Final Results - Part 2

Royal Bank of Scotland Group PLC 1 March 2001 PART 2 NOTES TO PRO FORMA BASIS RESULTS 1. Basis of preparation The pro forma results for the years ended 31 December 2000 and 1999 have been prepared on the following basis: 1. They incorporate the results of NatWest from 1 January 1999 and assume that the fair value adjustments were made on 31 December 1998. 2. Goodwill arising on the acquisition of NatWest of £11,390 million (see page 8), has been amortised over its estimated economic life of 20 years from 1 January 1999. Goodwill arising on other acquisitions made by the Group after 1 January 1999 - Green Flag, the commercial banking operations of State Street Corporation, and UST Corp. - has been amortised from the effective dates of acquisition, also over 20 years. Goodwill arising on acquisitions prior to 1 January 1999 was written off directly to reserves and has not been reinstated, as permitted by Financial Reporting Standard 10. 3. A surplus of £1,070 million in NatWest Pension Funds has been amortised, from 1 January 1999, over the estimated average remaining service life of members of the schemes. 4. An adjustment has been made to reflect the net funding of the acquisition of NatWest as if acquired on 1 January 1999. The net funding comprises cash paid and loan notes issued to NatWest shareholders of £7,349 million and fees and expenses relating to the acquisition of £176 million less net proceeds of £3,910 million from the issue of new ordinary and preference shares and £20 million of proceeds from the exercise of options over NatWest ordinary shares. 5. The results of businesses disposed of since 1 January 1999 and the profit arising on their sale have been excluded from the pro forma accounts. The principal disposals were RBS Trust Bank, Gartmore and the venture capital investments of NatWest. A funding adjustment has been made to recognise the benefit of estimated net proceeds of £ 1,500 million assuming that these funds were received on 1 January 1999. 6. All expenditure incurred to integrate the Group's existing operations with those of NatWest and relating to projects and initiatives to achieve the cost reduction and income enhancement targets set in connection with the acquisition of NatWest has been shown separately under the caption 'Integration costs'. In the six months to 31 December 1999 NatWest incurred restructuring costs of £113 million (mainly staff severance payments). These are classified as 'integration costs' in the prior year pro forma results. 7. Rentals receivable less depreciation on operating lease assets, which were included in net interest income in NatWest's accounts, are shown in 'Other operating income' and 'Depreciation and amortisation' respectively. 8. NatWest wrote off loans when the normal banking relationship with the borrower had ceased and the debt became subject to recovery procedures. This practice has been amended to bring it in line with the RBS approach of writing off when there is no realistic prospect of recovery. As a result, specific provisions for bad debts have increased by £1.0 billion at 31 December 2000 and £1.1 billion at 31 December 1999 with a corresponding increase in the gross amount of loans to customers and non-accrual loans. This adjustment does not affect profit before tax or net loans and advances. 9. Group operating profit excludes goodwill amortisation and integration costs which are shown separately on the face of the profit and loss account. 10. The consolidated balance sheet on page 7 incorporates fair value and other adjustments relating to the acquisition of NatWest. The balance sheet as at 31 December 2000 is the actual balance sheet; the balance sheet as at 31 December 1999 is on a pro forma basis. Page 19 of 32 NOTES TO PRO FORMA BASIS RESULTS (continued) 2. Accounting policies and presentation (i) Implementation by the Group of Financial Reporting Standard ('FRS') 15 'Tangible Fixed Assets' and FRS 16 'Current Tax' had no material effect on reported profits. From 1 January 2000, the Group's freehold and long leasehold buildings, following a reassessment of their useful economic lives, are being depreciated over 50 years. (ii) The following changes to the accounting presentation adopted by the Group have been made to give a fairer presentation of the results of the enlarged Group: a) Interest receivable and interest payable on trading assets and liabilities previously shown in net interest income are now included in dealing profits. As a result of this change there are reductions of £175 million (1999 - £155 million) and £159 million (1999 - £150 million) in interest receivable and interest payable respectively