The level 3 sensitivities above are calculated at a trade or low level portfolio basis. They are not calculated on an overall portfolio basis and therefore do not reflect the likely overall potential uncertainty on the whole portfolio. The figures are aggregated and do not reflect the correlated nature of some of the sensitivities. In particular, for some of the portfolios the sensitivities may be negatively correlated where a downwards movement in one asset would produce an upwards movement in another, but due to the additive presentation of the above figures this correlation cannot be observed. For example, with assets in the APS scheme, the downwards sensitivity on the underlying asset would be materially offset by the consequent upward movement of the APS derivative, so whilst the net sensitivity of the two positions may be lower, it would be shown with the gross upside and downside sensitivity of the two assets inflating the overall sensitivity figures in the above table. The actual potential downside sensitivity of the total portfolio may be less than the non-correlated sum of the additive figures as shown in the above table.
The favourable and unfavourable effects of reasonably possible alternative assumptions on financial instruments carried at fair value were £2,310 million and (£1,820) million respectively of which £860 million and (£940) million related to the APS credit derivative. The reduction in the APS sensitivity corresponds with a decrease in the overall value of the protection that the scheme provides.
Where markets are liquid or very liquid, little judgment is required. However, when the information regarding the liquidity in a particular market is not clear, a judgment may need to be made. This can be made more difficult as assessing the liquidity of a market may not always be straightforward. For an equity traded on an exchange, daily volumes of trading can be seen, but for an-over-the counter (OTC) derivative assessing the liquidity of the market with no central exchange can be more difficult.
The majority of derivative instruments are classified as level 2 as they are vanilla products valued using observable inputs. The valuation uncertainty on these is considered to be low and both input and output testing may be available. Examples of these products would be vanilla interest rate swaps, foreign exchange swaps and liquid single name credit derivatives.
Certain portfolios in level 2 contain instruments whose fair values incorporate the judgements discussed above. These include a portfolio of ABS in Non-Core of £5.7 billion that had more than average level of valuation uncertainty with a range of £5.6 billion to £5.9 billion using alternative valuation assumptions.
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.
The Group primarily uses an industry standard model to project the expected future cash flows to be received from the underlying mortgages and to forecast how these cash flows will be distributed to the various holders of the RMBS. This model utilises data provided by the servicer of the underlying mortgage portfolio, layering on assumptions for mortgage prepayments, probability of default, expected losses, and yield. The Group uses data from third-party sources to calibrate its assumptions, including pricing information from third-party pricing services, independent research, broker quotes, and other independent sources. An assessment is made of third-party data source to determine its applicability and reliability. The Group adjusts the model price with a liquidity premium to reflect the price that the instrument could be traded in the market and may also make adjustments for model deficiencies.
Collateralised debt obligations CDOs purchased from third-parties are valued using independent, thirdparty quotes or independent lead manager indicative prices. For super senior CDOs which have been originated by the Group no specific thirdparty information is available. The valuation of these super senior CDOs therefore takes into consideration outputs from a proprietary model, market data and appropriate valuation adjustments.
Collateralised loan obligations To determine the fair value of CLOs purchased from third parties, the Group uses third-party broker or lead manager quotes as the primary pricing source. These quotes are benchmarked to consensus pricing sources where they are available.
The APS is a single contract providing credit protection in respect of the covered assets. Under IFRS, credit protection is treated either as a financial guarantee contract or as a derivative financial instrument depending on the terms of the agreement and the nature of the protected assets and exposures. The Group has concluded, principally because the covered portfolio includes significant exposure in the form of derivatives, that the APS does not meet the criteria to be treated as a financial guarantee contract. The contract has therefore been accounted for as a derivative financial instrument. It was recognised initially and measured subsequently at fair value with changes in fair value recognised in profit or loss within income from trading activities. There is no change in the recognition and measurement of the covered assets as a result of the APS.
Where protection is provided on a particular seniority of exposure, as is the case with the APS, which requires initial losses to be taken by the Group, it is termed ‘tranched’ protection. The model being used to value the APS - a Gaussian Copula model with stochastic recoveries - is used by the Group to value tranches traded by the exotic credit desk and is a model that is currently used within the wider market.
During 2010, refinements were made to the treatment of derivative trades in the valuation model. This followed a change in the nature of protection provided in relation to certain structured credit trades involving mainly asset backed securities and associated bought protection credit derivatives: the risk of losses arising on the derivative trades due to counterparty risk was replaced by the risk of incurring losses on the underlying asset backed securities that are not recovered through the derivative trades. The valuation refinements were made to accurately reflect the impact of this change and ensure a consistent treatment across all derivative trades.
12 Financial instruments - valuation continued Credit derivatives - other The Group's other credit derivatives include vanilla and bespoke portfolio tranches, gap risk products and certain other unique trades.
Gap risk products are leveraged trades, with the counterparty's potential loss capped at the amount of the initial principal invested. Gap risk is the probability that the market will move discontinuously too quickly to exit a portfolio and return the principal to the counterparty without incurring losses, should an unwind event be triggered. This optionality is embedded within these portfolio structures and is very rarely traded outright in the market. Gap risk is not observable in the markets and, as such, these structures are deemed to be level 3 instruments.
Exotic options do not trade in active markets except in a small number of cases. Consequently, the Group uses models to determine fair value using valuation techniques typical for the industry. These techniques can be divided, firstly, into modelling approaches and, secondly, into methods of assessing appropriate levels for model inputs. The Group uses a variety of proprietary models for valuing exotic trades.
Exotic valuation inputs include correlation between interest rates, foreign exchange rates and commodity prices. Correlations for more liquid rate pairs are valued using independently sourced consensus pricing levels. Where a consensus pricing benchmark is unavailable, these instruments are classified as level 3.
relating to instruments held at year end 2010 £m £m £m £m £m £m £m £m £m £m £m Assets FVTPL (1) Loans and advances 1,059 169 — 10 — 169 (451) (165) 52 843 38 Debt securities 2,782 294 — 1,770 — 1,973 (386) (2,682) 33 3,784 154 Equity shares 711 414 — (26) — 654 — (1,027) (10) 716 54 Derivatives 6,429 (1,561) — 1,728 — 948 (299) (1,534) 26 5,737 (1,556)
relating to instruments held at year end 2009 £m £m £m £m £m £m £m £m £m £m Assets FVTPL (1) Loans and advances 3,148 130 — 330 (1,537) 22 (898) (136) 1,059 11 Debt securities 3,846 (49) — 104 (157) 378 (1,207) (133) 2,782 (165)
12 Financial instruments - valuation continued Fair value of financial instruments not carried at fair value The following table shows the carrying value and the fair value of financial instruments carried on the balance sheet at amortised cost.
Financial assets Cash and balances at central banks 57.0 57.0 52.3 52.3 12.4 12.4 Loans and advances to banks 36.2 36.1 46.3 46.0 82.0 81.9 Loans and advances to customers 493.1 468.8 684.1 650.9 821.1 776.1 Debt securities 7.1 6.4 9.9 9.0 13.0 11.5 Settlement balances 11.6 11.6 12.0 12.0 17.8 17.8
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. 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. As a wide range of valuation techniques is available, it may be inappropriate to compare the Group's fair value information to independent markets or other financial institutions.
Loans and advances to banks and customers Fair value is estimated by grouping loans into homogeneous portfolios and applying a discount rate to the cash flows. The discount rate is based on the market rate applicable at the balance sheet date for a similar portfolio with similar maturity and credit risk characteristics.
13 Financial instruments - maturity analysis Remaining maturity The following table shows the residual maturity of financial instruments, based on contractual date of maturity.
Settlement balances and short positions 16,981 37,128 54,109 17,952 32,924 50,876 24,448 29,829 54,277
Liabilities Deposits by banks — — — 93 — 93 1,802 — 1,802 Customer accounts 1,029 — 1,029 13,264 — 13,264 26 — 26 Debt securities in issue 1,460 7,282 8,742 4,965 6,823 11,788 7,253 6,926 14,179 Derivatives 25 206 231 53 393 446 227 134 361 Subordinated liabilities 307 7,741 8,048 130 8,632 8,762 424 9,890 10,314 325RBS Group 2010
13 Financial instruments - maturity analysis continued On balance sheet liabilities The following tables show 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. Group 0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2010 £m £m £m £m £m £m
Deposits by banks 43,396 4,417 1,243 304 651 374 Customer accounts 402,457 18,580 8,360 4,651 4,393 2,384 Debt securities in issue 89,583 43,032 31,862 22,569 24,209 6,697 Derivatives held for hedging 608 936 2,103 969 681 253 Subordinated liabilities 2,485 2,611 6,570 8,691 8,672 4,607 Settlement balances and other liabilities 12,423 59 136 177 385 25 550,952 69,635 50,274 37,361 38,991 14,340
2008 Deposits by banks 154,614 14,347 3,345 2,754 2,048 34 Customer accounts 523,268 33,450 6,577 6,337 7,298 5,319 Debt securities in issue 131,714 48,652 40,067 38,223 38,667 5,626 Derivatives held for hedging 394 2,216 2,543 1,334 2,682 1,373 Subordinated liabilities 1,753 4,271 6,824 5,793 24,503 13,030 Settlement balances and other liabilities 13,351 5 12 6 10 6 825,094 102,941 59,368 54,447 75,208 25,388
The table above shows the timing of cash outflows to settle financial liabilities, prepared on the following basis: 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 repayment is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the liability is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met. For example, if a structured note is automatically prepaid when an equity index exceeds a certain level, the cash outflow will be included in the less than three months' period whatever the level of the index at the year end. The settlement date of debt securities in issue given by certain securitisation vehicles consolidated by the Group depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date.
Held-for-trading assets and liabilities - held-for-trading assets and liabilities amounting to £665.0 billion (assets) and £586.1 billion (liabilities) (2009 - £650.5 billion assets and £568.5 billion liabilities) have been excluded from the table in view of their short term nature.
Recoveries of amounts previously written-off 90 321 — 411 399 319 Charged/(credited) to the income statement – continuing operations 6,195 3,070 (121) 9,144 13,090 6,478 Charged/(credited) to the income statement – discontinued operations 35 41 (34) 42 1,044 613 Unwind of discount (283) (172) — (455) (408) (194)
Notes: (1) Includes £127 million relating to loans and advances to banks (2009 - £157 million; 2008 - £127 million). (2) There is no provision for impairment losses in the company.
Notes: (1) Impairment provisions individually assessed. (2) Impairment provisions individually assessed on balances of £25,492 million (2009 - £24,540 million; 2008 - £11,313 million).
The Group enters into fair value hedges, cash flow hedges and hedges of net investments in foreign operations. The majority of the Group's interest rate hedges relate to the management of the Group's non-trading interest rate risk. The Group manages this risk within approved limits. Residual risk positions are hedged with derivatives principally interest rate swaps. Suitable larger ticket financial instruments are fair value hedged; the remaining exposure, where possible, is hedged by derivatives documented as cash flow hedges and qualifying for hedge accounting. The majority of the Group's fair value hedges involve interest rate swaps hedging the interest rate risk in recognised financial assets and financial liabilities. Cash flow hedges relate to exposures to the variability in future interest payments and receipts on forecast transactions and on recognised financial assets and financial liabilities. The Group hedges its net investments in foreign operations with currency borrowings and forward foreign exchange contracts.
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. As at 31 December 2010, variable rate financial assets of £41.7 billion and variable rate financial liabilities of £11.4 billion were hedged in such cash flow hedge relationships.
15 Derivatives continued The following table shows the notional amounts and fair values of the Group's derivatives.
Notional Notional Notional amount Assets Liabilities amount Assets Liabilities amount Assets Liabilities £bn £m £m £bn £m £m £bn £m £m Exchange rate contracts Spot, forwards and futures 2,807 39,859 41,424 2,004 26,744 24,898 2,316 83,065 83,568 Currency swaps 1,000 28,696 34,328 922 25,883 23,466 1,074 53,398 54,728 Options purchased 503 14,698 — 440 16,656 — 616 36,762 — Options written 544 — 13,623 476 — 15,555 668 — 35,017
Certain derivative asset and liability balances with the London Clearing House, which meet the offset criteria in IAS 32 ‘Financial Instruments: Presentation’, are shown net.
Fair value hedging Exchange rate contracts — — 160 38 1,257 1,412 Interest rate contracts 2,496 3,767 2,672 3,292 2,944 3,330
Net investment hedging Exchange rate contracts 30 102 10 90 114 596
The following tables show, for the Group, when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. Group 0-1 years £m 1-2 years £m 2-3 years £m 3-4 years £m 4-5 years £m 5-10 years £m 10-20 years £m
Hedged forecast cash flows affect on profit or loss Forecast receivable cash flows 871 758 659 548 421 1,284 397 40 4,978 Forecast payable cash flows (1,701) (1,576) (1,323) (1,023) (878) (2,771) (1,337) (128) (10,737)
Notional Notional Notional amount Assets Liabilities amount Assets Liabilities amount Assets Liabilities £bn £m £m £bn £m £m £bn £m £m
Exchange rate contracts — — — — — 225 331RBS Group 2010
2009 Held-for-trading 8,128 10,427 50,219 6,103 28,820 6,892 893 111,482 Designated as at fair value 122 3 402 483 394 1,178 21 2,603 Available-for-sale 19,071 12,972 45,512 11,210 51,044 3,365 124 143,298 Loans and receivables 1 — — — 7,924 1,853 93 9,871 27,322 23,402 96,133 17,796 88,182 13,288 1,131 267,254
Available-for-sale Gross unrealised gains 109 213 1,062 148 783 90 7 2,412 Gross unrealised losses (60) (89) (266) (119) (3,314) (56) (6) (3,910)
The following table analyses by issuer, the Group's available-for-sale debt securities and the related yield (based on weighted averages), by remaining maturity.
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 2010 £m % £m % £m % £m % £m %
Held-for-trading 19,110 76 19,186 14,394 49 14,443 15,894 1,160 17,054 Designated as at fair value through profit or loss 282 731 1,013
Available-for-sale Gross unrealised gains 67 232 299 293 312 605 1,505 172 1,677 Gross unrealised losses (17) (145) (162) (14) (68) (82) (225) (103) (328)
Dividend income from available-for-sale equity shares was £69 million (2009 - £78 million; 2008 - £276 million).
Notes on the accounts continued 18 Investments in Group undertakings Investments in Group undertakings are carried at cost less impairment. Movements during the year were as follows: Company 2010 2009 2008 £m £m £m
The principal subsidiary undertakings of the company are shown below. Their capital consists of ordinary and preference shares which are unlisted with the exception of certain preference shares issued by NatWest and RBS Holdings N.V.
The Royal Bank of Scotland plc, RBS Insurance Group Limited and RFS Holdings B.V. are directly owned by the company, and all of the other subsidiary undertakings are owned directly, or indirectly through intermediate holding companies, by these companies. All of these subsidiaries are included in the Group's consolidated financial statements and have an accounting reference date of 31 December.
The Royal Bank of Scotland plc Banking Great Britain 100% National Westminster Bank Plc (1) Banking Great Britain 100% Citizens Financial Group, Inc. Banking US 100% Coutts & Company (2) Private banking Great Britain 100% RBS Securities Inc. Broker dealer US 100% RBS Insurance Group Limited Insurance Great Britain 100% Ulster Bank Limited (3) Banking Northern Ireland 100% RBS Holdings N.V. (4) Banking The Netherlands 98%
Cost At 1 January 2010 42,643 2,553 4,139 4,815 54,150 Currency translation and other adjustments (374) (59) (63) (21) (517)
Accumulated amortisation and impairment At 1 January 2010 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 — 68 301 353 722 Charge for the year - discontinued operations — — 2 22 24 Write down of goodwill and other intangible assets 10 — — — 10 At 31 December 2010 14,611 462 1,822 3,441 20,336
Accumulated amortisation and impairment At 1 January 2009 30,062 1,407 2,369 3,408 37,246 Currency translation and other adjustments (2,046) (106) (137) (58) (2,347) Disposal of subsidiaries — — — (13) (13) Disposals and write-off of fully amortised assets — (1) — (138) (139) Charge for the year - continuing operations — 89 183 467 739 Charge for the year - discontinued operations — 173 162 119 454 Write down of goodwill and other intangible assets 363 — — — 363 At 31 December 2009 28,379 1,562 2,577 3,785 36,303
Net book value at 31 December 2009 14,264 991 1,562 1,030 17,847 335RBS Group 2010
Cost At 1 January 2008 42,953 2,344 3,489 3,882 52,668 Transfers to disposal groups (3,692) (240) (105) (146) (4,183) Currency translation and other adjustments 8,905 680 961 214 10,760 Acquisition of subsidiaries 524 — — — 524 Additions — — 23 602 625 Disposal of subsidiaries (3,066) — — (7) (3,073) Disposals and write-off of fully amortised assets — (4) (1) (21) (26)
Net book value at 31 December 2008 15,562 1,373 1,998 1,116 20,049
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 2,376 2,749 US Retail & Commercial Value in use 2,811 2,761 RBS Insurance Value in use 935 935
Impairment testing involves the comparison of the carrying value of a CGU or group of CGUs with its recoverable amount. The recoverable amount is the higher of the unit's fair value and its value in use. Value in use is the present value of expected future cash flows from the CGU or group of CGUs. Fair value is the amount obtainable for the sale of the CGU in an arm's length transaction between knowledgeable, willing parties.
