• The Government will have begun to sell its shares at a profit £1.9bn Group operating profit (1)
For accounting purposes, the Group values some of its issued debt (e.g. bond issues) at the current market price. Changes in this value are recorded in profit or loss. Part of this change results from market movements in the price of the Group’s credit: when the Group’s credit spreads tighten a loss is recorded, when they widen a gain is recorded.
Reduced balance sheet scale Continue to de-risk and shrink the Group’s balance sheet, including careful control of future asset growth.
Core revenue by division – 2010 Total revenue by geographic split – 2010
The risk of financial loss through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting.
Our success rests on how well we support our customers. We have a responsibility to help them through difficult and uncertain times. That’s why our charter for SME customers, published in November 2009, sets out clear commitments on what customers can expect from us and on how we will behave. In 2010, we put it into practice.
Helping businesses to start-up and grow We know that new businesses are vital to the recovering UK economy. In 2010, we opened on average more than 2,200 start-up accounts per week. Each one benefits from free transactional banking services in their first two years of operation.
2010 was a year of delivering the commitments we have made to support our customers. We are taking the necessary steps to restore the reputation of the Bank, brick by brick, and putting our customers at the heart of everything we do.
Many clients like to keep in touch by phone and our specialist service, Coutts24, which provides round-the-clock support, handled over one million calls in 2010. Client feedback on the service is extremely positive
• Income increased by 3% • Expenses broadly in line with 2009 • Operating profit increased by 12% • Risk-weighted assets fell by 4%
We’re using the experience of our people in making these changes, for example in designing new procedures for call-handling, feeding back on call quality and coaching the telephony agents. As a result, we’ve reduced the Average Handling Time of a call by 23% since January 2010. This means we are able to speak to more customers each day. It has also provided stronger links between our businesses, with our telephony agents able to hand over more customer leads to the Retail Direct Sales Centre.
Recognition We received a range of awards that recognised our industry leadership and commitment to staff, customers and the communities where we do business: • Citizens was named second in the US in delivering the best experience for small-business customers by the ath Power 2010 Small Business Banking Study™, moving up from No.10 in 2009.
In October, we sponsored an event at the Houses of Parliament to discuss the challenging environment the UK’s ‘compensation culture’ has created for the insurance industry. We continue to work alongside the Association of British Insurers in support of Lord Justice Jackson’s recommendations for reforming personal injury compensation claims.
• Portfolio & Banking agreed deals to dispose of non-core portfolio assets. Examples included the sale of a portfolio of US and European private equity fund interests, the sale of Leveraged Finance assets through a Collateralised Loan Obligation and the sale of property assets, such as the Cumberland and five other hotels.
In addition, we have a number of targeted community programmes that enable us to enhance our contribution to society. We aim to invest Group resources to maximise our impact, creating real and sustainable benefits in the communities in which we operate.
include the Chief Executive Officers of a number of our divisions.
The GSC reviews the Group’s overall sustainability strategy, values and policies.
We continued to invest in our Group MoneySense programmes in 2010. We improved and expanded our MoneySense for Schools programmes by developing new online resources, holding teacher training days and completing the 3rd annual MoneySense Panel Research. This research revealed the attitudes towards money of over 10,000 12-19 year olds. The 2nd annual RBS Personal Finance Education Awards for Schools recognised the 2010 achievements of primary and secondary schools.
smallbusinesscan provides guidance and support to help small businesses in the UK and Ireland and is supported by Ulster Bank.
We provide a suite of competitive employment policies, training and development opportunities and a bespoke benefits package and provide support when it is needed through our Employee Assistance programme.
In the United States, Citizens competes in the New England, Mid-Atlantic and Mid-West retail and mid-corporate banking markets with local and regional banks and other financial institutions. The Group also competes in the US in large corporate lending and specialised finance markets, and in fixed-income trading and sales. Competition is principally with the large US commercial and investment banks and international banks active in the US. The economic recovery in the US is proving weaker than expected and loan demand is weak in Citizens’ markets which in turn has dampened the level of competitive pressure in the deposit markets as funding pressures have eased.
The Group’s participation in the APS is costly and complex and may not produce the benefits expected and the occurrence of associated risks may have a material adverse impact on the Group’s business, capital or tax position, financial condition and results of operations. Any changes to the regulatory treatment of the APS may negatively impact the Group’s capital position and any withdrawal from, or termination of, the APS will be costly.
Earnings Basic loss per ordinary and B share from continuing operations improved from 146.2p to a loss of 6.3p. Adjusted loss per ordinary and B share improved from 43.1p to a loss of 13.2p per share. The number of ordinary shares in issue increased to 56,366 million at 31 December 2009, compared with 39,456 million in issue at 31 December 2008, reflecting the placing and open offer in April 2009. The Group also issued 51 billion B shares to Her Majesty's Treasury in December 2009.
Net insurance claims Bancassurance and general insurance claims, after reinsurance, increased by 11% to £4,357 million.
(4) Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities. (5) Interest receivable has been decreased by £90 million in respect of a non-recurring receivable (2009 - nil; 2008 - nil). (6) Interest payable has been increased by £319 million in respect of non-recurring adjustments (2009 - nil; 2008 - nil).
UK 588 244 832 635 348 983 Overseas 137 2,316 2,453 233 2,248 2,481 Customer accounts: demand deposits
2009 compared with 2008 - pro forma Net fees and commissions fell by £486 million primarily due to the withdrawal of the single premium payment protection insurance product and the restructuring of current account overdraft fees within UK Retail during the year, as well as to reduced fees received in Non-Core. This was partially offset by improved performance in GBM (£112 million) and US Retail & Commercial (£50 million).
Other operating income increased by £243 million. This improvement reflected a small gain in the fair value of securities and other assets and liabilities compared with a loss of £1.4 billion in 2008 partially offset by lower profits on sales of securities and properties and reduced dividend income.
