Investor Report. RBS Citizens Financial Group, Inc. September 30, 2013

Transcription

1 Investor Report RBS Citizens Financial Group, Inc. September 30, 2013 To the holders of the 4.15% Subordinated Notes due 2022 Issued under, and pursuant to the terms of, an indenture dated as of September 28, 2012 between RBS Citizens Financial Group, Inc. and The Bank of New York Mellon, as Trustee RBS Citizens Financial Group, Inc. is a subsidiary of The Royal Bank of Scotland plc. This report is being provided to the holders of the 4.15% Subordinated Notes due 2022 (the Subordinated Notes ) issued by RBS Citizens Financial Group, Inc. under the terms of the Subordinated Note Indenture dated as of September 28, 2012 between RBS Citizens Financial Group, Inc., as issuer, and The Bank of New York Mellon, as Trustee, as amended, supplemented or modified from time to time. This report is not intended for any other purpose.

2 Table of Contents Page SELECTED FINANCIAL DATA... 1 MANAGEMENT S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS... 2 FORWARD-LOOKING STATEMENTS... 2 INTRODUCTION... 3 EXECUTIVE OVERVIEW... 3 RESULTS OF OPERATIONS... 4 NET INCOME (LOSS)... 4 NET INTEREST INCOME... 5 PROVISION FOR CREDIT LOSSES... 7 NONINTEREST INCOME... 8 NONINTEREST EXPENSE... 9 PROVISION FOR INCOME TAXES...10 ANALYSIS OF FINANCIAL CONDITION...10 SECURITIES AVAILABLE FOR SALE ( AFS )...10 LOANS AND LEASES...11 ALLOWANCE FOR CREDIT LOSSES & NONPERFORMING ASSETS...12 NON-CORE ASSETS...13 DERIVATIVES...14 CAPITAL RESOURCES...15 OFF BALANCE SHEET ARRANGEMENTS...22 ENTERPRISE RISK MANAGEMENT...22 INDEPENDENT AUDITORS REVIEW REPORT...26 CONDENSED CONSOLIDATED BALANCE SHEETS...27 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS...28 CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)...29 CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER S EQUITY...30 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SIGNIFICANT ACCOUNTING POLICIES...32 SECURITIES...39 LOANS AND LEASES...43 ALLOWANCE FOR CREDIT LOSSES, NONPERFORMING ASSETS, AND CONCENTRATIONS OF CREDIT RISK...44 GOODWILL AND OTHER INTANGIBLE ASSETS...53 MORTGAGE BANKING...53 INCOME TAXES...55 DERIVATIVES...56 COMMITMENTS, GUARANTEES AND CONTINGENCIES...60 RELATED PARTY TRANSACTIONS...63 FAIR VALUE MEASUREMENTS...64 REGULATORY MATTERS...69 SUPPLEMENTAL CASH FLOW INFORMATION...70 RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME ( AOCI )...71 SUBSEQUENT EVENTS...72

3 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SELECTED FINANCIAL DATA The following tables present selected consolidated historical financial information of RBS Citizens Financial Group, Inc. and its subsidiaries ( RBS Citizens or the Company ). You should read this information together with the Condensed Consolidated Interim Financial Statements and related Notes to Condensed Consolidated Interim Financial Statements. The data for the three and nine months ended September 30, 2013 and 2012 and at September 30, 2013 and December 31, 2012 have been derived from the RBS Citizens unaudited and audited Consolidated Financial Statements. The Company has prepared the unaudited interim Condensed Consolidated Financial Statements on the same basis as the audited annual Consolidated Financial Statements. Three Months Ended Nine Months Ended September 30, September 30, (dollars in millions) STATEMENT OF OPERATIONS DATA: Net interest income $770 $810 $2,279 $2,455 Provision for credit losses Noninterest income ,253 1,277 Noninterest expense ,861 2,561 Noninterest expense, excluding goodwill impairment ,426 2,561 Income (loss) before income tax expense (benefit) (3,676) 860 Income tax expense (benefit) (98) 318 Net income (loss) (3,578) 542 Net income, excluding goodwill impairment OTHER DATA: Return on average tangible assets 0.52% 0.71% (4.32%) 0.62% Return on average tangible assets, excluding goodwill impairment Return on average tangible common equity (38.75) 6.07 Return on average tangible common equity, excluding goodwill impairment Net interest margin noninterest expense, net income (loss), return on average tangible assets, and return on average tangible common equity were calculated excluding the $4.4 billion pretax ($4.1 billion after tax) goodwill impairment recorded in June, and accordingly, these are non-gaap financial measures. September 30, December 31, (dollars in millions) BALANCE SHEET DATA: Total assets. $120,074 $127,053 Securities. 20,852 19,417 Total loans and leases. 85,493 87,248 Allowance for loan and lease losses. 1,219 1,255 Goodwill and other intangible assets. 7,562 11,945 Deposits. 93,930 95,148 Federal funds purchased and securities sold under agreements to repurchase 3,424 3,601 Borrowed funds 1,066 1,195 Stockholder's equity. 19,413 24,129 OTHER DATA: Capital ratios Tier % 14.2% Total Leverage ratio

