Annual Report and Accounts -

RNS Number : 7221P

HSBC Holdings PLC

31 March 2009

 



    Background and disclosure policy

(Audited)

As a result of the widespread deterioration in the markets for securitised and structured financial assets, and consequent disruption to the global financial system since mid-2007, it has become increasingly difficult to observe prices for structured credit risk, including prime tranches of such risk as the markets for these assets became illiquid. The resulting constraint on the ability of financial institutions to access wholesale markets to fund such assets added additional downward pressure on all asset prices. As a consequence, many financial institutions have recorded considerable reductions in the fair values of their asset-backed securities ('ABS's) and leveraged structured transactions, most significantly in sub-prime mortgages but in other asset classes too.

In light of increasing illiquidity and the risk to capital from further write-downs, many financial institutions took steps during 2008 to reduce leveraged exposures, build liquidity and raise additional capital. However, credit conditions suffered additional deterioration in the second half of the year, as the economic outlook worsened and unemployment rose, intensifying the pressure on the global financial system. Volatility in money markets also increased during the second half of 2008, resulting in wider interest spreads, and markets for securitised and structured financial assets continued to be thoroughly constrained. This instability triggered a series of significant events including the default of a number of major financial institutions, and the taking into public ownership of banks in a number of countries.

Deterioration in the measured fair value of assets supported by sub-prime mortgages continued in 2008 with the primary market for all but US government-sponsored issues remaining weak. Spreads widened due to credit and liquidity concerns as delinquencies on the underlying mortgages continued to increase beyond the levels priced into securitisations issued in recent years. The impact widened beyond sub-prime related assets, with the measured fair value of securities backed by Alt-A collateral, in particular, suffering significant deterioration.

During 2008, governments and central banks worldwide took unprecedented measures designed to stabilise and increase confidence in financial markets. These measures included providing vast amounts of liquidity via emergency funding, extending guarantees of financial assets, and launching various forms of rescue plans.

This section contains disclosures about the effect of the recent market turmoil on HSBC's securitisation activities and other structured products. HSBC's principal exposures to the US and the UK mortgage markets primarily take the form of credit risk from direct loans and advances to customers which were originated to be held to maturity or refinancing, details of which are provided on page 208.

Financial instruments which were most affected by the market turmoil include exposures to direct lending held at fair value through profit or loss and ABSs, including mortgage-backed securities ('MBS's) and collateralised debt obligations ('CDO's), and exposures to and contingent claims on monoline insurers in respect of structured credit activities and leveraged finance transactions which were originated to be distributed.

In accordance with HSBC's policy to provide meaningful disclosures that help investors and other stakeholders understand the financial position, performance and changes in the financial position of the Group, the information provided in this section goes beyond the minimum levels required by accounting standards, statutory and regulatory requirements and listing rules. In the specific context of facilitating an understanding of the recent market turmoil in markets for securitised and structured assets, HSBC has considered the recommendations relating to disclosure contained within the reports issued by the Financial Stability Forum on 'Enhancing Market and Institutional Resilience' (April and October 2008), the Committee of European Banking Supervisors on 'Banks' Transparency on Activities and Products Affected by the Recent Market Turmoil' (June and October 2008) and the International Accounting Standards Board Expert Advisory Panel on 'Measuring and disclosing the fair value of financial instruments in markets that are no longer active' (October 2008). In addition, HSBC has considered feedback from investors, regulators and other stakeholders on the disclosures that investors would find most useful. 

The specific topics covered in respect of HSBC's securitisation activities and exposure to structured products are as follows:

•     overview of exposure;

• business model;

•     risk management;

•     accounting policies;

•     nature and extent of HSBC's exposures;

•     fair values of financial instruments; and

•     special purpose entities.

Overview of exposure

(Audited)

At 31 December 2008, the aggregate carrying amount of HSBC's exposure to ABSs, trading loans held for securitisation and exposure to leveraged finance transactions was  US$91 billion (2007: US$131 billion), summarised as follows:

	At 31 December 2008				At 31 December 2007
	Carrying     amount		Including     sub-prime     and Alt-A		Carrying     amount		Including      sub-prime      and Alt-A
	US$bn		US$bn		US$bn		US$bn
ABSs	81		12		116		31
- fair value through profit or loss	14		1		33		7
- available for sale1	56		9		80		24
- held to maturity1	3		-		3		-
- loans and receivables	8		2		-		-
Loans at fair value through profit or loss	4		3		6		6
Leveraged finance loans	6		-		9		-
- fair value through profit or loss2	-		-		8		-
- loans and receivables	6		-		1		-
	91		15		131		37

1    Total includes holdings of ABSs issued by Freddie Mac and Fannie Mae.

2    Includes the carrying amount of funded loans plus the net exposure to unfunded leveraged finance commitments.

The majority of these exposures arise in the Global Banking and Markets business segment. 

Within the total carrying amount of ABSs on the balance sheet, ABS holdings of US$14.6 billion (2007: US$32.1 billion) are held through vehicles discussed on page 148, where significant first loss protection is provided by external investors on a fully collateralised basis. 

A reconciliation of the movement in the carrying amount of ABSs on the balance sheet of US$34.5 billion is set out below: 

• the write-downs of ABSs taken to the income statement - US$3.4 billion; 

• the movement in fair values on available-for-sale ABSs taken to equity - US$16.5 billion; 

• principal amortisation - US$11.4 billion; and,

• exchange differences and other movements - US$3.2 billion.

Due to the market dislocation in respect of these securities, the impact of purchases and sales on the total carrying amount of ABSs was not significant in 2008.

At 31 December 2008, of the total carrying amount of ABSs and trading loans held for securitisation in respect of sub-prime and Alt-A residential mortgage exposure, US$3.5 billion (2007: US$11.7 billion) was held through special purpose entities ('SPE's).

Reclassification of financial assets

In October 2008, the IASB issued amendments to IAS 39 'Financial Instruments: Recognition and Measurement' and IFRS 7 'Financial Instruments: Disclosures' which permitted an entity to reclassify non-derivative financial assets out of the held-for-trading category as described in the accounting policies on Note 2 (e) on the Financial Statements. This was done to better align IFRSs with US GAAP and was restricted to situations where the transferring entity had the intention and ability to hold the transferred position for the foreseeable future or until maturity.

