RBS 2009 Annual Report Download - page 196

Business review continued
RBS Group Annual Report and Accounts 2009194
2009 2008 2007
£m £m £m
Gross exposure to monolines 6,170 11,581 3,409
Hedges with financial institutions (531) (789) —
Credit valuation adjustment (3,796) (5,988) (862)
Net exposure to monolines 1,843 4,804 2,547
CVA as a % of gross exposure 62% 52% 25%
Key points
•The exposure to monoline insurers has decreased considerably during 2009 due to a combination of restructuring certain exposures and higher
prices of underlying reference instruments. The trades with monoline insurers are predominantly denominated in US dollars, and the strengthening
of sterling against the US dollar during 2009 has further reduced the exposure.
•The overall level of CVA has decreased, in line with the reduction in exposure to these counterparties. However, relative to the exposure to monoline
counterparties, the CVA has increased from 52% to 62% due to a combination of wider credit spreads and lower recovery rates. These moves have
been driven by deterioration in the credit quality of the monoline insurers as evidenced by rating downgrades (as shown in the table on the
following page, together with the Group’s exposure to monoline insurers by asset category).
RWAs*
Counterparty and credit RWAs relating to risk structures incorporating gross monoline exposures increased from £7.3 billion to £13.7 billion over the
year. The increase was driven by revised credit risk assessments of these counterparties in the first nine months of the year, partially off-set by
reductions in the last quarter due to restructuring.
Market turmoil exposures continued
Credit valuation adjustments continued
Monoline insurers
The Group has purchased protection from monolines, mainly against
specific asset-backed securities. Monolines specialise in providing
credit protection against the principal and interest cash flows due to the
holders of debt instruments in the event of default by the debt
instrument counterparty. This protection is typically held in the form of
derivatives such as credit default swaps (CDSs) referencing underlying
exposures held directly or synthetically by the Group.
The gross mark-to-market of the monoline protection depends on the
value of the instruments against which protection has been bought. A
positive fair value, or a valuation gain, in the protection is recognised if
the fair value of the instrument it references decreases. For the majority
of trades the gross mark-to-market of the monoline protection is
determined directly from the fair value price of the underlying reference
instrument. For the remainder of the trades the gross mark-to-market is
determined using industry standard models.
The methodology employed to calculate the monoline CVA uses CDS
spreads and recovery levels to determine the market’s implied level of
expected loss on monoline exposures of different maturities. CVA is
calculated at a trade level by applying the expected loss corresponding
to each trade’s expected maturity to the gross mark-to-market of the
monoline protection. The expected maturity of each trade reflects the
scheduled notional amortisation of the underlying reference instruments
and whether payments due from the monoline insurer are received at
the point of default or over the life of the underlying reference
instruments.
The table below summarises the Group’s exposure to monolines; all of
which are in the Non-Core division.
* unaudited