4 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MANAGEMENT S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS The following Management s Discussion and Analysis of Financial Condition and Results of Operations ( MD&A ) provides information that management believes will assist in understanding the financial performance of RBS Citizens. You should read the MD&A together with the Condensed Consolidated Financial Statements and the Notes to Condensed Consolidated Financial Statements. FORWARD-LOOKING STATEMENTS The information included in this report contains certain forward-looking statements. These forward-looking statements may relate to the Company s financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to expected earnings levels, the adequacy of the allowance for credit losses, delinquency trends, market risk and the impact of interest rate changes, capital market conditions, capital adequacy and liquidity, the effect of legal proceedings, and new accounting standards on the Company s financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words anticipate, believe, continues, expect, estimate, intend, project and similar expressions and future or conditional verbs such as will, would, should, could, might, can, may, or similar expressions are generally intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance, are based on management s current expectations and, by their nature, involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which are beyond the Company s control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to: the rate of growth in the economy and employment levels, as well as general business and economic conditions; changes in interest rates and market liquidity, as well as the magnitude of such changes, which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets; changes in federal bank regulatory and supervisory policies, including required levels of capital; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd Frank Act ) on the Company s businesses, business practices and costs of operations; the relative strength or weakness of the retail and commercial credit sectors and of the real estate markets in the markets in which the Company s borrowers are located; competition in the financial services industry; and legislative, tax, accounting or regulatory changes. Other possible events or factors that could cause results or performance to differ materially from those expressed in such forward-looking statements include the following: negative economic conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of nonperforming assets, charge-offs and provision expense; adverse movements and volatility in debt and equity capital markets; changes in market rates and prices, which may adversely impact the value of financial assets and liabilities; liabilities resulting from litigation and regulatory investigations; the Company s ability to grow its core businesses; decisions to downsize, sell or close units or otherwise change the Company s business mix; and management s ability to identify and manage these and other risks. 2

5 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS All forward-looking statements included in this document are based upon information available to the Company as of the date of this document, and other than as required by law, including the requirements of applicable securities laws. The Company assumes no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. INTRODUCTION RBS Citizens is a Bank Holding Company ( BHC ) and Financial Holding Company ( FHC ) headquartered in Providence, Rhode Island, and through its subsidiaries has approximately 1,400 branches, more than 3,600 ATMs, and nearly 19,000 employees. Its two bank subsidiaries, RBS Citizens, N.A. and Citizens Bank of Pennsylvania, operate a twelve-state branch network under the Citizens Bank brand in Connecticut, Delaware, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont; and under the Charter One brand in Illinois, Michigan and Ohio. RBS Citizens is a wholly-owned subsidiary of The Royal Bank of Scotland plc ( RBS ), a banking subsidiary of the ultimate parent, The Royal Bank of Scotland Group plc ( RBS Group or RBSG ). On December 1, 2008, the United Kingdom ( UK ) Government became the ultimate controlling party of RBS Group. The UK Government s shareholding is managed by UK Financial Investments Limited, a Company wholly owned by the UK Government. RBS Group reports the results of RBS Citizens core businesses as U.S. Retail and Commercial in its published financial statements in accordance with International Financial Reporting Standards ( IFRS ), as defined by the International Accounting Standards Board. The financial position and results of operations included herein are prepared in accordance with accounting principles generally accepted in the United States of America ( U.S. GAAP ) and represent all of RBS Citizens assets, including its non-core assets. RBS Citizens non-core assets include those loans and other assets that management considers to be outside the Company s core business strategy. See the Non-Core Assets section below for further detail. EXECUTIVE OVERVIEW During the second quarter of 2013, RBS Citizens recorded a $4.4 billion pre-tax goodwill impairment charge which resulted in a $3.6 billion net loss for the nine months ended September 30, The impairment charge was recorded in its Retail Banking reporting unit, and is a result of the prolonged delay in the full recovery of the U.S. economy and the impact of that delay on earnings estimates. The impairment charge is a non-cash item, and had minimal impact on RBS Citizens regulatory capital ratios and liquidity. RBS Citizens and each of its banking subsidiaries remain well capitalized. Excluding this non-cash charge, net income was $502 million for the nine months ended September 30, 2013 compared to $542 million for the same period a year ago. Net interest income for the nine months ended September 30, 2013 declined $176 million, or 7%, to $2.3 billion compared to the nine months ended September 30, 2012, reflecting challenges in the broader economy and driven by lower levels of average interest-earning assets, principally investments and retail lending. This is also reflected in the Company s third quarter 2013 revenue (net of interest expense) of $1.2 billion, which was down 6% from a year ago and net interest income, which declined $40 million, to $770 million. The low interest rate environment has limited opportunities for spread expansion, which decreased yields on both interest-earning assets and interest-bearing liabilities compared to the prior year. The period-end investment portfolio increased from the prior year-end due to current period purchases of debt securities in response to new reinvestment opportunities resulting from higher yields in the market. The provision for credit losses for the nine months ended September 30, 2013 was $347 million, up $36 million, or 12%, from $311 million for the nine months ended September 30, Current credit trends have improved with net charge-offs year-to-date of $386 million compared with $685 million in the same period in Noninterest income decreased slightly to $1.3 billion for the nine months ended September 30, 2013 compared to a year ago due primarily to continuing declines in deposit and card fee income offset by net gains earned on the sale of higher yielding investment securities. Additionally, higher mortgage servicing rights valuations at September 30, 2013 were offset by a decline in sales activity as more loans were retained in portfolio, which resulted in a slight decline in mortgage banking income for the nine months ended September 30, Noninterest income decreased $39 million, or 9% in the three months ended September 30, 2013 compared to the three months ended September 30, The primary drivers were lower deposit fees, mortgage banking income and gains on sales of securities offset by an increase in other income. 3

