I would like to assure you that the Committee has spent a great deal of time challenging and taking action in response to past events and considering how remuneration can help to drive appropriate behaviours at RBS in future. Individuals found culpable in relation to LIBOR have left the Group with no annual incentive awards for 2012 and full clawback of outstanding awards. The Committee has also taken action across the Group, particularly in the Markets division, to account for the reputational damage of these events.
Key financial achievements for 2012 were: Core Operating Profit of £6.3 billion, which represents a strong performance; Further significant progress in removing Non-Core assets, a key part in managing down legacy issues. Non-Core third party assets are down £36 billion in 2012 to £57 billion, representing 92% progress towards the 2013 target of c.£40 billion; Capital, funding and liquidity positions remain robust with key performance indicators (KPIs) on short-term wholesale funding, liquidity portfolio, leverage ratio, Core Tier 1 capital ratio and loan:deposit ratio all exceeding or in line with medium-term targets; Core Return on Equity (ROE) was 10%, with Retail & Commercial
As well as financial achievements, the Committee takes into account performance against a broader range of objectives, including support to customers. For example, in 2012 the Group accounted for 36% of all Small and Medium Enterprises (SME) lending, compared with its overall customer market share of 24%. The Group advanced £16 billion of UK home loans, including £3 billion to first time buyers. Using the Bank of England’s Funding for Lending Scheme the Group has offered lower interest rates and waived arrangement fees on certain SME loans, benefiting over 11,000 SMEs in the second half of 2012.
Decisions made on pay In addition to financial and non-financial measures, the Committee applies a rigorous accountability review process in determining pay outcomes. This framework enables us to claw back awards made in previous years where current or new information would change the decisions made in previous years. The review considers not only financial losses but also behavioural and reputational issues that have arisen.
The CEO, Stephen Hester, will not receive any salary increase in 2013. In addition, he decided during the year that it would not be appropriate for him to be considered for any annual incentive award. Whilst respecting his decision, I would like to put on record that the Committee believes the CEO continues to demonstrate strong performance and leadership. The Committee receives regular encouragement from institutional shareholders to improve the delivery of market competitive remuneration to the CEO.
Enhancements to remuneration policy The Committee continues to recognise the importance of driving cultural change both in terms of pay and in a wider sense. As Chair, I am actively involved in a number of initiatives relating to diversity, graduate recruitment and management development and many of these initiatives have received award-winning recognition.
It is clear that challenges remain in rebuilding the reputation of banks but progress has been made in evolving the culture of RBS. Our remuneration policy underpins this work by encouraging appropriate behaviours and adjusting for risk. Examples of enhancements are as follows: Simplification of sales incentives with a broad move to a balanced scorecard type approach focused on customer service and risk; All executives and Code Staff have culture included as part of their 2013 objectives supported by quantitative and qualitative measures; Full review of balanced scorecard metrics, supported by independent control function review in advance of variable pools being agreed; This year, all our employees will be paid salaries at or above the
Shareholding requirements for the executive directors have been strengthened and new requirements introduced for senior executives to better align their interests with those of shareholders.
Changes have been made to this report in line with a number of anticipated government reforms on remuneration reporting. The Remuneration Governance section covers the activities and decisionmaking process of the Committee; the Policy Report covers future remuneration policy; and the Implementation Report demonstrates how pay arrangements have been implemented over the past year.
As in previous years, we have consulted with our major shareholders, including UKFI, on remuneration matters. I would like to thank those shareholders who continue to recognise and support our efforts to reform remuneration practices at RBS. In this turnaround period where it has not been possible to pay ordinary dividends to shareholders, this support on pay decisions has been an essential part of our restructuring programme.
Finally, I would also like to thank my fellow Committee members for their expertise and guidance and all those who have supported the Committee in its efforts to make fair and appropriate judgements.
The terms of reference of the Group Performance and Remuneration Committee are available on the Group’s website www.rbs.com and these are reviewed at least annually by the Committee and approved by the Board.
Assessment of the performance to date of unvested LTIP awards and award levels and performance targets for 2012 awards.
Second quarter Outcomes of the first quarter accountability reviews; Review of remuneration proposals for Direct Line Insurance Group plc on divestment; Presentation from the Wealth division on business and strategic priorities and people plan; Review of government proposals on Shareholder Voting Rights and remuneration aspects of CRD IV; and
Performance evaluation process An external review of the effectiveness of the Board and Senior Committees, including the Group Performance and Remuneration Committee, was conducted during 2012. The Committee considered the outcomes of the evaluation and is satisfied with the way in which the evaluation has been conducted.
Variable pay pool determination The process for determining variable pools is discretionary, to avoid the unintended consequences of formulaic systems. However, the Committee's discretion is applied within a structured framework which starts with an assessment of risk adjusted financial performance measured against budget, prior year and long-term strategic plans. This analysis is used to adjust for performance and then consider outcomes in the context of competitive variable pay funding levels.
Accountability review process A summary of the accountability review process is as follows: Exists to enable RBS to respond in instances where current and/or new information would change the annual incentive and/or LTIP decisions made in previous years, and/or the decisions made in the current year.
Decisions must take into account not only any financial losses but also behavioural issues and reputational or internal costs.
A key principle is that clawback quantum should not be formulaic.
Collective responsibility may be considered where a committee or group of employees are deemed to have not appropriately discharged their duties.
These principles apply to all of our people and any leavers with unvested awards.
How have we applied this in practice? The assessment undertaken by the risk function and Board Risk Committee confirmed that, for some divisions, a number of risk-related events needed to be taken account of when determining variable pay pools, including regulatory, compliance and credit and market risk issues. The Board Risk Committee has concluded that the accountability review assessments approach is robust and complete from a perspective of all known material events having been considered.
will be disbanded once the 2012 performance review process is complete.
Supports the Group Performance and Remuneration Committee as they develop reward philosophy, strategy and policies across the
RBS Group. Provides input on market trends and compensation structures for the executives and the broader population in the Group.
Base salaries are reviewed annually and should reflect the talents, skills and competencies that the individual brings to the Group. Salaries should be sufficient so that inappropriate risk-taking is not encouraged.
To support a culture where employees recognise the importance of serving customers well and are rewarded for superior individual performance.
In certain circumstances, formulaic short-term incentive arrangements are used to align the objectives of employees with the strategy of the relevant division in which they work.
All incentive awards are subject to appropriate governance, including independent review by the risk management, finance and human resources functions, with oversight from the Group Performance and Reward Committee, which has delegated authority from the Committee over incentive schemes operating over a period of 12 months or less.
Awards are structured as performance-vesting shares. Vesting after a three year period will be based partly on divisional or functional performance and partly on performance across the Group. All awards are subject to clawback.
Base salary Reviewed annually and considered against annual market data and in the context of wider Group increases.
N/A A 2% increase to the salary of Bruce Van Saun to £765,000 with effect from 1 April 2013.
Annual incentive Any annual incentive to be awarded entirely in shares.
Balanced scorecard of KPIs measured over the financial year. KPIs are: Strategic progress; Business delivery and financial performance; Risk and control; Stakeholder management; and
2013 LTIP awards will be granted subject to an overall cap of 300% of salary at grant.
However, there is an overall cap on vesting equivalent to 300% of salary at grant.
Total Shareholder Return (TSR) relative to comparator group of international banks - 25%
The LTIP measures have been selected in consultation with shareholders. The objective is to have a balanced range of measures that encourage the building of a safer, stronger and more sustainable business. See page 329 for further details on the measures.
Pension allowance. Opportunity to sacrifice salary into defined contribution pension scheme.
The mix of executive directors’ remuneration The charts below show the composition of remuneration opportunity for on-target annual performance, with the long-term incentive awards shown at median performance vesting. Annual incentive payments earned in relation to 2013 performance will be deferred and will vest, subject to satisfactory performance. The actual value of the long term incentive awards will depend on performance over the period 2013 to 2015 and the share price at the time the awards vest.
The data shows that Stephen Hester is likely to receive just 22% of the maximum value of his incentives awarded over the last three years, and around 38% of his maximum total compensation. This is despite strong progress against a range of financial and non-financial targets measured over the three year period since 2010.
o ta l C o m p e n s a ti o n (
Annual incentive awards - performance criteria for 2013 The executive directors’ annual performance objectives, as set out below, are approved by the Committee. The risk objectives are reviewed by the Board Risk Committee.
Achievement of customer performance measures. Build/maintain strong and effective relationships with external stakeholders, including senior leaders in the new UK regulatory framework.
Continue to develop effective external relationships, including investors, rating agencies and regulators.
Ensure each division/function has a people plan. Embed the Group’s purpose, vision and values through high quality leadership teams. Build talent management and performance management. Maintain leadership and employee engagement as measured by the employee survey.
LTIP awards - performance criteria for awards to be granted in 2013 and due to vest in 2016 Awards that will be granted to executive directors in 2013 will be subject to four performance categories, each with equal weighting. These are set out below.
Relative Total Shareholder Return (25%) The relative TSR measure provides a direct connection between executive directors’ awards and relative performance delivered to shareholders. The measure compares the Group's performance against a group of comparator banks from the UK and overseas, weighted towards those companies most similar to the Group. Performance is measured over a three year performance period.
Does not meet 0% Over half of objectives not met Partially meets 25% Half of objectives met Significantly meets 62.5% Two-thirds of objectives met Fully meets 100% Objectives met or exceeded in all material respects Qualified by Group Performance and Remuneration Committee discretion taking into account changes in circumstances over the performance period, the relative importance of the measures, the margin by which individual targets have been missed or exceeded, and any other relevant factors.
Risk underpin and clawback The Committee will also review financial and operational performance against the Strategic Plan and risk performance prior to agreeing vesting of awards. In assessing this, the Committee will be advised independently by the Board Risk Committee. If the Committee considers that the vesting outcome calibrated in line with the performance conditions outlined above does not reflect the Group's underlying financial results or if the Committee considers that the financial results have been achieved with excessive risk, then the terms of the awards allow for an underpin to be used to reduce vesting of an award, or to allow the award to lapse in its entirety. All awards are subject to clawback.
Investors recognised the challenge faced by the Committee in balancing the need to pay competitively to support business goals but at the same time being mindful of the wider economic environment and the need to show restraint. Shareholders were supportive of the work being undertaken by the Committee and the Board, and recognised the progress the Group is making towards recovery.
There was widespread support for the Group Chief Executive and the efforts being made by the Committee to seek to reward him fairly for performance. There was discussion of the accountability review process and in particular the impact of major events such as LIBOR, together with questions around culture, turnover and the extent of people risk as a result of the Group’s pay positioning. The possible use of alternative plan structures was raised by certain shareholders supporting a requirement to hold shares until retirement, although there was not widespread support for this approach. The importance of value sharing between investors and employees remains a key concern for shareholders.
In relation to newly recruited executive directors, subject to the prior approval of the Committee, the notice period may be extended beyond twelve months if there is a clear case for this. Where a longer period of notice is initially approved on appointment, it will normally be structured such that it will automatically reduce to twelve months in due course. All new service contracts for executive directors are subject to approval by the Committee.
Stephen Hester 4 November 2008 12 months 12 months Bruce Van Saun 8 September 2009 12 months 12 months
Re-election Under the Articles of Association of the company, directors must stand for re-election by shareholders at least once every three years. However, in accordance with the provisions of the Code, all directors of the company stand for annual re-election by shareholders at the company’s Annual General Meetings.
Time commitments Letters of engagement make clear to non-executive directors the time commitment they are expected to give to their Board duties. Since 2010, non-executive directors letters of engagement specifically state that their time commitment should be in line with the Walker Review of corporate governance of banks and other financial institutions in respect of their general Board duties. Additional time will be spent as necessary in respect of committee duties, including in particular any committees which they chair.
Fees for non-executive directors The table below sets out the remuneration structure for non-executive directors for the year ended 31 December 2012. The Senior Independent Director and Chairs of the Board committees receive a composite fee and therefore do not receive additional fees for membership of any other committees or the Board.
Chairman’s fee £750,000 Senior Independent Director (composite fee) £150,000 Chairman of Group Audit Committee, Board Risk Committee or Group Performance and Remuneration Committee (composite fee) £150,000 Non-executive Director Group Board fee £72,500 Membership of Group Audit Committee, Board Risk Committee or Group Performance and Remuneration Committee fee £25,000 Membership of Group Sustainability Committee fee £12,500 Membership of Group Nominations Committee fee £5,500
No director received any expense allowances chargeable to UK income tax or compensation for loss of office/termination payment. The non-executive directors did not receive any annual incentive payments or benefits.
(3) Bruce Van Saun resigned as a non-executive director of ConvergEx Holdings LLC during 2012 and received a pro rated fee of US$62,500 for 2012. Mr Van Saun was appointed as a non-executive director of Lloyd’s of London Franchise Board during 2012 for which he received a pro rated fee of £19,450. He is also a non-executive director of Direct Line Insurance Group plc , the fees for which are paid direct to the Group and is a non-executive director of Worldpay (Ship Midco Limited) for which no fees are payable. Mr Van Saun makes contributions towards his pension through a salary sacrifice arrangement to an Unfunded Unapproved Retirement Benefit Scheme, which operates on a defined contribution basis. The total contribution to the defined contribution arrangements amounted to £408,000 in 2012 (£403,000 in 2011). The rate of return on his accrued contributions is determined annually by the Committee to reflect a long-term low risk investment return on an unsecured basis. For 2012 this rate was 6.2% reflecting December 2011 CPI plus 2%.
Non-executive directors Sandy Crombie 150 — 150 150 Alison Davis 73 41 114 43 Tony Di Iorio 73 55 128 43 Penny Hughes 150 — 150 150 Joe MacHale (1) 73 60 133 133 Brendan Nelson 150 — 150 150 Baroness Noakes 73 51 124 43 Art Ryan (2) 73 20 93 95 Philip Scott 150 — 150 150
Stephen Hester Stephen Hester’s performance is measured against a number of strategic and business objectives. In the course of 2012, the Group’s priority has been to deliver a revised Strategic Plan, given the continued challenges in the external environment. Re-balancing the Group towards the retail and commercial business, whilst continuing to strengthen the balance sheet and reduce risks remained key. Targets for capital, short-term wholesale funding, liquidity reserves, leverage and loan:deposit ratio were all met ahead of schedule. Stephen Hester gave strong leadership to the Group’s focus on customers following a technology incident and to ongoing cultural change. Stephen Hester has waived any annual incentive entitlement for the 2012 performance year.
Core ROE was stable at 10%, Retail and Commercial (ex Ulster) remained strong at 14%, and Markets improved to 10%. Operating profit for Core (£6.3 billion) and Group (£3.5 billion) were both ahead of budget. Core cost:income ratio was 59%, with Core Tier 1 ratio at 10.3%. Core bank business lending and home loans increased by £3 billion despite weak customer confidence. More than £58 billion loans and facilities were offered to UK businesses, of which over £30 billion was to SMEs; £16 billion of UK home loans were advanced, including £3 billion to first time buyers. The new Funding for Lending Scheme allowed RBS to cut interest rates on loans to small businesses and the cost of borrowing for first time homebuyers. Branch disposal did not proceed due to unexpected withdrawal of Santander; in contrast, Direct Line Insurance Group plc divestment successfully executed on time and with positive market reception.
All risk reduction quantitative measures were met or exceeded. The liquidity portfolio is ahead of target at £147 billion, while short-term wholesale funding was cut to £42 billion. The Group loan:deposit ratio improved to 100%, with Core loan:deposit ratio ahead of target at 90%. Leverage was on target at 15x. The new conduct risk framework was launched. As part of the response to the LIBOR findings and industrywide challenges on behaviour and ethics, led the development of the Group’s purpose, vision and values to support cultural and behavioural change. Performance against agreed APS objectives secured exit from the Scheme.
Achievement of customer franchise measures, maintain strong and effective relationships with external stakeholders and continue progress on Treating Customers Fairly (TCF) actions.
Customer metrics were impacted by the technology incident in the second half of 2012 - although strong leadership and successful delivery of ‘no customer out of pocket’. Constructive engagement with regulators overall and specifically on LIBOR, conduct risk/cultural change, and the technology incident. Early engagement with the new Financial Conduct Authority. Continued positive feedback from key shareholders. Increased engagement with external stakeholders on how banks should behave in society and cultural change. Continued good progress to address risks identified by UK/US regulators relating to TCF.
People management Ensure each division/function has high quality leadership teams, build out performance management, talent management and succession planning across the Group. Maintain effective employee engagement.
Continued achievement of ‘best in class’ for external reporting within the UK market, with risk disclosures seen as setting the standard; significant improvements with internal reporting processes. Led the ‘safety and soundness’ agenda across the Group, beating targets. Continued strong contribution to de-risking strategy with significant reduction in short term funding reliance; all liquidity requirements met, in compliance with FSA requirements. Actively driving out costs through the creation and embedding of a sizeable cost management programme, as well as making significant progress in the transformation of the Finance function through changes to operating model, ways of working and systems solutions.
More robust capital planning, recognising regulatory changes. Strong stewardship over the financial risk and control environment and good partnership working with risk function. Significant improvements in riskweighted assets reporting and control, and in data quality through leadership of a number of key initiatives across the group. Effective response to the technology incident, giving strong leadership to the function. Internal Audit strategy and plan well received by Group Audit Committee. All APS objectives met.
Key strategic hires for Group Internal Audit and Group Strategy positions working well; upgrades to their teams underway. Following LIBOR and other industry-wide challenges on ethical conduct behaviours, the Group’s purpose, vision and values were given early consideration by the Finance function to bring to life. Improved engagement within the Finance function as measured through the ‘Your Feedback 2012’ survey. Robust programmes for internal talent in place across all levels, as well as strong focus on initiatives in recognition, diversity and training & development.
Executive directors long-term incentive plan (LTIP) awards granted in 2009 and 2010 - assessment of performance outcome Awards to executive directors under the Executive Share Option Plan and Medium-term Performance Plan in 2009 did not vest in 2012 as a result of the relative and absolute TSR measures not being met.
Awards to executive directors under the LTIP granted in 2010 are subject to improvements in economic profit, relative TSR and absolute TSR. These awards are due to be formally assessed by the Committee in May 2013 to determine the final level of vesting.
Maximum: 100% vesting if the Group’s TSR is at the upper quartile of the companies in the comparator group. Pro-rata vesting in between these points.
Based on share price performance over the measurement period ending 31 December 2012, this element of the award will not vest.
Continued difficult economic conditions have been experienced in a number of our key markets, however threshold targets could be met.
Based on share price performance up to 31 December 2012, the threshold targets have not yet been met.
Majority of performance targets hit, particularly those around securing confidence in safety and soundness and being within risk appetite. On track to achieve other objectives by end of 2014.
Despite some difficult reputational issues, progress being made against most customer, community and employee metrics. Core cost: income ratio remains challenging to achieve due to market-driven income pressures.
Membership of the Group Performance and Remuneration Committee All members of the Committee are independent non-executive directors. The Committee held nine meetings in 2012. The Chair and members of the Committee, together with their attendance at meetings, are shown below: Attended / Scheduled
Notes: (1) Stepped down as a member of the Committee on 31 March 2012. (2) Became a member of the Committee on 30 May 2012.
PricewaterhouseCoopers LLP (PwC) were appointed as the Committee’s remuneration advisers on 14 September 2010, and their appointment was reconfirmed by the Committee in June 2012 after an annual review of the quality of the advice received and fees charged. PwC are signatories to the voluntary code of conduct in relation to remuneration consulting in the UK.
PwC also provide professional services in the ordinary course of business including assurance, advisory, tax and legal advice to subsidiaries of the Group. The Committee Chair is notified of other work that is being undertaken by PwC and is satisfied that there are processes in place to ensure that the advice the Committee receives is independent.
