Annual Financial Report - 23 of 41

RNS Number : 8659D

HSBC Holdings PLC

30 March 2011

 



All of the derivative transactions are with HSBC undertakings which are banking counterparties (2009: 100%).

The credit quality of the loans and advances to HSBC undertakings is assessed as strong/good, with 100% of the exposure being neither past due nor impaired (2009: 100%).

The credit ratings of the financial investments held by HSBC Holdings are within the Standard and Poor's ('S&P') ratings range of A to BBB+ (2009: A+ to A-).

Securitisation exposures and other structured products

(Audited)

The financial impact of the recent market disruption is lessening with net write-downs to the income statement of nil (2009: US$1.9bn net write-downs) and a reduction in the available-for-sale ABSs reserve deficit by US$5.8bn to US$6.4bn.

Following the dislocation in markets which began in 2007, there was a modest recovery in the risk appetite of investors in 2009. However, the first half of 2010 saw renewed uncertainty and concerns over sovereign credit risk. As a result, the prices of many assets perceived to be of higher risk fell. In addition, the widespread downgrading of securitised assets continued in the first half of 2010 as rating agencies changed their methodologies, reducing the appetite for securitised assets among institutions subject to the Basel II framework.

Increased stability returned in the second half of 2010 following the interventions of the EU and the International Monetary Fund. A modest increase in house prices in some areas and the continued low interest rate environment contributed to a rise in the price of some securitised assets. As a result, the levels of write-downs and losses on our holdings of structured assets remained modest. Unrealised losses in our available-for-sale reserve continued to reduce due to increases in fair value and the principal amortisation of ABSs as repayments were received at par. Expectations of cash losses on available-for-sale ABSs remained consistent with our previous estimates.

Overview of exposure

(Audited)

Accounting policies

Our accounting policies for 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 estimates in respect of valuation of financial instruments as described in Note 16 on the Financial Statements.

This section contains information about our exposure to the following:

·     ABSs, including mortgage-backed securities ('MBS's) and related collateralised debt obligations ('CDO's);

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

·     monolines;

·     credit derivative product companies ('CDPC's);

·     leveraged finance transactions; and

·     representations and warranties related to mortgage sales and securitisation activities.

The following table summarises our exposure to these products.

Overall exposure of HSBC

(Audited)

	At 31 December 2010				At 31 December 2009
	Carrying        amount		Including    sub-prime     and Alt-A		Carrying          amount		Including       sub-prime      and Alt-A
	US$bn		US$bn		US$bn		US$bn
Asset-backed securities ('ABS's) ................................................	73.9		8.5		70.6		10.8
- fair value through profit or loss .............................................	10.8		0.3		12.1		0.7
- available for sale38 .................................................................	54.7		7.1		48.1		8.2
- held to maturity38 ..................................................................	2.2		0.2		2.5		0.2
- loans and receivables .............................................................	6.2		0.9		7.9		1.7
Loans at fair value through profit or loss ...................................	1.6		1.2		2.0		1.6
Total ABS and direct lending at fair value through profit or loss	75.5		9.7		72.6		12.4
Less securities mitigated by credit derivatives with monolines and other financial institutions ..............................................	(8.3)		(0.4)		(10.2)		(1.0)
	67.2		9.3		62.4		11.4
Leveraged finance loans ............................................................	4.9		-		6.2		-
- fair value through profit or loss .............................................	0.3		-		0.2		-
- loans and receivables .............................................................	4.6		-		6.0		-
	72.1		9.3		68.6		11.4
Exposure including securities mitigated by credit derivatives with monolines and other financial institutions ......................	80.4		9.7		78.8		12.4

For footnote, see page 174.

Asset-backed securities and leveraged finance

(Audited)

We are or have been involved in the following activities involving ABSs and leveraged finance:

·     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 securities investment conduits ('SIC's) and money market funds, as described in Note 43 on the Financial Statements, 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 or holding them in order to earn interest margin over their lives.

These activities are not a significant part of GB&M's on‑going business, and GB&M 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, which was conducted in our US MBS business, was discontinued in 2007.

Nature of HSBC's exposures

MBSs are securities that represent interests in groups of mortgages and provide investors with the right to receive cash from future mortgage payments (interest and/or principal). An MBS which references mortgages with different risk profiles is classified according to the highest risk class.

