HSBC 2008 Annual Report Download - page 172

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Fair values of financial instruments > Carried at fair value / Not carried at fair value
170
Debt securities
When assessing available-for-sale debt securities for
objective evidence of impairment at the balance
sheet date, HSBC considers all available evidence,
including observable data or information about
events specifically relating to the securities which
may result in a shortfall in recovery of future cash
flows. These events may include a significant
financial difficulty of the issuer, a breach of contract
such as a default, bankruptcy or other financial
reorganisation, or the disappearance of an active
market for the debt security because of financial
difficulties relating to the issuer.
These types of specific event and other factors
such as information about the issuers’ liquidity,
business and financial risk exposures, levels of and
trends in default for similar financial assets, national
and local economic trends and conditions, and the
fair value of collateral and guarantees may be
considered individually, or in combination, to
determine if there is objective evidence of
impairment of a debt security.
In addition, when assessing available-for-sale
ABSs for objective evidence of impairment, HSBC
considers the performance of underlying collateral,
the extent and depth of market price declines and
changes in credit ratings. The primary indicators of
potential impairment are considered to be adverse
fair value movements, and the disappearance of an
active market for the securities.
At 31 December 2008, the population of
available-for-sale ABSs identified as being most at
risk of impairment included residential MBSs
backed by sub-prime and Alt-A mortgages
originated in the US, and CDOs with significant
exposure to this sector. The estimated future cash
flows of these securities are assessed to determine
whether any of their cash flows are unlikely to be
recovered as a result of events occurring on or before
the balance sheet date.
In particular, for residential MBSs the estimated
future cash flows are assessed by determining the
future projected cash flows arising on the underlying
collateral taking into consideration the delinquency
status of underlying loans, the probability of
delinquent loans progressing to default and the
proportion of the advances subsequently recoverable.
HSBC uses a modelling approach which
incorporates historically observed progression rates
to default, to determine if the decline in aggregate
projected cash flows from the underlying collateral
will lead to a shortfall in contractual cash flows. In
such cases the security is considered to be impaired.
In respect of CDOs, in order to determine
whether impairment has occurred, the expected
future cash flows of the CDOs are compared with
the total of the underlying collateral on the non-
defaulted assets and the recovery value of the
defaulted assets. In the event of a shortfall, the CDO
is considered to be impaired.
When a security benefits from a contract
provided by a monoline insurer that insures
payments of principal and interest, the expected
recovery on the contract is assessed in determining
the total expected credit support available to the
ABS.
Equity securities
Objective evidence of impairment for available-
for-sale equity securities may include specific
information about the issuer as detailed above, but
may also include information about significant
changes in technology, markets, economics or the
law that provides evidence that the cost of the equity
securities may not be recovered.
A significant or prolonged decline in the fair
value of the asset below its cost is also objective
evidence of impairment. In assessing whether it is
significant, the decline in fair value is evaluated
against the original cost of the asset at initial
recognition. In assessing whether it is prolonged, the
decline is evaluated against the period in which the
fair value of the asset has been below its original
cost at initial recognition.
For impairment losses on available-for-sale
debt and equity securities, see pages 34 and 30,
respectively. Any impairment losses recognised in
the income statement relating to ABSs are recorded
in the ‘Loan impairment charges and other credit risk
provisions’ line. Impairment losses incurred on
assets held by consolidated securities investment
conduits (excluding Solitaire) are offset by a credit
to the impairment line for the amount of the loss
borne by capital note holders.
Fair values of financial instruments not
carried at fair value
Financial instruments that are not measured at fair
value on the balance sheet include loans and
advances to banks and customers, deposits by banks,
customer accounts, debt securities in issue and
subordinated liabilities. Their fair values are,
however, provided for information by way of note
disclosure and are calculated as described below.
The calculation of fair value incorporates
HSBC’s estimate of the amount at which financial