can repeatedly roll over CP issuance and effectively achieve longer term funding. CP is issued in a wide range of denominations and can be either discounted or interestbearing.
Core Tier 1 capital ratio - core Tier 1 capital as a percentage of riskweighted assets.
CRD IV - in July 2011, the European Commission published its proposed legislation for a Capital Requirements Directive and a Capital Requirements Regulation, which together form the CRD IV package. The package implements the Basel III capital proposals and also includes new proposals on sanctions for non-compliance with prudential rules, corporate governance and remuneration. It is due to be implemented from 1 January 2013 with transitional arrangements for some of its requirements.
Credit derivatives - contractual agreements that provide protection against a credit event on one or more reference entities or financial assets. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency or failure to meet payment obligations when due. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event. Credit derivatives include credit default swaps, total return swaps and credit swap options.
Credit risk assets - loans and advances (including overdraft facilities), instalment credit, finance lease receivables and other traded instruments across all customer types.
Credit valuation adjustments - adjustments to the fair values of derivative assets to reflect the creditworthiness of the counterparty.
Customer accounts - money deposited with the Group by counterparties other than banks and classified as liabilities. They include demand, savings and time deposits; securities sold under repurchase agreements; and other short term deposits. Deposits received from banks are classified as deposits by banks.
Defined benefit plan - pension or other post-retirement benefit plan other than a defined contribution plan.
Delinquency - a debt or other financial obligation is considered delinquent when one or more contractual payments are overdue. Delinquency is usually defined in terms of days past due. Delinquent and in arrears are synonymous.
Fannie Mae (Federal National Mortgage Association) - a US Government Sponsored Enterprise. It buys mortgages, principally issued by banks, on the secondary market, pools them, and sells them as residential mortgage-backed securities to investors on the open market. Its obligations are not explicitly guaranteed by the full faith and credit of the US Government.
Federal Agencies - US federal agencies are independent bodies established by the US Government for specific purposes such as the management of natural resources, financial oversight or national security. A number of agencies, including Ginnie Mae, issue or guarantee publicly traded debt securities.
First/second lien - a lien is a charge such as a mortgage held by one party, over property owned by a second party, as security for payment of some debt, obligation, or duty owed by that second party. The holder of a first lien takes precedence over all other encumbrances on that property i.e. second and subsequent liens.
Freddie Mac (Federal Home Loan Mortgage Corporation) - a US Government Sponsored Enterprise. It buys mortgages, principally issued by thrifts, on the secondary market, pools them, and sells them as residential mortgage-backed securities to investors on the open market. Its obligations are not explicitly guaranteed by the full faith and credit of the US Government.
Key management - directors of RBSG and members of the Group Management Committee.
Monoline insurers - entities that specialise in providing credit protection against the notional and interest cash flows due to the holders of debt instruments in the event of default. This protection is typically in the form of derivatives such as credit default swaps.
Option - an option is a contract that gives the holder the right but not the obligation to buy (or sell) a specified amount of the underlying physical or financial commodity, at a specific price, at an agreed date or over an agreed period. Options can be exchange-traded or traded over-the- counter.
Glossary of terms continued Over-the-counter (OTC) derivatives - are derivatives with tailored terms and conditions negotiated bilaterally, in contrast to exchange traded derivatives that have standardised terms and conditions.
Potential problem loans (PPL) - loans for which an impairment event has taken place but no impairment provision is required. This category is used for fully collateralised advances which are not past due 90 days or revolving credit facilities where identification as 90 days overdue is not feasible.
Sovereign exposures - exposures to governments, ministries, departments of governments and central banks.
Special purpose entity (SPE) - an entity created by a sponsor, typically a major bank, finance company, investment bank or insurance company. An SPE can take the form of a corporation, trust, partnership, or a limited liability company. Its operations are typically limited for example in a securitisation to the acquisition and financing of specific assets or liabilities.
Sub-prime - mortgage loans to customers with one or more high risk characteristics, such as: unreliable or poor payment histories; loan-tovalue ratio of greater than 80%; high debt-to-income ratio; the loan is not secured on the borrower's primary residence; or a history of delinquencies or late payments on the loan.
Unaudited - financial information that has not been subjected to the audit procedures undertaken by the Group's auditor to enable them to express an opinion on the Group's financial statements.
Value-at-risk (VaR) - a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels.
Wrapped security - a debt security where the holder benefits from credit protection provided by a third party, typically a financial guarantor or monoline insurer.
Audit Committee Letter from the Chairman of the Group Audit Committee 263 Report of the Group Audit Committee 264
Available-for-sale financial assets Accounting policies 319 Notes on the consolidated accounts 340
Board Risk Committee report Letter from the Chairman of the Board Risk Committee 268 Report of the Board Risk Committee 269
Capital adequacy Capital ratios 95, 111 Capital resources 95, 112 Notes on the consolidated accounts 398
Consolidated financial statements Consolidated balance sheet 309 Consolidated cash flow statement 313 Consolidated income statement 307 Consolidated statement of changes in equity 310 Consolidated statement of comprehensive income 308 Notes on the consolidated accounts 327
Directors Biographies 253 Interests in shares 303 Remuneration 291 Remuneration policy 279 Report of the directors 298 Service contracts 289
Earnings per share Business review 42 Notes on the consolidated accounts 339
Employees Business review 62 Costs 329 Headcount 330 Report of the directors 299 Variable compensation 332
Insurance claims Accounting policy 317 Business review 55 Critical accounting policies 325 Notes on the consolidated accounts 379
Insurance premium income Accounting policies 317 Business review 53 Notes on the consolidated accounts 379
Net interest income Business review 46 Notes on the consolidated accounts 327
Pensions Accounting policies 315 Critical accounting policies 324 Directors’ pension arrangements 293 Notes on the consolidated accounts 333 Pension risk 245
Property, plant and equipment Accounting policies 316 Notes on the consolidated accounts 373
Remuneration Committee Directors’ remuneration report 274 Letter from the Chair of the Remuneration Committee 272
Securitisations and asset transfers Notes on the consolidated accounts 396 Special purpose entities 124
Segmental reporting Business review 60 Description of business 36 Notes on the consolidated accounts 411
Share-based payments Accounting policies 322 Notes on the consolidated accounts 331
Shareholder information Analysis of ordinary shareholders 467 Annual General Meeting 466 Shareholder enquiries 466
Tax Accounting policies 318 Business review 59 Critical accounting policies 325 Notes on the consolidated accounts 338 Notes on the consolidated accounts - deferred tax 378
RBS Holdings USA Inc. 600 Washington Blvd Stamford CT 06901 USA
NatWest Offshore 23/25 Broad Street St Helier Jersey Channel Islands JE4 OYX
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