Barclays 2012 Annual Report Download - page 267

The strategic report Governance Risk review Financial review Financial statements Risk management Shareholder information
18 Fair value of financial instruments continued
Asset backed products
Description: 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, CLOs and derivatives
with cash flows linked to securitisations.
Valuation: 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).
Observability: Where an asset backed product does not have an observable market price and the valuation is determined using a model, an
instrument is considered unobservable.
Level 3 sensitivity: The sensitivity analysis for asset backed products is based on external vendor pricing dispersion or bid offer ranges, defined at
position level. Half of the observed pricing dispersion or bid offer range is multiplied by the market value of the position to calculate the valuation
sensitivity. Where there is no observable dispersion of bid offer data, price movements on appropriate indices are used. Sensitivity is based on the
average of the largest upward and downward price movement in the preceding 12 month period.
Other credit products
Description: 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.
Valuation: 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 credit spreads, recovery rates, correlations and interest rates and is calibrated daily. The model is
calibrated to the index tranche market.
Observability: CDS contracts referencing entities that are not actively traded are considered unobservable. The correlation input to bespoke CDO
valuation is considered unobservable as it is proxied from the observable index tranche market.
Level 3 sensitivity: The sensitivity of valuations of the illiquid CDS portfolio is determined by applying a shift to each underlying reference asset.
The shift is based upon the average bid offer spreads observed in the market for similar CDS.
Bespoke Collateralised Synthetic Obligation (CSO) sensitivity is calculated using correlation levels derived from the range of contributors to a
consensus bespoke service.
Derivative exposure to monoline insurers
Description: These products are derivatives through which credit protection has been purchased on structured debt instruments (primarily CLOs)
from monoline insurers.
Valuation: 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.
Observability: Due to the counterparty credit risk associated with these insurers, derivative exposure to monoline counterparty insurers is generally
considered unobservable.
Level 3 sensitivity: Sensitivity is measured by stressing inputs to the counterparty valuation adjustment including our expected exposures and the
probability of default of the monoline derivative counterparty. The modelled expected exposures are stressed by shifting the recovery rate
assumptions on the underlying protected assets. The probability of default of the monoline derivative counterparty is stressed by shifting the
internal default curve.
barclays.com/annualreport Barclays PLC Annual Report 2012 I 265