Financial Markets 20 Retail Banking 26 Retail Direct 32 Manufacturing 36 Wealth Management 38 RBS Insurance 42 Ulster Bank 44 Citizens
Report and accounts 55 Section Operating and financial review 113 Section Governance 137 Section Financial statements 201 Section Additional information 221 Section Shareholder information
F in an ci al h ig hl ig ht s Financial highlights
The Group’s total income grew by 18% to £22,754 million in 2004.
The Group’s profit before tax, goodwill amortisation and integration costs increased by 15% to £8,101 million in 2004.
� Profit before tax, goodwill amortisation and integration costs up 15%
� Total shareholder return close to 100% over the last five years *2002 and 2003 have been restated following the implementation of FRS 17.
The directors have recommended a final dividend of 41.2p which, when added to the interim dividend of 16.8p, makes a total for 2004 of 58.0p, an increase of 15%.
At the end of 2004 The Royal Bank of Scotland Group was the world’s 5th largest banking group, with a market capitalisation of £56 billion.
The bulk of both our income and assets continues to be in the UK, although the US and Europe are making a growing contribution.
The number of people we employ and the number of customers buying banking products and financial services from the Group are growing in the UK and internationally. We now employ 137,000 people worldwide (on a full time equivalent basis).
In 2004 we maintained the momentum of our good performance of recent years. We achieved strong organic growth across our activities. In addition, through various acquisitions, we strengthened our existing businesses outside the UK and established additional options for future growth.
Financial performance In 2004 the Group profit before tax, goodwill amortisation and integration costs increased by 15% to £8,101 million (2003 – £7,068 million). Total income grew by 18% to £22,754 million (2003 – £19,281 million), while operating expenses grew by only 13% to £9,662 million (2003 – £8,524 million). The 2003 results have been restated following the implementation of FRS 17.
Acquisitions During 2004 we strengthened our activities outside the UK through several acquisitions.
In the United States, we acquired Charter One, which enabled Citizens to extend its franchise into six adjacent states. We completed the acquisition of Roxborough Manayunk Bank, in Pennsylvania, which had been announced in 2003, and also acquired the credit card business of People’s Bank and the merchant acquirer Lynk Systems, Inc.
Iain Robertson, Chairman of Corporate Banking & Financial Markets, will also retire at the annual general meeting. I recruited Iain to the bank 13 years ago, and in this period he created what is, in my opinion, the UK’s best corporate relationship bank and increased its contribution to our profits some 50 fold.
I would also like to acknowledge the excellent service of Norman McLuskie who retired from the Board in August 2004 as Chairman, Retail Direct. Norman joined the Group in 1982 and was appointed an executive director in 1992. He was a valued member of my senior team and held a number of key positions, including Deputy Chief Executive, UK Bank.
Emilio Botin and Juan Inciarte, both directors of SCH, resigned from the Board in November 2004, having served for over 15 and 9 years respectively. I would like to pass on my personal thanks for their contribution which has brought an extra dimension to Board discussions. During their Board membership a highlight of our strategic alliance with SCH, which began in 1988, was its financial support of the Group’s successful acquisition of NatWest in 2000.
In September 2004, three new non-executive directors were appointed. Archie Hunter was formerly Scottish senior partner of KPMG, Bud Koch was formerly chairman, president and chief executive officer of Charter One Financial, Inc., and Joe MacHale was formerly a senior executive with JP Morgan. Each of our new directors bring with them the experience to further strengthen the Board.
E xe cu tiv e’ s re vi ew Group Chief Executive’s review
In 2004 we continued to achieve strong growth across our activities, both organically and through acquisitions. We increased our total income by 18% and improved our cost:income ratio to 40.8%. Our profit before tax, goodwill amortisation and integration costs increased by 15% to £8,101 million. All our divisions increased their income and their contribution to Group profit.
It is pleasing that we continued to deliver strong organic growth across our businesses, on top of the strong performance in previous years.
Our people Our people are the key to our success. The continuing commitment of our employees, even after their very hard work in previous years completing the integration of NatWest, is evident from the results of our 2004 Employee Opinion Survey. In this survey, the response rate was 84%, our highest ever, and the Group improved its score in 14 of the 15 categories surveyed. We continue to invest in our employees through an extensive range of development and leadership programmes. As a result of organic growth and acquisitions, staff numbers increased by 15,700 in 2004.
Business outlook We continue to see strong growth in lending to commercial and mid-corporate customers, and some recovery in demand from large corporates, with consumers continuing to behave rationally given the prevailing climate and stimuli in their particular economies. Whilst in the UK context we would expect the transition away from consumer credit-led activity to continue, the outlook for employment and hence the economy remains positive.
In a number of respects, 2004 represented a continuation of established themes within our results: strong income growth, improving efficiency, good credit quality. Importantly however, the continued development, both organic and through acquisition, of our businesses has introduced further strength and diversity in key areas.
Through two of the UK’s best-known banking brands, The Royal Bank of Scotland and NatWest, Retail Banking has the largest network of bank branches and ATMs in the UK. It offers a wide range of banking, financial, insurance, life assurance and pension products through branches, direct banking and the internet. It is the leading bank for students and for small business customers. During 2004 Retail Banking continued to expand its customer base and grow its loan portfolio, particularly in mortgages and deposits.
Retail Direct has leading positions in the UK in credit card issuing, merchant acquiring, consumer finance and supermarket banking. It offers a comprehensive range of credit and charge cards through The Royal Bank of Scotland, NatWest and other brands, including MINT. Other products and services are offered to consumers through Tesco Personal Finance, The One account, First Active, Direct Line Financial Services, Lombard Direct and other brands. Through Streamline it is the leading merchant acquirer in the UK and Europe, and ranks 4th globally. Retail Direct also offers credit card issuing and acquiring services in the US and Europe, and a range of consumer finance products in Continental Europe.
Group Technology continually develops and maintains the infrastructure and technology that supports the branches, ATMs and internet banking for customers of CBFM, Retail Banking, Retail Direct, Wealth Management and RBS Insurance.
D iv is io na l p ro fil e Divisional profile continued
�Eighth largest commercial banking organisation in the US ranked by deposits
�Retail presence in 13 states and products and services available in over 30 states
Chairman, President and Geography Chief Executive Officer New England, Mid-Atlantic and Larry Fish Midwest regions of US
Citizens is now the eighth largest banking organisation in the US by deposits. The acquisition of Charter One in 2004 enabled it to expand into six adjacent states in the northeastern and midwestern US. Citizens offers personal banking, residential mortgages and home equity loans, and a wide variety of commercial banking services, through its growing network of city centre, local and supermarket branches.
BellSouth. Enabling new leadership in the US wireless industry: in 2004 RBS Greenwich Capital provided BellSouth, a Fortune 100 communications services company, with financing advice for Cingular’s acquisition of AT&T Wireless – creating the biggest wireless carrier in the United States. Acting as joint bookrunner, RBS Greenwich Capital placed US$1.5 billion of securities across the US, European and Asian markets.
��� We are committed to developing long-term relationships with our clients and providing solutions that are targeted at meeting their specific needs.
��� CBFM’s extensive product range includes cash and liquidity management and comprehensive debt, risk management and treasury services. Debt services include overdraft, bilateral and syndicated lending and primary bond issuance, trade finance and asset finance, and through our Structured Finance business, structured, property and acquisition finance, project and infrastructure finance (including PPP/PFI). Risk management and treasury services include global interest rate derivatives trading, corporate, institutional and sovereign debt trading, futures brokerage, foreign exchange, money markets, currency derivative and rate risk management services.
��� CBFM is also the market leader in large corporate banking in the UK, with relationships with over 95% of the FTSE 100, and over 75% of the FTSE 250. It has well established and rapidly expanding corporate and institutional client franchises in Continental Europe, North America and in selected markets in Asia Pacific.
��� As the UK market leader in the provision of corporate banking services, CBFM provides a full range of traditional banking services through 1,500 relationship managers in 150 offices across the country and offers additional products and services through a number of business areas that are tailored to different client needs.
��� RBS Commercial Services (RBSCS) is the largest invoice discounting business in the UK. RBSCS provides financing of debtors and stock, credit control services and bad debt protection for customers to cover against debtor default.
��� CBFM’s integrated approach ensures that customers also benefit from the full range of capabilities in the Structured Finance and Financial Markets businesses.
��� CBFM currently has relationships with over 90% of the Dow Jones Eurostoxx 50 index of leading European companies and we have made excellent progress developing relationships across Europe. In addition to growing operations in France, Germany, Spain and Italy, we are the leading property leasing company in the Nordic region. Our new branch in Stockholm offers a broad range of CBFM products to Scandinavian clients. In each of these countries we aim to be the top non-domestic corporate bank.
��� In the US, CBFM is successfully deploying the same relationship-led approach that is used in the UK and Continental Europe to progressively build the business. During 2004 we launched a new corporate bonds business that builds on our industryleading US government bonds and asset-backed securities operations at RBS Greenwich Capital.
��� Structured Finance has expertise in specialised financing around the globe. In Europe we are the market leader as an arranger of project finance, property finance, and acquisition finance, working particularly closely with the growing number of private equity sponsors. We are now seeing very good growth in these businesses in the US as well. We are also a leading European asset finance provider, particularly in trains and aircraft, through Angel Trains and RBS Aviation Capital.
��� Financial Markets has continued to grow in sterling, US dollar and euro bond markets and over the last two years RBS has been the fastest growing player in the euro bond market, providing further evidence of RBS’s position as a global force in the bond markets. Our foreign exchange business, where we are now one of the market leaders, is ranked 5th in the world.
For the last five years RBS has been the leading provider of banking services to UK businesses with a current market share of 33%.
�� Shire Foods Shire Foods, creators of “Football’s Famous Chicken Balti Pies”, now supply over 60 football clubs. Commercial Banking provided £3.7 million of property and leasing finance for a new production facility in Leamington Spa.
��� In Italy, we acted as Joint Bookrunner for the €1.3 billion senior notes offering for Lighthouse S. A. guaranteed by Seat Pagine Gialle. The transaction was the largest ever single tranche high yield bond issued in the European market and was named High Yield Deal of the Year by Credit Magazine.
��� We were Financial Adviser and Bookrunner for the record-breaking US$7.63 billion Qatargas II project financing, which provided funds for the development of offshore and liquefaction facilities in Qatar as well as an LNG import terminal in South Wales. Qatargas II was voted EMEA gas deal of the year by PFI Magazine.
��� In the United States we held the role of Joint Lead Arranger in the leveraged buyout of Mandalay Resort Group by MGM MIRAGE. At US$7 billion, the friendly acquisition was the largest leveraged deal of 2004.
��� Best Senior Debt Provider in Europe (for the 4th year running)
Student Banking. Access to cheap train travel is high on the priority list for many students across the UK. So offering a free Young Persons Railcard giving 30% off most rail fares for 5 years has proved a popular addition to NatWest’s student banking service. NatWest was once again the No.1 bank for students in 2004, increasing its market share of first year students in England and Wales from 25% to 42%.
Retail Banking has the largest network of bank branches and ATMs in the UK, and is the leading bank for small business customers. During 2004 Retail Banking expanded its customer base, grew its loan portfolio, particularly in mortgages, and increased its deposits. Retail Banking increased its total income by 6% to £4,742 million.
��� Retail Banking increased its personal customers by 268,000 (2%) and its personal current accounts by 291,000 (3%) in 2004. Retail Banking was particularly successful in recruiting youth and student accounts. Retail Banking also maintained its leading market share of small business customers.
��� Royal Bank of Scotland is rated number one for overall customer satisfaction in Scotland.
��� Royal Bank of Scotland launched its thirteenth mobile banking service in August, serving 20 villages near Helensburgh. Our mobile banks now serve more than 300 rural communities in Scotland.
��� A new system of screen prompts enables our branch and telephone banking staff to identify products or services that are directly relevant to our customers’ financial needs. These prompts help us to spot ways of saving our customers money – one customer in four has expressed interest in pursuing the conversation.
Products ��� Our new Offset Banking Service allows both NatWest and Royal Bank of Scotland customers to set their current and savings account balances against a mortgage. This saves interest and shortens the life of the mortgage. Unlike other banks, we offer the Offset Service to small businesses as well as personal customers.
��� Over 70,000 customers have signed up for the Royalties Premier Account, which combines all the features of a current account with a range of services to save them time and money. The benefits include a personal travel adviser, home emergency service, worldwide family travel insurance and discounts on a wide range of books, DVDs, restaurants and financial services.
Business customers ��� We helped our business customers to grow with total lending up 11% in 2004. Customer balances in our competitive range of deposit products grew by 7%.
��� NatWest and Royal Bank of Scotland lent £546 million last year to small businesses based in the most deprived areas of the UK.
��� Mentor, our small business advice service, saw a 49% increase in net income. Significant improvements in our service offering and stronger relationships with our Business Relationship Manager networks helped to increase our customer base by 44%.
�� Branch Network Alan Bembridge with his dog Henry is a regular visitor to Derby’s St Peter Street branch, one of over 2,200 branches in the Group. We are able to supply him with letters, brochures and statements in both large print and braille.
Retail Banking places customer service at the heart of its strategy, measuring and improving its delivery on a continuous basis.
��� Royal Bank of Scotland voted Remortgage Lender of the Year.
��� The MINT credit card was successfully rolled out in 2004. With its curved-shape card, MINT brought about the first development in the shape of the credit card in the UK since their introduction 38 years ago, and is recognised by customers as an innovative and forward-thinking brand. The new MINT brand makes full use of the internet channel, with over 45% of credit card applications being made online. By the end of 2004, 711,000 cards had been issued with balances amounting to £1 billion. MINT’s development continued with the launch of MINT loans in October 2004.
��� In merchant acquiring 2004 was another record year for Streamline, which processed over 2.7 billion transactions.
��� WorldPay, our internet payment specialist, also had a record year, reflecting strong growth in the volume of shopping on the internet. During 2004, WorldPay further strengthened its position following the acquisition of Bibit, an internet payment specialist based in the Netherlands. WorldPay is now the leading internet payment specialist in the EU, and provides services to internet retailers in over 40 countries.
��� Retail Direct opened a new state-of-the-art Credit Card Centre in Southend. This purpose-built centre creates an excellent working environment for our employees, helping them to deliver improved service for our customers.
��� Tesco Personal Finance launched an innovative new ‘Instant’ Life Insurance package, to augment the range of instant products already available in store including breakdown cover and travel insurance.
��� In Continental Europe, Retail Direct acquired Bibit, an internet payment specialist based in the Netherlands.
��� Retail Direct reached agreement with Tchibo to distribute consumer loan products to its customers. Tchibo is a leading retailer in Germany, where it has around 1,000 stores.
�� Tchibo We have expanded our distribution capability in Europe through our partnership with Tchibo, which has around 1,000 stores in Germany alone. The brand reaches over two thirds of Germany's households.
��� In the US, Retail Direct led the acquisition of the credit card business of People’s Bank. Migration of this business to the newly-established RBS National Bank is on track. Retail Direct also acquired Lynk Systems, the 9th largest merchant acquirer in the United States. Credit cards and merchant acquiring services will be offered to the business customers of Citizens, Charter One, and RBS Corporate Banking.
��� The One account – Bank Lender of the Year 2004 – Offset Mortgage Lender of the Year
Spinningfields, Manchester. Spinningfields has involved the re-development of a substantial brownfield site. The Group employs around 5,000 people in Manchester and has consolidated a number of its major businesses here on one campus. A similar strategy has been implemented in London and Birmingham, and Edinburgh will follow in 2005.
During 2004 Manufacturing supported increased volumes of business and made good progress on the IT integrations of Churchill and First Active. Manufacturing also completed regional centres for RBS employees in Birmingham and Manchester and maintained its leading position in purchasing.
��� We processed over 21 million CHAPS payments valued at over £40 trillion – 8% more in volume than 2003.
��� During 2004 call centres supporting The Royal Bank of Scotland and NatWest received 71 million calls, 3 million more than in 2003. Royal Bank of Scotland and NatWest customers can telephone their branch or use our automated service. They can speak to our UK based call centre staff 24 hours a day, 365 days a year.
��� During 2004 Group Technology helped RBS Insurance complete several major stages in the conversion of Churchill onto the core IT platform.
Mail Handling and Logistics During 2004 we transformed our mail handling and logistics, saving over 35 miles of paper every night, and creating a ‘next day’ delivery network.
��� A new mortgage system to support multiple brands across the Group was introduced in 2004. This has enabled a significant reduction in the time taken to process mortgage applications and improve customer service.
��� Manufacturing has introduced ‘Image and Workflow’ technology into its service centres to help reduce the amount of paper in circulation and improve efficiency. As each piece of paper comes into the centres, it is stored as an image that can be called up and processed at any location.
Ozwald Boateng. The name Ozwald Boateng is synonymous with the finest of Saville Row tailoring. During 2004, Coutts launched a new super premium charge card, designed by Ozwald Boateng. Cardholders benefit from a concierge service and hospitality packages at events such as Wimbledon, the Monaco Grand Prix and the Cannes Film Festival.
��� Investment assets under management increased by 7%, allowing for exchange rate movements, and excluding acquisitions and disposals.
��� Investment programmes within Wealth Management have grown by 25% to US$17 billion and continue to perform competitively against industry benchmarks. Coutts is a significant investor in multi-manager hedge funds with more than US$6 billion invested.
��� Across its range of brands and products, RBS Insurance increased its total policies in-force by 2 million to over 22 million. Within this total motor policies increased by 5% to almost 10 million.
��� The Direct Line red phone continues to have the highest awareness of any general insurance brand. Direct Line’s sponsorship of Channel 4’s set of top rating property programmes has proved extremely successful.
��� Churchill embarked on a new marketing campaign in June, featuring the popular nodding dog brand and his famous “Oh Yes!” catchphrase. The campaign focused on the benefits of the service and reinforced the potential savings that could be made by switching to Churchill. The campaign was a major success, delivering record levels of brand awareness and sales.
��� In October, a new intermediary business was created. The new company, RBS Insurance Brokers, provides commercial insurance for small business customers of Retail Banking.
��� NIG is the broker channel specialist within RBS Insurance, offering personal and commercial insurance through a large number of UK insurance brokers.
RBS is the strength behind some of the UK’s biggest and best known brands offering customers more choice and better products.
Motor Repair Centres Our network of motor repair centres, with teams of specialists to assess damage and complete repairs, ensure that our customers are back on the road as quickly as possible.
��� In addition to selling insurance under its own brands and through the broker channel, RBS Insurance sells a range of insurance products through partners under their brands, through UKI Partnerships, its dedicated partnerships division. UKI Partnerships continued to build on its position as a leading wholesale provider by adding to its impressive list of clients, and underlined its ability to work alongside high-profile brands.
��� Green Flag Motoring Assistance – Best Online Breakdown Cover Provider 2004 Your Money – Direct Awards
��� Ulster Bank achieved strong growth in both personal and business customers. It now has 1.5 million personal and business customers.
Awards ��� The Ulster Bank Switcher Mortgage – Top Home Loan
��� Ulster Bank’s Aimhigher campaign was recognised with a special citation for Corporate Social Responsibility
Citizens is now the 8th largest commercial banking organisation in the US by deposits. During 2004 Citizens acquired Charter One, which enabled it to extend its franchise into six adjacent states in the northeastern and midwestern US. As a result of this acquisition and strong organic growth, Citizens increased its income by 31% to US$3,923 million.
��� Citizens has increased its income and profit in each of the last 12 years as a result of strong organic growth and a series of successful acquisitions.
��� Citizens increased its business customer base by 174,000 to 400,000 during 2004. Excluding Charter One, business customers grew by 32,000 in the New England and Mid-Atlantic regions.
