HSBC 2009 Annual Report Download - page 181

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For impairment losses on available-for-sale
equity and debt securities, see pages 31 and 35,
respectively. Any impairment losses relating to
ABSs recognised in the income statement are
recorded as ‘Loan impairment charges and other
credit risk provisions’. 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 carried 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
assets could be exchanged, or financial liabilities
settled, between knowledgeable, willing parties in an
arm’s length transaction. It does not reflect the
economic benefits and costs that HSBC expects to
flow from the instruments’ cash flows over their
expected future lives. Other reporting entities
may use different valuation methodologies and
assumptions in determining fair values for which
no observable market prices are available, so
comparisons of fair values between entities may
not be meaningful and users are advised to exercise
caution when using this data.
As a consequence of the market turmoil there
has been a significant reduction in the secondary
market demand for US consumer lending assets.
Uncertainty over the extent and timing of future
credit losses, together with a near absence of
liquidity for non-prime ABSs and loans, continued
to be reflected in a low volume of bid prices at
31 December 2009. It is not possible from the
indicative market prices that are available to
distinguish between the relative discount to nominal
value within the fair value measurement that reflects
cash flow impairment due to expected losses to
maturity, and the discount that the market is
demanding for holding an illiquid asset. Under
impairment accounting for loans and advances, there
is no requirement to adjust the carrying value to
reflect illiquidity as HSBC’s intention is to fund
assets until the earlier of prepayment, charge-off or
repayment on maturity. The fair value, by contrast,
reflects both incurred loss and loss expected through
the life of the asset, a discount for illiquidity and a
credit spread which reflects the market’s current risk
preferences. This usually differs from the credit
spread applicable in the market at the time the loan
was underwritten and funded.
The estimated fair values at 31 December 2009
and 31 December 2008 of loans and advances to
customers in North America reflected the combined
effect of these conditions. As a result, the fair values
are substantially lower than the carrying amount of
customer loans held on-balance sheet and lower than
would otherwise be reported under more normal
market conditions. Accordingly, the fair values
reported do not reflect HSBC’s estimate of the
underlying long-term value of the assets. Fair values
at the balance sheet date of the assets and liabilities
set out below are estimated for the purpose of
disclosure as follows:
• Loans and advances to banks and customers
The fair value of loans and advances is based
on observable market transactions, where
available. In the absence of observable market
transactions, fair value is estimated using
discounted cash flow models. Performing
loans are grouped, as far as possible, into
homogeneous pools segregated by maturity and
coupon rates. In general, contractual cash flows
are discounted using HSBC’s estimate of the
discount rate that a market participant would use
in valuing instruments with similar maturity,
re-pricing and credit risk characteristics.
The fair value of a loan portfolio reflects
both loan impairments at the balance sheet
date and estimates of market participants’
expectations of credit losses over the life of
the loans. For impaired loans, fair value is
estimated by discounting the future cash flows
over the time period they are expected to be
recovered.
• Financial investments
The fair values of listed financial investments
are determined using bid market prices. The fair
values of unlisted financial investments are
determined using valuation techniques that take
into consideration the prices and future earnings
streams of equivalent quoted securities.
• Deposits by banks and customer accounts
For the purpose of estimating fair value,
deposits by banks and customer accounts are
grouped by remaining contractual maturity. Fair
values are estimated using discounted cash
flows, applying current rates offered for deposits