Interim Report 16 of 25

RNS Number : 6296J

HSBC Holdings PLC

10 August 2012

 



Overall exposure of HSBC

	At 30 June 2012				At 30 June 2011				At 31 December 2011
	Carrying     amount28		Including sub-prime   and Alt-A		Carrying      amount28		Including    sub-prime    and Alt-A		Carrying      amount28		Including    sub-prime    and Alt-A
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
Asset-backed securities ('ABS's) ...............	60.5		6.6		72.9		8.1		65.6		6.9
- fair value through profit or loss ............	3.2		0.2		10.1		0.3		3.0		0.2
- available for sale29 ................................	50.3		5.5		54.7		6.8		54.6		5.7
- held to maturity29 .................................	1.8		0.2		2.1		0.2		2.0		0.2
- loans and receivables .............................	5.2		0.7		6.0		0.8		6.0		0.8
Direct lending at fair value through profit or loss ...................................................	1.1		0.8		1.1		0.9		1.2		0.8
Total ABSs and direct lending at fair value through profit or loss ............................	61.6		7.4		74.0		9.0		66.8		7.7
Less securities subject to risk mitigation from credit derivatives with monolines and other financial institutions .............	(2.4)		(0.3)		(8.4)		(0.3)		(1.9)		(0.2)
	59.2		7.1		65.6		8.7		64.9		7.5
Leveraged finance loans ...........................	3.0		-		3.7		-		3.6		-
- fair value through profit or loss ............	0.1		-		0.1		-		0.2		-
- loans and receivables .............................	2.9		-		3.6		-		3.4		-
	62.2		7.1		69.3		8.7		68.5		7.5
Exposure including securities mitigated by credit derivatives with monolines and other financial institutions ....................	64.6		7.4		77.7		9.0		70.4		7.7

For footnotes, see page 180.

ABSs classified as available for sale

Our principal holdings of available-for-sale ABSs (see table below) are in GB&M through special purpose entities ('SPE's) which were established from the outset with the benefit of external investor
first loss protection support, together with positions held directly and by Solitaire, where we provide first loss risk protection of US$1.2bn through credit enhancement and a liquidity facility.

Movement in the available-for-sale ('AFS') reserve

	Half-year to 30 June 2012						Half-year to 30 June 2011						Half-year to 31 December 2011
	Directly       held/ Solitaire30		SPEs		Total		Directly        held/   Solitaire30		SPEs		Total		Directly        held/   Solitaire30		SPEs		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
AFS reserve at beginning of period .......................	(3,085)		(2,061)		(5,146)		(4,102)		(2,306)		(6,408)		(3,099)		(1,744)		(4,843)
Increase/(decrease) in fair value of securities ..........	475		267		742		618		355		973		4		(492)		(488)
Impairment charge:
-  borne by HSBC ..........	79		108		187		238		-		238		145		26		171
-  allocated to capital note holders31 ............	-		11		11		-		137		137		-		176		176
Repayment of capital ........	18		99		117		142		94		236		20		89		109
Other movements .............	148		22		170		5		(24)		(19)		(155)		(116)		(271)
AFS reserve at end of period	(2,365)		(1,554)		(3,919)		(3,099)		(1,744)		(4,843)		(3,085)		(2,061)		(5,146)

For footnotes, see page 180.

Securities investment conduits

The total carrying amount of ABSs held through SPEs in the above table represents holdings in which significant first loss protection is provided through capital notes issued by SICs, excluding Solitaire.

At each reporting date, we assess whether there is any objective evidence of impairment in the value of the ABSs held by SPEs. Impairment charges incurred on these assets are offset by a credit to the impairment line for the amount of the loss allocated to capital note holders, subject to the carrying amount of the capital notes being sufficient to offset the loss. During the first half of 2012 impairment charges in one SPE, Mazarin Funding Limited ('Mazarin'), exceeded the carrying value of the capital notes liability and a charge of US$108m (30 June 2011: nil; 31 December 2011: US$26m) was borne by HSBC as shown in the table below. In respect of the SICs, the capital notes held by third parties are expected to absorb the cash losses in the vehicles.