��� As a result of the acquisition of Charter One and organic growth, Citizens achieved a significant increase in its distribution outlets. Traditional branches increased from 605 to 1,117. In-store branches grew from 261 New England and Mid-Atlantic locations to a total of 496 across Citizens. ATMs grew from 1,638 to 2,804.
��� Citizens now ranks 7th in the US among commercial banking organisations in the number of branches and 9th in ATMs.
��� The acquisition of Roxborough Manayunk Bank strengthened Citizens’ position in Greater Philadelphia.
��� Citizens processed almost 1.1 million credit applications and closed US$20 billion of new consumer loans during 2004. Citizens is now a leading home equity lender and bank auto lender in the United States.
Citizens now ranks seventh in the US in the number of branches and ninth in ATMs.
Phillies. We’ve become a big player in Philadelphia following the successful acquisition of the Mellon regional banking franchise. The Phillies new Major League Baseball stadium, under Citizens’ sponsorship, has been renamed Citizens Bank Park, boosting awareness of the brand in the Mid-Atlantic region. Citizens’ “Ballpark Bankers” drive fans from the parking lots in golf carts and usher them to their seats in the stadium.
��� Citizens’ new online banking platform was launched in October. It offers bill payments, cheque imaging, email alerts and online statements, and positions its internet banking proposition strongly against other large banks in the United States.
��� Citizens’ new web-based cash management information reporting system, Money Manager GPS, features a full line of transaction-initiation options – including wire transfer, stop payments and positive pay decision-making. The Cash Management team invests more than US$5 billion per night in overnight sweep accounts and services more than 20,000 Cash Management customers.
��� Following extraordinary flooding damage in the wake of Hurricane Ivan, in September 2004, Citizens provided special lending offers to the community to help support flood relief efforts in western Pennsylvania. It also distributed emergency assistance funds to colleagues affected by the flooding.
�� New Branches Charter One has an extensive program of opening new branches to extend its market reach and provide additional customer convenience and choice.
Affordable Housing Allston Brighton Community Development Corporation provides affordable housing in Boston. Citizens provides homebuyer education, and financing of affordable homes for families like Clara Benites and her daughter, Serduce.
��� Citizens created The Citizens Housing Bank to provide up to US$200 million in low-interest loan funds to non-profit housing developers to create more affordable housing units in New England.
��� Since it began in 2002, Citizens’ innovative Community Champions program has assisted 35 small, non-profit agencies in New England and five in Pennsylvania dedicated to significant social service issues like community health care, disadvantaged youth services, homelessness, hunger and affordable housing. Citizens will extend this initiative into the Midwest within the next year.
��� More than 90 colleagues have benefited from Citizens’ military leave policy, which was extended above and beyond legal requirements, to bridge pay and benefits to cover the duration of military leave. We also gave employees with serving family members time off with pay, and help with travel expenses.
��� Our enhanced activity in the Charter One geography during 2004 included multi-year community partnerships with the Indianapolis Colts, the National Football League’s Indiana franchise, and the “Cuse Cares” community service program for student-athletes at Syracuse University in central New York.
��� Citizens Bank Park, the new home of Major League Baseball’s Philadelphia Phillies, opened in April 2004. The 25-year naming rights and promotional agreement with the Phillies has strengthened Citizens’ community presence and enhanced the brand in and around Philadelphia.
��� Citizens was the No.1 US Small Business Administration lender in the Mid-Atlantic and New England regions and the No. 2 lender in the US for the third consecutive year. We made 5,695 SBA-backed loans totalling more than US$232 million, a 38% increase in loan volume over 2003.
We improved our position to 2nd equal in the Dow Jones Sustainability World Index for the banking sector, scoring 22% above the global average for the sector.
The growth of the RBS Group depends as much on our understanding and fulfilment of our responsibilities as on our financial skills.
Benchmarking The Group participates in a number of corporate responsibility indexes and surveys: FTSE4Good The Group continues to meet the socially responsible investment criteria required for inclusion in the FTSE4Good Index.
Dow Jones Sustainability Indexes The Group has been selected as a component for both the Dow Jones Sustainability World Index (DJSI World) and Dow Jones STOXX Sustainability Index (DJSI STOXX).
Business in the Community We participated in the Business in the Community CR Index for the first time, achieving 91.5% and ranking 27th within the top 100.
�� Stocksbridge Training & Enterprise Partnership (STEP) in South Yorkshire, supported by the RBS Group, assists people in finding new forms of employment outside the declining steel industry.
�� Double Matching Give As You Earn 2,800 charities received £6.4 million through our unique, award winning double matching Give As You Earn scheme.
Our 2004 performance ��� We employ 137,000 people worldwide. We are one of the largest corporate taxpayers in the UK. In 2004, dividends to shareholders totalled £2.1 billion and payments to suppliers were over £5 billion.
��� 84% of employees completed the 2004 Employee Opinion survey. In 13 out of 14 categories the Group performed ahead of the ISR Global Financial Services norm.
��� We provide 45% of the finance to businesses in the most deprived inner-city areas. NatWest and the Royal Bank of Scotland are sponsoring “Rethinking Regeneration: Enterprise for All?” in conjunction with the Treasury. The programme supports talented entrepreneurs in some of the UK’s most deprived communities.
��� Citizens Bank in the USA is working to extend its “Outstanding” Community Reinvestment Act rating to the newly acquired Charter One Bank.
��� During 2004, the RBS Group established a partnership with Green-Works, a social enterprise, to ensure that all surplus Group furniture is recycled and reused by charities and educational establishments.
��� We have reduced courier mileage by an estimated 5 million miles per annum saving 500,000 litres of fuel. 35 miles of paper per night has been saved through delivering internal reports to our customer facing divisions electronically. 65,752 pieces of IT equipment were recycled.
Aimhigher roadshows, which promote the benefits of university education, reached 119,000 young people in the UK.
A new £3 million Supergrounds programme was announced to improve 450 primary school playgrounds.
Employment & enterprise In November 2004, the Group announced a £5 million extension over three years to its partnership with The Prince’s Trust. 800 employees volunteered for this good cause.
Our support for Fairbridge and The Prince’s Trust is helping 45,000 disadvantaged young people to improve their opportunities and prospects.
Contents 56 Presentation of information 57 Forward-looking statements 58 Description of business 60 Risk factors 60 Critical accounting policies 63 Accounting developments 66 Financial highlights 67 Summary consolidated profit and loss account 71 Analysis of results 79 Divisional performance 92 Consolidated balance sheet 94 Cash flow 95 UK GAAP compared with US GAAP
Certain sections in this document contain ‘forward-looking statements’ as that term is defined in the United States Private Securities Litigation Reform Act of 1995, such as statements that include the words ‘expect’, ‘estimate’, ‘project’, ‘anticipate’, ‘believes’, ‘should’, ‘intend’, ‘plan’, ‘probability’, ‘risk’, ‘Value-atRisk (“VaR”)’, ‘target’, ‘goal’, ‘objective’, ‘will’, ‘endeavour’, ‘outlook’, ‘optimistic’, ‘prospects’ and similar expressions or variations on such expressions including, but not limited to, sections such as ‘Chairman’s statement’ and ‘Group Chief Executive’s review’.
For a further discussion of certain risks faced by the Group, see Risk factors on page 60.
Retail Direct consists of the Group’s non-branch based retail businesses. Retail Direct issues a comprehensive range of credit, charge and debit cards to personal and corporate customers and provides merchant acquisition and processing facilities for retail businesses. It also includes Tesco Personal Finance (“TPF”), The One account, Direct Line Financial Services (“DLFS”), Lombard Direct, WorldPay Limited, the Group’s internet banking platform, the Primeline brand and in Europe, the Comfort Card businesses, all of which offer products to customers through direct channels.
Manufacturing supports the customer facing businesses in the UK and Ireland and manages the Group’s telephony, account management and money transmission operations. It is also responsible for information technology operations and development, global purchasing, property and other services.
O pe ra tin g an d fin an ci al r ev ie w underwrites personal insurance in Spain, Italy and Germany. UKI Partnerships is a leading provider of insurance and motoring related services through partner brands, including through Tesco Personal Finance. NIG sells personal and commercial products through a network of intermediaries, while Inter Group acts as an insurance administrator and Devitt Insurance Services operates as a specialist broker administrator.
Ulster Bank provides a comprehensive range of retail and corporate banking services in Northern Ireland and the Republic of Ireland. In retail banking, Ulster Bank operates a network of branches throughout Ireland serving personal and commercial customers. Corporate Banking and Financial Markets provides a wide range of services in the corporate and institutional markets.
In January 2004 Ulster Bank acquired First Active plc, a leading provider of mortgages, retail savings and investment products in the Republic of Ireland. First Active and Ulster Bank have retained their own distinctive brands, branch networks and customer propositions, with efficiencies derived from shared central manufacturing activities.
During 2004, Citizens completed the acquisitions of Thistle Group Holdings, Co., the holding company of Roxborough Manayunk Bank and Charter One Financial Group, Inc., the holding company of Charter One Bank.
In the personal banking segment the Group competes with UK banks and building societies, major retailers, life assurance companies and internet-only players. In the mortgage market where the Group competes with UK banks and building societies, re-mortgaging activity by customers has been at a high level. NatWest Life and Royal Scottish Assurance compete with Independent Financial Advisors and life assurance companies. The competitive situation in the long term savings market is dynamic due to the uncertainties created by regulatory change and continued evolution of institutions, particularly in the mutual sector.
In the UK credit card market large retailers and specialist card issuers, including major US operators, are active in addition to the UK banks and building societies. Competitive pressure includes aggressive pricing, loyalty and reward schemes, and packaged benefits. In addition to physical distribution channels, providers compete through direct marketing activity and, increasingly, the internet.
In Wealth Management, The Royal Bank of Scotland International and NatWest Offshore compete with other UK and international banks to offer offshore banking services. Coutts and Adam & Company compete as private banks with UK clearing and private banks, and with international private banks.
RBS Insurance competes in personal lines insurance and to a limited extent in commercial insurance. There is competition from a range of insurance companies which now operate telephone and internet direct sales businesses. RBS Insurance also competes with local insurance companies in the direct motor insurance markets in Spain, Italy and Germany.
The financial performance of the Group is affected by borrower credit quality and general economic conditions, in particular in the UK, US and Europe 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. Adverse changes in the credit quality of the Group’s borrowers and counterparties or a general deterioration in UK, US, European or global economic conditions, or arising from systemic risks in the financial systems, could affect the recoverability and value of the Group’s assets and require an increase in the provision for bad and doubtful debts and other provisions.
Critical accounting policies The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. The Group’s principal accounting policies are set out on pages 139 to 142. UK company law and accounting standards require the directors, in preparing the Group’s financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. Where UK GAAP allows a choice of policy, Financial Reporting Standard (“FRS”) 18 ‘Accounting Policies’ requires an entity to adopt those policies judged to be most appropriate to its particular circumstances for the purpose of giving a true and fair view.
Provisions for bad and doubtful debts The Group provides for losses existing in its lending book so as to state its loan portfolio at its expected ultimate net realisable value. Specific provisions are established against individual exposures and the general provision covers advances impaired at the balance sheet date but which have not been identified as such. Bad and doubtful debt provisions made during the year less amounts released and recoveries of amounts written-off in previous years are charged to the profit and loss account. Loans and advances are reported on the balance sheet net of specific and general provisions.
Other loans and advances are individually assessed and the specific provision is determined from a review of the financial condition of the borrower and any guarantor and takes into account the customer’s debt capacity and financial flexibility; the level and quality of earnings; the amount and sources of cash flows; the industry in which the customer operates; and the realisable value of any security held. The most significant estimates that affect the quantum of a specific provision are the receipts from the borrower and the amount that will be recovered from any security held.
Evaluating these estimates involves significant judgement as receipts will depend on the future performance of the borrower and the value of security, both of which will be affected by future economic conditions. Additionally, the security may not be readily marketable.
The general provision covers bad and doubtful debts that have not been separately identified at the balance sheet date but are known to be present in any portfolio of advances. The level of general provision is assessed in the light of past experience and reflects the size and diversity of the Group’s loan portfolio, the current state of the economies in which the Group operates, other factors affecting the business environment, recent trends in companies going into administration, receivership and bankruptcy and the Group’s monitoring and control procedures, including the scope of specific provisioning procedures.
Loans and advances – recognition of interest income Interest receivable from loans and advances is credited to the profit and loss account as it accrues unless there is significant doubt that it can be collected. If the collection of interest is in doubt, it is credited to a suspense account and excluded from interest receivable; it continues to be charged to the customer’s account.
Pensions The Group operates a number of defined benefit pension schemes as described in Note 3 on the financial statements. The assets of the schemes are measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. Any surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). An asset is only recognised to the extent that the surplus can be recovered through reduced contributions in the future or through refunds from the scheme. In determining the value of scheme liabilities assumptions are made as to price inflation, dividend growth, pension increases, earnings growth and employees. There is a range of assumptions that could be adopted in valuing the schemes' liabilities. Different assumptions could significantly alter the amount of the deficit recognised in the balance sheet and the pension cost charged to the profit and loss account. The assumptions underlying the 2004 deficit and pension cost are set out in Note 3 on the financial statements.
Fair value Securities and derivatives held for trading purposes are recognised in the financial statements at fair value. In the balance sheet, trading securities are included within Treasury and other eligible bills, Debt securities and Equity shares as appropriate. Positive fair values (assets) of trading derivatives are included in Other assets and negative fair values (liabilities) in Other liabilities. Positive and negative fair values of trading derivatives are offset where the contracts have been entered into under master netting agreements or other agreements that give a legally enforceable right of set-off. Gains or losses arising from changes in fair value are included in Dealing profits in the profit and loss account.
Fair value is the value at which a position could be closed out or sold in a transaction to a willing and knowledgeable counterparty over a reasonable period of time under current market conditions. Fair values are determined by reference to observable market prices where available and reliable. Where representative market prices for an instrument are not available or are unreliable because of poor liquidity, the fair value is derived from prices for its components using appropriate pricing or valuation models that are based on independently sourced market parameters, including interest rate yield curves, option volatilities and currency rates.
An impairment test is designed to assess the recoverable amount of an asset or, in the case of goodwill, an operating segment, by comparing its carrying value with the discounted value of future cash flows that it will generate. 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 valuation of the separable assets of each business whose goodwill is being reviewed and an assessment of the discount rate appropriate to the business. Under UK GAAP, impairment tests are only undertaken in the year following an acquisition or when there is evidence that impairment might have occurred. US GAAP requires annual impairment tests that are different from any UK tests and accordingly they may support a different carrying value for the asset being tested.
Accounting developments UK GAAP UITF Abstract 38 ‘Accounting for ESOP trusts’ and the consequential amendment to UITF Abstract 17 ‘Employee share schemes’ which are applicable for the year ended 31 December 2004 did not have a material effect on the Group.
International Financial Reporting Standards In June 2002, the European Union adopted a regulation that requires, from 1 January 2005, listed companies to prepare their financial statements in accordance with international accounting standards adopted by the EU. The Group’s 2005 financial statements will therefore be prepared in accordance with International Financial Reporting Standards (“IFRS”). These comprise not only IFRS but also International Accounting Standards (“IAS”).
Dividends – IFRS require dividends payable to be recorded in the period in which they are declared whereas under UK GAAP dividends are recorded in the period to which they relate.
Computer software – under UK GAAP, most software development costs are written off as incurred. Under IFRS, such costs are capitalised if certain conditions are met and amortised over the estimated useful life of the software.
Share-based payments – under UK GAAP, no compensation expense is recognised for Inland Revenue approved Save-asyou -earn share option schemes or for other share option schemes where the option has no intrinsic value (i.e. where at date of grant the exercise price equals the market value). IFRS require the fair value of share options at the date of grant to be recognised as an expense
O pe ra tin g an d fin an ci al r ev ie w Operating and financial review continued an instrument’s expected life to its net carrying value. It takes into account all fees and points paid that are an integral part of the yield, transaction costs and all other premiums and discounts. Under IFRS, the carrying value of a financial instrument held at amortised cost is calculated using the effective interest method.
Loan impairment – under UK GAAP, provisions for bad and doubtful debts are made so as to record impaired loans at their expected ultimate net realisable value. IFRS require impairment losses on financial assets carried at amortised cost to be measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the asset’s original effective interest rate. Impairment must be assessed individually for individually significant assets but can be assessed collectively for other assets.
Financial instruments: financial liabilities – IFRS require all financial liabilities to be measured at amortised cost except those held for trading and those that were designated as fair value through profit and loss on initial recognition. Under UK GAAP, short positions in securities and trading derivatives are carried at fair value, all other financial liabilities are recorded at amortised cost. In IFRS as adopted by the EU, the option to designate at fair value through profit and loss is not available.
Liabilities and equity – under UK GAAP, all issued shares are classified as shareholders’ funds, and analysed between equity and non-equity interests. There is no concept of non-equity shares in IFRS. Instruments are classified between equity and liabilities in accordance with the substance of the contractual arrangements. A non-derivative instrument is classified as equity if it does not include a contractual obligation either to deliver cash or to exchange financial instruments with another entity under potentially unfavourable conditions, and if the instrument will or may be settled by the issue of equity, settlement does not involve the issue of a variable number of shares.
Embedded derivatives – under IFRS, a derivative embedded in a contract must be accounted for separately from the host contract if the embedded derivative has economic characteristics that differ from those of the host contract. There is no equivalent requirement in UK GAAP.
Offset – for a financial asset and financial liability to be offset, IFRS require that an entity must intend to settle on a net basis or to realise the asset and settle the liability simultaneously. However, under UK GAAP an intention to settle net is not a requirement for set off, although the entity must have the ability to insist on net settlement and that ability is assured beyond doubt.
Transition – IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ (IFRS 1) will apply to the Group's 2005 financial statements. The standard requires an opening IFRS balance sheet to be prepared as at the date of transition to IFRS, being the beginning of the earliest comparative period presented under IFRS in its first IFRS financial statements (the transition date). Accounting policies must comply with each IFRS effective at the reporting date of the first IFRS financial statements, and applied throughout all periods presented.
IFRS 1 provides certain optional exemptions from the above principles: • Business combinations – past business combinations need not be restated in accordance with IFRS 3 'Business Combinations'.
• Employee benefits – under IAS 19 ‘Employee Benefits’, actuarial gains and losses on pension schemes may be unrecognised if they fall within a ‘corridor’. On first time application, an entity may determine the unrecognised gains and losses from inception of the pension scheme and recognise only those that would be recognised under IAS 19, or alternatively recognise all cumulative gains and losses at the transition date.
• Hedge accounting – at the transition date, all derivatives must be measured at fair value. Gains and losses deferred under previous accounting must be eliminated. Hedge accounting for relationships that do not qualify under IAS 39 must be discontinued in accordance with the hedge termination rules in IAS 39.
• Assets classified as held for sale and discontinued operations – entities with a transition date before 1 January 2005 must apply the transition rules in IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’.
US GAAP For a discussion of recent developments in US GAAP relevant to the Group, see Note 53 on the accounts.
Adjusted after-tax return on equity (%) (4) 20.1 20.1 18.3 2004 2003* 2002* at 31 December £m £m £m
Notes: (1) Cost:income ratio represents operating expenses excluding goodwill amortisation and integration costs, and after netting operating lease depreciation against rental income, expressed as a percentage of total income.
(3) Dividend cover represents the total ordinary dividend expressed as a multiple of profit attributable to ordinary shareholders adjusted for goodwill amortisation, integration costs and the Additional Value Shares dividend in 2002 and 2003.
