Presentation of information
In this document, and unless specified otherwise, the term ‘company’ means The Royal Bank of Scotland Group plc, ‘RBS’ or the ‘Group’ means the company and its subsidiaries, ‘the Royal Bank’ means The Royal Bank of Scotland plc and ‘NatWest’ means National Westminster Bank Plc.
The company publishes its financial statements in pounds sterling (‘£’ or ‘sterling’). The abbreviations ‘£m’ and ‘£bn’ represent millions and thousands of millions of pounds sterling, respectively, and references to ‘pence’ represent pence in the United Kingdom (‘UK’). Reference to ‘dollars’ or ‘$’ are to United States of America (‘US’) dollars. The abbreviations ‘$m’ and ‘$bn’ represent millions and thousands of millions of dollars, respectively, and references to ‘cents’ represent cents in the US. The abbreviation ‘€’ represents the ‘euro’, the European single currency, and the abbreviations ‘€m’ and ‘€bn’ represent millions and thousands of millions of euros, respectively.
Certain information in this report is presented separately for domestic and foreign activities. Domestic activities primarily consist of the UK domestic transactions of the Group. Foreign activities comprise the Group’s transactions conducted through those offices in the UK specifically organised to service international banking transactions and transactions conducted through offices outside the UK.
The geographic analysis in the average balance sheet and interest rates, changes in net interest income and average interest rates, yields, spreads and margins in this report have been compiled on the basis of location of office – UK and overseas. Management believes that this presentation provides more useful information on the Group’s yields, spreads and margins of the Group’s activities than would be provided by presentation on the basis of the domestic and foreign activities analysis used elsewhere in this report as it more closely reflects the basis on which the Group is managed. ‘UK’ in this context includes domestic transactions and transactions conducted through the offices in the UK which service international banking transactions.
The results, assets and liabilities of individual business units are classified as trading or non-trading based on their predominant activity. Although this method may result in some non-trading activity being classified as trading, and vice versa, the Group believes that any resulting misclassification is not material.
International Financial Reporting Standards
As required by the Companies Act 2006 and Article 4 of the European Union IAS Regulation, the consolidated financial statements of the Group are prepared 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 of the IASB (together ‘IFRS’) as adopted by the European Union. They also comply with IFRS as issued by the IASB.
Acquisition of ABN AMRO
On 17 October 2007, RFS Holdings B.V. (“RFS Holdings”), which at the time was owned by RBSG, Fortis N.V., Fortis S.A./N.V., Fortis Bank Nederland (Holding) N.V. (“Fortis”) and Banco Santander, S.A. (“Santander”), completed the acquisition of ABN AMRO Holding N.V. (which was renamed RBS Holdings N.V. on 1 April 2010).
RFS Holdings, which is now jointly owned by RBSG, the Dutch State (following its acquisition of Fortis) and Santander (the “Consortium Members”), is continuing the process of implementing an orderly separation of the business units of RBS Holdings N.V. As part of this reorganisation, on 6 February 2010, the businesses of RBS Holdings N.V. acquired by the Dutch State were legally demerged from the RBS Holdings 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. Certain assets within RBS Holdings N.V. continue to be shared by the Consortium Members. RBS Holdings N.V. is a fully operational bank within the Group and is independently rated and licensed and regulated by the Dutch Central Bank.
Statutory results
RFS Holdings is jointly owned by the consortium members. It is controlled by the company and is therefore fully consolidated in its financial statements. Consequently, the statutory results of the Group include the results of ABN AMRO. The interests of Fortis, and its successor the State of the Netherlands, and Santander in RFS Holdings are included in minority interests.
Presentation of information continued
Restatements
Divisional results for 2008 have been restated to reflect the Group’s new organisational structure that includes a Non-Core division comprising individual assets, portfolios and lines of business that the Group intends to run off or dispose. The Non-Core division is reported separately from the divisions which form the Core Group. In addition, separate reporting of Business Services (formerly Group Manufacturing) and Centre results has changed and, with the exception of certain items of a one off nature, costs incurred are now allocated to the customer-facing divisions and included in the measurement of the returns which they generate. The changes do not affect the Group’s results. Comparatives have been restated accordingly.
IAS 1 (Revised 2007) ‘Presentation of Financial Statements’ has required the Group to present a third balance sheet (31 December 2007) as a result of the restatement of the Group’s income statement following the implementation of IFRS 2 (see below). A fourth balance sheet (31 December 2006) has not been presented as there is no material impact on that period.
Results for 2008 have been restated for the amendment to IFRS 2 ‘Share-based Payment’. This has resulted in an increase in staff costs amounting to £169 million for 2008 with no material effect on earlier periods.
Glossary
A glossary of terms is detailed on pages 355 to 359.
Forward-looking statements
Certain sections in this document contain ‘forward-looking statements’ as that term is defined in the United States Private Securities Litigation Reform Act of 1995, such as statements that include the words ‘expect’, ‘estimate’, ‘project’, ‘anticipate’, ‘believes’, ‘should’, ‘intend’, ‘plan’, ‘probability’, ‘risk’, ‘Value-at-Risk (VaR)’, ‘target’, ‘goal’, ‘objective’, ‘will’, ‘endeavour’, ‘outlook’, ‘optimistic’, ‘prospects’ and similar expressions or variations on such expressions.
In particular, this document includes forward-looking statements relating, but not limited to: the Group’s restructuring plans, capitalisation, portfolios, capital ratios, liquidity, risk weighted assets, return on equity, cost:income ratios, leverage and loan:deposit ratios, funding and risk profile; the Group’s future financial performance; the level and extent of future impairments and write-downs; the protection provided by the APS; and to the Group’s potential exposures to various types of market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. These statements are based on current plans, estimates and projections, and are subject to inherent risks, uncertainties and other factors which could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. For example, certain of the market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and, as a result, actual future gains and losses could differ materially from those that have been estimated.
Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to: the full nationalisation of the Group or other resolution procedures under the Banking Act 2009; the global economy and instability in the global financial markets, and their impact on the financial industry in general and on the Group in particular; the financial stability of other financial institutions, and the Group’s counterparties and borrowers; the ability to complete restructurings on a timely basis, or at all, including the disposal of certain non-core assets and assets and businesses required as part of the EC State Aid restructuring plan; organizational restructuring; the ability to access sufficient funding to meet liquidity needs; cancellation or failure to renew governmental support schemes; the extent of future write-downs and impairment charges caused by depressed asset valuations; the inability to hedge certain risks economically; the value and effectiveness of any credit protection purchased by the Group; unanticipated turbulence in interest rates, foreign currency exchange rates, credit spreads, bond prices, commodity prices and equity prices; changes in the credit ratings of the Group; ineffective management of capital or changes to capital adequacy or liquidity requirements; changes to the valuation of financial instruments recorded at fair value; competition and consolidation in the banking sector; HM Treasury exercising influence over the operations of the Group; the ability of the Group to attract or retain senior management or other key employees; regulatory change or a change in UK Government policy; changes to the monetary and interest rate policies of the Bank of England, the Board of Governors of the Federal Reserve System and other G7 central banks; impairment of goodwill; pension fund shortfall; litigation and regulatory investigations; general operational risks; insurance claims; reputational risk; general geopolitical and economic conditions in the UK and in other countries in which the Group has significant business activities or investments, including the United States; the ability to achieve revenue benefits and cost savings from the integration of certain of RBS Holdings N.V.’s businesses and assets; changes in UK and foreign laws, regulations, accounting standards and taxes, including changes in regulatory capital regulations and liquidity requirements; the participation of the Group in the APS and the effect of such Scheme on the Group’s financial and capital position; the ability to access the contingent capital arrangements with HM Treasury; the conversion of the B Shares in accordance with their terms; limitations on, or additional requirements imposed on, the Group’s activities as a result of HM Treasury’s investment in the Group; and the success of the Group in managing the risks involved in the foregoing.
The forward-looking statements contained in this document speak only as of the date of this report, and the Group does not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
For a further discussion of certain risks faced by the Group, see Risk factors on pages 7 to 22.
Business review
Description of business
Introduction
The Royal Bank of Scotland Group plc is the holding company of a large global banking and financial services group. Headquartered in Edinburgh, the Group operates in the United Kingdom, the United States 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 United States, the Group’s subsidiary Citizens is a large commercial banking organisation. 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 in over 50 countries.
Following placing and open offers in December 2008 and in April 2009, HM Treasury owned 70.3% of the enlarged ordinary share capital of the company.
In December 2009, the company issued £25.5 billion of new capital to HM Treasury. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary shareholders but are convertible into ordinary shares and qualify as core tier one capital.
Following the issuance of B shares, HM Treasury’s holding of ordinary shares of the company remained at 70.3% although its economic interest rose to 84.4%.
HM Treasury has agreed not to convert its B shares into ordinary shares to the extent that its holding of ordinary shares following the conversion would represent more than 75% of the company’s issued ordinary share capital.
In March 2010, the company converted 935,228 non-cumulative dollar preference shares in the company into ordinary shares resulting in approximately 1.6 billion ordinary shares being issued. This increase in the company's issued ordinary share capital resulted in HMT's holding in the company's ordinary shares reducing to approximately 68.4%.
The Group had total assets of £1,696.5 billion and owners’ equity of £77.7 billion at 31 December 2009. The Group’s capital ratios, which included the equity minority interest of the State of the Netherlands and Santander in ABN AMRO, were a total capital ratio of 16.1 per cent., a core Tier 1 capital ratio of 11.0 per cent. and a Tier 1 capital ratio of 14.1 per cent., as at 31 December 2009.
Organisational structure and business overview
Following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. A Non-Core division has been created comprising those lines of business, portfolios and individual assets that the Group intends to run off or sell. Furthermore, Business Services (formerly Group Manufacturing) is no longer reported as a separate division and its costs are now allocated to the customer-facing divisions along with certain central costs. UK Retail & Commercial Banking has been split into three segments (UK Retail, UK Corporate and Wealth). Ulster Bank has become a specific segment. The remaining elements of Europe & Middle East Retail & Commercial Banking, Asia Retail & Commercial Banking and Share of shared assets form part of Non-Core. The segment measure is now Operating profit/(loss) before tax which differs from Contribution used previously; it excludes certain infrequent items and RFS Holdings minority interest, which is not an operating segment of the Group. Comparative data have been restated accordingly.
UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through the RBS and NatWest networks of branches and ATMs in the United Kingdom, and also through telephone and internet channels.
UK Corporate is a leading provider of banking, finance, and risk management services to the corporate and SME sector in the United Kingdom. It offers a full range of banking products and related financial services through a nationwide network of relationship managers, and also through telephone and internet channels. The product range includes asset finance through the Lombard brand.
Wealth provides private banking and investment services in the UK through Coutts & Co and Adam & Company, offshore banking through RBS International, NatWest Offshore and Isle of Man Bank, and international private banking through RBS Coutts.
Global Banking & Markets (GBM) is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. The division is organised along six principal business lines: money markets; rates flow trading; currencies and commodities; equities; credit markets and portfolio management & origination.
Global Transaction Services ranks among the top five global transaction services providers, offering global payments, cash and liquidity management, and trade finance and commercial card products and services. It includes the Group’s corporate money transmission activities in the United Kingdom and the United States as well as Global Merchant Services, the Group’s United Kingdom and international merchant acquiring business.
Ulster Bank is the leading retail and commercial bank in Northern Ireland and the third largest banking group on the island of Ireland. It provides a comprehensive range of financial services through both its Retail Markets division which has a network of branches and operates in the personal and bancassurance sectors, and its Corporate Markets division which provides services to SME business customers, corporates and institutional markets.
US Retail & Commercial provides financial services primarily through the Citizens and Charter One brands. US Retail & Commercial is engaged in retail and corporate banking activities through its branch network in 12 states in the United States and through non-branch offices in other states. It ranks among the top five banks in New England.
RBS Insurance sells and underwrites retail and SME insurance over the telephone and internet, as well as through brokers and partnerships. Its brands include Direct Line, Churchill and Privilege, which sell general insurance products direct to the customer, as well as Green Flag and NIG.
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Through its international division, RBS Insurance sells general insurance, mainly motor, in Germany and Italy. The Intermediary and Broker division sells general insurance products through independent brokers.
Business Services (formerly Group Manufacturing) supports the customer-facing businesses and provides operational technology, customer support in telephony, account management, lending and money transmission, global purchasing, property and other services. Business Services drives efficiencies and supports income growth across multiple brands and channels by using a single, scalable platform and common processes wherever possible. It also leverages the Group’s purchasing power and is the Group’s centre of excellence for managing large-scale and complex change.
Central Functions comprises group and corporate functions, such as treasury, funding and finance, risk management, legal, communications and human resources. The Centre manages the Group’s capital resources and Group-wide regulatory projects and provides services to the operating divisions.
Non-Core Division manages separately assets that the Group intends to run off or dispose. The division contains a range of businesses and asset portfolios primarily from the GBM division including RBS Sempra Commodities, linked to proprietary trading, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also includes a number of other portfolios and businesses including regional markets businesses that the Group has concluded are no longer strategic.
Business divestments
To comply with European Commission State Aid (EC State Aid) requirements the Group has agreed a series of restructuring measures to be implemented over a four year period. This will supplement the measures in the strategic plan previously announced by the Group. These include divesting fully RBS Insurance, Global Merchant Services and RBS Sempra Commodities, as well as divesting the RBS branch-based business in England & Wales and the NatWest branches in Scotland, along with the Direct SME customers across the UK.
Relationship with major shareholder
The UK Government currently owns 68.4 per cent. of the issued ordinary share capital of RBS. The UK Government’s shareholding in RBS is currently held by the Solicitor for the Affairs of HM Treasury as nominee for HM Treasury and managed by UK Financial Investments Limited (“UKFI”), a company wholly owned by HM Treasury. The relationship between HM Treasury and UKFI, and between UKFI and Government investee banks is set out in the UKFI Framework Document and Investment Mandate, agreed between HM Treasury and UKFI.
The Framework Document sets out UKFI’s overarching objective, to “develop and execute an investment strategy for disposing of the investments [in the banks] in an orderly and active way through sale, redemption, buy-back or other means within the context of an overarching objective of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and to acting in a way that promotes competition.”
It states that UKFI will manage the UK financial institutions in which HM Treasury holds an interest “at an arms length and on a commercial basis and will not intervene in day-to-day management decisions of the Investee Companies (including with respect to individual lending or remuneration decisions)”.This document also makes it clear that such UK financial institutions “will continue to have their own independent boards and management teams, determining their own strategies and commercial policies (including business plans and budgets).”
HM Treasury expects UKFI to act in the same way as any other engaged institutional shareholder would. The UKFI Investment Mandate states that it will “follow best institutional shareholder practice. This includes compliance with the Institutional Shareholders’ Committee’s Statement of Principles together with any developments to best institutional shareholder practice arising from recommendations or guidance contained in the Walker Review or elsewhere.”
For example, RBS announced on 17 February 2009 that it had reached an agreement with UKFI in respect of certain changes to its remuneration policy. RBS also undertook to conduct a review of its strategy and UKFI was actively engaged in reviewing the output of this review, as any other engaged shareholder would be expected to be. RBS has made a commitment to comply with the FSA Remuneration Code. These rules came into force on 1 January 2010 and are in line with the agreement reached by the G-20, setting global standards for the implementation of the Financial Stability Board’s remuneration principles. RBS agreed that it will be at the leading edge of implementing the G-20 principles. UKFI was granted consent rights over the shape and size of the RBS aggregate bonus pool for the 2009 performance year. Separate to the shareholding relationship, RBS has a number of relationships with the UK Government arising out of the Government’s provision of support.
As a result of the Government’s recapitalisation of RBS, an undertaking was given to UKFI in 2008 to appoint a new Chairman and three new Non-executive Directors to the Group Board. This undertaking has been completed by the following appointments: Philip Hampton as Chairman, Sandy Crombie as Senior Independent Director and Philip Scott and Penny Hughes as Non-executive Directors. In addition, Brendan Nelson was appointed as a Non-executive Director with effect from 1 April 2010. Subsequently, UKFI were consulted as majority shareholder on proposed Non-executive Director appointments but in all cases the usual process for appointments was followed i.e. candidates were considered by the Nominations Committee and then recommended to the Group Board for approval. For the avoidance of doubt, no member of the Board represents or acts on the instructions of UKFI or HMT. There is no further arrangement with UKFI in this regard, beyond usual shareholder rights, and no such arrangements with any other shareholder.
In connection with its accession to the APS (further details of which are set out above), RBS has undertaken to provide lending to creditworthy UK homeowners and businesses in a commercial manner. RBS’s compliance with this commitment is subject to a monthly reporting process to the UK Government. The lending commitment does not require RBS to engage in uncommercial practices.
Certain other considerations relating to RBS’s relationship with HM Treasury and UKFI are set out in the risk factors headed “HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the Group”.
Other than in relation to these areas, however, the UK Government has confirmed publicly that its intention is to allow the financial institutions in which it holds an interest to operate their business independently, as set out in UKFI’s governance documents described above.
As a result of the UK Government’s holding, the UK Government and UK Government controlled bodies became related parties of the Group. In the normal course of business the Group enters into transactions with many of these bodies on an arms' length basis.
The Group is not a party to any transaction with the UK Government or any UK Government controlled body involving goods or services which is material to the Group, or any such transaction that is unusual in its nature or conditions. To the Group's knowledge, the Group is not a party to any transaction with the UK Government or any UK Government controlled body involving goods or services which is material to the UK Government or any UK Government controlled body. However, given the nature and extent of the UK Government controlled bodies, the Group may not know whether a transaction is material for such a party.
Any outstanding loans made by the Group to or for the benefit of the UK Government or any UK Government controlled body, were made on an arm's length basis and (A) such loans were made in the ordinary course of business, (B) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and (C) did not involve more than the normal risk of collectibility or present other unfavorable features. The Group notes, however, that with respect to outstanding loans made by the Group to or for the benefit of the UK Government or any UK Government controlled body, there may not exist any comparable transactions with other persons.
Recent Developments
On 25 March 2010, the RBS Group announced its intention to launch (i) an offer to exchange certain subordinated debt securities issued by Group members for new senior debt and (ii) tender offers in respect of certain preference shares, preferred securities and perpetual securities issued by Group members. The RBS Group announced the offers on 6 April 2010 and will seek shareholder approvals as required in coordination with the annual general meeting of The Royal Bank of Scotland Group plc scheduled to take place on 28 April 2010.
In January 2010, the FSA informed the Group that it intended to commence an investigation into certain aspects of the handling of customer complaints. On 25 March 2010 FSA formally notified the Group of the appointment of investigators in respect of aspects of complaint handling relating to RBS and NatWest retail bank products and services. The company and its subsidiaries intend to co-operate fully with this investigation.
In March 2010, the company converted 935,228 non-cumulative dollar preference shares in the company into ordinary shares resulting in approximately 1.6 billion ordinary shares being issued. This increase in the company's issued ordinary share capital resulted in HMT's holding in the company's ordinary shares reducing to approximately 68.4%.
In the UK, the OFT has been investigating RBS Group for alleged conduct in breach of Article 101 of the Treaty on the Functioning of the European Union and/or the Chapter 1 prohibition of the Competition Act 1998 relating to the provision of loan products to professional services firms. RBS Group co-operated fully with the OFT's investigation. On 30 March 2010 the OFT announced that it has arrived at an early resolution agreement with RBS Group by which RBS Group will pay a (discounted) fine of £28.59 million and admit a breach in competition law relating to the provision of loan products to professional services firms.
Brendan Nelson has been appointed as a non-executive director with effect from 1 April 2010. Brendan will succeed Archie Hunter as Chairman of the Group Audit Committee with effect from the conclusion of the Group's Annual General Meeting on 28 April 2010.
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. Certain assets within RBS Holdings N.V. continue to be shared by the Consortium Members. RBS Holdings N.V. is a fully operational bank within the Group and is independently rated and licensed and regulated by the Dutch Central Bank.
Competition
The Group faces strong competition in all the markets it serves. However, the global banking crisis has reduced either the capacity or appetite of many institutions to lend and has resulted in the withdrawal or disappearance of a number of market participants and significant consolidation of competitors, particularly in the US and UK. Competition for retail deposits has intensified significantly as institutions have re-orientated their funding strategies following the difficulties experienced in the wholesale markets since late 2007.
Competition for corporate and institutional customers in the UK is from UK banks and from large foreign financial institutions who are also active and offer combined investment and commercial banking capabilities. In asset finance, the Group competes with banks and specialised asset finance providers, both captive and non-captive. In European and Asian corporate and institutional banking markets the Group competes with the large domestic banks active in these markets and with the major international banks.
In the small business banking market, the Group competes with other UK clearing banks, specialist finance providers and building societies.
In the personal banking segment the Group competes with UK banks and building societies, major retailers and life assurance companies. In the mortgage market the Group competes with UK banks and building societies. A number of competitors have either left or scaled back their lending in the mortgage and unsecured markets. The Group’s life assurance businesses compete with Independent Financial Advisers and life assurance companies.
In the UK credit card market large retailers and specialist card issuers, including major US operators, are active in addition to the UK banks. In addition to physical distribution channels, providers compete through direct marketing activity and the internet.
In Wealth Management, The Royal Bank of Scotland International competes with other UK and international banks to offer offshore banking services. Coutts and Adam & Company compete as private banks with UK clearing and private banks, and with international private banks. Competition in wealth management remains strong as banks maintain their focus on competing for affluent and high net worth customers.
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In Ireland, Ulster Bank competes in retail and commercial banking with the major Irish banks and building societies, and with other UK and international banks and building societies active in the market.
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.
Risk factors
Set out below are certain risk factors which could affect the Group’s future results and cause them to be materially different from expected results. The Group’s results are also affected by competition and other factors. The factors discussed in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.
The company and its United Kingdom bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act 2009.
Under the provisions of the Banking Act , substantial powers have been granted to HM Treasury and the Bank of England as part of the special resolution regime to stabilise banks that are in financial difficulties (the “SRR”), which includes certain consultation and consent rights granted to the FSA (the FSA, together with HM Treasury and the Bank of England, the “Authorities”). The SRR confers powers on the Bank of England: (i) to transfer to the private sector all or part of the business of a United Kingdom incorporated institution with permission to accept deposits pursuant to Part IV of the FSMA (a “relevant entity”) or the securities of such relevant entity; (ii) to transfer all or part of the business of the relevant entity to a “bridge bank” established by the Bank of England and also confers a power on HM Treasury to transfer into temporary public ownership (nationalise) the relevant entity or its United Kingdom incorporated holding company. The Banking Act also provides for two new insolvency and administration procedures for relevant entities.
The purpose of the stabilisation options is to address the situation where all or part of the business of a relevant entity has encountered, or is likely to encounter, financial difficulties. Accordingly, the stabilisation options may only be exercised if the FSA is satisfied that (i) a relevant entity such as the company’s United Kingdom banking subsidiaries, including The Royal Bank of Scotland plc (“RBS”) and National Westminster Bank Plc (“NatWest”), is failing, or is likely to fail, to satisfy the threshold conditions set out in Schedule 6 to the FSMA; and (ii) having regard to timing and other relevant circumstances, it is not reasonably likely that (ignoring the stabilisation options) action will be taken that will enable the relevant entity to satisfy those threshold conditions. The threshold conditions are conditions which an FSA-authorised institution must satisfy in order to retain its FSA authorisation. They are relatively wide-ranging and deal with most aspects of a relevant entity’s business, including, but not limited to, minimum capital resource requirements. It is therefore possible that the FSA may trigger one of the stabilisation options before an application for an insolvency or administration order could be made.
The stabilisation options may be exercised by means of powers to transfer property, rights or liabilities of a relevant entity and shares and other securities issued by a relevant entity. HM Treasury may also take the parent company of a relevant entity (such as the company) into temporary public ownership provided that certain conditions set out in Section 82 of the Banking Act are met. Temporary public ownership is effected by way of a share transfer order and can be actioned irrespective of the financial condition of the parent company.
If HM Treasury makes the decision to take the company into temporary public ownership, it may take various actions in relation to any securities issued by the company (the “Securities”) without the consent of holders of the Securities, including (among other things):
| (i) | transferring the Securities free from any contractual or legislative restrictions on transfer; |
| (ii) | transferring the Securities free from any trust, liability or encumbrance; |
| (iii) | extinguishing any rights to acquire Securities; |
| (iv) | delisting the Securities; |
| (v) | converting the Securities into another form or class (including for example, into equity securities); or |
| (vi) | disapplying any termination or acceleration rights or events of default under the terms of the Securities which would be triggered by the transfer. |
Where HM Treasury has made a share transfer order in respect of securities issued by the holding company of a relevant entity, HM Treasury may make an order providing for the property, rights or liabilities of the holding company or of any relevant entity in the holding company group to be transferred and where such property is held on trust, removing or altering the terms of such trust.
Accordingly, there can be no assurance that the taking of any such actions would not adversely affect the rights of holders of the Securities and/or adversely affect the price or value of their investment or that the ability of the company to satisfy its obligations under contracts related to the Securities would be unaffected. In such circumstances, such holders may have a claim for compensation under one of the compensation schemes currently existing under, or contemplated by, the Banking Act if any action is taken in respect of the Securities (for the purposes of determining an amount of compensation, an independent valuer must disregard actual or potential financial assistance provided by the Bank of England or HM Treasury). There can be no assurance that holders of the Securities would thereby recover compensation promptly and/or equal to any loss actually incurred.
If the company was taken into temporary public ownership and a partial transfer of its or any relevant entity’s business was effected, or if a relevant entity were made subject to the SRR and a partial transfer of its business to another entity was effected, the transfer may directly affect the company and/or its Group companies by creating, modifying or cancelling their contractual arrangements with a view to ensuring the provision of such services and facilities as are required to enable the bridge bank or private sector purchaser to operate the transferred business (or any
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part of it) effectively. For example, the transfer may (among other things) (i) require the company or Group companies to support and co-operate with the bridge bank or private sector purchaser; (ii) cancel or modify contracts or arrangements between the company or the transferred business and a Group company; or (iii) impose additional obligations on the company under new or existing contracts. There can be no assurance that the taking of any such actions would not adversely affect the ability of the company to satisfy its obligations under the issued Securities or related contracts.
If the company was taken into temporary public ownership and a partial transfer of its or any relevant entity’s business was effected, or if a relevant entity were made subject to the SRR and a partial transfer of its business to another entity was effected, the nature and mix of the assets and liabilities not transferred may adversely affect the company’s financial condition and increase the risk that the company may eventually become subject to administration or insolvency proceedings pursuant to the Banking Act.
While the main provisions of the Banking (Special Provisions) Act 2008 were in force, which conferred certain transfer powers on HM Treasury, the United Kingdom Government took action under that Act in respect of a number of United Kingdom financial institutions, including, in extreme circumstances, full and part nationalisation. There have been concerns in the market in the past year regarding the risks of such nationalisation in relation to the company and other United Kingdom banks. If economic conditions in the United Kingdom or globally were to deteriorate, or the events described in the following risk factors occur to such an extent that they have 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 United Kingdom 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 what effect 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.
If the relevant stabilisation option was effected in respect of the company or the stabilisation options were effected in respect of a relevant entity or its business within the Group, HM Treasury would be required to make certain compensation orders, which will depend on the stabilisation power adopted. For example, in the event that the Bank of England were to transfer some of the business of a relevant entity to a bridge bank, HM Treasury would have to make a resolution fund order including a third party compensation order pursuant to the Banking Act (Third Party Compensation Arrangements for Partial Property Transfers) Regulations 2009. However, there can be no assurance that compensation would be assessed to be payable or that holders of the Securities would recover any compensation promptly and/or equal to any loss actually incurred.
The Group’s businesses, earnings and financial condition have been and will continue to be affected by the global economy and instability in the global financial markets.
The performance of the Group has been and will continue to be influenced by the economic conditions of the countries in which it operates, particularly the United Kingdom, the United States and other countries throughout Europe, the Middle East and Asia. The outlook for the global economy over the near to medium term remains challenging, particularly in the United Kingdom, the United States and other European economies. In addition, the global financial system has yet to fully overcome the difficulties which first manifested themselves in August 2007 and financial markets conditions have not yet fully normalised. These conditions led to severe dislocation of financial markets around the world and unprecedented levels of illiquidity in 2008 and 2009, resulting in the development of significant problems at a number of the world’s largest corporate institutions operating across a wide range of industry sectors, many of whom are the Group’s customers and counterparties in the ordinary course of its business. In response to this economic instability and illiquidity in the market, a number of governments, including the United Kingdom Government, the governments of the other EU member states and the United States Government, have intervened in order to inject liquidity and capital into the financial system, and, in some cases, to prevent the failure of these institutions.
Despite such measures, the volatility and disruption of the capital and credit markets have continued, with many forecasts predicting only modest levels of GDP growth over the course of 2010. Similar conditions are likely to exist in a number of the Group’s key markets, including those in the United States and Europe, particularly Ireland. These conditions have exerted, and may continue to exert, downward pressure on asset prices and on availability and cost of credit for financial institutions, including the company, and will continue to impact the credit quality of the Group’s customers and counterparties. Such conditions, alone or in combination with regulatory changes or actions of other market participants, may cause the Group to incur losses or to experience further reductions in business activity, increased funding costs and funding pressures, lower share prices, decreased asset values, additional write-downs and impairment charges and lower profitability.
The performance of the Group may be affected by economic conditions impacting euro-zone member states. For example the financial problems experienced by the government of Greece, may lead to Greece issuing significant volumes of debt which may in turn reduce demand for debt issued by financial institutions and corporate borrowers. This could adversely affect the Group’s access to the debt capital markets and may increase the Group’s funding costs, having a negative impact on the Group’s earnings and financial condition. In addition, euro-zone countries in which the Group operates may be required to provide financial assistance to Greece, which may in turn have a negative impact on the financial condition of those EU member states. Should the economic conditions facing Greece be replicated in other euro-zone member states, the risks above would be exacerbated.
In addition, the Group will continue to be exposed to the risk of loss if major corporate borrowers or counterparty financial institutions fail or are otherwise unable to meet their obligations. The Group currently experiences certain business sector and country concentration risk, primarily focused in the United States, the United Kingdom and the rest of Europe and relating to personal and banking and financial institution exposures. The Group’s performance may also be affected by future recovery rates on assets and the historical assumptions underlying asset recovery rates, which (as has already occurred in certain instances) may no longer be accurate given the unprecedented market disruption and general economic instability. The precise nature of all the risks and uncertainties the Group faces as a result of current economic conditions cannot be predicted and many of these risks are outside the control of the Group.
The Group was required to obtain State Aid approval, for the aid given to the Group by HM Treasury and for the Group’s State Aid restructuring plan, from the European Commission. The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan. The State Aid restructuring plan includes a prohibition on the making of discretionary dividend or coupon payments on existing hybrid capital instruments (including preference shares and B Shares) for a two-year period commencing no later than 30 April 2010, which may impair the Group’s ability to raise new Tier 1 capital through the issuance of ordinary shares and other Securities.
The Group was required to obtain State Aid approval for the aid given to the Group by HM Treasury as part of the placing and open offer undertaken by the company in December 2008 (the “First Placing and Open Offer”), the issuance of £25.5 billion of B shares in the capital of the company which are, subject to certain terms and conditions, convertible into ordinary shares in the share capital of the company (the “B Shares”) to HM Treasury, a contingent commitment by HM Treasury to subscribe for up to an additional £8 billion of B Shares if certain conditions are met and the Group’s participation in the Asset Protection Scheme (the “APS”) (the “State Aid”).
As a result of the First Placing and Open Offer (approved as part of the European Commission’s approval of a package of measures to the banking industry in the United Kingdom in October 2008), the Group was required to cooperate with HM Treasury to submit a forward plan to the
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European Commission. This plan was submitted and detailed discussions took place between HM Treasury, the Group and the European Commission. The plan submitted not only had regard to the First Placing and Open Offer, but also the issuance of B Shares to HM Treasury, the commitment by HM Treasury to subscribe for additional B Shares if certain conditions were met and the Group’s participation in the APS. As part of its review, the European Commission was required to assess the State Aid and to consider whether the Group’s long-term viability would be assured, that the Group makes a sufficient contribution to the costs of its restructuring and that measures are taken to limit any distortions of competition arising from the State Aid provided to the Group by the United Kingdom Government. The Group, together with HM Treasury, agreed in principle with the European Competition Commissioner the terms of the State Aid and the terms of a restructuring plan (the “State Aid restructuring plan”). On 14 December 2009, the European Commission formally approved the Group’s participation in the APS, the issuance of £25.5 billion of B Shares to HM Treasury, a contingent commitment by HM Treasury to subscribe for up to an additional £8 billion of B Shares and the State Aid restructuring plan. The prohibition on the making of discretionary dividend (including preference shares and B Shares) or coupon payments on existing hybrid capital instruments for a two-year period commencing no later than 30 April 2010 will prevent the company from paying dividends on its ordinary and preference shares and coupons on other Tier 1 securities for the same duration, and it may impair the Group’s ability to raise new Tier 1 capital through the issuance of ordinary shares and other Securities.
It is possible a third party could challenge the approval decision in the European Courts (within specified time limits). The Group does not believe that any such challenge would be likely to succeed but, if it were to succeed, the European Commission would need to reconsider its decision, which might result in an adverse outcome for the Group, including a prohibition or amendment to some or all of the terms of the State Aid. The European Commission could also impose conditions that are more disadvantageous, potentially materially so, to the Group than those in the State Aid restructuring plan.
The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan. There is no assurance that the price that the Group receives for any assets sold pursuant to the State Aid restructuring plan will be at a level the Group considers adequate or which it could obtain in circumstances in which the Group was not required to sell such assets in order to implement the State Aid restructuring plan or if such sale were not subject to the restrictions (including in relation to potential purchasers of the United Kingdom branch divestment) contained in the terms thereof. Further, should the Group fail to complete any of the required disposals within the agreed timeframes for such disposals, under the terms of the State Aid clearance, a divestiture trustee can be empowered to conduct the disposals, with the mandate to complete the disposal at no minimum price.
Furthermore, if the Group is unable to comply with the terms of the State Aid approval it could constitute a misuse of aid. In circumstances where the European Commission doubts that the Group is complying with the terms of the State Aid approval, it may open a formal investigation. At the conclusion of this investigation, if the European Commission decides that there has been misuse of aid, it can issue a decision requiring HM Treasury to recover the misused aid which could have a material adverse impact on the Group.
In implementing the State Aid restructuring plan, the Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the Group’s business arising from implementing the State Aid restructuring plan) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals. Further, the loss of such revenues and related income may extend the time period over which the Group may pay any amounts owed to HM Treasury under the APS or otherwise. The implementation of the State Aid restructuring plan may also result in disruption to the retained business and give rise to significant strain on management, employee, operational and financial resources, impacting customers and giving rise to separation costs which could be substantial.
The implementation of the State Aid restructuring plan may result in the emergence of one or more new viable competitors or a material strengthening of one or more of the Group’s competitors in the Group’s markets. The effect of this on the Group’s future competitive position, revenues and margins is uncertain and there could be an adverse effect on the Group’s operations and financial condition and its business generally. If any or all of the risks described above, or any other currently unforeseen risks, materialise, there could be a materially negative impact on the Group’s business, operations, financial condition, capital position and competitive position.
The Group’s ability to implement its strategic plan depends on the success of the Group’s refocus on its core strengths and the balance sheet reduction programme arising out of its previously announced non-core restructuring plan and the State Aid restructuring plan.
In light of the changed global economic outlook, the Group has embarked on a financial and core business restructuring which is focused on achieving appropriate risk-adjusted returns under these changed circumstances, reducing reliance on wholesale funding and lowering exposure to capital intensive businesses. A key part of this restructuring is the programme announced in February 2009 to run-down and sell the Group’s non-core assets and the continued review of the Group’s portfolio to identify further disposals of certain non-core assets. Assets identified for this purpose and allocated to the Group's Non-Core division totalled £252 billion, excluding derivatives, as at 31 December 2008. At 31 December 2009, this total had reduced to £187 billion, excluding the Group's interest in RBS Sempra Commodities LLP (“RBS Sempra Commodities”), which was transferred to the Non-Core division during 2009. This balance sheet reduction programme will continue alongside the disposals under the State Aid restructuring plan approved by the European Commission.
Because the ability to dispose of assets and the price achieved for such disposals will be dependent on prevailing economic and market conditions, which may remain challenging, there is no assurance that the Group will be able to sell or run-down (as applicable) those businesses it is seeking to exit either on favourable economic terms to the Group or at all. Furthermore, where transactions are entered into for the purpose of selling non-core assets and businesses, they may be subject to conditions precedent, including government and regulatory approvals and completion mechanics that in certain cases may entail consent from customers. There is no assurance that such conditions precedent will be satisfied, or consents and approvals obtained, in a timely manner or at all. There is consequently a risk that the Group may fail to complete such disposals by any agreed longstop date.
Furthermore, in the context of implementing the State Aid restructuring plan, the Group is subject to certain timing and other restrictions which may result in the sale of assets at prices below those which the Group would have otherwise agreed had the Group not been required to sell such assets as part of the State Aid restructuring plan or if such sale were not subject to the restrictions contained in the terms of the State Aid conditions.
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In addition, the Group may be liable for any deterioration in businesses being sold between the announcement of the disposal and its completion. In certain cases, the period between the announcement of a transaction and its completion may be lengthy and may span many months. Other risks that may arise out of the disposal of the Group’s assets include ongoing liabilities up to completion of the relevant transaction in respect of the assets and businesses disposed of, commercial and other risks associated with meeting covenants to the buyer during the period up to completion, the risk of employee and customer attrition in the period up to completion, substantive indemnity obligations in favour of the buyer, the risk of liability for breach of warranty, the need to continue to provide transitional service arrangements for potentially lengthy periods following completion of the relevant transaction to the businesses being transferred and redundancy and other transaction costs. Further, the Group may be required to enter into covenants agreeing not to compete in certain markets for specific periods of time. In addition, as a result of the disposals, the Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the Group’s business arising from implementing the restructuring plans) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals.
Any of the above factors, either in the context of State Aid-related or non-core or other asset disposals, could affect the Group's ability to implement its strategic plan and have a material adverse effect on the Group's business, results of operations, financial condition, capital ratios and liquidity and could result in a loss of value in the Securities.