and an increase of £16 million (1999 - £5 million) in dealing profits. b) Fraud losses, formerly included in provisions for bad and doubtful debts are included in administrative expenses. The charge for bad and doubtful debt provisions has decreased by £ 13 million (1999 - £10 million) with a corresponding increase in administrative expenses - other. c) Credit card processing costs are now reported in fees and commissions payable increasing this profit and loss caption by £40 million (1999 - £37 million) and reducing administrative expenses - other. d) Following an analysis of staff costs, a net £14 million (1999 - £10 million) has been transferred within administrative expenses between staff costs and other costs. Comparative figures have been restated to reflect these changes in presentation which do not affect profit before tax. 3. Provisions for bad and doubtful debts Group operating profit is stated after charging provisions for bad and doubtful debts of £602 million (1999 - £526 million). The balance sheet provisions for bad and doubtful debts increased in the twelve months to 31 December 2000 from £3,152 million to £3,153 million, and the movements thereon were: Specific General Total £m £m £m At 1 January 2000 2,586 566 3,152 Acquisition of subsidiaries 55 - 55 Currency translation adjustment 31 11 42 Amounts written off net of recoveries (698) - (698) Transfers between provisions 19 (19) - Charge to profit & loss account 592 10 602 -------- -------- -------- At 31 December 2000 2,585 568 3,153 -------- -------- -------- Page 20 of 32 NOTES TO PRO FORMA BASIS RESULTS (continued) 4. Goodwill The amortisation of goodwill is based on an estimated economic life of 20 years, and comprises: 31 December 31 December 2000 1999 £m £m Goodwill on the acquisition of NatWest* 570 570 Other - from actual date of acquisition 65 6 -------- -------- 635 576 -------- -------- *assuming acquisition on 1 January 1999 5. Taxation The charge for taxation is based on a UK corporation tax rate of 30% for the year ended 31 December 2000 (1999 - 30.25%) and is made up as follows: 31 31 December December 2000 1999 £m £m Tax on profit before goodwill amortisation and 1,306 951 integration costs Tax relief on integration costs (135) (34) -------- -------- 1,171 917 -------- -------- The tax charge of £1,171 million, equivalent to 35% of pre-tax profit, is higher than the standard UK tax rate of 30% mainly due to goodwill amortisation, which is not allowable for UK tax. 6. Pro forma earnings per share The pro forma earnings per share have been calculated based on the following: 31 December 31 December 2000 1999 £m £m Earnings: Profit attributable to ordinary shareholders 1,779 1,415 ------- ------- Number of shares - millions Weighted average number of ordinary shares in issue during the period 2,660 2,643 -------- -------- Basic earnings per share 66.9p 53.6p Integration costs 11.7p 3.0p Goodwill amortisation 23.4p 21.7p --------- -------- Adjusted earnings per share 102.0p 78.3p --------- -------- Adjusted earnings are calculated by excluding from the profit attributable to ordinary shareholders the after tax effect of goodwill amortisation and integration costs. Page 21 of 32 NOTES TO PRO FORMA BASIS RESULTS (continued) 7. Ordinary Dividends The directors have declared a final dividend of 23.5p per share on the ordinary shares which, when added to the interim dividend of 9.5p per share makes a total of 33.0p per share, an increase of 16%. The final dividend will be paid on 18 May 2001 to shareholders registered on 16 March 2001. As an alternative to cash, a scrip dividend election is to be offered and shareholders will receive details of this by letter. 8. Other information The financial information does not constitute statutory accounts for the period ended 31 December 2000. Statutory accounts for the 15 months ended 31 December 2000 will be delivered to the Registrar of Companies following the company's annual general meeting. The auditors have reported on these accounts; their report was not qualified and did not contain a statement under Section 237 (2) or 3 of the Companies Act 1985. Page 22 of 32 INTEGRATION INFORMATION In the Offer Document issued on 16 December 1999, the Group made various estimates in respect of cost savings, staff reductions and revenue benefits. Those estimates were based on the latest available published information at that time, namely NatWest interim accounts for the half year to 30 June 1999 and the Group's accounts for the year to 30 September 1999. All the benefits detailed below are measured against this published information. On 19 April 2000, the Group revised its estimates as a consequence