General insurance net premium income 4,944 3,123 1,953 Non-interest income 13,546 10,980 9,167
Profit before other operating charges 13,092 10,757 9,235 General insurance net claims 3,480 2,195 1,350 Operating profit before provisions 9,612 8,562 7,885 Provisions for bad and doubtful debts 1,428 1,461 1,286 Amounts written off fixed asset investments 83 33 59 PROFIT BEFORE TAX, GOODWILL AMORTISATION AND INTEGRATION COSTS 8,101 7,068 6,540
Profit after tax 4,762 4,188 3,270 Minority interests (including non-equity) 250 210 133 Preference dividends – non-equity 256 261 305
Basic earnings per ordinary share 138.0p 76.9p 70.6p Additional Value Shares dividend — 49.9p 27.7p
The Group made a number of acquisitions during 2004 which had a bearing on the year's results. These included: In January 2004, Ulster Bank completed the acquisition of First Active plc, for a cash consideration of €887 million.
In March 2004, RBS completed the purchase of the credit card business of People's Bank in the US.
Non-interest income increased by 23% to £13,546 million and represents 60% of total income (2003 – 57%). Excluding acquisitions and at constant exchange rates, non-interest income was up 13%. There was good growth in transmission income and other fees, up 17% while general insurance premium income increased by 58%, reflecting organic growth and the acquisition of Churchill in September 2003. Gross income from rental assets grew by 18%, reflecting strong growth in operating lease assets.
Operating expenses Operating expenses, excluding goodwill amortisation and integration costs, rose by 13% to £9,662 million to support the strong growth in business volumes. Excluding acquisitions and at constant exchange rates, operating expenses were up by
Provisions The profit and loss charge for bad and doubtful debts and amounts written off fixed asset investments was £1,511 million compared with £1,494 million in 2003. The charge for provisions in 2004 represented 0.51% of gross loans and advances to customers (excluding reverse repurchase agreements), compared with 0.64% in 2003.
Credit quality Credit quality remains strong with no material change during 2004 in the distribution by grade of the Group's total risk assets.
The ratio of risk elements in lending to gross loans and advances to customers improved to 1.58% (2003 – 2.01%). Risk elements in lending and potential problem loans represented 1.66% of gross loans and advances to customers
Provision coverage of risk elements in lending and potential problem loans improved to 73% (2003 – 68%).
Earnings and dividends Basic earnings per ordinary share increased by 79%, from 76.9p to 138.0p. The final dividend on the Additional Value Shares (“AVS”) paid in December 2003 reduced earnings per ordinary share for that year by 49.9p. Adjusting for this and for goodwill amortisation and integration costs, earnings per ordinary share increased by 10%, from 157.2p to 172.5p.
A final dividend of 41.2p per ordinary share is recommended, making a total for the year of 58.0p per share, an increase of 15%. If approved, the final dividend will be paid on 3 June 2005 to shareholders registered on 11 March 2005. The total dividend is covered 2.9 times by earnings before goodwill amortisation and integration costs.
Balance sheet Total assets were £583 billion at 31 December 2004, 28% higher than total assets of £454 billion at 31 December 2003.
Capital ratios at 31 December 2004 were 7.0% (tier 1) and 11.7% (total), against 7.4% (tier 1) and 11.8% (total) at 31 December 2003.
Profitability The adjusted after-tax return on ordinary equity was stable at 20.1%. This is based on profit attributable to ordinary shareholders before goodwill amortisation, integration costs and in 2003 the AVS dividend, and average ordinary equity.
Net interest income increased by 6% to £8,301 million and represented 43% of total income (2002 – 46%). Average loans and advances to customers and average customer deposits grew by 12% and 8% respectively. The benefit of this growth more than offset the impact on net interest income of the Competition Commission inquiry into SME banking in the UK and the lower interest rate environment in the UK and the US which reduced income earned from deposits and investments.
Non-interest income increased by 20% to £10,980 million and represented 57% of total income (2002 – 54%). Fees receivable were up 8% with good growth in lending, transmission and card related fees reflecting higher volumes. General insurance premium income grew strongly, reflecting volume growth in both motor and home insurance products, and the acquisition of Churchill. In addition, volumes in financial markets were up strongly in both the UK and the US reflecting growth in customer-driven activity in interest rate protection, mortgage securitisation and foreign exchange.
Income from rental assets grew by 17% to £1,088 million, reflecting the growth in operating leases and investment properties.
Net interest margin The Group’s net interest margin at 2.97% was, in line with the first half, down from 3.13% in 2002 due to a reduced benefit from interest-free funds arising from the lower interest rate environment, and the outcome of the Competition Commission inquiry into SME banking.
Cost:income ratio The strong growth in income together with tight cost management resulted in a further improvement in the Group’s ratio of operating expenses (excluding goodwill amortisation and integration costs and after netting operating lease depreciation against rental income) to total income, to 42.6% from 44.2%. Excluding the effect of acquisitions, the cost:income ratio improved to 43.9%.
Net insurance claims General insurance claims, after reinsurance, increased by 63% to £2,195 million. Excluding Churchill, the increase was 29%, consistent with volume growth in the component parts of the insurance division.
Credit quality There was no material change during the year in the distribution by grade of the Group’s total risk assets.
The ratio of risk elements in lending to gross loans and advances to customers at 2.01% at 31 December 2003 showed an improving trend (31 December 2002 – 2.14%).
Risk elements in lending and potential problem loans represented 2.24% of gross loans and advances to customers compared with 2.66% at 31 December 2002.
All integration initiatives in relation to NatWest have been implemented. The programme benefits, comprising £890 million annual revenue benefits and £1,440 million annual cost savings, were fully implemented less than three years after the
O pe ra tin g an d fin an ci al r ev ie w Operating and financial review continued acquisition of NatWest. Total costs for the integration programme were £2.3 billion. Since 6 March 2000 the integration initiatives have contributed a cumulative £5.6 billion to the Group.
Earnings and dividends Basic earnings per ordinary share increased by 9%, from 70.6p to 76.9p. Earnings per ordinary share, adjusted for goodwill amortisation, integration costs and the dividend on Additional Value Shares (“AVS”), increased by 7%, from 146.3p to 157.2p.
The total ordinary dividend for the year was 50.3p per ordinary share an increase of 15%. The total dividend was covered 3.1 times by earnings before goodwill amortisation, integration costs and the AVS dividend.
Profitability The adjusted after-tax return on ordinary equity was 20.1% compared with 18.3% for 2002. This is based on profit attributable to ordinary shareholders before goodwill amortisation, integration costs and the AVS dividend, and average equity shareholders’ funds.
In April 2003, Citizens announced the acquisition of Port Financial Corp., the holding company of the Massachusetts savings bank, CambridgePort Bank for a cash consideration of US$285 million. This transaction was completed on 31 July 2003.
In May 2003, RBS announced the acquisition of Nordisk Renting AB, a Swedish leasing company, for a cash consideration of €104 million. This transaction was completed on 2 June 2003.
In May 2003, RBS announced the acquisition of the credit card and personal loans portfolios of Frankfurt-based Santander Direkt Bank for a cash consideration of €486 million. This transaction was completed on 31 July 2003.
In June 2003, RBS announced the acquisition of Churchill Insurance Group PLC for a cash consideration of £1.1 billion. This transaction was completed on 1 September 2003.
In September 2003, Citizens announced the acquisition of Thistle Group Holdings, Co., the holding company for Roxborough Manayunk Bank, for a cash consideration of US$136 million. This transaction was completed on 5 January 2004.
In October 2003, Coutts Bank (Switzerland) Limited announced the acquisition of a Swiss private bank, Bank von Ernst & Cie AG, for a cash consideration of Swiss Francs 500 million. This transaction was completed on 28 November 2003.
In October 2003, RBS announced that it had agreed terms for a recommended acquisition of First Active plc, for a cash consideration of €887 million. This transaction was completed on 5 January 2004.
Analysis of results Net interest income 2004 2003 2002 £m £m £m
Gross yield on interest-earning assets of the banking business 5.30 5.00 5.41 Cost of interest-bearing liabilities of the banking business (2.70) (2.32) (2.70) Interest spread of the banking business 2.60 2.68 2.71 Benefit from interest-free funds 0.32 0.29 0.42 Net interest margin of the banking business 2.92 2.97 3.13
Yields, spreads and margins of the banking business % % % Gross yield
The Royal Bank of Scotland plc base rate 4.38 3.69 4.00 London inter-bank three month offered rates: Notes: (1) Gross yield is the interest rate earned on average interest-earning assets of the banking business.
(3) Net interest margin is net interest income of the banking business as a percentage of average interest-earning assets of the banking business.
2003 compared with 2002 Net interest income increased by 6%, £452 million, to £8,301 million. Average interest-earning assets of the Group’s banking business increased by 12%, £29.1 billion, to £279.7 billion.
UK – Interest spread decreased from 2.72% to 2.68% with product margins remaining stable despite growth in the relatively lower margin mortgage business. The reduced benefit of interest-free funds due to the rate and volume impact described above resulted in the decrease in net interest margin from 3.14% to 2.95%.
Overseas – Interest spread increased from 2.69% to 2.71%. Asset spreads tightened in the US due to lower interest rates; however, this was more than offset by overall mix and volume improvements elsewhere. Lower interest rates led to a reduction in the benefit from interest-free funds, resulting in the decline in net interest margin from 3.09% to 3.02%.
Total interest-earning assets – banking business 315,250 16,696 5.30 279,714 13,998 5.00
Customer accounts: demand deposits – UK 67,519 1,569 2.32 64,469 1,028 1.59
Customer accounts: other time deposits – UK 51,591 1,712 3.32 49,880 1,478 2.96
O pe ra tin g an d fin an ci al r ev ie w 2002*
Liabilities and shareholders’ equity Deposits by banks – UK 21,090 544 2.58 Deposits by banks – Overseas 9,058 215 2.37 Customer accounts: demand deposits – UK 58,618 1,062 1.81 Customer accounts: demand deposits – Overseas 8,275 99 1.20 Customer accounts: savings deposits – UK 16,002 463 2.89 Customer accounts: savings deposits – Overseas 11,742 229 1.95 Customer accounts: other time deposits – UK 45,902 1,542 3.36 Customer accounts: other time deposits – Overseas 16,264 462 2.84 Debt securities in issue – UK 24,154 965 4.00 Debt securities in issue – Overseas 8,693 209 2.40 Loan capital – UK 13,154 640 4.87 Loan capital – Overseas 166 17 10.24 Internal funding of trading business – UK (20,129) (709) 3.52 Internal funding of trading business – Overseas (1,301) (26) 2.00
O pe ra tin g an d fin an ci al r ev ie w 2004 compared with 2003 Non-interest income increased by £2,566 million, 23% to £13,546 million and represents 60% of total income (2003 – 57%). Excluding acquisitions and at constant exchange rates, non-interest income was up 13%.
Fees and commissions payable increased by £617 million to £1,954 million reflecting higher brokerage costs in CBFM due to greater volumes of trading and structuring business and fees paid in Retail Direct in support of higher volumes. Commissions payable to brokers and intermediaries in the general insurance business were up reflecting the acquisition of Churchill in September 2003.
Other operating income increased by 12% to £1,855 million. This was principally due to higher gross income from rental assets reflecting strong growth in operating lease assets.
Within non-interest income, fees and commissions receivable increased by 8% or £444 million, to £5,693 million. This reflected an increase in lending and transmission fees, and good growth in insurance brokerage, cards related fees and ATM income.
Fees and commissions payable increased by £372 million to £1,337 million reflecting higher brokerage costs in CBFM, fees paid in Retail Direct in support of higher volumes and commissions payable to brokers and intermediaries following the acquisition of Churchill.
Dealing profits at £1,793 million were up £331 million, 23% on 2002. This reflected strong growth in volumes in all product areas. The performance in the first half of the year benefited from the unusually high levels of demand for mortgage backed securities in the US.
Other operating income increased by 17% to £1,650 million. This was due to growth in income from rental assets (comprising operating lease assets and investment properties) and higher investment securities gains.
Total administrative expenses 8,557 7,605 6,888 Depreciation of tangible fixed assets 1,105 919 893 * restated (see page 139)
2004 compared with 2003 Operating expenses, excluding goodwill amortisation and integration costs, rose by 13% to £9,662 million to support the strong growth in business volumes. Excluding acquisitions and at constant exchange rates, operating expenses were up by
Staff costs were up £703 million, 16% to £5,231 million reflecting acquisitions, business growth and higher pension costs following the implementation of FRS 17. The number of staff increased by 15,700, 13% to 136,600. Of the increase 10,500 was due to acquisitions.
Staff costs were up £474 million, 12% to £4,528 million reflecting acquisitions and business growth. The number of staff increased by 9,100, 8% to 120,900. Acquisitions in the year added 9,700 staff of which 8,500 related to Churchill.
The increase in other administrative expenses reflected higher business volumes and included expenditure in support of Group wide projects.
Premises and equipment 34 31 127 Other administrative expenses 120 73 298 Depreciation of tangible fixed assets 2 — 2
At 31 December Currency translation Charge to profit Utilised during At 31 December 2003 adjustments and loss account the year 2004 £m £m £m £m £m
Integration costs in 2003 comprise £143 million relating to the integration of NatWest, £63 million relating to the integration of Citizens' acquisitions and £23 million in respect of other acquisitions.
UK corporation tax rate 30.0 30.0 30.0 Effective tax rate 31.2 31.1 32.6
The actual tax charge differs from the expected tax charge computed by applying the standard rate of UK corporation tax as follows: 2004 2003* 2002* £m £m £m
Adjustments in respect of prior periods (168) (77) (15) Current tax charge for year 1,722 1,342 1,241 Deferred taxation: Origination and reversal of timing differences 482 581 397 Adjustments in respect of prior periods (49) (35) (56) Actual tax charge 2,155 1,888 1,582 * restated (see page 139)
Comprising: Provisions for bad and doubtful debts 1,428 1,461 1,286 Amounts written off fixed asset investments 83 33 59 Charge to profit and loss account 1,511 1,494 1,345
Divisional performance The contribution of each division before goodwill amortisation and integration costs and, where appropriate, Manufacturing costs is detailed below.
Profit before goodwill amortisation and integration costs 8,101 7,068 6,540 * prior periods have been restated to reflect the transfer in 2004 of certain activities from Wealth Management to Retail Banking and from other divisions, principally RBS Insurance and Ulster Bank, to Manufacturing.
Net interest income excluding funding cost of rental assets 2,959 2,653 2,631 Funding cost of rental assets (414) (329) (282) Net interest income 2,545 2,324 2,349 Fees and commissions receivable 1,723 1,537 1,394 Fees and commissions payable (277) (220) (157) Dealing profits (before associated direct costs) 1,855 1,661 1,338 Income on rental assets 1,282 1,088 931 Other operating income 381 307 197 Non-interest income 4,964 4,373 3,703
Fees receivable rose by £186 million, 12% to £1,723 million with growth driven by lending, structured finance and capital markets activities. Fees payable, including brokerage, were up £57 million to £277 million due to the greater volumes of trading and structuring business.
The asset rental business, comprising operating lease assets and investment properties continued to grow strongly. Rental assets increased to £11.2 billion and income after deducting funding costs and operating lease depreciation increased by 7%, £17 million to £258 million.
Other operating income also grew strongly, up £74 million or 24% to £381 million.
The charge for provisions for bad debts and amounts written off fixed asset investments amounted to £580 million, a decrease of 23%, £175 million. The reduction reflects an improvement in corporate credit quality and the economic environment in 2004.
Total income was up 11% or £645 million to £6,697 million with strong growth across all business areas.
Fees receivable rose by £143 million, 10% to £1,537 million due to growth in fees related to lending and from the expansion and success of capital markets activities. Fees payable including brokerage were up £63 million to £220 million due to higher volumes in Financial Markets.
Total banking assets 74.2 63.9 57.4 Loans and advances to customers – gross
Non-interest income rose by 8% or £116 million to £1,630 million. This reflected higher fee income associated with strong asset growth in both personal and business sectors together with increased volumes of money transmission activity.
Direct expenses increased by 4% or £44 million to £1,074 million. Staff expenses increased 5% or £41 million to £834 million, principally due to the deployment of an additional one thousand customer facing staff in the NatWest network. The increase in other expenses was 1% or £3 million, reflecting rigorous cost management.
The charge for provisions for bad debts increased by £60 million to £273 million. The overall quality of the loan portfolio remained stable and the increased charge reflected growth in lending over recent years particularly in NatWest since its acquisition.
Weighted risk assets 21.1 16.8 14.4 * prior periods have been restated to reflect the transfer in 2004 of certain activities to Manufacturing.
Direct expenses increased by 8% or £55 million to £712 million. Staff costs were up 23%, due to the acquisitions and increased headcount to support higher business volumes. Excluding acquisitions, staff costs were up 8%. The increase in other expenses was limited to 2%, as a result of tight cost management and efficiencies within the core businesses.
Total income was up 15% or £245 million to £1,835 million, reflecting continued strong growth in supermarket banking (TPF), mortgages and cards. Net interest income was up 13% or £100 million to £849 million. Average lending rose by 15% to £20.3 billion of which average mortgage lending was 20% higher at £7.6 billion mainly in The One account. Average customer deposits were up 5% to £4.4 billion. During 2003, the total number of customer accounts increased by 1.7 million.
Analysis: Group Purchasing and Property Operations 854 718 649 Customer Support and other operations 778 710 638 Total manufacturing costs 2,439 2,114 1,952 * prior periods have been restated to reflect the transfer in 2004 of certain activities, principally from RBS Insurance and Ulster Bank.
2004 compared with 2003 Manufacturing’s costs increased by £325 million, 15% to £2,439 million.
Manufacturing is now supporting RBS Insurance and Ulster Bank and of the £325 million increase, £82 million reflects technology and property operations of Churchill (2004 – £96 million; 2003 – £33 million) and First Active (2004 – £19 million; 2003 – £nil) which were acquired in September 2003 and January 2004 respectively.
The balance of the increase was required to support higher business volumes, to upgrade the Group's regional property portfolio and to invest in the Group Efficiency Programme initiatives that are improving the Group's overall efficiency.
2003 compared with 2002 Manufacturing’s costs increased by 8% or £162 million, to £2,114 million.
Group Technology costs increased by £21 million to £686 million. This reflected business as usual cost growth and a specific improvement programme, the majority of the cost of which will be borne by Group Technology. This is providing benefits across the Group and further investment opportunities were identified which will lead to further efficiency benefits across the Group.
Customer Support and other operations costs were £710 million, 11% or £72 million higher than the previous year. This reflected further expansion of business operations with increased expenditure in customer support areas of Lending, Telephony, Payments and Security. In telephony, the Royal Bank of Scotland customer service proposition was introduced to NatWest customers who can now choose between speaking to their local branch, to a customer service officer or using the automated telephone service.
Contribution before provisions 485 411 396 Provisions for bad and doubtful debts – charge/(release) 17 9 (11)
Loans to customers 9.2 7.9 7.3 Investment management assets – excluding deposits 22.3 22.3 16.1
Weighted risk assets 8.3 9.1 8.4 * prior periods have been restated to reflect the transfer of certain activities to Retail Banking and Manufacturing.
2004 compared with 2003 Contribution at £468 million was £66 million or 16% higher than 2003. Excluding the acquisition and adjusting for the disposal, contribution was up 14%, £54 million.
Total income increased by 17% or £139 million to £948 million, including a full year contribution from Bank von Ernst. Excluding the acquisition and disposal, income was 12%, £94 million higher.
Net interest income increased by 9% or £40 million to £497 million. The increase reflects growth in both lending and deposit volumes, combined with the benefit of higher average interest rates.
Expenses were up by 16% or £65 million to £463 million to support the growth in income and reflecting the acquisition of Bank von Ernst. Excluding the acquisition and disposal, expenses were up 9%, £33 million.
The charge for provisions for bad and doubtful debts was £17 million compared with £9 million in 2003, reflecting a small number of specific cases.
