Interim Report - 10 of 21

RNS Number : 9187Q

HSBC Holdings PLC

13 August 2010

 



Background and disclosure policy

Following the market turmoil which began in 2007, there was a modest recovery in the risk appetite of investors in 2009. The first quarter of 2010 saw renewed uncertainty regarding the future growth prospects of the global economy, however, and concerns over sovereign credit risk that began in Greece and extended to other obligors, particularly in Southern Europe. As a result, the second quarter of 2010 saw significant falls in the prices of many assets perceived to be of higher risk, although some stability was regained with the announcement of a package of measures by the EU and the International Monetary Fund.

Widespread downgrading of securitised assets continued in the first half of 2010 as rating agencies changed their rating methodologies in response to the new circumstances. Although these downgrades were largely expected and did not affect management's loss estimates, for those institutions subject to the Basel II framework, which ties capital requirements to external credit ratings, the appetite for securitised assets remained limited regardless of the actual level of expected loss on the securities.

Although the general environment remained difficult, some positive developments were observed in securities supported by US sub-prime and Alt-A mortgages. The prices of the securitised assets had been depressed due to expected further deterioration in the value of the supporting collateral. However, the first half of 2010 saw a stabilisation and in some areas a modest increase in house prices. This, combined with the continued low interest rate environment, contributed to a rise in the price of these securitised assets.

Notwithstanding the renewed uncertainty in the first half of 2010, the levels of write-downs and losses on holdings of structured assets remained modest.

This section contains disclosures about the effect of the market turmoil on HSBC's securitisation exposures and other structured products. HSBC's principal exposures to the US and the UK mortgage markets take the form of credit risk from direct loans and advances to customers which were originated to be held to maturity or refinancing. Details are provided on page 152.

Financial instruments which were most affected by the market turmoil include exposures to direct lending which are held at fair value through profit or

loss, or are classified as available for sale and are also held at fair value. Financial instruments included in these categories comprise asset-backed securities ('ABS's), including mortgage-backed securities ('MBS's) and collateralised debt obligations ('CDO's), exposures to and contingent claims on monoline insurers ('monolines') in respect of structured credit activities and leveraged finance transactions originated for distribution.

In accordance with HSBC's policy to provide meaningful disclosures that help investors and other stakeholders understand the Group's performance, financial position and changes thereto, the information provided in this section goes beyond the minimum levels required by accounting standards, statutory and regulatory requirements and listing rules.

HSBC has voluntarily adopted the draft British Bankers' Association Code on Financial Reporting Disclosure ('the draft BBA Code') with effect from its Annual Report and Accounts 2009. The draft code sets out five disclosure principles together with supporting guidance. These principles have been applied, as appropriate, in the context of the Interim Report 2010.

In order to facilitate an understanding of the turmoil in markets for securitised and structured assets and in line with the principles of the draft BBA Code, HSBC has continued to assess good practice recommendations issued from time to time by relevant regulators and standard setters, including the 'Assessment of banks' transparency in their 2009 audited annual reports' recently published by the Committee of European Banking Supervisors.

The particular 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

At 30 June 2010, the aggregate carrying amount of HSBC's exposure to ABSs, trading loans held for securitisation and exposure to leveraged finance transactions, including securities mitigated by credit derivatives with monolines and other financial institutions, was US$79.7 billion (30 June 2009: US$77.9 billion; 31 December 2009: US$78.8 billion), as summarised in the table below. The majority of these exposures arose in Global Banking and Markets.

HSBC's holdings of available-for-sale ABSs increased by US$5 billion to US$53 billion. The associated AFS reserve deficit improved by US$4 billion to US$8 billion.

Within the total carrying amount of ABSs on the balance sheet, ABS holdings of US$13.8 billion (30 June 2009: US$12.9 billion; 31 December 2009: US$14.0 billion) are held through vehicles discussed on page 101, where significant first loss protection is provided by external investors on a fully collateralised basis. This includes US$3.3 billion (30 June 2009: US$3.3 billion; 31 December 2009: US$3.3 billion) in respect of sub-prime and Alt‑A residential mortgage exposure.

Overall exposure of HSBC

	At 30 June 2010				At 30 June 2009				At 31 December 2009
	Carrying      amount		Including sub-prime   and Alt-A		Carrying        amount		Including    sub-prime    and Alt-A		Carrying        amount		Including    sub-prime    and Alt-A
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
ABSs ........................................................	72.6		9.4		69.0		10.6		70.6		10.8
- fair value through profit or loss ..............	10.8		0.5		11.4		0.8		12.1		0.7
- available for sale1 ...................................	53.2		7.5		47.1		7.9		48.1		8.2
- held to maturity1 ....................................	2.4		0.2		2.6		0.2		2.5		0.2
- loans and receivables ..............................	6.2		1.2		7.9		1.7		7.9		1.7
Loans at fair value through profit or loss ..	1.9		1.5		2.6		2.1		2.0		1.6
Total ABS and direct lending at fair value through profit or loss ............................	74.5		10.9		71.6		12.7		72.6		12.4
Less securities mitigated by credit derivatives with monolines and other financial institutions .............................	(8.6)		(0.6)		(9.2)		(0.8)		(10.2)		(1.0)
	65.9		10.3		62.4		11.9		62.4		11.4
Leveraged finance loans ...........................	5.2		-		6.3		-		6.2		-
- fair value through profit or loss ..............	0.2		-		0.3		-		0.2		-
- loans and receivables ..............................	5.0		-		6.0		-		6.0		-
	71.1		10.3		68.7		11.9		68.6		11.4
Exposure including securities mitigated by credit derivatives with monoline ...........	79.7		10.9		77.9		12.7		78.8		12.4

For footnote, see page 137.

Reconciliation of movement in carrying amount of ABSs

	Half-year to           30 June                2010
	US$bn
Balance at 1 January 2010...............................................................................................................................	70.6
Net ABS acquisitions (principally of US Government agency and sponsored enterprises) ................................	6.8
Principal amortisation of available-for-sale ABSs (repayment at par) .............................................................	(3.3)
Movement on fair values of available-for-sale ABSs .......................................................................................	2.7
Net sales, principal amortisation and write-downs of ABSs ..............................................................................	(2.7)
Exchange differences and other movements ...................................................................................................	(1.5)
Balance at 30 June 2010 .................................................................................................................................	72.6

Reclassification of financial assets

The accounting policy for reclassification is set out on page 370 of the Annual Report and Accounts 2009.

