Annual Financial Report - 22 of 44

RNS Number : 1467A

HSBC Holdings PLC

27 March 2012

 



officials. This process enabled us to form a view of the credit standing and the level of exposure that the counterparties have to peripheral eurozone sovereigns and banks. The majority of these counterparties are located in France, Germany and the Netherlands, where the exposures are disclosed in aggregate below. Vulnerable counterparties were identified, subject to enhanced monitoring and our exposure was managed in a way similar to the monitoring and management of direct exposures to the peripheral eurozone countries.

The overall quality of the portfolio was strong with most in‑country and cross-border limits extended to countries with high-grade internal credit risk ratings. We regularly update our assessment of higher risk countries and adjust our risk appetite accordingly.

Exposures to countries in the eurozone

(Unaudited)

2011 was a turbulent year for the global markets, dominated by the continuing eurozone debt crisis that started with the global financial crisis in 2007 and, by 2011, had developed into a severe sovereign debt crisis. The measures taken by governments during that period to avoid a financial collapse resulted in higher debt levels, large fiscal deficits and, in certain cases, social and political disruption. During 2011, a number of eurozone countries came under severe financial pressure and their ability to raise, refinance and service their debt was put into question by markets, as demonstrated by the record high spreads during most of the year. Greece, Ireland and Portugal were forced to seek support packages from the European Central Bank ('ECB') and the International Monetary Fund ('IMF') under strict conditions, while fear of contagion to other eurozone countries forced governments to reduce debt levels through austerity measures that, at least in the short term, were seen as the cause of slow growth for some countries and stagnation in others.

Despite a number of high profile summits and meetings the EU was unable to agree and implement a strong coherent policy response to the crisis, prompting fear of default or the exit from the euro of one or more members. Under pressure during most of 2011, EU members showed an increasing willingness to agree a structured common approach, but they also demonstrated divergent opinions on the way forward and on the measures to be taken. This resulted in the three major rating agencies either downgrading, or putting on the watch list for possible downgrade, a number of sovereigns which intensified the pressure, even on the stronger eurozone countries.

The ongoing sovereign debt crisis, slow economic growth, dearth of market financing for banks and private sector deleveraging severely affected the eurozone financial system, increasing the possibility of further banking stress in the region. The banking sector within the peripheral eurozone countries was particularly under threat as the credit risk of domestic and cross-border exposures increased significantly. This prompted calls from the European Banking Authority ('EBA') and the IMF for funding and liquidity support and/or the recapitalisation of certain European banks.

The ratings downgrade of a number of eurozone countries by major rating agencies in 2011 and January 2012 was generally anticipated and was, in most cases, not as large as feared, with the exception of Portugal which is now rated below investment grade. The downgrades are likely to have implications for the ratings of European banks and government guaranteed securities, as evidenced by the downgrade of the European Financial Stability Fund ('EFSF').

We continue to closely monitor events and have stress-tested our capital position for potential scenarios.

The tables below summarise our exposures to selected eurozone countries, including:

·     governments and central banks of selected eurozone countries along with near/quasi government agencies;

·     banks; and

·     other financial institutions and other corporates.

Exposures to banks, other financial institutions and other corporates are based on the country of domicile of the counterparty.

The following analysis of our exposures to selected European countries is made voluntarily to reflect developments in best practice disclosure. Whilst certain analysis is subject to audit and incorporated into the Group's risk management disclosure, it is not required for the purposes of compliance with IFRSs.

Basis of preparation

(Audited)

The countries presented were selected as they exhibited levels of market volatility during 2011 which exceeded other eurozone countries and demonstrated fiscal or political uncertainty. Certain of these countries also have high sovereign debt to GDP ratios and a short to medium-term maturity concentration of those liabilities.

The eurozone disclosure includes information about our exposures to France, Germany and the Netherlands as these countries are seen to have considerable exposure to the sovereign debt of the peripheral eurozone countries. In addition, these are countries where our total direct exposure is greater than 5% of the Group's equity at 31 December 2011. An analysis of loans and advances to customers by significant countries is provided on page 111.

The on-balance sheet exposures disclosed in the exposure tables below are presented based on the appropriate IFRSs classification. Trading assets are net of short positions as the fair value of the short positions reference the fair value of the trading assets. Derivative assets are shown gross and net of collateral and derivative liabilities that reduce the overall risk exposure.

Credit default swaps and off-balance sheet exposures

(Unaudited)

The Group purchased CDS protection on certain of its holdings of Greek government bonds. The net fair value of these CDS was US$0.5bn, and the net notional value was US$0.8bn as at 31 December 2011. The CDS were transacted with banks with investment grade credit ratings, and would pay out in the event of default and certain other credit events. There is no significant mismatch between the maturity of the Greek government bonds and the CDS protection. Other CDS contracts disclosed in the tables below were principally entered into for customer facilitation. These CDSs are mainly entered into with banks and financial institutions where their terms are typically drawn up in accordance with the guidance set out in the 2003 ISDA Credit Derivatives Definitions and the July 2009 Supplement. The credit events that trigger the payout of CDSs may differ as they are based on the terms of each agreement between the counterparties. Such credit events normally include bankruptcy, payment default on a reference asset or assets, restructuring and repudiation or moratoria.

Off-balance sheet exposures mainly relate to commitments to lend and the amount shown in the tables represents the maximum amount that could be drawn down by the counterparty. In some instances, limitations are imposed on a counterparty's ability to draw down on a facility. These limitations are governed by the legal documentation, which differs from counterparty to counterparty. In the majority of cases, we are bound to fulfil commitments made to third parties.