Resolution 2 To approve the Remuneration Report for the year ended 31 December 2011.
Shares beneficially owned or at date of appointment, if later (1)
Notes: (1) Share interests held at 1 January 2012 in the table above have been restated to reflect the sub-division and consolidation of ordinary shares which took effect in June 2012. The share interests of Penny Hughes have also been restated to reflect the notification to the company on 16 January 2013 of a transaction by a connected person which took place in March 2011. (2) Value is based on the share price at 31 December 2012, which was 324.5p. During the year ended 31 December 2012, the share price ranged from 196.6p to 325.0p. (3) Tony Di Iorio’s interests in the company’s shares are held in the form of American Depository Receipts (ADRs). Each ADR represents 2 ordinary shares of £1.00 each in the company. Tony Di Iorio has interests in 15,000 ADRs representing 30,000 ordinary shares.
No other current director had an interest in the company's ordinary shares during the year or held a non-beneficial interest in the shares of the company at 31 December 2012, at 1 January 2012 or date of appointment if later. The interests shown above include connected persons of the directors. As at 27 February 2013, there were no changes to the directors' interests in shares shown in the table above.
Directors’ interests under the Group’s share plans The tables and explanatory notes below and on page 340 have been audited by the company's auditors, Deloitte LLP.
Long-Term Incentive Plan (LTIP) No variation was made to any of the terms of the plan during the year. Awards to executive directors under the LTIP are subject to performance conditions and clawback provisions. The figures shown below have been adjusted to reflect the share sub-division and consolidation, which took effect in June 2012.
Deferred awards Awards are structured as conditional rights to receive shares under the RBS 2010 Deferral Plan and are subject to clawback. No variation has been made to any of the terms of the plan during the year. The figures shown below have been adjusted to reflect the share sub-division and consolidation, which took effect in June 2012.
Notes: (1) Stephen Hester previously waived his deferred award entitlement in respect of the 2009 and 2011 performance years and during 2012 he also waived any entitlement that might have been awarded for the 2012 performance year. (2) The awards granted on 7 March 2011 relate to an allocation of shares under the Share Bank arrangements for annual incentives in respect of the 2010 performance year. The awards will vest in two tranches with the final tranche due to vest on 7 March 2013 and any vested shares are subject to a further six month retention post-vesting. Mr Hester has voluntarily agreed to a total retention period of 12 months post-vesting.
Share options The Executive Share Option Plan (ESOP) was approved by shareholders in April 2007. No further awards will be made under the ESOP as it has been replaced by the LTIP. The options below lapsed in 2012 as the performance conditions, based on a combination of relative and absolute TSR measures, were not met. The figures shown below have been adjusted to reflect the share sub-division and consolidation, which took effect in June 2012.
Stephen Hester 955,000 955,000 3.72 — — Bruce Van Saun 90,530 90,530 5.67 — —
No options had their terms and conditions varied during the year ended 31 December 2012. No payment is required on the award of an option. The market price of the company's ordinary shares on 31 December 2012 was 324.5p and the range during the year ended 31 December 2012 was 196.6p to 325.0p.
Restricted Share Award No variation was made to any of the terms of the plan during the year and no awards were granted under the Restricted Share Plan in 2012. The figures shown below have been adjusted to reflect the share sub-division and consolidation, which took effect in June 2012.
Remuneration of executive directors and eight highest paid senior executives* All figures shown below are in GBP. No sign-on or severance awards have been made during 2012 to any of the individuals detailed below.
Fixed remuneration 1,200 750 1,735 775 700 421 311 775 394 650 Variable remuneration (cash) — — 2 2 2 2 2 — 2 — Variable remuneration (shares subject to retention) — — 410 280 158 101 116 — 105 — Deferred variable remuneration (bond) — — 1,023 698 393 252 289 — 173 — Deferred variable remuneration (shares subject to retention) — 980 615 420 237 152 174 — 70 — Total variable remuneration (1) — 980 2,050 1,400 790 507 581 — 350 — Total remuneration 1,200 1,730 3,785 2,175 1,490 928 892 775 744 650
LIBOR On 6 February 2013, RBS made an announcement regarding the investigations conducted in relation to attempts to manipulate LIBOR and the settlements reached with the FSA and US authorities. The investigations uncovered wrongdoing on the part of 21 employees, predominantly in relation to the setting of the bank’s Yen and Swiss Franc LIBOR submissions in the period October 2006 to November 2010.
The actions we have taken reinforce the messages we are sending on how seriously the Board takes integrity and risk and control issues. The impact of such issues on our shareholders and wider stakeholders extends beyond those directly involved in LIBOR, so it is appropriate that remuneration actions have a Group-wide impact.
FSA Remuneration Disclosure These disclosures are in accordance with the FSA’s Handbook for banks, building societies and investment firms (BIPRU) 11.5.18 (6) and (7).
1. Aggregate remuneration expenditure During the year, there were 368 Code Staff. Aggregate remuneration expenditure was as follows: Markets £m
Variable remuneration for 2012 performance Consisted of deferred awards payable over a three year period. Cash awards were limited to a maximum of £2,000 per employee.
Variable remuneration (cash) 0.3 0.3 Variable remuneration (shares subject to retention) 11.3 17.4 Deferred remuneration (bonds) 23.6 38.4 Deferred remuneration (shares) 11.3 19.8 0% of total variable remuneration was subject to a guaranteed commitment made on recruitment to secure the employment of key individuals.
Unvested from prior year 121.0 213.6 Awarded during the financial year 53.6 77.9 Paid out 41.0 111.8 Reduced from prior years 19.1 45.6 Unvested at year end 114.5 134.1 4. Sign-on and severance payments No sign-on or severance payments were made to Code Staff during the year.
The company has also implemented the recommendations arising from the Walker Review. The company has also complied in all material respects with the Financial Reporting Council Guidance on Audit Committees issued in September 2012.
The Board has established a process for the identification, evaluation and management of the significant risks faced by the Group, which operated throughout the year ended 31 December 2012 and to 27 February 2013, the date the directors approved the Report and Accounts. This is confirmed by a semi-annual Control Environment Certification process which requires senior members of the executive and management to assess the adequacy and effectiveness of their internal control framework and the compliance of their business with Group policies and associated standards (in accordance with the Group Policy Framework), and they meet the requirements of Sarbanes-Oxley Section 404 and the Code Section C2. The policies that govern these processes, and reports on internal controls arising from them, are regularly reviewed by the Board and meet the requirements of the guidance ‘Internal Control: Revised Guidance for Directors on the Combined Code’ issued by the Financial Reporting Council in October 2005. Enhancements have been made to the Risk Management framework throughout 2012, including the introduction of specific Conduct Risk standards, and further improvements will be made in 2013.
The effectiveness of the Group’s internal controls are reviewed regularly by the Board, the Group Audit Committee and the Board Risk Committee. Executive management committees or boards of directors in each of the Group’s businesses also receive regular reports on significant risks facing their business and how they are being controlled. In addition, the Board receives monthly risk management reports. Details of the Group’s approach to risk management are given in the Risk and balance sheet management section, on pages 107 to 293 of the Business review. The Group Audit Committee has received confirmation that management has taken, or is taking, the necessary action to remedy any material failings or weaknesses identified through the operation of the Group framework of controls.
The Group’s independent auditors present to the Group Audit Committee reports that include details of any significant internal control matters which they have identified. The system of internal controls of the authorised institutions and other regulated entities in the Group is also subject to regulatory oversight in the UK and overseas. Additional details of the Group’s regulatory oversight are given in the Supervision section on page 500.
Internal control over financial reporting The Group is required to comply with Section 404 of the US Sarbanes-Oxley Act of 2002 and assess the effectiveness of internal control over financial reporting as of 31 December 2012.
The Group assessed the effectiveness of its internal control over financial reporting as of 31 December 2012 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in ‘Internal Control - Integrated Framework'.
Disclosure controls and procedures As required by US regulations, management have conducted an evaluation of the effectiveness and design of the Group’s disclosure controls and procedures (as defined in the Exchange Act rules) as at 31 December 2012. Based on this evaluation, management concluded that the Group’s disclosure controls and procedures were effective as of the end of the period covered by this annual report.
The New York Stock Exchange As a foreign issuer with American Depository Shares representing ordinary shares, preference shares and debt securities listed on the New York Stock Exchange (the “NYSE”), the company must disclose any significant ways in which its corporate governance practices differ from those followed by US companies under the NYSE corporate governance listing standards. In addition, the company must comply fully with the provisions of the listing standards that relate to the composition, responsibilities and operation of Audit Committees. These provisions incorporate the relevant rules concerning audit committees of the Exchange Act.
The company has reviewed its corporate governance arrangements and is satisfied that these are consistent with the NYSE’s corporate governance listing practices, with the exception that the Chairman of the Board is also the Chairman of the Group Nominations Committee, which is permitted under the Code (since the Chairman was considered independent on appointment). The company’s Group Audit, Board Risk, Group Performance and Remuneration, Group Sustainability and Group Nominations Committees are otherwise composed solely of non-executive directors deemed by the Group Board to be independent. The NYSE corporate governance listing standards also require that a compensation committee has direct responsibility to review and approve the Group Chief Executive’s remuneration.
The directors present their report together with the audited accounts for the year ended 31 December 2012.
The company did not pay a dividend on ordinary shares in 2011 or 2012.
Discretionary dividends on certain non-cumulative preference shares and discretionary distributions on certain RBSG innovative securities payable after 4 May 2012 have been paid. Future coupons and dividends on RBSG hybrid capital instruments will only be paid subject to, and in accordance with, the terms of the relevant instruments.
Risk factors The Group’s future performance and results could be materially different from expected results depending on the outcome of certain potential risks and uncertainties. Certain risk factors the Group faces are summarised on page 43. Fuller details of these and other risk factors are set out on pages 503 to 515.
The reported results of the Group are also sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. Details of the Group’s critical accounting policies and key sources of accounting judgments are included in Accounting policies on pages 360 to 372.
Financial performance A review of the Group's performance during the year ended 31 December 2012, including details of each division, and the Group's financial position as at that date is contained in the Business review on pages 44 to 101.
In 2010, the Group reached agreement with Santander UK plc (‘Santander’) on the sale of certain UK branch-based businesses broadly comprising the RBS branch-based business in England and Wales, and the NatWest branch-based business in Scotland, along with certain SME and corporate activities across the UK. However, in October 2012, the Group announced Santander’s decision to pull out of the agreement. RBS is continuing to work to fulfil its obligations to divest these businesses.
Also in October 2012, the Group sold 34.7% of its interest in Direct Line Insurance Group plc through an initial public offering. This is the first step in meeting the requirement to cede control by the end of 2013 and complete full divestment by the end of 2014.
Employees As at 31 December 2012, the Group employed 137,200 employees (fulltime equivalent basis) throughout the world. Details of employee related costs are included in Note 3 on the consolidated accounts.
The Group operates certain employee share plans in which eligible employees are able to participate and which align the interests of employees with those of shareholders.
Employee learning and development The Group maintains a strong commitment to providing all its employees with the opportunity to grow through learning and development, which in turn helps to achieve business objectives and drive excellent customer service. Supporting the professionalisation of our front line staff, this year more than 6,000 of our customer facing employees participated in accredited development programmes. This helps our employees deliver the best service to our customers whilst working towards a recognised professional standard.
The Group Chief Executive and other senior Group executives regularly communicate with, and encourage feedback from, employees across a range of channels.
Employee consultation The Group recognises employee representative organisations such as trade unions and work councils in a number of businesses and countries.
The Group has a European Employee Council that provides elected representatives with an opportunity to understand better the Group’s European operations.
Inclusion is built into various policy areas and people management processes. For example; the Group continues to support disabled people ensuring they have equal opportunities in recruitment, employment, promotion and training.
This commitment to inclusion extends to supporting and participating in positive action programmes outside of the Group aimed at cultivating future leaders including ‘An Inspirational Journey’, the FTSE-100 crosscompany mentoring and Glass Ladder programmes. The Group continues to maintain its involvement with external charitable networks and events such as Manchester Pride.
Performance is monitored and reviewed at Group and divisional level and RBS remains supportive of the recommendations of Lord Davies’ Report. There are currently three female directors on the Board out of a total of 12, which meets Lord Davies’ aspirational target of 25 per cent female Board representation. As at 31 December 2012, 19 per cent of executives in the Group and 55 per cent of employees were female.
Further details on the Board diversity policy can be found at www.rbs.com
Code of conduct The code of conduct applies to everyone who works for RBS. It promotes honest and ethical conduct, including the handling of actual or apparent conflicts of interest between personal and professional relationships. The Group recognises that personal conduct, business integrity and the Group’s security are crucial, and the code of conduct serves to inform those who work for the Group of its expectations of their behaviour and practices.
The code of conduct is available on the Group’s website www.rbs.com and will also be provided to any person without charge, upon request, by contacting RBS Secretariat at the telephone number listed on page 539.
Sustainability The long term success of the Group relies on being safe, strong and sustainable. This underpins everything that RBS does and enables the Group to play a central role within society that enables people to run their daily lives and businesses. This, in turn, supports economic growth and brings wider benefits to society. There are further opportunities for the Group to build on this and explore ways in which we can create additional value for all stakeholder groups. For more information on the Group Sustainability programme, see pages 33 to 35.
Going concern The Group’s business activities and financial position, the factors likely to affect its future development and performance and its objectives and policies in managing the financial risks to which it is exposed and its capital are discussed in the Business review. The risk factors which could materially affect the Group’s future results are set out on pages 503 to 515. The Group’s regulatory capital resources and significant developments in 2012 and anticipated future developments are detailed on pages 128 to 136. The liquidity and funding section on pages 137 to 156, describes the Group’s funding and liquidity profile, including changes in key metrics, the build up of liquidity reserves and the outlook for 2013.
BBA disclosure code In September 2010, the British Bankers’ Association published its Code for Financial Reporting Disclosure. The code sets out five disclosure principles together with supporting guidance. The principles are that the Group and other major UK banks will provide high quality, meaningful and decision-useful disclosures; review and enhance their financial instrument disclosures for key areas of interest to market participants; assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of such guidance; seek to enhance the comparability of financial statement disclosures across the UK banking sector; and clearly differentiate in their annual reports between information that is audited and information that is unaudited. The Group’s 2012 financial statements have been prepared in compliance with the code’s principles.
Share capital Details of the ordinary and preference share capital at 31 December 2012 and movements during the year are shown in Note 26 on the consolidated accounts.
On 10 September 2012, the Company announced the allotment and issue of 52,661,227 new ordinary shares of £1 each with an aggregate nominal value of £52,661,227 for the purpose of ensuring 2012 coupon payments on discretionary hybrid capital securities were neutralised from a Core Tier 1 capital perspective. The shares were allotted to UBS AG at a subscription price of 227.87 pence per share determined by reference to the average market price during the period in which the shares were sold in the market following the Company’s interim results on 3 August 2012. The gross proceeds of the issue were £120 million. The share price at close of business on 10 September 2012 was 253 pence per share.
The rights and obligations attaching to the company’s ordinary shares and preference shares are set out in the company’s Articles of Association, copies of which can be obtained from Companies House in the UK or can be found on the Group’s website www.rbs.com
There are no restrictions on the transfer of ordinary shares in the company other than certain restrictions which may from time to time be imposed by laws and regulations (for example, insider trading laws). Pursuant to the Listing Rules of the FSA, certain employees of the company require the approval of the company to deal in the company’s shares.
John McFarlane stepped down from the Board on 31 March 2012.
Political donations At the Annual General Meeting in 2012, shareholders gave authority under Part 14 of the Companies Act, for a period of one year, for the company (and its subsidiaries) to make political donations and incur political expenditure up to a maximum aggregate sum of £100,000. This authorisation was taken as a precaution only, as the company has a longstanding policy of not making political donations or incurring political expenditure within the ordinary meaning of those words. During 2012, the Group made no political donations, nor incurred any political expenditure in the UK or EU and it is not proposed that the Group’s longstanding policy of not making contributions to any political party be changed. Shareholders will be asked to renew this authorisation at the Annual General Meeting in 2013.
At 31 December 2012, the Group’s trade creditors represented 25 days (2011 - 27 days) of amounts invoiced by suppliers.
Notes on the consolidated accounts 373 1 Net interest income 373 2 Non-interest income 374 3 Operating expenses 375 5 Auditor’s remuneration 385 7 Profit attributable to preference shareholders and paid-in equity holders 387 8 Ordinary dividends 387 9 Earnings per ordinary and B share 387 10 Financial instruments – classification 388 11 Financial instruments – valuation 393 12 Financial instruments – maturity analysis 412 13 Financial assets – impairments 415 15 Debt securities 419 16 Equity shares 420 17 Intangible assets 421 18 Property, plant and equipment 424 19 Prepayments, accrued income and other assets 426 20 Discontinued operations and assets and liabilities of disposal groups 427 21 Short positions 429 22 Accruals, deferred income and other liabilities 430 23 Deferred tax 432 24 Subordinated liabilities 434 25 Non-controlling interests 440 26 Share capital 441 27 Other equity 444 29 Securitisations, asset transfers and other collateral given 447 30 Special purpose entities 449 31 Capital resources 451 32 Memorandum items 453 33 Net cash (outflow)/inflow from operating activities 462 34 Analysis of the net investment in business interests and intangible assets 462 35 Interest received and paid 463 36 Analysis of changes in financing during the year 463 37 Analysis of cash and cash equivalents 463 38 Segmental analysis 464 39 Directors’ and key management remuneration 472 40 Transactions with directors and key management 472 41 Related parties 473 42 Post balance sheet events 474
Respective responsibilities of directors and auditor As explained more fully in the Statement of directors' responsibilities, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view.
Group's and of the company’s affairs as at 31 December 2012 and of the Group’s loss for the year then ended; the Group financial statements have been properly prepared in accordance with IFRS as adopted by the European Union; the company financial statements have been properly prepared in accordance with IFRS as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
Neither an audit nor a review provides assurance on the maintenance and integrity of the website, including controls used to achieve this, and in particular on whether any changes may have occurred to the financial information since first published. These matters are the responsibility of the directors but no control procedures can provide absolute assurance in this area. Legislation in the United Kingdom governing the preparation and dissemination of financial statements differs from legislation in other jurisdictions.
