Logotype

financial statements 2012

8. Fair value of financial instruments

Print this page

The fair value of a financial asset or liability on a given date is the amount for which it could be exchanged or settled, respectively, on that date between two knowledgeable, willing parties in an arm’s length transaction under market conditions. The most objective and common reference for the fair value of a financial asset or liability is the price that would be paid for it on an organized, transparent and deep market (“quoted price” or “market price”).

If there is no market price for a given financial asset or liability, its fair value is estimated on the basis of the price established in recent transactions involving similar instruments or, in the absence thereof, by using mathematical measurement models that are sufficiently tried and trusted by the international financial community. The estimates used in such models take into consideration the specific features of the asset or liability to be measured and, in particular, the various types of risk associated with the asset or liability. However, the limitations inherent in the measurement models and possible inaccuracies in the assumptions and parameters required by these models may mean that the estimated fair value of an asset or liability does not exactly match the price for which the asset or liability could be exchanged or settled on the date of its measurement.

The fair value of the financial derivatives included in the held-for-trading portfolios is based on daily quoted price if there is an active market for these financial derivatives. If for any reason their quoted price is not available on a given date, these financial derivatives are measured using methods similar to those used in over-the-counter (OTC) markets.

The fair value of OTC derivatives (“present value” or “theoretical price”) is equal to the sum of future cash flows arising from the instrument, discounted at the measurement date; these derivatives are valued using methods recognized by international financial markets: the “net present value” (NPV) method, option price calculation models, etc.

Determining the fair value of financial instruments

Below is a comparison of the carrying amount of the Group’s financial assets and liabilities in the accompanying consolidated balance sheets and their respective fair values:

Excel Download Excel
Fair Value and Carrying Amount Notes Millions of Euros
2012 2011 2010
Carrying Amount Fair Value Carrying Amount Fair Value Carrying Amount Fair Value
ASSETS-






Cash and balances with central banks 9 37,434 37,434 30,939 30,939 19,981 19,981
Financial assets held for trading 10 79,954 79,954 70,602 70,602 63,283 63,283
Other financial assets designated at fair value through profit or loss 11 2,853 2,853 2,977 2,977 2,774 2,774
Available-for-sale financial assets 12 71,500 71,500 58,144 58,144 56,456 56,456
Loans and receivables 13 383,410 403,606 381,076 389,204 364,707 371,359
Held-to-maturity investments 14 10,162 9,860 10,955 10,190 9,946 9,189
Fair value changes of the hedges items in portfolio hedges of interest rate risk 15 226 226 146 146 40 40
Hedging derivatives 15 4,894 4,894 4,552 4,552 3,563 3,563
LIABILITIES-






Financial assets held for trading 10 55,927 55,927 51,303 51,303 37,212 37,212
Other financial liabilities designated at fair value through profit or loss 11 2,516 2,516 1,825 1,825 1,607 1,607
Financial liabilities at amortized cost 23 506,487 504,267 497,904 473,886 453,164 453,504
Fair value changes of the hedged items in portfolio hedges of interest rate risk. 15 - - - - (2) (2)
Hedging derivatives 15 2,968 2,968 2,710 2,710 1,664 1,664

In the case of financial instruments whose carrying amount is not the same as their theoretical fair value, the fair value has been calculated as follows:

  • The fair value of “Cash and balances with central banks” has been considered equivalent to its carrying amount, because they are mainly short-term balances.
  • The fair value of “Held-to-maturity investments” is equivalent to their quoted price in active markets.
  • The fair values of “Loans and receivables” and “Financial liabilities at amortized cost” have been estimated by discounting estimated future cash flows using the market interest rates prevailing at each year-end.
  • The “Fair value changes of the hedged items in portfolio hedges of interest-rate risk” item in the accompanying consolidated balance sheets registers the difference between the carrying amounts of the hedged deposits lent, included under "Loans and Receivables", and the fair value calculated using internal models and observable variables of market data (see Note 15).

For financial instruments whose carrying amount is equivalent to their fair value, the measurement processes used are set forth below:

  • Level 1: Measurement using market observable quoted prices for the financial instrument in question, secured from independent sources and referred to active markets. This level includes listed debt securities, listed equity instruments, some derivatives and mutual funds.
  • Level 2: Measurement that applies techniques using inputs drawn from observable market data.
  • Level 3: Measurement using techniques where some of the inputs are not taken from market observable data. As of December 31, 2012, the affected instruments accounted for approximately 0.20% of financial assets and 0.01% of the Group’s financial liabilities. Model selection and validation is undertaken by control areas outside the market units.