During the second half of 2008, HSBC reclassified US$15.3 billion and US$2.6 billion of financial assets from the held-for-trading category to the loans and receivables and available-for-sale classifications, respectively. The effect on HSBC's profit before tax if the reclassifications had not been made, are tabulated below. HSBC has not undertaken any further reclassifications.

Reclassifications of HSBC's financial assets

	At 30 June 2010				At 30 June 2009				At 31 December 2009
	Carrying      amount		Fair          value		Carrying        amount		Fair           value		Carrying        amount		Fair           value
	US$m		US$m		US$m		US$m		US$m		US$m
Reclassification to loans and receivables
ABSs ........................................................	6,172		4,947		7,827		5,266		7,827		6,177
Trading loans - commercial mortgage loans .	484		440		605		551		553		506
Leveraged finance and syndicated loans ........	5,015		4,338		5,720		4,758		5,824		5,434
	11,671		9,725		14,152		10,575		14,204		12,117
Reclassification to available for sale
Corporate debt and other securities ...........	103		103		2,156		2,156		1,408		1,408
	11,774		9,828		16,308		12,731		15,612		13,525

Reconciliation of effect on profit before tax if reclassifications had not occurred

	Half-year to
	30 June		30 June		31 December
	2010		2009		2009
	US$m		US$m		US$m
Reported profit before tax .........................................................................	11,104		5,019		2,060
Profit before tax if reclassifications had not been made ..............................	11,093		4,758		3,820
Increase/(reduction) in profit before tax from reclassification ....................	11		261		(1,760)
	US$m		US$m		US$m
Attributable to increase/(reduction) in profit before tax in:
Europe ...................................................................................................	(82)		494		(1,425)
North America .......................................................................................	32		(238)		(379)
Middle East ............................................................................................	61		5		44

The following table shows the fair value gains and losses, income and expense recognised in the income statement and shows the impact that would have occurred if no reclassification had taken place.

HSBC's fair value gains and losses, income and expense

	Effect on income statement for half-year to 30 June 2010
	Recorded in the income    statement2		Assuming   no reclass-       ification3		Net effect    of reclass-       ification
	US$m		US$m		US$m
Financial assets reclassified to loans and receivables
ABSs ....................................................................................................................	214		538		(324)
Trading loans - commercial mortgage loans .........................................................	12		10		2
Leveraged finance and syndicated loans ................................................................	177		(170)		347
	403		378		25
Financial assets reclassified to available for sale
Corporate debt and other securities ......................................................................	55		69		(14)
	458		447		11

HSBC's fair value gains and losses, income and expense (continued)

	Effect on income statement for half-year to 30 June 2009						Effect on income statement for half-year to 31 December 2009
	Recorded in    the income      statement2		Assuming     no reclass-         ification3		Net effect      of reclass-         ification		Recorded in    the income      statement2		Assuming     no reclass-         ification3		Net effect      of reclass-         ification
	US$m		US$m		US$m		US$m		US$m		US$m
Financial assets reclassified to loans and receivables
ABSs .........................................	243		(466)		709		268		1,233		(965)
Trading loans - commercial mortgage loans .....................	15		(8)		23		17		23		(6)
Leveraged finance and syndicated loans ....................	210		679		(469)		224		815		(591)
	468		205		263		509		2,071		(1,562)
Financial assets reclassified to available for sale
Corporate debt and other securities ...............................	36		38		(2)		65		263		(198)
	504		243		261		574		2,334		(1,760)

For footnotes, see page 137.

Financial effect of market turmoil

The write-downs incurred by the Group for the last three half-year periods 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. Virtually all of these effects were recorded in Global Banking and Markets. Further analyses of the write-downs taken to the income statement by Global Banking and Markets and the net carrying amounts of the positions that generated these write-downs are shown in the succeeding table:

Financial effect of market turmoil on HSBC

	Half-year to
	30 June                2010		30 June                2009		31 December                2009
	US$bn		US$bn	US$bn	US$bn
(Write-downs)/write-backs taken to income statement ............................	0.1		(1.3)		(0.6)
Net movement on available-for-sale reserve on ABSs in the period .........	4.1		1.2		5.3
Closing balance of available-for-sale reserve relating to ABSs ..................	(8.1)		(17.5)		(12.2)

Global Banking and Markets write-downs/(write-backs) taken to the income statement and carrying amounts 

	Write-downs/(write-backs) during half-year to						Carrying amount at
	30 June             2010		30 June             2009		31 December              2009		30 June             2010		30 June            2009		31 December              2009
	US$m		US$m		US$m		US$m		US$m		US$m
Sub-prime mortgage-related assets
- loan securitisation ........................	(49)		156		80		478		943		758
- credit trading ...............................	(32)		83		17		146		303		282
Other ABSs ....................................	(125)		103		(196)		959		1,376		990
Impairments on reclassified assets ..	(25)		160		3		11,774		16,308		15,612
Derivative exposure to monolines
- investment grade counterparts .....	(6)		25		(78)		828		1,593		897
- non-investment grade counterparts ....................................................	(117)		241		45		276		510		408
Leveraged finance loans4 ....................	(30)		(11)		(120)		154		285		196
Other credit related items ...................	(3)		5		(19)		25		116		61
Available-for-sale impairments and other non-trading related items ...	256		564		833
	(131)		1,326		565

For footnote, see page 137.

Asset-backed securities classified as available for sale

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

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

The table below summarises the Group's exposure to ABSs which are classified as available for sale. The methodology used to determine the fair valuation of the securities and hence the available for sale reserve is described on page 114.

