RBS 2008 Annual Report Download - page 131

Business review continued
RBS Group Annual Report and Accounts 2008130
The Group’s largest concentration of RMBS assets relate to a portfolio
of US agency asset backed securities comprising mainly current year
vintage positions of £33.5 billion at 31 December 2008 (2007: £26.0
billion). Due to the US government backing explicit or implicit in these
securities, the counterparty credit risk exposure is low. The losses
arising from the movements in fair value recorded for these assets were
comparatively lower than other RMBS. Financial markets and economic
conditions have been extremely difficult in the US throughout 2008,
particularly in the last quarter. Credit conditions have deteriorated and
financial markets have experienced widespread illiquidity and elevated
levels of volatility due to forced de-leveraging. Transaction activity in the
securities portfolio has been reduced due to general market illiquidity.
Residential mortgages have been affected by the stress that consumers
experienced from depreciating house prices, rising unemployment and
tighter credit conditions, resulting in higher levels of delinquencies and
foreclosures. In particular, the deteriorating economy and financial
markets have negatively impacted the valuation, liquidity, and credit
quality of private-label securities.
Citizens maintains an available-for-sale investment securities portfolio to
provide high-quality collateral to provide a liquidity buffer and to
enhance earnings. The size of the portfolio has been relatively stable
through 2008, but both the absolute and relative size (% of earning
assets) declined in 2006-2007. The portfolio comprises high credit
quality mortgage-backed securities, to ensure both pledgeability and
liquidity. The U.S. Government guarantees on MBS, whether explicit or
implicit, put most of the portfolio in a secure credit position. The non-
agency MBS holdings derive credit support in two ways. Firstly, there is
senior and subordinated structuring, and Citizens hold only the most
senior tranches. Secondly, there is high quality supporting loan
collateral. The collateral quality is evidenced (a) by the vintages, with
82% issued in 2005 and earlier, (b) by the borrower’s weighted loan to
value (LTV) ratio of 65%, and (c) by the borrower’s weighted-average
FICO score of 734.
£7.6 billion (2007 – £6.0 billion) of the RMBS exposure consists of
available-for-sale portfolio of European RMBS in Group Treasury,
referencing primarily Dutch and Spanish government-backed loans, and
accordingly the quality of these assets has held up relative to other
RMBS types. A further £10.0 billion (2007 – £7.8 billion) European
RMBS comprised covered mortgage bonds.
The Group has other portfolios of RMBS from secondary trading
activities, warehoused positions previously acquired with the intention of
further securitisation and a portfolio of assets from the unwinding of a
securities arbitrage conduit. This conduit was established to benefit
from the margin between the assets purchased and the notes issued.
The majority of these held-for-trading RMBS have been grouped
together for management purposes.
Some of these assets (£7.0 billion) were reclassified from held-for-
trading category to the loans and receivables (£1.8 billion) and
available-for-sale categories during the year (£5.2 billion).
Overall, the Group has recognised significant fair value losses on RMBS
assets during the year due to reduced market liquidity and deteriorating
credit ratings of these assets. The Group has reduced its exposure to
RMBS predominantly through fair value hedges and asset sales during
the year. These decreases were partially offset by the weakening of
sterling relative to the US dollar and euro.
Commercial mortgage-backed securities (audited)
Commercial mortgages backed securities (CMBS) are securities that
are secured by mortgage loans on commercial land and buildings. The
securities are structured in the same way as an RMBS but typically the
underlying assets referenced will be of greater individual value. The
performance of the securities are highly dependent upon the sector of
commercial property referenced and the geographical region.
The Group accumulated CMBS for the purpose of securitisation and
secondary trading. The largest holding of CMBS arose as a result of the
Group’s purchase of senior tranches in mezzanine and high grade
CMBS structures from third parties. These securities are predominantly
hedged with monoline insurers. As a result, the Group’s risk is limited to
the counterparty credit risk exposure to the hedge. The Group also
holds CMBS arising from securitisations of European commercial
mortgages originated by the Group.
The following table shows the composition of the Groups holdings of CMBS portfolios.
2008 2007
US UK Europe ROW(1) Total US UK Europe ROW Total
£m £m £m £m £m £m £m £m £m £m
Office 435 938 402 — 1,775 599 534 ——1,133
Mixed use 32 106 1,048 45 1,231 — 73 192 — 265
Healthcare 805 143 ——948 1,210 ———1,210
Retail 295 43 17 48 403 398 13 ——411
Industry 24 13 81 — 118 61 ——100 161
Multi-family 40 — 49 — 89 48 ———48
Leisure — 76 ——76 —————
Hotel 40 35 ——75 36 ———36
Other 474 41 49 48 612 932 530 765 64 2,291
2,145 1,395 1,646 141 5,327 3,284 1,150 957 164 5,555
Note;
(1) Rest of the World.