Interim Results 2009. Part 1b

RNS Number : 0579X
Royal Bank of Scotland Group PLC
07 August 2009
 


Risk and capital management


Risk and capital management across the Group is based on the risk appetite set by the Board, which sets strategic direction, contributes to, and ultimately approves annual plans for each division, and regularly reviews and monitors the Group's performance in relation to risk through monthly Board reports.

Commentary and outlook

Whilst the future for many aspects of the global economy remains uncertain, it is clear that the first half of 2009 saw a decisive shift. The extreme volatility and risk aversion that characterised the end of 2008 moderated and equity and fixed income markets largely recovered value lost at the start of the year in a sustained rally that ran for most of the second quarter. Intervention by governments and central banks has prevented further failure in the world's financial system. At this point in what has already been a sharp economic slowdown, the key focus is on whether a broader economic recovery can be established, limiting the recession's duration.

For RBS, as for many of its peers, it appears that the full impact of the slowdown already witnessed has yet to be fully realised in terms of loan impairments. This is true for both retail portfolios, where unemployment is likely to rise further even if the broader economy stabilises, and corporate portfolios, where default rates have yet to peak.  The Group's investment in remedial and collection processes is therefore of major importance. The Group is committed to working with its customers to restructure debt and aid recovery wherever possible; doing so both maximises current value and supports the Group's franchises in the longer term.

As importantly, this approach drives a focus on early identification and intervention in portfolios most exposed to economic weakness. Responsibility for this rests with the Group's businesses and functions across the Group; the Group's risk management teams continue to work closely with customer and product groups to identify vulnerable customers or portfolio segments and to implement mitigation strategies.

Recovery from a slowdown as sharp as that recently experienced, especially as it will involve the correction of material imbalances in the global economy, is likely to be accompanied by periods of volatility. Whilst not anticipating a return to the extreme uncertainty and market dislocation witnessed during the past two years, a return to the extended period of extreme stability that preceded them is also not expected. The Group's profile - in both its core and non-core activities - remains such that events in many of the world's geographies and markets have the potential to impact the Group's performance.  

Effective risk management is therefore of strategic importance for RBS and refinements to the Group's risk management framework continue to be implemented. Updated limit frameworks for both credit and market risk support strategic priorities by targeting resources on areas that are core to the Group's future success.  The Group will continue to invest in people, both through recruitment and development, at all levels in the risk management organisation. Through these and other changes, the risk management framework and function are being developed to support the Group's execution against its strategic plan.



  

Risk and capital management (continued)


Risk governance 

Risk and capital management strategy is owned and set by the Group's Board of Directors, and implemented by executive management led by the Group Chief Executive. There are a number of committees and executives that support the execution of the business plan and strategy.

Refer to the Annual Report and Accounts 2008 for further information on the risk and capital management strategy, noting the following changes:

  • The Group Executive Management Committee has been replaced by the Executive Committee;

  • As a result of the Group adopting a new credit approval framework based on delegated individual authority, a new forum - the Executive Credit Group - was formed to consider, on behalf of the Board of Directors, credit applications that exceed the highest level of individual authority provided by the framework; and

  • The Group Chief Executive's Advisory Group (GCEAG) has been disbanded and its responsibilities assigned to other fora. Executive Committee and Management Committee members now meet twice weekly. The risk management scope of the GCEAG has been incorporated into the agenda of the Executive Risk Forum.


Presentation of information

The information in this section has been prepared on a pro forma basis (Group before RFS minority interests) unless otherwise indicated as prepared on a statutory basis.



  

Risk and capital management (continued)


Capital

The Group aims to maintain appropriate levels of capital. For details on capital adequacy, refer to the Annual Report and Accounts 2008.

Capital resources and ratios

The Group's regulatory capital resources on a proportional consolidation basis excluding RFS minority interest at 30 June 2009, in accordance with Financial Services Authority (FSA) definitions, were as follows:



 30 June 

 200

31 December 

 2008 

30 June 

 2008 


£m 

£m 

£m 

Capital base




Core Tier 1 capital: ordinary shareholders' funds and minority interests 

  less intangibles 

35,177 

34,041 

26,097 

Preference shares and tax deductible securities

13,949 

23,091 

16,200 

Tax on the excess of expected losses over provisions

599 

308 

437 

Less deductions from Tier 1 capital 

(329)

(316)

(218)





Tier 1 capital 

49,396 

57,124 

42,516 

Tier 2 capital 

18,879 

28,967 

25,966 

Tier 3 capital 

232 

260 

215 






68,507 

86,351 

68,697 

Less: Supervisory deductions 

(4,536)

(4,155)

(4,157)





Total regulatory capital

63,971 

82,196 

64,540 





Risk-weighted (or equivalent risk-weighted) assets 




Credit risk

404,100 

433,400 

385,000 

Counterparty risk

53,000 

61,100 

37,100 

Market risk 

56,300 

46,500 

32,500 

Operational risk

33,900 

36,800 

37,100 






547,300 

577,800 

491,700 





Risk asset ratio




Core Tier 1

6.4%

5.9%

5.3%

Tier 1

9.0%

9.9%

8.6%

Total

11.7%

14.2%

13.1%





Risk asset ratio (statutory basis)




Core Tier 1

7.0%

6.6%

6.5%

Tier 1

9.3%

10.0%

9.1%

Total

11.9%

14.1%

13.2%



  

Risk and capital management (continued)


Capital resources and ratios (continued)

The components of the Group's regulatory capital resources at 30 June 2009 in accordance with FSA definitions were as follows:



 30 June 

 200

31 December  

 2008 

30 June 

 2008 


£m 

£m 

£m 

Composition of regulatory capital




Tier 1 




Ordinary shareholders' equity

47,820 

45,525 

53,283 

Minority interests

2,123 

5,436 

5,808 

Adjustments for:




Goodwill and other intangible assets - continuing

(15,117)

(16,386)

(27,534)

Goodwill and other intangibles assets - discontinued

(47)

Unrealised losses on available-for-sale debt securities

4,194 

3,687 

919 

Reserves arising on revaluation of property and unrealised gains on 

available-for-sale equities

(25)

(984)

(2,623)

Reallocation of preference shares and innovative securities

(656)

(1,813)

(1,813)

Other regulatory adjustments

(263)

9 

(37)

Less expected losses over provisions net of tax

(1,502)

(770)

(1,095)

Less securitisation positions

(1,397)

(663)

(764)





Core Tier 1 capital

35,177 

34,041 

26,097 

Preference shares

11,207 

16,655 

10,608 

Innovative Tier 1 securities

2,742 

6,436 

5,592 

Tax on the excess of expected losses over provisions

599 

308 

437 

Less deductions from Tier 1 capital 

(329)

(316)

(218)





Total Tier 1 capital

49,396 

57,124 

42,516 





Tier 2 




Reserves arising on revaluation of property and unrealised gains on 

available-for-sale equities

25 

984 

2,623 

Collective impairment allowances

744 

666 

326 

Perpetual subordinated debt

4,094 

9,079 

8,419 

Term subordinated debt

17,832 

20,282 

17,012 

Minority and other interests in Tier 2 capital

11 

11 

100 

Less deductions from Tier 2 capital 

(3,827)

(2,055)

(2,514)





Total Tier 2 capital

18,879 

28,967 

25,966 





Tier 3 

232 

260 

215 





Supervisory deductions




Unconsolidated investments 

4,461 

4,044 

4,119 

Other deductions

75 

111 

38 





Total deductions other than from Tier 1 capital

4,536 

4,155 

4,157 





Total regulatory capital

63,971 

82,196 

64,540 




  

Risk and capital management (continued)


Credit risk

Key elements of the Group's credit risk management framework are laid out in the Annual Report & Accounts 2008.  Key developments in the first half of 2009 were:

  • The introduction of a new credit approval framework for wholesale credit, replacing credit committees with individual delegated authorities and requiring at least two individuals to approve each credit decision, one from the business and one from risk management. Both parties must hold sufficient delegated authority. The level of authority granted to an individual is dependent on their experience and expertise with only a small number of senior executives holding the highest authority provided under the framework.

  • Further refinement and embedding of the frameworks to manage the various dimensions of concentration risk: country, sector and single name.

Credit risk assets 

Credit risk assets consist of loans and advances (including overdraft facilities), instalment credit, finance lease receivables and other traded instruments across all customer types.  Reverse repurchase agreements and issuer risk are excluded.



30 June 

2009 


£bn 



UK Retail

98 

UK Corporate

100 

Wealth

14 

Global Banking & Markets

264 

Global Transaction Services

Ulster Bank

40 

US Retail and Commercial 

56 

RBS Insurance

Other



Core 

582 

Non-core

156 




738 


Total credit risk assets fell 14% to £738 billion at 30 June 2009, largely owing to a reduction in loans and advances to customers and banks and to the impact of sterling strengthening during the first half of the year.  In the UKcredit risk assets fell only 1% while outside the UK the reduction was 22%.


  

Risk and capital management (continued)


Credit risk (continued)

Credit concentration risk (including country risk) 

The country risk table below shows credit risk assets exceeding £1 billion by borrower domicile for countries designated internally as risk countries. Exposure is stated gross of mitigating action which may have been taken to reduce or eliminate exposure to country risk events.

 
30 June 2009
31 December 2008
 
Consumer
Banks, financial
institutions and sovereign
Corporate
Total 
Consumer
Banks, financial institutions and sovereign
Corporate
Total
 
£m
£m
£m
£m 
£m
£m
£m
£m
 
 
 
 
 
 
 
 
 
UAE
596
1,647
2,733
4,976 
757
1,813
2,989
5,559
India
970
906
3,047
4,923 
1,020
743
3,801
5,564
Russia
91
290
3,305
3,686 
51
362
5,361
5,774
Turkey
12
926
2,192
3,130 
25
966
3,036
4,027
China
22
1,477
1,473
2,972 
25
1,207
2,027
3,259
South Korea
1
1,339
1,004
2,344 
2
1,743
1,104
2,849
Taiwan
995
589
558
2,142 
1,019
1,394
825
3,238
Romania
512
478
836
1,826 
584
305
917
1,806
Mexico
1
234
1,589
1,824 
4
268
2,000
2,272
Czech Republic
2
697
818
1,517 
2
769
1,058
1,829
Kazakhstan
48
495
661
1,204 
70
917
859
1,846
Brazil
3
713
457
1,173 
4
1,012
642
1,658
Poland
6
178
983
1,167 
7
347
1,309
1,663
Hungary
4
79
1,078
1,161 
5
176
831
1,012
South Africa
33
543
452
1,028 
27
361
507
895
Saudi Arabia
23
392
597
1,012 
23
536
679
1,238


Note:
(1)
Risk countries are defined as those with an internal rating of A+ and below. In addition, United Arab Emirates is included which has a rating of AA.


The outlook for developing markets has improved but remains challenging in line with global trends.  Sovereigns are more resilient than during previous downturns, but the collapse in world trade resulted in a severe growth shock across all regions in the first half of 2009.  Although most economies have now stabilised and are showing tentative signs of recovery, prospects vary and significant risks remain.  Asia is still growing and best placed to rebound as sovereigns continue to provide strong fiscal stimulus, however, growth will remain below trend as export dependency is reduced only slowly. Middle East governments remain strong, but corporates have been hit by the real estate correction. Latin America is reasonably resilient, but still closely linked to the US and to commodities markets.  Risks are highest in some Eastern European countries owing to onerous private sector debt levels and weaker sovereign liquidity. 

  

Risk and capital management (continued)


Credit risk (continued)

Credit risk assets by industry and geography (Core and Non-Core)

Industry analysis plays an important part in assessing potential concentration risk in the loan portfolio.  Heightened monitoring applies to industry sectors where the Group believes there is a high degree of risk or potential for volatility in the future. 

 
30 June 
2009 
31 December 
2008 (1)
Credit risk assets by industry sector
£bn 
£bn 
 
 
 
Personal
184 
198 
Property (2)
152 
180 
Banks and building societies
104 
113 
Financial intermediaries
54 
68 
Transport and storage
50 
59 
Public sectors and quasi-government
35 
42 
Technology, media, telecommunications
32 
35 
Wholesale and retail trade
26 
29 
Building
25 
40 
Power, water and waste
20 
27 
Natural resources and nuclear
20 
25 
Tourism and leisure
18 
20 
Business services
14 
15 
Agricultural and fisheries
 
 
 
738 
855 


Notes:
(1)
Prior period amounts have been restated to reflect internal reclassifications of certain business lines.
(2)
Property includes direct property financing plus related exposures.




30 June 

2009 

31 December 

2008 

Credit risk assets by geography

£bn 

£bn 




United Kingdom

324 

327 

Western Europe (excluding UK)

182 

226 

North America

136 

178 

Asia & Pacific

41 

56 

Latin America

24 

31 

CEE & Central Asia

17 

22 

Middle East & Africa

14 

15 


 



738 

855 


Single name concentrations

Some progress was made against exceptions arising from the Group's refined single name concentration framework during the first half of the year, although illiquid markets have reduced the scope for exposure management In a number of cases, exposure has reduced, however negative rating migration has also created additional cases that exceed the framework's parameters. Overall there were fewer exceptions at the end of the period than at the beginning the number of corporate exceptions reduced from 552 to 501 while financial institution exceptions reduced from 150 to 122. Refining the framework and embedding it in core business processes remains a key focus going forward.

  

Risk and capital management (continued)


Credit risk (continued)

Credit risk asset quality 

Refer to the Annual Report and Accounts 2008 and 2008 Pillar 3 Disclosure for details of the Group's credit grading framework and processes.




30 June 

2009 

31 December

2008

Credit risk assets by asset quality band

PD range

£bn 

£bn





AQ1

0% - 0.034%

162 

208

AQ2

0.034% - 0.048%

24 

30

AQ3

0.048% - 0.095%

33 

45

AQ4

0.095% - 0.381%

119 

159

AQ5

0.381% - 1.076%

126 

157

AQ6

1.076% - 2.153%

102 

107

AQ7

2.153% - 6.089%

52 

48

AQ8

6.089% - 17.222%

26 

26

AQ9

17.222% - 100%

17 

12

AQ10

100%

34 

19

Other (1)


43 

44







738 

855


Notes:
(1)
“Other” largely comprises assets covered by the standardised approach for which a probability of default (PD) equivalent to those assigned to assets covered by the internal ratings based approach is not available.

