FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549


Report of Foreign Private Issuer

Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934


For August 6, 2010

Commission File Number: 001-10306

The Royal Bank of Scotland Group plc

RBS, Gogarburn, PO Box 1000
Edinburgh EH12 1HQ

(Address of principal executive offices)

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.

Form 20-F    X     Form 40-F        

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):_________

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):_________

Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes           No    X  



If "Yes" is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82- ________





The following information was issued as a Company announcement in London, England and is furnished pursuant to General Instruction B to the General Instructions to Form 6-K:


 

Risk and capital management (continued)

 

Other risk exposures

 

Explanatory note

These disclosures provide information on certain elements of the Group's credit market activities, the majority of which reside in Non-Core and, to a lesser extent, Global Banking & Markets (GBM), US Retail & Commercial and Group Treasury.  For certain disclosures - credit valuation adjustments, leverage finance and conduits - the information presented has been analysed between the Group's Core and Non-Core businesses.

 

Asset-backed securities

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 table below analyses the carrying value of the Group's debt securities.

 

 

30 June 

 2010 

31 December 

 2009 

 

£bn 

£bn 

 

     

 

Securities issued by central and local governments

132.8 

134.1 

 

Asset-backed securities

78.7 

87.6 

 

Securities issued by banks and building societies

12.9 

14.0 

 

Securities issued by corporates, US federal agencies and other entities

11.9 

13.4 

 

     

 

Total debt securities

236.3 

249.1 

 



 

The Group's credit market activities gave rise to risk concentrations in asset-backed securities (ABS). The Group has exposures to ABS which are predominantly debt securities, but can also be held in derivative form.  ABS have an interest in an underlying pool of referenced assets.  The risks and rewards of the referenced pool are passed onto investors by the issue of securities with varying seniority, by a special purpose entity.

 

Debt securities include residential mortgage-backed securities, commercial mortgage-backed securities, ABS collateralised debt obligations and collateralised loan obligations and other ABS.  In many cases the risk associated with these assets is hedged by way of credit derivative protection, purchased over the specific asset or relevant ABS indices.  The counterparty to some of these hedge transactions are monoline insurers.

 


 

Risk and capital management(continued)

 

Other risk exposures: Asset-backed securities (continued)

 

Asset-backed securities by geography

 

The table below analyses the gross, carrying values and net exposures of these ABS by geography of the underlying assets.

 

 

30 June 2010

 

31 December 2009

 

US 

UK 

Other 

 Europe 

RoW (1) 

Total 

 

US 

UK 

Other 

 Europe 

RoW (1) 

Total 

 

£m 

£m 

£m 

£m 

£m 

 

£m 

£m 

£m 

£m 

£m 

                       

Gross exposure: (2)

                     

RMBS: G10 governments (3)

23,790 

16 

6,283 

30,089 

 

26,644 

17 

7,016 

94 

33,771 

RMBS: covered bond

127 

193 

7,975 

8,295 

 

49 

297 

9,019 

9,365 

RMBS: prime

1,942 

4,869 

2,681 

849 

10,341 

 

2,965 

5,276 

4,567 

222 

13,030 

RMBS: non-conforming

1,255 

2,205 

118 

3,578 

 

1,341 

2,138 

128 

3,607 

RMBS: sub-prime

1,244 

394 

175 

246 

2,059 

 

1,668 

724 

195 

561 

3,148 

CMBS

3,802 

1,873 

1,524 

96 

7,295 

 

3,422 

1,781 

1,420 

75 

6,698 

CDOs

14,714 

129 

484 

15,327 

 

12,382 

329 

571 

27 

13,309 

CLOs

9,216 

114 

1,608 

378 

11,316 

 

9,092 

166 

2,169 

1,173 

12,600 

Other ABS

3,512 

1,199 

3,016 

2,013 

9,740 

 

3,587 

1,980 

5,031 

1,569 

12,167 

                       
 

59,602 

10,992 

23,864 

3,582 

98,040 

 

61,150 

 12,708 

30,116 

3,721 

107,695 

                       

Carrying value:

                     

RMBS: G10 governments (3)

24,461 

16 

5,799 

30,276 

 

26,984 

17 

6,870 

33 

33,904 

RMBS: covered bond

131 

195 

7,290 

7,616 

 

50 

288 

8,734 

9,072 

RMBS: prime

1,724 

3,884 

2,253 

256 

8,117 

 

2,696 

4,583 

4,009 

212 

11,500 

RMBS: non-conforming

961 

2,084 

118 

3,163 

 

958 

1,957 

128 

3,043 

RMBS: sub-prime

674 

254 

143 

227 

1,298 

 

977 

314 

146 

387 

1,824 

CMBS

3,337 

1,556 

1,026 

70 

5,989 

 

3,237 

1,305 

924 

43 

5,509 

CDOs

3,566 

64 

291 

3,921 

 

3,275 

166 

400 

27 

3,868 

CLOs

7,996 

82 

1,159 

235 

9,472 

 

6,736 

112 

1,469 

999 

9,316 

Other ABS

3,010 

1,085 

2,820 

1,938 

8,853 

 

2,886 

1,124 

4,369 

1,187 

9,566 

             

 

 

 

 

 

 