6 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Noninterest expense increased $4.3 billion to $6.9 billion for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012, due to the $4.4 billion goodwill impairment recorded in the second quarter of Noninterest expense included the goodwill impairment charge in the current year and a $138 million litigation expense in the prior year. Excluding these nonrecurring items, year-to-date expenses were flat compared to the prior year. Total assets declined $7.0 billion, or 5.5%, to $120 billion at September 30, 2013 from $127 billion at December 31, The primary drivers of this decline were the $4.4 billion goodwill impairment recorded in the second quarter and $1.8 billion lower total loans and leases at September 30, 2013 as compared to December 31, Return on average tangible assets declined 19 basis points ( bps ) to 0.52% from 0.71% for the three months ended September 30, 2013 and 2012, respectively. Additionally, return on average tangible common equity decreased 224 bps to 4.57% from 6.81% for the three months ended September 30, 2013 and 2012, respectively. RBS Citizens regulatory capital position remained strong at September 30, 2013 both in terms of quantity and quality of capital. Tier 1 capital and total capital ratios were 14.0% and 16.3% compared to 14.2% and 15.8% at December 31, 2012, respectively. Overall, the Company s capital remains well above the requirements to be considered well capitalized according to current and proposed regulatory standards. See additional discussion of RBS Citizens capital and liquidity position in the Capital Resources section of this MD&A. RBS Group recently announced its intention to accelerate its plans for a partial initial public offering of RBS Citizens in the second half of 2014, and to sell down its full position in the Company with further secondary offerings over 2015 and RBS Citizens has benefited from its long association with RBS Group, and expects to continue to maintain a strong business relationship with RBS Group throughout this period and beyond. This does not constitute an offer of any securities for sale. RESULTS OF OPERATIONS NET INCOME (LOSS) For the three months ended September 30, 2013, the Company recognized net income of $144 million, compared to $209 million for the third quarter of 2012, driven by a smaller base of interest-earning assets. RBS Citizens reported a net loss of $3.6 billion for the nine months ended September 30, 2013 after recording a goodwill impairment charge of $4.4 billion in the second quarter. Excluding this non-cash charge, the Company recognized net income of $502 million, down from $542 million for the first nine months of 2012, driven by lower yields on a smaller base of interest-earning assets. 4

7 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NET INTEREST INCOME The following tables show the major components of net interest income and net interest margin: Three Months Ended September 30, 2013 September 30, 2012 Increase (Decrease) Average Income/ Yields/ Average Income/ Yields/ Average Yields/ (dollars in millions) Balances Expense Rates Balances Expense Rates Balances Rates Assets Investments $20,988 $ % $23,981 $ % ($2,993) (0.15%) Commercial 28, , Commercial real estate 6, , (432) (0.17) Leases 3, , (0.49) Total commercial loans 38, , (0.02) Home equity lines of credit 16, , (810) 0.03 Residential mortgage 8, , (666) (0.33) Home equity loans 6, , (1,802) (0.25) Automobile 8, , (0.63) Student and other installment loans 3, , (365) 0.11 Credit cards 1, , Total retail loans 46, , (3,238) (0.24) Total loans and leases 84, , (2,524) (0.14) Loans held for sale (158) 0.14 Total earning assets 105, , (5,675) (0.12) Allowance for loan and lease losses (1,205) (1,469) 264 Goodwill and other intangible assets 7,208 11,921 (4,713) Other non earning assets 5,526 6,097 (571) Total non earning assets 11,529 16,549 (5,020) Total assets $117,386 $128,081 ($10,695) Liabilities and Stockholder's Equity Checking with interest $13,997 $2 0.06% $13,515 $3 0.08% $482 (0.02%) Money market & savings 42, , (0.07) Term deposits 11, , (1,946) (0.20) Total interest-bearing deposits 67, , (1,160) (0.11) Federal funds purchased and securities sold under agreements to repurchase 1 1, , (648) 2.61 Borrowed funds , (4,647) 1.54 Total borrowed funds 2, , (5,295) 4.12 Total interest-bearing liabilities 69, , (6,455) (0.18) Total demand deposits 25,598 24, Other liabilities 2,250 2,614 (364) Stockholder's equity 19,627 24,104 (4,477) Total liabilities and stockholder's equity $117,386 $128,081 ($10,695) Net interest income $770 $810 ($40) Net interest margin 2.88% 2.88% 0.00% 1 Balances are net of certain short-term receivables associated with reverse repurchase agreements; interest expense includes the full cost of the repurchase agreements and certain hedging costs. 5