  

Risk and capital management (continued)


Credit risk (continued)

Key credit portfolios (Analysis refers to combined Core/Non-Core portfolios unless otherwise stated)

The discussions below relate to credit risk assets in specific portfolios within the Group.

Commercial property

The commercial property portfolio credit risk assets total £90.8 billion, an 8% decrease from the beginning of the year, split between:  UK (£58.0 billion); Western Europe (£22.1 billion); North America (£6.8 billion); and other regions (£3.9 billion). As part of the strategic review, 40% of the Group's commercial property portfolio was designated Non-Core.  

Lending is spread across: investment (70%); development (28%); and other (2%). Speculative lending represents less than 2% of the portfolio. The Group's appetite for originating speculative commercial property lending is limited and any such business requires exceptional approval under the credit approval framework. 

The decrease in asset valuations continues to place strain on the portfolio with more clients seeking covenant renegotiations while discussing structural enhancements and/or potential equity injections. The average loan-to-value (LTV) is 89%. The average interest coverage ratios for GBM and UK Corporate portfolios are 168% and 162% respectively.  

The Group's lending approach has always been predominantly cashflow driven and that has mitigated the impact of asset devaluation, however, the outlook remains challenging with further pressure on asset values expected, limited liquidity to support refinancing and increasing concerns about tenant failures. The Group is working closely with clients to restructure loans and achieve outcomes that benefit both parties. Portfolios are subject to specific monitoring within originating divisions and a separate unit has been established and staffed in the first half of 2009 to ensure that specialised expertise is deployed to actively manage this portfolio on a global and coordinated basis. 13% of the portfolio was non-performing at 30 June 2009, compared to 6% at 31 December 2008. 

UK residential mortgages

The UK mortgage portfolio totalled £79 billion at 30 June 2009, an increase of 6% during the first half of the year and 9% higher than June 2008, due to strong sales growth and lower redemption rates.  Brands are the Royal Bank of Scotland, NatWest, the One Account, and First Active. The assets comprise prime mortgage lending and include 7% (£5.4 billion) of exposure to residential buy-to-let. There is a very small legacy self certification book (0.4% of total assets) which was withdrawn from sale in 2004.

The average LTV for new business was 65% in the first half of 2009 versus 67% for 2008. The maximum LTV available to new customers remains 90% and there has been strong volumes of low LTV applications in the first half of the year coupled with continued subdued demand for higher LTV business.

The arrears rate (three or more payments missed) on the combined Royal Bank of Scotland and NatWest brands was 1.8% at 30 June 2009, up from 1.5% as at 31 December 2008 and 1.16% as at June 2008. The arrears rate on the buy-to-let portfolio was 1.6% at 30 June 2009 (1.5% at 31 December 2008; 0.9% at 30 June 2008).

The mortgage impairment charge was £65 million in the first half of 2009 versus £33 million for the full year 2008.  The increase is mainly attributable to declining house prices driving lower recoveries.  Provision cover at 30 June 2009 was 0.20% versus 0.18% at 31 December 2008.


  

Risk and capital management (continued)


Credit risk (continued)

The number of repossessions in the first half of 2009 totalled 567, versus 551 in the second half of 2008. Forbearance policies support customers in financial difficulty and include not initiating repossession proceedings for 6 months after a customer falls in to arrears. The Group also participates in the Government's Mortgage Rescue and Homeowner Mortgage Support Schemes.


The Republic of Ireland and Northern Ireland residential mortgages

The residential mortgage portfolio in Ireland across the Ulster Bank and First Active brands totalled £21.8 billion at 30 June 200991.7% is in the Republic of Ireland and 8.3% in Northern Ireland This represents a decline of 2% in the Republic of Ireland and an increase of 2% in Northern Ireland from balances at 31 December 2008. 

During the first half of 2009 loan to value and affordability criteria were further tightened, particularly in higher risk segments, e.g. buy to let.  The bank also introduced new products - Momentum and SecureStep - in both Northern Ireland and the Republic of Ireland. These products aim to support market activity while continuing to meet the bank's risk criteria.

The arrears rate (three or more payments missed) increased to 2.7% at 30 June 2009 from 1.5% at 31 December 2008. As a result the loan loss impairment charge for the first half of the year was £42 million versus £23 million for the full year 2008. 

Repossessions remained low and totalled 21 for first half of the year, similar to levels experienced in 2008.

US residential mortgages

Citizens Financial Group's (CFG) residential real estate portfolio totalled $45.9 billion at 30 June 2009 (versus $50.1 billion at 31 December 2008) comprising $13.3 billion in first mortgages and $32.6 billion of home equity loans and lines. Included in this $4.2 billion decline, is the sale of $2.4 billion in real estate assets from December through May 2009 to the Federal National Mortgage Association (Fannie Mae) with the remaining fall attributed to pre-payment and declining originations.

CFG has historically adopted conservative risk policies in comparison to the general market. Loan acceptance criteria were tightened further during 2009 to reflect deteriorating economic conditions. Limited exposures to sub-prime underwriting (FICO <=620, approximately 0.6%), and Alt-A /other non-conforming balances combined with reduced lending to volatile geographic regions have protected the Bank.

Excluding the Serviced By Others portfolio (SBO) of $6 billion at 30 June 2009the portfolio average indexed LTV increased to 68% for June 2009, up from 63in December 2008. *

Due to general US economic conditions, delinquencies in the both home equity and mortgage books are steadily rising. At 30 June 2009, 2.7% of home equity loans and 3.7% of mortgages were one payment or more past due (compared to 1.5% and 1.7% respectively at 31 December 2008).  Significant investment has been made in problem debt management capability. Loan modification options are being used where appropriate to support troubled customers, including government-sponsored programmes.

Due to its loan to value and geographic profile, the SBO home equity portfolio continues to be particularly affected by the current economic climate, with net credit losses of $291 million, equivalent to an annualised 9.4% of balances, in the first half of the year (versus 5.3% in 2008). The LTV trend is obscured by the portfolio's contraction with higher LTV a key driver of losses taken to date: average LTV stood at 101% at 30 June 2009 verses 100% at 31 December 2008.  Management action to contain losses through optimising problem debt management performance continues to be a specific focus.


* Prior period figure has been restated to incorporate updated methodology and additional data.

  

Risk and capital management (continued)


Credit risk (continued)

Automotive sector

Exposure to the automotive sector decreased from £13.3 billion at 31 December 2008(1) to £10.8 billion at 30 June 2009.


Credit risk assets by sector

£bn 

% 




Original equipment manufacturer / Commercial vehicles

1.9

18 

Captive finance companies

0.6

Component suppliers

1.5

14 

Retail / Services

5.0

46 

Rental

1.8

17 




Total

10.8

100 


Credit risk assets by geography

£bn 

% 

 



Americas

2.4

22 

Central Eastern Europe

0.7

UK

4.1

38 

Western Europe

2.9

27 

Asia

0.7




Total

10.8

100 


The sector faces numerous challenges: its exposure to discretionary consumer spending; historically high leverage; volatile input prices; and ongoing political and societal pressure to reduce fuel emissions forcing fundamental changes to business and franchise models. The Group therefore maintains a cautious stance against the sector and remains focused on larger, more diversified customers. Notwithstanding this approach, the scale of downturn has impacted the performance of the portfolio with negative rating migration and higher default rates occurring. 

Over the past six months, the Group's exposure to the large US automobile manufacturers has been subject to close scrutiny and material reductions in direct lending have been achieved.  The resulting size and structure of the facilities were such that minimal provisions were required on exposure to these names.  

Note:
(1)
Prior period figure has been restated to incorporate updated methodology and additional data.



Shipping

The Group's shipping portfolio largely comprises financing exposure, distributed as shown in the table below.


Credit risk assets by sector

£bn 

% 




Dry bulk

2.5

25 

Tankers

4.2

41 

Container

1.1

11 

Gas/offshore

1.8

17 

Other

0.6

6 




Total

10.2

100 


88% of exposure (against delivered tonnage) is secured on vessels built in the last 8 years.

Despite the significant fall in asset values and the challenging outlook across all sectors, all shipping loans are performing.  The Group's focus on modern assets, with stronger cash flow and liquidity, is reflected in the fact that only £1.5 billion of the portfolio was subject to enhanced monitoring as at 30 June 2009.  

  

Risk and capital management (continued)


Credit risk (continued)

Oil and gas

Credit risk assets by sector

£bn 

%




Vertically integrated

5.9

32

Exploration and production

2.7

14

Oilfield services

2.2

12

Midstream

3.2

17

Refining and marketing

3.1

17

Other

1.5

8




Total

18.6

100


RBS and ABN AMRO had a number of exposures that overlapped, primarily in relation to well rated, vertically integrated companies and several of the larger global exploration and production companies.  The Group's strategy is to continue to focus primarily on the more stable midstream and integrated oil sectors, together with well secured exposures to larger exploration and production companies based on a conservative outlook for oil prices that is regularly reassessed. Unsecured exposures are primarily to oil majors and state owned entities.  



  

Risk and capital management (continued)


Credit risk (continued)

Asset quality

Loans and advances to customers by geography and industry

The following table analyses the balance sheet carrying value of loans and advances to customers (excluding reverse repurchase agreements and stock borrowing) by industry and geography.



30 June 2009

31 December

2008

30 June

2008

Core

Non-core

Total 


£m

£m

£m 

£m

£m







UK Domestic






Central and local government

3,302 

138 

3,440 

3,091

3,381

Finance 

17,480 

7,462 

24,942 

28,013

17,940

Individuals - home

85,462 

2,048 

87,510 

80,967

79,114

Individuals - other

23,028 

1,096 

24,124 

26,979

27,264

Other commercial and industrial comprising:






- Manufacturing

10,762 

1,996 

12,758 

15,067

14,078

- Construction

5,261 

3,513 

8,774 

10,171

10,565

- Service industries and business activities

42,149 

12,532 

54,681 

58,552

58,938

- Agriculture, forestry and fishing

2,839 

86 

2,925 

2,972

2,969

- Property

17,203 

33,623 

50,826 

52,087

50,301

Finance leases and instalment credit

5,026 

11,494 

16,520 

17,363

15,964

Interest accruals

605 

188 

793 

1,687

1,749








213,117 

74,176 

287,293 

296,949

282,263







UK International






Central and local government

1,213 

61 

1,274 

3,015

1,255

Finance 

19,453 

3,810 

23,263 

35,009

23,541

Individuals - other

375 

73 

448 

490

476

Other commercial and industrial comprising:






- Manufacturing

7,436 

607 

8,043 

10,932

7,757

- Construction

2,173 

820 

2,993 

3,255

2,645

- Service industries and business activities

23,161 

3,137 

26,298 

29,782

23,562

- Agriculture, forestry and fishing

133 

25 

158 

146

124

- Property

12,670 

9,365 

22,035 

21,923

18,231

Interest accruals

445 

448 

37

31








66,617 

18,343 

84,960 

104,589

77,622







Overseas






Europe






Central and local government

960 

534 

1,494 

1,830

2,709

Finance 

2,619 

6,134 

8,753 

9,731

13,501

Individuals - home

14,461 

6,582 

21,043 

23,394

17,893

Individuals - other

2,387 

660 

3,047 

4,641

4,642

Other commercial and industrial comprising:






- Manufacturing

10,417 

6,571 

16,988 

25,842

15,158

- Construction

2,163 

1,670 

3,833 

5,183

4,674

- Service industries and business activities

25,341 

8,195 

33,536 

40,444

43,463

- Agriculture, forestry and fishing

1,023 

64 

1,087 

1,327

1,297

- Property

9,846 

9,627 

19,473 

19,769

16,108

Finance leases and instalment credit

322 

1,187 

1,509 

1,815

1,705

Interest accruals

220 

234

454 

798

799








69,759 

41,458 

111,217 

134,774

121,949


  

Risk and capital management (continued)


Credit risk (continued)

Asset quality (continued)

Loans and advances to customers (continued)


30 June 2009

31 December 

2008 

30 June 

2008 

Core 

Non-core 

Total 


£m 

£m 

£m 

£m 

£m 







US 






Central and local government

224 

62 

286 

482 

346 

Finance 

12,924 

816 

13,740 

16,088 

12,016 

Individuals - home

23,142 

4,830 

27,972 

34,235 

26,544 

Individuals - other

8,209 

3,920 

12,129 

14,368 

10,691 

Other commercial and industrial comprising:






- Manufacturing

6,955 

1,997 

8,952 

13,127 

8,529 

- Construction

407 

282 

689 

885 

673 

- Service industries and business activities

17,644 

4,620 

22,264 

27,913 

18,973 

- Agriculture, forestry and fishing

219 

221 

30 

24 

- Property

1,944 

3,906 

5,850 

6,579 

4,731 

Finance leases and instalment credit

2,563 

35 

2,598 

3,066 

2,308 

Interest accruals

236 

119 

355 

471 

383 








74,467 

20,589 

95,056 

117,244 

85,218 







Rest of World






Central and local government

375 

378 

7,079 

4,942 

Finance 

8,491 

1,378 

9,869 

11,722 

13,968 

Individuals - home

397 

343 

740 

795 

723 

Individuals - other

1,320 

560 

1,880 

4,592 

2,853 

Other commercial and industrial comprising:






- Manufacturing

3,558 

2,380 

5,938 

6,196 

5,001 

- Construction

232 

423 

655 

756 

231 

- Service industries and business activities

7,589 

2,264 

9,853 

13,152 

10,674 

- Agriculture, forestry and fishing

32 

187 

219 

153 

104 

- Property

693 

1,455 

2,148 

2,918 

2,800 

Finance leases and instalment credit

34 

40 

111 

34 

Interest accruals

87 

62 

149 

270 

226 








22,808 

9,061 

31,869 

47,744 

41,556 







Total






Central and local government

6,074 

798 

6,872 

15,497 

12,633 

Finance 

60,967 

19,600 

80,567 

100,563 

80,966 

Individuals - home

123,462 

13,803 

137,265 

139,391 

124,274 

Individuals - other

35,319 

6,309 

41,628 

51,070 

45,926 

Other commercial and industrial comprising:






- Manufacturing

39,128 

13,551 

52,679 

71,164 

50,523 

- Construction

10,236 

6,708 

16,944 

20,250 

18,788 

- Service industries and business activities

115,884 

30,748 

146,632 

169,843 

155,610 

- Agriculture, forestry and fishing

4,246 

364 

4,610 

4,628 

4,518 

- Property

42,356 

57,976 

100,332 

103,276 

92,171 

Finance leases and instalment credit

7,945 

12,722 

20,667 

22,355 

20,011 

Interest accruals

1,151 

1,048 

2,199 

3,263 

3,188 







Loans and advances to customers - gross

446,768 

163,627 

610,395 

701,300 

608,608 

Loan impairment provisions

(5,449)

(8,198)

(13,647)

(9,324)

(5,031)







Total loans and advances to customers

441,319 

155,429 

596,748 

691,976 

603,577 



Risk and capital management (continued)


Credit risk (continued)

Asset quality (continued)

Risk elements in lending 

The following table shows the estimated amount of loans classified as non-accrual, accruing past due and potential problem loans. The figures are stated before deducting the value of security held or related provisions. 