Note: (1) Pro forma excludes amortisation of purchased intangible assets, integration and restructuring costs, bonus tax, gains on pensions curtailment and write-down of goodwill and other intangible assets.
2009 compared with 2008 Losses relating to monoline exposures were £2,387 million in 2009 compared with £3,093 million in 2008.
The development of the RBS and NatWest Customer Charters aims to deliver those elements that customers have said are most important to them, and has been well received by both customers and staff. The division is reaping continuing benefits from investment in process improvements and automation, resulting in gains in both service quality and cost efficiency.
Risk-weighted assets decreased by 5% to £48.8 billion, with lower unsecured lending, improving portfolio credit metrics and small procyclicality benefits more than offsetting growth in mortgages.
Direct staff costs declined by 9%, as the division benefited from strong cost control, a focus on process re-engineering and a 10% reduction in headcount.
Impairment losses increased to $1,099 million as loan impairments as a percentage of loans and advances increased from 0.9% to 1.4%.
Analysis of income by product Rates - money markets 65 1,714 1,641 Rates - flow 1,985 3,142 1,386 Currencies & commodities 870 1,277 1,539 Credit and mortgage markets 2,215 2,255 (3,435) Portfolio management and origination 1,844 1,196 858 Equities 933 1,474 368 Total income 7,912 11,058 2,357
Total income was £3,146 million lower in 2010 driven by increased risk aversion in the market during Q3 and Q4 2010, combined with the nonrepeat of favourable market conditions seen in the first half of 2009.
Higher revenue across the Rates and Currencies businesses during 2009 was driven by rapidly falling interest rates and wide bid-offer spreads generating exceptional revenue opportunities, which have not been repeated in 2010.
Expenses increased 17%, reflecting higher performance-related costs and the impact of adverse exchange rate movements, partly offset by restructuring and efficiency benefits. Less than half of the change in staff costs related to increases in 2009 bonus awards.
2010 operating losses in Non-Core were 62% lower than those recorded in 2009. The improvement in performance was driven by significantly lower trading losses, reduced expenses and a marked decline in impairments.
Prepayments, accrued income and other assets 12,568 18,604 21,573 12,576 20,985 24,402
Net cash flows from financing activities of £18,791 million primarily arose from the capital raised from the issue of B shares of £25,101 million, the placing and open offer of £5,274 million and the issue of subordinated liabilities of £2,309 million. This was offset in part by the cash outflow on repayment of subordinated liabilities of £5,145 million, redemption of preference shares of £5,000 million, interest paid on subordinated liabilities of £1,746 million and dividends paid of £1,248 million.
It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the Financial Services Authority (FSA). The FSA uses Risk Asset Ratio (RAR) as a measure of capital adequacy in the UK
Acts on all strategic risk and control matters across the Group including, but not limited to, credit risk, market risk, operational risk, compliance and regulatory risk, enterprise risk, treasury and liquidity risk, reputational risk, insurance risk and country risk.
Market risk The risk that the value of an asset or liability may change as a result of a change in market factors.
The tables below analyse the movement in the year of Core Tier 1 capital on a proportional and statutory basis.
A substantial part of the mitigating impacts mentioned in the following paragraphs relate to run-off in the normal course of business and deleveraging of legacy positions and securitisations, including Non-Core. The Group is also devoting considerable resource to enhancing its models to improve management of market and counterparty exposures. A key mitigating action related to counterparty risk involves enhancement to internal models, which is a significant undertaking. There could be various hedging strategies and business decisions taken as part of mitigation which may have an adverse, but manageable, impact on revenues.
The net impact of these adjustments is expected to be manageable as most of these drivers reduce or are eliminated by 2014.
CRD III required the Commission of European Banking Supervisors (CEBS) to issue guidelines on sound remuneration policies which comply with its principles and these were issued on 10 December 2010 (the “Guidelines”).
Stress testing Simulated liquidity stress testing is periodically performed for each business and applied to the major operating subsidiary balance sheets. A variety of firm-specific and market related scenarios are used at the consolidated level and in individual countries. These scenarios include assumptions about significant changes in key funding sources, credit ratings, contingent uses of funding, and political and economic conditions in certain countries. Stress tests are regularly updated based on changing market conditions.
Structural foreign currency exposures Structural foreign exchange exposures represent net investment in subsidiaries, associates and branches, the functional currencies of which are currencies other than sterling. The Group hedges structural foreign exchange exposures only in limited circumstances. The Group’s objective is to ensure, where practical, that its consolidated capital ratios are largely protected from the effect of changes in exchange rates.
Responsibility for development of Group-wide policies, credit risk frameworks, Group-wide portfolio management and assessment of provision adequacy sits within the functional Group Credit Risk organisation (GCR) under the management of the Group Chief Credit Officer. Execution of these policies and frameworks is the responsibility of the risk management organisations located within the Group’s business divisions. These divisional credit risk functions work together with GCR to ensure that the Board’s expressed risk appetite is met within a clearly defined and managed control environment. Each credit risk function within the division is managed by a Chief Credit Officer who reports jointly to a divisional Chief Risk Officer and to the Group Chief Credit Officer. Divisional activities within credit risk include credit approval, transaction and portfolio analysis, early problem recognition and ongoing credit risk stewardship.