45,860 

9,220 

20,899 

2,726 

78,705 

 

47,799 

9,866 

27,049 

2,888 

87,602 

                       

Net exposure: (4)

                     

RMBS: G10 governments (3)

24,461 

16 

5,799 

30,276 

 

26,984 

17 

6,870 

33 

33,904 

RMBS: covered bond

131 

195 

7,290 

7,616 

 

50 

288 

8,734 

9,072 

RMBS: prime

1,669 

3,001 

1,452 

176 

6,298 

 

2,436 

3,747 

3,018 

172 

9,373 

RMBS: non-conforming

958 

2,084 

118 

3,160 

 

948 

1,957 

128 

3,033 

RMBS: sub-prime

237 

242 

135 

194 

808 

 

565 

305 

137 

290 

1,297 

CMBS

2,608 

1,398 

663 

46 

4,715 

 

2,245 

1,228 

595 

399 

4,467 

CDOs

 

1,098 

 

23 

 

269 

 

 

1,390 

 

743 

124 

382 

26 

1,275 

CLOs

 

1,297 

 

56 

 

920 

 

43 

 

2,316 

 

1,636 

86 

1,104 

39 

2,865 

Other ABS

 

2,475 

 

1,057 

 

2,792 

 

1,937 

 

8,261 

 

2,117 

839 

4,331 

1,145 

8,432 

             

 

 

 

 

 

 

 

34,934 

 

8,072 

 

19,438 

 

2,396 

 

64,840 

 

37,724 

8,591 

25,299 

2,104 

73,718 



 

For notes to this table refer to page 130.


Risk and capital management(continued)

 

Other risk exposures: Asset-backed securities (continued)

 

Asset-backed securities by measurement classification

 

The table below analyses the gross and net exposures and carrying values of these ABS by measurement classification - held-for-trading (HFT), available-for-sale (AFS), loans and receivables (LAR) and designated as at fair value through profit or loss (DFV).

 

 

30 June 2010

 

 

31 December 2009

 

HFT 

AFS 

LAR 

DFV 

Total 

 

HFT 

AFS 

LAR 

DFV 

Total 

 

£m 

£m 

£m 

£m 

£m 

 

£m 

£m 

£m 

£m 

£m 

                       

Gross exposure: (2)

                     

RMBS: G10 governments (3)

9,973 

20,116 

30,089 

 

13,536 

20,235 

33,771 

RMBS: covered bond

8,295 

8,295 

 

9,365 

9,365 

RMBS: prime

4,886 

5,277 

177 

10,341 

 

6,274 

5,761 

848 

147 

13,030 

RMBS: non-conforming

594 

1,483 

1,499 

3,578 

 

635 

1,498 

1,474 

3,607 

RMBS: sub-prime

1,049 

779 

231 

2,059 

 

1,632 

1,020 

479 

17 

3,148 

CMBS

3,827 

1,712 

1,540 

216 

7,295 

 

2,936 

1,842 

1,711 

209 

6,698 

CDOs

10,119 

5,078 

129 

15,327 

 

9,080 

3,923 

305 

13,309 

CLOs

4,410 

6,424 

482 

11,316 

 

5,346 

6,581 

673 

12,600 

Other ABS

1,496 

5,081 

3,163 

9,740 

 

2,912 

5,252 

3,985 

18 

12,167 

                       
 

36,354 

54,245 

7,221 

220 

98,040 

 

42,351 

55,477 

9,475 

392 

107,695 

                       

Carrying value:

                     

RMBS: G10 governments (3)

10,077 

20,199 

30,276 

 

13,397 

20,507 

33,904 

RMBS: covered bond

7,616 

7,616 

 

9,072 

9,072 

RMBS: prime

3,359 

4,597 

161 

8,117 

 

5,133 

5,643 

583 

141 

11,500 

RMBS: non-conforming

426 

1,238 

1,499 

3,163 

 

389 

1,180 

1,474 

3,043 

RMBS: sub-prime

596 

482 

220 

1,298 

 

779 

704 

324 

17 

1,824 

CMBS

2,764 

1,549 

1,444 

232 

5,989 

 

2,279 

1,637 

1,377 

216 

5,509 

CDOs

1,768 

2,029 

124 

3,921 

 

2,064 

1,600 

203 

3,868 

CLOs

3,351 

5,682 

438 

9,472 

 

3,296 

5,500 

520 

9,316 

Other ABS

1,273 

4,317 

3,262 

8,853 

 

1,483 

4,621 

3,443 

19 

9,566 

             

 

 

 

 

 

 

23,614 

47,709 

7,148 

234 

78,705 

 

28,820 

50,464 

7,924 

394 

87,602 

                       

Net exposure: (4)

                     

RMBS: G10 governments (3)

10,077 

20,199 

30,276 

 

13,397 

20,507 

33,904 

RMBS: covered bond

7,616 

7,616 

 

9,072 

9,072 

RMBS: prime

1,538 

4,597 

162 

6,298 

 

3,167 

5,480 

584 

142 

9,373 

RMBS: non-conforming

423 

1,238 

1,499 

3,160 

 

379 

1,180 

1,474 

3,033 

RMBS: sub-prime

236 

352 

220 

808 

 

529 

427 

324 

17 

1,297 

CMBS

863 

1,986 

1,444 

422 

4,715 

 

1,331 

1,556 

1,377 

203 

4,467 

CDOs

 

722 

 

544 

 

124 

 

 

1,390 

 

521 

550 

203 

1,275 

CLOs

 

451 

 

1,426 

 

438 

 

 

2,316 

 

673 

1,672 

520 

2,865 

Other ABS

 

812 

 

4,318 

 

3,131 

 

 

8,261 

 

483 

4,621 

3,309 

19 

8,432 

             

 

 

 

 

 

 

 

15,122 

 

42,276 

 

7,018 

 

424 

 

64,840 

 

20,480 

45,065 

7,791 

382 

73,718 



 

For notes to this table refer to page 130.