2003 compared with 2002 Contribution was £402 million, £5 million or 1% lower than 2002. Excluding the acquisition and disposals, income was up 1%, with contribution before provisions up 4%. The charge for provisions for bad and doubtful debts was £9 million compared with a net release of £11 million in 2002.
Net interest income increased by 1% or £6 million to £457 million. The benefit from growth in lending volumes was partly negated by the effect of lower interest rates which also caused a tightening of deposit margins.
Investment management assets increased by £6.2 billion or 39% to £22.3 billion principally due to the acquisition of Bank von Ernst in the year.
Expenses were down by 6% or £27 million to £398 million reflecting tight cost control in difficult market conditions and the 7% reduction in staff numbers since 31 December 2002.
Provisions for bad and doubtful debts were £9 million compared with a net release of £11 million in 2002.
2004 compared with 2003 Contribution increased by 42% or £253 million to £862 million and included the first full year's contribution from Churchill, which was acquired in September 2003. Excluding Churchill, contribution grew by 13%, £73 million.
After reinsurance, insurance premium income was up 58% or £1,821 million to £4,944 million. Excluding Churchill, net insurance premium income grew by 17%. At 31 December 2004, the number of UK in-force motor insurance policies was 8.3 million and the number of in-force motor policies in Continental Europe was 1.6 million. The International Division passed the milestone of 1 million motor policies in Spain in December. Non-motor policies, including home, rescue and pet insurance, increased to 10.9 million at 31 December 2004.
Net fees and commissions payable increased from £161 million to £488 million, due mainly to commissions payable to intermediaries in the broker division acquired as part of Churchill. Other income was up due to the acquisition of Churchill and increased investment income driven by higher business volumes.
Net claims, after reinsurance, increased by 59% or £1,285 million to £3,480 million. Excluding Churchill, net claims increased by 20%, consistent with mix and volume growth.
After reinsurance, insurance premium income was up 60% or £1,170 million to £3,123 million. Excluding Churchill, insurance premium income (net of reinsurance) grew by 25% or £490 million. The number of UK in-force motor insurance policies increased by 3.4 million of which 3.1 million was from Churchill, while the number of UK in-force home insurance policies increased by 3.6 million including 3.4 million from Churchill. The number of motor policies in Continental Europe increased by 260,000 during the year.
Expenses increased by 32% or £108 million to £441 million. Excluding Churchill, expenses increased by 10% or £33 million. Staff numbers, excluding Churchill, increased by 4% (400) to support growth in business volumes, particularly in the partnership business.
Net interest income 550 396 339 Non-interest income 193 185 181
Average exchange rate – €/£ 1.474 1.445 1.591 Spot exchange rate – €/£ 1.418 1.416 1.536 * prior periods have been restated to reflect the transfer in 2004 of certain activities to Manufacturing.
Total income increased by 28% or £162 million to £743 million reflecting the acquisition of First Active and strong organic growth, particularly in residential mortgages. Adjusting for First Active and the disposal in October 2003 of NCB Stockbrokers ('NCB'), income increased by 12% at constant exchange rates. During 2004, the number of customers increased by 454,000, of which 374,000 relate to First Active.
Net interest income rose by 39% or £154 million to £550 million, reflecting strong growth across all customer lending products and in customer deposits. Excluding First Active and NCB and at constant exchange rates, net interest income increased by 14%. The net interest margin decreased mainly due to strong growth in low risk mortgage lending both organic and due to the acquisition of First Active, a leading mortgage provider in the Republic of Ireland. Underlying product margins remain stable.
Expenses increased by 21% or £40 million to £235 million. Excluding First Active and NCB expenses increased by 8% to support the growth in business.
Net interest income rose by 17% or £57 million to £396 million, reflecting strong growth in both average customer lending and deposits which increased by 26% or £2.1 billion, to £10.1 billion and by 13% or £1.0 billion, to £8.9 billion respectively.
Non-interest income increased by £4 million to £185 million. Strong growth in lending, transmission and card fee income was partially offset by lower dealing profits. Uncertainty in equity markets adversely affected brokerage fees in the stockbroking business which was sold in October 2003.
Expenses increased by 8% or £15 million to £195 million. This reflected the annual pay award and the additional costs to support increased business volumes.
The charge for provisions for bad debts was up £10 million to £32 million reflecting growth in lending.
Total income was up 31% or $939 million to $3,923 million. During 2004, Citizens increased its personal customer base by 1,993,000 accounts and its business customers by 174,000. Excluding the acquisitions, Citizens increased its personal customers by 199,000 and its business customers by 30,000.
Provisions increased by only $1 million to $146 million, with credit quality metrics remaining strong.
2003 compared with 2002 Contribution which increased by 12% or £91 million to £857 million was diminished by the weakening of the US dollar in relation to sterling. In US dollar terms, contribution increased by 22% or $250 million to $1,401 million.
Total income was up 16% or $406 million to $2,984 million.
Net interest income increased by 14% or $268 million to $2,143 million. Excluding the acquisitions, net interest income was up 9% or $164 million (£100 million), reflecting strong organic growth in personal loans and deposits. Excluding the acquisitions, average loans were up 29% or $8.0 billion and average deposits were up 20% or $9.1 billion. The benefit of this growth was reduced by a narrowing interest margin due to reductions in US interest rates.
Non-interest income rose by 20% or $138 million to $841 million. Excluding the acquisitions, non-interest income was up 16% or $115 million (£70 million).
Provisions were up $3 million from $142 million to $145 million. Excluding the acquisitions, provisions were $2 million (£1 million), or 1%, lower than 2002. Credit quality metrics remained strong and total non-performing loans were 0.40% of total loans and advances at 31 December 2003 compared with 0.57% at the end of 2002.
In 2003, Citizens increased its personal customer base by 376,000 accounts and its business customers by 36,000 due to growth through both traditional and supermarket branches, and the acquisition of Commonwealth Bancorp, Inc., Port Financial Corp. and Community Bancorp, Inc.
Funding costs at £284 million, were up 32% or £69 million reflecting the funding of the various acquisitions undertaken by the Group during the year.
Central departmental costs and other corporate items at £595 million were £99 million or 20% higher than 2003. This is principally due to higher Group pension costs, up £48 million, the centralisation of certain functions and expenditure on Group-wide projects such as International Accounting Standards and Basel II.
2003 compared with 2002 Total Central items increased by £213 million to £711 million.
Funding costs were £215 million. Increased income from higher shareholders’ funds was offset by the funding costs associated with the acquisition of Churchill in September 2003 and the £1.5 billion AVS dividend paid in December 2003.
Long-term assurance assets attributable to policyholders 3,800 3,557 Total assets 583,467 454,428
Liabilities Deposits by banks 99,081 67,323 Items in the course of transmission to other banks 802 958 Customer accounts 285,062 236,963 Debt securities in issue 58,960 41,016 Settlement balances and short positions 32,990 21,369 Other liabilities 26,152 20,584 Accruals and deferred income 15,588 13,155 Post-retirement benefit liabilities 1,901 1,445 Provisions for liabilities and charges 3,071 2,249 Subordinated liabilities 20,366 16,998 Minority interests – equity 158 (11) – non-equity 3,671 2,724 Shareholders’ funds
Debt securities increased by £11.3 billion, 14%, to £91.2 billion, principally due to increased holdings in Financial Markets and the acquisition of First Active.
Equity shares were up £0.7 billion, 29%, to £3.0 billion, mainly due to the acquisition of Charter One and growth in Financial Markets trading activity.
Intangible fixed assets increased by £4.4 billion, 34% to £17.6 billion. Goodwill arising on the acquisitions made during 2004 amounted to £5.9 billion, including £4.7 billion in respect of Charter One. This was partially offset by goodwill amortisation, £0.9 billion and the adverse effect of exchange rate movements, £0.5 billion.
Tangible fixed assets were up £2.4 billion, 17% to £16.3 billion, mainly reflecting growth in operating lease assets, up £1.4 billion, 22% to £7.8 billion.
Other assets rose by £4.4 billion, 25% to £22.3 billion, mainly due to an increase in the mark-to-market value of trading derivatives and acquisitions.
Deposits by banks increased by £31.8 billion, 47% to £99.1 billion to fund business growth, with repurchase agreements and stock lending (“repos”) up £16.3 billion, 60%, to £43.3 billion and inter-bank deposits up £15.5 billion, 38% to £55.8 billion.
Customer accounts were up £48.1 billion, 20% at £285.1 billion. Within this, repos were up £15.1 billion, 56% to £42.1 billion reflecting growth in trading activities. Excluding repos, deposits rose by £33.0 billion, 16%, to £243.0 billion with growth in CBFM, £6.3 billion, Retail Banking, £4.1 billion, Wealth Management, £2.7 billion, Citizens, £15.8 billion, including the acquisition of Charter One and Ulster Bank, £3.8 billion, including First Active. In $ terms, Citizens grew US$36.4 billion, 58%, including US$29.1 billion related to acquisitions.
Other liabilities rose by £5.6 billion, 27% to £26.2 billion, principally due to an increase in the mark-to-market value of trading derivatives.
Accruals and deferred income increased by £2.4 billion, 18% to £15.6 billion.
Post-retirement benefit liabilities, recognised on the adoption of FRS 17, were up £0.5 billion, 32% to £1.9 billion with actuarial losses, net of deferred tax, up £1.1 billion, mainly due to changes in actuarial assumptions, partially offset by asset growth and a £750 million payment to the RBS Group Pension Fund.
Non-equity minority interests were up £0.9 billion, 35% to £3.7 billion mainly reflecting the issues by subsidiaries of the Group of US$950 million (£0.5 billion) non-cumulative trust preferred securities in August 2004 and US$1,000 million (£0.6 billion) noncumulative trust preferred securities in August/September 2004.
Capital expenditure and financial investment (1,526) (6,965) (9,185) Acquisitions and disposals (7,674) (1,571) (281) Equity and AVS dividends paid (1,235) (2,235) (1,527)
Net sales of investment securities of £1,232 million and net purchases of fixed assets of £2,758 million, including operating lease assets and investment properties, comprised the net cash inflow from capital expenditure and financial investment.
The major factors contributing to the net cash inflow of £19,708 million from operating activities in 2003 were the profit before tax of £6,076 million, increases in deposits and debt securities in issue of £33,935 million, increases in short positions and settlement balances of £3,202 million and decreases in treasury and other eligible bills of £6,626 million, partially offset by the net increase in loans and advances of £23,343 million and increases in securities of £9,871 million.
Interest on subordinated liabilities of £557 million and dividends of £399 million to preference and minority shareholders were paid during the year.
Equity and Additional Value Shares (‘AVS’) dividends paid includes the final dividend on the AVS of £1,463 million.
Net purchases of investment securities of £6,629 million and fixed assets of £2,556 million, including operating lease assets, comprised the net cash outflow from capital expenditure and financial investment.
UK GAAP compared with US GAAP The Group’s financial statements are prepared in accordance with UK GAAP, which differs in certain material respects from US GAAP as described on pages 187 to 199.
The net income available for ordinary shareholders under US GAAP was £3,948 million, £308 million lower than profit attributable to ordinary shareholders under UK GAAP of £4,256 million. The principle reasons for the decrease are: • A reduction of £437 million relating to derivatives and hedging. Under US GAAP, non-derivative financial instruments cannot be designated as hedges of the foreign exchange exposure of available-for-sale securities; such hedging is permitted under UK GAAP. Under US GAAP, the Group has not designated any of its non-trading derivatives as hedges and these are recorded at fair value. Furthermore, US GAAP requires certain embedded derivatives to be accounted for separately from the host instrument.
• Higher pension costs under US GAAP compared with UK GAAP principally reflecting deferral of actuarial gains and losses over the average remaining service lives of current employees under US GAAP. Actuarial gains and losses are recognised in full in the statement of total recognised gains and losses for the period under UK GAAP.
The above decreases are partially offset by an increase of £780 million in net income under US GAAP relating to intangible assets. Goodwilll amortisation is charged to the profit and loss account under UK GAAP whereas under US GAAP only intangible assets with finite lives are amortised. Goodwill is not amortised but instead is reviewed annually for impairment.
US GAAP shareholders’ equity at £36,191 million is £4,326 million higher than shareholders’ equity under UK GAAP, principally due to the reinstatement of goodwill amortised under UK GAAP and the reversal of the final dividend.
Less: investments in insurance subsidiaries, associated undertakings and other supervisory deductions (5,165) (4,618) (3,146) (2,698) (2,228)
UK banking sector, comparing a bank’s capital resources with its weighted risk assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a tier 1 component of not less than 4%. At 31 December 2004, the Group’s total RAR was 11.7% (2003 – 11.8%) and the tier 1 RAR was 7.0% (2003 – 7.4%).
• Advances Committee – is an executive committee that deals with all transactions that exceed the Group Credit Committee’s delegated authority, which in turn approves facility limits in excess of the authorities delegated to divisional credit committees.
In addition to the responsibilities at Board level outlined above, operational authority and oversight is delegated to the Group Executive Management Committee (“GEMC”), which is responsible for implementing a risk management framework consistent with the Board's risk appetite. The GEMC, in turn, is supported by: • Group Risk Committee (“GRC”), which recommends and approves limits, processes and policies in respect of the effective management of all material risks across the Group.
• Group Risk Management (“GRM”) reports to the GEMC through the Group Finance Director and is responsible for risk policy, measurement and controls across the Group. An assessment of the adequacy and effectiveness of each divisional risk management team is undertaken by GRM on a continuous basis to ensure effective control of risks. Each divisional risk function has a direct reporting line to the Director of Group Risk Management, which reinforces these controls and ensures independence of risk management within each division.
• Group Treasury (“GT”) also reports to the GEMC through the Group Finance Director, and is responsible for the management of the Group’s balance sheet, capital raising, liquidity and hedging policies. GT assesses and monitors the effectiveness of the divisional asset and liability management teams.
The credit risk framework The management of credit risk is undertaken within an agreed and regulated Credit Risk Framework which is defined in the Group’s ‘Principles for Managing Credit Risk’. These set out minimum standards for managing credit risk, defining and maintaining the credit risk framework, approving credit risk taken by the Group, credit stewardship and reviewing the effectiveness of the credit culture. These standards are used to manage the Group’s portfolio of credit risk assets.
GRM and the GEMC review the reports on the Group’s portfolio of credit risks on a monthly basis.
Asset quality S&P equivalent AQ1 AAA to BBBAQ2 BB+ to BB AQ3 BB- to B+ AQ4 B+ to B AQ5 B and below
Loans and advances to banks – gross 58,266 51,898 44,303 Total loans and advances – gross 407,957 308,351 271,547
Finance leases and instalment credit 16,326 14,340 13,132 Total loans and advances to customers – gross 349,691 256,453 227,244 l Industry analysis Industry analysis plays an important part in assessing potential concentration risk within the loan portfolio. Particular attention is given to industry sectors where the Group believes there is a higher degree of risk or potential for volatility in the future.
Geographically, 90% of loans and advances to customers fall within the UK or US, both of which have experienced stable or improving economic growth. Europe accounts for about 9% of loans and advances to customers.
Accrual loans past due 90 days (3) 725 642 492 Troubled debt restructurings 24 83 204
REIL increased to £5,529 million, a rise of 7% compared with 2003 partly due to acquisitions made in 2004. REIL as a proportion of total loans and advances to customers was 1.58%
Credit risk (continued) Specific and general provisions Provisions fall into one of two categories, specific or general: • Specific provisions: arise when the creditworthiness of a borrower has undergone a significant deterioration and the recovery of the advance is in significant doubt. The amount of specific provision reflects the financial condition of the borrower, the realisable value of security and the costs of recovery.
• General provisions: cover losses that have not yet been specifically identified but are known from experience to be present in any portfolio of loans. The level of general provision reflects the size and diversity of the Group’s loan portfolio, past experience, the current state of the economies in which the Group operates and the scope of specific provisioning procedures.
Total bad and doubtful debt provisions increased to £4,222 million in 2004, compared with £3,922 million in 2003, a rise of 8%, reflecting acquisitions, new provisions and write-offs net of recoveries and currency translations. The ratio of provisions to loans and advances to customers reduced from 1.53% at the end of 2003 to 1.21%.
Charge to profit and loss account for bad and doubtful debts 1,428 1,461 1,286 Charge as a percentage of average loans and advances to customers 0.48% 0.59% 0.61%
(2) The geographic analysis is based on location of office. The UK includes domestic transactions and transactions conducted through the offices in the UK which service international banking transactions.
The following table shows amounts previously written off and subsequently recovered during the year by industry and geographical area.
Liquidity risk Liquidity management within the Group focuses on both overall balance sheet structure and the control, within prudent limits, of risk arising from the mismatch of maturities across the balance sheet and from undrawn commitments and other contingent obligations.
In addition to their consolidation within the Group’s daily liquidity management process, it is also the responsibility of all Group subsidiaries and branches outside the UK to ensure compliance with any separate local regulatory liquidity requirements where applicable.
The short-term maturity structure of the Group’s assets and liabilities is also managed on a daily basis to ensure that contractual cash flow obligations, and potential cash flows arising from undrawn commitments and other contingent obligations, can be met as they arise from day to day, either from cash inflows from maturing assets, new borrowing or the sale or repurchase of debt securities held.
Short-term liquidity risk is managed on a consolidated basis for the whole Group excluding the activities of Citizens and insurance businesses, which are subject to regulatory regimes that necessitate the separate management of liquidity.
Internal liquidity mismatch limits are set for all other subsidiaries and non-UK branches which have material local treasury activities in external markets, to ensure those activities do not compromise daily maintenance of the Group’s overall liquidity risk position within the Group’s policy parameters.
The degree of maturity mismatch within the overall long-term structure of the Group’s assets and liabilities is also managed within internal policy limits, to ensure that term asset commitments may be funded on an economic basis over their life. In managing its overall term structure, the Group analyses and takes into account the effect of retail and corporate customer behaviour on actual asset and liability maturities where they differ materially from the underlying contractual maturities.
The Group also periodically undertakes stress tests and sensitivity analysis to analyse the potential impact on its liquidity risk. Contingency plans are maintained to anticipate and respond to any approaching or actual material deterioration in market conditions.
The Group remains well placed to access various wholesale funding sources from a wide range of counterparties and markets, and the changing mix evident between customer repos, deposits by banks and debt securities in issue primarily reflects comparative pricing, maturity considerations and investor/ counterparty demand rather than any material perceived trend.
Sources of funding Excluding capital and other liabilities, customer accounts continue to provide a majority of the Group’s funding and represent a well diversified and stable source of funds from a wide range of retail, corporate and non-bank institutional customers.
Customer accounts (excluding repos): Total customer accounts (excluding repos) 242,928 51 209,942 58 194,101 60
Liquidity risk (continued) Customer lending and customer accounts Net customer lending rose by £32,137 million as the growth in loans and advances to customers exceeded the growth in customer accounts. Structural liquidity risk continues to be maintained within the Group’s policy parameters.
Loans and advances to customers (gross, excluding reverse repos) 297,507 232,384 205,303 Customer accounts (excluding repos) 242,928 209,942 194,101 Customer lending less customer accounts 54,579 22,442 11,202
Customer accounts as % of loans and advances to customers (excluding repos) 81.7% 90.3% 94.5%
Sterling liquidity Over 47% of the Group’s total assets are denominated in sterling. The FSA requires the Group, on a consolidated basis, to maintain daily a minimum ratio of 100% between: 1. a stock of qualifying high quality liquid assets (primarily UK and EU government securities, treasury bills, and cash held in branches) and 2. the sum of: • sterling wholesale net outflows contractually due within 5 working days (offset up to a limit of 50%, by 85% of sterling certificates of deposit held which mature beyond five working days); and
• 5% of retail deposits with a residual contractual maturity of five working days or less.
The Group has operated within its non-sterling liquidity policy mismatch limits at all times during 2004 and operational processes are actively managed to ensure that will continue to be the case going forward.