Available-for-sale ABSs exposure

	At 30 June 2010						At 30 June 2009						At 31 December 2009
	Directly       held/ Solitaire5		SPEs		Total		Directly        held/ Solitaire5		SPEs		Total		Directly        held/ Solitaire5		SPEs		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
Total carrying amount of net principal exposure ........................................................................................................	39,391		13,774		53,165		34,153		12,898		47,051		34,040		14,021		48,061
Total available-for-sale reserves ..................	(4,914)		(3,168)		(8,082)		(10,898)		(6,587)		(17,485)		(7,349)		(4,864)		(12,213)

	Half-year to 30 June 2010						Half-year to 30 June 2009						Half-year to 31 December 2009
	Directly       held/ Solitaire5		SPEs		Total		Directly        held/ Solitaire5		SPEs		Total		Directly        held/ Solitaire5		SPEs		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
Impairment charge:
- borne by HSBC .....................	277		-		277		539		-		539		883		-		883
- allocated to capital note holders6 ...............................	-		488		488		-		646		646		-		20		20
Total impairment charge .............	277		488		765		539		646		1,185		883		20		903

For footnotes, see page 137.

Securities investment conduits (special purpose entities)

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

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.

The economic first loss protection remaining at 30 June 2010 amounted to US$2.2 billion (30 June 2009: US$2.2 billion; 31 December 2009: US$2.2 billion).

On an IFRSs accounting basis, the carrying value of the liability for the capital notes at 30 June 2010 amounted to US$0.3 billion (30 June 2009: US$0.6 billion; 31 December 2009: US$0.7 billion). The impairment charge recognised during the first half of 2010 amounted to US$488 million (first half of 2009: US$646 million; second half of 2009: US$20 million).

At 30 June 2010, the available-for-sale reserve in respect of securities held by the SICs was a deficit of US$3.4 billion (30 June 2009: US$7.7 billion; 31 December 2009: US$5.2 billion). Of this, US$3.2 billion related to ABSs (30 June 2009: US$6.6 billion; 31 December 2009: US$4.9 billion).

Impairments recognised during the first half of 2010 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 and from drawings against the liquidity facility provided by HSBC, were US$277 million (first half of 2009: US$539 million; second half of 2009: US$883 million), based on a notional principal value of securities which were impaired of US$0.4 billion (30 June 2009: US$0.7 billion; 31 December 2009: US$2.6 billion). The reduction in impairment charges compared with the first half of 2009 is due to the stabilising of loss severities and delinquency roll rates which have resulted in lower losses in the underlying collateral pools causing losses in the assets held. The 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 judges that the assets which are most sensitive to possible future impairment are sub-prime and Alt-A residential MBSs within HSBC's holdings of available-for-sale ABSs.

Excluding those held in the SPEs discussed above, available-for-sale holdings in these higher risk categories amounted to US$4.2 billion at 30 June 2010 (30 June 2009: US$4.6 billion; 31 December 2009: US$4.9 billion). The deficit in the available-for-sale fair value reserve at 30 June 2010 in relation to these securities was US$3.3 billion (30 June 2009: US$5.0 billion; 31 December 2009: US$4.3 billion).

Details of HSBC's methodology for assessing available-for-sale ABSs for objective evidence of impairment at each balance sheet date, are described on page 122.

Available-for-sale ABS impairment and cash loss projections

At 31 December 2009, management undertook an analysis of the portfolio to estimate the further potential impairments and expected cash losses on the available-for-sale ABS portfolio. This exercise comprised a shift of projections of future loss severities, default rates and prepayment rates. The analysis showed that the portfolio is now primarily sensitive to impairments arising on Alt-A securities. The sensitivity of Global Banking and Markets' available-for-sale ABS positions to the loss of protection from monolines reduced during 2009 and is no longer expected to be a significant contributor to future impairment charges. The results of the analysis indicate that further impairment charges of some US$1.1 billion and expected cash losses of some US$450 million could arise over the next two to three years. At 30 June 2010, management re-performed the stress test and the outcome, taking into account the impairment charges in 2010, was consistent with the exercise at 31 December 2009.

HSBC's regular impairment assessment utilises an industry standard valuation model which uses data with reference to the underlying asset pools and models the future projected cash flows of the underlying pools. The key assumptions and inputs to the models are the delinquency status of the underlying loans, the probability of delinquent loans progressing to default, the proportion of assets subsequently recoverable, the prepayment profiles of the underlying assets and the loss severity in the event of default. The projected cash flows of the pools are then used to determine whether payment of principal and interest on the securities held by HSBC will be made. For the purposes of identifying impairment at the reporting date, the future projected cash flows reflect the effect of loss events that have occurred at or prior to the reporting date. For the purposes of performing stress tests to estimate potential future impairment charges, the future projected cash flows reflect additional assumptions about future loss events after the balance sheet date.

This analysis makes assumptions in respect of the future behaviour of loss severities, default rates and prepayment rates. Movements in the parameters are not independent of each other. For example, increased default rates and increased loss severities, which would imply greater impairments, generally arise under economic conditions that give rise to reduced levels of prepayment, reducing the potential for impairment charges. Conversely, economic conditions which increase the rates of prepayment are generally associated with reduced default rates and decreased loss severities. The assumptions used by management in the roll-forward analysis have been set in the context of further increases in loss severities and raised levels of default rates partly offset by stable prepayment rates in the short to medium term.

At 30 June 2010, the incurred and projected impairment charges measured for accounting purposes significantly exceeded the expected cash losses on the securities. Over the lives of the available-for-sale ABSs the cumulative impairment charges will converge towards the level of cash losses.

Business model

Asset-backed securities and leveraged finance

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

·     purchasing US mortgage loans with the intention of structuring and placing securitisations into the market;

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

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

·     holding MBSs and other ABSs as part of investment portfolios, including the structured investment vehicles ('SIV's), SICs and money market funds described under 'Special purpose entities' below, with the intention of earning net interest income and management fees;

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

·     originating leveraged finance 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.

These activities are not 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.

Special purpose entities

HSBC enters into certain transactions with customers in the ordinary course of business which involves 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 in this way 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 125.

Risk management

The effect of the 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 policies and procedures in response to the market conditions are set out in the following sections:

·     Credit risk - 'Credit exposure' (see page 141);

·     Liquidity risk - 'The impact of market turmoil on liquidity risk' (see page 175); and

·     Market risk - 'The impact of market turmoil on market risk' (see page 177).

