HSBC 2012 Annual Report Download - page 262

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Risk > Appendix – Risk policies and practices > Credit risk / Liquidity and funding
260
Our exposure to non-residential mortgage-related ABSs and direct lending includes securities with collateral relating
to:
• commercial property mortgages;
• leveraged finance loans;
• student loans; and
• other assets, such as securities with other receivable-related collateral.
Categories of
ABSs and CDOs Definition Classification
Sub-prime Loans to customers who have limited credit histories,
modest incomes or high debt-to-income ratios or have
experienced credit problems caused by occasional
delinquencies, prior charge-offs, bankruptcy or other
credit-related actions.
For US mortgages, a FICO score of 620 or less has
primarily been used to determine whether a loan is sub-
prime. For non-US mortgages, management judgement
is used.
US Home Equity Lines
of Credit (‘HELoC’s)
A form of revolving credit facility provided to
customers, which is supported in the majority of
circumstances by a second lien or lower ranking charge
over residential property.
Holdings of HELoCs are classified as sub-prime.
US Alt-A Lower risk loans than sub-prime, but they share higher
risk characteristics than lending under fully conforming
standard criteria.
US credit scores and the completeness of
documentation held (such as proof of income), are
considered when determining whether an Alt-A
classification is appropriate. Non sub-prime mortgages
in the US are classified as Alt-A if they are not eligible
for sale to the major US Government mortgage
agencies or sponsored entities.
US Government agency
and sponsored
enterprises mortgage-
related assets
Securities that are guaranteed by US Government
agencies such as the Government National Mortgage
Association (‘Ginnie Mae’), or by US Government
sponsored entities including the Federal National
Mortgage Association (‘Fannie Mae’) and the Federal
Home Loan Mortgage Corporation (‘Freddie Mac’).
Holdings of US Government agency and US
Government sponsored enterprises’ mortgage-related
assets are classified as prime exposures.
UK non-conforming
mortgages
UK mortgages that do not meet normal lending criteria.
Examples include mortgages where the expected level
of documentation is not provided (such as income with
self-certification), or where poor credit history
increases risk and results in pricing at a higher than
normal lending rate.
UK non-conforming mortgages are treated as sub-
prime exposures.
Other mortgages Residential mortgages, including prime mortgages, that
do not meet any of the classifications described above.
Prime residential mortgage-related assets are included
in this category.
Impairment methodologies
(Audited)
To identify objective evidence of impairment for available-for-sale ABSs, an industry standard valuation model is
normally applied which uses data with reference to the underlying asset pools and models their projected future cash
flows. The estimated future cash flows of the securities are assessed at the specific financial asset level to determine
whether any of them are unlikely to be recovered as a result of loss events occurring on or before the reporting date.
The principal assumptions and inputs to the models are typically the delinquency status of the underlying loans, the
probability of delinquent loans progressing to default, the prepayment profiles of the underlying assets and the loss
severity in the event of default. However, the models utilise other variables relevant to specific classes of collateral to
forecast future defaults and recovery rates. Management uses externally available data and applies judgement when
determining the appropriate assumptions in respect of these factors. We use a modelling approach which incorporates
historically observed progression rates to default to determine if the decline in aggregate projected cash flows from
the underlying collateral will lead to a shortfall in contractual cash flows. In such cases, the security is considered to
be impaired.
In respect of CDOs, expected future cash flows for the underlying collateral are assessed to determine whether there
is likely to be a shortfall in the contractual cash flows of the CDO.