8 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Nine Months Ended September 30, 2013 September 30, 2012 Increase (Decrease) Average Income/ Yields/ Average Income/ Yields/ Average Yields/ (dollars in millions) Balances Expense Rates Balances Expense Rates Balances Rates Assets Investments $20,825 $ % $24,019 $ % ($3,194) (0.44%) Commercial 28, , ,516 (0.04) Commercial real estate 6, , (738) (0.06) Leases 3, , (0.42) Total commercial loans 38, , (0.08) Home equity lines of credit 17, , (557) 0.04 Residential mortgage 9, , (585) (0.38) Home equity loans 6, , (1,963) (0.17) Automobile 8, , (0.74) Student and other installment loans 3, , (407) 0.15 Credit cards 1, , Total retail loans 46,868 1, ,680 1, (2,812) (0.27) Total loans and leases 85,266 2, ,097 2, (1,831) (0.19) Loans held for sale, at lower of cost or fair value (70) (0.13) Total earning assets 106,535 2, ,630 2, (5,095) (0.21) Allowance for loan and lease losses (1,217) (1,565) 348 Goodwill and other intangible assets 10,320 11,922 (1,602) Other non earning assets 5,388 6,189 (801) Total non earning assets 14,491 16,546 (2,055) Total assets $121,026 $128,176 ($7,150) Liabilities and Stockholder's Equity Checking with interest $14,154 $6 0.06% $13,491 $8 0.08% $663 (0.02%) Money market & savings 42, , ,024 (0.04) Term deposits 11, , (2,605) (0.95) Total interest-bearing deposits 68, , (0.25) Federal funds purchased and securities sold under agreements to repurchase 1 1, , (793) 7.47 Borrowed funds , (5,158) 0.30 Total borrowed funds 2, , (5,951) 5.67 Total interest-bearing liabilities 70, , (5,869) (0.18) Total demand deposits 25,140 24, Other liabilities 2,303 2,716 (413) Stockholder's equity 22,667 23,814 (1,147) Total liabilities and stockholder's equity $121,026 $128,176 ($7,150) Net interest income $2,279 $2,455 ($176) Net interest margin 2.85% 2.93% (0.08%) 1 Balances are net of certain short-term receivables associated with reverse repurchase agreements; interest expense includes the full cost of the repurchase agreements and certain hedging costs. For the three months ended September 30, 2013, net interest income was $770 million and the net interest margin was 2.88%. This reflects a $40 million decline when compared to the three months ended September 30, The decline was driven by a smaller interest-earning balance sheet as well as historically low interest rates, which led to lower yields on both earning assets and interest-bearing liabilities compared to the prior year. On the assets side, net average loan balances as of September 30, 2013 decreased $2.5 billion compared to September 30, 2012, and interest income on loans decreased $54 million. Yields on earning assets declined 12 bps compared to the same period last year. Additionally, yields on the investment portfolio dropped 15 bps from Declines are attributed to maturities, sales and faster prepayment speeds of higher-yielding, fixed rate assets and reinvestment into securities with lower yields. 6

9 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the nine month period ended September 30, 2013, net interest income was $2.3 billion and net interest margin was 2.85%. This reflects a decline of $176 million and 8 bps, respectively, when compared to the nine month period ended September 30, Driven by historically low interest rates, yields on both earning assets and interest bearing liabilities declined sharply compared to prior year. On the assets side, net average loan balances decreased $1.8 billion in 2013 and interest on loans decreased $176 million. Loan yields declined 19 bps compared to the same period last year. Additionally, yields on the investment portfolio dropped 44 bps from Both of these declines are attributed to run-off and prepayment of higher-yielding, fixed rate assets and new purchases / originations with lower yields. The Company currently has $2.7 billion in higher cost, legacy pay-fixed interest-rate swaps tied to Federal funds. Hedge accounting for these swaps and the underlying hedged items affects both RBS Citizens deposit costs and borrowing costs. The hedge documentation allows for hedging of various types of borrowings and certain deposit balances. These swaps originally hedged deposits and borrowings, with the cost of the hedges allocated between these two categories. Over time, the deposit balances that were hedged have diminished, leaving the cost of the remaining swaps to be borne by the remaining borrowings balances. In addition, when permitted by U.S. GAAP, the Company nets short-term receivables associated with its reverse repurchase agreements with short-term payables associated with its repurchase agreements, while associated income is not netted. As a result, the 8.38% quarterly yield and 10.83% nine month yield on Federal funds purchased and securities sold for repurchase agreement appear high. The overall pay-fixed swap expense noted above declined to $48 million for the quarter ended September 30, 2013 compared to $66 million a year ago. The expense declined to $160 million through September 30, 2013 from $225 million a year ago. Over the same time, the notional swap balances have matured by $2.5 billion to a remaining balance of $2.7 billion. Total interest-bearing deposit costs, excluding the hedge costs, were 0.27% and 0.42% for the quarters ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, the rate on total interest-bearing deposits, excluding the hedge costs, were 0.32% and 0.44%, respectively. Many deposit products have hit pricing floors at or near zero, limiting further rate reductions and thus compressing margin. Excluding the impact of the hedging expense on the term deposits, the rates were 0.72% and 1.17% for the quarters ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, excluding the impact of the hedging expense on the term deposits, the rates were 0.86% and 1.23%, respectively. Excluding the impact of the hedge expense and the netting of repurchase agreement balances, total borrowed funds rates were 3.70% and 3.09% for the quarters ended September 30, 2013 and 2012, respectively. The increase includes the interest expense of the $350 million 4.15% subordinated debt issued on September 28, 2012 and the $333 million 5.158% subordinated debt issued on June 28, Additionally, the Company issued $333 million of new subordinated debt to RBSG on September 30, 2013 with a fixed-to-floating rate of 4.771% due in The impact on earnings will be seen in the year-end results. For the nine months ended September 30, 2013 and 2012, the rates on total borrowed funds, excluding the hedge costs and netting of repurchase agreement balances, were 3.15% and 3.63%, respectively. PROVISION FOR CREDIT LOSSES Current credit trends have improved with net charge-offs year-to-date of $386 million compared with $685 million in the same period in The provision for credit losses for the nine months ended September 30, 2013 was $347 million, up $36 million, or 12%, from $311 million for the nine months ended September 30, The total provision for credit losses includes the provision for loan and lease losses as well as the provision for unfunded commitments. The provision for loan and lease losses is the result of a detailed analysis performed to estimate an appropriate and adequate allowance for loan and lease losses ( ALLL ). Refer to Allowance for Credit Losses and Nonperforming Assets below for more details. 7