Accounting policies

HSBC's accounting policies regarding the classification and valuation of financial instruments are described in the accounting policies on pages 369 to 385 of the Annual Report and Accounts 2009, and the use of assumptions and estimation in respect of the valuation of financial instruments is described on page 63 of the Annual Report and Accounts 2009.

Nature and extent of HSBC's exposures

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; 

·     monolines;

·     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 Alt‑A exposures is classified as sub-prime.

CDOs are securities in which ABSs and/or 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 include exposure to sub-prime mortgage assets where these are part of the underlying assets or reference assets. As there can be uncertainty surrounding the precise nature of the underlying collateral supporting CDOs, all CDOs supported by residential mortgage-related assets, irrespective of the level of sub-prime assets referenced or contained therein, 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 or high debt-to-income ratios or have experienced credit problems caused by occasional delinquencies,

prior charge-offs, bankruptcy or other credit-related actions. For US mortgages, standard US credit scores are primarily used to determine whether a loan is sub-prime. US Home Equity Lines of Credit ('HELoC's) are classified as sub-prime. For non-US mortgages, management judgement is used to identify loans with similar risk characteristics to sub-prime, for example, UK non-conforming mortgages (see below);

·     US Home Equity Lines of Credit: 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 fully conforming standard criteria. US credit scores, as well as the level and completeness of mortgage documentation held (such as whether there is proof of income), are considered when determining whether an Alt-A classification is appropriate. Mortgages in the US which are not eligible to be sold to the major government sponsored mortgage agencies, Ginnie Mae (Government National Mortgage Association), Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation), are classified as Alt-A if they do not meet the criteria for classification as sub-prime;

·     US Government agency and US Government sponsored enterprises mortgage-related assets: securities that are guaranteed by US Government agencies, such as Ginnie Mae, or 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.

Included in the tables on pages 105 to 109 are ABSs which are held through SPEs that are consolidated by HSBC. Although HSBC consolidates these assets in full, 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 125.

The exposures detailed in the table on page 105 include long positions where risk is mitigated by specific credit derivatives with monolines and other financial institutions. These positions comprise:

·     residential MBSs with a carrying amount of US$0.6 billion (30 June 2009: US$0.9 billion; 31 December 2009: US$1.0 billion);

·     residential MBS CDOs with a carrying amount of US$13 million (30 June 2009: US$16 million; 31 December 2009: US$15 million); and

·     ABSs other than residential MBSs and MBS CDOs with a carrying amount of US$8.0 billion (30 June 2009: US$8.3 billion; 31 December 2009: US$9.2 billion).

In the tables on pages 107 to 109, carrying amounts and gains and losses are given for securities except those where risk is mitigated through specific credit derivatives with monolines, as detailed above, with a total carrying amount of US$8.6 billion (30 June 2009: US$9.2 billion; 31 December 2009: US$10.2 billion). The counterparty credit risk arising from the derivative transactions undertaken with monolines is covered in the monoline exposure analysis on page 111.

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

	Trading		Available     for sale		Held to   maturity	Designated at fair value      through      profit or loss			Loans and receivables		Total	Of which             held through consolidated            SPEs
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2010
Mortgage-related assets: Sub-prime residential ..........	1,891		2,626		-		-		658		5,175		3,077
Direct lending .................	1,438		-		-		-		-		1,438		883
MBSs and MBS CDOs7 ....	453		2,626		-		-		658		3,737		2,194
US Alt-A residential............	115		4,907		193		-		536		5,751		3,720
Direct lending .................	102		-		-		-		-		102		-
MBSs7 ............................	13		4,907		193		-		536		5,649		3,720
US Government agency and sponsored enterprises
MBSs7 ............................	472		19,341		2,254		-		-		22,067		347
Other residential..................	1,243		4,063		-		59		1,303		6,668		2,771
Direct lending .................	348		-		-		-		-		348		2,735
MBSs7 ............................	895		4,063		-		59		1,303		6,320		36
Commercial property
MBSs and MBS CDOs7 ....	751		8,111		-		75		1,905		10,842		6,470
	4,472		39,048		2,447		134		4,402		50,503		16,385
Leveraged finance-related assets
ABSs and ABS CDOs7 .........	413		6,310		-		-		516		7,239		4,173
Student loan-related assets
ABSs and ABS CDOs7 .........	141		5,241		-		-		144		5,526		4,192
Other assets
ABSs and ABS CDOs7 .........	1,715		2,566		-		5,852		1,116		11,249		2,439
	6,741		53,165		2,447		5,986		6,178		74,517		27,189
At 30 June 2009
Mortgage-related assets: Sub-prime residential ..........	2,498		2,876		-		-		732		6,106		3,156
Direct lending .................	1,923		-		-		-		-		1,923		864
MBSs and MBS CDOs7 ....	575		2,876		-		-		732		4,183		2,292
US Alt-A residential ...........	371		5,057		190		-		953		6,571		3,356
Direct lending .................	207		-		-		-		-		207		-
MBSs7 ............................	164		5,057		190		-		953		6,364		3,356
US Government agency and sponsored enterprises
MBSs7 ............................	102		14,074		2,388		-		-		16,564		-
Other residential..................	1,274		4,175		-		25		1,262		6,736		2,801
Direct lending .................	498		-		-		-		-		498		-
MBSs7 ............................	776		4,175		-		25		1,262		6,238		2,801
Commercial property
MBSs and MBS CDOs7 ....	390		6,575		-		227		2,126		9,318		4,815
	4,635		32,757		2,578		252		5,073		45,295		14,128
Leveraged finance-related assets
ABSs and ABS CDOs7 .........	252		4,690		-		-		563		5,505		3,825
Student loan-related assets
ABSs and ABS CDOs7 .........	203		5,136		-		-		141		5,480		4,334
Other assets
ABSs and ABS CDOs7 .........	2,409		4,468		-		6,346		2,092		15,315		2,726
	7,499		47,051		2,578		6,598		7,869		71,595		25,013

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

(continued)