CDOs are securities backed by a pool of bonds, loans or other assets such as ABSs. CDOs may include exposure to sub-prime or Alt-A mortgage assets where these are part of the underlying assets or reference assets. As there is often uncertainty surrounding the precise nature of the underlying collateral supporting CDOs, all CDOs supported by residential mortgage-related assets are classified as sub-prime. Our holdings of ABSs and CDOs and direct lending positions, and the categories of mortgage collateral and lending activity, are described below.

Categories of ABSs and CDOs		Definition		Classification
Sub-prime		Loans to customers who have limited credit histories, modest incomes or high debt-to-income ratios or have experienced credit problems caused by occasional delinquencies, prior charge-offs, bankruptcy or other credit-related actions.		For US mortgages, standard US credit scores are primarily used to determine whether a loan is sub-prime; for non-US mortgages, management judgement is used.
US Home Equity Lines of Credit ('HELoC's)		A form of revolving credit facility provided to customers, which is supported by a first or second lien charge over residential property.		Holdings of HELoCs are classified as sub-prime.
US Alt-A		Lower risk loans than sub-prime, but they share higher risk characteristics than lending under fully conforming standard criteria.		US credit scores and the completeness of documentation held (such as proof of income), are considered when determining whether an Alt-A classification is appropriate. Non sub-prime mortgages in the US are classified as Alt-A if they are not eligible for sale to the major US Government sponsored mortgage agencies.
US Government agency and sponsored enterprises mortgage-related assets		Securities that are guaranteed by US Government agencies such as the Government National Mortgage Association ('Ginnie Mae'), or by US Government sponsored entities including the Federal National Mortgage Association ('Fannie Mae') and the Federal Home Loan Mortgage Corporation ('Freddie Mac').		Holdings of US Government agency and US Government sponsored enterprises' mortgage-related assets are classified as prime exposures.
UK non-conforming mortgages		UK mortgages that do not meet normal lending criteria. Examples include mortgages where the expected level of documentation is not provided (such as income with self-certification), or where poor credit history increases risk and results in pricing at a higher than normal lending rate.		UK non-conforming mortgages are treated as sub-prime exposures.
Other mortgages		Residential mortgages, including prime mortgages, that do not meet any of the classifications described above.		Prime residential mortgage-related assets are included in this category.

Our exposure to non-residential mortgage-related ABSs and direct lending includes securities with collateral relating to:

·     commercial property mortgages;

·     leveraged finance loans;

·     student loans; and

·     other assets, such as securities with other receivable-related collateral.

ABSs classified as available for sale

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

The following table summarises our exposure to ABS's classified as available for sale:

Available-for-sale ABSs exposure

(Audited)

	At 31 December 2010						At 31 December 2009
	Directly          held/   Solitaire39		SPEs		Total		Directly           held/     Solitaire39		SPEs		Total
	US$m		US$m		US$m		US$m		US$m		US$m
Total carrying amount of net principal exposure ..................................................	41,106		13,586		54,692		34,040		14,021		48,061
Notional principal value of impaired securities ..................................................	3,015		2,399		5,414		2,641		1,565		4,206
Carrying value of capital notes liability .......	-		(254)		(254)		-		(740)		(740)

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

(Audited)

	2010						2009
	Directly          held/   Solitaire39		SPEs		Total		Directly           held/     Solitaire39		SPEs		Total
	US$m		US$m		US$m		US$m		US$m		US$m
AFS reserve at 1 January .............................	(7,349)		(4,864)		(12,213)		(11,528)		(7,204)		(18,732)
Increase in fair value of securities ................	2,175		1,543		3,718		3,419		704		4,123
Impairment charge:
-  borne by HSBC ....................................	444		-		444		1,422		-		1,422
-  allocated to capital note holders40 ........	-		531		531		-		666		666
Repayment of capital ..................................	540		187		727		431		668		1,099
Other movements .......................................	88		297		385		(1,093)		302		(791)
AFS reserve at 31 December ........................	(4,102)		(2,306)		(6,408)		(7,349)		(4,864)		(12,213)

For footnotes, see page 174.

Securities investment conduits

(Audited)

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

At each reporting date, we assess whether there is any objective evidence of impairment in the value of the ABSs held by SPEs. Impairment charges incurred on these assets are offset by a credit to the impairment line for the amount of the loss allocated to capital note holders.