(Loss)/profit from discontinued operations, net of tax (172) 348 (809) Loss for the year (5,806) (1,969) (1,666)
Consolidated statement of comprehensive income for the year ended 31 December 2012 £m
Loss for the year (5,806) (1,969) (1,666) Other comprehensive income/(loss) Available-for-sale financial assets 645 2,258 (389) Cash flow hedges 1,006 1,424 1,454 Currency translation (900) (440) 81 Actuarial (losses)/gains on defined benefit plans 4 (2,270) (581) 158 Other comprehensive (loss)/income before tax (1,519) 2,661 1,304 Tax credit/(charge) 228 (1,472) (309) Other comprehensive (loss)/income after tax (1,291) 1,189 995 Total comprehensive loss for the year (7,097) (780) (671)
Total comprehensive loss is attributable to: Non-controlling interests (116) (24) (197) Preference shareholders 273 — 105 Paid-in equity holders 15 — 19 Ordinary and B shareholders (7,269) (756) (598)
Assets Cash and balances at central banks 10 79,290 79,269 57,014 Loans and advances to banks 10 63,951 83,310 100,518 Loans and advances to customers 10 500,135 515,606 555,260 Debt securities subject to repurchase agreements 29 91,173 79,480 80,104 Other debt securities 66,265 129,600 137,376 Debt securities 15 157,438 209,080 217,480 Equity shares 16 15,232 15,183 22,198 Settlement balances 5,741 7,771 11,605 Derivatives 14 441,903 529,618 427,077 Intangible assets 17 13,545 14,858 14,448 Property, plant and equipment 18 9,784 11,868 16,543 Deferred tax 23 3,443 3,878 6,373 Prepayments, accrued income and other assets 19 7,820 10,976 12,576 Assets of disposal groups 20 14,013 25,450 12,484 Total assets 1,312,295 1,506,867 1,453,576
Consolidated statement of changes in equity for the year ended 31 December 2012 £m £m £m
Available-for-sale reserve At 1 January (957) (2,037) (1,755) Unrealised gains 1,939 1,769 179 Realised (gains)/losses (1) (1,319) 486 (519) Tax 50 (1,175) 74 Transfer to retained earnings (59) — — Recycled to profit or loss on disposal of businesses (2) — — (16)
Foreign exchange reserve At 1 January 4,775 5,138 4,528 Retranslation of net assets (1,056) (382) 997 Foreign currency gains/(losses) on hedges of net assets 177 (10) (458) Tax 17 23 63 Transfer to retained earnings (2) — — Recycled to profit or loss on disposal of businesses (3) 6 8 At 31 December 3,908 4,775 5,138
Equity preference dividends paid (273) — (105) Paid-in equity dividends paid, net of tax (15) — (19) Transfer from available-for-sale reserve 59 — — Transfer from foreign exchange reserve 2 — — Transfer from merger reserve — 50 12,250 Transfer from paid-in equity - gross — — 2 - tax — — (1) Equity owners gain on withdrawal of non-controlling interest - gross — — 40 - tax — — (11) Redemption of equity preference shares — — (2,968) Gain on redemption of equity preference shares — — 609 Redemption of preference shares classified as debt — — (118) Actuarial (losses)/gains recognised in retirement benefit schemes - gross (2,270) (581) 158 - tax 380 86 (71) Loss on disposal of own shares held (196) — — Purchase of non-controlling interest — — (38) Shares issued under employee share schemes (87) (58) (13) Share-based payments - gross 117 200 385 - tax (6) (10) 6 At 31 December 10,596 18,929 21,239
Movements in available-for-sale securities - unrealised gains/(losses) 3 1 (56) - realised losses 22 2 37 - tax — (1) 5 - recycled to profit or loss on disposal of discontinued operations (4) — — (7) Movements in cash flow hedging reserve - amount recognised in equity — — (120) - tax — — 39 - recycled to profit or loss on disposal of discontinued operations (5) — — 1,036 Equity raised 875 — 559 Equity withdrawn and disposals (23) (421) (11,298) Transfer from retained earnings 361 — (40)
Notes: (1) The year ended 31 December 2011 includes an impairment loss of £1,099 million in respect of the Group’s holding of Greek government bonds, together with £169 million of related interest rate hedge adjustments. (2) Net of tax (year ended 31 December 2010 - £5 million credit). (3) Net of tax (year ended 31 December 2010 - £19 million charge). (4) Net of tax (year ended 31 December 2010 - £2 million credit). (5) Net of tax (year ended 31 December 2010 - £340 million charge).
Investing activities Sale and maturity of securities 49,079 80,093 47,604 Purchase of securities (22,987) (77,019) (43,485) Sale of property, plant and equipment 2,215 1,840 2,011 Purchase of property, plant and equipment (1,484) (3,472) (2,113) Net investment in business interests and intangible assets 34 352 (1,428) 3,446 Transfer out of discontinued operations — — (4,112) Net cash flows from investing activities 27,175 14 3,351
Financing activities Issue of ordinary shares 120 2 1 Issue of subordinated liabilities 2,093 — — Proceeds of non-controlling interests issued 889 — 559 Redemption of paid-in equity — — (132) Redemption of preference shares — — (2,359) Redemption of non-controlling interests (23) (382) (5,282) Disposal/(purchase) of own shares 243 20 (700) Repayment of subordinated liabilities (258) (627) (1,588)
Consolidated cash flow statement for the year ended 31 December 2012
The company is incorporated in the UK and registered in Scotland and its accounts are presented in accordance with the Companies Act 2006.
There are two amendments to IFRS that were effective for the Group from 1 January 2012. They have not had a material effect on the financial statements of the Group or the company: ‘Deferred Tax: Recovery of Underlying Assets (Amendments to IAS 12 ‘Income Taxes’)’ clarifies that recognition of deferred tax should have regard to the expected manner of recovery or settlement of the asset or liability.
‘Disclosures - Transfers of Financial Assets (Amendments to IFRS 7 ‘Financial Instruments: Disclosures’)’ replaces IFRS 7’s existing derecognition disclosure requirements with disclosures about (a) transferred assets that have not been derecognised in their entirety and (b) transferred assets that have been derecognised in their entirety but where the reporting entity has continuing involvement in those assets.
Financial assets and financial liabilities held for trading or designated as at fair value through profit or loss are recorded at fair value. Changes in their fair value are recognised in profit or loss.
4. Assets held for sale and discontinued operations A non-current asset (or disposal group) is classified as held for sale if the Group will recover its carrying amount principally through a sale transaction rather than through continuing use. A non-current asset (or disposal group) classified as held for sale is measured at the lower of its carrying amount and fair value less costs to sell. If the asset (or disposal group) is acquired as part of a business combination it is initially measured at fair value less costs to sell. Assets and liabilities of disposal groups classified as held for sale and non-current assets classified as held for sale are shown separately on the face of the balance sheet. The results of discontinued operations - comprising the post-tax profit or loss of discontinued operations and the post-tax gain or loss recognised either on measurement to fair value less costs to sell or on disposal of the discontinued operation - are shown as a single amount on the face of the income statement; an analysis of this amount is presented in Note 20 on the accounts. A discontinued operation is a cash generating unit or a group of cash generating units that either has been disposed of, or is classified as held for sale, and (a) represents a separate major line of business or geographical area of operations, (b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale.
Accounting policies continued 7. Property, plant and equipment Items of property, plant and equipment (except investment property - see Accounting policy 9) are stated at cost less accumulated depreciation and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately.
If an asset does not generate cash flows that are independent from those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. For the purposes of impairment testing, goodwill acquired in a business combination is allocated to each of the Group’s cash-generating units or groups of cash-generating units expected to benefit from the combination. The recoverable amount of an asset or cash-generating unit is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cashgenerating unit that have not been taken into account in estimating future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets
Finance lease receivables are included in the balance sheet, within Loans and advances to banks and Loans and advances to customers, at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment and included in Interest receivable. Unguaranteed residual values are subject to regular review; if there is a reduction in their value, income allocation is revised and any reduction in respect of amounts accrued is recognised immediately.
Rental income from operating leases is recognised in income on a straight-line basis over the lease term unless another systematic basis better represents the time pattern of the asset’s use. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see Accounting policy 7). Operating lease rentals receivable are included in Other operating income.
Fair value - fair value for a net open position in a financial asset that is quoted in an active market is the current bid price times the number of units of the instrument held. Fair values for financial assets not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial assets (see Note 11 Financial instruments - valuation).
Except for US retail portfolios, where write off of the irrecoverable amount takes place within 60 - 180 days, the typical time frames from initial impairment to write off for the Group’s collectively-assessed portfolios are: Retail mortgages: write off occurs within 5 years, and is accelerated where accounts are closed earlier.
Credit cards: write off of the irrecoverable amount takes place at 12 months; the rest is expected to be recovered over a further 3 years following which any remaining amounts outstanding are written off.
Business and commercial loans: write offs of commercial loans are determined in the light of individual circumstances; the period does not exceed 5 years. Business loans are generally written off within 5 years.
20. Derecognition A financial asset is derecognised when the contractual right to receive cash flows from the asset has expired or when it has been transferred and the transfer qualifies for derecognition. A transfer requires that the Group either (a) transfers the contractual rights to receive the asset's cash flows; or (b) retains the right to the asset's cash flows but assumes a contractual obligation to pay those cash flows to a third party. After a transfer, the Group assesses the extent to which it has retained the risks and rewards of ownership of the transferred asset. The asset remains on the balance sheet if substantially all the risks and rewards have been retained. It is derecognised if substantially all the risks and rewards have been transferred. If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement; if the Group has not retained control of the asset, it is derecognised.
A financial liability is removed from the balance sheet when the obligation is discharged, or cancelled, or expires. On the redemption or settlement of debt securities (including subordinated liabilities) issued by the Group, the Group derecognises the debt instrument and records a gain or loss being the difference between the debt's carrying amount and the cost of redemption or settlement. The same treatment applies where the debt is exchanged for a new debt issue that has terms substantially different from those of the existing debt. The assessment of whether the terms of the new debt instrument are substantially different takes into account qualitative and quantitative characteristics including a comparison of the present value of the cash flows under the new terms with the present value of the remaining cash flows of the original debt issue discounted at the effective interest rate of the original debt issue.
22. Netting Financial assets and financial liabilities are offset and the net amount presented in the balance sheet when, and only when, the Group currently has a legally enforceable right to set off the recognised amounts and it intends either to settle on a net basis or to realise the asset and settle the liability simultaneously. The Group is party to a number of arrangements, including master netting agreements, that give it the right to offset financial assets and financial liabilities but where it does not intend to settle the amounts net or simultaneously and therefore the assets and liabilities concerned are presented gross.
Incremental costs that are directly attributable to an equity transaction are deducted from equity net of any related tax.
The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a highly probable forecast transaction (cash flow hedges); and hedges of the net investment in a foreign operation.
Hedge of net investment in a foreign operation - in the hedge of a net investment in a foreign operation, the portion of foreign exchange differences arising on the hedging instrument determined to be an effective hedge is recognised in other comprehensive income. Any ineffective portion is recognised in profit or loss. Non-derivative financial liabilities as well as derivatives may be the hedging instrument in a net investment hedge. On disposal or partial disposal of a foreign operation, the amount accumulated in equity is reclassified from equity to profit or loss.
26. Cash and cash equivalents In the cash flow statement, cash and cash equivalents comprises cash and demand deposits with banks together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.
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 credit 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).
Goodwill is the excess of the cost of an acquired business over the fair value of its net assets. The determination of the fair value of assets and liabilities of businesses acquired requires the exercise of management judgement; for example those financial assets and liabilities for which there are no quoted prices, and those non-financial assets where valuations reflect estimates of market conditions, such as property. Different fair values would result in changes to the goodwill arising and to the post-acquisition performance of the acquisition. Goodwill is not amortised but is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.
Impairment testing inherently involves a number of judgmental areas: the preparation of cash flow forecasts for periods that are beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the business; estimation of the fair value of cashgenerating units; and the valuation of the separable assets of each business whose goodwill is being reviewed. Sensitivity to changes in assumptions is discussed in Note 17 on pages 423 and 424.
Provisions for litigation - the Group and members of the Group are party to legal proceedings in the United Kingdom, the United States and other jurisdictions, arising out of their normal business operations. The measurement and recognition of liabilities in respect of litigation involves a high degree of management judgement. Before the existence of a present obligation as the result of a past event can be confirmed, numerous facts may need to be established, involving extensive and time-consuming discovery, and novel or unsettled legal questions addressed. Once it is determined there is an obligation, assessing the probability of economic outflows and estimating the amount of any liability can be very difficult. In many proceedings, it is not possible to determine whether any loss is probable or to estimate the amount of any loss. Furthermore, for an individual matter, there can be a wide range of possible outcomes and often it is not practicable to quantify a range of such outcomes. The Group’s outstanding litigation is periodically assessed in consultation with external professional advisers, where appropriate, to determine the likelihood of the Group incurring a liability. A detailed description of the Group’s material legal proceedings and a discussion of the nature of the associated uncertainties are given in Note 32.
At 31 December 2012, loans and advances to customers classified as loans and receivables totalled £397,846 million (2011 - £427,805 million; 2010 - £482,710 million) and customer loan impairment provisions amounted to £21,136 million (2011 - £19,760 million; 2010 - £18,055 million).
Deposits by banks and customer accounts (held-for-trading and designated as at fair value though profit or loss) - deposits measured at fair value principally include repurchase agreements (repos) and cash collateral.
Effective for 2013 The following IFRSs and amendments to IFRS have an effective date of 1 January 2013: IFRS 10 ‘Consolidated Financial Statements’ replaces SIC-12 ‘Consolidation - Special Purpose Entities’ and the consolidation elements of the existing IAS 27 ‘Consolidated and Separate Financial Statements’. IFRS 10 adopts a single definition of control: a reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity so as to vary returns for the reporting entity. IFRS 10 requires retrospective application. The Group continues to assess aspects of IFRS 10. However implementation is not expected to have a material effect on the Group’s financial statements.
IFRS 13 ‘Fair Value Measurement’ sets out a single IFRS framework for defining and measuring fair value and requiring disclosures about fair value measurements. Implementation of IFRS 13 will not have a material effect on the Group’s financial statements.
IAS 19 ‘Employee Benefits’ (revised) requires: the immediate recognition of all actuarial gains and losses eliminating the ‘corridor approach’; interest cost to be calculated on the net pension liability or asset at the long-term bond rate, an expected rate of return will no longer be applied to assets; and all past service costs to be recognised immediately when a scheme is curtailed or amended. If the Group had adopted IAS 19 revised as at 31 December 2012, profit after tax for the period ended 31 December 2012 would have been lower by £84 million (2011 - £154 million; 2010 - £105 million) and other comprehensive income after tax higher by the same amounts.
In December 2011, the IASB issued ’Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32)’. The amendments add application guidance to IAS 32 to address inconsistencies identified in applying some of the standard’s criteria for offsetting financial assets and financial liabilities. The amendments are effective for annual periods beginning on or after 1 January 2014 and must be applied retrospectively.
The Group is reviewing these amendments to determine their effect on the Group’s financial reporting.
In December 2011, 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. Additional transition disclosures must be given if implementation takes place after 2012.
Customer accounts: demand deposits 853 1,149 1,231 Customer accounts: savings deposits 1,612 1,307 1,148 Customer accounts: other time deposits 1,026 1,075 1,345 Deposits by banks 600 982 1,333 Debt securities in issue 2,023 3,371 3,277 Subordinated liabilities 815 740 417 Internal funding of trading businesses 199 109 (181)
Property, plant and equipment (see Note 18) 1,097 1,254 1,415 Intangible assets (see Note 17) 705 585 710 Depreciation and amortisation 1,802 1,839 2,125
Bank levy The Finance Act 2011 introduced an annual bank levy in the UK. The levy is collected through the existing quarterly Corporation Tax collection mechanism.
The levy was charged at a rate of 0.088 per cent for 2012. Three different rates applied during 2011, these average to 0.075 per cent. The cost of the levy to the Group for 2012 is £175 million (2011 - £300 million) (included in Other administrative expenses). As the Group continues to target a reduction in wholesale funding, the cost should decline over time absent further rate increase. The levy for 2013 is currently 0.13 per cent.
Restructuring costs included in operating expenses comprise: 2012 2011 2010 £m £m £m
Staff costs 700 342 341 Premises and equipment 141 155 117 Other administrative expenses 261 268 96 Depreciation and amortisation 142 — — Continuing operations 1,244 765 554 Discontinued operations 50 23 20 1,294 788 574
Divestment costs included in operating expenses comprise: 2012 2011 2010 £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 123,500 (2011 - 129,200; 2010 - 138,600); on the same basis there were 15,000 people employed in discontinued operations (2011 - 15,100; 2010 - 27,200). The average number of temporary employees during 2012 was 10,900 (2011 - 11,400; 2010 - 10,800). The number of persons employed in the continuing operations of the Group at 31 December, excluding temporary staff, were as follows: UK Retail 27,600 29,500 30,500 UK Corporate 13,000 13,400 13,100 Wealth 5,200 5,500 5,300 International Banking 4,000 4,900 4,900 Ulster Bank 4,400 4,400 4,400 US Retail & Commercial 15,400 16,200 16,600 Retail & Commercial 69,600 73,900 74,800 Markets 9,800 12,300 12,800 Central items 5,900 5,300 4,300 Non-Core 2,900 4,100 6,400 Business Services 30,500 31,300 31,900 Integration and restructuring 500 600 300 Total 119,200 127,500 130,500
UK 71,200 76,600 79,000 USA 22,300 23,100 23,900 Europe 9,200 9,800 9,800 Rest of the World 16,500 18,000 17,800 Total 119,200 127,500 130,500
The number of shares and exercise prices for all previous share awards have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares in June 2012.
Note: (1) Adjusted for the sub-division and one-for-ten consolidation of ordinary shares in June 2012.
Options are exercisable within six months of vesting; 0.2 million were exercisable at 31 December 2012 (2011 - 0.3 million; 2010 - 2.3 million). The weighted average share price at the date of exercise of options was £2.78 (2011 - £4.21; 2010 - £4.51). At 31 December 2012, exercise prices ranged from £2.33 to £39.27 and the average contractual life was 3.9 years (2011 - £2.33 to £39.27 and 3.7 years; 2010 - £3.80 to £39.27 and 3.3 years). The fair value of options granted in 2012 was £28 million (2011 - £43 million; 2010 - £48 million).
At 1 January 345 58 37 219 25 38 122 1 41 Granted 157 59 — 154 37 1 115 24 — Exercised (15) (4) (1) (6) (1) — — — — Lapsed (112) (15) (16) (22) (3) (2) (18) — (3)
At 31 December 2012, a provision of £1 million had been made in respect of 0.1 million share awards and 0.3 million options over shares that may be cash-settled (2011 - £3 million in respect of 0.4 million share awards and 1.4 million options over shares; 2010 - £6 million in respect of 0.3 million share awards and 1.6 million options over shares).
The fair value of options granted in 2012 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 awards The following tables analyse the Group and Markets variable compensation awards for 2012 (1).
Total variable compensation pre clawback (3) 679 789 (14) 287 360 (20) Clawback of prior year deferred awards (4) (72) — — (72) — — Total variable compensation (3) 607 789 (23) 215 360 (40)
Increase in operating profit (5) in 2012 90% 68% Variable compensation (pre clawback) as a % of operating profit (5) 20% 43% 19% 40% Variable compensation (pre clawback) as a % of operating profit before variable compensation (6) 16% 28% 16% 25% Variable compensation (post clawback) as a % of operating profit before variable compensation (6) 15% 28% 12% 25% Proportion of variable compensation pre clawback that is deferred 85% 87% 91% 92%
Variable compensation awarded 679 789 Less: deferral of charge for amounts awarded for current year (262) (298) Add: current year charge for amounts deferred from prior years 299 484 Income statement charge for variable compensation (3) 716 975
Year in which income statement charge is expected to be taken for deferred variable compensation £m 2014 and beyond £m
Variable compensation deferred from 2009 and earlier 155 75 — — Variable compensation deferred from 2010 329 93 78 4 Variable compensation deferred from 2011 — 190 49 21 Clawback of variable compensation — (59) (10) (3)
3 Operating expenses continued Variable compensation awards continued LIBOR On 6 February 2013, the Group made an announcement in relation to the investigations conducted in relation to attempts to manipulate LIBOR and the settlements reached with the FSA and US authorities. The investigations uncovered wrongdoing on the part of 21 employees, predominantly in relation to the setting of the bank’s Yen and Swiss Franc LIBOR submissions in the period October 2006 to November 2010.
The Board has acknowledged that there were serious shortcomings in our risk and control systems and also in the integrity of a small group of our employees, and has taken action to ensure full and proper accountability: All 21 wrongdoers referred to in the regulatory findings have left the organisation or been subject to disciplinary action.
Reduction of variable compensation awards and long-term incentive awards and prior year clawback has been made across RBS and particularly in the Markets division to account for the reputational damage of these events and the risk of additional outstanding legal and regulatory action.