	Trading		Available       for sale		Held to     maturity	Designated at fair value        through profit or loss			Loans and   receivables		Total	Of which held through consolidated             SPEs
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2009
Mortgage-related assets: Sub-prime residential ..........	2,063		2,782		-		-		837		5,682		3,213
Direct lending .................	1,439		-		-		-		-		1,439		913
MBSs and MBS CDOs7 ....	624		2,782		-		-		837		4,243		2,300
US Alt-A residential............	191		5,403		192		-		882		6,668		3,672
Direct lending .................	113		-		-		-		-		113		-
MBSs7 ............................	78		5,403		192		-		882		6,555		3,672
US Government agency and sponsored enterprises
MBSs7 ............................	375		13,332		2,333		-		-		16,040		322
Other residential..................	1,646		4,582		-		335		1,401		7,964		3,160
Direct lending .................	452		-		-		-		-		452		-
MBSs7 ............................	1,194		4,582		-		335		1,401		7,512		3,160
Commercial property
MBSs and MBS CDOs7 ....	414		7,535		-		103		2,143		10,195		5,730
	4,689		33,634		2,525		438		5,263		46,549		16,097
Leveraged finance-related assets
ABSs and ABS CDOs7 .........	555		5,150		-		-		484		6,189		4,144
Student loan-related assets
ABSs and ABS CDOs7 .........	141		4,948		-		-		145		5,234		4,127
Other assets
ABSs and ABS CDOs7 .........	2,302		4,329		-		6,025		1,987		14,643		2,696
	7,687		48,061		2,525		6,463		7,879		72,615		27,064

For footnote, see page 137.

The above table excludes leveraged finance transactions, which are shown separately on page 113.

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

	Half-year to 30 June 2010								At 30 June 2010
	Gross fair value movements			Realised							Credit
Income                                                statement9			Other compre- hensive income10	gains/ (losses) in the income   statement11		Impair-      ment	Reclassi-        fied12		Gross principal13	default swap        gross protection14			Net principal exposure15		Carrying amount16
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Mortgage-related assets
Sub-prime residential
Direct lending ...............	(15)		-		(14)		-		2,064		-		2,064		1,438
MBSs7 ...........................	329		186		52		315		5,268		456		4,812		3,142
- high grade8 .................	2		102		2		38		1,968		331		1,638		1,423
- rated C to A ...............	327		84		50		277		3,194		125		3,068		1,717
- not publicly rated .......	-		-		-		-		106		-		106		2
MBS CDOs7 ..................	9		3		52		-		676		14		662		31
- high grade8 .................	-		2		52		-		14		-		14		16
- rated C to A ...............	9		1		-		-		524		14		510		13
- not publicly rated .......	-		-		-		-		138		-		138		2
	323		189		90		315		8,008		470		7,538		4,611
US Alt-A residential
Direct lending ...............	-		-		-		-		113		-		113		102
MBSs7 ...........................	-		359		9		884		11,384		100		11,284		5,580
- high grade8 .................	-		29		-		30		818		100		718		610
- rated C to A ...............	-		323		9		855		10,381		-		10,381		4,811
- not publicly rated .......	-		7		-		(1)		185		-		185		159
	-		359		9		884		11,497		100		11,397		5,682
US Government agency and sponsored enterprises
MBSs7
- high grade8 .................	(2)		415		(3)		(63)		21,271		-		21,271		22,067
Other residential
Direct lending ...............	40		-		16		-		341		-		341		348
MBSs7 ...........................	116		108		22		4		7,141		-		7,141		6,320
- high grade8 .................	46		106		22		7		6,242		-		6,242		5,580
- rated C to A ...............	70		-		-		(3)		705		-		705		633
- not publicly rated .......	-		2		-		-		194		-		194		107
	156		108		38		4		7,482		-		7,482		6,668
Commercial property
MBS and MBS CDOs7.....	(163)		946		(31)		170		12,635		412		12,223		10,580
- high grade8 .................	(174)		601		(47)		119		8,682		100		8,582		7,644
- rated C to A ...............	12		345		15		48		3,821		312		3,509		2,838
- not publicly rated .......	(1)		-		1		3		132		-		132		98
Leveraged finance-related assets
ABSs and ABS CDOs7 ........	57		462		4		40		8,372		514		7,858		6,725
- high grade8 ....................	57		328		1		23		6,943		346		6,598		5,815
- rated C to A ..................	-		134		3		17		1,383		168		1,214		864
- not publicly rated ..........	-		-		-		-		46		-		46		46
Student loan-related assets
ABSs and ABS CDOs7 ........	3		132		2		(3)		7,317		-		7,317		5,438
- high grade8 ....................	5		93		2		(2)		4,898		-		4,898		4,311
- rated C to A ..................	(2)		46		-		(1)		1,649		-		1,649		835
- not publicly rated ..........	-		(7)		-		-		770		-		770		292
Other assets
ABS and ABS CDOs7 .........	(204)		118		64		55		12,775		7,076		5,699		4,160
- high grade8 ....................	(312)		(8)		4		3		9,176		6,613		2,563		1,794
- rated C to A ..................	107		131		50		52		2,784		463		2,321		1,758
- not publicly rated ..........	1		(5)		10		-		815		-		815		608
Total ....................................	170		2,729		173		1,402		89,357		8,572		80,785		65,931