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 variables more significant to each assessment are presented below.
The recoverable amounts for all CGUs at 30 September 2010 were based on the value in use test, using management's latest five-year forecasts. The long-term growth rates have been based on respective country GDP rates adjusted for inflation. The risk discount rates are based on observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
The recoverable amount of UK Retail, based on a 3% (2009 - 4%) terminal growth rate and 15.7% (2009 - 14.6%) pre tax discount rate, exceeded the carrying amount by £6.9 billion (2009 - £0.7 billion). A 1% change in the discount rate or the terminal growth rate would change the recoverable amount by approximately £1.5 billion (2009 - £0.9 billion) and £0.9 billion (2009 - £0.5 billion) respectively. In addition, a 5% change in the forecast pre tax earnings would change the recoverable amount by approximately £0.9 billion (2009 - £0.4 billion).
The recoverable amount of UK Corporate, based on 3% (2009 - 4%) terminal growth rate and a 15.6% (2009 - 15.1%) pre tax discount rate, exceeded its carrying value by £5.3 billion (2009 - £6.1 billion). A 1% change in the discount rate or the terminal growth rate would change the recoverable amount by approximately £1.6 billion (2009 - £1.4 billion) and £0.9 billion (2009 - £0.9 billion) respectively. In addition, a 5% change in the forecast pre tax earnings would change the recoverable amount by approximately £1.0 billion (2009 - £0.8 billion).
The recoverable amount of Wealth, based on a 3% (2009 - 4%) terminal growth rate and a 12.0% (2009 - 15.3%) pre tax discount rate, exceeded its carrying value by more than 100% and was insensitive to a reasonably possible change in key assumptions.
The recoverable amount of RBS Insurance, based on a 3% (2009 - 3%) terminal growth rate and a 13.1% (2009 - 13.9%) pre tax discount rate, exceeded the carrying amount by over £2.4 billion (2009 - £3.0 billion) and was insensitive to a reasonably possible change in key assumptions.
In 2008, the recoverable amounts for all CGUs were based on value in use tests. Goodwill write downs were recorded in Global Banking & Markets, US Retail & Commercial, Europe & Middle East Retail & Commercial Banking and Asia Retail & Commercial Banking divisions. In addition, an impairment charge of £14.5 billion was recorded in respect of goodwill attributable to the State of Netherlands minority interest arising on the acquisition of ABN AMRO.
Operating lease assets Total 2010 £m £m £m £m £m £m £m
Cost or valuation At 1 January 2010 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 (405) — — — — — (405) Disposals and write-off of fully depreciated assets (821) (72) (6) (100) (322) (1,363) (2,684)
Accumulated impairment, depreciation and amortisation At 1 January 2009 — 422 79 492 1,916 1,635 4,544 Transfers to disposal groups — — — (7) (31) — (38) Currency translation and other adjustments — (1) — (11) (48) (69) (129) Disposal of subsidiaries — (1) — — (14) — (15) Write down of property, plant and equipment — 5 — 5 — — 10 Disposals and write-off of fully depreciated assets — — — (2) (126) (419) (547) Charge for the year - continuing operations — 92 8 142 621 564 1,427 Charge for the year - discontinued operations — 36 — 22 78 53 189 At 31 December 2009 — 553 87 641 2,396 1,764 5,441
Cost or valuation At 1 January 2008 3,431 3,645 215 1,688 3,929 11,437 24,345 Transfer to disposal groups — (262) — (188) (349) — (799) Currency translation and other adjustments 320 452 5 149 436 1,313 2,675 Acquisition of subsidiaries — — — 30 31 — 61 Disposal of subsidiaries — — — (2) (57) (5,015) (5,074) Reclassifications — (176) — 197 (14) (7) — Additions 417 486 22 61 837 3,794 5,617 Expenditure on investment properties 8 — — — — — 8 Change in fair value of investment properties (86) — — — — — (86) Disposals and write-off of fully depreciated assets (222) (113) (18) (68) (645) (2,188) (3,254)
Rental income from investment properties was £279 million (2009 - £233 million; 2008 - £257 million). Direct operating expenses of investment properties were £42 million (2009 - £16 million; 2008 - £22 million).
Property, plant and equipment, excluding investment properties, include £298 million (2009 - £213 million; 2008 - £1,132 million) assets in the course of construction.
Freehold and long leasehold properties with a net book value of £2 million (2009 - £5 million; 2008 - nil) were sold subject to operating leases.
Pension schemes in net surplus 105 58 36 — — —
(a) Loss from discontinued operations, net of tax 2010 2009 2008 £m £m £m
Businesses acquired exclusively with a view to disposal comprise those ABN AMRO businesses, including Banca Antonveneta, Asset Management and Private Equity, classified as disposal groups on the acquisition of ABN AMRO on 17 October 2007. The Asset Management business was sold to Fortis on 3 April 2008. Banca Antonveneta, excluding its subsidiary Interbanca, was sold to Banca Monte dei Paschi di Siena S.p.A. on 30 May 2008.
(b) Cash flows attributable to discontinued operations Included within the Group's cash flows are the following amounts attributable to discontinued operations: 2010 2009 2008 £m £m £m
(c) Assets and liabilities of disposal groups Sempra Other 2010 2009 2008 £m £m £m £m £m Assets of disposal groups Cash and balances at central banks — 184 184 129 — Loans and advances to banks 629 22 651 388 — Loans and advances to customers 440 4,573 5,013 3,216 — Debt securities and equity shares 17 3 20 904 —
Settlement balances 555 — 555 1,579 — Property, plant and equipment 18 — 18 136 66 Other assets 260 444 704 5,417 — Discontinued operations and other disposal groups 6,687 5,606 12,293 18,368 66 Assets acquired exclusively with a view to disposal — 191 191 174 1,515 6,687 5,797 12,484 18,542 1,581
24 Accruals, deferred income and other liabilities Group Company 2010 2009 2008 2010 2009 2008 £m £m £m £m £m £m
Note: (1) The table above includes property provisions and other provisions arising in the normal course of business.
Transfers to disposal groups — — 2 — — (2) — — — — — 11 11 (Disposal)/ acquisition of subsidiaries — — — — — — — — — — — (8) (8) Charge/(credit) to income statement 691 (165) (740) (81) (6) 164 (483) 397 165 (6) (973) 305 (732) (Credit)/charge to equity directly (1,033) — — (501) 1 — 126 — 204 — 554 1 (648) Currency translation and other adjustments — (104) 72 107 52 7 1 (63) 54 1 15 (76) 66 At 1 January 2010 (724) 2,815 (1,480) 136 (373) (184) (391) 1,108 (60) (8) (5,134) 67 (4,228) Transfers to disposal groups — (120) — — — — 1 — — — — — (119)
Charge/(credit) to income statement 46 (91) (24) (21) 77 (20) (160) (12) 273 (12) 470 (102) 424 Charge/(credit) to equity directly 73 — — (2) — — (434) — 133 (6) 397 6 167 Currency translation and other adjustments (1) 52 (96) (25) — 112 23 (36) (61) (5) (7) 42 (2)
Insurance premium income 5,379 5,529 6,009 Reinsurers' share (251) (263) (300)
Outstanding claims provisions are not discounted for the time value of money except for claims, principally motor, settled by periodical payments under the Courts Act 2003. Total reserves for claims outstanding in respect of periodical payments are £1,180.0 million (2009 - £91.6 million; 2008 - £29.0 million) gross and £826.6 million (2009 - £26.1 million; 2008 - £3.6 million) net of reinsurance. The corresponding undiscounted amounts are £4,320.9 million (2009 - £275.7 million; 2008 - £85.0 million) gross and £2,659.6 million (2009 - £61.8 million; 2008 - £12.1 million) net of reinsurance. The amounts for 2010 include a provision for estimated periodical payment orders incurred but not reported which is excluded from 2009 and 2008. The rate of interest used for the calculation of present values is 4.5% (2009 - 4.1%; 2008 - 5.0%). The average interval between the date of the last future cash flow being discounted and the end of the financial year is 49.4 years on open and settled cases.
(ii) Provisions for unearned premiums and unexpired short-term insurance risks. Group Gross Reinsurance Net £m £m £m
Opening net assets 554 588 604 Profit from existing business 43 (3) 26 New business contribution (1) 18 31 14 Operating assumption changes — 10 2 Investment return variances (12) 32 (46) Economic assumption changes 2 (4) (2) Transfer to shareholders' funds (71) (106) — Disposal of subsidiaries (402) — —
Movement in provision for liabilities under life contracts and under linked and other investment contracts
Debt securities — 4,484 4,500 Equity securities — 4,642 4,816 Cash and cash equivalents — 102 81
2001 £m 2002 £m 2003 £m 2004 £m 2005 £m 2006 £m 2007 £m 2008 £m 2009 £m 2010 £m
Estimate of ultimate claims costs: At end of accident year 2,395 3,013 3,658 3,710 4,265 4,269 4,621 4,080 4,383 4,459 38,853 One year later (70) 91 (140) (186) (92) (275) (71) 29 120 (594)
Seven years later 6 (14) 28 20 Eight years later 4 14 18 Nine years later 9 9 Current estimate of cumulative claims 2,326 3,046 3,285 3,365 3,920 3,903 4,559 4,118 4,503 4,459 37,484 Cumulative payments to date (2,256) (2,976) (3,144) (3,131) (3,670) (3,482) (3,902) (3,301) (3,157) (2,044) (31,063) 70 70 141 234 250 421 657 817 1,346 2,415 6,421 Liability in respect of earlier years 172 Claims handling costs 133 Gross general insurance claims liability 6,726
Estimate of ultimate claims costs: At end of accident year 2,011 2,584 3,215 3,514 4,168 4,215 4,572 4,034 4,360 4,435 37,108
Seven years later — (11) 20 9 Eight years later 1 10 11 Nine years later 8 8 Current estimate of cumulative claims 1,935 2,577 2,872 3,155 3,820 3,854 4,481 4,067 4,459 4,435 35,655 Cumulative payments to date (1,887) (2,525) (2,786) (2,970) (3,590) (3,435) (3,849) (3,276) (3,133) (2,030) (29,481) 48 52 86 185 230 419 632 791 1,326 2,405 6,174 Liability in respect of earlier years 109 Claims handling costs 133 Net general insurance claims liability 6,416
Claims reserves It is the Group’s policy to hold claims reserves (including reserves to cover claims which have been incurred but not reported (IBNR reserves)) for all classes at a sufficient level to meet all liabilities as they fall due.
The following table shows the expected maturity of undiscounted insurance liabilities up to 20 years, excluding those linked directly to the financial assets backing these contracts (2010 - nil; 2009 - £4,175 million; 2008 - £4,189 million).
A similar series of exchange and tender offers completed in April 2009 and resulted in a gain of £3,790 million and £829 million being recorded in equity.
The Group has agreed that RBS Holdings N.V. will not pay investors any coupons on, or exercise any call rights in relation to, specified hybrid capital instruments for an effective period of two years from 1 April 2011, unless in any such case there is a legal obligation to do so. RBS Holdings N.V. and its group companies are also subject to restrictions on the exercise of call rights in relation to their other hybrid capital instruments.
27 Subordinated liabilities continued The following tables analyse the remaining contractual maturity of subordinated liabilities by (1) the final redemption date; and (2) the next call date.
Group 2009 2010 2011-2013 2014-2018 Thereafter Perpetual Total 2008 - final redemption £m £m £m £m £m £m £m
Group Currently 2009 2010 2011-2013 2014-2018 Thereafter Perpetual Total 2008 - call date £m £m £m £m £m £m £m £m
Company 2010 2011 2012-2014 2015-2019 Thereafter Perpetual Total 2009 - final redemption £m £m £m £m £m £m £m
The Royal Bank of Scotland plc €300 million 4.875% subordinated notes 2009 — — 298
First Active plc £60 million 6.375% subordinated bonds 2018 (callable April 2013) 66 66 66
RBS NV and subsidiaries €182 million 6.00% fixed rate subordinated notes 2009 — — 169 €182 million 6.13% fixed rate subordinated notes 2009 — — 165 €1,150 million 4.63% fixed rate subordinated notes 2009 — — 1,104 €250 million 4.70% CMS linked subordinated notes 2019 181 189 195 €800 million 6.25% fixed rate subordinated notes 2010 (redeemed June 2010) — 733 795 €100 million 5.13% flip flop Bermudan callable subordinated notes 2017 (callable December 2012) 69 84 89 €500 million floating rate Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013) (6) — 426 455 €1,000 million floating rate Bermudan callable subordinated lower tier 2 notes 2016 (callable September 2011) (6) — 862 923 €13 million zero coupon subordinated notes 2029 9 4 8 €82 million floating rate subordinated notes 2017 (6) — 68 72 €103 million floating rate subordinated lower tier 2 notes 2020 (6) — 83 89 €170 million floating rate sinkable subordinated notes 2041 240 190 205 €15 million CMS linked floating rate subordinated lower tier 2 notes 2020 10 10 10 €1,500 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable March 2011) 1,283 1,326 1,419 €5 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable October 2011) 4 4 5 €65 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable October 2010) (6) — 58 62
Notes: (1) On-lent to The Royal Bank of Scotland plc on a subordinated basis. (2) Unconditionally guaranteed by the company. (3) In the event of certain changes in tax laws, dated loan capital issues may be redeemed in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (4) Except as stated above, claims in respect of the Group's dated loan capital are subordinated to the claims of other creditors. None of the Group's dated loan capital is secured. (5) Interest on all floating rate subordinated notes is calculated by reference to market rates. (6) Transferred to the Dutch State on legal separation of ABN AMRO Holding N.V.
The company US$106 million (2009 - US$163 million; 2008 - US$350 million) undated floating rate primary capital notes (callable on any interest payment date) (1,2) 69 101 240 US$762 million (2009 - US$762 million; 2008 - US$1,200 million) 7.648% perpetual regulatory tier one securities (callable September 2031) (1,3,4) 494 473 831
First Active plc £20 million 11.75% perpetual tier two capital 26 26 26 €38 million 11.375% perpetual tier two capital 50 51 52 £1.3 million floating rate perpetual tier two capital 2 2 2
Notes: (1) Partially repurchased following completion of the exchange and tender offers in April 2009. (2) Partially repurchased following completion of the exchange and tender offers in May 2010. (3) On-lent to The Royal Bank of Scotland plc on a subordinated basis. (4) The company can satisfy interest payment obligations by issuing sufficient ordinary shares to appointed Trustees to enable them, on selling these shares, to settle the interest payment. (5) Guaranteed by the company. (6) Exchangeable at the option of the issuer into 8.392% (gross) non-cumulative preference shares of £1 each of National Westminster Bank Plc at any time. (7) Except as stated above, claims in respect of the Group's undated loan capital are subordinated to the claims of other creditors. None of the Group's undated loan capital is secured. (8) In the event of certain changes in tax laws, undated loan capital issues may be redeemed in whole, but not in part, at the option of the Group, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (9) Interest on all floating rate subordinated notes is calculated by reference to market rates. (10) Transferred to the Dutch State on legal separation of ABN AMRO Holding N.V.