Risk and capital management(continued)

 

Other risk exposures: Asset-backed securities (continued)

 

Asset-backed securities by rating

 

The table below summarises the ratings (refer to note 5 below) of ABS carrying values.

 

 

AAA rated 

AA- rated 

 and above 

A- rated 

 and above 

BBB- rated 

 and above 

Sub- 

investment 

 grade 

Not 

 publicly 

 rated 

Total 

 

£m 

£m 

£m 

£m 

£m 

£m 

£m 

               

30 June 2010

             

Carrying value:

             

RMBS: G10 governments (3)

28,773 

1,375 

128 

30,276 

RMBS: covered bond

7,297 

85 

111 

16 

107 

7,616 

RMBS: prime

5,887 

761 

566 

157 

717 

29 

8,117 

RMBS: non-conforming

1,823 

168 

72 

385 

704 

11 

3,163 

RMBS: sub-prime

357 

114 

223 

17 

513 

74 

1,298 

CMBS

3,678 

509 

1,095 

438 

254 

15 

5,989 

CDOs

717 

507 

297 

582 

1,631 

187 

3,921 

CLOs

4,556 

2,649 

1,184 

595 

432 

56 

9,472 

Other ABS

3,242 

1,199 

1,172 

2,042 

365 

833 

8,853 

               
 

56,330 

7,367 

4,848 

4,232 

4,616 

1,312 

78,705 

               

31 December 2009

             

Carrying value:

             

RMBS: G10 governments (3)

33,779 

125 

33,904 

RMBS: covered bond

8,645 

360 

67 

9,072 

RMBS: prime

9,211 

676 

507 

547 

558 

11,500 

RMBS: non-conforming

1,981 

197 

109 

160 

594 

3,043 

RMBS: sub-prime

578 

121 

306 

87 

579 

153 

1,824 

CMBS

3,441 

599 

1,022 

298 

147 

5,509 

CDOs

615 

944 

254 

944 

849 

262 

3,868 

CLOs

2,718 

4,365 

607 

260 

636 

730 

9,316 

Other ABS

4,099 

1,555 

1,014 

1,947 

152 

799 

9,566 

 

 

 

 

 

 

 

 

 

65,067 

8,942 

3,886 

4,243 

3,515 

1,949 

87,602 



 

Notes:

(1)

Rest of the World.

(2)

Gross exposures represent the principal amounts relating to asset-backed securities.

(3)

RMBS: G10 government securities comprises securities that are:

 

(a)

Guaranteed or effectively guaranteed by the US government, by way of its support for US federal agencies and government sponsored enterprises; and

 

(b)

Guaranteed by the Dutch government.

(4)

Net exposures represent the carrying value after taking account of the hedge protection purchased from monoline insurers and other counterparties, but exclude the effect of counterparty credit valuation adjustments.  The hedge provides credit protection of both 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.

(5)

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



 


 

Risk and capital management (continued)

 

Other risk exposures: Asset-backed securities (continued)

 

Key points

·

ABS carrying values decreased by 10%, from £87.6 billion at 31 December 2009 to £78.7 billion, principally due to net sales and maturities of £32.1 billion, partially offset by additions of £20.1 billion, foreign exchange movements of £2.6 billion and fair value increases.

   

·

US government-backed securities were £24.5 billion at 30 June 2010 (31 December 2009 - £27.0 billion). This  comprised:

   
 

·

HFT securities of £10.1 billion down from £13.4 billion at the end of 2009, reflecting repositioning and net sell down in GBM mortgage trading of US agency positions following market developments.

   
 

·

AFS exposures of £14.4 billion (31 December 2009 - £13.6 billion) of liquidity portfolios in US Retail & Commercial; the increase in the period reflected foreign exchange movements.

     

·

Dutch government guaranteed RMBS exposures in Group Treasury's liquidity portfolio decreased to £5.8 billion at 30 June 2010 from £6.9 billion at 31 December 2009 reflecting foreign exchange effects and lower fair values.

     

·

Covered bonds issued by both Dutch and Spanish financial institutions, also in Group Treasury's liquidity portfolio, decreased by £1.5 billion to £7.6 billion at 30 June 2010, mainly due to disposals, maturities and foreign exchange movements.

   

·

CDOs remained flat at £3.9 billion at 30 June 2010, where amortisation offset credit spread related fair value gains and foreign exchange movements.

     

·

CLOs increased from £9.3 billion at 31 December 2009 to £9.5 billion at 30 June 2010, driven primarily by foreign exchange movements and tightening spreads.