The extensive organisational restructuring may adversely affect the Group’s business, results of operations and financial condition.
As part of its refocus on core strengths and its disposal programme, the Group has undertaken and continues to undertake extensive organisational restructuring involving the allocation of assets identified as non-core assets to a separate Non-Core Division, and the run-down and sale of those assets over a period of time. In addition, to comply with State Aid clearance, the Group agreed to undertake a series of measures to be implemented over a four-year period from December 2009, which include disposing of RBS Insurance (subject to potentially maintaining a minority interest until the end of 2014). the company will also divest by the end of 2013 Global Merchant Services, subject to the company retaining up to 20 per cent. of each business within Global Merchant Services if required by the purchaser, and its interest in RBS Sempra Commodities, as well as divesting the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the direct small and medium-sized enterprise (“SME”) customers and certain mid-corporate customers across the United Kingdom. On 16 February 2010, the company announced that RBS Sempra Commodities had agreed to sell its Metals, Oil and European Energy business lines, subject to certain conditions including regulatory approvals. The Group and its joint venture partner, Sempra Energy, are continuing to consider ownership alternatives for the remaining North American Power and Gas businesses of RBS Sempra Commodities.
In order to implement the restructurings referred to above, various businesses and divisions within the Group will be re-organised, transferred or sold, or potentially merged with other businesses and divisions within the Group. As part of this process, personnel may be reallocated, where permissible, across the Group, new technology may be implemented, and new policies and procedures may be established in order to accommodate the new shape of the Group. As a result, the Group may experience a high degree of business interruption, significant restructuring charges, delays in implementation, and significant strain on management, employee, operational and financial resources. Any of the above factors could affect the Group’s ability to achieve its strategic objectives and have a material adverse effect on its business, results of operations and financial condition or could result in a loss of value in the Securities.
Lack of liquidity is a risk to the Group’s business and its ability to access sources of liquidity has been, and will continue to be, constrained.
Liquidity risk is the risk that a bank will be unable to meet its obligations, including funding commitments, as they fall due. This risk is inherent in banking operations and can be heightened by a number of enterprise specific factors, including an over-reliance on a particular source of funding (including, for example, short-term and overnight funding), changes in credit ratings or market-wide phenomena such as market dislocation and major disasters. During the course of 2008 and 2009, credit markets worldwide experienced a severe reduction in liquidity and term-funding. During this time, perception of counterparty risk between banks also increased significantly. This increase in perceived counterparty risk also led to reductions in inter-bank lending, and hence, in common with many other banking groups, the Group’s access to traditional sources of liquidity has been, and may continue to be, restricted.
The Group’s liquidity management focuses on maintaining a diverse and appropriate funding strategy for its assets, controlling the mismatch of maturities and carefully monitoring its undrawn commitments and contingent liabilities. However, the Group’s ability to access sources of liquidity (for example, through the issue or sale of financial and other instruments or through the use of term loans) during the recent period of liquidity stress has been constrained to the point where it, like other banks, has had to rely on shorter term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks. While during the course of 2009 money market conditions improved, with the Group seeing a material reduction of funding from central banks and the issuance of non-government guaranteed term debt, further tightening of credit markets could have a negative impact on the Group. The Group, in line with other financial institutions, may need to seek funds from alternative sources, potentially at higher costs of funding than has previously been the case.
In addition, there is also a risk that corporate and institutional counterparties with credit exposures may look to reduce all credit exposures to banks, given current risk aversion trends. It is possible that credit market dislocation becomes so severe that overnight funding from non-government sources ceases to be available.
Like many banking groups, the Group relies on customer deposits to meet a considerable portion of its funding. Furthermore, as part of its ongoing strategy to improve its liquidity position, the Group is actively seeking to increase the proportion of its funding represented by customer deposits. However, such deposits are subject to fluctuation due to certain factors outside the Group’s control, such as a loss of confidence, increasing competitive pressures or the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors, which could result in a significant outflow of deposits within a short period of time. There is currently heavy competition among United Kingdom banks for retail customer deposits, which has increased the cost of procuring new deposits and impacted the Group’s ability to grow its deposit base. An inability to grow, or any material decrease in, the Group’s deposits could, particularly if accompanied by one of the other factors described above, have a negative impact on the Group’s ability to satisfy its liquidity needs unless corresponding actions were taken to improve the liquidity profile of other deposits or to reduce assets. In particular, the liquidity position of the Group may be negatively impacted if it is unable to achieve the run-off and sale of non-core and other assets as expected. Any significant delay in those plans may require the Group to consider disposal of other assets not previously identified for disposal to achieve its funded balance sheet target level.
The governments of some of the countries in which the Group operates have taken steps to guarantee the liabilities of the banks and branches operating in their respective jurisdiction. Whilst in some instances the operations of the Group are covered by government guarantees alongside
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other local banks, in other countries this may not necessarily always be the case. This may place the Group’s subsidiaries operating in those countries, such as Ulster Bank Ireland Ltd, which did not participate in such government guarantee schemes, at a competitive disadvantage to the other local banks and therefore may require the Group to provide additional funding and liquidity support to these operations.
There can be no assurance that these measures, alongside other available measures, will succeed in improving the funding and liquidity in the markets in which the Group operates, or that these measures, combined with any increased cost of any funding currently available in the market, will not lead to a further increase in the Group’s overall cost of funding, which could have an adverse impact on the Group’s financial condition and results of operations or result in a loss of value in the Securities.
Governmental support schemes may be subject to cancellation, change or withdrawal or may fail to be renewed, which may have a negative impact on the availability of funding in the markets in which the Group operates.
Governmental support schemes may be subject to cancellation, change or withdrawal (on a general or individual basis, subject to relevant contracts) or may fail to be renewed, based on changing economic and political conditions in the jurisdiction of the relevant scheme. To the extent government support schemes are cancelled, changed or withdrawn in a manner which diminishes their effectiveness, or to the extent such schemes fail to generate additional liquidity or other support in the relevant markets in which such schemes operate, the Group, in common with other banking groups, may continue to face limited access to, have insufficient access to, or incur higher costs associated with, funding alternatives, which could have a material adverse impact on the Group’s business, financial condition, results of operations and prospects or result in a loss of value in the Securities.
The financial performance of the Group has been and will be affected by borrower credit quality.
Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of the Group’s businesses. Whilst some economies stabilised over the course of 2009, the Group may continue to see adverse changes in the credit quality of its borrowers and counterparties, for example, as a result of their inability to refinance their indebtedness, with increasing delinquencies, defaults and insolvencies across a range of sectors (such as the personal and banking and financial institution sectors) and in a number of geographies (such as the United Kingdom, the United States, the Middle East and the rest of Europe, particularly Ireland). This trend has led and may lead to further and accelerated impairment charges, higher costs, additional write-downs and losses for the Group or result in a loss of value in the Securities.
The actual or perceived failure or worsening credit of the Group’s counterparties has adversely affected and could continue to adversely affect the Group.
The Group’s ability to engage in routine funding transactions has been and will continue to be adversely affected by the actual or perceived failure or worsening credit of its counterparties, including other financial institutions and corporate borrowers. The Group has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients. As a result, defaults by, or even the perceived creditworthiness of or concerns about, one or more corporate borrowers, financial services institutions or the financial services industry generally, have led to market-wide liquidity problems, losses and defaults and could lead to further losses or defaults, by the Group or by other institutions. Many of these transactions expose the Group to credit risk in the event of default of the Group’s counterparty or client and the Group does have significant exposures to certain individual counterparties (including counterparties in certain weakened sectors and markets). In addition, the Group’s credit risk is exacerbated when the collateral it holds cannot be realised or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is due to the Group, which is most likely to occur during periods of illiquidity and depressed asset valuations, such as those recently experienced. Any such losses could have a material adverse effect on the Group’s results of operations and financial condition or result in a loss of value in the Securities.
The Group’s earnings and financial condition have been, and its future earnings and financial condition may continue to be, affected by depressed asset valuations resulting from poor market conditions.
Financial markets continue to be subject to significant stress conditions, where steep falls in perceived or actual asset values have been accompanied by a severe reduction in market liquidity, as exemplified by recent events affecting asset-backed collateralised debt obligations, residential mortgage-backed securities and the leveraged loan market. In dislocated markets, hedging and other risk management strategies have proven not to be as effective as they are in normal market conditions due in part to the decreasing credit quality of hedge counterparties, including monoline and other insurance companies and credit derivative product companies. Severe market events have resulted in the Group recording large write-downs on its credit market exposures in 2007, 2008 and 2009. Any deterioration in economic and financial market conditions could lead to further impairment charges and write-downs. Moreover, market volatility and illiquidity (and the assumptions, judgements and estimates in relation to such matters that may change over time and may ultimately not turn out to be accurate) make it difficult to value certain of the Group’s exposures. Valuations in future periods, reflecting, among other things, then-prevailing market conditions and changes in the credit ratings of certain of the Group’s assets, may result in significant changes in the fair values of the Group’s exposures, even in respect of exposures, such as credit market exposures, for which the Group has previously recorded write-downs. In addition, the value ultimately realised by the Group may be materially different from the current or estimated fair value. Any of these factors could require the Group to recognise further significant write-downs or realise increased impairment charges, any of which may adversely affect its capital position, its financial condition and its results of operations or result in a loss of value in the Securities.
Further information about the write-downs which the Group has incurred and the assets it has reclassified can be found in the Risk, capital and liquidity management section of the Business review.
The value or effectiveness of any credit protection that the Group has purchased from monoline and other insurers and other market counterparties (including credit derivative product companies) depends on the value of the underlying assets and the financial condition of the insurers and such counterparties.
The Group has credit exposure arising from over-the-counter derivative contracts, mainly credit default swaps (“CDSs”), which are carried at fair value. The fair value of these CDSs, as well as the Group’s exposure to the risk of default by the underlying counterparties, depends on the valuation and the perceived credit risk of the instrument against which protection has been bought. Since 2007, monoline and other insurers and other market counterparties (including credit derivative product companies) have been adversely affected by their exposure to residential mortgage linked and corporate credit products, whether synthetic or otherwise, and their actual and perceived creditworthiness has deteriorated
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rapidly, which may continue. If the financial condition of these counterparties or their actual or perceived creditworthiness deteriorates further, the Group may record further credit valuation adjustments on the credit protection bought from these counterparties under the CDSs in addition to those already recorded and such adjustments may have a material adverse impact on the Group’s financial condition and results of operations.
Changes in interest rates, foreign exchange rates, credit spreads, bond, equity and commodity prices and other market factors have significantly affected and will continue to affect the Group’s business.
Some of the most significant market risks the Group faces are interest rate, foreign exchange, credit spread, bond, equity and commodity price 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 the past year. 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-United Kingdom subsidiaries (principally Citizens Financial Group, Inc. (“Citizens”) and RBS Securities Inc.) and may affect income from foreign exchange dealing. 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 reductions in the value of such portfolios. 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.
The Group’s borrowing costs and its access to the debt capital markets depend significantly on its and the United Kingdom Government’s credit ratings.
The company and other Group members have been subject to a number of downgrades in the recent past. Any future reductions in the long-term or short-term credit ratings of the company or one of its principal subsidiaries (particularly RBS) would further increase its borrowing costs, require the Group to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit the Group’s access to capital and money markets and trigger additional collateral requirements in derivatives contracts and other secured funding arrangements. Furthermore, given the extent of the United Kingdom Government ownership and support provided to the Group through HM Treasury’s guarantee scheme (announced by the United Kingdom Government on 8 October 2008) (the “Credit Guarantee Scheme”), any downgrade in the United Kingdom Government’s credit ratings could adversely affect the Group’s own credit ratings and may have the effects noted above. All credit rating agencies have reaffirmed the United Kingdom Government’s AAA rating, although S&P changed its outlook to “negative” on 21 May 2009. Fitch reaffirmed the United Kingdom Government’s stable outlook on 31 July 2009 and Moody’s reiterated the United Kingdom Government’s stable outlook on 26 October 2009. Credit ratings of the company, RBS, ABN AMRO Holding N.V. (which was renamed “RBS Holdings N.V.” on 1 April 2010) (“ABN AMRO”), The Royal Bank of Scotland N.V. (which was renamed from “ABN AMRO Bank N.V.” on 6 February 2010), Ulster Bank and Citizens are also important to the Group when competing in certain markets, such as over-the-counter derivatives. As a result, any further reductions in the company’s long-term or short-term credit ratings or those of its principal subsidiaries could adversely affect the Group’s access to liquidity and competitive position, increase its funding costs and have a negative impact on the Group’s earnings and financial condition or result in a loss of value in the Securities.
The Group’s business performance could be adversely affected if its capital is not managed effectively or if there are changes to capital adequacy and liquidity requirements.
Effective management of the Group’s capital is critical to its ability to operate its businesses, to grow organically and to pursue its strategy of returning to standalone strength. The Group is required by regulators in the United Kingdom, the United States and in other jurisdictions in which it undertakes regulated activities, to maintain adequate capital resources. The maintenance of adequate capital is also necessary for the Group’s financial flexibility in the face of continuing turbulence and uncertainty in the global economy. Accordingly, the purpose of the issuance of the £25.5 billion of B Shares, the grant of the Contingent Subscription (as defined below) and the previous placing and open offers was to allow the Group to strengthen its capital position. The FSA’s recent liquidity policy statement articulates that firms must hold sufficient eligible securities to survive a liquidity stress and this will result in banks holding a greater amount of government securities, to ensure that these institutions have adequate liquidity in times of financial stress.
In addition, 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". If the proposals made by the Basel Committee are implemented, these could result in the Group being subject to significantly higher capital requirements. The proposals include: (a) the build-up of a counter-cyclical capital buffer in excess of the regulatory minimum capital requirement, which is large enough to enable the Group to remain above the minimum capital requirement in the face of losses expected to be incurred in a feasibly severe downturn; (b) an increase in the capital requirements for counterparty risk exposures arising from derivatives, repo-style transactions and securities financing transactions; (c) the imposition of a leverage ratio as a supplementary measure to the existing Basel II risk-based measure; (d) the phasing out of hybrid capital instruments as Tier 1 capital and the requirement that the predominant form of Tier 1 capital must be common shares and retained earnings; and (e) the imposition of global minimum liquidity standards that include a requirement to hold a stock of unencumbered high quality liquid assets sufficient to cover cumulative net cash outflows over a 30-day period under a prescribed stress scenario. The proposed reforms are subject to a consultative process and an impact assessment and are not likely to be implemented before the end of 2012. The Basel Committee will also consider appropriate transition and grandfathering arrangements.
These and other future changes to capital adequacy and liquidity requirements in the jurisdictions in which it operates may require the Group to raise additional Tier 1, Core Tier 1 and Tier 2 capital by way of further issuances of securities, including in the form of Ordinary Shares or B Shares and could result in existing Tier 1 and Tier 2 securities issued by the Group ceasing to count towards the Group’s regulatory capital, either at the same level as present or at all. The requirement to raise additional Core Tier 1 capital could have a number of negative consequences for the company and its shareholders, including impairing the company’s ability to pay dividends on or make other distributions in respect of Ordinary Shares and diluting the ownership of existing shareholders of the company. If the Group is unable to raise the requisite Tier 1 and Tier 2 capital, it may be required to further reduce the amount of its risk-weighted assets and engage in the disposition of core and other non-core businesses, which may not occur on a timely basis or achieve prices which would otherwise be attractive to the Group. In addition, pursuant to the State Aid approval, should the Group’s Core Tier 1 capital ratio decline to below 5 per cent. at any time before 31 December 2014, or should the Group fall short of its funded balance sheet target level (after adjustments) for 31 December 2013 by £30 billion or more, the Group will be required to reduce its risk-weighted assets by a further £60 billion in excess of its plan through further disposals of identifiable businesses and their
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associated assets. As provided in the Acquisition and Contingent Capital Agreement (as defined below), the Group would also be subject to restrictions on payments on its hybrid capital instruments should its Core Tier 1 ratio fall below 6 per cent. or if it would fall below 6 per cent. as a result of such payment.
As at 31 December 2009, the Group’s Tier 1 and Core Tier 1 capital ratios were 14.1 per cent. and 11.0 per cent., respectively, calculated in accordance with FSA definitions (see page 69). Any change that limits the Group’s ability to manage effectively its balance sheet and capital resources going forward (including, for example, reductions in profits and retained earnings as a result of write-downs or otherwise, increases in risk-weighted assets, delays in the disposal of certain assets or the inability to syndicate loans as a result of market conditions, a growth in unfunded pension exposures or otherwise) or to access funding sources, could have a material adverse impact on its financial condition and regulatory capital position or result in a loss of value in the Securities.
The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate.
Under IFRS, the Group recognises at fair value: (i) financial instruments classified as “held-for-trading” or “designated as at fair value through profit or loss”; (ii) financial assets classified as “available-for-sale”; and (iii) derivatives. Generally, to establish the fair value of these instruments, the Group relies on quoted market prices or, where the market for a financial instrument is not sufficiently active, internal valuation models that utilise observable market data. In certain circumstances, the data for individual financial instruments or classes of financial instruments utilised by such valuation models may not be available or may become unavailable due to changes in market conditions, as has been the case during the recent financial crisis. In such circumstances, the Group’s internal valuation models require the Group to make assumptions, judgements and estimates to establish fair value. In common with other financial institutions, these internal valuation models are complex, and the assumptions, judgements and estimates the Group is required to make often relate to matters that are inherently uncertain, such as expected cash flows, the ability of borrowers to service debt, residential and commercial property price appreciation and depreciation, and relative levels of defaults and deficiencies. Such assumptions, judgements and estimates may need to be updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments has had and could continue to have a material adverse effect on the Group’s earnings and financial condition. Also, recent market volatility and illiquidity have challenged the factual bases of certain underlying assumptions and have made it difficult to value certain of the Group’s financial instruments. Valuations in future periods, reflecting prevailing market conditions, may result in further significant changes in the fair values of these instruments, which could have a negative effect on the Group’s results of operations and financial condition or result in a loss of value in the Securities.
The Group operates in markets that are highly competitive and consolidating. If the Group is unable to perform effectively, its business and results of operations will be adversely affected.
Recent consolidation among banking institutions in the United Kingdom, the United States and throughout Europe is changing the competitive landscape for banks and other financial institutions. If financial markets continue to be volatile, more banks may be forced to consolidate. This consolidation, in combination with the introduction of new entrants into the United States and United Kingdom markets from other European and Asian countries, could increase competitive pressures on the Group. In addition, certain competitors may have access to lower cost funding and/or be able to offer retail deposits on more favourable terms than the Group and may have stronger multi-channel and more efficient operations as a result of greater historical investments. Furthermore, the Group’s competitors may be better able to attract and retain clients and talent, which may have a negative impact on the Group’s relative performance and future prospects.
Furthermore, increased government ownership of, and involvement in, banks generally may have an impact on the competitive landscape in the major markets in which the Group operates. Although, at present, it is difficult to predict what the effects of this increased government ownership and involvement will be or how they will differ from jurisdiction to jurisdiction, such involvement may cause the Group to experience stronger competition for corporate, institutional and retail clients and greater pressure on profit margins. Future disposals and restructurings by the Group and the compensation structure and restrictions imposed on the Group may also have an impact on its ability to compete effectively. Since the markets in which the Group operates are expected to remain highly competitive in all areas, these and other changes to the competitive landscape could adversely affect the Group’s business, margins, profitability and financial condition or result in a loss of value in the Securities.
As a condition to HM Treasury support, the company has agreed to certain undertakings which may serve to limit the RBS Group’s operations.
Under the terms of the First Placing and Open Offer, the company provided certain undertakings aimed at ensuring that the subscription by HM Treasury of the relevant ordinary shares and preference shares and the RBS Group’s participation in the Credit Guarantee Scheme offered by HM Treasury as part of its support for the United Kingdom banking industry are compatible with the common market under EU law. These undertakings include (i) supporting certain initiatives in relation to mortgage lending and lending to SMEs until 2011, (ii) regulating management remuneration and (iii) regulating the rate of growth of the RBS Group’s balance sheet. Under the terms of the placing and open offer undertaken by the company in April 2009, the RBS Group’s undertakings in relation to mortgage lending and lending to SMEs were extended to larger commercial and industrial companies in the United Kingdom. Pursuant to these arrangements, the company agreed to make available to creditworthy borrowers on commercial terms, £16 billion above the amount the company had budgeted to lend to United Kingdom businesses and £9 billion above the amount the company had budgeted to lend to United Kingdom homeowners in the year commencing 1 March 2009.
In relation to the 2009 commitment period, which ended on 28 February 2010, the RBS Group’s net mortgage lending to UK homeowners was £12.7 billion above the amount it had originally budgeted to lend. In relation to its business lending commitment, the RBS Group achieved £60 billion of gross new lending to businesses, including £39 billion to SMEs but, in the economic environment prevailing at the time, many customers were strongly focused on reducing their borrowings and repayments consequently increased. Moreover, the withdrawal of foreign lenders was less pronounced than anticipated, there was a sharp increase in capital market issuance and demand continued to be weak. As a result, the RBS Group’s net lending did not reach the £16 billion targeted.
In March 2010, the company agreed with the United Kingdom government certain adjustments to the lending commitments for the 2010 commitment period (the 12 month period commencing 1 March 2010), to reflect expected economic circumstances over the period. As part of the amended lending commitments, the company has committed, among other things, to make available gross new facilities, drawn or undrawn, of £50 billion to UK businesses in the period 1 March 2010 to 28 February 2011. In addition, the company has agreed with the United Kingdom government to make available £8 billion of net mortgage lending in the 2010 commitment period. This is a decrease of £1 billion on the net
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mortgage lending target that previously applied to the 2010 commitment period which ends on 28 February 2011, to reflect that the mortgage lending commitment for the 2009 commitment period was increased from £9 billion to £10 billion.
The RBS Group has also agreed to certain other commitments, which are material for the structure of the RBS Group and its operations, under the State Aid restructuring plan approved by the European Commission in relation to State Aid.
In addition, the RBS Group, together with HM Treasury, has agreed with the European Commission a prohibition on the making of discretionary dividends (including on preference shares and B Shares) or coupon payments on existing hybrid capital instruments for a two-year period from a date commencing no later than 30 April 2010 (which the RBS Group has subsequently announced shall be 30 April 2010). It is possible that the RBS Group may, in future, be subject to further restrictions on payments on such hybrid capital instruments, whether as a result of undertakings given to regulatory bodies, changes to capital requirements such as the proposals published by the Basel Committee on 17 December 2009 or otherwise. The RBS Group has also agreed to certain other undertakings in the Acquisition and Contingent Capital Agreement.
The undertakings described above may serve to limit the RBS Group’s operations. See “HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the Group.”
The Group could fail to attract or retain senior management, which may include members of the Board, or other key employees, and it may suffer if it does not maintain good employee relations.
The Group’s ability to implement its strategy depends on the ability and experience of its senior management, which may include directors, and other key employees. The loss of the services of certain key employees, particularly to competitors, could have a negative impact on the Group’s business. The Group’s future success will also depend on its ability to attract, retain and remunerate highly skilled and qualified personnel competitively with its peers. This cannot be guaranteed, particularly in light of heightened regulatory oversight of banks and heightened scrutiny of, and (in some cases) restrictions placed upon, management compensation arrangements, in particular those in receipt of Government funding (such as the company). The Group has made a commitment to comply with the FSA Remuneration Code. These rules came into force on 1 January 2010 and are in line with the agreement reached by the G-20, setting global standards for the implementation of the Financial Stability Board’s remuneration principles. The Group agreed that it will be at the leading edge of implementing the G-20 principles and granted UK Financial Investments Limited (“UKFI”) consent rights over the shape and size of its aggregate bonus pool for the 2009 performance year. The level of the 2009 bonus pool and the deferral and claw-back provisions implemented by the Group may impair the ability of the Group to attract and retain suitably qualified personnel in various parts of the Group’s businesses.
The Group is also altering certain of the pension benefits it offers to staff. Some employees continue to participate in defined benefit arrangements. The following two changes have been made to the main defined benefit pension plans: (i) a yearly limit on the amount of any salary increase that will count for pension purposes; and (ii) a reduction in the severance lump sum for those who take an immediate undiscounted pension for redundancy. In addition to the effects of such measures on the Group’s ability to retain senior management and other key employees, the marketplace for skilled personnel is becoming more competitive, which means the cost of hiring, training and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could place the Group at a significant competitive disadvantage and prevent the Group from successfully implementing its strategy, which could have a material adverse effect on the Group’s financial condition and results of operations or result in a loss of value in the Securities.
In addition, certain of the Group’s employees in the United Kingdom, continental Europe and other jurisdictions in which the Group operates are represented by employee representative bodies, including trade unions. Engagement with its employees and such bodies is important to the Group and a breakdown of these relationships could adversely affect the Group’s business, reputation and results. As the Group implements cost-saving initiatives and disposes of, or runs-down, certain assets or businesses (including as part of its expected restructuring plans), it faces increased risk in this regard and there can be no assurance that the Group will be able to maintain good relations with its employees or employee representative bodies in respect of all matters. As a result, the Group may experience strikes or other industrial action from time to time, which could have a material adverse effect on its business and results of operations and could cause damage to its reputation.
Each of the Group’s businesses is subject to substantial regulation and oversight. Any significant regulatory developments could have an effect on how the Group conducts its business and on its results of operations and financial condition.
The Group is subject to financial services laws, regulations, corporate governance requirements, administrative actions and policies in each location in which it operates. All of these are subject to change, particularly in the current market environment, where there have been unprecedented levels of government intervention and changes to the regulations governing financial institutions, including recent nationalisations in the United States, the United Kingdom and other European countries. As a result of these and other ongoing and possible future changes in the financial services regulatory landscape (including requirements imposed by virtue of the Group’s participation in government or regulator-led initiatives), the Group expects to face greater regulation in the United Kingdom, the United States and other countries in which it operates, including throughout the rest of Europe. Compliance with such regulations may increase the Group’s capital requirements and costs and have an adverse impact on how the Group conducts its business, on the products and services it offers, on the value of its assets and on its results of operations and financial condition or result in a loss of value in the Securities.
Other areas where governmental policies and regulatory changes could have an adverse impact include, but are not limited to:
| · | the monetary, interest rate, capital adequacy, liquidity, balance sheet leverage and other policies of central banks and regulatory authorities; |
| · | general changes in government or regulatory policy or changes in regulatory regimes that may significantly influence investor decisions in particular markets in which the Group operates, increase the costs of doing business in those markets or result in a reduction in the credit ratings of the company or one of its subsidiaries; |
| · | changes to financial reporting standards; |
| · | changes in regulatory requirements relating to capital and liquidity, such as limitations on the use of deferred tax assets in calculating Core Tier 1 and/or Tier 1 capital, or prudential rules relating to the capital adequacy framework; |
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| · | other general changes in the regulatory requirements, such as the imposition of onerous compliance obligations, restrictions on business growth or pricing, new levies or fees, requirements in relation to the structure and organisation of the Group and requirements to operate in a way that prioritises objectives other than shareholder value creation; |
| · | changes in competition and pricing environments; |
| · | further developments in financial reporting, corporate governance, corporate structure, conduct of business and employee compensation; |
| · | differentiation among financial institutions by governments with respect to the extension of guarantees to bank customer deposits and the terms attaching to such guarantees, including requirements for the entire Group to accept exposure to the risk of any individual member of the Group, or even third party participants in guarantee schemes, failing; |
| · | implementation of, or costs related to, local customer or depositor compensation or reimbursement schemes; |
| · | transferability and convertibility of currency risk; |
| · | expropriation, nationalisation and confiscation of assets; |
| · | changes in legislation relating to foreign ownership; and |
| · | other unfavourable political, military or diplomatic developments producing social instability or legal uncertainty which, in turn, may affect demand for the Group’s products and services. |
The Group’s results have been and could be further adversely affected in the event of goodwill impairment.
The Group capitalises goodwill, which is calculated as the excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired. Acquired goodwill is recognised initially at cost and subsequently at cost less any accumulated impairment losses. As required by IFRS, the Group tests goodwill for impairment annually or more frequently, at external reporting dates, when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. The value in use and fair value of the Group’s cash generating units are affected by market conditions and the performance of the economies in which the Group operates. Where the Group is required to recognise a goodwill impairment, it is recorded in the Group’s income statement, although it has no effect on the Group’s regulatory capital position. For the year ended 31 December 2009, the Group recorded a £363 million accounting write down of goodwill and other intangibles relating to prior year acquisitions (see page 257).
The Group may be required to make further contributions to its pension schemes if the value of pension fund assets is not sufficient to cover potential obligations.
The Group maintains a number of defined benefit pension schemes for past and a number of current employees. Pensions risk is the risk that the liabilities of the Group’s various defined benefit pension schemes which are long term in nature will exceed the schemes’ assets, as a result of which the Group is required or chooses to make additional contributions to the schemes. The schemes’ assets comprise investment portfolios that are held to meet projected liabilities to the scheme members. Risk arises from the schemes because the value of these asset portfolios and returns from them may be less than expected and because there may be greater than expected increases in the estimated value of the schemes’ liabilities. In these circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes, and during recent periods, the Group has voluntarily made such contributions. Given the current economic and financial market difficulties and the prospect that they may continue over the near and medium term, the Group may experience increasing pension deficits or be required or elect to make further contributions to its pension schemes and such deficits and contributions could be significant and have a negative impact on the Group’s capital position, results of operations or financial condition or result in a loss of value in the Securities. The next funding valuation of the Group’s major defined benefit pension plan, The Royal Bank of Scotland Group Pension Fund, will take place with an effective date of 31 March 2010.
The Group is and may be subject to litigation and regulatory investigations that may impact its business.
The Group’s operations are diverse and complex, and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory investigation and other regulatory risk. As a result, the Group is, and may in the future be, involved in various disputes, legal proceedings and regulatory investigations in the United Kingdom, the EU, the United States and other jurisdictions, including class action litigation, anti-money laundering investigations and review by the European Commission under State Aid rules. Furthermore, the Group, like many other financial institutions, has come under greater regulatory scrutiny over the last year and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and anti-terrorism laws and regulations, as well as the provisions of applicable sanctions programmes. Disputes, legal proceedings and regulatory investigations are subject to many uncertainties, and their outcomes are often difficult to predict, particularly in the earlier stages of a case or investigation. Adverse regulatory action or adverse judgments in litigation could result in restrictions or limitations on the Group’s operations or result in a material adverse effect on the Group’s reputation or results of operations or result in a loss of value in the Securities. For details about certain litigation and regulatory investigations in which the Group is involved, see Note 32 on the Financial statements.
Operational risks are inherent in the Group’s operations.
The Group’s operations are dependent on the ability to process a very large number of transactions efficiently and accurately while complying with applicable laws and regulations where it does business. The Group has complex and geographically diverse operations and operational risk and losses can result from internal and external fraud, errors by employees or third parties, failure to document transactions properly or to obtain proper authorisation, failure to comply with applicable regulatory requirements and conduct of business rules (including those arising out of anti-money laundering and anti-terrorism legislation, as well as the provisions of applicable sanctions programmes), equipment failures, natural disasters or the inadequacy or failure of systems and controls, including those of the Group’s suppliers or counterparties. Although the Group has
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implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures, to identify and rectify weaknesses in existing procedures and to train staff, it is not possible to be certain that such actions have been or will be effective in controlling each of the operational risks faced by the Group. Any weakness in these systems or controls, or any breaches or alleged breaches of applicable laws or regulations, could have a materially negative impact on the Group’s business, reputation and results of operations and the price of any Securities. Notwithstanding anything contained in this risk factor, it should not be taken as implying that the company will be unable to comply with its obligations as a company with securities admitted to the Official List of the United Kingdom Listing Authority (the “Official List”) nor that it, or its relevant subsidiaries, will be unable to comply with its or their obligations as supervised firms regulated by the FSA.
The Group is exposed to the risk of changes in tax legislation and its interpretation and to increases in the rate of corporate and other taxes in the jurisdictions in which it operates.
The Group’s activities are subject to tax at various rates around the world computed in accordance with local legislation and practice. Action by governments to increase tax rates or to impose additional taxes or to restrict the tax reliefs currently available to the Group would reduce the Group’s profitability. Revisions to tax legislation or to its interpretation might also affect the Group’s results in the future.
HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the Group.
UKFI manages HM Treasury’s shareholder relationship with the company. Although HM Treasury has indicated that it intends to respect the commercial decisions of the Group and that the Group will continue to have its own independent board of directors and management team determining its own strategy, should its current intentions change, HM Treasury's position as a majority shareholder (and UKFI’s position as manager of this shareholding) means that HM Treasury or UKFI may be able to exercise a significant degree of influence over, among other things, the election of directors and the appointment of senior management. In addition, as the provider of the APS, HM Treasury has a range of rights that other shareholders do not have. These include rights under the terms of the APS over the Group's remuneration policy and practice. The manner in which HM Treasury or UKFI exercises HM Treasury’s rights as majority shareholder or in which HM Treasury exercises its rights under the APS could give rise to conflict between the interests of HM Treasury and the interests of other shareholders. The Board has a duty to promote the success of the company for the benefit of its members as a whole.
The Group’s insurance businesses are subject to inherent risks involving claims.
Future claims in the Group’s general and life assurance business may be higher than expected as a result of changing trends in claims experience resulting from catastrophic weather conditions, demographic developments, changes in the nature and seriousness of claims made, changes in mortality, changes in the legal and compensatory landscape and other causes outside the Group’s control. These trends could affect the profitability of current and future insurance products and services. The Group reinsures some of the risks it has assumed and is accordingly exposed to the risk of loss should its reinsurers become unable or unwilling to pay claims made by the Group against them.
The Group’s operations have inherent reputational risk.
Reputational risk, meaning the risk to earnings and capital from negative public opinion, is inherent in the Group’s business. Negative public opinion can result from the actual or perceived manner in which the Group conducts its business activities, from the Group’s financial performance, from the level of direct and indirect government support or from actual or perceived practices in the banking and financial industry. Negative public opinion may adversely affect the Group’s ability to keep and attract customers and, in particular, corporate and retail depositors. The Group cannot ensure that it will be successful in avoiding damage to its business from reputational risk.
In the United Kingdom and in other jurisdictions, the Group is responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers.
In the United Kingdom, the Financial Services Compensation Scheme (the “Compensation Scheme”) was established under the FSMA and is the United Kingdom’s statutory fund of last resort for customers of authorised financial services firms. The Compensation Scheme can pay compensation to customers if a firm is unable, or likely to be unable, to pay claims against it and may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under the Banking Act. The Compensation Scheme is funded by levies on firms authorised by the FSA, including the Group. In the event that the Compensation Scheme raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the Group may have a material impact on its results of operations and financial condition. During the financial year ended 31 December 2009, the Group has accrued £135 million for its share of Compensation Scheme management expenses levies for the 2009/10 and 2010/2011 Compensation Scheme years.
In addition, to the extent that other jurisdictions where the Group operates have introduced or plan to introduce similar compensation, contributory or reimbursement schemes (such as in the United States with the Federal Deposit Insurance Corporation), the Group may make further provisions and may incur additional costs and liabilities, which may negatively impact its financial condition and results of operations or result in a loss of value in the Securities.
The Group’s business and earnings may be affected by geopolitical conditions.
The performance of the Group is significantly influenced by the geopolitical and economic conditions prevailing at any given time in the countries in which it operates, particularly the United Kingdom, the United States and other countries in Europe and Asia. For example, the Group has a presence in countries where businesses could be exposed to the risk of business interruption and economic slowdown following the outbreak of a pandemic, or the risk of sovereign default following the assumption by governments of the obligations of private sector institutions. Similarly, the Group faces the heightened risk of trade barriers, exchange controls and other measures taken by sovereign governments which may impact a borrower’s ability to repay. Terrorist acts and threats and the response to them of governments in any of these countries could also adversely affect levels of economic activity and have an adverse effect upon the Group’s business.
The restructuring proposals for ABN AMRO are complex and may not realise the anticipated benefits for the Group.
The restructuring plan in place for the integration and separation of ABN AMRO (called The Royal Bank of Scotland N.V. with effect from 6 February 2010) into and among the businesses and operations of the Consortium Members (as defined below) is complex, involving substantial reorganisation of ABN AMRO’s operations and legal structure. The restructuring plan is being implemented and significant elements have been completed within the planned timescales and the integration of the Group’s businesses continues. As part of this reorganisation, on 6 February 2010, the majority of the businesses of ABN AMRO acquired by the Dutch State were legally demerged from the ABN AMRO businesses acquired
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by the Group and were transferred into a newly established company, ABN AMRO Bank N.V. (formerly named ABN AMRO II N.V.). This company was transferred to ABN AMRO Group N.V., a company wholly owned by the Dutch State, on 1 April 2010. Certain assets and liabilities of ABN AMRO acquired by the Dutch State were not part of the transfer which occurred on 1 April 2010 and remain within ABN AMRO (now The Royal Bank of Scotland N.V.). These will be transferred to the Dutch State as soon as possible. In addition, certain assets within ABN AMRO (The Royal Bank of Scotland N.V.) continue to be under shared ownership by the Consortium Members.
The Group may not realise the benefits of the acquisition or the restructuring when expected or to the extent projected. The occurrence of any of these events, including as a result of staff losses or performance issues, or as a result of further disposals or restructurings by the Group, may have a negative impact on the Group’s financial condition and results of operations.
The recoverability and regulatory capital treatment of certain deferred tax assets recognised by the Group depends on the Group's ability to generate sufficient future taxable profits and there being no adverse changes to tax legislation, regulatory requirements or accounting standards.
In accordance with IFRS, the Group has recognised deferred tax assets on losses available to relieve future profits from tax only to the extent that it is probable that they will be recovered. The deferred tax assets are quantified on the basis of current tax legislation and accounting standards and are subject to change in respect of the future rates of tax or the rules for computing taxable profits and allowable losses. Failure to generate sufficient future taxable profits or changes in tax legislation or accounting standards may reduce the recoverable amount of the recognised deferred tax assets.