30 June 2009

31 December

2008

30 June

2008


Core 

Non-core  

Total 


£m

£m  

£m 

£m

£m

Loans accounted for on a non-accrual basis (2):






- Domestic

5,295 

6,676 

11,971 

8,579

5,940

- Foreign

3,242

12,016 

15,258 

8,503

2,148








8,537

18,692 

27,229 

17,082

8,088







Accruing loans which are contractually overdue 90 days or more as to principal or interest (3):






- Domestic

1,460

984 

2,444 

1,201

642

- Foreign

244

812 

1,056 

508

102








1,704

1,796 

3,500 

1,709

744







Total risk elements in lending

10,241

20,488 

30,729 

18,791

8,832







Potential problem loans:(4)






- Domestic

110

163 

273 

218

139

- Foreign

13

10 

23 

8

2








123

173 

296 

226

141













Closing provisions for impairment as a % of total risk elements in lending and potential problem loans 

54%

40% 

44% 

50%

56%







Risk elements in lending as a % of gross lending to customers excluding reverse repos  

2.26%

12.52% 

5.04% 

2.66%

1.45%







Risk elements in lending and potential problem loans as a % of gross lending to customers excluding reverse repos  

2.29%

12.63% 

5.08% 

2.69%

1.47%


Notes:

(1)

For the analysis above, 'Domestic' consists of the United Kingdom domestic transactions of the Group. 'Foreign' comprises the Group's transactions conducted through offices outside the UK and through those offices in the UK specifically organised to service international banking transactions.

(2)

All loans against which an impairment provision is held are reported in the non-accrual category.

(3)

Loans where an impairment event has taken place but no impairment recognised. This category is used for fully collateralised non-revolving credit facilities.

(4)

Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for fully collateralised advances and revolving credit facilities where identification as 90 days overdue is not feasible.


  

Risk and capital management (continued)


Credit risk (continued)

Impairments

Impairment loss provision methodology 

Refer to the Annual Report and Accounts 2008 for information regarding the impairment loss provision methodology.


Impairment charge 

The following table shows total impairment losses charged to the income statement.



First half  2009

First half 

2008

Full year 

2008


Core 

Non-core  

Total 


£m

£m  

£m 

£m

£m







New impairment losses

2,257

5,404 

7,661 

1,617

7,693

Less: recoveries of amounts previously written off

80

60 

140 

138

261







Charge to income statement

2,177

5,344 

7,521 

1,479

7,432







Comprising:






Loan impairment losses

2,170

4,626 

6,796 

1,406

6,478

Impairment losses on available-for-sale securities

7

718 

725 

73

954







Charge to income statement

2,177

5,344 

7,521 

1,479

7,432



First half   

2009 

First half  

2008 

Full year 

2008 


£m 

£m 

£m 





Impairment losses by division:




UK Retail 

824 

440 

1,019 

UK Corporate

551 

96 

321 

Wealth

22 

16 

Global Banking & Markets

237 

17 

541 

Global Transaction Services

13 

48 

Ulster Bank

157 

18 

106 

US Retail & Commercial

369 

126 

437 

RBS Insurance

42 

Other

(2)

(36)

(18)





Core

2,177 

670 

2,512 

Non-core

5,344 

809 

4,920 






7,521 

1,479 

7,432 


Analysis of loan impairment charge


First half 2009

First half  

2008

Full year  

2008


Core 

Non-core  

Total 


£m

£m  

£m 

£m

£m







Latent loss impairment charge

454

270 

724 

328

769

Collectively assessed impairment charge

1,274

729 

2,003 

940

2,391

Individually assessed impairment charge (1)

434

3,627 

4,061 

138

3,200







Charge to income statement

2,162

4,626 

6,788 

1,406

6,360







Charge as a % of customer loans and advances - gross (2) 

0.97%

5.65% 

2.22% 

0.46%

0.91%


Notes:

(1) Excludes loan impairment charge against loans and advances to banks of £8 million (first half 2008 - nil; full year 2008 - £118 million).

(2) Gross of provisions and excluding reverse repurchase agreements.


Risk and capital management (continued)


Credit risk (continued)

Impairments (continued)


Loan impairment provisions

Operating loss is stated after charging loan impairment losses of £6,796 million (first half 2008 - £1,406 million; full year 2008 - £6,478 million). The balance sheet loan impairment provisions increased in the half year ended 30 June 2009 from £9,451 million to £13,773 million, and the movements thereon were:



First half 2009

First half

2008

Full year

2008


Core  

Non-core  

Total  


£m 

£m 

£m 

£m

£m







At 1 January

4,905 

4,546 

9,451 

4,956 

4,956 

Transfers to disposal groups

(147)

Currency translation and other adjustments

(529)

24 

(505)

72 

1,023 

Disposals

(40)

(178)

Amounts written-off

(952)

(980)

(1,932)

(1,261)

(2,897)

Recoveries of amounts previously written-off

80 

60 

140 

138 

261 

Charge to the income statement

2,170 

4,626 

6,796 

1,406 

6,478 

Unwind of discount

(99)

(78)

(177)

(90)

(192)







Total

5,575 

8,198 

13,773 

5,034 

9,451 


Provisions at 30 June 2009 include £126 million (31 December 2008 - £127 million; 30 June 2008 - £3 million) in respect of loans and advances to banks.


Analysis of loan impairment provisions


30 June 2009

31 December

2008

30 June

2008


Core 

Non-core 

Total 


£m

£m 

£m 

£m

£m







Latent loss provisions

1,477

822

2,299 

1,719

859

Collectively assessed provisions

3,219

1,334

4,553 

3,692

3,134

Individually assessed provisions

753

6,042

6,795 

3,913

1,038







Total provisions (1) 

5,449

8,198

13,647 

9,324

5,031







Total provision as a % of customer loans and advances - gross (2) 

1.2%

5.0%

2.2% 

1.3%

0.8%


Notes:
(1)
Excludes provisions against loans and advances to banks of £126 million (31 December 2008 - £127 million; 30 June 2008 - £3 million).
(2)
Gross of provisions and excluding reverse repurchase agreements.



Provisions coverage

The Group's provision coverage ratios are shown in the table below.



30 June 2009

31 December

2008

30 June

2008


Core 

Non-core 

Total 







Total provision expressed as a:






% of REIL

54%

40%

45% 

50%

57%

% of REIL and PPL

54%

40%

44% 

50%

56%


  

Risk and capital management


Liquidity risk

The policy of the Group is to ensure that it is able to meet its obligations as they fall due.

The Group has an approved risk appetite supported by explicit targets and metrics to control the size and extent of both short term liquidity and long term funding risk. The Group Asset and Liability Committee (GALCO) chaired by the Group Finance Director has the responsibility to set Group policy and ensure that this is cascaded and communicated to the business divisions.

Group Treasury is the functional area with responsibility for the monitoring and control of the Group's funding and liquidity positions. Group Treasury is supported by a governance process that includes a weekly Liquidity Risk forum comprising functional areas across the organisation responsible for liquidity management, and divisional and regional asset and liability committees.

Structural balance sheet management

The maturity mismatch between deposits and lending is limited and controlled by policies aimed at ensuring assets can be funded over the term of their economic life. The mismatch analysis takes into account the impact of behaviour under normal and stress conditions to evaluate the appropriate balance of funding resources.

Stress testing

The Group uses stress tests as a tool to evaluate the impact of both disrupted market conditions and specific events to measure the impact both on, and off, balance sheet. The stress tests show the degree of resilience in times of stress and the ability for contingency actions to mitigate stressed conditions. The assumptions and nature of the risks driving the stress tests are refined and updated in the light of changing conditions.

Contingency planning

Contingency plans are developed to anticipate the potential for deterioration in market conditions and ensure that the Group has considered how it can respond to adverse developments. The contingency plan considers actions including the use of liquid assets, reduction in lending commitments, increased deposit balances and the use of collateral and management of derivative exposures. 

Global developments in 2009

Liquidity conditions in money and debt markets have improved significantly since the beginning of Q2 2009. Following a difficult first quarter, most indicators of stresses in financial markets are close to or better than before the collapse of Lehman Brothers in September 2008. Contributing to the improvement has been a combination of ongoing central bank and other official liquidity support schemes, guarantee schemes and rate cuts. Signs of improvement in underlying macroeconomic trends also helped to sustain a recovery in markets for risky assets, including in debt markets. 

Policy rates have reached low levels for the economic cycle in the major currency areas.  Unsecured interbank rates, as benchmarked by Libor/Euribor have fallen to all-time lows - 3 month rates are now well below 1% for prime banks in the G3 currency areas.  Trading activity at longer term maturities has also picked up and interbank repo of non-government collateral appears to have recovered strongly following the severe stress experienced in 2008.  The US Federal Deposit Insurance Corporation's ('FDIC') Temporary Liquidity Guarantee Program ('TLGP') allowed around $300 billion of debt to be issued by US financial firms in the first half of the year A similar amount has been issued by European banks, mostly in EUR and USD, covered by institutions' respective home-country guarantee initiatives.  However in recent months unguaranteed financial debt issuance, including bank capital has become possible and guaranteed issuance has slowed markedly since May.

  

Risk and capital management


Liquidity risk (continued)

Important developments in central bank liquidity programmes since February include:


  • In the UK, the Bank of England reduced interest rates to 0.5% in March, and later the same month the Bank of England initiated 'quantitative easing' through its Asset Purchase Facility.  Gilt purchases dominate activity to date, while direct purchases of commercial paper and corporate bonds have been relatively small. 

  • In the US, the Federal Reserve has maintained its target for the funds rate at 0-0.25% while supplementing its credit-easing programmes with a new Term Asset-Backed Securities Loan Facility ('TALF') although initial take up of the TALF has been slow. 

  • In the Euro Area, the European Central Bank ('ECB') decided in early May to hold three 1-year repo operations against its general collateral list.  The first of these was received enthusiastically in June, resulting in significant supply of ECB liquidity to the banking system and bringing downward pressure on short term rates.


Liquidity management

The reduction in the size of the overall funded balance sheet of the Group has reduced reliance on wholesale funding markets. The funding markets have been recovering throughout the course of 2009 and this has eased pressure on the funding position of the Group. The improvements in the markets have enabled the Group to issue £4.9 billion of unguaranteed term debt with maturity beyond 12 months and there has been a reduction of funding in short term debt markets. The structure of the balance sheet has improved and the gap between customer loans and customer deposits (excluding repos) fell by £49,325 million from £240,982 million as at 31 December 2008 to £191,657 million as at 30 June 2009. As a result, the loan to deposit ratio reduced from 152.4% to 144.5%. 

The Group continues to develop diversified sources of funding across its retail, corporate and wholesale franchises in line with the strategy to rely more on retail and other customer funds to support its lending business. 

The Group will seek to build on this improvement in its funding position in the expectation that trading in term markets improve providing the opportunity to increase the maturity profile of wholesale liabilities.

 
First half
2009
 
Full year
2008
 
 
£m
%
£m
%
 
 
 
 
 
Deposits by Banks
135,601
16.3
178,943
18.8
 
 
 
 
 
Debt securities in issue:
 
 
 
 
 Commercial paper
49,270
5.9
69,891
7.3
 Certificates of deposits
76,095
9.2
73,925
7.8
 MTNs
104,190
12.5
94,298
9.9
 Other (bonds)
4,394
0.5
14,231
1.5
 Securitisations
14,761
1.8
17,113
1.8
 
 
 
 
 
 
248,710
29.9
269,458
28.3
 
 
 
 
 
Subordinated debt
32,106
3.9
43,678
4.6
 
 
 
 
 
Total wholesale funding
416,417
50.1
492,079
51.7
Customer deposits
415,267
49.9
460,318
48.3
 
 
 
 
 
Total
831,684
100.0
952,397
100.0


Customer accounts

Customer accounts are the largest source of funding for the Group and are highly diversified across both retail and corporate franchisesrepresenting a stable source of core funding. The level of customer deposits decreased over the period from £460,318 million at 31 December 2008 to £415,267 million at 30 June 2009.

  

Risk and capital management


Liquidity risk (continued)

Repo agreements

The repo market represents borrowings that are secured against a range of debt assets and other securities. Repo activity represents an ongoing source of financing activity and the market has not stabilised. 

Debt securities in issue and subordinated liabilities

The proportion of outstanding debt instruments issued, with a remaining maturity of greater than 12 months has increased from 45% in 31 December 2008 to 47% in June 2009 reflecting a lengthening of the maturity profile of debt issuance over the period.

 
First half
2009
 
Full year
2008
 
 
£m
%
£m
%
 
 
 
 
 
Less than one year
149,265
53.2
172,234
55.0
1-5 years
67,390
24.0
61,842
19.8
More than 5 years
64,161
22.8
79,060
25.2
 
 
 
 
 
Total
280,816
100.0
313,136
100.0


The reduction in the amount of debt instruments with maturities of less than one year reflects the Group's strategy to reduce its reliance on short-term markets and instruments coupled with favourable exchange rate movements. The net movement in maturities of greater than one year is mainly as a result of the exchange and tender offers completed in April 2009 partially offset by new debt issuance.