     

·

AAA rated assets decreased from £65.1 billion at 31 December 2009 to £56.3 billion at 30 June 2010, primarily as a result of the sell-down activity of prime and US government-backed securities. The US government ended its main mortgage-backed securities purchase programme in Q1 2010 due to improved economic conditions.  GBM anticipated downward pressure on prices and demand and sold off positions, mainly in Q1 2010.  The increase in sub-investment grade assets of £1.1 billion is largely driven by downgrades of CDOs.

   

·

Life-to-date net valuation losses on ABS held at 30 June 2010, including impairment provisions, were £19.3 billion (31 December 2009 - £20.1 billion) comprising:

     
 

·

RMBS: £3.9 billion (31 December 2009 - £3.6 billion), of which £0.6 billion (31 December 2009 - £0.7 billion) was in US sub-prime and £2.9 billion (31 December 2009 - £2.3 billion) on European assets of which £1.2 billion related to Group Treasury's AFS liquidity portfolio, reflecting recent market events.

     
 

·

CMBS: £1.3 billion (31 December 2009 - £1.2 billion) of primarily European assets.

   

 

 

·

CDOs and CLOs of £11.4 billion (31 December 2009 - £9.4 billion) and £1.8 billion (31 December 2009 - £3.3 billion) respectively, significantly all relating to US assets in Non-Core. Many of these assets have market hedges in place giving rise to a significant difference between the carrying value and the net exposure.  The increase in CDOs reflects decreases in average prices and the decrease in CLOs reflects a rally in prices, principally in Q1 2010.

   

 

 

·

Other ABS: £0.9 billion (31 December 2009 - £2.6 billion).

     
         


 

 

Risk and capital management(continued)

 

Other risk exposures

 

Credit valuation adjustments (CVA)

CVA represents an estimate of the adjustment to arrive at fair value that a market participant would make to incorporate the credit risk inherent in counterparty derivative exposures.

 

The table below details the CVA at 30 June 2010.

 

 

30 June 

2010 

31 December 

2009 

 

£m 

£m 

     

Monoline insurers

3,599 

3,796 

CDPCs

791 

499 

Other counterparties

1,916 

1,588 

     

Total credit valuation adjustments

6,306 

5,883 



 

Monoline insurers

The Group has purchased protection from monoline insurers, mainly against specific ABS. Monolines specialise in providing credit protection against both the principal and interest cash flows due to the holders of debt instruments in the event of default by the debt instrument counterparty.  This protection is typically held in the form of derivatives, such as credit default swaps, referencing underlying exposures held directly or synthetically by the Group.

 

The gross mark-to-market of the monoline protection depends on the value of the instruments against which protection has been bought. A positive fair value, or a valuation gain, in the protection is recognised if the fair value of the instrument it references decreases. For the majority of trades, the gross mark-to-market of the monoline protection is determined directly from the fair value price of the underlying reference instrument, however for the remainder of the trades, the gross mark-to-market is determined using industry standard models.

 

The methodology employed to calculate the monoline CVA uses CDS spreads and internally assessed recovery levels to determine the market implied level of expected loss on monoline exposures of different maturities.  The probability of default is calculated with reference to market observable credit spreads and recovery rates.  CVA is calculated at a trade level by applying the expected loss corresponding to the expected maturity of each trade to the gross mark-to-market of the monoline protection. The expected maturity of each trade reflects the scheduled notional amortisation of the underlying reference instruments and whether payments due from the monoline insurer are received at the point of default or over the life of the underlying reference instruments.


Risk and capital management (continued)

 

Other risk exposures: Credit valuation adjustments (continued)

 

Monoline insurers (continued)

 

The table below summarises the Group's exposure to monolines, all of which are in Non-Core.

 

 

30 June 

2010 

31 December 

2009 

 

£m 

£m 

     

Gross exposure to monolines

5,495 

6,170 

Hedges with financial institutions

(73)

(531)

Credit valuation adjustment

(3,599)

(3,796)

     

Net exposure to monolines

1,823 

1,843 

     

CVA as a % of gross exposure

65%

62%



 

 

 

Notional 

 amount: 

 protected 

 assets 

Fair value: 

protected 

 assets 

Gross  

 exposure 

Credit 

 valuation 

 adjustment 

Hedges 

Net exposure 

 to monoline 

 insurers 

 

£m 

£m

£m 

£m 

£m 

£m 

             

30 June 2010

           

AA rated

7,474 

6,342 

1,132 

439 

693 

Sub-investment grade

12,247 

7,884 

4,363 

3,160 

73 

1,130 

             

Total

19,721 

14,226 

5,495 

3,599 

73 

1,823 

             

Of which:

           

CDOs

1,658 

496 

1,162 

836 

   

RMBS

   

CMBS

4,496 

2,335 

2,161 

1,565 

   

CLOs

10,321 

9,167 

1,154 

648 

   

Other ABS

2,708 

1,924 

784 

419 

   

Other

535 

301 

234 

131 

   
             
 

19,721 

14,226 

5,495 

3,599 

   



 


 

Risk and capital management (continued)

 

Other risk exposures: Credit valuation adjustments (continued)

 