The economic first loss protection remaining at 31 December 2010 amounted to US$2.2bn (2009: US$2.2bn). On an IFRSs accounting basis, the carrying value of the liability for the capital notes at 31 December 2010 amounted to US$0.3bn (2009: US$0.7bn). The impairment charge recognised during 2010 amounted to US$531m (2009: US$666m).

At 31 December 2010, the available-for-sale reserve in respect of securities held by the SICs was a deficit of US$2.7bn (2009: US$5.2bn). Of this, US$2.3bn related to ABSs (2009: US$4.9bn).

Impairments recognised during 2010 from assets held directly or within Solitaire, in recognition of the first loss protection of US$1.2bn we provide through credit enhancement and from drawings against the liquidity facility we provide, were US$444m (2009: US$1.4bn). The reduction in impairment charges compared with 2009 was due to the stabilising of loss severities and delinquency roll rates which have resulted in lower losses in the underlying collateral pools. The level of impairment recognised in comparison with the deficit in the available-for-sale reserve was a reflection of the credit quality and seniority of the assets held.

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

(Audited)

The assets which are most sensitive to possible future impairment are sub-prime and Alt-A residential MBSs. Available-for-sale holdings in these higher risk categories where HSBC does not benefit from significant first loss protection amounted to US$3.8bn at 31 December 2010 (2009: US$4.9bn). For these securities the cumulative fair value losses not recognised in the income statement at 31 December 2010 was US$1.6bn (2009: losses of US$3.2bn). Other holdings in these higher risk categories classified as available-for-sale are held in vehicles where third party first loss protection exists, as described in the section on securities investment conduits, above.

During 2010, the credit ratings on certain ABSs held directly by HSBC, Solitaire and the SICs were downgraded. A downgrade of a security's credit rating is not, of itself, evidence of impairment. Consequently, the actions of the rating agencies alone have no direct impact on the measurement of impairment losses. The impairment losses recognised on these securities at 31 December 2010 are set out above.

Impairment methodologies

(Audited)

The accounting policy for impairment and indicators of impairment is set out in Note 2j on the Financial Statements.

For available-for-sale ABSs, to identify objective evidence of impairment, an industry standard valuation model is normally applied which uses data with reference to the underlying asset

pools and models their projected future cash flows. The estimated future cash flows of the securities are assessed at the specific financial asset level to determine whether any of them are unlikely to be recovered as a result of loss events occurring on or before the reporting date.

The principal assumptions and inputs to the models are typically the delinquency status of the underlying loans, the probability of delinquent loans progressing to default, the prepayment profiles of the underlying assets and the loss severity in the event of default. However, the models utilise other variables relevant to specific classes of collateral to forecast future defaults and recovery rates. Management uses externally available data and applies judgement when determining the appropriate assumptions in respect of these factors. HSBC uses a modelling approach which incorporates historically observed progression rates to default, to determine if the decline in aggregate projected cash flows from the underlying collateral will lead to a shortfall in contractual cash flows. In such cases the security is considered to be impaired.

In respect of CDOs, expected future cash flows for the underlying collateral are assessed to determine whether there is likely to be a shortfall in the contractual cash flows of the CDO.

When a security benefits from a contract provided by a monoline insurer that insures payments of principal and interest, the expected recovery on the contract is assessed in determining the total expected credit support available to the ABS.

Impairment and cash loss projections

(Unaudited)

At 31 December 2009, management undertook an analysis to estimate 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 results of the analysis indicated that further impairment charges of some US$1.1bn and expected cash losses of some US$450m could arise over the next two to three years.

At 31 December 2010, management re‑performed the stress test. After taking into account the cash losses experienced during 2010, the remaining cash loss projections of US$250m were consistent with those as at 31 December 2009. However, the impairment charge projections showed an additional charge of US$300m arising over the next two years in relation to the SICs, after taking into account the impairments recognised in 2010, resulting in future impairment charges of US$950m, including the US$300m relating to the SICs. This additional charge reflects where the accounting impairments will exceed the carrying amount of the capital notes held by third parties.

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 projected future cash flows reflect additional assumptions about future loss events after the balance sheet date.

