HSBC 2012 Annual Report Download - page 57

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Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
of the allowance required based on a range of factors
such as the realisable value of security, the likely
dividend available on liquidation or bankruptcy, the
viability of the customer’s business model and the
capacity to trade successfully out of financial
difficulties and generate sufficient cash flow to
service debt obligations.
Under certain specified conditions, we provide
loan forbearance to borrowers experiencing financial
difficulties by agreeing to modify the contractual
payment terms of loans in order to improve the
management of customer relationships, maximise
collection opportunities and, if possible, avoid
default or repossession. Where forbearance activities
are significant, higher levels of judgement and
estimation uncertainty are involved in determining
their effects on loan impairment allowances.
Forbearance activities take place in both retail
and wholesale loan portfolios, but our largest
concentration is in the US, in HSBC Finance’s
CML portfolio.
The exercise of judgement requires the use of
assumptions which are highly subjective and very
sensitive to the risk factors, in particular to changes
in economic and credit conditions across a large
number of geographical areas. Many of the factors
have a high degree of interdependency and there
is no single factor to which our loan impairment
allowances as a whole are sensitive, though they are
particularly sensitive to general economic and credit
conditions in North America. For example, a 10%
increase in impairment allowances on collectively
assessed loans and advances in North America
would have increased loan impairment allowances
by US$0.5bn at 31 December 2012 (2011: US$0.7bn).
It is possible that the outcomes within the next
financial year could differ from the assumptions
used, and this could result in a material adjustment
to the carrying amount of loans and advances.
Goodwill impairment
Our accounting policy for goodwill is described in
Note 2p on the Financial Statements. Note 23 on the
Financial Statements lists our cash generating units
(‘CGU’s) by geographical region and global
business. HSBC’s total goodwill amounted to
US$21bn at 31 December 2012 (2011: US$21bn).
The review of goodwill for impairment reflects
management’s best estimate of the future cash flows
of the CGUs and the rates used to discount these
cash flows, both of which are subject to uncertain
factors as follows:
• the future cash flows of the CGUs are sensitive
to the cash flows projected for the periods for
which detailed forecasts are available and to
assumptions regarding the long-term pattern
of sustainable cash flows thereafter. Forecasts
are compared with actual performance and
verifiable economic data, but they necessarily
reflect management’s view of future business
prospects at the time of the assessment; and
• the rates used to discount future expected cash
flows are based on the costs of capital assigned
to individual CGUs and the rates can have a
significant effect on their valuation. The cost
of capital percentage is generally derived from a
Capital Asset Pricing Model, which incorporates
inputs reflecting a number of financial and
economic variables, including the risk-free
interest rate in the country concerned and a
premium for the risk of the business being
evaluated. These variables are subject to
fluctuations in external market rates and
economic conditions beyond our control and
are consequently subject to uncertainty and
require the exercise of significant judgement.
A decline in a CGU’s expected cash flows
and/or an increase in its cost of capital reduces the
CGU’s estimated recoverable amount. If this is
lower than the carrying value of the CGU, a charge
for impairment of goodwill is recognised in our
income statement for the year.
The accuracy of forecast cash flows is subject
to a high degree of uncertainty in volatile market
conditions. In such market conditions, management
retests goodwill for impairment more frequently than
annually to ensure that the assumptions on which the
cash flow forecasts are based continue to reflect
current market conditions and management’s best
estimate of future business prospects.
During 2012, no impairment of goodwill was
identified (2011: nil). In addition to the annual
impairment test which was performed as at 1 July
2012, management reviewed the current and expected
performance of the CGUs as at 31 December 2012
and determined that there was no indication of
potential impairment of the goodwill allocated to
them, except for the GB&M – Europe CGU, which
experienced significantly reduced profitability in
the second half of 2012 compared with the first half
of 2012. The reduced forecast profitability resulted
in a reduction in the recoverable amount of the CGU
over its carrying amount (‘headroom’).
Consequently, the results of the goodwill impairment
testing for this CGU are more sensitive to key
assumptions used. Management retested the goodwill