Summary on-balance sheet exposures to peripheral eurozone countries

(Unaudited)

	Greece		Ireland		Italy		Portugal		Spain		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2011
Sovereign and agencies ................................	0.4		0.3		2.3		0.5		1.2		4.7
Banks ..........................................................	0.7		1.9		2.0		0.5		3.1		8.2
Other financial institutions and corporate ...	3.9		3.2		2.6		0.1		6.0		15.8
Personal ......................................................	1.0		-		-		-		-		1.0
	6.0		5.4		6.9		1.1		10.3		29.7

Eurozone sovereigns and agencies

(Unaudited)

During 2011, Portugal joined Greece and Ireland in the list of the eurozone countries requiring rescue packages to remain solvent. Greece required a second support package, which was formalised as EU leaders announced a three-year programme totalling €109bn (US$155bn). In addition, the EFSF rules were changed to allow it to buy bonds on the secondary market, finance the recapitalisation of banks and provide pre-emptive credit lines to eurozone countries under pressure in debt markets. The announcement of the second package was followed by months of negotiations between the parties to determine its details. Final agreement was eventually reached in February 2012 ahead of the March 2012 deadline for the euro bond payment of €14.5bn (US$19bn) by the Greek government, calming fears of a disorderly default. The total support package has increased to €130bn (US$172bn) and includes debt swap arrangements, direct support by ECB and an additional haircut by private debt holders.

In 2012, we forecast that the eurozone will continue to experience slow growth or possibly recession, with unemployment reaching record high levels and households continuing to reduce debt. We expect that the ECB, along with countries in the eurozone, will continue to focus on resolving intra-eurozone imbalances, rebuilding public finances, improving fiscal discipline, strengthening the banking system and managing cross-border risk. Concerns of contagion of the debt crisis in Greece, Ireland and Portugal to other countries, notably Italy and Spain, are likely to persist, causing the risk premium on most European countries' sovereign debt to remain high. The German economy has demonstrated positive signs of stability and has experienced positive growth during the year and, although it has shown modest growth, the French economy is expected to stay resilient should the crisis spread to other eurozone countries.

At 31 December 2011, our exposure to the sovereign and agency debt of Greece, Ireland, Italy, Portugal and Spain was US$4.7bn, US$2.2bn lower than at the end of 2010. Of the total financial investments available for sale in these countries, approximately 46% mature within one year, 21% between one and three years and 33% in excess of three years.

At 31 December 2011, our exposure to the sovereign and agency debt of Germany, France and the Netherlands was US$87bn. Of the total financial investments available for sale in these countries, approximately 26% mature within one year, 28% between one and three years and 46% in excess of three years. Our exposure in the Netherlands predominantly comprises cash placements with the Dutch Central Bank, which in turn are put into the euro clearing system (Target 2) managed by the
ECB. Our exposure in Germany and France is commensurate to the size of our operations and is well diversified across sectors and products.

During 2011, an impairment charge of US$212m was recognised in respect of Greek sovereign and agency exposures classified as available for sale, reflecting the further deterioration in Greece's fiscal position and the expected effect of the range of recently announced support measures. The amount of the impairment charge represented the cumulative fair value loss on these securities as at the end of 2011, and does not necessarily represent the expectation of future cash losses. The impairment charge was transferred from the available-for-sale reserve to the income statement. Our sovereign exposures to Ireland, Italy, Portugal and Spain were not considered to be impaired at 31 December 2011 because, despite financial difficulties in these countries, the situation is not severe enough to conclude that loss events have occurred which will have an impact on the future cash flows of these countries' sovereign securities.

Exposures to peripheral eurozone countries - sovereigns and agencies

(Audited)

	Greece		Ireland		Italy		Portugal		Spain		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2011
Cash and balances at central banks	-		-		-		-		0.1		0.1
Financial investments held to maturity ...................................	-		-		0.1		-		-		0.1
- fair value ...............................	-		-		0.1		-		-		0.1
Financial investments available for sale11 ...................................	0.1		0.1		0.8		0.1		0.9		2.0
- cumulative impairment ..........	0.2		-		-		-		-		0.2
- amortised cost .......................	-		0.1		0.8		0.1		0.9		1.9
Net trading assets .........................	0.3		0.2		1.4		0.4		0.1		2.4
- gross trading assets .................	0.4		0.3		8.3		0.6		1.8		11.4
- short positions .......................	(0.1)		(0.1)		(6.9)		(0.2)		(1.7)		(9.0)
Derivatives12 ................................	-		-		-		-		0.1		0.1
- gross derivative assets ............	-		0.3		0.7		0.3		0.2		1.5
- collateral and derivative liabilities ...........................	-		(0.3)		(0.7)		(0.3)		(0.1)		(1.4)
Total ............................................	0.4		0.3		2.3		0.5		1.2		4.7
Of which, on-balance sheet exposures held to meet insurance liabilities ....................	-		0.1		0.3		0.1		0.4		0.9
- discretionary participatory ....	-		0.1		0.3		0.1		0.4		0.9
Off-balance sheet exposures .........	-		-		-		-		1.0		1.0
- commitments ........................	-		-		-		-		1.0		1.0
Total credit default swaps
- CDS asset positions ................	1.2		0.2		0.6		0.4		0.4		2.8
- CDS liability positions ...........	(0.7)		(0.2)		(0.6)		(0.3)		(0.4)		(2.2)
- CDS asset notionals ...............	1.8		0.9		3.9		1.2		3.3		11.1
- CDS liability notionals ...........	1.0		0.9		3.8		1.2		3.5		10.4

For footnotes, see page 185.

Summary balance sheet exposures to core eurozone countries - sovereigns and agencies

(Audited)

	France		Germany		The Netherlands		Total
	US$bn		US$bn		US$bn		US$bn
At 31 December 2011 ................................................................	27		20		40		87

Eurozone banks

(Unaudited)

As a direct result of the eurozone sovereign debt crisis, economic slowdown, uncertain property markets and low credit growth, banks in the eurozone area continue to face severe stress.