Series 1 US$65 million (2009 and 2008 - US$1,000 million) 9.118% (redeemable at option of issuer) (3) 43 630 698
Non-cumulative convertible preference shares of £0.01 Series 1 £15 million (2009 and 2008 - £200 million) 7.387% (redeemable at option of issuer) (3) 15 199 211
Notes: (1) Further details of the contractual terms of the preference shares are given in Note 29. (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 (see Note 29). (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.
Trust preferred securities 2010 2009 2008 £m £m £m €391 million (2009 - €391 million; 2008 - €1,250 million) 6.467% (redeemable June 2012) (1,2) 339 362 1,325 US$486 million (2009 - US$486 million; 2008 - US$750 million) 6.8% (perpetual callable September 2009) (1,2) 289 300 514 US$318 million (2009 - US$322 million; 2008 - US$850 million) 4.709% (redeemable July 2013) (1,2,3) 190 196 640 US$394 million (2009 - US$394 million; 2008 - US$650 million) 6.425% (redeemable January 2034) (1,2) 291 280 677
Notes: (1) 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
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.
below, if RBS Holdings N.V. pays a dividend on its ordinary shares or on its parity securities or redeems or repurchases such securities. (5) The trust preferred securities are subject to restrictions on dividend payments agreed with the European Commission (see Note 29).
At 1 January 2009 16,183 5,436 21,619 Currency translation and other adjustments (1,282) (152) (1,434) (Loss)/profit attributable to non-controlling interests - continuing operations (266) 648 382 - discontinued operations (33) — (33) Dividends paid — (313) (313) Gains/(losses) on available-for-sale financial assets, net of tax 133 (336) (203) Movements in cash flow hedging reserves, net of tax (150) — (150) Actuarial gains recognised in retirement benefit schemes, net of tax 92 — 92 Equity raised — 9 9
Losses on available-for-sale financial assets, net of tax (21) — (21) Movements in cash flow hedging reserves, net of tax 955 — 955 Equity raised 501 58 559 Equity withdrawn and disposals (10,525) (773) (11,298) Transfer to retained earnings — (40) (40)
(2) The trust preferred securities are subject to restrictions on dividend payments agreed with the European Commission (see Note 29). (3) Partially repurchased following completion of the exchange and tender offers in April 2009. (4) Partially repurchased following completion of the exchange and tender offers in May 2010.
At 1 January 2009 39,456,005 Shares issued in respect of the placing and open offer 16,909,716 At 1 January 2010 56,365,721 Shares issued 2,092,410 At 31 December 2010 58,458,131
Notes: (1) Prior to the Companies Act 2006, the authorised share capital of UK companies was divided between issued share capital and unissued share capital whose allotment was determined by the Articles of Association of a company and specific authorities granted to directors. Since 15 December 2009 when the company changed its constitution to reflect the Companies Act 2006, there is no authorised share capital. The meeting approving the changes also resolved to grant the directors the power to issue a nominal amount of £1,610 million B shares of 1p each and £44,250 million ordinary shares of 25p each in connection with the company's participation in the UK Government's Asset Protection Scheme.
Ordinary shares During the year, the ordinary share capital was increased by 3.7 million ordinary shares allotted as a result of the exercise of options under the company's executive and sharesave plans.
The employee share trusts incurred costs of £3.7 million in purchasing the company's ordinary shares.
In December 2010, the company converted 185,134 non-cumulative convertible preference shares of £0.01 into ordinary shares resulting in approximately 487 million ordinary shares being issued.
The B shares do not generally carry voting rights at general meetings of ordinary shareholders. Each B share is entitled to the same cash dividend as an ordinary share (subject to anti-dilution adjustments). The B shares may be converted into ordinary shares at a fixed ratio of issue price (50p) divided by the conversion price (50p subject to antidilution adjustments) at the option of the holder at any time after issue.
Other securities Certain of the Group's subordinated securities in the legal form of debt are classified as equity under IFRS.
29 Share capital continued Non-cumulative preference shares Non-cumulative preference shares entitle the holders thereof (subject to the terms of issue) to receive periodic non-cumulative cash dividends at specified fixed rates for each Series payable out of distributable profits of the company.
Class of preference share Number of shares in issue Interest rate Redemption date on or after Redemption price per share Debt/equity
Non-cumulative preference shares of US$0.01 Series F 6.3 million 7.65% 31 March 2007 US$25 Debt
Under the arrangements for the placing and open offer in December 2008, the company issued shares in exchange for shares in Encuentro Limited. No share premium was recorded in the company financial statements through the operation of the merger relief provisions of the Companies Act 2006. The subsequent redemption of these shares gave rise to distributable profits of £14,273 million which were transferred from merger reserve to retained earnings.
Under the arrangements for accession to APS in December 2009, the company issued B shares in exchange for shares in Aonach Mor Limited. No share premium was recorded in the company financial statements through the operation of the merger relief provisions of the Companies Act 2006. The subsequent redemption of some of these shares gave rise to distributable profits of £12,250 million (2009 - £9,950 million) which were transferred from merger reserve to retained earnings.
At 31 December 2010, 1,717,095,004 (2009 - 138,695,912) ordinary shares of 25p each of the company were held by Employee Share Trusts in respect of share awards and options granted to employees.
Amounts recognised as income and expense Finance leases - contingent rental income (160) (139) (37) Operating leases - minimum rentals payable 519 556 566
Residual value exposures The tables below give details of the unguaranteed residual values included in the carrying value of finance lease receivables (see pages 300 to 303) and operating lease assets (see pages 338 and 339).
Securitisations and other asset transfers Continued recognition The table below sets out the asset categories together with the carrying amounts of the assets and associated liabilities for those securitisations (see page 217) and other asset transfers where substantially all the risks and rewards of the asset have been retained by the Group.
Liabilities secured by Group assets Deposits by banks 10,565 12,724 15,429 Customer accounts 3,599 3,319 10,907 Debt securities in issue — 1,237 109 Derivatives 93,570 65,225 137,667 107,734 82,505 164,112
Less excess of expected losses over provisions net of tax (1,900) (2,558) (770) Less securitisation positions (2,321) (1,353) (663) Less APS first loss (4,225) (5,106) — Core Tier 1 capital 49,604 59,524 46,190 Preference shares 5,410 11,265 16,655 Innovative Tier 1 securities 4,662 5,213 7,383 Tax on the excess of expected losses over provisions 758 1,020 308 Less material holdings (310) (601) (689)
Tier 2 Reserves arising on revaluation of property and unrealised gains on AFS equities 25 207 984 Collective impairment provisions 778 796 666 Perpetual subordinated debt 1,852 4,950 9,829 Term subordinated debt 16,745 20,063 23,162 Non-controlling and other interests in Tier 2 capital 11 11 11 Less excess of expected losses over provisions (2,658) (3,578) (1,078) Less securitisation positions (2,321) (1,353) (662) Less material holdings (310) (601) (689) Less APS first loss (4,225) (5,106) — Total Tier 2 capital 9,897 15,389 32,223
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 offbalance 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.
34 Memorandum items Contingent liabilities and commitments The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group's expectation of future losses.
Commitments Undrawn formal standby facilities, credit lines and other commitments to lend
Commitments Commitments to lend - under a loan commitment the Group agrees to make funds available to a customer in the future. Loan commitments, which are usually for a specified term may be unconditionally cancellable or may persist, provided all conditions in the loan facility are satisfied or waived. Commitments to lend include commercial standby facilities and credit lines, liquidity facilities to commercial paper conduits and unutilised overdraft facilities.
Group £m £m £m Operating leases Minimum rentals payable under non-cancellable leases (1)
Notes: (1) Predominantly property leases. (2) Of which due within 1 year: £263 million (2009 - £370 million; 2008 - £3,769 million). (3) Of which due within 1 year: £283 million (2009 - £480 million; 2008 - £1,129 million).
The FSCS will receive funds from asset sales, surplus cash flow, or other recoveries in relation to these institutions which will be used to reduce the principal amount of the FSCS's borrowings. After the interest only period a schedule for repayment of any outstanding borrowings will be agreed between the FSCS and HM Treasury in the light of market conditions at that time and the FSCS will begin to raise compensation levies (principal repayments). No provision has been made for these levies as the amount is not yet known.
The Group has accrued £144 million for its share of FSCS management expenses levies for the 2010/11 and 2011/12 scheme years.
Litigation As a participant in the financial services industry, RBS Group operates in a legal and regulatory environment that exposes it to potentially significant litigation risks. As a result, the company and other members of RBS Group are involved in various disputes and legal proceedings in the United Kingdom, the United States and other jurisdictions, including litigation. Such cases are subject to many uncertainties, and their outcome is often difficult to predict, particularly in the earlier stages of a case.
Unarranged overdraft charges In the US, Citizens Financial Group, in common with other US banks, has been named as a defendant in a class action asserting that Citizens charges excessive overdraft fees. The plaintiffs claim that overdraft fees resulting from point of sale and automated teller machine (ATM) transactions violate the duty of good faith implied in Citizens’ customer account agreement and constitute an unfair trade practice. RBS Group considers that it has substantial and credible legal and factual defences to these claims and will defend them vigorously. RBS Group is unable reliably to estimate the liability, if any, that might arise or its effect on RBS Group’s consolidated net assets, operating results or cash flows in any particular period.
Shareholder litigation RBS Group and a number of its subsidiaries and certain individual officers and directors have been named as defendants in a class action filed in the United States District Court for the Southern District of New York. The consolidated amended complaint alleges certain false and misleading statements and omissions in public filings and other communications during the period 1 March 2007 to 19 January 2009, and variously asserts claims under Sections 11, 12 and 15 of the US Securities Act of 1933, Sections 10 and 20 of the US Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder.
On 11 January 2011, the District Court dismissed all claims except those based on the purchase of RBS Group Series Q, R, S, T, and/or U noncumulative dollar preference shares. The Court has not yet considered potential grounds for dismissal of the remaining claims, and directed RBS Group to re-file its motion to dismiss those claims within 45 days of its ruling. On 28 January 2011, a new complaint was filed asserting claims under Sections 10 and 20 of the Exchange Act on behalf of a putative class of purchasers of ADRs.
World Online International N.V. In November 2009, the Supreme Court in the Netherlands gave a declaratory judgment against World Online International N.V., Goldman Sachs International and ABN AMRO Bank N.V. (now known as The Royal Bank of Scotland N.V.) (“RBS NV”) in relation to claims arising out of the World Online initial public offering of 2000. It held that these defendants had committed certain wrongful acts in connection with the initial public offering. The judgment does not establish liability or the amount of any loss. The defendant banks have agreed to pay settlement sums to certain investors. RBS Group does not believe that such settlements or any final liability or loss will have a significant effect on RBS Group’s financial position or profitability.
Madoff In December 2010, Irving Picard, as trustee for the bankruptcy estates of Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC filed a claim against RBS NV for $270 million. This is a clawback action similar to claims filed against six other institutions in December. RBS NV (or its subsidiaries) invested in Madoff funds through feeder funds. The Trustee alleges that RBS NV received $71 million in redemptions from the feeder funds and $200 million from its swap counterparties while RBS NV “knew or should have known of Madoff’s possible fraud.” The Trustee alleges that those transfers were preferences or fraudulent conveyances under the US bankruptcy code and New York law and he asserts the purported right to claw them back for the benefit of Madoff’s estate. RBS Group considers that it has substantial and credible legal and factual defences to the claim and intends to defend it vigorously.
Summary of other disputes, legal proceedings and litigation Members of RBS Group are engaged in other litigation 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. RBS 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 significant effect on RBS Group’s financial position or profitability in any particular period.
Political and regulatory scrutiny of the operation of retail banking and consumer credit industries in the United Kingdom and elsewhere continues. The nature and impact of future changes in policies and regulatory action are not predictable and are beyond RBS Group’s control but could have a significant effect on RBS Group’s businesses and earnings.
34 Memorandum items continued MasterCard appealed against the decision to the European Court of First Instance on 1 March 2008, and RBS Group has intervened in the appeal proceedings. In addition, in summer 2008, MasterCard announced various changes to its scheme arrangements. The EC was concerned that these changes might be used as a means of circumventing the requirements of the infringement decision. In April 2009, MasterCard agreed an interim settlement on the level of cross-border MIFs with the EC pending the outcome of the appeal process and, as a result, the EC has advised it will no longer investigate the non-compliance issue (although MasterCard is continuing with its appeal).
The outcome of these investigations is not known, but they may have a significant effect on the consumer credit industry in general and, therefore, on RBS Group’s business in this sector.
Payment Protection Insurance Having conducted a market study relating to Payment Protection Insurance (PPI), on 7 February 2007 the OFT referred the PPI market to the Competition Commission (CC) for an in-depth inquiry. The CC published its final report on 29 January 2009 and announced its intention to order a range of remedies, including a prohibition on actively selling PPI at point of sale of the credit product (and for 7 days thereafter), a ban on single premium policies and other measures to increase transparency (in order to improve customers’ ability to search and improve price competition). Barclays Bank PLC subsequently appealed certain CC findings to the CAT. On 16 October 2009, the CAT handed down a judgment quashing the ban on selling PPI at the point of sale of credit products and remitted the matter back to the CC for review. On 14 May 2010, the CC published its Provisional Decision following its review of remedies in the PPI market indicating that the CC still intends to impose a prohibition on selling PPI at point of sale of the credit product. On 14 October 2010, the CC published its final decision on remedies following the remittal which confirmed the point of sale prohibition. The CC intends to make the final order in the first quarter of 2011, with the key measures coming into force in October 2011 and April 2012.
The Financial Services Authority (FSA) has been conducting a broad industry thematic review of 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 On 16 July 2008, the OFT published the results of its market study into Personal Current Accounts (PCA) in the United Kingdom. The OFT found evidence of competition and several positive features in the personal current account market but believed that the market as a whole was not working well for consumers and that the ability of the market to function well had become distorted.
On 22 December 2009, the OFT published a further report in which it stated that it continued to have significant concerns about the operation of the personal current account market in the United Kingdom, in particular in relation to unarranged overdrafts, and that it believed that fundamental changes are required for the market to work in the best interests of bank customers. The OFT stated that it would discuss these issues intensively with banks, consumer groups and other organisations, with the aim of reporting on progress by the end of March 2010. On 16 March 2010, the OFT announced that it had secured agreement from the banks on four industry-wide initiatives, namely minimum standards on the operation of opt-outs from unarranged overdrafts, new working groups on information sharing with customers, best practice for PCA customers in financial difficulties and incurring charges, and PCA providers to publish their policies on dealing with PCA customers in financial difficulties. The OFT also announced its plan to conduct six-monthly ongoing reviews, to fully review the market again in 2012 and to undertake a brief analysis on barriers to entry. The first six-monthly ongoing review was completed in September 2010. The OFT noted progress in the areas of switching, transparency and unarranged overdrafts for the period March to September 2010, as well as highlighting further changes the OFT expects to see in the market. The next progress report is expected to be published by the OFT in March 2011.
Independent Commission on Banking On 16 June 2010, HM Treasury published the terms of reference for the Government’s Independent Commission on Banking (ICB). The ICB is considering the structure of the United Kingdom banking sector and is looking at structural and non-structural measures to reform the banking system and to promote competition. It is mandated to formulate policy recommendations with a view to: (i) reducing systemic risk in the banking sector, exploring the risk posed by banks of different size, scale and function; (ii) mitigating moral hazard in the banking system; (iii) reducing the likelihood and impact of a bank’s failure; and (iv) promoting competition in retail and investment banking with a view to ensuring that the needs of banks’ customers are served efficiently and considering the extent to which large banks can gain competitive advantage from being perceived as “too big to fail”.
The ICB reports to the Cabinet Committee on Banking Reform and is required to produce a final report by the end of September 2011. RBS Group has responded to the call for evidence by the ICB. In addition it has attended a private hearing, as well as public hearings in Edinburgh and Cardiff in December 2010. An issues paper by the ICB is expected in spring 2011. At this stage it is not possible to estimate the effect of the ICB’s report and recommendations upon RBS Group, if any.