The actions we have taken reinforce the messages we are sending on the how seriously the Board takes integrity and risk and control issues. The impact of such issues on our shareholders and wider stakeholders extends beyond those directly involved in LIBOR, so it is appropriate that remuneration actions have a Group-wide impact.
Variable compensation award reduction 110 Long term incentive award reduction 30 Clawback of prior year awards (including LTIP) 112 Committed future reduction 2013/2014 50 Total 302 4 Pensions The Group sponsors a number of pension schemes in the UK and overseas, predominantly defined benefit schemes, whose assets are independent of the Group’s finances. The principal defined benefit scheme is The Royal Bank of Scotland Group Pension Fund (the “Main scheme”) which accounts for 85% (2011 - 85%; 2010 - 84%) of the Group’s retirement benefit obligations.
Discount rate 4.5 5.0 5.5 4.4 5.2 5.4 Expected return on plan assets 5.3 5.7 6.7 5.3 5.6 6.3 Rate of increase in salaries 1.8 1.8 1.8 1.7 2.0 2.0 Rate of increase in pensions in payment 2.8 3.0 3.3 2.6 2.9 3.0 Inflation assumption 2.9 3.0 3.3 2.8 3.0 3.2
The sterling yield curve (applied to 91% of the Group’s defined benefit obligations) is constructed by reference to yields on ‘AA’ corporate bonds from which a single discount rate is derived based on a cash flow profile similar in structure and duration to the pension obligations. Significant judgement is required when setting the criteria for bonds to be included in the population from which the yield curve is derived. The criteria include issuance size, quality of pricing and the exclusion of outliers. Judgement is also required in determining the shape of the yield curve at long durations: a constant credit spread relative to gilts is assumed. In previous years, the discount rate was determined by reference to the upper quartile yield on the iBoxx over 15 year sterling corporate bond index, less a margin determined by reference to the shape of the yield curve and the spread of yields among the index’s constituents.
Discount rates for other currencies are derived using a variety of methodologies. In the case of US dollar defined pension obligations, a matching portfolio of high-quality ‘AA’ corporate bonds is used for the first 30 years’ cash flows; cash flows beyond 30 years are discounted using a yield curve determined in a similar way to the UK. For euro defined pension obligations, a similar approach to the UK has been used at 31 December 2012. However, at longer durations, rates are derived by extrapolating yields on ‘A’ and ‘AAA’ corporate bonds to derive equivalent ‘AA’ yields. Prior to 2012, extrapolation was not used at longer durations and different criteria were used to determine the reference pool of ‘AA’ bonds.
Inflation rate swaps 5,474 20 335 2,585 67 178 2,132 69 8 Interest rate swaps 19,304 3,424 2,811 15,149 2,232 1,864 10,727 270 110 Total return swaps 515 6 — 2,085 169 — 466 16 — Currency swaps 2,539 326 259 2,861 116 117 (973) — 1 Credit default swaps 709 11 12 238 6 — — — — Equity and bond futures 2,109 16 17 3,745 80 10 4,851 49 14 Currency forwards 8,551 41 — 2,078 8 — 4,883 35 91 Equity and bond call options 963 94 — 814 67 4 — — — Equity and bond put options 963 13 31 665 11 — — — —
The investment strategy of other schemes is similar to that of the Main scheme, adjusted to take account of the nature of liabilities, risk appetite of the trustees, size of the scheme and any local regulatory constraints. The use of derivative instruments outside of the Main scheme is not material.
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 £521 million of collateral at 31 December 2012 (2011 - £375 million; 2010 - £210 million).
Longevity at age 60 for future pensioners currently aged 40 (years) Males 29.5 29.3 29.3 Females 31.0 30.9 30.8
Net assets of schemes in surplus (included in Prepayments, accrued income and other assets, Note 19) (144) (188) (105) Net liabilities of schemes in deficit 3,884 2,239 2,288 3,740 2,051 2,183
Curtailment gains of £9 million (2011 - nil; 2010 - £78 million) were recognised in 2012 arising from changes to pension benefits in a subsidiary’s scheme. Settlement gains of £32 million were recognised in 2012 (2011 and 2010 - nil) in respect of subsidiaries schemes.
The Group expects to contribute a total of £766 million to its defined benefit pension schemes in 2013 (Main scheme - £650 million). Of the net liabilities of schemes in deficit, £168 million relates to unfunded schemes.
Cumulative net actuarial losses of £7,075 million (2011 - £4,805 million; 2010 - £4,224 million) have been recognised in the statement of comprehensive income, of which £5,367 million losses (2011 - £3,589 million; 2010 - £3,252 million) relate to the Main scheme.
History of defined benefit schemes 2012 £m 2010 £m £m 2008 £m £m 2009 £m £m
Experience (losses)/gains on plan liabilities (232) (208) (858) 135 (55) (207) (200) (882) 328 (65) Experience gains/(losses) on plan assets 210 759 1,718 993 (4,784) 373 636 1,797 1,344 (6,051) Actual return/(loss) on pension schemes assets 1,388 2,017 2,832 2,022 (3,513) 1,763 2,124 3,225 2,897 (4,186) Actual return/(loss) on pension schemes assets - % 6.6% 10.6% 17.2% 13.8% (19.0%) 7.1% 9.3% 15.6% 11.4% (14.5%)
Notes: (1) Includes fees of £1.0 million (2011 - £0.8 million) in relation to reviews of interim financial information, £2.9 million (2011 - £2.4 million) in respect of reports to the Group’s regulators in the UK and overseas, £0.5 million (2011 - £1.0 million) in respect of internal controls assurance and £0.2 million (2011 - £0.3 million) in relation to non-statutory audit opinions. (2) Includes fees of £1.6 million (2011 - £1.0 million) in respect of work performed by the auditors as reporting accountants on debt and equity issuances undertaken by the Group, including securitisations, and £4.1 million (2011 - £0.7 million) in respect of reporting accountant services in connection with planned divestments by the Group.
Non-taxable items - gain on sale of RBS Aviation Capital 26 — — - gain on sale of Global Merchant Services — 12 221 - gain on redemption of own debt — — 11 - other non-taxable items 104 242 341 Taxable foreign exchange movements (1) 4 4 Losses brought forward and utilised 2 2 2 Reduction in carrying value of deferred tax asset in respect of losses in - Australia (191) — — - Ireland (203) — — Adjustments in respect of prior years (2) (47) 199 355 Actual tax charge (469) (1,127) (703)
7 Profit attributable to preference shareholders and paid-in equity holders £m
Paid-in equity holders Interest on securities classified as equity, net of tax 15 — 19 Total (1) 288 — 124
Notes: (1) Discretionary dividends on certain non-cumulative preference shares and discretionary distributions on certain innovative securities recommenced on 4 May 2012. (2) Between 1 January 2013 and the date of approval of these accounts, dividends amounting to US$107 million and £0.4 million have been declared in respect of equity preference shares for payment 8 Ordinary dividends The company did not pay an ordinary dividend in 2012, 2011 or 2010.
Note: (1) 2011 and 2010 have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares in June 2012.
Notes on the consolidated accounts continued 10 Financial instruments - classification The following tables show the Group’s financial assets and liabilities in accordance with the categories of financial instruments in IAS 39 with assets and liabilities outside the scope of IAS 39 shown separately.
liabilities Total 2012 £m £m £m £m £m £m £m £m £m
Assets Cash and balances at central banks — — — 79,269 79,269 Loans and advances to banks - reverse repos 34,659 — — 4,781 39,440 - other (1) 20,317 — — 23,553 43,870 Loans and advances to customers - reverse repos 53,584 — — 7,910 61,494 - other (2) 25,322 476 — 419,895 8,419 454,112 Debt securities 95,076 647 107,298 6,059 209,080 Equity shares 12,433 774 1,976 15,183 Settlement balances — — — 7,771 7,771 Derivatives 521,935 7,683 529,618 Intangible assets 14,858 14,858 Property, plant and equipment 11,868 11,868 Deferred tax 3,878 3,878 Prepayments, accrued income and other assets — — — 1,309 9,667 10,976 Assets of disposal groups 25,450 25,450 763,326 1,897 7,683 109,274 550,547 8,419 65,721 1,506,867
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
The tables below show the carrying value, fair value and the effect on profit or loss of reclassifications undertaken by the Group in 2008 and 2009. There were no reclassifications in 2010, 2011 or 2012.
(Increase)/ reduction in profit or loss as a result of reclassification
Reclassified from AFS to LAR (2) Debt securities 167 90 7 — 7 — 6,278 5,517 (229) (11) 800 1,040
IPV is performed at a frequency to match the availability of independent data. For liquid instruments, the standard is to perform IPV daily. The minimum frequency of review in the Group is monthly for exposures in the regulatory trading book and quarterly for exposures in the regulatory banking book. Monthly meetings are held between the business and the support functions to discuss the results of the IPV and reserves process in detail. The IPV control includes formalised reporting and escalation of any valuation differences in breach of established thresholds. The Global Pricing Unit (GPU) determines IPV policy, monitors adherence to that policy and performs additional independent reviews on highly subjective valuation issues for Markets and Non-Core.
During 2012, the Group has made a significant and ongoing investment into enhancing its already robust control environment. This included continuing investment into a 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, Markets and NonCore Senior Management Valuations Control Committees and other relevant issues. This committee covers key material and subjective valuation issues within the trading businesses 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, the Group Head of Market and Insurance Risk, the Markets Chief Financial Officer, the Non-Core Chief Financial Officer, the Head of QuaRC, the Head of GPU and representation from Front Office Trading and Finance.
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 (refer to pages 399 and 400) and judgment may be required as to which level the instrument is classified.
Notes on the consolidated accounts continued 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.
Interest rates - these are principally benchmark interest rates such as the London Interbank Offered Rate (LIBOR), Overnight Index Swaps rate (OIS) and other quoted interest rates in the swap, bond and futures markets.
Foreign currency exchange rates - there are observable markets both for spot and forward contracts and futures in the world's major currencies.
The Group may use consensus prices for the source of independent pricing for some assets. The consensus service encompasses the equity, interest rate, currency, commodity, credit, property, fund and bond markets, providing comprehensive matrices of vanilla prices and a wide selection of exotic products. Markets and Non-Core contribute to consensus pricing services where there is a significant interest either from a positional point of view or to test models for future business use. Data sourced from consensus pricing services is used for a combination of control processes including direct price testing, evidence of observability and model testing. In practice this means that the Group submits prices for all material positions for which a service is available.
Note: (1) Includes bid-offer reserves of £625 million (2011 - £806 million), funding valuation adjustment of £475 million (2011 - £552 million), product and deal specific reserves of £763 million (2011 - £1,040 million), valuation basis reserves of £103 million (2011 - £253 million) and other reserves of £31 million (2011 - £53 million).
CDPCs gross exposure decreased by £1.3 billion from £1.9 billion in
December 2011 to £0.6 billion at 31 December 2012. This was primarily driven by tighter credit spreads of the underlying reference loans and bonds together with a decrease in the relative value of senior tranches compared with the underlying reference portfolio and the impact of restructuring certain exposures in the first half of the year. The valuation adjustment, incorporating transactions and related risk mitigation strategies that are now in place, decreased on an absolute basis in line with the decrease in exposure while remaining stable on a relative basis.
The increase in credit valuation adjustment held against exposure to other counterparties was driven by the impact of counterparty rating downgrades and an increase in sector specific reserves, partially offset by tighter credit spreads.
Within other reserves, bid-offer reserves decreased, primarily reflecting restructuring in the second half of 2012, due to risk reduction and the impact of Greek government debt restructuring.
The methodology employed to calculate the monoline CVA uses market implied probability of defaults and internally assessed recovery levels to determine the level of expected loss on monoline exposures of different maturities. The probability of default is calculated with reference to market observable credit spreads and recovery levels. CVA is calculated at a trade level by applying the expected loss corresponding to each trade’s expected maturity, to the gross mark-to-market of the monoline protection. The expected maturity of each trade reflects the scheduled notional amortisation of the underlying reference instruments and whether payments due from the monoline are received at the point of default or over the life of the underlying reference instruments.
Credit derivative product companies (CDPC) A CDPC is a company that sells protection on credit derivatives. CDPCs are similar to monoline insurers, however they are not regulated as insurers.
Where exposure exists to a counterparty that is considered to be close to default, the CVA is calculated by applying expected losses to the current level of exposure. Otherwise, expected losses are applied to estimated potential future exposures which are modelled to reflect the volatility of the market factors which drive the exposures and the correlation between those factors. Potential future exposures arising from vanilla products (including interest rate and foreign exchange derivatives) are modelled jointly using the Group's core counterparty risk systems. The majority of the Group's CVA held in relation to other counterparties arises on these vanilla products together with exposures to counterparties which are considered to be close to default. The exposures arising from all other product types are modelled and assessed individually. The potential future exposure to each counterparty is the aggregate of the exposures arising on the underlying product types.
Risk data are used as the primary sources of information within bid-offer calculations and are aggregated when they are more granular than market standard buckets. Bid-offer adjustments for each risk factor (including delta (the degree to which the price of an instrument changes in response to a change in the price of the underlying), vega (the degree to which the price of an instrument changes in response to the volatility in the price of the underlying), correlation (the degree to which prices of different instruments move together) and others) are determined by aggregating similar risk exposures arising on different products. Additional basis bid-offer reserves are taken where these are charged in the market. Risk associated with non-identical underlying exposures is not netted down unless there is evidence that the cost of closing the combined risk exposure is less than the cost of closing on an individual basis.
Amounts deferred on initial recognition On initial recognition of financial assets and liabilities valued using valuation techniques incorporating information other than observable market data, any difference between the transaction price and that derived from the valuation technique is deferred. Such amounts are recognised in profit or loss over the life of the transaction; when market data becomes observable; or when the transaction matures or is closed out as appropriate. At 31 December 2012, net gains of £153 million (2011 - £161 million; 2010 - £167 million) were carried forward. During the year, net gains of £39 million (2011 - £89 million; 2010 - £62 million) were deferred and £47 million (2011 - £95 million; 2010 - £99 million) recognised in the income statement.
The fair value of the Group's derivative financial liabilities has also been adjusted to reflect the Group's own credit risk. The adjustment takes into account collateral posted by it and the effects of master netting agreements.
The own credit adjustment for fair value does not alter cash flows, is not used for performance management, is disregarded for regulatory capital reporting processes and will reverse over time as the liabilities mature.
The reserve movement between periods will not equate to the reported profit or loss for own credit. The balance sheet reserves are stated by conversion of underlying currency balances at spot rates for each period whereas the income statement includes intra-period foreign exchange sell-offs.
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued The following table shows the cumulative own credit adjustment recorded on securities held-for-trading (HFT), classified as fair value through profit or loss (DFV) and derivative liabilities.
Senior issued debt adjustments are determined with reference to secondary debt issuance spreads. At 31 December 2012, the five year level tightened to c.100 basis points from c.450 basis points at 31 December 2011, primarily due to increased demand from investors following quantitative easing measures from the European Central Bank and US Federal Reserve and the announcement of the Group’s liability management exercise.
Valuation hierarchy The following tables show financial instruments carried at fair value on the Group’s balance sheet by valuation hierarchy - level 1, level 2 and level 3.
Assets Loans and advances to banks Reverse repos — 33.4 — 33.4 — 34.7 — 34.7 — 38.2 — 38.2 Derivative collateral — 12.8 — 12.8 — 19.7 — 19.7 — 25.1 — 25.1 Other — 0.1 0.4 0.5 — 0.2 0.4 0.6 — 0.6 0.4 1.0 — 46.3 0.4 46.7 — 54.6 0.4 55.0 — 63.9 0.4 64.3 Loans and advances to customers Reverse repos — 70.0 — 70.0 — 53.6 — 53.6 — 41.1 — 41.1 Derivative collateral — 22.5 — 22.5 — 22.0 — 22.0 — 14.4 — 14.4 Other — 1.9 0.6 2.5 — 3.4 0.4 3.8 — 6.2 0.4 6.6 — 94.4 0.6 95.0 — 79.0 0.4 79.4 — 61.7 0.4 62.1 Debt securities UK government 15.6 0.1 — 15.7 22.4 — — 22.4 13.5 — — 13.5 US government 31.0 5.4 — 36.4 35.5 5.0 — 40.5 31.0 7.0 — 38.0 Other government 34.4 8.9 — 43.3 53.9 8.7 — 62.6 62.3 13.6 — 75.9 Corporate — 2.2 0.1 2.3 — 5.0 0.5 5.5 — 6.5 1.2 7.7 Financial institutions 2.6 48.0 4.7 55.3 3.0 61.6 7.4 72.0 3.5 64.8 7.0 75.3 83.6 64.6 4.8 153.0 114.8 80.3 7.9 203.0 110.3 91.9 8.2 210.4 Of which ABS RMBS — 38.5 0.9 39.4 — 48.2 0.6 48.8 — 46.1 0.4 46.5 CMBS — 3.7 — 3.7 — 2.1 0.1 2.2 — 3.4 0.3 3.7 CDO — 0.2 0.5 0.7 — 0.2 1.7 1.9 — 0.9 2.4 3.3 CLO — 0.6 2.4 3.0 — 1.5 3.7 5.2 — 3.6 2.1 5.7 Other — 2.1 0.4 2.5 — 3.1 0.9 4.0 — 4.0 1.4 5.4
Of which Core 96.4 637.3 5.6 739.3 126.9 724.5 7.2 858.6 129.4 617.6 7.2 754.2 Non-Core 0.4 7.3 4.8 12.5 0.5 13.9 9.2 23.6 1.1 22.3 8.5 31.9 96.8 644.6 10.4 751.8 127.4 738.4 16.4 882.2 130.5 639.9 15.7 786.1
Of which Core 34.9 35.7 0.6 71.2 53.6 46.9 0.6 101.1 52.8 49.2 1.0 103.0 Non-Core 0.1 1.0 2.8 3.9 — 2.7 5.5 8.2 0.6 5.8 3.7 10.1 35.0 36.7 3.4 75.1 53.6 49.6 6.1 109.3 53.4 55.0 4.7 113.1
Liabilities Deposits by banks Repos — 36.4 — 36.4 — 23.3 — 23.3 — 20.6 — 20.6 Derivative collateral — 28.6 — 28.6 — 31.8 — 31.8 — 26.6 — 26.6 Other — 1.9 0.1 2.0 — 2.4 — 2.4 — 1.6 — 1.6 — 66.9 0.1 67.0 — 57.5 — 57.5 — 48.8 — 48.8 Customer accounts Repos — 82.2 — 82.2 — 65.5 — 65.5 — 53.0 — 53.0 Derivative collateral — 8.0 — 8.0 — 9.2 — 9.2 — 10.4 — 10.4 Other — 10.3 0.1 10.4 — 10.8 — 10.8 — 8.7 0.1 8.8 — 100.5 0.1 100.6 — 85.5 — 85.5 — 72.1 0.1 72.2 Debt securities in issue — 33.1 1.4 34.5 — 45.0 2.2 47.2 — 49.0 2.2 51.2 Short positions 23.6 4.0 — 27.6 34.4 6.3 0.3 41.0 35.0 7.3 0.8 43.1 Derivatives Foreign exchange — 69.3 1.2 70.5 — 80.6 0.4 81.0 0.1 89.3 — 89.4 Interest rate 0.1 345.0 0.4 345.5 0.4 405.2 1.1 406.7 0.2 298.0 1.0 299.2 Credit — 9.6 0.8 10.4 — 24.9 1.8 26.7 — 25.0 0.3 25.3 Equities and commodities — 7.0 0.9 7.9 — 9.1 0.5 9.6 0.1 9.6 0.4 10.1 0.1 430.9 3.3 434.3 0.4 519.8 3.8 524.0 0.4 421.9 1.7 424.0 Subordinated liabilities — 1.1 — 1.1 — 0.9 — 0.9 — 1.1 — 1.1 23.7 636.5 4.9 665.1 34.8 715.0 6.3 756.1 35.4 600.2 4.8 640.4
Of which Core 23.7 634.4 4.7 662.8 34.8 708.9 5.7 749.4 35.4 586.9 3.8 626.1 Non-Core — 2.1 0.2 2.3 — 6.1 0.6 6.7 — 13.3 1.0 14.3 23.7 636.5 4.9 665.1 34.8 715.0 6.3 756.1 35.4 600.2 4.8 640.4
The following table analyses level 3 balances and related valuation sensitivities.