Contingency plans are also maintained to enable the Group to respond effectively to unforeseen market liquidity or major payment systems problems that may emerge from time to time.
l Interest rate risk Non-trading interest rate risk arises from the Group’s treasury activities and retail and corporate banking businesses.
Any residual non-trading interest rate exposures are controlled by limiting repricing mismatches in the individual balance sheets. Potential exposures to interest rate movements in the medium to long term are measured and controlled using a version of the same VaR methodology that is used for the Group’s trading portfolios but without discount factors. Net interest income exposures are measured and controlled in terms of sensitivity over time to movements in interest rates.
Citizens was the main contributor to the Group’s non-trading interest rate VaR. It invests its surplus retail deposits in a portfolio of highly rated and liquid investments principally mortgage-backed securities. This balance sheet management approach is common for US retail banks where mortgages are originated and then sold to Federal agencies for funding through the capital markets. The significant increase in VaR during 2003 and 2004 reflects substantial growth in retail deposits in Citizens and asset growth in home equity loans and mortgage backed securities both organically and through acquisition. VaR, like all interest rate risk measures, has its limitations when applied to retail banking books and the management of Citizens’ interest rate exposures involves a number of other interest rate risk measures and related limits. Two measures that are reported both to Citizens ALCO and Board are: • the sensitivity of their net interest income to a series of parallel movements in interest rates; and
Percent increase/(decrease) in Citizens EVE 2% parallel upward 2% parallel downward movement in movement in US interest rates US interest rates (no negative rates allowed)
At Group level, the other major structural interest rate risk arises from a low interest rate environment, particularly in sterling, sustained for a number of years. In such a scenario deposit pricing may reach effective floors below which it is not reasonable to reduce rates further whilst variable rate asset pricing continues to decline. A sustained low rate scenario would also generate progressively reduced income from the medium and long term hedging of non-interest bearing liabilities. GALCO regularly reviews the impact of successive declines in rates to ensure that appropriate risk management strategies are employed. This may involve execution of derivatives, product development and tactical pricing changes.
p er at in g a nd fin an ci al r ev ie w l Currency risk The Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investments in overseas subsidiaries and associated undertakings and their related currency funding. The Group’s policy in relation to structural positions is to match fund the structural foreign currency exposure arising from net asset value, including goodwill, in overseas subsidiaries, equity accounted investments and branches, except where doing so would materially increase the sensitivity of either the Group’s or the subsidiary’s regulatory capital ratios to currency movements. The policy requires structural foreign exchange positions to be reviewed regularly by GALCO. Gains or losses on foreign currency investments net of any gains or losses on related foreign currency funding or hedges are recognised in the statement of total recognised gains and losses.
The tables below set out the Group’s structural foreign currency exposures. Foreign currency Structural Net investments borrowings foreign in overseas hedging net currency operations investments exposures
l Equity risk Non-trading equity risk arises principally from the Group’s strategic investments, its venture capital activities and its general insurance business.
VaR is not an appropriate risk measure for the Group’s venture capital investments, which comprise a mix of quoted and unquoted investments, or its portfolio of strategic investments. At 31 December 2004, equity shares held as investment securities had a book value of £2,440 million (2003 – £1,821 million) and a valuation of £2,882 million (2003 – £2,238 million).
The management of insurance risk is overseen by a Pricing Committee that meets weekly to review underwriting factors, e.g. car groups, terms and conditions, claims experience. This is supplemented by a range of system controls and processes including risk acceptance, with regular independent reviews of underwriting across the business. Primary focus is on high volume and relatively straightforward products for example home and motor. This facilitates the generation of comprehensive underwriting and claims data, which is used to monitor and accurately price the risks accepted. This attention to data analysis is reinforced by tight controls on costs and claims handling procedures.
Underwriting concentrations and catastrophe exposure are reviewed and, where necessary, mitigated by reinsurance which is spread across a number of reinsurers. Reviews of the Group’s general insurance reserves by external actuaries are conducted annually.
External risk is defined as the risk arising from outside of the organisation in three main areas: • Business – risks arising from product performance, competitor activity, supplier unreliability or customer activity.
• Political – risks caused by political unrest or uncertainty, activity by public interest groups or extremists, and noncompliance with, or changes to, current legislation.
Contents 114 Board of directors and secretary 116 Report of the directors 120 Corporate governance 124 Directors’ remuneration report 134 Directors’ interests in shares 135 Statement of directors’ responsibilities
B oa rd o f di re ct or s an d se cr et ar y Board of directors and secretary
Sir Angus Grossart (age 67) CBE, DBA, LLD, FRSE, DL, FCIBS, D.Litt C Appointed to the Board in September 1985 and as ViceChairman in April 1996, Sir Angus Grossart is an advocate and Chartered Accountant with a career in merchant banking. He is chairman and chief executive of Noble Grossart Limited. His directorships of public companies include Scottish and Newcastle Plc and Trinity Mirror Plc. He is a trustee of the National Heritage Memorial Fund and a former chairman of the trustees of the National Galleries of Scotland. He has also served on the boards of a wide range of other companies in the UK, the USA and Canada.
Executive directors Sir Fred Goodwin (age 46) DUniv, FCIBS, FCIB, LLD Group Chief Executive C Appointed to the Board in August 1998, Sir Fred Goodwin is a Chartered Accountant. He was formerly chief executive and director, Clydesdale Bank PLC and Yorkshire Bank PLC. He is chairman of The Prince’s Trust and a former president of the Chartered Institute of Bankers in Scotland.
Lawrence Fish (age 60) Chairman, President and Chief Executive Officer of Citizens Financial Group, Inc.
Gordon Pell (age 54) FCIBS, FCIB Chairman, Retail Banking and Wealth Management Appointed to the Board in March 2000, Gordon Pell was formerly group director of Lloyds TSB UK Retail Banking before joining National Westminster Bank Plc as a director in February 2000 and then becoming chief executive, Retail Banking. He is currently also a director of Race for Opportunity and Southampton University Development Trust.
Non-executive directors Colin Buchan* (age 50) A (Acting Chairman), R Appointed to the Board in June 2002, Colin Buchan was educated in South Africa and spent the early part of his career in South Africa and the
Far East. He has considerable international investment banking experience, as well as experience in very large risk management in the equities business. He was formerly a member of the group management board of UBS AG and head of equities of UBS Warburg. He is vice-chairman of Standard Life Investments Limited and a director of Merrill Lynch World Mining Trust Plc, Merrill Lynch Gold Limited, Royal Scottish National Orchestra Society Limited, UBS Securities Canada Inc. and World Mining Investment Company Limited.
Iain Robertson (age 59) CBE, FCIBS Chairman, Corporate Banking and Financial Markets Appointed to the Board in January 1993, Iain Robertson is a Chartered Accountant. He is chairman of British Empire Securities and General Trust plc, Cairn Capital Limited and BT Scotland, and a director of John Menzies plc.
Bob Scott* (age 63) CBE, FCIBS C, N, R (Chairman) Appointed to the Board in January 2001, Bob Scott is an Australian national. He is the senior independent director. Bob Scott has many years experience in the international insurance business and played a leading role in the consolidation of the UK insurance industry. He is a former group chief executive of CGNU plc and chairman of the board of the Association of British Insurers. He is chairman of Yell Group plc, a nonexecutive director of Swiss Reinsurance Company (Zurich), Jardine Lloyd Thompson Group plc and Focus Wickes Group Limited, and a trustee of the Crimestoppers Trust.
The directors have pleasure in presenting their report together with the audited accounts for the year ended 31 December 2004.
An interim dividend of 16.8p per ordinary share was paid on 8 October 2004 totalling £529 million (2003 – £431 million). The directors now recommend that a final dividend of 41.2p per ordinary share totalling £1,308 million (2003 – £1,059 million) be paid on 3 June 2005 to members on the register at the close of business on 11 March 2005. If this recommendation is approved by shareholders at the annual general meeting on 20 April 2005, the retained profit for the year will amount to £2,419 million (2003 – £764 million). Subject to the approval of the dividend by shareholders at the annual general meeting, shareholders will be offered the choice of taking ordinary shares in lieu of cash in respect of the final dividend.
Activities and business review The company is a holding company owning the entire issued ordinary share capital of the Royal Bank, the principal direct operating subsidiary undertaking of the company. The “Group” comprises the company and all its subsidiary and associated undertakings, including the Royal Bank and NatWest. The Group is engaged principally in providing a comprehensive range of banking, insurance and other financial services. Details of the principal subsidiary undertakings of the company are shown in Note 17. A review of the business for the year to 31 December 2004, of recent events and of likely future developments is contained in the Operating and financial review.
In March 2004, Citizens completed the purchase of the credit card portfolio of People’s Bank in the US.
In August 2004, Citizens completed the acquisition of Charter One Financial, Inc.
In September 2004, Citizens completed the acquisition of Lynk Systems Inc, a US based merchant acquiring business.
Directors The names and brief biographical details of the directors are shown on page 115. All directors, except: • Archie Hunter and Joe MacHale, who were appointed to the Board on 1 September 2004,
• Bud Koch, who was appointed to the Board on 29 September 2004,
• Norman McLuskie, who retired from the Board on 23 August 2004, and
Sir Angus Grossart, Lord Vallance and Iain Robertson will retire at the forthcoming annual general meeting. Jim Currie, Sir Fred Goodwin, Archie Hunter, Bud Koch, Joe MacHale and Sir Steve Robson will retire and offer themselves for election or re-election.
Directors’ interests The interests of the directors in the shares of the company at 31 December 2004 are shown on page 134. None of the directors held an interest in the loan capital of the company or in the shares and loan capital of any of the subsidiary undertakings of the company, during the period from 1 January
Employee recruitment To assist those within the Group responsible for recruitment, online toolkits have been developed in conjunction with interview skills training, which equip them effectively to recruit the best people for specific roles. In addition, the Group encourages movement within the organisation through the provision of an online appointments section which enables employees to apply for new or different roles throughout the Group.
The profile of the Group led to over 10,000 applications being received during its 2003/4 graduate campaign for some 200 places. The 2004 UK-based CBFM graduate intake, included 37 per cent Continental European entrants with an additional 21 Continental European graduates and interns placed within CBFM businesses in Frankfurt, Milan, Madrid and Paris. All applications were received online through the graduate website.
To complement this work a Group wide employee induction event was conducted, which provided opportunities to network with other new joiners and facilitated the exchange of ideas and information. Within the last year the Group rose 23 places to rank 15th in the Times Top 100 Graduate employers table.
Shareholdings As at 23 February 2005, the company had been notified of the following interests in its shares, in accordance with section 198 of the Companies Act 1985: Number of shares % held Number of shares % held
Ordinary shares: 51⁄2% cumulative preference shares: Cater Allen International 107,628,711 3.42 Commercial Union Assurance plc 91,429 22.86 Legal & General Group plc 98,761,695 3.40 Mr P. S. and Mrs J. Allen 86,999 21.75 Barclays PLC 93,254,320 3.14 Bassett-Patrick Securities Limited* 46,255 11.56 The Capital Group of Companies, Inc 95,578,555 3.01 E M Behrens Charitable Trust 20,000 5.00 11% cumulative preference shares: Mrs Gina Wild 19,800 4.95 Guardian Royal Exchange Trustees of The Stephen Cockburn
Assurance plc 129,830 25.97 Limited Pension Scheme 19,879 4.97 Windsor Life Assurance Miss Elizabeth Hill 16,124 4.03
Employee reward Under Total Reward the Group offers one of the most comprehensive remuneration and benefits packages in the financial services sector, consisting of salary, bonus, share schemes and competitive pension benefits. Salary awards recognise both market competitor movements and individual performance, with the largest increases being directed towards high performers.
Through RBSelect, the Group's benefits choice programme, all UK employees have the flexibility to customise their remuneration and tailor it to their particular lifestyle needs. This includes the opportunity to access subsidised childcare vouchers, discounted personal insurance products and discounted shopping vouchers at a range of high street stores.
The Group provides pension plan membership for most employees in the UK and overseas. The largest plan is The Royal Bank of Scotland Group Pension Fund, which has over 80,000 employee members in the UK. Through this and a number of additional pension arrangements in the UK and overseas, the Group ensures that employees benefit from competitive pension provision as part of their Total Reward. The actuarial valuation of the main UK pension scheme as at 31 March 2004 resulted in a deficit of £1,994 million. To address this the Group made a special cash contribution of £750 million to the scheme in December 2004. It also increased its contribution rate to 21.5 percent of pensionable salaries with effect from April 2004.
Diversity The Group continues to participate in a range of programmes and activities designed to promote diversity and effective people management. Reflecting its commitment to a business model based on meritocracy and inclusiveness, the Group encourages employees to develop their full potential, irrespective of their race, gender, marital status, age, disability, religious belief, political opinion or sexual orientation.
Health, safety, well being and security The health, safety, well being and security of employees and customers are of vital concern to the Group, which constantly reviews its position on policies in these areas to reflect current legislation and best practice. Furthermore, the Group focuses on ensuring that those policies are closely linked to the operational needs of the business.
Auditors The auditors, Deloitte & Touche LLP, have indicated their willingness to continue in office. A resolution to re-appoint Deloitte & Touche LLP as the company’s auditor will be proposed at the forthcoming annual general meeting.
Throughout the year ended 31 December 2004, the company has complied with all of the provisions set out in the revised Combined Code issued by the Financial Reporting Council in July 2003 (the ‘Code’) except in relation to the authority reserved to the Board to make the final determination of the remuneration of the executive directors, which is explained below in the paragraph headed ‘Remuneration Committee’.
Under the US Sarbanes-Oxley Act of 2002, enhanced standards of corporate governance and business and financial disclosure apply to companies, including the company, with securities registered in the US. The Group complies with all sections of the Sarbanes-Oxley Act of 2002 currently applicable.
Board of directors The Board is the principal decision making forum for the company. It has overall responsibility for leading and controlling the company and is accountable to shareholders for financial and operational performance. The Board approves Group strategy and monitors performance. The Board has adopted a formal schedule of matters detailing key aspects of the company’s affairs reserved to it for its decision. This schedule is reviewed annually.
All directors participate in discussing strategy, performance and financial and risk management of the company and meetings of the Board are structured to allow open discussion.
The Board met 10 times during 2004 and was supplied with comprehensive papers in advance of each Board meeting covering the Group’s principal business activities. Members of the executive management attend and make regular presentations as appropriate at meetings of the Board.
Board balance and independence The Board currently comprises the Chairman, four executive directors and 12 non-executive directors. The Board functions effectively and efficiently and is considered to be of an appropriate size in view of the scale of the company and the diversity of its businesses. The directors provide the Group with the knowledge, mix of skills, experience and networks of contacts required. The Board Committees contain directors with a variety of relevant skills and experience so that no undue reliance is placed on any one individual.
The composition of the Board is subject to continuing review and the provisions of the Code will be taken into account in respect of the balance of the Board. The Code requires the Board to determine whether its non-executive members are independent.
Following the annual general meeting in April 2005 when Sir Angus Grossart, Lord Vallance and Iain Robertson will stand down from the Board, the Board will comprise eight independent and five non-independent directors (including executive directors), in addition to the Chairman. Bob Scott has been nominated as the senior independent director.
The Board considers that all non-executive directors are independent for the purposes of the Code, with the following exceptions: • Sir Angus Grossart and Lord Vallance, who have served on the Board for 19 and 12 years, respectively.
• Iain Robertson who was formerly an executive director of the company.
In addition, each director discussed his or her own performance with the Chairman and the senior independent director met individually with the executive directors and with the nonexecutive directors as a group without the Chairman present, to consider the Chairman’s performance. The report on the Board evaluation, which was designed to assist the Board in further improving its performance, was considered and discussed by the Board as a whole and specific actions are currently being implemented. A performance evaluation is conducted on an annual basis.
Audit Committee All members of the Audit Committee are independent nonexecutive directors. The Audit Committee has five meetings each year, two of which are held immediately prior to submission of the interim and year-end financial statements to the Group Board. The Audit Committee meets executive directors and management and the external and internal auditors privately.
The Board is satisfied that the Audit Committee members have recent and relevant financial experience. Although the Board has determined that each member of the Audit Committee is an ‘Audit Committee Financial Expert’ as defined in the SEC rules under the US Securities Exchange Act of 1934, the members of the Audit Committee are selected with a view to the expertise and experience of the Audit Committee as a whole, and the Audit Committee reports to the Board as a single entity. The designation of a director or directors as an ‘Audit Committee Financial Expert’ does not impose on any such director any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such director as a member of the Audit Committee and Board in the absence of such a designation. Nor does the designation of a director as an ‘Audit Committee Financial Expert’ affect the duties, obligations or liability of any other member of the Board.
The Audit Committee is responsible for assisting the Board in discharging its responsibilities and making all relevant disclosures in relation to the financial affairs of the Group, the arrangements for accounting and financial reporting and regulatory compliance, the standards of internal control, and arrangements for internal audit, risk management and the external auditors.
The Audit Committee has a policy on the engagement of the external auditors to supply audit and non-audit services, which takes into account relevant legislation regarding the provision of such services by an external audit firm. Details of the audit and non-audit services carried out by the external auditors are set out in Note 4 to the Group’s accounts. This policy is reviewed annually by the Audit Committee. In addition, the Audit Committee reviews and monitors the independence and objectivity of the external auditors when it approves non-audit work to be carried out by them, taking into consideration relevant legislation and ethical guidance. A detailed submission is also made by management to the Audit Committee prior to certain appointments. The submission contains, in particular, details as to why the proposed appointment would not breach auditor independence.
C or po ra te g ov er na nc e
Communication with the company’s largest institutional shareholders is undertaken as part of the company’s investor relations programme. During the year, the directors received copies of the analysts’ reports and a monthly report from the Group’s investor relations team which includes an analysis of share price movements, the Group’s performance against the sector, and key broker comments. In addition, information on major investor relations activities and changes to external ratings are provided. In 2004, the senior independent director attended the analysts’ presentation at the interim results to enhance his understanding of the issues and concerns of the major shareholders and would be available to shareholders if concerns could not be addressed through the normal channels. The mechanisms used to ensure that directors develop an understanding of the views of major shareholders are considered as part of the annual Board performance evaluation.
The effectiveness of the Group’s internal control system is reviewed regularly by the Board and the Audit Committee. Executive management committees or boards of directors in each of the Group’s businesses receive quarterly reports on significant risks facing their business and how they are being controlled. These reports are combined and submitted to the Board as quarterly risk and control assessments. Additional details of the Group’s approach to risk management are given in the ‘Risk management’ section of the ‘Operating and financial review’ on pages 96 to 112. The Audit Committee also receives regular reports from Group Risk Management and Group Internal Audit. In addition, the Group’s independent auditors present to the Audit Committee reports that include details of any significant internal control matters which they have identified. The system of internal controls of the authorised institutions and other regulated entities in the Group are also subject to regulatory oversight in the UK and overseas. Additional details of the Group’s regulatory oversight are given in the Supervision and Regulation section.
D ire ct or s’ re m un er a tio n re po rt Directors’ remuneration report
The Remuneration Committee The following directors, all of whom are independent nonexecutive directors, were members of the Remuneration Committee during the year ended 31 December 2004.
During the accounting period, the Remuneration Committee confirmed the appointments of Ernst & Young and Mercer Human Resource Consulting to provide advice on matters relating to directors’ remuneration in the UK and US respectively. In addition, the Remuneration Committee has taken account of the views of the Chairman and the Group Chief Executive on performance assessment of the executive directors.
Remuneration policy The executive remuneration policy is kept under review by the Remuneration Committee and is set out below. There have been no material changes to the policy which was approved by shareholders at the company’s annual general meeting in 2004.
• Remuneration arrangements will strike an appropriate balance between fixed and performance related rewards. Performance related elements will comprise the major part of executive remuneration packages.
