HSBC 2009 Annual Report Download - page 166

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Overview of exposure > Monolines / Leveraged finance transactions
164
The above table can be analysed as follows.
HSBC has derivative transactions referenced to
underlying securities with a notional value of
US$10.0 billion (2008: US$12.4 billion), whose
value at 31 December 2009 indicated a potential
claim against the protection purchased from the
monolines of some US$2.3 billion (2008:
US$3.9 billion). On the basis of a credit assessment
of the monolines, a credit risk adjustment of
US$1.0 billion has been taken (2008:
US$1.5 billion), leaving US$1.3 billion exposed
(2008: US$2.4 billion), of which US$0.9 billion is
recoverable from monolines rated investment grade
at 31 December 2009 (2008: US$2.1 billion). The
provisions taken imply in aggregate that 90 cents in
the dollar will be recoverable from investment grade
monolines and 31 cents in the dollar from non-
investment grade monolines (2008: 74 cents and
32 cents, respectively).
For the CDSs, market prices are generally not
readily available. Therefore the CDSs are valued
based upon 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) 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 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 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. 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 a claim is believed to be high.
At 31 December 2009, US$2,566 million
notional value of securities referenced by monoline
CDS transactions with a market value of
US$1,863 million, were held in the loans and
receivables category, having been included in the
reclassification of financial assets described on
page 153. At the date of reclassification, the market
value of the assets was US$1,926 million. 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 2009 would
have been an increase in profit of US$5 million
(2008: decrease in profit of US$115 million). This
amount represents the difference between the
increase in market value of the securities during
2009 and the accretion recognised under the
amortised cost method in 2009.
HSBC’s exposure to direct lending and
irrevocable commitments to lend to
monoline insurers
HSBC has minimal liquidity facilities at
31 December 2009 (2008: US$47 million) to
monolines, all of which were drawn at 31 December
2009 (2008: US$2 million drawn).
HSBC’s exposure to debt securities which
benefit from guarantees provided by
monoline insurers
Within both the trading and available-for-sale
portfolios, HSBC holds bonds that are ‘wrapped’
with a credit enhancement from a monoline. 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 2009. For wrapped bonds held in the
trading portfolio, the mark-to-market movement has
been reflected through the income statement. For
wrapped bonds held in the available-for-sale
portfolio, the mark-to-market movement is reflected
in equity unless there is objective evidence of
impairment, in which case the impairment loss is
reflected in the income statement. No wrapped bonds
were included in the reclassification of financial
assets described on page 153.
HSBC’s exposure to Credit Derivative
Product Companies
CDPCs 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
corporate credit spreads widened, but these
exposures reduced during 2009 as corporate credit