RBS 2013 Annual Report Download - page 536
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Additional information
534
Risk factors continued
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. 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, for example, the assets
included in the CRG. Valuations in future periods, reflecting, among
other things, the 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, including 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.
Certain of the Group’s assets that were part of its Non-Core division
together with additional assets identified as part of a HM Treasury review,
form part of CRG as of 1 January 2014. In connection with the
establishment of CRG, the Group has indicated its clear aspiration to
remove the vast majority, if not all of these assets within three years
which has led to increased impairments of £4.5 billion which were
recognised in Q4 2013. Despite these impairments, these assets may be
difficult to sell and could be subject to further write-downs or, when sold,
realised losses. Any of these factors could require the Group to recognise
further 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 in recent years
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 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. Pension risk is the risk that the
assets of the Group’s various defined benefit pension schemes which are
long-term in nature do not fully match the timing and amount of the
schemes’ liabilities, as a result of which the Group is required or chooses
to make additional contributions to the schemes. Pension scheme
liabilities vary with changes to long-term interest rates, inflation,
pensionable salaries and the longevity of scheme members as well as
changes in applicable legislation. 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, returns from them and any additional future
contributions to the schemes, 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. Given the recent economic
and financial market difficulties and the risk that such conditions may
occur again over the near and medium term, the Group could 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 an adverse impact on the Group’s results of
operations or financial condition. The most recent tri-annual funding
valuation, at 31 March 2010 was agreed during 2011. It showed the value
of liabilities exceeded the value of assets by £3.5 billion at 31 March
2010, a ratio of assets to liabilities of 84%.
In order to eliminate this deficit, the Group has been and will continue to
pay additional contributions each year over the period 2011 until 2018.
Contributions started at £375 million per annum in 2011, increased to
£400 million per annum in 2013 and will further increase from 2016
onwards in line with price inflation. These contributions are in addition to
the regular annual contributions of around £200 million for on-going
accrual of benefits as well as contributions to meet the expenses of
running the schemes.
The Banking Reform Act 2013 will require banks to ring-fence specific
activities (principally retail and small business deposits) from certain other
activities. Ring-fencing is likely to entail changes to the structure of the
Group’s existing defined benefit pension schemes, which could affect
assessments of the schemes’ deficits. Such assessments may also be
affected by other measures introduced in the Banking Reform Act 2013,
including the categorisation of deposits eligible for compensation under
the Financial Services Compensation Scheme as preferential debts.
The financial performance of the Group has been, and continues to be,
materially affected by counterparty credit quality and 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 2013 credit risk assets in the UK were £320.0 billion, in
North America £96.1 billion and in Western Europe (excluding the UK)
£104.3 billion); and within certain business sectors, namely personal
finance, financial institutions, shipping and commercial real estate (at 31
December 2013 personal finance lending amounted to £177.1 billion,
lending to financial institutions was £91.0 billion, lending against ocean
going vessels was £8.6 billion and commercial real estate lending was
£52.6 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
continues to implement 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.