During the second half of 2008, HSBC reclassified financial assets from the held-for-trading category as tabulated below. The amount reclassified was the fair value of the financial assets at the date of reclassification, subject to the transition rules noted below. In October 2008, HSBC reclassified US$12.5 billion and US$0.4 billion of held-for-trading financial assets as loans and receivables and available for sale, respectively. During November and December 2008, HSBC reclassified a further US$2.8 billion and US$2.2 billion of held-for-trading financial assets as loans and receivables and available for sale, respectively. The financial consequence of the reclassification is that the reclassified assets are no longer marked-to-market through the income statement. Amounts reclassified as loans and receivables are accounted as such from the date of reclassification and tested thereafter for

	On reclassification						At 31 December 2008
	Amount     reclassified1		Estimate of     future     cash flows2		Effective     interest rate		Carrying     amount		Fair value
	US$m		US$m		%		US$m		US$m
Reclassification to loans and receivables
ABSs	8,194		11,642		8		7,991		6,139
Trading loans - commercial mortgage loans	650		741		5		587		557
Leveraged finance loans	6,458		8,481		7		5,670		4,239
	15,302		20,864				14,248		10,935
Reclassification to available for sale
Corporate debt and other securities	2,549		3,626		5		2,401		2,401
	17,851		24,490				16,649		13,336

1    Amounts reclassified that are denominated in foreign currencies have been translated using the rate of exchange at the date of reclassification; all other amounts denominated in foreign currencies have been translated into the functional currency at the rate of exchange ruling at the balance sheet date.

2    The estimate of future cash flows represents the cash flows expected to be recovered at the date of reclassification.

impairment. Amounts reclassified as available for sale are held at fair value with changes in the fair value recognised in equity, and tested for impairment. In line with the transition rules, for reclassifications made during October 2008, the reclassified financial assets were treated as having been so reclassified as at 1 July 2008. The impact of back-dating these retrospective reclassifications was that fair value movements between 1 July 2008 and October 2008 of US$835 million were not recorded in the income statement. 

The reclassifications resulted from significant reductions in market liquidity for these assets and a change in HSBC's intention to hold them for the foreseeable future or to maturity. These circumstances arose in the wider context of market turmoil. As a result, the Group decided to reclassify financial assets that would have met the definition of loans and receivables at initial recognition, as permitted by the IAS 39 amendments. In addition, as permitted by the IAS 39 amendments in rare circumstances, the Group reclassified securities, that did not meet the definition of loans and receivables on initial recognition, as the conditions of market turmoil prevailing in the second half of 2008 were considered rare.

If these reclassifications had not been made, the Group's pre-tax profit would have been reduced by US$3.5 billion from US$9.3 billion to US$5.8 billion. The reduction would have been US$0.9 billion in the North America and US$2.6 billion in the Europe segments. There was no significant impairment identified on the loans transferred even though the fair value continued to fall as a consequence of illiquidity and market sentiment.

The following table shows the fair value gains and losses, income and expense recognised in the income statement both before and after the date of reclassification:

	Effect on income statement
	Prior to reclassification				After  reclassification1			Assuming no     reclassification2		Net effect of      reclassification
	2008		2007			2008		2008		2008
	US$m		US$m			US$m		US$m		US$m
Reclassifications to loans and receivables
ABSs	(1,020)		(357)			303		(1,549)		1,852
Trading loans - commercial mortgage loans	(16)		-			17		(13)		30
Leveraged finance loans	(253)		(158)			192		(1,239)		1,431
	(1,289)		(515)			512		(2,801)		3,313
Reclassifications to available for sale
Corporate debt and other securities	(82)		(2)			22		(202)		224
	(1,371)		(517)			534		(3,003)		3,537

1        Income and expense recorded in the income statement after reclassification represents the accrual of the effective interest rate and also includes US$26 million in respect of impairment of leveraged finance loans. The group recorded no impairment charges on other financial assets reclassified during the second half of 2008.

2    Effect on the income statement which would have arisen from the date of reclassification, had the reclassification not occurred.

Financial effect of market turmoil

As described in the background to market turmoil on page 144, the dislocation of financial markets which developed in the second half of 2007 continued throughout 2008. For the three half-year periods affected to date, the write-downs incurred by the Group on ABSs, trading loans held for securitisation, leveraged finance transactions and the movement in fair values on available-for-sale ABSs taken to equity, plus impairment losses on specific exposures to banks, are summarised in the following table:

	Half-year to
	31 December     2008		30 June     2008		31 December     2007
	US$bn		US$bn	US$bn	US$bn
Write-downs taken to income statement	(2.3)		(4.0)		(2.3)
Fair value movement taken to available-for-sale reserve on ABSs in the period	(10.4)		(6.1)		(2.2)
Closing balance of available-for-sale reserve relating to ABSs	(18.7)		(8.3)		(2.2)

Virtually all of these effects were recorded in Global Banking and Markets. Included in write-downs taken to the income statement is US$209 million in respect of impairment losses on the collapse of financial institutions, of which US$126 million was incurred on the collapse of Icelandic banks. The group took no material write-downs to the income statement in respect of exposures to Lehman Brothers.

Further analysis of the write-downs taken to the income statement by Global Banking and Markets, and the net carrying amounts of the positions that have generated these write-downs, are shown in the following table:

Global Banking and Markets write-downs taken to the income statement and carrying amounts 

	Write-downs during half-year to						Carrying amount at
	31 December     2008		30 June     2008		31 December     2007		31 December    2008		30 June    2008		31 December     2007
	US$m		US$m		US$m		US$m		US$m		US$m
Sub-prime mortgage-related assets
- loan securitisation	292		301		529		1,213		1,565		1,965
- credit trading	150		665		463		428		1,377		1,700
Other ABSs	486		1,327		459		2,201		8,923		9,830
Derivative transactions with monolines
- investment grade counterparts	130		598		133		2,089		1,206		1,209
- non-investment grade counterparts	370		608		214		352		78		-
Leveraged finance loans1	26		278		195		271		7,375		7,772
Other credit related items	95		99		142		186		321		446
Available-for-sale impairments and other non-trading related items	655		55		-
	2,204		3,931		2,135

1        The carrying amount includes funded loans plus the net exposure to unfunded leveraged finance commitments, held within fair value through the profit or loss.

Global Banking and Markets asset-backed securities classified as available for sale 

HSBC's principal holdings of ABSs are in the Global Banking and Markets' business through special purpose entities ('SPE's) which have the benefit of external investor first loss protection 

support, positions held directly and by Solitaire Funding Limited ('Solitaire') where HSBC has first loss risk.

The table below summarises these Global Banking and Markets' exposures to ABSs which are held on an available-for-sale basis.

Global Banking and Markets available-for-sale ABSs exposure

	At 31 December 2008						At 31 December 2007
	Directly     held1		SPEs		Total		Directly     held1		SPEs		Total
	US$m		US$m		US$m		US$m		US$m		US$m
Total carrying amount of net principal exposure	35,736		14,610		50,346		43,826		32,105		75,931
-  which includes sub-prime/Alt-A exposure	5,155		3,516		8,671		11,801		11,664		23,465
Available-for-sale reserves relating to sub-prime/Alt-A exposure	(5,920)		(3,573)		(9,493)		(1,122)		-		(1,122)

	Half year to						Half year to						Half year to
	31 December 2008						30 June 2008						31 December 2007
	Directly  held1  US$m		SPEs US$m		Total US$m		Directly held1 US$m		SPEs US$m		Total US$m		Directly     held1 US$m		SPEs US$m		Total US$m
Impairment charge:
-  borne by HSBC	224		-		224		55		-		55		-		-		-
-  allocated to capital note  holders	-		159		159		-		134		134		-		-		-
Total impairment charge	224		159		383		55		134		189		-		-		-

1    'Directly held' includes both assets held by Solitaire where HSBC provides first loss protection and those assets held directly by the Group. 