The non-executive directors’ fees are reviewed annually by the Board, on the recommendation of the Chairman. The level of remuneration reflects the responsibility and time commitment of directors and the level of fees paid to non-executive directors of comparable major UK companies. Non-executive directors do not participate in any incentive or performance plan.
Executives directors are eligible to receive a choice of various employee benefits or a cash equivalent, on a similar basis to other employees. In addition, like other employees, executive directors are eligible also to participate in Sharesave, Buy As You Earn and the Group profit sharing scheme, which currently pays up to 10 per cent of salaries, depending on the Group’s performance. These schemes are not subject to performance conditions since they are operated on an all-employee basis. Executive directors also receive death in service benefits.
Medium-term performance plan The medium-term performance plan was approved by shareholders in April 2001. Each executive director is eligible for an annual award under the plan in the form of share or share equivalent awards. Whilst the rules of the plan allow grants of awards of up to one and a half times earnings, the Remuneration Committee has adopted a policy of granting awards based on a multiple of salary. Normally awards are made at one times salary with one and a half times salary being granted in the case of the Group Chief Executive. No changes will be made to this policy without prior consultation with shareholders.
As a result of that review, proposals will be submitted at the annual general meeting to introduce a cash long term incentive plan, which will replace the Citizens Phantom 2000 Plan in which Mr Fish participated from 2001. Subject to agreement to these proposals, the total remuneration policy for him will be as follows: Base salary will be set having regard to the levels of base salary in other US banks and the appropriate balance of fixed and variable remuneration for US based executives of UK listed companies operating within the corporate governance frameworks of the UK. In light of this policy, and having reviewed the relevant market data, Mr Fish’s base salary was increased to $1.5 million with effect from 1 October 2004.
Benefits Mr Fish accrues pension benefits under a number of arrangements in the US. Details are provided on page 133. In addition he is entitled to receive other benefits on a similar basis to other Citizens employees.
• A grant under the RBS medium-term performance plan within the levels, and on the same terms, available to UK based executives.
• A grant under the executive share option scheme within the levels, and on the same terms, available to UK based executives.
Service contracts The company’s policy in relation to the duration of contracts with directors is that executive directors’ contracts generally continue until termination by either party, subject to the required notice, or until retirement date. The notice period under the service contracts of executive directors will not normally exceed 12 months. However, the notice period may exceed 12 months if existing service contracts have notice periods greater than 12 months and the Remuneration Committee considers it appropriate not to reduce the existing notice period. In relation to newly recruited executive directors, subject to the prior approval of the Remuneration Committee, the notice period from the employing company required to terminate the contract will not normally exceed 12 months unless there is a clear case for this. Where a longer period of notice is initially approved on appointment, it will normally be structured such that it will automatically reduce to 12 months in due course.
Information regarding executive directors’ service contracts is summarised in the table and notes below.
Mr Pell 22 May 2002 60 12 months 6 months National Westminster Bank Plc
Mr Watt 28 September 2000 60 12 months 6 months The Royal Bank of Scotland plc
Mr Fish 18 February 2004 65 12 months 12 months Citizens Financial Group, Inc.
Iain Robertson entered into a contract to reflect his role as a non-executive director, which took effect on 25 June 2003. Under this contract, his appointment will terminate at the company’s annual general meeting on 20 April 2005, unless terminated earlier by either party on one month’s written notice.
Basic salary is the only component of the remuneration package which is pensionable.
* includes £167,000 in respect of Mr Robertson’s service as an executive director. From 25 June 2003, Mr Robertson has carried out his role as Chairman, Corporate Banking and Financial Markets and as a director in a non-executive capacity. He also provides general advice on business issues to the Board and Board Committees as appropriate, including attendance as required at the Group Audit Committee and the Advances Committee. For these services Mr Robertson receives a fee of £100,000 per annum.
No director received any expense allowances chargeable to UK income tax or compensation for loss of office/termination payment. The non-executive directors did not receive any bonus payments or benefits.
Options held at Options Market price at 1 January granted in date of exercise Option price Options held at 31 December 2004 2004 2004 Number £ £ Number Exercise period * Options held under the sharesave and option 2000 schemes, which are not subject to performance conditions.
No options had their terms and conditions varied during the accounting period to 31 December 2004. No payment is required on the award of an option.
(share equivalents) at granted award vested in vesting vested exercised exercise equivalents) at conditions to 1 January 2004 in 2004 £ 2004* £ £ in 2004 £ 31 December 2004 be fulfilled
Phantom 2000 units at Units awarded Market price qualifying conditions Benefits received Phantom 2000 units at 1 January 2004 during year on award to be fulfilled during year 31 December 2004
No variation was made to any of the terms of the plan during the year. The performance measures are detailed on page 126.
The pension entitlements of Sir Fred Goodwin, Mr Pell, Mr Robertson, and Mr Watt within the RBS Fund are restricted by Inland Revenue limits as set out in the Finance Act 1989. Additional life assurance cover in excess of these limits is provided by a separate arrangement. Arrangements have been made to provide Sir Fred Goodwin and Mr Pell with additional pension benefits on a defined benefit basis outwith the RBS Fund. The figures shown below include the accrual in respect of these arrangements. Mr Watt is provided with additional pension benefits on a defined contribution basis and contributions made in the year are shown below.
Sir George Mathewson receives life insurance cover under an individual arrangement. The non-executive directors do not accrue pension benefits, other than Mr Robertson who continues to accrue benefits in the RBS Fund after his appointment as a non-executive director.
Lawrence Fish accrues pension benefits under a number of arrangements in the USA. Defined benefits are built up under the Citizens’ Qualified Plan, Excess Plan and Supplemental Executive Retirement Arrangement. In addition, he is a member of two defined contribution arrangements – a Qualified 401(k) Plan and an Excess 401(k) Plan.
Age at 31 December 31 December 31 December 31 December 31 December 31 December 31 December 31 December 2004 2004 2004* 2004 2003 2004 2004*
(3) The figures for Mr Pell include an additional pension secured by a transfer from his previous employer which increases in line with statutory revaluation, not salary inflation.
(5) The transfer value for Mr Fish as at 31 December 2004 is based on a retirement age of 65.
Ordinary shares The following directors held a beneficial interest in the company’s ordinary shares: 31 December 1 January 2004 or date 31 December 1 January 2004 or date 2004 of appointment if later 2004 of appointment if later
Mr Buchan 5,000 5,000 Sir George Mathewson 250,816 247,978 Mr Fish 11,120 11,120 Mr Pell 582 582 Sir Fred Goodwin 64,960 64,718 Mr Robertson 129,632 125,139 Mr Hunter 1,500 1,500 Mr Scott 2,448 1,445 Mr Koch 20,000 20,000 Lord Vallance 2,500 2,500 Mr MacHale 10,000 — Mr Watt 58,408 7,453 Miss Mackay 6,341 6,140
Preference shares Lawrence Fish held 20,000 non-cumulative preference shares of US$0.01 each at 31 December 2004 (2003 – 20,000). No other director had an interest in the preference shares during the year.
No director held a non-beneficial interest in the shares of the company at 31 December 2004, at 1 January 2004 or date of appointment if later.
S ta te m en t of di re ct or s’
United Kingdom company law requires the directors to prepare accounts for each financial year which give a true and fair view of the state of affairs of the company and of the Group as at the end of the financial year and of the profit or loss of the Group for that year. In preparing those accounts, the directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; and
Contents 138 Independent auditors’ report 139 Accounting policies 143 Consolidated profit and loss account 144 Consolidated balance sheet 145 Statement of consolidated total recognised gains and losses 145 Reconciliation of movements in consolidated shareholders’ funds 146 Consolidated cash flow statement 147 Balance sheet – the company 148 Notes on the accounts
We report to you our opinion as to whether the financial statements give a true and fair view and whether the financial statements and the part of the directors’ remuneration report described as having been audited have been properly prepared in accordance with the Companies Act 1985. We also report to you if, in our opinion, the directors’ report is not consistent with the financial statements, if the company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and transactions with the company and other members of the Group is not disclosed.
We review whether the corporate governance statement reflects the company's compliance with the nine provisions of the Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the Board's statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group's corporate governance procedures or its risk and control procedures.
Basis of audit opinion We conducted our audit in accordance with United Kingdom auditing standards issued by the Auditing Practices Board and with the standards of the United States Public Company Accounting Oversight Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the directors’ remuneration report described as having been audited. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements and of whether the accounting policies are appropriate to the circumstances of the company and the Group, consistently applied and adequately disclosed.
The accounts have been prepared in accordance with applicable Accounting Standards in the UK and the Statements of Recommended Accounting Practice issued by the British Bankers’ Association and by the Finance and Leasing Association. The Statement of Recommended Practice issued by the Association of British Insurers (2003) has been followed by the insurance members of the Group; they have been consolidated in the recognised manner for banking groups, in particular, by using the embedded value method for life business. A summary of the more important accounting policies is set out below. The consolidated accounts are prepared in accordance with the special provisions of Part VII of the Companies Act 1985 (“the Act”) relating to banking groups.
Change of accounting policy FRS 17 ‘Retirement Benefits’ (“FRS 17”) supersedes Statement of Standard Accounting Practice 24 'Pension costs’ (“SSAP24”) and the Urgent Issues Task Force Abstract 6 ‘Accounting for post-retirement benefits other than pensions’. All the disclosure requirements of FRS 17 were adopted by the Group in its 2002 financial statements. In November 2002, the Accounting Standards Board deferred the effective date of the recognition and measurement elements of the standard to accounting periods beginning on or after 1 January 2005. The Group has, however, implemented the recognition and measurement provisions of FRS 17 in 2004 in the light of the introduction of International Financial Reporting Standards from 1 January 2005; the measurement principles in the equivalent international accounting standard (IAS 19 ‘Employee Benefits’) are similar to those in FRS 17.
FRS 17 requires assets in a defined benefit scheme to be measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that are mutually compatible and lead to the best estimate of the future cash flows. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. The surplus/deficit in a defined benefit scheme is the excess/shortfall of the value of the assets in the scheme over/below the value of the scheme liabilities. A surplus is recognised as an asset to the extent that the employer is able to recover the surplus either through reduced contributions in the future or through refunds from the scheme. A deficit is recognised as a liability to the extent of the employer’s legal or constructive obligation to fund it. The current service cost (the increase in scheme liabilities arising from employee service in the current period), past service costs (the cost of improvements to benefits for service relating to prior periods) and interest cost (the unwind of the discount on scheme liabilities) net of the expected return on scheme assets are charged to the profit and loss account. Actuarial gains and losses (changes in surpluses or deficits due to experience gains and losses and to changes in actuarial assumptions) are recognised in full in the statement of total recognised gains and losses for the period.
1 Accounting convention and bases of consolidation The accounts are prepared under the historical cost convention modified by the periodic revaluation of premises and certain investments. To avoid undue delay in the presentation of the Group’s accounts, the accounts of certain subsidiary undertakings have been made up to 30 November. There have been no changes in respect of these subsidiary undertakings, in the period from their balance sheet dates to 31 December, that materially affect the view given by the Group’s accounts.
2 Revenue recognition Interest is credited to the profit and loss account as it accrues unless there is significant doubt that it can be collected (as described in the accounting policy on loans and advances).
An annual fee payable by a credit card holder is charged at the beginning of each year but is deferred and taken to income over the period of the service i.e. 12 months.
Securities and derivatives held for trading are recorded at fair value. Changes in fair value are recognised in dealing profits together with dividends from, and interest receivable and payable on, trading business assets and liabilities.
3 Goodwill Goodwill is the excess of the cost of acquisition of subsidiary and associated undertakings over the fair value of the Group’s share of net tangible assets acquired. Goodwill arising on acquisitions of subsidiary and associated undertakings after 1 October 1998 is capitalised on the balance sheet and amortised on a straight-line basis over its estimated useful economic life, currently over periods up to 20 years. Capitalised goodwill is reviewed for impairment at the end of the first full year following an acquisition and subsequently if events or changes in circumstances indicate that its carrying value may not be recoverable in full. Goodwill arising on acquisitions of subsidiary and associated undertakings prior to 1 October 1998, previously charged directly against profit and loss account reserves, was not reinstated under the transitional provisions of FRS 10 ‘Goodwill and Intangible Assets’. It will be written back only on disposal and reflected in the calculation of the gains or losses arising.
4 Foreign currencies Monetary assets and liabilities denominated in foreign currencies are translated into sterling at the rates of exchange ruling at the balance sheet date. Profit and loss accounts of overseas branches and subsidiary undertakings are translated at the average rates of exchange for the period. Exchange differences arising from the application of closing rates of exchange to the opening net assets of overseas branches and subsidiary undertakings and from restating their results from average to period-end rates are taken to profit and loss account reserves, together with exchange differences arising on related foreign currency borrowings. All other exchange differences are included in operating profit.
The current service cost and any past service costs are charged to the profit and loss account within Administrative expenses – staff costs. The expected return on scheme assets less the unwinding of the discount on the scheme liabilities is included in Other operating income. Actuarial gains and losses are recognised in the statement of total recognised gains and losses, net of related notional deferred tax.
Fi na nc ia l st at em en ts 7 General insurance General insurance comprises short-duration contracts and include principally property and liability insurance contracts. Due to the nature of the products sold – retail based property and casualty, motor, home and personal health insurance contracts – the insurance protection is provided on an even basis throughout the term of the policy.
In calculating operating profit from general insurance activities, premiums (net of reinsurance premiums) are recognised in the accounting period in which they begin. Unearned premiums represent the proportion of the net premiums that relate to periods of insurance after the balance sheet date and are calculated over the period of exposure under the policy, on a daily basis, 24th’s basis or allowing for the estimated incidence of exposure under policies which are longer than twelve months. Provision is made where necessary for the estimated amount required over and above unearned premiums net of reinsurance, including that in respect of future written business on discontinued lines under the run-off of delegated underwriting authority arrangements. It is designed to meet future claims and related expenses and is calculated across related classes of business on the basis of a separate carry forward of deferred acquisition expenses after making allowance for investment income.
8 Long-term life assurance business The Group’s long-term assurance business includes whole-life, guaranteed renewable term life, endowment, annuity and universal life contracts that are expected to remain in force for an extended period of time, generally five to forty years.
9 Loans and advances The Group makes provisions for bad and doubtful debts, through charges to the profit and loss account, so as to record impaired loans and advances at their expected ultimate net realisable value.
Investment properties are revalued annually to open market value. No depreciation is charged on freehold investment properties, in accordance with the requirements of Statement of Standard Accounting Practice 19 ‘Accounting for investment properties’. This is a departure from the requirements of the Companies Act 1985 which requires all tangible fixed assets to be depreciated. Investment properties are held not for consumption but for investment and the directors consider that to depreciate them would not give a true and fair view. It is not practicable to assess estimated useful lives for investment properties, and accordingly the effect of not depreciating them cannot be reasonably quantified.
14 Derivatives The Group enters into derivative transactions including futures, forwards, swaps and options principally in the interest rate, foreign exchange and equity markets. The accounting treatment for these instruments is dependent upon whether they are entered into for trading or non-trading (hedging) purposes.
Interest receivable – interest receivable and similar income arising from debt securities 1,517 1,519 1,591 – other interest receivable and similar income 15,179 12,479 11,970
Profit before provisions for bad and doubtful debts 8,428 7,570 6,197 Provisions for bad and doubtful debts 13 1,428 1,461 1,286 Amounts written off fixed asset investments 83 33 59 Profit on ordinary activities before tax 4 6,917 6,076 4,852 Tax on profit on ordinary activities 5 2,155 1,888 1,582 Profit on ordinary activities after tax 4,762 4,188 3,270 Minority interests (including non-equity) 32 250 210 133 Profit for the financial year 4,512 3,978 3,137 Preference dividends – non-equity 6 256 261 305
Assets Cash and balances at central banks 4,293 3,822 Items in the course of collection from other banks 2,629 2,501 Treasury bills and other eligible bills 10 6,110 4,846 Loans and advances to banks 11 58,260 51,891 Loans and advances to customers 350,229 253,392 Less: non-returnable finance 12 4,760 861
Debt securities in issue 25 58,960 41,016 Settlement balances and short positions 26 32,990 21,369
Subordinated liabilities – dated loan capital 30 11,013 9,312 – undated loan capital including convertible debt 31 9,353 7,686
Retained profit for the year 2,419 764 767 Issue of ordinary and preference shares 4,603 775 560 Conversion of exchangeable undated loan capital 460 — — Redemption of preference shares –– (364) (600) Actuarial (losses)/gains recognised in post-retirement benefit schemes (1,134) 36 (1,692) Own shares held in relation to employee share scheme (7) –– –– Goodwill previously written off to reserves –– 40 — Other recognised gains and losses (343) (21) 4 Currency translation adjustment on share premium account (231) (203) (283) Net increase/(decrease) in shareholders’ funds 5,767 1,027 (1,244)
Reconciliation of movements in consolidated shareholders’ funds for the year ended 31 December 2004
C on so lid a te d ca sh f lo w s ta te m en t
Net cash inflow from operating activities 43 6,307 19,708 13,737 Dividends received from associated undertakings 9 9 1 Returns on investments and servicing of finance Preference dividends paid (253) (269) (317) Additional Value Shares dividend paid — (1,463) (798) Dividends paid to minority shareholders in
(net of cash sold) 45 22 179 29 Net cash outflow from acquisitions and disposals (7,674) (1,571) (281) Ordinary equity dividends paid (1,235) (772) (729) Net cash (outflow)/inflow before financing (6,583) 6,536 535 Financing Proceeds from issue of ordinary share capital 2,845 184 85 Proceeds from issue of preference share capital 1,358 — — Proceeds from issue of trust preferred securities 1,075 883 1,242 Redemption of preference share capital — (364) (600) Issue of subordinated liabilities 4,624 3,817 2,157 Repayment of subordinated liabilities (718) (336) (202) Increase/(decrease) in minority interests 185 (56) 29 Net cash inflow from financing 9,369 4,128 2,711
Fixed assets Investments: Shares in Group undertakings 17 36,870 32,354 Loans to Group undertakings 18 4,101 4,554
Current assets Debtors: Due by subsidiary undertakings 458 238 Debtors and prepayments 174 202
Net current liabilities (2,637) (2,824) Total assets less current liabilities 38,334 34,084
Creditors Amounts falling due beyond one year: Loans from subsidiary undertakings 162 186 Dated loan capital 30 4,810 3,714 Undated loan capital including convertible debt 31 1,085 1,639
Capital and reserves Called up share capital 33 822 769 Share premium account 34 12,964 8,175
N ot es o n th e ac co un ts Notes on the accounts 1 Dealing profits 2004 2003* 2002*
Dealing profits include interest income and expense recognised on trading-related interest-earning assets and interest-bearing liabilities and exclude direct costs and administrative expenses.
(4) Includes interest rate swaps, forward rate agreements, interest rate options, interest rate futures and credit derivatives and related hedges and funding.
The Group operates a number of pension schemes which are predominantly defined benefit schemes whose assets are independent of the Group's finances. In addition to the main scheme, The Royal Bank of Scotland Group Pension Fund, the Group operates a number of other UK and overseas pension schemes. It also provides other post-retirement benefits, principally through subscriptions to private healthcare schemes in the UK and the US and unfunded post-retirement benefit plans. Provision for the costs of these benefits is charged to the profit and loss account over the average remaining future service lives of the eligible employees. The amounts are not material.
