HSBC 2007 Annual Report Download - page 433

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from the discount that the market is demanding for holding an illiquid asset. Under IFRSs, HSBC recognises loan
impairment based on losses incurred up to the balance sheet date: no recognition is given to losses which are expected
to arise in the future, but where the loss event has not yet occurred. Neither is the asset written down to reflect its
illiquidity as the intention is to fund the asset until the earlier of its prepayment, charge-off or repayment on maturity.
Market fair values reflect not only incurred loss, but also loss expected through the life of the asset, as well as a
discount for illiquidity and a credit spread which reflects the market’s current risk preference rather than the credit
spread which existed in the market at the time the loan was underwritten.
The estimated fair values at 31 December 2007 of loans and advances to customers in North America reflect the
combined effect of these conditions. This results in fair values that are substantially lower than the carrying value 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.
The following types of financial instruments are measured at amortised cost unless they are held for trading or
designated at fair value through profit or loss. Where assets or liabilities are hedged by derivatives designated and
qualifying as fair value hedges, the carrying value of the assets or liabilities so hedged includes a fair value
adjustment for the hedged risk only. Fair values at the balance sheet date of the assets and liabilities set out below are
estimated for the purpose of disclosure as follows:
(i) 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, repricing 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.
(ii) 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 either the prices of,
or future earnings streams of, equivalent quoted securities.
(iii) Deposits by banks and customer accounts
For the purposes of estimating fair value, deposits by banks and customer accounts are grouped by residual
maturity. Fair values are estimated using discounted cash flows, applying current rates offered for deposits of
similar remaining maturities. The fair value of a deposit repayable on demand is assumed to be the amount
payable on demand at the balance sheet date.
(iv) Debt securities in issue and subordinated liabilities
Fair values are determined using quoted market prices at the balance sheet date where available, or by reference
to quoted market prices for similar instruments.
The fair values in this note are stated at a specific date and may be significantly different from the amounts which
will actually be paid on the maturity or settlement dates of the instruments. In many cases, it would not be possible to
realise immediately the estimated fair values given the size of the portfolios measured. Accordingly, these fair values
do not represent the value of these financial instruments to HSBC as a going concern.
For all classes of financial instruments, fair value represents the product of the value of a single instrument,
multiplied by the number of instruments held. No block discount or premium adjustments are made.