There is currently no restriction in respect of deferred tax assets recognised by the Group for regulatory purposes. Changes in regulatory rules may restrict the amount of deferred tax assets that can be recognised and such changes could lead to a reduction in the Group’s Core Tier 1 capital ratio. In particular, on 17 December 2009, the Basel Committee published a consultative document setting out certain proposed changes to capital requirements (see risk factor above headed “The Group’s business performance could be adversely affected if its capital is not managed effectively or if there are changes to capital adequacy and liquidity requirements”). Those proposals included a requirement that deferred tax assets which rely on future profitability of the Group to be realised should be deducted from the common equity component of Tier 1 and therefore not count towards Tier 1 capital.
RBS has entered into a credit derivative and a financial guarantee contract with The Royal Bank of Scotland N.V. which may adversely affect the Issuer Group’s results
RBS has also entered into a credit derivative and a financial guarantee contract with The Royal Bank of Scotland N.V., which is a subsidiary undertaking of RBSG, under which it has sold credit protection over the exposures held by The Royal Bank of Scotland N.V. and its subsidiaries that are subject to the APS. These agreements may adversely affect the Issuer Group's results as: (a) they cover 100% of losses on these assets whilst the APS provides 90% protection if losses on the whole APS portfolio exceed the first loss; and (b) the basis of valuation of the APS and the financial guarantee contract are asymmetrical: the one measured at fair value and the other at the higher of cost less amortisation and the amount determined in accordance with IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”.
Risks relating to the Group’s participation in the Asset Protection Scheme, the B Shares, the Contingent B Shares and the Dividend Access Share
Owing to the complexity, scale and unique nature of the APS and the uncertainty surrounding the duration and severity of the recent economic recession, there may be unforeseen issues and risks that are relevant in the context of the Group’s participation in the APS and in the impact of the APS on the Group’s business, operations and financial condition. In addition, the assets or exposures to be covered by the APS may not be those with the greatest future losses or with the greatest need for protection.
Since the APS is a unique form of credit protection over a complex range of diversified assets and exposures (the “Covered Assets”) in a number of jurisdictions and there is significant uncertainty about the duration and severity of the recent economic recession, there may be unforeseen issues and risks that may arise as a result of the Group’s participation in the APS and the impact of the APS on the Group’s business, operations and financial condition cannot be predicted with certainty. Such issues or risks may have a material adverse effect on the Group. Moreover, the Group’s choice of assets or exposures to be covered by the APS was based on predictions at the time of its accession to the APS regarding the performance of counterparties and assumptions about market dynamics and asset and liability pricing, all or some of which may prove to be inaccurate. There is, therefore, a risk that the Covered Assets will not be those with the greatest future losses or with the greatest need for protection and, as a result, the Group’s financial condition, income from operations and the value of any Securities may still suffer due to further impairments and credit write-downs.
There is no assurance that the Group’s participation in the APS and the issue of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares will achieve the Group’s goals of improving and maintaining the Group’s capital ratios in the event of further losses. Accordingly, the Group’s participation in the APS and the issue of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares may not improve market confidence in the Group and the Group may still face the risk of full nationalisation or other resolution procedures under the Banking Act.
The Group’s participation in the APS, together with the issue of £25.5 billion of B Shares in December 2009 and, if required, the £8 billion Contingent B Shares (as defined below), has improved its consolidated capital ratios. In the event that the Group’s Core Tier 1 capital ratio declines to below 5 per cent., and if certain conditions are met, HM Treasury is committed to subscribe (the “Contingent Subscription”) for up to an additional £8 billion of B Shares (the “Contingent B Shares”) and, in connection with such subscription, would receive further enhanced dividend rights under the associated series 1 dividend access share in the capital of the company (the “Dividend Access Share”). However, 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 Contingent B, the Group remains exposed to a substantial first loss amount of £60 billion in respect of the Covered Assets and for 10 per cent. of Covered Assets losses after the first loss amount. In addition, as mentioned in the previous risk factor, the assets or exposures covered by the APS may not be those with the greatest future losses or with the greatest need for protection. Moreover, the Group continues to carry the risk of losses, impairments and write-downs with respect to assets not covered by the APS. Therefore, there can be no assurance that any regulatory capital benefits and the additional Core Tier 1 capital will be sufficient to maintain the Group’s capital ratios at the requisite levels in the event of further losses (even with the £8 billion Contingent B Shares). If the Group is unable to improve its capital ratios sufficiently or to maintain its capital ratios in the event of further losses, its business, results of operations and financial condition will suffer, its credit ratings may fall, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of the
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Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of the Securities would be subject to the provisions of the Banking Act, and investors may receive no value for their Securities.
In the event that the Group’s Core Tier 1 capital ratio declines to below 5 per cent., HM Treasury is committed to subscribe for up to an additional £8 billion of Contingent B Shares if certain conditions are met. If such conditions are not met, and the Group is unable to issue the £8 billion Contingent B Shares, the Group may be unable to find alternative methods of obtaining protection for stressed losses against severe or prolonged recessionary periods in the economic cycle and improving its capital ratios, with the result that the Group may face increased risk of full nationalisation or other resolution procedures under the Banking Act.
In the event that the Group’s Core Tier 1 capital ratio declines to below 5 per cent., HM Treasury is committed to subscribe for up to an additional £8 billion of Contingent B Shares if certain conditions are met. Such conditions include that the European Commission’s decision that the State Aid is compatible with article 87 of the consolidated version of the Treaty establishing the European Community continues to be in force, that the European Commission has not opened a formal investigation under article 88(2) of such Treaty in relation to the possible misuse of State Aid, that there has been no breach by the company of the State Aid Commitment Deed and that no Termination Event has occurred.
If such conditions are not met, and the Group is unable to issue the £8 billion Contingent B Shares, the Group may be unable to find alternative methods of obtaining protection for stressed losses against severe or prolonged recessionary periods in the economic cycle and improving its capital ratios, with the result that the Group may face increased risk of full nationalisation or other resolution procedures under the Banking Act.
In these circumstances, if the Group is unable to issue the £8 billion Contingent B Shares, the Group will need to assess its strategic and operational position and will be required to find alternative methods for achieving the requisite capital ratios. Such methods could include an accelerated reduction in risk-weighted assets, disposals of certain businesses, increased issuance of Tier 1 capital securities, increased reliance on alternative government-supported liquidity schemes and other forms of government assistance. There can be no assurance that any of these alternative methods will be available or would be successful in increasing the Group’s capital ratios to the desired or requisite levels. If the Group is unable to issue the £8 billion Contingent B Shares, the Group’s business, results of operations, financial condition and capital position and ratios will suffer, its credit ratings may drop, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities or other regulatory bodies in the other jurisdictions in which RBS and its subsidiaries operate, which could include full nationalisation, other resolution procedures under the Banking Act or revocation of permits and licences necessary to conduct the Group’s businesses. Any compensation payable to holders of Securities would be subject to the provisions of the Banking Act, and investors may receive no value for their Securities (see the risk factor headed “the company and its United Kingdom bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act 2009” above).
The Group may have included Covered Assets that are ineligible (or that later become ineligible) for protection under the APS. Protection under the APS may be limited or may cease to be available where Covered Assets are not correctly or sufficiently logged or described, where a Covered Asset is disposed of (in whole or in part) prior to a Trigger, where the terms of the APS do not apply or are uncertain in their application, where the terms of the protection itself potentially give rise to legal uncertainty, where certain criminal conduct has or may have occurred or where a breach of bank secrecy, confidentiality, data protection or similar laws may occur. In addition, certain assets included in the APS do not satisfy the eligibility requirements of the Scheme Documents. In each case this would reduce the anticipated benefits to the Group of the APS.
The Covered Assets comprise a wide variety and a very large number of complex assets and exposures. As a result of the significant volume, variety and complexity of assets and exposures and the resulting complexity of the Scheme Documents, there is a risk that the Group may have included assets or exposures within the Covered Assets that are not eligible for protection under the APS, with the result that such assets or exposures may not be protected by the APS. Furthermore, if Covered Assets are not correctly or sufficiently logged or described for the purposes of the APS, protection under the APS may, in certain circumstances and subject to certain conditions, not be available or may be limited, including by potentially being limited to the terms of the assets “as logged”. If a Covered Asset is disposed of prior to the occurrence of a failure to pay, a bankruptcy or a restructuring, as described in the UK Asset Protection Scheme Terms and Conditions (the “Scheme Conditions”) (a “Trigger”) in respect of that Covered Asset, the Group will also lose protection under the APS in respect of that disposed asset or, if the Covered Asset is disposed of in part, in respect of that disposed part of the Covered Asset or in some circumstances all of the Covered Asset, in each case with no rebate of the fee payable to HM Treasury, unless an agreement otherwise is reached with HM Treasury at the relevant time. Moreover, since the terms of the credit protection available under the APS are broad and general (given the scale and purpose of the APS and the wide variety and very large number of complex assets and exposures intended to be included as Covered Assets) and also very complex and in some instances operationally restrictive, certain Scheme Conditions may not apply to particular assets, exposures or operational scenarios or their applicability may be uncertain (for example, in respect of overdrafts). In addition, many of these provisions apply from 31 December 2008 and therefore may not have been complied with between this date and the date of the Group’s accession to the APS on 22 December 2009. In each case this may result in a loss or reduction of protection. There are certain limited terms and conditions of the Scheme Conditions which are framed in such a way that may give rise to lack of legal certainty. Furthermore, if a member of the Group becomes aware after due and reasonable enquiry that there has been any material or systemic criminal conduct on the part of the Group (including its directors, officers and employees) relating to or affecting any of the Covered Assets, some or all of those assets may cease to be protected by the APS. HM Treasury may also require the withdrawal or the company may itself consider it necessary to withdraw Covered Assets held in certain jurisdictions where disclosure of certain information to HM Treasury may result in a breach of banking secrecy, confidentiality, data protection or similar laws. In addition, at the time of accession to the APS, approximately £3 billion of derivative and structured finance assets were identified as having been included in the APS which, for technical reasons, did not or which were anticipated at some stage not to, satisfy the eligibility requirements specified in the Scheme Documents. HM Treasury and the company agreed to negotiate in good faith to establish as soon as practicable whether (and if so, to what extent) coverage should extend to these derivative assets. These negotiations remain ongoing. The £3 billion of derivative and structured finance assets referred to above were in addition to approximately £1.2 billion of Covered Assets across a broad range of asset classes which were withdrawn from the APS at the time of accession.
The effect of (i) failures to be eligible and/or to log or correctly describe Covered Assets, (ii) disposals of Covered Assets prior to a Trigger, (iii) the uncertainty of certain Scheme Conditions and the exclusion of certain assets and exposures from the APS and potential lack of legal certainty, (iv) the occurrence of material or systemic criminal conduct on the part of the company or its representatives relating to or affecting Covered Assets or breach of banking secrecy, confidentiality, data protection or similar laws and (v) failure or potential failure of HM Treasury and the company to
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reach agreement in respect of whether (and if so, to what extent) cover should extend to certain ineligible assets, may (or, in respect of assets which HM Treasury and the company have agreed are ineligible, will) impact the enforceability and/or level of protection available to the Group and may materially reduce the protection anticipated by the Group for its stressed losses. Further, there is no ability to nominate additional or alternative assets or exposures in place of those which turn out not to be covered under the APS. If the Group is then unable to find alternative methods for improving and maintaining its capital ratios, its business, results of operations and financial condition will suffer, its credit ratings may drop, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of Securities would be subject to the provisions of the Banking Act, and investors may receive no value for their Securities.
During the life of the APS, certain or all of the Covered Assets may cease to be protected due to a failure to comply with continuing obligations under the APS, reducing the benefit of the APS to the Group.
The Group is subject to limitations on actions it can take in respect of the Covered Assets and certain related assets and to extensive continuing obligations under the Scheme Conditions relating to governance, asset management, audit and reporting. The Group’s compliance with the Scheme Conditions is dependent on its ability to (i) implement efficiently and accurately new approval processes and reporting, governance and management systems in accordance with the Scheme Conditions and (ii) comply with applicable laws and regulations where it does business. The Group has complex and geographically diverse operations, and operational risk in the context of the APS may result from errors by employees or third-parties, failure to document transactions or procedures properly or to obtain proper authorisations in accordance with the Scheme Conditions, equipment failures or the inadequacy or failure of systems and controls. Although the Group has devoted substantial financial and operational resources, and intends to devote further substantial resources, to developing efficient procedures to deal with the requirements of the APS and to training staff, it is not possible to be certain that such actions will be effective to control each of the operational risks faced by the Group or to provide the necessary information in the necessary time periods in the context of the APS. Since the Group’s operational systems were not originally designed to facilitate compliance with these extensive continuing obligations, there is a risk that the Group will fail to comply with a number of these obligations. This risk is particularly acute in the period immediately following the APS becoming effective. Certain of the reporting requirements, in particular, are broad in their required scope and challenging in their required timing. There is, as a result, a real possibility that the Group, at least initially, will not be able to achieve full compliance. Where the Group is in breach of its continuing obligations under the Scheme Conditions in respect of any of the Covered Assets, related assets or other obligations, or otherwise unable to provide or verify information required under the APS within the requisite time periods, recovery of losses under the APS may be adversely impacted, may lead to an indemnity claim and HM Treasury may in addition have the right to exercise certain step-in rights, including the right to require the Group to appoint a step-in manager who may exercise oversight, direct management rights and certain other rights including the right to modify certain of the Group’s strategies, policies or systems. Therefore, there is a risk that Covered Assets in relation to which the Group has failed to comply with its continuing obligations under the Scheme Conditions, will not be protected or fully protected by the APS. As there is no ability to nominate additional or alternative assets or exposures for cover under the APS, the effect of such failures will impact the level of protection available to the Group and may reduce or eliminate in its entirety the protection anticipated by the Group for its stressed losses, in which case its business, results of operations and financial condition will suffer, its credit ratings may drop, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of Securities would be subject to the provisions of the Banking Act, and investors may receive no value for their Securities.
The Scheme Conditions may be modified by HM Treasury in certain prescribed circumstances, which could result in a loss or reduction in the protection provided under the APS in relation to certain Covered Assets, increased costs to the Group in respect of the APS or limitations on the Group’s operations.
HM Treasury may, following consultation with the Group, modify or replace certain of the Scheme Conditions in such a manner as it considers necessary (acting reasonably) to:
| · | remove or reduce (or remedy the effects of) any conflict between: (i) the operation, interpretation or application of certain Scheme Conditions; and (ii) any of the overarching principles governing the APS; |
| · | correct any manifest error contained in certain Scheme Conditions; or |
| · | take account of any change in law. |
HM Treasury can only effect a modification or replacement of a Scheme Condition if (i) it is consistent with each of the Scheme Principles, (ii) there has been no formal notification from the FSA that such modification would result in any protection provided to the Group under the APS ceasing to satisfy certain requirements for eligible credit risk mitigation and (iii) HM Treasury has considered in good faith and had regard to any submissions, communications or representations of or made by the Group regarding the anticipated impact of the proposed modification under any non-United Kingdom capital adequacy regime which is binding on the company or a Covered Entity.
Such modifications or replacements may be retrospective and may result in a loss of or reduction in the protection expected by the Group under the APS in relation to certain Covered Assets, an increase in the risk weightings of the Covered Assets (either in the United Kingdom or overseas), a material increase in the continuing reporting obligations or asset management conditions applicable to the Group under the Scheme Conditions or a material increase in the expenses incurred or costs payable by the Group under the APS. Modifications by HM Treasury of the Scheme Conditions could result in restrictions or limitations on the Group’s operations. The consequences of any such modifications by HM Treasury are impossible to quantify and are difficult to predict and may have a material adverse effect on the Group’s financial condition and results of operations.
Owing to the complexity of the APS and possible regulatory capital developments, the operation of the APS and the issue of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares may fail to achieve the desired effect on the Group’s regulatory capital position. This may mean the Group’s participation in the APS and the issuance of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares does not improve market confidence in the Group sufficiently or at all. This may result in the Group facing the risk of full nationalisation or other resolution procedures under the Banking Act.
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One of the key objectives of the APS and the issuance of £25.5 billion of B Shares in December 2009 and, if required, the £8 billion Contingent B Shares was to improve capital ratios at a consolidated level for the Group and at an individual level for certain relevant Group members. The Group has entered and may in the future enter into further back-to-back arrangements with Group members holding assets or exposures to be covered by the APS in order to ensure the capital ratios of these entities are also improved by virtue of the APS. As the APS and certain of the associated back-to-back arrangements are a unique form of credit protection over a complex range of diversified Covered Assets in a number of jurisdictions, there is a risk that the interpretation of the relevant regulatory capital requirements by one or more of the relevant regulatory authorities may differ from that assumed by the Group, with the result that the anticipated improvement to the Group’s capital ratios will not be fully achieved. There is a further risk that, given that the current regulatory capital requirements and the regulatory bodies governing these requirements are subject to unprecedented levels of review and scrutiny both globally and locally, regulatory capital treatment that differs from that assumed by the Group in respect of the APS, the treatment of the B Share issuance or the back-to-back arrangement may also occur because of changes in law or regulation, regulatory bodies or interpretation of the regulatory capital regimes applicable to the Group and/or the APS and/or the B Shares and/or the back-to-back arrangements described above. If participation in the APS and the issuance of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares are not sufficient to maintain the Group’s capital ratios, this could cause the Group’s business, results of operations and financial condition to suffer, its credit rating to drop, its ability to lend and access to funding to be further limited and its cost of funding to increase. The occurrence of any or all of such events may cause the price of the Securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of Securities would be subject to the provisions of the Banking Act and investors may receive no value for their Securities.
The costs of the Group’s participation in the APS may be greater than the amounts received thereunder.
The costs of participating in the APS incurred by the Group to HM Treasury include a fee of £700 million per annum, payable in advance for the first three years of the APS and £500 million per annum thereafter until the earlier of (i) the date of termination of the APS and (ii) 31 December 2099. The fee may be paid in cash or, subject to HM Treasury consent, by the waiver of certain United Kingdom tax reliefs that are treated as deferred tax assets (pursuant to three agreements which provide the right, at the company’s option, subject to HM Treasury consent, to satisfy all or part of the annual fee in respect of the APS and £8 billion of Contingent B Shares, and the exit fee payable in connection with any termination of the Group’s participation in the APS, by waiving the right to certain United Kingdom tax reliefs that are treated as deferred tax assets (“Tax Loss Waiver”)) or be funded by a further issue of B Shares to HM Treasury. The Group has paid in cash the fee of £1.4 billion in respect of 2009 and 2010. On termination of the Group’s participation in the APS, the fees described in the risk factor below headed “The Group may have to repay any net pay-outs made by HM Treasury under the APS in order to terminate its participation in the APS” will apply. Furthermore, the Group may be subject to additional liabilities in connection with the associated intra group arrangements. Significant costs either have been or will also be incurred in (i) establishing the APS (including a portion of HM Treasury’s costs attributed to the Group by HM Treasury), (ii) implementing the APS, including the Group’s internal systems building and as a consequence of its on-going management and administration obligations under the Scheme Conditions, such as complying with (a) the extensive governance, reporting, auditing and other continuing obligations of the APS and (b) the asset management objective which is generally applied at all times to the Covered Assets and will require increased lending in certain circumstances and (iii) paying the five-year annual fee for the £8 billion of Contingent B Shares of £320 million less 4 per cent. of: (a) the value of any B Shares subscribed for under the Contingent Subscription; and (b) the amount by which the Contingent Subscription has been reduced pursuant to any exercise by the company of a partial termination of the Contingent Subscription (payable in cash or, with HM Treasury’s consent, by waiving certain United Kingdom tax reliefs that are treated as deferred tax assets (pursuant to the Tax Loss Waiver), or funded by a further issue of B Shares to HM Treasury). In addition, there will be ongoing expenses associated with compliance with the Scheme Conditions, including the company’s and HM Treasury’s professional advisers’ costs and expenses. These expenses are expected to be significant due to the complexity of the APS, the need to enhance the Group’s existing systems in order to comply with reporting obligations required by the APS and the Group’s obligations under the Scheme Conditions to pay HM Treasury’s and its advisers’ costs in relation to the APS. In addition, the Group has certain other financial exposures in connection with the APS including (i) an obligation to indemnify HM Treasury, any governmental entity or their representatives and (ii) for the minimum two-year period from a Trigger until payment is made by HM Treasury under the APS, exposure to the funding costs of retaining assets and exposures on its balance sheet whilst receiving interest based on the “Sterling General Collateral Repo Rate” as displayed on the Bloomberg service, or such other rate as may be notified by HM Treasury from time to time as reflecting its costs of funds. The aggregate effect of the joining, establishment and operational costs of the APS and the on-going costs and expenses, including professional advisers’ costs, may significantly reduce or even eliminate the anticipated amounts to be received by the Group under the APS.
The amounts received under the APS (which amounts are difficult to quantify precisely) may be less than the costs of participation, as described above. There are other, non-cash, anticipated benefits of the Group’s participation, which include the regulatory capital benefits referred to above and the potential protection from future losses, which are themselves also difficult to quantify.
The Group may have to repay any net pay-outs made by HM Treasury under the APS in order to terminate its participation in the APS.
During its participation in the APS, RBS will pay an annual participation fee to HM Treasury. The annual fee, which is payable in advance, is £700 million per annum for the first three years of the Group’s participation in the APS and £500 million per annum thereafter until the earlier of (i) the date of termination of the APS and (ii) 31 December 2099. The Group has paid in cash the fee of £1.4 billion in respect of 2009 and 2010. Pursuant to the Accession Agreement and the Tax Loss Waiver, subject to HM Treasury consent, all or part of the exit fee (but not the refund of the net payments the Group has received from HM Treasury under the APS) may be paid by the waiver of certain United Kingdom tax reliefs that are treated as deferred tax assets (pursuant to the Tax Loss Waiver). The directors of the company may, in the future, conclude that the cost of this annual fee, in combination with the other costs of the Group’s participation in the APS, outweighs the benefits of the Group’s continued participation and therefore that the Group’s participation in the APS should be terminated. However, in order to terminate the Group’s participation in the APS, the Group must have FSA approval and pay an exit fee which is an amount equal to (a) the larger of (i) the cumulative aggregate fee of £2.5 billion and (ii) 10 per cent. of the annual aggregate reduction in Pillar I capital requirements in respect of the assets covered by the APS up to the time of exit less (b) the aggregate of the annual fees paid up to the date of exit. In the event that the Group has received payments from HM Treasury under the APS in respect of losses on any Covered Assets in respect of which a Trigger occurs (“Triggered Assets”), it must either negotiate a satisfactory exit payment to exit the APS, or absent such agreement, refund to HM Treasury any net payments made by HM Treasury under the APS in respect of losses on the Triggered Assets.
The effect of the payment of the exit fee and potentially the refund of the net pay-outs it has received from HM Treasury under the APS may significantly reduce or even eliminate the anticipated further regulatory capital benefits to the Group of its participation in the APS or if FSA approval for the proposed termination is not obtained and could have an adverse impact on the Group’s financial condition and results of operation
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or result in a loss of value in the Securities. Alternatively, if the Group is unable to repay to HM Treasury in full the exit fee and potentially the net pay-outs it has received under the APS and, therefore, unable to terminate its participation in the APS, the Group will be required under the Scheme Conditions to continue to pay the annual fee to HM Treasury until 31 December 2099, which could have an adverse impact on the Group’s financial condition and results of operation or result in a loss of value in the Securities.
Under certain circumstances, the Group cannot be assured that assets of ABN AMRO (and certain other entities) will continue to be covered under the APS, either as a result of a withdrawal of such assets or as a result of a breach of the relevant obligations.
If HM Treasury seeks to exercise its right to appoint one or more step-in managers in relation to the management and administration of Covered Assets held by ABN AMRO or its wholly-owned subsidiaries, ABN AMRO will, in certain circumstances, need to seek consent from the Dutch Central Bank to allow it to comply with such step-in. If this consent is not obtained by the date (which will fall no less than 10 business days after the notice from HM Treasury) on which the step-in rights must be effective, and other options to effect compliance are not possible (at all or because the costs involved prove prohibitive), those assets would need to be withdrawn by the Group from the APS where permissible under the Scheme Conditions or, otherwise, with HM Treasury consent. If the Group cannot withdraw such Covered Assets from the APS, it would be likely to lose protection in respect of these assets under the APS and/or may be liable under its indemnity to HM Treasury. If the Group loses cover under the APS in respect of any Covered Asset held by ABN AMRO or its wholly-owned subsidiaries, any losses incurred on such asset will continue to be borne fully by the Group and may have a material adverse impact on its financial condition, profitability and capital ratios. Similar issues apply in certain other jurisdictions but the relevant Covered Assets are of a lower quantum.
The extensive governance, asset management and information requirements under the Scheme Conditions and HM Treasury’s step-in rights may serve to limit materially the Group’s operations. In addition, the market’s reaction to such controls and limitations may have an adverse impact on the price of the Securities.
Under the Scheme Conditions, the Group has extensive governance, asset management, audit and information obligations aimed at ensuring (amongst other things) that (i) there is no prejudice to, discrimination against, or disproportionate adverse effect on the management and administration of Covered Assets when compared with the management and administration of other assets of the Group that are outside of the APS and (ii) HM Treasury is able to manage and assess its exposure under the APS, perform any other functions within HM Treasury’s responsibilities or protect or enhance the stability of the United Kingdom financial system. Any information obtained by HM Treasury through its information rights under the APS may be further disclosed by HM Treasury to other government agencies, the United Kingdom Parliament, the European Commission, and more widely if HM Treasury determines that doing so is required, for example, to protect the stability of the United Kingdom financial system.
Moreover, HM Treasury has the right under the Scheme Conditions to appoint one or more step-in managers (identified or agreed to by HM Treasury) to exercise certain step-in rights upon the occurrence of certain specified events. The step-in rights are extensive and include certain oversight, investigation, approval and other rights, the right to require the modification or replacement of any of the systems, controls, processes and practices of the Group and extensive rights in relation to the direct management and administration of the Covered Assets. For further information on these rights. If the Group does not comply with the instructions of the step-in manager, once appointed, the Group may lose protection under the APS in respect of all or some of the Covered Assets. The step-in manager may be a person identified by HM Treasury and not by the company.
The payment obligations of HM Treasury under the Scheme Documents are capable of being transferred to any third party (provided the transfer does not affect the risk weightings the Group is entitled to apply to its exposures to Covered Assets). The step-in rights, together with all other monitoring, administration and enforcement rights, powers and discretions of HM Treasury under the Scheme Documents, are capable of being transferred to any government entity.
The obligations of the Group and the rights of HM Treasury may, individually or in the aggregate, impact the way the Group runs its business and may serve to limit the Group’s operations with the result that the Group’s business, results of operations and financial condition will suffer.
Any conversion of the B Shares, in combination with any future purchase by HM Treasury of Ordinary Shares, would increase HM Treasury’s ownership interest in the company, and could result in the delisting of the company’s Securities.
On 22 December 2009, the company issued £25.5 billion of B Shares to HM Treasury. The B Shares are convertible, at the option of the holder at any time, into Ordinary Shares at an initial conversion price of £0.50 per Ordinary Share. Although HM Treasury has agreed not to convert any B Shares it holds if, as a result of such conversion, it would hold more than 75 per cent. of the Ordinary Shares, if HM Treasury were to acquire additional ordinary shares otherwise than through the conversion of the B Shares, such additional acquisitions could significantly increase HM Treasury’s ownership interest in the company to above 75 per cent. of the company’s ordinary issued share capital, which would put the company in breach of the FSA’s Listing Rules requirement that at least 25 per cent. of its issued ordinary share capital must be in public hands. Although the company may apply to the UK Listing Authority for a waiver in such circumstances, there is no guarantee that such a waiver would be granted, the result of which could be the delisting of the company from the Official List and potentially other exchanges where its Securities are currently listed and traded. In addition, HM Treasury will not be entitled to vote in respect of the B Shares or in respect of the Dividend Access Share to the extent, but only to the extent, that votes cast on such B Shares and/or on such Dividend Access Share, together with any other votes which HM Treasury is entitled to cast in respect of any other Ordinary Shares held by or on behalf of HM Treasury, would exceed 75 per cent. of the total votes eligible to be cast on a resolution presented at a general meeting of the company. In addition, holders of the B Shares will only be entitled to receive notice of and to attend any general meeting of the company and to speak to or vote upon any resolution proposed at such meeting if a resolution is proposed which either varies or abrogates any of the rights and restrictions attached to the B Shares or proposes the winding up of the company (and then in each such case only to speak and vote upon any such resolution).
A significant proportion of senior management’s time and resources will have to be committed to the APS, which may have a material adverse effect on the rest of the Group’s business.
The Group expects that significant senior management and key employee time and resources will have to be committed to the ongoing operation of the APS, including governance, asset management and reporting and generally to ensure compliance with the Scheme Conditions. The time and resources required to be committed to the APS by the Group’s senior management and other key employees is likely to place significant additional demands on senior management in addition to the time and resources required to be dedicated to the rest of the Group’s business. In addition, and separately from the Group’s participation in the APS, significant headcount reductions are being introduced at all levels of
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management in the context of a restructuring of the Group. The Group’s ability to implement its overall strategy depends on the availability of its senior management and other key employees. If the Group is unable to dedicate sufficient senior management resources to the Group’s business outside the APS, its business, results of operations and financial condition will suffer.
The cost of the Tax Loss Waiver and related undertakings is uncertain and the Group may be subject to additional tax liabilities in connection with the APS.
It is difficult to value accurately the cost to the Group if it opts, subject to HM Treasury consent, to satisfy the annual fee in respect of both the APS and the Contingent Subscription and any exit fee (payable to terminate the Group’s participation in the APS) by waiving certain United Kingdom tax reliefs that are treated as deferred tax assets pursuant to the Tax Loss Waiver. The cost will depend on unascertainable factors including the extent of future losses, the extent to which the Group regains profitability and any changes in tax law. In addition to suffering greater tax liabilities in future years as a result of the Tax Loss Waiver, the Group may also be subject to further tax liabilities in the United Kingdom and overseas in connection with the APS and the associated intra-group arrangements which would not otherwise have arisen. The Tax Loss Waiver provides that the Group will not be permitted to enter into arrangements which have a main purpose of reducing the net cost of the Tax Loss Waiver. It is unclear precisely how these restrictions will apply, but it is possible that they may limit the operations and future post-tax profitability of the Group.
In order to fulfil its disclosure obligations under the APS, the Group may incur the risk of civil suits, criminal liability or regulatory actions.
The Scheme Conditions require that certain information in relation to the Covered Assets be disclosed to HM Treasury to enable HM Treasury to quantify, manage and assess its exposure under the APS. The FSA has issued notices to the Group requiring the information that HM Treasury required under the Scheme Documents prior to the Group’s accession to and participation in the APS (and certain other information which HM Treasury requires under the Scheme Documents following the Group’s accession), be provided to it through its powers under the FSMA and the Banking Act. To the extent regulated by the FSA, the Group has a legal obligation to comply with these disclosure requests from the FSA. However, in complying with these disclosure obligations and providing such information to the FSA, the Group may, in certain jurisdictions, incur the risk of civil suits or regulatory action (which could include fines) to the extent that disclosing information related to the Covered Assets results in the Group breaching common law or statutory confidentiality laws, contractual undertakings, data protection laws, banking secrecy and other laws restricting disclosure. There can be no guarantee that future requests for information will not be made by the FSA in the same manner. Requests made directly by HM Treasury pursuant to the terms of the APS are likely to expose the Group to a greater risk of such suits or regulatory action. Adverse regulatory action or adverse judgments in litigation could result in a material adverse 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 (in the case of criminal liability) be required to remove Covered Assets from the APS so as not to be required to disclose to HM Treasury, such information, 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.
Where the Group discloses information to HM Treasury as set out above, HM Treasury may disclose that information to a number of third parties for certain specified purposes. Such disclosures by HM Treasury may put the Group in breach of common law or statutory confidentiality laws, contractual undertakings, data protection laws, banking secrecy or other laws restricting disclosure.
Business review continued |
Key financials
| | | 2009 | | | Restated (1) 2008 | | | 2007 | |
| For year ended 31 December 2009 | | | £m | | | | £m | | | | £m | |
| Total income | | | 38,690 | | | | 25,868 | | | | 30,366 | |
| Operating (loss)/profit before tax | | | (2,595 | ) | | | (40,836 | ) | | | 9,832 | |
| (Loss)/profit attributable to ordinary and B shareholders | | | (3,607 | ) | | | (24,306 | ) | | | 7,303 | |
| Cost:income ratio | | | 55.5 | % | | | 209.5 | % | | | 45.9 | % |
| Basic (loss)/earnings per ordinary and B share from continuing operations (pence) | | | (6.3p | ) | | | (146.2p | ) | | | 64.0 | p |
| | | 2009 | | | 2008 | | | 2007 | |
| At 31 December 2009 | | | £m | | | | £m | | | | £m | |
| Total assets | | | 1,696,486 | | | | 2,401,652 | | | | 1,840,829 | |
| Loans and advances to customers | | | 728,393 | | | | 874,722 | | | | 828,538 | |
| Deposits | | | 756,346 | | | | 897,556 | | | | 994,657 | |
| Owners’ equity | | | 77,736 | | | | 58,879 | | | | 53,038 | |
| Risk asset ratio | | | | | | | | | | | | |
| – Core Tier 1 | | | 11.0 | % | | | 6.6 | % | | | 4.5 | % |
| – Tier 1 | | | 14.1 | % | | | 10.0 | % | | | 7.3 | % |
| – Total | | | 16.1 | % | | | 14.1 | % | | | 11.2 | % |
| (1) | The results for 2008 have been restated for the amendment to IFRS 2 ‘Share-based Payment’. This has resulted in an increase in staff costs amounting to £169 million. |
Overview of results
As discussed on page 2, the results of ABN AMRO are fully consolidated in the Group’s financial statements. Consequently, the results of RBS for the year ended 31 December 2009 and 2008 include the results of ABN AMRO for the full year, and for the year ended 31 December 2007 include the results of ABN AMRO for 76 days. The interests of the State of the Netherlands and Santander in RFS Holdings are included in minority interests.
Business review continued |
Summary consolidated income statement for the year ended 31 December 2009
| | | 2009 | | | Restated (1) 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income | | | 16,504 | | | | 18,675 | | | | 12,069 | |
| Fees and commissions receivable | | | 9,831 | | | | 9,831 | | | | 8,278 | |
| Fees and commissions payable | | | (2,822 | ) | | | (2,386 | ) | | | (2,193 | ) |
| Other non-interest income | | | 9,633 | | | | (6,578 | ) | | | 6,125 | |
| Insurance net premium income | | | 5,544 | | | | 6,326 | | | | 6,087 | |
| Non-interest income | | | 22,186 | | | | 7,193 | | | | 18,297 | |
| Total income | | | 38,690 | �� | | | 25,868 | | | | 30,366 | |
| Operating expenses | | | (21,478 | ) | | | (54,202 | ) | | | (13,942 | ) |
| Profit/(loss) before other operating charges and impairment losses | | | 17,212 | | | | (28,334 | ) | | | 16,424 | |
| Insurance net claims | | | (4,857 | ) | | | (4,430 | ) | | | (4,624 | ) |
| Impairment losses | | | (14,950 | ) | | | (8,072 | ) | | | (1,968 | ) |
| Operating (loss)/profit before tax | | | (2,595 | ) | | | (40,836 | ) | | | 9,832 | |
| Tax credit/(charge) | | | 371 | | | | 2,323 | | | | (2,044 | ) |
| (Loss)/profit from continuing operations | | | (2,224 | ) | | | (38,513 | ) | | | 7,788 | |
| (Loss)/profit from discontinued operations, net of tax | | | (99 | ) | | | 3,971 | | | | (76 | ) |
| (Loss)/profit for the year | | | (2,323 | ) | | | (34,542 | ) | | | 7,712 | |
| Minority interests | | | (349 | ) | | | 10,832 | | | | (163 | ) |
| Preference shares and other dividends | | | (935 | ) | | | (596 | ) | | | (246 | ) |
| (Loss)/profit attributable to ordinary and B shareholders | | | (3,607 | ) | | | (24,306 | ) | | | 7,303 | |
| | | | | | | | | | | | | |
| Basic (loss)/earnings per ordinary and B share from continuing operations | | | (6.3p | ) | | | (146.2p | ) | | | 64.0 | p |
| (1) | The results for 2008 have been restated for the amendment to IFRS 2 ‘Share-based Payment’. This has resulted in an increase in staff costs amounting to £169 million. |
Business review continued |
2009 compared with 2008
Operating loss before tax
Operating loss before tax for the year was £2,595 million compared with a loss of £40,836 million in 2008. The reduction in the loss is primarily a result of a substantial increase in non-interest income and a substantial fall in the write-down of goodwill and other intangible assets partially offset by a significant increase in impairment losses and lower net interest income.
After tax, minority interests and preference share and other dividends, the loss attributable to ordinary and B shareholders was £3,607 million, compared with an attributable loss of £24,306 million in 2008.
Total income
Total income increased 50% to £38,690 million in 2009 primarily reflecting a significant reduction in credit and other market losses and a gain on redemption of own debt. Increased market volatility and strong customer demand in a positive trading environment also contributed to this improvement. While income was down marginally in UK Corporate and held steady in Retail & Commercial Banking and RBS Insurance, a significant improvement occurred in Global Banking & Markets, reflecting the reduced credit and other market losses and a more buoyant trading market during the year compared to 2008.
Net interest income
Net interest income fell by 12% to £16,504 million, with average loans and advances to customers stable and average customer deposits down 1%. Group net interest margin fell from 2.12% to 1.83% largely reflecting the pressure on liability margins, given rates on many deposit products already at floors in the low interest rate environment, and strong competition, particularly for longer-term deposits and the build up of the Group’s liquidity portfolio.
Non-interest income
Non-interest income increased to £22,186 million from £7,193 million in 2008, largely reflecting the sharp improvement in income from trading activities, as improved asset valuations led to lower credit market losses and GBM benefited from the restructuring of its business to focus on core customer franchises. The Group also recorded a gain of £3,790 million on a liability management exercise to redeem a number of Tier 1 and upper Tier 2 securities. However, fees and commissions fell as a result of the withdrawal of the single premium payment protection insurance product and the restructuring of UK current account overdraft fees, offset by higher fees in businesses attributable to RFS Holdings minority interest..