34 Memorandum items continued Securitisation and collateralised debt obligation business In September and October 2010, the SEC requested voluntary production of information concerning residential mortgage backed securities underwritten by subsidiaries of RBS Group during the period from September 2006 to July 2007 inclusive. In November 2010, the SEC commenced formal proceedings and requested testimony from RBS employees. The investigation is in its preliminary stages and it is difficult to predict any potential exposure that may result.
In issuing RMBS, GBM N.A. generally assigned certain representations and warranties regarding the characteristics of the underlying loans made by the originator of the residential mortgages; however, in some circumstances, GBM N.A. made such representations and warranties itself. Where GBM N.A. has given those or other representations and warranties (whether relating to underlying loans or otherwise), GBM N.A. may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of such representations and warranties. In certain instances where it is required to repurchase loans or related securities, GBM N.A. may be able to assert claims against third parties who provided representations or warranties to GBM N.A. when selling loans to it; although the ability to make recoveries against such parties and outcome of such claims would be uncertain. During the two-year period ended 31 December 2010, GBM N.A. has received approximately US$38 million in repurchase demands in respect of loans made and related securities sold where obligations in respect of contractual representations or warranties were undertaken by GBM N.A. However, repurchase demands presented to GBM N.A. are subject to challenge and, to date, GBM N.A. has rebutted a significant percentage of these claims.
GBM N.A. has been named as a defendant in a number of suits relating to its role as issuer and underwriter of RMBS (see section above ‘other securitisation and securities related litigation in the United States’). Those lawsuits are in their early stages and we are not able to predict the outcome of such proceedings or their effect on the Group.
Citizens Financial Group (CFG) has not been an issuer or underwriter of non-agency RMBS. However, CFG is an originator and servicer of residential mortgages, and it routinely sells such mortgage loans in the secondary market and to GSEs. In the context of such sales, CFG makes certain representations and warranties regarding the characteristics of the underlying loans and, as a result, may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of the representations and warranties concerning the underlying loans. During the two-year period ended 31 December 2010, CFG has received approximately US$26 million in repurchase demands in respect of loans originated. However, repurchase demands presented to CFG are subject to challenge and, to date, CFG has rebutted a significant percentage of these claims.
In July 2010, the FSA notified RBS Group that it was commencing an investigation into the sale by Coutts & Co of ALICO (American Life Insurance Company) Premier Access Bond Enhanced Variable Rate Fund to customers between 2001 and 2008 as well as its subsequent review of those sales. On 11 January 2011, the FSA amended the date range on which their investigation is focused and the investigation start date is now December 2003. RBS Group and its subsidiaries are cooperating fully with this investigation.
In the United States, RBS Group and certain subsidiaries have received requests for information from various governmental agencies, selfregulatory organisations, and state governmental agencies including in connection with sub-prime mortgages and securitisations, collateralised debt obligations and synthetic products related to sub-prime mortgages. In particular, during March 2008, RBS Group was advised by the SEC that it had commenced a non-public, formal investigation relating to RBS Group’s United States sub-prime securities exposures and United States residential mortgage exposures. RBS Group and its subsidiaries are cooperating with these various requests for information and investigations.
The Federal Reserve and state banking supervisors have been reviewing RBS Group’s US operations and RBS Group and its subsidiaries have been required to make improvements with respect to various matters, including enterprise-wide governance, Bank Secrecy Act and anti-money laundering compliance, risk management and asset quality. RBS Group is in the process of implementing measures for matters identified to date. RBS Group may become subject to formal and informal supervisory actions and may be required by its US banking supervisors to take further actions and implement additional remedial measures with respect to these and additional matters. Any limitations or conditions placed on RBS Group’s activities in the United States, as well as the terms of any supervisory action applicable to RBS Group and its subsidiaries, could have a material adverse effect on RBS Group’s business, results of operations and financial condition.
Fair value given for businesses acquired (210) (115) (1,810) Non-cash consideration — — (17) Net outflow of cash in respect of purchases (210) (115) (1,827)
The Group's reported results from continuing operations for 2009 and 2008 would not have been materially affected had all acquisitions occurred on 1 January 2008 or 1 January 2009. The profit on disposal in 2008 arose on the sales of Angel Trains, Tesco Personal Finance and the European Consumer Finance.
Share capital, share premium, paid-in equity and merger reserve Subordinated liabilities
Share capital, share premium, paid-in equity and merger reserve Subordinated liabilities 2010 £m 2009 £m £m
At 1 January 64,240 49,323 31,806 37,652 49,154 38,043 53,359 38,442 20,925 8,762 10,314 7,743 Issue of ordinary shares 1 — 49 — — — 1 — 49 — — — Redemption of preference shares 117 (5,000) — — — — 117 (5,000) — — — — Placing and open offers — 5,274 19,741 — — — — 5,274 19,741 — — — Rights issue — — 12,000 — — — — — 12,000 — — — Issue of B shares — 25,101 — — — — — 12,801 — — — — Redemption of paid-in equity (132) (308) — — — — (132) (308) — — — — Cancellation of non- voting deferred shares (27) — — — — — (27) — — — — — Issue of subordinated liabilities — — — — 2,309 2,413 — — — — — — Repayment of subordinated liabilities — — — (1,588) (5,145) (1,727) — — — (98) (458) — Net cash (outflow)/inflow from financing (41) 25,067 31,790 (1,588) (2,836) 686 (41) 12,767 31,790 (98) (458) — Investment in subsidiaries — — — — — — — 12,300 — — — —
39 Analysis of cash and cash equivalents Group Company £m £m
Comprising: Cash and balances at central banks 56,590 51,811 12,007 — — — Treasury bills and debt securities 5,672 15,818 15,623 — — — Loans and advances to banks 90,268 76,557 107,295 2,357 16,448 5,069 Cash and cash equivalents 152,530 144,186 134,925 2,357 16,448 5,069
Certain subsidiary undertakings are required to maintain balances with the Bank of England which, at 31 December 2010, amounted to £424 million (2009 - £450 million; 2008 - £393 million). Certain subsidiary undertakings are required by law to maintain reserve balances with the Federal Reserve Bank in the US. Such reserve balances were nil at 31 December 2010, 2009 and 2008. RBS NV had mandatory reserve deposits of €1 million at 31 December 2010 (2009 - €6 million; 2008 - €3 million).
40 Segmental analysis (a) Divisions The directors manage the Group primarily by class of business and present the segmental analysis on that basis. This includes the review of net interest income for each class of business - interest receivable and payable for all reportable segments is therefore presented net. Segments charge market prices for services rendered to other parts of the Group; funding charges between segments are determined by Group Treasury, having regard to commercial demands. The segment measure is operating profit/(loss) before tax, which differs from that reported previously in that it excludes fair value of own debt. Comparative data have been restated accordingly.
RBS Insurance provides a wide range of general insurance products to consumers through a number of well known brands including; Direct Line, Churchill and Privilege. It also provides insurance services for third party brands through its UKI Partnerships division. In the commercial sector, its NIG and Direct Line for Business operations provide insurance products for businesses via brokers or direct respectively. Through its international division, RBS Insurance sells general insurance, mainly motor, in Germany and Italy. In addition to insurance services, RBS Insurance continues to provide support and reassurance to millions of UK motorists through its Green Flag breakdown recovery service and Tracker stolen vehicle recovery and telematics business.
Central items comprises Group and corporate functions, such as treasury, funding and finance, risk management, legal, communications and human resources. The Centre manages the Group's capital resources and Group-wide regulatory projects and provides services to the operating divisions.
UK Retail 3,452 1,629 5,081 (3,170) (3) (1,679) 229 UK Corporate 2,292 1,290 3,582 (1,376) (154) (927) 1,125 Wealth 663 446 1,109 (645) (11) (33) 420 Global Transaction Services 912 1,575 2,487 (1,462) (13) (39) 973 Ulster Bank 780 254 1,034 (748) (5) (649) (368)
Global Banking & Markets 2,375 8,683 11,058 (4,518) (142) (640) 5,758 RBS Insurance 354 4,106 4,460 (4,363) (31) (8) 58 Central items (284) 617 333 1,053 (1,000) (1) 385 Core 12,319 19,549 31,868 (17,292) (1,431) (4,678) 8,467 Non-Core 1,248 (3,549) (2,301) (2,593) (442) (9,221) (14,557)
Reconciling items RFS Holdings minority interest (179) (142) (321) (32) (3) — (356) Fair value of own debt — (142) (142) — — — (142) Amortisation of purchased intangible assets — — — — (272) — (272) Integration and restructuring costs — — — (1,268) (18) — (1,286) Gain on redemption of own debt — 3,790 3,790 — — — 3,790 Strategic disposals — 132 132 — — — 132 Bonus tax — — — (208) — — (208) Gains on pensions curtailment — — — 2,148 — — 2,148 Write-down of goodwill and other intangible assets — — — (363) — — (363)
UK Retail 3,187 1,935 5,122 (3,378) (2) (1,019) 723 UK Corporate 2,448 1,289 3,737 (1,487) (150) (319) 1,781 Wealth 578 481 1,059 (686) (9) (16) 348 Global Transaction Services 937 1,494 2,431 (1,372) (3) (54) 1,002 Ulster Bank 708 331 1,039 (715) — (106) 218 US Retail & Commercial 1,726 861 2,587 (1,471) (151) (437) 528 Global Banking & Markets 2,326 31 2,357 (3,736) (252) (522) (2,153) RBS Insurance 496 3,934 4,430 (3,767) (37) (42) 584 Central items 1,710 (2,073) (363) 1,179 (685) 19 150 Core 14,116 8,283 22,399 (15,433) (1,289) (2,496) 3,181 Non-Core 1,648 (4,680) (3,032) (2,840) (543) (4,936) (11,351)
UK Retail 6,998 401 7,399 7,156 599 7,755 8,416 1,652 10,068 UK Corporate 4,347 132 4,479 4,563 118 4,681 8,309 225 8,534 Wealth 957 617 1,574 813 820 1,633 1,125 2,122 3,247 Global Transaction Services 2,850 85 2,935 2,923 60 2,983 2,937 81 3,018 Ulster Bank 1,386 134 1,520 1,604 104 1,708 2,762 748 3,510 US Retail & Commercial 3,660 286 3,946 4,080 378 4,458 4,200 475 4,675 Global Banking & Markets 9,999 7,195 17,194 13,805 9,142 22,947 10,702 11,078 21,780 RBS Insurance 4,918 10 4,928 5,018 19 5,037 5,040 33 5,073 Central items 2,953 8,549 11,502 2,057 10,825 12,882 350 13,388 13,738 Core 38,068 17,409 55,477 42,019 22,065 64,084 43,841 29,802 73,643 Non-Core 5,622 1,051 6,673 3,358 1,292 4,650 4,242 1,657 5,899 43,690 18,460 62,150 45,377 23,357 68,734 48,083 31,459 79,542 Reconciling items RFS Holdings minority interest (141) — (141) (155) — (155) 425 (11) 414 Fair value of own debt 174 — 174 (142) — (142) 1,232 — 1,232 Gain on redemption of own debt 553 — 553 3,790 — 3,790 — — — Strategic disposals 171 — 171 132 — 132 442 — 442 Asset Protection Scheme credit default swap - fair value changes (1,550) — (1,550) — — — — — —
RFS Holdings minority interest Total £m £m £m £m £m £m £m £m £m £m £m
At 1 January 2008 2,803 2,741 753 2,396 858 5,392 4,191 1,064 4,334 18.421 42,953 Transfers to disposal groups — — — — — — — — — (3,692) (3,692) Currency translation and other adjustments — — 56 680 133 2,013 879 7 801 4,336 8,905 Acquisitions — — — 35 — — 147 — 342 — 524 Disposals — — — — — — — — (49) (3,017) (3,066) Write-down of goodwill
Net interest income 8,932 3,128 1,384 765 14,209 Net fees and commissions 3,272 1,557 591 562 5,982 Income from trading activities 2,106 1,963 197 251 4,517 Other operating income/(loss) 1,376 232 836 (412) 2,032 Insurance premium income (net of reinsurers' share) 4,809 — 319 — 5,128 Total income 20,495 6,880 3,327 1,166 31,868
Net interest income 7,759 2,674 1,741 1,214 13,388 Net fees and commissions 3,640 1,586 316 406 5,948 Income from trading activities 131 2,396 584 650 3,761 Other operating income/(loss) 6,015 (37) (977) (338) 4,663 Insurance premium income (net of reinsurers' share) 4,879 — 387 — 5,266 Total income 22,424 6,619 2,051 1,932 33,026
Total assets 1,304,714 607,511 368,290 121,137 2,401,652 Total liabilities 1,253,814 592,272 361,590 113,478 2,321,154 Net assets attributable to equity owners and non-controlling interests 50,900 15,239 6,700 7,659 80,498 Contingent liabilities and commitments 200,763 131,435 79,941 21,122 433,261 Cost to acquire property, plant and equipment and intangible assets 3,415 445 2,204 186 6,250
The executive directors may participate in the company's executive share option and sharesave schemes and details of their interests in the company's shares arising from their participation are given in the Directors' remuneration report. Details of the remuneration received by each director during the year and each director's pension arrangements are also given in the Directors' remuneration report.
Key management have banking relationships with Group entities which are entered into in the normal course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with other persons of a similar standing or, where applicable, with other employees. These transactions did not involve more than the normal risk of repayment or present other unfavourable features.
Key management had no reportable transactions or balances with the company.
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 29). Other transactions include the payment of: taxes including UK corporation tax and value added tax; national insurance contributions; local authority rates; and regulatory fees and levies; together with banking transactions such as loans and deposits undertaken in the normal course of banker-customer relationships. The volume and diversity of these transactions are such that disclosure of their amounts is impractical.
No impairment losses were recognised by the Group in 2010, 2009 or 2008 in respect of balances with UK Government and UK Government controlled bodies.
This right is exercisable if certain step-in triggers occur. These include: losses on covered assets in total exceed 125% of the first loss amount or losses on an individual covered asset class exceed specified thresholds; a breach of specified obligations in the APS rules or the accession agreement; the Group has failed or is failing to comply with any of the conditions in the APS rules in relation to asset management, monitoring and reporting, and governance and oversight and such failure is persistent and material or it is evidence of a systematic problem; and material or systematic data deficiencies in the information provided to HMT in accordance with the terms of APS.
HMT may at any time elect to cease to exercise its step-in rights in whole or part when it is satisfied that the step-in triggers have been remedied.
The APS is a single contract providing credit protection in respect of a portfolio of financial assets. Under IFRS, credit protection is treated either as a financial guarantee contract or as a derivative financial instrument depending on the terms of the agreement and the nature of the protected assets and exposures. The Group has concluded, principally because the covered portfolio includes significant exposure in the form of derivatives, that the APS does not meet the criteria to be treated as a financial guarantee contract. The contract has been accounted for as a derivative financial instrument. It is recognised at fair value of £550 million (2009 - £1,400 million) and included within the Derivative asset balance sheet caption. Changes in fair value of £1,550 million (2009 - nil) were recognised in profit or loss within Income from trading activities. Details of the valuation methodology for the APS are set out in Note 12 Financial instruments on pages 320 and 321.
Bank of England facilities include: Open market operations - these provide market participants with funding at market rates on a tender basis in the form of short and long-term repos on a wide range of collateral and outright purchases of high-quality bonds to enable them to meet the reserves that they must hold at the Bank of England.
As at 31 December 2010, the Group's utilisation of these facilities amounted to £16.1 billion (2009 - £21.4 billion; 2008 - £41.8 billion).
As at 31 December 2010, the Group had obtained funding from the Bank of England and issued debt guaranteed by the Government totalling £41.5 billion (2009 - £51.5 billion; 2008 - £32.2 billion).
c) In accordance with IAS 24, transactions or balances between Group entities that have been eliminated on consolidation are not reported.