of the experience gained by having detailed access to NatWest following the acquisition on 6 March 2000. These revised estimates are shown in the tables below as 'plan' . Period ending REVENUE BENEFITS December December December March 2000 2001 2002 2003 * Cumulative gross revenue initiatives implemented at the end of each period (£m) plan 120 350 550 595 actual as at 31 December 2000 147 December 2003 * Impact on profit before tax (£m) plan 50 120 240 390 actual year to 31 December 2000 52 The gross revenue initiatives generated income in the profit and loss account of £71 million, which, net of costs, gave rise to a profit of £52 million in the year to 31 December 2000. Period ending COST SAVINGS December December December March 2000 2001 2002 2003 * Cumulative cost savings implemented at the end of each period (£m) plan 550 900 1,200 1,340 actual as at 31 December 2000 653 December 2003 * Impact on profit before tax (£m) plan 290 700 1,050 1,300 actual year to 31 December 2000 448 Period ending STAFF REDUCTIONS December December December March 2000 2001 2002 2003 * Cumulative total plan 9,000 14,000 16,000 18,000 actual as at 31 December 2000 13,000 Period ending INTEGRATION COSTS December December December March 2000 2001 2002 2003 * Cumulative total charge to P&L (£m) plan 650 1,150 1,350 1,400 actual as at 31 December 2000 547* * includes £113 million incurred by NatWest in the second half of 1999. Page 23 of 32 CONSOLIDATED PROFIT AND LOSS ACCOUNT (pro forma basis) 31 December 2000 31 December 1999 Second First Second First half half half half £m £m £m £m Net interest income 3,061 2,868 2,681 2,593 -------- -------- -------- -------- Dividend income 29 17 19 18 Fees and commissions receivable 2,109 1,970 1,844 1,753 Fees and commissions payable (410) (394) (341) (334) Dealing profits 557 574 501 526 Other operating income 509 489 521 552 -------- -------- -------- -------- 2,794 2,656 2,544 2,515 General insurance - earned income 725 621 504 425 - reinsurance (196) (171) (119) (78) -------- -------- -------- -------- Non-interest income 3,323 3,106 2,929 2,862 -------- -------- -------- -------- Total income 6,384 5,974 5,610 5,455 -------- -------- -------- -------- Administrative expenses - staff costs 1,693 1,747 1,741 1,771 - premises and equipment 414 425 462 430 - other 797 769 732 673 Depreciation of tangible fixed assets 380 389 355 399 -------- -------- -------- -------- Operating expenses 3,284 3,330 3,290 3,273 -------- -------- -------- -------- Profit before other operating charges 3,100 2,644 2,320 2,182 General insurance - gross claims 520 462 408 356 - reinsurance (145) (139) (96) (67) -------- -------- -------- -------- Operating profit before provisions 2,725 2,321 2,008 1,893 Provisions for bad and doubtful debts 318 284 284 242 Amounts written off investments 17 26 4 12 -------- -------- -------- -------- Group operating profit before goodwill amortisation and integration costs 2,390 2,011 1,720 1,639 Goodwill amortisation 324 311 292 284 Integration costs 245 189 113 - -------- -------- -------- -------- Group profit before tax 1,821 1,511 1,315 1,355 Tax 623 548 433 484 -------- -------- -------- -------- Group profit after tax 1,198 963 882 871 Minority interests 32 22 16 27 -------- -------- -------- -------- Profit after minority interests 1,166 941 866 844 Preference dividends 166 162 150 145 -------- -------- -------- -------- Profit attributable to ordinary 1,000 779 716 699 shareholders -------- -------- -------- -------- Page 24 of 32 DIVISIONAL PERFORMANCE (pro forma basis) 31 December 2000 31 December 1999 Second First Second First half half half half £m £m £m £m Corporate Banking and Financial 1,393 1,337 1,226 1,265 Markets Retail Banking 1,265 1,202 1,100 1,044 Retail Direct 196 177 174 128 ------- -------- ------- ------- Contribution before manufacturing 2,854 2,716 2,500 2,437 costs Manufacturing (801) (859) (939) (927) -------- -------- -------- -------- Operating profit 2,053 1,857 1,561 1,510 Wealth Management 205 200 183 145 Direct Line Insurance Group 125 76 64 36 Ulster Bank 104 96 83 83 Citizens 182 167 133 125 Central items (279) (385) (304) (260) -------- -------- -------- -------- Group operating profit before goodwill amortisation and integration costs 2,390 2,011 1,720 1,639 -------- -------- -------- -------- Page 25 of 32 AVERAGE BALANCE SHEET (pro forma basis) 2000 1999 Average Average Balance Rate Balance Rate £m % £m % Year ended 31 December Assets Treasury and other eligible bills UK 463 4.5 825 5.2 Overseas 131 4.6 378 1.6 Loans and advances to banks UK 14,965 5.8 17,435 5.2 Overseas 8,884 6.7 8,764 5.5 Loans and advances to customers UK 106,302 