RBS 2013 Annual Report Download - page 423
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Notes on the consolidated accounts
421
Notes:
(1) Residential mortgage-backed securities.
(2) Commercial mortgage-backed securities.
(3) Collateralised debt obligations.
(4) Collateralised loan obligations.
(5) Sensitivity represents the favourable and unfavourable effect on the income statement or the statement of comprehensive income due to reasonably possible changes to valuations using reasonably
possible alternative inputs in the Group’s valuation techniques or models. Level 3 sensitivities are calculated at a sub-portfolio level and hence these aggregated figures do not reflect the correlation
between some of the sensitivities. In particular, for some portfolios, the sensitivities may be negatively correlated where a downward movement in one asset would produce an upward movement in
another, but due to the additive presentation above, this correlation cannot be shown.
(6) Transfers between levels are deemed to have occurred at the beginning of the quarter in which the instruments were transferred.
(7) Level 1: valued using unadjusted quoted prices in active markets, for identical financial instruments. Examples include G10 government securities, listed equity shares, certain exchange-traded
derivatives and certain US agency securities.
Level 2: valued using techniques based significantly on observable market data. Instruments in this category are valued using:
(a) quoted prices for similar instruments or identical instruments in markets which are not considered to be active; or
(b) valuation techniques where all the inputs that have a significant effect on the valuations are directly or indirectly
based on observable market data.
The type of instruments that trade in markets that are not considered to be active, but are based on quoted market prices, banker dealer quotations, or alternative pricing sources with reasonable
levels of price transparency and those instruments valued using techniques include non-G10 government securities, most government agency securities, investment-grade corporate bonds, certain
mortgage products, including CLOs, most bank loans, repos and reverse repos, less liquid listed equities, state and municipal obligations, most notes issued, and certain money market securities and
loan commitments and most OTC derivatives.
Level 3: instruments in this category have been valued using a valuation technique where at least one input which could have a significant effect on the instrument’s valuation, is not based on
observable market data. Where inputs can be observed from market data without undue cost and effort, the observed input is used. Otherwise, the Group determines a reasonable level for the input.
Financial instruments primarily include cash instruments which trade infrequently, certain syndicated and commercial mortgage loans, certain emerging markets instruments, unlisted equity shares,
certain residual interests in securitisations, majority of CDOs, other mortgage-backed products and less liquid debt securities, certain structured debt securities in issue, and OTC derivatives where
valuation depends upon unobservable inputs such as certain credit and exotic derivatives. No gain or loss is recognised on the initial recognition of a financial instrument valued using a technique
incorporating significant unobservable data.
Key points
• Level 3 instruments are primarily in Markets, comprising instruments
held in the normal course of business, and Non-Core, relating to
legacy securities and derivatives positions.
• Level 3 assets of £6.8 billion represented 1.3% of the total (31
December 2012 - £10.4 billion, 1.4%), a decrease of £3.6 billion.
This reflected sales, maturities and amortisation of instruments,
particularly securities in Non-Core.
• Level 3 liabilities decreased by £0.3 billion to £4.6 billion primarily
related to settlements of instruments.
• The favourable and unfavourable effects of reasonably possible
alternative assumptions on level 3 instruments carried at fair value
were £0.7 billion (31 December 2012 - £1.0 billion) and £0.5 billion
(31 December 2012 - £0.7 billion) respectively.
• Improvements in IPV methodology (see page 412) resulted in £0.4
billion assets and £0.5 billion liabilities, principally derivatives
transfers from level 3 to level 2. Transfers from level 2 to level 3
comprised: derivatives (assets £0.9 billion and liabilities £0.5 billion),
debt securities in issue of £0.3 billion and debt securities of £0.2
billion relating to securities, primarily ABS, in Non-Core. Market
illiquidity towards the end of June was a major cause for the
transfers. There were no significant transfers between level 1 and
level 2.