During the year, banks with direct exposure to eurozone sovereigns saw their costs and access to funding deteriorate. The concern about solvency of weaker banks intensified further following the rescue of Dexia Bank Belgium and the failure of MF Global Holdings in the US, which lost access to the funding markets due to its significant exposures to eurozone sovereign debt. Market volatility and funding issues were further exacerbated due to downgrades of European banks by the major credit rating agencies, citing concerns over their ability to absorb losses due to possible sovereign debt default, reliance on volatile wholesale funding markets and a perceived weakening in government support. A crisis of confidence emerged and banks became increasingly reluctant to lend to each other through the inter-bank market, prompting the ECB to take a number of extraordinary measures to ease funding pressures in the banking system. These included two unlimited liquidity operations with a three-year maturity, the widening of eligibility criteria for collateral, assistance in providing access to liquidity for more (medium-sized) banks and lowering reserve requirements from 2% to 1%. The slowdown in the inter-bank funding market and the ECB's liquidity measures resulted in the provision of a large part of eurozone market liquidity being transferred to central banks of highly rated countries, which was a further indicator of de-risking by banks in the eurozone. These measures helped to ease the liquidity crisis in the short term, though medium-term funding challenges remain.

The measures taken by policymakers and banks to strengthen the sector have had mixed results. Banks have deleveraged by selling certain types of assets and investing in safe haven assets in a flight to quality. The EBA conducted an industry-wide stress test exercise in July 2011 with further updates in October and December 2011. Those banks in which a capital shortfall was identified were required to submit plans to respective national regulators by 20 January 2012 and reach a minimum core tier 1 capital ratio of 9% by the end of June 2012. The total capital shortfall covering 71 large banks was calculated as €109bn (US$146bn) within the peripheral eurozone countries, with Greece, Italy, Portugal and Spain comprising 68% of the estimate.

HSBC successfully passed these stress tests with a core tier 1 ratio of 10.5% under the modelled adverse scenario, exceeding the post-stress minimum core tier 1 capital requirement of 5% used in the December 2011 update to the exercise.

We expect challenging market conditions for eurozone banks to persist for most of 2012. There are significant sovereign and bank refinancing requirements and private sector deleveraging will continue, the eurozone sovereign debt crisis will remain and growth will stay low with the risk of recession in some developed economies. In addition, the pace of a multitude of regulatory reforms and related initiatives that have been launched and/or outlined by various policymakers will gather speed in 2012, most notably in the areas of capital, liquidity and systemic risk (Basel III, CRD IV and capital surcharges), new banking structures in the UK and revised supervisory structures.

Our exposure within the eurozone is largely to the banks in stronger countries. We continue to closely monitor and manage eurozone bank exposures in the peripheral eurozone countries, and are cautious in lending to this sector. We regularly update our assessment of higher-risk eurozone banks and adjust our risk appetite accordingly. Where possible, we also seek to play a positive role in maintaining credit and liquidity supply. We have not recognised any impairment as a result of the eurozone crisis, in respect of the exposures outlined below.

Exposures to peripheral eurozone countries - banks

(Audited)

	Greece		Ireland		Italy		Portugal		Spain		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2011
Loans and advances ......................	0.1		0.1		0.5		0.3		0.2		1.2
Financial investments held to maturity ...............................	-		0.2		0.2		-		-		0.4
-  fair value ..............................	-		0.2		0.2		-		-		0.4
Financial investments available for sale11 ...................................	-		0.4		0.3		-		0.4		1.1
- amortised cost .......................	-		0.4		0.3		-		0.4		1.1
Net trading assets .........................	0.4		0.9		0.6		0.1		2.0		4.0
- gross trading assets .................	0.4		0.9		0.6		0.1		2.4		4.4
- short positions .......................	-		-		-		-		(0.4)		(0.4)
Derivatives12 ................................	0.2		0.3		0.4		0.1		0.5		1.5
- gross derivative assets ............	0.7		8.3		1.9		0.2		3.6		14.7
- collateral and derivative liabilities ...........................	(0.5)		(8.0)		(1.5)		(0.1)		(3.1)		(13.2)
Total ............................................	0.7		1.9		2.0		0.5		3.1		8.2
Of which, on-balance sheet exposures held to meet insurance liabilities ....................	-		0.2		0.4		-		0.4		1.0
- discretionary participatory ....	-		0.2		0.4		-		0.4		1.0
Off-balance sheet exposures .........	0.2		-		0.1		-		0.4		0.7
- guarantees and other ..............	0.2		-		0.1		-		0.4		0.7
Total credit default swaps
- CDS asset positions ................	-		-		0.5		0.1		0.1		0.7
- CDS liability positions ...........	-		-		(0.5)		(0.1)		(0.1)		(0.7)
- CDS asset notionals ...............	-		-		3.5		0.6		1.5		5.6
- CDS liability notionals ...........	-		-		3.5		0.5		1.4		5.4

For footnotes, see page 185.

Summary balance sheet exposures to core eurozone countries - banks

(Audited)

	France		Germany		The Netherlands		Total
	US$bn		US$bn		US$bn		US$bn
At 31 December 2011 ................................................................	47		21		15		83

Other financial institutions and other corporates

(Unaudited)

The credit quality of other financial institutions and other corporate portfolios remains strong with no significant impairments recognised in respect of them. The portfolios largely comprise large

multinational corporates and other financial institutions with significant operations outside these countries that mitigate the risk. At 31 December 2011, our exposure to Greek shipping companies amounted to US$2.0bn. We believe the industry is less sensitive to the Greek economy as it is mainly dependent on international trade.

Exposures to peripheral eurozone countries - other financial institutions and corporates

(Audited)