Short term debt and bank deposits

The short term debt markets have improved markedly over the course of 2009 and the Group has been able to readily access this source of funding with increased maturities and reduced costs of spread.  This easing of market conditions has enabled the Group to reduce reliance on central bank facilities and move toward its strategic objective of self reliance in the markets.

Undrawn commitments

The Group has seen a decrease in undrawn commitments from £352 billion at 31 December 2008 to £299 billion at 30 June 2009 both as a result of the strengthening of sterling against the US dollar and the euro as well as decreased volumes. The decrease in volumes is consistent with the strategic objective to reduce liquidity risk in off-balance sheet activity.

Conduits

The Group has a multi seller conduit business that funds assets through the issuance of short term asset backed commercial paper.  The total of assets held in Group sponsored conduits fell from £49.9 billion at December 2008 to £35.0 billion at 30 June 2009 as the Group reduced its exposure to this business in line with strategy. 


  

Risk and capital management


Market risk

Market risk arises from changes in interest rates, foreign currency, credit spread, equity prices and risk related factors such as market volatilities. The Group manages market risk centrally within its trading and treasury portfolios through a comprehensive market risk management framework. This framework contains limits based on, but not limited to: value-at-risk (VaR), scenario analysis, position and sensitivity analyses

The Group discloses market risk in VaR terms. VaR is a measure that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels.  The Group uses a historical simulation methodology with a two year time horizon and a 99% confidence level.

At the Group level the risk appetite is expressed in the form of a combination of VaR, sensitivity and scenario limits. The Group recently changed its VaR confidence level from 95% to 99% as it believes this provides greater clarity in respect of potential economic outcomes. The table below sets out VaR for the Group's portfolios with prior periods restated to reflect the 99% confidence level for consistency and comparability. 

The Group continued to update and enhance its market risk management framework during the first half of 2009. In addition to the move to VaR based on a 99% confidence level, the Group has improved and strengthened its market risk limit framework, increasing the transparency of market price risk taken across the Group's businesses in both the trading and non-trading portfolios.

The Group's market risk appetite is defined within this limit framework which is cascaded down through legal entity, division, business and ultimately trader level market risk limits.

The VaR disclosure is broken down into trading and non-trading (referred to in previous disclosures as Treasury VaR), where trading VaR relates to the main trading activities of the Group and non-trading reflects the VaR associated with reclassified assets, money market business and the management of internet funds flow within the Group's businesses.

As part of the Strategic Review announced on 26 February 2009, the designation of assets between Core and Non-Core divisions was completed during the period. The period end Core/Non-Core VaR as of 30 June 2009 shown below reflects the conclusion of this process. Average, Maximum and Minimum VaR for Core/Non-Core are measures that require daily data.  The Non-Core division was not defined at the start of the period and average, maximum and minimum VaR are measures that require daily data. These three measures have been prepared on a best efforts basis and reflect the process of designating Non-Core assets.



Average

Period end 

Maximum

Minimum 


£m

£m 

£m

£m 

Trading VaR (pro forma and statutory basis)










Interest rate

65.6

81.4 

112.8

42.5 

Credit spread

125.3

199.6 

231.2

66.9 

Currency

17.7

15.6 

35.8

9.2 

Equity 

13.0

11.7 

21.6

8.3 

Commodity

12.7

11.5 

21.4

6.5 

Diversification effects


(129.2)








30 June 2009

143.3

190.6 

229.0

76.8 






Core (30 June 2009)

99.6

94.3 

135.6

54.2

Non-Core (30 June 2009)

77.3

130.4 

166.5

28.6


  

Risk and capital management


Market risk (continued)



Average

Period end 

Maximum

Minimum


£m

£m 

£m

£m






Interest rate

38.7

54.4 

94.0

18.2

Credit spread

71.5

61.5 

130.8

51.7

Currency

7.6

17.0 

18.0

3.5

Equity 

22.4

18.3 

42.6

11.0

Commodity

9.9

10.0 

25.8

0.2

Diversification effects


(52.4)





 



31 December 2008 

82.3

108.8 

155.7

49.3






Interest rate

29.1

33.7 

56.1

18.2

Credit spread

72.7

75.5 

96.3

51.7

Currency

6.0

7.1 

8.6

3.5

Equity 

23.1

19.9 

42.6

11.0

Commodity

9.5

23.0 

25.3

0.2

Diversification effects


(67.7)








30 June 2008 

70.4

91.5 

106.0

49.3








Average

Period end 

Maximum

Minimum 


£m

£m 

£m

£m 

Non-trading VaR (pro forma and statutory basis)










Interest rate

17.6

16.6 

26.1

12.9 

Credit spread

198.9

205.4 

270.3

65.4 

Currency

1.2

1.1 

3.8

0.2 

Equity 

4.0

3.7 

7.2

2.2 

Diversification effects


(27.0)








30 June 2009

199.6

199.8 

274.9

76.1 






Core (30 June 2009)

82.6

81.6 

133.5

55.0

Non-Core (30 June 2009)

123.1

132.6 

145.3

20.2






Interest rate

10.6

24.4 

32.9

5.2

Credit spread

10.5

65.2 

65.2

5.5

Currency

0.6

2.2 

5.7

0.1

Equity 

3.4

7.0 

8.0

0.8

Diversification effects


(22.7)








31 December 2008 

14.8

76.1 

76.1

7.7



Average

Period end 

Maximum

Minimum


£m

£m 

£m

£m






Interest rate

7.4

9.1 

10.2

5.2

Credit spread

7.7

7.0 

10.6

5.6

Currency

0.4

0.3 

1.0

0.2

Equity 

1.7

1.7 

2.6

0.8

Diversification effects


(8.7)








30 June 2008 

10.0

9.4 

13.4

7.7


  

Risk and capital management


Market risk (continued)


The data in the tables above exclude exposures to super senior tranches of asset-backed CDOs, as VaR does not provide an appropriate measure of risk for these exposures due to the continued illiquidity and opaqueness of pricing of these instruments.  For these exposures, the maximum potential loss is equal to the aggregate net exposure of £548 million at 30 June 2009. For more information, please refer to market turmoil exposure - Super senior CDOs on page 130 and Note 11Financial instruments - collateralised debt obligations.

The Group uses the most recent two years of market data in its VaR model. Accordingly the VaR at June 2009 incorporates all of the market volatility experienced since the credit crisis began in August 2007. On average this means that a given underlying risk position expressed in VaR terms will be considerably larger than previously reported. If one assumes future volatility declines in comparison to the average over the last two years then the half year may well represent a peak VaR number for a given position.  The Group has reduced its underlying trading positions in the first half of 2009, but the increase in market volatility factored into the VaR calculation has more than offset this; consequently the Trading VaR has increased when compared with previous periods.

Non-Core credit spread trading VaR increased materially during the period, not only for the reason described above, but also owing to additional hedges against the risk of counterparty failure. Athis counterparty risk is itself not in VaR, these hedges increase reported VaR.

The non-trading VaR increased not only because of more volatile market data in the VaR models, but also as a result of reclassification of certain trading portfolio assets.

The Group's VaR should be interpreted in light of the limitations of the methodologies used, detailed as follows:

  • Historical Simulation VaR may not provide the best estimate of future market movements. It can only provide a prediction of the future based on events that occurred in the two year time series. Therefore, events that are more severe than those in the historical data series cannot be predicted.
  • VaR that uses a 99% confidence level does not reflect the extent of potential losses beyond that percentile.
  • VaR uses a one-day time horizon which will not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day.

  • The Group computes the VaR of trading portfolios at the close of business. Positions may change substantially during the course of the trading day and intraday profit and losses will be incurred

These limitations mean that the Group cannot guarantee that losses will not exceed the VaR.

  

Risk and capital management


Market risk (continued)

The following table details the combined other than trading (non-trading businesses and retail and commercial banking activities) VaR at a 99% confidence level, which relates mainly to interest rate risk and credit spreads.


Statutory basis

Average

Period end 

Maximum

Minimum 

£m

£m 

£m

£m 






30 June 2009

187.2

190.6

203.2

177.3






31 December 2008

133.1

134.9

197.0

86.4








Structural interest rate and currency VaR (statutory basis)

Structural interest rate risks mainly arise in retail and commercial banking assets and liabilities.

Statutory basis

Average

£m

Period end

£m

Maximum

£m

Minimum

£m






30 June 2009

91.3

100.4

112.5

69.3






31 December 2008

128.1

60.1

194.6

60.3









30 June 

2009 

Statutory basis

£m 



EUR 

39.3 

GBP

25.2 

USD

83.8 

Other

5.1 



  

Risk and capital management


Currency risk (statutory basis) 

The Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding. The Group's policy in relation to structural positions is to match fund the structural foreign currency exposure arising from net asset value, including goodwill, in foreign subsidiaries, equity accounted investments and branches, except where doing so would materially increase the sensitivity of either the Group's or the subsidiary's regulatory capital ratios to currency movements. The policy requires structural foreign exchange positions to be reviewed regularly by GALCO. GALCO approves open structural exposures, primarily in USD and EUR and expressed in currency notional amounts, which are sufficient to reduce the sensitivity of regulatory capital ratios to exchange rate movements within defined tolerance limits. 

Foreign exchange differences arising on the translation of foreign operations are recognised directly in equity together with the effective portion of foreign exchange differences arising on hedging instruments. 

Equity classification of foreign currency denominated preference share issuances requires that these shares be held on the balance sheet at historic cost. Consequently, these share issuances have the effect of increasing the Group's structural foreign currency position. 

See the Annual Report and Accounts 2008 for background on the Group's structural currency risk exposures. 

The tables below set out the Group's structural foreign currency exposures.



Net assets of overseas operations

Minority

Interests

Net investments

in foreign operations

Net 

investment 

 hedges 

Structural foreign currency exposures

30 June 2009

£m

£m

£m

£m

£m 







US dollar

15,551

(3)

15,554

(3,330)

12,224 

Euro

18,282

13,619 

4,663

(1,300)

3,363 

Other non sterling

5,639

536 

5,103

(3,585)

1,51







Total

39,472

14,152 

25,320

(8,215)

17,105 







31 December 2008












US dollar

17,480

(19)

17,499

(3,659)

13,840 

Euro

26,943

15,431 

11,512

(7,461)

4,051 

Chinese RMB

3,928

1,898 

2,030

(1,082)

948 

Other non sterling

5,088

62

4,467

(3,096)

1,37







Total

53,439

17,931 

35,508

(15,298)

20,210 


Retranslation gains and losses on the Group's net investments in operations, together with those on instruments hedging these investments, are recognised directly in equity. Changes in foreign currency exchange rates will affect equity in proportion to the structural foreign currency exposure. A five percent strengthening of foreign currencies would result in a gain of £900 million (31 December 2008 - £1,010 million) recognised in equity. A five percent weakening of foreign currencies would result in a loss of £810 million (31 December 2008 - £960 million) recognised in equity.  There are no Chinese RMB exposures at 30 June 2009 following the sale of the Group's interest in Bank of China.  These movements in equity would offset retranslation effects on the Group's foreign currency denominated risk weighted assets, reducing the sensitivity of the Group's tier 1 capital ratio to movements in foreign currency exchange rates.


  

Risk and capital management


Market turmoil exposures

Explanatory note

These disclosures are focused around certain of the Group's exposures which have been particularly affected by the widespread market disruptions. They reflect the recommendations in the report of the Financial Stability Forum on Enhancing Market and Institutional Resilience and Committee of European Banking Supervisors report on banks' transparency on activities and products affected by the recent market turmoil.




Acronyms used in Market turmoil exposures section


The following acronyms are used in this section



ABCP

Asset-backed commercial paper

ABS

Asset-backed security

CDO

Collateralised debt obligation

CDPC

Credit derivative product company

CDS

Credit default swap

CLO

Collateralised loan obligation

CP

Commercial paper

CMBS

Commercial mortgage-backed security

Fannie Mae

Federal National Mortgage Association

Freddie Mac

Federal Home Loan Mortgage Corporation

Ginnie Mae

Government National Mortgage Association

GSE

Government Sponsored Entity

IASB

International Accounting Standards Board

RoW

Rest of the world, excluding Europe and US

RMBS

Residential mortgage-backed security

SIV

Structured investment vehicle

SPE

Special purpose entity

US agencies

Ginnie Mae, Fannie Mae, Freddie Mac and similar entities


  

Risk and capital management


Market turmoil exposures (continued)

Asset-backed exposures

The carrying value of the Group's debt securities at 30 June 2009 was £229.1 billion compared to £253.2 billion at 31 December 2008 ('2008'). This comprised securities issued by central and local governments of £104.7 billion (2008 - £95.0 billion), asset-backed securities of £90.5 billion (2008 - £111.1 billion), £13.4 billion (2008 - £15.0 billion) of securities issued by banks and building societies and £20.5 billion (2008 - £32.0 billion) issued by corporates, US federal agencies and other entities. This section focuses on asset-backed securities, an area of interest following the market dislocations in 2008.

The Group's credit market activities give rise to risk concentrations that have been particularly affected by the market turmoil experienced since the second half of 2007. 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 tables below summarise the net exposures and balance sheet carrying values of these securities by measurement classification, product and geography of underlying assets at 30 June 2009 ('2009') and 31 December 2008.


Held-for-trading

Available-for-sale

Loans and receivables

Designated at fair value

Total


2009 

2008 

2009 

2008 

2009 

2008 

2009 

2008 

2009 

2008


£m 

£m 

£m 

£m 

£m 

£m 

£m 

£m 

£m 

£m












Net exposure (1)











RMBS: G10 governments (2)

16,228 

18,631 

29,649 

32,926 

- 

- 

45,877 

51,557

RMBS: other

4,003 

5,831 

7,559 

11,524 

2,602 

2,578 

133 

182 

14,297 

20,115

CMBS

1,326 

1,178 

1,531 

918 

1,413 

1,437 

193 

13 

4,463 

3,546

CDOs & CLOs

961 

2,463 

1,751 

2,538 

890 

1,282 

- 

3,603 

6,283

Other ABS

461 

195 

4,466 

6,572 

3,841 

3,621 

16 

40 

8,784 

10,428












Total

22,979 

28,298 

44,956 

54,478 

8,746 

8,918 

343 

235 

77,024 

91,929












Carrying value: 











RMBS: G10 governments (2)

16,228 

18,631 

29,649 

32,926 

- 

- 

45,877 

51,557

RMBS: other

5,962 

9,218 

7,839 

11,865 

2,602 

2,618 

133 

182 

16,536 

23,883

CMBS

2,241 

2,751 

1,704 

1,126 

1,413 

1,437 

204 

13 

5,562 

5,327

CDOs & CLOs

6,629 

7,774 

5,159 

9,579 

890 

1,284 

- 

12,679 

18,637

Other ABS

1,479 

1,505 

4,466 

6,572 

3,841 

3,621 

16 

41 

9,802 

11,739












Total

32,539 

39,879 

48,817 

62,068 

8,746 

8,960 

354 

 236 

90,456 

111,143


Notes:

(1)

Net exposures represent the carrying value after taking account of hedge protection purchased from monolines and other counterparties but exclude the effect of counterparty credit valuation adjustments. The hedges provide credit protection of 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.

