The Group’s market capitalisation at 31 December 2005 was £56.1 billion compared with £55.6 billion a year earlier.
�4.6 million personal customers, 450,000 business customers and 1.6 million retail credit card customer accounts
RBS Italy led three banks in the underwriting of the first closed-end real estate fund for the €3.3 billion transfer of property from the Italian Ministry of Economy and Finance to the newly created FIP.
Retail Direct has leading positions in the UK in credit card issuing, merchant acquiring, consumer finance and supermarket banking. In 2005 Retail Direct increased its total income by 11% to £1,966 million.
��� The Offshore Bank grew income by 7% and launched a Spanish Mortgage product available across the Group to all customers. Offshore mortgage balances increased by 35% and Royal Bank of Scotland International is a leading provider in the UK offshore islands of electronic banking services.
First Active. For Jill Hewitt and her nine year old son Jack, value for money is important. Last May after consolidating her mortgage and a home improvement loan into a fixed rate mortgage with First Active, she saved over £100 a month.
��� Product development has been a key factor in Ulster Bank Group’s success. In November 2005 we launched a radical overhaul of personal current accounts in Northern Ireland to provide free banking to all personal customers.
� Profit contribution £1,575 million (2004 – £1,069 million) � Total income up 43% � Profit up 47%
��� Our supermarket banking programme continued its momentum during 2005, adding 34 branches in strategic locations with our primary partners. With around 520 Citizens Bank and Charter One in-store branches, Citizens is now the second-largest supermarket banker in the US.
Citizens was the No.2 US Small Business Administration lender in the US for the fourth consecutive year.
Citizens’ International Cash Management collaboration with Corporate Markets resulted in 300 new Citizens accounts with existing RBS customers.
��� Citizens was the No.1 US Small Business Administration (SBA) lender in the Mid-Atlantic, Midwest and New England regions in 2005, and the No.2 lender in the US for the fourth consecutive year. We made over 10,000 SBA-backed loans, totalling more than US$416 million, which represented a 79% increase in volume over 2004.
��� Línea Directa became Spain’s sixth largest motor insurer this year with 1.2 million in-force policies and is now selling breakdown cover direct to customers. Direct Line in Germany launched motor legal protection.
��� We now have dedicated centres dealing with corporate customers – helping to make the Group one of the top service providers for corporate and commercial customers in 2005.
��� Offshore Operations took part in the Jersey workplace challenge which contributed to raising over £25,000 for Jersey Hospice and Save the Children in 2005.
Gogarburn. Gogarburn provides a first class working environment and has received a number of awards for environmental best practice.
To allow more meaningful comparison with the 2005 results, pro forma results have been prepared for 2004. The pro forma results include the effect of standards relating to financial instruments and insurance contracts (IAS 32, IAS 39 and IFRS 4) and the basis of preparation of these results is described on page 57.
Wealth Management provides private banking and investment services to its clients through a number of leading UK and overseas private banking subsidiaries and offshore banking businesses. Coutts is one of the world’s leading international wealth managers with over 20 offices worldwide, including Switzerland, Dubai, Monaco, Hong Kong and Singapore, as well as its premier position in the UK. Adam & Company is the major private bank in Scotland. The offshore banking businesses – The Royal Bank of Scotland International and NatWest Offshore – deliver retail banking services to local and expatriate customers, principally in the Channel Islands, the Isle of Man and Gibraltar.
Net interest margin The Group’s net interest margin at 2.55% was down from 2.81% in 2004, due mainly to growth in corporate and mortgage lending and a flattening of the US dollar yield curve.
Risk elements in lending and potential problem loans represented 1.60% of gross loans and advances to customers excluding reverse repos at 31 December 2005 (1 January 2005 – 1.84%).
(3) Interest income has been adjusted by £115 million (2004 – £49 million) and interest expense by £307 million (2004 – £99 million) to record interest on financial assets and liabilities designated as at fair value through profit or loss. Related interest-earning assets and interest-bearing liabilities have also been adjusted.
Other operating income increased by 39%, £738 million to £2,620 million. This was principally due to higher income from rental assets, increased bancassurance income and realised investment securities gains.
Integration costs were £458 million compared with £520 million in 2004 comprising amortisation of internally developed software and other expenditure. Software costs were previously written off as incurred under UK GAAP but under IFRS are now amortised over 3-5 years. All software relating to the
Non-interest income grew by 28% to £4,598 million. After deducting operating lease depreciation and rental asset funding costs, non-interest income now accounts for 69% of Global Banking & Markets revenues.