Monoline insurers (continued)

 

 

 

Notional 

 amount: 

 protected 

 assets 

Fair value: 

protected 

 assets 

Gross 

 exposure 

Credit 

 valuation 

 adjustment 

Hedges 

Net exposure 

 to monoline 

 insurers 

 

£m 

£m 

£m 

£m 

£m 

£m 

             

31 December 2009

           

AA rated

7,143 

5,875 

1,268 

378 

890 

Sub-investment grade

12,598 

7,696 

4,902 

3,418 

531 

953 

             

Total

19,741 

13,571 

6,170 

3,796 

531 

1,843 

             

Of which:

           

CDOs

2,284 

797 

1,487 

1,059 

   

RMBS

82 

66 

16 

   

CMBS

4,253 

2,034 

2,219 

1,562 

   

CLOs

10,007 

8,584 

1,423 

641 

   

Other ABS

2,606 

1,795 

811 

410 

   

Other

509 

295 

214 

122 

   
             
 

19,741 

13,571 

6,170 

3,796 

   


 

Credit ratings are based on those from rating agencies S&P and Moody's. Where the ratings differ, the lower of the two is taken.

 

The net effect to the income statement relating to monoline exposures is shown below.

 

£m 

   

Credit valuation adjustment  at 1 January 2010

(3,796)

Credit valuation adjustment at 30 June 2010

(3,599)

   

Decrease in credit valuation adjustment

197 

Net debit relating to realisation, hedges, foreign exchange and other movements

(56)

Net debit relating to reclassified debt securities

(220)

   

Net debit to income statement (1)

(79)



 

Note:

(1)

Includes £139 million of losses recorded as income from trading activities.



 

A number of debt securities with monoline protection were reclassified from HFT to AFS with effect from 1 July 2008. Changes in the fair value since the reclassification are only recognised in the income statement to the extent that the debt securities are considered to be impaired. Changes in the fair value of the related monoline CDS continue to be recorded in the income statement. The fair value of these reclassified debt securities at 30 June 2010 was £5,826 million (1 July 2008 - £6,823 million after adjusting for both principal based cash flows and foreign exchange effects between 1 July 2008 and 30 June 2010).  As a result of the reclassifications, total cumulative losses of £466 million have not been recognised in the income statement. 


 

Risk and capital management (continued)

 

Other risk exposures: Credit valuation adjustments (continued)

 

Monoline insurers (continued)

 

Key points

·

The decrease in CVA held against exposures to monoline insurers reflects the reduction in exposure due to a combination of higher prices of underlying reference instruments, primarily CLOs and CMBS, and restructuring of certain exposures. The decrease was partially offset by credit spreads widening, recovery rate movements and the weakening of sterling against the US dollar.

   

·

Following market events in the first quarter, the CVA calculation was modified to reference more conservative internally assessed recovery levels, resulting in a higher CVA reserve.

   

·

The CVA decreased on a total basis, in line with the reduction in exposure, but increased on a relative basis reflecting widening credit spreads and lower recovery rates.

   

·

The majority of the current exposure is to monoline counterparties that are classified as sub-investment grade.

   

·

Counterparty and credit RWAs relating to risk structures incorporating gross monoline exposures decreased from £13.7 billion at 31 December 2009 to £9.2 billion at 30 June 2010. Regulatory intervention on certain monolines, triggered credit events during the first quarter, resulting in capital deductions of £171 million, instead of being included in the RWA calculations.  This combined with an improvement in the rating of an underlying bond portfolio held by the Group to investment grade status, were the main drivers of the reduction.*

   

·

Net monoline related losses, including those from restructuring certain exposures, were partly offset by foreign exchange movements. The net effect of reclassified debt securities reflects the difference between accounting impairments and mark-to-market gains that would have been reported on the assets if they had been accounted for on a fair value through profit or loss basis.

     


 

 

The Group also has indirect exposures to monoline insurers through wrapped securities and other assets with credit enhancement from monoline insurers. 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.

 

 

 

* not reviewed


 

Risk and capital management (continued)

 

Other risk exposures: Credit valuation adjustments (continued)

 

Credit derivative product companies (CDPC)

A CDPC is a company that sells protection on credit derivatives. CDPCs are similar to monoline insurers, but they are not regulated as insurers.

 

The Group has purchased credit protection from CDPCs through tranched and single name credit derivatives. The Group's exposure to CDPCs is predominantly to tranched credit derivatives (tranches).  A tranche references a portfolio of loans and bonds 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 gross mark-to-market of the CDPC protection is determined using industry standard models.  The methodology employed to calculate the CDPC CVA is different to that outlined above for monolines, as there are no market observable credit spreads and recovery levels for these entities. The level of expected loss on CDPC exposures is estimated with reference to recent market events impacting CDPCs, including commutation activity and by analysing the underlying trades and the cost of hedging expected default losses in excess of the capital available in each vehicle.

