Fair Value Measurements

Accounting principles related to fair value measurements provide a framework for measuring fair value and focus on an exit price that would be received to sell an asset or paid to transfer a liability in the principal market (or in the absence of the principal market, the most advantageous market) accessible in an orderly transaction between willing market participants (the “Fair Value Framework”). Where required by the applicable accounting standards, assets and liabilities are measured at fair value using the “highest and best use” valuation premise. Fair value measurement guidance clarifies that financial instruments do not have alternative use and, as such, the fair value of financial instruments should be determined using an “in-exchange” valuation premise. Although the fair value measurement literature provides a valuation exception and permits an entity to measure the fair value of a group of financial assets and financial liabilities with offsetting credit risk and/or market risks based on the exit price it would receive or pay to transfer the net risk exposure of a group of assets or liabilities if certain conditions are met, we have not elected to make fair value adjustments to a group of derivative instruments with offsetting credit and market risks.

Fair Value Adjustments The best evidence of fair value is quoted market price in an actively traded market, where available. In the event listed price or market quotes are not available, valuation techniques that incorporate relevant transaction data and market parameters reflecting the attributes of the asset or liability under consideration are applied. Where applicable, fair value adjustments are made to ensure the financial instruments are appropriately recorded at fair value. The fair value adjustments reflect the risks associated with the products, contractual terms of the transactions, and the liquidity of the markets in which the transactions occur.

Credit risk adjustment - The credit risk adjustment is an adjustment to a group of financial assets or financial liabilities to reflect the credit quality of the parties to the transaction in arriving at fair value. A credit valuation adjustment to a financial asset is required to reflect the default risk of the counterparty. Where applicable, we take into consideration the credit risk mitigating arrangements including collateral agreements and master netting arrangements in estimating the credit risk adjustments.

Valuation Control Framework A control framework has been established which is designed to ensure that fair values are validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the measurement of fair values rests with the HSBC U.S. Valuation Committee. The HSBC U.S. Valuation Committee establishes policies and procedures to ensure appropriate valuations. Fair values for long-term debt for which we have elected fair value option are measured by a third-party valuation source (pricing service) by reference to external quotations on the identical or similar instruments. Once fair values have been obtained from the third-party valuation source, an independent price validation process is performed and reviewed by the HSBC U.S. Valuation Committee. For price validation purposes, we obtain quotations from at least one other independent pricing source for each financial instrument, where possible. We consider the following factors in determining fair values:


Ÿ	similarities between the asset or the liability under consideration and the asset or liability for which quotation is received;


Ÿ	collaboration of pricing by reference to other independent market data such as market transactions and relevant benchmark indices;


Ÿ	whether the security is traded in an active or inactive market;


Ÿ	consistency among different pricing sources;


Ÿ	the valuation approach and the methodologies used by the independent pricing sources in determining fair value;


Ÿ	the elapsed time between the date to which the market data relates and the measurement date; and


Ÿ	the manner in which the fair value information is sourced.

Greater weight is given to quotations of instruments with recent market transactions, pricing quotes from dealers who stand ready to transact, quotations provided by market-makers who originally underwrote such instruments, and market consensus pricing based on inputs from a large number of participants. Any significant discrepancies among the external quotations are reviewed by management and adjustments to fair values are recorded where appropriate.

Fair values for derivatives are determined by management using valuation techniques, valuation models and inputs that are developed, reviewed, validated and approved by the Markets Independent Model Review Team of an HSBC affiliate. The models used apply appropriate control processes and procedures to ensure that the derived inputs are used to value only those instruments that share similar risk to the relevant benchmark indexes and therefore demonstrate a similar response to market factors.

We have various controls over our valuation process and procedures for receivables held for sale. As these fair values are generally determined using value estimates from third party and affiliate valuation specialists, the controls may include analytical reviews of quarterly value trends, corroboration of inputs by observable market data, direct discussion with potential investors and results of actual sales of such receivable, all of which are submitted to the HSBC U.S. Valuation Committee for review.

Fair Value of Financial Instruments The fair value estimates, methods and assumptions set forth below for our financial instruments, including those financial instruments carried at cost, are made solely to comply with disclosures required by generally accepted accounting principles in the United States and should be read in conjunction with the financial statements and notes included in this Form 10-Q. The following table summarizes the carrying values and estimated fair value of our financial instruments at June 30, 2016 and December 31, 2015.