Structured investment vehicles and securities investment conduits (special purpose entities)

In the table above, the total carrying amount of ABSs on the balance sheet in respect of SPEs represent holdings in which significant first loss protection is provided through the capital notes issued by the structured investment conduits ('SIC's), excluding Solitaire. The economic first loss protection remaining at 31 December 2008 amounted to US$2.2 billion (2007: US$2.3 billion). As set out on page 174, on an IFRS accounting basis the impairment charge of US$293 million was allocated to the capital note holders at 31 December 2008 (2007: n/a).

At each balance sheet date, an assessment is made as to whether there is any objective evidence of impairment in the value of available-for-sale ABSs. Impairment charges incurred on assets held by these SPEs are offset by a credit to the impairment line for the amount of the loss allocated to capital note holders.

Impairments recognised at 31 December 2008 from assets held directly or within Solitaire in recognition of the first loss protection of US$1.2 billion provided by HSBC through credit enhancement were US$279 million (2007: nil), based on a notional principal value of securities which were impaired of US$570 million (2007: nil). The low level of impairment recognised in comparison with the deficit in the available-for-sale reserve is a reflection of the credit quality and seniority of the assets held.

Sub-prime and Alt-A residential mortgage-backed securities

Management's current assessment of the holdings of available-for-sale ABSs with the most sensitivity to possible future impairment is focused on sub-prime and Alt-A residential mortgage-backed securities ('MBS's). 

Excluding holdings in the SPEs discussed above, available-for-sale holdings in these categories within Global Banking and Markets amounted to US$5.2 billion at 31 December 2008 (2007: US$11.8 billion). During the year ended 31 December 2008, the movement in fair values of these securities taken to equity was a reduction of US$4.8 billion. The deficit in the available-for-sale fair value reserve as at 31 December 2008 in relation to these securities was US$5.9 billion (2007: US$1.1 billion).

The main factors in the reduction in fair value of these securities over the period were the effects of reduced market liquidity and negative market sentiment. The level of actual credit losses experienced was low in 2008, notwithstanding the deterioration in the performance of the underlying mortgages in the period as US house prices fell and defaults increased. The absence of material credit losses is judged to be attributable to the seniority of the tranches held by HSBC as well as the priority for cash flow held by these tranches.

During February 2009, the credit ratings on a proportion of ABSs held directly by HSBC, Solitaire and the SICs were downgraded. In particular, Moody's Investor Services downgraded the ratings on substantially all the Group's holdings of US AltߛA residential MBSs issued during 2006 and 2007.

As discussed on page 170, when assessing available-for-sale ABSs for objective evidence of impairment at the balance sheet date HSBC considers all available evidence including the performance of the underlying collateral. A downgrade of a security's credit rating is not, of itself, evidence of impairment. Consequently, Moody's action has no direct impact on the measurement of impairment losses. The impairment losses recognised on these securities at 31 December 2008 is set out on page 148.

Stress analysis

(Unaudited)

HSBC's regular impairment assessment uses an industry standard model with inputs which are corroborated using observable market data where available. At 31 December 2008, management performed a stress test on the available-for-sale ABS positions, based on the fair value of the positions at that date. The outcome of the stress test was particularly sensitive to expected loss and prepayment rates for Alt-A securities and the loss of credit protection from certain monoline insurers on US Home Equity Lines of Credit ('HELoC's). The results of the stress test showed that, by applying different inputs to those currently observed, a further potential impairment charge to the income statement of some US$2 billion to US$2.5 billion could arise over the next three years. These different inputs were calculated by increasing the net impact of expected loss and prepayment rates for Alt-A securities by between a third and a half depending on loan vintage and by removing all credit protection from monoline insurers rated below AAA by S&P on the HELoC positions. However, management believes that the loss which would be realised in cash terms would be considerably lower than the impairment charge above and potentially cost some US$0.6 billion to US$0.8 billion over the next four years.

Business model

(Audited)

Asset-backed securities and leveraged finance

HSBC is or has been involved in the following activities in these areas:

•     the purchase of US mortgage loans with the intention of structuring and placing securitisations into the market;

•     trading in ABSs, including MBSs, in secondary markets; 

•     the holding of MBSs and other ABSs in balance sheet management activities, with the intention of earning net interest income over the life of the securities;

•     the holding of MBSs and other ABSs as part of investment portfolios, including the SIVs, SICs and money market funds described under 'Special purpose entities' below, with the intention of earning net interest income and management fees;

• MBSs or other ABSs held in the trading portfolio hedged through credit derivative protection, typically purchased from monoline insurers, with the intention of earning the spread differential over the life of the instruments; and

•     leveraged finance: originating loans for the purposes of syndicating or selling them down in order to generate a trading profit and holding them in order to earn interest margin over their lives.

Historically, these activities have not been a significant part of Global Banking and Markets' business, and Global Banking and Markets is not reliant on them for any material aspect of its business operations or profitability. 

The purchase and securitisation of US mortgage loans and the secondary trading of US MBSs was conducted in HSBC's US MBSs business. This business was discontinued in 2007.

Special purpose entities

HSBC enters into certain transactions with customers in the ordinary course of business which involve the establishment of SPEs to facilitate customer transactions. SPEs are used in HSBC's business in order to provide structured investment opportunities for customers, facilitate the raising of funding for customers' business activities, or diversify HSBC's sources of funding and/or improve capital efficiency.

The use of SPEs is not a significant part of HSBC's activities and HSBC is not reliant on the use of SPEs for any material part of its business operations or profitability. Detailed disclosures of HSBC's sponsored SPEs are provided on page 173.

Risk management

(Audited)

The effect of the recent market turmoil on HSBC's risk exposures, the way in which HSBC has managed risk exposures in this context, and any changes made in HSBC's risk management polices and procedures in response to the market conditions are set out in the following sections:

•     Liquidity risk - 'The impact of market turmoil on the Group's liquidity risk position' (see page 239).

•     Market risk - 'The impact of market turmoil on market risk' (see page 242).

• Credit Risk - 'Credit exposure' (see page 197).

Accounting policies

(Audited)

HSBC's accounting policies regarding the classification and valuation of financial instruments are in accordance with the requirements of IAS 32 'Financial Instruments: Presentation' and IAS 39 'Financial Instruments: Recognition and Measurement', as described in Note 2 on the Financial Statements, and the use of assumptions and estimation in respect of valuation of financial instruments as described on page 63.

Nature and extent of HSBC's exposures

(Audited)

This section contains information on HSBC's exposures to the following:

• direct lending held at fair value through profit or loss; 

• ABSs including MBSs and CDOs; 

• monoline insurers; 

• credit derivative product companies ('CDPC's); and

• leveraged finance transactions.