This analysis makes assumptions in respect of the future behaviour of loss severities, default rates and prepayment rates. Movements in the parameters are not independent of each other. For example, increased default rates and increased loss severities, which would imply greater impairments, generally 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.

At 31 December 2010, the incurred and projected impairment charges, measured in accordance with accounting requirements, significantly exceeded the expected cash losses on the securities. Over the lives of the available-for-sale ABSs the cumulative impairment charges will converge towards the level of cash losses. In respect of the SICs, in particular, the capital notes held by third parties are expected to absorb the cash losses arising in the vehicles.

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

(Audited)

	Trading		Available     for sale		Held to   maturity		Designated          at fair value     through           profit		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 2010
Mortgage-related assets
Sub-prime residential ....	1,297		2,565		-		-		652		4,514		2,763
Direct lending ..........	1,078		-		-		-		-		1,078		632
MBSs and MBS CDOs41 ....................	219		2,565		-		-		652		3,436		2,131
US Alt-A residential .....	180		4,545		191		-		270		5,186		3,651
Direct lending ..........	96		-		-		-		-		96		-
MBSs41 .....................	84		4,545		191		-		270		5,090		3,651
US Government agency and sponsored enterprises
MBSs41 .....................	657		21,699		2,032		-		-		24,388		6
Other residential ..........	1,075		4,024		-		-		1,111		6,210		2,669
Direct lending ..........	417		-		-		-		-		417		-
MBSs41 .....................	658		4,024		-		-		1,111		5,793		2,669
Commercial property
MBSs and MBS CDOs41 ....................	546		8,160		-		111		1,942		10,759		6,441
	3,755		40,993		2,223		111		3,975		51,057		15,530
Leveraged finance-related assets
ABSs and ABS CDOs41 .	392		5,418		-		-		414		6,224		3,886
Student loan-related assets
ABSs and ABS CDOs41 .	163		5,178		-		-		150		5,491		4,251
Other assets
ABSs and ABS CDOs41 .	1,936		3,103		-		6,017		1,710		12,766		2,526
	6,246		54,692		2,223		6,128		6,249		75,538		26,193
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 CDOs41 ....................	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		-
MBSs41 .....................	78		5,403		192		-		882		6,555		3,672
US Government agency and sponsored enterprises
MBSs41 .....................	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		-
MBSs41 .....................	1,194		4,582		-		335		1,401		7,512		3,160
Commercial property
MBSs and MBS CDOs41 ....................	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 CDOs41 .	555		5,150		-		-		484		6,189		4,144
Student loan-related assets
ABSs and ABS CDOs41 .	141		4,948		-		-		145		5,234		4,127
Other assets
ABSs and ABS CDOs41 .	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 174.

The above table excludes leveraged finance transactions, which are shown separately on page 139.

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

(Audited)

