Derivatives and hedging (454) (119) 73 Liabilities and equity 177 74 — Implementation timing difference – intangibles (62) (66) (95)
Net income available for ordinary shareholders – US GAAP 5,440 4,475 3,909
Pensions Details of the Group’s pension schemes are provided in Note 3. The provisions of SFAS 87 ‘Employers’ Accounting for Pensions’ and SFAS 158 have been applied to the main scheme and defined benefit plans of some of the subsidiaries, which together cover most of the Group’s employees; the effect of the other schemes on the Group’s US GAAP reporting is considered to be inconsequential. The required disclosures of SFAS 158 for these pension plans are set out below.
Projected benefit obligation at beginning of year 19,293 1,997 21,290 16,192 13,963 Foreign exchange movements — (81) (81) — —
Projected benefit obligation at end of year 19,174 1,945 21,119 19,293 16,192
Change in plan assets: Fair value of plan assets at beginning of year 15,934 1,434 17,368 13,598 11,822 Foreign exchange movements — (59) (59) — —
Market value of plan assets at end of year 17,374 1,585 18,959 15,934 13,598
Change in accumulated other comprehensive income: Foreign exchange movements — (5) (5) Unrecognised losses 4,436 — 4,436 Other comprehensive income (43) (74) (117) Accumulated other comprehensive income 4,393 (79) 4,314
Components of net periodic pension cost: Expected return on plan assets (1,028) (96) (1,124) (932) (840) Amortisation of prior service cost 5 7 12 4 1
Weighted average assumptions used at 31 December: % per annum % per annum % per annum % per annum % per annum
Weighted average allocations of market value of plan assets at 31 December: % % % % %
Amounts the Group expects to contribute to these pension plans in 2007 408 40 448
The estimated net actuarial loss and prior service cost for the schemes that will be amortised from the accumulated other comprehensive income into net periodic pension cost in 2007 are £1 million and £209 million respectively.
The additional minimum liability included in accumulated other comprehensive income at 31 December 2005 was £4,457 million in respect of the main scheme. Prior to the implementation of FAS 158 at 31 December 2006, this was £2,593 million.
48 Restatement of cash flow statements The Group cash flow statements for the years ended 31 December 2005 and 2004 and the company cash flow statement for the year ended 31 December 2005 have been restated to correct an inadvertent error in the calculation of the effects of foreign exchange rate changes on cash and cash equivalents. No other caption is affected and the amount of cash and cash equivalents is unchanged.
The tables below show the effect of the restatements: (a) Cash flow statements 2005 2004
Company Elimination of foreign exchange differences and other non-cash items (16) (134) Net cash inflow from trading activities 2,499 2,381 Net cash flows from operating activities before tax 4,549 4,431 Net cash flows from operating activities 4,531 4,413 Effects of foreign exchange rate changes on cash and cash equivalents (76) 42
(b) Note 37 – Net cash inflow from operating activities 2005 2004
Financial summary The Group’s accounts are prepared in accordance with IFRS, which differ in certain significant respects from US GAAP. For a discussion of such differences and a reconciliation between IFRS and US GAAP, see Note 47 on the accounts.
The dollar financial information included below has been converted from sterling at a rate of £1.00 to US$1.9586, being the Noon Buying Rate on 29 December 2006 (the last business day in 2006).
Notes: (1) Includes gain on sale of strategic investment of £333 million in 2005.
2006 2006 2005 2004 Summary consolidated balance sheet – IFRS $m £m £m £m
Debt securities and equity shares 275,683 140,755 130,266 98,631 Derivatives and settlement balances 243,074 124,106 101,668 23,482
Earnings per ordinary share – pence 194.7 169.4 157.4 Diluted earnings per ordinary share – pence (1) 193.2 168.3 155.9 Adjusted earnings per ordinary share – pence 200.0 175.9 170.2 Dividends per ordinary share – pence 77.3 60.6 52.5
– including interest on deposits 1.64 1.69 1.94 – excluding interest on deposits 6.87 6.50 9.70
(3) Return on average total assets represents profit attributable to ordinary shareholders as a percentage of average total assets.