MBSs are securities that represent interests in a group of mortgages. Investors in these securities have the right to cash received from future mortgage payments (interest and/or principal). Where an MBS references mortgages with different risk profiles, the MBS is classified according to the highest risk class. Consequently, an MBS with both sub-prime and AltߛA exposures is classified as sub-prime. 

CDOs are securities in which ABSs and/or certain other related assets have been purchased and securitised by a third-party, or securities which pay a return which is referenced to those assets. CDOs may feature exposure to sub-prime mortgage assets through the underlying assets. As there is often uncertainty surrounding the nature of the underlying collateral supporting CDOs, all CDOs supported by residential mortgage-related assets, irrespective of the level of sub-prime assets, are classified as sub-prime.

HSBC's holdings of ABSs and CDOs, and its direct lending positions, include the following categories of collateral and lending activity: 

•     sub-prime: loans to customers who have limited credit histories, modest incomes, 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, US credit scores are primarily used to determine whether a loan is sub-prime. US home equity lines of credit are classified as sub-prime. For non-US mortgages, management judgement is used to identify loans of similar risk characteristics to sub-prime, for example, UK non-conforming mortgages (see below);

• US home equity lines of credit ('HELoC's): a form of revolving credit facility provided to customers, which is supported by a first or second lien charge over residential property. Global Banking and Markets' holdings of HELoCs are classified as US sub-prime residential mortgage assets;

•     US Alt-A: loans classified as Alt-A are regarded as lower risk than sub-prime, but they share higher risk characteristics than lending under normal criteria. US credit scores, as well as the level of mortgage documentation held (such as proof of income), are considered when determining whether an Alt-A classification is appropriate. Non-agency mortgages in the US are classified as Alt-A if they do not meet the criteria for classification as sub-prime. These are mortgages not eligible to be sold to the major US Government agency, Ginnie Mae (Government National Mortgage Association), and government sponsored enterprises in the mortgage market, Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation);

•     US government agency mortgage-related assets: securities that are guaranteed by US Government agencies, such as Ginnie Mae;

•     US Government sponsored enterprises mortgage-related assets: securities that are guaranteed by US Government sponsored entities, including Fannie Mae and Freddie Mac;

•     UK non-conforming mortgage-related assets: UK mortgages that do not meet normal lending criteria. This includes instances where the normal level of documentation has not been provided (for example, in the case of self-certification of income), or where increased risk factors, such as poor credit history, result in lending at a rate that is higher than the normal lending rate. UK non-conforming mortgages are treated as sub-prime exposures; and

•     other mortgage-related assets: residential mortgage-related assets that do not meet any of the classifications described above. Prime residential mortgage-related assets are included in this category.

HSBC's exposure to non-residential mortgage-related ABSs and direct lending includes:

•     commercial property mortgage-related assets: MBSs with collateral other than residential mortgage-related assets;

•     leveraged finance-related assets: securities with collateral relating to leveraged finance loans;

•     student loan-related assets: securities with collateral relating to student loans; and

•     other assets: securities with other receivable-related collateral.

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

	At 31 December 2008
	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
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
Sub-prime residential  mortgage-related assets	3,372		3,741		-		1		453		7,567		4,230
Direct lending	2,789		-		-		-		-		2,789		1,300
MBSs and MBS CDOs1	583		3,741		-		1		453		4,778		2,930
US Alt-A residential  mortgage-related assets	618		5,829		185		-		1,056		7,688		3,831
Direct lending	246		-		-		-		-		246		-
MBSs1	372		5,829		185		-		1,056		7,442		3,831
US government agency  mortgage-related assets
MBSs1	640		7,418		494		-		-		8,552		441
US government-sponsored enterprises mortgage-related assets
MBSs1	487		12,894		1,918		51		-		15,350		-
Other residential mortgage- related assets	1,633		4,272		-		31		2,135		8,071		2,822
Direct lending	677		-		-		-		-		677		-
MBSs1	956		4,272		-		31		2,135		7,394		2,822
Commercial property mortgage-related assets
MBSs and MBS CDOs1	589		6,802		-		86		1,402		8,879		4,985
Leveraged finance-related assets
ABSs and ABS CDOs1	784		4,489		-		-		204		5,477		3,667
Student loan-related assets
ABSs and ABS CDOs1	214		4,809		-		3		81		5,107		4,028
Other assets
ABSs and ABS CDOs1	3,068		5,957		-		6,371		2,660		18,056		3,941
	11,405		56,211		2,597		6,543		7,991		84,747		27,945

For footnotes, see page 162.

The above table excludes leveraged finance transactions, which are shown separately on page 160.

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

	At 31 December 2007
	Trading		Available    for sale		Held to    maturity	Designated     at fair value    through     profit or loss			Total	Of which     held through     consolidated     SPEs
	US$m		US$m		US$m		US$m		US$m		US$m
Sub-prime residential mortgage-related assets	9,431		9,311		-		2		18,744		11,504
Direct lending	5,825		-		-		-		5,825		3,596
MBSs and MBS CDOs1	3,606		9,311		-		2		12,919		7,908
US Alt-A residential mortgage-related assets	3,288		14,760		173		-		18,221		11,193
Direct lending	342		-		-		-		342		-
MBSs1	2,946		14,760		173		-		17,879		11,193
US government agency mortgage-related assets
MBSs1	204		5,239		552		-		5,995		-
US government-sponsored enterprises  mortgage-related assets
MBSs1	2,583		11,414		1,881		26		15,904		-
Other residential mortgage-related assets	5,243		5,701		-		289		11,233		4,441
Direct lending	416		-		-		-		416		-
MBSs1	4,827		5,701		-		289		10,817		4,441
Commercial property mortgage-related assets
MBSs and MBS CDO1	3,467		10,505		-		105		14,077		8,600
Leveraged finance-related assets
ABSs and ABS CDOs1	263		5,820		-		-		6,083		5,126
Student loan-related assets
ABSs and ABS CDOs1	144		7,052		-		-		7,196		6,308
Other assets	6,252		10,683		-		7,736		24,671		9,495
Direct lending	3		-		-		-		3		-
ABSs and ABS CDOs1	6,249		10,683		-		7,736		24,668		9,495
	30,875		80,485		2,606		8,158		122,124		56,667

For footnotes, see page 162.

The above table excludes leveraged finance transactions, which are shown separately on page 160.

Included in the above table are ABSs which are held through SPEs that are consolidated by HSBC. Although HSBC includes these assets in full on its balance sheet, the risks arising from the assets are mitigated to the extent of third-party investment in notes issued by those SPEs. For a description of HSBC's holdings of and arrangements with SPEs, see page 173. 

The exposure detailed above includes long positions where risk is mitigated by specific credit derivatives with monoline insurers ('monolines') and other financial institutions. These positions comprise:

• residential MBSs with a carrying amount of US$0.9 billion (2007: US$2.1 billion);

• residential MBS CDOs with a carrying amount of US$39 million (2007: US$349 million); and

• ABSs other than residential MBSs and MBS CDOs with a carrying amount of US$9.8 billion (2007: US$10.8 billion).