(2) 

RMBS: G10 government securities comprises securities that are:


(a)

guaranteed or effectively guaranteed by the US government, via its support for US federal agencies and GSEs.


(b)

guaranteed by the Dutch government.


(c)

covered bonds, referencing primarily Dutch and Spanish government-backed loans.

  

Risk and capital management


Market turmoil exposures (continued)

Asset-backed exposures (continued)



US

UK

Europe

RoW

Total


2009

2008

2009

2008

2009

2008

2009

2008

2009

2008


£m

£m

£m

£m

£m

£m

£m

£m

£m

£m

Net exposure:











RMBS: G10 governments

30,798

33,508

271

321

14,771

17,682

37

46

45,877

51,557

RMBS: other

4,589

7,012

5,521

6,981

3,728

5,592

459

530

14,297

20,115

CMBS

2,691

1,147

1,115

1,225

618

1,095

39

79

4,463

3,546

CDOs& CLOs

1,886

3,276

124

386

1,578

2,450

15

171

3,603

6,283

Other ABS

2,392

3,508

1,154

1,368

4,644

4,299

594

1,253

8,784

10,428












Total

42,356

48,451

8,185

10,281

25,339

31,118

1,144

2,079

77,024

91,929












Carrying value: 











RMBS: G10 governments

30,798

33,508

271

321

14,771

17,682

37

46

45,877

51,557

RMBS: other

5,067

8,558

6,243

8,105

4,719

6,593

507

627

16,536

23,883

CMBS

3,201

2,144

1,199

1,395

1,017

1,646

145

142

5,562

5,327

CDOs & CLOs

10,094

14,703

224

588

2,185

3,046

176

300

12,679

18,637

Other ABS

2,966

3,582

1,252

1,622

4,694

5,098

890

1,437

9,802

11,739












Total

52,126

62,495

9,189

12,031

27,386

34,065

1,755

2,552

90,456

111,143


  

Risk and capital management


Market turmoil exposures (continued)

Asset-backed exposures (continued)

Asset backed securities ('ABS') are securities with an interest in an underlying pool of referenced assets. The risks and rewards of the referenced pool are passed on to investors by the issue by a special purpose entity of securities with varying seniority. The tables below analyse carrying values of the Group's ABS by rating, measurement classification and fair value hierarchy level.


RMBS




G10 govern-ments

Prime

Non conforming

Sub-prime


CMBS


CDOs

 & CLOs


Other ABS


Total

30 June 2009

£m

£m

£m

£m


£m


£m


£m


£m














AAA rated:(1)













Held-for-trading

16,228

4,317

194

306


1,789


3,816


486


27,136

Available-for-sale

29,261

4,786

706

401


1,311


4,014


3,341


43,820

Loans and receivables

-

582

1,327

194


229


320


939


3,591

Designated at fair value

-

120

-

13


199


-


-


332















45,489

9,805

2,227

914


3,528


8,150


4,766


74,879














BBB- and above rated:(1)













Held-for-trading

-

640

67

230


416


771


634


2,758

Available-for-sale

388

867

245

200


271


461


988


3,420

Loans and receivables

-

163

156

159


1,169


549


1,972


4,168

Designated at fair value

-

-

-

-


5


-


16


21















388

1,670

468

589


1,861


1,781


3,610


10,367














Non-investment grade:(1)













Held-for-trading

-

24

91

92


36


1,439


70


1,752

Available-for-sale

-

257

265

111


3


411


17


1,064

Loans and receivables

-

6

5

10


7


-


285


313

Designated at fair value

-

-

-

-


-


-


-


-















-

287

361

213


46


1,850


372


3,129














Not publicly rated:













Held-for-trading

-

1

-

-


-


603


289


893

Available-for-sale

-

-

1

-


119


273


120


513

Loans and receivables

-

-

-

-


8


21


645


674

Designated at fair value

-

-

-

-


-


1


-


1















-

1

1

-


127


898


1,054


2,081














Total:













Held-for-trading

16,228

4,982

352

628


2,241


6,629


1,479


32,539

Available-for-sale

29,649

5,910

1,217

712


1,704


5,159


4,466


48,817

Loans and receivables

-

751

1,488

363


1,413


890


3,841


8,746

Designated at fair value

-

120

-

13


204


1


16


354














Total

45,877

11,763

3,057

1,716


5,562


12,679


9,802


90,456














Of which carried at fair value:













Level 2(2)

45,877

10,562

1,559

1,342


3,794


9,611


5,301


78,046

Level 3(3)

-

448

11

11


355


2,180


658


3,663















45,877

11,010

1,570

1,353


4,149


11,791


5,959


81,709


  

Risk and capital management


Market turmoil exposures (continued)

Asset-backed exposures (continued)


RMBS




G10 govern-ments

Prime

Non conforming

Sub-prime


CMBS

CDOs

 & CLOs

Other ABS

Total

31 December 2008

£m

£m

£m

£m


£m

£m

£m

£m











AAA rated:(1)










Held-for-trading

18,622

6,226

203

393


2,306

4,698

380

32,828

Available-for-sale

32,926

8,384

1,914

522


982

6,459

4,826

56,013

Loans and receivables

-

476

1,415

431


405

652

1,443

4,822

Designated at fair value

-

166

-

16


9

-

-

191












51,548

15,252

3,532

1,362


3,702

11,809

6,649

93,854











BBB- and above rated:(1)










Held-for-trading

-

985

79

564


407

1,439

890

4,364

Available-for-sale

-

338

194

267


144

1,642

1,292

3,877

Loans and receivables

-

94

64

105


1,031

561

1,296

3,151

Designated at fair value

-

-

-

-


4

-

41

45












-

1,417

337

936


1,586

3,642

3,519

11,437











Non-investment grade:(1)










Held-for-trading

-

59

69

636


38

1,299

120

2,221

Available-for-sale

-

47

74

124


-

1,057

50

1,352

Loans and receivables

-

-

3

30


-

-

72

105

Designated at fair value

-

-

-

-


-

-

-

-












-

106

146

790


38

2,356

242

3,678











Not publicly rated:










Held-for-trading

9

2

1

1


-

338

115

466

Available-for-sale

-

-

1

-


-

421

404

826

Loans and receivables

-

-

-

-


1

71

810

882

Designated at fair value

-

-

-

-


-

-

-

-












9

2

2

1


1

830

1,329

2,174











Total:










Held-for-trading

18,631

7,272

352

1,594


2,751

7,774

1,505

39,879

Available-for-sale

32,926

8,769

2,183

913


1,126

9,579

6,572

62,068

Loans and receivables

-

570

1,482

566


1,437

1,284

3,621

8,960

Designated at fair value

-

166

-

16


13

-

41

236











Total

51,557

16,777

4,017

3,089


5,327

18,637

11,739

111,143











Of which carried at fair value:










Level 2(2)

51,322

16,062

2,485

2,459


3,316

14,643

6,677

96,964

Level 3(3)

235

145

50

64


574

2,710

1,441

5,219












51,557

16,207

2,535

2,523


3,890

17,353

8,118

102,183

Notes:

(1)

Credit ratings are based on those from rating agencies Standard & Poor's (S&P). Moody's and Fitch and have been mapped onto the S&P scale.

(2)

Valuation is based significantly on observable market data. Instruments in this category are valued using:


(a)

quoted prices for identical instruments in markets which are not considered to be active; or quoted prices for similar instruments trading in active or not so active markets; or


(b)

valuation techniques where all the inputs that have a significant effect on the valuation are directly or indirectly based on observable market data.  

(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.



Risk and capital management


Market turmoil exposures (continued)

Residential mortgage-backed securities

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 of the underlying mortgages and the credit enhancement in 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 guarantees over the value of the exposures, often provided by monoline insurers. 

The Group's ABS are analysed below by geographic region and nature of collateral. The US market has more established definitions for the quality of the underlying mortgage collateral and these are used as the basis for the Group's RMBS categorisation:

G10 governments - collateral comprises guaranteed mortgages and covered mortgage bonds.  Guaranteed mortgages are mortgages that form part of a mortgage backed security issuance by a government agency, or in the US, an entity that benefits from a guarantee (direct or indirect) provided by the US government. For US RMBS, this category includes, amongst others, RMBS issued by US agencies such as Ginnie Mae, Freddie Mac and Fannie Mae. For European RMBS this includes mortgages guaranteed by the Dutch government.  Covered mortgage bonds, primarily referencing Dutch and Spanish government-backed loans, are debt instruments that have recourse to a pool of mortgage assets, where investors have a preferred claim if a default occurs.  These underlying assets are segregated from the other assets held by the issuing entity. 

Prime - the underlying mortgages are of a higher credit quality than non-conforming and sub-prime mortgages (see below)but exclude G10 government mortgages.


Non-conforming (or 'Alt-A' used for US exposures) - the underlying mortgages have a higher credit quality than sub-prime mortgages, but lower than those for prime borrowers. Within the US mortgage industry, non-conforming mortgages are those that do not meet the lending criteria for US agency mortgages (described above). For non-US mortgages, judgement is applied in identifying loans with similar characteristics to US non-conforming loans, and also includes self-certified loans. Alt-A describes a category of mortgages in which lenders consider the risk to be greater than prime mortgages though less than sub-prime. The offered interest rate is usually representative of the associated risk level.


Sub-prime - the underlying mortgages are loans to sub-prime borrowers typically having weakened credit histories that include payment delinquencies, and potentially more severe problems such as court judgements and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, high debt-to-income ratios, or other criteria indicating heightened risk of default. 






Risk and capital management


Market turmoil exposures (continued)

Residential mortgage-backed securities (continued)

The tables below shows the Group's RMBS net exposures and carrying values by underlying asset type, measurement classification, the geographical location of the property securing the mortgage and the year in which the underlying securitisation was originated. 



30 June 2009


31 December 2008


G10 govern-ments 

Prime 

Non conforming 

Sub-prime 

Total


G10 govern-ments 

Prime 

Non conforming 

Sub-prime 

Total


£m

£m

£m

£m

£m


£m

£m

£m

£m

£m

Total












Net exposure:(1)












Held-for-trading

16,228

3,218

346

439

20,231


18,631

5,140

346

345

24,462

Available-for-sale

29,649

5,910

1,217

432

37,208


32,926

8,768

2,184

572

44,450

Loans and receivables

-

751

1,488

363

2,602


-

569

1,482

527

2,578

Designated at fair value

-

120

-

13

133


-

166

-

16

182














45,877

9,999

3,051

1,247

60,174


51,557

14,643

4,012

1,460

71,672













Carrying values:(2)











Held-for-trading

16,228

4,982

352

628

22,190


18,631

7,272

352

1,594

27,849

Available-for-sale

29,649

5,910

1,217

712

37,488


32,926

8,769

2,183

913

44,791

Loans and receivables

-

751

1,488

363

2,602


-

570

1,482

566

2,618

Designated at fair value

-

120

-

13

133


-

166

-

16

182














45,877

11,763

3,057

1,716

62,413


51,557

16,777

4,017

3,089

75,440


Notes:

(1)

Net exposures represent the carrying value after taking account of hedge protection purchased from monolines and other counterparties but excludes the effect of counterparty credit valuation adjustment. Carrying value is the amount recorded on the balance sheet.

(2)

Carrying value is the amount recorded on the balance sheet.

(3

G10 government RMBS net exposures and carrying values include:


(a)

£6.7 billion (2008 - £7.6 billion) available-for-sale exposures guaranteed by the Dutch government.


(b)

£6.9 billion (2008 - £5.7 billion) guaranteed by the US government via Ginnie Mae of which £1.1 billion (2008 - £0.5 billion) are held-for-trading.


(c)

£23.8 billion (2008 - £ 27.8 million) effectively guaranteed by the US government by way of its support for Freddie Mac and Fannie Mae of which £15.1 billon (2008 - £18.1 billion) are held-for-trading.


(d)

£8.0 billion (2008 - £10.0 billion) all classified as available-for-sale, covered bonds.