	June 30, 2016
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(in millions)
Financial assets:
Cash	$	271	$	271	$	271	$	—	$	—
Securities purchased under agreements to resell	2,771		2,771		—		2,771		—
Real estate secured receivables⁽¹⁾:
First lien	6,452		6,401		—		—		6,401
Second lien	1,586		1,039		—		—		1,039
Total real estate secured receivables	8,038		7,440		—		—		7,440
Real estate secured receivables held for sale	3,796		3,868		—		707		3,161
Due from affiliates	77		77		—		77		—
Financial liabilities:
Due to affiliates carried at fair value	484		484		—		484		—
Due to affiliates not carried at fair value	4,928		5,189		—		5,189		—
Long-term debt carried at fair value	1,419		1,419		—		1,419		—
Long-term debt not carried at fair value	3,810		4,140		—		4,140		—



	December 31, 2015
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(in millions)
Financial assets:
Cash	$	124	$	124	$	124	$	—	$	—
Securities purchased under agreements to resell	2,724		2,724		—		2,724		—
Real estate secured receivables⁽¹⁾:
First lien	7,237		7,174		—		—		7,174
Second lien	1,750		1,156		—		—		1,156
Total real estate secured receivables	8,987		8,330		—		—		8,330
Real estate secured receivables held for sale	8,265		8,668		—		—		8,668
Due from affiliates	128		128		—		128		—
Financial liabilities:
Due to affiliates carried at fair value	496		496		—		496		—
Due to affiliates not carried at fair value	5,429		5,693		—		5,693		—
Long-term debt carried at fair value	3,257		3,257		—		3,257		—
Long-term debt not carried at fair value	6,253		6,664		—		6,664		—

⁽¹⁾

The receivable held for investment carrying value included in this table reflects the principal amount outstanding on the loan net of any charge-off recorded in accordance with our existing charge-off policies and includes certain basis adjustments to the loan such as unearned income, unamortized deferred fees and costs on originated loans, purchase accounting fair value adjustments and premiums or discounts on purchased loans. The receivable held for investment carrying value included in this table also includes accrued finance charges and is net of credit loss reserves. However, the basis adjustments on the loans, accrued finance charges and credit loss reserves are excluded in other presentations of dollars of two-months-and-over contractual delinquency, nonaccrual receivable and nonperforming receivables held for investment account balances.

Receivable values presented in the table above were determined using the Fair Value Framework for measuring fair value, which is based on our best estimate of the amount within a range of values we believe would be received in a sale at the balance sheet date (i.e. exit price). The secondary market demand and estimated value for our receivables may be heavily influenced by economic conditions, including house price depreciation, elevated unemployment, changes in consumer behavior, changes in discount rates and the lack of financing options available to support the purchase of receivables. For certain consumer receivables, investors incorporate numerous assumptions in predicting cash flows, such as future interest rates, higher charge-off levels, slower voluntary prepayment speeds, different default and loss curves and estimated collateral values than we, as the servicer of these receivables, believe will ultimately be the case. The investor's valuation process reflects this difference in overall cost of capital assumptions as well as the potential volatility in the underlying cash flow assumptions, the combination of which may yield a significant pricing discount from our intrinsic value. The estimated fair values at June 30, 2016 and December 31, 2015 reflect these market conditions. The estimated fair value of total real estate secured receivables held for investment as a percentage of carrying value at June 30, 2016 was essentially flat as compared with December 31, 2015 reflecting stable conditions in the housing industry during the first half of 2016. The fair value of receivables held for sale in total at June 30, 2016 continues to exceed the carrying value of these receivables as they are carried at the lower of amortized cost or fair value.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis The following table presents information about our assets and liabilities measured at fair value on a recurring basis at June 30, 2016 and December 31, 2015, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Netting⁽¹⁾			Total of Assets (Liabilities) Measured at Fair Value
	(in millions)
June 30, 2016:
Derivative financial assets:
Currency swaps	$	—	$	148		$	—	$	—		$	148
Derivative netting	—		—			—		(148		)	(148		)
Total derivative financial assets	—		148			—		(148		)	—
Total assets	$	—	$	148		$	—	$	(148	)	$	—
Due to affiliates carried at fair value	$	—	$	(484	)	$	—	$	—		$	(484	)
Long-term debt carried at fair value	—		(1,419		)	—		—			(1,419		)
Derivative related liabilities:
Currency swaps	—		(251		)	—		—			(251		)
Derivative netting	—		—			—		251			251
Total derivative related liabilities	—		(251		)	—		251			—
Total liabilities	$	—	$	(2,154	)	$	—	$	251		$	(1,903	)
December 31, 2015:
Derivative financial assets:
Interest rate swaps	$	—	$	24		$	—	$	—		$	24
Currency swaps	—		111			—		—			111
Derivative netting	—		—			—		(135		)	(135		)
Total derivative financial assets	—		135			—		(135		)	—
Total assets	$	—	$	135		$	—	$	(135	)	$	—
Due to affiliates carried at fair value	$	—	$	(496	)	$	—	$	—		$	(496	)
Long-term debt carried at fair value	—		(3,257		)	—		—			(3,257		)
Derivative related liabilities:
Interest rate swaps	—		(304		)	—		—			(304		)
Currency swaps	—		(379		)	—		—			(379		)
Derivative netting	—		—			—		626			626
Total derivative related liabilities	—		(683		)	—		626			(57		)
Total liabilities	$	—	$	(4,436	)	$	—	$	626		$	(3,810	)


⁽¹⁾	Represents counterparty and swap collateral netting which allow the offsetting of amounts relating to certain contracts when certain conditions are met.

Significant Transfers Between Level 1 and Level 2 There were no transfers between Level 1 and Level 2 for assets and liabilities recorded at fair value on a recurring basis during the three and six months ended June 30, 2016 or 2015.