In the tables which follow, carrying amounts and gains and losses are given for securities except those where risk is mitigated through specific credit derivatives with monolines. The counterparty credit risk arising from the derivative transactions undertaken with monolines is covered in the monoline exposure analysis on page 159. 

US government-sponsored enterprises mortgage-related assets shown in the table above include holdings of securities issued by Freddie Mac of US$8.0 billion (2007: US$6.8 billion) and by Fannie Mae of US$6.6 billion (2007: US$8.5 billion).

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

	2008								At 31 December 2008
Unrealised     gains and     (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
US sub-prime residential mortgage-related assets
Direct lending	(494)		7		-		-		3,653		-		3,653		2,789
MBSs1	(784)		1		(1,578)		-		6,845		794		6,051		3,044
- high grade2	(243)		6		(290)		-		2,903		507		2,396		1,634
- rated C to A	(444)		(4)		(1,288)		-		3,913		287		3,626		1,399
- not publicly rated	(97)		(1)		-		-		29		-		29		11
MBS CDOs1	(110)		-		(55)		(50)		1,042		234		808		61
- high grade2	-		-		(78)		-		172		27		145		45
- rated C to A	(110)		-		23		(50)		870		207		663		16
	(1,388)		8		(1,633)		(50)		11,540		1,028		10,512		5,894
US Alt-A residential  mortgage-related assets
Direct lending	(11)		-		-		-		264		-		264		246
MBSs1	(737)		9		(6,416)		(510)		16,860		436		16,424		7,174
- high grade2	(446)		17		(3,012)		(82)		9,804		317		9,487		4,869
- rated C to A	(292)		(7)		(3,404)		(428)		7,041		119		6,922		2,293
- not publicly rated	1		(1)		-		-		15		-		15		12
	(748)		9		(6,416)		(510)		17,124		436		16,688		7,420
US government agency  mortgage-related assets
MBSs1
- high grade2	3		9		122		-		8,448		-		8,448		8,551
US government-sponsored enterprises mortgage-related assets
MBSs1
- high grade2	(54)		31		270		-		15,022		-		15,022		15,349
Other US residential  mortgage-related assets
Direct lending	23		(9)		-		-		691		-		691		677
MBSs1	(65)		(37)		33		-		1,039		284		755		614
- high grade2	(63)		(37)		33		-		959		262		697		574
- rated C to A	(2)		-		-		-		80		22		58		40
	(42)		(46)		33		-		1,730		284		1,446		1,291
Commercial property  mortgage-related assets
MBS and MBS CDOs1	(57)		(19)		(1,709)		-		5,797		553		5,244		3,182
- high grade2	(57)		(18)		(1,696)		-		5,658		553		5,105		3,059
- rated C to A	-		(1)		(13)		-		108		-		108		94
- not publicly rated	-		-		-		-		31		-		31		29
Balance carried forward	(2,286)		(8)		(9,333)		(560)		59,661		2,301		57,360		41,687

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

	2008								At 31 December 2008
Unrealised     gains and     (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Balance brought forward	(2,286)		(8)		(9,333)		(560)		59,661		2,301		57,360		41,687
Leveraged finance-related assets
ABSs and ABS CDOs1	(15)		-		(1,000)		-		5,212		551		4,661		3,390
- high grade2	(15)		-		(996)		-		5,193		551		4,642		3,375
- rated C to A	-		-		(4)		-		19		-		19		15
Student loan-related assets
ABSs and ABS CDOs1	(63)		(4)		(1,959)		-		7,610		279		7,331		4,908
- high grade2	(47)		(4)		(1,649)		-		6,888		279		6,609		4,523
- rated C to A	(16)		-		(310)		-		722		-		722		385
Other assets
ABS and ABS CDOs1	(247)		(90)		(807)		(33)		7,885		1,539		6,346		4,277
- high grade2	(153)		(71)		(589)		-		5,216		1,370		3,846		2,725
- rated C to A	(94)		(19)		(218)		(13)		1,916		169		1,747		805
- not publicly rated	-		-		-		(20)		753		-		753		747
Total	(2,611)		(102)		(13,099)		(593)		80,368		4,670		75,698		54,262

	2007								At 31 December 2007
Unrealised     gains and     (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
US sub-prime residential mortgage-related assets11
Direct lending	(385)		(251)		-		-		6,288		-		6,288		5,825
MBSs1	(564)		(69)		(290)		-		9,576		657		8,919		7,981
- high grade2	(121)		(10)		(289)		-		9,079		647		8,432		7,807
- rated C to A	(275)		(36)		(1)		-		462		10		452		153
- not publicly rated	(168)		(23)		-		-		35		-		35		21
MBS CDOs1	(21)		-		(45)		-		1,157		652		505		440
- high grade2	(19)		-		(40)		-		923		454		469		411
- rated C to A	(2)		-		(5)		-		234		198		36		29
	(970)		(320)		(335)		-		17,021		1,309		15,712		14,246
US Alt-A residential  mortgage-related assets
Direct lending	-		-		-		-		341		-		341		342
MBSs1	(128)		(36)		(802)		-		19,175		205		18,970		17,708
- high grade2	(122)		(6)		(802)		-		19,099		205		18,894		17,640
- rated C to A	(6)		(30)		-		-		64		-		64		56
- not publicly rated	-		-		-		-		12		-		12		12
	(128)		(36)		(802)		-		19,516		205		19,311		18,050
US government agency  mortgage-related assets
MBSs1
- high grade2	2		3		49		-		5,996		-		5,996		5,995
Balance carried forward	(1,096)		(353)		(1,088)		-		42,533		1,514		41,019		38,291

	2007								At 31 December 2007
Unrealised     gains and     (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Balance brought forward	(1,096)		(353)		(1,088)		-		42,533		1,514		41,019		38,291
US government-sponsored enterprises mortgage-related assets
MBSs1
- high grade2	12		(39)		3		-		16,125		-		16,125		15,904
Other US residential  mortgage-related assets
Direct lending	(10)		(29)		-		-		424		-		424		416
MBSs1	(34)		-		(1)		-		1,587		821		766		756
- high grade2	(30)		-		(1)		-		1,565		799		766		756
- rated C to A	(4)		-		-		-		22		22		-		-
	(44)		(29)		(1)		-		2,011		821		1,190		1,172
Commercial property  mortgage-related assets
MBS and MBS CDOs1	(30)		-		(141)		-		5,981		685		5,296		5,196
- high grade2	(30)		-		(141)		-		5,760		685		5,075		4,983
- not publicly rated	-		-		-		-		221		-		221		213
Leveraged finance-related assets
ABSs and ABS CDOs1
- high grade2	(6)		-		(89)		-		4,930		322		4,608		4,432
Student loan-related assets
ABSs and ABS CDOs1	5		-		(338)		-		7,352		-		7,352		7,196
- high grade2	7		-		(338)		-		7,312		-		7,312		7,159
- rated C to A	(2)		-		-		-		40		-		40		37
Other assets
ABS and ABS CDOs1	(100)		(3)		(134)		-		8,943		2,735		6,208		6,204
- high grade2	(99)		(3)		(134)		-		8,233		2,707		5,526		5,557
- rated C to A	(1)		-		-		-		595		28		567		550
- not publicly rated	-		-		-		-		115		-		115		97
Total	(1,259)		(424)		(1,788)		-		87,875		6,077		81,798		78,395

For footnotes, see page 162.