	Greece		Ireland		Italy		Portugal		Spain		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2011
Loans and advances ......................	3.8		2.1		1.4		-		5.6		12.9
- gross ......................................	4.0		2.1		1.4		-		5.7		13.2
- impairment allowances ..........	(0.2)		-		-		-		(0.1)		(0.3)
Financial investments available for sale11 ...................................	-		0.3		0.3		0.1		0.1		0.8
- available-for-sale reserve .......	-		(0.1)		-		-		-		(0.1)
- amortised cost .......................	-		0.4		0.2		0.1		0.1		0.8
Net trading assets .........................	-		0.3		0.2		-		0.1		0.6
- gross trading assets .................	-		0.3		0.2		-		0.2		0.7
- short positions .......................	-		-		-		-		(0.1)		(0.1)
Derivatives12 ................................	0.1		0.5		0.7		-		0.2		1.5
- gross derivative assets ............	0.1		0.7		1.0		-		0.2		2.0
- collateral and derivative liabilities ...........................	-		(0.2)		(0.3)		-		-		(0.5)
Total ............................................	3.9		3.2		2.6		0.1		6.0		15.8
Of which, on-balance sheet exposures held to meet insurance liabilities ....................	-		-		0.2		0.1		0.1		0.4
- discretionary participatory ....	-		-		0.2		0.1		0.1		0.4
Off-balance sheet exposures .........	1.4		0.3		1.3		-		0.6		3.6
- guarantees and other ..............	0.6		0.2		0.4		-		0.5		1.7
- commitments ........................	0.8		0.1		0.9		-		0.1		1.9
Total credit default swaps
- CDS asset positions ................	0.1		-		0.3		0.1		0.1		0.6
- CDS liability positions ...........	(0.1)		-		(0.2)		(0.1)		(0.1)		(0.5)
- CDS asset notionals ...............	0.2		0.3		3.7		0.6		1.4		6.2
- CDS liability notionals ...........	0.3		0.3		3.5		0.7		1.3		6.1

For footnotes, see page 185.

Summary balance sheet exposures to core eurozone countries - other financial institutions and corporates

(Audited)

	France		Germany		The Netherlands		Total
	US$bn		US$bn		US$bn		US$bn
At 31 December 2011 .................................................................	35		7		9		51

Intra-Group funding to peripheral eurozone countries

(Unaudited)

We fund our business through local bank deposits and by extending intra-Group loans from parts of HSBC with surplus funds. Funding carries risk in the event of the exit of a member country from the eurozone and the redenomination to national currencies which would follow and may result in their significant depreciation. Measures taken to mitigate these risks include changes to composition of internal funding sources and seeking access to alternative external funding sources to reduce potential currency mismatches.

US budget deficit

(Unaudited)

During 2011, the US economy expanded moderately. In August 2011, Standard and Poor's ('S&P') lowered its long term debt rating for the US to AA+, citing the rising public debt burden and policymaking uncertainty as the key reasons. Fitch and Moody's changed the US debt rating's outlook from 'stable' to 'negative' for similar reasons. To date, the effect of the US downgrade has been less severe than originally feared.

We expect low growth to continue in 2012 despite the projected continuing fiscal and monetary expansion and positive business outlook. However, political gridlock continues to cast doubts on the administration's ability to approve a medium-term fiscal consolidation plan aimed at reducing public debt to more sustainable levels while pursuing expansionary policies. A European banking crisis is likely to cause severe damage to the global financial system, including the US, and will certainly affect the credit supply to consumers and businesses there, despite strong liquidity and de-leveraging by US banks during 2011.

We continue to closely monitor events and have stress-tested our capital position for potential scenarios at Group level and for the US business only. These results inform Group and US-specific capital planning and risk appetite setting as part of our annual operating planning process.

Middle East and North Africa

(Unaudited)

Although significant unrest and political changes were witnessed in the Middle East and North Africa in 2011, the majority of the Group's exposures in the region were concentrated in our associate investment in Saudi Arabia and in the UAE, where the respective political landscapes remained stable and economic growth continued to recover. In the countries in which we have a presence and there was unrest or political change (or which exhibited similar socio-economic, political and demographic profiles to countries experiencing unrest), we continued to carefully monitor and respond to developments while assisting our customers in managing their own risks in the volatile environment.

We also continued to work closely with Dubai World and the various entities related to the Government of Dubai to address their prevailing issues. In March 2011, Dubai World signed a final deal with HSBC and other creditors restructuring US$25bn of its debt. The arrangement extends loan maturities for five to eight years at discounted rates, allowing Dubai World to sell off its non-core assets while focusing on its core earnings businesses.

Commercial real estate

(Unaudited)

Our exposure to the commercial real estate sector is concentrated in Hong Kong, the UK and North America. The market in Hong Kong was relatively buoyant in 2011; however, transaction volumes declined and asset prices began to stabilise following initiatives taken by supervisory authorities. The UK continued to exhibit relative strength in London and the South East, though many other regions were negatively affected by weak growth in the UK economy. We are closely monitoring re-financing requirements in the UK market over the next two to three years. In North America, the market has continued to be relatively stable, in part supported by the low levels of interest rates.

On a constant currency basis, the aggregate of our commercial real estate and other property-related lending was US$113bn at 31 December 2011, an increase of 7% compared with 31 December 2010, representing 12% of total loans and advances to customers. In 2011, credit quality across this sector showed some deterioration from 2010 and there remains risk of stress in certain markets. Accordingly, across our portfolios, credit risk is mitigated by long-standing and conservative policies on asset origination which focus on relationships with long-term customers and limited initial leverage. Group Risk, in conjunction with major subsidiaries, designates real estate as a Controlled Sector and, accordingly, implements enhanced exposure approval, monitoring and reporting procedures. We set and monitor risk appetite limits for the sector at both Group and regional levels to detect and prevent higher risk concentrations. A quarterly report comparing the risk-weighted exposures of the regions and global businesses with these appetite limits is provided to senior management. While individual regions may differ with regard to local market regulatory and legal structures and real estate market characteristics, typically, origination LTV ratios would be less than 65% across the Group where loans are secured on commercial real estate assets. Lending to the sector also includes lending to large real estate developers which is typically not secured directly by charges over the underlying real estate assets.

Personal lending

(Unaudited)

We provide a broad range of secured and unsecured personal lending products to meet customer needs. Given the diverse nature of the markets in which we operate, the product is not standard across all countries but is tailored to meet local demands while using appropriate distribution channels and, wherever possible, global IT platforms.

Personal lending includes advances to customers for asset purchases, such as residential property and motor vehicles, where the loans are typically secured by the assets being acquired. We also offer loans secured on existing assets, such as first and second liens on residential property; unsecured lending products such as overdrafts, credit cards and payroll loans; and debt consolidation loans which may be secured or unsecured.