  

Risk and capital management


Market turmoil exposures (continued)

Residential mortgage-backed securities (continued)


30 June 2009


31 December 2008


US agency 

Prime 

Alt-A

Sub-prime 

Total


US agency 

Prime 

Alt-A

Sub-prime 

Total


£m

£m

£m

£m

£m


£m

£m

£m

£m

£m

United States












Net exposure:












Held-for-trading

16,191

433

346

439

17,409


18,577

968

346

302

20,193

Available-for-sale

14,607

2,667

566

51

17,891


14,932

4,364

760

53

20,109

Loans and receivables

-

84

-

3

87


-

215

-

3

218














30,798

3,184

912

493

35,387


33,509

5,547

1,106

358

40,520













Carrying values:












Held-for-trading

16,191

490

353

575

17,609


18,577

1,043

352

1,427

21,399

Available-for-sale

14,607

2,668

566

328

18,169


14,932

4,364

760

394

20,450

Loans and receivables

-

84

-

3

87


-

215

-

3

218














30,798

3,242

919

906

35,865


33,509

5,622

1,112

1,824

42,067













Of which originated in:











2004 and earlier

8,260

701

95

308

9,364


5,534

709

122

474

6,839

2005 

3,131

801

501

164

4,597


6,014

2,675

718

259

9,666

2006

1,039

925

105

187

2,256


1,690

614

115

718

3,136

2007 and later

18,368

815

218

247

19,648


20,271

1,624

157

373

22,425














30,798

3,242

919

906

35,865


33,509

5,622

1,112

1,824

42,067



30 June 2009


31 December 2008


Guaranteed 

Prime 

Non conforming 

Sub-prime 

Total


Guaranteed 

Prime 

Non conforming 

Sub-prime 

Total


£m

£m

£m

£m

£m


£m

£m

£m

£m

£m

United Kingdom












Net exposure:












Held-for-trading

-

239

-

-

239


9

249

-

33

291

Available-for-sale

271

2,493

651

79

3,494


313

3,133

1,423

154

5,023

Loans and receivables

-

314

1,364

248

1,926


-

118

1,482

205

1,805

Designated at fair value

-

120

-

13

133


-

166

-

16

182














271

3,166

2,015

340

5,792


322

3,666

2,905

408

7,301













Carrying values:












Held-for-trading

-

954

-

5

959


9

1,336

-

70

1,415

Available-for-sale

271

2,493

651

81

3,496


313

3,133

1,423

154

5,023

Loans and receivables

-

314

1,364

248

1,926


-

118

1,482

205

1,805

Designated at fair value

-

120

-

13

133


-

166

-

16

182














271

3,881

2,015

347

6,514


322

4,753

2,905

445

8,425













Of which originated in:












2004 and earlier

7

273

-

32

312


9

806

-

72

887

2005 

-

776

-

24

800


-

1,000

652

42

1,694

2006

8

1,957

464

127

2,556


13

2,295

756

209

3,273

2007 and later

256

875

1,551

164

2,846


300

652

1,497

122

2,571














271

3,881

2,015

347

6,514


322

4,753

2,905

445

8,425


Risk and capital management


Market turmoil exposures (continued)

Residential mortgage-backed securities (continued)



30 June 2009


31 December 2008


Guaranteed (1)

Covered bonds (2)

Prime and non-conforming (3)

Sub-prime

Total


Guaranteed (1)

Covered bonds (2)

Prime

Sub-prime

Total

Europe

£m

£m

£m

£m

£m


£m

£m

£m

£m

£m













Net exposure












Held-for-trading

-

-

2,542

-

2,542


-

-

3,898

10

3,908

Available-for-sale

6,722

8,049

592

41

15,404


7,642

10,040

1,106

57

18,845

Loans and receivables

-

-

450

103

553


-

-

208

313

521














6,722

8,049

3,584

144

18,499


7,642

10,040

5,212

380

23,274













Carrying values












Held-for-trading

-

-

3,525

8

3,533


-

-

4,839

30

4,869

Available-for-sale

6,722

8,049

592

41

15,404


7,642

10,040

1,107

57

18,846

Loans and receivables

-

-

451

102

553


-

-

208

352

560














6,722

8,049

4,568

151

19,490


7,642

10,040

6,154

439

24,275













Of which originated in:












2004 and earlier

377

632

684

25

1,718


418

702

954

48

2,122

2005 

1,033

2,364

754

27

4,178


1,165

2,993

1,090

17

5,265

2006

1,758

3,822

1,585

84

7,249


2,059

4,466

2,466

148

9,139

2007 and later

3,554

1,231

1,545

15

6,345


4,000

1,879

1,644

226

7,749














6,722

8,049

4,568

151

19,490


7,642

10,040

6,154

439

24,275


Notes:

(1)

Guaranteed by the Dutch government

(2) 

Covered bonds referencing primarily Dutch and Spanish mortgages

(3)

Non-conforming net exposures and carrying values: £123 million at 30 June 2009 (2008 - nil)


  

Risk and capital management


Market turmoil exposures (continued)

Residential mortgage-backed securities (continued)



30 June 2009


31 December 2008


Guaranteed

Prime

Sub-prime

Total


Guaranteed

Prime

Sub-prime

Total

Rest of the World

£m

£m

£m

£m


£m

£m

£m

£m











Net exposure










Held-for-trading

37

4

-

41


46

24

-

70

Available-for-sale

-

156

263

419


-

164

308

472

Loans and receivables

-

28

8

36


-

28

6

34












37

188

271

496


46

216

314

576











Carrying values










Held-for-trading

37

11

41

89


46

54

67

167

Available-for-sale

-

157

262

419


-

164

308

472

Loans and receivables

-

28

8

36


-

28

6

34












37

196

311

544


46

246

381

673











Of which originated in:










2004 and earlier

-

25

58

83


-

37

65

102

2005 

-

1

33

34


-

30

34

64

2006

37

3

175

215


46

2

187

235

2007 and later

-

167

45

212



177

95

272












37

196

311

544


46

246

381

673


  

Risk and capital management


Market turmoil exposures (continued)

Residential mortgage-backed securities (continued)

US - the Group's largest concentration of RMBS assets is the portfolio of US agency asset-backed securities comprising mainly current year vintage positions amounting to £30.8 billion at 30 June 2009 (2008: £33.5 billion). Due to the US government backing, explicit or implicit, in these securities, the counterparty credit risk exposure is low. £16.2 billion (2008: £18.6 billion) is held in actively traded portfolios, actively transacted, and possesses a high degree of liquidity. Trading in this portfolio has driven a shift to more recent vintages.  However, the majority of the decrease in exposure during the period has been due to the strengthening of sterling against the US dollar. Available-for-sale exposures of £14.6 billion (£14.9 billion) relate to liquidity portfolios held by US Retail & Commercial. 

Europe - these are liquidity portfolios comprising £6.7 billion (2008 - £7.6 billion) available-for-sale portfolio of European RMBS, referencing primarily Dutch and Spanish government-backed loans and £8.0 billion (2008 - £10.0 billion) of European RMBS comprised covered mortgage bonds. The decrease in both of these portfolios primarily reflects exchange rate movements. These exposures are part of the liquidity portfolios held by Group Treasury.

UK and the rest of the world - the Group has other portfolios of RMBS from secondary trading activities, warehoused positions previously acquired with the intention of further securitisation and a portfolio of assets from the unwinding of a securities arbitrage conduit. This conduit was established to benefit from the margin between the assets purchased and the notes issued. 

Material disposals of prime RMBS occurred in the period, in particular £1.5 billion of 2005 vintage US securities, £0.5 billion of Spanish and Portuguese mortgages and £0.6 billion of positions which have synthetic hedges against them. Other declines were due to redemptions and foreign exchange movements.  Sub-prime balances reduced across ratings, geographies and vintages, due to pay downs, maturities and sales during the period, while non-conforming exposures fell mainly due to UK available-for-sale redemptions.




Risk and capital management


Market turmoil exposures (continued)

Commercial mortgage-backed securities

Commercial mortgage-backed securities ('CMBS') are securities that are secured by loans mortgaged on commercial land and buildings. The securities are structured in the same way as an RMBS but typically the underlying assets referenced will be of greater individual value. The performance of the securities is dependent on the sector of the occupier of the commercial property and the geographical region. 


The Group accumulated CMBS for the purpose of re-securitisation and secondary trading.  The largest holding of CMBS arose as a result of the Group's purchase of senior tranches in mezzanine and high grade CMBS structures from third parties. These securities are predominantly hedged with monoline insurers. As a result, the Group's risk is limited to the counterparty credit risk exposure on the hedge provider.  


The following table shows the composition of the Group's holdings of CMBS portfolios. 



30 June 2009


31 December 2008


US

UK

Europe

RoW

Total


US

UK

Europe

RoW

Total


£m

£m

£m

£m

£m


£m

£m

£m

£m

£m













US federal agency

1,418

n/a

n/a

n/a

1,418


649

n/a

n/a

n/a

649

Office

641

770

242

-

1,653


428

915

402

-

1,745

Retail

460

45

66

39

610


295

43

2

49

389

Mixed use

62

27

473

3

565


20

99

975

45

1,139

Multi-family

279

131

3

-

413


159

143

-

-

302

Hotel

119

26

-

-

145


40

35

-

-

75

Healthcare

1

30

75

-

106


24

13

81

-

118

Leisure

-

77

-

-

77


-

76

-

-

76

Industry

63

-

8

-

71


40

-

49

-

89

Other

159

92

150

103

504


490

71

137

47

745














3,202

1,198

1,017

145

5,562


2,145

1,395

1,646

141

5,327


Underlying CMBS carrying values declined due to foreign exchange movements driven by the strengthening of sterling against the US dollar and the euro, as well as modest pay downs, sales and write-downs.  This was partially offset by revised asset classifications, including US federal agency issued securities. 


There have been no material acquisitions of CMBS by the Group in the period. Where exposures within CMBS types have increased, this is due to a change of sector exposure from permitted substitutions, particularly within US structures, and revised sector classifications.


Asset-backed collateralised debt and loan obligations

Collateralised debt obligations ('CDOs') are securities whose performance is dependant on a portfolio of underlying cash and synthetic exposures to referenced assets generally ABS, but may also include other classes of assets. The collateralised loan obligations ('CLOs') have referenced portfolios which primarily consist of leveraged loans. 


The Group's ABS CDO and CLO net exposures comprised:


30 June 2009

31 December 2008


£m

£m




Super senior CDOs

548

1,182

Other CDOs 

909

1,658

CLOs

2,146

3,443





3,603

6,283


  

Risk and capital management


Market turmoil exposures (continued)

The Group's CDO exposures comprise:


  • Super senior CDO risk structured by the Group from 2003 to 2007 that the Group was unable to sell to third parties due to prevailing illiquid markets, with net exposures of £0.5 billion (2008: £1.2 billion).

  • Other CDO net exposures of £0.9 billion (2008:£1.7 billion) purchased from third parties, some of which are fully hedged through CDS with other banks or monoline insurers.


Given the significance of net losses incurred on super senior CDOs in recent years, additional disclosures on these exposures are discussed below.  


Super senior CDOs

Super senior CDOs represent the most senior positions in a CDO Instruments subordinate to the super senior CDO (usually a combination of equity, mezzanine and senior notes) absorb losses before the super senior note is affected. Losses will only be suffered by the super senior note holders once defaults on the underlying reference assets exceed a specified threshold. This threshold is usually referred to in terms of a percentage of defaults in the asset pool; known as the 'attachment point'. These super senior instruments carry an AAA rating at origination or are senior to other AAA rated notes in the same structure. The level of defaults occurring on recent vintage sub-prime mortgages and other asset classes has been higher than originally expected. As a result the protection afforded by the subordinate securities has been significantly eroded and consequently the super senior notes have a higher probability of suffering losses than at origination. The majority of the underlying collateral is now rated below investment grade.

Depending on the quality of the underlying reference assets on issue, the super senior tranches will be either classified as high grade or mezzanine. The majority of the Group's exposure relates to high grade super senior tranches of ABS CDOs. The table below summarises the carrying amounts and net exposures after hedge protection of the Group's super senior CDOs as at 30 June 2009. The collateral rating is determined with reference to S&P ratings where available. Where S&P ratings are not available the lower of Moody's and Fitch ratings have been used.



30 June 2009(1)

31 December 2008(2)


High grade 

Mezzanine 

Total 

High grade 

Mezzanine 

Total 


£m 

£m 

£m 

£m 

£m 

£m 








Gross exposure

6,314 

2,586 

8,900 

7,104 

2,884 

9,988 

Hedges and protection

(3,040)

(614)

(3,654)

(3,423)

(691)

(4,114)





 




3,274 

1,972 

5,246 

3,681 

2,193 

5,874 

Write-downs on net open

  positions and amortisations

(2,756)

(1,942)

(4,698)

(2,592)

(2,100)

(4,692)








Net exposure after hedges and

  write-downs

518 

30 

548 

1,089 

93 

1,182 








Average price

17% 

3% 

16% 

29% 

6% 

23% 


Notes:
(1)
Net exposure represents the carrying value after taking account of hedge protection purchased from monolines and other counterparties but excludes the effect of counterparty credit valuation adjustment; includes portfolios carried at fair value only.
(2)
Exposures at 31 December 2008 have been restated to reflect transactions that have been liquidated and now represent long positions in asset-backed securities.


  

Risk and capital management


Market turmoil exposures (continued)

The change in net exposure during the year is analysed in the table below.



High grade

Mezzanine

Total

 

£m

£m

£m





Net exposure at 1 January 2009

1,089 

93 

1,182 

Write downs

(417)

(50)

(467)

Foreign exchange and other movements

(154)

(13)

(167)





Net exposure at 30 June 2009

518 

30 

548 


During 2009 the super senior exposures, which are predominantly US positions, have fallen by approximately 50%. This reflects the further price declines in the underlying collateral as well as the foreign exchange effect as sterling has strengthened against the US dollar in the first half of 2009.

Other CDOs 

The net exposure of the Group's other senior CDO exposures was £0.9 billion after hedge protection with financial institutions (more than 80%) or monolines.  The unhedged exposures comprise smaller positions with various types of underlying collateral, rating and vintage characteristics. The positions hedged with derivative protection from financial institutions include a number of positions referencing early vintages of RMBS and other ABS assets. The Group therefore has no net exposure to these CDOs before credit valuation adjustment. Due to the early vintage, the assets underlying these structures have not deteriorated to the same degree as the more recently issued securities.  During 2009 the other CDO exposures, which are predominantly US positions, have fallen significantly. This reflects further price declines in the underlying collateral as well as the strengthening of sterling against the US dollar in the first half of 2009. The price declines relate to exposures with more recent vintages.

CLOs

The Group's CLO exposures arise from its trading activities and consist of retained interests and from notes purchased from third-party structures. The Group holds super senior securities in two CLO structures which were originated by the Group in 2005 and 2007. The underlying collateral of these structures predominantly references leveraged loans.

In the first half of 2009, there were further write downs in line with the decline in the market, some deal amortisations and disposal of positions where market opportunities occurred. 


  

Risk and capital management


Market turmoil exposures (continued)

Other asset backed securities

Other asset backed securities are securities issued by securitisation vehicles, similar to those in RMBS and CMBS structures, which reference cash flow generating assets other than mortgages.  The wide variety of referenced underlying assets results in diverse asset performance levels. 


The Group has accumulated these assets from a range of trading and funding activities.  The carrying value of the Group's other asset-backed securities by underlying asset type and geographical region are shown below.



