Bank of Scotland plc Report and Accounts 2020 Member of Lloyds Banking Group Bank of Scotland plc Contents Strategic report 2 Directors’ report 10 Directors 14 Forward looking statements 15 Independent auditors’ report 16 Consolidated income statement 25 Statements of comprehensive income 26 Balance sheets 28 Statements of changes in equity 30 Cash flow statements 32 Notes to the accounts 33 Subsidiaries and related undertakings 122 Registered office: The Mound, Edinburgh EH1 1YZ. Registered in Scotland No. 327000 Bank of Scotland plc Strategic report Principal activities Bank of Scotland plc (the Bank) and its subsidiaries (together, the Group) provide a wide range of banking and financial services. The Group’s revenue is earned through interest and fees on a broad range of financial services products including current and savings accounts, personal loans, credit cards and mortgages within the retail market; loans and other products to commercial, corporate and asset finance customers; and private banking. Business review In the year to 31 December 2020, the Group recorded a profit before tax of £883 million compared to £1,278 million in the year to 31 December 2019. Total income decreased by £886 million, or 15 per cent, to £5,147 million in the year ended 31 December 2020 compared to £6,033 million in 2019 with a £220 million decrease in net interest income combined with a reduction of £666 million in other income. Net interest income was £5,208 million in the year ended 31 December 2020, a decrease of £220 million, or 4 per cent compared to £5,428 million in 2019 reflecting the lower rate environment, actions taken during the year to support customers and reduced levels of customer activity and demand during the coronavirus pandemic. Other income was £666 million lower at a net loss of £61 million in the year ended 31 December 2020 compared to a net gain of £605 million in 2019. Net fee and commission income was £121 million lower at £199 million in the year ended 31 December 2020 compared to £320 million in 2019, reflecting lower levels of customer activity, largely due to the coronavirus pandemic. Net trading income was £614 million lower at a net loss of £369 million in the year ended 31 December 2020 due to losses incurred on hedging arrangements entered into with fellow Lloyds Banking Group undertakings. Other operating income was £69 million higher at £109 million in the year ended 31 December 2020 compared to a net gain of £40 million in 2019. Total operating expenses of £2,642 million were 39 per cent lower than in 2019, driven by significantly lower regulatory provisions and continued reductions in other operating expenses. Regulatory provisions benefitted from a £1,040 million reduction in charges in respect of payment protection insurance compared to 2019. Other operating expenses were down £553 million, driven by lower staff costs and ongoing cost management. Impairment losses increased by £1,172 million to £1,622 million in the year ended 31 December 2020 compared with £450 million in 2019, largely reflecting potential future losses in light of the Group’s revised economic outlook for the UK as a consequence of the coronavirus pandemic. The tax credit for the year ended 31 December 2020 was £30 million representing an effective negative tax rate of 3 per cent compared to a tax expense of £604 million in 2019 representing an effective tax rate of 47 per cent. This is primarily as a result of a credit of £182 million on remeasurement of the Group’s deferred tax balances following the UK government’s decision to maintain the corporation tax rate at 19 per cent, which was substantively enacted on 17 March 2020. Total assets were £65,446 million lower at £310,328 million at 31 December 2020 compared to £375,774 million at 31 December 2019. Loans and advances to customers increased in the year by £5,451 million to £263,766 million, compared to £258,315 million at 31 December 2019, driven by open mortgage book growth reflecting the strength of the UK housing market. Amounts due from fellow Lloyds Banking Group undertakings were £68,546 million lower at £28,988 million compared to £97,534 million at 31 December 2019 as a result of increased levels of settlement activity during 2020. Customer deposits were £11,156 million higher at £163,001 million at 31 December 2020 compared to £151,845 million at 31 December 2019 as a result of lower levels of customer spending during the pandemic and inflows to the Group’s trusted brands. Amounts due to fellow Lloyds Banking Group undertakings were £69,665 million lower at £91,953 million at 31 December 2020 compared to £161,618 million at the previous year end, as a result of increased