RBS 2012 Annual Report Download - page 413

RBS GROUP 2012
411
The fair value is the amount an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm's length
transaction. Quoted market values are used where available; otherwise,
fair values have been estimated based on discounted expected future
cash flows and other valuation techniques. These techniques involve
uncertainties and require assumptions and judgments covering
prepayments, credit risk and discount rates. Furthermore there is a wide
range of potential valuation techniques. Changes in these assumptions
would significantly affect estimated fair values. The fair values reported
would not necessarily be realised in an immediate sale or settlement.
The fair values of intangible assets, such as core deposits, credit card
and other customer relationships are not included in the calculation of
these fair values as they are not financial instruments.
The assumptions and methodologies underlying the calculation of fair
values of financial instruments at the balance sheet date are as follows:
For certain short-term financial instruments, fair value approximates to
carrying value: cash and balances at central banks, items in the course of
collection from other banks, settlement balances, items in the course of
transmission to other banks and demand deposits.
Loans and advances to banks and customers
In estimating the fair value of loans and advances to banks and
customers measured at amortised cost, the Group’s loans are
segregated into appropriate portfolios reflecting the characteristics of the
constituent loans. Two principal methods are used to estimate fair value:
(a) Contractual cash flows are discounted using a market discount rate
that incorporates the current spread for the borrower or where this is
not observable, the spread for borrowers of a similar credit standing.
This method is used for portfolios where counterparties have external
ratings: large corporate loans in UK Corporate and institutional and
corporate lending in International Banking and Markets.
(b) Expected cash flows (unadjusted for credit losses) are discounted at
the current offer rate for the same or similar products. This approach
is adopted for lending portfolios in UK Retail, Ulster Bank, US Retail
& Commercial and Wealth and SME loans in UK Corporate reflecting
the homogeneous nature of these portfolios.
For certain portfolios where there are very few or no recent transactions,
such as Ulster Bank’s commercial real estate portfolio, and high loan to
value mortgages, a bespoke approach is used based on available market
data.
The discount to amortised cost predominantly reflects stressed markets
for commercial real estate loans, in both Non-Core and Core as well as
high loan to value tracker mortgages.
Debt securities
Fair values are determined using discounted cash flow valuation
techniques.
Deposits by banks and customer accounts
Fair values of deposits are estimated using discounted cash flow
valuation techniques.
Debt securities in issue and subordinated liabilities
Fair values are determined using quoted prices where available or by
reference to valuation techniques, adjusting for own credit spreads where
appropriate.