RBS 2011 Annual Report Download - page 458

456 RBS Group 2011
Risk factors continued
Financial services institutions that deal with each other are inter-related
as a result of trading, investment, clearing, counterparty and other
relationships. Within the financial services industry, the default of any one
institution could lead to defaults by other institutions. Concerns about, or
adefault by, one institution could lead to significant liquidity problems and
losses or defaults by other institutions, as the commercial and financial
soundness of many financial institutions may be closely related as a
result of this credit, trading, clearing and other relationships. Even the
perceived lack of creditworthiness of, or questions about, a counterparty
may lead to market-wide liquidity problems and losses for, or defaults by,
the Group. This systemic risk may adversely affect financial
intermediaries, such as clearing agencies, clearing houses, banks,
securities firms and exchanges with which the Group interacts on a daily
basis, all of which could have a material adverse effect on the Group’s
access to liquidity or could result in losses which could have a material
adverse effect on the Group’s financial condition, results of operations
and prospects or result in a loss of value in its securities.
In the US during recent years, there has been disruption in the ability of
certain financial institutions to complete foreclosure proceedings in a
timely manner (or at all), including as a result of interventions by certain
states and local governments. This disruption has lengthened the time to
complete foreclosures, increased the backlog of repossessed properties
and, in certain cases, has resulted in the invalidation of purported
foreclosures. In addition, a number of other financial institutions have
experienced increased repurchase demands in respect of US mortgage
loans or other related securities originated and sold. However, the Group
has not experienced a significant volume of repurchase demands in
respect of similar loans or related securities it originated or sold and has
not ceased any of its US foreclosure activities.
The trends and risks affecting borrower and counterparty credit quality
have caused, and in the future may cause, the Group to experience
further and accelerated impairment charges, increased repurchase
demands, higher costs, additional write-downs and losses for the Group
and an inability to engage in routine funding transactions, and may result
in a loss of value of its securities.
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
Financial markets continue to be subject to significant stress conditions,
where steep falls in perceived or actual asset values have been
accompanied by a severe reduction in market liquidity, as exemplified by
losses 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. 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 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. Valuations in
future periods, reflecting, among other things, 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, even 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. Any of these factors
could require the Group to recognise further significant write-downs in
addition to those already recorded or realised or realise increased
impairment charges, which may have a material adverse effect on its
financial condition, results of operations and capital ratios or result in a
loss of value of its securities.
The value or effectiveness of any credit protection that the Group has
purchased depends on the value of the underlying assets and the
financial condition of the insurers and counterparties
The Group has credit exposure arising from over-the-counter derivative
contracts, mainly credit default swaps (CDSs), and other credit
derivatives, such as the APS, each of which are carried at fair value. The
fair value of these CDSs, as well as the Group’s exposure to the risk of
default by the underlying counterparties, depends on the valuation and
the perceived credit risk of the instrument against which protection has
been bought. Market counterparties have been adversely affected by
their exposure to residential mortgage linked and corporate credit
products, whether synthetic or otherwise, and their actual and perceived
creditworthiness may deteriorate rapidly. If the financial condition of these
counterparties or their actual or perceived creditworthiness deteriorates,
the Group may record further credit valuation adjustments on the credit
protection bought from these counterparties under the CDSs. The Group
also recognises any fluctuations in the fair value of other credit
derivatives, such as the APS. If market conditions improve and credit
spreads for assets covered by the APS narrow, the value of the
protection decreases and a loss is recognised. If credit spreads widen,
the protection is more valuable, giving rise to a gain. Any such
adjustments or fair value changes may have a material adverse impact
on the Group’s financial condition and results of operations.
Additional information continued