Operating expenses
Total operating expenses decreased from £54,202 million in 2008 to £21,478 million, largely resulting from the substantial decrease in the write-down of goodwill and other intangible assets, down to £363 million compared with £32,581 million in 2008. Staff costs, excluding curtailment gains, were up 13% with most of the movement relating to adverse movements in foreign exchange rates and some salary inflation. Changes in incentive compensation, primarily in Global Banking & Markets, represented most of the remaining change. This was offset by a gain of £2,148 million arising from the curtailment of prospective pension benefits in the defined benefit scheme and certain other subsidiary schemes. The Group cost:income ratio improved to 56%, compared with 210% in 2008.
Net insurance claims
Bancassurance and general insurance claims, after reinsurance, increased by 10% to £4,857 million.
Impairment losses
Impairment losses increased to £14,950 million from £8,072 million in 2008, with Core bank impairments rising by £2,182 million, Non-Core by £4,285 million and RFS Holdings minority interest by £411 million. Signs that impairments might be plateauing appear to have been borne out in the latter part of the year, and there are indications that the pace of downwards credit rating migration for corporates is slowing. Nonetheless, the financial circumstances of many consumers and businesses remain fragile, and rising refinancing costs, whether as a result of monetary tightening or of increased regulatory capital requirements, could expose some customers to further difficulty.
Impairments represented 2.0% of gross loans and advances, excluding reverse repos, in 2009 compared with 0.8% in 2008.
Risk elements in lending and potential problem loans at 31 December 2009 represented 5.5% of loans and advances, excluding reverse repos, compared with 2.5% a year earlier. Provision coverage was 44%, compared with 51% at 31 December 2008 as a consequence of the growth in risk elements in lending being concentrated in secured, property-related loans. These loans require relatively lower provisions in view of their collateralised nature.
Taxation
The effective tax rate for 2009 was 14.3% compared with 5.7% in 2008.
Earnings
Basic earnings per ordinary and B share, including discontinued operations, improved from a loss of 146.7p to a loss of 6.4p.
Balance Sheet
Total assets of £1,696.5 billion at 31 December 2009 were down £705.2 billion, 29%, compared with 31 December 2008, principally reflecting substantial repayments of customer loans and advances, as corporate customer demand fell and corporates looked to deleverage their balance sheets. Lending to banks also fell in line with significantly reduced wholesale funding activity. There were also significant falls in the value of derivative assets, with a corresponding reduction in derivative liabilities.
Loans and advances to banks decreased by £46.4 billion, 34%, to £91.8 billion with reverse repurchase agreements and stock borrowing (‘reverse repos’) down by £23.7 billion, 40% to £35.1 billion and lower bank placings, down £22.7 billion, 29%, to £56.7 billion, largely as a result of reduced wholesale funding activity in Global Banking & Markets.
Business review continued |
Loans and advances to customers were down £146.3 billion, 17%, at £728.4 billion. Within this, reverse repos increased by 4%, £1.7 billion to £41.0 billion. Excluding reverse repos, lending decreased by £148.0 billion to £687.4 billion or by £141.8 billion, 17%, before impairment provisions.
Capital
Capital ratios at 31 December 2009 were 11.0% (Core Tier 1), 14.1% (Tier 1) and 16.1% (Total).
2008 compared with 2007
Operating loss before tax
Operating loss before tax was £40,836 million compared with an operating profit before tax of £9,832 million in 2007. The results have been adversely affected by the write-down of goodwill and other assets, a substantial decline in non-interest income, a number of specific losses such as counterparty failures, and a marked increase in the credit impairment charge, reflecting weakness in financial markets and a deteriorating global economy.
Losses from credit market exposures increased to £7,781 million, compared with £1,410 million in 2007, with the great majority incurred in the first half of the year. Write-down of goodwill and other assets was £32,581 million. Other one-off items amounted to a credit of £1,674 million, 25% higher than in 2007, principally as a result of a £1,232 million increase in the carrying value of own debt carried at fair value.
Loss attributable to ordinary shareholders was £24,306 million, compared with an attributable profit of £7,303 million in 2007.
Total income
Total income declined by 15% to £25,868 million, with a significant deterioration experienced during the second half of the year principally as a result of £5.8 billion of trading asset write-downs, counterparty failure and incremental reserving within GBM and Non-Core. While income increased in 2008 in Global Transaction Services, UK Corporate, Ulster Bank and US Retail & Commercial, a significant reduction occurred in UK Retail, and in Global Banking & Markets and Non-Core, where a strong performance in rates, currencies and commodities was offset by marked deterioration in credit markets and equities.
Net interest income
Net interest income increased by 55% to £18,675 million, with average loans and advances to customers up 61% and average customer deposits up 53%. Group net interest margin fell from 2.32% to 2.12% largely reflecting tightened margins within UK Retail as market interest rates fell, with deposit markets remaining competitive and price adjustments on lending taking some time to feed through to the back book.
Non-interest income
Non-interest income was severely affected by the weakness in financial markets experienced over the course of the year, particularly in the fourth quarter. Non-interest income decreased to £7,193 million principally due to the credit market write-downs of £7,781 million offset by a movement in the fair value of own debt of £1,232 million. While the decline was particularly marked in GBM and Non-Core credit markets and equities businesses, with reduced business volumes and mounting mark-to-market trading losses, UK Retail also saw non-interest income fall in the latter part of the year as declining consumer confidence led to lower demand for credit and other financial products.
Operating expenses
Total operating expenses rose to £54,202 million, with cost growth in the Group’s core retail and commercial banking franchises offset by efficiency programmes. Integration and restructuring costs were £1,357 million compared with £108 million in 2007. Write-down of goodwill and other assets was £32,581 million.
Net insurance claims
Bancassurance and general insurance claims, after reinsurance, decreased by 4% to £4,430 million, reflecting improved risk selection, better claims management and the non-recurrence of the severe floods experienced in 2007 and as a result of movements in financial market values.
Impairment losses
Impairment losses increased to £8,072 million in 2008, compared with £1,968 million in 2007. The Group experienced a pronounced deterioration in impairments in the second half of the year, as financial stress spread to a broad range of customers. The greatest increase in impairments occurred in GBM and Non-Core, where fourth quarter impairments included a loss of approximately £900 million on the Group’s exposure to LyondellBasell. However businesses in all geographies also experienced a noticeable increase in impairments in the second half, particularly in the UK and Irish corporate and US personal segments.
Impairments represented 0.44% of gross loans and advances, excluding reverse repos, in the first half but reached 1.27% in the second half. For 2008 as a whole, impairments amounted to 0.82% of loans and advances, excluding reverse repos, compared with 0.28% in 2007. Risk elements in lending and potential problem loans at 31 December 2008 represented 2.52% of gross loans and advances to customers, excluding reverse repos, compared with 1.64% a year earlier. Provision coverage was 51%, compared with 57% at 31 December 2007 reflecting the higher proportion of secured loans included in risk elements in lending and potential problem loans.
Credit market losses
Losses for 2008 relating to the Group’s previously identified credit market exposures totalled £7,781 million, net of hedging gains of £1,642 million. This includes impairment losses of £466 million incurred on credit market assets reclassified out of the ‘held-for-trading’ category in line with the amendments to IAS 39 ‘Financial Instruments: Recognition and Measurement’ issued in October 2008. While the majority of these write-downs were incurred in the first half of 2008, the severity of the financial market dislocation intensified in the fourth quarter, resulting in further losses in particular on the Group’s structured credit portfolios.
Business review continued |
Write-down of goodwill and other intangible assets
After reviewing the carrying value of goodwill and other purchased intangible assets, the Group recorded an impairment charge of £32,581 million. Of this charge, £23,348 million relates to part of the goodwill in respect of the acquisition of ABN AMRO, while other significant impairments have been recorded on part of the Citizens/Charter One goodwill of £4,382 million, part of the NatWest goodwill (principally allocated to Global Banking & Markets) of £2,742 million and other goodwill of £720 million. Other intangible asset impairments of £1,389 million principally relate to the write down in the value of customer relationships recognised on the acquisition of ABN AMRO.
These impairments have no cash impact, and minimal impact on the Group’s capital ratios.
Other non-operating items
Integration and restructuring costs totalled £1,357 million, primarily reflecting the integration of ABN AMRO into the Group, while the amortisation of purchased intangibles increased to £582 million from £124 million.
Taxation
The Group recorded a tax credit of £2,323 million in 2008, compared with a tax charge of £2,044 million in 2007. The effective tax rate for 2008 was 5.7% compared with 20.8% in 2007.
Earnings
Basic earnings per ordinary share, including discontinued operations, decreased from 64.0p to (146.7p).
The number of shares in issue increased to 39,456 million at 31 December 2008, compared with 10,006 million in issue at 31 December 2007, reflecting the Group’s capital raisings in June and December and the capitalisation issue in lieu of the interim dividend for 2008.
Business review continued |
Analysis of results
Net interest income
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Interest receivable | | | 33,835 | | | | 49,522 | | | | 32,252 | |
| Interest payable | | | (17,331 | ) | | | (30,847 | ) | | | (20,183 | ) |
| Net interest income | | | 16,504 | | | | 18,675 | | | | 12,069 | |
| | | % | | | % | | | % | |
Gross yield on interest-earning assets of the banking business (1) | | | 3.76 | | | | 5.61 | | | | 6.19 | |
| Cost of interest-bearing liabilities of the banking business | | | (2.18 | ) | | | (3.79 | ) | | | (4.36 | ) |
Interest spread of the banking business (2) | | | 1.58 | | | | 1.82 | | | | 1.83 | |
| Benefit from interest-free funds | | | 0.25 | | | | 0.30 | | | | 0.49 | |
Net interest margin of the banking business (3) | | | 1.83 | | | | 2.12 | | | | 2.32 | |
| Yields, spreads and margins of the banking business | | % | | | % | | | % | |
Gross yield (1) | | | | | | | | | |
| Group | | | 3.76 | | | | 5.61 | | | | 6.19 | |
| UK | | | 3.35 | | | | 5.72 | | | | 6.69 | |
| Overseas | | | 4.09 | | | | 5.54 | | | | 5.52 | |
Interest spread (2) | | | | | | | | | | | | |
| Group | | | 1.58 | | | | 1.82 | | | | 1.83 | |
| UK | | | 1.50 | | | | 1.92 | | | | 2.30 | |
| Overseas | | | 1.67 | | | | 1.76 | | | | 1.20 | |
Net interest margin (3) | | | | | | | | | | | | |
| Group | | | 1.83 | | | | 2.12 | | | | 2.32 | |
| UK | | | 1.81 | | | | 2.39 | | | | 2.55 | |
| Overseas | | | 1.85 | | | | 1.91 | | | | 1.99 | |
| | | | | | | | | | | | | |
| The Royal Bank of Scotland plc base rate (average) | | | 0.64 | | | | 4.67 | | | | 5.51 | |
| London inter-bank three month offered rates (average): | | | | | | | | | | | | |
| Sterling | | | 1.21 | | | | 5.51 | | | | 6.00 | |
| Eurodollar | | | 0.69 | | | | 2.92 | | | | 5.29 | |
| Euro | | | 1.21 | | | | 4.63 | | | | 4.28 | |
| (1) | Gross yield is the interest rate earned on average interest-earning assets of the banking business. |
| (2) | Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities of the banking business. |
| (3) | Net interest margin is net interest income of the banking business as a percentage of average interest-earning assets of the banking business. |
Business review continued |
Average balance sheet and related interest
| | | | 2009 | | | 2008 | |
| | | | Average Balance | | | Interest | | | Rate | | | Average Balance | | | Interest | | | Rate | |
| | | | | £m | | | | £m | | | % | | | | £m | | | | £m | | | % | |
| Assets | | | | | | | | | | | | | | | | | | | | | | | |
| Loans and advances to banks | – UK | | | 21,616 | | | | 310 | | | | 1.43 | | | | 19,039 | | | | 939 | | | | 4.93 | |
| | – Overseas | | | 32,367 | | | | 613 | | | | 1.89 | | | | 31,388 | | | | 1,417 | | | | 4.51 | |
| Loans and advances to customers | – UK | | | 333,230 | | | | 11,940 | | | | 3.58 | | | | 319,696 | | | | 19,046 | | | | 5.96 | |
| | – Overseas | | | 376,382 | | | | 16,339 | | | | 4.34 | | | | 393,405 | | | | 22,766 | | | | 5.79 | |
| Debt securities | – UK | | | 52,470 | | | | 1,414 | | | | 2.69 | | | | 33,206 | | | | 1,276 | | | | 3.84 | |
| | – Overseas | | | 84,822 | | | | 3,220 | | | | 3.80 | | | | 85,625 | | | | 4,078 | | | | 4.76 | |
| Total interest-earning assets | – banking business (2, 3) | | 900,887 | | | | 33,836 | | | | 3.76 | | | | 882,359 | | | | 49,522 | | | | 5.61 | |
| | – trading business (4) | | 291,092 | | | | | | | | | | | | 425,454 | | | | | | | | | |
| Total interest-earning assets | | | | 1,191,979 | | | | | | | | | | | | 1,307,813 | | | | | | | | | |
Non-interest-earning assets (2, 3) | | | | 831,501 | | | | | | | | | | | | 732,872 | | | | | | | | | |
| Total assets | | | | 2,023,480 | | | | | | | | | | | | 2,040,685 | | | | | | | | | |
| Percentage of assets applicable to overseas operations | | | | 47.4 | % | | | | | | | | | | | 48.6 | % | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and owners’ equity | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits by banks | – UK | | | 24,837 | | | | 679 | | | | 2.73 | | | | 46,217 | | | | 1,804 | | | | 3.90 | |
| | – Overseas | | | 104,396 | | | | 2,362 | | | | 2.26 | | | | 113,592 | | | | 4,772 | | | | 4.20 | |
| Customer accounts: demand deposits | – UK | | | 110,294 | | | | 569 | | | | 0.52 | | | | 99,852 | | | | 2,829 | | | | 2.83 | |
| | – Overseas | | | 82,177 | | | | 1,330 | | | | 1.62 | | | | 70,399 | | | | 1,512 | | | | 2.15 | |
| Customer accounts: savings deposits | – UK | | | 54,270 | | | | 780 | | | | 1.44 | | | | 42,870 | | | | 1,708 | | | | 3.98 | |
| | – Overseas | | | 83,388 | | | | 2,114 | | | | 2.54 | | | | 72,473 | | | | 2,203 | | | | 3.04 | |
| Customer accounts: other time deposits | – UK | | | 68,625 | | | | 932 | | | | 1.36 | | | | 94,365 | | | | 4,011 | | | | 4.25 | |
| | – Overseas | | | 71,315 | | | | 2,255 | | | | 3.16 | | | | 105,660 | | | | 4,097 | | | | 3.88 | |
| Debt securities in issue | – UK | | | 116,536 | | | | 2,830 | | | | 2.43 | | | | 101,520 | | | | 4,095 | | | | 4.03 | |
| | – Overseas | | | 117,428 | | | | 2,500 | | | | 2.13 | | | | 132,699 | | | | 5,846 | | | | 4.41 | |
| Subordinated liabilities | – UK | | | 26,053 | | | | 834 | | | | 3.20 | | | | 26,300 | | | | 1,356 | | | | 5.16 | |
| | – Overseas | | | 12,468 | | | | 656 | | | | 5.26 | | | | 12,385 | | | | 788 | | | | 6.36 | |
| Internal funding of trading business | – UK | | | (60,284 | ) | | | (317 | ) | | | 0.53 | | | | (85,664 | ) | | | (3,445 | ) | | | 4.02 | |
| | – Overseas | | | (14,845 | ) | | | (192 | ) | | | 1.29 | | | | (18,090 | ) | | | (729 | ) | | | 4.03 | |
| Total interest-bearing liabilities | – banking business (2, 3) | | 796,658 | | | | 17,332 | | | | 2.18 | | | | 814,578 | | | | 30,847 | | | | 3.79 | |
| | – trading business (4) | | 331,380 | | | | | | | | | | | | 466,610 | | | | | | | | | |
| Total interest-bearing liabilities | | | | 1,128,038 | | | | | | | | | | | | 1,281,188 | | | | | | | | | |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | – UK | | | 38,220 | | | | | | | | | | | | 37,568 | | | | | | | | | |
| | – Overseas | | | 27,149 | | | | | | | | | | | | 17,625 | | | | | | | | | |
Other liabilities (3, 4) | | | | 772,770 | | | | | | | | | | | | 645,760 | | | | | | | | | |
| Owners’ equity | | | | 57,303 | | | | | | | | | | | | 58,544 | | | | | | | | | |
| Total liabilities and owners’ equity | | | | 2,023,480 | | | | | | | | | | | | 2,040,685 | | | | | | | | | |
| Percentage of liabilities applicable to overseas operations | | | | 45.8 | % | | | | | | | | | | | 47.2 | % | | | | | | | | |
| (1) | The analysis into UK and Overseas has been compiled on the basis of location of office. |
| Interest-earning assets and interest-bearing liabilities include the Retail bancassurance assets and liabilities attributable to policyholders. |
| Interest income and interest expense do not include interest on financial assets and liabilities designated as at fair value through profit or loss. |
| Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities. |
Business review continued |
Average balance sheet and related interest
| | | | 2007 | |
| | | | Average Balance | | | Interest | | | Rate | |
| | | | | £m | | | | £m | | | % | |
| Assets | | | | | | | | | | | | |
| Loans and advances to banks | – UK | | | 21,133 | | | | 1,024 | | | | 4.85 | |
| | – Overseas | | | 12,654 | | | | 546 | | | | 4.31 | |
| Loans and advances to customers | – UK | | | 268,911 | | | | 18,506 | | | | 6.88 | |
| | – Overseas | | | 175,301 | | | | 10,062 | | | | 5.74 | |
| Debt securities | – UK | | | 10,883 | | | | 600 | | | | 5.51 | |
| | – Overseas | | | 31,792 | | | | 1,514 | | | | 4.76 | |
| Total interest-earning assets | – banking business (2, 3) | | | 520,674 | | | | 32,252 | | | | 6.19 | |
| | – trading business (4) | | | 313,110 | | | | | | | | | |
| Total interest-earning assets | | | | 833,784 | | | | | | | | | |
Non-interest-earning assets (2, 3) | | | | 289,188 | | | | | | | | | |
| Total assets | | | | 1,122,972 | | | | | | | | | |
Percentage of assets applicable to overseas operations | | | | 38.0 | % | | | | | | | | |
| | | | | | | | | | | | | | |
| Liabilities and owners’ equity | | | | | | | | | | | | | |
| Deposits by banks | – UK | | | 52,951 | | | | 2,234 | | | | 4.22 | |
| | – Overseas | | | 31,073 | | | | 1,172 | | | | 3.77 | |
| Customer accounts: demand deposits | – UK | | | 93,764 | | | | 3,296 | | | | 3.52 | |
| | – Overseas | | | 30,739 | | | | 1,031 | | | | 3.35 | |
| Customer accounts: savings deposits | – UK | | | 36,334 | | | | 1,658 | | | | 4.56 | |
| | – Overseas | | | 27,645 | | | | 902 | | | | 3.26 | |
| Customer accounts: other time deposits | – UK | | | 88,089 | | | | 4,201 | | | | 4.77 | |
| | – Overseas | | | 43,141 | | | | 2,100 | | | | 4.87 | |
| Debt securities in issue | – UK | | | 57,140 | | | | 3,060 | | | | 5.36 | |
| | – Overseas | | | 49,848 | | | | 2,627 | | | | 5.27 | |
| Subordinated liabilities | – UK | | | 23,502 | | | | 1,300 | | | | 5.53 | |
| | – Overseas | | | 4,509 | | | | 230 | | | | 5.10 | |
| Internal funding of trading business | – UK | | | (68,395 | ) | | | (3,307 | ) | | | 4.84 | |
| | – Overseas | | | (7,454 | ) | | | (321 | ) | | | 4.31 | |
| Total interest-bearing liabilities | – banking business (2, 3) | | | 462,886 | | | | 20,183 | | | | 4.36 | |
| | – trading business (4) | | | 316,453 | | | | | | | | | |
| Total interest-bearing liabilities | | | | 779,339 | | | | | | | | | |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | |
| Demand deposits | – UK | | | 18,416 | | | | | | | | | |
| | – Overseas | | | 14,455 | | | | | | | | | |
Other liabilities (3, 4) | | | | 267,403 | | | | | | | | | |
| Owners’ equity | | | | 43,359 | | | | | | | | | |
| Total liabilities and owners’ equity | | | | 1,122,972 | | | | | | | | | |
| Percentage of liabilities applicable to overseas operations | | | | 35.9 | % | | | | | | | | |
| (1) | The analysis into UK and Overseas has been compiled on the basis of location of office. |
| (2) | Interest-earning assets and interest-bearing liabilities include the Retail bancassurance assets and liabilities attributable to policyholders. |
| (3) | Interest income and interest expense do not include interest on financial assets and liabilities designated as at fair value through profit or loss. |
| (4) | Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities. |
Business review continued |
Analysis of change in net interest income – volume and rate analysis
Volume and rate variances have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. Changes due to a combination of volume and rate are allocated pro rata to volume and rate movements.
| | | 2009 over 2008 | | | 2008 over 2007 | |
| | | Increase/(decrease) due to changes in: | | | Increase/(decrease) due to changes in: | |
| | | Average | | | Average | | | Net | | | Average | | | Average | | | Net | |
| | | volume | | | rate | | | change | | | volume | | | rate | | | change | |
| | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | |
| Interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans and advances to banks | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 113 | | | | (742 | ) | | | (629 | ) | | | (103 | ) | | | 18 | | | | (85 | ) |
| Overseas | | | 43 | | | | (847 | ) | | | (804 | ) | | | 845 | | | | 26 | | | | 871 | |
| Loans and advances to customers | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 775 | | | | (7,881 | ) | | | (7,106 | ) | | | 3,221 | | | | (2,681 | ) | | | 540 | |
| Overseas | | | (949 | ) | | | (5,478 | ) | | | (6,427 | ) | | | 12,621 | | | | 83 | | | | 12,704 | |
| Debt securities | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 594 | | | | (456 | ) | | | 138 | | | | 906 | | | | (230 | ) | | | 676 | |
| Overseas | | | (38 | ) | | | (820 | ) | | | (858 | ) | | | 2,564 | | | | — | | | | 2,564 | |
| Total interest receivable of the banking business | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 1,482 | | | | (9,079 | ) | | | (7,597 | ) | | | 4,024 | | | | (2,893 | ) | | | 1,131 | |
| Overseas | | | (944 | ) | | | (7,145 | ) | | | (8,089 | ) | | | 16,030 | | | | 109 | | | | 16,139 | |
| | | | 538 | | | | (16,224 | ) | | | (15,686 | ) | | | 20,054 | | | | (2,784 | ) | | | 17,270 | |
| Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits by banks | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 683 | | | | 442 | | | | 1,125 | | | | 481 | | | | (51 | ) | | | 430 | |
| Overseas | | | 360 | | | | 2,050 | | | | 2,410 | | | | (3,708 | ) | | | 108 | | | | (3,600 | ) |
| Customer accounts: demand deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | (268 | ) | | | 2,528 | | | | 2,260 | | | | 117 | | | | 350 | | | | 467 | |
| Overseas | | | (228 | ) | | | 410 | | | | 182 | | | | (376 | ) | | | (105 | ) | | | (481 | ) |
| Customer accounts: savings deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | (369 | ) | | | 1,297 | | | | 928 | | | | (29 | ) | | | (21 | ) | | | (50 | ) |
| Overseas | | | (306 | ) | | | 395 | | | | 89 | | | | (1,248 | ) | | | (53 | ) | | | (1,301 | ) |
| Customer accounts: other time deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 881 | | | | 2,198 | | | | 3,079 | | | | 75 | | | | 115 | | | | 190 | |
| Overseas | | | 1,175 | | | | 667 | | | | 1,842 | | | | (1,751 | ) | | | (246 | ) | | | (1,997 | ) |
| Debt securities in issue | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | (540 | ) | | | 1,805 | | | | 1,265 | | | | (785 | ) | | | (250 | ) | | | (1,035 | ) |
| Overseas | | | 609 | | | | 2,737 | | | | 3,346 | | | | (2,930 | ) | | | (289 | ) | | | (3,219 | ) |
| Subordinated liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 13 | | | | 509 | | | | 522 | | | | (36 | ) | | | (20 | ) | | | (56 | ) |
| Overseas | | | (5 | ) | | | 137 | | | | 132 | | | | (588 | ) | | | 30 | | | | (558 | ) |
| Internal funding of trading business | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | (795 | ) | | | (2,333 | ) | | | (3,128 | ) | | | 83 | | | | 55 | | | | 138 | |
| Overseas | | | (112 | ) | | | (425 | ) | | | (537 | ) | | | 390 | | | | 18 | | | | 408 | |
| Total interest payable of the banking business | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | (395 | ) | | | 6,446 | | | | 6,051 | | | | (94 | ) | | | 178 | | | | 84 | |
| Overseas | | | 1,493 | | | | 5,971 | | | | 7,464 | | | | (10,211 | ) | | | (537 | ) | | | (10,748 | ) |
| | | | 1,098 | | | | 12,417 | | | | 13,515 | | | | (10,305 | ) | | | (359 | ) | | | (10,664 | ) |
| Movement in net interest income | | | | | | | | | | | | | | | | | | | | | | | | |
| UK | | | 1,087 | | | | (2,633 | ) | | | (1,546 | ) | | | 3,930 | | | | (2,715 | ) | | | 1,215 | |
| Overseas | | | 549 | | | | (1,174 | ) | | | (625 | ) | | | 5,819 | | | | (428 | ) | | | 5,391 | |
| | | | 1,636 | | | | (3,807 | ) | | | (2,171 | ) | | | 9,749 | | | | (3,143 | ) | | | 6,606 | |
Note:
| (1) | The analysis into UK and Overseas has been compiled on the basis of location of office. |
Business review continued |
Non-interest income
| | 2009 | 2008 | 2007 |
| | £m | £m | £m |
| Fees and commissions receivable | 9,831 | 9,831 | 8,278 |
| Fees and commissions payable | (2,822) | (2,386) | (2,193) |
| Income/(loss) from trading activities | 3,881 | (8,477) | 1,292 |
| Gain on redemption of own debt | 3,790 | — | — |
| Other operating income (excluding insurance net premium income) | 1,962 | 1,899 | 4,833 |
| | 16,642 | 867 | 12,210 |
| Insurance premium income | 5,807 | 6,626 | 6,376 |
| Reinsurers’ share | (263) | (300) | (289) |
| | 5,544 | 6,326 | 6,087 |
| | 22,186 | 7,193 | 18,297 |
2009 compared with 2008
Net fees and commissions fell by £436 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).
Income from trading activities rose substantially during the year by £12,358 million, principally due to lower credit market losses reflecting improved underlying asset prices compared with 2008. Increased market volatility and strong customer demand in a positive trading environment also contributed to this improvement.
In the second quarter of 2009 the Group recorded a gain of £3,790 million on a liability management exercise to redeem a number of Tier 1 and upper Tier 2 securities.
Other operating income increased by £63 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. This was partially offset by lower profits on sales of securities and properties and reduced dividend income, together with a loss on sale of subsidiaries and associates of £0.1 billion compared with a profit of £0.9 billion in 2008, which included a gain of £600 million on the sale of Angel Trains.
Insurance net premium income fell by £782 million principally reflecting lower bancassurance fees, and lower general insurance premiums.
2008 compared with 2007
Non-interest income, decreased by 61%, £11,104 million to £7,193 million. Non-interest income was severely affected by the weakness in financial markets experienced over the course of the year. While the decline was particularly marked in Global Banking & Markets and Non-Core credit markets and equities businesses, with reduced business volumes and mounting mark-to-market trading losses, UK Retail also saw non-interest income fall in the latter part of the year as declining consumer confidence led to lower demand for credit and other financial products.
Excluding general insurance premium income, non-interest income fell by £11,343 million to £867 million.
Within non-interest income, fees and commissions receivable increased by 19% or £1,553 million, to £9,831 million, while fees and commissions payable increased by 9%, £193 million to £2,386 million.
Income from trading activities was down from £1,292 million to a loss of £8,477 million. Currency trading activities benefited from increased volatility in the markets. However, this improvement was more than offset by substantial credit market write downs during the year.
Other operating income also decreased, falling by 61%, £2,934 million to £1,899 million. This was principally due to a fall in the fair value of securities and other financial assets and liabilities partially offset by profits from the sale of subsidiaries and associates.
Insurance premium income, after reinsurance, increased by 4% to £6,326 million primarily reflecting a full year of ABN AMRO businesses in comparison with 76 days in 2007. This was partly offset by the discontinuation of less profitable partnership contracts.
Business review continued |
Operating expenses
| | | 2009 | | | Restated (1) 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Administrative expenses: | | | | | | | | | | | | |
| Staff costs | | | | | | | | | | | | |
| – excluding gains on pensions curtailment | | | 11,783 | | | | 10,410 | | | | 7,338 | |
| – gains on pensions curtailment | | | (2,148 | ) | | | — | | | | — | |
| Premises and equipment | | | 3,087 | | | | 2,593 | | | | 1,703 | |
| Other administrative expenses | | | 5,584 | | | | 5,464 | | | | 2,969 | |
| Total administrative expenses | | | 18,306 | | | | 18,467 | | | | 12,010 | |
| Depreciation and amortisation | | | 2,809 | | | | 3,154 | | | | 1,932 | |
| Write-down of goodwill and other intangible assets | | | 363 | | | | 32,581 | | | | — | |
| | | | 21,478 | | | | 54,202 | | | | 13,942 | |
| (1) | The results for 2008 have been restated for the amendment to IFRS 2 ‘Share-based Payment’. This has resulted in an increase in staff costs amounting to £169 million. |
2009 compared with 2008
Staff costs, excluding pension schemes curtailment gains, were up £1,373 million with most of the movement relating to adverse movements in foreign exchange rates and some salary inflation. Changes in incentive compensation, primarily in Global Banking & Markets, represented most of the remaining change.
Pension curtailment gains of £2,148 million were recognised in 2009 arising from changes to prospective pension benefits in the defined benefit scheme and certain other subsidiary schemes.
Premises and equipment costs rose by £494 million primarily due to the impact of expanded Group premises in London and the US.
Other expenses fell by £120 million due to integration benefits in GBM partially offset by increased deposit insurance levies in the US.
2008 compared with 2007
Operating expenses increased by £40,260 million to £54,202 million, primarily reflecting the write-down of goodwill and other assets of £32,581 million following a review of the carrying value of goodwill and other assets. Cost growth in the Group’s core retail and commercial banking franchises was offset by efficiency programmes. The 2008 costs reflect a full year of the retained ABN AMRO businesses in comparison with 76 days in 2007.
Business review continued |
Integration costs
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Staff costs | | | 365 | | | | 503 | | | | 18 | |
| Premises and equipment | | | 78 | | | | 25 | | | | 4 | |
| Other administrative expenses | | | 398 | | | | 486 | | | | 26 | |
| Depreciation and amortisation | | | 18 | | | | 36 | | | | 60 | |
| | | | 859 | | | | 1,050 | | | | 108 | |
2009 compared with 2008
Integration costs in 2009 were £859 million compared with £1,050 million in 2008. Integration and restructuring costs decreased primarily due to restructuring activity resulting from the strategic review undertaken earlier in the year. This was more than offset by lower ABN AMRO integration activity during the year.
2008 compared with 2007
Integration costs in 2008 were £1,050 million compared with £108 million in 2007. The significant increase reflects a full year of integration costs being incurred in respect of the ABN AMRO acquisition, compared to 76 days in 2007.
Accruals in relation to integration costs are set out below.
| | | At 31 December 2007 | | | At 31 December 2008 | | | Currency translation adjustments | | | Charge to income statement | | | Utilised .during the year | | | At 31 December 2009 | |
| | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | |
| Staff costs – redundancy | | | — | | | | — | | | | — | | | | 158 | | | | (158 | ) | | | — | |
| Staff costs – other | | | 4 | | | | 5 | | | | — | | | | 207 | | | | (212 | ) | | | — | |
| Premises and equipment | | | 2 | | | | 1 | | | | — | | | | 78 | | | | (39 | ) | | | 40 | |
| Other | | | 1 | | | | 3 | | | | — | | | | 416 | | | | (418 | ) | | | 1 | |
| | | | 7 | | | | 9 | | | | — | | | | 859 | | | | (827 | ) | | | 41 | |
Restructuring costs
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Staff costs | | | 328 | | | | 251 | | | | — | |
| Premises and equipment | | | 48 | | | | 15 | | | | — | |
| Other administrative expenses | | | 51 | | | | 41 | | | | — | |
| | | | 427 | | | | 307 | | | | — | |
Accruals in relation to restructuring costs are set out below.
| | | At | | | At | | | Currency | | | Charge | | | Utilised | | | At | |
| | | 31 December | | | 31 December | | | translation | | | to income | | | during | | | 31 December | |
| | | 2007 | | | 2008 | | | adjustments | | | statement | | | the year | | | 2009 | |
| | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | |
| Staff costs – redundancy | | | — | | | | 284 | | | | (13 | ) | | | 299 | | | | (315 | ) | | | 255 | |
| Staff costs – other | | | — | | | | — | | | | — | | | | 29 | | | | (25 | ) | | | 4 | |
| Premises and equipment | | | — | | | | 15 | | | | — | | | | 48 | | | | (26 | ) | | | 37 | |
| Other | | | — | | | | 51 | | | | (4 | ) | | | 51 | | | | (63 | ) | | | 35 | |
| | | | — | | | | 350 | | | | (17 | ) | | | 427 | | | | (429 | ) | | | 331 | |
Business review continued |
Impairment losses
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| New impairment losses | | | 15,349 | | | | 8,391 | | | | 2,310 | |
| less: recoveries of amounts previously written-off | | | (399 | ) | | | (319 | ) | | | (342 | ) |
| Charge to income statement | | | 14,950 | | | | 8,072 | | | | 1,968 | |
| | | | | | | | | | | | | |
| Comprising: | | | | | | | | | | | | |
| Loan impairment losses | | | 14,134 | | | | 7,091 | | | | 1,946 | |
| Impairment of available-for-sale securities | | | 816 | | | | 981 | | | | 22 | |
| Charge to income statement | | | 14,950 | | | | 8,072 | | | | 1,968 | |
Refer to pages 98 to 101 for additional analysis.
2009 compared with 2008
Impairment losses were £14,950 million compared with £8,072 million. Impairment losses in the Core divisions increased by £2,182 million, Non-Core losses increased by £4,285 million and RFS Holdings minority interest losses increased by £411 million.
In the Core business, the biggest increases were in UK Retail, UK Corporate and Ulster Bank, reflecting the difficult economic environment.
Non-Core losses also increased substantially, particularly across the corporate and property sectors.
2008 compared with 2007
Credit impairment losses increased to £8,072 million in 2008, compared with £1,968 million in 2007. The Group experienced a pronounced deterioration in impairments during the year, as financial stress spread to a broad range of customers. The greatest increase in impairments occurred in Non-Core and Global Banking & Markets. However, businesses in all geographies also experienced a noticeable increase in impairments during the year, particularly in the UK SME and US personal segments.
Total balance sheet provisions for impairment amounted to £11,016 million compared with £6,452 million in 2007.
Total provision coverage (the ratio of total balance sheet provisions for impairment to total risk elements in lending) decreased from 60% to 52%. The ratio of total balance sheet provisions for impairment to total risk elements in lending and potential problem loans also decreased to 51% compared with 57% in 2007.
Business review continued |
Credit market exposures
| | | 2009 | | | 2008 | |
Credit and other market losses (1) | | | £m | | | | £m | |
| Monoline exposures | | | 2,387 | | | | 3,093 | |
| CDPCs | | | 957 | | | | 615 | |
Asset-backed products (2) | | | 288 | | | | 4,778 | |
| Other credit exotics | | | 558 | | | | 947 | |
| Equities | | | 47 | | | | 948 | |
| Leveraged finance | | | — | | | | 1,088 | |
| Banking book hedges | | | 1,727 | | | | (1,642 | ) |
| Other | | | 188 | | | | 268 | |
| Group | | | 6,152 | | | | 10,095 | |
| (1) | Included in ‘Income/(loss) from trading activities’. |
| (2) | Includes super senior asset-backed structures and other asset-backed products. |
2009 compared with 2008
Losses relating to monoline exposures were £2,387 million in 2009 compared with £3,093 million in 2008.
| • | The credit quality of the monolines has continued to deteriorate and the level of CVA held against exposures to monoline counterparties has increased from 52% to 62% during the year. This was driven by a combination of wider credit spreads and lower recovery rates. |
| • | The gross exposure to monoline counterparties has decreased primarily due to a combination of higher prices of underlying reference instruments and restructuring certain exposures. |
| • | The increase in CVA resulting from the credit quality deterioration was partially offset by the decrease in CVA requirement following the reduction in gross exposure due to higher prices of underlying reference instruments. Consequently the net losses incurred in this regard were lower than in 2008 when there was both an increase in gross exposure and deterioration in credit quality. |
Losses relating to CDPC exposures were £957 million in 2009 compared with £615 million in 2008.
| • | The credit quality of the CDPCs has continued to deteriorate and the level of CVA held against exposures to CDPC counterparties has increased from 27% to 39% during the year. |
| • | The gross exposure to CDPC counterparties has reduced primarily due to a combination of tighter credit spreads of the underlying reference loans and bonds, and a decrease in the relative value of senior tranches compared with the underlying reference portfolios. |
| • | The decrease in CVA requirement following the reduction in gross exposure was partially offset by the increase in CVA requirement resulting from the credit quality deterioration. Consequently there were net gains in this regard in 2009 compared with losses in 2008 when there was both an increase in gross exposure and deterioration in credit quality. |
| • | Net losses were incurred in 2009 due to hedges put in place at the end of 2008 and during 2009 which effectively cap the exposure to certain CDPCs. As the exposure to these CDPCs has reduced, losses have been incurred on the hedges. |
Losses relating to asset-backed products were £288 million in 2009 compared with £4,778 million in 2008.
| • | Losses reported in 2009 primarily relate to super senior CDOs. The significant price declines of the underlying predominantly mortgage-backed securities seen in 2008 were not repeated in 2009. |
| • | Losses on other mortgage backed securities were greatly reduced in 2009 as many of these positions were sold or substantially written down in 2008 resulting in reduced net exposure in 2009. |
Losses relating to credit exotics were £558 million in 2009 compared with £947 million in 2008. These losses were reduced in 2009 as hedges were put in place to mitigate the risk.