387 Financial summary 395 Exchange rates 396 Economic and monetary environment 397 Supervision 398 Regulatory developments and reviews 399 Description of property and equipment 399 Major shareholders 399 Material contracts 405 Risk factors
Summary consolidated income statement 2010 $m £m £m £m £m £m
Operating (loss)/profit before tax (614) (399) (2,647) (25,691) 9,636 9,186 Tax (charge)/credit (976) (634) 429 2,167 (2,011) (2,689) (Loss)/profit from continuing operations (1,590) (1,033) (2,218) (23,524) 7,625 6,497 (Loss)/profit from discontinued operations, net of tax (974) (633) (105) (11,018) 87 — (Loss)/profit for the year (2,564) (1,666) (2,323) (34,542) 7,712 6,497
Notes: (1) Includes gains on strategic disposals of £171 million (2009 - £132 million; 2008 - £442 million). (2) Includes gain on redemption of own debt of £553 million (2009 - £3,790 million). (3) Includes fair value of own debt of £174 million profit (2009 - £142 million loss; 2008 - £1,232 million profit). (4) Includes integration and restructuring costs of £1,032 million (2009 - £1,286 million; 2008 - £1,357 million; 2007 - £108 million; 2006 - £134 million). (5) Includes amortisation of purchased intangible assets of £369 million (2009 - £272 million; 2008 - £443 million; 2007 - £162 million; 2006 - £94 million). (6) Includes write-down of goodwill and other intangible assets of £10 million (2009 - £363 million; 2008 - £16,911 million). (7) Includes gains on pensions curtailment of £2,148 million in 2009.
Notes: (1) The number of ordinary shares in issue in 2008, 2007 and 2006 were adjusted retrospectively for the bonus element of the rights issue completed in June 2008 and the capitalisation issue in
After 5 years £m £m 2007 £m £m UK Central and local government 2,421 3 1,495 3,919 3,174 3,091 3,135 6,732 Finance 32,902 3,223 2,850 38,975 36,283 42,432 70,006 25,017 Residential mortgages 2,833 3,430 94,894 101,157 92,583 80,967 73,916 70,884 Personal lending 14,747 4,525 3,964 23,236 25,254 26,989 28,186 27,922 Property 14,447 15,306 12,204 41,957 48,895 52,127 50,051 39,296 Construction 4,164 1,111 1,065 6,340 7,780 10,171 10,202 8,251 Manufacturing 5,717 2,059 1,335 9,111 11,432 15,074 13,452 11,051 Service industries and business activities 20,017 10,199 15,469 45,685 51,855 58,638 53,965 43,887 Agriculture, forestry and fishing 1,098 363 1,297 2,758 2,913 2,972 2,473 2,767 Finance leases and instalment credit 3,010 5,736 4,628 13,374 16,186 17,363 15,632 14,218 Accrued interest 500 9 49 558 992 2,463 2,344 1,497 Total domestic 101,856 45,964 139,250 287,070 297,347 312,287 323,362 251,522 Overseas residents 38,234 33,489 16,027 87,750 89,891 119,656 98,845 69,242 Total UK offices 140,090 79,453 155,277 374,820 387,238 431,943 422,207 320,764
Loan impairment provisions at end of year Customers 18,055 17,126 10,889 6,449 3,933 Banks 127 157 127 3 2 18,182 17,283 11,016 6,452 3,935
% of loans to total loans £m % £m % £m % £m % £m % Domestic Central and local government — 0.7 — 0.4 — 0.3 — 0.4 — 1.4 Manufacturing 100 1.6 153 1.5 127 1.7 93 1.6 94 2.4 Construction 605 1.1 355 1.0 254 1.1 75 1.2 63 1.8 Finance 98 6.8 26 4.9 67 4.8 52 8.4 33 5.3 Service industries and business activities 1,073 8.0 962 7.0 778 6.6 562 6.5 647 9.3 Agriculture, forestry and fishing 27 0.5 20 0.4 19 0.3 21 0.3 25 0.6 Property 2,071 7.3 908 6.6 490 5.9 85 6.0 70 8.3 Residential mortgages 302 17.6 196 12.4 36 9.1 36 8.8 37 15.1 Personal lending 2,504 4.1 2,527 3.4 2,235 3.0 2,054 3.4 1,826 5.9 Finance leases and instalment credit 435 2.3 341 2.2 194 2.0 132 1.9 103 3.0 Accrued interest — 0.1 — 0.1 — 0.3 — 0.3 — 0.3 Total domestic 7,215 50.1 5,488 39.9 4,200 35.1 3,110 38.8 2,898 53.4 Foreign 8,190 49.9 8,562 60.1 4,745 64.9 2,289 61.2 442 46.6 Impaired book provisions 15,405 100.0 14,050 100.0 8,945 100.0 5,399 100.0 3,340 100.0 Latent book provisions 2,650 3,076 1,944 1,050 593 Total provisions 18,055 17,126 10,889 6,449 3,933 391RBS Group 2010
Financial summary continued Analysis of write-offs The following table analyses amounts written-off by geographical area and type of domestic customer.
The following table shows the estimated amount of loans that would be reported using the SEC's classifications. The figures are stated before deducting the value of security held or related provisions.
Closing provisions for impairment as a % of total risk elements in lending 47% 46% 52% 60% 62% Closing provisions for impairment as a % of total risk elements in lending and potential problem loans 46% 45% 51% 57% 62% Risk elements in lending as a % of gross lending to customers excluding reverse repos (5) 7.3% 5.4% 2.5% 1.6% 1.6%
Rest of the World 77,966 237,553 287,950 Total overseas offices 213,608 363,628 441,113
Over 12 months £m Total £m UK based companies and branches Certificates of deposit 3,325 1,784 1,894 247 7,250 Other time deposits 23,180 4,282 2,872 11,462 41,796
Consolidation rate (2) Period end rate 1.5524 1.6222 1.4604 2.0043 1.9651 Average rate for the year 1.5455 1.5657 1.8528 2.0015 1.8436
The general improvement in economic conditions must be viewed against a backdrop of financial market turbulence at various points in the year, most notably the sovereign debt crisis that affected the Eurozone periphery. This led to a marked fall in risk appetite in Q2 2010 and, again, in Q4 2010. Equity prices fell in the banking sector and there was a ‘flight to quality’, which pushed down long-term interest rates on government debt in some countries. This included the UK, where the 10-year gilt rate fell from more than 4 per cent at the start of 2010, to less than 3 per cent in October. UK gilt yields subsequently rose in the final months of 2010, in anticipation of interest rate rises in 2011.
The economic outlook We expect the global recovery to be maintained, but to remain uneven. The pace of growth in the major developed economies, including the UK and the US, is likely to remain sluggish by historic standards, and volatile. This reflects high levels of indebtedness, fiscal rebalancing and the expectation that interest rates will gradually rise. Emerging markets, especially Asia, will continue to outperform as they are less encumbered by balance sheet strains. Moreover, growth in countries like China and India will continue to be underpinned by the process of ‘catch-up’ with industrial nations.
Supervision United Kingdom The UK Financial Services Authority (FSA) is the consolidated supervisor of the Group. As at 31 December 2010, 30 companies in the Group (excluding subsidiaries of RBS NV), spanning a range of financial services sectors (banking, insurance and investment business), were authorised to conduct financial activities regulated by the FSA.
Investment management business is principally undertaken by companies in the Wealth Management division, including Coutts & Co, Adam & Company Investment Management Limited, and in the Global Banking & Markets division, through RBS Asset Management Limited.
The Group's US broker dealer, RBS Securities Inc. (RBSSI), formerly known as Greenwich Capital Markets, Inc., is 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. The futures activities of RBSSI are subject to regulation and oversight by the US Commodity Futures Trading Commission (CFTC) and the Chicago Board of Trade (CBOT). The Group's US commodities business, RBS Sempra Commodities LLP and its subsidiaries, which was largely sold in 2010, are primarily regulated by the Federal Reserve Bank of Boston, the Federal Energy Regulatory Commission (FERC), the Commodity Futures Trading Commission (CFTC), the CME Group-owned exchanges, and The Intercontinental Exchange.
Netherlands The consolidated supervisor of RBS NV is the Dutch Central Bank, De Nederlandsche Bank (DNB). The DNB operates as prudential supervisor of banks, insurance companies and pension funds, and also as part of the European System of Central Banks.
Other jurisdictions The Group operates in over 50 countries through a network of branches, local banks and non-bank subsidiaries and these activities are subject to supervision in most cases by a local regulator or central bank.
The Group and its subsidiaries have co-operated fully with various regulatory reviews and developments in the UK and internationally, including enquiries or investigations into alleged or possible breaches of regulations.
The Group has actively engaged with, and contributed to, a number of inquiries regarding the future of banking. These included the Independent Banking Commission, the OFT’s retail banking review and various Treasury Select Committee inquiries. It has contributed to debates on resolution frameworks, including possible mechanisms such as contingent capital and bail-in arrangements, and is participating in the FSA's pilot for the development of Recovery and Resolution Plans ("Living Wills"). It will be developing suitable Living Wills in line with forthcoming regulatory requirements.
The Group has continued to play an active role in the development of requirements impacting products and processes. Examples include the FSA’s review of mortgages (Mortgage Market Review) and of investment advice (Retail Distribution Review). With regard to payment cards, the Group worked closely with the Government (the Department of Business Innovation and Skills) and the industry to develop and implement appropriate measures to improve product features and transparency. With regard to the OFT’s review of Cash ISAs, the Group worked closely with the industry to agree a series of voluntary improvements to the product and switching process.
UK regulated firms within the Group are members of the Financial Services Compensation Scheme (FSCS), which provides compensation to eligible customers of authorised financial services firms that are unable to meet their obligations. The FSCS is a contributor to depositor confidence and financial stability and the Group is supporting the FSCS in increasing awareness amongst UK consumers. In addition, during 2010 RBS developed and implemented a new ‘single customer view’ systems capability, which provides tailored information to the FSCS in order to facilitate fast payment of compensation to depositors within seven days.
The Group also continues to co-operate with the Information Commissioner’s Office, the UK’s independent public body set up to uphold information rights in the public interest, promoting openness by public bodies and data privacy for individuals. The Group continues to improve its processes in line with changing guidelines in order to meet information security requirements.
Also notable in 2010 was significant work by the European Commission and the Committee of European Securities Regulators to review the Markets in Financial Instruments Directive in areas such as transparency, investor protection and a widening of the scope of the Directive. Additionally, proposals to revise legislation on market infrastructure, to encourage central clearing of derivative instruments, were put forward by the Commission. The Group provided input in all these areas.
United States In the US the Group continues to engage constructively with regulators and other bodies on regulatory and legislative change and seeks to ensure proper implementation and compliance. Current issues include regulatory implementation of recently enacted US financial regulatory reform legislation, mortgage and credit card lending and consumer disclosures, debit and credit card interchange fees, and account overdraft protection.
In December 2008, The Solicitor for the Affairs of Her Majesty's Treasury (HM Treasury) acquired 22,854 million ordinary shares representing 57.92% 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.
In 2010, the company converted certain non-cumulative convertible preference shares into ordinary shares in the company. As a result, HM Treasury’s holding in the company’s ordinary shares reduced to 67.8%.
At 23 February 2011, the directors of the company had options to purchase a total of 10,455,306 ordinary shares of the company.
As at 31 December 2010, almost all of the company's US$ denominated preference shares and American Depository Shares representing ordinary shares were held by shareholders registered in the US. All other shares were predominantly held by shareholders registered outside the US.
Material contracts continued Second Placing and Open Offer Agreement Pursuant to a placing and open offer agreement dated 19 January 2009 entered into between the company, UBS, Merrill Lynch International and HM Treasury, (i) the company agreed to invite qualifying shareholders to apply to subscribe for new shares at the issue price of 31.75 pence per new share by way of the Second Open Offer, (ii) UBS and Merrill Lynch International were appointed as joint sponsors, joint bookrunners and joint placing agents and agreed to use reasonable endeavours to procure placees to subscribe for the new shares on such terms as may be agreed by the company and HM Treasury at not less than the issue price of 31.75 pence per new share on the basis that the new shares placed will be subject to clawback to the extent they are taken up under the Second Open Offer and (iii) HM Treasury agreed that, to the extent not placed or taken up under the Second Open Offer and subject to the terms and conditions set out in the Second Placing and Open Offer Agreement, HM Treasury would subscribe for such new shares itself at the issue price of 31.75 pence per new share.
Lending Commitments Letter On 26 February 2009, the company entered into a deed poll in favour of certain UK Government departments under which it undertook to support lending to creditworthy borrowers in the UK in a commercial manner with effect from 1 March 2009. On 18 May 2009, the company entered into an amendment to this deed poll which took effect from 29 May 2009 and on 20 November 2009, the company executed a further amendment to this deed poll. This lending commitment was a pre-requisite to the company's participation in the APS and other Government backed schemes, the objective of which was to reinforce the stability of the financial system and support the recovery of the economy.
The company's compliance with its lending commitments is monitored by the UK Government, and is subject to a reporting process.
The company also made certain undertakings as regards marketing in support of its lending commitments and certain other matters relating to its business and residential lending practices and policies. The lending commitments made in the deed poll supersede the commitments given by the company in the First Placing and Open Offer Agreement and the Second Placing and Open Offer Agreement.
On 23 March 2010, the company agreed with the UK government certain adjustments to the above lending commitments for the 2010 commitment period (the 12 month period commencing 1 March 2010), to reflect expected economic circumstances over the period. As part of the amended lending commitments, the company has committed, among other things, to make available gross new facilities, drawn or undrawn, of £50 billion to UK businesses in the period 1 March 2010 to 28 February 2011. In addition, the company has agreed with the UK government to make available £8 billion of net mortgage lending in the 2010 commitment period. This is a decrease of £1 billion on the net mortgage lending target that previously applied to the 2010 commitment period which ends on 28 February 2011, to reflect that the mortgage lending commitment for the 2009 commitment period was increased from £9 billion to £10 billion.
B Share Acquisition and Contingent Capital Agreement On 26 November 2009, the company and HM Treasury entered into the Acquisition and Contingent Capital Agreement pursuant to which HM Treasury subscribed for the initial B shares and the Dividend Access Share (the "Acquisitions") and agreed the terms of HM Treasury's subscription for an additional £8 billion in aggregate in the form of further B shares (the "Contingent B shares"), which will be issued on the same terms as the initial B shares. The Acquisitions were subject to the satisfaction of various conditions, including the company having obtained the approval of its shareholders in relation to the Acquisitions.
The company and HM Treasury further agreed the terms of the £8 billion Contingent Subscription of the Contingent B shares in the Acquisition and Contingent Capital Agreement. For a period of five years from 22 December 2009 or, if earlier, until the occurrence of a termination event or until the company decides (with FSA consent) to terminate such Contingent Subscription (the "Contingent Period"), if the Core Tier 1 ratio of the company falls below five per cent (and if certain other conditions are met) HM Treasury has committed to subscribe for the Contingent B shares in no fewer than two tranches of £6 billion and £2 billion (or such smaller amounts as the company and HM Treasury may agree). Any unused portion of the £8 billion may be subscribed in one or more further tranches.
The company agreed to a number of undertakings, including with respect to: (i) restrictions on the payment of dividends or other distributions on, and the redemption of, certain securities; (ii) expectations regarding the repurchase of the B shares by the company; (iii) renegotiations of the terms of the Contingent Subscription as a result of future legislative or regulatory changes; (iv) negotiating in good faith to maintain the status of the B shares and Dividend Access Share as Core Tier 1 capital; and (v) restrictions in relation to the company's share premium account.
The State Aid Commitment Deed also provides that if the European Commission adopts a decision that the UK Government must recover any State Aid (a "Repayment Decision") and the recovery order of the Repayment Decision has not been annulled or suspended by the Court of First Instance or the European Court of Justice, then the Group must repay HM Treasury any aid ordered to be recovered under the Repayment Decision.
The taking of any such actions may adversely affect the rights of holders of the Securities, the price or value of their investment in the Securities and/or the ability of the company to satisfy its obligations under the Securities and/or contracts related to the Securities. Where the transfer powers are effected, HM Treasury is required to make certain compensation or resolution fund orders and holders of Securities may have a claim for compensation under one of the compensation schemes contemplated by the Banking Act if any action is taken in respect of the Securities (and if the relevant order provides for the amount of compensation payable to be determined by an independent valuer, then for the purposes of determining an amount of compensation, the independent valuer must disregard actual or potential financial assistance provided by the Bank of England or HM Treasury). However, there can be no assurance that compensation would be assessed to be payable or that holders of the Securities would recover any compensation promptly and/or equal to any loss actually incurred.