Balance Favourable Unfavourable Balance Favourable Unfavourable Balance Favourable Unfavourable £bn £m £m £bn £m £m £bn £m £m
Derivatives Foreign exchange 1.4 140 (40) 1.6 100 (100) 0.1 — — Interest rate 0.6 60 (80) 1.1 80 (80) 1.7 150 (140)
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued Level 3 valuation assumptions
Derivatives Foreign exchange Proprietary model correlation, volatility Interest rate Proprietary model correlation, volatility Equities and commodities Proprietary model correlation, long dated volatility, dividends Credit Proprietary CVA model, industry option and correlation model correlation, counterparty credit risk, volatility
Notes: (1) Sensitivity represents the favourable and unfavourable effect on the income statement or the statement of comprehensive income due to reasonably possible changes to valuations using reasonably possible alternative inputs to the Group's valuation techniques or models. Totals for sensitivities are not indicative of the total potential effect on the income statement or the statement of comprehensive income.
Key points Total assets carried at fair value decreased by £130.4 billion in the year to £751.8 billion at 31 December 2012, principally reflecting decreases in derivative assets (£87.7 billion), debt securities (£50.0 billion) and derivative collateral (£6.4 billion), partially offset by increases in reverse repos (£15.1 billion).
Level 3 assets of £10.4 billion represented 1.4% of the total (2011 - £16.4 billion and 1.9%), a decrease of £6.0 billion (derivatives £2.9 billion and debt securities £3.1 billion). This reflected transfers from level 3 to level 2 of £1.1 billion as well as maturity and sale of instruments, particularly securities in Non-Core. These transfers from level 3 were based on the re-assessment of the impact and nature of unobservable inputs used in valuation models. £1.6 billion was transferred from level 2 to level 3, principally relating to securities of £1 billion, primarily ABS in Non-Core Markets and certain derivatives £0.4 billion.
Level 3 liabilities decreased by £1.4 billion during the year to £4.9 billion primarily due to buy-back and maturity of instruments.
The favourable and unfavourable effects of reasonably possible alternative assumptions on level 3 instruments carried at fair value were £1.0 billion (2011 - £1.7 billion) and £(0.7) billion (2011 - £(1.0) billion) respectively.
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. The actual potential downside sensitivity of the total portfolio may be less than the noncorrelated sum of the additive figures as shown in the above table.
A key related issue is where a market moves from liquid to illiquid or vice versa. Where this change is considered to be temporary, the classification is not changed. For example, if there is little market trading in a product on a reporting date but at the previous reporting date and during the intervening period the market has been considered to be liquid, the instrument will continue to be classified in the same level in the hierarchy. This is to provide consistency so that transfers between levels are driven by genuine changes in market liquidity and do not reflect short term or seasonal effects.
The breadth and depth of this data allows a good assessment to be made of liquidity and pricing uncertainty, which assists with the process of allocation to an appropriate level. Where suitable independent pricing information is not readily available the instrument will be considered to be level 3.
The availability and quality of independent pricing information is considered during the classification process. An assessment is made regarding the quality of the independent information. For example where consensus prices are used for non-modelled products, a key assessment of the quality of a price is the depth of the number of prices used to provide the consensus price. If the depth of contributors falls below a set hurdle rate, the instrument is considered to be level 3. This hurdle rate is consistent with the rate used in the IPV process to determine whether or not the data is of sufficient quality to adjust the instrument’s valuations. However, where an instrument is generally considered to be illiquid, but regular quotes from market participants exist, these instruments may be classified as level 2 depending on frequency of quotes, other available pricing and whether the quotes are used as part of the IPV process or not.
Commercial mortgages These senior and mezzanine commercial mortgages are loans secured on commercial land and buildings that were originated or acquired by the Group for securitisation. Senior commercial mortgages carry a variable interest rate and mezzanine or more junior commercial mortgages may carry a fixed or variable interest rate. Factors affecting the value of these loans may include, but are not limited to, loan type, underlying property type and geographic location, loan interest rate, loan-to-value ratios, debt service coverage ratios, prepayment rates, cumulative loan loss information, yields, investor demand, market volatility since the last securitisation and credit enhancement. Where observable market prices for a particular loan are not available, the fair value will typically be determined with reference to observable market transactions in other loans or credit related products including debt securities and credit derivatives. Assumptions are made about the relationship between the loan and the available benchmark data.
Residential mortgage-backed securities (RMBS) RMBS where the underlying assets are US agency-backed mortgages and there is regular trading are generally classified as level 2 in the fair value hierarchy. RMBS are also classified as level 2 when regular trading is not prevalent in the market, but similar executed trades or third-party data including indices, broker quotes and pricing services can be used to substantiate the fair value. RMBS are classified as level 3 when trading activity is not available and a model with significant unobservable data is utilised.
Equity shares Private equity investments include unit holdings and limited partnership interests primarily in corporate private equity funds, debt funds and fund of hedge funds. Externally managed funds are valued using recent prices where available. Where not available, the fair value of investments in externally managed funds is generally determined using statements or other information provided by the fund managers.
Equity derivatives Equity derivative products are split into equity exotic derivatives and equity hybrids. Exotic equity derivatives have payouts based on the performance of one or more stocks, equity funds or indices. Most payouts are based on the performance of a single asset and are valued using observable market option data. Unobservable equity derivative trades are typically complex basket options on stocks. Such basket option payouts depend on the performance of more than one equity asset and require correlations for their valuation. Valuation is then performed using industry standard valuation models, with unobservable correlation inputs calculated by reference to correlations observed between similar underlyings.
Reasonably possible alternative assumptions of unobservable inputs used to determine discount rates applied to collateralised derivatives result in a favourable valuation movement of £23 million and an unfavourable valuation movement of £23 million.
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued
AFS Debt securities 1,325 26 511 2,909 — 306 (458) (274) 34 4,379 10 Equity shares 749 (4) (39) (118) — 22 (2) (343) 14 279 (4)
Notes: (1) Net losses on HFT instruments of £1,528 million (2011 - £860 million; 2010 - £694 million) were recorded in income from trading activities. Net gains on other instruments of £141 million (2011 - £143 million; 2010 - £141 million) were recorded in other operating income, interest income and impairment losses as appropriate. (2) Consolidated statement of comprehensive income. (3) Fair value through profit or loss.
Financial assets Cash and balances at central banks 79.3 79.3 79.3 79.3 57.0 57.0 Loans and advances to banks 17.3 17.3 28.3 28.2 36.2 36.1 Loans and advances to customers 405.1 385.4 436.2 406.3 493.1 468.8 Debt securities 4.5 4.0 6.1 5.5 7.1 6.4 Settlement balances 5.7 5.7 7.8 7.8 11.6 11.6
The fair value is the amount an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Quoted market values are used where available; otherwise, fair values have been estimated based on discounted expected future cash flows and other valuation techniques. These techniques involve uncertainties and require assumptions and judgments covering prepayments, credit risk and discount rates. Furthermore there is a wide range of potential valuation techniques. Changes in these assumptions would significantly affect estimated fair values. The fair values reported would not necessarily be realised in an immediate sale or settlement.
The assumptions and methodologies underlying the calculation of fair values of financial instruments at the balance sheet date are as follows: For certain short-term financial instruments, fair value approximates to carrying value: cash and balances at central banks, items in the course of collection from other banks, settlement balances, items in the course of transmission to other banks and demand deposits.
Debt securities Fair values are determined using discounted cash flow valuation techniques.
Notes on the consolidated accounts continued 12 Financial instruments - maturity analysis Remaining maturity The following table shows the residual maturity of financial instruments, based on contractual date of maturity.
Assets Cash and balances at central banks 79,290 — 79,290 79,269 — 79,269 56,997 17 57,014 Loans and advances to banks 63,143 808 63,951 80,905 2,405 83,310 98,789 1,729 100,518 Loans and advances to customers 197,855 302,280 500,135 197,338 318,268 515,606 199,626 355,634 555,260 Debt securities 26,363 131,075 157,438 45,311 163,769 209,080 42,678 174,802 217,480 Equity shares — 15,232 15,232 — 15,183 15,183 — 22,198 22,198 Settlement balances 5,741 — 5,741 7,767 4 7,771 11,605 — 11,605 Derivatives 51,021 390,882 441,903 60,250 469,368 529,618 65,639 361,438 427,077
Liabilities Deposits by banks 90,704 10,701 101,405 100,499 8,305 108,804 95,241 3,549 98,790 Customer accounts 494,405 26,874 521,279 487,428 15,527 502,955 492,609 18,084 510,693 Debt securities in issue 20,296 74,296 94,592 68,889 93,732 162,621 94,048 124,324 218,372 Settlement balances and short positions 8,573 24,896 33,469 15,248 33,268 48,516 16,981 37,128 54,109 Derivatives 51,503 382,830 434,333 61,734 462,249 523,983 71,306 352,661 423,967 Subordinated liabilities 2,351 24,422 26,773 624 25,695 26,319 964 26,089 27,053
Assets and liabilities by contractual cash flow maturity The tables below show the contractual undiscounted cash flows receivable and payable, up to a period of 20 years, including future receipts and payments of interest of on-balance sheet assets by contractual maturity. The balances in the following table do not agree directly with the consolidated balance sheet, as the table includes all cash flows relating to principal and future coupon payments, presented on an undiscounted basis. The tables have been prepared on the following basis: The contractual maturity of on-balance sheet assets and liabilities highlights the maturity transformation which underpins the role of banks to lend long-term, but to fund themselves predominantly by short-term liabilities such as customer deposits. This is achieved through the diversified funding franchise of the Group across an extensive retail, wealth and SME customer base, and across a wide geographic network. In practice, the behavioural profiles of many assets and liabilities exhibit greater stability and longer maturity than the contractual maturity.
Financial assets have been reflected in the time band of the latest date on which they could be repaid, unless earlier repayment can be demanded by the Group. Financial liabilities are included at the earliest date on which the counterparty can require repayment, regardless of whether or not such early repayment results in a penalty. If the repayment of a financial instrument is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the asset is included in the time band that contains the latest date on which it can be repaid, regardless of early repayment. The liability is included in the time band that contains the earliest possible date on which the conditions could be fulfilled, without considering the probability of the conditions being met.
Notes on the consolidated accounts continued 12 Financial instruments - maturity analysis continued 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
Assets by contractual maturity Cash and balances at central banks 79,269 — — — — — Loans and advances to banks 26,326 1,294 544 121 114 — Debt securities 7,237 9,569 23,137 21,003 39,148 15,869 Settlement balances 7,759 8 — 1 — — Other financial assets 397 158 — 16 738 — Total maturing assets 120,988 11,029 23,681 21,141 40,000 15,869 Loans and advances to customers 97,318 90,894 108,331 55,785 62,085 56,259 Derivatives held for hedging 519 1,556 3,438 1,695 596 138 218,825 103,479 135,450 78,621 102,681 72,266
Note: (1) Includes £114 million relating to loans and advances to banks (2011 - £123 million; 2010 - £127 million).
Loans and advances to customers 5,292 7,241 9,157 Loans and advances to banks 23 — (13)
2012 2011 2010 Carrying Carrying Carrying Cost Provision value Cost Provision value Cost Provision value £m £m £m £m £m £m £m £m £m
Loans and receivables Loans and advances to banks (1) 134 114 20 137 123 14 145 127 18 Loans and advances to customers (2) 38,352 19,176 19,176 38,610 17,774 20,836 35,556 15,405 20,151 38,486 19,290 19,196 38,747 17,897 20,850 35,701 15,532 20,169
Notes: (1) Impairment provisions individually assessed. (2) Impairment provisions individually assessed on balances of £26,931 million (2011 - £29,196 million; 2010 - £25,492 million).
Residential property 67 60 47 Other property 46 73 139 Cash 49 56 127 Other assets 1 2 28 163 191 341
14 Derivatives Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.
For cash flow hedge relationships of interest rate risk, the hedged items are actual and forecast variable interest rate cash flows arising from financial assets and financial liabilities with interest rates linked to LIBOR, EURIBOR or the Bank of England Official Bank Rate. The financial assets are customer loans and the financial liabilities are customer deposits and LIBOR linked medium-term notes and other issued securities. At 31 December 2012, variable rate financial assets of £61 billion (2011 - £49 billion) and variable rate financial liabilities of £9 billion (2011 - £13 billion) were hedged in such cash flow hedge relationships.
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 2012, fixed rate financial assets of £25 billion (2011 - £33 billion) and fixed rate financial liabilities of £39 billion (2011 - £41 billion) were hedged by interest rate swaps in fair value hedge relationships.
The following table shows the notional amounts and fair values of the Group's derivatives.
Exchange rate contracts Spot, forwards and futures 2,259 23,237 22,721 2,127 30,249 28,868 2,807 39,859 41,424 Currency swaps 1,071 22,238 30,223 1,071 25,212 33,541 1,000 28,696 34,328 Options purchased 683 17,580 — 640 19,031 — 503 14,698 — Options written 684 — 17,536 641 — 18,571 544 — 13,623
Interest rate contracts Interest rate swaps 25,474 300,907 286,620 29,976 346,682 333,968 29,792 251,312 243,807 Options purchased 1,934 61,798 — 2,398 74,600 — 2,619 57,359 — Options written 1,884 — 58,289 2,592 — 71,998 2,731 — 54,141 Futures and forwards 4,191 749 653 3,756 874 743 4,618 3,060 1,261
14 Derivatives continued Included in the table above are derivatives held for hedging purposes as follows: 2012 2011 2010 Assets Liabilities Assets Liabilities Assets Liabilities £m £m £m £m £m £m
Net investment hedging Exchange rate contracts 6 32 148 148 30 102
Hedge ineffectiveness recognised in other operating income comprised: 2012 2011 2010 £m £m £m
Fair value hedging Gains on the hedged items attributable to the hedged risk 178 557 343 Losses on the hedging instruments (132) (541) (405) Fair value hedging ineffectiveness 46 16 (62) Cash flow hedging ineffectiveness 26 20 (37)
The following table shows, when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges.
Held-for-trading 7,692 17,349 27,165 2,243 21,876 2,015 78,340 18,619 Designated as at fair value through profit or loss — — 123 86 610 54 873 516 Available-for-sale 7,950 19,040 15,995 7,227 23,294 231 73,737 30,184 Loans and receivables 5 — — 365 3,728 390 4,488 3,707 15,647 36,389 43,283 9,921 49,508 2,690 157,438 53,026
Notes on the consolidated accounts continued 15 Debt securities continued The following table analyses the Group's available-for-sale debt securities and the related yield (based on weighted averages) by remaining maturity and issuer. Within 1 year After 1 but within 5 years After 5 but within 10 years After 10 years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield 2012 £m % £m % £m % £m % £m %
Available-for-sale Gross unrealised gains 58 172 230 69 317 386 67 232 299 Gross unrealised losses (54) (13) (67) (19) (114) (133) (17) (145) (162)
Gross gains of £166 million (2011 - £152 million; 2010 - £82 million) and gross losses of £2 million (2011 - £2 million; 2010 - £63 million) were realised on the sale of available-for-sale equity shares in continuing operations. Gross gains of £23 million (2011 - nil; 2010 - £1 million) were realised on the sale of available-for-sale equity shares in discontinued operations.
Accumulated amortisation and impairment At 1 January 14,419 495 1,951 3,620 20,485 Transfers to disposal groups (444) — (10) (136) (590) Currency translation and other adjustments (289) (13) (55) (356) (713) Disposals and write-off of fully amortised assets (76) (426) (1,542) (638) (2,682) Charge for the year - continuing operations — 20 157 528 705 - discontinued operations — — 1 37 38 Write down of goodwill and other intangible assets - continuing operations 18 7 94 5 124 - discontinued operations 394 — — — 394 At 31 December 14,022 83 596 3,060 17,761
Cost At 1 January 27,139 612 2,458 4,575 34,784 Transfers to disposal groups (95) — — — (95) Currency translation and other adjustments (219) 8 (60) 59 (212) Acquisitions of subsidiaries 18 — — — 18 Additions — — 34 1,050 1,084 Disposals and write-off of fully amortised assets — — — (236) (236)
Net book value at 31 December 12,424 125 481 1,828 14,858
Accumulated amortisation and impairment At 1 January 28,379 1,562 2,577 3,785 36,303 Currency translation and other adjustments (510) (29) (31) (24) (594)
Disposals and write-off of fully amortised assets — — — (391) (391) Charge for the year - continuing operations — 68 301 341 710 - discontinued operations — — 2 34 36 Write down of goodwill and other intangible assets - continuing operations 1 — — — 1 - discontinued operations 9 — — — 9 At 31 December 14,611 462 1,822 3,441 20,336
Net book value at 31 December 12,528 150 636 1,134 14,448
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
UK Retail Value in use 2,697 2,697 UK Corporate Value in use 2,693 2,693 Wealth Value in use 611 611 Global Transaction Services Value in use 2,370 2,376 US Retail & Commercial Value in use 2,826 2,811 Direct Line Group Value in use 935 935
Note: (1) At 31 December 2012, Direct Line Group was reclassified as a disposal group and all assets, including goodwill, were reported at fair value.
Impairment testing inherently involves a number of judgmental areas: the preparation of cash flow forecasts for periods that are beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the business; estimation of the fair value of CGUs; and the valuation of the separable assets of each business whose goodwill is being reviewed. Sensitivity to the more significant variables in each assessment are presented below.
The recoverable amount of International Banking, based on a 4.7% terminal growth rate and a 12.2% pre tax discount rate, exceeded its carrying value by £0.3 billion. A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion and £1.2 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.6 billion.
Direct Line Group has been reclassified as a disposal group in 2012 and its goodwill is assessed as part of its fair value at 31 December 2012.
2011 and 2010 The recoverable amount of UK Retail, based on a 3% (2010 - 3%) terminal growth rate and a 14% (2010 - 15.7%) pre tax discount rate, exceeded the carrying amount by £5.5 billion (2010 - £6.9 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) and £0.6 billion (2010 - £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 - £0.9 billion).
The recoverable amount of UK Corporate, based on a 3% (2010 - 3%) terminal growth rate and a 14.1% (2010 - 15.6%) pre tax discount rate, exceeded its carrying value by £2.1 billion (2010 - £5.3 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.6 billion) and £0.5 billion (2010 - £0.9 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).
The recoverable amount of Wealth, based on a 3% (2010 - 3%) terminal growth rate and an 11.0% (2010 - 12.0%) pre tax discount rate, exceeded its carrying value by more than 100% and was insensitive to a reasonably possible change in key assumptions.