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

	Half-year to 30 June 2009								At 30 June 2009
	Gross fair value movements			Realised							Credit
Income                                                  statement9			Other compre-   hensive    income10	gains/ (losses) in the income   statement11		Impair-       ment	Reclassi-         fied12		Gross principal13	default swap         gross protection14			Net principal exposure15		Carrying   amount16
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Mortgage-related assets
Sub-prime residential
Direct lending ...............	(154)		11		11		-		2,253		-		2,253		1,923
MBSs7 ...........................	(142)		(631)		(7)		449		8,001		436		7,565		3,534
- high grade8 .................	(16)		163		(2)		27		3,142		392		2,750		1,874
- rated C to A ...............	(126)		(794)		(5)		422		4,811		44		4,767		1,657
- not publicly rated .......	-		-		-		-		48		-		48		3
MBS CDOs7 ..................	-		(15)		-		2		394		35		359		26
- high grade8 .................	-		(6)		-		-		41		17		24		15
- rated C to A ...............	-		(9)		-		2		351		18		333		9
- not publicly rated .......	-		-		-		-		2		-		2		2
	(296)		(635)		4		451		10,648		471		10,177		5,483
US Alt-A residential
Direct lending ...............	-		-		-		-		231		-		231		207
MBSs7 ...........................	(41)		891		-		455		15,195		303		14,892		6,228
- high grade8 .................	(9)		3,191		1		(54)		2,521		142		2,379		1,754
- rated C to A ...............	(32)		(2,300)		(1)		509		12,663		161		12,502		4,463
- not publicly rated .......	-		-		-		-		11		-		11		11
	(41)		891		-		455		15,426		303		15,123		6,435
US Government agency and sponsored enterprises
MBSs7
- high grade8 .................	8		35		236		(120)		16,460		-		16,460		16,564
Other residential
Direct lending ...............	(41)		104		104		-		526		-		526		498
MBSs7 ...........................	(43)		35		(4)		-		7,969		-		7,969		6,112
- high grade8 .................	(17)		63		(5)		-		7,309		-		7,309		5,708
- rated C to A ...............	(16)		(28)		1		-		580		-		580		358
- not publicly rated .......	(10)		-		-		-		80		-		80		46
	(84)		139		100		-		8,495		-		8,495		6,610
Commercial property
MBS and MBS CDOs7 ....	(92)		(723)		13		-		13,855		359		13,496		9,111
- high grade8 .................	(64)		(519)		12		-		12,718		359		12,359		8,437
- rated C to A ...............	(28)		(204)		2		-		1,119		-		1,119		669
- not publicly rated .......	-		-		(1)		-		18		-		18		5
Leveraged finance-related assets
ABSs and ABS CDOs7 ........	(1)		143		-		-		7,372		758		6,614		5,075
- high grade8 ....................	(1)		156		-		-		6,755		271		6,484		4,963
- rated C to A ..................	-		(13)		-		-		617		487		130		112
Student loan-related assets
ABSs and ABS CDOs7 ........	(3)		507		(1)		-		7,397		-		7,397		5,308
- high grade8 ....................	(1)		381		-		-		6,890		-		6,890		5,201
- rated C to A ..................	(2)		126		(1)		-		507		-		507		107
Other assets
ABS and ABS CDOs7 .........	(153)		80		(4)		24		20,208		9,617		10,591		7,793
- high grade8 ....................	(10)		528		(2)		1		8,089		3,179		4,910		4,250
- rated C to A ..................	(131)		(448)		(2)		33		5,268		295		4,973		2,902
- not publicly rated ..........	(12)		-		-		(10)		6,851		6,143		708		641
Total ....................................	(662)		437		348		810		99,861		11,508		88,353		62,379

	Half-year to 31 December 2009								At 31 December 2009
	Gross fair value movements			Realised							Credit
Income                                                  statement9			Other compre-   hensive    income10	gains/ (losses) in the income   statement11		Impair-       ment	Reclassi-         fied12		Gross principal13	default swap         gross protection14			Net principal exposure15		Carrying   amount16
	US$m		US$m		US$m		US$m		US$m	US$m	US$m	US$m	US$m	US$m	US$m
Mortgage-related assets
Sub-prime residential
Direct lending ...............	(73)		(11)		(51)		-		1,703		-		1,703		1,439
MBSs7 ...........................	98		818		(123)		346		7,483		1,248		6,235		3,419
- high grade8 .................	-		14		3		107		2,762		603		2,159		1,719
- rated C to A ...............	101		804		(126)		239		4,616		645		3,971		1,700
- not publicly rated .......	(3)		-		-		-		105		-		105		-
MBS CDOs7 ..................	(2)		6		-		-		138		15		123		29
- high grade8 .................	-		5		-		-		36		15		21		17
- rated C to A ...............	(1)		1		-		-		89		-		89		10
- not publicly rated .......	(1)		-		-		-		13		-		13		2
	23		813		(174)		346		9,324		1,263		8,061		4,887
US Alt-A residential
Direct lending ...............	-		-		-		-		129		-		129		113
MBSs7 ...........................	136		(230)		(143)		1,238		13,546		491		13,055		6,427
- high grade8 .................	-		(2,830)		-		371		1,625		428		1,197		1,237
- rated C to A ...............	135		2,600		(143)		867		11,885		63		11,822		5,176
- not publicly rated .......	1		-		-		-		36		-		36		14
	136		(230)		(143)		1,238		13,675		491		13,184		6,540
US Government agency and sponsored enterprises
MBSs7
- high grade8 .................	108		217		(238)		(3)		15,827		-		15,827		16,040
Other residential
Direct lending ...............	120		(104)		(34)		-		463		-		463		452
MBSs7 ...........................	114		590		41		50		8,741		91		8,650		7,443
- high grade8 .................	93		554		42		75		7,884		91		7,793		6,440
- rated C to A ...............	11		38		(1)		(34)		773		-		773		941
- not publicly rated .......	10		(2)		-		9		84		-		84		62
	234		486		7		50		9,204		91		9,113		7,895
Commercial property
MBS and MBS CDOs7 ....	127		1,425		(21)		(104)		13,734		395		13,339		9,954
- high grade8 .................	136		1,202		(20)		(90)		9,805		264		9,541		7,537
- rated C to A ...............	(9)		221		(2)		(12)		3,860		131		3,729		2,365
- not publicly rated .......	-		2		1		(2)		69		-		69		52
Leveraged finance-related assets
ABSs and ABS CDOs7 ........	-		578		-		(40)		7,516		895		6,621		5,612
- high grade8 ....................	15		602		-		(41)		6,620		414		6,206		5,301
- rated C to A ..................	(15)		(24)		-		1		881		481		400		295
- not publicly rated ..........	-		-		-		-		15		-		15		16
Student loan-related assets
ABSs and ABS CDOs7 ........	(3)		62		3		32		7,192		224		6,968		5,122
- high grade8 ....................	3		249		-		32		6,690		30		6,660		5,019
- rated C to A ..................	(6)		(187)		3		-		477		194		283		76
- not publicly rated ..........	-		-		-		-		25		-		25		27
Other assets
ABS and ABS CDOs7 .........	227		335		(13)		67		17,608		8,797		8,811		6,327
- high grade8 ....................	28		(240)		12		30		12,846		8,607		4,239		3,564
- rated C to A ..................	171		600		(27)		52		4,126		190		3,936		2,245
- not publicly rated ..........	28		(25)		2		(15)		636		-		636		518
Total ....................................	852		3,686		(579)		1,586		94,080		12,156		81,924		62,377

For footnotes, see page 137.