Product/asset class Retail: a formal risk appetite framework establishes Group-level statements and thresholds that are cascaded through all retail franchises in the Group and to granular business lines. These include measures that relate to both aggregate portfolios and to origination asset quality that are monitored frequently to ensure consistency with Group standards and appetite. This appetite setting and monitoring then informs the processes and parameters employed in origination activities that require a large volume of small scale credit decisions, typically involving an application for a new product or a change in facilities on an existing product. The majority of these decisions are based upon automated strategies utilising credit and behaviour scoring techniques. Scores and strategies are typically segmented by product, brand and other significant drivers of credit risk. These data driven strategies utilise a wide range of credit information relating to a customer including, where appropriate, information across customers’ holdings. A small number of credit decisions are subject to additional manual underwriting by authorised approvers in specialist units. These include higher value, more complex, small business and personal unsecured transactions and some residential mortgage applications.
Single name Within wholesale portfolios, much of the activity undertaken by the credit risk function is organised around the assessment, approval and management of the credit risk associated with a borrower or group of related borrowers.
The framework for the Group’s appetite for country risk is set by the Executive Risk Forum (ERF) in the form of limits by country risk grade, with sub-limits on medium-term exposure. Authority is delegated to the Group Country Risk Committee to manage exposures within the framework, with escalation where needed to ERF. Specific limits are set for individual countries based on a risk assessment taking into account the Group’s franchise and business mix in that country. Additional limitations (for example, on foreign-currency exposure and product types with higher potential for loss in case of country events) may be established to address specific vulnerabilities in the context of a country's outlook and/or the Group's business strategy in a particular country. A country watch list framework is in place to proactively monitor emerging issues and facilitate the development of mitigation strategies.
Risk management: Credit risk continued Global Restructuring Group continued Depending on the case in question, GRG may employ a combination of these options in order to achieve the best outcome. It may also consider alternative approaches, either alone or together with the options listed above.
Retail businesses: each customer account is separately scored using models based on the most material drivers of default. In general, scorecards are statistically derived using customer data. Customers are assigned a score, which in turn is mapped to a probability of default. The probabilities of default are used to group customers into risk pools. Pools are then assigned a weighted average probability of default using regulatory default definitions.
The country risk tables below show credit risk assets exceeding £1 billion by borrowers domiciled in countries with an external rating of A+ and below from Standard & Poor’s, Moody’s or Fitch and selected eurozone countries. The numbers are stated gross of mitigating action which may have been taken to reduce or eliminate exposure to country risk events.
Reductions were seen in corporate and personal exposures, particularly in the Non-Core portfolios. This contrasted with increases in financial institutions in a number of countries, mostly due to increases in RRM exposure. Some countries in Asia have seen increased exposures during 2010, including two of the Group’s strategically important countries in this region, China and India, following reductions in 2008 and 2009.
The Group broadened its country risk framework in 2010, to capture advanced as well as emerging market countries. Cross-country assessments were conducted to identify portfolio vulnerabilities to a number of risk scenarios, including a eurozone sovereign debt crisis. Limit controls are being applied on a risk differentiated basis and selected exposure actions have been taken. Further scenario stress testing is continuing, and covers the potential for economic and political shocks in the eurozone and in the broader global environment.
The commercial real estate lending portfolio totalled £87 billion at 31 December 2010, a 11% decrease over the prior year (2009 - £98 billion). The Non-Core portion of the portfolio totalled £46 billion (52% of the portfolio) in 2010 (2009 - £47 billion, or 48% of the portfolio) and includes exposures in Ulster Bank Group as discussed on page 165.
Commercial real estate will remain challenging for key markets, such as the UK, Republic of Ireland and US; new business will be accommodated within a reduced limit framework.
Notes: (1) Excludes RRM and contingent obligations. (2) Includes on demand and past due assets.
The Group may agree maturity extensions, interest roll-ups and other remedial measures, as part of the Group’s early problem management framework for customers experiencing temporary financial difficulties. Excluding Ulster Bank Group, customers with loans totalling £0.6 billion (where exposures exceeded £10 million) benefited from such measures during 2010. Within GRG a restructured loan without an impairment provision is returned to the performing book once the revised terms are being met by the customer. During 2010, within GRG (excluding Ulster Bank Group), such activity for counterparties with exposures in excess of £5 million amounted to £0.3 billion. Refer to page 161 for a discussion on Ulster Bank Group.
The current weighted average LTV of the real estate portfolio increased slightly from 74.5% at 31 December 2009 to 75.3% at 31 December 2010, driven by a down turn in home prices. The current weighted average LTV of the real estate portfolio excluding SBO is 70.0%.
Retail credit assets: Personal lending The Group's personal lending portfolio includes credit cards, unsecured loans, auto finance and overdrafts. The majority of personal lending exposures exist in the UK and the US. New defaults as a proportion of average loans and receivables are shown in the following table.
Non-banks and financial institutions 167 88 255 46 24 70 4 — 4 217 112 329
The arrears rate continues to increase due to the continued challenging economic environment. At 31 December 2010, the arrears rate was 6.0%, compared to 3.3% at 31 December 2009. As a result, the impairment charge for 2010 was £336 million compared with £116 million for 2009. Repossessions totalled 76 in 2010, compared with 96 in 2009; 75% of the repossessions were voluntary.
Other financial instruments Commitments Contingent liabilities Total 2010 £m £m £m £m £m £m £m £m £m
2009 Held-for-trading 8,128 10,427 50,150 6,103 28,820 6,892 893 111,413 Designated as at fair value through profit or loss 122 3 385 418 394 1,087 20 2,429 Available-for-sale 18,350 12,789 33,727 7,472 50,464 2,550 30 125,382 Loans and receivables 1 — — — 7,924 1,853 93 9,871 Group before RFS MI 26,601 23,219 84,262 13,993 87,602 12,382 1,036 249,095 RFS MI 721 183 11,871 3,803 580 906 95 18,159 Short positions (HFT) (5,805) (8,957) (14,491) (1,951) (3,616) (2,199) (512) (37,531)
Note: (1) The amounts shown above include loans and advances to customers that are past due through administrative and other delays in recording payments or in finalising documentation and other events unrelated to credit quality.
