RBS 2012 Annual Report Download - page 409

RBS GROUP 2012
407
Other considerations
Valuation adjustments
CVA applied to derivative exposures to other counterparties and own
credit adjustments applied to derivative liabilities (DVA) are calculated on
a portfolio basis. Whilst the methodology used to calculate each of these
adjustments references certain inputs which are not based on observable
market data, these inputs are not considered to have a significant effect
on the net valuation of the related portfolios. The classification of the
derivative portfolios which the valuation adjustments are applied to is not
determined by the observability of the valuation adjustments, and any
related sensitivity does not form part of the level 3 sensitivities presented.
CVA is calculated by applying expected losses to potential future
exposures whilst DVA is calculated by applying expected gains to
potential future liabilities. Expected losses and gains are determined from
market implied probability of defaults and internally assessed recovery
levels. The probability of default is calculated with reference to
observable credit spreads and observable recovery levels. For
counterparties where observable data do not exist, the probability of
default is determined from the credit spreads and recovery levels of
similarly rated entities. A weighting is applied to arrive at the expected
loss or gain. The weighting reflects portfolio churn and varies according
to counterparty credit quality and hedging considerations.
The unobservable inputs include certain inputs used in the calculation of
potential future exposures and liabilities, probabilities of default, and
recovery levels together with the weightings applied. Reasonably
possible alternative assumptions of unobservable inputs result in a
favourable valuation movement of £68 million and an unfavourable
valuation movement of £216 million.
Funding valuation adjustments
The discount rates applied to derivative cash-flows in determining fair
value reflect any underlying collateral agreements. Collateralised
derivatives are generally discounted at the relevant OIS rates whilst
uncollateralised derivatives are discounted with reference to funding
levels. Whilst the discount rates applied reference certain inputs which
are not based on observable market data, these inputs are not
considered to have a significant effect on the valuation of the individual
trades. The classification of derivatives is not determined by the
observability of the discount rates applied, and any related sensitivity
does not form part of the level 3 sensitivities presented.
Reasonably possible alternative assumptions of unobservable inputs
used to determine discount rates applied to collateralised derivatives
result in a favourable valuation movement of £23 million and an
unfavourable valuation movement of £23 million.
Own credit - issued debt
For issued debt and structured notes the own credit adjustment is based
on debt issuance spreads above average inter-bank rates (at a range of
tenors). Whilst certain debt issuance spreads are not based on
observable market data, these inputs are not considered to have a
significant effect on the valuation of individual trades. The classification of
issued debt and structured notes is not determined by the observability of
the debt issuance spreads applied, and any related sensitivity does not
form part of the level 3 sensitivities presented.