(5) Adjusted return on average ordinary shareholders’ equity represents profit attributable to ordinary shareholders before integration costs, amortisation of purchased intangibles and net gain on sale of strategic investments and subsidiaries expressed as a percentage of average ordinary shareholders’ equity.
(6) For this purpose, earnings consist of income before tax and minority interests, plus fixed charges less the unremitted income of associated undertakings (share of profits less dividends received). Fixed charges consist of total interest expense, including or excluding interest on deposits and debt securities in issue, as appropriate, and the proportion of rental expense deemed representative of the interest factor (one third of total rental expenses).
After 1 Within but within After 2006 £m £m £m £m £m £m
Service industries and business activities 26,603 8,446 8,838 43,887 40,687 30,867
Finance leases and instalment credit 3,175 4,410 6,633 14,218 13,909 13,044
Loans and advances to customers – gross 267,437 61,655 141,734 470,826 421,110 351,419 Loan impairment provisions (3,933) (3,884) (4,168) Loans and advances to customers – net 466,893 417,226 347,251
The Group monitors the geographical breakdown of these exposures based on the country of domicile of the borrower or guarantor of ultimate risk.
Republic of Ireland 8,530 6,008 * Norway 7,768 * * Japan 7,725 * * Italy 7,506 * *
Loan impairment provisions For a discussion of the factors considered in determining the amount of the provisions, see ‘Loan impairment’ on page 86 and ‘Critical accounting polices – Loan impairment provisions’ on page 136.
The following table shows the elements of loan impairment provisions. IFRS
As a % of average loans and advances to customers during the year: Total customer provisions charged to income statement 0.42% 0.42% 0.47%
Finance leases and instalment credit 103 3.0 88 3.3 122 3.7 Accrued interest — 0.3 — 0.3
Latent book provisions 593 543 Specific provisions 3,607 General provision 561
Service industries and business activities 212 176 163 Agriculture, forestry and fishing 5 4 9
Loans accounted for on a non-accrual basis (2): Accruing loans which are contractually overdue 90 days or more as to principal or interest (3): Loans not included above which are classified as ‘troubled debt restructurings’ by the SEC: Foreign — — 10
Risk elements in lending as a % of gross lending to customers excluding reverse repos 1.55% 1.60% 1.83%
(3) Loans where an impairment event has taken place but no impairment recognised. This category is used for fully collateralised non-revolving credit facilities.
UK Domestic: Demand deposits – interest-free 39,149 28,833 22,307 Demand deposits – interest-bearing 118,315 91,564 72,938 Time deposits – savings 31,656 27,091 21,012 Time deposits – other 80,496 73,097 76,995 Overseas residents: Demand deposits – interest-free 573 396 387 Demand deposits – interest-bearing 37,729 26,663 16,965 Time deposits – savings 1,122 1,108 1,209 Time deposits – other 51,568 53,997 52,629 Total UK offices 360,608 302,749 264,442 Overseas Demand deposits – interest-free 12,173 13,248 10,371 Demand deposits – interest-bearing 27,441 17,886 12,975 Time deposits – savings 19,049 21,691 21,153 Time deposits – other 97,094 97,700 74,257 Total overseas offices (see below) 155,757 150,525 118,756
Commercial paper Outstanding at year end 12,675 14,110 8,391 Maximum outstanding at any month end during the year 14,402 16,853 8,391 Approximate average amount during the year 13,225 15,329 7,450 Approximate weighted average interest rate during the year 4.9% 3.7% 1.9% Approximate weighted average interest rate at year end 5.0% 4.2% 2.6%
Over 3 months Over 6 months Within but within but within Over 2006 3 months 6 months 12 months 12 months Total £m £m £m £m £m
Other financial data based upon US GAAP 2006 2005 2004 2003 2002
Notes: (1) The dollar information included above has been converted from sterling at a rate of US$1.9586, the Noon Buying Rate on 29 December 2006.
(2) All convertible preference shares have a dilutive effect in 2006 and 2005 and as such have been included in the computation of diluted earnings per share. In prior years their effect was anti-dilutive.
