Our three principal areas of operation are the UK, US and Europe. In each of these the scale of our businesses has significantly grown over the past five years through strong organic growth and acquisitions. We are also expanding our activities in the increasingly important Asia Pacific region.
All integrations of recently acquired businesses are on track. Several major stages in the IT conversion of Churchill have been completed successfully. Implementation of the plan to integrate First Active is well under way and the initial stages in the conversion of Charter One have already been implemented. In each case, we are confident that we shall be able to deliver the expected transaction benefits.
�No.1 in UK for Clearing House Automated Payment System (CHAPS) transactions
RBS is the fastest growing corporate relationship bank in Europe. CBFM has relationships with 80% of the CAC 40, the largest companies in France. In Germany we have relationships with more than 75% of the DAX 30 companies.
��� NatWest is the number one bank for students. Of first year students in England and Wales, 42% chose to open an account with us, compared with 25% last year.
��� Our internet banking service continues to see strong growth. Active customer numbers are up 39% on 2003, and the number of customers applying to use the service rose by 41%. The average daily volume of internet payments rose by 49% in 2004.
��� Our new mortgage processing system has improved the efficiency and quality of our service. This is reflected in the numerous awards we have won for our mortgage services.
��� Since April 2004, when we enabled customers to top-up their prepay mobile phones through our ATM network, there have been a total of 1.4 million such transactions through Royal Bank of Scotland, NatWest and Tesco Personal Finance ATMs.
�� Churchill Pet Insurance Churchill gives pet owners the peace of mind that they can meet the cost of treatment for their pets, should they need it.
In 2004 we published our first Corporate Responsibility Report. While the Annual Report quantifies our financial success, the Corporate Responsibility Report provides a qualitative insight behind the figures into the policies and practices which ensure that our financial returns are sustainable in the long term.
�� £1m Donation The RBS Group donated £1 million at Christmas to the top ten charities selected by our employees.
Description of business Introduction The Royal Bank of Scotland Group plc is the holding company of one of the world’s largest banking and financial services groups, with a market capitalisation of £55.6 billion at the end of 2004. Headquartered in Edinburgh, the Group operates in the UK, US and internationally through its two principal subsidiaries, the Royal Bank and NatWest. Both the Royal Bank and NatWest are major UK clearing banks whose origins go back over 275 years. In the US, the Group’s subsidiary, Citizens is ranked the eighth largest commercial banking organisation by deposits. The Group has a large and diversified customer base and provides a wide range of products and services to personal, commercial and large corporate and institutional customers.
During 2004 Retail Direct expanded its international operations. In the US, it acquired the credit card business of People’s Bank, Lynk systems Inc., a leading merchant acquirer and entered into an agreement to issue credit cards to the customers of Kroger, a leading supermarket chain. In continental Europe, Retail Direct acquired Bibit NV, a leading internet payment specialist and agreed to provide consumer finance services through the outlets of Tchibo, a leading German retailer.
The future credit quality of the Group’s lending book is subject to uncertainties that could cause actual credit losses to differ materially from reported loan loss provisions. These uncertainties include the economic environment, notably interest rates and their effect on customer spending, the unemployment level, payment behaviour and bankruptcy trends and changes in the Group’s portfolios.
Fees and commissions receivable 6,634 5,693 5,249 Fees and commissions payable (1,954) (1,337) (965)
O pe ra tin g an d fin an ci al r ev ie w Operating and financial review continued 2004 compared with 2003 Profit Profit before tax, goodwill amortisation and integration costs increased by 15% or £1,033 million, from £7,068 million to £8,101 million. At constant exchange rates the increase was 18% or £1,278 million.
Provisions The profit and loss charge for bad debts and amounts written off fixed asset investments was £1,494 million compared with £1,345 million in 2002. The profit and loss charge is in line with the growth in loans and advances.
The increase in other administrative expenses reflected business volume growth and continued expenditure in support of Group wide projects.
2004 compared with 2003 Gross new provisions were up 6%, £92 million to £1,658 million. Recoveries of amounts previously written more than doubled to £147 million. Consequently the net charge to the profit and loss account was up £17 million, 1% to £1,511 million.
Direct expenses increased by 15% or £342 million to £2,664 million. Excluding operating lease depreciation, operating expenses were up 14%, £250 million. This was mainly due to the mix effect of faster growth in businesses with inherently higher cost:income ratios, such as Capital Markets and our overseas businesses, together with the investment in new revenue initiatives in the US.
The charge for provisions for bad and doubtful debts increased by £116 million to £389 million. The increased charge reflects the anticipated increase in delinquency rates in the NatWest portfolio following growth in unsecured lending in recent years. NatWest credit experience is now broadly consistent with the RBS portfolio which has been stable for a number of years. As reported in the first half, there has also been a higher incidence of fraud which has led to some deterioration in recovery rates.
