HSBC 2009 Annual Report Download - page 178

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Fair values of financial instruments > Carried at fair value
176
Reflected in profit or loss Reflected in equity
Favourable
changes
Unfavourable
changes
Favourable
changes
Unfavourable
changes
US$m US$m US$m US$m
At 31 December 2008 ...................................................
Private equity investments ............................................ 28 (28) 234 (261)
Asset-backed securities ................................................ 90 (91) 667 (660)
Leveraged finance ........................................................ 2 (2) – –
Loans held for securitisation ........................................ 41 (41) – –
Structured notes ............................................................ 8 (8) – –
Derivatives with monolines .......................................... 341 (250) – –
Other derivatives ........................................................... 652 (224) – –
Other portfolios ............................................................. 134 (89) 83 (84)
Favourable and unfavourable changes are
determined on the basis of changes in the value of
the instrument as a result of varying the levels of the
unobservable parameters using statistical techniques.
When parameters are not amenable to statistical
analysis, quantification of uncertainty is
judgemental.
When the fair value of a financial instrument is
affected by more than one unobservable assumption,
the above table reflects the most favourable or most
unfavourable change from varying the assumptions
individually.
In respect of private equity investments, the
valuations are assessed on an asset by asset basis
using a valuation methodology appropriate to the
specific investment, in line with industry guidelines.
In many of the methodologies, the principal
assumption is the valuation multiple to be applied to
the main financial indicators. This may be
determined with reference to multiples for
comparable listed companies and includes discounts
for marketability.
For ABSs whose prices are unobservable,
models are used to generate the expected value
of the asset. The principal assumptions in these
models are based on benchmark information about
prepayment speeds, default rates, loss severities and
the historical performance of the underlying assets.
The models used are calibrated by using securities
for which external market information is available.
For leveraged finance, loans held for
securitisation and derivatives with monolines the
principal assumption concerns the appropriate value
to be attributed to the counterparty credit risk.
This requires estimation of exposure at default,
probability of default and recovery in the event
of default. For loan transactions, assessment of
exposure at default is straightforward. For derivative
transactions, a future exposure profile is generated
on the basis of current market data. Probabilities of
default and recovery levels are estimated using
market evidence, which may include financial
information, historical experience, CDS spreads and
consensus recovery levels.
In the absence of such evidence, management’s
best estimate is used.
For structured notes and other derivatives,
principal assumptions concern the value to be
attributed to future volatility of asset values and the
future correlation between asset values. These
principal assumptions include credit volatilities and
correlations used in the valuation of structured credit
derivatives (including leveraged credit derivatives).
For such unobservable assumptions, estimates are
based on available market data, which may include
the use of a proxy method to derive a volatility or a
correlation from comparable assets for which market
data is more readily available, and/or an examination
of historical levels.
Changes in fair value recorded in the income
statement
The following table quantifies the changes in fair
values recognised in profit or loss during the year in
respect of assets and liabilities held at the end of the
year whose fair values are estimated using valuation
techniques that incorporate significant assumptions
that are not evidenced by prices from observable
current market transactions in the same instrument,
and are not based on observable market data:
2009 2008
US$m US$m
Recorded profit/(loss) on:
Derivatives, trading assets and
trading liabilities ...................... (4,620) 779
Financial assets and liabilities
designated at fair value ............ 95 109
The loss during the year included changes in the
fair value of monoline and CDPC-related credit
derivatives which use a valuation technique with
significant unobservable inputs. Additionally, there
was a decline in the fair value of other structured
credit derivatives attributable to the tightening of
credit spreads during the year.