Impairment losses on securities - debt securities 40 41 81 98 503 601 858
Available-for-sale debt securities and related reserves The table below analyses available-for-sale (AFS) debt securities by issuer and related AFS reserves, for countries exceeding £0.5 billion at any reporting date below, together with the total of those individually less than £0.5 billion.
All the disclosures in this section (pages 193 to 198) are audited unless indicated otherwise with an asterisk (*).
The VaR model has been approved by the FSA to calculate regulatory capital for the trading book. The approval covers general market risk in interest rate, foreign exchange, equity and limited commodity products and specific risk in interest rate and equity products.
The VaR for the Group’s 2010 trading portfolios analysed by type of market risk exposure is shown below.
Risk management: Operational risk* continued Through the three lines of defence model the Group obtains assurance that the standards in the GPF are being adhered to. GPF defines requirements for testing and gathering evidence which demonstrates that each division and function is appropriately controlled.
Information security The Group is committed to protecting customer, employee and Group information with regard to the loss of confidentiality, integrity and availability. This extends to all physical and electronic information. All employees and related third parties of the Group are responsible for the protection of Group assets, systems and information. All customer information is treated as confidential and appropriate security is applied to protect the information. Additionally, the Group’s information security policy is reviewed regularly and includes processes for managing and monitoring compliance with the policy. The same standards apply to information controlled by the Group or managed by authorised third parties.
Net exposure RMBS: G10 government 33,464 25 7,642 46 41,177 18,631 — 22,546 — RMBS: covered bond 44 296 10,040 — 10,380 — — 10,380 — RMBS: prime 5,548 3,667 5,212 215 14,642 5,138 166 8,768 570 RMBS: non-conforming 1,106 2,906 — — 4,012 346 — 2,184 1,482 RMBS: sub-prime 358 408 380 313 1,459 346 16 571 526 CMBS 1,147 1,225 1,095 79 3,546 1,178 13 918 1,437 CDOs 2,402 127 311 — 2,840 1,618 — 873 349 CLOs 874 259 2,139 171 3,443 845 — 1,665 933 Other ABS 3,507 1,367 4,299 1,256 10,429 196 40 6,572 3,621 48,450 10,280 31,118 2,080 91,928 28,298 235 54,477 8,918 Notes: (1) Fair value through profit or loss. (2) Rest of the world. (3) Held-for-trading. (4) Designated as at fair value. (5) Available-for-sale. (6) Loans and receivables.
A summary of the Group's exposure to CDPCs all of which are in NonCore is detailed below.
The table below sets out the asset categories, together with the carrying value of the assets and associated liabilities for those securitisations and other asset transfers, other than conduits (discussed below), where the assets continue to be recorded on the Group's balance sheet 2010 2009 2008 Assets Liabilities Assets Liabilities Assets Liabilities £m £m £m £m £m £m
References to 'Group' in this section relate to 'Group before RFS MI'.
(3) Under the Scheme rules, the Group may apply to the APA for loss credits in respect of the disposal of non-triggered assets. A loss credit counts towards the first loss threshold and is typically determined by the APA based on the expected loss of the relevant asset.
Share capital Details of the ordinary share capital and preference share capital at 31 December 2010 and movements during the year, are shown in Note 29 on the accounts.
There are no restrictions on the transfer of ordinary shares in the company other than certain restrictions which may from time to time be imposed by laws and regulations (for example, insider trading laws). Pursuant to the Listing Rules of the Financial Services Authority (FSA), certain employees of the company require the approval of the company to deal in the company’s shares.
Re-election of directors In accordance with the provisions of the new Code, all directors of the company will stand for re-election by shareholders at the company’s 2011 Annual General Meeting and annually thereafter. Colin Buchan will stand down as a non-executive director on 5 August 2011 following the announcement of the Group’s interim results, having served just over nine years on the Board.
A formal and rigorous internal evaluation of the performance of the Board and Nominations Committee during 2010 was carried out by the Group Secretary. A detailed framework of questions was used to structure individual meetings held by the Group Secretary with each director and regular meeting attendees. The Group Secretary then discussed the outcomes and recommendations with the Chairman. Amongst the areas reviewed were the role and organisation of the Board and Board Committees, Board and Committee composition, Board processes, the structure and frequency of meetings, Board performance and reporting, strategy and risk management and external relationships, including those with shareholders and regulators.
Shareholders are given the opportunity to ask questions at the Annual General Meeting or submit written questions in advance. The chairmen of the Audit, Board Risk, Remuneration and Nominations Committees are available to answer questions at the Annual General Meeting. The Senior Independent Director is also available.
The Audit Committee is satisfied that it has complied with the relevant provisions of the Code and the new Code.
The Audit Committee was regularly advised of whistleblowing events which occurred within the Group; of complaints raised with members of the Group’s executive team; of significant internal investigations undertaken within the Group; and of internal regulatory reviews and investigations.
I am pleased to be presenting the Group’s Remuneration Report for 2010.
The individual elements of employees' remuneration packages are as follows: Base salary Base salaries should be appropriate in the specific market for the business in which an individual works and also reflect the talents, skills and competencies that the individual brings to the Group. There should be a sufficient level of fixed pay so that inappropriate risk-taking is not encouraged.
Long-term incentives The Group provides long-term incentives which are designed to link reward with the long-term success of the Group and recognise the responsibility participants have in driving its future success and delivering value for shareholders.
Relative TSR (applying to 25% of overall 2011 LTIP award in total) Relative TSR has been retained in the LTIP to provide a direct connection between the reward provided to executive directors and the relative performance delivered to our shareholders.
equity is defined as tangible equity allocated to the Core businesses, with adjustments to strip out distorting impacts arising from fair value of own debt, available-for-sale reserves, cashflow hedging reserve, and APS.