Available-for-sale reserve and economic first loss protection in SICs, excluding Solitaire

	SICs excluding Solitaire at
	30 Jun		30 Jun		31 Dec
	2012		2011		2011
	US$m		US$m		US$m
Available-for-sale reserve .....................................................................................	(1,873)		(1,973)		(2,701)
- related to ABSs ..............................................................................................	(1,554)		(1,744)		(2,061)
Economic first loss protection .............................................................................	2,286		2,286		2,286
Carrying amount of capital notes liability ............................................................	167		354		154
Impairment charge for the period:
- borne by HSBC ..............................................................................................	108		-		26
- allocated to capital note holders31 .................................................................	11		137		176

For footnote, see page 180.

Impairment methodologies

The accounting policy for impairment and indicators of impairment is set out on page 301 of the Annual Report and Accounts 2011.

A summary of our impairment methodologies is provided in the Appendix to Risk on page 183.

Impairment and cash loss projections

At each reporting date, management undertakes a stress analysis. This exercise comprises a shift of projections of future loss severities, default rates and prepayment rates. The results of the analysis at 30 June 2011 indicated that further impairment charges of US$900m and expected cash losses of US$400m could arise over the next two to three years.    This exercise was re-performed at 30 June 2012 and the results remained consistent with this guidance.

For the purpose of identifying impairment at the reporting date, the projected future cash flows reflect the effect of loss events that have occurred at or prior to the reporting date. For the purpose of performing
stress tests to estimate potential future impairment charges, the projected future cash flows reflect additional assumptions about future loss events after the balance sheet date.

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 occur 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.

At 30 June 2012, the incurred and projected impairment charges, measured in accordance with accounting requirements, significantly exceeded the expected cash losses on the securities. Over the lives of the available-for-sale ABSs the cumulative impairment charges will converge towards the level of cash losses. In respect of the SICs, in particular, the capital notes held by third parties are expected to absorb the cash losses arising in the vehicles.

Carrying amount of HSBC's consolidated holdings of ABSs, and direct lending held at fair value through profit or loss

	Trading		Available     for sale		Held to   maturity		Designated at fair value      through      profit or loss		Loans and receivables		Total		Of which held through consolidated            SPEs		Gross    principal   exposure32		Credit        default            swap protection33		Net    principal    exposure34
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2012
Mortgage-related assets:
Sub-prime residential .............................	835		2,086		-		-		506		3,427		2,308		5,835		266		5,569
Direct lending ...................................	668		-		-		-		-		668		441		1,555		-		1,555
MBSs and MBS CDOs ........................	167		2,086		-		-		506		2,759		1,867		4,280		266		4,014
US Alt-A residential ..............................	169		3,414		146		-		200		3,929		2,772		7,825		100		7,725
Direct lending ...................................	91		-		-		-		-		91		-		97		-		97
MBSs ................................................	78		3,414		146		-		200		3,838		2,772		7,728		100		7,628
US Government agency and sponsored enterprises:
MBSs ................................................	214		23,103		1,656		-		-		24,973		-		23,401		-		23,401
Other residential ...................................	568		3,052		-		-		952		4,572		1,855		5,221		97		5,124
Direct lending ...................................	321		-		-		-		-		321		-		316		-		316
MBSs ................................................	247		3,052		-		-		952		4,251		1,855		4,905		97		4,808
Commercial property
MBSs and MBS CDOs ........................	295		7,107		-		107		1,450		8,959		5,898		10,440		-		10,440
	2,081		38,762		1,802		107		3,108		45,860		12,833		52,722		463		52,259
Leveraged finance-related assets:
ABSs and ABS CDOs .............................	389		5,322		-		-		317		6,028		4,306		6,837		758		6,079
Student loan-related assets:
ABSs and ABS CDOs .............................	172		4,651		-		-		151		4,974		4,036		6,505		99		6,406
Other assets:
ABSs and ABS CDOs .............................	1,455		1,598		-		65		1,586		4,704		1,716		6,593		1,326		5,267
	4,097		50,333		1,802		172		5,162		61,566		22,891		72,657		2,646		70,011