2003 compared with 2002 Contribution increased by 24% or £173 million to £881 million.
Non-interest income was up 17% or £145 million to £986 million. There was good growth in insurance and ATM income resulting from increased volumes, particularly in TPF and in the Cards Business.
A number of initiatives aimed at improving efficiency and customer service were introduced in the year, including a sales prompt system on screens in NatWest branches and in RBS and NatWest telephony: enhanced fraud prevention; conversion of paper based branch reports to screen; image and workflow capability in service centres; the introduction of a new image enabled mortgage platform which has improved the efficiency and quality of our service and the introduction of an on-line customer query management system.
Gross insurance reserves – total (£m) 7,394 6,582 3,002 * prior periods have been restated to reflect the transfer in 2004 of certain activities to Manufacturing and to recognise a reclassification of income from net fees and commissions to insurance premium income.
Total income was up 52% or £1,689 million to £4,934 million. Excluding Churchill, total income grew by 17%, £450 million.
Non-interest income increased by £8 million, 4% to £193 million. Strong growth in lending fees and sales of treasury products was partially offset by a reduction in brokerage fees following the disposal of NCB. Excluding First Active and NCB, non-interest income was up 6%, £10 million.
Departmental and corporate costs 595 496 283 Total Central items 879 711 498 * prior periods have been restated following the implementation of FRS 17.
Equity and AVS dividends paid includes the second dividend on the AVS of £798 million.
The increase in Finance was principally due to higher level of reverse repurchase agreements which by industry were as follows: Reverse repurchase agreements £m £m £m
The Group’s retail portfolios which consist of small value, high volume credits have highly efficient largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery measures.
Specific provision as a percentage of loans and advances to customers 1.04% 1.31% 1.46% General provision as a percentage of loans and advances to customers 0.17% 0.22% 0.26% Total provisions as a percentage of loans and advances to customers 1.21% 1.53% 1.72%
Market risk The Group is exposed to market risk because of positions held in its trading portfolios and its non-trading business including the Group’s treasury operations. The Group manages the market risk in its trading and treasury portfolios through its market risk management framework, which is based on valueat -risk (“VaR”) limits, together with, but not limited to, stress testing, scenario analysis, and position and sensitivity limits. Stress testing measures the impact of abnormal changes in market rates and prices on the fair value of the Group’s trading portfolios. GEMC approves the high-level VaR and stress limits for the Group. The Group market risk function, independent from the Group’s trading businesses, is responsible for setting and monitoring the adequacy and effectiveness of the Group’s market risk management processes.
Trading The principal focus of the Group’s trading activities is client facilitation - providing products to the Group’s client base at competitive prices. The Group also undertakes: market making – quoting firm bid (buy) and offer (sell) prices with the intention of profiting from the spread between the quotes; arbitrage – entering into offsetting positions in different but closely related markets in order to profit from market imperfections; and proprietary activity – taking positions in financial instruments as principal in order to take advantage of anticipated market conditions. The main risk factors are interest rates, credit spreads and foreign exchange. Financial instruments held in the Group’s trading portfolios include, but are not limited to, debt securities, loans, deposits, securities sale and repurchase agreements and derivative financial instruments (futures, forwards, swaps and options). For a discussion of the Group’s accounting policies for, and information with respect to, its exposures to derivative financial instruments, see Accounting policies and Note 39 on the accounts.
The US dollar open structural foreign currency exposure reflects the action taken to mitigate the effect of the acquisition of Charter One on the Group’s capital ratios. The structural foreign currency exposure in euros is principally due to Ulster Bank running an open structural foreign exchange position to minimise the sensitivity of its capital ratios to possible movements in the Euro exchange rate against Sterling.
Employee learning and development The Group actively encourages professional development and lifelong learning and is committed to creating and providing experiences outside the workplace that benefit the employee, the community they work in and the Group. The Prince's Trust initiative, for example, enables employees to participate in volunteer and mentoring programmes and contributes to the Group's Community Investment and Corporate Responsibility aims.
The Group Chief Executive and other senior Group executives regularly communicate directly with employees through ‘Question Time’ style programmes, some of which are broadcast on the Group’s internal television network. This is used to convey information ranging from annual and interim financial results to employee training and development issues.
At 31 December 2004, the Group’s trade creditors represented 27 days (2003 – 27 days) of amounts invoiced by suppliers. The company does not have any trade creditors.
The roles of the Chairman and Group Chief Executive are distinct and separate, with a clear division of responsibilities. The Chairman leads the Board and ensures the effective engagement and contribution of all non-executive and executive directors. The Group Chief Executive has responsibility for all Group businesses and acts in accordance with the authority delegated from the Board. Responsibility for the development of policy and strategy and operational management is delegated to the Group Chief Executive and other executive directors.