(5) For this purpose, earnings consist of income before tax and minority interests, plus fixed charges less the unremitted income of associated undertakings (share of profits less dividends received). Fixed charges consist of total interest expense, including or excluding interest on deposits and debt securities in issue, as appropriate, and the proportion of rental expense deemed representative of the interest factor (one third of total rental expenses).
General insurance claims (net) 3,480 2,195 1,350 Profit before provisions 8,428 7,570 6,197 Provisions for bad and doubtful debts 1,428 1,461 1,286 Amounts written off fixed asset investments 83 33 59 Profit on ordinary activities before tax 6,917 6,076 4,852 Tax on profit on ordinary activities 2,155 1,888 1,582 Profit on ordinary activities after tax 4,762 4,188 3,270 Minority interests (including non-equity) 250 210 133 Preference dividends – non-equity 256 261 305 4,256 3,717 2,832 Additional Value Shares dividend – non-equity — 1,463 798 Profit attributable to ordinary shareholders 4,256 2,254 2,034
Note: (1) Includes integration expenditure of £269 million for the year ended 31 December 2004 (2003 – £229 million; 2002 – £957 million).
Loans and advances to banks (net of provisions) 58,260 51,891 44,296 Loans and advances to customers (net of provisions) 345,469 252,531 223,324 Debt securities and equity shares 94,171 82,249 68,928 Intangible fixed assets 17,576 13,131 12,697 Other assets 67,991 54,626 61,793
Called up share capital 822 769 754 Share premium account 12,964 8,175 7,608
Subordinated liabilities 20,366 16,998 13,965 Total capital resources 56,060 45,809 40,875 Deposits by banks 99,081 67,323 54,720
Earnings per ordinary share – pence 138.0 76.9 70.6 Diluted earnings per ordinary share – pence (1) 136.9 76.3 69.6 Adjusted earnings per ordinary share – pence 172.5 157.2 146.3 Dividends per ordinary share – pence 58.0 50.3 43.7 Dividend payout ratio 43.2% 66.1% 62.3% Share price per ordinary share at period end – £ 17.52 16.46 14.88 Market capitalisation at period end – £bn 55.6 48.8 43.2 Net asset value per ordinary share – £ 8.62 7.82 7.43 Return on average total assets (2) 0.82% 0.51% 0.52% Return on average equity shareholders’ funds (3) 16.0% 9.8% 8.8% Adjusted return on average equity shareholders’ funds (4) 20.1% 20.1% 18.3% Average shareholders’ equity as a percentage of average total assets 5.7% 5.9% 6.8% Risk asset ratio – Tier 1 7.0% 7.4% 7.3% Risk asset ratio – Total 11.7% 11.8% 11.7% Ratio of earnings to combined fixed charges and preference share dividends (5)
(2) Return on average total assets represents profit attributable to ordinary shareholders as a percentage of average total assets.
Service industries and business activities 30,850 29,290 26,022 Agriculture, forestry and fishing 2,480 2,562 2,463
Cross border exposures The table below sets out the Group’s cross border outstandings in excess of 0.75% of Group total assets (including acceptances), which totalled £583.8 billion at 31 December 2004 (2003 – £455.0 billion). None of these countries has experienced repayment difficulties that have required refinancing of outstanding debt.
Customer provision at end of year as % of loans and advances to customers at end of year: Average loans and advances to customers (gross) 298,150 245,798 211,206
% of loans % of loans % of loans Closing to total Closing to total Closing to total provision loans provision loans provision loans £m % £m % £m %
Domestic Central and local government — 0.5 — 0.5 — 0.6
(3) On 27 February 2007, the Noon Buying Rate was £1.00 = US$1.9661.
Special purpose entities (“SPEs”) SPEs are vehicles set up for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms – trusts, partnerships and companies – and fulfil many different functions. They constitute a key element of securitisation transactions in which an SPE acquires financial assets funded by the issue of securities. In the normal course of business, the Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to obtain funding. It has established a number of SPEs to act as commercial paper conduits for customers. SPEs are also utilised in its fund management activities to structure investment funds to which the Group provides investment management services.