Analysis of exposures and significant movements

Sub-prime residential mortgage-related assets

Sub-prime residential mortgage-related assets included US$3.5 billion (30 June 2009: US$4.3 billion; 31 December 2009: US$3.7 billion) relating to US-originated assets and US$1.1 billion (30 June 2009: US$1.1 billion; 31 December 2009: US$1.1 billion) relating to UK non-conforming residential mortgage-related assets. Of the non‑high grade assets held of US$1.7 billion, US$1.5 billion (30 June 2009: US$1.5 billion; 31 December 2009: US$1.7 billion) related to US‑originated assets, reflecting the higher quality of the UK‑originated assets.

A modest increase in observable values of sub‑prime assets took place in the first half of 2010. However, further impairment of US$100 million on assets classified as available for sale was recognised in the first half of 2010 (first half of 2009: US$542 million; second half of 2009: US$17 million) as losses were incurred under current accounting impairment rules which require the full fair value deficit to be recognised when there is objective evidence of impairment that has an impact on the estimated future cash flows of the instrument, without reference to the amount of the expected loss. The expectation of losses on the underlying assets did not increase from that at 31 December 2009. Of the impairment above, US$98 million (first half of 2009: US$275 million; second half of 2009: US$37 million) occurred in the SICs and was borne by the capital note holders.

US Alt-A residential mortgage-related assets

During the first half of 2010, spreads on Alt-A mortgage-related assets tightened from the levels seen in 2009. Further impairments of US$598 million (first half of 2009: US$631 million; second half of 2009: US$741 million) were recorded in respect of Alt-A mortgage-related assets as losses were incurred under the current accounting rules described in the paragraph above, without reference to the amount of expected loss. The expectation of losses in the underlying assets did not increase from that at 31 December 2009. Of the impairment above, US$369 million (first half of 2009: US$352 million; second half of 2009: write-back of US$6 million) occurred in the SICs and was borne by the capital note holders.

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 principal13 of US sub-prime mortgage-backed securities at						Gross principal13 of US Alt-A mortgage-backed securities at
	30 June		30 June		31 December		30 June		30 June		31 December
	2010		2009		2009		2010		2009		2009
	US$m		US$m		US$m		US$m		US$m		US$m
Mortgage vintage
Pre-2006 .......................................	1,358		1,571		1,748		1,389		2,237		2,108
2006 .............................................	2,074		3,262		2,827		5,499		7,076		6,225
2007 .............................................	1,060		1,851		1,187		4,496		5,882		5,213
	4,492		6,684		5,762		11,384		15,195		13,546

For footnote, see page 137.

US Government agency and sponsored enterprises mortgage-related assets

During the first half of 2010, HSBC increased its holdings of US Government agency and sponsored enterprises mortgage-related assets by US$6.0 billion.

Other residential mortgage-related assets

The majority of other residential mortgage-related assets were originated in the UK (30 June 2010: US$4.2 billion; 30 June 2009: US$4.0 billion; 31 December 2009: US$4.7 billion). No impairments were recognised in respect of these UK-originated assets in the first half of 2010 (first and second halves of 2009: nil), reflecting credit support within the asset portfolio.

Commercial property mortgage-related assets

Of the total of US$10.6 billion (30 June 2009: US$9.1 billion; 31 December 2009: US$10.0 billion) of commercial property mortgage-related assets, US$5.4 billion related to US-originated assets (30 June 2009: US$3.9 billion; 31 December 2009: US$4.3 billion). Spreads tightened on both US and non-US commercial property mortgage-related assets during 2009. Impairments of US$11 million (first half of 2009: US$14 million; second half of 2009: US$74 million) were recognised in the first half of 2010.

Leveraged finance-related assets

The majority of assets related to US-originated exposures; almost all (30 June 2010: 86 per cent; 30 June 2009: 98 per cent; 31 December 2009: 94 per cent) were high grade with no impairments recorded in the period (first and second halves of 2009: nil).

Student loan-related assets

Holdings in student loan-related assets were US$5.4 billion (30 June 2009: US$5.3 billion; 31 December 2009: US$5.1 billion). No impairments were recorded on student loan-related assets in the first half of 2010 (first and second halves of 2009: nil).

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 at the time within the trading portfolio.

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

	Notional           amount	Net exposure       before credit risk adjustment17			Credit risk adjustment18		Net exposure     after credit                 risk adjustment
	US$m		US$m		US$m		US$m
At 30 June 2010
Derivative transactions with monoline counterparties
Monoline - investment grade (BBB- or above) .	5,103		920		(92)		828
Monoline - sub-investment grade (below BBB-)	2,464		751		(475)		276
	7,567		1,671		(567)		1,104
At 30 June 2009
Derivative transactions with monoline counterparties
Monoline - investment grade (BBB- or above) .	7,259		2,308		(715)		1,593
Monoline - sub-investment grade (below BBB-)	3,683		1,357		(847)		510
	10,942		3,665		(1,562)		2,103
At 31 December 2009
Derivative transactions with monoline counterparties
Monoline - investment grade (BBB- or above) .	5,623		997		(100)		897
Monoline - sub-investment grade (below BBB-)	4,400		1,317		(909)		408
	10,023		2,314		(1,009)		1,305

For footnotes, see page 137.

During the first half of 2010, the notional value of derivative contracts with monolines and HSBC's overall credit exposure to monolines decreased as a number of transactions were commuted, and others matured. The above table sets out the fair value, essentially the replacement cost, of the remaining derivative transactions at 30 June 2010, 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 further analyse that risk, the value of protection purchased is shown subdivided between those monolines that were rated by Standard & Poor's ('S&P') at 'BBB-' or above at 30 June 2010, and those that were 'below BBB-' ('BBB-' is the S&P cut-off for an investment grade classification). The 'Credit risk adjustment' column indicates the valuation adjustment taken by HSBC against the net exposures, and reflects HSBC's best estimate of the likely loss of value on purchased protection arising from the deterioration in creditworthiness of the monolines. These valuation adjustments, which reflect a measure of the irrecoverability of the protection purchased, have been charged to the income statement. During the first half of 2010, the CRA on derivative contracts with monolines decreased as a number of transactions were commuted and others matured.

