HSBC 2006 Annual Report Download - page 308

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
Note 2
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– 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. Any loss is
charged in the income statement. The carrying amount of impaired loans on the balance sheet is reduced through
the use of an allowance account.
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 analyses 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.