Residential mortgage and credit card securitisations – in the UK and Ireland, the Group has securitised portfolios of residential mortgages and credit card receivables totalling £18,589 million as at 31 December 2006. These assets have been transferred to SPEs funded by the issue of notes to thirdparty investors. These SPEs are consolidated under IFRS and US GAAP and the securitised assets remain on the Group’s balance sheet.
Further disclosures about the Group’s securitisations are given in Note 12 on the accounts.
Contingent liabilities and commitments The table below summarises the Group’s contingent liabilities and commitments by remaining maturity.
Guarantees and assets pledged as collateral security 5,897 1,655 2,230 3,231 13,013
Undrawn formal standby facilities, credit lines and other commitments to lend 148,469 23,361 35,672 28,084 235,586
Guarantees and assets pledged as collateral security 1,584 3,916 3,760 2,993 12,253
Contractual cash obligations The table below summarises the Group’s contractual cash obligations by remaining maturity.
Economic and monetary environment The Group’s earnings are affected by the economic and monetary environment in its key markets.
The UK interest rate cycle turned in 2006, with the Monetary Policy Committee (“MPC”) lifting the Bank Rate from 4.5% to 4.75% in August, and to 5% in November. Despite market expectations that there would be more to come from the MPC in 2007, longer-term interest rates were below the policy rate at year-end, as was the case for most of 2006 (e.g. the 10-year benchmark gilt yield was 4.74%). The Bank Rate was increased in response to the threat that stronger economic activity posed to the medium-term inflation outlook, and the risk that the energy-induced increase in CPI inflation during 2006 would dislodge expectations ahead of the 2007 wage bargaining round (CPI inflation was 3% in December 2006; the government-set target is 2%).
The European Central Bank lifted the Refi Rate to 2.25% in January 2006. Prior to that, the Refi had been on hold at 2% for two and a half years. Four more quarter-point increases followed, taking the Refi to 3.25% by year-end. Markets expect this ‘normalisation’ to continue in 2007, as the improved economic environment meant that ultra-low interest rates were no longer needed to stimulate demand.
Exchange rates are an important driver of monetary conditions; they also affect earnings reported by the Group’s non-UK subsidiaries, and the value of non-sterling denominated assets and liabilities. The pound rose by 25c against the dollar over the course of the year, or 14%, in response to the unexpected (at the start of 2006) increase in UK interest rates. Sluggish growth in the US towards the end of the year, and the market’s perception that this would lead to lower interest rates in 2007, also put downward pressure on the dollar.
Supervision and regulation 1 United Kingdom 1.1 The regulatory regime applying to the UK financial services industry The Financial Services and Markets Act 2000 (“FSMA 2000”), containing an integrated legislative framework for regulating most of the UK financial services industry, came into force at the end of 2001. This and subsequent amendments established the Financial Services Authority (the “FSA”) as the single statutory regulator responsible for regulating deposit taking, insurance, mortgage and investment business in the UK.
The FSA’s statutory objectives are to maintain confidence in, and to promote public understanding of, the UK financial system; to secure an appropriate degree of consumer protection; and to reduce the scope for financial crime. In achieving these objectives, the FSA must take account of certain ‘principles of good regulation’ which include recognising the responsibilities of authorised firms’ own management, facilitating innovation and competition and acting proportionately in imposing burdens on the industry.
1.2 Authorised firms in the Group As at 31 December 2006, 33 companies in the Group, spanning a range of financial services sectors (banking, insurance and investment business), are authorised to conduct activities regulated by the FSA. These companies are referred to as 'authorised firms'.
The FSA supervises the banking business of the UK based banks in the Group, including The Royal Bank of Scotland, NatWest, Coutts & Co, Ulster Bank Limited and Tesco Personal Finance Limited.
Many of the standards relating to the capital which firms must hold to absorb losses arising from risks to its business are determined by EU legislation or are negotiated internationally. The current capital adequacy regime requires firms to maintain certain levels of capital, of certain specified types (or tiers), against particular business risks.