We recorded good growth in fees earned from customer services in risk management, financial structuring and debtraising. A strong performance from RBS Greenwich Capital, which has been brought together with other Corporate Markets activities in North America, contributed to steady growth in income from trading activities. Customer volumes were higher across all products and particularly good in our credit markets businesses. Average trading Value at Risk was held steady at a very conservative level, £12 million.
Growth in expenses, excluding operating lease depreciation, was 20%, reflecting variable performance-related costs.
Overall customer numbers have increased since December 2004 with personal customers up 274,000 (2%) and registered internet customers up 30%. During 2005 we continued to demonstrate our commitment to customer service, with significant progress in terms of the proportion of our customers who are “extremely’’ satisfied and we are making pleasing progress in the current account switcher market. Among the high street banks, Royal Bank of Scotland ranks first for customer satisfaction with NatWest now in joint second place. NatWest remains the number one bank for students. In 2005, 44% of first year students in England and Wales chose to open new accounts with us compared with 42% in 2004.
Non-interest income was up 72% to $2,079 million. Excluding acquisitions, non-interest income grew by 15% to $1,004 million, benefiting from higher fee income, increased student loan and leasing activities, and investment gains.
RBS Insurance produced a good performance in 2005, with total income increasing by 8% to £5,489 million and contribution by 5% to £926 million. The integration of Churchill was completed in September 2005, ahead of plan, and Churchill delivered greater transaction benefits than anticipated at the time of the acquisition. Following the integration of Churchill, all our direct businesses in the UK now operate on a common platform.
Repurchase agreements and stock lending Deposits by banks 47,905 47,841 43,342
p er at in g a nd fin an ci al r ev ie w
Governance framework The Board sets the overall risk appetite and philosophy for the Group. Various Board and executive sub-committees support these goals, as follows: • Group Audit Committee is a non-executive committee that supports the Board in carrying out its responsibilities for financial reporting including accounting policies and in respect of internal control and risk assessment. The Group Audit Committee monitors the ongoing process of the identification, evaluation and management of all significant risks throughout the Group. The Committee is supported by Group Internal Audit which provides an independent assessment of the design, adequacy and effectiveness of the Group’s internal controls.
• Group Credit Committee (“GCC”) is a credit approval committee which deals with all transactions that exceed the delegated authority of divisional credit committees.
(1) All loans against which an impairment provision is held are reported in the non-accrual category.
An impairment provision calculated using the effective interest rate method leaves a discounted asset; the discount unwinds at a constant effective rate until the outstanding asset is completely realised.
Risk is managed within limits approved by GALCO through the execution of cash and derivative instruments. Execution of the hedging is carried out by the relevant division through the Group’s treasury functions. The residual risk position is reported to divisional asset and liability committees, GALCO and the Board.
The following types of reinsurance are used where appropriate: • Excess of loss ‘per individual risk’ reinsurance to protect against significantly large individual losses.
Fluctuations in the social, economic and legislative climate are a source of uncertainty in the Group’s general liability account, and in particular court judgements and legislation (for example periodic payments under the Courts Act, a review of the Ogden tables used by the courts when setting personal injury claim values), significant events (for example terrorist attacks) and any emerging new heads of damage, types of claim that are not envisaged when the policy is written.
• Assets – risk of damage, misappropriation or theft of the Group’s physical, logical and intangible assets.
The Group is also committed to ensuring that all prospective applicants for employment are treated fairly and equitably throughout the recruitment process. Its comprehensive resourcing standards cover the attraction and retention of individuals with disabilities. Reasonable adjustments are provided to support applicants in the recruitment process where these are required. The Group provides reasonable workplace adjustments for new entrants into the Group and for existing employees who become disabled during their employment.
In addition, the Nominations Committee considers succession planning for the Chairman, Group Chief Executive and nonexecutive directors. The Nominations Committee takes into account the knowledge, mix of skills, experience and networks of contacts which are anticipated to be needed on the Board in the future. The Chairman, Group Chief Executive and nonexecutive directors meet to consider executive succession planning. No director is involved in decisions regarding his or her own succession.
In accordance with normal market practice, Mr Whittaker will be recompensed for the value of restricted stock and unvested options he forfeited on his departure from his previous employer. In this respect he will be provided with ordinary shares in The Royal Bank of Scotland Group plc worth £1,000,000 and restricted stock worth £1,450,000, the latter vesting in 3 tranches between 2007 and 2009. As Mr Whittaker forfeited his performance bonus from his previous employer, he received a cash payment of £1,195,181 and will receive restricted stock worth £962,785, the latter vesting in 4 tranches between 2007 and 2010. The provision of ordinary shares and the vesting of restricted stock is subject to certain conditions set out in Mr Whittaker’s service contract.