Leveraged finance assets were reclassified on 1 July 2009. Changes in the fair value of these assets are only recognised in the income statement to the extent that they are considered impairments.
Losses relating to banking book hedges were £1,727 million in 2009 compared with profits of £1,642 million in 2008. These trades hedge counterparty risk that arises from loans and bonds on the regulatory banking book. As credit spreads have generally tightened in 2009 the value of these hedges has decreased resulting in losses. These hedges gave rise to gains in 2008 due to credit spreads generally widening.
Business review continued |
Additional disclosures on these and other related exposures can be found in the following sections:
| Disclosure | | Section | | Sub-section | | Page |
| Further analysis of credit market exposures | | Risk and capital management | | Market turmoil exposures | | 137 |
| Valuation aspects | | Financial statements | | Note 11 Financial instruments | | 234 |
| | | Financial statements | | Critical accounting policies | | 211 |
| Reclassification of financial instruments | | Financial statements | | Note 11 Financial instruments | | 231 |
Taxation
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Tax credit/(charge) | | | 371 | | | | 2,323 | | | | (2,044 | ) |
| | | | | | | | | | | | | |
| | | % | | | % | | | % | |
| UK corporation tax rate | | | 28.0 | | | | 28.5 | | | | 30.0 | |
| Effective tax rate | | | 14.3 | | | | 5.7 | | | | 20.8 | |
The actual tax credit differs from the expected tax credit computed by applying the standard rate of UK corporation tax as follows:
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Expected tax credit/(charge) | | | 727 | | | | 11,638 | | | | (2,950 | ) |
| Non-deductible goodwill impairment | | | (102 | ) | | | (8,292 | ) | | | (12 | ) |
| Unrecognised timing differences | | | 274 | | | | (274 | ) | | | (29 | ) |
| Other non-deductible items | | | (508 | ) | | | (378 | ) | | | (222 | ) |
| Non-taxable items: | | | | | | | | | | | | |
| – gain on redemption of own debt | | | 693 | | | | — | | | | — | |
| – other | | | 410 | | | | 491 | | | | 595 | |
| Taxable foreign exchange movements | | | 1 | | | | (80 | ) | | | (16 | ) |
| Reduction in deferred tax liability following change in the rate of UK corporation tax | | | — | | | | — | | | | 189 | |
| Foreign profits taxed at other rates | | | (320 | ) | | | (203 | ) | | | 25 | |
| Losses in year not recognised | | | (780 | ) | | | (942 | ) | | | (2 | ) |
| Losses brought forward and utilised | | | 94 | | | | 11 | | | | 11 | |
| Adjustments in respect of prior periods | | | (118 | ) | | | 352 | | | | 367 | |
| Actual tax credit/(charge) | | | 371 | | | | 2,323 | | | | (2,044 | ) |
The effective tax rate for the year was 14.3% (2008 – 5.7%; 2007 – 20.8%). The tax credit is lower than that arising from applying the standard rate of UK corporation tax of 28% to the loss for the period, principally due to certain carried forward losses on which no tax relief has been recognised.
Business review continued |
Divisional performance
The results of each division are set out below. The results are stated before amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax.
Business Services directly attributable costs have been allocated to the operating divisions, based on their service usage. Where services span more than one division an appropriate measure is used to allocate the costs on a basis which management considers reasonable. Business Services costs are fully allocated and there are no residual unallocated costs.
Group Centre directly attributable costs have been allocated to the operating divisions, based on their service usage. Where services span more than one division, the costs are allocated on a basis management considers reasonable. The residual unallocated costs remaining in the Group centre relate to volatile corporate items that do not naturally reside within a division.
Treasury costs are allocated to operating divisions as follows: term funding costs are allocated or rewarded based on long term funding gap or surplus; liquidity buffer funding costs are allocated based on share of overall liquidity buffer derived from divisional stresses; and capital cost or benefit is allocated based on share of divisional risk-adjusted RWAs.
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| UK Retail | | | 229 | | | | 723 | | | | 1,232 | |
| UK Corporate | | | 1,125 | | | | 1,781 | | | | 1,803 | |
| Wealth | | | 420 | | | | 348 | | | | 491 | |
| Global Banking & Markets | | | 5,709 | | | | (1,796 | ) | | | 1,024 | |
| Global Transaction Services | | | 973 | | | | 1,002 | | | | 895 | |
| Ulster Bank | | | (368 | ) | | | 218 | | | | 317 | |
| US Retail & Commercial | | | (113 | ) | | | 528 | | | | 743 | |
| RBS Insurance | | | 58 | | | | 584 | | | | 542 | |
| Central items | | | 292 | | | | 1,025 | | | | 845 | |
| Core | | | 8,325 | | | | 4,413 | | | | 7,892 | |
| Non-Core | | | (14,557 | ) | | | (11,351 | ) | | | 2,147 | |
| | | | (6,232 | ) | | | (6,938 | ) | | | 10,039 | |
| Reconciling items | | | | | | | | | | | | |
| RFS Holdings minority interest | | | (304 | ) | | | 41 | | | | 163 | |
| Amortisation of purchased intangible assets | | | (272 | ) | | | (443 | ) | | | (262 | ) |
| Write-down of goodwill and other intangible assets | | | (363 | ) | | | (32,581 | ) | | | — | |
| Integration and restructuring costs | | | (1,286 | ) | | | (1,357 | ) | | | (108 | ) |
| Gain on redemption of own debt | | | 3,790 | | | | — | | | | — | |
| Strategic disposals | | | 132 | | | | 442 | | | | — | |
| Gains on pensions curtailment | | | 2,148 | | | | — | | | | — | |
| Bonus tax | | | (208 | ) | | | — | | | | — | |
| Group operating (loss)/profit before tax | | | (2,595 | ) | | | (40,836 | ) | | | 9,832 | |
The performance of each of the divisions is reviewed on pages 40 to 64.
| | | 2009 | | | 2008 | | | 2007 | |
| Impairment losses by division | | | £m | | | | £m | | | | £m | |
| UK Retail | | | 1,679 | | | | 1,019 | | | | 975 | |
| UK Corporate | | | 927 | | | | 319 | | | | 178 | |
| Wealth | | | 33 | | | | 16 | | | | 3 | |
| Global Banking & Markets | | | 640 | | | | 522 | | | | 66 | |
| Global Transaction Services | | | 39 | | | | 54 | | | | 14 | |
| Ulster Bank | | | 649 | | | | 106 | | | | 46 | |
| US Retail & Commercial | | | 702 | | | | 437 | | | | 246 | |
| RBS Insurance | | | 8 | | | | 42 | | | | — | |
| Central items | | | 1 | | | | (19 | ) | | | 3 | |
| Core | | | 4,678 | | | | 2,496 | | | | 1,531 | |
| Non-Core | | | 9,221 | | | | 4,936 | | | | 399 | |
| | | | 13,899 | | | | 7,432 | | | | 1,930 | |
| Reconciling item | | | | | | | | | | | | |
| RFS Holdings minority interest | | | 1,051 | | | | 640 | | | | 38 | |
| Group impairment losses | | | 14,950 | | | | 8,072 | | | | 1,968 | |
Business review continued |
| | | 2009 | | | 2008 | | 2007(1) |
| Net interest margin by division | | % | | | % | | % |
| UK Retail | | | 3.59 | | | | 3.58 | | |
| UK Corporate | | | 2.22 | | | | 2.40 | | |
| Wealth | | | 4.38 | | | | 4.51 | | |
| Global Banking & Markets | | | 1.38 | | | | 1.34 | | |
| Global Transaction Services | | | 9.22 | | | | 8.25 | | |
| Ulster Bank | | | 1.87 | | | | 1.89 | | |
| US Retail & Commercial | | | 2.37 | | | | 2.68 | | |
| Non-Core | | | 0.69 | | | | 0.87 | | |
| | | | | | | | | | |
| Group | | | 1.83 | | | | 2.12 | | 2.32 |
| | | 2009 | | | 2008 | | 2007(1) |
| Risk-weighted assets by division | | £bn | | | £bn | | £bn |
| UK Retail | | | 51.3 | | | | 45.7 | | |
| UK Corporate | | | 90.2 | | | | 85.7 | | |
| Wealth | | | 11.2 | | | | 10.8 | | |
| Global Banking & Markets | | | 123.7 | | | | 151.8 | | |
| Global Transaction Services | | | 19.1 | | | | 17.4 | | |
| Ulster Bank | | | 29.9 | | | | 24.5 | | |
| US Retail & Commercial | | | 59.7 | | | | 63.9 | | |
| Other | | | 9.4 | | | | 7.1 | | |
| Core | | | 394.5 | | | | 406.9 | | |
| Non-Core | | | 171.3 | | | | 170.9 | | |
| Group before benefit of APS | | | 565.8 | | | | 577.8 | | 490.0 |
| Benefit of APS | | | (127.6 | ) | | | — | | — |
| Group before RFS Holdings minority interest | | | 438.2 | | | | 577.8 | | 490.0 |
| RFS Holdings minority interest | | | 102.8 | | | | 118.0 | | 119.0 |
| Total | | | 541.0 | | | | 695.8 | | 609.0 |
| (1) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
UK Retail
| | | 2009 | | | 2008 | | | 2007(2) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income | | | 3,452 | | | | 3,187 | | | | 3,230 | |
| Net fees and commissions | | | 1,320 | | | | 1,577 | | | | 1,754 | |
| Other non-interest income | | | 309 | | | | 358 | | | | 754 | |
| Non–interest income | | | 1,629 | | | | 1,935 | | | | 2,508 | |
| Total income | | | 5,081 | | | | 5,122 | | | | 5,738 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (845 | ) | | | (924 | ) | | | (936 | ) |
| – other | | | (421 | ) | | | (421 | ) | | | (424 | ) |
| Indirect expenses | | | (1,773 | ) | | | (1,851 | ) | | | (1,653 | ) |
| | | | (3,039 | ) | | | (3,196 | ) | | | (3,013 | ) |
| Insurance net claims | | | (134 | ) | | | (184 | ) | | | (518 | ) |
| Impairment losses | | | (1,679 | ) | | | (1,019 | ) | | | (975 | ) |
| Operating profit before tax | | | 229 | | | | 723 | | | | 1,232 | |
| | | | | | | | | | | | | |
| Analysis of income by product | | | | | | | | | | | | |
| Personal advances | | | 1,192 | | | | 1,244 | | | | | |
| Personal deposits | | | 1,349 | | | | 2,037 | | | | | |
| Mortgages | | | 1,214 | | | | 500 | | | | | |
| Bancassurance | | | 380 | | | | 401 | | | | | |
| Cards | | | 869 | | | | 831 | | | | | |
| Other | | | 77 | | | | 109 | | | | | |
| Total income | | | 5,081 | | | | 5,122 | | | | 5,738 | |
| | | | | | | | | | | | | |
| Analysis of impairment by sector | | | | | | | | | | | | |
| Mortgages | | | 124 | | | | 31 | | | | | |
| Personal | | | 1,023 | | | | 568 | | | | | |
| Cards | | | 532 | | | | 420 | | | | | |
| Total impairment | | | 1,679 | | | | 1,019 | | | | 975 | |
| | | | | | | | | | | | | |
| Loan impairment charge as % of gross customer loans and advances by sector | | | | | | | | | | | | |
| Mortgages | | | 0.15 | % | | | 0.04 | % | | | | |
| Personal | | | 7.52 | % | | | 3.71 | % | | | | |
| Cards | | | 8.58 | % | | | 6.67 | % | | | | |
| | | | 1.63 | % | | | 1.09 | % | | | | |
| | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | |
Return on equity (1) | | | 4.2 | % | | | 13.1 | % | | | | |
| Net interest margin | | | 3.59 | % | | | 3.58 | % | | | | |
| Cost:income ratio | | | 59.8 | % | | | 62.4 | % | | | 52.5 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | £bn | | | £bn | | | £bn | |
| Capital and balance sheet | | | | | | | | | | | | |
| Loans and advances to customers – gross | | | | | | | | | | | 86.6 | |
| – mortgages | | | 83.2 | | | | 72.2 | | | | | |
| – personal | | | 13.6 | | | | 15.3 | | | | | |
| – cards | | | 6.2 | | | | 6.3 | | | | | |
| Customer deposits (excluding bancassurance) | | | 87.2 | | | | 78.9 | | | | 76.1 | |
| Assets under management (excluding deposits) | | | 5.3 | | | | 5.7 | | | | 7.0 | |
| Risk elements in lending | | | 4.6 | | | | 3.8 | | | | | |
| Loan:deposit ratio (excluding repos) | | | 115 | % | | | 116 | % | | | | |
| Risk-weighted assets | | | 51.3 | | | | 45.7 | | | | | |
| (1) | Return on equity is based on divisional operating profit after tax, divided by divisional notional equity (based on 7% of divisional risk-weighted assets, adjusted for capital deductions). |
| (2) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
2009 compared with 2008
Operating profit before tax of £229 million was £494 million lower than in 2008. Profit before impairments was up £166 million or 10%, but impairments rose by £660 million as the economic environment deteriorated, albeit with signs of conditions stabilising in the second half of the year.
The division has focused in 2009 on growing secured lending to meet its Government targets while at the same time building customer deposits, thereby reducing the Group’s reliance on wholesale funding. Loans and advances to customers grew 10%, with a change in mix from unsecured to secured as the Group sought actively to reduce its risk profile, with 15% growth in mortgage lending and an 8% reduction in unsecured lending.
| • | Mortgage growth was due to good retention of existing customers and new business sourced predominantly from the existing customer base. Gross mortgage lending market share increased to 12% from 7% in 2008, with the Group on track to exceed its Government targets on net lending by £3 billion. |
| • | Customer deposits grew 11% on 2008 reflecting the strength of the UK Retail customer franchise, which outperformed the market in an increasingly competitive environment. Savings balances grew by £6 billion or 11% and account acquisition saw a 20% increase, with 2.2 million accounts opened. Personal current account balances increased by 12% on 2008 with a 3% growth in accounts to 12.8 million. |
Net interest income increased significantly by 8% to £3,452 million, driven by strong balance sheet growth. Net interest margin was flat at 3.59%, with decreasing liability margins in the face of stiff competition for deposits offsetting wider asset margins. The growth in mortgages and the reduction in higher margin unsecured balances also had a negative impact on the blended net interest margin.
Non-interest income declined 16% to £1,629 million, principally reflecting the withdrawal of the single premium payment protection insurance product and the restructuring of current account overdraft fees in the final quarter of 2009, with the annualised impact of the overdraft fee restructuring further affecting income in 2010. The weak economic environment presented little opportunity in 2009 to grow credit card, private banking and bancassurance fees.
Expenses decreased by 5%, with the cost:income ratio improving from 62% to 60%.
| • | 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. |
| • | RBS continues to progress towards a more convenient, lower cost operating model, with over 4 million active users of online banking and a record share of new sales achieved through direct channels. More than 5.5 million accounts have switched to paperless statements and 254 branches now utilise automated cash deposit machines. |
Impairment losses increased 65% to £1,679 million reflecting the deterioration in the economic environment, and its impact on customer finances.
| • | The mortgage impairment charge was £124 million (2008 – £31 million) on a total book of £83.2 billion. Mortgage arrears rates stabilised in the second half of 2009 and remain well below the industry average, as reported by the Council of Mortgage Lenders. Repossessions show only a small increase on 2008, as the Group continues to support customers facing financial difficulties. |
| • | The unsecured lending impairment charge was £1,555 million (2008 – £988 million) on a book of £19.8 billion. Industry benchmarks for cards arrears showed a slightly improving trend in the final quarter of 2009, which is consistent with the Group’s experience. RBS continues to perform better than the market on arrears. |
Risk weighted assets increased by 12% to £51.3 billion due to higher lending and the upward pressure from procyclicality, more than offsetting the adoption of a through-the-cycle loss given default approach for mortgages.
2008 compared with 2007
Due to an economic environment which became markedly weaker in the second half of the year, UK Retail Banking saw an 11% decrease in total income to £5,122 million, whilst direct costs remained in line with 2007. However the deterioration in the macroeconomic environment resulted in a 5% increase in impairment losses. Consequently, operating profit before tax decreased 41%, to £723 million. In the personal segment, RBS retained top position and NatWest was again joint second for customer satisfaction amongst main high street banks. UK Retail continues to maintain availability of lending while managing risk exposure and focusing on supporting customers through a difficult economic environment.
Net interest income decreased 1% to £3,187 million. There was good volume growth coupled with improving new lending margins. Spot loans and advances to customers increased 8% and average deposits were up 4%. Despite increasing competitive pressure in a slowing market, at year end deposit balances were £3 billion higher than in 2007. Net interest margin reduced to 3.58%, reflecting increased funding and liquidity costs.
UK Retail mortgage balances grew 12% despite more muted demand in the second half, and net mortgage lending market share increased to 18% (2007 – 2%). Personal unsecured lending slowed, however, particularly in the second half of the year.
Business review continued |
Non-interest income declined 23% to £1,935 million. Bancassurance sales grew 3% to £353 million annual premium equivalent in the year, however the negative performance of debt and equity markets reduced investment income by £48 million. Excluding BBU, non-interest income declined 20% reflecting reduced demand for unsecured lending and lower sales of payment protection insurance.
Direct expenses remained in line with 2007. Direct staff costs reduced 1% reflecting increased efficiency. Other direct costs rose by 2% as a result of increased investment in selected business lines. During 2008 the division almost doubled the number of branches open on a Saturday and introduced 1,000 MoneySense advisers into branches to provide impartial advice to customers on managing their money.
Impairment losses increased 5% to £1,019 million, reflecting the changed economic environment, particularly in the second half. The increase in impairments has been driven by mortgage impairment charges of £33 million (2007 – £21 million) on a total book of £72.3 billion, and a slight increase in unsecured personal lending impairments to £986 million (2007 – £954 million). Higher Loan-to-Value ratio mortgages have been restricted and affordability criteria tightened. The average LTV for new business was 67% (2007 – 63%). Repossessions represented 0.06% of outstanding mortgage balances at 31 December 2008, compared with a Council of Mortgage Lenders’ average at December 2008 of 0.21%.
Risk weighted assets totalled £45.7 billion at year end.
Business review continued |
UK Corporate
| | | 2009 | | | 2008 | | | 2007(2) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income | | | 2,292 | | | | 2,448 | | | | 2,252 | |
| Net fees and commissions | | | 858 | | | | 829 | | | | 518 | |
| Other non-interest income | | | 432 | | | | 460 | | | | 709 | |
| Non–interest income | | | 1,290 | | | | 1,289 | | | | 1,227 | |
| Total income | | | 3,582 | | | | 3,737 | | | | 3,479 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (753 | ) | | | (801 | ) | | | (721 | ) |
| – other | | | (268 | ) | | | (318 | ) | | | (295 | ) |
| Indirect expenses | | | (509 | ) | | | (518 | ) | | | (482 | ) |
| | | | (1,530 | ) | | | (1,637 | ) | | | (1,498 | ) |
| Impairment losses | | | (927 | ) | | | (319 | ) | | | (178 | ) |
| Operating profit before tax | | | 1,125 | | | | 1,781 | | | | 1,803 | |
| | | | | | | | | | | | | |
| Analysis of income by business | | | | | | | | | | | | |
| Corporate and commercial lending | | | 2,401 | | | | 2,166 | | | | | |
| Asset and invoice finance | | | 232 | | | | 241 | | | | | |
| Corporate deposits | | | 985 | | | | 1,266 | | | | | |
| Other | | | (36 | ) | | | 64 | | | | | |
| Total income | | | 3,582 | | | | 3,737 | | | | 3,479 | |
| | | | | | | | | | | | | |
| Analysis of impairment by sector | | | | | | | | | | | | |
| Banks and financial institutions | | | 15 | | | | 9 | | | | | |
| Hotels and restaurants | | | 98 | | | | 25 | | | | | |
| Housebuilding and construction | | | 106 | | | | 42 | | | | | |
| Manufacturing | | | 51 | | | | 14 | | | | | |
| Other | | | 150 | | | | 53 | | | | | |
| Private sector education, health, social work, recreational and community services | | | 59 | | | | 15 | | | | | |
| Property | | | 259 | | | | 24 | | | | | |
| Wholesale and retail trade, repairs | | | 76 | | | | 37 | | | | | |
| Asset and invoice finance | | | 113 | | | | 100 | | | | | |
| Total impairment | | | 927 | | | | 319 | | | | 178 | |
| | | | | | | | | | | | | |
| Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector | | | | | | | | | | | | |
| Banks and financial institutions | | | 0.29 | % | | | 0.17 | % | | | | |
| Hotels and restaurants | | | 1.75 | % | | | 0.41 | % | | | | |
| Housebuilding and construction | | | 3.12 | % | | | 0.81 | % | | | | |
| Manufacturing | | | 1.38 | % | | | 0.26 | % | | | | |
| Other | | | 0.36 | % | | | 0.14 | % | | | | |
| Private sector education, health, social work, recreational and community services | | | 0.80 | % | | | 0.20 | % | | | | |
| Property | | | 0.93 | % | | | 0.08 | % | | | | |
| Wholesale and retail trade, repairs | | | 0.97 | % | | | 0.41 | % | | | | |
| Asset and invoice finance | | | 1.33 | % | | | 1.18 | % | | | | |
| | | | 0.83 | % | | | 0.27 | % | | | | |
| Performance ratios | | | | | | | | | | | | |
Return on equity (1) | | | 10.3 | % | | | 18.0 | % | | | | |
| Net interest margin | | | 2.22 | % | | | 2.40 | % | | | | |
| Cost:income ratio | | | 42.7 | % | | | 43.8 | % | | | 43.1 | % |
Notes:
| (1) | Return on equity is based on divisional operating profit after tax, divided by divisional notional equity (based on 8% of divisional risk-weighted assets, adjusted for capital deductions). |
| (2) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
| | | 2009 | | | 2008 | | | 2007(2) | |
| | | £bn | | | £bn | | | £bn | |
| Capital and balance sheet | | | | | | | | | |
| Total assets | | | 114.9 | | | | 121.0 | | | | |
| Loans and advances to customers – gross | | | | | | | | | | | 101.5 | |
| – Banks and financial institutions | | | 5.2 | | | | 5.4 | | | | | |
| – Hotels and restaurants | | | 5.6 | | | | 6.1 | | | | | |
| – Housebuilding and construction | | | 3.4 | | | | 5.2 | | | | | |
| – Manufacturing | | | 3.7 | | | | 5.3 | | | | | |
| – Other | | | 42.0 | | | | 38.1 | | | | | |
| – Private sector education, health, social work, recreational and community services | | | 7.4 | | | | 7.4 | | | | | |
| – Property | | | 28.0 | | | | 31.8 | | | | | |
| – Wholesale and retail trade, repairs | | | 7.8 | | | | 9.1 | | | | | |
| – Asset and invoice finance | | | 8.5 | | | | 8.5 | | | | | |
| Customer deposits | | | 87.8 | | | | 82.0 | | | | 83.4 | |
| Risk elements in lending | | | 2.3 | | | | 1.3 | | | | | |
| Loan:deposit ratio | | | 126 | % | | | 142 | % | | | | |
| Risk-weighted assets | | | 90.2 | | | | 85.7 | | | | | |
| (1) | Return on equity is based on divisional operating profit after tax, divided by divisional notional equity (based on 8% of divisional risk-weighted assets, adjusted for capital deductions). |
| (2) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
2009 compared with 2008
Operating profit before tax of £1,125 million was £656 million lower than in 2008, largely due to an increase of £608 million in impairments.
Net interest margin levels were rebuilt during the second half as asset pricing was amended to reflect increased funding and credit costs. For the year as a whole net interest margin was 18 basis points lower than in 2008, reflecting higher funding costs and continued competitive pricing for deposits.
Gross new lending to customers remained resilient in 2009, with a noticeable acceleration of lending activity in the second half of the year. However, as customers have deleveraged and turned increasingly to capital markets, repayments have accelerated even more sharply. Loans and advances to customers, therefore, declined by 5% to £111.5 billion.
Initiatives aimed at increasing customer deposits have been successful, with balance growth of 7%, although margins declined as a result of increased competition for balances.
Non-interest income was flat, with stable fee income from refinancing and structuring activity.
A reduction in costs of 7% was driven by lower staff expenses as a result of the Group’s restructuring programme, together with restraint on discretionary spending levels.
Impairment losses increased substantially reflecting both a rise in the number of corporate delinquencies requiring a specific impairment and a higher charge to recognise losses not yet specifically identified.
Risk-weighted assets grew 5% despite the fall in customer lending, reflecting the impact of procyclicality, which was most pronounced in the first half of 2009.
2008 compared with 2007
UK Corporate experienced a solid performance in the first half of 2008, with the second half of 2008 being impacted by the marked deterioration in economic conditions. Total income increased by 7% to £3,737 million. However, growth in impairments, especially in the second half of the year, resulted in a 1% fall in operating profit before tax to £1,781 million.
Net interest income rose 9% to £2,448 million. Loans and advances were 6% higher than 2007, reflecting the Group’s continuing support for the UK economy. New business margins widened in the second half to reflect increasing risk premia, however, higher funding costs on the back book impacted net interest income.
Non interest income increased 5% to £1,289 million. 2007 benefited from the profit on disposal of the Securities Services Group business. Year on year growth reflects increased sales of interest rate and currency risk management products.
Direct expenses increased by 10% to £1,119 million, reflecting the recruitment of additional front line staff in the second half of 2008.
Impairment losses totalled £319 million, a sharp increase from the low levels seen in 2007. Losses were concentrated in the smaller end of the corporate sector, although a number of specific exposures in the larger corporate sector have also impacted the charge.
Business review continued |
| | | 2009 | | | 2008 | | | 2007(1) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income | | | 663 | | | | 578 | | | | 653 | |
| Net fees and commissions | | | 363 | | | | 405 | | | | 410 | |
| Other non-interest income | | | 83 | | | | 76 | | | | 55 | |
| Non-interest income | | | 446 | | | | 481 | | | | 465 | |
| Total income | | | 1,109 | | | | 1,059 | | | | 1,118 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (357 | ) | | | (377 | ) | | | (346 | ) |
| – other | | | (139 | ) | | | (156 | ) | | | (139 | ) |
| Indirect expenses | | | (160 | ) | | | (162 | ) | | | (139 | ) |
| | | | (656 | ) | | | (695 | ) | | | (624 | ) |
| Impairment losses | | | (33 | ) | | | (16 | ) | | | (3 | ) |
| Operating profit before tax | | | 420 | | | | 348 | | | | 491 | |
| | | | | | | | | | | | | |
| Analysis of income | | | | | | | | | | | | |
| Private Banking | | | 916 | | | | 819 | | | | | |
| Investments | | | 193 | | | | 240 | | | | | |
| Total income | | | 1,109 | | | | 1,059 | | | | 1,118 | |
| | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | |
| Net interest margin | | | 4.38 | % | | | 4.51 | % | | | | |
| Cost:income ratio | | | 59.2 | % | | | 65.6 | % | | | 55.8 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | £bn | | | £bn | | | £bn | |
| Capital and balance sheet | | | | | | | | | | | | |
| Loans and advances to customers – gross | | | | | | | | | | | 10.2 | |
| – mortgages | | | 6.5 | | | | 5.3 | | | | | |
| – personal | | | 4.9 | | | | 5.0 | | | | | |
| – other | | | 2.3 | | | | 2.1 | | | | | |
| Customer deposits | | | 35.7 | | | | 34.1 | | | | 33.6 | |
| Assets under management (excluding deposits) | | | 30.7 | | | | 34.7 | | | | 35.0 | |
| Risk elements in lending | | | 0.2 | | | | 0.1 | | | | | |
| Loan:deposit ratio | | | 38 | % | | | 36 | % | | | | |
| Risk-weighted assets | | | 11.2 | | | | 10.8 | | | | | |
| (1) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
2009 compared with 2008
Wealth produced strong growth in operating profit before tax, up 21% to £420 million, reflecting the increased value of the division’s healthy deposit base in an increasingly competitive market for funding. Deposit balances increased by 5% from 2008, though the deposit market remains highly competitive.
Total income was up 5%, with strong growth in net interest income, reflecting the increased internal pricing applied to Wealth’s deposit base. This was offset by a marked decrease in investment income year on year as assets under management decreased by 12% during 2009, with investors turning to more liquid assets and away from longer term investments.
Loans and advances increased by 10% over 2008, primarily in the UK. Lending margins improved, particularly for mortgages, and credit metrics for new business remain satisfactory.
Expenses were down 6%, reflecting a rigorous focus on cost management, with staff costs decreasing by 5% as a result of planned headcount reduction. The cost:income ratio improved from 65.6% to 59.2%.
Impairments increased by £17 million over 2008 reflecting some isolated difficulties in the UK and offshore mortgage books (representing mortgages for second properties for expatriates). Provisions as a percentage of lending to customers increased slightly to 0.25%.
Business review continued |
2008 compared with 2007
Total income decreased by 5% to £1,059 million despite an increase in underlying business which was more than offset by a movement in the Group's funds transfer pricing mechanism. Operating profit before tax decreased by 29% to £348 million.
Average loans and advances to customers rose by 22% but average customer deposits by only 1%. Deposit growth, which had been strong up to the end of Q4 2008 ceased and a deposit outflow occurred during the most volatile parts of Q4 2008. Deposit margins were also adversely affected by the deep falls in base rates in Q4 2008.
Non interest income grew by 3% to £481 million as higher fee income was offset by lower investment income. Average assets under management were 1% lower than in 2007, as investor risk appetite dropped sharply in Q4 2008.
Direct expenses rose by 10% to £533 million partly due to increased headcount and higher deposit protection scheme contributions.
Impairments rose from £3 million in 2007 to £16 million and represented approximately 0.1% of the total Wealth lending book.
Business review continued |
Global Banking & Markets
| | | 2009 | | | 2008 | | | 2007(2) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income from banking activities | | | 2,424 | | | | 2,390 | | | | 467 | |
| Funding costs of rental assets | | | (49 | ) | | | (64 | ) | | | (49 | ) |
| Net interest income | | | 2,375 | | | | 2,326 | | | | 418 | |
| Net fees and commissions receivable | | | 1,144 | | | | 973 | | | | 960 | |
| Income/(loss) from trading activities | | | 7,954 | | | | (493 | ) | | | 2,486 | |
| Other operating income | | | (464 | ) | | | (92 | ) | | | (17 | ) |
| Non-interest income | | | 8,634 | | | | 388 | | | | 3,429 | |
| Total income | | | 11,009 | | | | 2,714 | | | | 3,847 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (2,930 | ) | | | (2,056 | ) | | | (1,802 | ) |
| – other | | | (965 | ) | | | (1,269 | ) | | | (552 | ) |
| Indirect expenses | | | (765 | ) | | | (663 | ) | | | (403 | ) |
| | | | (4,660 | ) | | | (3,988 | ) | | | (2,757 | ) |
| Impairment losses | | | (640 | ) | | | (522 | ) | | | (66 | ) |
| Operating profit/(loss) before tax | | | 5,709 | | | | (1,796 | ) | | | 1,024 | |
| | | | | | | | | | | | | |
| Analysis of income by product | | | | | | | | | | | | |
| Rates – money markets | | | 1,714 | | | | 1,641 | | | | | |
| Rates – flow | | | 3,142 | | | | 1,386 | | | | | |
| Currencies & commodities | | | 1,277 | | | | 1,539 | | | | | |
| Equities | | | 1,474 | | | | 368 | | | | | |
| Credit markets | | | 2,255 | | | | (3,435 | ) | | | | |
| Portfolio management and origination | | | 1,196 | | | | 858 | | | | | |
| Fair value of own debt | | | (49 | ) | | | 357 | | | | | |
| Total income | | | 11,009 | | | | 2,714 | | | | 3,847 | |
| | | | | | | | | | | | | |
| Analysis of impairment by sector | | | | | | | | | | | | |
| Manufacturing and infrastructure | | | 91 | | | | 39 | | | | | |
| Property and construction | | | 49 | | | | 12 | | | | | |
| Transport | | | 3 | | | | — | | | | | |
| Banks and financial institutions | | | 348 | | | | 186 | | | | | |
| Other | | | 149 | | | | 285 | | | | | |
| Total impairment | | | 640 | | | | 522 | | | | 66 | |
| | | | | | | | | | | | | |
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) | | | 0.59 | % | | | 0.29 | % | | | | |
| | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | |
Return on equity (1) | | | 30.7 | % | | | (8.4 | %) | | | | |
| Net interest margin | | | 1.38 | % | | | 1.34 | % | | | | |
| Cost:income ratio | | | 42.3 | % | | | 146.9 | % | | | 71.7 | % |
| (1) | Return on equity is based on divisional operating profit after tax, divided by divisional notional equity (based on 10% of divisional risk-weighted assets, adjusted for capital deductions). |
| (2) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
| | | 2009 | | | 2008 | | | 2007 | (1) |
| | | £bn | | | £bn | | | £bn | |
| Capital and balance sheet | | | | | | | | | |
| Loans and advances (including banks) | | | 127.8 | | | | 224.2 | | | | 188.0 | |
| Reverse repos | | | 73.3 | | | | 88.8 | | | | 278.4 | |
| Securities | | | 106.0 | | | | 127.5 | | | | 205.7 | |
| Cash and eligible bills | | | 74.0 | | | | 20.2 | | | | 22.7 | |
| Other assets | | | 31.1 | | | | 38.0 | | | | 38.7 | |
| Total third party assets (excluding derivatives mark to market) | | | 412.2 | | | | 498.7 | | | | 733.5 | |
| Net derivative assets (after netting) | | | 68.0 | | | | 121.0 | | | | 49.4 | |
| Customer deposits (excluding repos) | | | 46.9 | | | | 87.8 | | | | 93.3 | |
| Risk elements in lending | | | 1.8 | | | | 0.9 | | | | | |
| Loan:deposit ratio | | | 194 | % | | | 192 | % | | | | |
| Risk-weighted assets | | | 123.7 | | | | 151.8 | | | | | |
| (1) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
2009 compared with 2008
Operating profit before tax improved to £5,709 million in 2009, compared with an operating loss before tax of £1,796 million in 2008. Although the buoyant market conditions experienced in the first quarter levelled off over the course of the year, the refocusing of the business on its core franchises was successful. Global Banking & Markets (GBM) has tightened its balance sheet management over the course of the year, with disciplined deployment of capital to support its targeted client base.
In an often volatile market environment, GBM responded quickly to its clients’ needs to strengthen their balance sheets and to take advantage of the attractive environment for debt and equity issues. RBS participated in the five largest equity issues worldwide in 2009, and in six out of the ten largest debt capital markets transactions.
Income grew significantly, reflecting a very strong first quarter benefiting from market volatility, client activity and a marked improvement from Credit Markets. Rates flow business, up 127%, benefited from good client activity, while strong equity capital markets drove a fourfold increase in Equities.
Portfolio management and origination grew 39% as financial institutions and corporate clients refinanced through the debt capital markets. The refocused Credit Markets delivered a much improved result from greater liquidity and a more positive trading environment.
Despite quarterly movement in the Group’s credit spreads, overall spreads remained broadly flat over the year resulting in a small loss from movements in the fair value of own debt compared with a £357 million gain in 2008.
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.
Staff costs represented 27% of income. The Group introduced new deferral policies in 2009, which have led to changes in accrual patterns. Adjusting for both 2008 and 2009 deferrals, GBM’s compensation ratio in 2009 would have been 28%.
Higher impairments principally reflected a large individual failure recognised in the third quarter. Impairments represented 0.59% of loans and advances to customers compared with 0.29% in the prior year, reflecting the marked reduction in loans and advances.
Total third party assets, excluding derivatives, were down 17% compared with 31 December 2008, driven by a 43% reduction in loans and advances as customers took advantage of favourable capital market conditions to raise alternative forms of finance to bank debt. This reduction was partially offset by an increase in liquid assets.
Risk-weighted assets decreased 19%, reflecting the fall in third party assets and the Group’s continued focus on reducing its risk profile and balance sheet usage.
2008 compared with 2007
GBM’s operating profit before tax fell from £1,024 million in 2007 to a loss of £1,796 million. This decline reflected the effect of the market turmoil which adversely affected the division’s results in 2008. GBM incurred losses from counterparty failures (notably Lehman), write-downs of our subprime mortgage related positions and higher credit impairments as the effects of the down-turn widened. These were only partly offset by good performances in a number of businesses, most notably in rates and currencies, the inclusion of the ABN AMRO businesses for a full twelve months and gains on the fair value of own debt.
Costs were up by 45%, with the inclusion of the acquired businesses of ABN AMRO for a full year outweighing reduced bonus payments. Credit impairments rose sharply from a very low level, £66 million, to £522 million, resulting in a 2008 operating loss before tax of £1,796 million.
Net interest income grew by £1,908 million to £2,326 million, with the rates business benefiting from the declining interest rate environment. Non-interest income reduced by £3,041 million to £388 million. Fees and commissions increased mainly as a result of the inclusion of the ABN AMRO businesses for a full twelve months partially offset by a decline in origination volumes. Income from trading activities fell from £2,486 million to a loss of £493 million, primarily as a result of counterparty failures and mortgage trading asset write-downs. Other operating income was a loss of £92 million, reflecting losses incurred on European loan sales.
Business review continued |
By business line, the rates and currencies business achieved a particularly strong performance in 2008, with high volumes of customer activity and flow trading. The Sempra Commodities joint venture performed ahead of expectations in the nine months since its formation. Equities improved slightly primarily as a result of the inclusion of a full year of ABN AMRO related businesses.
In a reduced market for debt origination, credit markets improved its market positions in a number of key areas such as international bond issuance. Results, however, were severely affected by the continuing market weakness, particularly in the second half of the year.
Portfolio management income remained resilient, but some losses were incurred, including on capital and credit exposure management.
Credit impairments increased sharply to £522 million primarily reflecting higher IAS latent provisions.