The total pension costs for the Group were as follows: Main UK Other 2004 2003 2002 scheme schemes Total Total Total
Amount charged to profit and loss account £m £m £m £m £m
Expected return on pension scheme assets (840) (82) (922) (826) (988) Interest on pension scheme liabilities 759 78 837 774 787 Net return credited to other operating income (81) (4) (85) (52) (201)
Past service cost — 11 11 — 3 Net pension cost defined benefit schemes 319 58 377 319 124 Defined contribution schemes and other retirement benefits — 44 44 37 19
Actual return less expected return on pension scheme assets 411 872 (2,645) Experience gains and losses arising on scheme liabilities (631) 7 (25) Changes in assumptions underlying the present value of scheme liabilities (1,378) (810) 278 Actuarial (losses)/gains (1,598) 69 (2,392) Current tax relief 56 — — Deferred tax asset/(liability) 408 (33) 700 Actuarial (losses)/gains recognised in post-retirement benefit schemes (1,134) 36 (1,692)
(Deficit)/surplus in the pension schemes at 1 January (1,968) (1,856) 492 Movement in year: Current service cost (451) (371) (322) Past service cost (11) — (3)
N ot es o n th e ac co un ts Notes on the accounts continued 3 Pension costs (continued)
Difference between expected and actual return on scheme assets: Percentage of scheme assets 2.8% 6.8% (22.6%)
Experience gains and losses on scheme liabilities: Percentage of the present value of scheme liabilities (3.6%) — (0.2%)
Total amount recognised in the statement of total recognised gains and losses: Percentage of the present value of scheme liabilities (9.0%) 0.5% (17.7%)
Income Aggregate amounts receivable under finance leases, hire purchase and conditional sale contracts 1,345 1,161 1,342
Aggregate amounts receivable under operating leases 1,103 939 811 Profit on disposal of investment securities 167 172 85 Share of associated undertakings’ net profit 35 12 2
Expenses Operating lease rentals of premises 338 321 255 Operating lease rentals of computers and other equipment 15 13 16 Finance charges on leased assets 13 8 23 Interest on subordinated liabilities 681 551 659 Integration expenditure* relating to: – acquisition of NatWest — 143 810 * Integration expenditure comprises: Premises and equipment 34 31 127 Other administrative expenses 120 73 298
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 5 Tax on profit on ordinary activities £m £m £m
The following factors may affect future tax charges: (1) No deferred tax is recognised on the unremitted reserves of overseas subsidiary and associated undertakings. A substantial proportion of such reserves are required to be retained by the overseas undertakings to meet local regulatory requirements.
(2) Deferred tax assets of £110 million (2003 – £127 million) resulting from tax losses carried forward have not been recognised as there is insufficient evidence that the asset will be recoverable. These assets may be recoverable if the losses can be offset against suitable future taxable profits arising in the same tax jurisdiction.
(4) Freehold and long leasehold properties are revalued (see Note 20). No provision has been made for deferred tax on gains recognised on revaluing Group properties except where there is a commitment to sell the asset and any taxable gain will not be subject to rollover relief. The tax that could be payable if these assets were disposed of at their revalued amount is estimated at £129 million (2003 – £109 million), including tax on rolled over gains (see (5) below). No such tax is expected to be payable in the foreseeable future.
Non-cumulative preference shares of US$0.01 105 99 141 Non-cumulative convertible preference shares of US$0.01 90 100 108 Non-cumulative convertible preference shares of €0.01 33 37 32 Non-cumulative preference shares of €0.01 4 –– –– Non-cumulative convertible preference shares of £0.25 — — 1 Non-cumulative convertible preference shares of £0.01 15 15 15 11% cumulative preference shares of £1 (1) — — — 5.5% cumulative preference shares of £1 (2) — — — Appropriation for premium payable on redemption and issue costs 9 10 8 Total preference dividends 256 261 305 Additional Value Shares — 1,463 798 Total non-equity dividends 256 1,724 1,103
Earnings: Profit attributable to ordinary shareholders 4,256 2,254 2,034 Add back dividends on dilutive convertible non-equity shares 66 — — Diluted earnings attributable to ordinary shareholders 4,322 2,254 2,034
Number of ordinary shares: Weighted average number of ordinary shares in issue during the year 3,085 2,931 2,881 Effect of dilutive share options and convertible non-equity shares 73 22 43 Diluted weighted average number of ordinary shares during the year 3,158 2,953 2,924
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 10 Treasury bills and other eligible bills £m £m
– three months or less 26,112 25,525 – one year or less but over three months 11,902 8,357 – five years or less but over one year 266 422 – over five years 556 479
N ot es o n th e ac co un ts Notes on the accounts continued 12 Loans and advances to customers £m £m
Amounts above include: Subordinated advances 220 73 Amounts receivable under finance leases 9,968 8,405 Amounts receivable under hire purchase and conditional sale agreements 6,358 5,935
Currency translation and other adjustments (22) (76) (98) (23) (39) (62)
Recoveries of amounts written off in previous periods 147 –– 147 72 — 72 Charge to profit and loss account 1,412 16 1,428 1,459 2 1,461 14 Interest in suspense In certain cases, interest may be charged to a customer’s account but, because its recoverability is in doubt, not recognised in the Group’s consolidated profit and loss account. Such interest is held in a suspense account and netted off against loans and advances in the consolidated balance sheet.
(ii) Mortgage securitisations – following the acquisition of First Active in 2004, the Group is party to a number of mortgage securitisations that qualify for linked presentation. Mortgages have been transferred to special purpose vehicles, held ultimately by charitable trusts, funded principally through the issue of floating rate notes. The Group is not obliged, and does not intend, to support losses that may be suffered by the note holders. There are no arrangements for the Group to repurchase the mortgages. The note holders have agreed that they will be paid, as to interest and principal, only to the extent that sufficient funds are generated by the mortgage loans and their underlying security. The Group has entered into arm's length fixed/floating interest rate swaps with the securitisation vehicles and provides mortgage management and agency services to the vehicles. On repayment of the financing, any further amounts generated by the mortgages will be paid to the Group. At 31 December 2004, mortgages of £1,519 million are subject to non-recourse finance of £1,479 million. During the year the Group recognised net income of £26 million comprising interest receivable of £72 million less interest payable and other expenses of £46 million.
During the year the Group recognised net income of £37 million (2003 – £39 million; 2002 – £40 million) comprising interest million) less interest payable and other expenses of £79 million
(v) Loan transfer – during 2004, loans originated by the Group and another bank were transferred to a special purpose vehicle which funded the purchase through the issue of notes. The Group is not obliged, and does not intend, to support losses that may be suffered by the note holders. There are no arrangements for the Group to repurchase the loan. The note holders have agreed that they will be paid, as to interest and principal, only to the extent that sufficient funds are generated by the loans. At 31 December 2004, the gross loan amounted to £301 million and the non-recourse financing of £301 million. Gross and net income in 2004 were less than £1 million.
N ot es o n th e ac co un ts Notes on the accounts continued 15 Debt securities Gross Gross Gross Gross 2004 unrecognised unrecognised 2004 2003 unrecognised unrecognised 2003 Book value gains losses Valuation Book value gains losses Valuation £m £m £m £m £m £m £m £m
Investment securities: Other debt securities: Other public sector bodies 37 37 36 36 Bank and building society 604 604 407 407
Due within one year 18,060 16,943 Due one year and over 73,151 63,006
Movements in debt securities which are held as investment securities were as follows: Discounts and
Provisions made net of write backs –– –– (71) (71) Transfers to other debt securities (7,429) 6 1 (7,422) Amortisation of discounts and premiums –– (9) –– (9) Amounts written off (16) –– 16 ––
The following table categorises the Group’s investment debt securities by maturity and yield (based on weighted averages) at 31 December 2004: After 1 but After 5 but Within 1 year within 5 years within 10 years After 10 years Total
Securities issued by the states of the US — — 18 4.9 16 4.1 18 3.4 52 4.1
16 Equity shares Gross Gross Gross Gross 2004 unrecognised unrecognised 2004 2003 unrecognised unrecognised 2003 Book value gains losses Valuation Book value gains losses Valuation £m £m £m £m £m £m £m £m
Investment securities: Other securities: Banking business 2,474 1,872 Trading business 486 428
Movements in equity shares which are held as investment securities were as follows: Cost Provisions Book value £m £m £m
Gross gains of £96 million (2003 – £68 million) and gross losses of nil (2003 – £7 million) were realised on the sale of investment equity shares.
The above information is provided in relation to the principal related undertakings as permitted by Section 231(5) of the Companies Act 1985. Full information on all related undertakings will be included in the Annual Return filed with the UK Companies House.
Cost: Currency translation and other adjustments (558) Arising on acquisitions during the year 5,899 Disposals (20)
N ot es o n th e ac co un ts Notes on the accounts continued 20 Tangible fixed assets Long Short Computers Assets on Freehold leasehold leasehold and other operating premises premises premises equipment leases Total £m £m £m £m £m £m
Cost or valuation: Currency translation and other adjustments (18) — (10) (41) (185) (254)
Disposals and write-off of fully depreciated assets (302) (21) (48) (136) (1,352) (1,859)
Accumulated depreciation and amortisation: Currency translation and other adjustments (1) 3 (3) (17) (29) (47)
Disposals and write-off of fully depreciated assets (19) (2) (4) (56) (251) (332)
Net book value at 31 December 2004 5,227 1,283 562 1,464 7,758 16,294
Net book value at 31 December 2003 4,810 1,252 405 1,106 6,354 13,927
On the historical cost basis, the Group’s freehold and long leasehold premises would have been included at £6,249 million (2003 – £5,886 million).
Freehold and long leasehold properties are revalued on a rolling basis, each property being valued at least every five years. Interim valuations outwith the five year cycle are carried out on properties where there is an indication that their value has changed significantly, given market conditions. The directors are not aware of any material change in the valuation of the Group’s properties and therefore no additional interim valuations were required.
Properties occupied by the Group are valued on the basis of Existing Use Value, except for certain specialised properties which are valued on a Depreciated Replacement Cost basis. Investment properties and properties to be disposed of are valued to reflect Open Market Value. Valuations are carried out by internal and external qualified surveyors who are members of the Royal Institution of Chartered Surveyors or, in the case of some overseas properties, locally qualified valuers.
Land and buildings occupied for own use 2,768 2,391 Investment properties 3,715 3,628 Properties under development 570 429 Properties to be disposed of 19 19
Contracts for future capital expenditure not provided for in the accounts at the year end Premises and equipment 406 104 Assets on operating leases 196 498
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 21 Other assets 2004 2003*
22 Long-term assurance business The long-term assurance assets and liabilities attributable to policyholders comprise: £m £m
Increase in value for the year after tax 66 51 * The value of the long-term assurance business is calculated by discounting estimated future flows of statutory profits from in-force business at a discount rate that includes a risk margin. The future flows are based on prudent assumptions about long-term economic and business experience determined with the advice of qualified actuaries. The risk margin is designed to reflect uncertainties in expected future flows.
The key assumptions used are: Risk discount rate (net of tax) 8.0 8.5 Growth of unit-linked funds (gross of tax) 6.9 6.7 Growth of non-unit-linked funds (gross of tax) 4.7 5.0 Basic tax rate 20.0 20.0 Shareholder taxation – life 30.0 30.0 Expense inflation 3.5 3.5 23 Deposits by banks £m £m
– three months or less 66,542 64,797 – one year or less but over three months 15,502 7,608 – five years or less but over one year 7,803 3,288 – over five years 1,227 696
Banking business 243,929 210,925 Trading business 41,133 26,038 25 Debt securities in issue £m £m
Bonds and medium term notes, by remaining maturity – one year or less 7,736 2,227 – two years or less but over one year 3,034 1,063 – five years or less but over two years 3,606 3,614 – over five years 1,328 3,525
– three months or less 31,849 23,414 – one year or less but over three months 9,786 6,188 – two years or less but over one year 1,598 977 – five years or less but over two years 23 8
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 28 Deferred taxation Provision for deferred taxation has been made as follows: £m £m
Deferred tax liability 2,873 2,036 Deferred tax asset (included in Note 21, Other assets) (47) (48) Net deferred tax 2,826 1,988 £m £m
Short-term timing differences (56) (49) Capital allowances 3,248 2,440 Bad and doubtful debt provisions (399) (441) Deferred gains 33 38 Net deferred tax 2,826 1,988
The deferred taxation balance at 31 December 2004 does not include any amounts in respect of the Group’s post-retirement benefit liabilities which is shown on the balance sheet after deduction of a deferred taxation asset of £995 million (2003 – £566 million) (see Note 3). The opening provision for deferred taxation has been restated following implementation of FRS 17 (see page 139).
Prior year adjustment arising on implementation of FRS 17 — (43) — (43)
US$675 million 5.05% subordinated notes 2015 (issued December 2004) (3) 347 —
The Royal Bank of Scotland plc £125 million subordinated floating rate notes 2005 (4) 125 125
US$150 million floating rate notes 2009 (5) — 84 £35 million floating rate step-up subordinated notes 2010 35 35 US$350 million floating rate subordinated notes 2012 181 196 €130 million floating rate subordinated notes 2012 92 92 US$500 million floating rate subordinated notes 2012 258 280
US$50 million floating rate subordinated notes 2013 26 28 €1,000 million floating rate subordinated notes 2013 (callable October 2008) 704 705 US$1,250 million floating rate subordinated notes 2014 (issued May 2004; callable July 2009) (7) 646 — A$590 million 6.0% subordinated notes 2014 (issued October 2004; callable October 2009) (8) 238 — A$410 million floating rate subordinated notes 2014 (issued October 2004; callable October 2009) (9) 165 —
RBSG Capital Corporation US$250 million 10.125% guaranteed capital notes 2004 (12) — 140
National Westminster Bank Plc £100 million 12.5% subordinated unsecured loan stock 2004 (13) — 104 US$400 million guaranteed floating rate capital notes 2005 206 223 US$1,000 million 7.375% subordinated notes 2009 513 553 US$650 million floating rate subordinated step-up notes 2009 (14) — 366 £300 million 8.125% step-up subordinated notes 2011 (callable December 2006) 301 303
Greenwich Capital Holdings, Inc. US$105 million subordinated loan capital 2004 floating rate notes –– 59 US$105 million subordinated loan capital 2006 floating rate notes 54 ––
(2) Repayable in five equal annual instalments in May in each of the years 2001 to 2005.
(4) Repayable in whole, at the option of The Royal Bank of Scotland plc, prior to maturity, on conditions governing the respective debt obligation, including prior approval of the UK Financial Services Authority.
(18) 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.
(19) Interest payable on the Group’s floating rate dated issues is at a margin over London interbank rates. Interest on £1,450 million, US$4,425 million, €5,405 million and A$590 million of fixed rate dated issues is swapped into floating rates at a margin over London interbank rates.
(2) Interest is payable at a rate of 0.25% per annum over an average calculated by reference to six month euro dollar deposits in London for each interest period.
(3) Redeemable in certain circumstances related to changes in the tax laws of the UK, in whole or in part, at the option of the company on any interest payment date. Exchangeable, in whole or in part, at the option of the company on any interest payment date, or in certain circumstances related to changes in the tax laws of the UK, in whole but not in part, into the company’s non-cumulative preference shares of US$0.01 each.
(4) Exchanged for 34 million non-cumulative dollar preference shares of US0.01, Series L on 30 September 2004.
(5) Redeemable by the company on or after 30 September 2031 or on any interest payment date thereafter or at any time on the occurrence of certain events, subject to the prior approval of the UK Financial Services Authority.
(12) Exchangeable at the option of the issuer into 20 million 8.75% (gross) non-cumulative preference shares of US$25 each of National Westminster Bank Plc at any time.
(15) 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.
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 32 Minority interests – non-equity £m £m
(2) The £140 million 9% non-cumulative preference shares, Series A, of £1 each are non-redeemable.
These securities have no maturity date and are not redeemable at the option of the holders at any time. The securities may, with the consent of the FSA, be redeemed, in whole or in part, 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.
* issued in 2004, net proceeds received US$941 million (£523 million) and US$994 (£552 million), respectively.
(4) Minority interests in the consolidated profit and loss account includes £138 million (2003 – £127 million; 2002 – £67 million) in respect of non-equity interests.
33 Share capital Allotted, called up and fully paid Authorised 1 January Issued during 31 December 31 December 31 December £m £m £m £m £m
Non-equity shares Additional Value Shares of £0.01 — — — 27 27 Non-cumulative preference shares of US$0.01 1 — 1 2 2 Non-cumulative convertible preference shares of US$0.01 — — — — — Non-cumulative preference shares of €0.01 — — — — — Non-cumulative convertible preference shares of €0.01 — — — — — Non-cumulative convertible preference shares of £0.25 — — — 225 225 Non-cumulative convertible preference shares of £0.01 — — — — —
Consideration of £2,845 million was received on the issue of ordinary shares for cash and dividends of £394 million were satisfied by the issue of shares.
Preference shares In August 2004, the company issued 37 million Series M noncumulative preference shares of US$0.01 each at US$25 per share, the net proceeds being US$896 million.
Non-cumulative preference shares Non-cumulative preference shares entitle the holders thereof to receive periodic non-cumulative cash dividends at specified fixed rates for each Series payable out of distributable profits of the company.
Non-cumulative convertible preference shares of US$0.01 Series 1 1 million 31 March 2010 US$1,000 Series 2 0.5 million 31 March 2005 US$1,000 Series 3 0.4 million 31 December 2005 US$1,000
On a winding-up or liquidation of the company, the holders of the non-cumulative preference shares will be entitled to receive, out of any surplus assets available for distribution to the company’s shareholders (after payment of arrears of dividends on the cumulative preference shares up to the date of repayment) pari passu with the cumulative preference shares, the non-cumulative sterling preference shares and all other shares of the company ranking pari passu with the noncumulative preference shares as regards participation in the surplus assets of the company, a liquidation distribution of US$25 per non-cumulative preference share of US$0.01, US$1,000 per non-cumulative convertible preference share of US$0.01, €1,000 per non-cumulative convertible preference share of €0.01 and £1,000 per non-cumulative convertible preference share of £0.01, together with an amount equal to dividends for the then current dividend period accrued to the date of payment, before any distribution or payment may be made to holders of the ordinary shares as regards participation in the surplus assets of the company.
The tax effect of gains and losses taken directly to reserves was nil (2003 – nil).
Included in the closing balances of the Group’s revaluation reserves and profit and loss account at 31 December 2004 are cumulative net losses of £320 million (2003 – net gains £90 million) relating to the retranslation of opening net assets of subsidiary and associated undertakings offset by foreign currency borrowing.
Shares issued during the year 4,550 760 685 4,550 Conversion of exchangeable undated loan capital 460 — — 460 Preference shares redeemed during the year — — (268) —
Revaluation of interests in subsidiary undertakings — — — (1,887) Revaluation of premises 56 (69) (33) — Transfer from/(to) profit and loss account 29 (4) — —
Profit and loss account As previously reported 7,848 6,768 5,956 2,588 Prior year adjustment arising on implementation of FRS 17 (2,001) (1,981) (353) —
The cumulative goodwill arising on acquisitions of subsidiary and associated undertakings which are still part of the Group and written off directly against profit and loss account reserves of the Group amounted to £1,133 million at 31 December 2004.
Assets: denominated in sterling 276,291 232,779 denominated in currencies other than sterling 307,176 221,649
Treasury and other eligible bills 1,593 761 Debt securities 32,129 24,231
Loans and advances to customers 11,509 1,196 Debt securities 4,344 2,628 Tangible fixed assets 1,268 1,162 Loans to banks — 73 Other — 53
The principal types of derivative contracts into which the Group enters are described below.
Swaps These are over-the-counter (“OTC”) agreements between two parties to exchange periodic payments of interest, or payments for the change in value of a commodity, or related index, over a set period based on notional principal amounts. The Group enters into swap transactions in several markets. Interest rate swaps exchange fixed rates for floating rates of interest based on notional amounts. Basis swaps exchange floating or fixed interest calculated using different bases. Cross currency swaps are the exchange of interest based on notional values of different currencies. Equity and commodity swaps exchange interest for the return on an equity or commodity, or equity or commodity index.