	2010								At 31 December 2010
	Gross fair value movements				Realised						Credit
	Income statement43	Impair-      ment	Other compre- hensive income44	Impair-      ment	gains/ (losses) in the income statement45	Impair-      ment	Reclassi-       fied46		Gross principal47		default        swap        gross   protection48		Net principal exposure49		Carrying Amount50
	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 .........	(35)		-		(20)		-		2,233		-		2,233		1,078
MBSs41 ...................	58		313		14		385		5,104		336		4,768		3,135
- high grade42 .........	6		151		5		52		1,996		292		1,704		1,458
- rated C to A ........	52		162		7		333		3,006		44		2,962		1,645
- not publicly rated	-		-		2		-		102		-		102		32
MBS CDOs41 ...........	-		7		-		(3)		90		12		78		17
- high grade42 .........	-		-		-		-		2		-		2		1
- rated C to A ........	-		6		-		(3)		86		12		74		14
- not publicly rated	-		1		-		-		2		-		2		2
	23		320		(6)		382		7,427		348		7,079		4,230
US Alt-A residential
Direct lending .........	(1)		-		-		-		108		-		108		96
MBSs41 ...................	4		575		3		1,564		9,957		100		9,857		5,013
- high grade42 .........	-		35		3		45		660		100		560		473
- rated C to A ........	4		539		-		1,520		9,254		-		9,254		4,503
- not publicly rated	-		1		-		(1)		43		-		43		37
	3		575		3		1,564		10,065		100		9,965		5,109
US Government agency and sponsored enterprises
MBSs41
- high grade42 .........	3		226		(11)		(43)		23,739		-		23,739		24,388
Other residential
Direct lending .........	63		-		35		-		424		-		424		417
MBSs41 ...................	6		163		4		(7)		6,571		-		6,571		5,793
- high grade42 .........	5		149		4		(7)		5,841		-		5,841		5,256
- rated C to A ........	1		14		-		-		648		-		648		450
- not publicly rated	-		-		-		-		82		-		82		87
	69		163		39		(7)		6,995		-		6,995		6,210
Commercial property
MBS and MBS CDOs41 ...................	45		1,366		6		112		12,625		421		12,204		10,493
- high grade42 .........	5		540		4		71		6,341		15		6,326		5,791
- rated C to A ........	40		826		2		36		6,201		406		5,795		4,637
- not publicly rated	-		-		-		5		83		-		83		65
Leveraged finance-related assets ..........................
ABSs and ABS CDOs41	5		453		-		18		7,148		788		6,360		5,721
- high grade42 ............	3		308		-		(8)		6,078		351		5,727		5,148
- rated C to A ...........	2		145		-		26		971		437		534		472
- not publicly rated ...	-		-		-		-		99		-		99		101
Student loan-related assets
ABSs and ABS CDOs41	7		230		3		(6)		7,161		100		7,061		5,459
- high grade42 ............	9		44		3		(4)		4,080		-		4,080		3,626
- rated C to A ...........	(2)		157		-		(2)		2,620		100		2,520		1,663
- not publicly rated ...	-		29		-		-		461		-		461		170
Other assets
ABS and ABS CDOs41 .	2		385		1		67		15,497		7,765		7,732		5,622
- high grade42 ............	-		188		-		1		10,947		7,447		3,500		2,884
- rated C to A ...........	2		188		1		46		4,059		318		3,741		2,379
- not publicly rated ...	-		9		-		20		491		-		491		359
Total ..............................	157		3,718		35		2,087		90,657		9,522		81,135		67,232

	2009								At 31 December 2009
	Gross fair value movements			Realised							Credit
Income                                                 statement43			Other compre-   hensive    income44	gains/ (losses) in the income   statement45		Impair-       ment	Reclassi-         fied46		Gross principal47	default swap         gross protection48			Net principal exposure49		Carrying Amount50
	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 ...............	(227)		-		(40)		-		1,703		-		1,703		1,439
MBSs41 ..........................	(44)		187		(130)		795		7,483		1,248		6,235		3,419
- high grade42 ................	(16)		177		1		134		2,762		603		2,159		1,719
- rated C to A ...............	(25)		10		(131)		661		4,616		645		3,971		1,700
- not publicly rated .......	(3)		-		-		-		105		-		105		-
MBS CDOs41 .................	(2)		(9)		-		2		138		15		123		29
- high grade42 ................	-		(1)		-		-		36		15		21		17
- rated C to A ...............	(1)		(8)		-		2		89		-		89		10
- not publicly rated .......	(1)		-		-		-		13		-		13		2
	(273)		178		(170)		797		9,324		1,263		8,061		4,887
US Alt-A residential
Direct lending ...............	-		-		-		-		129		-		129		113
MBSs41 ..........................	95		661		(143)		1,693		13,546		491		13,055		6,427
- high grade42 ................	(9)		361		1		317		1,625		428		1,197		1,237
- rated C to A ...............	103		300		(144)		1,376		11,885		63		11,822		5,176
- not publicly rated .......	1		-		-		-		36		-		36		14
	95		661		(143)		1,693		13,675		491		13,184		6,540
US Government agency and sponsored enterprises
MBSs41
- high grade42 ................	116		252		(2)		(123)		15,827		-		15,827		16,040
Other residential
Direct lending ...............	79		-		70		-		463		-		463		452
MBSs41 ..........................	71		625		37		50		8,741		91		8,650		7,443
- high grade42 ................	76		617		37		75		7,884		91		7,793		6,440
- rated C to A ...............	(5)		10		-		(34)		773		-		773		941
- not publicly rated .......	-		(2)		-		9		84		-		84		62
	150		625		107		50		9,204		91		9,113		7,895
Commercial property
MBS and MBS CDOs41 ...	35		702		(8)		(104)		13,734		395		13,339		9,954
- high grade42	72		683		(8)		(90)		9,805		264		9,541		7,537
- rated C to A ...............	(37)		17		-		(12)		3,860		131		3,729		2,365
- not publicly rated .......	-		2		-		(2)		69		-		69		52
Leveraged finance-related assets ................................
ABSs and ABS CDOs41 .......	(1)		721		-		(40)		7,516		895		6,621		5,612
- high grade42 ..................	14		758		-		(41)		6,620		414		6,206		5,301
- rated C to A ..................	(15)		(37)		-		1		881		481		400		295
- not publicly rated ..........	-		-		-		-		15		-		15		16
Student loan-related assets
ABSs and ABS CDOs41 ......	(6)		569		2		32		7,192		224		6,968		5,122
- high grade42 ..................	2		630		-		32		6,690		30		6,660		5,019
- rated C to A ..................	(8)		(61)		2		-		477		194		283		76
- not publicly rated ..........	-		-		-		-		25		-		25		27
Other assets
ABS and ABS CDOs41 ........	74		415		(17)		91		17,608		8,797		8,811		6,327
- high grade42 ..................	18		288		10		31		12,846		8,607		4,239		3,564
- rated C to A ..................	40		152		(29)		85		4,126		190		3,936		2,245
- not publicly rated ..........	16		(25)		2		(25)		636		-		636		518
Total ....................................	190		4,123		(231)		2,396		94,080		12,156		81,924		62,377

