HSBC 2009 Annual Report Download - page 158

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Overview of exposure > AFS ABSs impairment // Business model / Risk management / Accounting policies / Nature and extent of exposures
156
Services downgraded the ratings on substantially all
US Alt-A residential MBSs issued during 2006 and
2007, including those held by HSBC.
As discussed on page 178, when assessing
available-for-sale ABSs for objective evidence of
impairment at each balance sheet date, HSBC
considers all available evidence including the
performance of the underlying collateral. A
downgrade of a security’s credit rating is not, of
itself, evidence of impairment. Consequently,
Moody’s actions alone have no direct impact on the
measurement of impairment losses. The impairment
losses recognised on these securities at 31 December
2009 are set out on page 155.
Available-for-sale ABS impairment and cash
loss projections
(Unaudited)
HSBC’s regular impairment assessment employs
an industry standard model with inputs which are
corroborated using observable market data where
available. At 31 December 2008, management
performed a stress test on the available-for-sale ABS
positions, based on the fair value of the positions at
that date. The main impacts of the stress test arose
from increasing the net effect of expected loss and
prepayment rates for Alt-A securities by between a
third and a half depending on loan vintage and by
removing all credit protection from monolines rated
below AAA by S&P on the HELoC positions. The
results of the stress test showed that, by applying
different inputs to those then observed across the
available-for-sale ABS population, a further
potential impairment charge to the income statement
of some US$2 billion to US$2.5 billion could arise
in the period 2009 to 2011 with expected cash losses
of US$600 million to US$800 million in the period
2009 to 2012.
In 2009, the Global Banking and Markets’
available-for-sale ABS portfolio experienced
US$1.4 billion of impairment charges with
US$378 million of associated expected cash losses.
At 31 December 2009, management undertook an
analysis of the portfolio to estimate the further
potential impairments and expected cash losses on
the available-for-sale ABS portfolio. This exercise
comprised a further shift of projections as at
31 December 2009 of future loss severities, default
rates and prepayment rates. The analysis showed
that the portfolio is now primarily sensitive to
impairments arising on Alt-A securities. The
sensitivity of Global Banking and Markets’
available-for-sale ABS positions to the loss of
protection from monolines reduced during 2009 and
is no longer expected to be a material contributor to
future impairment charges. The results of the
analysis indicate that further impairment charges
of some US$1.1 billion and expected cash losses of
some US$450 million could arise over the next two
to three years. These are at the upper end of the
guidance previously given.
This analysis makes assumptions in respect of
the future behaviour of loss severities, default rates
and prepayment rates. Movements in the parameters
are not independent of each other. For example,
increased default rates and increased loss severities,
which would imply greater impairments, generally
arise under economic conditions that give rise to
reduced levels of prepayment, reducing the potential
for impairment charges. Conversely, economic
conditions which increase the rates of prepayment
are generally associated with reduced default rates
and decreased loss severities. The assumptions used
by management in the roll-forward analysis have
been set in the context of further increases in loss
severities and elevated levels of default rates partly
offset by stable prepayment rates in the short to
medium term.
At 31 December 2009, the incurred and
projected impairment charges measured for
accounting purposes significantly exceeded the
expected cash losses on the securities. Over the
lives of the available-for-sale ABS securities the
cumulative impairment charges will converge
towards the level of cash losses.
Business model
(Audited)
Asset-backed securities and leveraged
finance
HSBC is or has been involved in the following
activities in these areas:
• purchasing US mortgage loans with the
intention of structuring and placing
securitisations into the market;
• trading in ABSs, including MBSs, in secondary
markets;
• holding MBSs and other ABSs in balance sheet
management activities, with the intention of
earning net interest income over the life of the
securities;
• holding MBSs and other ABSs as part of
investment portfolios, including the structured
investment vehicles (‘SIV’s), SICs and money
market funds described under ‘Special purpose
entities’ below, with the intention of earning net
interest income and management fees;