Firms must also meet standards relating to senior management and internal controls and systems and must comply with rules designed to reduce the scope for firms to be used for money laundering. Revised Joint Money Laundering Steering Group Guidance Notes were published in February 2006 and came into force six months later. The EU has published its draft Third Money Laundering Directive which will supersede the two previous Anti Money Laundering Directives. Implementation is required by December 2007.
2 Europe Much of the regulatory agenda in the UK and other European Member States in which the Group operates continues to be set by the European Union. Legislation comprising the EU’s Financial Services Action Plan is nearly complete and implemented, with attention now turning to the policy agenda through to 2010. The Commission wishes to pursue a different approach to policymaking: costed, evidence-based and targeted. Nonetheless, there are some major initiatives already in the pipeline; including a revised Consumer Credit Directive, a directive to establish a legal framework for the euro payments area, Solvency II (a revised EU capital framework for insurance companies), and possible legislation on mortgage credit and investment funds. The Group has been increasingly engaged with the EU and national policymakers on all these priority measures, and will aim to maintain this level of involvement.
3 United States As the ultimate parent of Citizens’ subsidiary US banks, the company is a bank holding company within the meaning of, and subject to regulation and supervision under, the US Bank Holding Company Act of 1956, as amended (the ”BHCA”), by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Under current Federal Reserve Board policy, the company is expected to act as a source of financial strength to its US bank subsidiaries. Bank holding companies that meet certain eligibility criteria may elect to become ‘financial holding companies’ under the BHCA. The company elected to become a financial holding company effective in February 2004. As a financial holding company, the company may engage in any activity, and may acquire and retain the shares of any company engaged in any activity, that the Federal Reserve Board has determined to be ‘financial in nature’ or ‘incidental’ or ‘complementary’ thereto. Activities that meet these criteria include unrestricted securities underwriting and dealing, insurance underwriting, and various venture capital or investment activities. Financial holding companies must give the Federal Reserve Board after-the-fact notice of any such new activities.
4 Other jurisdictions Through its Corporate Markets and Wealth Management divisions, the Group conducts business in various other jurisdictions and is regulated by many financial and other regulatory bodies around the world. These jurisdictions include among others China, Hong Kong, Japan, Singapore and Australia in the Asia Pacific region; Abu Dhabi, Dubai and Bahrain where the Group has branches and representative offices; and Switzerland and the Channel Islands.
The Group has submitted a request to the FSA (generally referred to as a ‘waiver’) to adopt the Advanced Internal Ratings-Based approach (“AIRB”) for the majority of the Group’s EU credit risk exposures from the earliest possible date, January 2008. In order to satisfy the requirements for AIRB, which is the most sophisticated option available to firms, banks are required to have risk grading, scoring and validation approaches that calculate the Probability of Default, Exposure at Default and Loss Given Default for each facility. Outputs from these models, along with other factors, such as maturity, are then used to calculate RWAs according to regulatory formulas.
Shareholder information 252 Financial calendar 252 Shareholder enquiries 252 Capital gains tax 253 Analyses of ordinary shareholders 254 Trading market 256 Dividend history 257 Taxation for US holders 259 Exchange controls 259 Memorandum and articles of association 259 Documents on display 260 Important addresses 260 Principal offices
Financial calendar Annual General Meeting 25 April 2007 at 2.00 pm
Dividends Payment dates: Ordinary shares (2006 Final) 8 June 2007 Ordinary shares (2007 Interim) October 2007 Cumulative preference shares 31 May and 31 December 2007 Non-cumulative dollar preference shares 30 March, 29 June, 28 September and 31 December 2007
Ex-dividend dates: Ordinary shares (2006 Final) 7 March 2007 Cumulative preference shares 2 May 2007
Analyses of ordinary shareholders at 31 December 2006 Number of shares %
In March 2006, the company redeemed the 7 million Series D non-cumulative preference shares of US$0.01 each and the 12 million Series I non-cumulative preference shares of US$0.01 each.
In January 2007, the company redeemed the 8 million Series E non-cumulative preference shares of US$0.01 each, the 10 million Series G non-cumulative preference shares of US$0.01 each and the 16 million Series K non-cumulative preference shares of US$0.01 each.