Group credit policy prescribes the range of acceptable residential property LTV thresholds with the acceptable maximum upper limit for new loans set between 75% and 95%. Specific LTV thresholds and debt-to-income ratios are managed at regional and country levels and, although such parameters must adhere with Group policy, strategy and risk appetite, they differ in the various locations in which we operate in order to reflect different economic and housing market conditions, regulations, portfolio performance, pricing and other product features.

In 2011, credit quality in most personal lending portfolios improved, reflecting a recovery of economic conditions in many markets. Loan impairment charges declined, particularly in those countries which had previously been most affected by rising unemployment and house price depreciation.

In recent years, the Group has undertaken a review of consumer finance activities and has reduced the sale of consumer finance and higher-risk personal lending products in favour of lower-risk facilities and loans secured by owner-occupied residential properties. Most notably, we have curtailed the use of third party sales agents for lending products and the sale of second lien mortgages has been significantly restricted, contributing to the balance reductions set out on page 123. Individual businesses continue to monitor, review and amend their debt-to-income ratios, LTV thresholds and other lending criteria to reflect risk appetite, portfolio performance and regulatory requirements in different countries.

In the US, the origination of new personal lending is extremely limited as we have progressively closed the consumer finance distribution network since 2007, completely discontinuing all new consumer finance real estate originations following the closure of the Consumer Lending branch network at the beginning of 2009. As a result, we are managing sizeable reductions in customer balances across HSBC Finance portfolios as detailed on page 122.

In the UK, we reduced our risk appetite. Underwriting was enhanced across all UK businesses, most notably through the use of improved credit bureau information and the

centralisation of the approval process. A range of account management tools were deployed with the aim of identifying and supporting customers who appear to be encountering financial hardship.

In Hong Kong, we adopted more conservative LTV thresholds and debt-to-income ratios, partially in response to regulatory requirements, and increased our focus on offering lending products to our existing customer base, particularly within the higher quality Premier and Advance segments.

The commentary that follows is on a constant currency basis.

At 31 December 2011, total personal lending was US$394bn, 6% lower than at 31 December 2010. Excluding the reclassification of balances held for sale, total personal lending grew, primarily in the UK and Hong Kong residential mortgage segment. Within our personal lending portfolios, total loan impairment charges of US$9.3bn were 18% lower than in 2010 with the most significant fall in the US reflecting the continued run-off of the CML portfolio and lower balances and improved delinquency rates in our Card and Retail Services business.

Total personal lending in the UK increased by 4% from 31 December 2010 to US$133bn, due to an increase in residential mortgage balances, driven by successful marketing initiatives and competitive pricing focused on our target customers. (UK mortgage lending is discussed in greater detail on page 122). This was partly offset by a 13% fall in other personal lending balances, reflecting the continued shift from unsecured products such as credit cards and personal loans.

In Hong Kong, total personal lending grew by 10% to US$63bn, due to growth in residential mortgage lending, mainly in the first half of 2011. Personal lending balances in Rest of Asia-Pacific also reflected a strong property sector with residential mortgage lending growth of 13%, most notably in Singapore and Australia.

Total personal lending in the US at 31 December 2011 was US$67bn, a decrease of 39% compared with the end of 2010 reflecting the reclassification of balances to held for sale and the run-off of the CML portfolio.

For an analysis of loan impairment allowances and impaired loans, see page 134.

Exposures to countries in the eurozone

(Unaudited)

Our retail activities within the eurozone countries are limited, with our only significant exposures in France and Greece. In France, our exposure to personal lending at 31 December 2011 was US$14bn. This exposure was mainly in residential mortgages, loans secured by a national guarantee scheme and unsecured personal loans, and both delinquency and impairment charges remained low. Our exposure within Greece totalled US$1.0bn, substantially in the form of residential mortgages. The portfolio remained well secured and delinquencies stable as we took measures to manage and contain the risks therein.

Total personal lending

(Unaudited)

	UK		Rest of      Europe		US13		Rest of        North    America		Other     regions14		Total
	US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2011
Residential mortgages ..................................	111,224		8,678		52,484		20,794		85,783		278,963
Other personal lending ................................	22,218		24,027		14,087		7,971		46,359		114,662
- motor vehicle finance ...........................	-		24		20		29		4,494		4,567
- credit cards ...........................................	11,279		2,192		833		1,262		13,922		29,488
- second lien mortgages ...........................	694		-		7,063		468		233		8,458
- other ....................................................	10,245		21,811		6,171		6,212		27,710		72,149
Total personal lending .................................	133,442		32,705		66,571		28,765		132,142		393,625
Impairment allowances
Residential mortgages ..............................	(383)		(58)		(4,551)		(27)		(302)		(5,321)
Other personal lending .............................	(745)		(366)		(1,659)		(109)		(1,560)		(4,439)
- motor vehicle finance .......................	-		(4)		-		-		(164)		(168)
- credit cards .......................................	(177)		(148)		(46)		(35)		(428)		(834)
- second lien mortgages .......................	(42)		(1)		(740)		(9)		-		(792)
- other ................................................	(526)		(213)		(873)		(65)		(968)		(2,645)
Total impairment allowances on personal lending .....................................................	(1,128)		(424)		(6,210)		(136)		(1,862)		(9,760)
- as a percentage of total personal lending	0.8%		1.3%		9.3%		0.5%		1.4%		2.5%
At 31 December 2010
Residential mortgages ..................................	103,037		8,581		57,630		21,212		78,221		268,681
Other personal lending ................................	25,636		24,463		51,686		8,589		46,265		156,639
- motor vehicle finance ...........................	-		35		72		55		5,886		6,048
- credit cards ...........................................	11,612		1,916		33,744		1,334		13,778		62,384
- second lien mortgages ...........................	846		2		9,322		578		422		11,170
- other ....................................................	13,178		22,510		8,548		6,622		26,179		77,037
Total personal lending .................................	128,673		33,044		109,316		29,801		124,486		425,320
Impairment allowances
Residential mortgages ..............................	(275)		(58)		(3,592)		(25)		(297)		(4,247)
Other personal lending .............................	(1,348)		(467)		(4,436)		(179)		(1,616)		(8,046)
- motor vehicle finance .......................	-		(5)		-		-		(244)		(249)
- credit cards .......................................	(506)		(216)		(2,256)		(62)		(483)		(3,523)
- second lien mortgages .......................	(58)		-		(889)		(19)		-		(966)
- other ................................................	(784)		(246)		(1,291)		(98)		(889)		(3,308)
Total impairment allowances on personal lending .....................................................	(1,623)		(525)		(8,028)		(204)		(1,913)		(12,293)
- as a percentage of total personal lending	1.3%		1.6%		7.3%		0.7%		1.5%		2.9%

For footnotes, see page 185.

