HSBC 2006 Annual Report Download - page 114

HSBC HOLDINGS PLC
Report of the Directors: Financial Review (continued)
Critical accounting policies
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• the amount and timing of expected receipts and
recoveries;
• the likely dividend available on liquidation or
bankruptcy;
• the extent of other creditors’ commitments
ranking ahead of, or pari passu with, HSBC and
the likelihood of other creditors continuing to
support the company;
• the complexity of determining the aggregate
amount and ranking of all creditor claims and
the extent to which legal and insurance
uncertainties are evident;
• the realisable value of security (or other credit
mitigants) and likelihood of successful
repossession;
• the likely deduction of any costs involved in
recovery of amounts outstanding;
• the ability of the borrower to obtain, and make
payments in, the currency of the loan if not
denominated in local currency; and
• when available, the secondary market price of
the debt.
Impairment losses are calculated by discounting
the expected future cash flows of a loan at its
original effective interest rate, and comparing the
resultant present value with the loan’s current
carrying amount.
The carrying amount of impaired loans on the
balance sheet is reduced through the use of an
allowance account. HSBC’s policy requires a review
of the level of impairment allowances on individual
facilities above materiality thresholds at least half-
yearly, or more regularly when individual
circumstances require. This normally includes a
review of collateral held (including re-confirmation
of its enforceability) and an assessment of actual and
anticipated receipts.
Collectively assessed loans
Impairment is assessed on a collective basis in two
circumstances:
• to cover losses which have been incurred but
have not yet been identified on loans subject to
individual assessment; and
• for homogeneous groups of loans that are not
considered individually significant.
Incurred but not yet identified impairment
Individually assessed loans for which no evidence of
loss has been specifically identified on an individual
basis are grouped together according to their credit
risk characteristics for the purpose of calculating an
estimated collective loss. This reflects impairment
losses incurred at the balance sheet date which will
only be individually identified in the future.
The collective impairment allowance is
determined after taking into account:
• historical loss experience in portfolios of similar
credit risk characteristics (for example, by
industry sector, loan grade or product);
• the estimated period between impairment
occurring and the loss being identified and
evidenced by the establishment of an
appropriate allowance against the individual
loan; and
• management’s experienced judgement as to
whether current economic and credit conditions
are such that the actual level of inherent losses is
likely to be greater or less than that suggested by
historical experience.
The period between a loss occurring and its
identification is estimated by local management for
each identified portfolio.
Homogeneous groups of loans
For homogeneous groups of loans that are not
considered individually significant, two alternative
methods are used to calculate allowances on a
portfolio basis:
When appropriate empirical information is
available, HSBC utilises roll-rate methodology. This
methodology employs statistical analysis of
historical trends of delinquency and default to
estimate the likelihood that loans will progress
through the various stages of delinquency and
ultimately prove irrecoverable. The estimated loss is
the difference between the present value of expected
future cash flows, discounted at the original effective
interest rate of the portfolio, and the carrying amount
of the portfolio. Current economic conditions are
also evaluated when calculating the appropriate level
of allowance required to cover inherent loss. In
certain highly developed markets, sophisticated
models also take into account behavioural and
account management trends as revealed in, for
example, bankruptcy and rescheduling statistics.
In other cases, when the portfolio size is small
or when information is insufficient or not reliable
enough to adopt a roll-rate methodology, HSBC
adopts a formulaic approach which allocates
progressively higher percentage loss rates the longer
a customer’s loan is overdue. Loss rates are