	Trading		Available       for sale		Held to     maturity		Designated at fair value        through profit or loss		Loans and   receivables		Total		Of which held through consolidated             SPEs		Gross      principal     exposure32		Credit          default             swap   protection33		Net      principal      exposure34
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2011
Mortgage-related assets:
Sub-prime residential .............................	1,022		2,556		-		-		598		4,176		2,696		6,783		305		6,478
Direct lending ...................................	830		-		-		-		-		830		560		1,854		-		1,854
MBSs and MBS CDOs ........................	192		2,556		-		-		598		3,346		2,136		4,929		305		4,624
US Alt-A residential ..............................	163		4,231		177		-		255		4,826		3,417		9,232		100		9,132
Direct lending ...................................	80		-		-		-		-		80		-		90		-		90
MBSs ................................................	83		4,231		177		-		255		4,746		3,417		9,142		100		9,042
US Government agency and sponsored enterprises:
MBSs ................................................	217		22,570		1,933		-		-		24,720		17		23,815		-		23,815
Other residential ...................................	800		3,801		-		-		990		5,591		2,332		6,322		-		6,322
Direct lending ...................................	188		-		-		-		-		188		-		187		-		187
MBSs ................................................	612		3,801		-		-		990		5,403		2,332		6,135		-		6,135
Commercial property
MBSs and MBS CDOs ........................	552		8,119		-		111		1,935		10,717		6,439		12,217		395		11,822
	2,754		41,277		2,110		111		3,778		50,030		14,901		58,369		800		57,569
Leveraged finance-related assets:
ABSs and ABS CDOs .............................	379		5,695		-		-		399		6,473		4,450		7,289		806		6,483
Student loan-related assets:
ABSs and ABS CDOs .............................	137		5,110		-		-		151		5,398		4,411		6,819		100		6,719
Other assets:
ABSs and ABS CDOs .............................	1,791		2,595		-		6,053		1,637		12,076		1,783		14,799		7,924		6,875
	5,061		54,677		2,110		6,164		5,965		73,977		25,545		87,276		9,630		77,646

Carrying amount of HSBC's consolidated holdings of ABSs, and direct lending held at fair value through profit or loss (continued)

	Trading		Available       for sale		Held to     maturity		Designated at fair value        through profit or loss		Loans and   receivables		Total		Of which held through consolidated             SPEs		Gross      principal     exposure32		Credit          default             swap   protection33		Net      principal      exposure34
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2011
Mortgage-related assets:
Sub-prime residential .............................	896		2,134		-		-		598		3,628		2,367		6,222		275		5,947
Direct lending ...................................	733		-		-		-		-		733		487		1,684		-		1,684
MBSs and MBS CDOs ........................	163		2,134		-		-		598		2,895		1,880		4,538		275		4,263
US Alt-A residential ..............................	190		3,516		166		-		243		4,115		2,827		8,610		100		8,510
Direct lending ...................................	114		-		-		-		-		114		-		119		-		119
MBSs ................................................	76		3,516		166		-		243		4,001		2,827		8,491		100		8,391
US Government agency and sponsored enterprises:
MBSs ................................................	38		26,152		1,813		-		-		28,003		-		26,498		-		26,498
Other residential ...................................	670		3,286		-		-		978		4,934		2,098		5,702		-		5,702
Direct lending ...................................	314		-		-		-		-		314		-		309		-		309
MBSs ................................................	356		3,286		-		-		978		4,620		2,098		5,393		-		5,393
Commercial property
MBSs and MBS CDOs ........................	300		7,240		-		107		1,816		9,463		5,795		11,222		-		11,222
	2,094		42,328		1,979		107		3,635		50,143		13,087		58,254		375		57,879
Leveraged finance-related assets:
ABSs and ABS CDOs .............................	362		5,566		-		-		347		6,275		4,324		7,112		782		6,330
Student loan-related assets:
ABSs and ABS CDOs .............................	179		4,665		-		-		153		4,997		4,114		6,681		199		6,482
Other assets:
ABSs and ABS CDOs .............................	1,477		2,044		-		94		1,818		5,433		1,473		7,539		1,391		6,148
	4,112		54,603		1,979		201		5,953		66,848		22,998		79,586		2,747		76,839

For footnotes, see page 180.