10 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NONINTEREST INCOME The following table details the significant components of total noninterest income: Three Months Nine Months Ended September 30, Increase Ended September 30, Increase (dollars in millions) (Decrease) (Decrease) Service charges on deposits $129 $141 (9%) $385 $423 (9%) Mortgage banking (59) (1) ATM and debit card (6) Net gains on sales of securities available for sale (52) Trust and investment services revenue Other service fee income (11) (6) International fees (4) (8) Credit card fees (7) Bank-owned life insurance (8) (3) Capital markets fee income (8) (8) Other income (loss) 2 25 (2) NM (9) Total noninterest income $383 $422 (9%) $1,253 $1,277 (2%) 1 NM - not meaningful 2 Includes net impairment losses recognized in earnings, other net gains (losses), and other income. Noninterest income decreased $39 million, or 9% in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, which was primarily driven by lower deposit fees, mortgage banking income and gains on sales of securities offset by an increase in other income. Mortgage banking fees decreased $29 million for the three months ended September 30, 2013, due to lower origination volume and increased retention in portfolio. Other income increased $27 million for the three months ended September 30, 2013, primarily driven by a $20 million improvement in customer derivatives credit quality. Noninterest income for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012 was down slightly, primarily driven by lower deposit, ATM and debit card fee income offset by net gains earned on the sale of higher yielding investment securities. Lower transaction volumes contributed to the $7 million decline in ATM and debit card fee income for the nine months ended September 30, Higher mortgage servicing rights valuations in the period were offset by a decline in sales activity as more loans were kept in portfolio, which resulted in a slight decline in mortgage banking income for the nine months ended September 30,

11 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NONINTEREST EXPENSE The following table displays the significant components of total noninterest expense: Three Months Nine Months Ended September 30, Increase Ended September 30, Increase (dollars in millions) (Decrease) (Decrease) 1 Salaries and employee benefits $403 $407 (1%) $1,261 $1,265 (0%) Outside Services Occupancy (4) Equipment expense Amortization of other intangible assets Promotional expense (18) (13) Goodwill impairment ,435 - NM Other operating expense (11) (34) Total noninterest expense $788 $791 (0%) $6,861 $2,561 NM Total noninterest expense excluding goodwill impairment 2 $788 $791 (0%) $2,426 $2,561 (5%) 1 NM - not meaningful 2 Excludes the $4.4 billion goodwill impairment and is a non-gaap financial measure. Total noninterest expense for the three months ended September 30, 2013 remained flat compared to the three months ended September 30, Noninterest expense increased $4.3 billion for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012, due to the goodwill impairment described below of $4.4 billion recorded in the second quarter of Excluding the impact of the impairment, noninterest expense decreased $135 million, or 5% in the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012, which included a $138 million charge to settle overdraft fee litigation that occurred in the first quarter of Excluding the impact of the impairment and litigation, noninterest expense remained flat. U.S. GAAP requires the Company to review goodwill for impairment annually, or more frequently if events or circumstances indicate any of its business units fair value might be less than its carrying value. RBS Citizens allocates its goodwill to two reporting units Retail Banking and Commercial Banking. The valuation of goodwill is dependent on forward-looking expectations related to the performance of the U.S. economy and the associated financial performance of the Company. The prolonged delay in the full recovery of the U.S. economy, and the impact of that delay on earnings expectations, prompted a goodwill impairment test as of June 30, Although the U.S. economy has demonstrated signs of recovery, notably improvements in unemployment and housing, the pace and extent of recovery in these indicators, as well as in overall Gross Domestic Product, have lagged previous expectations. The impact of the slow recovery is most evident in the Company s Retail Banking reporting unit. The latest forecasted economic growth for the U.S., coupled with the continuing impact of the new regulatory framework in the financial industry, have resulted in a deceleration of expected growth for the Retail Banking reporting unit s future profits, and an associated goodwill impairment. After recording the impairment charge in the Retail Banking reporting unit, the remaining carrying value of goodwill is $6.9 billion. In 2008, RBS Citizens recorded a similar goodwill impairment charge of $1.5 billion in its U.S. GAAP based reports and at that time also recorded a $6.4 billion goodwill impairment charge under IFRS in RBS Group s consolidated results. No similar charge is warranted under IFRS in 2013, and the carrying value of RBS Citizens goodwill under an IFRS basis is now comparable to that reported under U.S. GAAP. 9