 

A summary of the Group's exposure to CDPCs, which is mostly in Non-Core, is detailed below:

 

 

30 June 

2010 

31 December 

2009 

 

£m 

£m 

     

Gross exposure to CDPCs

1,747 

1,275 

Credit valuation adjustment

(791)

(499)

     

Net exposure to CDPCs

956 

776 

     

CVA as a % of gross exposure

45%

39%



 

 

Notional 

 amount: 

protected assets 

Fair value: 

protected 

reference assets 

Gross 

exposure 

Credit 

 valuation 

 adjustment 

Net exposure 

 to CDPCs 

 

£m 

£m 

£m 

£m 

£m 

           

30 June 2010

         

AAA rated

1,128 

1,115 

13 

AA rated

668 

642 

26 

14 

12 

Sub-investment grade

20,051 

18,655 

1,396 

586 

810 

Rating withdrawn

3,742 

3,430 

312 

182 

130 

           
 

25,589 

23,842 

1,747 

791 

956 

           

31 December 2009

         

AAA rated

1,658 

1,637 

21 

16 

BBB rated

1,070 

1,043 

27 

18 

Sub-investment grade

17,696 

16,742 

954 

377 

577 

Rating withdrawn

3,926 

3,653 

273 

108 

165 

           
 

24,350 

23,075 

1,275 

499 

776 



 

Credit ratings are based on those from rating agencies S&P and Moody's. Where the ratings differ, the lower of the two is taken.


Risk and capital management(continued)

 

Other risk exposures: Credit valuation adjustments (continued)

 

Credit derivative product companies (continued)

 

The net income statement effect arising from CDPC exposures is shown below.  

 

 

£m 

   

Credit valuation adjustment  at 1 January 2010

(499)

Credit valuation adjustment at 30 June 2010

(791)

   

Increase in credit valuation adjustment

(292)

Net credit relating to realisation, hedges, foreign exchange and other movements

204 

   

Net debit to income statement (included in income from trading activities)

(88)



 

Key points

·

Exposure to CDPCs increased over the period, due to a combination of wider credit spreads of the referenced assets and an increase in the relative value of senior tranches compared to the underlying reference portfolios. The weakening of sterling against the US and Canadian dollar also contributed to the increase.

   

·

CVA increased both on a total and relative basis, reflecting the increased exposure and recent market events.

   

·

The Group has predominantly traded senior tranches with CDPCs. The average attachment and detachment points were 13% and 50% respectively at 30 June 2010 (31 December 2009 - 15% and 51% respectively), and the majority of the loans and bonds in the reference portfolios are investment grade.

   

·

Counterparty and credit RWAs relating to gross CDPC exposures increased from £7.5 billion to £8.8 billion during the period. Capital deductions at 30 June 2010 were £292 million (31 December 2009 - £347 million). Where the Group limits exposures to certain CDPCs with  hedges, these exposures are excluded from the RWA calculations and instead, capital deductions are taken.

     


 

CVA attributable to other counterparties

CVA for all other counterparties is calculated on a portfolio basis reflecting an estimate of the amount a third party would charge to assume the credit risk.

 

Expected losses are determined from market implied probability of defaults and internally assessed recovery levels. The probability of default is calculated with reference to observable credit spreads and observable recovery levels. For counterparties where observable data do not exist, the probability of default is determined from the average credit spreads and recovery levels of similarly rated entities. A weighting of 50% to 100% is applied to arrive at the CVA. The weighting reflects portfolio churn and varies according to the counterparty credit quality.

 

 

 

* not reviewed

 

Risk and capital management (continued)

 

Other risk exposures: Credit valuation adjustments (continued)

 

CVA attributable to other counterparties (continued)

Expected losses are applied to estimated potential future exposures which are, in general, modelled to reflect the volatility of the market factors which drive the exposures and the correlation between those factors. Potential future exposures arising from vanilla products (including interest rate and foreign exchange derivatives) are modelled jointly using the Group's core counterparty risk systems. At 30 June 2010, the majority of the Group's CVA held in relation to other counterparties arises on these vanilla products. The exposures arising from all other product types are modelled and assessed individually. The potential future exposure to counterparties is the aggregate of the exposures arising on the underlying product types.

 

The correlation between exposure and counterparty risk is also incorporated within the CVA calculation where this risk is considered significant. The risk primarily arises on trades with emerging market counterparties where the gross mark-to-market value of the trade, and therefore the counterparty exposure, increases as the strength of the local currency declines.

 

Collateral held under a credit support agreement is factored into the CVA calculation.  In such cases where the Group holds collateral against counterparty exposures, CVA is held to the extent that residual risk remains.

 

CVA is held against exposures to all counterparties with the exception of the CDS protection that the Group has purchased from HM Treasury, as part of its participation in the Asset Protection Scheme, which is due to the unique features of this derivative.

 

The net income statement effect arising from the change in level of CVA for all other counterparties and related trades is shown in the table below.

 

 

£m 

   

Credit valuation adjustment  at 1 January 2010

(1,588)

Credit valuation adjustment at 30 June 2010

(1,916)

   

Increase in credit valuation adjustment

(328)

Net credit relating to realisation, hedges, foreign exchange and other movements

197 

   

Net debit to income statement (included in income from trading activities)

(131)



 

Key points

·

The increase in CVA was primarily driven by widening credit spreads and rating downgrades of certain counterparties during the year.

   

·

The primary driver of the gain arising on hedges, foreign exchange and other movements is the  widening of credit spreads.