The Audit Committee will make recommendations to the Board in relation to the remuneration and terms of engagement of the external auditors and the re-appointment by the shareholders at the annual general meeting in April 2005 of Deloitte & Touche LLP as the external auditors.
Changes in internal controls There was no change in the company’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
The Remuneration Committee approves the remuneration arrangements of senior executives below Board level who are members of the Group Executive Management Committee, on the recommendation of the Group Chief Executive, and reviews all long-term incentive arrangements which are operated by the Group.
Benefits UK-based executive directors are eligible to participate in The Royal Bank of Scotland Group Pension Fund (‘the RBS Fund’). The RBS Fund is a non-contributory defined benefit fund which provides pensions and other benefits within Inland Revenue limits. Certain directors receive additional pension and life assurance benefits in excess of Inland Revenue limits. Details of pension arrangements of directors are shown on page 133.
Phantom 2000 Plan Awards granted during year End of the period for
Contributions and allowances paid in the year ended 31 December 2004 under defined contribution arrangements were: Mr Watt £128 £109 Mr Fish $91 $90
We read the directors’ report and the other information contained in the 2004 Annual Report as described in the contents section including the unaudited part of the directors’ remuneration report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements.
Accounting principles generally accepted in the United Kingdom vary in certain significant respects from accounting principles generally accepted in the United States of America. The application of the latter would have affected the determination of net income for each of the three years in the period ended 31 December 2004 and the determination of shareholders’ equity as at 31 December 2004 and 2003, to the extent summarised in Note 53 to the financial statements.
Under SSAP24 for the main defined benefit scheme the profit and loss account charge comprised the cost of accruing benefits for active employees and the amortisation of the surplus recognised on the acquisition of NatWest offset by a credit for the amortisation of the scheme surplus. A pension prepayment was included in the Group’s balance sheet.
The Group has reinsured contracts that transfer significant insurance risk. Within net assets, the reinsurance cash flows are recognised when they become payable. For most contracts this effectively spreads the cost of reinsurance over the life of the reinsured contracts. In some cases, the acquisition costs are financed by the reinsurer offering a nil premium payment period. In these cases, the acquisition costs incurred on the underlying insurance contracts are compared with the benefit arising with respect to the nil premium paying period on the reinsurance contract.
Specific provisions are made against individual loans and advances that the Group no longer expects to recover in full. For the Group’s portfolios of smaller balance homogeneous advances, such as credit card receivables, specific provisions are established on a portfolio basis taking into account the level of arrears, security and past loss experience. For loans and advances that are individually assessed, the specific provision is determined from a review of the financial condition of the borrower and any guarantor and takes into account the nature and value of any security held.
All items dealt with in arriving at profit on ordinary activities before tax relate to continuing operations.
Accruals and deferred income 15,588 13,155 Post-retirement benefit liabilities 3 1,901 1,445 Provisions for liabilities and charges
Wages, salaries and other staff costs 4,543 3,997 4,001 Social security costs 295 248 239 Pension costs (see Note 3) 506 408 344 * restated (see page 139)
Other operating income 85 52 201 Actuarial (losses)/gains (1,598) 69 (2,392) Acquisition of subsidiaries (32) — — Exchange and other movements (20) (1) 1
4 Profit on ordinary activities before tax Profit on ordinary activities before tax is stated after taking account of the following: £m £m £m
N ot es o n th e ac co un ts Notes on the accounts continued 6 Preference and Additional Value Shares dividends £m £m £m
9 Earnings per ordinary share The earnings per share are based on the following: £m £m £m
Treasury bills and similar securities 5,538 3,917 Other eligible bills 572 929
After 1 year After 2 years Within but within but within After 1 year 2 years 5 years 5 years Total 2004 £m £m £m £m £m
On the historical cost basis, shares in Group undertakings at 31 December 2004 would have been included at a cost of
Repayable on demand 30,279 20,995 With agreed maturity dates or periods of notice, by remaining maturity
Banking business 57,200 39,899 Trading business 1,760 1,117 26 Settlement balances and short positions £m £m
National Westminster Bank Plc US$500 million primary capital floating rate notes, Series A (callable on any interest payment date) 258 280 US$500 million primary capital floating rate notes, Series B (callable on any interest payment date) 258 280 US$500 million primary capital floating rate notes, Series C (callable on any interest payment date) 258 280 US$500 million 7.875% exchangeable capital securities (callable on any interest payment date) (12) 258 280 US$500 million 7.75% reset subordinated notes (callable October 2007) 255 275 €100 million floating rate undated subordinated step-up notes (callable October 2009) 71 70 €400 million 6.625% fixed/floating rate undated subordinated notes (callable October 2009) 280 280 £325 million 7.625% undated subordinated step-up notes (callable January 2010) 329 330 £200 million 7.125% undated subordinated step-up notes (callable October 2022) 203 203 £200 million 11.5% undated subordinated notes (callable December 2022) (13) 281 285
In November 2004, the company issued 1.25 million Series 1 non-cumulative preference shares of €0.01 each at €1,000 per share, the net proceeds being €1,225 million.
