RBS 2012 Annual Report Download - page 507

RBS GROUP 2012
505
In addition, UKFI manages HM Treasury’s shareholder relationship with
the Group and, 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. The manner
in which HM Treasury or UKFI exercises HM Treasury’s rights as majority
shareholder 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 Group for the benefit of its members as a
whole.
The Group is subject to other global risks
By virtue of the Group’s global presence, the Group is exposed to risks
arising out of geopolitical events, such as the existence of trade barriers,
the implementation of exchange controls and other measures taken by
sovereign governments that can hinder economic or financial activity
levels. Furthermore, unfavourable political, military or diplomatic events,
armed conflict, pandemics and terrorist acts and threats, and the
response to them by governments could also adversely affect levels of
economic activity and have an adverse effect upon the Group’s business,
financial condition and results of operations.
Market and credit related risks
The Group’s earnings and financial condition have been, and its future
earnings and financial condition may continue to be, materially affected
by depressed asset valuations resulting from poor market conditions
Severe market events have resulted in the Group recording large write-
downs on its credit market exposures in recent years; particularly early in
the financial crisis (£10.1 billion in 2008 and £6.2 billion in 2009). Any
deterioration in economic and financial market conditions or continuing
weak economic growth 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. As part of the Group’s
strategy it has materially reduced the size of its balance sheet mainly
through the sale and run-off of non-core assets. The Group’s assets that
remain in its Non-Core division may be more difficult to sell and could be
subject to further write-downs or, if sold, realised losses. Any of these
factors could require the Group to recognise additional significant write-
downs or realise increased impairment charges, which may have a
material adverse effect on its financial condition, results of operations and
capital ratios. In addition, steep falls in perceived or actual asset values
have been accompanied by a severe reduction in market liquidity, as
exemplified by losses arising out of asset-backed collateralised debt
obligations, residential mortgage-backed securities and the leveraged
loan market. In dislocated markets, hedging and other risk management
strategies may not be as effective as they are in normal market
conditions due in part to the decreasing credit quality of hedge
counterparties.
The financial performance of the Group has been, and continues to be,
materially affected by deteriorations in borrower and counterparty credit
quality and further deteriorations could arise due to prevailing economic
and market conditions and legal and regulatory developments
The Group has exposure to many different industries and counterparties,
and risks arising from actual or perceived changes in credit quality and
the recoverability of monies due from borrowers and counterparties are
inherent in a wide range of the Group’s businesses. In particular, the
Group has significant exposure to certain individual counterparties in
weakened business sectors and geographic markets and also has
concentrated country exposure in the UK, the US and across the rest of
Europe (principally Germany, The Netherlands, Ireland and France) (at
31 December 2012 credit risk assets in the UK were £316 billion, in North
America £101 billion and in Western Europe (excluding the UK) £147
billion); and within certain business sectors, namely personal finance,
financial institutions and commercial real estate (at 31 December 2012
residential and personal lending amounted to £182 billion, lending to
financial institutions was £114 billion and commercial real estate lending
was £63 billion). The Group expects its exposure to the UK to increase
proportionately as its business becomes more concentrated in the UK,
with exposures generally being reduced in other parts of its business as it
implements its strategy.
The credit quality of the Group’s borrowers and counterparties is
impacted by prevailing economic and market conditions and by the legal
and regulatory landscape in their respective markets.
A further deterioration in economic and market conditions or changes to
legal or regulatory landscapes could worsen borrower and counterparty
credit quality and also impact the Group’s ability to enforce contractual
security rights. 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 experienced in
recent years. This has been particularly the case with respect to large
parts of the Group’s commercial real estate portfolio. Any such losses
could have an adverse effect on the Group’s results of operations and
financial condition.