     


 


Risk and capital management (continued)

 

Other risk exposures: Leveraged finance

 

Leveraged finance is commonly employed to facilitate corporate finance transactions, such as acquisitions or buy-outs, and is called so, due to the high ratio of debt to equity (leverage) common in such transactions. A bank acting as a lead manager for a leveraged finance transaction will typically underwrite a loan, alone or with others, and then syndicate the loan to other participants. The Group typically holds a portion of these loans as part of its long-term portfolio once primary syndication is completed ('hold portfolio'). Most of the leveraged finance loans held as part of syndicated lending portfolio were reclassified from held-for-trading to loans and receivables with effect from 1 July 2008.

 

The table below details the Group's global markets sponsor-led leveraged finance exposures, all in Non-Core, by industry and geography.  The gross exposure represents the total amount of leveraged finance committed by the Group.  The net exposure represents the balance sheet carrying value of drawn leveraged finance and the total undrawn amount.  The difference between the gross and net exposures is principally due to the cumulative effect of impairment provisions and historic write-downs on assets prior to reclassification.

 

 

30 June 2010

 

31 December 2009

 

Americas 

UK 

Other 

Europe 

RoW 

Total 

 

Americas 

UK 

Other 

Europe 

RoW 

Total 

 

£m 

£m 

£m 

£m 

£m 

 

£m 

£m 

£m 

£m 

£m 

                       

Gross exposure:

                     

TMT (1)

1,044 

1,592 

849 

531 

4,016 

 

1,781 

1,656 

1,081 

605 

5,123 

Industrial

726 

1,110 

1,334 

334 

3,504 

 

1,584 

1,523 

1,781 

207 

5,095 

Retail

24 

380 

1,083 

60 

1,547 

 

17 

476 

1,354 

71 

1,918 

Other

235 

1,301 

1,022 

231 

2,789 

 

244 

1,527 

1,168 

191 

3,130 

                       
 

2,029 

4,383 

4,288 

1,156 

11,856 

 

3,626 

5,182 

5,384 

1,074 

15,266 

                       

Net exposure:

                     

TMT (1)

928 

1,430 

845 

428 

3,631 

 

1,502 

1,532 

1,045 

590 

4,669 

Industrial

535 

1,001 

1,178 

329 

3,043 

 

524 

973 

1,594 

205 

3,296 

Retail

24 

366 

1,028 

57 

1,475 

 

17 

445 

1,282 

68 

1,812 

Other

233 

1,232 

1,013 

232 

2,710 

 

244 

1,461 

1,147 

191 

3,043 

                       
 

1,720 

4,029 

4,064 

1,046 

10,859 

 

2,287 

4,411 

5,068 

1,054 

12,820 

                       

Of which:

                     

Drawn

1,313 

3,604 

3,332 

870 

9,119 

 

1,944 

3,737 

3,909 

950 

10,540 

Undrawn

407 

425 

732 

176 

1,740 

 

343 

674 

1,159 

104 

2,280 

                       
 

1,720 

4,029 

4,064 

1,046 

10,859 

 

2,287 

4,411 

5,068 

1,054 

12,820 



 

Notes:

(1)

Telecommunications, media and technology.

(2)

All of the above exposures are in Non-Core and are classified as LAR, except for £154 million (31 December 2009 - £143 million) that is classified as HFT.



 


Risk and capital management (continued)

 

Other risk exposures: Leveraged finance (continued)

 

The table below analyses the movements in leveraged finance exposures for the period ended 30 June 2010.

 

 

Drawn 

Undrawn

Total

 

£m 

£m

£m

       

Balance at 1 January 2010

10,540 

2,280 

12,820 

Transfers in (from credit trading business)

57 

19 

76 

Sales and restructurings

(1,289)

(213)

(1,502)

Repayments and facility reductions

(224)

(283)

(507)

Funded deals

41 

(41)

Changes in fair value

15 

15 

Accretion of interest

28 

28 

Recoveries net of impairments

70 

70 

Exchange and other movements

(119)

(22)

(141)

       

Balance at 30 June 2010

9,119 

1,740 

10,859 



 

Key points

·

The Group's exposure to leveraged finance has reduced as a result of sales and restructurings of £1.5 billion, repayments of £0.5 billion and facility reductions and exchange rate movements.

   

·

Credit impairments in the first half of 2010 were £274 million which were more than, offset by recoveries of £344 million, following debt restructuring by the Group.

   

·

Approximately 90% of the above exposures represent senior lending.

     


 

Not included in the table above are:

·

UK Corporate leveraged finance net exposures of £7.2 billion at 30 June 2010 (31 December 2009 - £7.1 billion) related to debt and banking facilities provided to UK mid-corporates. Of this £4.0 billion (31 December 2009 - £4.0 billion) relates specifically to debt transactions financing UK mid-market buyouts, supplementing equity capital provided by third party private equity investors.  The balance was senior debt transactions to mid-corporate clients supporting acquisitions, recapitalisations or general corporate purposes where higher leverage criteria were met.

   

·

Ulster Bank leveraged finance net exposure was £0.6 billion at 30 June 2010 and 31 December 2009. 

     


 


Risk and capital management (continued)

 

Other risk exposures

 

Special purpose entities

 

The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets, or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE), which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions.  As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.