Mortgage lending

(Unaudited)

We offer a wide range of mortgage products designed to meet customer needs, including capital repayment, interest-only, affordability and offset mortgages. The commentary that follows is on a constant currency basis.

At 31 December 2011, the total mortgage lending balance, comprising residential and second lien lending, was US$287bn, 3% higher than at the end of 2010. Our most significant concentrations of mortgage lending were in the UK, the US and Hong Kong.

US mortgage lending

US mortgage lending balances, including second lien mortgages, were US$59.5bn at 31 December 2011, a decline of 11% compared with the end of 2010. Overall, US mortgage lending represented 15% of our total personal lending compared with 16% at 31 December 2010.

Mortgage lending in HSBC Finance was US$44.1bn at 31 December 2011, 11% of our gross loans and advances to personal customers. These balances declined by 13% from 31 December 2010 as the run-off of the CML portfolio continued. However, despite the continued low interest rate environment, our loan repayment rates declined compared with historical experience, in part due to our ongoing efforts to assist customers avoid foreclosure through our loan modification programmes which have resulted in slower repayment rates.

HSBC Finance US mortgage lending15 (Unaudited)
	At 31 December 2011						At 31 December 2010
	Mortgage       Services		Consumer       Lending		Total		Mortgage         Services		Consumer         Lending		Total
	US$m		US$m		US$m		US$m		US$m		US$m
First lien .......................................	13,141		26,467		39,608		15,300		30,016		45,316
Second lien ...................................	1,724		2,796		4,520		2,269		3,349		5,618
	14,865		29,263		44,128		17,569		33,365		50,934
Impairment allowances .................	1,846		3,242		5,088		1,837		2,474		4,311
- as a percentage of the above balances ................................	12.4%		11.1%		11.5%		10.5%		7.4%		8.5%

For footnote, see page 185.

At HSBC Bank USA, mortgage lending balances were US$15.4bn at 31 December 2011, a reduction of 4% compared with the end of 2010. This was primarily due to the reclassification of balances relating to the pending sale of certain non-strategic branches to assets held for sale in the third quarter of 2011, partly offset by an increase in new mortgage sales to our Premier customers.

As previously reported, the Federal Reserve Board completed an industry-wide examination into foreclosure practices in 2010. The resulting Servicing Consent Order required us to take prescribed actions to address certain deficiencies in our foreclosure processes, as well as review all foreclosures pending or completed between January 2009 and December 2010. We continue to work closely with the regulators to align our processes as required and are implementing operational changes as necessary. Although we have resumed foreclosures in 48 states, it will be a number of months before we fully resume all foreclosure activities in all states, as we need to ensure that all necessary enhancements have been satisfactorily implemented.

During 2011, certain courts and state legislatures issued new rules relating to foreclosures. In some courts, scrutiny of documentation increased, while in others additional verification of information was required prior to foreclosure. This combination of factors led to a significant backlog of foreclosures which will take some time to resolve, and may result in additional delays which could have an adverse effect on house prices resulting in higher loss severities.

For discussion of credit trends in the US mortgage lending portfolio and the steps taken to mitigate risk, see 'US personal lending - credit quality' on page 124.

Mortgage lending - rest of the world

Mortgage lending in the UK was US$112bn at 31 December 2011, our largest concentration of this exposure, representing 12% of total gross lending to customers. The balance was 8% higher than at the end of 2010. 

In the UK, the majority of mortgage lending was to existing customers holding current or savings account relationships with HSBC. We continued to restrict lending for the purchase of residential property for the purpose of rental, and almost all new business was originated through our own sales force, with self-certification of income not permitted. These lending practices helped to ensure that our UK mortgage portfolio remained of high quality, and our average LTV ratios for new business and our total mortgage books were 53% and 52%, respectively.

Loan impairment charges and delinquency levels in our UK mortgage book remained at very low levels, reflecting the strong credit quality of the portfolio and the low interest rate environment which helped to make mortgage repayments more affordable for customers, some of whom were actively reducing their outstanding debt levels.

In Hong Kong, mortgage lending was US$46.8bn, an increase of 10% compared with the end of 2010. It was supported by the low interest rate environment and the strength of the local property market. The strong growth in the property market led the Hong Kong Monetary Authority ('HKMA') to introduce measures in both the second half of 2010 and June 2011 such as increasing deposit requirements, reducing the maximum LTV ratios for new loans and capping the maximum debt-to-income ratios. These resulted in a reduction in property prices in the second half of the year and lower sales volumes. The quality of our mortgage book remained strong with an average LTV ratio of 49% on new mortgage sales and 37% on our total mortgage books.

The following table shows the levels of mortgage lending products in our various portfolios in the US, the UK and the rest of the Group.