Balance Sheet & Risk and Strategic Scorecard (applying to 50% of overall 2011 LTIP award in total) For the 2011 awards, 25% of the overall award will vest based on achievement of Balance Sheet & Risk targets and 25% of the overall award will vest on achievement of Strategic Scorecard targets, over a three year period.
These measures have been chosen to complement the Core bank Economic Profit and Relative TSR measures in aligning the LTIP with the advancement of the strategic position and capability of the organisation and the building of a sustainable business. The 2011 measures will have a particular focus on risk reduction, the resolution of the Non-Core business and the building of a sustainable and responsible franchise for the Group.
All new service contracts for executive directors are subject to approval by the Remuneration Committee. Those contracts normally include standard clauses covering the performance review process, the company's normal disciplinary procedure, and terms for dismissal in the event of failure to perform or in situations involving actions in breach of the Group's policies and standards.
Information regarding directors' service contracts is shown below: Date of current contract Notice period –
The non-executive directors do not have service contracts or notice periods although they have letters of engagement reflecting their responsibilities and commitments. These letters make clear to nonexecutive directors the time commitment they are expected to give to their Board duties. Brendan Nelson, Philip Scott and Penny Hughes' letters of engagement specifically state that their time commitment should be in line with the Walker Review in respect of their general Board duties and additional time as necessary in respect of Committee duties, including in particular any Committees which they chair.
As disclosed in the 2009 remuneration report, no payment for loss of office was made to Guy Whittaker (who ceased to be a director on 30 September 2009). After leaving the Group, Mr Whittaker was paid a total of £729,381 representing salary and benefits due under his contract of employment for the balance of his notice period.
The performance conditions for the LTIP awards focus on shareholder value, while factoring in the growing regulatory emphasis on risk-adjusted financial metrics.
The proportion of benefits represented by funded pension schemes for Gordon Pell is 39%.
Derivatives 15 423,967 424,141 971,364 231 446 361 Accruals, deferred income and other liabilities 24 23,089 30,327 31,482 1,034 1,357 47 Retirement benefit liabilities 4 2,288 2,963 2,032 — — —
1. Presentation of accounts The accounts are prepared on a going concern basis (see page 232 of the Report of the directors) and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) of the IASB as adopted by the European Union (EU) (together IFRS). The EU has not adopted the complete text of IAS 39 ‘Financial Instruments: Recognition and Measurement’; it has relaxed some of the standard's hedging requirements. The Group has not taken advantage of this relaxation and has adopted IAS 39 as issued by the IASB: the Group's financial statements are prepared in accordance with IFRS as issued by the IASB.
The results of subsidiaries acquired are included in the consolidated income statement from the date control passes up until the Group ceases to control them through a sale or significant change in circumstances. Changes in interest that do not result in a loss of control are recognised in equity.
Hedge of net investment in a foreign operation - in the hedge of a net investment in a foreign operation, the portion of foreign exchange differences arising on the hedging instrument determined to be an effective hedge is recognised directly in equity. Any ineffective portion is recognised in profit or loss. Non-derivative financial liabilities as well as derivatives may be the hedging instrument in a net investment hedge.
Fair value - financial instruments Financial instruments classified as held-for-trading or designated as at fair value through profit or loss and financial assets classified as available-for-sale are recognised in the financial statements at fair value. All derivatives are measured at fair value. Gains or losses arising from changes in the fair value of financial instruments classified as held-fortrading or designated as at fair value through profit or loss are included in the income statement. Unrealised gains and losses on available-for-sale financial assets are recognised directly in equity unless an impairment loss is recognised.
In October 2010, IFRS 9 was updated to include the classification and measurement of liabilities. It is not markedly different from IAS 39 except for liabilities measured at fair value where the movement is due to changes in credit rating of the preparer it is recognised not in profit or loss but in other comprehensive income.
US Retail & Commercial 16,500 16,400 17,300 Global Banking & Markets 15,500 15,100 15,700
Current tax Charge for the year (251) (494) (1,386) Over provision in respect of prior periods 41 191 254 Relief for overseas tax — — 34 (210) (303) (1,098) Deferred tax (Charge)/credit for the year (738) 1,041 3,167 Over/(under) provision in respect of prior periods 314 (309) 98 Tax (charge)/credit for the year (634) 429 2,167
The actual tax (charge)/credit differs from the expected tax credit computed by applying the standard rate of UK corporation tax of 28% (2009 - 28%; 2008 - 28.5%) as follows: 2010 2009 2008 £m £m £m
Notes: (1) Prior year tax adjustments include releases of tax provisions in respect of structured transactions and investment disposals, and adjustments to reflect submitted tax computations in the UK and overseas. (2) In the Budget on 22 June 2010, the UK Government proposed, amongst other things, to reduce Corporation Tax rates in four annual decrements of 1% with effect from 1 April 2011. The first decrement was enacted in the Finance (No 2) Act 2010 and as a consequence the closing deferred tax assets and liabilities have been recognised at an effective rate of 27%. The impact of this change on the tax charge for the year is set out in the table above.
11 Financial instruments - classification continued The following tables analyse the company's financial assets and financial liabilities in accordance with the categories of financial instruments in IAS 39. Assets and liabilities outside the scope of IAS 39 are shown separately.
Liabilities Customer accounts (4) — 1,029 1,029 Debt securities in issue — 8,742 8,742 Derivatives (4) 231 — 231 Accruals, deferred income and other liabilities — — 1,034 1,034 Subordinated liabilities — 8,048 8,048 231 — 17,819 1,034 19,084 Equity 59,224 2009 Assets Loans and advances to banks (1) — 31,238 31,238 Loans and advances to customers (2) — 2,777 2,777 Debt securities (2) — 1,286 1,286 Investments in Group undertakings 64,766 64,766 Settlement balances 11 11 Derivatives (2) 930 239 1,169 Deferred tax 2 2 Prepayments, accrued income and other assets — — 43 43 930 239 35,301 64,822 101,292
All IPV variances are classified as either ‘hard’ or ‘soft’. A variance is hard where the independent information represents tradable or liquid prices, and soft where it does not. Adjustments are required for all hard variances and for aggressive soft variances, but with conservative variances not requiring adjustment.