All of the above securities could be resold or repledged by the holder. Securities received as collateral under reverse repurchase agreements amounted to £91.4 billion (2003 – £57.7 billion), of which £85.1 billion (2003 – £53.6 billion) had been resold or repledged as collateral for the Group’s own transactions.
N ot es o n th e ac co un ts Notes on the accounts continued 39 Derivatives (continued)
Cumulative interest rate sensitivity gap (40,596) (30,913) (15,600) 9,119 30,815 *restated (see page 139)
(4) For loans which reprice frequently or are linked to the Group’s base rate, and for which there has been no significant change in credit risk since inception, carrying value represents a reasonable estimate of fair value. For other loans, fair values are estimated by discounting expected future cash flows, using current interest rates appropriate to the type of loan, and making adjustments for credit risk.
Members of the Group are engaged in other litigation in the United Kingdom and a number of overseas jurisdictions, including the United States, involving claims by and against them arising in the ordinary course of business. The directors of the company have reviewed these other actual, threatened and known potential claims and proceedings and, after consulting with the Group’s legal advisers are satisfied that the outcome of these claims and proceedings will not have a material adverse effect on the Group’s consolidated net assets, results of operations or cash flows.
The estimated contribution to the Group’s results, before funding costs of the acquisitions, is shown below: Year ended 31 December 2004*
Corporate Banking and Financial Markets 2,545 4,964 7,509 (2,664) (580) 4,265
Net income available for ordinary shareholders – US GAAP 3,948 2,564 3,108
53 Significant differences between UK and US generally accepted accounting principles (continued)
Net change in debt securities in issue Operating activities Financing activities
In 2004, awards totalling 373,140 options (2003 – 341,269; 2002 – 59,869) with negligible exercise prices and 93,367 shares (2003 – 59,525; 2002 – nil) were made under the Group’s medium-term performance plan. Under the plan, the amount of shares or options that vest ranges from nil to 200% of the award depending on the annual growth in the Group’s earnings per share and its performance relative to that of a comparator group of companies principally from the UK financial services sector.
Cash flow discount rate 2-33% 2-78% 2-12% Impact on fair value of 10% adverse change £9.4m £20.0m £0.6m Impact on fair value of 20% adverse change £18.4m £38.7m £1.2m
Notes: (1) The years ended 31 December 2003 and 2002 have been restated following the implementation of FRS 17. It is not practicable to restate prior years.
After 1 Within but within After 2004 £m £m £m £m £m £m £m £m
Gross loans and advances to customers Domestic 196,588 167,377 145,274 127,650 116,310
UK Domestic: Demand deposits – interest-free 22,249 20,567 22,067 Demand deposits – interest-bearing 78,178 78,670 66,118 Time deposits – savings 18,205 13,238 12,180 Time deposits – other 68,662 57,994 59,819 Overseas residents: Demand deposits – interest-free 376 830 908 Demand deposits – interest-bearing 12,740 9,559 8,897 Time deposits – savings 836 1,014 1,559 Time deposits – other 64,141 32,531 21,824 Total UK offices 265,387 214,403 193,372 Overseas Demand deposits – interest-free 10,371 7,937 6,698 Demand deposits – interest-bearing 12,975 7,471 10,148 Time deposits – savings 21,153 15,450 15,189 Time deposits – other 74,257 59,025 48,474 Total overseas offices (see below) 118,756 89,883 80,509
Contractual obligations The table below summarises the Group’s contractual cash obligations by remaining maturity.
The UK government sets an inflation target, which changed in December 2003 from a 2.5% target based on the retail prices index excluding mortgage interest payments to a 2% target based on the consumer prices index, in line with other European countries.
Prior Treaty – effect of UK tax credit An individual shareholder who is resident in the UK for UK tax purposes and who receives a dividend from the company is entitled to claim a tax credit in the UK against its income tax liability attributable to the dividend.
Estate and gift tax A non-cumulative dollar preference share or ADS held 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 noncumulative 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.
A US Holder will, upon the sale, exchange or redemption of X-CAPs, generally recognise capital gain or loss for US federal income tax purposes (assuming in the case of a redemption, that such US Holder does not own, and is not deemed to own, any ordinary shares of the company). A US Holder who is liable for both UK and US tax on gain recognised on the disposal of the X-CAPs will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.
The Royal Bank of Scotland plc 42 St Andrew Square Edinburgh EH2 2YE 280 Bishopsgate London EC2M 4RB