 

The table below sets out the asset categories, together with the carrying value 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 2010

 

31 December 2009

 

Assets 

Liabilities 

 

Assets 

Liabilities 

 

£m 

£m 

 

£m 

£m 

           

Residential mortgages

71,022 

15,012 

 

69,927 

15,937 

Credit card receivables

4,148 

1,585 

 

2,975 

1,592 

Other loans

34,097 

986 

 

36,448 

1,010 

Finance lease receivables

621 

621 

 

597 

597 



 

 

Conduits

Group-sponsored conduits can be divided into multi-seller conduits and own-asset conduits. The Group consolidates both types of conduits where the substance of the relationship between the Group and the conduit vehicle is such that the vehicle is controlled by the Group.  Liquidity commitments from the Group to the conduit exceed the nominal amount of assets funded by the conduit as liquidity commitments are sized to cover the funding cost of the related assets.

 

During the period both multi-seller and own asset conduit assets have been reduced in line with wider Group balance sheet management.  The total assets held by Group-sponsored conduits were £22.5 billion at 30 June 2010 (31 December 2009 - £27.4 billion).


Risk and capital management (continued)

 

Other risk exposures: Special purpose entities (continued)

 

The exposure to conduits which are consolidated by the Group is set out below.
 

 

30 June 2010

 

31 December 2009

 

Core 

Non-Core 

Total 

 

Core 

Non-Core 

Total 

 

£m 

£m 

£m 

 

£m 

£m 

£m 

               

Total assets held by the conduits

18,645 

3,841 

22,486 

 

23,409 

3,957 

27,366 

               

Commercial paper issued

17,987 

2,592 

20,579 

 

22,644 

2,939 

25,583 

               

Liquidity and credit enhancements:

             

Deal specific liquidity:

             

-  drawn

637 

1,274 

1,911 

 

738 

1,059 

1,797 

-  undrawn

26,049 

3,367 

29,416 

 

28,628 

3,852 

32,480 

PWCE (1)

1,119 

316 

1,435 

 

1,167 

341 

1,508 

               
 

27,805 

4,957 

32,762 

 

30,533 

5,252 

35,785 

               

Maximum exposure to loss (2)

26,686 

4,641 

31,327 

 

29,365 

4,911 

34,276 



 

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. Third party maximum exposure to loss is reduced by repo trades conducted with an external counterparty.



 

Multi-seller conduits accounted for 43% of the total liquidity and credit enhancements committed by the Group at 30 June 2010 and 31 December 2009.  The Group's multi-seller conduits have continued to fund the vast majority of their assets solely through asset-backed commercial paper (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.

 

Key points

·

The maturity of the commercial paper issued by the Group's conduits is managed to mitigate the short-term contingent liquidity risk of providing back-up facilities. The Group's limits sanctioned for such liquidity facilities at 30 June 2010 totalled approximately £24.3 billion (31 December 2009 - £25.0 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 Group's maximum exposure to loss on its multi-seller conduits is £24.5 billion (31 December - £25.2 billion), being the total amount of the Group's liquidity commitments plus the extent of PWCE of conduit assets for which liquidity facilities were not provided by third parties.

   

·

In the first half of the year a broader range of money market investors returned to the ABCP market, including corporate and municipal funds.

   

·

The average maturity of ABCP issued by the Group's conduits at 30 June 2010 was 62.7 days (31 December 2009 - 58.4 days).

     


 

 

Risk and capital management (continued)

 

Other risk exposures

 

Own-asset conduits

 

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

 

Key points

·

The Group holds two own-asset conduits, which have assets that were previously funded by the Group. The Group's maximum exposure to loss on these two conduits was £6.9 billion at 30 June 2010 (31 December 2009 - £9.1 billion), with £4.2 billion of ABCP outstanding at that date (31 December 2009 - £7.7 billion).

   

·

Additionally the Group has established an own-asset conduit with a committed liquidity of £26.0 billion (31 December 2009 - £25.1 billion) to access the Bank of England's open market operations for contingent funding purposes. This conduit had no commercial paper outstanding at 30 June 2010 or 31 December 2009 and is therefore not included in the table above.

     


 

Third-party conduits

The Group also extends liquidity commitments to multi-seller conduits sponsored by other banks, but typically does not consolidate these entities as the Group does not retain the majority of risks and rewards.  The Group's exposure from third-party conduits is analysed below.

 

 

30 June 2010

 

31 December 2009

 

Core 

Non-Core 

Total 

 

Core 

Non-Core 

Total 

 

£m 

£m 

£m 

 

£m 

£m 

£m 

               

Liquidity and credit enhancements:

             

Deal specific liquidity:

             

- drawn

234 

129 

363 

 

223 

120 

343 

- undrawn

38 

40 

 

206 

38 

244 

               
 

236 

167 

403 

 

429 

158 

587 

               

Maximum exposure to loss (1)

236 

167 

403 

 

429 

158 

587 



 

Note:

(1)

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.



 








Signatures



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



Date:   August 6, 2010

  THE ROYAL BANK OF SCOTLAND GROUP plc (Registrant)


  By: /s/ Jan Cargill

  Name:
Title:
Jan Cargill
Deputy Secretary