The above table can be analysed as follows. HSBC has derivative transactions referenced to underlying securities with a notional value of US$7.6 billion (30 June 2009: US$10.9 billion; 31 December 2009: US$10.0 billion), whose value at 30 June 2010 indicated a potential claim against the protection purchased from the monolines of some US$1.7 billion (30 June 2009: US$3.7 billion; 31 December 2009: US$2.3 billion). On the basis of a credit assessment of the monolines, a provision of US$0.6 billion has been taken (30 June 2009: US$1.6 billion; 31 December 2009: US$1.0 billion), leaving US$1.1 billion exposed (30 June 2009: US$2.1 billion; 31 December 2009: US$1.3 billion), of which US$0.8 billion is recoverable from monolines rated investment grade at 30 June 2010 (30 June 2009: US$1.6 billion; 31 December 2009: US$0.9 billion). The provisions taken imply in aggregate that 90 cents in the dollar will be recoverable from investment grade monolines and 37 cents in the dollar from non-investment grade monolines (30 June 2009: 69 cents and 38 cents, respectively; 31 December 2009: 90 cents and 31 cents, respectively).

For the CDSs, market prices are generally not readily available. Therefore the CDSs are valued on the basis of market prices of the referenced securities.

The credit risk adjustment against monolines is determined by one of a number of methodologies, dependent upon the internal credit rating of the monoline. HSBC's assignment of internal credit ratings is based upon detailed credit analysis, and may differ from external ratings.

·     For highly-rated monolines, the standard credit risk adjustment methodology (as described on page 170 of the Annual Report and Accounts 2009) applies, with the exception that the future exposure profile is deemed to be constant (equal to the current mark value) over the weighted average life of the referenced security, and the credit risk adjustment cannot fall below 10 per cent of the mark-to-market exposure.

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

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

At 30 June 2010, US$1.6 billion (31 December 2009: US$2.6 billion) notional value of securities referenced by monoline CDS transactions with a market value of US$1.2 billion (31 December 2009: US$1.9 billion), were held in the loans and receivables category, having been included in the reclassification of financial assets described on page 98. At the date of reclassification, the market value of the assets was US$1.9 billion. The reclassification resulted in an accounting asymmetry between the CDSs, which continue to be held at fair value through profit and loss, and the reclassified securities, which are accounted for on an amortised cost basis. If the reclassifications had not occurred, the impact on the income statement for the first half of 2010 would have been an increase in profit of US$30 million (first half of 2009: increase in profit of US$23 million; second half of 2009: decrease in profit of US$18 million). This amount represents the difference between the increase in market value of the securities during the first half of 2010 and the accretion recognised under the amortised cost method in 2010.

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

HSBC has no liquidity facilities to monolines at 30 June 2010 (30 June 2009: US$2 million; 31 December 2009: minimal).

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. As the bonds are traded explicitly with the benefit of this enhancement, any deterioration in the credit profile of the monoline is reflected in market prices and, therefore, in the carrying amount of these securities at 30 June 2010. 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 other comprehensive income 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 98.

HSBC's exposure to Credit Derivative Product Companies

CDPCs are independent companies that specialise in selling credit default protection on corporate exposures. At 30 June 2010, HSBC had purchased from CDPCs credit protection with a notional value of US$5.0 billion (30 June 2009: US$6.2 billion; 31 December 2009: US$5.0 billion) which had a fair value (replacement cost) of US$0.4 billion (30 June 2009: US$0.7 billion; 31 December 2009: US$0.3 billion), against which a credit risk adjustment (a provision) of US$0.1 billion was held (30 June 2009: US$0.2 billion; 31 December 2009: US$0.1 billion). At 30 June 2010, 23 per cent of exposure was to CDPCs with investment grade ratings (30 June 2009: 80 per cent; 31 December 2009: 83 per cent). The deterioration reflects the downgrade of a CDPC to below investment grade in the first quarter of 2010.

Leveraged finance transactions

Leveraged finance transactions include sub-investment grade acquisition or event-driven financing.

The following tables show HSBC's 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 table on page 105.

HSBC's exposure to leveraged finance transactions

	Exposures at 30 June 2010						Exposures at 30 June 2009						Exposures at 31 December 2009
	Funded19		Un- funded20		Total		Funded19		Un-   funded20		Total		Funded19		Un-   funded20		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
Europe .......................................	3,369		393		3,762		3,747		455		4,202		3,790		368		4,158
Rest of Asia-Pacific ...................	63		24		87		13		73		86		70		22		92
North America ..........................	1,204		184		1,388		1,833		173		2,006		1,713		188		1,901
	4,636		601		5,237		5,593		701		6,294		5,573		578		6,151
Held within:
- loans and receivables ..........	4,633		450		5,083		5,589		420		6,009		5,569		386		5,955
- fair value through profit or loss ......................	3		151		154		4		281		285		4		192		196

For footnotes, see page 137.

Movement in leveraged finance exposures

			Funded      exposures19		Unfunded      exposures20		Total       exposures
			US$m		US$m		US$m
At 1 January 2010 ..................................................................................			5,573		578		6,151
Additions ................................................................................................			1		-		1
Fundings .................................................................................................			(19)		19		-
Sales, repayments and other movements ................................................			(949)		5		(944)
Write-backs ............................................................................................			30		(1)		29
At 30 June 2010 .....................................................................................			4,636		601		5,237

For footnotes, see page 137.

Leveraged finance commitments held by HSBC were US$5.5 billion at 30 June 2010 (30 June 2009: US$6.7 billion; 31 December 2009: US$6.5 billion), of which US$4.9 billion (30 June 2009: US$6.0 billion; 31 December 2009: US$5.9 billion) was funded.

As described on page 98, certain leveraged finance loans were reclassified from held-for-trading to loans and receivables. As a result, these loans are held at amortised cost subject to impairment and are not marked to market, and net losses of US$0.3 billion (first half of 2009: net gains of US$0.6 billion; second half of 2009: net gains of US$0.6 billion) were not taken to the income statement in the first half of 2010.

 

END

 

 

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