(2) Sensitivity represents the favourable and unfavourable effect on the income statement or the statement of comprehensive income due to reasonably possible changes to valuations using reasonably possible alternative inputs to the Group's valuation techniques or models. Totals for sensitivities are not indicative of the total potential effect on the income statement or the statement of comprehensive income.
The availability and quality of independent pricing information is considered during the classification process. An assessment is made regarding the quality of the independent information. For example where consensus prices are used for non-modelled products, a key assessment of the quality of a price is the depth of the number of prices used to provide the consensus price. If the depth of contributors falls below a set hurdle rate, the instrument is considered to be level 3. This hurdle rate is consistent with the rate used in the IPV process to determine whether or not the data is of sufficient quality to adjust the instrument’s valuations. However where an instrument is generally considered to be illiquid, but regular quotes from market participants exist, these instruments may be classified as level 2 depending on frequency of quotes, other available pricing and whether the quotes are used as part of the IPV process or not.
The option to exit the APS is not usually present in such tranched trades and consequently, there is no standard market practice for reflecting this part of the trade within the standard model framework. The approach that has been adopted assumes that the Group will not exit the trade before the minimum level of fees has been paid and at this point it will be clear whether it should exit the trade or not. The APS derivative is valued as the payment of the minimum level of fees in return for protection receipts which are in excess of both the first loss and the total future premiums.
Financial liabilities Deposits by banks 50.0 50.4 88.5 88.3 176.9 176.3 Customer accounts 438.5 438.6 552.8 552.1 575.5 576.4 Debt securities in issue 167.2 163.8 222.1 218.5 248.8 241.3 Settlement balances 11.0 11.0 10.4 10.4 11.7 11.7 Subordinated liabilities 25.9 21.9 36.4 31.6 47.6 36.4
The fair values of the company’s financial assets and liabilities are not materially different from their carrying values apart from subordinated liabilities, 2010 carrying value £8.0 billion, fair value £5.8 billion (2009 - carrying value £8.8 billion; fair value £4.9 billion; 2008 - carrying value £10.3 billion; fair value £8.8 billion) and debt securities, 2010 carrying value £1.5 billion, fair value £1.8 billion (2009 - carrying value £1.3 billion, fair value £1.3 billion; 2008 - nil)
Cost Provision value Cost Provision value Cost Provision value £m £m £m £m £m £m £m £m £m Loans and receivables Loans and advances to banks (1) 145 127 18 206 157 49 129 127 2 Loans and advances to customers (2) 35,556 15,405 20,151 34,801 14,050 20,751 19,350 8,945 10,405
Available-for-sale Gross unrealised gains 41 41 1,104 1,372 1,238 332 266 4,394 Gross unrealised losses — (166) (3,457) (168) (3,533) (426) (80) (7,830)
Notes: (1) The company does not hold any of the NatWest preference shares in issue. (2) Coutts & Company is incorporated with unlimited liability. Its registered office is 440 Strand, London WC2R 0QS. (3) Ulster Bank Limited and its subsidiaries also operate in the Republic of Ireland. (4) RFS Holdings B.V. (RFS) owns 100% of the outstanding shares of RBS Holdings N.V. (ABN AMRO Holding N.V. prior to 1 April 2010). Until 31 December 2010, the company owned 38% of RFS; the balance of shares were held by the State of the Netherlands, successor to Fortis N.V., Fortis SA/NV, and Banco Santander S.A. (the consortium members). Although the company did not control a majority of the voting rights in RFS, through the terms of the Consortium and Shareholders' Agreement and RFS's Articles of Association, it controlled the board of RFS and RFS is a subsidiary of the company. RFS Holdings has substantially completed the separation of the business units of ABN AMRO Holding N.V. As part of this reorganisation, on 6 February 2010, the businesses of ABN AMRO Holding N.V. acquired by the Dutch State were legally demerged from the ABN AMRO Holding N.V. businesses acquired by the Group and were transferred into a newly established holding company, ABN AMRO Bank N.V. (save for certain assets and liabilities acquired by the Dutch State that were not part of the legal separation and which will be transferred to the Dutch State as soon as possible). Legal separation of ABN AMRO Bank N.V. occurred on 1 April 2010, with the shares in that entity being transferred by RBS Holdings N.V. to a holding company called ABN AMRO Group N.V., which is owned by the Dutch State. Following legal separation, RBS Holdings N.V. has one direct subsidiary, The Royal Bank of Scotland N.V. (RBS N.V.), a fully operational bank within the Group. RBS N.V. is independently rated and regulated by the Dutch Central Bank. On 31 December 2010, the shareholdings of RFS were amended such that approximately 98% of its issued share capital is now held by the company with the remainder owned by the State of the Netherlands and Banco Santander S.A. Certain assets within RBS N.V. continue to be shared by the Consortium Members. On the division of an entity by demerger, Dutch law establishes a cross liability between surviving entities in respect of the creditors at the time of the demerger. RBS N.V.’s cross liability is limited by law to the lower of its equity and the debts of ABN AMRO Bank N.V. on 1 April 2010. The likelihood of any cross liability crystallising is considered remote.
