Barclays 2009 Annual Report Download - page 299

www.barclays.com/annualreport09 Barclays PLC Annual Report 2009 297
50 Fair value of financial instruments continued
The significant movements in the level 3 positions during the year ended 31st December 2009 are explained below:
–Purchases of £5.1bn were primarily composed of £1.7bn of asset backed products, £1.5bn of credit derivatives and £0.6bn of equity products.
– Sales of £14.6bn include the disposal of £7.5bn of assets backed products and Monoline exposures through the Protium transaction.
The Crescent debt restructuring, disclosed in Note 40, resulted in the sale of £1.0bn of commercial real estate loans and there were additional sales
of £3.8bn asset backed products and £0.6bn Monoline exposures during the period.
– Issuances of £3.1bn were driven by £1.3bn of new credit-linked notes and equity, credit and commodity derivatives of £1.7bn.
– Losses in Trading Income of £7.6bn were primarily attributable to the £4.4bn of writedowns on the credit market exposures summarised in Note 47,
along with writedowns on other asset backed products, funds and other Monoline insurers. These were offset by gains on interest rate and commodity
products.
– Losses in Other Income of £0.6bn were driven by the writedown and impairment of commercial real estate loans.
– Transfers into level 3 were largely due to the lack of observable valuation inputs for certain securities as well as curves becoming unobservable for certain
derivative products.
– Transfers out of level 3 were principally due to unobservable valuation inputs being deemed insignificant to the overall valuation of certain instruments
particularly on investment grade asset backed products.
There were no significant transfers between level 1 and level 2.
Valuation techniques
Valuations based on observable inputs include financial instruments such as swaps and forwards which are valued using market standard pricing
techniques; and options that are commonly traded in markets where all the inputs to the market standard pricing models are observable.
Valuation models are reviewed at least annually for model performance and calibration. Current year valuation methodologies were consistent with
the prior year unless otherwise noted below. These methodologies are commonly used by market participants.
The main products whose valuation includes unobservable inputs are described below.
Commercial real estate loans
This category includes lending on a range of commercial property types including retail, hotels, office and development properties.
The valuations are considered unobservable due to the bespoke nature of the instruments and the high level of volatility in the commercial real estate
market at present. Fair value is calculated using a risk adjusted spread based methodology performed on a loan by loan basis with consideration of
characteristics such as property type, geographic location, yields, credit quality and property performance reviews.
The valuation inputs are reviewed with reference to CMBX and CMBS bond indices. Initial spreads are sourced from market quoted origination spreads by
property type and classified into Loan-to-Value (LTV) buckets which are adjusted for internal credit rating and subordination of the loans. The internal credit
ratings used in the valuation model are subject to a monthly review process. The model is calibrated monthly based on external quotes of new origination
property type spreads and the latest internal credit ratings.
The methodology used differs to the prior period in that internal credit ratings, additional risk factors and property performance reviews are now
incorporated. The changes were made to take advantage of data that has become available and to enhance the assessment of credit risk.
Asset backed products
These are debt and derivative products that are linked to the cash flows of a pool of referenced assets. This category includes asset backed loans; CDOs
(cash underlyings); CLOs; asset backed credit derivatives; asset and mortgage backed securities.
Within this population, valuation inputs are unobservable for non-investment grade ABS; non-agency residential mortgage backed securities (RMBS)
and asset backed credit derivatives. The valuations are determined using industry standard cash flow models that calculate fair value based on loss
projections, prepayment, recovery and discount rates. These parameters are determined by reference to underlying collateral performance, independent
research, ABX indices, broker quotes, observable trades on similar securities and third party pricing sources.
The determination of parameter levels takes account of a range of factors such as deal vintage, underlying asset composition (historical losses; borrower
characteristics; various loan attributes such as loan-to-value and debt-to-income ratios and geographic concentration), credit ratings (original and current),
home price changes and interest rates.