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

	2008								At 31 December 2008
Unrealised     gains and      (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
UK non-conforming residential mortgage-related assets
MBSs1	(3)		-		(294)		-		1,425		-		1,425		1,100
- high grade2	(1)		-		(268)		-		1,349		-		1,349		1,051
- rated C to A	(2)		-		(26)		-		76		-		76		49
Other UK residential  mortgage-related assets
MBSs1	(47)		(8)		(709)		-		5,781		-		5,781		4,568
- high grade2	(27)		(10)		(694)		-		5,289		-		5,289		4,185
- rated C to A	(20)		2		(15)		-		488		-		488		382
- not publicly rated	-		-		-		-		4		-		4		1
Balance carried forward	(50)		(8)		(1,003)		-		7,206		-		7,206		5,668

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

	2008								At 31 December 2008
Unrealised     gains and      (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Balance brought forward	(50)		(8)		(1,003)		-		7,206		-		7,206		5,668
Commercial property  mortgage-related assets
MBS and MBS CDOs1	(112)		(6)		(571)		-		3,836		-		3,836		3,017
- high grade2	(83)		(6)		(560)		-		3,665		-		3,665		2,910
- rated C to A	(29)		-		(11)		-		156		-		156		101
- not publicly rated	-		-		-		-		15		-		15		6
Leveraged finance-related assets
ABSs and ABS CDOs1
- high grade2	-		-		(77)		-		761		384		377		293
Student loan-related assets
ABSs and ABS CDOs1
- high grade2	-		-		-		-		98		-		98		55
Other assets
ABS and ABS CDOs1	(10)		(4)		(413)		-		7,623		5,102		2,521		1,997
- high grade2	(8)		(4)		(52)		-		1,751		-		1,751		1,607
- rated C to A	(2)		-		(361)		-		770		-		770		390
- not publicly rated	-		-		-		-		5,102		5,102		-		-
Total	(172)		(18)		(2,064)		-		19,524		5,486		14,038		11,030

	2007								At 31 December 2007
Unrealised     gains and      (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
UK non-conforming residential mortgage-related assets
MBSs1	(5)		-		(15)		-		3,355		-		3,355		3,211
- high grade2	(3)		-		(15)		-		3,321		-		3,321		3,183
- rated C to A	(2)		-		-		-		28		-		28		24
- not publicly rated	-		-		-		-		6		-		6		4
Other UK residential  mortgage-related assets
MBSs1	(53)		(14)		(121)		-		5,943		-		5,943		5,640
- high grade2	(22)		(14)		(118)		-		5,411		-		5,411		5,156
- rated C to A	(31)		-		(3)		-		520		-		520		472
- not publicly rated	-		-		-		-		12		-		12		12
Commercial property  mortgage-related assets
MBS and MBS CDOs1	(64)		(2)		(40)		-		5,330		-		5,330		4,902
- high grade2	(54)		(2)		(39)		-		4,437		-		4,437		4,095
- rated C to A	(10)		-		(1)		-		173		-		173		113
- not publicly rated	-		-		-		-		720		-		720		694
Leveraged finance-related assets
ABSs and ABS CDOs1	-		-		(8)		-		675		330		345		336
- high grade2	-		-		(8)		-		366		21		345		336
- not publicly rated	-		-		-		-		309		309		-		-
Other assets
ABS and ABS CDOs1	(13)		-		(38)		-		9,385		6,802		2,583		2,511
- high grade2	(8)		-		(38)		-		2,225		-		2,225		2,170
- rated C to A	(5)		-		-		-		26		-		26		29
- not publicly rated	-		-		-		-		7,134		6,802		332		312
Total	(135)		(16)		(222)		-		24,688		7,132		17,556		16,600

For footnotes, see page 162.

HSBC's consolidated holdings of ABSs, and direct lending held at fair value through profit or loss, other than those supported by US and UK-originated assets

	2008								At 31 December 2008
Unrealised     gains and      (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Non-US and non-UK non- sub-prime residential  mortgage-related assets
MBSs1	-		-		-		(8)		47		-		47		39
- high grade2	-		-		-		(8)		46		-		46		38
- rated C to A	-		-		-		-		1		-		1		1
MBS CDOs1	(15)		-		(3)		-		53		-		53		26
- high grade2	(14)		-		(3)		-		40		-		40		23
- rated C to A	(1)		-		-		-		11		-		11		1
- not publicly rated	-		-		-		-		2		-		2		2
Other non-US and non-UK residential mortgage-related assets
MBSs1	(66)		(27)		(62)		-		2,411		-		2,411		2,051
- high grade2	(59)		(28)		(62)		-		2,184		-		2,184		1,878
- rated C to A	(6)		-		-		-		149		-		149		127
- not publicly rated	(1)		1		-		-		78		-		78		46
Commercial property  mortgage-related assets
MBS and MBS CDOs1	(123)		(2)		(463)		-		3,051		-		3,051		2,311
- high grade2	(91)		(14)		(453)		-		2,928		-		2,928		2,234
- rated C to A	(32)		12		(7)		-		112		-		112		69
- not publicly rated	-		-		(3)		-		11		-		11		8
Leveraged finance-related assets
ABSs and ABS CDOs1
- high grade2	(4)		1		(229)		-		1,419		1		1,418		1,098
Other assets
ABS and ABS CDOs1	(209)		(13)		(241)		(51)		5,604		1,853		3,751		3,188
- high grade2	(168)		(6)		(92)		-		4,379		1,679		2,700		2,199
- rated C to A	(41)		(7)		(149)		-		906		174		732		707
- not publicly rated	-		-		-		(51)		319		-		319		282
Total	(417)		(41)		(998)		(59)		12,585		1,854		10,731		8,713

	2007								At 31 December 2007
Unrealised     gains and      (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Non-US and non-UK non- sub-prime residential  mortgage-related assets
MBSs1	-		-		-		-		624		-		624		385
- high grade2	-		-		-		-		447		-		447		279
- rated C to A	-		-		-		-		104		-		104		38
- not publicly rated	-		-		-		-		73		-		73		68
Other non-US and non-UK residential mortgage-related assets
MBSs1	(20)		(10)		(6)		-		4,001		814		3,187		3,055
- high grade2	(16)		(8)		(6)		-		3,703		710		2,993		2,869
- rated C to A	(6)		-		-		-		130		90		40		36
- not publicly rated	2		(2)		-		-		168		14		154		150
Balance carried forward	(20)		(10)		(6)		-		4,625		814		3,811		3,440

