HSBC 2015 Annual Report Download - page 205

HSBC HOLDINGS PLC
203
Strategic Report Financial Review Corporate Governance Financial Statements Shareholder Information
Additionally, risk may be managed by employing other types of collateral and credit risk enhancements such as second
charges, other liens and unsupported guarantees, but the valuation of such mitigants is less certain and their financial effect
has not been quantified.
Refinance risk
Many types of lending require the repayment of a significant proportion of the principal at maturity. Typically, the mechanism
of repayment for the customer is through the acquisition of a new loan to settle the existing debt. Refinance risk arises where
a customer is unable to repay such term debt on maturity, or to refinance debt at commercial rates. When there is evidence
that this risk may apply to a specific contract, HSBC may need to refinance the loan on concessionary terms that we would not
otherwise have considered, in order to recoup the maximum possible cash flows from the contract and potentially avoid the
customer defaulting on the repayment of principal. When there is sufficient evidence that borrowers, based on their current
financial capabilities, may fail at maturity to repay or refinance their loans, these loans are disclosed as impaired with
recognition of a corresponding impairment allowance where appropriate.
Nature of HSBC’s securitisation and other structured exposures
Mortgage-backed securities (‘MBS’s) are securities that represent interests in groups of mortgages and provide investors with
the right to receive cash from future mortgage payments (interest and/or principal). An MBS which references mortgages with
different risk profiles is classified according to the highest risk class.
Collateralised debt obligations (‘CDO’s) are securities backed by a pool of bonds, loans or other assets such as asset-backed
securities (‘ABS’s). CDOs may include exposure to sub-prime or Alt-A mortgage assets where these are part of the underlying
assets or reference assets. As there is often uncertainty surrounding the precise nature of the underlying collateral supporting
CDOs, all CDOs supported by residential mortgage-related assets are classified as sub-prime. Our holdings of ABSs and CDOs
and direct lending positions, and the categories of mortgage collateral and lending activity, are described below.
Our exposure to non-residential mortgage-related ABSs 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.
Definitions and classifications of ABSs and CDOs
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)
(categorised within
‘Sub-prime’)
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 Fannie Mae and
Freddie Mac.
Holdings of US Government agency and US
Government sponsored enterprises’ mortgage-
related assets are classified as prime exposures.