GBM’s total third party assets including derivatives were reduced by £165.8 billion to £619.7 billion at 31 December 2008, a reduction of 18% from a year earlier. Within this total, loans and advances were £224.2 billion, an increase of 18%. This increase was more than offset by significant reductions in reverse repos and securities holdings, both of which have been managed down over the course of the year. Net derivative assets totalled £121.0 billion, compared with £49.4 billion at the end of 2007.
Business review continued |
Global Transaction Services
| | | 2009 | | | 2008 | | | 2007(1) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income | | | 912 | | | | 937 | | | | 647 | |
| Non-interest income | | | 1,575 | | | | 1,494 | | | | 1,150 | |
| Total income | | | 2,487 | | | | 2,431 | | | | 1,797 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (371 | ) | | | (362 | ) | | | (251 | ) |
| – other | | | (161 | ) | | | (149 | ) | | | (127 | ) |
| Indirect expenses | | | (943 | ) | | | (864 | ) | | | (510 | ) |
| | | | (1,475 | ) | | | (1,375 | ) | | | (888 | ) |
| Impairment losses | | | (39 | ) | | | (54 | ) | | | (14 | ) |
| Operating profit before tax | | | 973 | | | | 1,002 | | | | 895 | |
| | | | | | | | | | | | | |
| Analysis of income by product | | | | | | | | | | | | |
| Domestic cash management | | | 805 | | | | 795 | | | | | |
| International cash management | | | 734 | | | | 722 | | | | | |
| Trade finance | | | 290 | | | | 241 | | | | | |
| Merchant acquiring | | | 528 | | | | 554 | | | | | |
| Commercial cards | | | 130 | | | | 119 | | | | | |
| Total income | | | 2,487 | | | | 2,431 | | | | 1,797 | |
| | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | |
| Net interest margin | | | 9.22 | % | | | 8.25 | % | | | | |
| Cost:income ratio | | | 59.3 | % | | | 56.6 | % | | | 49.4 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | £bn | | | £bn | | | £bn | |
| Capital and balance sheet | | | | | | | | | | | | |
| Total third party assets | | | 18.4 | | | | 22.2 | | | | 21.8 | |
| Loans and advances | | | 12.7 | | | | 14.8 | | | | 17.7 | |
| Customer deposits | | | 61.8 | | | | 61.8 | | | | 55.7 | |
| Risk elements in lending | | | 0.2 | | | | 0.1 | | | | | |
| Loan:deposit ratio | | | 21 | % | | | 25 | % | | | | |
| Risk-weighted assets | | | 19.1 | | | | 17.4 | | | | | |
Note:
| (1) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
2009 compared with 2008
Operating profit before tax declined by 3%, largely reflecting pressure on deposit income. The attrition of deposit balances experienced in the first half was reversed in the second, but margins remain compressed due to both a very competitive deposit market as well as the low rate environment.
Customer deposit balances at £61.8 billion were flat on the previous year, with growth in the UK and international business offset by weaker US domestic balances. Loans and advances were down 14% due to reduced overdraft utilisation and lower trade volumes.
International payment fees increased by 2%, while trade finance income increased by 20%, with improved penetration in the Asia-Pacific region. Merchant acquiring income, however, declined by 5%, as consumers continued to switch to lower margin debit card transactions in preference to using credit cards.
Expenses were up 7%, as cost savings and efficiencies that helped to mitigate the impact of investment in infrastructure were offset by movements in foreign exchange rates. Staff expenses were up 2%, primarily as a result of movements in foreign exchange rates, with headcount down 5%. The cost:income ratio was 59.3%, a deterioration of 2.7 percentage points.
Impairment losses were £39 million, down £15 million versus 2008. Overall defaults remain modest at 0.3% of loans and advances.
2008 compared with 2007
Global Transaction Services (GTS) grew income by 35% to £2,431 million and operating profit before tax by 12% to £1,002 million for the full year 2008, reflecting the full year income of ABN AMRO business and the strength and enhanced international capability of the cash management, trade finance and merchant acquiring platforms. The income growth rate was maintained in the second half of the year, despite difficult market conditions.
Business review continued |
Growth was driven by a strong performance in cash management, in particular international cash management in ABN AMRO. Steady growth was achieved in the RBS UK and US domestic markets. Average customer deposits were higher mitigating the impact of lower interest rates. International overdrafts have been re-priced, reflecting the increased cost of funds and higher risk premia during the second half of the year. Fee income from payment transactions increased strongly, particularly in the US and internationally. The division was successful throughout the year in winning new international cash management mandates from existing RBS Group clients due to the strength of the international payments platform and network.
Trade finance made good progress, with income continuing to grow strongly as the ABN AMRO platform enabled GTS to substantially improve its penetration into the Asia-Pacific market, and has expanded its supply chain finance activities with an enhanced product suite. Margins improved throughout the year reflecting the additional risk premium in the market conditions.
Merchant services and commercial cards delivered growth despite the worsening economic climate. Acquiring transaction volumes were up in the year driven by good growth in online volumes, but weaker consumer confidence in the latter part of the year meant that average transaction values decreased, slowing income growth. Commercial cards income saw strong growth for the full year, driven by higher interchange income the small and middle markets.
Direct expenses rose by 35% to £511 million, reflecting the full year costs of the ABN AMRO business. The full year cost growth reflected investment in staffing and infrastructure to support GTS’s development.
Impairment losses were £54 million, up from £14 million in 2007, reflecting in particular the downturn in the global economy and some growth in defaults amongst mid-corporates and SMEs.
Business review continued |
Ulster Bank
| | | 2009 | | | 2008 | | | 2007(2) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income | | | 780 | | | | 708 | | | | 659 | |
| Net fees and commissions | | | 228 | | | | 238 | | | | 163 | |
| Other non-interest income | | | 26 | | | | 103 | | | | 165 | |
| Non-interest income | | | 254 | | | | 331 | | | | 328 | |
| Total income | | | 1,034 | | | | 1,039 | | | | 987 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (325 | ) | | | (330 | ) | | | (258 | ) |
| – other | | | (85 | ) | | | (93 | ) | | | (101 | ) |
| Indirect expenses | | | (343 | ) | | | (292 | ) | | | (265 | ) |
| | | | (753 | ) | | | (715 | ) | | | (624 | ) |
| Impairment losses | | | (649 | ) | | | (106 | ) | | | (46 | ) |
| Operating (loss)/profit before tax | | | (368 | ) | | | 218 | | | | 317 | |
| | | | | | | | | | | | | |
| Analysis of income by business | | | | | | | | | | | | |
| Corporate | | | 580 | | | | 618 | | | | | |
| Retail | | | 412 | | | | 396 | | | | | |
| Other | | | 42 | | | | 25 | | | | | |
| Total income | | | 1,034 | | | | 1,039 | | | | 987 | |
| | | | | | | | | | | | | |
| Analysis of impairment by sector | | | | | | | | | | | | |
| Mortgages | | | 74 | | | | 17 | | | | | |
| Corporate | | | | | | | | | | | | |
| – property | | | 306 | | | | 37 | | | | | |
| – other | | | 203 | | | | 7 | | | | | |
| Other | | | 66 | | | | 45 | | | | | |
| Total impairment | | | 649 | | | | 106 | | | | 46 | |
| | | | | | | | | | | | | |
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector | | | | | | | | | | | | |
| Mortgages | | | 0.46 | % | | | 0.09 | % | | | | |
| Corporate | | | | | | | | | | | | |
| – property | | | 3.03 | % | | | 0.34 | % | | | | |
| – other | | | 1.85 | % | | | 0.05 | % | | | | |
| Other | | | 2.75 | % | | | 2.14 | % | | | | |
| | | | 1.63 | % | | | 0.24 | % | | | | |
| Performance ratios | | | | | | | | | | | | |
Return on equity (1) | | | (13.3 | %) | | | 10.1 | % | | | | |
| Net interest margin | | | 1.87 | % | | | 1.89 | % | | | | |
| Cost:income ratio | | | 72.8 | % | | | 68.8 | % | | | 63.2 | % |
| | | | | | | | | | | | | |
| | | £bn | | | £bn | | | £bn | |
| Capital and balance sheet | | | | | | | | | | | | |
| Loans and advances to customers – gross | | | | | | | | | | | 33.9 | |
| – mortgages | | | 16.2 | | | | 18.1 | | | | | |
| – corporate | | | | | | | | | | | | |
| – property | | | 10.1 | | | | 10.9 | | | | | |
| – other | | | 11.0 | | | | 12.9 | | | | | |
| – other | | | 2.4 | | | | 2.1 | | | | | |
| Customer deposits | | | 21.9 | | | | 24.3 | | | | 21.8 | |
| Risk elements in lending | | | | | | | | | | | | |
| – mortgages | | | 0.6 | | | | 0.3 | | | | | |
| – corporate | | | | | | | | | | | | |
| – property | | | 0.7 | | | | 0.5 | | | | | |
| – other | | | 0.8 | | | | 0.3 | | | | | |
| – other | | | 0.2 | | | | 0.1 | | | | | |
| Loan: deposit ratio | | | 177 | % | | | 179 | % | | | | |
| Risk-weighted assets | | | 29.9 | | | | 24.5 | | | | | |
| (1) | Return on equity is based on divisional operating profit after tax, divided by divisional notional equity (based on 7% of divisional risk-weighted assets, adjusted for capital deductions). |
| (2) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
2009 compared with 2008
Operating results were in line with expectations but deteriorated during 2009 as economic conditions across the island of Ireland worsened, with an operating loss before tax for the year of £368 million.
Net interest income increased by 10% reflecting movements in foreign exchange rates and asset repricing initiatives, largely offset by the tightening of deposit margins in an increasingly competitive market. Net interest margin for the year at 1.87% remained broadly stable despite the challenging market conditions.
Loans to customers decreased by 10% from the prior year as new business demand weakened. Customer deposits reduced by 10% in 2009, reflecting an increasingly competitive Irish deposit market and reductions in wholesale funding during the first quarter. During the second half of the year the market stabilised and the division recorded strong growth in customer balances resulting in an improved funding profile.
Non-interest income declined by 23% due to lower fee income driven by reduced activity levels across all business lines.
Total costs for the year increased by 5%. Direct expenses were down 3% during 2009, driven by the bank’s restructuring programme, which incorporates the merger of the First Active and Ulster Bank businesses. The rollout of the programme has resulted in a downward trend in direct expenses throughout 2009. The reduction in direct expenses has been offset by a 17% increase in indirect expenses primarily reflecting provisions relating to the bank’s own property recognised in the fourth quarter.
Impairment losses increased to £649 million from £106 million driven by the continued deterioration in the Irish economic environment and resultant impact on loan performance across the retail and wholesale portfolios.
Necessary fiscal budgetary action allied to the well-entrenched downturn in property markets in Ireland has fed through to higher loan losses. Mortgage impairments have been driven by rising unemployment and lower incomes. Loans to the property sector experienced a substantial rise in defaults as the Irish property market declined, reflecting the difficult economic backdrop and the uncertainty surrounding the possible effect of the Irish Government's National Asset Management Agency on asset values. Sectors driven by consumer spending have been affected by the double digit decline in 2009 with rising default rates evident.
Customer account numbers increased by 3% during 2009, with growth fuelled by strong current account activity and new-to-bank savings customers.
2008 compared with 2007
The significant deterioration in global and local market conditions has impacted the main Ulster Bank Group markets, with operating profit before tax falling to £218 million, 31% lower than in 2007. A significant driver of this reduction has been an increase of £60 million in impairments, albeit from a low base, reflecting deterioration in credit quality as economic conditions have slowed.
Total income was up 5% at £1,039 million benefiting from movements in exchange rates, net interest income increased by 7%, with average loans and advances to customers up 30% in the year. The benefit from growth in lending, particularly in the first half of the year has been offset by increased funding costs associated with the wholesale funding market dislocation. Non-interest income rose 1%, reflecting a slowdown in particular in the bancassurance and wealth businesses.
Mortgage balances were 13% higher than 2007. New mortgage volumes in the second half of the year were significantly lower than in the first six months, although levels of redemptions have also fallen.
Deposit flows were strong in the latter part of the year and into the early months of 2009. During 2008, we opened 119,000 new current accounts driven by particularly successful current account switcher and student campaigns.
Direct expenses rose by 18% to £423 million, reflecting the impact of the movement in exchange rates and the full year impact of the now completed investment programme in Ulster Bank’s footprint and operations. Cost growth in the second half of 2008 was significantly lower, reflecting disciplined management of the cost base.
Impairment losses rose to £106 million, reflecting the impact on credit quality of the slowdown in the Irish economy, with the final quarter showing the most notable decline in both activity and sentiment. This was reflected in a significantly increased flow of cases into the problem debt management process.
Business review continued |
In January 2009, Ulster Bank announced its intention to adopt a single brand strategy under the Ulster Bank brand. This will see the merger of the operations of Ulster Bank and First Active in the Republic of Ireland (“RI”) by the end of 2009. This action is being taken to strengthen the Ulster Bank Group franchise by positioning it to deal with the prevailing local and global market conditions. A number of cost management initiatives have also commenced across the business.
Ulster Bank has launched a series of initiatives to support its customers in this difficult economic period. We announced in February 2009 that we will be making significant funds available to the Northern Ireland (“NI”) SME market. A similar announcement will be made in the coming weeks regarding the RI SME market. Ulster Bank has also indicated that it is adopting the RBS Group pledge regarding certainty of overdraft limits for this sector.
The Momentum and Secure Step mortgages have been launched in NI and RI respectively to support First Time Buyers and the Bank has confirmed its pledge of a six-month moratorium to mortgage customers facing potential repossession. In support of our retail customers across the island of Ireland the Group’s MoneySense programme is being rolled out, with trained advisers being introduced to all Ulster Bank branches.
Business review continued |
US Retail & Commercial
| | | 2009 | | | 2008 | | | 2007(2) | | | 2009 | | | 2008 | | | 2007(2) | |
| | | | £m | | | | £m | | | | £m | | | | $m | | | | $m | | | | $m | |
| Net interest income | | | 1,775 | | | | 1,726 | | | | 1,613 | | | | 2,777 | | | | 3,200 | | | | 3,227 | |
| Net fees and commissions | | | 714 | | | | 664 | | | | 648 | | | | 1,119 | | | | 1,231 | | | | 1,296 | |
| Other non-interest income | | | 235 | | | | 197 | | | | 153 | | | | 368 | | | | 362 | | | | 305 | |
| Non-interest income | | | 949 | | | | 861 | | | | 801 | | | | 1,487 | | | | 1,593 | | | | 1,601 | |
| Total income | | | 2,724 | | | | 2,587 | | | | 2,414 | | | | 4,264 | | | | 4,793 | | | | 4,828 | |
| Direct expenses | | | | | | | | | | | | | | | | | | | | | | | | |
| – staff | | | (776 | ) | | | (645 | ) | | | (563 | ) | | | (1,214 | ) | | | (1,194 | ) | | | (1,126 | ) |
| – other | | | (593 | ) | | | (354 | ) | | | (291 | ) | | | (929 | ) | | | (654 | ) | | | (582 | ) |
| Indirect expenses | | | (766 | ) | | | (623 | ) | | | (571 | ) | | | (1,196 | ) | | | (1,157 | ) | | | (1,142 | ) |
| | | | (2,135 | ) | | | (1,622 | ) | | | (1,425 | ) | | | (3,339 | ) | | | (3,005 | ) | | | (2,850 | ) |
| Impairment losses | | | (702 | ) | | | (437 | ) | | | (246 | ) | | | (1,099 | ) | | | (811 | ) | | | (491 | ) |
| Operating (loss)/profit before tax | | | (113 | ) | | | 528 | | | | 743 | | | | (174 | ) | | | 977 | | | | 1,487 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Analysis of income by product | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgages and home equity | | | 499 | | | | 375 | | | | | | | | 781 | | | | 695 | | | | | |
| Personal lending and cards | | | 451 | | | | 333 | | | | | | | | 706 | | | | 617 | | | | | |
| Retail deposits | | | 828 | | | | 1,000 | | | | | | | | 1,296 | | | | 1,853 | | | | | |
| Commercial lending | | | 542 | | | | 405 | | | | | | | | 848 | | | | 751 | | | | | |
| Commercial deposits | | | 398 | | | | 377 | | | | | | | | 624 | | | | 698 | | | | | |
| Other | | | 6 | | | | 97 | | | | | | | | 9 | | | | 179 | | | | | |
| Total income | | | 2,724 | | | | 2,587 | | | | 2,414 | | | | 4,264 | | | | 4,793 | | | | 4,828 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Average exchange rate – US$/£ | | | 1.566 | | | | 1.853 | | | | 2.001 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Analysis of impairment by sector | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgages | | | 72 | | | | 41 | | | | | | | | 113 | | | | 76 | | | | | |
| Home equity | | | 167 | | | | 67 | | | | | | | | 261 | | | | 125 | | | | | |
| Corporate & Commercial | | | 326 | | | | 181 | | | | | | | | 510 | | | | 335 | | | | | |
| Other consumer | | | 137 | | | | 148 | | | | | | | | 215 | | | | 275 | | | | | |
| Total impairment | | | 702 | | | | 437 | | | | 246 | | | | 1,099 | | | | 811 | | | | 491 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgages | | | 1.11 | % | | | 0.43 | % | | | | | | | 1.07 | % | | | 0.55 | % | | | | |
| Home equity | | | 1.08 | % | | | 0.36 | % | | | | | | | 1.04 | % | | | 0.46 | % | | | | |
| Corporate & Commercial | | | 1.67 | % | | | 0.76 | % | | | | | | | 1.61 | % | | | 0.97 | % | | | | |
| Other consumer | | | 1.84 | % | | | 1.51 | % | | | | | | | 1.77 | % | | | 1.92 | % | | | | |
| | | | 1.44 | % | | | 0.71 | % | | | | | | | 1.39 | % | | | 0.90 | % | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | | | | | | | | | | | | | |
Return on equity (1) | | | (1.8 | %) | | | 7.7 | % | | | | | | | (1.7 | %) | | | 9.7 | % | | | | |
| Net interest margin | | | 2.37 | % | | | 2.68 | % | | | | | | | 2.37 | % | | | 2.68 | % | | | | |
| Cost:income ratio | | | 78.3 | % | | | 62.7 | % | | | 59.0 | % | | | 78.3 | % | | | 62.7 | % | | | 59.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | £bn | | | £bn | | | £bn | | | US$bn | | | US$bn | | | US$bn | |
| Capital and balance sheet | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | | 74.8 | | | | 87.5 | | | | 67.1 | | | | 121.3 | | | | 127.8 | | | | 134.1 | |
| Loans and advances to customers – gross | | | | | | | | | | | 44.8 | | | | | | | | | | | | 89.9 | |
| – residential mortgages | | | 6.5 | | | | 9.5 | | | | | | | | 10.6 | | | | 13.9 | | | | | |
| – home equity | | | 15.4 | | | | 18.7 | | | | | | | | 25.0 | | | | 27.2 | | | | | |
| – corporate and commercial | | | 19.5 | | | | 23.7 | | | | | | | | 31.6 | | | | 34.7 | | | | | |
| – other consumer | | | 7.5 | | | | 9.8 | | | | | | | | 12.1 | | | | 14.3 | | | | | |
| Customer deposits | | | 60.1 | | | | 63.9 | | | | 52.6 | | | | 97.4 | | | | 93.4 | | | | 105.4 | |
| Risk elements in lending | | | | | | | | | | | | | | | | | | | | | | | | |
| – retail | | | 0.4 | | | | 0.2 | | | | | | | | 0.6 | | | | 0.3 | | | | | |
| – commercial | | | 0.2 | | | | 0.2 | | | | | | | | 0.4 | | | | 0.2 | | | | | |
| Loan: deposit ratio | | | 80 | % | | | 96 | % | | | | | | | 80 | % | | | 96 | % | | | | |
| Risk-weighted assets | | | 59.7 | | | | 63.9 | | | | | | | | 96.9 | | | | 93.2 | | | | | |
| Spot exchange rate – US$/£ | | | 1.622 | | | | 1.460 | | | | 2.004 | | | | | | | | | | | | | |
| (1) | Excluding reverse repurchase agreements by sector. |
| (2) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
2009 compared with 2008
The recessionary economic environment, historically low interest rates and deteriorating credit conditions resulted in an operating loss before tax of £113 million. However, the business has now successfully refocused on its core customer franchises in New England, the Mid-Atlantic region and the Midwest. In dollar terms, an operating loss before tax of $174 million was recorded.
The division achieved very strong growth in mortgage origination volumes, with significantly higher penetration through the branch network and improved profitability, particularly on recent origination vintages. Cross-selling of card, deposit and checking account products has increased substantially, with over 65% of new mortgage customers also taking out a checking account. The division has also increased commercial banking market penetration, with lead bank share within its footprint increasing, in dollar terms, from 6% to 7% in the $5 million to $25 million segment and from 6% to 8% in the $25 million to $500 million segment.
Net interest income was up 3%, principally as a result of movements in exchange rates. However, net interest margin was down 31bps for the full year, reflecting the decline in deposit margins resulting from the low interest rate environment, though margins have been partially rebuilt in the second half from the lows experienced in the first half, as the business repriced lending rates and aggressively reduced pricing on term and time deposits.
Expenses increased by 32%, reflecting increased FDIC deposit insurance levies, higher employee benefit costs as well as increased costs relating to loan workout and collection activity. In dollar terms, expenses increased by 11%. Successful execution of restructuring activities resulted in approximately $75 million of cost savings.
Impairment losses increased to £702 million ($1,099 million) as charge-offs climbed to 0.90% of loans, an increase of 34bps compared with 2008.
Loans and advances were down 21%, reflecting subdued customer demand.
Customer deposits decreased 6% from the prior year. In dollar terms, customer deposits increased 4% as the deposit mix improved significantly, with strong growth in checking balances combined with migration away from higher priced term and time deposits as the division adjusted its pricing strategies. Over 58,000 consumer checking accounts were added over the course of the year, and more than 13,000 small business checking accounts. Consumer checking balances grew by 8% and small business balances by 12%.
2008 compared with 2007
US Retail & Commercial Banking increased income by 7% to £2,587 million, primarily as a result of movements in exchange rates, but experienced a sharp increase in impairment losses as economic conditions progressively worsened over the course of the year. As a result, operating profit before tax declined to £528 million, down 29%. In dollar terms, total income was down 1% at $4,793 million while operating profit before tax declined by 34% to $977 million.
Net interest income grew by 7% to £1,726 million. Average loans and advances to retail customers decreased as a result of the slowing economy and tighter underwriting standards, but this decline was offset by continued strong growth in corporate and commercial lending. Core customer deposits declined by 5% and the division further reduced its reliance on brokered deposits by 80%, leading to an overall decline of 11% in total customer deposits. Net interest margin was held steady at 2.82%, reflecting widening asset margins and management of savings rates in a competitive deposit market.
Direct expenses increased by 17% to £999 million, reflecting increased costs from the expansion of the commercial banking relationship management teams, write-downs on mortgage servicing rights, and higher costs related to loan work-out and collection activity together with movements in exchange rates. In dollar terms, direct expenses increased by 8% to $1,848 million.
Credit conditions worsened significantly over the course of the year as the housing market continued to deteriorate and unemployment rose, exacerbating already challenging conditions. Impairment losses totalled £437 million, up from £246 million in 2007 reflecting the deterioration in economic conditions. In dollar terms, impairment losses totalled $811 million, up 65% from 2007. Stress has emerged in all consumer segments during the second half of the year: non-performing loans represented 0.36% of home equity balances, 0.35% of auto balances and 1.04% of residential mortgage balances. Commercial non-performing loans represented 0.41% of loans. US Retail & Commercial does not originate negative amortization mortgages or option adjustable rate mortgages. Closing provision balances for the portfolio were £588 million ($859 million) compared with £275 million ($552 million) at the end of 2007.
The US business has continued to evaluate opportunities to optimise capital allocation by exiting or reducing exposure to lower growth or sub-scale segments. In the fourth quarter, 18 rural branches in the Adirondacks region were sold to Community Bank System. An agreement has also been announced to sell the Indiana retail branch banking network, consisting of 65 branches, and the business banking and regional banking activities, to Old National Bank.
Business review continued |
RBS Insurance
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Earned premiums | | | 4,519 | | | | 4,512 | | | | 4,615 | |
| Reinsurers’ share | | | (165 | ) | | | (206 | ) | | | (190 | ) |
| Insurance net premium income | | | 4,354 | | | | 4,306 | | | | 4,425 | |
| Net fees and commissions | | | (366 | ) | | | (396 | ) | | | (465 | ) |
| Other income | | | 472 | | | | 520 | | | | 614 | |
| Total income | | | 4,460 | | | | 4,430 | | | | 4,574 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (267 | ) | | | (286 | ) | | | (282 | ) |
| – other | | | (222 | ) | | | (225 | ) | | | (228 | ) |
| Indirect expenses | | | (270 | ) | | | (261 | ) | | | (239 | ) |
| | | | (759 | ) | | | (772 | ) | | | (749 | ) |
| Gross claims | | | (3,690 | ) | | | (3,136 | ) | | | (3,358 | ) |
| Reinsurers’ share | | | 55 | | | | 104 | | | | 75 | |
| Net claims | | | (3,635 | ) | | | (3,032 | ) | | | (3,283 | ) |
| Operating profit before impairment losses | | | 66 | | | | 626 | | | | 542 | |
| Impairment losses | | | (8 | ) | | | (42 | ) | | | — | |
| Operating profit before tax | | | 58 | | | | 584 | | | | 542 | |
| | | | | | | | | | | | | |
| Analysis of income by product | | | | | | | | | | | | |
| Motor own-brand | | | 2,005 | | | | 1,942 | | | | 1,931 | |
| Household and Life own-brands | | | 849 | | | | 806 | | | | 525 | |
| Motor partnerships and broker | | | 577 | | | | 686 | | | | 827 | |
| Household and Life, partnerships and broker | | | 330 | | | | 354 | | | | 625 | |
| Other (international, commercial and central) | | | 699 | | | | 642 | | | | 666 | |
| Total income | | | 4,460 | | | | 4,430 | | | | 4,574 | |
| | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | |
Return on equity (1) | | | 1.6 | % | | | 18.3 | % | | | 17.2 | % |
| Cost:income ratio | | | 17.0 | % | | | 17.4 | % | | | 16.4 | % |
Adjusted cost:income ratio (2) | | | 92.0 | % | | | 55.2 | % | | | 58.0 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| In-force policies (000’s) | | | | | | | | | | | | |
| – Motor own-brand | | | 4,858 | | | | 4,492 | | | | 4,445 | |
| – Own-brand non-motor (home, rescue, pet, HR24) | | | 6,307 | | | | 5,560 | | | | 3,752 | |
| – Partnerships and broker (motor, home, rescue, pet, HR24) | | | 5,328 | | | | 5,898 | | | | 6,765 | |
| – Other (International, commercial and central) | | | 1,217 | | | | 1,206 | | | | 1,068 | |
| | | | | | | | | | | | | |
| General insurance reserves – total (£m) | | | 7,030 | | | | 6,672 | | | | 6,707 | |
| (1) | Based on divisional operating profit after tax, divided by divisional notional equity (based on regulatory capital). |
| (2) | Based on total income and operating expenses above and after netting insurance claims against income. |
Business review continued |
2009 compared with 2008
Operating profit before tax was severely affected by the rising costs of bodily injury claims, declining to £58 million. Significant price increases were implemented in the latter part of the year to mitigate the industry trend of rising claims costs.
Income grew by 1%, with premium income stable but lower reinsurance costs. Investment income was 16% lower, reflecting the impact of low interest rates and returns on the investment portfolio partially offset by gains realised on the sale of equity investments.
In-force policies grew by 3%, driven by the success of own brands, up 11%. Churchill and Privilege have benefited from deployment on selected price comparison websites, with motor policy numbers up 19% and 3% respectively, and home policies up 32% and 109% respectively, compared with prior year. Direct Line motor and home policies grew by 4% and 2% respectively. The partnerships and broker segment declined by 10% in line with business strategy.
Expenses fell by 2% in 2009, with wage inflation, higher industry levies and professional fees offset by cost efficiencies, reduction in headcount and lower marketing expenditure.
Net claims were 20% higher than in 2008 driven by a £448 million increase in bodily injury claims as well as by adverse weather experienced in the fourth quarter. Significant price increases were implemented in the latter part of the year to mitigate the industry trend of rising claims costs, and additional significant initiatives have also been undertaken to adapt pricing models and enhance claims management.
The UK combined operating ratio, including business services costs, was 105.9% compared with 93.6% in the previous year, with the impact of the increase in reserves for bodily injury claims and the bad weather experience only partially mitigated by commission and expense ratio improvement.
2008 compared with 2007
RBS Insurance made good progress in 2008, with operating profit before tax rising by £42 million, an increase of 8%. Total income was £144 million lower at £4,430 million, reflecting a fall in insurance premium income following the continuation of the strategic decision to exit less profitable partnership contracts and the effect of financial market conditions.
Own-brand businesses increased income by 2% and contribution before impairments and excluding indirect expenses by 12%. In the UK motor market the Group increased premium rates to offset claims inflation and continued to target lower risk drivers, with price increases concentrated in higher risk categories in order to improve profitability. During 2008 selected brands were successfully deployed on a limited number of aggregator web sites. Our international businesses in Italy and Germany performed well, with income up 25% and contribution up 74%. Over the last year own-brand motor policy numbers have again begun to increase, and rose by 1% to 4.5 million.
In own-brand non-motor insurance we have continued to achieve good sales through the RBS Group, where home insurance policies in force have increased by 33%. In addition, Privilege and Churchill have grown home policies by 90% and 13% respectively compared with 2007, mainly due to an increase in online sales as a result of successful marketing campaigns. A new commercial insurance offering, Direct Line for Business, was launched, and has grown rapidly over the year with particularly strong performances in Residential Property and Tradesman policies. Overall own-brand non-motor policies in force have grown by 48% to 5.6 million, benefiting from the addition of rescue cover to RBS and NatWest current account package customers.
Results from partnerships and broker business confirmed the Group’s strategy of refocusing on the more profitable opportunities in this segment, where we provide underwriting and processing services to third parties. The Group did not renew a number of rescue contracts and pulled back from some less profitable segments of the broker market. As a result partnership and broker in-force policies have fallen by 13% over the last year with a corresponding 12% reduction in income, yet contribution grew by 30%.
For RBS Insurance as a whole, insurance premium income, net of fees and commissions, was broadly maintained at £4 billion, reflecting 6% growth in the Group’s own brands offset by a 14% decline in the partnerships and broker segment. Investment income was maintained at £367 million. Other income decreased by 15% to £520 million.
Direct expenses increased by less than 1% to £511 million, despite accelerated marketing development in own brands, including the launch of Direct Line for Business.
Net claims fell by 8% to £3,032 million, benefiting from ongoing claims containment and more benign weather conditions. Impairments of £42 million reflect impairments recognised in corporate bond and equities investment portfolios.
The UK combined operating ratio for 2008, including manufacturing costs, decreased to 93.6% from 98.8%
Business review continued |
Central items
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Fair value of own debt | | | (93 | ) | | | 875 | | | | 152 | |
| Other | | | 385 | | | | 150 | | | | 693 | |
| Operating profit before tax | | | 292 | | | | 1,025 | | | | 845 | |
2009 compared with 2008
Funding and operating costs have been allocated to operating divisions, based on direct service usage, requirement for market funding and other appropriate drivers where services span more than one division.
Residual unallocated items relate to volatile corporate items that do not naturally reside within a division.
Items not allocated during the year amounted to a net credit of £292 million. The Group’s credit spreads have fluctuated over the course of the year, but ended the year slightly tighter, resulting in an increase in the carrying value of own debt. This was offset by a net credit on unallocated Group treasury items, including the impact of economic hedges that do not qualify for IFRS hedge accounting. 2008’s results included some significant disposal gains.
2008 compared with 2007
Items not allocated during the year amounted to a net credit of £1,025 million reflecting the benefit from a decrease in the carrying value of own debt, profit on the sale of Tesco Personal Finance offset by a net debit on economic hedges which do not qualify for IFRS hedge accounting.