The following table shows the main financial instruments carried at fair value in the accompanying consolidated balance sheets, broken down by the measurement technique used to determine their fair value:

Excel Download Excel
Fair Value by Levels Notes Millions of Euros
2012 2011 2010
Level 1 Level 2 Level 3 Level 1 Level 2 Level 3 Level 1 Level 2 Level 3
ASSETS-









Financial assets held for trading 10 30,944 48,597 412 22,986 46,915 700 28,914 33,568 802
Loans and advances to customers
244 - - - - - - - -
Debt securities
27,053 718 295 19,731 793 451 22,930 921 508
Equity instruments
2,713 140 70 2,033 97 68 5,034 92 134
Trading derivatives
934 47,740 47 1,222 46,025 182 950 32,555 160
Other financial assets designated at fair value through profit or loss 11 2,768 86 - 2,358 619 - 2,326 448 -
Loans and advances to credit institutions
- 24 - - - - - - -
Debt securities
692 62 - 647 61 - 624 64 -
Equity instruments
2,076 - - 1,711 558 - 1,702 384 -
Available-for-sale financial assets 12 51,682 18,551 757 41,286 15,249 1,067 41,500 13,789 668
Debt securities
48,484 18,359 700 37,286 15,025 602 37,024 13,352 499
Equity instruments
3,198 192 57 4,000 224 465 4,476 437 169
Hedging derivatives 15 111 4,784 - 289 4,263 - 265 3,298 -
LIABILITIES-









Financial liabilities held for trading 10 7,371 48,519 38 5,813 45,467 23 4,961 32,225 25
Trading derivatives
791 48,519 38 1,202 45,467 23 916 32,225 25
Short positions
6,580 - - 4,611 - - 4,046 - -
Other financial liabilities designated at fair value through profit or loss 11 - 2,516 - - 1,825 - - 1,607 -
Hedging derivatives 15 - 2,951 17 - 2,710 - 96 1,568 -

The heading “Available-for-sale financial assets” in the accompanying consolidated balance sheets as of December 31, 2012, 2011 and 2010 additionally includes €510 million, €541 million and €499 million, respectively, accounted for at cost, as indicated in the section of this Note entitled “Financial instruments at cost”.

The following table sets forth the main measurement techniques, hypothesis and inputs used in the estimation of fair value of the financial instruments classified under Levels 2 and 3, based on the type of financial asset and liability and the corresponding balances as of December 31, 2012:

Financial Instruments Level 2 Measurement techniques Main assumptions Main inputs used 2012
Fair value (millions of euros)
Debt securities Present-value method Determining the present value of financial instruments as the current value of future cash flows (discounted at market interest rates), taking into account:
• the estimate of prepayment rates;
• the issuer credit risk; and
• current market interest rates.
• Net Asset Value (NAV) published recurrently, but not more frequently than every quarter.
• Risk premiums.
• Observable market interest rates
Trading portfolio
Debt securities 718
Equity instruments 140
Other financial assets at fair value through profit and loss
Equity instruments Debt securities 62
Deposits from credit institutions 24
Available-for-sale financial assets
Debt securities 18,359
Equity instruments 192
Other financial liabilities designated at fair value through profit or loss 2,516
Derivatives Analytic/semi-analytic formulae For share, currency, inflation or commodity derivatives:
• The Black-Scholes assumptions take into account possible convexity adjustments

For interest rate derivatives:
• Black-Scholes assumptions apply a lognormal process for forward rates and consider possible convexity adjustments.
For share, inflation, currency or commodity derivatives:
• Forward structure of the underlying asset.
• Volatility of options.
• Observable correlations between underlying assets.

For interest-rate derivatives:
• The term structure of interest rates.
• Volatility of underlying asset.

For credit derivatives:
• Credit default swap (CDS) prices.
• Historical CDS volatility.
Assets
Trading derivatives 47,740
Hedging derivatives 4,784
For share, currency or commodity derivatives:
• Monte Carlo simulations.
Local volatility model: assumes a constant diffusion of the underlying asset with the volatility depending on the value of the underlying asset and the term Liabilities
For interest-rate derivatives:
• Black-Derman-Toy Model, Libor Market Model and SABR.
• HW 1 factor
This model assumes that:
• The forward rates in the term structure of the interest rate curve are perfectly correlated.
Trading derivatives 48,519
For credit derivatives:
• Diffusion models.
These models assume a constant diffusion of default intensity. Hedging derivatives 2,951
Financial Instruments Level 3 Measurement techniques Main assumptions Main unobservable inputs 2012
Fair value (millions of euros)
Debt securities Present-value method
“Time default” model for financial instruments in the collateralized debt obligations (CDO) family.
Determining the current value of financial instruments as the current value of future cash flows (discounted at market interest rates), taking into account:
• estimate of prepayment rates;
• issuer credit risk; and
• current market interest rates.

In the case of measurement of asset-backed securities (ABS), the future prepayments are calculated according to conditional prepayment rates supplied by the issuers themselves.