Risk factors continued Contractual arrangements between the company, other companies within the Group and/or the bridge bank or private sector purchaser may be created, modified or cancelled. If the company were taken into temporary public ownership and a partial transfer of its or any relevant entity’s business were effected, or if a relevant entity were made subject to the SRR and a partial transfer of its business to another entity were effected, the transfer may directly affect the company and/or its Group companies by creating, modifying or cancelling its or their contractual arrangements with a view to ensuring the provision of such services and facilities as are required to enable the bridge bank or private sector purchaser to operate the transferred business (or any part of it) effectively. For example, the transfer may (among other things) (i) require the company or Group companies to support and co-operate with the bridge bank or private sector purchaser; (ii) cancel or modify contracts or arrangements between the company or the transferred business and a Group company; or (iii) impose additional obligations on the company under new or existing contracts. There can be no assurance that the taking of any such actions would not adversely affect the ability of the company to satisfy its obligations under the issued Securities or related contracts.
If a relevant stabilisation option were effected in respect of the company or the stabilisation options were effected in respect of a relevant entity or its business within the Group, HM Treasury would be required to make certain compensation or resolution fund orders, which would depend on the stabilisation power adopted. For example, in the event that the Bank of England were to transfer some of the business of a relevant entity to a bridge bank, HM Treasury would have to make a resolution fund order including a third party compensation order pursuant to the Banking Act (Third Party Compensation Arrangements for Partial Property Transfers) Regulations 2009. However, there can be no assurance that compensation would be assessed to be payable or that holders of the Securities would recover any compensation promptly and/or equal to any loss actually incurred.
Despite such measures, the volatility and disruption of the capital and credit markets have continued, with many forecasts predicting only modest levels of GDP growth in the near to medium term. Similar conditions are likely to exist in a number of the Group’s key markets, including those in the US and Europe, particularly Ireland. These conditions have exerted, and may continue to exert, downward pressure on asset prices and on availability of credit for financial institutions and upward pressure on the cost of credit for financial institutions, including the company, the Royal Bank, RBS Holdings N.V. and The Royal Bank of Scotland N.V., and will continue to impact the credit quality of the Group’s customers and counterparties. Such conditions, alone or in combination with regulatory changes or actions of other market participants, may cause the Group to incur losses or to experience further reductions in business activity, increased funding costs and funding pressures, lower prices of the ordinary shares, decreased asset values, additional writedowns and impairment charges and lower profitability.
In particular, the performance of the Group may be affected by economic conditions impacting EU member states. For example, the financial problems recently experienced by the governments of certain EU member states (including Greece and Ireland) may lead to the issuance of significant volumes of debt by such member states and European Union entities, which may in turn reduce demand for debt issued by financial institutions and corporate borrowers. This, as well as credit rating downgrades experienced by such member states, could adversely affect the Group’s access to the debt capital markets and may increase the Group’s funding costs, which could have a material adverse impact on the Group’s earnings, cash flow and financial condition. In addition, EU member states in which the Group operates have agreed to provide financial assistance to certain member states, currently Greece and Ireland, and may be required to provide financial assistance to other EU member states in the future, which may in turn have a negative impact on the financial condition of those EU member states providing the assistance. The Group’s exposure to the economies of such member states, in particular Ireland, has resulted in the Group making significant provisions. Should the adverse economic conditions currently faced by such member states be replicated in other EU member states, the risks discussed above would be exacerbated.
In addition, the Group will continue to be exposed to the risk of loss if major corporate borrowers or counterparty financial institutions fail or are otherwise unable to meet their obligations. The Group is currently exposed to country concentration risk in the US, the UK and the rest of Europe and certain business sector concentration risk relating to personal and banking and financial institution exposures. The Group’s performance may also be affected by future recovery rates on assets and the historical assumptions underlying asset recovery rates, which (as has already occurred in certain instances) may no longer be accurate given the unprecedented market disruption and general economic instability. The precise nature of all the risks and uncertainties the Group faces as a result of current economic conditions cannot be predicted and many of these risks are outside the control of the Group.
Risk factors continued In implementing the State Aid restructuring plan, the Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the Group’s business arising from implementing the State Aid restructuring plan) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals. Further, the loss of such revenues and related income may extend the time period over which the Group may pay any amounts owed to HM Treasury under the APS or otherwise. The implementation of the State Aid restructuring plan may also result in disruption to the retained business and give rise to significant strain on management, employee, operational and financial resources, impacting customers and employees and giving rise to separation costs which could be substantial.
If any or all of the risks described above, or any other currently unforeseen risks, materialise, there could be a materially adverse impact on the Group’s business, operations, financial condition, capital position and competitive position.
The Group’s ability to implement its strategic plan depends on the success of the Group’s refocus on its core strengths and its balance sheet reduction programme. In light of the changed global economic outlook, the Group is engaged in a financial and core business restructuring which is focused on achieving appropriate risk-adjusted returns under these changed circumstances, reducing reliance on wholesale funding and lowering exposure to capital intensive businesses. A key part of this restructuring is the programme announced in February 2009 to run-down and sell the Group’s non-core assets and businesses and the continued review of the Group’s portfolio to identify further disposals of certain non-core assets and businesses. Assets identified for this purpose and allocated to the Group's Non-Core division totalled £252 billion, excluding derivatives, as at 31 December 2008. At 31 December 2010, this total had reduced to £137.9 billion, excluding derivatives, largely as a result of the progress made in business disposals and portfolio sales during the course of 2010. This balance sheet reduction programme continues alongside the disposals under the State Aid restructuring plan approved by the European Commission.
The Group’s liquidity management focuses on maintaining a diverse and appropriate funding strategy for its assets, controlling the mismatch of maturities and carefully monitoring its undrawn commitments and contingent liabilities. However, the Group’s ability to access sources of liquidity (for example, through the issue or sale of financial and other instruments or through the use of term loans) during recent periods of liquidity stress has been constrained to the point where it, in common with many other banking groups, has had to rely on shorter term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks. While money market conditions improved during the course of 2009 and 2010, with the Group seeing a material reduction of funding from central banks and the issuance of non-government guaranteed term debt, further tightening of credit markets could have a materially adverse impact on the Group. The Group, in common with other banking groups, may need to seek funds from alternative sources and potentially at higher costs than has previously been the case.
The Group has participated in governmental support schemes including the UK Government Credit Guarantee Scheme and the Special Liquidity Scheme. The Credit Guarantee Scheme closed for new issuance in February 2010 and the Special Liquidity Scheme closed for new transactions in January 2009. All of the Group’s financing under the United Kingdom Government Credit Guarantee Scheme and the Special Liquidity Scheme matures in 2011 and 2012. As at 31 December 2010, the total amount outstanding of debt instruments issued by RBS which benefit from the United Kingdom Government Credit Guarantee scheme was £41.5 billion. The Group expects to mitigate the impact of this refinancing concentration through a combination of seeking funds from alternative sources, the continuation of the Group’s balance sheet reduction programme and other reductions in the Group’s net wholesale funding requirement. However, there can be no assurance that such mitigation efforts will be successful.
The financial performance of the Group has been materially affected by deteriorations in borrower credit quality and it may continue to be impacted by any further deteriorations, including as a result of prevailing economic and market conditions, and legal and regulatory developments. Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of the Group’s businesses. Whilst some economies stabilised over the course of the last two years, the Group may continue to see adverse changes in the credit quality of its borrowers and counterparties, for example as a result of their inability to refinance their debts, with increasing delinquencies, defaults and insolvencies across a range of sectors (such as the personal and financial institution sectors) and in a number of geographies (such as the UK, the US and the rest of Europe, particularly Ireland).
Risk factors continued The credit quality of the Group’s borrowers and counterparties is impacted by prevailing economic and market conditions, as well as by the legal and regulatory landscape in their respective markets, and if there is a further deterioration in economic and market conditions in one or more markets in which the Group operates or there are changes to the legal or regulatory landscapes in such markets, this could worsen the credit quality of the Group’s borrowers and counterparties and also impact the Group's ability to enforce contractual security rights.
The actual or perceived failure or worsening credit of the Group’s counterparties has adversely affected and could continue to adversely affect the Group. The Group’s ability to engage in routine funding transactions has been and will continue to be adversely affected by the actual or perceived failure or worsening credit of its counterparties, including other financial institutions and corporate borrowers. The Group has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients. As a result, defaults by, or even the perceived creditworthiness of or concerns about, one or more corporate borrowers, financial institutions, sovereign counterparties or the financial services industry generally, have led to market-wide liquidity problems, losses and defaults and could lead to further losses being incurred by the Group or by other institutions. Many of these transactions expose the Group to credit risk in the event of default of the Group’s counterparty or client and the Group does have significant exposures to certain individual counterparties (including counterparties in certain weakened sectors and geographic markets, particularly the United States and Europe). In addition, the Group’s credit risk is exacerbated when the collateral it holds cannot be realised or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is due to the Group, which is most likely to occur during periods of illiquidity and depressed asset valuations, such as those experienced in recent years. Any such losses could have an adverse effect on the Group’s results of operations and financial condition or result in a loss of value in the Securities.
Risk factors continued The Basel Committee's package of reforms includes increasing the minimum common equity requirement from 2% (before the application of regulatory adjustments) to 4.5% (after the application of stricter regulatory adjustments). The total Tier 1 capital requirement, which includes common equity and other qualifying financial instruments, will increase from 4% to 6%. The total capital requirement (which comprises Tier 1 capital and Tier 2 capital) remains at 8%. In addition, banks will be required to maintain, in the form of common equity (after the application of deductions), a capital conservation buffer of 2.5% to withstand future periods of stress, bringing the total common equity requirements to 7%. If there is excess credit growth in any given country resulting in a systemwide build up of risk, a countercyclical buffer within a range of 0% to 2.5% of common equity (or possibly other fully loss absorbing capital) is to be applied as an extension of the conservation buffer. In addition, a leverage ratio will be introduced, together with a liquidity coverage ratio and a net stable funding ratio. The liquidity coverage ratio is intended to promote resilience to potential liquidity stress scenarios lasting for a 30-day period. The net stable funding ratio is intended to limit over reliance on shortterm wholesale funding and has been developed to provide a sustainable maturity structure of assets and liabilities. The Basel Committee is conducting further work on systemically important financial institutions and contingent capital in close coordination with the Financial Stability Board. The Basel Committee has stated that measures may include capital surcharges, contingent capital and bail-in debt (which could be introduced by statute, possibly impacting existing as well as future issues of debt and exposing them to the risk of conversion into equity and/or write-down of principal amount). Such measures would be in addition to proposals for the write-off of Tier 1 and Tier 2 debt (and its possible conversion into ordinary shares) if a bank becomes non-viable.
The Basel Committee is expected to complete by early to mid 2011 a methodology for identifying global systemically important financial institutions with a view to the Financial Stability Board and national authorities determining by mid-2011 those institutions to which the recommendations for global systemically important financial institutions will initially apply. In addition, by mid-2011, the Basel Committee is to complete a study of how much additional loss absorbency capacity global systemically important financial institutions should have and how much of such capacity could be provided by the various proposed instruments (which include contingent capital securities and bail-in debt).
The implementation of the Basel III reforms will begin on 1 January 2013, however the requirements are subject to a series of transitional arrangements and will be phased in over a period of time, to be fully effective by 2019.
As at 31 December 2010, the Group’s Tier 1 and Core Tier 1 capital ratios were 12.9 per cent and 10.7 per cent., respectively, calculated in accordance with FSA requirements. Any change that limits the Group’s ability to manage effectively its balance sheet and capital resources going forward (including, for example, reductions in profits and retained earnings as a result of write-downs or otherwise, increases in riskweighted assets, delays in the disposal of certain assets or the inability to syndicate loans as a result of market conditions, a growth in unfunded pension exposures or otherwise) or to access funding sources, could have a material adverse impact on its financial condition and regulatory capital position or result in a loss of value in the securities.
The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate. Under IFRS, the Group recognises at fair value: (i) financial instruments classified as “held-for-trading” or “designated as at fair value through profit or loss”; (ii) financial assets classified as “available-for-sale”; and (iii) derivatives. Generally, to establish the fair value of these instruments, the Group relies on quoted market prices or, where the market for a financial instrument is not sufficiently active, internal valuation models that utilise observable market data. In certain circumstances, the data for individual financial instruments or classes of financial instruments utilised by such valuation models may not be available or may become unavailable due to changes in market conditions, as has been the case during the recent financial crisis. In such circumstances, the Group’s internal valuation models require the Group to make assumptions, judgements and estimates to establish fair value. In common with other financial institutions, these internal valuation models are complex, and the assumptions, judgements and estimates the Group is required to make often relate to matters that are inherently uncertain, such as expected cash flows, the ability of borrowers to service debt, residential and commercial property price appreciation and depreciation, and relative levels of defaults and deficiencies. Such assumptions, judgements and estimates may need to be updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments has had and could continue to have a material adverse effect on the Group’s earnings and financial condition.
In addition, certain competitors may have access to lower cost funding and/or be able to attract retail deposits on more favourable terms than the Group and may have stronger multi-channel and more efficient operations as a result of greater historical investments. Furthermore, the Group’s competitors may be better able to attract and retain clients and key employees, which may have a negative impact on the Group’s relative performance and future prospects.
In relation to the 2009 commitment period, which ended on 28 February 2010, the Group’s net mortgage lending to UK homeowners was £12.7 billion above the amount it had originally budgeted to lend. In relation to its business lending commitment, the Group extended £41 billion of gross new facilities, drawn and undrawn, to UK businesses, including £27 billion to SMEs but, in the economic environment prevailing at the time, many customers were strongly focused on reducing their borrowings and repayments consequently increased. Moreover, the withdrawal of foreign lenders was less pronounced than anticipated, there was a sharp increase in capital market issuance and demand continued to be weak. As a result, the Group’s net lending did not reach the £16 billion targeted.
Risk factors continued In March 2010, the Royal Bank agreed with the UK Government to certain adjustments to the lending commitments for the 2010 commitment period (the 12 month period which commenced on 1 March 2010), to reflect expected economic circumstances over the period. As part of the amended lending commitments, the Royal Bank has committed, among other things, to make available gross new facilities, drawn or undrawn, of £50 billion to UK businesses in the period 1 March 2010 to 28 February 2011. In addition, the Royal Bank has agreed with the UK Government to make available £8 billion of net mortgage lending in the 2010 commitment period. This is a decrease of £1 billion on the net mortgage lending target that previously applied to the 2010 commitment period which ends on 28 February 2011, to reflect that the mortgage lending commitment for the 2009 commitment period was increased from £9 billion to £10 billion. At 31 December 2010, RBS was on track to meet both its business and mortgage lending targets.
The undertakings described above may serve to limit the Group’s operations. See also “HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the Group.”
The Group could fail to attract or retain senior management, which may include members of the Board, or other key employees, and it may suffer if it does not maintain good employee relations. The Group’s ability to implement its strategy depends on the ability and experience of its senior management, which may include directors, and other key employees. The loss of the services of certain key employees, particularly to competitors, could have an adverse impact on the Group’s business. The Group’s future success will also depend on its ability to attract, retain and remunerate highly skilled and qualified personnel competitively with its peers. This cannot be guaranteed, particularly in light of heightened regulatory oversight of banks and heightened scrutiny of, and (in some cases) restrictions placed upon, management and employee compensation arrangements, in particular those in receipt of Government funding (such as the Group). In connection with its accession to the APS, the Group agreed with HM Treasury that it will be at the leading edge of implementing the G-20 principles and to consult with UK Financial Investments Limited (“UKFI”) in connection with the Group’s remuneration policy and the Group made a commitment to HM Treasury to comply with the FSA Remuneration Code which came into force on 1 January 2010. On 1 January 2011, a revised FSA Remuneration Code came into effect to implement the requirements of the Capital Requirements Directive III. In addition, as a result of its accession to the APS, the Group also has reached agreement with HM Treasury in relation to remuneration arrangements for the executive directors of the Group and certain employees involved in the APS, including approval rights for the Asset Protection Agency on annual APSrelated performance targets. The deferral and claw-back provisions implemented by the Group may impair the ability of the Group to attract and retain suitably qualified personnel in various parts of the Group’s businesses.
