HSBC 2012 Annual Report Download - page 56

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Financial summary > Critical accounting policies
54
Critical accounting policies
(Audited)
Introduction
The results of HSBC are sensitive to the accounting
policies, assumptions and estimates that underlie the
preparation of our consolidated financial statements.
The significant accounting policies are described in
Note 2 on the Financial Statements.
The accounting policies that are deemed critical
to our results and financial position, in terms of the
materiality of the items to which the policies are
applied and the high degree of judgement involved,
including the use of assumptions and estimation, are
discussed below.
Impairment of loans and advances
Our accounting policy for losses arising from the
impairment of customer loans and advances is
described in Note 2g on the Financial Statements.
Loan impairment allowances represent
management’s best estimate of losses incurred
in the loan portfolios at the balance sheet date.
Management is required to exercise judgement
in making assumptions and estimates when
calculating loan impairment allowances on both
individually and collectively assessed loans and
advances.
The majority of the collectively assessed loan
impairment allowances are in North America, where
they were US$5.2bn, representing 54% (2011:
US$6.8bn; 62%) of the Group’s total collectively
assessed loan impairment allowances and 32% of the
Group’s total impairment allowances. Of the North
American collective impairment allowances
approximately 86% (2011: 75%) related to the
US CML portfolio.
The methods used to calculate collective
impairment allowances on homogeneous groups
of loans and advances that are not considered
individually significant are disclosed in Note 2g
on the Financial Statements. They are subject to
estimation uncertainty, in part because it is not
practicable to identify losses on an individual loan
basis because of the large number of individually
insignificant loans in the portfolio.
The estimation methods include the use of
statistical analyses of historical information,
supplemented with significant management
judgement, to assess whether current economic and
credit conditions are such that the actual level of
inherent losses is likely to be greater or less than
that suggested by historical experience. Where
changes in economic, regulatory or behavioural
conditions result in the most recent trends in
portfolio risk factors being not fully reflected in the
statistical models, risk factors are taken into account
by adjusting the impairment allowances derived
solely from historical loss experience.
Risk factors include loan portfolio growth,
product mix, unemployment rates, bankruptcy trends,
geographical concentrations, loan product features,
economic conditions such as national and local
trends in housing markets, the level of interest rates,
portfolio seasoning, account management policies
and practices, changes in laws and regulations, and
other influences on customer payment patterns.
Different factors are applied in different regions
and countries to reflect local economic conditions,
laws and regulations. The methodology and the
assumptions used in calculating impairment losses
are reviewed regularly in the light of differences
between loss estimates and actual loss experience.
For example, roll rates, loss rates and the expected
timing of future recoveries are regularly
benchmarked against actual outcomes to ensure
they remain appropriate.
In 2012, a portfolio risk factor adjustment of
US$225m was made to increase the collective
loan impairment allowances for our US mortgage
lending portfolios. The adjustment was made
following a review completed in the fourth quarter of
2012 which concluded that the estimated average
period of time from current status to write-off was
ten months for real estate loans (previously a period
of seven months was used). During 2013, this
revised estimate will be incorporated into the
statistical impairment allowance models.
Where loans are individually assessed for
impairment, management judgement is required in
determining whether there is objective evidence that
a loss event has occurred, and if so, the measurement
of the impairment allowance. In determining
whether there is objective evidence that a loss event
has occurred, judgement is exercised in evaluating
all relevant information on indicators of impairment,
which is not restricted to the consideration of
whether payments are contractually past-due but
includes broader consideration of factors indicating
deterioration in the financial condition and outlook
of borrowers affecting their ability to pay. A higher
level of judgement is required for loans to borrowers
showing signs of financial difficulty in market
sectors experiencing economic stress, particularly
where the likelihood of repayment is affected by the
prospects for refinancing or the sale of a specified
asset. For those loans where objective evidence of
impairment exists, management determine the size