levels of settlement activity during 2020. Total equity increased by £298 million from £13,090 million at 31 December 2019 to £13,388 million at 31 December 2020 with total comprehensive income of £929 million and the issue of £1,000 million of other equity instruments more than offsetting £1,500 million of redemptions and £164 million of distributions on other equity instruments. The Bank’s common equity tier 1 capital ratio increased to 15.5 per cent (31 December 2019: 13.5 per cent), largely reflecting profits for the year, with the impact of the impairment charge partially mitigated through the increase in IFRS 9 transitional relief for capital. The tier 1 capital ratio increased to 19.1 per cent (31 December 2019: 18.2 per cent) following the increase in common equity tier 1 capital, partially offset by a net reduction in AT1 instruments following a redemption and the subsequent issuance of a new instrument. The total capital ratio increased to 22.1 per cent (31 December 2019: 22.0 per cent) reflecting the increase in tier 1 capital, largely offset by a reduction in tier 2 capital which reflected movements in the regulatory value of tier 2 instruments, partially offset by the issuance of a new tier 2 instrument and a net increase in eligible provisions and other adjustments. Risk-weighted assets reduced by £29 million to £61,304 million at 31 December 2020 compared to £61,333 million at 31 December 2019, with reductions in operational and market risk-weighted assets broadly offset by an increase in credit risk-weighted assets driven by open mortgage book growth, credit migrations and retail model calibrations and updates. Post-tax return on average assets was stable at 0.2 per cent. 2 Bank of Scotland plc Strategic report Future developments Information about future developments is provided with the Principal risks and uncertainties section below. Capital position at 31 December 2020 Following a change in approach, the capital position of Bank of Scotland plc is now restated on the basis of the Bank where previously this was presented on the basis of the Group. Prior period comparatives reflect the position of the Bank at 31 December 2019. The Bank’s capital position as at 31 December 2020, applying transitional rules in respect of legacy capital securities subject to current grandfathering provisions and IFRS 9 transitional arrangements, is set out in the following section. Bank capital ratios (audited) At 31 December At 31 December 2020 2019 Capital resources (transitional) £m £m Common equity tier 1 Shareholders’ equity per balance sheet 10,770 9.972 Cash flow hedging reserve 45 41 Other adjustments 771 246 11,586 10,259 Less: deductions from common equity tier 1 Goodwill and other intangible assets (470) (461) Prudent valuation adjustment (79) (92) Removal of defined benefit pension surplus (50) (37) Deferred tax assets (1,477) (1,362) Common equity tier 1 capital 9,510 8,307 Additional tier 1 Additional tier 1 instruments 2,221 2,872 Total tier 1 capital 11,731 11,179 Tier 2 Tier 2 instruments 1,943 2,572 Eligible provisions and other adjustments (97) (232) Total tier 2 capital 1,846 2,340 Total capital resources 13,577 13,519 Risk-weighted assets (unaudited) 61,304 61,333 Common equity tier 1 capital ratio1 15.5% 13.5% Tier 1 capital ratio1 19.1% 18.2% Total capital ratio1 22.1% 22.0% 1 Reflecting the full impact of IFRS 9 at 31 December 2020, without the application of transitional arrangements, the Bank’s common equity tier 1 capital ratio would be 14.2 per cent, the tier 1 capital ratio would be 17.8 per cent and the total capital ratio would be 21.4 per cent. 3 Bank of Scotland plc Strategic report Table 1.2: Risk-weighted assets (unaudited)‌‌‌‌ At 31 December At 31 December 2020 2019 £m £m Risk-weighted assets (Bank) Foundation Internal Ratings Based (IRB) Approach 4,245 4,500 Retail IRB Approach 39,137 36,696 Other IRB Approach 1,958 1,778 IRB Approach 45,340 42,974 Standardised Approach 5,815 7,278 Credit risk 51,155 50,252 Counterparty credit risk 473 481 Credit valuation adjustment risk 100 78 Operational risk 8,801 9,357 Market risk 220 492 Underlying risk-weighted assets 60,749 60,660 Threshold risk-weighted assets 555 673 Total risk-weighted assets 61,304 61,333 4 Bank of Scotland plc Strategic report Section 172(1) Statement In accordance with the Companies Act 2006 (the ‘Act’), the Directors provide this statement describing how they have had regard to the matters set out in section 172(1) of the Act, when performing their duty to promote the success of the Bank, under section 172. This statement also provides details of how the Directors have engaged with and had regard to the interests of key stakeholders.