The market price of the company’s ordinary shares at 31 December 2005 was £17.55 and the range during the year to 31 December 2005 was £15.22 to £18.33.
End of the period for Phantom 2000 units at Units awarded Market price qualifying conditions Benefits received Phantom 2000 units at 1 January 2005 during year on award to be fulfilled during year 31 December 2005
No changes are proposed to the level or form of pension benefits for any of the current directors as a result of the changes in pension legislation which come into force in April 2006 although as stated above directors will be able to opt out of tax-approved pension provision if they wish and receive a salary supplement in lieu. In addition consideration will be given to funding a greater proportion of the benefits.
Shares beneficially owned at Shares 1 January 2005 beneficially or date of owned at appointment 31 December if later 2005
We read the directors’ report and the other information contained in the 2005 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.
4. Revenue recognition Interest income on financial assets that are classified as loans and receivables, available-for-sale or held-to-maturity and interest expense on financial liabilities other than those at fair value through profit or loss are determined using the effective interest rate method. The effective interest rate method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument’s initial carrying amount. Calculation of the effective interest rate takes into account fees receivable, that are an integral part of the instrument’s yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.
Financial assets and financial liabilities held-for-trading or designated as at fair value through profit or loss are recorded at fair value. Changes in fair value are recognised in profit or loss together with dividends and interest receivable and payable.
Expenditure on internally generated goodwill and brands is written-off as incurred. Acquired goodwill being the excess of the cost of an acquisition over the Group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary, associate or joint venture acquired is initially recognised at cost and subsequently at cost less any accumulated impairment losses. Goodwill arising on the acquisition of subsidiaries and joint ventures is included in the balance sheet caption ‘Intangible fixed assets’ and that on associates within their carrying amounts. The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill.
Depreciation is charged to profit or loss on a straight-line basis so as to write-off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases (except investment property – see note 20 below)) over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and long leasehold buildings 50 years Short leaseholds unexpired period of the lease Property adaptation costs 10 to 15 years Computer equipment up to 5 years Other equipment 4 to 15 years 8. Impairment of intangible assets and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent from those of other assets or groups of assets, recoverable amount is determined for the cash-generating unit to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cash generating unit that have not been reflected in the estimation of future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value does not exceed that which it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
15. Financial liabilities A financial liability is classified as held-for-trading if it is incurred principally for the purpose of selling in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of shortterm profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise. Financial liabilities that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss and are subsequently measured at fair value. Gains and losses on financial liabilities that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
Gains and losses arising from changes in fair value of a derivative are recognised as they arise in profit or loss unless the derivative is the hedging instrument in a qualifying hedge. The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a forecast transaction (cash flow hedges); and hedges of the net investment in a foreign entity.
Hedge of net investment in a foreign operation – where a foreign currency liability hedges a net investment in a foreign operation, the portion of foreign exchange differences arising on translation of the liability determined to be an effective hedge is recognised directly in equity. Any ineffective portion is recognised in profit or loss.
20. Investment property Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. It is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices in an active market for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognised in profit or loss. Rental income from investment property is recognised on a straight-line basis over the term of the lease. Lease incentives granted are recognised as an integral part of the total rental income.
Held-for-trading 44,965 — Designated as at fair value through profit or loss 282 — Loans and receivables 25,340 9,122
Cost or valuation: Currency translation and other adjustments (55) 17 11 18 67 469 527
Interest rate contracts Interest rate swaps 7,234 65,618 67,156 Options purchased 814 5,988 — Options written 719 — 5.557 Futures and forwards 1,482 268 325
Unrecognised Deferred gains and gains and losses losses 2004 £m £m
Amounts above include: Items in the course of transmission to other banks 722 802 Due to subsidiaries 944 108 22 Customer accounts Group Company £m £m £m £m
Currency translation and other movements 1 (1) — Charge to income statement 7 7 14 Releases to income statement (14) (2) (16)
– arising from current year claims 3,943 (484) 3,459 – arising from prior year claims (139) 217 78
Designated as at fair value through profit or loss 150 — Amortised cost 28,124 9,242
Under IFRS, certain of the Group's preference shares are classified as debt and are now included in subordinated liabilities on the balance sheet. The following table shows the re-classification of the Group’s non-equity shares at 31 December 2004 in to equity shares and subordinated liabilities (see Note 28) upon implementation of IAS 32 on 1 January 2005. All preference share capital redeemed during the year was classified as debt and all capital issued during the year is classified as equity in accordance with IAS 32.