The CGUs of the Group, excluding RFS Holdings minority interest, where the goodwill is significant, principally arose on the acquisitions of NatWest, ABN AMRO, Charter One and Churchill and are as follows: Recoverable amount based on
Liabilities of disposal groups Deposits by banks 266 — 266 618 — Customer accounts 352 1,915 2,267 8,907 — Derivatives 5,021 21 5,042 6,683 — Settlement balances 907 — 907 950 — Subordinated liabilities — — — 6 — Other liabilities 393 532 925 1,675 — Discontinued operations and other disposal groups 6,939 2,468 9,407 18,839 — Liabilities acquired exclusively with a view to disposal — 21 21 51 859 6,939 2,489 9,428 18,890 859
Company Currently 2010 2011 2012-2014 2015-2019 Thereafter Perpetual Total 2009 - call date £m £m £m £m £m £m £m £m
National Westminster Bank Plc US$1,000 million 7.375% subordinated notes 2009 — — 697 €600 million 6% subordinated notes 2010 (redeemed January 2010) — 564 623
Loans and advances to banks 27,271 25,712 43,126 Loans and advances to customers 46,352 38,924 53,894 Debt securities 7,200 8,723 13,191 80,823 73,359 110,211
Banks, financial corporations and public corporations Total £m £m £m £m £m £m £m £m £m £m £m £m
Potential problem loans (4) Domestic 506 424 218 63 47 Foreign 127 585 8 608 5
Total UK offices 395,875 392,718 456,443 Overseas Demand deposits - interest-free 29,919 36,458 29,253
Economic and monetary environment Global recovery has continued in 2010, but the strength of the recovery remains unevenly spread. Although most developed countries have avoided a double-dip, they have been unable to find a firm footing from which to build a solid recovery. This reflects the burden of high levels of public and private sector debt, low consumer confidence and high levels of unemployment.
General insurance business is principally undertaken by Direct Line Insurance plc and Churchill Insurance Company Limited.
The company also made a commitment to increase lending to homeowners, including first time buyers, in the United Kingdom. The company undertook to increase its residential mortgage lending by at least £9 billion above the amount previously budgeted in the 12 months commencing 1 March 2009.
Accession Agreement and the UK Asset Protection Scheme Terms and Conditions The company acceded to the APS through an accession agreement (the "Accession Agreement") entered into with HM Treasury, which became effective on 22 December 2009. Supplemental agreements were signed on 27 August 2010, 20 December 2010 and 10 February 2011. The Accession Agreement incorporates the terms and conditions of the APS set out in the document entitled ‘UK Asset Protection Scheme Terms and Conditions’ which is available on HM Treasury's website (the ‘Scheme Conditions’). The Accession Agreement which incorporates the Scheme Conditions is accounted for as a credit derivative and it tailors the APS to the company (by, amongst other things, setting applicable bank-specific thresholds and addressing a limited number of other bank-specific issues).
The company and its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act 2009. Under the Banking Act 2009 (the “Banking Act”), substantial powers have been granted to HM Treasury, the Bank of England and the FSA (together, the “Authorities”) as part of a special resolution regime (the “SRR”). These powers enable the Authorities to deal with UK banks, building societies and other institutions with permission to accept deposits pursuant to Part IV of the Financial Services and Markets Act 2000 (“FSMA”) (each, a “relevant entity”) where the conditions set out in the next paragraph headed “The SRR may be triggered prior to the insolvency of the company or its UK bank subsidiaries” are met. The SRR consists of three stabilisation options and two insolvency and administration procedures applicable to UK banks which may be commenced by the Authorities. The stabilisation options provide for: (i) transfer of all or part of the business of the relevant entity to a private sector purchaser; (ii) transfer of all or part of the business of the relevant entity to a “bridge bank” established by the Bank of England; and (iii) temporary public ownership (nationalisation) of the relevant entity or its UK-incorporated holding company. In each case, the Authorities have been granted wide powers under the Banking Act including powers to modify contractual arrangements in certain circumstances and powers for HM Treasury to disapply or modify laws (with possible retrospective effect) to enable the powers under the Banking Act to be used effectively. The following paragraphs of this risk factor headed “The company and its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act 2009” set out some of the possible consequences of the exercise of those powers under the SRR.
While the main provisions of the Banking (Special Provisions) Act 2008 were in force, which conferred certain transfer powers on HM Treasury, the UK Government took action under that Act in respect of a number of UK financial institutions, including, in extreme circumstances, full and partial nationalisation. There have been concerns in the market in recent years regarding the risks of such nationalisation in relation to the company and other UK banks. If economic conditions in the UK or globally were to deteriorate, or the events described in the following risk factors were to occur to such an extent that they had a materially adverse impact on the financial condition, perceived or actual credit quality, results of operations or business of any of the relevant entities in the Group, the UK Government may decide to take similar action in relation to the company under the Banking Act. Given the extent of the Authorities’ powers under the Banking Act, it is difficult to predict the effect that such actions might have on the Group and any securities issued by the company or Group companies. However, potential impacts may include full nationalisation of the company, the total loss of value in Securities issued by the company and the inability of the company to perform its obligations under the Securities.
Changes in interest rates, foreign exchange rates, credit spreads, bond, equity and commodity prices, basis, volatility and correlation risks and other market factors have significantly affected and will continue to affect the Group’s business and results of operations. Some of the most significant market risks the Group faces are interest rate, foreign exchange, credit spread, bond, equity and commodity price and basis, volatility and correlation risks. Changes in interest rate levels, yield curves and spreads may affect the interest rate margin realised between lending and borrowing costs, the effect of which may be heightened during periods of liquidity stress, such as those experienced in recent years. Changes in currency rates, particularly in the sterling-US dollar and sterling-euro exchange rates, affect the value of assets, liabilities, income and expenses denominated in foreign currencies and the reported earnings of the company’s non-UK subsidiaries (principally Citizens Financial Group, Inc. (“Citizens”), The Royal Bank of Scotland N.V. (which was renamed from “ABN AMRO Bank N.V.” on 6 February 2010) (“RBS N.V.”) and RBS Securities Inc.) and may affect income from foreign exchange dealing. The company prepares its consolidated financial statements in sterling. Fluctuations in the exchange rates used to translate other currencies into sterling affect the company’s reported consolidated financial condition, results of operations and cash flows from year to year and those of the Group’s operations whose functional currency is not sterling.