Futures and forwards Short-term interest rate futures, bond futures and forward foreign exchange contracts are all agreements to deliver, or take delivery of, a specified amount of an asset or financial instrument based on the specified rate, price or index applied against the underlying asset or financial instrument, at a specified date. Futures are exchange traded at standardised amounts of the underlying asset or financial instrument. Forward contracts are OTC agreements and are principally dealt in by the Group in interest rates as forward rate agreements and in currency as forward foreign exchange contracts.
Collateral The Group may require collateral in respect of the credit risk in derivative transactions. The amount of credit risk is principally the positive fair value of contracts. Collateral may be in the form of cash or in the form of a lien over a customer’s assets entitling the Group to make a claim for current and future liabilities.
At 31 December 2004, the potential credit risk exposure, which is after netting and allowing for collateral received, of the Group’s trading and non-trading derivatives, was £6,290 million (2003 – £5,405 million) to banks and investment firms and £7,900 million (2003 – £5,985 million) to other counterparties.
Trading derivatives The following table shows the fair values of instruments in the derivatives trading portfolio: End of period fair value End of period fair value
Exchange rate contracts: Spot, forwards and futures 17,133 18,566 18,299 20,325
Average fair values (before netting): Equity and commodity contracts 1,325 920 877 624
Exchange rate contracts: Interest rate contracts: Non-trading derivatives The Group establishes non-trading derivatives positions externally with third parties and also internally. It should be noted that the following tables include the components of the internal hedging programme that transfers risks to the trading portfolios in the Group or to external third party participants in the derivatives markets.
The following table summarises the fair values and book values of derivatives held for non-trading activities and includes internal trades: Fair value Book value Fair value Book value
Positive Negative Positive Negative Positive Negative Positive Negative £m £m £m £m £m £m £m £m
Exchange rate contracts: Interest rate contracts: The following table analyses, by maturity and contract type, the notional principal amounts of the Group’s non-trading derivatives (third party and internal): Within One to Two to Over 2004 Within One to Two to Over 2003 one year two years five years five years Total one year two years five years five years Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Exchange rate contracts: Interest rate contracts: RBS Annual Report 136-199 7/3/05 11:16 am Page 174
After After After 3 months 6 months 1 year Non-interest Banking Trading
Internal funding of trading book (42,516) (313) (1,088) (9) — — (43,926) 43,926 ––
The Group’s objectives and policies in managing the risks that arise in connection with the use of financial instruments are set out in the Operating and financial review under ‘Market risk’, ‘Currency risk’ and ‘Equity risk’.
Interest rate sensitivity gap The tables below summarise the Group’s interest rate sensitivity gap for its non-trading book at 31 December 2004 and 31 December 2003. The tables show the contractual repricing for each category of asset, liability and for off-balance sheet items. A liability (or negative) gap position exists when liabilities reprice more quickly or in greater proportion than assets during a given period and tends to benefit net interest income in a declining interest rate environment. An asset (or positive) gap position exists when assets reprice more quickly or in greater proportion than liabilities during a given period and tends to benefit net interest income in a rising interest rate environment. Contractual repricing terms do not reflect the potential impact of early repayment or withdrawal. Positions may not be reflective of those in subsequent periods. Major changes in positions can be made promptly as market outlooks change. In addition, significant variations in interest rate sensitivity may exist within the re-pricing periods presented and among the currencies in which the Group has interest rate positions.
Assets Loans and advances to banks 11,149 3,780 5,188 122 32 1,087 21,358 30,533 51,891 Loans and advances to customers 155,920 11,832 7,763 27,992 18,463 1,486 223,456 29,075 252,531 Treasury bills and debt securities 18,906 2,594 4,835 5,525 11,175 2,316 45,351 39,444 84,795
Internal funding of trading business (22,447) (1,060) (1,239) (379) (197) — (25,322) 25,322 —
The Group’s structural currency exposures were as follows: Foreign 2004 Foreign 2003 Net currency Structural Net currency Structural investments borrowings foreign investments borrowings foreign in overseas hedging net currency in overseas hedging net currency operations investments exposures operations investments exposures
The following table analyses the VaR for the Group’s trading portfolios by type of market risk exposure at the period end and as an average for the period and the maximum and minimum for the period: 31 December Year ended 31 December 2004 31 December Year ended 31 December 2003 2004 Maximum Minimum Average 2003 Maximum Minimum Average £m £m £m £m £m £m £m £m
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts amount value amount value Trading business Note £m £m £m £m
Liabilities Deposits by banks and customer accounts (3) 80,815 80,815 52,300 52,300
Carrying Fair Carrying Fair amount value amount value Banking business Note £m £m £m £m
(5) Fair values of marketable securities are based on quoted market prices. Where these are unavailable, fair value is estimated using other valuation techniques.
(7) The fair value of loan capital, non-equity minority interests and preference shares is based on quoted market prices where available. For unquoted loan capital, fair value has been estimated using other valuation techniques.
Fair values of financial instruments The following tables set out the fair values of the Group’s financial instruments. Fair value is the amount at which an instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. 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 judgements 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; nor are there plans to settle liabilities prior to contractual maturity. As there is a wide range of valuation techniques, it may be inappropriate to compare the Group’s fair value information to independent markets or other financial institutions’ fair value.
Hedges Derivatives and debt securities held for hedging purposes are accounted for in accordance with the treatment of the hedged transaction. As a result, any gains or losses on the hedging instrument arising from changes in fair values are not recognised in the profit and loss account immediately but are accounted for in the same manner as the hedged item.
Losses expected to be recognised in the year to 31 December 2006 or later (year to 31 December 2005 or later) (1,278) (365) (1,834) (29)
– less than one year 109,653 85,424 – one year and over 69,577 51,827
Contingent liabilities Acceptances – in accepting a bill of exchange drawn on it by a customer a bank undertakes to pay the holder of the bill at maturity. Most acceptances are presented for payment and reimbursement by the customer is usually immediate. In the UK, bills accepted by certain banks designated by the Bank of England are eligible for rediscount at the Bank of England.
Commitments Documentary credits and other short-term trade related transactions – documentary letters are commercial letters of credit providing for payment by the Group to a named beneficiary against presentation of specified documents.
Additional contingent liabilities arise in the normal course of the Group’s business. It is not anticipated that any material loss will arise from these transactions.
Litigation Since December 2003, members of the Group have been joined as defendants in a number of legal actions in the United States following the collapse of Enron. Collectively, the claims are, to a substantial degree, unquantified and in each case they are made against large numbers of defendants. The Group intends to defend these claims vigorously. The US Courts dealing with the main Enron actions have ordered that the Group join the non-binding, multi-party mediation which commenced in late 2003. Based on current knowledge including applicable defences and given the unquantified nature of these claims, the directors are unable at this stage to predict with certainty the eventual loss in these matters. In addition, pursuant to requests received from the US Securities and Exchange Commission and the US Department of Justice, the Group has been providing copies of Enron-related materials to these authorities and the Group continues to cooperate fully with them.
Although not required, as it is not a material acquisition for the Group, separate purchase accounting disclosures for Charter One Financial, Inc. are set out below. The provisional fair values of the assets and liabilities acquired and the consideration paid are shown in the table below: Book value of net assets Fair value Fair value to acquired adjustments the Group At date of acquisition £m £m £m
Deferred tax provisions (534) 46 (488) Post-retirement pension liabilities (17) — (17) Dated loan capital (222) (22) (244) Net assets acquired 1,320* (351) 969 Goodwill 4,654 Total consideration 5,623
Fair value adjustments reflect the restatement of balances to their estimated fair values at the date of acquisition, and the related tax effect.
Net interest income 220 Non-interest income 129 Total income 349 Operating expenses (177) Contribution before provisions 172 Provisions (16) Contribution before goodwill amortisation 156 Goodwill amortisation (76) Contribution 80
The contribution above is after charging goodwill amortisation and includes the post-acquisition effect of fair value adjustments.
Accruals and deferred income (27) (38) (65) Deferred tax provisions (6) (20) (26) Post-retirement benefit liabilities (15) — (15)
Dated loan capital (81) (7) (88) Undated loan capital (36) (29) (65) Minority interest-equity (4) — (4) Net assets acquired 1,384 (143) 1,241 Goodwill 1,245 Total consideration 2,486
Satisfied by: Payment of cash 2,468 Loan notes 4 Fees and expenses relating to the acquisitions 14
N ot es o n th e ac co un ts Notes on the accounts continued 43 Reconciliation of operating profit to net cash inflow from operating activities 2004 2003* 2002*
Depreciation and amortisation of tangible and intangible fixed assets 2,022 1,682 1,626 Increase in value of long-term assurance business (94) (73) (61) Net cash inflow from trading activities 9,349 9,100 7,542 (Increase)/decrease in items in the course of collection (128) 240 547 (Increase)/decrease in treasury and other eligible bills (1,264) 6,626 (1,323) (Increase)/decrease in loans and advances to banks (3,370) 2,797 (2,756) Increase in loans and advances to customers (69,543) (26,140) (32,670) (Increase)/decrease in securities (10,367) (9,871) 1,799 Increase in other assets (3,503) (977) (1,181) Decrease in items in the course of transmission (156) (300) (851) Increase in deposits by banks 24,310 11,188 14,512 Increase in customer accounts 29,107 15,669 19,383 Increase in debt securities in issue 17,163 7,078 3,269 Increase/(decrease) in other liabilities 4,817 (168) 3,817 Increase in settlement balances and short positions 8,796 3,202 482 Effect of other accruals/deferrals and other non-cash movements 1,096 1,264 1,167 Net cash inflow from operating activities 6,307 19,708 13,737 * restated (see page 139)
Net assets disposed of 2 66 13 Goodwill written back — 40 —
Profit on disposal 4 63 13 Net inflow of cash in respect of disposals (net of expenses) 22 179 29 46 Analysis of changes in financing during the year Share capital
Net cash inflow/(outflow) from financing 4,203 (180) (515) 3,906 3,481 1,955 Acquisition of subsidiaries — — — 397 — — Other non-cash movements 870 965 802 (460) — —
Profit before goodwill amortisation and integration costs 8,301 10,980 19,281 (10,719) (1,494) 7,068 Goodwill amortisation — — — (763) — (763) Integration costs — — — (229) — (229) Profit on ordinary activities before tax 8,301 10,980 19,281 (11,711) (1,494) 6,076
In the tables below, the analyses of net assets are included in compliance with Statement of Standard Accounting Practice 25 ‘Segmental Reporting’. The fungible nature of liabilities within the banking industry results in allocations of liabilities which, in some cases, are necessarily subjective. The directors believe that it is more meaningful to analyse total assets and the result of this analysis is therefore also included in the tables.
CBFM Banking Direct Management Insurance Bank Citizens Centre Total £m £m £m £m £m £m £m £m £m
Cost: Currency translation and other adjustments –– –– (31) 1 –– 1 (529) –– (558) Arising on acquisitions during the year 9 98 592 — 19 478 4,703 –– 5,899
Amortisation: At 1 January 2004 14 –– 6 1 69 –– 331 2,206 2,627 Currency translation and other adjustments –– –– (1) –– –– 1 (35) –– (35)
General insurance premium income (net of reinsurance) 4,794 –– 150 –– 4,944
Profit on ordinary activities before tax 4,776 1,389 625 127 6,917
General insurance premium income (net of reinsurance) 2,981 — 142 — 3,123
General insurance premium income (net of reinsurance) 1,874 — 79 — 1,953
Profit/(loss) on ordinary activities before tax 3,928 618 340 (34) 4,852 *restated (see page 139)
Non-executive directors – emoluments 874 759 Chairman and executive directors – emoluments 8,421 7,945 Chairman and executive directors – contributions and allowances in respect of defined contribution pension schemes 178 164
The executive directors may also participate in the company’s executive share option, sharesave and option 2000 schemes and details of their interests in the company’s shares arising from their participation are contained on page 131. Details of the remuneration received by each director during the year and each directors’ pension arrangements are given on pages 130 to 133.
Subsidiary undertakings In accordance with Financial Reporting Standard 8 ‘Related Party Disclosures’ (“FRS 8”), transactions or balances between Group entities that have been eliminated on consolidation are not reported.
Pension Fund The Group recharges The Royal Bank of Scotland Group Pension Fund with the cost of administration services incurred by it. The amounts involved are not material to the Group.
The consolidated financial statements of the Group are prepared in accordance with UK generally accepted accounting principles (“GAAP”) that differ in certain material respects from US GAAP. The significant differences are summarised as follows: (a) Acquisition accounting Under UK GAAP, all integration costs relating to acquisitions are expensed as post-acquisition expenses. Under US GAAP, certain restructuring and exit costs incurred in the acquired business are treated as liabilities assumed on acquisition and taken into account in the calculation of goodwill.
Depreciation charged and gains or losses on disposal under UK GAAP are based on the revalued amount of freehold and long leasehold properties; no depreciation is charged on investment properties which are revalued annually. Under US GAAP, the depreciation charge and gains or losses on disposal are based on the historical cost for all properties.
(d) Leasehold property provisions Under UK GAAP, provisions are raised on leasehold properties when there is a commitment to vacate the property. US GAAP requires provisions to be recognised at the time the property is vacated.
(f) Loan origination Under UK GAAP, certain loan fees are recognised when received. Under US GAAP, applicable non-refundable loan fees and certain direct costs are deferred and recognised over the period of the related loan or facility.
(g) Pension costs Under UK GAAP, pension assets are measured at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit method and discounted at the current rate of return on a high quality corporate bond of equivalent term and currency. Any surplus or deficit of 52 Related party transactions 53 Significant differences between UK and US generally accepted accounting principles 51 Transactions with directors, officers and others
N ot es o n th e ac co un ts Notes on the accounts continued 53 Significant differences between UK and US generally accepted accounting principles (continued)
(h) Long-term assurance business The shareholders’ interest in the long-term assurance fund is valued as the discounted value of the cash flows expected to be generated from in-force policies together with net assets in excess of the statutory liabilities. Under US GAAP, for traditional business, premiums are recognised as revenue when due from the policyholders. Costs of claims are recognised when insured events occur. A liability for future policy benefits is established based upon the present value of future benefits less the present value of future net premiums. Acquisition costs for traditional business contracts are charged to the profit and loss account in proportion to premium revenue recognised. For unit-linked business, premiums and front-end load-type charges receivable from customers and acquisition costs relating to the acquisition of new contracts are capitalised and depreciated in proportion to the present value of estimated gross profits. Costs of claims are recognised when insured events occur.
(j) Leasing In accordance with UK GAAP, the Group’s accounting policy for finance lease income receivable is to allocate total gross earnings to accounting periods so as to give a constant periodic rate of return on the net cash investment, and certain operating lease assets are depreciated on a reverse-annuity basis. Under US GAAP, finance lease income is recognised so as to give a level rate of return on the investment in the lease but without taking into account the associated tax flows, and all operating lease assets are depreciated on a straight-line basis.
(k) Securities Under UK GAAP, the Group’s debt securities and equity shares are classified as being held as investment securities or for dealing purposes. Investment securities are stated at cost less provision for any permanent diminution in value. Premiums and discounts on dated debt securities are amortised to interest income over the period to maturity. Securities held for dealing purposes are carried at fair value with changes in fair value recognised in the profit and loss account. Under US GAAP, securities held by the Group’s private equity business are considered to be held by investment companies and are carried at fair value, with changes in fair value being reflected in net income. The Group’s other investment debt securities and marketable investment equity shares are classified as available-for-sale securities with unrealised gains and losses reported in a separate component of equity, except when the unrealised loss is considered other than temporary in which case the loss is included in net income. Under US GAAP, the Group recognises an other than temporary impairment on an available-for-sale equity share when its carrying value has exceeded its market value for more than twelve months.
SFAS 133 also requires derivatives embedded in other financial instruments to be accounted for on a stand-alone basis if they have economic characteristics and risks that differ from those of the host instrument.
(m) Software development costs Under UK GAAP, most software development costs are written off as incurred. Under US GAAP, certain costs relating to software developed for own use that are incurred after 1 January 1999 are capitalised and depreciated over the estimated useful life of the software.
(n) Share-based compensation Under UK GAAP, no compensation expense is recognised for the Group’s executive share option schemes, under which options are granted at the higher of nominal value and market value on the date of grant and for the Group’s Sharesave schemes, under which employees are granted options at a 20% discount to market value at date of grant. Under US GAAP, the compensation expense based on the options’ intrinsic value is charged to the profit and loss account over the period to their average vesting date.
(o) Consolidation UK GAAP requires consolidation of entities controlled by an enterprise where control means the enterprise’s ability to direct the financial and operating policies of an entity with a view to gaining economic benefits. US GAAP requires consolidation by the primary beneficiary of a variable interest entity (“VIE”). An enterprise is the primary beneficiary of a VIE if it will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both.
(p) Acceptances Acceptances outstanding and the matching customers’ liabilities are not reflected in the consolidated balance sheet, but are disclosed as memorandum items. Under US GAAP, acceptances outstanding and the matching customers’ liabilities are reflected in the consolidated balance sheet.
(r) Deferred taxation Accounting for deferred tax under UK GAAP is consistent with US GAAP except that deferred tax is not recognised under UK GAAP on certain timing differences resulting from the roll-over of gains on disposal of properties, but is provided under US GAAP on such differences.
Profit attributable to ordinary shareholders – UK GAAP 4,256 2,254 2,034 Adjustments in respect of: Acquisition accounting 66 33 — Amortisation of intangible assets 780 721 681 Property revaluation and depreciation (69) (41) (18) Leasehold property provisions (19) 83 —
Derivatives and hedging (437) 232 770 Software development costs (261) (300) 283 Share-based payment (26) (32) —
Shareholders’ funds – UK GAAP 31,865 26,098 Adjustments in respect of: Acquisition accounting 517 451 Intangible assets 3,002 2,222 Property revaluation and depreciation (262) (249) Leasehold property provisions 64 83 Proposed dividend 1,308 1,059 Loan origination (373) (288) Pension costs 190 2,828 Long-term assurance business (205) (178) Extinguishment of liabilities (178) (84)
Tax effect on cumulative UK/US GAAP adjustments (733) (1,128) Tax effect on other comprehensive income 684 155 Deferred tax (59) (47)
Prior periods have been restated following the implementation of FRS 17 and the reclassification of perpetual regulatory securities.
Total assets under US GAAP, adjusted to reflect the consolidation of variable interest entities, inclusion of acceptances, provisions for contingent liabilities and commitments, the fair value of financial guarantees and the grossing-up of certain netting arrangements under UK GAAP, together with the effect of adjustments made to net income and shareholders’ funds, were £631 billion (2003 – £488 billion).
No. of Per share No. of Per share No. of Per share Income* shares amount Income* shares amount Income* shares amount £m million pence £m million pence £m million pence
The assets of the plan are held under separate trusts and, in the long-term, the funding policy is to maintain assets sufficient to cover the benefits in respect of service to date, with due allowance for future earnings increases. The plan assets consist mainly of fixed-income securities and listed securities. The investment policy followed for the plan seeks to deploy the plan assets primarily in UK and overseas equity shares and UK government securities.
Outstanding options to purchase shares are excluded from the computation of diluted EPS where the exercise prices of the options are greater than the average market price of the ordinary shares during the relevant period. At 31 December 2004, there were 8.7 million such options outstanding (2003 –
Net actuarial loss/(gain) 1,568 902 (217) Benefits and expenses paid (527) (511) (473) Projected benefit obligation at year end 16,192 13,963 12,526
Expected return on plan assets (840) (757) (901) Amortisation of prior service cost 1 1 1 Amortisation of loss 263 287 138 Amortisation of net transition asset (8) (8) (8) Net periodic pension cost 604 569 248