RBS 2012 Annual Report Download - page 215

RBS GROUP 2012
213
Asset-backed securities
Introduction
The Group structures, originates, distributes and trades debt in the form
of loan, bond and derivative instruments in all major currencies and debt
capital markets in North America, Western Europe, Asia and major
emerging markets. The carrying value of the Group's debt securities is
detailed below.
The Group’s credit market activities gave rise to risk concentrations in
asset-backed securities (ABS). The Group has exposures to ABS, which
are predominantly debt securities, but can also be held in derivative form.
ABS have an interest in an underlying pool of referenced assets. The
risks and rewards of the referenced pool are passed onto investors by the
issue of securities with varying seniority by a special purpose entity.
Debt securities include residential mortgage-backed securities (RMBS),
commercial mortgage-backed securities (CMBS), collateralised debt
obligations (CDOs), collateralised loan obligations (CLOs) and other
ABS. In many cases, the risk associated with these assets is hedged by
credit derivatives. The counterparties to some of these hedge
transactions are monoline insurers.
The following tables summarise the gross and net exposures and
carrying values of these securities by the location of the underlying
assets at 31 December 2012, 2011 and 2010 and by IFRS measurement
classification of held-for-trading (HFT), designated at fair value (DFV),
available-for-sale (AFS) and loans and receivables (LAR). Gross
exposures represent the principal amounts relating to ABS. Government
sponsored or similar RMBS comprises securities that are: (a) guaranteed
or effectively guaranteed by the US government, by way of its support for
US federal agencies and government sponsored enterprises or (b)
guaranteed by the Dutch government. Net exposures represent the
carrying value after taking account of protection purchased from monoline
insurers and other counterparties, but exclude the effect of counterparty
credit valuation adjustments. The hedge provides credit protection of both
principal and interest cash flows in the event of default by the
counterparty. The value of this protection is based on the underlying
instrument being protected.
Residential mortgage-backed securities
RMBS are securities that represent an interest in a portfolio of residential
mortgages. Repayments made on the underlying mortgages are used to
make payments to holders of the RMBS. The risk of the RMBS will vary
primarily depending on the quality and geographic region in which the
underlying mortgage assets are located and the credit enhancement of
the securitisation structure. Several tranches of notes are issued, each
secured against the same portfolio of mortgages, but providing differing
levels of seniority to match the risk appetite of investors. The most junior
(or equity) notes will suffer early capital and interest losses experienced
by the referenced mortgage collateral, with each more senior note
benefiting from the protection provided by the subordinated notes below.
Additional credit enhancements may be provided to the holder of senior
RMBS notes, including provided by monoline insurers.
The main categories of mortgages that serve as collateral to RMBS held
by the Group with related vintages are set out below and described in the
Glossary on pages 528 to 535. The US market has more established
definitions of differing underlying mortgage quality and these are used as
the basis for the Group's RMBS categorisation.
The Group RMBS classifications include sub-prime and non-conforming.
Non-conforming RMBS include Alt-A RMBS. Classification as sub-prime
or Alt-A is based on Fair Isaac Corporation scores (FICO), level of
documentation and loan-to-value (LTV) ratios of the underlying mortgage
loans. RMBS are classified as sub-prime if the mortgage portfolio
comprises loans with FICO scores between 500 and 650 with full or
limited documentation. Mortgages in Alt-A RMBS portfolios have FICO
scores of 640 to 720, limited documentation and an original LTV of 70%
to 100%.