30 June 2009


31 December 2008


US

UK

Europe

RoW

Total


US

UK

Europe

RoW

Total


£m

£m

£m

£m

£m


£m

£m

£m

£m

£m













Covered bonds

-

-

2,190

-

2,190


-

-

3,301

-

3,301

Consumer

245

182

1,071

499

1,997


956

408

118

729

2,211

Aircraft leases

380

13

8

65

466


459

23

-

273

755

Other leases

16

611

286

-

913


1

492

455

-

948

Student loans

694

-

-

-

694


953

-

-

-

953

Trade receivables

623

7

-

-

630


15

9

-

-

24

Utilities and energy

241

2

283

177

703


47

19

48

143

257

Auto and equipment

90

8

337

3

438


160

30

466

29

685

Film/entertainment

-

-

-

-

-


86

-

-

-

86

Other 

677

429

519

146

1,771


904

641

710

263

2,518














2,966

1,252

4,694

890

9,802


3,581

1,622

5,098

1,437

11,738


The covered bonds comprise asset-backed securities issued by Spanish financial institutions.  These securities benefit from credit enhancement provided by the issuing institutions.  The reduction in carrying value of the Group's Other ABS exposures reflects asset disposals, and the strengthening of sterling against the US dollar and the euro There have been no material acquisitions of other ABS by the Group in the period. Where exposures within specific asset types have increased, this is due to a combination of permitted substitutions within structures and revised sector classifications, particularly in relation to other consumer and trade receivable positions.




Risk and capital management


Market turmoil exposures (continued)

Counterparty valuation adjustments

Credit valuation adjustments

Counterparty valuation adjustments ('CVAs') represent an estimate of the adjustment to fair value that a market participant would make to incorporate the credit risk inherent in counterparty derivative exposures. During 2009, as credit spreads of monoline insurers have generally widened, there has been an increase in the total CVA as set out in the table below.



30 June 

2009

31 December

 2008


£m

£m




Monoline insurers

6,845

5,988

CDPCs

821

1,311

Other counterparties 

1,821

1,738




Total CVA adjustments

9,487

9,037


The Group has purchased protection from monoline insurers ('monolines') mainly against specific ABS, CDOs and CLOs.  Monolines are entities which specialise in providing credit protection against the notional and interest cash flows due to the holders of debt instruments in the event of default by the debt security counterparty.  This protection is typically held in the form of derivatives such as credit default swaps ('CDS') referencing the underlying exposures held by the Group.

The Group has also purchased credit protection, both tranched and single name credit derivatives, from credit derivative product companies ('CDPC') CDPCs are similar to monolines however they are not regulated as insurers.  The Group's exposure to CDPCs is predominantly due to tranched credit derivatives ('tranches').  A tranche references a portfolio of assets and provides protection against total portfolio default losses exceeding a certain percentage of the portfolio notional (the attachment point) up to another percentage (the detachment point).  The Group has predominantly traded senior tranches with CDPCs, the average attachment and detachment points are 15% and 50% respectively, and the majority of the loans and bonds in the reference portfolios are investment grade. 

The CVA for monolines is calculated on a trade-by-trade basis, and is derived using market observable monoline credit spreads.  The majority of the monoline CVA relates to credit derivatives hedging exposures to ABS.  The CDPC CVA is calculated using a similar approach.  However, in the absence of market observable credit spreads, the cost of hedging the counterparty risk is estimated by analysing the underlying trades and the cost of hedging expected default losses in excess of the capital available in each vehicle.  

The CVA for all other counterparties is calculated with reference to observable credit spreads.  The calculation is performed on a portfolio basis reflecting an estimate of the amount a third party would charge to assume the risk. 

The widening of monoline credit spreads during the year contributed to a significant increase in the total size of CVA adjustments recorded.


  

Risk and capital management


Market turmoil exposures (continued)

Monoline insurers

The Group's monoline exposures are predominantly denominated in US dollars and the weakening of the US dollar against sterling has significantly reduced the gross exposure to these counterparties.  This has been partially offset by an increase in the fair value of the CDS protection from monolines as the market price of the securities protected continued to decline.

The perceived credit quality of the monolines has also continued to deteriorate as reflected by ratings downgrades, wider credit spreads and lower recovery rate assumptions seen in the market.  This has resulted in increased levels of CVA being recorded against the Group's monoline exposure.  

Summary of the Group's exposure to monoline counterparties:



30 June 

 2009 

31 December 

 2008 


£m 

£m 




Gross exposure to monolines

10,950 

11,581 

Hedges with financial institutions

(524)

(789)

Credit valuation adjustment

(6,845)

(5,988)




Net exposure to monolines

3,581 

4,804 


The net income statement effect arising from the change in level of monoline CVA and related trades is shown below. The US dollar weakening against sterling is the primary cause of the loss arising on foreign exchange, hedges and other movements. 



£m



Credit valuation adjustment at 1 January 2009

(5,988)

Credit valuation adjustment at 30 June 2009

(6,845)



Increase in credit valuation adjustment

(857)

Foreign exchange and other movements

(937)

Net effect relating to reclassified debt securities

(27)




(1,821)





Risk and capital management


Market turmoil exposures (continued)

Monoline insurers (continued)

The asset categories protected by CDSs written by monolines and the related CVA by monoline credit rating at the balance sheet date are analysed in the table below.



30 June 2009


31 December 2008


Notional amount: protected assets

Fair value:

Protected

 assets

Gross exposure

Credit valuation adjustment


Notional amount: protected assets

Fair value: protected assets

Gross

 exposure

Credit valuation adjustment


£m

£m

£m

£m


£m

£m

£m

£m











AAA/AA rated:










CDO of RMBS 


-

-

-

-

RMBS

-


3

2

1

-

CMBS

503 

357 

146 

61


613

496

117

51

CLOs

5,610 

4,219 

1,391 

599


6,506

4,882

1,624

718

Other ABS

1,308 

849 

459 

206


1,548

990

558

251

Other

265 

174 

91 

44


267

167

100

47












7,689 

5,601 

2,088 

910


8,937

6,537

2,400

1,067











A/BBB rated:










CDO of RMBS 


5,385

1,363

4,022

1,938

RMBS


90

63

27

10

CMBS


4,236

1,892

2,344

1,378

CLOs


6,009

4,523

1,486

778

Other ABS


910

433

477

243

Other


265

122

143

79













16,895

8,396

8,499

4,426











Sub-investment grade:










CDO of RMBS 

4,972 

687 

4,285 

2,745


394

32

362

263

RMBS

76 

64 

12 

2


-

-

-

-

CMBS

3,757 

1,212 

2,545 

1,886


-

-

-

-

CLOs

4,953 

3,795 

1,158 

797


350

268

82

60

Other ABS

1,747 

1,129 

618 

353


1,208

1,037

171

123

Other

488 

244 

244 

152


237

169

68

49




 








15,993 

7,131 

8,862 

5,935


2,189

1,506

683

495











Total:










CDO of RMBS 

4,972 

687 

4,285 

2,745


5,779

1,395

4,384

2,201

RMBS

79 

66 

13 

2


93

65

28

10

CMBS

4,260 

1,569 

2,691 

1,947


4,849

2,388

2,461

1,429

CLOs

10,563 

8,014 

2,549 

1,396


12,865

9,673

3,192

1,557

Other ABS

3,055 

1,978 

1,077 

559


3,666

2,460

1,206

616

Other

753 

418 

335 

196


769

458

311

176












23,682 

12,732 

10,950 

6,845


28,020

16,439

11,581

5,988


The Group also has indirect exposure to monolines through wrapped securities and other assets with credit enhancement monolines These securities are traded with the benefit of this credit enhancement Any deterioration in the credit rating of the monoline is reflected in the fair value of these assets. 




Risk and capital management


Market turmoil exposures (continued)

Credit derivative product companies

The Group's exposure to CDPCs has reduced considerably due to a combination of tighter credit spreads and a decrease in the relative value of senior tranches compared to the underlying reference portfolios. The trades with CDPCs are predominantly denominated in US and Canadian dollars and therefore the strengthening of sterling against these currencies has further reduced the exposure.


The overall level of CVA has decreased in line with the reduction in the exposure, however, on a relative basis the CVA has increased. This reflects the perceived deterioration of the credit quality of the CDPCs as reflected by ratings downgrades.


Summary of the Group's exposure to CDPC:


 
30 June 
2009 
31 December 
2008 
 
£m 
£m 
 
 
 
Gross exposure to CDPCs
2,303 
4,776 
Credit valuation adjustment
(821)
(1,311)
 
 
 
Net exposure to CDPCs
1,482 
3,465 


The net income statement effect arising from the change in level of CVA and related trades is shown in the table below. The Group has additional market risk hedges in place which effectively cap the exposure to CDPCs where the Group has significant risk. As the exposure to these CDPCs has reduced, losses have been incurred on the additional hedges. These losses, together with losses arising on trades hedging CVA, are the primary cause of the loss arising on hedges, foreign exchange and other movements.



£m 



Credit valuation adjustment at 1 January 2009

(1,311)

Credit valuation adjustment at 30 June 2009

(821)



Decrease in credit valuation adjustment

490 

Hedges, foreign exchange and other movements

(1,059)




(569)




  

Risk and capital management


Market turmoil exposures (continued)

Credit derivative product companies (continued)

Further analysis of the Group's exposure to CDPCs by CDPC credit rating is shown below.  Some of the CDPCs with the AAA/AA and A/BBB rating at 31 December 2008 were subsequently downgraded or had ratings withdrawn.



30 June 2009


31 December 2008


Notional amount: protected assets

Fair value: protected reference assets

Gross exposure

Credit valuation adjustment


Notional amount: protected assets

Fair value: protected reference assets

Gross exposure

Credit valuation adjustment


£m

£m

£m

£m


£m

£m

£m

£m











AAA/AA rated

1,636

1,580

56

18


19,092

15,466

3,626

908

A/BBB rated

15,965

14,484

1,481

470


6,147

4,997

1,150

403

Sub-investment grade

1,399

1,097

302

151


-

-

-

-

Rating withdrawn

3,914

3,450

464

182


-

-

-

-












22,914

20,611

2,303

821


25,239

20,463

4,776

1,311




Risk and capital management


Market turmoil exposures (continued)

Leveraged finance

Leveraged finance is employed to facilitate corporate finance transactions, such as acquisitions or buy-outs. A bank acting as a lead manager will typically underwrite a loan, alone or with others, and then syndicate the loan to other participants ('syndicate portfolio'). The Group has typically also held a portion of these loans as part of its long term portfolio once primary syndication is completed ('hold portfolio').

Since the beginning of the credit market dislocation in the second half of 2007, investor appetite for leveraged loans and similar risky assets has fallen dramatically, with secondary prices falling due to selling pressure and margins increasing, and reduced activity in the primary market. There were a small number of modest deals with reduced leverage executed in the first half of 2008 priced at less than mid-2007 levels. Concerted efforts to sell positions during the first half of 2008 were only partially successful due to the rapid deterioration in market conditions since origination of the loans. Most of the leveraged finance loans held as part of syndicated lending activity were reclassified from the held-for-trading to loans and receivables in the second half of 2008.

During the first half of 2009, there have been a small number of sales and further impairments have been recorded The strengthening of sterling against other major currencies also had a substantial impact on this book, which has significant US dollar and euro positions.

The table below shows the Group's leveraged finance exposures by industry and geography.


30 June 2009


31 December 2008


Americas

UK

Europe

RoW

Total


Americas

UK

Europe

RoW

Total


£m

£m

£m

£m

£m


£m

£m

£m

£m

£m













Gross exposure:












TMT (1)

1,625

1,652

1,477

506

5,260


2,507

1,484

2,001

535

6,527

Industrial

1,616

1,553

1,641

175

4,985


1,686

1,612

1,924

188

5,410

Retail

69

1,134

1,327

79

2,609


268

1,285

1,440

89

3,082

Other

350

1,566

1,228

131

3,275


487

1,391

1,282

126

3,286














3,660

5,905

5,673

891

16,129


4,948

5,772

6,647

938

18,305













Net exposure:












TMT (1)

1,283

1,517

1,367

506

4,673


2,247

1,385

1,982

534

6,148

Industrial

578

1,126

1,416

172

3,292


607

1,157

1,758

186

3,708

Retail

69

537

1,257

79

1,942


223

978

1,424

89

2,714

Other

350

1,383

1,204

131

3,068


484

1,307

1,281

127

3,199














2,280

4,563

5,244

888

12,975


3,561

4,827

6,445

936

15,769

Of which:












Drawn

1,825

3,859

4,193

813

10,690


2,511

4,125

5,159

824

12,619

Undrawn

455

704

1,051

75

2,285


1,050

702

1,286

112

3,150














2,280

4,563

5,244

888

12,975


3,561

4,827

6,445

936

15,769













Of which:












Syndicate portfolio (2)

1,428

1,398

1,125

88

4,039


2,138

2,121

1,663

101

6,023

Hold portfolio

852

3,165

4,119

800

8,936


1,423

2,707

4,783

835

9,746














2,280

4,563

5,244

888

12,975


3,561

4,827

6,445

936

15,769













Notes:

(1)

Telecommunications, media and technology

(2)

includes held-for-trading exposures of £38 million (2008 - £102 million)


  

Risk and capital management


Market turmoil exposures (continued)

Leveraged finance (continued)

The table below analyses the movement in the amounts reported above.



Drawn 

Undrawn 

Total 


£m 

£m 

£m 





Balance at 1 January 2009

12,619 

3,150 

15,769 

Transfers in (from credit trading business)

506 

41 

547 

Sales

(327)

(147)

(474)

Repayments and facility reductions

(549)

(314)

(863)

Funded deals

97 

(97)

Lapsed/collapsed deals

(28)

(19)

(47)

Changes in fair value

(34)

(6)

(40)

Accretion of interest

71 

n/a 

71 

Impairment provisions

(679)

n/a 

(679)

Exchange and other movements

(986)

(323)

(1,309)





Balance at 30 June 2009

10,690 

2,285 

12,975 


  

Risk and capital management


Market turmoil exposures (continued)

SPEs and conduits 

SPEs

For background on the Group's involvement with securitisations and special purpose entities ('SPEs'), refer to Business Review - SPEs and conduits in the Annual Report and Accounts 2008.


The table below sets out the asset categories together with the carrying amount of the assets and associated liabilities for those securitisations and other asset transfers, other than conduits (discussed below), where the assets continue to be recorded on the Group's balance sheet.