The "time-to-default" model is used to measure the probability of default. One of the main variables used is the correlation of defaults extrapolated from several index tranches (ITRA00 and CDX) with the underlying portfolio of our CDOs.
• Prepayment rates
• Default correlation
• Credit spread (1)
Trading portfolio
Debt securities 295
Equity instruments 70
Available-for-sale financial assets
Debt securities 700
Equity instruments • Present-value method Net asset value (NAV) for hedge funds and for equity instruments listed in thin or less active markets • Credit spread (1)
• NAV supplied by the fund administrator or issuer of the securities.
Equity instruments 57
Trading derivatives Trading derivatives for interest rate futures and forwards:
• Present-value method
• “Libor Market” model.
The "Libor Market” model models the complete term structure of the interest-rate curve, assuming a constant elasticity of variance (CEV) lognormal process. The CEV lognormal process is used to measure the presence of a volatility shift. Correlation decay (2) Assets
For variable income and foreign options:
• Monte Carlo simulations
• Numerical integration
• Heston
The options are measured through generally accepted valuation models, to which the observed implied volatility is added. • Vol-of-Vol (3)
• Reversion factor (4)
• Volatility Spot Correlation (5)
Trading derivatives 47
Liabilities
• Credit baskets These models assume a constant diffusion of default intensity. • Default correlation.
• Historical CDS volatility
Trading derivatives
Hedging derivatives
38
17
(1) Credit spread: The spread between the interest rate of a risk-free asset (e.g. Treasury securities) and the interest rate of any other security that is identical in every respect except for asset quality. Spreads are considered as Level 3 inputs when referring to illiquid securities, based on spreads of similar issuers. (2) Correlation decay: This is the factor that allows us to calculate changes in correlation between the different pairs of forward rates. (3) Vol-of-Vol: Volatility of implied volatility. This is a statistical measure of the changes of the spot volatility. (4) Reversion Factor: The speed with which volatility reverts to its natural value. (5) Volatility - Spot Correlation: A statistical measure of the linear relationship (correlation) between the spot price of a security and its volatility.

The changes in the balance of Level 3 financial assets and liabilities included in the accompanying consolidated balance sheets are as follows:

Excel Download Excel
Financial Assets Level 3
Changes in the Period
Millions of Euros
2012 2011 2010

Assets Liabilities Assets Liabilities Assets Liabilities
Balance at the beginning 1,767 23 1,469 25 1,707 96
Valuation adjustments recognized in the income statement (*) 50 2 (1) (12) (123) 12
Valuation adjustments not recognized in the income statement (3) - - - (18) -
Acquisitions, disposals and liquidations (278) 29 268 9 (334) (100)
Net transfers to Level 3 (134) - 33 - 236 -
Exchange differences and others (233) 1 (2) 1 1 17
Exchange differences and others 1,169 55 1,767 23 1,469 25
(*) Profit or loss that are attributable to gains or losses relating to those assets and liabilities held at the end of the reporting period

As of December 31, 2012, the profit/loss on sales of financial instruments classified as level 3 recognized in the accompanying income statement was insignificant.

The financial instruments transferred between the different levels of measurement in 2012 are at the following amounts in the accompanying consolidated balance sheets as of December 31, 2012:

Excel Download Excel
Transfer between levels From:
To:
Millions of Euros
Level I Level 2 Level 3
Level 2 Level 3 Level 1 Level 3 Level 1 Level 2
ASSETS






Financial assets held for trading
- - - - - -
Available-for-sale financial assets
78 - 454 18 12 137
LIABILITIES-






As of December 31, 2012, the effect on the consolidated income and consolidated equity of changing the main hypotheses used for the measurement of Level 3 financial instruments for other reasonably possible models, taking the highest (most favorable hypotheses) or lowest (least favorable hypotheses) value of the range deemed probable, would be as follows:

Excel Download Excel
Financial Assets Level 3 Sensitivity Analysis Millions of Euros
Potential Impact on Consolidated Income Statement Potential Impact on Total Equity
Most Favorable Hypotheses Least Favorable Hypotheses Most Favorable Hypotheses Least Favorable Hypotheses
ASSETS



Financial assets held for trading 22 (15) - -
Available-for-sale financial assets - - 10 (10)
LIABILITIES-



Financial liabilities held for trading 4 (4) - -
Total 26 (19) 10 (10)
Loans and financial liabilities at fair value through profit or loss

As of December 31, 2012, 2011 and 2010, there were no loans or financial liabilities at fair value other than those recognized under the headings “Financial assets held for trading - Loans and advances to customers”, "Other financial assets designated at fair value through profit or loss" and "Other financial liabilities designated at fair value through profit or loss" in the accompanying consolidated balance sheets.

Financial instruments at cost

As of December 31, 2012, 2011 and 2010, equity instruments, derivatives with these equity instruments as underlying assets, and certain discretionary profit-sharing arrangements in some companies, were recognized at cost in the Group’s consolidated balance sheets because their fair value could not be reliably determined, as they are not traded in organized markets and thus their unobservable inputs are significant. On the above dates, the balance of these financial instruments recognized in the portfolio of available-for-sale financial assets amounted to €510 million, €541 million and €499 million, respectively.

The table below outlines the financial assets and liabilities carried at cost that were sold in 2012, 2011 and 2010:

Excel Download Excel
Sales of financial instruments at cost Millions of Euros
2012 2011 2010
Amount of Sale 29 19 51
Carrying Amount at Sale Date 5 8 36
Gains/Losses 24 11 15
Tools