Mortgage lending products (Unaudited)
	UK		Rest of     Europe		US13		Rest of       North  America	Other	Other   regions14		Total
	US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2011
Residential mortgages ...............................	111,224		8,678		52,484		20,794		85,783		278,963
Second lien mortgages ...............................	694		-		7,063		468		233		8,458
Total mortgage lending .............................	111,918		8,678		59,547		21,262		86,016		287,421
Second lien as a percentage of total mortgage lending....................................	0.6%		-		11.9%		2.2%		0.3%		2.9%
Impairment allowances
Residential mortgages ............................	(383)		(58)		(4,551)		(27)		(302)		(5,321)
Second lien mortgages ...........................	(42)		(1)		(740)		(9)		-		(792)
Total impairment allowances on mortgage lending ..................................................	(425)		(59)		(5,291)		(36)		(302)		(6,113)
Interest-only (including offset) mortgages	46,886		48		-		667		1,256		48,857
Affordability mortgages, including ARMs ..	177		496		17,089		277		6,894		24,933
Other ........................................................	106		-		-		-		189		295
Total interest-only and affordability mortgages .............................................	47,169		544		17,089		944		8,339		74,085
- as a percentage of total mortgage lending ..............................................	42.1%		6.3%		28.7%		4.4%		9.7%		25.8%
At 31 December 2010
Residential mortgages ...............................	103,037		8,581		57,630		21,212		78,221		268,681
Second lien mortgages ...............................	846		2		9,322		578		422		11,170
Total mortgage lending .............................	103,883		8,583		66,952		21,790		78,643		279,851
Second lien as a percentage of total mortgage lending....................................	0.8%		0.0%		13.9%		2.7%		0.5%		4.0%
Impairment allowances
Residential mortgages ............................	(275)		(58)		(3,592)		(25)		(297)		(4,247)
Second lien mortgages ...........................	(58)		-		(889)		(19)		-		(966)
Total impairment allowances on mortgage lending ..................................................	(333)		(58)		(4,481)		(44)		(297)		(5,213)
Interest-only (including offset) mortgages	45,039		51		-		908		1,282		47,280
Affordability mortgages, including ARMs ..	1,089		326		18,494		274		7,855		28,038
Other ........................................................	102		-		-		-		183		285
Total interest-only and affordability mortgages .............................................	46,230		377		18,494		1,182		9,320		75,603
- as a percentage of total mortgage lending ..............................................	44.5%		4.4%		27.6%		5.4%		11.9%		27.0%

For footnotes, see page 185.

US personal lending

(Unaudited)

Credit quality

During 2011, economic conditions in the US remained challenging. However, they began to show signs of improvement during the fourth quarter as employment growth accelerated, in part due to seasonal hiring, and increased consumer spending. House prices remained under pressure during 2011 due to foreclosure levels, which remained high, despite the industry-wide delays in foreclosure processing.

Unemployment rates, which are a major factor in the deterioration of credit quality, remained high at 8.5% in December 2011, down from 9.4% in December 2010. Unemployment rates were at or above the US national average in 17 states.

A future improvement in the US economy remains dependant upon a recovery in the housing market, a fall in unemployment rates, the stabilisation of energy prices and improved consumer confidence. Any further weakening in these factors may continue to adversely affect consumer payment patterns and credit quality.

Mortgage lending

In 2011, we further reduced our mortgage exposure in the US as balances continued to run-off in the CML portfolio, as discussed on page 122. At 31 December 2011, residential mortgage lending balances were US$52.5bn, a decline of 9% compared with the end of 2010. The ratio of impairment allowances to total mortgage lending in HSBC Finance increased from 8.5% at 31 December 2010 to 11.5% at 31 December 2011. This increase largely reflected the effects of the delays in foreclosure activity and the increased forbearance activity within the portfolio.

Real estate markets in the US have been affected by stagnation or declines in property values. As a result, LTV ratios for our real estate secured loans have generally deteriorated since origination. Lending balances with LTV ratios of greater than 100% have historically had a greater likelihood of becoming delinquent, resulting in higher loss severity which could adversely affect our loan impairment allowances. For more information on residential mortgages by levels of collateral, see page 144.

In the CML portfolio, two months or more delinquent balances increased compared with the end of 2010. This was due to the temporary suspension of foreclosure activities, which resulted in a slowing in the rate at which lending balances were transferred to foreclosed. As a result, in our Consumer Lending portfolio, two months or more delinquent balances increased in dollar terms from US$4.9bn at 31 December 2010 to US$5.1bn at 31 December 2011, while in our Mortgage Services portfolio they remained unchanged at US$2.8bn.

At HSBC Bank USA, two months or more delinquency rates increased from 7.9% to 8.2% at 31 December 2011, reflecting the suspension of foreclosure activities.

Second lien mortgage loans have a risk profile characterised by higher LTV ratios because in the majority of cases the loans were taken out to complete the refinancing of properties. Loss experience on default of second lien loans has typically approached 100% of the amount outstanding, as any equity in the property is initially applied to the first lien loan. The majority of second lien loans are to customers that hold a first lien mortgage issued by a third party. Impairment allowances for these loans are determined by applying a roll-rate migration analysis which captures the propensity of these loans to default based on past experience. Approximately 97% of our US second lien mortgages, where the first lien mortgages are held or serviced by us and have a delinquency status of 90 days or more past due, are themselves 90 days or more past due. Once we assume a second lien mortgage loan is likely to progress to write-off, the loss severity assumed in establishing our impairment allowance is close to 100%. In the US, second lien mortgage balances declined by 24% to US$7.1bn at 31 December 2011, representing 12% of the overall US mortgage lending portfolio. Two months or more delinquent balances were US$0.7bn at 31 December 2011 compared with US$0.8bn at 31 December 2010.

Prior to foreclosure, carrying amounts of the loans in excess of fair value less costs to sell are written down to the discounted cash flows expected to be recovered, including from the sale of the property. Broker price opinions are obtained and updated every 180 days and real estate price trends are reviewed quarterly to reflect any improvement or additional deterioration. Our methodology is regularly validated by comparing the discounted cash flows expected to be recovered based on current market conditions (including estimated cash flows from the sale of the property) to the updated broker price opinion, adjusted for the estimated historical difference between interior and exterior appraisals. The fair values of foreclosed properties are initially determined based on broker price opinions. Within 90 days of foreclosure, a more detailed property valuation is performed reflecting information obtained from a physical interior inspection of the property and additional loan impairment allowances or write-downs are recorded as appropriate. Updates to the valuation are performed no less than once every 45 days until the property is sold, with declines recorded through an impairment allowance on the property. Increases to the valuation are recorded to the extent of cumulative losses previously recognised through the impairment allowance on the property.

In late 2010, we temporarily suspended all new foreclosure proceedings and in early 2011 ceased foreclosures where judgement had yet to be entered while we enhanced our processes. As a result, and together with an increase in foreclosed property sales, the number of foreclosed properties at HSBC Finance decreased compared with the end of December 2010.