12 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PROVISION FOR INCOME TAXES The provision for income taxes was $76 million and $123 million, for the three months ended September 30, 2013 and 2012, respectively. The provision represents an actual 34.6% effective tax rate for the three months ended September 30, 2013 and a projected annualized 37.0% effective tax rate for the three months ended September 30, The decrease in the effective rate from 2012 to 2013 represents the tax rate impact of a 2012 state tax settlement. The provision (benefit) for income taxes was ($98) million and $318 million, for the nine months ended September 30, 2013 and 2012, respectively. The provision represents an actual 2.7% effective tax rate for the nine months ended September 30, 2013 and a projected annualized 37.0% effective tax rate for the nine months ended September 30, The decrease in the effective rate from 2012 to 2013 represents the tax rate impact of the 2013 goodwill impairment in addition to the tax rate impact of a 2012 state tax settlement. Goodwill not deductible for tax purposes comprised 78.4% of the total goodwill impairment charge and generated a 33.1% reduction in the effective tax rate for the nine month period ended September 30, ANALYSIS OF FINANCIAL CONDITION SECURITIES AVAILABLE FOR SALE ( AFS ) RBS Citizens securities portfolio is managed to promote the maximization of return while maintaining prudent levels of quality, market risk and liquidity. Substantially all of the Company s AFS securities are held for asset and liability management and liquidity management purposes. The table below presents RBS Citizens AFS portfolio. See further discussion of the Company s AFS portfolio in the Condensed Consolidated Financial Statements. September 30, 2013 December 31, 2012 Increase (dollars in millions) Amort. Cost Fair Value Amort. Cost Fair Value (Decrease) in Fair Value U.S. Treasury $15 $15 $15 $15 0% State and political subdivisions (52) Mortgage-backed securities: Federal agencies and U.S. government sponsored entities 17,646 17,722 16,368 16,904 5 Other / non-agency 2,169 2,117 1,452 1, Total mortgage-backed securities 19,815 19,839 17,820 18,301 8 Total debt securities 19,841 19,864 17,855 18,337 8 Marketable equity securities Other equity securities Total equity securities Total available for sale securities $19,863 $19,888 $17,872 $18,356 8% The fair value of AFS securities increased by $1.5 billion in the nine months ended September 30, 2013, or 8%, compared to December 31, U.S. Government-guaranteed notes and government sponsored entity issued mortgage backed securities ( MBS ) comprise the majority of AFS holdings. Reinvestments have been directed predominantly into fixed rate products, and as of September 30, 2013, the AFS portfolio had an average expected life of 4.75 years. As longterm interest rates rose during the quarter, reinvestment of agency MBS cash flows was more aggressive than recent prior quarters. The Other non-agency MBS inventory, which had been in run off mode for quite some time, also reinvested cash flows back into the market. Recent movement in longer-term rates and improved credit support has prompted the bank to purchase back into this sector starting in early third quarter of

13 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the three months ended September 30, 2013, AFS portfolio interest income was $113 million, down $25 million from 2012, and the yield on the portfolio was 2.46%. The portfolio yield decreased 16 bps driven by faster prepayments in the MBS portfolio coupled with related sales. MBS cash flows and sales, net of purchases, during the third quarter 2013 totaled $551 million. MBS purchases during the third quarter 2013 totaled $5.1 billion. Additionally, sales conducted during 2013 decreased the net yield on the portfolio. LOANS AND LEASES The following table shows the composition of total loans and leases. See further discussion of the Company s loan and lease portfolio in the Condensed Consolidated Financial Statements. September 30, December 31, Increase (dollars in millions) (Decrease) Commercial $28,984 $28,856 0% Commercial real estate 6,524 6,459 1 Leases 3,576 3,415 5 Total commercial 39,084 38,730 1 Residential mortgages 29,762 31,101 (4) Home equity products serviced by others 2,281 2,960 (23) Other secured retail 10,427 10,568 (1) Unsecured retail 3,939 3,889 1 Total retail 46,409 48,518 (4) Total loans and leases $85,493 $87,248 (2%) RBS Citizens loans and leases are disclosed in portfolio segments and classes. The Company s loan and lease portfolio segments are commercial and retail. The classes of loans and leases are: commercial, commercial real estate, leases, residential (includes residential mortgages and home equity loans and lines of credit), home equity products serviced by others (includes certain purchased home equity loans and lines of credit), other secured retail (includes automobile loans and other installment loans), and unsecured retail (includes student loans and credit card). Loan balances as of September 30, 2013, compared to December 31, 2012, reflect growth in total commercial offset by decreases, primarily in home equity products serviced by others and residential mortgages. The following table is a summary of loans and leases by remaining maturity or re-pricing date: September 30, December 31, Increase (dollars in millions) (Decrease) Due in one year or less $46,846 $46,110 2% Due after one year through five years 15,902 16,588 (4) Due after five years 22,745 24,550 (7) Total loans and leases $85,493 $87,248 (2%) 11