7.9 91,014 7.4 Overseas 23,271 7.8 16,112 7.0 Instalment credit and finance lease receivables UK 14,113 8.5 14,370 9.2 Overseas 1,796 7.0 1,426 6.4 Debt securities UK 18,004 5.7 20,172 5.8 Overseas 9,812 6.3 8,229 5.8 ----------- ----------- Interest-earning assets - banking 197,741 7.4 178,725 6.9 business Interest-earning assets - trading 53,946 6.4 47,767 5.6 business ----------- ----------- Total interest-earning assets 251,687 7.2 226,492 6.6 Non-interest-earning assets 52,931 53,194 ----------- ----------- Total assets 304,618 279,686 ----------- ----------- Liabilities Deposits by banks UK 13,851 5.4 14,878 4.0 Overseas 7,667 5.7 7,880 4.8 Customer accounts UK 106,012 4.7 97,885 4.3 Overseas 22,297 4.7 16,785 3.9 Debt securities in issue UK 14,831 5.9 16,411 5.9 Overseas 7,881 6.3 6,463 5.3 Loan capital UK 9,829 7.1 8,468 6.8 Overseas 502 9.8 473 9.5 Internal funding of trading business UK (10,774) 4.9 (9,944) 5.4 Overseas (1,025) 5.1 (1,971) 4.5 ----------- --------- Interest-bearing liabilities - banking business 171,071 5.1 157,328 4.5 Interest-bearing liabilities - trading 50,336 6.1 44,964 5.3 business ---------- -------- Total interest-bearing liabilities 221,407 5.3 202,292 4.7 Non-interest-bearing liabilities ---------- -------- demand deposits 21,938 18,688 other liabilities 38,520 37,334 Shareholders' equity 22,753 21,372 Total liabilities and shareholders' ---------- --------- equity 304,618 279,686 ----------- --------- The analysis into UK and overseas in the above table has been compiled on the basis of location of office. Page 26 of 32 AVERAGE INTEREST RATES, YIELDS, SPREADS AND MARGINS (pro forma basis) 2000 1999 Average Average Rate Rate % % Year ended 31 December The Group's base rate 6.0 5.3 London inter-bank offered rate: three month sterling 6.2 5.5 three month eurodollar 6.5 5.4 Yields, spreads and margins of the banking business: Gross yield (1) Group 7.4 6.9 UK 7.5 7.1 Overseas 7.2 6.3 Interest spread (2) Group 2.3 2.4 UK 2.4 2.6 Overseas 1.9 1.8 Net interest margin (3) Group 3.0 3.0 UK 3.1 3.1 Overseas 2.7 2.5 (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. Page 27 of 32 RISK ELEMENTS IN LENDING The Group's loan control and review procedures do not include the classification of loans as non-accrual, accruing past due, restructured and potential problem loans, as defined by the Securities and Exchange Commission ('SEC') in the US. The following table shows the estimated amount of loans which would be reported using the SEC's classifications. The figures incorporate estimates and are stated before deducting the value of security held or related provisions. Actual Pro forma 31 31 December December 2000 1999 £m £m Loans accounted for on a non-accrual basis: Domestic 2,482 2,462 Foreign 344 629 -------- -------- 2,826 3,091 -------- -------- Accruing loans which are contractually overdue 90 days or more as to principal or interest*: Domestic 662 558 Foreign 168 144 -------- -------- 830 702 -------- -------- Loans not included above which are classified as 'troubled debt restructurings' by the SEC: Domestic 43 22 Foreign 122 110 -------- -------- 165 132 -------- -------- Total risk elements 3,821 3,925 -------- -------- Closing provisions for bad and doubtful debts as a % of total risk 83% 80% elements in lending * Generally, lending by way of overdraft has no fixed repayment schedule and consequently is not included in this category Loans that are current as to payment of principal and interest and not reflected in the above table, but in respect of which management has serious doubts about the ability of the borrower to comply with contractual repayment terms, totalled approximately £772 million at 31 December 2000 (31 December 1999 - £898 million). Substantial security is held in respect of these loans and appropriate provisions have already been made in accordance with the Group's provisioning policy for bad and doubtful debts. Page 28 of 32 MARKET RISK (pro forma basis) The Group manages the market risk in its trading and treasury portfolios through value-at-risk (VaR) limits as well as stress testing, position and sensitivity limits. VaR is a technique that produces estimates of the potential negative change in the market value of a portfolio over a specified time horizon at a given confidence level. The table below sets out the VaR for the Group as if NatWest had been part of the Group throughout the periods presented. The Group's VaR assumes a 95% confidence level and one-day time horizon. Year ended 31 December At 31 December Maximum Minimum Average £m £m £m £m Trading 2000 9.8* 12.4 8.1 9.7 1999 9.4 11.9 7.4 9.6 Treasury 2000 5.4 5.7 2.8 4.0 1999 5.1 13.1 4.6 9.4 The