For footnotes, see page 174.

Analysis of exposures and significant movements

(Audited)

Sub-prime residential mortgage-related assets

Sub-prime residential mortage-related assets included US$3.1bn (2009: US$3.7bn) related to US‑originated assets and US$1.1bn (2009: US$1.1bn) relating to UK non-conforming residential mortgage-related assets. Of the non-high grade assets held of US$1.7bn (2009: US$1.7bn), US$1.5bn (2009: US$1.6bn) related to US-originated assets, reflecting the higher quality of the UK‑originated assets.

A modest increase in observable values of our sub-prime assets took place in 2010. Further net impairment of US$48m on assets classified as available for sale was recognised in 2010 (2009: US$559m) as losses were incurred under current accounting impairment rules. Our expectation of cash losses on the underlying assets did not increase from that at 31 December 2009. Of the above impairment, US$54m (2009: US$312m) occurred in the SICs and was borne by the capital note holders.

US Alt-A residential mortgage-related assets

During 2010, spreads on Alt-A mortgage-related assets tightened modestly from the levels seen in 2009. Further impairments of US$884m (2009: US$1,372m) were recorded in respect of Alt-A mortgage-related assets as losses were incurred under the accounting rules described in the paragraph above, without reference to the amount of expected loss. Our expectation of losses in the underlying assets did not increase from that at 31 December 2009. Of the impairment above, US$450m (2009: US$346m) occurred in the SICs and was borne by the capital note holders.

The downgrade of our US Alt-A residential MBSs is reflected in the disclosure of fair value movements in the above tables as if the downgrade had taken effect on 1 January 2010.

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

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

(Audited)

	Gross principal47 of US sub-prime mortgage-backed securities at 31 December				Gross principal47 of US Alt-A mortgage-backed securities at 31 December
	2010		2009		2010		2009
	US$m		US$m		US$m		US$m
Mortgage vintage
Pre-2006 ...........................................................................	1,061		1,748		1,159		2,108
2006 ..................................................................................	1,822		2,827		5,147		6,225
2007 ..................................................................................	979		1,187		3,651		5,213
	3,862		5,762		9,957		13,546

For footnote, see page 174.

US Government agency and sponsored enterprises mortgage-related assets

During 2010, we increased our holdings of US Government agency and sponsored enterprises mortgage-related assets by US$8.3bn.

Other residential mortgage-related assets

The majority of our other residential mortgage‑related assets were originated in the UK (2010: US$3.9bn; 2009: US$4.7bn). No impairments were recognised in respect of these UK originated assets in 2010 (2009: nil), reflecting credit support within the asset portfolio.

Commercial property mortgage-related assets

Of our total of US$10.5bn (2009: US$10.0bn) of commercial property mortgage-related assets, US$5.2bn related to US originated assets (2009: US$4.3bn). Spreads tightened on both US and non-US commercial property mortgage-related assets during 2010. Impairments of US$5m (2009: US$88m) were recognised in 2010.