Cost or valuation At 1 January 4,170 2,938 291 1,832 4,239 9,235 22,705 Transfers to disposal groups — (107) (12) (93) (49) (5,355) (5,616) Currency translation and other adjustments (103) 2 (4) (6) (77) 3 (185) Reclassifications 57 8 (38) (35) 8 — — Additions 1,262 68 46 174 532 1,384 3,466 Expenditure on investment properties 14 — — — — — 14 Change in fair value of investment properties - continuing operations (139) — — — — — (139) Disposals and write-off of fully depreciated assets (793) (54) (10) (49) (174) (1,375) (2,455)
Cost or valuation At 1 January 4,883 4,098 214 1,803 4,282 9,558 24,838 Currency translation and other adjustments — 31 2 81 227 231 572 Disposal of subsidiaries — (1,118) — (104) (372) (369) (1,963) Reclassifications — (104) 76 15 13 — — Additions 511 103 5 137 411 1,178 2,345 Expenditure on investment properties 2 — — — — — 2 Change in fair value of investment properties - continuing operations (405) — — — — — (405) Disposals and write-off of fully depreciated assets (821) (72) (6) (100) (322) (1,363) (2,684)
Notes on the consolidated accounts continued 18 Property, plant and equipment continued Investment properties are valued to reflect fair value, that is, the market value of the Group's interest at the reporting date excluding any special terms or circumstances relating to the use or financing of the property and transaction costs that would be incurred in making a sale. Observed market data such as rental yield, replacement cost and useful life, reflect relatively few transactions involving property that is not necessarily identical to property owned by the Group.
The fair value of investment properties includes £186 million of depreciation since purchase (2011 - £146 million; 2010 - £248 million).
Property, plant and equipment, excluding investment properties, include £35 million (2011 - £186 million; 2010 - £298 million) assets in the course of construction.
19 Prepayments, accrued income and other assets 2012 2011 2010 £m £m £m
Profit before insurance net claims and impairment losses 2,296 3,394 4,474 Insurance net claims (2,427) (2,968) (4,698) Impairment losses — (2) (21) Operating (loss)/profit before tax (131) 424 (245) Tax (charge)/credit (53) (123) 69 (Loss)/profit after tax from discontinued general insurance business (184) 301 (176)
Other Total income 29 42 1,433 Operating expenses (3) (5) (803) Profit before insurance net claims and impairment losses 26 37 630 Insurance net claims — — (161)
Other 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. The (loss)/profit from discontinued operations includes a loss of £112 million (2011 - £42 million profit; 2010 - £605 million loss) attributable to non-controlling interests.
Notes on the consolidated accounts continued 20 Discontinued operations and assets and liabilities of disposal groups continued (c) Assets and liabilities of disposal groups 2012
Liabilities of disposal groups Deposits by banks — 1 1 1 266 Customer accounts — 753 753 22,610 2,267 Derivatives 4 3 7 126 5,042 Settlement balances — — — 8 907 Insurance liabilities 6,193 — 6,193 — — Subordinated liabilities 529 — 529 — — Other liabilities 2,541 138 2,679 1,233 925 Discontinued operations and other disposal groups 9,267 895 10,162 23,978 9,407 Liabilities acquired exclusively with a view to disposal — 8 8 17 21 9,267 903 10,170 23,995 9,428
Disposal groups at 31 December 2012 primarily comprise Direct Line Group (DLG). To comply with EC state aid requirements, the Group has agreed to cede control of DLG by the end of 2013 and divest completely by the end of 2014. Following the successful initial public offering in which the Group sold 34.7% of its shareholding, DLG was classified as a disposal group and discontinued operation on 31 December 2012. On being classified as held-for-sale, disposal groups are required to be measured at the lower of carrying amount and fair value less costs to sell. DLG’s carrying amount exceeded its fair value less costs to sell (based on the quoted price for DLG shares on 31 December 2012) by £394 million and goodwill attributable to DLG has been written down by this amount. The write down is recorded in other expenses within discontinued operations.
In 2011, £80 million of allocated goodwill was written off against operating expenses in respect of the UK branch-based businesses. No adjustment was made in respect of the RBS Aviation Capital business.
(e) Direct Line Group assets and liabilities 2012 2011 2010 General insurance business assets and liabilities £m £m £m
Loans and advances to banks 2,036 2,579 2,484 Loans and advances to customers 881 893 1,118 Debt securities and equity shares 7,156 7,992 7,868 Derivatives 12 — — Intangible assets 750 1,065 985 Property, plant and equipment 222 132 138 Prepayments, accrued income and other assets 1,640 1,200 1,382 Assets of disposal group 12,697
Outstanding claims are not discounted for the time value of money, except for claims settled by periodical payments under the Courts Act 2003. Of the insurance liabilities above, £818 million (2011 - £835 million: 2010 - £827 million) relates to claims that are being or may be settled by periodical payments, net of reinsurance.
Debt securities - Government 23,551 32,895 34,056 - Other issuers 3,429 6,164 6,961 Equity shares 611 1,980 2,101 27,591 41,039 43,118
Technology incident redress (7) Property (8) Other Total Provisions for liabilities and charges £m £m £m £m £m £m £m £m £m £m
At 1 January 2012 745 — — — — 5 — 381 180 1,311 Transfer from accruals and other liabilities — — 119 — 125 111 — — 94 449 745 — 119 — 125 116 — 381 274 1,760 Transfers to disposal groups — — — — — — — — (1) (1) Currency translation and other movements — — — — — (4) 1 (2) 1 (4) Charge to income statement - continuing operations 1,110 700 141 381 75 190 175 153 34 2,959 Releases to income statement - continuing operations — — (2) — — (8) — (50) — (60)
Notes: (1) In April 2011, following dismissal by the High Court of a Judicial Review application by the British Bankers’ Association, the Group reached agreement with the FSA and the Financial Ombudsman Service on the handling of Payment Protection Insurance (PPI) complaints in accordance with FSA Policy Statement PS 10/12. The statement sets out the framework for reviewing individual complaints. It also requires firms to undertake root cause analysis; proactive contact exercises are required for certain categories of customer if systemic issues are identified.
(2) In June 2012, following an industry wide review, the FSA announced that the Group and other UK banks had agreed to: - provide automatically fair and reasonable redress to non-sophisticated customers who were sold structured collars; - review the sales of interest rate hedging products (other than caps or structured collars) to non-sophisticated customers to determine whether redress is due; and - review the sale of caps to non-sophisticated customers to determine whether redress is due if a complaint is made by the customer during the review.
Number of customer transactions qualifying for redress (i) +/-5 +/-29 Proportion of customer transactions qualifying for full redress (i) +/-5 +/-42
As the redress and review exercise progresses it is likely that the level of the provision will change. There remain significant uncertainties over the number of transactions that will qualify for redress and the nature and cost of that redress.
(3) The Group has provided for customer redress in relation to certain other retail products. None of these provisions is individually material.
(6) Arising out of its normal business operations, the Group is party to legal proceedings in the United Kingdom, the United States and other jurisdictions. Litigation provisions at 31 December 2012 related to numerous proceedings; no individual provision is material. Detailed descriptions of the Group’s legal proceedings and discussion of the associated uncertainties are given in Note 32.
Deferred tax liability 1,141 1,945 2,142 Deferred tax asset (3,443) (3,878) (6,373) Net deferred tax asset (2,302) (1,933) (4,231)
Charge/(credit) to income statement - continuing operations 222 26 339 262 77 46 (13) (178) 22 (3) 394 (94) 1,100 - discontinued operations 1 1 5 — — — — — — — — (58) (51) (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 At 1 January 2012 (493) 2,306 (1,274) 359 (219) (33) (52) 252 550 (17) (3,294) (18) (1,933) Transfers to disposal groups 1 — — — — — 2 — — — — — 3 (Disposal)/acquisition of subsidiaries (2) (38) (85) — — (6) (4) — — — — 52 (83) Charge/(credit) to income statement - continuing operations 71 (482) 237 (13) 84 25 (18) (15) (128) — 225 (75) (89)
UK tax losses carried forward - The Royal Bank of Scotland plc 2,654 2,623 143 - UK branch of RBS N.V. 322 166 3,361 - National Westminster Bank Plc 66 93 349 - RBS Management Services (UK) Ltd 30 51 — 3,072 2,933 3,853 Overseas tax losses carried forward - Ulster Bank Ireland 72 284 260 - RBS Citizens Financial Group 87 — — - RBS N.V. Australia — 77 — - RBS Aerospace — — 161 159 361 421 3,231 3,294 4,274
The Royal Bank of Scotland plc reported a taxable profit in 2011 and a tax loss in 2012. The tax loss in 2012 reflects the reversal of previous own credit gains offset by core banking profitability. Based on the Group’s strategic plan, all of the carried forward losses will be substantially utilised against future taxable profits of The Royal Bank of Scotland plc by the end of 2018. A 20% reduction in forecast profits would extend the recovery period by one year to 2019.
National Westminster Bank Plc - the deferred tax asset in respect of tax losses at 31 December 2012 relates to residual unrelieved trading losses that arose between 2009 and 2012. 95% of the losses that arose were relieved against taxable profits arising in other UK Group companies. Based on the Group’s strategic plan, the residual carried forward losses will be fully utilised against future taxable profits of the company by the end of 2015. A 20% reduction in forecast profits would extend the recovery period by one year to 2016.
RBS Citizens Financial Group - a deferred tax asset of £87 million has been recognised in respect of total tax losses of £239 million carried forward at 31 December 2012. The losses on which a deferred tax asset has been recognised will be utilised against future taxable profits in 2013. A 20% reduction in forecast profits would not extend the recovery period beyond 2013.
In a series of exchange and tender offers in May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. In March 2012, the Group exchanged certain subordinated debt securities for new subordinated debt securities. 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.
CAD420 million 10.5% subordinated notes 2022 (issued March 2012) callable March 2017 Lower Tier 2 269 — —
National Westminster Bank Plc €500 million 5.125% subordinated notes 2011 — — 442 £300 million 7.875% subordinated notes 2015 Lower Tier 2 360 371 370 £300 million 6.5% subordinated notes 2021 Lower Tier 2 410 400 367
The Royal Bank of Scotland Group plc (1) Non-cumulative preference shares of US$0.01 Series F US$156 million 7.65% (callable any time from March 2007) (2) Tier 1 97 101 101 Series H US$242 million 7.25% (callable any time from March 2004) (2) Tier 1 150 157 156 Series L US$751 million 5.75% (callable any time from October 2009) (2) Tier 1 465 485 484
Non-cumulative convertible preference shares of US$0.01 Series 1 US$65 million 9.118% (callable any time from March 2010) (3) Tier 1 41 43 43
Non-cumulative convertible preference shares of £0.01 Series 1 £15 million 7.387% (callable any time from December 2010) (3) Tier 1 15 15 15
Non-cumulative preference shares of US$25 Series C US$246 million 7.7628% (callable quarterly from April 2002) (2,4) Tier 1 161 169 168
Notes: (1) Further details of the contractual terms of the preference shares are given in Note 26. (2) Partially repurchased following completion of the exchange and tender offers in May 2010. (3) Partially converted into ordinary shares in the company in 2010. (4) Series C preference shares each carry a gross dividend of 8.625% inclusive of associated tax credit. Redeemable at the option of the issuer at par.
Services Authority, be redeemed by the issuer on the dates specified above or on any interest payment date thereafter. They may also be redeemed in whole, but not in part, upon the occurrence of certain tax and regulatory events. Dividends are non-cumulative and may, subject to the restrictions described in (5) below, be paid provided distributable profits are sufficient unless payment would breach the capital adequacy requirements of the UK Financial Services Authority. Distributions are not made if dividends are not paid on any series of the company’s non-cumulative preference shares. The company classifies its obligations to these subsidiaries as dated loan capital.
At 1 January 2011 — 295 1,424 1,719 Currency translation and other adjustments — (20) (34) (54) (Loss)/profit attributable to non-controlling interests - continuing operations — (7) (7) (14)
Losses on available-for-sale financial assets, net of tax — 2 — 2 Equity withdrawn and disposals — (29) (392) (421) At 1 January 2012 — 283 951 1,234 Currency translation and other adjustments — (12) (6) (18) (Loss)/profit attributable to non-controlling interests - continuing operations — (43) 32 (11)
Dividends paid — — (13) (13) Losses on available-for-sale financial assets, net of tax — 25 — 25 Equity raised 873 — 2 875 Equity withdrawn and disposals — — (23) (23) Transfer from retained earnings 361 — — 361 At 31 December 2012 1,109 266 943 2,318
Other non-controlling interests include the following trust preferred securities: 2012 2011 2010 £m £m £m
Notes: (1) Partially repurchased following completion of the exchange and tender offers in May 2010. (2) The trust preferred securities issued by subsidiaries have no maturity date and are not redeemable at the option of the holders at any time. These securities may, with the consent of the UK Financial
(3) The trust preferred securities were subject to restrictions on dividend payments agreed with the European Commission (see page 434).
Ordinary shares of 25p (1) 14,807 82 (14,889) — Ordinary shares of £1 (1) — 115 5,956 6,071 B shares of £0.01 510 — — 510 Dividend access share of £0.01 — — — — Non-cumulative preference shares of US$0.01 1 — — 1 Non-cumulative convertible preference shares of US$0.01 — — — — Non-cumulative preference shares of €0.01 — — — — Non-cumulative convertible preference shares of £0.01 — — — — Non-cumulative preference shares of £1 — — — — Cumulative preference shares of £1 1 — — 1
At 1 January 2011 58,458,131 Shares issued 770,281 At 1 January 2012 59,228,412 Shares issued (ordinary shares of 25p) 325,907 Share sub-division and consolidation (1) (53,598,887) Shares issued (ordinary shares of £1) 115,333 At 31 December 2012 6,070,765
Notes on the consolidated accounts continued 26 Share capital continued Ordinary shares Following approval at the Group’s Annual General Meeting on 30 May 2012, the sub-division and consolidation of the Group’s ordinary shares on a one-for-ten basis took effect on 6 June 2012. The nominal value of the ordinary shares was amended to £1. The sub-division and consolidation of the Group’s ordinary shares resulted in the creation of 59,554,319,127 deferred shares of 15p each, which were cancelled on 6 June 2012.
In 2012, the company issued 326 million ordinary shares of 25p each prior to the sub-division and consolidation and 62 million ordinary shares of £1 each following the sub-division and consolidation, in connection with employee share schemes.
In September 2012, 52.7 million ordinary shares of £1 each were issued at 227.87 pence each to yield gross proceeds of £120 million for the purpose of neutralising the Core Tier 1 effects of paying coupons on discretionary hybrid capital securities. The shares were listed on allotment to UBS AG. The subscription price was determined by reference to the average market price between 3 August and 10 September 2012 when the share price closed at 253 pence per share.
The dividend access share entitles the holder to dividends equal to the greater of 7% of the aggregate issue price of B shares issued to HM Treasury and 250% of the ordinary dividend rate multiplied by the number of B shares issued, less any dividends paid on the B shares and on ordinary shares issued on conversion. Dividends on the dividend access share are discretionary unless a dividend has been paid on the ordinary shares, in which case dividends became mandatory. The dividend access share does not generally carry voting rights at general meetings of ordinary shareholders and is not convertible into ordinary shares.
Class of preference share Number of shares in issue Interest rate Redemption date on or after Redemption price per share Debt/equity (1)
Own shares held - at 31 December 2012, 51 million ordinary shares of £1 each of the company (2011 - 164 million; 2010 - 172 million, restated to reflect the share sub-division and consolidation which took effect in June 2012) were held by Employee Share Trusts in respect of share awards and options granted to employees. Employee share trusts awarded 22.5 million ordinary shares in satisfaction of the exercise of awards under employee share plans during the year.
Finance lease contracts and hire purchase agreements Operating lease assets: Year in which receipt will occur Gross amounts £m
Within 1 year 3,605 (330) (40) 3,235 293 After 1 year but within 5 years 5,963 (600) (197) 5,166 512 After 5 years 4,984 (1,709) (315) 2,960 291 Total 14,552 (2,639) (552) 11,361 1,096
Within 1 year 3,996 (340) (29) 3,627 406 After 1 year but within 5 years 6,806 (763) (193) 5,850 605 After 5 years 5,822 (2,710) (270) 2,842 359 Total 16,624 (3,813) (492) 12,319 1,370
Nature of operating lease assets on the balance sheet Transportation 1,432 1,549 6,162 Cars and light commercial vehicles 606 995 1,016 Other 165 161 208 2,203 2,705 7,386
Amounts recognised as income and expense Finance leases - contingent rental income (110) (133) (160) Operating leases - minimum rentals payable 392 490 519
Finance lease contracts and hire purchase agreements Accumulated allowance for uncollectable minimum receivables 278 347 401
The Group provides asset finance to its customers through acting as a lessor. It purchases plant, equipment and intellectual property, renting them to customers under lease arrangements that, depending on their terms, qualify as either operating or finance leases.
Covered bond programme Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of covered bonds by the Group. The Group retains all of the risks and rewards of these loans, the partnerships are consolidated, the loans retained on the Group’s balance sheet and the related covered bonds included within debt securities in issue.
The following table shows: (i) the asset categories that have been pledged to secured funding structures, including assets backing publicly issued own-asset securitisations and covered bonds; and
Other collateral given This primarily relates to cash collateral relating to derivative contracts as well as assets pledged for bank and other borrowings.
The Group transferred certain assets resulting in their derecognition, but the Group has continuing involvement as defined in IFRS 7 in these assets through holdings of debt securities with a carrying value of £398 million (fair value - £339 million) at 31 December 2012. Income for the year was £13 million.
The Group sponsors and arranges own-asset securitisations, whereby the sale of assets or interests in a pool of assets into an SPE is financed by the issuance of securities to investors. The pool of assets held by the SPE may be originated by the Group, or (in the case of whole loan programmes) purchased from third parties, and may be of varying credit quality. Investors in the debt securities issued by the SPE are rewarded through credit-linked returns, according to the credit rating of their securities. The majority of securitisations are supported through liquidity facilities, other credit enhancements and derivative hedges extended by financial institutions, some of which offer protection against initial defaults in the pool of assets. Thereafter, losses are absorbed by investors in the lowest ranking notes in the priority of payments. Investors in the most senior ranking debt securities are typically shielded from loss, since any subsequent losses may trigger repayment of their initial principal.
Residential and commercial mortgages and credit card receivables form the types of assets generally included in cash securitisations, while corporate loans and commercial mortgages typically serve as reference obligations in synthetic securitisations.
Conduits The Group sponsors and administers a number of asset-backed commercial paper (ABCP) conduits. A conduit is a SPE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed by further commercial paper issuance, repayment of assets or funding from liquidity facilities. Commercial paper is typically short-dated, usually up to three months.
Total assets held by the conduits 2,839 765 3,604 11,208 1,893 13,101 16,390 3,624 20,014 Commercial paper issued (1) 717 — 717 10,590 859 11,449 15,522 2,540 18,062
Notes: (1) Includes £0.7 billion of ABCP issued to RBS plc at 31 December 2012 (2011 - £0.3 billion; 2010 - £0.7 billion). (2) Programme-wide credit enhancement (PWCE) is an additional programme-wide credit support which would absorb the first loss on transactions where liquidity support is provided by a third party. (3) Maximum exposure to loss quantifies the Group’s exposure to its sponsored conduits. It is determined as the Group’s liquidity commitment to its sponsored conduits and additional PWCE which would absorb the first loss on transactions where liquidity support is provided by third parties. Historically, PWCE has been greater than third party liquidity. Therefore the maximum exposure to loss is total deal specific liquidity.
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) 2012 £m
Non-controlling interests Non-controlling interests per balance sheet 2,318 1,234 1,719 Non-controlling preference shares (548) (548) (548) Other adjustments to non-controlling interests for regulatory purposes (1,367) (259) (259)
Other Tier 1 capital Preference shares - equity 4,313 4,313 4,313 Preference shares - debt 1,054 1,094 1,097 Innovative/hybrid Tier 1 securities 4,125 4,667 4,662 9,492 10,074 10,072
It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the FSA. The FSA uses risk asset ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank's capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. The Group has complied with the FSA’s capital requirements throughout the year.