Group's VaR should be interpreted in the light of the assumptions underlying the methodologies adopted and their limitations. Historical data used in computing VaR may not be indicative of future market conditions. *Actual as at 31 December 2000. Page 29 of 32 REGULATORY RATIOS AND OTHER INFORMATION Actual Actual 31 December 30 June 2000 2000 Weighted risk assets (£m) Banking book - on balance sheet 146,600 139,300 - off balance sheet 16,200 15,800 Trading book 12,400 10,500 ----------- ----------- 175,200 165,600 ----------- ----------- Risk asset ratio - tier 1 6.9% 6.4% - total 11.5% 11.4% Share price at period end £15.82 £11.06 Market capitalisation £42.4bn £29.4bn Employee numbers (pro forma basis) Actual Pro forma 31 December 31 December 2000 1999 Corporate Banking and Financial Markets 13,100 14,600 Retail Banking 28,900 34,300 Retail Direct 5,800 6,200 Manufacturing 19,200 20,800 Wealth Management 6,800 6,800 Direct Line Insurance Group 6,700 5,800 Ulster Bank 4,600 4,900 Citizens 7,300 5,600 Central items 1,600 2,300 ---------- ----------- Group total 94,000 101,300 ---------- ----------- Effect of acquisitions by:- Direct Line 800 800 Citizens 1,900 200 ---------- ----------- Underlying 91,300 100,300 ----------- ----------- Integration headcount savings Integration headcount reductions are measured against the 'base number' i.e 30 June 1999 staff numbers for NatWest plus those at 30 September 1999 for RBS. The 'base number' of 103,500 staff reduces to 93,000 excluding Direct Life Insurance Group and Citizens as they are not materially affected by integration savings. On the same basis, group total staff numbers at 31 December 2000 are 80,000, a reduction of 13,000 compared with the adjusted base number. Forward looking statements Certain sections of this document contain forward-looking statements. We use words such as 'plan', 'expect', 'believe', 'risk' and 'VaR' to identify forward-looking statements. Our statements are subject to certain risks and uncertainties, as discussed in the Operating and Financial Review and Risk Management sections of the Annual Report and Accounts. These risks and uncertainties could cause actual results to differ materially from our statements. Page 30 of 32 Independent Review Report to The Royal Bank of Scotland GROUP plc Introduction We have been instructed by the company to review the pro forma financial information set out on pages 4 to 22, 24 and 25, which has been prepared as described on page 19 and in accordance with the accounting policies referred to on page 20. This pro forma financial information is not subject to the Listing Rules of the UK Listing Authority. We have read the other information contained in the results announcement and, solely on that basis, have considered whether it contains any apparent misstatements or material inconsistencies with the pro forma financial information. Directors' responsibilities The results announcement, including the pro forma financial information contained therein, is the responsibility of, and has been approved by, the directors. The directors have determined that the accounting policies and presentation applied to the figures are consistent with those applied in preparing the preceding annual accounts except for those changes that are disclosed. Review work performed We conducted our review having regard to guidance contained in Bulletin 1999/4 issued by the Auditing Practices Board. A review consists principally of making enquiries of group management and applying analytical procedures to the pro forma financial information and underlying financial data and based thereon, assessing whether the accounting policies and presentation have been consistently applied unless otherwise disclosed. A review excludes audit procedures such as tests of controls and verification of assets, liabilities and transactions. It is substantially less in scope than an audit performed in accordance with Auditing Standards and therefore provides a lower level of assurance than an audit. Accordingly, we do not express an audit opinion on the pro forma financial information. Review conclusion On the basis of our review we are not aware of any material modifications that should be made to the pro forma financial information as presented for the year ended 31 December 2000. Deloitte & Touche Chartered Accountants Edinburgh 28 February 2001 Page 31 of 32 CONTACTS Fred Goodwin Group Chief Executive 020 7427 8116 0131 523 2033 Fred Watt Group Finance Director 020 7427 8412 0131 523 2028 Grahame Whitehead Deputy Group Finance Director 020 7427 9450 0131 523 2970 1 March 2001 END Page 32 of 32

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