In recent years, the Group has altered certain of the pension benefits it offers to staff and some employees continue to participate in defined benefit arrangements. The following two changes have been made to the main defined benefit pension plans: (i) a yearly limit on the amount of any salary increase that will count for pension purposes; and (ii) a reduction in the severance lump sum for those who take an immediate undiscounted pension for redundancy.
In addition to the effects of such measures on the Group’s ability to retain senior management and other key employees, the marketplace for skilled personnel is becoming more competitive, which means the cost of hiring, training and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could place the Group at a significant competitive disadvantage and prevent the Group from successfully implementing its strategy, which could have a material adverse effect on the Group’s financial condition and results of operations or result in a loss of value in the Securities.
Each of the Group’s businesses is subject to substantial regulation and oversight. Significant regulatory developments could have an adverse effect on how the Group conducts its business and on its results of operations and financial condition. The Group is subject to financial services laws, regulations, corporate governance requirements, administrative actions and policies in each jurisdiction in which it operates. All of these are subject to change, particularly in the current regulatory and market environment, where there have been unprecedented levels of government intervention, changes to the regulations governing financial institutions and reviews of the industry, including nationalisations or injections of government capital in the US, the UK and other European countries. In recent years, there has also been increasing focus in the UK, US and other jurisdictions in which the Group operates on compliance with anti-bribery, anti-money laundering, anti-terrorism and other similar sanctions regimes.
As a result of the environment in which the Group operates, increasing regulatory focus in certain areas and ongoing and possible future changes in the financial services regulatory landscape (including requirements imposed by virtue of the Group’s participation in government or regulator-led initiatives), the Group expects to face greater regulation and scrutiny in the UK, the US and other countries in which it operates.
For further information about certain investigations, supervisory matters and litigation matters to which the Group is subject, please refer to Note 34 to the Group’s financial statements.
The Group is and may be subject to litigation and regulatory investigations that may impact its business. The Group’s operations are diverse and complex, and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory investigation and other regulatory risk. As a result, the Group is, and may in the future be, involved in various disputes, legal proceedings and regulatory investigations in the UK, the EU, the US and other jurisdictions, including class action litigation, anti-money laundering charges and sanctions, compliance investigations and review by the European Commission under State Aid rules. Furthermore, the Group, like many other financial institutions, has come under greater regulatory scrutiny in recent years and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and anti-terrorism laws and regulations, as well as the provisions of applicable sanctions programmes. Disputes, legal proceedings and regulatory investigations are subject to many uncertainties, and their outcomes are often difficult to predict, particularly in the early stages of a case or investigation. Adverse regulatory action or adverse judgments in litigation could result in restrictions or limitations on the Group’s operations or have a significant effect on the Group’s reputation or results of operations or result in a loss of value in the Securities.
Risk factors continued The Group’s results have been and could be further materially adversely affected in the event of goodwill impairment. The Group capitalises goodwill, which is calculated as the excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired. Acquired goodwill is recognised initially at cost and subsequently at cost less any accumulated impairment losses. As required by IFRS, the Group tests goodwill for impairment annually or more frequently, at external reporting dates, when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of the value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. The value in use and fair value of the Group’s cash generating units are affected by market conditions and the performance of the economies in which the Group operates. Where the Group is required to recognise a goodwill impairment, it is recorded in the Group’s income statement, although it has no effect on the Group’s regulatory capital position. For the year ended 31 December 2008, the Group recorded a £32.6 billion accounting write-down of goodwill and other intangibles principally relating to RBS Holdings N.V. (formerly ABN AMRO Holding N.V.) and NatWest goodwill allocated to non-core businesses. The Group recorded a write down of goodwill and other intangibles of £363 million for the year ended 31 December 2009 and £10 million for the year ended 31 December 2010.
The Group is exposed to the risk of changes in tax legislation and its interpretation and to increases in the rate of corporate and other taxes in the jurisdictions in which it operates. The Group’s activities are subject to tax at various rates around the world computed in accordance with local legislation and practice. Action by governments to increase tax rates or to impose additional taxes or to restrict the tax reliefs currently available to the Group would reduce the Group’s profitability. Revisions to tax legislation or to its interpretation might also affect the Group’s results in the future. From January 2011, the UK Government increased the standard rate of value added tax from 17.5 per cent. to 20 per cent. and on 1 January 2011, the UK Government introduced the banking levy. These changes, together with any future changes, such as the possible introduction of a financial activities tax, could reduce the Group’s profitability.
HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the Group. UKFI manages HM Treasury’s shareholder relationship with the company. Although HM Treasury has indicated that it intends to respect the commercial decisions of the Group and that the Group will continue to have its own independent board of directors and management team determining its own strategy, should its current intentions change, HM Treasury's position as a majority shareholder (and UKFI’s position as manager of this shareholding) means that HM Treasury or UKFI may be able to exercise a significant degree of influence over, among other things, the election of directors and the appointment of senior management. In addition, as the provider of the APS, HM Treasury has a range of rights that other shareholders do not have. These include rights under the terms of the APS over the Group's remuneration policy and practice. The manner in which HM Treasury or UKFI exercises HM Treasury’s rights as majority shareholder or in which HM Treasury exercises its rights under the APS could give rise to conflict between the interests of HM Treasury and the interests of other shareholders. The Board has a duty to promote the success of the company for the benefit of its members as a whole.
The offer or sale by the UK Government of all or a portion of its stake in the company could affect the market price of the Securities and related securities. The UK Government currently holds approximately 68 per cent. of the issued ordinary share capital of the company. On 22 December 2009, the company issued £25.5 billion of B shares to the UK Government. The B shares are convertible, at the option of the holder at any time, into ordinary shares. The UK Government has agreed that it shall not exercise the rights of conversion in respect of the B shares if and to the extent that following any such conversion it would hold more than 75 per cent. of the total issued shares in the company. The UK Government may sell all or a part of the ordinary shares that it owns at any time. Offers or sales by the UK Government of a substantial number of ordinary shares or securities convertible or exchangeable into ordinary shares, or an expectation that it may undertake such an offer or sale, could affect prevailing market prices for the Securities and related securities.
The Group’s insurance businesses are subject to inherent risks involving claims. Future claims in the Group’s insurance business may be higher than expected as a result of changing trends in claims experience resulting from catastrophic weather conditions, demographic developments, changes in the nature and seriousness of claims made, changes in mortality, changes in the legal and compensatory landscape and other causes outside the Group’s control. These trends could affect the profitability of current and future insurance products and services. The Group reinsures some of the risks it has assumed and is accordingly exposed to the risk of loss should its reinsurers become unable or unwilling to pay claims made by the Group against them.
In the UK and in other jurisdictions, the Group is responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers. In the UK, the Financial Services Compensation Scheme (the “Compensation Scheme”) was established under the FSMA and is the UK’s statutory fund of last resort for customers of authorised financial services firms. The Compensation Scheme can pay compensation to customers if a firm is unable, or likely to be unable, to pay claims against it and may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under the Banking Act. The Compensation Scheme is funded by levies on firms authorised by the FSA, including the Group. In the event that the Compensation Scheme raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the Group may have an adverse impact on its results of operations and financial condition. As at 31 December 2010, the Group had accrued £144.4 million for its share of Compensation Scheme management expenses levies for the 2010/2011 and 2011/2012 Compensation Scheme years.
In addition, to the extent that other jurisdictions where the Group operates have introduced or plan to introduce similar compensation, contributory or reimbursement schemes (such as in the United States with the Federal Deposit Insurance Corporation), the Group may make further provisions and may incur additional costs and liabilities, which may have an adverse impact on its financial condition and results of operations or result in a loss of value in the Securities.
The Group’s business and earnings may be adversely affected by geopolitical conditions. The performance of the Group is significantly influenced by the geopolitical and economic conditions prevailing at any given time in the countries in which it operates, particularly the UK, the US and other countries in Europe and Asia. For example, the Group has a presence in countries where businesses could be exposed to the risk of business interruption and economic slowdown following the outbreak of a pandemic, or the risk of sovereign default following the assumption by governments of the obligations of private sector institutions. Similarly, the Group faces the heightened risk of trade barriers, exchange controls and other measures taken by sovereign governments which may impact a borrower’s ability to repay. Terrorist acts and threats and the response to them of governments in any of these countries could also adversely affect levels of economic activity and have an adverse effect upon the Group’s business.
Risk factors continued The restructuring plan for RBS Holdings N.V. is complex and may not realise the anticipated benefits for the Group. In 2007, the Group acquired an interest, through RFS Holdings B.V., in ABN AMRO Holding N.V. (which was renamed RBS Holdings N.V. on 1 April 2010). The restructuring plan in place for the integration and separation of ABN AMRO Holding N.V. into and among the businesses and operations of the Consortium Members (RBSG, the Dutch State and Santander) is complex, involving substantial reorganisation of RBS Holdings N.V.’s operations and legal structure. The restructuring plan is being implemented and significant elements have been completed within the planned timescales and the integration of the Group’s businesses continues.
As part of this reorganisation, on 6 February 2010, the majority of the businesses of RBS Holdings N.V. acquired by the Dutch State were legally demerged from the RBS Holdings N.V. businesses acquired by the Group and were transferred into a newly established company, ABN AMRO Bank N.V. (formerly named ABN AMRO II N.V.). This company was transferred to ABN AMRO Group N.V., a company wholly owned by the Dutch State, on 1 April 2010. Certain assets and liabilities of RBS Holdings N.V. acquired by the Dutch State were not part of the transfer which occurred on 1 April 2010 and remain within ABN AMRO Bank N.V. (now The Royal Bank of Scotland N.V.). These will be transferred to the Dutch State as soon as possible. In addition, certain assets within RBS N.V. continue to be under shared ownership by the Consortium Members.
As the Group does not currently own 100 per cent. of RFS Holdings B.V. and as certain of the assets of RFS Holdings B.V. are owned indirectly by the Dutch State and Banco Santander S.A. (“Santander”), the Group may experience delays in implementing the planned integration of the businesses of RFS Holdings B.V. which are owned by the Group and such integration may place a strain on management, employee, operational and financial resources. Any such delays may also restrict the ability of the Group to realise the expected benefits of the acquisition. In addition, the Group may not realise the benefits of the acquisition or the restructuring when expected or to the extent projected. Any of these events may have an adverse impact on the Group’s financial condition and results of operations.
There is currently no restriction in respect of deferred tax assets recognised by the Group for regulatory purposes. Changes in regulatory capital rules may restrict the amount of deferred tax assets that can be recognised and such changes could lead to a reduction in the Group’s Core Tier 1 capital ratio. In particular, on 16 December 2010, the Basel Committee published the Basel III rules setting out certain changes to capital requirements (see the risk factor above headed “The Group’s business performance could be adversely affected if its capital is not managed effectively or as a result of changes to capital adequacy and liquidity requirements”). Those rules include a requirement that deferred tax assets which rely on future profitability of the Group to be realised may only receive limited recognition when calculating the common equity component of Tier 1 which therefore limits the amount of deferred tax assets which can count towards that component of Tier 1 capital. The implementation of the Basel III reforms will begin on 1 January 2013, however the restrictions on recognition of deferred tax assets within the common equity component of Tier 1 are subject to a phased-in deduction starting on 1 January 2014, to be fully effective by 1 January 2018.
The Group’s participation in the APS is costly and may not produce the benefits expected and the occurrence of associated risks may have a material adverse impact on the Group’s business, capital position, financial condition and results of operations. On 22 December 2009, the Group acceded to the APS with HM Treasury acting on behalf of the United Kingdom Government. Under the APS, the Group purchased credit protection over a portfolio of specified assets and exposures of RBS and certain members of the Group from HM Treasury in return for an annual fee. If losses on assets covered by the APS exceed £60 billion (net of recoveries), HM Treasury will bear 90 per cent. of further losses. In the event of a further severe or prolonged economic downturn, which could result in extreme credit losses on the Group’s asset portfolio, the APS provides additional protection to the Group’s capital ratios and financial position.
Therefore, there can be no assurance that any regulatory capital benefits and the additional Core Tier 1 capital will be sufficient to maintain the Group’s capital ratios at the requisite levels in the event of further losses. If the Group is unable to improve its capital ratios sufficiently or to maintain its capital ratios in the event of further losses, its business, results of operations and financial condition will suffer, its credit ratings may fall, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. In that case, any compensation payable to holders of the Securities would be subject to the provisions of the Banking Act and investors may receive no value for their Securities.
There are limits on APS coverage and uncovered exposures and risks may have a material adverse impact on the Group’s business, financial condition, capital position, liquidity and results of operations. As a result of the significant volume, variety and complexity of assets and exposures and the resulting complexity of the APS documents, there is a risk that the Group may have included assets or exposures within the Covered Assets which are, or may later become, ineligible for protection under the APS, which would reduce the anticipated benefits to the Group of the APS. Further, there is no ability to nominate additional or alternative assets or exposures in place of any which may turn out not to be covered under the APS.
Protection under the APS may be limited or may cease to be available where (i) Covered Assets are not correctly or sufficiently logged or described, (ii) a Covered Asset is disposed of (in whole or in part) prior to a trigger event, (iii) the terms of the APS do not apply or are uncertain in their application, (iv) the terms of the protection itself potentially give rise to legal uncertainty, (v) certain criminal conduct has or may have occurred in respect of Covered Assets, (vi) a breach of bank secrecy, confidentiality, data protection or similar laws has occurred or may occur, (vii) certain of the extensive governance, asset management, audit and reporting obligations under the UK Asset Protection Scheme Terms and Conditions (the “Scheme Conditions”) are not complied with, (viii) the Group does not comply with the instructions of a step-in manager appointed by HM Treasury or (ix) HM Treasury seeks to appoint a step-in manager in respect of Covered Assets held within the RBS Holdings N.V. group (or in certain other jurisdictions) and it is not possible to obtain consent from the Dutch Central Bank (if required) to such step-in.
Risk factors continued The Group is subject to limitations on actions it can take in respect of the Covered Assets and certain related assets and to extensive governance, asset management, audit and reporting obligations under the Scheme Conditions. The Group’s compliance with the Scheme Conditions is dependent on its ability to (i) implement efficiently and accurately approval processes and reporting, governance and management systems in accordance with the Scheme Conditions and (ii) comply with applicable laws and regulations where it does business. Since the Group’s operational systems were not originally designed to facilitate compliance with these extensive continuing obligations, there is a risk that the Group will fail to comply with a number of these obligations. Where the Group is in breach of its continuing obligations under the Scheme Conditions or otherwise unable to provide or verify information as required under the APS, recovery of losses under the APS may be adversely impacted, may lead to an indemnity claim and HM Treasury may in addition have the right to exercise certain step-in rights, including the right to require the Group to appoint a step-in manager who may exercise oversight, direct management rights and certain other rights. The occurrence of the risks or circumstances referred to above may impact the enforceability and/or level of protection available to the Group and may materially reduce the protection anticipated by the Group for its stressed losses, in which case its business, results of operations and financial condition will suffer, its credit ratings may drop, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of Securities would be subject to the provisions of the Banking Act, and investors may receive no value for their Securities.
There is a further risk that, given that the current regulatory capital requirements and the regulatory bodies governing these requirements are subject to unprecedented levels of review and scrutiny both globally and locally, the regulatory capital treatment may differ from that assumed by the Group in respect of the APS, the treatment of the B Share issuance or the back-to-back arrangement may also occur. If participation in the APS and the issuance of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares are not sufficient to maintain the Group’s capital ratios, this could cause the Group’s business, results of operations and financial condition to suffer, its credit ratings to drop, its ability to lend and access to funding to be further limited and its cost of funding to increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of Securities would be subject to the provisions of the Banking Act and investors may receive no value for their Securities.
The amounts that may be received under the APS (which amounts are difficult to quantify precisely) may be less than the costs of participation which are themselves also difficult to quantify. The aggregate effect of the joining, establishment, operational and exit costs and fees and expenses of, and associated with, the APS may significantly reduce or even eliminate the benefit to the Group of the APS.