HSBC's consolidated holdings of ABSs, and direct lending held at fair value through profit or loss, other than those supported by US and UK-originated assets (continued)

	2007								At 31 December 2007
Unrealised     gains and      (losses)3			Realised     gains and      (losses)4	Fair value    movements     through      equity5		Impair-    ment	Impair-     ment6		Gross     principal7		CDS     gross     protection8		Net     principal     exposure9		Carrying     amount10
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Balance brought forward	(20)		(10)		(6)		-		4,625		814		3,811		3,440
Commercial property  mortgage-related assets
MBS and MBS CDOs1	(9)		-		(20)		-		3,576		238		3,338		3,051
- high grade2	(6)		-		(20)		-		3,212		102		3,110		2,827
- rated C to A	(3)		-		-		-		185		136		49		49
- not publicly rated	-		-		-		-		179		-		179		175
Leveraged finance-related assets
ABSs and ABS CDOs1	(3)		-		(20)		-		1,356		3		1,353		1,315
- high grade2	(3)		-		(20)		-		1,281		2		1,279		1,244
- not publicly rated	-		-		-		-		75		1		74		71
Other assets
Direct lending	-		-		-		-		3		-		3		3
ABS and ABS CDOs1	(2)		6		(18)		(36)		7,929		1,702		6,227		6,113
- high grade2	(5)		(2)		(18)		(36)		7,310		1,443		5,867		5,550
- rated C to A	-		5		-		-		547		259		288		522
- not publicly rated	3		3		-		-		72		-		72		41
	(2)		6		(18)		(36)		7,932		1,702		6,230		6,116
Total	(34)		(4)		(64)		(36)		17,489		2,757		14,732		13,922

For footnotes, see page 162.

The following table shows the vintages of the collateral assets supporting HSBC's holdings of US sub-prime and Alt-A MBSs. Market prices for these instruments generally incorporate higher discounts for later vintages. The majority of HSBC's holdings of US sub-prime MBSs are originated pre-2007; holdings of US Alt-A MBSs are more evenly distributed between pre- and post-2007 vintages.

Vintages of US sub-prime and Alt-A mortgage-backed securities

	Gross principal7 of US sub-prime mortgage-backed securities  at 31 December				Gross principal7     of US Alt-A mortgage-backed securities  at 31 December
	2008		2007		2008		2007
	US$m		US$m		US$m		US$m
Mortgage vintage
Pre-2006	2,012		3,170		2,695		2,870
2006	4,287		5,186		7,712		7,777
2007	1,588		2,377		6,453		8,528
	7,887		10,733		16,860		19,175

For footnotes, see page 162.

Transactions with monoline insurers

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

HSBC's principal exposure to monolines is through a number of over-the-counter ('OTC') derivative transactions, mainly credit default swaps ('CDS's). HSBC entered into these CDSs primarily to purchase credit protection against securities held within the trading portfolio.

During 2008, the notional value of contracts with monolines decreased as certain transactions were commuted and others matured. Nevertheless, HSBC's overall credit exposure to monolines increased as the fair value of the underlying securities declined, causing the value of the CDS protection purchased to increase. The table below sets out the fair value, essentially the replacement cost, of the derivative transactions at 31 December 2008, 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. In order to illustrate that risk, the value of protection purchased is shown subdivided between those monolines that were rated by S&P at 'BBB or above' at 31 December 2008, and those that were 'below BBB' ('BBB' is the S&P cut-off for an investment grade classification). As certain monolines were downgraded during 2008, exposure to monolines rated 'below BBB' at 31 December 2008 increased from the position as at 31 December 2007. The 'Credit risk adjustment' column indicates the valuation adjustment (the provision) taken against the net exposures, and reflects the assessed 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.

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

	Notional     amount	Net exposure     before credit     risk adjustment12			Credit risk     adjustment13		Net exposure     after credit      risk adjustment
	US$m		US$m		US$m		US$m
At 31 December 2008
Derivative transactions with monoline counterparties
Monoline - BBB or above	9,627		2,829		(740)		2,089
Monoline - below BBB	2,731		1,104		(752)		352
	12,358		3,933		(1,492)		2,441
At 31 December 2007
Derivative transactions with monoline counterparties
Monoline - BBB or above	14,314		1,342		(133)		1,209
Monoline - below BBB	1,120		214		(214)		-
	15,434		1,556		(347)		1,209

For footnotes, see page 162.

The above table can be analysed as follows. HSBC has derivative transactions referenced to underlying securities with a nominal value of US$12.4 billion, whose value at 31 December 2008 indicated a potential claim against the protection purchased from the monolines of some US$3.9 billion. On the basis of a credit assessment of the standing of the monolines, a provision of US$1.5 billion has been taken, leaving US$2.4 billion exposed, of which US$2.1 billion is recoverable from monolines rated investment grade at 31 December 2008. The provisions taken imply in aggregate that 74 cents in the dollar will be recoverable from investment grade monolines and 32 cents in the dollar from non-investment grade monolines.

HSBC's exposure to direct lending and irrevocable commitments to lend to monoline insurers

HSBC has outstanding liquidity facilities totalling US$47 million to monoline insurers, of which US$2 million was drawn at 31 December 2008 (2007: US$158 million, none drawn).

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

Within both the trading and available-for-sale portfolios, HSBC holds bonds that are 'wrapped' with a credit enhancement from a monoline insurer. As the bonds are traded explicitly with the benefit of this enhancement, any deterioration in the credit profile of the monoline insurer is reflected in market prices and, therefore, in the carrying amount of these securities on HSBC's balance sheet at 31 December 2008. For wrapped bonds held in the 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 on page 145. 

HSBC's exposure to Credit Derivative Product Companies 

CDPCs are independent companies that specialise in selling credit default protection on corporate exposures. As corporate credit spreads widened during the second half of 2008, increasing the potential value of claims against the CDPCs, the creditworthiness of CDPCs became a focus. At 31 December 2008, HSBC had purchased credit protection from CDPCs with a notional value of US$6.4 billion (2007: US$5.7 billion) which had a fair value (essentially, replacement cost) of US$1.2 billion (2007: US$218 million), against which a credit risk adjustment (a provision) of US$228 million (2007: nil) was held. All of the fair value exposures at 31 December 2008 and 2007 represented exposure to CDPCs with investment grade ratings.

Leveraged finance transactions

Leveraged finance transactions include sub-investment grade acquisition or event-driven financing. During the second half of 2008, HSBC reclassified US$6.5 billion of leveraged finance loans from the held-for-trading category to loans and receivables as detailed on page 146 as its intention now is to hold these assets for the foreseeable future or until maturity. Impairment on these reclassified assets is now recognised on an incurred loss basis. The following tables show HSBC's gross commitments and exposure to leveraged finance transactions arising from primary transactions and the movement in that leveraged finance exposure in the year. HSBC's additional exposure to leveraged finance loans through holdings of ABSs from its trading and investment activities is shown in the tables on pages 151 and 152.