The above table excludes leveraged finance transactions, which are shown separately on page 161.

Exposures and significant movements

Sub-prime residential mortgage-related assets

Sub-prime residential mortage-related assets included US$2.2bn (30 June 2011: US$2.8bn; 31 December 2011: US$2.4bn) relating to US-originated assets and US$0.8bn (30 June 2011: US$1.1bn; 31 December 2011: US$1.0bn) relating to UK non-conforming residential mortgage-related assets.

At 30 June 2012, 24% (US$0.8bn) of our sub-prime residential mortgage-related assets were rated AA or AAA (30 June 2011: 31%, US$1.3bn; 31 December 2011: 25%, US$0.9bn). Of the non-high grade assets held of US$2.6bn (30 June 2011: US$2.9bn; 31 December 2011: US$2.7bn), US$1.1bn (30 June 2011: US$1.5bn; 31 December 2011: US$1.2bn) related to US-originated assets.

There was an increase in market prices for subprime assets during the first half of 2012; this effect was coupled with principal paydowns. A further net writeback of US$29m on assets was recognised in the first half of 2012 (30 June 2011: writeback of US$2m; 31 December 2011: impairment of US$44m). Of the above, there were US$30m of writebacks (30 June 2011: writeback of US$41m; 31 December 2011: impairment of US$36m) in the SICs of which US$14m of writebacks (30 June 2011: writeback of US$41m; 31 December 2011: impairment of US$36m) was attributed to the capital note holders.

US Alt-A residential mortgage-related assets

During the first half of 2012, principal paydowns along with general spread tightening, contributed to an increase in the carrying values for Alt-A assets. Further impairments of US$144m (30 June 2011: US$364m; 31 December 2011: US$323m) were recorded as losses were incurred under the accounting rules. Of this impairment, US$149m (30 June 2011: US$168m; 31 December 2011: US$176m) occurred in the SICs, of which US$25m (30 June 2011: US$168m; 31 December 2011: US$150m) was borne by the capital note holders. At 30 June 2012, 8% (US$0.3bn) of these assets were rated AA or AAA (30 June 2011: 9%, US$0.5bn; 31 December 2011: 9%, US$0.4bn).

Commercial property mortgage-related assets

Of our total of US$9.0bn (30 June 2011: US$10.7bn; 31 December 2011: US$9.5bn) of commercial property mortgage-related assets, US$4.4bn related to US originated assets (30 June 2011: US$4.9bn; 31 December 2011: US$4.9bn). Spreads continued to tighten on both US and non-US commercial property mortgage-related assets during the first half of 2012. Impairments of US$127m were recognised (30 June 2011: nil; 31 December 2011: US$36m).

Transactions with monoline insurers

HSBC's exposure to derivative transactions entered into directly with monolines

Our principal exposure to monolines is through a number of OTC derivative transactions, mainly CDSs. We entered into these CDSs primarily to purchase credit protection against securities held at the time within the trading portfolio.

During the first half of 2012, the notional value of contracts with monolines reduced, primarily due to the maturity of a structured transaction. The table overleaf sets out the fair value, essentially the replacement cost of the derivative transactions at 30 June 2012, and hence the amount at risk if the CDS protection purchased were to be wholly ineffective because, for example, the monoline insurer was unable to meet its obligations. The value of protection purchased is shown subdivided between those monolines that were rated by Standard and Poor's ('S&P') at 'BBB- or above' at 30 June 2012, and those that were 'below BBB-' ('BBB-' is the S&P cut-off for an investment grade classification). The 'Credit valuation adjustment' column indicates the valuation adjustment taken against the net exposures, and reflects our best estimate of the likely loss of value on purchased protection arising from the deterioration in creditworthiness of the monolines. These valuation adjustments, which reflect a measure of the irrecoverability of the protection purchased, have been charged to the income statement. During the first half of 2012, the credit valuation adjustment on derivative contracts with monolines rose despite the overall decrease in exposure due to an increase in the estimates of loss against investment grade monolines.