Business review continued |
Non-Core
| | | 2009 | | | 2008 | | | 2007(4) | |
| | | | £m | | | | £m | | | | £m | |
| Net interest income from banking activities | | | 1,504 | | | | 2,028 | | | | 1,365 | |
| Funding costs of rental assets | | | (256 | ) | | | (380 | ) | | | (324 | ) |
| Net interest income | | | 1,248 | | | | 1,648 | | | | 1,041 | |
| Net fees and commissions receivable | | | 472 | | | | 889 | | | | 834 | |
| Loss from trading activities | | | (5,123 | ) | | | (7,716 | ) | | | (804 | ) |
| Insurance net premium income | | | 784 | | | | 986 | | | | 962 | |
| Other operating income | | | 318 | | | | 1,161 | | | | 2,994 | |
| Non-interest income | | | (3,549 | ) | | | (4,680 | ) | | | 3,986 | |
| Total income | | | (2,301 | ) | | | (3,032 | ) | | | 5,027 | |
| Direct expenses | | | | | | | | | | | | |
| – staff | | | (851 | ) | | | (988 | ) | | | (508 | ) |
| – other | | | (1,044 | ) | | | (1,156 | ) | | | (1,004 | ) |
| Indirect expenses | | | (552 | ) | | | (539 | ) | | | (242 | ) |
| | | | (2,447 | ) | | | (2,683 | ) | | | (1,754 | ) |
| Insurance net claims | | | (588 | ) | | | (700 | ) | | | (727 | ) |
| Impairment losses | | | (9,221 | ) | | | (4,936 | ) | | | (399 | ) |
| Operating (loss)/profit before tax | | | (14,557 | ) | | | (11,351 | ) | | | 2,147 | |
| | | | | | | | | | | | | |
| Analysis of income | | | | | | | | | | | | |
| Banking & Portfolio | | | (1,338 | ) | | | 2,324 | | | | | |
International Businesses & Portfolios | | | 2,262 | | | | 2,980 | | | | | |
| Markets | | | (3,225 | ) | | | (8,336 | ) | | | | |
| | | | (2,301 | ) | | | (3,032 | ) | | | 5,027 | |
| | | | | | | | | | | | | |
| Performance ratios | | | | | | | | | | | | |
| Net interest margin | | | 0.69 | % | | | 0.87 | % | | | | |
| Cost:income ratio | | | (106.3 | %) | | | (88.5 | %) | | | 34.9 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | £bn | | | £bn | | | £bn | |
Capital and balance sheet (1) | | | | | | | | | | | | |
Total third party assets (including derivatives (2)) | | | 220.9 | | | | 342.9 | | | | 256.4 | |
| Loans and advances to customers – gross | | | 149.5 | | | | 191.4 | | | | 161.4 | |
| Customer deposits | | | 12.6 | | | | 27.4 | | | | 27.2 | |
| Risk elements in lending | | | 22.9 | | | | 11.1 | | | | | |
| Loan:deposit ratio | | | 1,121 | % | | | 683 | % | | | | |
Risk-weighted assets (3) | | | 171.3 | | | | 170.9 | | | | | |
| (1) | Includes disposal groups. |
| (2) | Derivatives were £19.9 billion at 31 December 2009 (31 December 2008 – £85.0 billion). |
| (3) | Includes Sempra: 31 December 2009 Third Party Assets (TPAs) £14.2 billion, RWAs £10.2 billion (31 December 2008 – TPAs £17.8 billion, RWAs £10.6 billion). |
| (4) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
| | | 2009 | | | 2008 | | | 2007(4) | |
| | | | £m | | | | £m | | | | £m | |
Credit and other market write-downs (1) | | | | | | | | | | | | |
| Monoline exposures | | | 2,387 | | | | 3,121 | | | | | |
| CDPCs | | | 947 | | | | 615 | | | | | |
Asset backed products (2) | | | 288 | | | | 3,220 | | | | | |
| Other credit exotics | | | 558 | | | | 935 | | | | | |
| Equities | | | 47 | | | | 947 | | | | | |
| Leveraged finance | | | — | | | | 1,088 | | | | | |
| Banking book hedges | | | 1,613 | | | | (1,690 | ) | | | | |
| Other | | | (679 | ) | | | (497 | ) | | | | |
| | | | 5,161 | | | | 7,739 | | | | | |
| | | | | | | | | | | | | |
| Impairment losses | | | | | | | | | | | | |
| Banking & Portfolio | | | 4,215 | | | | 938 | | | | | |
| International Businesses & Portfolios | | | 4,494 | | | | 1,832 | | | | | |
| Markets | | | 512 | | | | 2,166 | | | | | |
| | | | 9,221 | | | | 4,936 | | | | 399 | |
| | | | | | | | | | | | | |
Loan impairment charge as % of gross customer loans and advances (3) | | | | | | | | | | | | |
| Banking & Portfolio | | | 4.91 | % | | | 0.90 | % | | | | |
| International Businesses & Portfolios | | | 6.56 | % | | | 2.28 | % | | | | |
| Markets | | | 5.34 | % | | | 13.32 | % | | | | |
| Total | | | 5.66 | % | | | 2.18 | % | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | £bn | | | £bn | | | | | |
| Gross customer loans and advances | | | | | | | | | | | | |
| Banking & Portfolio | | | 82.0 | | | | 97.0 | | | | | |
| International Businesses & Portfolios | | | 65.6 | | | | 79.9 | | | | | |
| Markets | | | 1.9 | | | | 14.5 | | | | | |
| | | | 149.5 | | | | 191.4 | | | | 161.4 | |
| | | | | | | | | | | | | |
| Risk-weighted assets | | | | | | | | | | | | |
| Banking & Portfolio | | | 58.2 | | | | 63.1 | | | | | |
| International Businesses & Portfolios | | | 43.8 | | | | 50.1 | | | | | |
| Markets | | | 69.3 | | | | 57.7 | | | | | |
| | | | 171.3 | | | | 170.9 | | | | | |
| (1) | Included in ‘Loss from trading activities’ on page 60. |
| (2) | Asset backed products include super senior asset backed structures and other asset backed products. |
| (3) | Includes disposal groups. |
| (4) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
Loan impairment losses by donating division and sector
| | | 2009 | | | 2008 | | | 2007(1) | |
| | | | £m | | | | £m | | | | £m | |
| UK Retail | | | | | | | | | | | | |
| Mortgages | | | 5 | | | | 1 | | | | | |
| Personal | | | 48 | | | | 42 | | | | | |
| Other | | | — | | | | 62 | | | | | |
| Total UK Retail | | | 53 | | | | 105 | | | | | |
| | | | | | | | | | | | | |
| UK Corporate | | | | | | | | | | | | |
| Manufacturing & infrastructure | | | 87 | | | | 42 | | | | | |
| Property & construction | | | 637 | | | | 281 | | | | | |
| Transport | | | 10 | | | | (3 | ) | | | | |
| Banks & financials | | | 101 | | | | 4 | | | | | |
| Lombard | | | 122 | | | | 61 | | | | | |
| Invoice finance | | | 3 | | | | — | | | | | |
| Other | | | 717 | | | | 142 | | | | | |
| Total UK Corporate | | | 1,677 | | | | 527 | | | | | |
| | | | | | | | | | | | | |
| Global Banking & Markets | | | | | | | | | | | | |
| Manufacturing & infrastructure | | | 1,405 | | | | 1,280 | | | | | |
Property & construction | | | 1,413 | | | | 710 | | | | | |
| Transport | | | 178 | | | | 12 | | | | | |
| Telecoms, media & technology | | | 545 | | | | 55 | | | | | |
| Banks & financials | | | 567 | | | | 870 | | | | | |
| Other | | | 619 | | | | 177 | | | | | |
| Total Global Banking & Markets | | | 4,727 | | | | 3,104 | | | | | |
| | | | | | | | | | | | | |
| Ulster Bank | | | | | | | | | | | | |
| Mortgages | | | 42 | | | | 6 | | | | | |
| Commercial investment & development | | | 302 | | | | 9 | | | | | |
| Residential investment & development | | | 716 | | | | 229 | | | | | |
| Other | | | 217 | | | | 60 | | | | | |
| Other EMEA | | | 107 | | | | 116 | | | | | |
| Total Ulster Bank | | | 1,384 | | | | 420 | | | | | |
| | | | | | | | | | | | | |
| US Retail & Commercial | | | | | | | | | | | | |
| Auto & consumer | | | 136 | | | | 140 | | | | | |
| Cards | | | 130 | | | | 63 | | | | | |
| SBO/home equity | | | 445 | | | | 321 | | | | | |
| Residential mortgages | | | 55 | | | | 6 | | | | | |
| Commercial real estate | | | 228 | | | | 54 | | | | | |
| Commercial & other | | | 85 | | | | 20 | | | | | |
| Total US Retail & Commercial | | | 1,079 | | | | 604 | | | | | |
| | | | | | | | | | | | | |
| Other | | | | | | | | | | | | |
| Wealth | | | 251 | | | | 174 | | | | | |
| Global Transaction Services | | | 49 | | | | (2 | ) | | | | |
| Central items | | | 1 | | | | 4 | | | | | |
| Total Other | | | 301 | | | | 176 | | | | | |
| | | | | | | | | | | | | |
| Total impairment losses | | | 9,221 | | | | 4,936 | | | | 399 | |
| (1) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
Gross loans and advances to customers by donating division and sector (excluding reverse repurchase agreements)
| | | 2009 | | | 2008 | | 2007(1) |
| | | £bn | | | £bn | | £bn |
| UK Retail | | | | | | | |
| Mortgages | | | 1.9 | | | | 2.2 | | |
| Personal | | | 0.7 | | | | 1.1 | | |
| Total UK Retail | | | 2.6 | | | | 3.3 | | |
| | | | | | | | | | |
| UK Corporate | | | | | | | | | |
| Manufacturing & infrastructure | | | 0.3 | | | | 0.3 | | |
| Property & construction | | | 10.8 | | | | 11.3 | | |
| Lombard | | | 2.7 | | | | 3.7 | | |
| Invoice finance | | | 0.4 | | | | 0.7 | | |
| Other | | | 20.7 | | | | 22.1 | | |
| Total UK Corporate | | | 34.9 | | | | 38.1 | | |
| | | | | | | | | | |
| Global Banking & Markets | | | | | | | | | |
| Manufacturing & infrastructure | | | 17.5 | | | | | | |
Property & construction | | | 25.7 | | | | | | |
| Transport | | | 5.8 | | | | | | |
| Telecoms, media & technology | | | 3.2 | | | | | | |
| Banks & financials | | | 16.0 | | | | | | |
| Other | | | 13.5 | | | | | | |
| Total Global Banking & Markets | | | 81.7 | | | | 104.8 | | |
| | | | | | | | | | |
| Ulster Bank | | | | | | | | | |
| Mortgages | | | 6.0 | | | | 6.5 | | |
| Commercial investment & development | | | 3.0 | | | | 2.9 | | |
| Residential investment & development | | | 5.6 | | | | 5.9 | | |
| Other | | | 1.1 | | | | 1.1 | | |
| Other EMEA | | | 1.0 | | | | 1.3 | | |
| Total Ulster Bank | | | 16.7 | | | | 17.7 | | |
| | | | | | | | | | |
| US Retail & Commercial | | | | | | | | | |
| Auto & consumer | | | 3.2 | | | | 4.2 | | |
| Cards | | | 0.5 | | | | 0.7 | | |
| SBO/home equity | | | 3.7 | | | | 5.2 | | |
| Residential mortgages | | | 0.8 | | | | 1.1 | | |
| Commercial real estate | | | 1.9 | | | | 3.0 | | |
| Commercial & other | | | 0.9 | | | | 1.4 | | |
| Total US Retail & Commercial | | | 11.0 | | | | 15.6 | | |
| | | | | | | | | | |
| Other | | | | | | | | | |
| Wealth | | | 2.6 | | | | 3.6 | | |
| Global Transaction Services | | | 0.8 | | | | 1.4 | | |
| RBS Insurance | | | 0.2 | | | | 0.2 | | |
| Central items | | | (3.2 | ) | | | — | | |
| Total Other | | | 0.4 | | | | 5.2 | | |
| | | | | | | | | | |
| Total loans and advances to customers | | | 147.3 | | | | 184.7 | | |
| (1) | As noted on page 5, following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. The company has also improved the granularity of certain segment information resulting in the provision of supplementary disclosures. However, it is not possible to source certain elements of these supplementary disclosures for 2007 without undue cost. |
Business review continued |
2009 compared with 2008
Losses from trading activities have declined significantly as underlying asset prices rallied. Mark to market values for exposures such as monolines, super senior high grade collateralised debt obligations, and many negative basis trade asset classes have risen over the course of 2009. However, the £1.6 billion gain recorded on banking book hedging in 2008 unwound over the course of the year to a loss of £1.6 billion in 2009, as spreads continued to tighten throughout the year, ending almost in line with origination levels.
Impairment losses increased to £9.2 billion, reflecting continued weakness in the economic environment, particularly across the corporate and property sectors. There were signs of a slowdown in the rate of provisioning towards the end of the year.
Staff costs decreased by 14% over the year, due to headcount reductions and business divestments, notably Linea Directa and Tesco Personal Finance. Lower depreciation charges followed the 2008 sale of the Angel Trains business.
Third party assets, excluding derivatives, decreased by £56.9 billion in the year as the division has run down exposures and pursued opportunities to dispose of loan portfolios. Sales of equity stakes, including Bank of China, were concluded while further disposals announced in 2009, including Asian retail and commercial operations, are moving towards completion in 2010.
Risk weighted assets increased by 0.2% in 2009. The reduction of 15% since 30 September 2009, reflects active management to reduce trading book exposures, largely offset by the impact of procyclicality, monoline downgrades and adverse market risk.
2008 compared with 2007
Overall results for 2008 deteriorated significantly due to the worsening of global economies and credit markets resulting in large increases in impairment losses and credit and other market write downs on trading activities. In addition 2008 included a full year of results from the acquisition of ABN AMRO compared with 76 days in the previous year.
Net interest income increased to £1,648 million and net fees and commissions increased to £889 million principally due to the inclusion of a full year of income for ABN AMRO. In 2008, losses from trading activities totalled £7,716 million compared with a loss of £804 million in 2007 including £10,172 million of credit and other market write downs, partially offset by £1,690 million gain on credit default swaps, particularly in the fourth quarter of 2008.
Other operating income reduced significantly due to the sale of a number of our private equity portfolios including Southern Water in 2007 which was not repeated in 2008.
The increase in operating expenses mainly reflects the inclusion of a full year of the ABN AMRO cost base partially offset by a reduction in bonus related expenses in 2008.
Insurance premiums and claims including Linea Directa were relatively stable.
Impairment losses increased to £4,936 million from £399 million, of which £3,105 million related to global corporate clients previously managed in our Global Banking & Markets division.
Third party assets had small increases in most areas. Loans and advances increased by £31 billion or 19%. Global clients saw increases of £15 billion, with steady, but smaller increases in the retail & commercial markets of UK, EME, Asia and the US.
Customer deposits remained largely unchanged.
Employee numbers at 31 December
(full time equivalents rounded to the nearest hundred)
| | | 2009 | | | 2008 | | | 2007 | |
| UK Retail | | | 25,500 | | | | 28,400 | | | | 28,400 | |
| UK Corporate | | | 12,300 | | | | 13,400 | | | | 12,500 | |
| Wealth | | | 4,600 | | | | 5,200 | | | | 5,100 | |
| Global Banking & Markets | | | 16,800 | | | | 16,500 | | | | 22,000 | |
| Global Transaction Services | | | 3,500 | | | | 3,900 | | | | 3,100 | |
| Ulster Bank | | | 4,500 | | | | 5,400 | | | | 5,400 | |
| US Retail & Commercial | | | 15,500 | | | | 16,200 | | | | 16,300 | |
| RBS Insurance | | | 13,900 | | | | 14,500 | | | | 15,700 | |
| Central items | | | 4,200 | | | | 4,300 | | | | 4,300 | |
| Core | | | 100,800 | | | | 107,800 | | | | 112,800 | |
| Non-Core | | | 15,100 | | | | 19,000 | | | | 16,300 | |
| | | | 115,900 | | | | 126,800 | | | | 129,100 | |
| Business services | | | 44,200 | | | | 47,600 | | | | 44,700 | |
| Integration | | | 500 | | | | 900 | | | | — | |
| RFS Holdings minority interest | | | 23,100 | | | | 24,500 | | | | 21,600 | |
| Group total | | | 183,700 | | | | 199,800 | | | | 195,400 | |
Business review continued |
Consolidated balance sheet at 31 December 2009
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Assets | | | | | | | | | | | | |
| Cash and balances at central banks | | | 52,261 | | | | 12,400 | | | | 17,866 | |
| Net loans and advances to banks | | | 56,656 | | | | 79,426 | | | | 43,519 | |
| Reverse repurchase agreements and stock borrowing | | | 35,097 | | | | 58,771 | | | | 175,941 | |
| Loans and advances to banks | | | 91,753 | | | | 138,197 | | | | 219,460 | |
| Net loans and advances to customers | | | 687,353 | | | | 835,409 | | | | 686,181 | |
| Reverse repurchase agreements and stock borrowing | | | 41,040 | | | | 39,313 | | | | 142,357 | |
| Loans and advances to customers | | | 728,393 | | | | 874,722 | | | | 828,538 | |
| Debt securities | | | 267,254 | | | | 267,549 | | | | 294,656 | |
| Equity shares | | | 19,528 | | | | 26,330 | | | | 53,026 | |
| Settlement balances | | | 12,033 | | | | 17,832 | | | | 16,589 | |
| Derivatives | | | 441,454 | | | | 992,559 | | | | 277,402 | |
| Intangible assets | | | 17,847 | | | | 20,049 | | | | 49,916 | |
| Property, plant and equipment | | | 19,397 | | | | 18,949 | | | | 18,745 | |
| Deferred taxation | | | 7,039 | | | | 7,082 | | | | 3,119 | |
| Prepayments, accrued income and other assets | | | 20,985 | | | | 24,402 | | | | 15,662 | |
| Assets of disposal groups | | | 18,542 | | | | 1,581 | | | | 45,850 | |
| Total assets | | | 1,696,486 | | | | 2,401,652 | | | | 1,840,829 | |
| | | | | | | | | | | | | |
| Liabilities | | | | | | | | | | | | |
| Bank deposits | | | 104,138 | | | | 174,378 | | | | 149,256 | |
| Repurchase agreements and stock lending | | | 38,006 | | | | 83,666 | | | | 163,038 | |
| Deposits by banks | | | 142,144 | | | | 258,044 | | | | 312,294 | |
| Customers deposits | | | 545,849 | | | | 581,369 | | | | 547,447 | |
| Repurchase agreements and stock lending | | | 68,353 | | | | 58,143 | | | | 134,916 | |
| Customer accounts | | | 614,202 | | | | 639,512 | | | | 682,363 | |
| Debt securities in issue | | | 267,568 | | | | 300,289 | | | | 274,172 | |
| Settlement balances and short positions | | | 50,876 | | | | 54,277 | | | | 91,021 | |
| Derivatives | | | 424,141 | | | | 971,364 | | | | 272,052 | |
| Accruals, deferred income and other liabilities | | | 30,327 | | | | 31,482 | | | | 34,208 | |
| Retirement benefit liabilities | | | 2,963 | | | | 2,032 | | | | 460 | |
| Deferred taxation | | | 2,811 | | | | 4,165 | | | | 5,400 | |
| Insurance liabilities | | | 10,281 | | | | 9,976 | | | | 10,162 | |
| Subordinated liabilities | | | 37,652 | | | | 49,154 | | | | 38,043 | |
| Liabilities of disposal groups | | | 18,890 | | | | 859 | | | | 29,228 | |
| Total liabilities | | | 1,601,855 | | | | 2,321,154 | | | | 1,749,403 | |
| | | | | | | | | | | | | |
| Minority interests | | | 16,895 | | | | 21,619 | | | | 38,388 | |
| Owners’ equity | | | 77,736 | | | | 58,879 | | | | 53,038 | |
| Total equity | | | 94,631 | | | | 80,498 | | | | 91,426 | |
| | | | | | | | | | | | | |
| Total liabilities and equity | | | 1,696,486 | | | | 2,401,652 | | | | 1,840,829 | |
Commentary on consolidated balance sheet: 2009 compared with 2008
Total assets of £1,696.5 billion at 31 December 2009 were down £705.2 billion, 29%, compared with 31 December 2008, principally reflecting substantial repayments of customer loans and advances as corporate customer demand fell and corporates looked to deleverage their balance sheets. Lending to banks also fell in line with significantly reduced wholesale funding activity. There were also significant falls in the value of derivative assets, with a corresponding fall in derivative liabilities.
Cash and balances at central banks were up £39.9 billion to £52.3 billion due to the placing of short-term cash surpluses, including the proceeds from the issue of B shares in December, with central banks.
Loans and advances to banks decreased by £46.4 billion, 34%, to £91.8 billion with reverse repurchase agreements and stock borrowing (‘reverse repos’) down by £23.7 billion, 40% to £35.1 billion and lower bank placings, down £22.7 billion, 29%, to £56.7 billion largely as a result of reduced wholesale funding activity in Global Banking & Markets.
Loans and advances to customers were down £146.3 billion, 17%, at £728.4 billion. Within this, reverse repos increased by 4%, £1.7 billion to £41.0 billion. Excluding reverse repos, lending decreased by £148.0 billion, 18%, to £687.4 billion or by £141.8 billion, 17%, before impairment provisions. This reflected reductions in Global Banking & Markets of £71.4 billion, and planned reductions in Non-Core of £30.1 billion, including a £3.2 billion transfer to disposal groups in respect of RBS Sempra Commodities and the Asian and Latin American businesses. Reductions were also experienced in US Retail & Commercial, £7.4 billion; UK Corporate & Commercial, £5.4 billion; Ulster Bank, £1.8 billion; and the effect of exchange rate movements, £33.1 billion, following the strengthening of sterling during the year, partially offset by growth in UK Retail of £9.2 billion, and in Wealth of £1.4 billion.
Debt securities were flat at £267.3 billion and equity shares decreased by £6.8 billion, 26%, to £19.5 billion, principally due to the sale of the Bank of China investment and lower holdings in Global Banking & Markets and Non-Core, largely offset by growth in Group Treasury, in part reflecting an £18.0 billion increase in the gilt liquidity portfolio, and in the RFS Holdings minority interest.
Business review continued |
Movements in the value of derivative assets, down £551.1 billion, 56%, to £441.5 billion, and liabilities, down £547.2 billion, 56%, to £424.1 billion, reflect the easing of market volatility, the strengthening of sterling and significant tightening in credit spreads in the continuing low interest rate environment.
Increases in assets and liabilities of disposal groups reflect the inclusion of the RBS Sempra Commodities business and the planned sale of a number of the Group’s retail and commercial activities in Asia and Latin America.
Deposits by banks declined by £115.9 billion, 45%, to £142.1 billion due to a decrease in repurchase agreements and stock lending (‘repos’), down £45.7 billion, 55%, to £38.0 billion and reduced inter-bank deposits, down £70.2 billion, 40% to £104.1 billion principally in Global Banking & Markets, reflecting reduced reliance on wholesale funding, and in the RFS Holdings minority interest.
Customer accounts were down £25.3 billion, 4%, to £614.2 billion. Within this, repos increased £10.2 billion, 18%, to £68.4 billion. Excluding repos, deposits were down £35.5 billion, 6%, to £545.8 billion, primarily due to; reductions in Global Banking & Markets, down £43.6 billion; Non-Core, £13.0 billion; including the transfer of £8.9 billion to disposal groups; and Ulster Bank, £1.2 billion; together with exchange rate movements, £21.3 billion, offset in part by growth across all other divisions, up £23.0 billion, and in the RFS Holdings minority interest, up £20.6 billion.
Debt securities in issue were down £32.7 billion, 11% to £267.6 billion mainly as a result of movements in exchange rates, together with reductions in Global Banking & Markets, Non-Core and the RFS Holdings minority interest.
Retirement benefit liabilities increased by £0.9 billion, 46%, to £3.0 billion, with net actuarial losses of £3.7 billion, arising from lower discount rates and higher assumed inflation, partially offset by curtailment gains of £2.1 billion due to changes in prospective pension benefits.
Subordinated liabilities were down £11.5 billion, 23% to £37.7 billion, reflecting the redemption of £5.0 billion undated loan capital, £1.5 billion trust preferred securities and £2.7 billion dated loan capital, together with the effect of exchange rate movements and other adjustments, £2.9 billion, partly offset by the issue of £2.3 billion undated loan capital within the RFS Holdings minority interest.
Equity minority interests decreased by £4.7 billion, 22%, to £16.9 billion. Equity withdrawals of £3.1 billion, due to the disposal of the investment in the Bank of China attributable to minority shareholders and the redemption, in part, of certain trust preferred securities, exchange rate movements of £1.4 billion, the recycling of related available-for-sale reserves to income, £0.5 billion, and dividends paid of £0.3 billion, were partially offset by attributable profits of £0.3 billion.
Owners' equity increased by £18.9 billion, 32% to £77.7 billion. The issue of B shares to HM Treasury in December 2009 raised £25.1 billion, net of expenses, and was offset in part by the creation of a £1.2 billion reserve in respect of contingent capital B shares. The placing and open offer in April 2009 raised £5.3 billion to fund the redemption of the £5.0 billion preference shares issued to HM Treasury in December 2008. Actuarial losses, net of tax, of £2.7 billion; the attributable loss for the period, £2.7 billion; exchange rate movements of £1.9 billion; the payment of other owners dividends of £0.9 billion including £0.3 billion to HM Treasury on the redemption of preference shares, and partial redemption of paid-in equity £0.3 billion were partly offset by increases in available-for-sale reserves, £1.8 billion; cash flow hedging reserves, £0.6 billion; and the equity owners gain on withdrawal of minority interests, net of tax, of £0.5 billion arising from the redemption of trust preferred securities.
Commentary on consolidated balance sheet: 2008 compared with 2007
Total assets of £2,401.7 billion at 31 December 2008 were up £560.8 billion, 30%, compared with 31 December 2007.
Loans and advances to banks decreased by £81.3 billion, 37%, to £138.2 billion. Reverse repurchase agreements and stock borrowing (‘reverse repos’) were down by £117.2 billion, 67% to £58.8 billion. Excluding reverse repos, bank placings increased by £35.9 billion, 83%, to £79.4 billion.
Loans and advances to customers were up £46.2 billion, 6%, at £874.7 billion or £68.0 billion, 8% following the disposal of the Banco Real and other businesses to Santander and Tesco Personal Finance. Within this, reverse repos decreased by 72%, £103.0 billion to £39.3 billion. Excluding reverse repos, lending rose by £149.2 billion, 22% to £835.4 billion reflecting both organic growth and the effect of exchange rate movements following the weakening of sterling during the second half of 2008.
Debt securities decreased by £27.1 billion, 9%, to £267.5 billion and equity shares decreased by £26.7 billion, 50%, to £26.3 billion principally due to lower holdings in Global Banking & Markets.
Business review continued |
Movements in the value of derivatives, assets and liabilities, primarily reflect changes in interest and exchange rates, together with growth in trading volumes.
Intangible assets declined by £29.9 billion, 60% to £20.0 billion, reflecting impairment of £32.6 billion and the disposals of the Asset Management business of ABN AMRO, Banca Antonveneta and the Banco Real and other businesses of ABN AMRO acquired by Santander, £7.2 billion. This was offset by exchange rate movements of £11.8 billion, goodwill of £0.2 billion arising on the Sempra joint venture and £0.3 billion on the buyout of the outstanding ABN AMRO shareholdings not previously owned by the Group.
Deferred tax assets increased £4.0 billion to £7.1 billion principally due to carried forward trading losses.
Prepayments, accrued income and other assets were up £8.7 billion, 56% to £24.4 billion.
Assets and liabilities of disposal groups decreased following completion of the sales of the Asset Management business of ABN AMRO to Fortis, Banca Antonveneta to Monte dei Paschi di Sienna and the majority of ABN AMRO’s Private Equity business to third parties.
Deposits by banks declined by £54.3 billion, 17% to £258.0 billion. This reflected decreased repurchase agreements and stock lending (‘repos’), down £79.4 billion, 49% to £83.7 billion partly offset by increased inter-bank deposits, up £25.1 billion, 17% to £174.4 billion.
Customer accounts were down £42.9 billion, 6% to £639.5 billion or £21.6 billion, 3% excluding disposals of subsidiaries. Within this, repos decreased £76.8 billion, 57% to £58.1 billion. Excluding repos, deposits rose by £33.9 billion, 6%, to £581.4 billion.
Debt securities in issue were up £26.1 billion, 10% to £300.3 billion mainly resulting from the effect of exchange rate movements.
Settlement balances and short positions were down £36.7 billion, 40%, to £54.3 billion reflecting reduced customer activity.
Accruals, deferred income and other liabilities decreased £2.7 billion, 8%, to £31.5 billion primarily as a result of disposals.
Retirement benefit liabilities increased by £1.6 billion to £2.0 billion due to reduced asset values only partly offset by the effect of increased discount rates.
Deferred taxation liabilities decreased by £1.2 billion, 23% to £4.2 billion due in part to the sale of Angel Trains.
Subordinated liabilities were up £11.1 billion, 29% to £49.2 billion. The issue of £2.4 billion dated loan capital and the effect of exchange rate and other adjustments, £11.3 billion, were partially offset by the redemption of £1.6 billion of dated loan capital, £0.1 billion undated loan capital and £0.9 billion in respect of the disposal of the Banco Real and other businesses of ABN AMRO to Santander.
Equity minority interests decreased by £16.8 billion, 44% to £21.6 billion. Attributable losses of £ 10.8 billion, including £15.7 billion of write downs of goodwill and other intangible assets in respect of the State of the Netherlands investment in RFS Holdings, equity withdrawals of £13.6 billion, including £12.3 billion by Santander following the disposals of Banca Antonveneta and Banco Real, reductions in the market value of available-for-sale securities of £1.4 billion, mainly the investment in Bank of China attributable to minority shareholders, movements in cash flow hedging reserves, £0.8 billion, actuarial losses on defined benefit pension schemes net of tax of £0.5 billion and dividends paid of £0.3 billion, were partially offset by effect of exchange rate movements of £9.1 billion of which £8.0 billion related to the State of the Netherlands and Santander investments in RFS Holdings, the £0.8 billion equity raised as part of the Sempra joint venture and £0.4 billion additional equity in respect of the buy-out of the ABN AMRO minority shareholders.
Owners’ equity increased by £5.8 billion, 11% to £58.9 billion. Proceeds of £12.0 billion from the rights issue, net of £246 million expenses, and £19.7 billion from the placing and open offer, net of expenses of £265 million, together with exchange rate movements of £6.8 billion and other movements of £0.2 billion were partially offset by the attributable loss for the period of £23.7 billion, a £4.6 billion decrease in available-for-sale reserves, net of tax, reflecting £1.0 billion in the Group’s share in the investment in Bank of China and £3.6 billion in other securities, the majority of which related to Global Banking & Markets, actuarial losses net of tax of £1.3 billion, the payment of the 2007 final ordinary dividend of £2.3 billion and other dividends of £0.6 billion, and a reduction in the cash flow hedging reserve of £0.3 billion.
Business review continued |
Cash flow
| | | 2009 | | | 2008 | | | 2007 | |
| | | | £m | | | | £m | | | | £m | |
| Net cash flows from operating activities | | | (992 | ) | | | (75,338 | ) | | | 25,604 | |
| Net cash flows from investing activities | | | 54 | | | | 16,997 | | | | 15,999 | |
| Net cash flows from financing activities | | | 18,791 | | | | 15,102 | | | | 29,691 | |
| Effects of exchange rate changes on cash and cash equivalents | | | (8,592 | ) | | | 29,209 | | | | 6,010 | |
| Net increase/(decrease) in cash and cash equivalents | | | 9,261 | | | | (14,030 | ) | | | 77,304 | |
2009
The major factors contributing to the net cash outflow from operating activities of £992 million were the net operating loss before tax of £2,696 million from continuing and discontinued operations, the decrease of £15,964 million in operating liabilities less operating assets, partly offset by the elimination of foreign exchange differences of £12,217 million and other items of £5,451 million.
Net cash flows from investing activities of £54 million relate to the net sales and maturities of securities of £2,899 million and a net cash inflow of £105 million in respect of other acquisitions and disposals less the net cash outflow on disposals of property, plant and equipment of £2,950 million.
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.
2008
The major factors contributing to the net cash outflow from operating activities of £75,338 million were the net operating loss before tax of £36,628 million from continuing and discontinued operations, the decrease of £42,219 million in operating liabilities less operating assets, and the elimination of foreign exchange differences of £41,874 million, partly offset by the write down of goodwill and other intangible assets, £32,581 million and other non-cash items, £8,772 million.
Proceeds on disposal of discontinued activities of £20,113 million was the largest element giving rise to net cash flows of investing activities of £16,997 million. Outflow from net purchases of securities of £1,839 million and net disposals of property, plant and equipment, £3,529 million less the net cash inflow of £2,252 million in respect of other acquisitions and disposals represented the other principal factors.
Net cash flows from financing activities of £15,102 million primarily arose from the capital raised from the placing and open offer of £19,741 million and the rights issue of £12,000 million, the issue of subordinated liabilities of £2,413 million and proceeds of minority interests, £1,427 million. This was offset in part by the cash outflow on redemption of minority interests of £13,579 million, repayment of subordinated liabilities of £1,727 million, dividends paid of £3,193 million and interest paid on subordinated liabilities of £1,967 million.
2007
The major factors contributing to the net cash inflow from operating activities of £25,604 million were the increase of £28,261 million in operating liabilities less operating assets and the profit before tax of £9,900 million, partly offset by the elimination of foreign exchange differences of £10,282 million and income taxes paid of £2,442 million.
The acquisition of ABN AMRO, included within net investment in business interests and intangible assets of £13,640 million, was the largest element giving rise to net cash flows from investing activities of £15,999 million, with cash and cash equivalents acquired of £60,093 million more than offsetting the cash consideration paid of £45,856 million. Net sales and maturities of securities of £1,987 million and net disposals of property, plant and equipment, £706 million less the net cash outflow of £597 million in respect of other acquisitions and disposals represented the other principle factors.
Net cash flows from financing activities of £29,691 million primarily relate to the cash injection of £31,019 million from the consortium partners in relation to the acquisition of ABN AMRO, together with the issue of £4,829 million of equity securities and £1,018 million of subordinated liabilities, offset in part by dividend payments of £3,411 million, the repayment of £1,708 million subordinated liabilities, interest on subordinated liabilities of £1,522 million and the redemption of £545 million of minority interests.
Business review continued |
Capital resources
The following table analyses the Group’s regulatory capital resources on a fully consolidated basis at 31 December, the basis monitored by the FSA for regulatory purposes (refer to page 74 for further details):
| | | 2009 | | | 2008 | | | 2007 | | | 2006 | | | 2005 | |
| | | | £m | | | | £m | | | | £m | | | | £m | | | | £m | |
| Capital base | | | | | | | | | | | | | | | | | | | | |
| Tier 1 capital | | | 76,421 | | | | 69,847 | | | | 44,364 | | | | 30,041 | | | | 28,218 | |
| Tier 2 capital | | | 15,389 | | | | 32,223 | | | | 33,693 | | | | 27,491 | | | | 22,437 | |
| Tier 3 capital | | | — | | | | 260 | | | | 200 | | | | — | | | | — | |
| | | | 91,810 | | | | 102,330 | | | | 78,257 | | | | 57,532 | | | | 50,655 | |
| Less: Supervisory deductions | | | (4,565 | ) | | | (4,155 | ) | | | (10,283 | ) | | | (10,583 | ) | | | (7,282 | ) |
| Total capital | | | 87,245 | | | | 98,175 | | | | 67,974 | | | | 46,949 | | | | 43,373 | |
| | | | | | | | | | | | | | | | | | | | | |
| Risk-weighted assets | | | | | | | | | | | | | | | | | | | | |
| Credit risk | | | 513,200 | | | | 551,300 | | | | | | | | | | | | | |
| Counterparty risk | | | 56,500 | | | | 61,100 | | | | | | | | | | | | | |
| Market risk | | | 65,000 | | | | 46,500 | | | | | | | | | | | | | |
| Operational risk | | | 33,900 | | | | 36,900 | | | | | | | | | | | | | |
| | | | 668,600 | | | | 695,800 | | | | | | | | | | | | | |
| APS relief | | | (127,600 | ) | | | — | | | | | | | | | | | | | |
| | | | 541,000 | | | | 695,800 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Banking book: | | | | | | | | | | | | | | | | | | | | |
| On-balance sheet | | | | | | | | | | | 480,200 | | | | 318,600 | | | | 303,300 | |
| Off-balance sheet | | | | | | | | | | | 84,600 | | | | 59,400 | | | | 51,500 | |
| Trading book | | | | | | | | | | | 44,200 | | | | 22,300 | | | | 16,200 | |
| | | | | | | | | | | | 609,000 | | | | 400,300 | | | | 371,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Risk asset ratios | | % | | | % | | | % | | | % | | | % | |
| Core Tier 1 | | | 11.0 | | | | 6.6 | | | | 4.5 | | | | | | | | | |
| Tier 1 | | | 14.1 | | | | 10.0 | | | | 7.3 | | | | 7.5 | | | | 7.6 | |
| Total | | | 16.1 | | | | 14.1 | | | | 11.2 | | | | 11.7 | | | | 11.7 | |
| (1) | The data for 2009 and 2008 are on a Basel II basis; prior periods are on a Basel I basis. |
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 banking sector, comparing a bank’s capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. At 31 December 2009, the Group’s total RAR was 16.1% (2008 – 14.1%, 2007 – 11.2%) and the Tier 1 RAR was 14.1% (2008 – 10.0%, 2007 – 7.3%).
Risk, capital and liquidity management
Risk, capital and liquidity management
On pages 70 to 159 of the Business review certain information has been audited and is part of the Group’s financial statements as permitted by IFRS 7. Other disclosures are unaudited and labelled with an asterisk (*). Key points within this section generally relate to the Group before RFS Holdings minority interest.
Overview*
Conditions during the year continued to prove challenging as the ongoing deterioration in economic conditions and financial markets seen during 2008 continued into 2009. Market stress peaked during the first quarter of 2009 with broad improvement since then. This reflects a global effort by many governments and central banks to ease monetary conditions, increase liquidity within the financial system and support banks with a combination of increased capital, guarantees and strengthened deposit insurance. One resulting benefit for banks generally has been a significant improvement in the liquidity of money and debt markets. At the same time, regulatory oversight of the banking sector has increased globally and is expected to continue at a heightened level.
More recently, the major economies have started to demonstrate a gradually improving macroeconomic position, although conditions remain fragile. Areas of particular uncertainty include possible effects from governments ending their financial stimulus initiatives and central banks moving to exit from positions of historically very low interest rates, as well as reversing quantitative easing. These look likely to occur against a backdrop of heightened personal and corporate insolvency as well as rising unemployment.
The Group has been developing and adapting to an evolving economic environment, against a background of the strategic review which includes a clearly stated ambition to achieve standalone strength. The core aims of the strategic plan are to improve the risk profile of the Group and to reposition the balance sheet around the Group’s core strengths. The Group level risk appetite statements and limits have been reviewed to ensure they are in line with the strategy. Any potential areas of misalignment between risk appetite and the Group strategy have been discussed by the Executive Risk Forum and remediation plans have been put in place.
Enhancements have been made to a number of the risk frameworks, including:
| · | A new credit approval process has been introduced during the year, based on a pairing of business and risk managers authorised to approve credit. This replaced the former credit committee process; |
| · | Exposure to higher risk countries has been reduced and a new risk limits framework has been implemented across the Group; |
| · | Single name and sector wide credit concentrations continue to receive a high level of attention and further enhancements to the frameworks were agreed in the fourth quarter of the year; |
| · | In addition to the move to value-at-risk (VaR) based on a 99% confidence level, from 95%, the Group has improved and strengthened its market risk limit framework increasing the transparency of market risk taken across the Group’s businesses in both the trading and non-trading portfolios; |
| · | The Group’s funding and liquidity profile is supported by explicit targets and metrics to control the size and extent of both short-term and long-term liquidity risk; and |
| · | An improved reporting programme has been implemented to increase transparency and improve the management of risk exposures. |
Credit impairments in 2009 were materially higher than the previous year. As the year progressed, the level of impairments moderated, with the highest quarterly charge incurred in the second quarter. It is expected that the results for 2010 and 2011 will continue to be affected by a heightened level of credit impairments as exposures in the Non-Core division are managed down and the economic environment continues to impact the Core business. The risk weightings applied to assets are also expected to increase due to procyclicality and as a result the amount of capital that banks generally are required to hold will increase. Future regulatory changes are also expected to increase the capital requirements of the banking sector. Against this background, the Non-Core portfolio is reducing and the Group has materially strengthened its capital base through the B share issuance in December 2009.
Business review continued
Risk, capital and liquidity governance*
The risk, capital and liquidity management strategies are owned and set by the Group’s Board of Directors, and implemented by executive management led by the Group Chief Executive. There are a number of committees and executives that support the execution of the business plan and strategy, as set out below. Representation by and interaction between the individual risk disciplines is a key feature of the governance structure, with the aim of promoting cross-risk linkages.
Note:
| For key changes to the risk, capital and liquidity governance structure, refer to the table overleaf. |
Business review
Risk, capital and liquidity management
Risk, capital and liquidity governance* continued
| The role and remit of these committees is as follows: | |
| Committee | | | Focus | | | Membership |
| Group Audit Committee (GAC) | | | Financial reporting and the application of accounting policies as part of the internal control and risk assessment process. From a historical perspective, GAC monitors the identification, evaluation and management of all significant risks throughout the Group. | | | Independent non-executive directors |
| Board Risk Committee | | | A new committee, formed to provide oversight and advice to the Group Board in relation to current and potential future risk exposures of the Group and future risk strategy. Reports to the Group Board, identifying any matters within its remit in respect of which it considers an action or improvement is needed, and making recommendations as to the steps to be taken. Provides quantitative and qualitative advice to the Remuneration Committee upon the Group Remuneration Policy and the implications for risk management. | | | At least three independent non-executive directors, one of whom is the Chairman of the Group Audit Committee |
| Executive Credit Group | | | Formed to replace the Advances Committee and the Group Credit Committee, the ECG decides on requests for the extension of existing or new credit limits on behalf of the Board of Directors which exceed the delegated authorities of individuals throughout the Group as determined by the credit approval grid. The Head of Restructuring and Risk or the Group Chief Credit Officer must be present along with at least one other member to ensure the meeting is quorate. | | | Group Chief Executive Head of Restructuring and Risk Group Chief Risk Officer Group Chief Credit Officer Chief Executive Officer from each divisionGroup Finance Director |
| Executive Committee | | | A newly formed committee responsible for managing Group wide issues and those operational issues material to the broader Group. | | | Group Chief Executive Business and function heads, as determined by the Group Chief Executive/Board Head of Restructuring and Risk Group Finance Director |
| Group Risk Committee | | | Recommends limits and approves processes and major policies to ensure the effective management of all material risks across the Group. | | | Head of Restructuring and Risk Group Chief Risk Officer Group Head of each risk function Group Head of Country Risk Global Head of Risk Architecture Deputy Group Finance Director Chief Operating Officer, RBS Risk Management Chief Executive and Chief Risk Officer from each division |
| Group Asset and Liability Management Committee | | | Identifies, manages and controls the Group balance sheet risks. | | | Group Finance Director Deputy Group Finance Director Head of Restructuring and Risk Chief Executive from each division Group Chief Accountant Group Treasurer and Deputy Group Treasurer Chief Financial Officer, ABN AMRO Director, Group Corporate Finance Director, Group Financial Planning & Analysis Head of Balance Sheet Management, Group Treasury |
| Executive Risk Forum | | | 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. | | | Group Chief Executive Head of Restructuring and Risk Group Chief Risk Officer Group Finance Director Chief Executive Officer from each division |
| Note: |
| These committees are supported at a divisional level by a risk governance structure embedded in the businesses. |
* unaudited
Business review continued |
Risk, capital and liquidity governance* continued
Management responsibilities
All employees have a role to play in the day-to-day management of capital, liquidity and risk which is set and managed by specialist staff in:
| · | Risk Management: credit risk, market risk, operational risk, regulatory risk, reputational risk, insurance risk and country risk, together with risk analytics; and |
| · | Group Treasury: balance sheet, capital management, intra-group exposure, funding, liquidity and hedging policies. |
Independence underpins the approach to risk management, which is reinforced throughout the Group by appropriate reporting lines. Risk Management and Group Treasury functions are independent of the revenue generating business. As part of the move towards greater functional independence, the divisional Chief Risk Officers have a direct reporting line to the Head of Restructuring and Risk as well as to their divisional CEOs.