14 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ALLOWANCE FOR CREDIT LOSSES & NONPERFORMING ASSETS Overall Asset Quality RBS Citizens portfolio of retail and commercial loans and leases totaled $85.5 billion at September 30, 2013, down approximately 2.0% from $87.2 billion at December 31, 2012, and increased slightly from the June 30, 2013 balance. The portfolio is discussed in segments consisting of commercial and retail. In line with the Company s business strategy to have a more balanced retail and commercial business mix, the commercial portfolio, which totaled $39.1 billion (or 45.7% of the total portfolio) at September 30, 2013, up from $38.7 billion, or 44.4%, at year-end December 31, The retail portfolio declined by $2.1 billion to $46.4 billion over the same period. The allowance for credit losses at September 30, 2013 was $1.3 billion, an increase of $14 million or 1.1% from June 30, Overall credit performance is measured in terms of the net charge-off rate (net loans charged off as uncollectible as a percentage of total loans and leases), delinquency rate (total loans and leases past due 30 or more days as a percentage of total loans and leases), nonperforming loans & leases ratio (nonperforming loans & leases as a percentage of total loans & leases), and criticized commercial loans (consisting of special mention, substandard and doubtful) as a percentage of total loans and leases. Charge-offs incurred in connection with additional troubled debt restructuring ( TDR ) recognition led to a slightly higher allowance / nonperforming loans ratio of 72.1% at September 30, 2013 compared to the June 30, 2013 ratio of 68.5%. Approximately $608 million ($80 million in commercial and $528 million of retail) of nonperforming loans attract no specific reserve (as these are largely TDRs that have already been charged down to market value). Removing the TDRs (with zero reserve) from the nonperforming loans increased the allowance / nonperforming loans ratio to 112.5% from 111.1% in the second quarter. The total loan portfolio credit performance continued to improve in The net charge-off rate fell to 0.6% (annualized) through the nine months ended September 2013, and is much improved from 1.0% for the full year The delinquency rate improved to 1.9% in September 2013 from 2.5% at year-end Nonperforming loans were nearly unchanged at 2.0% ($1.7 billion) of the portfolio in September 2013 versus 2.1% in December Commercial Asset Quality RBS Citizens commercial portfolio consists of traditional commercial and commercial real estate businesses. The portfolio is focused primarily on high quality, in-footprint customers where the Company s local delivery model provides for strong client connectivity with its bank subsidiaries. Modest growth of $354 million, or 0.9%, was achieved in the commercial portfolio from December 31, 2012 with the portfolio ending at $39.1 billion at September 30, Meanwhile non-core assets continued to decrease, down 31% to $575 million for the nine months ended September 30, The improving credit quality trends of 2012 continued over the first three quarters in Total criticized assets have declined 24% ending at $2.3 billion with even greater improvement in classified assets (substandard and doubtful) down 30% for the nine months ended September 30, Nonperforming commercial balances have declined by $270 million, or 44%, and ended the period at $340 million while losses are near historic low levels. Actual gross charge-offs totaled $72 million for the nine months ended September 30, 2013, resulting in net charge-offs of only $3 million due to strong recoveries. On an annualized basis, gross losses are down 63% over year-end 2012 and net charge-offs are down 98%. Retail Asset Quality RBS Citizens retail portfolio remains predominately focused on lending across the New England, Mid-Atlantic, and Midwest regions, with continued geographic expansion in the vehicle secured business. Originations within the footprint are primarily initiated through the branch network whereas out-of-footprint lending is driven by dealer networks (indirect auto). The retail portfolio balance as of September 30, 2013 decreased $2.1 billion, or 4.3%, from December 31, 2012, driven by continued run-off of the non-core serviced-by-others ( SBO ) portfolio and general attrition across certain core portfolios. The annualized net charge-off rate (core and non-core) of 1.1% in the third quarter of 2013, decreased 41 bps from prior year, driven by improved performance across all lines of business except the home equity line of credit ( HELOC ) portfolio, which is experiencing elevated delinquencies and losses. This unfavorable trend is driven by payment shock for customers exiting the ten year interest-only draw period who then face either a final balloon payment or 12