Market prices are generally not readily available for CDSs, so they are valued on the basis of market prices of the referenced securities. Our monoline credit valuation adjustment calculation utilises a number of approaches which depend upon the internal credit rating of the monoline. Our assignment of internal credit ratings is based upon detailed credit analysis, and may differ from external ratings. The net effect of utilising the methodology adopted for 'highly-rated' monolines across all monolines would be a reduction in credit valuation adjustment of US$71m (30 June 2011: US$117m;

HSBC's exposure to derivative transactions entered into directly with monoline insurers

	Notional            amount		Net exposure   before credit        valuation     adjustment35		Credit         valuation     adjustment36		Net exposure      after credit         valuation      adjustment
	US$m		US$m		US$m		US$m
At 30 June 2012
Derivative transactions with monoline counterparties
Monolines - investment grade (BBB- or above) .....	4,213		789		(118)		671
Monolines - sub-investment grade (below BBB-) ....	1,502		343		(216)		127
	5,715		1,132		(334)		798
At 30 June 2011
Derivative transactions with monoline counterparties
Monolines - investment grade (BBB- or above) .....	5,269		846		(85)		761
Monolines - sub-investment grade (below BBB-) ....	2,224		539		(372)		167
	7,493		1,385		(457)		928
At 31 December 2011
Derivative transactions with monoline counterparties
Monolines - investment grade (BBB- or above) .....	4,936		873		(87)		786
Monolines - sub-investment grade (below BBB-) ....	1,552		370		(217)		153
	6,488		1,243		(304)		939

For footnotes, see page 180.

31 December 2011: US$76m). The net effect of utilising a methodology based on CDS spreads would be an increase in credit valuation adjustment of US$52m (30 June 2011: US$49m; 31 December 2011: US$178m).

Credit valuation adjustments for monolines

·   For highly-rated monolines, the standard credit valuation adjustment methodology (as described on page 232) applies, with the exception that the future exposure profile is deemed to be constant (equal to the current market value) over the weighted average life of the referenced security, and the credit valuation adjustment cannot fall below 15% of the mark-to-market exposure. 

·   In respect of monolines where default has either occurred or there is a strong possibility of default in the near term, the adjustment is determined based on the estimated probabilities of various potential scenarios, and the estimated recovery in each case.

·  For other monoline exposures, the credit valuation adjustment follows the methodology for highly-rated monolines, adjusted to include the probability of a claim arising in respect of the referenced security, and applies implied probabilities of default where the likelihood of a claim is believed to be high.

HSBC's exposure to direct lending and irrevocable commitments to lend to monolines

We had no liquidity facilities to monolines at 30 June 2012 (30 June 2011: nil; 31 December 2011: nil).

HSBC's exposure to debt securities which benefit from guarantees provided by monolines

Within both the trading and available-for-sale portfolios, we hold bonds that are 'wrapped' with a credit enhancement from a monoline. As the bonds are traded explicitly with the benefit of this enhancement, any deterioration in the credit profile of the monoline is reflected in market prices and, therefore, in the carrying amount of these securities at 30 June 2012. For wrapped bonds held in our trading portfolio, the mark-to-market movement has been reflected through the income statement. For wrapped bonds held in the available-for-sale portfolio, the mark-to-market movement is reflected in equity unless there is objective evidence of impairment, in which case the impairment loss is reflected in the income statement. No wrapped bonds were included in the reclassification of financial assets described in Note 10 on the Financial Statements.