Contingent liabilities Guarantees and assets pledged as collateral security 9,525 2,605 5,453 1,581 19,164 25,032 31,101 Other contingent liabilities 4,428 2,158 2,328 1,783 10,697 10,912 12,254 13,953 4,763 7,781 3,364 29,861 35,944 43,355
Contingent liabilities Guarantees - the Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer's obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount as disclosed in the table above. The Group expects most guarantees it provides to expire unused.
Notes on the consolidated accounts continued 32 Memorandum items continued Contractual obligations for future expenditure not provided for in the accounts The following table shows contractual obligations for future expenditure not provided for in the accounts at the year end.
Operating leases Minimum rentals payable under non-cancellable leases (1) - within 1 year 399 468 497 - after 1 year but within 5 years 1,253 1,453 1,515 - after 5 years 2,286 2,714 2,892 3,938 4,635 4,904 Property, plant and equipment Contracts to buy, enhance or maintain investment properties — — 2 Contracts to buy assets to be leased under operating leases (2,3) — 2,607 2,585 Other capital expenditure 37 35 150 37 2,642 2,737
Notes: (1) Predominantly property leases. (2) Of which due within 1 year: nil (2011 - £486 million; 2010 - £263 million). (3) At 31 December 2011, £2,607 million related to the RBS Aviation Capital business which was sold in 2012. (4) Of which due within 1 year: £444 million (2011 - £483 million; 2010 - £440 million).
Litigation, investigations and reviews The Group and certain Group members are party to legal proceedings, investigations and regulatory matters in the United Kingdom, the United States and other jurisdictions, arising out of their normal business operations. All such matters are periodically reassessed with the assistance of external professional advisers, where appropriate, to determine the likelihood of the Group incurring a liability. The Group recognises a provision for a liability in relation to these matters when it is probable that an outflow of economic benefits will be required to settle an obligation which has arisen as a result of past events, and for which a reliable estimate can be made of the amount of the obligation.
In many proceedings, it is not possible to determine whether any loss is probable or to estimate the amount of any loss. Numerous legal and factual issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, and by addressing novel or unsettled legal questions relevant to the proceedings in question, before a liability can be reasonably estimated for any claim. The Group cannot predict if, how, or when such claims will be resolved or what the eventual settlement, fine, penalty or other relief, if any, may be, particularly for claims that are at an early stage in their development or where claimants seek substantial or indeterminate damages.
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 2012.
The material legal proceedings, investigations and reviews involving the Group are described below. If 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.
Notes on the consolidated accounts continued 32 Memorandum items continued 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 pending individual and class action cases involve the issuance of more than US$85 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 45 lawsuits brought by purchasers of MBS, including the purported class actions identified below.
Unarranged overdraft charges RBS Citizens Financial Group, Inc (RBS Citizens) and its affiliates were among more than thirty banks named as defendants in US class action lawsuits alleging that the manner in which defendant banks posted transactions to consumer accounts caused customers to incur excessive overdraft fees. The complaints against RBS Citizens, which concern the period between 2002 and 2010 and were consolidated into one case, alleged that this conduct violated its duty of good faith and fair dealing, was unconscionable and constituted an unfair trade practice and a conversion of customers' funds. RBS Citizens has agreed to settle this matter for US$137.5 million and, as a result, the matter has been stayed. The Group has made a one-time payment of the settlement amount into a settlement fund which, upon final approval of the settlement, will be used to make payments to class members. A motion for final approval of the settlement was filed on 10 January 2013. If the settlement is given final approval by the United States District Court for the Southern District of Florida, consumers who do not opt out of the settlement will be deemed to have released any claims related to the allegations in the lawsuits.
Summary of other disputes, legal proceedings and litigation In addition to the matters described above, members of the Group are engaged in other disputes and 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 material adverse effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
Political and regulatory scrutiny of the operation of retail banking and consumer credit industries in the United Kingdom, United States and elsewhere continues. The nature and impact of future changes in policies and regulatory action are not predictable and are beyond the Group’s control.
It is not possible to estimate reliably what effect the outcome of these remaining investigations, any regulatory findings and any related developments may have on the Group, including the timing and amount of further fines, sanctions or settlements, which may be material.
The incident, the Group's handling of the incident and the systems and controls surrounding the processes affected, are the subject of regulatory enquiries (both from the UK and Ireland) and the Group could become a party to litigation. In particular, the Group could face legal claims from those whose accounts were affected and could itself have claims against third parties.
The Group will provide fair and reasonable redress to non-sophisticated customers classified as retail clients, who were mis-sold interest rate hedging products. In relation to non-sophisticated customers classified as retail clients who were sold interest rate products other than interest rate caps on or after 1 December 2001 up to 29 June 2012, the Group is required to (i) make redress to customers sold structured collars; and (ii) write to customers sold other interest rate hedging products offering a review of their sale and, if it is appropriate in the individual circumstances, the Group will propose fair and reasonable redress on a case by case basis. Furthermore, non-sophisticated customers classified as retail clients who have purchased interest rate caps during the period on or after 1 December 2001 to 29 June 2012 will be entitled to approach the Group and request a review.
FSA mystery shopping review On 13 February 2013 the FSA announced the results of a mystery shopping review it undertook into the investment advice offered by banks and building societies to retail clients. As a result of that review the FSA announced that firms involved were cooperative and agreed to take immediate action. The Group was one of the firms involved. The action required includes a review of the training provided to advisers, considering whether changes are necessary to advice processes and controls for new business, and undertaking a past business review to identify historic poor advice (and where breaches of regulatory requirements are identified, to put this right for customers). The Group will be required to appoint an independent third party to either carry out or oversee this work. The scope and terms of the past business review and the appointment of the independent third party have not yet been determined. The Group cannot predict the outcome of this review at this stage.
In March 2008, the EC also opened a formal inquiry into Visa’s MIF arrangements for cross border payment card transactions with Visa branded debit and consumer credit cards in the EEA. In April 2009 the EC announced that it had issued Visa with a formal Statement of Objections. However, in 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. In July 2012 Visa made a request to re-open the settlement in order to modify the fee. The EC rejected the request and in October 2012 Visa filed an appeal to the General Court seeking to have that decision annulled. The EC is continuing its investigations into Visa’s cross border MIF arrangements for deferred debit and credit transactions. On 31 July 2012 the EC announced that it had issued Visa with a supplementary Statement of Objections regarding consumer credit cards in the EEA.
The outcome of these investigations is not known, but they may have a material adverse effect on the consumer credit industry in general and, therefore, on the Group’s business in this sector.
Payment Protection Insurance The FSA conducted a broad industry thematic review of Payment Protection Insurance (PPI) sales practices and in September 2008, the FSA announced that it intended to escalate its level of regulatory intervention. Substantial numbers of customer complaints alleging the mis-selling of PPI policies have been made to banks and to the Financial Ombudsman Service (FOS) and many of these are being upheld by the FOS against the banks.
Personal current accounts In July 2008 the OFT published a market study report into Personal Current Accounts (PCAs) raising concerns as regards the way the market was functioning. In October 2009 the OFT summarised initiatives agreed with industry to address these concerns. In 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 UK, in particular in relation to unarranged overdrafts, and that it believed that fundamental changes were required for the market to work in the best interests of bank customers. In March 2010, the OFT announced that it had secured agreement from the banks on four industry-wide initiatives designed to address its concerns, 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 that it would conduct six-monthly reviews and would also review the market again fully in 2012 and undertake a brief analysis on barriers to entry.
On 13 July 2012, the OFT launched its planned full review of the PCA market. The review was intended to consider whether the initiatives agreed by the OFT with banks to date have been successful and whether the market should be referred to the Competition Commission (CC) for a fuller market investigation.
Private motor insurance In December 2011, the OFT launched a market study into private motor insurance, with a focus on the provision of third party vehicle repairs and credit hire replacement vehicles to claimants. The OFT issued its report in May 2012 and advised that it believed there were features of the market that potentially restrict, distort or prevent competition in the market meriting a referral to the CC. On 28 September 2012 the OFT referred the private motor insurance market to the CC for a market investigation. The CC has until 27 September 2014 to publish its findings. At this stage, it is not possible to estimate the effect the market investigation may have on Direct Line Insurance Group plc.
In 2007, the New York State Attorney General issued subpoenas to a wide array of participants in the securitisation and securities industry, focusing on the information underwriters obtained from the independent firms hired to perform due diligence on mortgages. The Group completed its production of documents requested by the New York State Attorney General in 2008, principally producing documents related to loans that were pooled into one securitisation transaction. In May 2011, at the New York State Attorney General's request, representatives of the Group attended an informal meeting to provide additional information about the Group's mortgage securitisation business. The investigation is ongoing and the Group continues to provide requested information.
The Group’s operations include businesses outside the United States that are responsible for processing US dollar payments. The Group has been conducting a review of its policies, procedures and practices in respect of such payments, has voluntarily made disclosures to US and UK authorities with respect to its historical compliance with US economic sanctions regulations, and is continuing to co-operate with related investigations by government authorities. The Group has also, over time, enhanced its relevant systems and controls. Further, the Group has initiated disciplinary proceedings against a number of its employees as a result of its investigation into employee conduct relating to this matter. Although the Group cannot currently determine the outcome of its discussions with the relevant authorities, the investigation costs, remediation required or liability incurred could have a material adverse effect on the Group’s net assets, operating results or cash flows in any particular period.
Notes on the consolidated accounts continued 33 Net cash (outflow)/inflow from operating activities
Operating loss before tax - continuing operations (5,165) (1,190) (154) Operating (loss)/profit before tax - discontinued operations (111) 482 (786) Decrease/(increase) in prepayments and accrued income 787 976 (67) Interest on subordinated liabilities 841 740 500 Decrease in accruals and deferred income (3,653) (2,897) (1,915) Provisions for impairment losses 5,283 8,709 9,298 Loans and advances written-off net of recoveries (3,925) (4,000) (5,631) Unwind of discount on impairment losses (476) (484) (455) Profit on sale of property, plant and equipment (20) (22) (50) (Profit)/loss on sale of subsidiaries and associates (95) 28 107 Profit on sale of securities (1,235) (882) (496) Charge for defined benefit pension schemes 446 349 540 Pension schemes curtailment and settlement gains (41) — (78) Cash contribution to defined benefit pension schemes (977) (1,059) (832) Other provisions charged net of releases 2,899 963 381 Other provisions utilised (1,507) (513) (211) Depreciation and amortisation 1,854 1,875 2,220 Gain on redemption of own debt (454) (255) (553) Write-down of goodwill and other intangible assets 518 91 10 Elimination of foreign exchange differences 7,140 2,702 (691) Other non-cash items 1,809 1,340 494 Net cash inflow from trading activities 3,918 6,953 1,631 Decrease in loans and advances to banks and customers 30,719 15,800 42,766 Decrease in securities 13,537 10,418 8,723 Decrease in other assets 1,672 4,991 445 Decrease/(increase) in derivative assets 88,134 (102,972) 10,741 Changes in operating assets 134,062 (71,763) 62,675 (Decrease)/increase in deposits by banks and customers (7,848) 24,096 (24,794) (Decrease)/increase in insurance liabilities (119) (482) 494 Decrease in debt securities in issue (68,029) (55,496) (28,493) (Decrease)/increase in other liabilities (4,022) 1,827 1,108 (Decrease)/increase in derivative liabilities (89,763) 100,133 2,454 (Decrease)/increase in settlement balances and short positions (13,017) (1,759) 3,651 Changes in operating liabilities (182,798) 68,319 (45,580) Income taxes (paid)/received (295) (184) 565 Net cash (outflow)/inflow from operating activities (45,113) 3,325 19,291 34 Analysis of the net investment in business interests and intangible assets Acquisitions and disposals £m
Fair value given for businesses acquired (68) (44) (210) Other assets sold 1,317 (299) 4,539 Non-cash consideration (90) — — Loss on disposal 95 (28) (107) Net inflow/(outflow) of cash in respect of disposals 1,322 (327) 4,432 Dividends received from joint ventures 22 11 7 Cash expenditure on intangible assets (924) (1,068) (783)
The Group's reported results from continuing operations for 2012, 2011 and 2010 would not have been materially affected had all acquisitions occurred on 1 January 2010.
At 1 January 52,972 52,750 64,240 26,319 27,053 37,652 Issue of ordinary shares 120 2 1 — — — Redemption of preference shares — — 117 — — — Redemption of paid-in equity — — (132) — — — Cancellation of non-voting deferred shares — — (27) — — — Net proceeds from issue of subordinated liabilities — — — 2,093 — — Repayment of subordinated liabilities — — — (258) (627) (1,588) Net cash inflow/(outflow) from financing 120 2 (41) 1,835 (627) (1,588) Transfer to retained earnings — (50) (12,252) — — — Share capital sub-division and consolidation (8,933) — — — — — Ordinary shares issued in respect of employee share schemes 437 270 803 — — — Other adjustments including foreign exchange (1) — — — (1,381) (107) (9,011)
At 1 January - cash 109,888 102,573 95,330 - cash equivalents 42,767 49,957 48,856 152,655 152,530 144,186 Disposal of subsidiaries — — (4,112) Net cash (outflow)/inflow (19,814) 125 12,456 At 31 December 132,841 152,655 152,530
Bank of England £0.4bn £0.4bn £0.4bn US Federal Reserve US$1.2bn US$1.2bn US$1.0bn De Nederlandsche Bank €0.4bn €1.0bn €1.0bn
Although Direct Line Group has been reclassified as a discontinued operation, it continues to be presented as a reportable operating segment.
Statutory basis including the results of Direct Line Group discontinued operations 11,680 9,963 21,643 (19,806) (1,854) (5,279) (5,296) Direct Line Group discontinued operations (1) (278) (3,424) (3,702) 3,781 52 — 131 Statutory basis 11,402 6,539 17,941 (16,025) (1,802) (5,279) (5,165)
UK Retail 4,302 1,206 5,508 (2,699) — (788) 2,021 UK Corporate 3,092 1,771 4,863 (1,974) (172) (793) 1,924 Wealth 645 459 1,104 (820) (11) (25) 248 International Banking 1,157 1,398 2,555 (1,623) (9) (168) 755 Ulster Bank 736 211 947 (546) (1) (1,384) (984) US Retail & Commercial 1,900 1,137 3,037 (2,057) (117) (326) 537 Markets 67 4,348 4,415 (3,319) (159) (38) 899 Direct Line Group (1) 343 3,729 4,072 (3,583) (35) — 454 Central items (201) 221 20 950 (781) 2 191 Core 12,041 14,480 26,521 (15,671) (1,285) (3,520) 6,045 Non-Core 648 540 1,188 (1,133) (357) (3,919) (4,221)
Reconciling items Own credit adjustments — 1,914 1,914 — — — 1,914 Asset Protection Scheme — (906) (906) — — — (906) Payment Protection Insurance costs — — — (850) — — (850) Sovereign debt impairment — — — — — (1,099) (1,099) Interest rate hedge adjustments on impaired available-for-sale sovereign debt — — — — — (169) (169) Amortisation of purchased intangible assets — — — — (222) — (222)
Statutory basis including the results of Direct Line Group discontinued operations 14,209 17,659 31,868 (20,861) (2,150) (9,256) (399) Direct Line Group discontinued operations (1) (427) (4,819) (5,246) 5,445 25 21 245 Statutory basis 13,782 12,840 26,622 (15,416) (2,125) (9,235) (154)
Reconciling items Own credit adjustments (4,649) — (4,649) 1,914 — 1,914 242 — 242 Asset Protection Scheme (44) — (44) (906) — (906) (1,550) — (1,550) Integration and restructuring costs — — — (5) — (5) — — — Gain on redemption of own debt 454 — 454 255 — 255 553 — 553 Strategic disposals 113 — 113 (24) — (24) 171 — 171 RFS Holdings minority interest (2) — (2) (3) — (3) (141) — (141)
Cost to acquire fixed assets and intangible assets £m Assets £m Liabilities £m
Currency translation and other adjustments — — 25 (22) 172 — — 1 (40) 136 Write-down of goodwill - continuing operations — — (1) — — — — — — (1)
Net interest income 8,536 3,128 1,353 765 13,782 Net fees and commissions 3,582 1,557 600 562 6,301 Income from trading activities 2,106 1,963 197 251 4,517 Other operating income/(loss) 1,253 232 835 (412) 1,908 Insurance premium income (net of reinsurers' share) 114 — — — 114 Total income 15,591 6,880 2,985 1,166 26,622
Operating profit/(loss) before tax 1,105 2,091 (2,448) (902) (154) 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 1,218 1,137 Chairman and executive directors - emoluments 3,853 4,671 - contributions and allowances in respect of money purchase schemes 408 403 5,479 6,211 - amounts receivable under long-term incentive plans 1,223 1,594 6,702 7,805
No directors are accruing benefits under defined benefit schemes (2011 - nil). One director is accruing benefits under a money purchase scheme (2011 - one).
Compensation of key management The aggregate remuneration of directors and other members of key management during the year was as follows: Short-term benefits 32,512 36,371 Post-employment benefits 699 3,547 Share-based payments 24,533 21,062 57,744 60,980 40 Transactions with directors and key management (a) At 31 December 2012, amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group, as defined in UK legislation, were £36,915 in respect of loans to six persons who were directors of the company at any time during the financial period.
(b) For the purposes of IAS 24 ‘Related Party Disclosures’, key management comprise directors of the company and members of the Group Management Committee. The captions in the Group's primary financial statements include the following amounts attributable, in aggregate, to key management: Loans and advances to customers 11,748 19,366 Customer accounts 36,250 33,149
The Group enters into transactions with many of these bodies on an arm’s length basis. The principal transactions during 2012, 2011 and 2010 were: the Asset Protection Scheme, Bank of England facilities and the issue of debt guaranteed by the UK Government discussed below. In addition, the redemption of non-cumulative sterling preference shares and the placing and open offer in April 2009 was underwritten by HM Treasury and, in December 2009, B shares were issued to HM Treasury and a contingent capital agreement concluded with HM Treasury (see Note 26). Other transactions include the payment of: taxes principally UK corporation tax (page 386) and value added tax; national insurance contributions; local authority rates; and regulatory fees and levies (including the bank levy (page 375) and FSCS levies (page 454)); together with banking transactions such as loans and deposits undertaken in the normal course of banker-customer relationships.
There was no change in the recognition and measurement of the covered assets as a result of the APS.
In connection with its participation in the APS, the Group agreed to a number of behavioural commitments in respect of lending for businesses in the UK and personal current accounts in the UK. These commitments ran for two years and were completed by the end of February 2011.
Members of the Group that are UK authorised institutions are required to maintain non-interest bearing (cash ratio) deposits with the Bank of England amounting to 0.11% of their eligible liabilities. They also have access to Bank of England reserve accounts: sterling current accounts that earn interest at the Bank of England Rate.
Notes on the consolidated accounts continued 41 Related parties continued National Loan Guarantee Scheme The Group participated in the National Loan Guarantee Scheme (NLGS), providing loans and facilities to eligible customers at a discount of one percent. It did not issue any guaranteed debt under the scheme and consequently, it was not committed to providing a particular volume of reduced rate facilities. Lending under the scheme, amounting to £898 million at 31 December 2012, is accounted for in accordance with the Group’s accounting policy for loans and receivables. The NLGS was superseded by the Funding for Lending Scheme.