Currency translation adjustments — (231) — (231) Shares issued during the year 1,972 4,550 1,972 4,550 Conversion of exchangeable undated loan capital — 460 — 460 Other movements — 10 — 10
AAA 1 AAA- 1 AA 3 AA- 2 A 2 A- 1 34 Financial instruments (continued)
Three years later 12 (12) — — — — Four years later (40) — — — — (40)
Sensitivity factor Description of sensitivity factor applied Interest rate and investment return Change in market interest rates of ± 1%.
Assets Cash and balances at central banks 4,293 — — — — — 4,293 Treasury bills and other eligible bills 2,201 2,555 1,354 — — — 6,110 Loans and advances to banks 36,482 11,867 11,902 266 556 — 61,073 Loans and advances to customers 103,672 32,403 38,990 54,788 117,398 — 347,251
Assets Loans and advances to banks 435 1,476 780 1,510 4,921 9,122 Loans and advances to customers — — — 262 305 567 Derivatives at fair value — — — 55 — 55
Loans and advance to banks Held-for-trading 44,965 44,965 — — Designated as at fair value through profit or loss 282 282 — —
Service industries and business activities 53,504 3,404 2,148 162 59,218 6,290
Currency translation and other adjustments (5) — (3) (4) 809 — (11) — 786 Arising on acquisitions during the year 1 1 8 — — 103 — — 113 41 Segmental analysis (continued)
Cost to acquire property, plant and equipment and intangible assets 3,811 6,178 1,736 2 11,727
N ot es o n th e ac co un ts Notes on the accounts continued 42 Directors’ and key management remuneration Group
(c) Leasing Finance lease income is recognised so as to give a level rate of return on the net cash investment in the lease; tax cash flows are taken into account in allocating income.
(d) Dividends Dividends payable on ordinary shares are recorded in the period to which they relate.
Subordinated liabilities 16,998 — — — — — — — — — — 16,998
Under US GAAP, these debt securities 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.
Applicable non-refundable loan fees and certain direct costs are deferred and recognised over the period of the related loan or facility.
(3) Includes integration expenditure of £458 million for the year ended 31 December 2005 (2004 – £520 million).
Other financial data based upon US GAAP: 2005 2004 2003 2002 2001
Total capital resources 56,060 45,809 40,875 39,783 Deposits by banks 99,081 67,323 54,720 40,038 Customer accounts 285,062 236,963 219,161 198,995 Debt securities in issue 58,960 41,016 33,938 30,669
Banking business 303,328 251,986 Trading business 80,815 52,300 Total deposits 384,143 304,286
Guarantees and other contingent liabilities The Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer’s obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount. The Group expects most guarantees it provides to expire unused. Other contingent liabilities include those arising from standby letters of credit that support customer debt issues and those relating to customers’ trading activities such as performance and customs bonds, warranties and indemnities.
Changes to consumer credit regulation are being promulgated at both national and EU levels. A number of changes to the UK regime took effect in May 2005, and the Consumer Credit Bill, once enacted in 2006, will make further, more fundamental, changes. Negotiations also continue on a draft EU Consumer Credit Directive, to harmonise core regulatory standards in each EU Member State. The UK regime will need to change again when this Directive is implemented in 2008 or later.
As at 31 December 2005, almost all of the company’s US$ denominated preference shares were held by shareholders registered in the US. All other shares were predominantly held by shareholders registered outside the US.
Disposal (including redemption) A disposal (including redemption) of X-CAPs by a noncorporate US Holder will not give rise to any liability to UK taxation on capital gains unless the US Holder carries on a trade (which for this purpose includes a profession or vocation) in the UK through a branch or agency and the X-CAPs are, or have been, held or acquired for the purposes of that trade, branch or agency. The exchange by such US Holder of X-CAPs for preference shares or ADSs pursuant to the company’s exercise of its exchange right will not give rise to a charge to UK tax on capital gains even if such US Holder would be subject to tax on a disposal of such holder’s X-CAPs in accordance with the tax treatment referred to previously.
Interest on the PROs constitutes UK source income for UK tax purposes and, as such, may be subject to income tax by direct assessment even where paid without withholding. However, interest with a UK source received without deduction or withholding on account of UK tax will not be chargeable to UK tax in the hands of a US Holder unless, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a UK permanent establishment or in the case of other US Holders, such persons carry on a trade, profession or vocation in the UK through a UK branch or agency in connection with which the interest is received or to which the PROs are attributable. There are exemptions for interest received by certain categories of agents (such as some brokers and investment managers).