Leveraged finance-related assets

The majority of these assets related to US-originated exposures; 90% (2009: 94%) were high grade with no impairments recorded in the year (2009: nil).

Student loan-related assets

Our holdings in student loan-related assets were US$5.5bn (2009: US$5.1bn). No impairments were recorded on student loan-related assets in 2010 (2009: nil).

Transactions with monoline insurers

(Audited)

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

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

During 2010, the notional value of derivative contracts with monolines and our overall credit exposure to monolines decreased as a number of transactions were commuted, others matured, and credit spreads narrowed. The table below sets out the fair value, essentially the replacement cost, of the remaining derivative transactions at 31 December 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 S&P at 'BBB‑ or above' at 31 December 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 against the net exposures, and reflects our best estimate of the likely loss of value on purchased protection arising from the deterioration in creditworthiness of the monolines. These valuation adjustments, which reflect a measure of the irrecoverability of the protection purchased, have been charged to the income statement. During 2010, the credit risk adjustment on derivative contracts with monolines decreased as a number of transactions commuted and others matured.

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

(Audited)

	Notional            amount		Net exposure   before credit                    risk adjustment51		Credit risk     adjustment52		Net exposure      after credit                   risk adjustment
	US$m		US$m		US$m		US$m
At 31 December 2010
Derivative transactions with monoline counterparties
Monoline - investment grade (BBB- or above) ......	5,179		876		(88)		788
Monoline - sub-investment grade (below BBB-) .....	2,290		648		(431)		217
	7,469		1,524		(519)		1,005
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 174.

The above table can be analysed as follows. HSBC has derivative transactions referenced to underlying securities with a notional value of US$7.5bn (2009: US$10.0bn), whose value at 31 December 2010 indicated a potential claim against the protection purchased from the monolines of some US$1.5bn (2009: US$2.3bn). On the basis of a credit assessment of the monolines, a provision of US$519m has been taken (2009: US$1.0bn), leaving US$1.0bn exposed (2009: US$1.3bn), of which US$788m is recoverable from monolines rated investment grade at 31 December 2010 (2009: US$897m). The provisions taken imply in aggregate that 90 cents in the dollar will be recoverable from investment grade monolines and 33 cents in the dollar from non-investment grade monolines (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. Our assignment of internal credit ratings is based upon detailed credit analysis, and may differ from external ratings.

Credit risk adjustments for monolines

·   For highly-rated monolines, the standard credit risk adjustment methodology (as described on page 312) applies, with the exception that the future exposure profile is deemed to be constant (equal to the current market value) over the weighted average life of the referenced security, and the credit risk adjustment cannot fall below 10% of the mark-to-market exposure. 

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

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

As described above, HSBC's monoline credit risk adjustment calculation utilises a range of approaches dependent upon the credit quality of the monoline. The net impact of utilising the methodology adopted for 'highly-rated' monolines across all monolines would be a reduction in credit risk adjustment of US$94m. The net impact of utilising a methodology based on credit default swap spreads would be an increase in credit risk adjustment of US$8m.

At 31 December 2010, US$1.4bn (2009: US$2.6bn) notional value of securities referenced by monoline CDS transactions with a market value of US$1.0bn (2009: US$1.9bn) were held in the loans and receivables category, having been included in the reclassification of financial assets described in Note 18 on the Financial Statements. At the date of reclassification, the market value of the remaining assets was US$1.2bn. 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 2010 would have been a decrease in profit of US$3m (2009: increase in profit of US$5m). This amount represents the difference between the increase in market value of the securities during 2010 and the accretion recognised under the amortised cost method in 2010.

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

HSBC had no liquidity facilities to monolines at 31 December 2010 (2009: minimal).

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

Within both the trading and available-for-sale portfolios, we hold bonds that are 'wrapped' with a credit enhancement from a monoline. As the bonds are traded explicitly with the benefit of this enhancement, any deterioration in the credit profile of the monoline is reflected in market prices and, therefore, in the carrying amount of these securities at 31 December 2010. For wrapped bonds held in our trading portfolio, the mark-to-market movement has been reflected through the income statement. For wrapped bonds held in the available-for-sale portfolio, the mark-to-market movement is reflected in equity unless there is objective evidence of impairment, in which case the impairment loss is reflected in the income statement. No wrapped bonds were included in the reclassification of financial assets described in Note 18 on the Financial Statements.