Group Internal Audit supports the GAC in providing an independent assessment of the design, adequacy and effectiveness of the internal controls relating to risk management.
Risk appetite
Risk appetite is an expression of the maximum level of risk that the Group is prepared to accept in order to deliver its business objectives. Risk and capital management across the Group is based on the risk appetite set by the Board, who ultimately approve annual plans for each division and regularly reviews and monitors the Group’s performance in relation to risk.
Risk appetite is defined in both quantitative and qualitative terms as follows:
| · | Quantitative: encompassing stress testing, risk concentration, VaR, liquidity and credit related metrics; and |
| · | Qualitative: ensuring that the Group applies the correct principles, policies and procedures. |
Different techniques are used to ensure that the Group’s risk appetite is achieved. The Board Risk Committee considers and recommends for approval by the Group Board, the Group’s risk appetite framework and tolerance for current and future strategy, taking into account the Group’s capital adequacy and the external risk environment. The ERF is responsible for ensuring that the implementation of strategy and operations are in line with the risk appetite determined by the Board. This is reinforced through policy and limit frameworks ensuring that all staff within the Group make appropriate risk and reward trade-offs within pre-agreed boundaries.
The annual business planning and performance management processes and associated activities together ensure that the expression of risk appetite remains appropriate. Both GRC and GALCO support this work.
Remuneration responsibilities
In August 2009, the Financial Services Authority (FSA) published its Code of Remuneration Practices (the Code). The Code requires the Group to establish, implement and maintain remuneration policies, procedures and practices that promote and are consistent with effective risk management.
The Risk Management function provides input to the Remuneration Committee on the remuneration policy for the Group. Each division is allocated risk objectives as part of the strategic plan and achievement of these objectives is evaluated as part of the annual performance management process.
During 2009 Risk Management provided formal independent 360° feedback for key individuals, reviewing their capability and performance in relation to managing risk. Individuals selected perform roles of significant influence and their activities have, or could have, a material impact on the Group’s risk profile.
An annual report on the risk performance of each division, including both qualitative and quantitative information is provided to the Remuneration Committee to allow consideration of adjustments relating to the compensation for the performance year.
Capital*
Capital resources
It is the Group’s policy to maintain a strong capital base 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 FSA. The FSA uses Risk Asset Ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its risk-weighted assets (RWAs) (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. At 31 December 2009, the Group’s total RAR was 16.1% (2008 – 14.1%) and the Tier 1 RAR was 14.1% (2008 – 10.0%).
As part of the annual planning and budgeting cycle, each division is allocated capital based upon RWAs and associated regulatory deductions. The budgeting process considers risk appetite, available capital resources, stress testing results and business strategy. The budget is agreed by the Board and allocated to divisions to manage their allocated RWAs.
Group Treasury and GALCO monitor available capital and its utilisation across divisions. GALCO makes the necessary decisions around reallocation of budget and changes in RWA allocations.
Risk, capital and liquidity management
Capital* continued
Capital resources continued
In addition to the fully consolidated basis monitored by the FSA for regulatory purposes, the Group also monitors its regulatory capital resources on a proportional consolidation basis reflecting the pending separation of the RFS Minority Interest. The Group’s regulatory capital resources on a proportional consolidation basis at 31 December 2009 and in accordance with the FSA definitions were as follows:
| | | 2009 | | | 2008 | |
Composition of regulatory capital (proportional) | | | £m | | | | £m | |
Tier 1 | | | | | | | | |
Ordinary and B shareholders' equity | | | 69,890 | | | | 45,525 | |
Minority interests | | | 2,227 | | | | 5,436 | |
Adjustments for: | | | | | | | | |
– Goodwill and other intangible assets – continuing | | | (14,786 | ) | | | (16,386 | ) |
– Goodwill and other intangible assets of discontinued businesses | | | (238 | ) | | | — | |
– Unrealised losses on available-for-sale debt securities | | | 1,888 | | | | 3,687 | |
– Reserves arising on revaluation of property and unrealised gains on available-for-sale equities | | | (207 | ) | | | (984 | ) |
– Reallocation of preference shares and innovative securities | | | (656 | ) | | | (1,813 | ) |
– Other regulatory adjustments | | | (950 | ) | | | 9 | |
Less excess of expected losses over provisions net of tax | | | (2,558 | ) | | | (770 | ) |
Less securitisation positions | | | (1,353 | ) | | | (663 | ) |
Less APS first loss | | | (5,106 | ) | | | — | |
Core Tier 1 capital | | | 48,151 | | | | 34,041 | |
Preference shares | | | 11,265 | | | | 16,655 | |
Innovative Tier 1 securities | | | 2,772 | | | | 6,436 | |
Tax on the excess of expected losses over provisions | | | 1,020 | | | | 308 | |
Less deductions from Tier 1 capital | | | (310 | ) | | | (316 | ) |
Total Tier 1 capital | | | 62,898 | | | | 57,124 | |
| |
Tier 2 | | | | | | | | |
Reserves arising on revaluation of property and unrealised gains on available-for-sale equities | | | 207 | | | | 984 | |
Collective impairment allowances | | | 796 | | | | 666 | |
Perpetual subordinated debt | | | 4,200 | | | | 9,079 | |
Term subordinated debt | | | 18,120 | | | | 20,282 | |
Minority and other interests in Tier 2 capital | | | 11 | | | | 11 | |
Less deductions from Tier 2 capital | | | (5,241 | ) | | | (2,055 | ) |
Less APS first loss | | | (5,106 | ) | | | — | |
Total Tier 2 capital | | | 12,987 | | | | 28,967 | |
| |
Tier 3 | | | — | | | | 260 | |
| |
Supervisory deductions | | | | | | | | |
Unconsolidated investments | | | | | | | | |
– RBS Insurance | | | (4,068 | ) | | | (3,628 | ) |
– Other investments | | | (404 | ) | | | (416 | ) |
Other | | | (93 | ) | | | (111 | ) |
Deductions from total capital | | | (4,565 | ) | | | (4,155 | ) |
| |
Total regulatory capital | | | 71,320 | | | | 82,196 | |
| |
Risk weighted assets | | | | | | | | |
Credit risk | | | 410,400 | | | | 433,400 | |
Counterparty risk | | | 56,500 | | | | 61,100 | |
Market risk | | | 65,000 | | | | 46,500 | |
Operational risk | | | 33,900 | | | | 36,800 | |
| | | | 565,800 | | | | 577,800 | |
APS relief | | | (127,600 | ) | | | — | |
| | | | 438,200 | | | | 577,800 | |
| |
Risk asset ratio | | | | | | | | |
Core Tier 1 | | | 11.0 | % | | | 5.9 | % |
Tier 1 | | | 14.4 | % | | | 9.9 | % |
Total | | | 16.3 | % | | | 14.2 | % |
Capital* continued
Capital resources continued
The following table analyses the Group's regulatory capital resources on a fully consolidated basis at 31 December, the basis monitored by the FSA for regulatory purposes (refer to page 74 for further details):
| | | | | | | |
| | | 2009 | | | 2008 | |
Composition of regulatory capital (statutory) | | | £m | | | | £m | |
Tier 1 | | | | | | | | |
Ordinary and B shareholders' equity | | | 69,890 | | | | 45,525 | |
Minority interests | | | 16,895 | | | | 21,619 | |
Adjustments for: | | | | | | | | |
– Goodwill and other intangible assets – continuing | | | (17,847 | ) | | | (20,049 | ) |
– Goodwill and other intangible assets of discontinued businesses | | | (238 | ) | | | — | |
– Unrealised losses on available-for-sale debt securities | | | 1,888 | | | | 3,687 | |
– Reserves arising on revaluation of property and unrealised gains on available-for-sale equities | | | (207 | ) | | | (984 | ) |
– Reallocation of preference shares and innovative securities | | | (656 | ) | | | (1,813 | ) |
– Other regulatory adjustments | | | (1,184 | ) | | | (362 | ) |
Less excess of expected losses over provisions net of tax | | | (2,558 | ) | | | (770 | ) |
Less securitisation positions | | | (1,353 | ) | | | (663 | ) |
Less APS first loss | | | (5,106 | ) | | | — | |
Core Tier 1 capital | | | 59,524 | | | | 46,190 | |
Preference shares | | | 11,265 | | | | 16,655 | |
Innovative Tier 1 securities | | | 5,213 | | | | 7,383 | |
Tax on the excess of expected losses over provisions | | | 1,020 | | | | 308 | |
Less deductions from Tier 1 capital | | | (601 | ) | | | (689 | ) |
Total Tier 1 capital | | | 76,421 | | | | 69,847 | |
| |
Tier 2 | | | | | | | | |
Reserves arising on revaluation of property and unrealised gains on available-for-sale equities | | | 207 | | | | 984 | |
Collective impairment allowances | | | 796 | | | | 666 | |
Perpetual subordinated debt | | | 4,950 | | | | 9,829 | |
Term subordinated debt | | | 20,063 | | | | 23,162 | |
Minority and other interests in Tier 2 capital | | | 11 | | | | 11 | |
Less deductions from Tier 2 capital | | | (5,532 | ) | | | (2,429 | ) |
Less APS first loss | | | (5,106 | ) | | | — | |
Total Tier 2 capital | | | 15,389 | | | | 32,223 | |
| |
Tier 3 | | | — | | | | 260 | |
| |
Supervisory deductions | | | | | | | | |
Unconsolidated investments | | | (4,472 | ) | | | (4,044 | ) |
Other | | | (93 | ) | | | (111 | ) |
Deductions from total capital | | | (4,565 | ) | | | (4,155 | ) |
| |
Total regulatory capital | | | 87,245 | | | | 98,175 | |
| |
Risk-weighted assets | | | | | | | | |
Credit risk | | | 513,200 | | | | 551,300 | |
Counterparty risk | | | 56,500 | | | | 61,100 | |
Market risk | | | 65,000 | | | | 46,500 | |
Operational risk | | | 33,900 | | | | 36,900 | |
| | | | 668,600 | | | | 695,800 | |
APS relief | | | (127,600 | ) | | | — | |
| | | | 541,000 | | | | 695,800 | |
| |
Risk asset ratio | | | | | | | | |
Core Tier 1 | | | 11.0 | % | | | 6.6 | % |
Tier 1 | | | 14.1 | % | | | 10.0 | % |
Total | | | 16.1 | % | | | 14.1 | % |
Business review
Risk, capital and liquidity management
Capital* continued
Regulatory developments continued
The Group has seen a continuation of challenging financial market and economic conditions during 2009. Although some signs of improvement have started to emerge, the performance of key economies remains uncertain and the Group has continued to experience material impairment losses and credit market write-downs, including further write-downs in respect of monoline exposures. The majority of these are in the Non-Core division, which in time will be run down, significantly reducing the size of the Group’s balance sheet and associated capital requirements.
In April 2009, £5 billion of preference shares were redeemed and replaced by ordinary shares using the proceeds of the Second Placing and Open Offer. This strengthened the Group’s Core Tier 1 capital, enhancing its financial stability during a tough economic and market period.
As an interim measure pending full compliance with Basel II, the Group, with the agreement of the regulators, consolidates the RWAs of ABN AMRO on the basis of Basel I plus an adjustment factor. The Group is advanced in its preparation for moving to a Basel II compliant approach for the ABN AMRO businesses it will retain. As part of this transition the Group has agreed with the FSA to increase the adjustment factor with effect from 31 December 2009 to reflect changing circumstances. This change has increased RWAs by approximately £8 billion thereby reducing the Core Tier 1 ratio at 31 December 2009 by 20 basis points.
Asset Protection Scheme
On 22 December 2009, the Group acceded to the Asset Protection Scheme (‘APS’ or ‘the Scheme’). The key commercial terms and details of the assets covered by the Scheme are set out on page 127.
Following the accession to the APS, HM Treasury provides loss protection against potential losses arising in a pool of assets. HM Treasury also subscribed to £25.5 billion of capital in the form of B shares and a Dividend Access Share with a further £8 billion of capital in the form of B shares, potentially available as contingent capital. The Group pays annual fees in respect of the protection and contingent capital. The Group has the option, subject to HM Treasury consent, to pay the annual premium, contingent capital and the exit fee payable in connection with any termination of the Group’s participation in the APS in whole or in part, by waiving the entitlements of members of the Group to certain UK tax reliefs.
Following accession to the APS, arrangements were put in place within the Group that extended effective APS protection to all other regulated entities holding assets covered by the APS.
On 19 January 2009, the FSA announced that it expects each bank participating in the UK Government’s recapitalisation scheme to have a minimum Core Tier 1 ratio of 4% on a stressed basis. As at 31 December 2009 the Group’s Core Tier 1 ratio was 11.0% (2008 – 6.6%). While the RWA relief from the APS enabled the Group to maintain robust capital ratios, it is clear that the next few years pose continuing challenges in respect of impairment levels, trading performance and the return to profitability, RWA volatility including procyclical effects, and increasing regulatory demands.
The Group’s policy will be to continue to maintain a strong capital base, to develop this base as appropriate and to utilise it efficiently throughout the Group’s activities in order to optimise shareholder returns while maintaining a prudent relationship between the capital base and the underlying risks of the business.
The subscription for £25.5 billion of B shares improved the Group’s Core Tier 1 capital ratio by 580 basis points at 31 December 2009.
Regulatory capital impact of the APS
Methodology
The regulatory capital requirements for assets covered by the Scheme are calculated using the securitisation framework under the FSA prudential rules. The calculation is as follows (known as ‘the Uncapped Amount’):
| · | First Loss – the residual first loss, after impairments and writedowns, to date, is deducted from the available capital – split equally between Core Tier 1 and Tier 2 capital; |
| · | HM Treasury share of covered losses – after the first loss piece has been deducted, the 90% of assets covered by HM Treasury are risk weighted at 0%; and |
| · | RBS share of covered losses – the remaining 10% share of loss is borne by RBS and is risk weighted in the normal way. |
Should the Uncapped Amount be higher than those of the underlying assets (ignoring the Scheme), the capital requirements for the Scheme are capped at the level of the requirements for the underlying assets (‘Capped Amount’). Where capped, the Group apportions the Capped Amount up to the level of the First Loss as calculated above; any unused Capped Amount after the First Loss capital deduction will be taken as RWAs for the Group’s share of covered losses.
Adjustments to the regulatory capital calculation can be made for either currency or maturity mismatches. These occur where there is a difference between the currency or maturity of the protection and that of the underlying asset. These mismatches will have an impact upon the timing of the removal of the cap and level of regulatory capital benefit on the Uncapped Amount, but this effect is not material.
Impact at accession
The Group expects initially to calculate its capital requirements in accordance with the Capped basis. Accordingly, the APS itself (viewed separately from the B share issuance) at accession had no impact on the Pillar 1 regulatory capital requirement in respect of the assets covered by the APS. It will, however, improve the total capital ratios, and the Core Tier 1 ratios, of the Group as a whole. It is also expected that the protection afforded by the APS will assist the Group in satisfying the forward looking stress testing framework applied by the FSA.
* unaudited
Business review continued |
Capital* continued
Future regulatory capital effects
As impairments on the pool of assets arise, these will be required to be deducted in full from Core Tier 1 Capital in the normal way. The Group will be entitled to apply these impairments to reduce the First Loss deduction for the Scheme, potentially leading to a position where the capital requirement on the Uncapped Basis would no longer for the assets covered by the APS exceed the Non-APS Requirement and, as a result, the Group would expect to start reporting the regulatory capital treatment on the Uncapped Basis.
For further information on APS refer to pages 127 to 136.
Regulatory developments
European Directives
The Group is undertaking the necessary preparations to comply with the new European Directives which will, or are expected to, come into force on or before 1 January 2011. These deal with inter alia, the eligibility of hybrid capital; restrictions on large exposures; enhanced risk management of securitisation exposures (including a requirement that banks cannot invest in a securitisation where the originator has not retained an economic interest); higher capital requirements for re-securitisations; and strengthening capital requirements for the trading book.
Basel Committee on Banking Supervision
In December 2009, the Basel Committee issued proposals to strengthen capital and liquidity of banks. The key elements include: raising the quality, consistency and transparency of regulatory capital; increased capital requirements for counterparty exposures on derivatives, repurchase agreements and securities financing activities; the introduction of a leverage ratio; promotion of countercyclical measures to encourage build up of capital buffers and a more forward-looking provisioning based on expected losses instead of the current ‘incurred loss’ provisioning model; and the introduction of a global minimum liquidity standard for internationally active banks, including a short-term liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio. The Committee is carrying out an impact assessment in the first part of 2010 to calibrate the new requirements before issuing final proposals by the end of 2010 for phased implementation commencing in 2012.
The Group is working with the trade bodies in responding to the various consultations and will participate fully in the impact assessment.
Basel II
The Group adopted Basel II on 1 January 2008. Pillar 1 focuses on the calculation of minimum capital required to support the credit, market and operational risks in the business. For credit risk, the majority of the Group uses the Advanced Internal Ratings Based Approach for calculating RWAs.
The Group manages market risk in the trading and non-trading (treasury) portfolios through the market risk management framework. The framework includes VaR limits, back-testing, stress testing, scenario analysis and position/sensitivity analysis.
For operational risk, the Group uses the Standardised Approach, which calculates operational RWAs based on gross income. In line with other banks, the Group is considering adopting the advanced measurement approach for all or part of the business.
Using these approaches, the RWA requirements, by division, are as follows: |
| | | 2009 | | | 2008 | |
RWAs | | £bn | | | £bn | |
UK Retail | | | 51.3 | | | | 45.7 | |
UK Corporate | | | 90.2 | | | | 85.7 | |
Wealth | | | 11.2 | | | | 10.8 | |
Global Banking & Markets | | | 123.7 | | | | 151.8 | |
Global Transaction Services | | | 19.1 | | | | 17.4 | |
Ulster Bank | | | 29.9 | | | | 24.5 | |
US Retail & Commercial | | | 59.7 | | | | 63.9 | |
Other | | | 9.4 | | | | 7.1 | |
Core | | | 394.5 | | | | 406.9 | |
Non-Core | | | 171.3 | | | | 170.9 | |
| | | | 565.8 | | | | 577.8 | |
Benefit of APS | | | (127.6 | ) | | | n/a | |
| Group before RFS Holdings minority interest | | | 438.2 | | | | 577.8 | |
| RFS Holdings minority interest | | | 102.8 | | | | 118.0 | |
| Group | | | 541.0 | | | | 695.8 | |
Business review
Risk, capital and liquidity management
Capital* continued
Capital resources continued
In addition to the calculation of minimum capital requirements for credit, market and operational risk, banks are required to undertake an Individual Capital Adequacy Assessment Process (ICAAP) for other risks. The Group’s ICAAP, in particular, focuses on pension fund risk, interest rate risk in the banking book together with stress tests to assess the adequacy of capital over one year and the economic cycle.
The Group publishes its Pillar 3 (Market disclosures) on its website, providing a range of additional information relating to Basel II and risk and capital management across the Group. The disclosures focus on Group level capital resources and adequacy, discuss a range of credit risk approaches and their associated RWAs under various Basel II approaches such as credit risk mitigation, counterparty credit risk and provisions. Detailed disclosures are also made on equity, securitisation, operational and market risk, as well as providing Interest Rate Risk in the Banking Book disclosures.
Stress and scenario testing
Stress testing forms part of the Group’s risk and capital framework and an integral component of Basel II. As a key risk management tool, stress testing highlights to senior management potential adverse unexpected outcomes related to a mixture of risks and provides an indication of how much capital might be required to absorb losses, should adverse scenarios occur. Stress testing is used at both a divisional and Group level to assess risk concentrations, estimate the impact of stressed earnings, impairments and write-downs on capital. It determines the overall capital adequacy under a variety of adverse scenarios. The principal business benefits of the stress testing framework include: understanding the impact of recessionary scenarios; assessing material risk concentrations; forecasting the impact of market stress and scenarios on the Group’s balance sheet liquidity.
At Group level, a series of stress events are monitored on a regular basis to assess the potential impact of an extreme yet plausible event on the Group. There are four core elements of scenario stress testing:
| · | Macroeconomic stress testing considers the impact on both earnings and capital for a range of scenarios. They entail multi-year systemic shocks to assess the Group’s ability to meet its capital requirements and liabilities as they fall due under a downturn in the business cycle and/or macroeconomic environment; |
| · | Enterprise wide stress testing considers scenarios that are not macroeconomic in nature but are sufficiently broad in nature to impact across multiple risks or divisions and are likely to impact earnings, capital and funding; |
| · | Cross-divisional stress testing includes scenarios which have impacts across divisions relating to sensitivity to a common risk factor(s). This would include sector based stress testing across corporate portfolios and sensitivity analysis to stress in market factors. These stress tests are discussed with senior divisional management and are reported to senior committees across the Group; and |
| · | Divisional and risk specific stress testing is undertaken to support risk identification and management. Current examples include the daily product based stress testing using a hybrid of hypothetical and historical scenarios within market risk. |
Portfolio analysis, using historic performance and forward looking indicators of change, uses stress testing to facilitate the measurement of potential exposure to events and seeks to quantify the impact of an adverse change in factors which drive the performance and profitability of a portfolio.
Business review continued |
Capital* continued
Risk coverage
The main risks facing the Group are shown below.
Risk type | Definition | Features |
Credit risk (including country and political risks) | The risk arising from the possibility that the Group will incur losses owing to the failure of customers to meet their financial obligations to the Group. | Loss characteristics vary materially across portfolios. Significant correlation between losses and the macroeconomic environment. Concentration risk - potential for large material losses. |
| | The risk arising from country events. | Country risks correlated with macroeconomic developments. Country vulnerabilities changing structurally in the aftermath of the financial crisis. |
Funding and liquidity risk | The risk of being unable to meet obligations as they fall due. | Potential to disrupt the business model and stop normal functions of the Group. |
Market risk | The risk that the value of an asset or liability may change as a result of a change in market risk factors. | Potential for large, material losses. Significantly correlated with equity risk and the macroeconomic environment. Potential for losses due to stress events. |
Insurance risk | 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. | Frequent small losses. Infrequent material losses. |
Operational risk | The risk of financial, customer or reputational loss resulting from inadequate or failed internal processes or systems; from improper behaviour; or from external events. | Frequent small losses. Infrequent material losses. |
Regulatory risk | The risks arising from regulatory changes and enforcement. | Risk of regulatory changes. Compliance with regulations. Potential for fines and/or restrictions in business activities. |
Other risk | The risks arising from reputation risk. | Additional regulation can be introduced as a result of other risk losses. Failure to meet expectations of stakeholders. |
| | Pension risk is the risk that the Group may have to make additional contributions to its defined benefit pension schemes. | Pension risk arises because of the uncertainty of future investment returns and the projected value of schemes’ liabilities. |
Risk, capital and liquidity management
Credit risk
Credit risk is the risk arising from the possibility that the Group will incur losses owing to the failure of customers to meet their financial obligations. The quantum and nature of credit risk assumed in the Group’s different businesses varies considerably, while the overall credit risk outcome usually exhibits a high degree of correlation to the macroeconomic environment. All of the disclosures in this section (pages 80 to 101) are audited unless indicated otherwise with an asterisk (*).
Principles for credit risk management
The key principles for credit risk management in the Group are as follows:
| · | A credit risk assessment of the customer and credit facilities is undertaken prior to approval of credit exposure. Typically, this includes both quantitative and qualitative elements including: the purpose of the credit and sources of repayment; compliance with affordability tests; repayment history; ability to repay; sensitivity to economic and market developments; and risk-adjusted return based on credit risk measures appropriate to the customer and facility type; |
| · | Credit risk authority is specifically granted in writing to individuals involved in the approval of credit extensions. In exercising credit authority, individuals are required to act independently of business considerations and must declare any conflicts of interest; |
| · | Credit exposures, once approved, are monitored, managed and reviewed periodically against approved limits. Lower quality exposures are subject to more frequent analysis and assessment; |
| · | Credit risk management works with business functions on the ongoing management of the credit portfolio, including decisions on mitigating actions taken against individual exposures or broader portfolios; |
| · | Customers with emerging credit problems are identified early and classified accordingly. Remedial actions are implemented promptly and are intended to restore the customer to a satisfactory status and minimise any potential loss to the Group; and |
| · | Stress testing of portfolios is undertaken to assess the potential credit impact of non-systemic scenarios and wider macroeconomic events on the Group’s income and capital. |
Credit risk organisation
The credit risk function is organised within a divisionally aligned structure to ensure appropriate proximity to the businesses it covers and to develop and provide the specialisation required to manage the associated credit risk. The function comprises a number of activities: credit approval; transaction/customer assessment; policy formulation and development (in the context of the Group-wide policy framework); portfolio reporting; and quantitative portfolio analytics.
In addition to the activities undertaken within divisional functions, a Group-wide credit risk function sets the overall framework and highest level credit risk policy standards; produces Group-wide credit risk portfolio reporting and analysis; and approves credit transactions which exceed divisional credit authority.
The Group Risk Committee (GRC) considers detailed reports of credit risk performance such as monthly risk portfolio performance trend information. The Group Credit Risk Policy Committee, a subcommittee of the GRC, approves material new credit risk policy standards.
For wholesale credit portfolios, an updated Group-wide credit approval and authority framework was introduced in early 2009, replacing the previous structure of credit committees. The authority held by an individual in respect of a particular extension of credit is determined by a Group-wide credit approval grid which links total credit limit amount for a customer group with customer credit quality (expressed as a credit grade) and the individual’s credit experience and expertise (which determines the authority level assigned to them). The Executive Credit Group (ECG) considers credit decisions which exceed the delegated authorities of individuals throughout the Group.
Global Restructuring Group (GRG)
GRG manages problem and potential problem exposures in the Group’s wholesale credit portfolios. Its primary function is to work closely with the Group’s customer facing businesses to support the proactive management of any problem lending. This may include assisting with the restructuring of a customer’s business and/or renegotiation of credit.
GRG reports to the Head of Restructuring and Risk and is structured with specialist teams focused on: large corporate cases (higher value, multiple lenders); small and medium size business cases (lower value, bilateral relationships); and recovery/litigations.
Originating business units liaise with GRG upon the emergence of a potentially negative event or trend that may impact a borrower’s ability to service its debt. This may be a significant deterioration in some aspect of the borrower’s activity, such as trading, where a breach of covenant is likely or where a borrower has missed or is expected to miss a material contractual payment to the Group or another creditor.
On transfer of a relationship to GRG a strategy is devised to:
| · | Work with the borrower to facilitate changes that will maximise the potential for turnaround of their situation and return them to profitability; |
| · | Define the Group’s role in the turnaround situation and assess the risk/return dimension of the Group’s participation; |
| · | Return customers to the originating business unit in a sound and stable condition or, if such recovery cannot be achieved, avoid additional losses and maximise recoveries; and |
| · | Ensure key lessons learned are fed back into origination policies and procedures. |
Retail collections and recoveries
There are collections and recoveries functions in each of the consumer businesses. Their role is to provide support and assistance to customers who are currently experiencing difficulties meeting their financial obligations. Where possible, the aim of the collections and recoveries teams is to return the customer to a satisfactory position, by working with them to restructure their finances. If this is not possible, the team has the objective of reducing the loss to the Group.
The ongoing investment in collections and recoveries operations has continued in 2009. Investment has increased staffing levels in all collections and recoveries functions, enhanced staff training to improve efficiency and effectiveness as well as upgraded technology and infrastructure.
Business review continued |
Credit risk continued
Retail collections and recoveries continued
In the UK and Ireland, the Group has introduced new forbearance policies for customers in financial difficulty based on various government sponsored schemes, customer affordability and prospects. In the US there has been an increase in agreed loan modification programmes, including those sponsored by the US government.
Credit risk framework
The approach taken to managing credit risk varies significantly between wholesale portfolios (loans, and other products giving rise to credit risk, to all but the smaller corporate customers, to financial institutions and to government entities) and retail portfolios (secured and unsecured loans and related products to individuals and small businesses).
Wholesale portfolios
Wholesale risk limits are aggregated at the counterparty level to determine the level of credit approval required and to facilitate consolidated credit risk management.
The credit approval process has two stages, assessment and decision. Credit applications for corporate customers are prepared by relationship managers in the units originating the credit exposures or by the relationship management team with lead responsibility for a counterparty where a customer has relationships with different divisions and business units across the Group. This includes the assignment of risk parameter estimates (probability of default, loss given default and exposure at default) using approved models.
Credit approval authority is discharged by way of a framework of individual delegated authorities that requires at least two individuals to approve each credit decision, one from the business and one from the credit risk management function. Both parties must hold sufficient delegated authority under the Group-wide authority grid. The level of authority granted to an individual is dependent on their experience and expertise with only a small number of senior executives holding the highest authority provided under the framework.
Daily monitoring of individual counterparty limits is undertaken. For certain counterparties early warning indicators are also in place to detect deteriorating trends of concern in limit utilisation or account performance. A framework is also in place to monitor changes in credit quality at the portfolio level.
As a minimum, credit relationships are reviewed and re-approved annually. The renewal process addresses: borrower performance, including reconfirmation or adjustment of risk parameter estimates; the adequacy of security; and compliance with terms and conditions.
Retail portfolios
Retail business operations 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 best practice 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 a customer’s 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 transactions and some residential mortgage applications.
Divisional risk management committees focus on portfolio level decisions which drive credit quality, changes to policy and strategy, and the setting of credit scorecard cut-offs. The divisional risk management committees are also responsible for reviewing ongoing performance of the business and, if necessary, making or recommending adjustments to risk appetite.
Credit risk measurement
Credit risk models are used throughout the Group to support the quantitative risk assessment element of the credit approval process, ongoing credit risk management, monitoring and reporting and portfolio analytics. Credit risk models used by the Group may be divided into three categories.
Probability of default/customer credit grade (PD)
These models assess the probability that a customer will fail to make full and timely repayment of their obligations. The probability of a customer failing to do so is measured over a one year period through the economic cycle, although certain retail scorecards use longer periods for business management purposes.
| · | Wholesale businesses: each counterparty is assigned an internal credit grade which is in turn assigned to a default probability range. There are a number of different credit grading models in use across the Group, each of which considers risk characteristics particular to that type of customer. The credit grading models score a combination of quantitative inputs (for example, recent financial performance) and qualitative inputs, (for example, management performance or sector outlook). Scores are then mapped to grades within each model. Grades are calibrated centrally to default probabilities. Obligor grades can, under certain circumstances, be cascaded to other borrowing entities within the obligor group where there is sufficient dependence on the graded entity. The credit grades for sovereign and central bank entities are assigned by a specialist country risk analysis team using a sovereign grading model. This team is independent of the origination function and is comprised of economists. Certain grading models also cover customers or transactions categorised as specialised lending (for example certain types of investment property and asset finance such as shipping). |
| · | 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 probability of default is used within the credit approval process and ongoing credit risk management, monitoring and reporting. 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. |
Risk, capital and liquidity management
Credit risk management continued
Exposure at default (EAD)
Facility usage models estimate the expected level of utilisation of a credit facility at the time of a borrower’s default. For revolving and variable draw down type products which are not fully drawn, the EAD will typically be higher than the current utilisation. The methodologies used in EAD modelling provide an estimate of potential exposure and recognise that customers may make more use of their existing credit facilities as they approach default.
Counterparty credit risk exposure measurement models calculate the market driven credit risk exposure for products where the exposure is not based solely upon principal and interest due. These models are most commonly used for derivative and other traded instruments where the amount of credit risk exposure may be dependent upon one or more underlying market variables such as interest or foreign exchange rates. These models drive internal credit risk activities such as limit and excess management.
Loss given default (LGD)
These models estimate the economic loss that may be experienced – the amount that cannot be recovered – by the Group on a credit facility in the event of default. The Group’s LGD models take into account both borrower and facility characteristics for unsecured or partially unsecured facilities, as well as the quality of any risk mitigation that may be in place for secured facilities, plus the cost of collections and a time discount factor for the delay in cash recovery.
Credit risk mitigation
The Group employs a number of structures and techniques to mitigate credit risk:
| · | Netting of debtor and creditor balances is utilised in accordance with relevant regulatory and internal policies and requires a formal agreement with the customer to net the balances and a legal right of set-off; |
| · | Under market standard documentation net exposure on over-the-counter (OTC) derivative and secured financing transactions is further mitigated by the exchange of financial collateral; |
| · | The Group enhances its position as a lender in a range of transactions, from retail mortgage lending to large wholesale financing, by structuring a security interest in a physical or financial asset; |
| · | Credit derivatives, including credit default swaps, credit linked debt instruments, and securitisation structures are used to mitigate credit risk; and |
| · | Guarantees and similar instruments (for example, credit insurance) from related and third parties are used in the management of credit portfolios, typically to mitigate credit concentrations in relation to an individual obligor, a borrower group or a collection of related borrowers. |
The use and approach to credit risk mitigation varies by product type, customer and business strategy. Minimum standards applied across the Group cover:
| · | General requirements, including acceptable credit risk mitigation types and any conditions or restrictions applicable to those mitigants; |
| · | The maximum loan-to-value (LTV) percentages, minimum haircuts or other volatility adjustments applicable to each type of mitigant including, where appropriate, adjustments for currency mismatch, obsolescence and any time sensitivities on asset values; |
| · | The means by which legal certainty is to be established, including required documentation and all necessary steps required to establish legal rights; |
| · | Acceptable methodologies for the initial and any subsequent valuations of collateral and the frequency with which they are to be revalued (for example, daily in the trading book); |
| · | Actions to be taken in the event the current value of mitigation falls below required levels; |
| · | Management of the risk of correlation between changes in the credit risk of the customer and the value of credit risk mitigation, for example, any situations where customer default materially impacts the value of a mitigant and applying a haircut or recovery value adjustment which reflects the potential correlation risk; |
| · | Management of concentration risks, for example, setting thresholds and controls on the acceptability of credit risk mitigants and on lines of business that are characterised by a specific collateral type or structure; and |
| · | Collateral management to ensure that credit risk mitigation is legally effective and enforceable. |
Business review continued |
Credit risk continued
Credit risk assets*
Credit risk assets consist of loans and advances (including overdraft facilities), instalment credit, finance lease receivables and traded instruments across all customer types. Reverse repurchase agreements and issuer risk (primarily debt securities – see page 104) are excluded. Where relevant, and unless otherwise stated, data reflects the effect of credit mitigation techniques.
The discussions and disclosures in this section (pages 83-94) relate only to the Group before RFS Holdings minority interest. Facilities included within RFS Holdings minority interests have not been migrated to the RBS risk systems, as they will not be part of the Group following separation of the ABN AMRO business. All the disclosures in this section are unaudited and are labelled with an asterisk (*)
| | | 2009 | | | 2008 | (1) |
| Credit risk assets | | | £m | | | | £m | |
UK Retail | | | 103,029 | | | | 97,069 | |
UK Corporate | | | 109,908 | | | | 126,736 | |
Wealth | | | 15,951 | | | | 17,604 | |
Global Banking & Markets | | | 224,355 | | | | 450,321 | |
Global Transaction Services | | | 7,152 | | | | 8,995 | |
Ulster Bank | | | 42,042 | | | | 64,695 | |
US Retail & Commercial | | | 52,104 | | | | 82,862 | |
Other | | | 2,981 | | | | 6,594 | |
Core(1) | | | 557,522 | | | | n/a | |
Non-Core | | | 151,264 | | | | n/a | |
| | | | 708,786 | | | | 854,876 | |
Note:
(1) The 2008 analysis between Core and Non-Core is not available.
| · | Total credit risk assets reduced by £146 billion, or 17% during 2009 or 13% on a constant currency basis. |
| · | Reductions occurred across industry sectors and in most regions. The largest reductions were in lending balances and derivatives. |
| · | As part of the strategic review, the designation of assets between Core and Non-Core divisions was completed during the first half of 2009, hence the portfolio is reported according to the divisional structure as at 31 December 2009 in the table above. |
Credit concentration risk
The Group defines four key areas of concentration in credit risk that are monitored, reported and managed at both Group and divisional levels. These are single name, industry/sector, country and product/asset class. Frameworks to address single name, industry/sector and country concentrations are established and continue to be enhanced and embedded into business processes across the Group. Aspects of the product/asset class framework are in place whilst others will be developed during the course of 2010.
Under the Group’s credit approval framework, the required approval level is linked to the size of exposure with exposures above a certain level requiring the highest level of approval, held by a very small number of executives. In addition, the Group’s single name concentration framework includes specific approval requirements; additional reporting and monitoring; and the requirement to develop plans to address and reduce excess exposures.
The Group has also developed a more robust approach and framework for managing sector concentrations, a major outcome of which is the regular review of the most material concentrations at the Executive Risk Forum (ERF). These reviews include an assessment of the Group’s franchise in a particular sector, an analysis of the outlook (including downside outcomes), identification of key vulnerabilities and stress/scenario tests.
Reviews conclude with specific sector caps and other portfolio strategies to align the Group’s exposure profile with its appetite.
Country risk
Country risk arises from sovereign events (for example, default or restructuring); economic events (for example, contagion of sovereign default to other parts of the economy, cyclical economic shock); political events (for example, convertibility restrictions and expropriation or nationalisation); and natural disaster or conflict. Losses are broadly defined and include credit, market, liquidity, operational and franchise risk related losses.
The Group’s appetite for country risk is set by the ERF in the form of limits by country risk grade, with sub-limits on term exposure. Countries where exposures exceed this limit framework are approved by the ERF while authority is delegated to the Group Country Risk Committee (GCRC) to manage exposures within the framework. Specific limits are set for each country based on a risk assessment taking into account the Group’s franchise and business mix in that country. Additional limitations – on product types with higher loss potential, for example – are 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.
