HSBC 2008 Annual Report Download - page 152

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Risk management / Accounting policies / Nature and extent of exposures
150
Risk management
(Audited)
The effect of the recent market turmoil on HSBC’s
risk exposures, the way in which HSBC has
managed risk exposures in this context, and any
changes made in HSBC’s risk management polices
and procedures in response to the market conditions
are set out in the following sections:
• Liquidity risk – ‘The impact of market turmoil
on the Group’s liquidity risk position’ (see
page 239).
• Market risk – ‘The impact of market turmoil
on market risk’ (see page 242).
• Credit Risk – ‘Credit exposure’ (see page 197).
Accounting policies
(Audited)
HSBC’s accounting policies regarding the
classification and valuation of financial instruments
are in accordance with the requirements of IAS 32
‘Financial Instruments: Presentation’ and IAS 39
‘Financial Instruments: Recognition and
Measurement’, as described in Note 2 on the
Financial Statements, and the use of assumptions and
estimation in respect of valuation of financial
instruments as described on page 63.
Nature and extent of HSBC’s
exposures
(Audited)
This section contains information on HSBC’s
exposures to the following:
• direct lending held at fair value through profit or
loss;
• ABSs including MBSs and CDOs;
• monoline insurers;
• credit derivative product companies (‘CDPC’s);
and
• leveraged finance transactions.
MBSs are securities that represent interests in a
group of mortgages. Investors in these securities
have the right to cash received from future mortgage
payments (interest and/or principal). Where an MBS
references mortgages with different risk profiles, the
MBS is classified according to the highest risk class.
Consequently, an MBS with both sub-prime and
Alt-A exposures is classified as sub-prime.
CDOs are securities in which ABSs and/or
certain other related assets have been purchased and
securitised by a third-party, or securities which pay a
return which is referenced to those assets. CDOs
may feature exposure to sub-prime mortgage assets
through the underlying assets. As there is often
uncertainty surrounding the nature of the underlying
collateral supporting CDOs, all CDOs supported by
residential mortgage-related assets, irrespective of
the level of sub-prime assets, are classified as sub-
prime.
HSBC’s holdings of ABSs and CDOs, and its
direct lending positions, include the following
categories of collateral and lending activity:
• sub-prime: loans to customers who have
limited credit histories, modest incomes, high
debt-to-income ratios or have experienced credit
problems caused by occasional delinquencies,
prior charge-offs, bankruptcy or other credit-
related actions. For US mortgages, US credit
scores are primarily used to determine whether a
loan is sub-prime. US home equity lines of
credit are classified as sub-prime. For non-US
mortgages, management judgement is used to
identify loans of similar risk characteristics to
sub-prime, for example, UK non-conforming
mortgages (see below);
• US home equity lines of credit (‘HELoC’s): a
form of revolving credit facility provided to
customers, which is supported by a first or
second lien charge over residential property.
Global Banking and Markets’ holdings of
HELoCs are classified as US sub-prime
residential mortgage assets;
• US Alt-A: loans classified as Alt-A are regarded
as lower risk than sub-prime, but they share
higher risk characteristics than lending under
normal criteria. US credit scores, as well as the
level of mortgage documentation held (such as
proof of income), are considered when
determining whether an Alt-A classification is
appropriate. Non-agency mortgages in the US
are classified as Alt-A if they do not meet the
criteria for classification as sub-prime. These are
mortgages not eligible to be sold to the major
US Government agency, Ginnie Mae
(Government National Mortgage Association),
and government sponsored enterprises in the
mortgage market, Fannie Mae (the Federal
National Mortgage Association) and Freddie
Mac (the Federal Home Loan Mortgage
Corporation);
• US government agency mortgage-related
assets: securities that are guaranteed by US
Government agencies, such as Ginnie Mae;