42 Post balance sheet events There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.
Assets Loans and advances to banks 3 24,066 18,368 19,535 Loans and advances to customers 3 1,266 4,056 6,689 Debt securities 7 1,522 1,568 1,454 Investments in Group undertakings 8 54,995 53,871 49,125 Derivatives 6 511 1,502 1,475 Prepayments, accrued income and other assets 20 25 30 Total assets 82,380 79,390 78,308
Liabilities Deposits by banks 3 1,455 1,091 — Customer accounts 3 838 977 1,029 Debt securities in issue 3 9,310 8,373 8,742 Derivatives 6 7 79 231 Accruals, deferred income and other liabilities 9 491 704 1,034 Subordinated liabilities 10 11,305 8,777 8,048 Total liabilities 23,406 20,001 19,084 Owners’ equity 58,974 59,389 59,224 Total liabilities and equity 82,380 79,390 78,308
Merger reserve At 1 January 2,341 2,391 14,641 Transfer to retained earnings — (50) (12,250)
Contingent capital reserve At 1 January and 31 December (1,208) (1,208) (1,208)
Retained earnings At 1 January 18,308 18,365 13,262 Loss attributable to ordinary and B shareholders and other equity owners (684) (107) (4,554) Equity preference dividends paid (273) — (105) Paid-in equity dividends paid, net of tax (15) — (19) Transfer from paid-in equity - gross — — 2 - tax — — (1) Redemption of equity preference shares — — (2,968) Gain on redemption of equity preference shares — — 616 Redemption of preference shares classified as debt — — (118) Transfer from merger reserve — 50 12,250 At 31 December 17,336 18,308 18,365
Total comprehensive loss recognised in the statement of changes in equity is attributable to: Preference shareholders 273 — 105 Paid-in equity holders 15 — 19 Ordinary and B shareholders (972) (107) (4,677)
Cash flow statement for the year ended 31 December 2012 £m
Operating activities Operating loss before tax (529) (34) (4,471) Profit on disposal of investment in subsidiaries (157) — — Adjustments for: Write-down of investment in subsidiaries 1,785 570 5,124 Interest on subordinated liabilities 486 419 462 Impairment of loans to Group entities 1,409 — — Gain on redemption of own debt — — (53) Elimination of foreign exchange differences (194) (4) 272 Other non-cash items (1) (5) (1) Net cash flows from trading activities 2,799 946 1,333 Changes in operating assets and liabilities (3,725) 2,964 (10,238) Net cash flows from operating activities before tax (926) 3,910 (8,905) Income taxes paid (58) (95) (133) Net cash flows from operating activities 12 (984) 3,815 (9,038)
Investing activities Investment in subsidiaries (2,900) (4,568) (1,884) Disposal of subsidiaries 892 — 6 Net cash flows from investing activities (2,008) (4,568) (1,878)
Financing activities Issue of ordinary shares 120 2 1 Redemption of paid-in equity — — (132) Issue of subordinated liabilities 2,747 940 — Redemption of preference shares — — (2,352) Repayment of subordinated liabilities — (193) (98) Dividends paid (288) — (124) Interest on subordinated liabilities (423) (415) (475) Net cash flows from financing activities 2,156 334 (3,180) Effects of exchange rate changes on cash and cash equivalents (50) (55) 5
Total comprehensive loss is attributable to: Preference shareholders 273 — 105 Paid-in equity holders 15 — 19 Ordinary and B shareholders (972) (107) (4,677)
The company did not pay an ordinary dividend in 2012, 2011 or 2010.
Prepayments, accrued income and other assets - non-financial assets 20 25 30
Debt securities in issue - amortised cost 9,310 8,373 8,742 Derivatives held-for-trading (2) 7 79 231 Accruals, deferred income and other liabilities - non-financial liabilities 491 704 1,034 Subordinated liabilities - amortised cost 11,305 8,777 8,048
Carrying value £bn Fair value £bn Carrying value £bn Fair value £bn Carrying value £bn Fair value £bn
12 months More than 12 months Total Less than 12 months More than 12 months Total Less than 12 months More than 12 months Total £m £m £m £m £m £m £m £m £m
On balance sheet liabilities The following table shows by contractual maturity, the undiscounted cash flows payable up to a period of 20 years from the balance sheet date, including future payments of interest.
Deposits by banks 6 338 325 958 — — Customer accounts 18 97 742 — — — Debt securities in issue 1,975 3,663 2,406 567 1,194 — Subordinated liabilities 85 826 1,796 680 3,158 2,314 2,084 4,924 5,269 2,205 4,352 2,314
8 Investments in Group undertakings Investments in Group undertakings are carried at cost less impairment. Movements during the year were as follows: At 1 January 53,871 49,125 64,766 Currency translation and other adjustments (37) (2) (49) Additional investments in Group undertakings 3,710 4,607 1,884 Additions — 761 — Redemption of investments in Group undertakings (29) (50) (12,346)
£m Thereafter £m Perpetual £m Total £m £m Thereafter £m Perpetual £m Total £m £m Thereafter £m Perpetual £m Total £m 2012 2011 2010 Dated loan capital £m £m £m
US$2,250 million 6.125% subordinated notes 2022 (issued December 2012) (1) 1,392 — — €1,250 million floating rate 2042 (callable quarterly from June 2012) (1,2) 1,019 1,079 1,111 US$750 million 6.8% 2042 (callable quarterly from December 2042) (1,2) 464 485 483 US$850 million 4.709% 2043 (callable quarterly from July 2013) (1,2) 526 548 546 US$650 million 6.425% 2043 (callable quarterly from January 2034) (1,2) 399 417 416 €500 million 4.243% 2046 (callable quarterly from January 2016) (1,2) 424 435 449 US$950 million 5.512% 2044 (callable quarterly from September 2014) (1,2) 595 621 619 US$550 million floating rate 2044 (callable quarterly from September 2014) (1,2) 340 354 353 US$450 million floating rate 2044 (callable quarterly from September 2014) (1,2) 278 291 290 £400 million 5.6457% 2047 (callable quarterly from June 2017) (2) 413 413 411
US$106 million undated floating rate primary capital notes (callable semi-annually from December 1990) (1) 66 69 69 US$762 million 7.648% perpetual regulatory tier one securities (callable quarterly from September 2031) (2) 477 497 494 £940 million floating rate perpetual subordinated loan 1,004 950 — US$150 million 8.000% perpetual subordinated loan (issued April 2012) 98 — — US$136 million 7.750% perpetual subordinated loan (issued April 2012) (callable on any date from May 2023) 88 — — £200 million floating rate perpetual subordinated loan (issued June 2012) 209 — — £885 million floating rate perpetual subordinated loan (issued September 2012) 904 — — £100 million floating rate perpetual subordinated loan (issued December 2012) 100 — —
Non-cumulative preference shares of US$0.01 Series F US$156 million 7.65% (callable anytime from March 2007) (2) 97 101 101 Series H US$242 million 7.25% (callable anytime from March 2004) (2) 150 157 156 Series L US$751 million 5.75% (callable anytime from October 2009) (2) 465 485 484
Non-cumulative convertible preference shares of US$0.01 Series 1 US$65 million 9.118% (callable anytime from March 2010) (3) 41 43 43
Cumulative preference shares of £1 £0.5 million 11% and £0.4 million 5.5% (not callable) 1 1 1
12 Net cash (outflow)/inflow from operating activities 2012 2011 2010 £m £m £m
13 Interest received and paid £m 14 Analysis of changes in financing during the year
Comprising: Loans and advances to banks 997 1,883 2,357 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 472 provides detailed disclosures.
17 Related parties Key management had no reportable transactions or balances with the company.
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 2012 are presented below.
Net interest income 11,402 12,303 13,782 12,928 14,847 Non-interest income (1,2,3) 6,539 12,348 12,840 14,650 330 Total income 17,941 24,651 26,622 27,578 15,177 Operating expenses (4,5,6,7,8) (17,827) (17,134) (17,456) (16,569) (34,051) Profit/(loss) before insurance net claims and impairment losses 114 7,517 9,166 11,009 (18,874) Insurance net claims — — (85) (134) (184)
Tax (charge)/credit (469) (1,127) (703) 490 2,388 Loss from continuing operations (5,634) (2,317) (857) (2,526) (24,067) (Loss)/profit from discontinued operations, net of tax (172) 348 (809) 203 (10,475)
Loss attributable to: Non-controlling interests (123) 28 (665) 349 (10,832) Preference shareholders 273 — 105 878 536 Paid-in equity holders 15 — 19 57 60 Ordinary and B shareholders (5,971) (1,997) (1,125) (3,607) (24,306)
Notes: (1) The number of ordinary shares in issue in prior years has been restated for the effect of the ordinary share sub-division and consolidated in June 2012. The number of ordinary shares in issue in 2008 were adjusted retrospectively for the bonus element of the rights issue completed in June 2008 and the capitalisation issue in September 2008. (2) None of the convertible securities had a dilutive effect in 2012, 2011, 2010, 2009 or 2008. (3) Return on average total assets represents (loss)/profit attributable to ordinary and B shareholders as a percentage of average total assets. (4) Return on average ordinary and B shareholders' equity represents (loss)/profit attributable to ordinary and B shareholders expressed as a percentage of average ordinary and B shareholders' equity. (5) 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).
UK Central and local government 1,636 12 1,852 3,500 4,617 3,919 3,174 3,091 Finance 7,399 3,874 2,451 13,724 39,158 38,975 36,283 42,432 Residential mortgages 2,612 6,463 100,117 109,192 100,376 101,157 92,583 80,967 Personal lending 12,957 4,906 1,823 19,686 19,802 23,236 25,254 26,989 Property 16,957 15,606 12,584 45,147 35,654 41,957 48,895 52,127 Construction 3,606 1,279 641 5,526 5,004 6,340 7,780 10,171 Manufacturing 5,730 2,587 1,038 9,355 7,083 9,111 11,432 15,074 Service industries and business activities 17,372 17,289 15,339 50,000 35,364 45,685 51,855 58,638 Agriculture, forestry and fishing 947 531 1,221 2,699 2,505 2,758 2,913 2,972 Finance leases and instalment credit 2,867 4,451 3,198 10,516 11,216 13,374 16,186 17,363 Accrued interest 305 26 34 365 423 558 992 2,463 Total domestic 72,388 57,024 140,298 269,710 261,202 287,070 297,347 312,287 Overseas residents 74,159 7,776 2,832 84,767 89,943 87,750 89,891 119,656 Total UK offices 146,547 64,800 143,130 354,477 351,145 374,820 387,238 431,943
The scheduled repayments for retail loans generally include an amortisation of principal. However, the Group has a portfolio of interest only loans including mortgages linked to endowment policies and to personal equity plans, individual savings accounts and personal pension arrangements. From December 2012, the Royal Bank and NatWest no longer offer interest only residential mortgages: buy-to-let interest only mortgages are still available. The Ulster Bank Group and Coutts continue to offer their high net worth customers interest only mortgages. In the US, Citizens Financial Group provides its customers with mortgages, home equity lines of credit and student loans with flexible payment schedules including interest only periods. The Group also offers interest only personal loans. As discussed on page 176, as part of its retail forbearance programmes the Group may agree conversions to interest only. Interest only retail loans at 31 December 2012 amounted to £60.0 billion. Included within this total are £8.8 billion of mortgages which are on mixed repayment, split between interest only and capital repayment and £2.1 billion of forbearance interest only arrangements.
Provisions at the end of the year (2) Domestic 8,652 7,728 8,199 6,670 4,474 Foreign 12,598 12,155 9,983 10,613 6,542 21,250 19,883 18,182 17,283 11,016 Gross loans and advances to customers Domestic 269,710 261,202 287,070 297,347 312,287 Foreign 251,561 274,164 286,245 448,172 573,324 521,271 535,366 573,315 745,519 885,611
Notes: (1) Includes £23 million charge relating to loans and advances to banks (2011 - nil; 2010 - £13 million release; 2009 - £34 million charge; 2008 - £118 million charge). (2) Includes closing provisions against loans and advances to banks of £114 million (2011 - £123 million; 2010 - £127 million; 2009 - £157 million; 2008 - £127 million). (3) For the purpose of these ratios, closing customer provisions and customer charge relating to loans and advances to banks are excluded.
Loan impairment provisions at end of year Customers 21,136 19,760 18,055 17,126 10,889 Banks 114 123 127 157 127 21,250 19,883 18,182 17,283 11,016
As a % of average loans and advances to customers during the year Total customer provisions charged to income statement 1.0% 1.3% 1.5% 1.6% 0.7% Amounts written-off (net of recoveries) - customers 0.7% 0.7% 0.9% 0.8% 0.3%
Analysis of closing customer loan impairment provisions The following table analyses customer loan impairment provisions by geographical area and type of domestic customer.
Note: (1) Includes £29 million written-off in respect of loans and advances to banks in 2012.
Financial summary continued Risk elements in lending Risk elements in lending (REIL) comprises impaired loans and accruing loans past due 90 days or more as to principal or interest.
Impaired loans (2) Domestic 15,323 14,528 15,471 13,572 8,588 Foreign 23,163 24,219 20,230 21,453 10,891 Total 38,486 38,747 35,701 35,025 19,479 Accruing loans which are contractually overdue 90 days or more as to principal or interest Domestic 2,007 1,697 2,363 2,224 1,201 Foreign 634 401 534 1,000 581 Total 2,641 2,098 2,897 3,224 1,782 Total risk elements in lending 41,127 40,845 38,598 38,249 21,261
Closing provisions for impairment as a % of total risk elements in lending 52% 49% 47% 46% 52% Risk elements in lending as a % of gross lending to customers excluding reverse repos (4) 9.1% 8.6% 7.3% 5.4% 2.5%
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) Impaired loans at 31 December 2012 include £5,350 million of loans whose terms were renegotiated or secured retail loans subject to forbearance granted during 2012. (4) Includes disposal groups.
Renegotiations and forbearance The table below shows wholesale loans renegotiated and retail loans granted forbearance during the year. These loans are unimpaired: either the loan was performing before and after the renegotiation or the granting of forbearance or the loan was non-performing before but subsequently transferred to the performing book. Loans with impairment provisions subject to renegotiation or forbearance continue to be reported as impaired loans.
Notes: (1) Wholesale renegotiations include only those arrangements above thresholds set individually by the divisions, ranging from nil to £10 million. (2) For 2012, wholesale renegotiations were £4,302 million (refer to page 174) and secured retail loans subject to forbearance were £4,026 million (refer to page 177). Unsecured retail loans subject to forbearance are not included. The balance of unsecured retail loans subject to forbearance amounts to £182 million.
United States 21,201 14,382 36,813 72,396 14,240 58,156 France 17,293 16,007 6,756 40,056 4,285 35,771 Germany 22,962 6,276 10,467 39,705 4,685 35,020 Netherlands 2,900 3,055 10,824 16,779 951 15,828 Japan 7,983 6,962 7,542 22,487 409 22,078 Spain 1,401 4,248 11,589 17,238 1,357 15,881 Republic of Ireland 199 3,789 3,101 7,089 131 6,958 Italy 6,409 1,083 2,188 9,680 3,183 6,497
Held-for-trading 161,242 137,326 116,189 Designated as at fair value through profit or loss 6,323 5,627 4,824 Amortised cost 455,119 468,806 488,470 Total deposits 622,684 611,759 609,483
Overseas US 129,478 135,919 135,642 Rest of the World 67,585 75,194 77,966 Total overseas offices 197,063 211,113 213,608
Overseas based companies and branches Certificates of deposit 689 112 24 12 837 Other time deposits 13,227 1,295 2,007 5,707 22,236 35,076 5,080 6,792 13,874 60,822
At year end - balance (£bn) 132 80 3 3 218 129 93 16 16 254 271 - weighted average interest rate 0.5% 0.5% 0.3% 1.0% 0.5% 0.6% 0.9% 0.9% 1.4% 0.8% 0.6%
During the year - maximum balance (£bn) 181 103 18 20 322 175 111 32 39 357 378 - average balance (£bn) 149 82 9 11 251 142 93 22 31 288 330 - weighted average interest rate 0.5% 0.6% 0.6% 1.2% 0.5% 0.9% 1.1% 0.7% 1.2% 1.0% 0.7%
The Group's undrawn formal facilities, credit lines and other commitments to lend were £215,808 million (2011 - £239,963 million). While the Group has given commitments to provide these funds, some facilities may be subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.
Consolidation rate (2) Period end rate 1.6164 1.5475 1.5524 1.6222 1.4604 Average rate for the year 1.5850 1.6039 1.5455 1.5657 1.8528
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 26 February 2013, the Noon Buying Rate was £1.00 = US$1.5125.
In July, the Bank of England and HM Treasury launched the Funding for Lending Scheme (FLS). It is designed to boost lending to households and non-financial firms. Early indications from the Bank’s Credit Conditions Survey suggested that the supply of credit had expanded towards the end of the year.
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 where there is a large foreign-owned sector that remits profits overseas. GNP increased by 1.2%.
The Group is subject to extensive regulations that impose obligations on financial institutions to maintain appropriate policies, procedures and controls to ensure compliance with the rules and regulations to which they are subject.
United States RBSG is both a bank holding company and a financial holding company within the meaning of the US Bank Holding Company Act of 1956. As such, it is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Among other things, the Group's direct and indirect activities and investments in the United States are limited to those that are 'financial in nature' or 'incidental' or 'complementary' to a financial activity, as determined by the Federal Reserve. The Group is also required to obtain the prior approval of the Federal Reserve before acquiring directly or indirectly, the ownership or control of more than 5% of any class of the voting shares of any US bank or holding company. Under current Federal
Reserve policy, the Group is required to act as a source of financial strength for its US bank subsidiaries. Among other things, this source of strength obligation could require the Group to inject capital into any of its US bank subsidiaries if any of them became undercapitalised.
The Group's US bank and non-bank subsidiaries and the Royal Bank's US branches are also subject to supervision and regulation by a variety of other US regulatory agencies. RBS Citizens N.A. is supervised by the Office of the Comptroller of the Currency, which is charged with the regulation and supervision of nationally chartered banks. RBS Citizens N.A. owns CCO Investments Services Corp., a US broker dealer subject to regulation and supervision by the US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) with respect to its securities activities. Citizens Bank of Pennsylvania is subject to the regulation and supervision of the US Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking. Both banks are subject to supervision and regulation by the Consumer Financial Protection Bureau (CFPB). The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 established the CFPB.
RBS Citizens Financial Group, Inc. is under the supervision of the Federal Reserve as a bank holding company. The Royal Bank's New York branch is supervised by the New York State Department of Financial Services and the Federal Reserve Bank of New York, and its Connecticut branch is supervised by the Connecticut Department of Banking. Both branches are also subject to supervisory oversight by the Federal Reserve Bank of Boston.
The Group's primary US broker dealer, RBS Securities Inc. (RBSSI), formerly known as Greenwich Capital Markets, Inc., is also subject to regulation and supervision by the SEC and FINRA with respect to its securities activities. The futures activities of RBSSI are subject to regulation and oversight by the US Commodity Futures Trading Commission and the Chicago Mercantile Exchange Group-owned exchanges.
Netherlands The consolidated supervisor of RBS N.V. is the De Nederlandsche Bank (DNB). The DNB operates as independent central bank and prudential supervisor of banks, insurance companies, pension funds and securities firms domiciled in the Netherlands, and also as part of the European System of Central Banks.
Major shareholders In December 2008, The Solicitor for the Affairs of Her Majesty's Treasury (HM Treasury) acquired 22,854 million ordinary shares representing 57.9% of the company's issued ordinary share capital. During 2009, HM Treasury acquired a further 16,791 million ordinary shares raising their holding to 70.3% of the company's issued ordinary share capital.
In December 2009, HM Treasury acquired 51 billion B shares in the company representing the entire issued B share capital. At 31 December 2012, HM Treasury’s holding in the company’s ordinary shares was 65.3%.
As far as the company is aware, 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 27 February 2013. All shareholders within a class of the company's shares have the same voting rights.