30 June 2009

31 December 2008


Assets

Liabilities

Assets

Liabilities


£m

£m

£m

£m











Residential mortgages

62,799

17,812

49,184

20,075

Credit card receivables

2,975

1,567

3,004

3,197

Other loans

10,472

1,031

1,679

1,071

Finance lease receivables

950

750

1,077

857


The increase in residential mortgage and other loan assets above primarily relate to balances that have been securitised to facilitate access to central bank special liquidity schemesAs all the notes issued by the SPEs are purchased by Group companies, securitised assets are significantly greater than secured liabilities.

Conduits 

The Group sponsors and administers a number of asset-backed commercial paper ('ABCP') conduits. A conduit is an SPE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed either by further commercial paper issuance, repayment of assets or funding from liquidity facilities. Commercial paper is short-dated, typically up to three months. 

The Group's conduits can be divided into multi-seller conduits and own-asset conduits. The Group consolidates both types of conduit where the substance of the relationship between the Group and the conduit vehicle is such that the vehicle is controlled by the Group.  The Group also extends liquidity commitments to multi-seller conduits sponsored by other banks, but typically does not consolidate these entities. 

Funding and liquidity 

The Group's multi-seller conduits have continued to fund the vast majority of their assets solely through ABCP issuance.  There have been no significant systemic failures within the financial markets similar to that experienced in the second half of 2008 following Lehman Brothers bankruptcy filing in September 2008. The improvement in market conditions has allowed these conduits to move towards more normal ABCP funding and reduced the need for backstop funding from the Group.

The Group's own-asset conduit programmes have been established to diversify the Group's funding.  The conduits allow the Group to access central government funding schemes and the external ABCP market. 

The average maturity of ABCP issued by the Group's conduits as at 30 June 2009 was 55.2 days compared with 72.1 days at 31 December 2008 due to a combination of restructured deals having shorter terms than normal rolling periods and effect of issuers seeking longer terms at end of any year due to general illiquidity at the end of the year/early January

  

Risk and capital management


Market turmoil exposure(continued).

The total assets held by the Group's sponsored conduits are £35.0 billion (31 December 2008 - £49.9 billion). Since the related backstop liquidity facilities are sanctioned on the basis of total conduit purchase commitments, the liquidity facility commitments exceed the level of assets held, with the difference representing undrawn commitments. 


Multi-seller conduits 

The Group sponsors six multi-seller conduits which finance assets from Europe, North America and Asia-Pacific. Assets purchased or financed by the multi-seller conduits include auto loans, residential mortgages, credit card receivables, consumer loans and trade receivables.  These conduits were established to provide customers of the Group access to diversified and flexible funding sources.

The third-party assets financed by the conduits receive credit enhancement from the originators of the assets.  This credit enhancement, which is specific to each transaction, can take the form of over-collateralisation, excess spread or subordinated loan, and typically ensures the asset acquired by the conduit has a rating equivalent to at least a single-A credit.  In additionin line with general market practice, the Group provides a small second-loss layer of programme-wide protection to the multi-seller conduits. Given the nature and investment grade equivalent quality of the first loss enhancement provided by the originators of the assets, the Group has only a minimal risk of loss on its programme wide exposure.  The issued ABCP is rated A-1 / P-1 by Moody's and Standard & Poor's. 

The Group provides liquidity back-up facilities to the conduits it sponsors.  The conduits are able to draw funding under these facilities in the event of a disruption in the ABCP market, or when certain trigger events prevent the issue of ABCP The maturity of commercial paper issued by the Group's conduits is managed to mitigate the short-term contingent liquidity risk of providing back-up facilities. Group limits sanctioned for such liquidity facilities as at 30 June 2009 totalled approximately £28.2 billion (31 December 2008 - £42.9 billion).  For a very small number of transactions within one multi-seller conduit the liquidity facilities have been provided by third-party banks, this typically occurs on transactions where the third-party bank does not use, or have, its own conduit vehicles. 

The multi-seller conduits form the majority of the Group's conduit business (64.2% (31 December 2008 - 69.4%). 

The Group's maximum exposure to loss on its multi-seller conduits is £28.3 billion (31 December 2008 - £43.2 billion), being the total amount of the Group's liquidity commitments plus the extent of programme-wide credit enhancements of conduit assets for which liquidity facilities were provided by third parties. 

Own-asset conduits

The Group also holds three own-asset conduits which have assets that have previously been funded by the Group. These vehicles represent 28% (31 December 2008 - 25%) of the Group's conduit business (as a percentage of the total liquidity and credit enhancements committed by the Group), with £11.8 billion of ABCP outstanding at 30 June 2009 (31 December 2008 - £14.8 billion). The Group's maximum exposure to loss on its own-asset conduits is £12.9 billion (31 December 2008 - £15.9 billion), being the total drawn and undrawn amount of the Group's liquidity commitments to these conduits. 

Securitisation arbitrage conduits

The Group no longer sponsors any securitisation arbitrage conduits.

  

Risk and capital management


Market turmoil exposure(continued).

Conduits (continued)

The Group's exposure from conduits which are consolidated by the Group including those to which the Group is economically exposed on a shared basis with other consortium members and its involvement with third-party conduits, are set out below. 


30 June 2009


31 December 2008


Sponsored conduits

Third

party

Total


Sponsored conduits

Third

party

Total


£m

£m

£m


£m

£m

£m









Total assets held by the conduits

35,007




49,857











Commercial paper issued

33,452




48,684











Liquidity and credit enhancements:








Deal specific liquidity: 








- drawn

1,440

2,361

3,801


1,172

3,078

4,250

- undrawn

39,744

1,161

40,905


57,929

198

58,127

Programme-wide liquidity:








- drawn

-

99

99


-

102

102

- undrawn

-

-

-


-

504

504

PWCE (1)

1,663

-

1,663


2,391

-

2,391










42,847

3,621

46,468


61,492

3,882

65,374

















Maximum exposure to loss (2)

41,184

3,621

44,805


59,101

3,882

62,983


Notes:

(1)

Programme-wide credit enhancement

(2)

Maximum exposure to loss is determined as the Group's total liquidity commitments to the conduits and additionally programme-wide credit support which would absorb first loss on transactions where liquidity support is provided by a third party. 


The Group's exposures from the conduit shared with the other consortium members is set out below:



30 June

2009

31 December 2008


£m

£m




Total assets held by the conduits

11,189

13,286




Commercial paper issued

11,189

13,028




Liquidity and credit enhancements:



Deal specific liquidity:



- drawn

-

258

- undrawn

11,311

13,566





11,311

13,824




Maximum exposure to loss

11,311

13,824



During the period both multi-seller and own asset conduit assets have been reduced in line with the wider Group balance sheet management.

  

Risk and capital management


Market turmoil exposures (continued)

Conduits (continued)

Collateral analysis, geographic, profile, credit ratings and weighted average lives of the assets in the assets relating to the Group's consolidated conduits and related undrawn commitments are set out in the tables below.



Funded assets

Undrawn

Liquidity for third parties

Total exposure

Loans

Securities

Total


£m

£m

£m

£m

£m 

£m








30 June 2009







Auto loans

5,785

280

6,065

1,838

-

7,903

Corporate loans

213

9,193

9,406

186

-

9,592

Credit card receivables

3,375

-

3,375

1,601

-

4,976

Trade receivables

1,437

-

1,437

790

-

2,227

Student loans

1,260

-

1,260

265

(132)

1,393

Consumer loans

1,742

-

1,742

520

-

2,262

Mortgages:







- Prime

3,971

1,900

5,871

230

-

6,101

- Non-conforming 

1,821

-

1,821

468

-

2,289

- Sub-prime 

-

-

-

-

-

-

- Commercial

656

499

1,155

87

(22)

1,220

- Buy-to-let

-

-

-

-

-

-

CDOs

-

-

-

-

-

-

Other

1,349

1,526

2,875

292

-

3,167









21,609

13,398

35,007

6,277

(154)

41,130















31 December 2008







Auto loans

9,924

383

10,307

1,871

- 

12,178

Corporate loans

430

11,042

11,472

534

- 

12,006

Credit card receivables

5,844  

-

5,844

922

- 

6,766

Trade receivables

2,745

-

2,745

1,432

(71)

4,106

Student loans

2,555

-

2,555

478

(132)

2,901

Consumer loans

2,371

-

2,371

409

- 

2,780

Mortgages







- Prime

4,416

2,250

6,666

1,188

- 

7,854

- Non-conforming 

2,181

-

2,181

727

- 

2,908

- Sub-prime 

-

-

-

-

- 

-

- Commercial

1,228

507

1,735

66

(23)

1,778

- Buy-to-let

-

-

-

-

- 

-

CDOs

-

-

-

-

- 

-

Other

1,851

2,130

3,981

1,615

- 

5,596









33,545

16,312

49,857

9,242

(226)

58,873



  

Risk and capital management


Market turmoil exposures (continued)

Conduits (continued) 


CP funded assets


Geographic distribution

Weighted average life

Years

Credit ratings (S&P equivalent)



UK


Europe


US


RoW


Total


AAA


AA 


A


BBB

Below BBB


£m

£m

£m

£m

£m

£m

£m

£m

£m

£m













30 June 2009












Auto loans

595

1,075

3,846

549

6,065

1.9

3,085

2,274

706

-

-

Corporate loans

1,266

3,640

2,738

1,762

9,406

1.7

9,078

223

105

-

-

Credit card receivables

390

-

2,796

189

3,375

1.0

2,794

212

369

-

-

Trade receivables

-

465

637

335

1,437

1.1

349

561

496

31

-

Student loans

116

-

1,144

-

1,260

1.2

1,144

116

-

-

-

Consumer loans

657

999

86

-

1,742

2.4

71

132

1,539

-

-

Mortgages












  Prime

-

1,896

-

3,975

5,871

2.8

2,364

3,448

20

-

39

  Non-conforming 

808

1,013

-

-

1,821

4.5

316

460

1,045

-

-

  Sub-prime 

-

-

-

-

-

-

-

-

-

-

-

  Commercial

685

373

57

40

1,155

15.1

-

31

745

373

6

  Buy-to-let

-

-

-

-

-

-

-

-

-

-

-

CDOs

-

-

-

-

-

-

-

-

-

-

-

Other

243

900

383

1,349

2,875

2.4

90

432

2,210

143

-














4,760

10,361

11,687

8,199

35,007

2.4

19,291

7,889

7,235

547

45













31 December 2008












Auto loans

801

1,706

7,402

398

10,307

1.7

6,075

883

3,349

-

-

Corporate Loans

1,714

4,347

3,289

2,122

11,472

4.9

10,767

132

573

-

-

Credit card receivables

633

-

4,999

212

5,844

0.7

3,465

62

2,171

146

-

Trade receivables

68

922

1,371

384

2,745

0.7

120

1,025

1,600

-

-

Student loans

144

-

2,411

-

2,555

2.6

2,296

144

115

-

-

Consumer loans

708

1,195

468

-

2,371

1.7

387

993

923

68

-

Mortgages












  Prime

-

2,244

-

4,422

6,666

2.8

2,675

3,876

115

-

-

  Non-conforming 

960

1,221

-

-

2,181

4.6

351

368

475

987

-

  Sub-prime 

-

-

-

-

-

-

-

-

-

-

-

  Commercial

713

453

74

495

1,735

11.0

274

518

474

469

-

  Buy-to-let

-

-

-

-

-

-

-

-

-

-

-

CDOs

-

-

-

-

-

-

-

-

-

-

-

Other

166

1,198

684

1,933

3,981

1.2

3

958

2,786

234

-














5,907

13,286

20,698

9,966

49,857

3.0

26,413

8,959

12,581

1,904

-




Risk and capital management


Market turmoil exposures (continued)

Structured investment vehicles

The Group does not sponsor any structured investment vehicles.


Investment funds set up and managed by the Group

The Group has established and manages a number of money market funds for its customers. When a new money market fund is launched, the Group typically provides a limited amount of seed capital to the funds. The Group has investments in these funds of £723.2 million at 30 June 2009 (31 December 2008: £107.0 million). These funds are not consolidated by the Group.


Money market funds

The Group's money market funds held assets of £13.2 billion at 30 June 2009 (31 December 2008 - £13.9 billion). The sub-categories of money market funds are:

  • £9.1 billion (31 December 2008 - £8.3 billion) in money market funds managed by the Group denominated in sterling, US dollars and euro. The funds invest in short-dated, highly rated money market securities with the objective of ensuring stability of capital and net asset value per share, appropriate levels of liquid assets, together with an income which is comparable to the short dated money market interest rate in the relevant currency.

  • £0.7 billion (31 December 2008 - £0.8 billion) in money market 'Plus' funds managed by the Group denominated in sterling, US dollars and euro. The funds invest in longer-dated, highly rated securities with the objective of providing enhanced returns over the average return on comparable cash deposits.

  • £3.4 billion (31 December 2008 - £4.8 billion) in third party multi-manager money market funds denominated in sterling, US dollars and euro. The funds invest in short dated, highly rated securities with the objective of maximising current income consistent with the preservation of capital and liquidity.


Non-money market funds

The Group has also established a number of non-money market funds to enable investors to invest in a range of assets including bonds, equities, hedge funds, private equity and real estate. As the Group does not have significant holdings in these funds, they are not consolidated by the Group.

The Group non-money market funds had total assets of £14.2 billion at 30 June 2009 (31 December 2008 - £17.7 billion). The sub-categories of non-money market funds are:

  • £1.1 billion (31 December 2008 - £1.1 billion) in committed capital to generate returns from equity and equity-like investments in private companies.

  • £12.8 billion (31 December 2008 - £16.5 billion) in third party, multi-manager funds. These funds offer multi-manager and fund of funds' products across bond, equity, hedge fund, private equity and real estate asset classes.

  • £0.3 billion (31 December 2008 - £0.1 billion) in various derivative instruments with the objective of providing returns linked to the performance of underlying equity indices.

The investors in both money market and non money market funds have recourse to the assets of the funds only.  At 30 June 2009 the Group had exposure to one fund amounting to £145 million (31 December 2008 - £144 million).



This information is provided by RNS
The company news service from the London Stock Exchange
 
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