Total dividends on equity shares 177.4 90.6 72.5 58.0 50.3 43.7
For further information, see Notes 6 and 7 on the accounts.
Taxation for US Holders The following discussion summarises certain US federal and UK tax consequences of the acquisition, ownership and disposition of non-cumulative dollar preference shares, ADSs or PROs by a beneficial owner that is a citizen or resident of the United States or that otherwise will be subject to US federal income tax on a net income basis in respect of the noncumulative dollar preference shares, ADSs or PROs (a “US Holder”). This summary assumes that a US Holder is holding non-cumulative dollar preference shares, ADSs or PROs, as applicable, as capital assets. This summary does not address the tax consequences to a US Holder (i) that is resident (or, in the case of an individual, ordinarily resident) in the UK for UK tax purposes or (ii) generally, that is a corporation which alone or together with one or more associated companies, controls, directly or indirectly, 10% or more of the voting stock of the company.
The statements and practices set forth below regarding US and UK tax laws, including the US/UK double taxation convention relating to income and capital gains which entered into force on 31 March 2003 (the “Treaty”), and the US/UK double taxation convention relating to estate and gift taxes (the “Estate Tax Treaty”), are based on those laws and practices as in force and as applied in practice on the date of this Report. This summary is not exhaustive of all possible tax considerations and holders are advised to satisfy themselves as to the overall tax consequences, including specifically the consequences under US federal, state, local and other laws, and possible changes in taxation law, of the acquisition, ownership and disposition of non-cumulative dollar preference shares, ADSs or PROs by consulting their own tax advisers.
For the purposes of the Treaty, the Estate Tax Treaty and the US Internal Revenue Code of 1986, as amended (the “Code”), US Holders of ADSs will be treated as owners of the noncumulative dollar preference shares underlying such ADSs.
Dividends paid by the company will constitute foreign source dividend income for US federal income tax purposes to the extent paid out of the current or accumulated earnings and profits of the company, as determined for US federal income tax purposes. Payments will not be eligible for the dividendsreceived deduction allowed to corporate US Holders.
Estate and gift tax Subject to the discussion of the Estate Tax Treaty in the next paragraph, non-cumulative dollar preference shares or ADSs beneficially owned by an individual may be subject to UK inheritance tax (subject to exemptions and reliefs) on the death of the individual or in certain circumstances, if the non-cumulative dollar preference shares or ADSs are the subject of a gift (including a transfer at less than market value) by such individual. (Inheritance tax is not generally chargeable on gifts to individuals made more than seven years before the death of the donor). Non-cumulative dollar preference shares or ADSs held by the trustees of a settlement will also be subject to UK inheritance tax. Special rules apply to such settlements.
A non-cumulative dollar preference share or ADS beneficially owned by an individual, whose domicile is determined to be the United States for purposes of the Estate Tax Treaty and who is not a national of the UK, will not be subject to UK inheritance tax on the individual’s death or on a lifetime transfer of the non-cumulative dollar preference share or ADS, except in certain cases where the non-cumulative dollar preference share or ADS (i) is comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the UK); (ii) is part of the business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where the non-cumulative dollar preference share or ADS is subject to both UK inheritance tax and US federal estate or gift tax.
Any paying agent or other person by or through whom interest is paid to, or by whom interest is received on behalf of, an individual, may be required to provide information in relation to the payment and the individual concerned to HM Revenue & Customs. HM Revenue & Customs may communicate this information to the tax authorities of other jurisdictions.
Memorandum and articles of association The company’s Memorandum of Association and Articles of Association as in effect at the date of this annual report are registered with the Registrar of Companies of Scotland. The Articles of Association were last amended on 29 April 2004 and have been filed with the SEC.
RBS Insurance Direct Line House 3 Edridge Road Croydon Surrey CR9 1AG Churchill Court Westmoreland Road Bromley BR1 1DP
The Royal Bank of Scotland International Limited Royal Bank House 71 Bath Street St Helier Jersey Channel Islands JE4 8PJ
NatWest Offshore 23/25 Broad Street St Helier Jersey Channel Islands JE4 8QJ