HSBC's exposure to credit derivative product companies

Credit derivative product companies ('CDPC's) are independent companies that specialise in selling credit default protection on corporate exposures. At 30 June 2012, we had purchased from CDPCs credit protection with a notional value of US$4.3bn (30 June 2011: US$4.8bn; 31 December 2011: US$4.4bn) which had a fair value of US$0.3bn (30 June 2011: US$0.2bn; 31 December 2011: US$0.4bn), against which a credit valuation adjustment (a provision) of US$51m (30 June 2011: US$49m; 31 December 2011: US$93m) was held. At 30 June 2012, none of our exposure was to CDPCs with investment grade ratings (30 June 2011: nil; 31 December 2011: nil).

Leveraged finance transactions

Leveraged finance transactions include sub-investment grade acquisition or event-driven financing. The following table shows our exposure to leveraged finance transactions arising from primary transactions. Our additional exposure to leveraged finance loans through holdings of ABSs from our trading and investment activities is shown in the table on page 156.

We held leveraged finance commitments of US$3.0bn at 30 June 2012 (30 June 2011: US$3.8bn; 31 December 2011: US$3.7bn), of which US$2.7bn (30 June 2011: US$3.3bn; 31 December 2011: US$3.3bn) was funded. At 30 June 2012, our principal exposures were to companies in two sectors: US$0.8bn to data processing (30 June 2011: US$1.5bn; 31 December 2011: US$1.3bn) and US$1.9bn to communications and infrastructure (30 June 2011: US$1.8bn; 31 December 2011: US$1.9bn).

HSBC's exposure to leveraged finance transactions

	Exposures at 30 June 2012						Exposures at 30 June 2011						Exposures at 31 December 2011
	Funded37		Un- funded38		Total		Funded37		Un-   funded38		Total		Funded37		Un-   funded38		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
Europe .....................................	2,194		221		2,415		2,761		289		3,050		2,795		253		3,048
North America .........................	443		126		569		489		127		616		445		126		571
	2,637		347		2,984		3,250		416		3,666		3,240		379		3,619
Held within:
- loans and receivables .........	2,593		323		2,916		3,249		356		3,605		3,120		328		3,448
- fair value through profit or loss ...................................	44		24		68		1		60		61		120		51		171

For footnotes, see page 180.

Representations and warranties related to mortgage sales and securitisation activities

We have been involved in various activities related to the sale and securitisation of residential mortgages, which are not recognised on our balance sheet. These activities include:

·     the purchase of US$24bn of third-party originated mortgages by HSBC Bank USA and the securitisation of these by HSBC Securities (USA) Inc. ('HSI') between 2005 and 2007;

·     HSI acting as underwriter for third-party issuance of private label MBSs with an original issuance value of US$37bn, most of which were sub-prime; and

·     the origination and sale by HSBC Bank USA of mortgage loans, primarily to government sponsored entities.

In sales and securitisations of mortgage loans, various representations and warranties regarding the loans may be made to purchasers of the mortgage loans and MBSs. In respect of the purchase and securitisation of third-party originated mortgages and the underwriting of third-party MBSs, the obligation to repurchase loans in the event of a breach of loan level representations and warranties resides predominantly with the organisation that originated the loan.

Participants in the US mortgage securitisation market that purchased and repackaged whole loans have been the subject of lawsuits and governmental and regulatory investigations and inquiries which have been directed at groups within the US mortgage market such as servicers, originators, underwriters, trustees or sponsors of securitisations. Further details are provided in Note 25 on the Financial Statements.

At 30 June 2012, a liability of US$222m (30 June 2011: US$237m; 31 December 2011: US$237m) was recognised in respect of various representations and warranties relating to the origination and sale by HSBC Bank USA of mortgage loans, primarily to government sponsored entities. These relate to, among other things, the ownership of the loans, the validity of the liens, the loan selection and origination process, and compliance with the origination criteria established by the agencies. In the event of a breach of our representations and warranties, HSBC Bank USA may be obliged to repurchase the loans with identified defects or to indemnify the buyers. The liability is estimated based on the level of outstanding repurchase demands, the level of outstanding requests for loan files and estimated future demands in respect of mortgages sold to date which are either two or more payments delinquent or are expected to become delinquent at an estimated conversion rate. Repurchase demands of US$167m were outstanding at 30 June 2012 (30 June 2011: US$103m; 31 December 2011: US$113m).

 

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