Barclays 2011 Annual Report Download - page 234

Notes to the financial statements
For the year ended 31 December 2011 continued
20 Fair value of financial instruments continued
Valuation techniques
Current year valuation methodologies were consistent with the prior year unless otherwise noted below. These methodologies are commonly used by
market participants. The valuation techniques used for the main products that are not determined by reference to unadjusted quoted prices (Level 1),
are described below.
Commercial real estate loans
This category includes lending on a range of commercial property types including retail, hotel, office, multi-family and industrial properties.
Performing loans are valued using a spread-based approach, with consideration of characteristics such as property type, geographic location, yields,
credit quality and property performance reviews. Where there is significant uncertainty regarding loan performance, valuation is based on the
underlying collateral, whose value is determined through property-specific information such as third party valuation reports and bids for the underlying
properties.
Since each commercial real estate loan is unique in nature and the secondary commercial loan market is relatively illiquid, valuation inputs are generally
considered unobservable.
Asset backed products
These are debt and derivative products that are linked to the cash flows of a pool of referenced assets via securitisation. This category includes
residential mortgage backed securities, commercial mortgage backed securities, asset backed securities, CDOs (collateralised debt obligations), CLOs
(collateralised loan obligations) and derivatives with cash flows linked to securitisations.
Where available, valuations are based on observable market prices which are sourced from broker quotes and inter-dealer prices. Otherwise, valuations
are determined using industry standard cash flow models that calculate fair value based on loss projections, prepayment, recovery and discount rates.
These inputs are determined by reference to a number of sources including proxying to observed transactions, market indices or market research, and
by assessing underlying collateral performance.
Proxying to observed transactions, indices or research requires an assessment and comparison of the relevant securities’ underlying attributes
including collateral, tranche, vintage, underlying asset composition (historical losses, borrower characteristics, and loan attributes such as loan-to-value
ratio and geographic concentration) and credit ratings (original and current).
Other credit products
These products are linked to the credit spread of a referenced entity, index or basket of referenced entities. This category includes synthetic CDOs,
single name and index CDS and Nth to default basket swaps. Within this population, valuation inputs are unobservable for CDS with illiquid reference
assets and certain synthetic CDOs.
CDS are valued using a market standard model that incorporates the credit curve as its principal input. Credit spreads are observed directly from broker
data, third party vendors or priced to proxies. Where credit spreads are unobservable, they are determined with reference to recent transactions or bond
spreads from observable issuances of the same issuer or other similar entities as a proxy.
Synthetic CDOs are valued using a model that calculates fair value based on observable and unobservable parameters including credit spreads,
recovery rates, correlations and interest rates and is calibrated daily. For index and bespoke synthetic CDOs with unobservable inputs, correlation is set
with reference to the index tranche market.
Derivative exposure to monoline insurers
These products are derivatives through which credit protection has been purchased on structured debt instruments (primarily CLOs) from monoline
insurers.
The value of the CDS is derived from the value of the cash instrument that it protects. A valuation adjustment is then applied to reflect the counterparty
credit risk associated with the relevant monoline. This adjustment is calculated using an assessment of the likely recovery of the protected cash security,
which is derived from a scenario-based calculation of the mark-to-market of the instrument using an appropriate valuation model; and the probability
of default and loss given default of the monoline counterparty, as estimated from independent fundamental credit analysis. Due to the counterparty
credit risk associated with these insurers, derivative exposure to monoline counterparty insurers is generally considered unobservable.
232 Barclays PLC Annual Report 2011 www.barclays.com/annualreport