HSBC 2008 Annual Report Download - page 173

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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.
Since August 2007, the unstable market
conditions in the US mortgage lending industry have
resulted in 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 an absence of liquidity
for non-prime ABSs, continued to be reflected in a
lack of bid prices at 31 December 2008. It is not
possible to distinguish from the indicative market
prices that are available, 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 and
out of favour asset. Under impairment accounting for
loans and advances, there is no need nor requirement
to adjust carrying amounts to reflect illiquidity as
HSBC’s intention is to fund assets until the earlier of
prepayment, charge-off or repayment on maturity.
Market fair values, on the other hand, reflect 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 2008
and 31 December 2007 of loans and advances to
customers in North America reflect 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,
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.
• 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 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.
• 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