15 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS increased payments associated with contractual amortization. To mitigate this structural and industry wide phenomenon, a comprehensive plan has been initiated to manage the $3.4 billion (20% of the total HELOC portfolio) of current balances expected to mature by December The overall rate of delinquency more than 30 days past due improved 32 bps to 2.7% as of September 30, 2013 from 3.0% as of December 31, 2012, driven by favorable movement across all retail lines of business, excluding the aforementioned HELOC portfolio. While delinquencies are trending favorably, nonperforming loans at 2.9% in the third quarter of 2013 increased 32 bps from December 31, 2012 as a result of the placement of certain performing TDRs on nonaccrual status, as required by regulatory guidance. At September 30, 2013, the balance of cash basis impaired retail loans was $176 million and $5 million of cash basis income was recorded on these loans or the nine months ended September 30, The credit composition of the portfolio and new business remained strong and well-positioned across all product lines with an average refreshed Fair Isaac Company credit score ( FICO ) of 753 (Prime) and real estate combined loan-tovalue ( CLTV ) of 70.7% as of September 30, Excluding the SBO portfolio, the real estate CLTV was 67.8% as of September 30, This is compared to an average credit score of 754 and a CLTV of 74.8% as of December 31, Excluding the SBO portfolio, the CLTV was 71.4% as of December 31, The favorable reduction in CLTV was driven by recent improvements in home values and higher quality originations. New origination credit quality composition yearto-date through September 2013 exhibited even stronger credit characteristics relative to the rest of the retail portfolio, with an average FICO of 776 (Super Prime) and CLTV of 64.2%. NON-CORE ASSETS Non-core assets are primarily loans that do not fit the current strategy of RBS Citizens due to geographic location, industry or product type. These loans have been actively managed down since June 30, Since designating certain loans and other assets as non-core in 2009, RBS Citizens has run-off approximately $8.5 billion, charged off $3.8 billion, transferred $2.7 billion to the core portfolio, and sold $1.3 billion. Non-core balances have now declined nearly 80% since the designation of the non-core portfolios. In 2013, total non-core assets have continued to decline with third quarter balances of $4.2 billion, down $890 million, or 17.6%, in the third quarter and $1.5 billion, 26.9%, in the first nine months of Commercial non-core balances are down 31% year-to-date at $575 million while the larger retail balances of $3.5 billion have reduced $1.3 billion, or 26%. The larger than normal decrease in the third quarter was driven by a non-core to core transfer of $585 million of conforming student, SBO and residential mortgage loans. The table below is a composition of RBS Citizens non-core assets as of the dates indicated: (Date of Designation) September 30, December 31, June 30, Decrease Decrease (dollars in millions) from 2012 from 2009 Commercial $127 $187 $1,900 (32%) (93%) Commercial real estate ,412 (30) (87) Total commercial ,312 (31) (89) Residential mortgages 741 1,012 2,082 (27) (64) Home equity products serviced by others 2,357 2,897 6,180 (19) (62) Other secured retail - - 4,037 - (100) Unsecured retail ,490 (52) (83) Total retail 3,519 4,778 14,789 (26) (76) Other assets (24) (79) Total non-core assets $4,175 $5,714 $20,479 (27%) (80%) 13

16 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Year-to-date charge-off trends in non-core continue to improve with commercial reporting $6 million in net charge-offs and retail reporting $154 million in net charge-offs versus $23 million and $286 million, respectively, for the same period in Charge-off rates are better than expected across commercial and retail non-core assets, currently supported by reduced delinquencies and displaying a solid improvement over the same period in The private student loan portfolio, which makes up 12% of the retail book, accounted for 26% of the net retail non-core charge-offs. Commercial real estate accounts for 77.9% of the commercial non-core balances and most of the net charge-offs in Likewise, the home equity balances, originally SBO, comprise 67% of the retail non-core balances and account for 64% of the net charge-offs. The SBO portfolio is a liquidating portfolio consisting of pools of home equity loans and lines of credit purchased between 2003 and The SBO book has been closed to new purchases since the third quarter of 2007, with exposure down to $2.4 billion as of September 30, 2013 from $2.9 billion as of December 31, This portfolio represents 7.4% of the entire retail real estate portfolio and 5.1% of the overall retail portfolio as of September 30, The SBO portfolio has a forecasted full year charge-off rate of 4.9% through September 30, 2013 and a cumulative charge-off rate of 26.2% as of September 30, The elevated charge-off rate is attributed to out-of-footprint geographies (CA, NV, AZ, and FL), high (95%) second lien concentration, and high loan-to-value exposure. Performance on SBO continues to improve with delinquencies and losses decreasing steadily. The 90+ delinquency rate continues to trend lower at 1.6% as of September 30, 2013, a 22 bps reduction from December 31, The continued improvement in performance is driven by portfolio liquidation (the weakest loans have been charged off), as well as more effective account servicing and collection strategies. Non-core assets are expected to continue to decline through a combination of the factors described above. DERIVATIVES Historically, RBS Citizens has used plain vanilla pay-fixed swaps to synthetically lengthen liabilities, offsetting duration in fixed-rate assets. With material prepayment of fixed-rate mortgages and home equity loans since 2008, these swaps were no longer needed. Most have been terminated or allowed to run-off. The Company implemented a new hedging program during the quarter ended March 31, 2013 to help partially offset the margin gap created by a downsized investment portfolio and reduce overall balance sheet asset sensitivity. The Company uses plain vanilla receive-fixed swaps to minimize the exposure to variability in the interest cash flows on its floating rate assets. This is reflected in the interest rate swaps line in the table below. As of September 30, 2013, $4 billion receive-fixed swaps had been executed. The assets and liabilities for derivatives designated as hedges reflect the market value of these hedge instruments. The Company also sells interest rate swaps and foreign exchange forwards to commercial customers. Offsetting swap and forward agreements are simultaneously transacted to effectively eliminate the Company s market risk associated with the customer derivative products. The assets and liabilities for derivatives not designated as hedges reflect the market value of these transactions. 14