The performance of financial markets may affect bond, equity and commodity prices and, therefore, cause changes in the value of the Group’s investment and trading portfolios. This has been the case during the period since August 2007, with market disruptions and volatility resulting in significant variations in the value of such portfolios. As part of its ongoing derivatives operations, the Group also faces significant basis, volatility and correlation risks for which materialisation is highly dependent on relative changes in the first order risks referred to above. While the Group has implemented risk management methods to mitigate and control these and other market risks to which it is exposed, it is difficult, particularly in the current environment, to predict with accuracy changes in economic or market conditions and to anticipate the effects that such changes could have on the Group’s financial performance and business operations.
On 17 December 2009, the Basel Committee on Banking Supervision (the “Basel Committee”) proposed a number of fundamental reforms to the regulatory capital framework in its consultative document entitled “Strengthening the resilience of the banking sector”. On 12 September 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee, announced further details of the proposed substantial strengthening of existing capital requirements, and the reforms were endorsed by the G-20 leaders after the G-20 Summit in Seoul in November 2010. On 16 December 2010, the Basel Committee published the Basel III rules in documents entitled “Basel III: A global regulatory framework for more resilient banks and banking systems” (containing the reforms relating to capital) and “Basel III: International framework for liquidity risk measurement, standards and monitoring” (containing the reforms relating to liquidity).
Notwithstanding the Group’s participation in the APS and the issue of the £25.5 billion of B Shares and, if required, the issue of the £8 billion of Contingent B Shares, the Group remains exposed to a substantial first loss amount of £60 billion (net of recoveries) in respect of the Covered Assets and for 10 per cent. of Covered Assets losses after the first loss amount. There is therefore no assurance that the Group’s participation in the APS and the issue of B Shares and, if required, the Contingent B Shares will achieve the Group’s goals of improving and maintaining the Group’s capital ratios in the event of further losses and improving market confidence in the Group. Moreover, the Group continues to carry the risk of losses, impairments and write-downs with respect to assets not covered by the APS.
Participation in the APS may give rise to litigation and regulatory risk. In order to fulfil (or as a consequence of fulfilling) its disclosure obligations under the APS by disclosing certain information to HM Treasury (and, as a result of notices issued by it, the FSA), the Group may incur the risk of civil suits, criminal liability or regulatory actions. Adverse regulatory action or adverse judgments in litigation could have a significant effect on the Group’s reputation or results of operations or result in a loss of value in the Securities. Alternatively, in order to avoid the risk of such civil suits or regulatory actions or to avoid the risk of criminal liability, the Group may choose to or be required to remove Covered Assets from the APS so as not to be required to disclose such information to HM Treasury, with the result that such assets will not be protected by the APS. The effect of the removal of such Covered Assets will impact the level of protection available to the Group and may materially reduce the protection anticipated by the Group for its stressed losses, in which case its business, results of operations and financial condition will suffer.
More detailed information on this or similar activity can be found on the FSA website (www.fsa.gov.uk/pages/consumerinformation)
Trading market continued Ordinary shares The following table shows, for the periods indicated, the high and low sales prices for the company's ordinary shares on the London Stock Exchange, as derived from the Daily Official List of the UK Listing Authority. Prices for 2008, 2007 and 2006 were restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.
On 22 February 2011, the closing price of the ordinary shares on the London Stock Exchange was £0.48, equivalent to $0.77 per share translated at the Noon Buying Rate of $1.6129 per £1.00 on 22 February 2011.
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 Taxation 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 ordinary shares, non-cumulative dollar preference shares, ordinary ADSs, preference ADSs or PROs by consulting their own tax advisers.
UK stamp duty and stamp duty reserve tax (SDRT) The following is a summary of the UK stamp duty and SDRT consequences of transferring an ADS or ADR in registered form (otherwise than to the custodian on cancellation of the ADS) or of transferring an ordinary share or a non-cumulative dollar preference share. A transfer of a registered ADS or ADR executed and retained in the United States will not give rise to stamp duty and an agreement to transfer a registered ADS or ADR will not give rise to SDRT. Stamp duty or SDRT will normally be payable on or in respect of transfers of ordinary shares or non-cumulative dollar preference shares and accordingly any holder who acquires or intends to acquire ordinary shares or noncumulative dollar preference shares is advised to consult its own tax advisers in relation to stamp duty and SDRT.
Constant proportion portfolio insurance notes (CPPI notes) - CPPI is the name given to a trading strategy that is designed to ensure that a fixed minimum return is achieved either at all times or more typically, at a set date in the future. Essentially the strategy involves continuously re- balancing the portfolio of investments during the term of the product between performance assets and safe assets using a pre-set formula. CPPI notes provide investors with a return linked to a CPPI portfolio.
International Accounting Standards Board (IASB) - is the independent standard-setting body of the IASC Foundation. Its members are responsible for the development and publication of International Financial Reporting Standards (IFRS) and for approving Interpretations of IFRS as developed by the International Financial Reporting Interpretations Committee (IFRIC).
Interest rate swap - a contract under which two counterparties agree to exchange periodic interest payments on a predetermined monetary principal, the notional amount.
Residential mortgage backed securities (RMBS ) - are asset-backed securities for which the underlying asset portfolios are residential mortgages.
Regulatory reviews and developments 398 Insurance premium income Accounting policy 278 Related parties 383 Notes on the accounts 344