HSBC 2007 Annual Report Download - page 351

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(e) Loans and advances to banks and customers
Loans and advances to banks and customers include loans and advances originated by HSBC which are not
classified either as held for trading or designated at fair value. Loans and advances are recognised when cash is
advanced to borrowers. They are derecognised when either borrowers repay their obligations, or the loans are
sold or written off, or substantially all the risks and rewards of ownership are transferred. They are initially
recorded at fair value plus any directly attributable transaction costs and are subsequently measured at amortised
cost using the effective interest method, less impairment losses. Where loans and advances are hedged by
derivatives designated and qualifying as fair value hedges, the carrying value of the loans and advances so
hedged includes a fair value adjustment for the hedged risk only.
For certain leveraged finance and syndicated lending activities, HSBC may commit to underwrite loans on fixed
contractual terms for specified periods of time, where the drawdown of the loan is contingent upon certain future
events outside the control of HSBC. Where the loan arising from the lending commitment is expected to be held
for trading, the commitment to lend is recorded as a trading derivative. Where it is not HSBC’s intention to trade
the loan, a provision is only recorded where it is probable that HSBC will incur a loss as a result of the loan
commitment. This may occur, for example, where a loss of principal is probable or the interest rate charged on
the loan is lower than the cost of funding. On inception of the loan, the hold portion is recorded at its fair value.
Where this fair value is lower than the cash amount advanced (for example, due to the rate of interest charged on
the loan being below the market rate of interest), the write down is charged to the income statement. The write
down will be recovered over the life of the loan, through the recognition of interest income using the effective
interest rate method, unless the loan is impaired. The write down is recorded as a reduction to other operating
income.
(f) Impairment of loans and advances
Losses for impaired loans are recognised promptly when there is objective evidence that impairment of a loan or
portfolio of loans has occurred. Impairment allowances are calculated on individual loans and on groups of loans
assessed collectively. Impairment losses are recorded as charges to the income statement. The carrying amount
of impaired loans on the balance sheet is reduced through the use of impairment allowance accounts. Losses
expected from future events are not recognised.
Individually assessed loans and advances
For all loans that are considered individually significant, HSBC assesses on a case-by-case basis at each balance
sheet date whether there is any objective evidence that a loan is impaired. For those loans where objective
evidence of impairment exists, impairment losses are determined considering the following factors:
– HSBC’s aggregate exposure to the customer;
– the viability of the customer’s business model and their capacity to trade successfully out of financial
difficulties and generate sufficient cash flow to service debt obligations;
– 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.