The average total loss on foreclosed properties and the average loss on sale of foreclosed properties both increased compared with the end of 2010. This was a result of the continued decline in house prices, as well as a greater mix of foreclosed properties being sold which we have held for longer periods of time. Typically the longer the holding period, the greater the loss we recognise by the time of sale. See the table 'HSBC Finance foreclosed properties in the US' below for more detail.

Since their introduction in 2010, HSBC Finance has increased the use of deed-in-lieu and 'short sales' to assist our real estate secured receivable customers. Under a deed-in-lieu agreement, the borrower agrees to surrender the deed to the property without being subject to foreclosure proceedings and HSBC Finance releases the borrower from further obligation. Under a short sale, the property is offered for sale to potential buyers at a price which has been pre-negotiated between HSBC Finance and the borrower. This pre-negotiated price is based on updated property valuations and the expectation of future cash flows from the customer. Short sales also release the borrower from further obligations. HSBC's total losses on deed-in-lieu and short sales are generally lower than losses from foreclosed loans, or loans where we have previously elected not to pursue foreclosure, and the practices generally obtain resolution of the delinquent receivable over a shorter period of time than the normal foreclosure proceedings. HSBC Finance currently expects that the use of deed-in-lieu and short sales will continue to be significant in the future as it works with its customers.

HSBC Finance foreclosed properties in the US

(Unaudited)

			Half-year ended
	2011		31 Dec              2011		30 Jun              2011		2010
Number of foreclosed properties at end of period ...............	3,511		3,511		6,982		10,940
Number of properties added to foreclosed inventory in the year/quarter ....................................................................	11,187		3,116		8,071		20,489
Average loss on sale of foreclosed properties16 ..................	8%		9%		8%		5%
Average total loss on foreclosed properties17 .....................	56%		57%		55%		51%
Average time to sell foreclosed properties (days) ...............	185		200		168		161

For footnotes, see page 185.

Credit cards

In the second half of 2011, we announced the sale of our Card and Retail Services business, which includes both our credit card and private label operations. We have reclassified the associated balances to assets held for sale. We will continue to offer all card products and services during transition. HSBC Bank USA continues to offer credit cards to branch-based customers and corporate cards to commercial and wholesale banking clients.

Two months or more delinquency rates in our credit card portfolio declined from 4.7% at 31 December 2010 to 3.8% at 31 December 2011 while, in our private label cards portfolio, two months or more delinquency rates decreased from 3.0% at 31 December 2010 to 2.5% at 31 December 2011 reflecting an increasing willingness on the part of customers to make repayments and reduce outstanding credit card debt levels.

Personal non-credit card

Personal non-credit card lending balances in the US decreased significantly, largely due to continued run‑off. As a result two months or more delinquency balances declined from US$0.8bn at 31 December 2010 to US$0.5bn at 31 December 2011.

Two months and over contractual delinquency in the US

(Unaudited)

	At 31 December
	2011		2010		2009
	US$m		US$m		US$m
In Personal Lending in the US
Residential mortgages ...................................................................................	9,065		8,632		9,551
Of which:
Mortgage services .....................................................................................	2,783		2,757		3,093
Consumer lending .....................................................................................	5,139		4,861		5,380
Other mortgage lending ............................................................................	1,143		1,014		1,078
Second lien mortgage lending ........................................................................	674		847		1,194
Of which:
Mortgage services .....................................................................................	157		245		384
Consumer lending .....................................................................................	344		423		642
Other mortgage lending ............................................................................	173		179		168
Vehicle finance .............................................................................................	-		-		267
Credit card ....................................................................................................	714		957		1,798
Private label .................................................................................................	316		404		622
Personal non-credit card ...............................................................................	513		811		1,548
Total ............................................................................................................	11,282		11,651		14,980
	%18		%18		%18
Residential mortgages ...................................................................................	17.1		15.0		14.5
Second lien mortgage lending ........................................................................	8.5		9.1		10.1
Vehicle finance .............................................................................................	-		-		4.6
Credit card ....................................................................................................	3.8		4.7		7.4
Private label .................................................................................................	2.5		3.0		4.1
Personal non-credit card ...............................................................................	8.3		9.5		12.6
Total ............................................................................................................	11.4		10.7		11.1

For footnote, see page 185.

Credit quality of financial instruments

(Audited)

The five classifications describing the credit quality of our lending, debt securities portfolios and derivatives are defined in the Appendix to Risk on page 188. Additional credit quality information in respect of our consolidated holdings of ABSs is provided on page 152.

During 2011, we amended our presentation of impaired loans for portfolios with significant levels of forbearance to provide more relevant information on the effect of forbearance on the credit risk of loans and advances. This change in presentation does not affect the accounting policy for the recognition of loan impairment allowances. Further details are provided on page 133.

For the purpose of the following disclosure, retail loans which are past due up to 89 days and are not otherwise classified as impaired in accordance with our disclosure convention (see page 133), are not disclosed within the expected loss ('EL') grade to which they relate, but are separately classified as past due but not impaired.

2011 compared with 2010

We assess credit quality on all financial instruments which are subject to credit risk, as shown in the table on page 127. The balance of these financial instruments was US$2,413bn, an increase of 5% in 2011, of which US$1,649bn or 68% was classified as strong. This percentage was broadly in line with 2010. The proportion of financial instruments classified as good and satisfactory remained broadly stable at 16% and 12%, respectively, while the proportion of sub-standard financial instruments was 2% in both 2011 and 2010.

Derivative assets increased by 33% to US$346bn. This increase was mainly in Europe, reflecting an increase in the fair value of interest rate contracts compounded by an increase in the notional value of outstanding contracts during the period. The credit quality of our derivatives portfolio remained strong with 81% of balances in this classification, broadly in line with 2010.

Cash and balances at central banks, on which credit quality has been assessed, more than doubled to US$130bn. This increase was mainly in Europe and in North America as we deposited a larger portion of our excess liquidity with central banks in these regions. As the increases in placements are

 

END

 

 

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