HSBC's gross commitments to leveraged finance transactions by geographical segment

	Funded     commitments		Unfunded    commitments		Total      commitments
	US$m		US$m		US$m
At 31 December 2008
Europe	3,818		543		4,361
Rest of Asia-Pacific	25		12		37
North America	1,987		268		2,255
	5,830		823		6,653

	Funded     commitments		Unfunded    commitments		Total      commitments
	US$m		US$m		US$m
At 31 December 2007
Europe	4,004		1,822		5,826
Hong Kong	-		160		160
Rest of Asia-Pacific	45		182		227
North America	1,991		733		2,724
	6,040		2,897		8,937

HSBC's exposure to leveraged finance transactions

	At 31 December
	Funded     exposures14		Unfunded     exposures15		Total      exposures
	US$m		US$m		US$m
2008
Europe	3,554		480		4,034
Rest of Asia-Pacific	25		12		37
North America	1,825		258		2,083
	5,404		750		6,154
Held within:
- loans and receivables	5,401		482		5,883
- fair value through the profit or loss	3		268		271

	At 31 December
	Funded     exposures14		Unfunded     exposures15		Total      exposures
	US$m		US$m		US$m
2007
Europe	3,903		1,813		5,716
Hong Kong	-		160		160
Rest of Asia-Pacific	45		182		227
North America	1,917		722		2,639
	5,865		2,877		8,742
Held within:
- loans and receivables	424		546		970
- fair value through the profit or loss	5,441		2,331		7,772

For footnotes, see page 162.

Movement in leveraged finance exposures

			Funded     exposures14		Unfunded     exposures15		Total      exposures
			US$m		US$m		US$m
At 31 December 2007			5,865		2,877		8,742
Additions			128		647		775
Fundings			834		(834)		-
Sales, repayments and other movements			(1,184)		(1,875)		(3,059)
Write-downs			(239)		(65)		(304)
At 31 December 2008			5,404		750		6,154

For footnotes, see page 162.

The fall in unfunded exposures during 2008 primarily relates to the depreciation in sterling against the US dollar.

As described in the background to market turmoil on page 144, the dislocation of financial markets developed in the second half of 2007 and continued throughout 2008. Consequently, income statement write-downs on leveraged finance transactions are presented for the three half-year periods affected to date.

	Half-year to
	31 December     2008		30 June      2008		31 December    2007
	US$m		US$m		US$m
Write-downs taken to income statement	-		278		195
Impairment of leveraged finance loans taken to the income statement	26		-		-

For footnotes, see page 162.

As a result of the reclassification of certain leveraged finance loans from held-for-trading to loans and receivables, write-downs of US$1.2 billion were not taken to the income statement for the half year to 31 December 2008.

At 31 December 2008, HSBC's principal exposures were to companies in two sectors: 

US$3.6 billion to data processing (2007: US$3.8 billion) and US$1.7 billion to communications and infrastructure (2007: US$2.7 billion). During the year, 99 per cent of the total write-downs were against exposures in these two sectors.

Footnotes to 'Nature and extent of HSBC's exposures'

  1    Mortgage-backed securities ('MBSs'), asset-backed securities ('ABSs') and collateralised debt obligations ('CDOs').

      2    High grade assets rated AA or AAA.

      3    Unrealised gains and losses on the net principal exposure (see footnote 9) recognised in the income statement as a result of changes in the fair value of the asset, adjusted for the cumulative amount of transfers to realised gains and losses as a result of the disposal of assets. 

      4    Realised gains and losses on the net principal exposure (see footnote 9) recognised in the income statement as a result of the disposal of assets.

  5    Fair value gains and losses on the net principal exposure (see footnote 9) recognised in equity as a result of the changes in the fair value of available-for-sale assets, adjusted for transfers from the available-for-sale reserve to the income statement as a result of impairment, and adjusted for transfers to realised gains and losses following the disposal of assets.

      6    Impairment losses recognised in the income statement in respect of the net principal exposure (see footnote 9) of available-for-sale and held-to-maturity assets.

      7    The gross principal is the redemption amount on maturity or, in the case of an amortising instrument, the sum of the future redemption amounts through the residual life of the security.

  8    A CDS is a credit default swap. CDS gross protection is the gross principal of the underlying instrument that is protected by CDSs.

  9    Net principal exposure is the gross principal amount of assets that are not protected by CDSs. It includes assets that benefit from monoline protection, except where this protection is purchased with a CDS.

    10    Carrying amount of the net principal exposure.

    11    During 2008, the Group reclassified holdings of HELoCs to US sub-prime residential mortgage-related assets from Other US residential mortgage-related assets, and restated the amounts of certain direct lending exposures presented in the ABS tables to show the gross carrying amount of assets on the consolidated balance sheet rather than the net exposure, consistent with other direct lending exposures. 2007 amounts have been restated accordingly, resulting in an increase of US$6.3 billion in the reported balance of US subߛprime mortgage-related assets as at 31 December 2007.

    12    Net exposure after legal netting and any other relevant credit mitigation prior to deduction of the credit risk adjustment.

13    Cumulative fair value adjustment recorded against OTC derivative counterparty exposures to reflect the creditworthiness of the counterparty. 

14    Funded exposure represents the loan amount advanced to the customer, less any fair value write-downs, net of fees held on deposit.

15    Unfunded exposures represent the contractually committed loan facility amount not yet drawn down by the customer, less any fair value write-downs, net of fees held on deposit.

Fair values of financial instruments

(Audited)

The classification of financial instruments is determined in accordance with the accounting policies set out in Note 2 on the Financial Statements, and the use of assumptions and estimation in respect of valuation of financial instruments as described on page 63. The following is a description of HSBC's methods of determining fair value and its related control framework, and a quantification of its exposure to financial instruments measured at fair value.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. 

Financial instruments measured at fair value on an ongoing basis include trading assets and liabilities, instruments designated at fair value, derivatives and financial investments classified as available for sale (including treasury and other eligible bills, debt securities, and equity securities).

Fair values of financial instruments carried at fair value

Control framework

Fair values are subject to a control framework designed to ensure that they are either determined or validated by a function independent of the risk-taker. To this end, ultimate responsibility for the determination of fair values lies with Finance, which reports functionally to the Group Finance Director. Finance establishes the accounting policies and procedures governing valuation, and is responsible for ensuring that they comply with all relevant accounting standards.

For all financial instruments where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent price determination or validation is utilised. In inactive markets, direct observation of a traded price may not be possible. In these circumstances, HSBC will source alternative market information to validate the financial instrument's fair value, with greater weight given to information that is considered to be more relevant and reliable. The factors that are considered in this regard are, inter alia:

• the extent to which prices may be expected to represent genuine traded or tradeable prices;

  • the degree of similarity between financial instruments;

• the degree of consistency between different sources;

• the process followed by the pricing provider to derive the data;

 

END

 

 

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