There are significant costs associated with termination of the Group’s participation in the APS. In order to terminate the Group’s participation in the APS, the Group must have FSA approval and must pay an exit fee. The effect of the payment of the exit fee and potentially the refund of the net pay-outs it has received from HM Treasury under the APS may significantly reduce or even eliminate the anticipated further regulatory capital benefits to the Group of its participation in the APS and could have an adverse impact on the Group’s results of operation or result in a loss of value in the Securities. Alternatively, if the Group is unable to repay to HM Treasury in full the exit fee and potentially the net pay-outs it has received under the APS and, therefore, is unable to terminate its participation in the APS, the Group will be required under the Scheme Conditions to continue to pay the annual fee to HM Treasury until 31 December 2099, which could have an adverse impact on the Group’s results of operation or result in a loss of value in the Securities.
Although HM Treasury has agreed not to convert any B Shares it holds if, as a result of such conversion, it would hold more than 75 per cent. of the ordinary shares, if HM Treasury were to acquire additional ordinary shares otherwise than through the conversion of the B Shares, such additional acquisitions could significantly increase HM Treasury’s ownership interest in the company to above 75 per cent. of the company’s ordinary issued share capital, which would put the company in breach of the FSA’s Listing Rules requirement that at least 25 per cent. of its issued ordinary share capital must be in public hands. Although the company may apply to the FSA in its capacity as the competent authority under the FSMA for a waiver in such circumstances, there is no guarantee that such a waiver would be granted, the result of which could be the delisting of the company from the Official List and potentially other exchanges where its Securities are currently listed and traded.
424 Financial calendar 424 Shareholder enquiries 425 Analyses of ordinary shareholders 426 Trading market 429 Dividend history 430 Taxation for US Holders 433 Exchange controls 433 Memorandum and Articles of Association 433 Incorporation and registration 433 Code of conduct 434 Glossary of terms 440 Index 443 Important addresses 443 Principal offices
Non-cumulative preference shares 30 December 2011 Ex-dividend date Cumulative preference shares 4 May 2011 Record date Cumulative preference shares 6 May 2011
For further information on the payment of dividends, see page 429.
Shareholder enquiries Shareholdings in the company may be checked by visiting the ‘Shareholder Services’ section of our website (www.rbs.com/shareholder). You will need the shareholder reference number printed on your share certificate or tax voucher to gain access to this information.
It is not just the novice investor that has been duped in this way; many of the victims had been successfully investing for several years. Shareholders are advised to be very wary of any unsolicited advice, offers to buy shares at a discount or offers of free company reports. If you receive any unsolicited investment advice: make sure you get the correct name of the person and organisation; check that they are properly authorised by the FSA before getting involved by visiting; www.fsa.gov.uk/pages/register; report the matter to the FSA either by calling +44 (0)845 606 1234 or visiting (www.fsa.gov.uk/pages/consumerinformation); and if the calls persist, hang up.
If you deal with an unauthorised firm, you will not be eligible to receive payment under the Financial Services Compensation Scheme. The FSA can be contacted by completing an online form at (www.fsa.gov.uk/pages/doing/regulated/law/alerts/form.shtml)
Details of any share dealing facilities that the company endorses will be included in company mailings.
December 2010 High 0.4231 2010: Q3 High 0.5210 2009 High 0.5765 Low 0.3782 Low 0.3896 Low 0.1030 November 2010 High 0.4714 2010: Q2 High 0.5804 2008 High 3.7054 Low 0.3759 Low 0.4143 Low 0.4140 October 2010 High 0.4949 2010: Q1 High 0.4560 2007 High 6.0208 Low 0.4455 Low 0.3125 Low 3.3265 September 2010 High 0.5015 2009: Q4 High 0.5055 2006 High 5.5770 Low 0.4580 Low 0.2841 Low 4.6559 August 2010 High 0.5210 2009: Q3 High 0.5765
On 22 February 2011, the closing price of the ordinary ADSs on the New York Stock Exchange was $15.24.
Deferral period"), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the deferral period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.
Notes: (1) Each American Depository Share represents 20 ordinary shares. As discussed under Trading market, the American Depository Shares were issued in October 2007 and consequently did not receive any of the above dividends prior to the final dividend in respect of 2007. (2) In 2008, the company issued new ordinary shares by way of a capitalisation issue rather than paying an interim dividend. (3) Final dividends for each year were proposed in the indicated year and paid in the following year.
The US Treasury has expressed concerns that parties to whom depositary receipts are released before shares are delivered to the depositary, or intermediaries, in the chain of ownership between US holders and the issuer of the security underlying the depositary receipts may be taking actions that are inconsistent with the claiming of foreign tax credits for US holders of depositary receipts. Such actions would also be inconsistent with the claiming of the reduced rate of US tax applicable to dividends received by certain non-corporate US holders. Accordingly, the availability of the reduced tax rate for dividends received by certain non-corporate US holders of ordinary ADSs could be affected by actions taken by such parties or intermediaries.
Taxation of capital gains A US Holder that is not resident (or, in the case of an individual, ordinarily resident) in the UK will not normally be liable for UK tax on capital gains realised on the disposition of an ordinary share, a non-cumulative dollar preference share, an ordinary ADS or a preference ADS unless at the time of the disposal, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a permanent establishment or, in the case of any other US Holder, such US Holder carries on a trade, profession or vocation in the UK through a UK branch or agency and, in each case, such ordinary share, non-cumulative dollar preference share, ordinary ADS or preference ADS is or has been used, held or acquired by or for the purposes of such trade (or profession or vocation), carried on through such permanent establishment, branch or agency. Special rules apply to individuals who are temporarily not resident or ordinarily resident in the UK.
A US Holder will, upon the sale or other disposition of an ordinary share, a non-cumulative dollar preference share, an ordinary ADS or a preference ADS, or upon the redemption of a non-cumulative dollar preference share or preference ADS, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption of a non-cumulative dollar preference share or a preference ADS, such US Holder does not own, and is not deemed to own, any ordinary shares or ordinary ADSs of the company) in an amount equal to the difference between the amount realised (excluding in the case of a redemption any amount treated as a dividend for US federal income tax purposes, which will be taxed accordingly) and the US Holder's tax basis in such share or ADS. This capital gain or loss will be long-term capital gain or loss if the US Holder held the share or ADS so sold, disposed or redeemed for more than one year.
Estate and gift tax Subject to the discussion of the Estate Tax Treaty in the following paragraph, ordinary shares, non-cumulative dollar preference shares, ordinary ADSs or preference ADSs beneficially owned by an individual may be subject to UK inheritance tax (subject to exemptions and reliefs) on the death of the individual or in certain circumstances, if such shares or ADSs are the subject of a gift (including a transfer at less than market value) by such individual. Inheritance tax is not generally chargeable on gifts to individuals made more than seven years before the death of the donor. Ordinary shares, non-cumulative dollar preference shares, ordinary ADSs or preference ADSs held by the trustees of a settlement may also be subject to UK inheritance tax. Special rules apply to such settlements.
Interest on the PROs constitutes UK source income for UK tax purposes and, as such, may be subject to income tax by direct assessment even where paid without withholding. However, interest with a UK source received without deduction or withholding on account of UK tax will not be chargeable to UK tax in the hands of a US Holder unless, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a UK permanent establishment or in the case of other US Holders, such persons carry on a trade, profession or vocation in the UK through a UK branch or agency in each case in connection with which the interest is received or to which the PROs are attributable. There are also exemptions for interest received by certain categories of agents (such as some brokers and investment managers).
Glossary of terms Adjustable rate mortgage (ARM) - in the US a variable-rate mortgage. ARMs include: hybrid ARMs which typically have a fixed-rate period followed by an adjustable-rate period; interest-only ARMs where interest only is payable for a specified number of years, typically for three to ten years; and payment-option ARMs that allow the borrower to choose periodically between various payment options.
Arrears are the aggregate of contractual payments due on a debt that have not been met by the borrower. A loan or other financial asset is said to be 'in arrears' when payments have not been made.
Commercial paper conduit is a special purpose entity 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 either by further commercial paper issuance, repayment of assets or liquidity drawings.
Currency swap - an arrangement in which two parties exchange specific principal amounts of different currencies at inception and subsequently interest payments on the principal amounts. Often, one party will pay a fixed interest rate, while the other will pay a floating exchange rate (though there are also fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are usually re-exchanged.
Glossary of terms continued Discontinued operation - is a component of the Group that either has been disposed of or is classified as held for sale. A discontinued operation is either: a separate major line of business or geographical area of operations or part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations; or a subsidiary acquired exclusively with a view to resale.
Forbearance - is the term generally applied to an agreement, principally in relation to secured loans with retail customers experiencing temporary financial difficulty, to a payment moratorium, to reduced repayments or to roll up arrears. Forbearance loans are a subset of Renegotiated loans.
Guaranteed mortgages - are mortgages that are guaranteed by a government or government agency. In the US, government loan guarantee programmes are offered by the Federal Housing Administration, the Department of Veterans Affairs and the Department of Agriculture's Rural Housing Service. In the Netherlands, the Gemeentegarantie programme is run partly by the central government and partly by the municipalities.
Home equity loan - is a type of loan in which the borrower uses the equity in their home as collateral. A home equity loan creates a charge against the borrower's house.
Impairment losses - for impaired financial assets measured at amortised cost, impairment losses - the difference between carrying value and the present value of estimated future cash flows discounted at the asset's original effective interest rate - are recognised in profit or loss and the carrying amount of the financial asset reduced by establishing a provision (allowance). For impaired available-for-sale financial assets, the cumulative loss that had been recognised directly in equity is removed from equity and recognised in profit or loss as an impairment loss.
Individually assessed loan impairment provisions - impairment loss provisions for individually significant impaired loans assessed on a caseby -case basis, taking into account the financial condition of the counterparty and any guarantor and the realisable value of any collateral held.
Interest spread - is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities.
Leveraged loans - funding (leveraged finance) provided to a business resulting in an overall level of debt that exceeds that which would be considered usual for the business or for the industry in which it operates. Leveraged finance is commonly employed to achieve a specific, often temporary, objective: to make an acquisition, to effect a buy-out or to repurchase shares.
Liquidity enhancements - make funds available to ensure that the issuer of securities, usually a commercial paper conduit, can redeem the securities at maturity. They typically take the form of a committed facility from a third-party bank.
Loan impairment provisions - are established to recognise incurred impairment losses on a portfolio of loans classified as loans and receivables and carried at amortised cost. It has three components: individually assessed loan impairment provisions, collectively assessed loan impairment provisions and latent loss provisions.
Monoline insurers - are entities that specialise in providing credit protection against the notional and interest cash flows due to the holders of debt instruments in the event of default. This protection is typically in the form of derivatives such as credit default swaps.
Mortgage-backed securities - are asset-backed securities for which the underlying asset portfolios are loans secured on property. See Residential mortgage backed securities and Commercial mortgage backed securities.
Mortgage servicing rights - are the rights of a mortgage servicer to collect mortgage payments and forward them, after deducting a fee, to the mortgage lender.
Mortgage vintage - the year in which a mortgage loan was made to the customer.
Net interest income - is the difference between interest receivable on financial assets classified as loans and receivables or available-for-sale and interest payable on financial liabilities carried at amortised cost.
Net interest margin - is net interest income as a percentage of average interest-earning assets.
Net principal exposure - is the carrying value of a financial asset after taking account of credit protection purchased but excluding the effect of any counterparty credit valuation adjustment to that protection.
Private equity investments - are equity investments in operating companies not quoted on a public exchange. Capital for private equity investment is raised from retail or institutional investors and used to fund investment strategies such as leveraged buyouts, venture capital, growth capital, distressed investments and mezzanine capital.
Regular way purchase or sale - is a purchase or sale of a financial asset under a contract whose terms require delivery of the asset within the time frame established generally by regulation or convention in the marketplace concerned.
Renegotiated loans - loans are generally renegotiated either as part of the ongoing banking relationship with a creditworthy customer or in response to a borrower's financial difficulties. In the latter case, renegotiation encompasses not only revisions to the terms of a loan such as a maturity extension, a payment moratorium, a concessionary rate of interest but also the restructuring of all or part of the exposure including debt forgiveness or a debt for equity swap. Loans renegotiated as part of the ongoing banking relationship with a creditworthy customer, are treated as new loans.
Reverse repurchase agreement (Reverse repo) - see Sale and repurchase agreements.
Risk-weighted assets - assets adjusted for their associated risks using weightings established in accordance with the Basel Capital Accord as implemented by the FSA. Certain assets are not weighted but deducted from capital.
Sale and repurchase agreements - in a sale and repurchase agreement one party, the seller, sells a financial asset to another party, the buyer, at the same time the seller agrees to reacquire, and the buyer to resell, the asset at a later date. From the seller's perspective such agreements are repurchase agreements (repos) and from the buyer's reverse repurchase agreements (reverse repos).
Securitisation - is a process by which assets or cash flows are transformed into transferable securities. The underlying assets or cash flows are transferred by the originator or an intermediary, typically an investment bank, to a special purpose entity which issues securities to investors. Asset securitisations involve issuing debt securities (assetbacked securities) that are backed by the cash flows of incomegenerating assets (ranging from credit card receivables to residential mortgage loans). Liability securitisations typically involve issuing bonds that assume the risk of a potential insurance liability (ranging from a catastrophic natural event to an unexpected claims level on a certain product type).
Structured Investment Vehicle (SIV) - is a limited-purpose operating company that undertakes arbitrage activities by purchasing highly rated medium and long-term, fixed-income assets and funding itself with shortterm, highly rated commercial paper and medium-term notes.
Student loan related assets - are assets that are referenced to underlying student loans.
Subordinated liabilities - are liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer.
Tier 1 capital ratio - Tier 1 capital as a percentage of risk-weighted assets.
Wrapped security - a wrapped security is a debt security where the holder benefits from credit protection provided by a third party, typically a financial guarantor or monoline insurer.
Derivatives 329 Available-for-sale financial assets Accounting policies 280 Description of business 53 Notes on the accounts 300
Notes on the accounts 297, 298 Business divestments Business review 54 Earnings per share 299 Notes on the accounts 341
Cash flow statement Financial instruments Business review 111 Accounting policies 279, 281 Consolidated 274 Critical accounting policies 284 Notes on the accounts 374, 375, 376 Notes on the accounts 300 Parent company 274
Financial statements Central functions/items 38, 53, 100, 377 Balance sheets 106, 270
Cash flow statements 111, 274 Chairman’s statement 2 Income statement 57, 268 Statement of changes in equity 271 Charitable contributions 234 Statement of comprehensive income 269
Operating expenses Going concern Business review 71 Report of the directors 232 Notes on the accounts 289
Goodwill Pensions Accounting policy 277 Accounting policy 276 Notes on the accounts 335, 381 Critical accounting policies 284
Principal subsidiaries 334 Income statement Business review 57 Property, plant and equipment Consolidated 268 Accounting policy 277 Parent company 298 Notes on the accounts 338
Insurance claims Provisions Accounting policy 278 Accounting policy 279 Critical accounting policies 285 Notes on the accounts 328 Notes on the accounts 344
Capital 126 Internal control 239 Credit risk 146 Equity risk 145 Investigations 369 Funding and liquidity risk 134
Securitisations Summary of Group results 387 Notes on the accounts 364 Other risk exposures 217 Supervision 397
Segmental reporting Sustainability 42 Business review 77 Description of business 53 Tax Notes on the accounts 377 Accounting policy 279
Shareholder enquiries Registrar Computershare Investor Services PLC The Pavilions Bridgwater Road Bristol BS99 6ZZ Telephone: +44 (0)870 702 0135 Facsimile: +44 (0)870 703 6009 Website: www.investorcentre.co.uk/contactus
Group Secretariat The Royal Bank of Scotland Group plc PO Box 1000 Gogarburn Edinburgh EH12 1HQ Telephone: +44 (0)131 556 8555 Facsimile: +44 (0)131 626 3081
RBS Insurance Direct Line House 3 Edridge Road Croydon Surrey CR9 1AG Churchill Court Westmoreland Road Bromley Kent BR1 1DP