HSBC 2007 Annual Report Download - page 135

133
rates, bankruptcy trends, geographic concentrations,
loan product features, economic conditions such as
national and local trends in housing markets, the
level of interest rates, portfolio seasoning, account
management policies and practices, changes in laws
and regulations, and other factors that can affect
customer payment patterns. Different factors are
applied in different regions and countries to reflect
different economic conditions and laws and
regulations. The assumptions underlying this
judgement are highly subjective. The methodology
and the assumptions used in calculating impairment
losses are reviewed regularly in the light of
differences between loss estimates and actual loss
experience. For example, roll rates, loss rates and the
expected timing of future recoveries are regularly
benchmarked against actual outcomes to ensure they
remain appropriate.
The total amount of the Group’s impairment
allowances on homogeneous groups of loans is
inherently uncertain because it is highly sensitive to
changes in economic and credit conditions across a
large number of geographical areas. Economic and
credit conditions within geographical areas are
influenced by many factors with a high degree of
interdependency so that there is no one single factor
to which the Group’s loan impairment allowances as
a whole are particularly sensitive. However, HSBC’s
loan impairment allowances are particularly
sensitive to general economic and credit conditions
in North America. For example, a 10 per cent
increase in impairment allowances on collectively
assessed loans and advances in North America
would increase loan impairment allowances
by US$1.2 billion at 31 December 2007
(2006: US$714 million). It is possible that the
outcomes within the next financial year could be
different from the assumptions built into the models,
resulting in a material adjustment to the carrying
amount of loans and advances.
Goodwill impairment
HSBC’s accounting policy for goodwill is described
in Note 2o on the Financial Statements. Note 22 on
the Financial Statements sets out the Group’s cash
generating units (‘CGUs’) by geographical region
and global business. The most significant amount of
goodwill relates to the Personal Financial Services –
North America CGU, which amounts to
US$10.2 billion or 30 per cent of total goodwill.
The process of identifying and evaluating
goodwill impairment is inherently uncertain because
it requires significant management judgement in
making a series of estimations, the results of which
are highly sensitive to the assumptions used. The
review of goodwill impairment represents
management’s best estimate of the factors below.
Firstly, significant management judgement is
required in estimating the future cash flows of the
CGUs. These values are sensitive to the cash flows
projected for the periods for which detailed forecasts
are available, and to assumptions regarding the long-
term pattern of sustainable cash flows thereafter.
Forecasts are compared with actual performance and
verifiable economic data in future years; however,
the cash flow forecasts necessarily and appropriately
reflect management’s view of future business
prospects. Note 22 shows how the key assumptions
used in estimating future cash flows for each CGU
have changed from 2006 to 2007.
Secondly, the cost of capital assigned to an
individual CGU and used to discount its future cash
flows can have a significant effect on the CGU’s
valuation. The cost of capital percentage is generally
derived from a Capital Asset Pricing Model, which
incorporates inputs reflecting a number of financial
and economic variables, including the risk-free
interest rate in the country concerned and a premium
to reflect the inherent risk of the business being
evaluated. These variables are established on the
basis of significant management judgement and are
subject to uncertainty.
When this exercise demonstrates that the
expected cash flows of a CGU have declined and/or
that its cost of capital has increased, the effect is to
reduce the CGU’s estimated fair value. If this results
in an estimated recoverable amount that is lower
than the carrying value of the CGU, a charge for
impairment of goodwill will be recorded, thereby
reducing by a corresponding amount HSBC’s profit
for the year.
Note 22 on the Financial Statements includes
details of the CGUs with significant balances of
goodwill, and states the key assumptions used to
assess the goodwill in each CGU for impairment.
Goodwill impairment testing performed in 2007
and 2006 indicated that there was no impairment of
goodwill. It is possible that the outcomes within the
next financial year could be different from the
assumptions used, resulting in a material adjustment
to the carrying amount of goodwill. In particular, the
deterioration in the economic and credit conditions
in North America has resulted in a severe decline in
the profitability of the North American consumer
finance business during 2007, and as a result
goodwill impairment in the Personal Financial
Services – North America CGU was re-tested as at
31 December 2007. Notwithstanding these
conditions, the recoverable amount based on