HSBC's exposure to Credit Derivative Product Companies

(Audited)

Credit Derivative Product Companies ('CDPC's) are independent companies that specialise in selling credit default protection on corporate exposures. OTC derivative exposure to CDPCs became a focus during the second half of 2008 as the spreads widened, but these exposures reduced during 2009 as the spreads tightened again. At 31 December 2010, HSBC had purchased from CDPCs credit protection with a notional value of US$4.9bn (2009: US$5.0bn) which had a fair value of US$0.2bn (2009: US$0.3bn), against which a credit risk adjustment (a provision) of US$0.1bn (2009: US$0.1bn) was held. At 31 December 2010, none of the exposure was to CDPCs with investment grade ratings (2009: 83%). The deterioration reflects rating downgrades and withdrawals during 2010.

Leveraged finance transactions

(Audited)

Leveraged finance transactions include sub-investment grade acquisition or event-driven financing. The following table shows our exposure to leveraged finance transactions arising from primary transactions. Our additional exposure to leveraged finance loans through holdings of ABSs from our trading and investment activities is shown in the table on page 133.

HSBC's exposure to leveraged finance transactions

(Audited)

	At 31 December 2010						At 31 December 2009
	Funded   exposures53		Unfunded   exposures53		Total    exposures		Funded     exposures53		Unfunded     exposures53		Total       exposures
	US$m		US$m		US$m		US$m		US$m		US$m
Europe ............................................	3,337		298		3,635		3,790		368		4,158
Rest of Asia-Pacific ........................	17		22		39		70		22		92
North America ...............................	1,066		185		1,251		1,713		188		1,901
	4,420		505		4,925		5,573		578		6,151
Held within:
- loans and receivables ................	4,199		393		4,592		5,569		386		5,955
- fair value through profit or loss	221		112		333		4		192		196

For footnotes, see page 174.

We held leveraged finance commitments of US$5.1bn at 31 December 2010 (2009: US$6.5bn), of which US$4.6bn (2009: US$5.9bn) was funded. 

As described in Note 18 on the Financial Statements, 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 gains of US$0.1bn (2009: net gains of US$1.2bn) were not taken to the income statement in 2010.

At 31 December 2010, our principal exposures were to companies in two sectors: US$2.8bn to data processing (2009: US$3.8bn) and US$1.8bn to communications and infrastructure (2009: US$1.9bn). During 2010, 99% of the total fair value movement not recognised was against exposures in these two sectors (2009: 99%).

Representations and warranties related to mortgage sales and securitisation activities

(Audited)

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

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

·     HSI acting as underwriter for third party issuance of private label MBSs with an original issuance value of US$37bn, most of which were sub-prime, as well as underwriting US$6bn of MBSs issued by HSBC Finance; and

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

In sales and securitisations of mortgage loans, various representations and warranties regarding the loans may be made to purchasers of the mortgage loans and MBSs. In respect of the purchase and securitisation of third party originated mortgages and the underwriting of third party MBSs, the obligation to repurchase loans in the event of a breach of loan level representations and warranties resides predominantly with the organisation that originated the loan. While certain of these originators are or may become financially impaired, and therefore, unable to fulfil their repurchase obligations, we do not believe we have significant exposure for repurchases on these loans.

At 31 December 2010, a liability of US$262m was recognised in respect of various representations and warranties, relating to the origination and sale by HSBC Bank USA of mortgage loans, primarily to government sponsored entities (2009: US$66m). These relate to, among other things, the ownership of the loans, the validity of the liens, the loan selection and origination process, and the compliance to the origination criteria established by the agencies. In the event of a breach of our representations and warranties, HSBC Bank USA may be obliged to repurchase the loans with identified defects or to indemnify the buyers. The liability is estimated based on the level of outstanding repurchase demands, the level of outstanding requests for loan files and estimated future demands in respect of mortgages sold to date which are either two or more payments delinquent or expected to become delinquent at an estimated conversion rate. Repurchase demands of US$115m were outstanding at 2010 (2009: US$123m).

 

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