Information on Level 3 Assets and Liabilities There were no assets or liabilities recorded at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and six months ended June 30, 2016 or 2015.

Assets and Liabilities Recorded at Fair Value on a Non-recurring Basis The following table presents information about our assets and liabilities measured at fair value on a non-recurring basis at June 30, 2016 and 2015, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. Certain of the fair values in the table below were not obtained as of June 30, 2016 or 2015 but during the periods then ended. See Note 2, "Summary of Significant Accounting Policies and New Accounting Pronouncements," in our 2015 Form 10-K for discussion of our policy in measuring fair value.



	Non-Recurring Fair Value Measurements at June 30, 2016								Total Gains (Losses) for the Three Months Ended June 30, 2016			Total Gains (Losses) for the Six Months Ended June 30, 2016
	Level 1		Level 2		Level 3		Total					Total Gains (Losses) for the Six Months Ended June 30, 2016
	(in millions)
Real estate secured receivables held for sale	$	—	$	707	$	3,089	$	3,796	$	(62	)	$	(130	)
Receivables held for investment carried at the lower of amortized cost or fair value of the collateral less cost to sell⁽¹⁾	—		268		—		268		(5		)	(31		)
Real estate owned⁽²⁾	—		69		—		69		(5		)	(10		)
Total assets at fair value on a non-recurring basis	$	—	$	1,044	$	3,089	$	4,133	$	(72	)	$	(171	)



	Non-Recurring Fair Value Measurements at June 30, 2015								Total Gains (Losses) for the Three Months Ended June 30, 2015			Total Gains (Losses) for the Six Months Ended June 30, 2015
	Level 1		Level 2		Level 3		Total					Total Gains (Losses) for the Six Months Ended June 30, 2015
	(in millions)
Real estate secured receivables held for sale	$	—	$	109	$	10,201	$	10,310	$	(54	)	$	(71	)
Receivables held for investment carried at the lower of amortized cost or fair value of the collateral less cost to sell⁽¹⁾	—		342		—		342		(55		)	(127		)
Real estate owned⁽²⁾	—		155		—		155		(5		)	(9		)
Total assets at fair value on a non-recurring basis	$	—	$	606	$	10,201	$	10,807	$	(114	)	$	(207	)


⁽¹⁾	Total gains (losses) for the three and six months ended June 30, 2016 and 2015 include amounts recorded on receivables that were subsequently transferred to held for sale.


⁽²⁾	Real estate owned is required to be reported on the balance sheet net of transactions costs. The real estate owned amounts in the table above reflect the fair value of the underlying asset unadjusted for transaction costs.

Significant Transfers Between Level 1 and Level 2 There were no transfers between Level 1 and Level 2 for assets and liabilities recorded at fair value on a non-recurring basis during the three and six months ended June 30, 2016 or 2015.

Significant Transfers Between Level 2 and Level 3 We transferred real estate secured receivables held for sale from Level 3 to Level 2 prior to the sale of these receivables totaling $3,627 million and $4,926 million during the three and six months ended June 30, 2016, respectively, compared with $109 million and $442 million, respectively, during the three and six months ended June 30, 2015. Receivables held for sale are reclassified from Level 3 to Level 2 upon execution of a sale agreement.

The following table presents quantitative information about non-recurring fair value measurements of assets and liabilities classified as Level 3 in the fair value hierarchy at June 30, 2016 and December 31, 2015:



	Fair Value						Range of Inputs
Financial Instrument Type	June 30, 2016		Dec. 31, 2015		Valuation Technique	Significant Unobservable Inputs	June 30, 2016				December 31, 2015
	(in millions)
Receivables held for sale carried at the lower of amortized cost or fair value:
Real estate secured	$	3,089	$	8,265	Third party appraisal valuation based on	Collateral loss severity rates⁽¹⁾	0	%	-	100%	0	%	-	100%
					estimated loss severities, including collateral values, cash flows and	Expenses incurred through collateral disposition	5	%	-	10%	5	%	-	10%
					market discount rate	Market discount rate	4	%	-	15%	4	%	-	14%


⁽¹⁾	At June 30, 2016 and December 31, 2015, the weighted average collateral loss severity rate was 44 percent and 42 percent, respectively, taking into consideration both expected net cash flows as well as current collateral values.

Valuation Techniques The following summarizes the valuation methodologies used for assets and liabilities recorded at fair value on both a recurring and non-recurring basis and for estimating fair value for financial instruments not recorded at fair value but for which fair value disclosures are required.

Cash: Carrying amount approximates fair value due to the liquid nature of cash.

Securities purchased under agreements to resell: The fair value of securities purchased under agreements to resell approximates carrying amount due to the short-term maturity of the agreements.

Receivables and receivables held for sale: The estimated fair value of our receivables and receivables held for sale is determined by developing an approximate range of value from a mix of various sources appropriate for the respective pools of assets aggregated by similar risk characteristics. These sources include recently observed over-the-counter transactions where available and fair value estimates obtained from an HSBC affiliate and, for receivables held for sale, a third party valuation specialist for distinct pools of receivables. These fair value estimates are based on discounted cash flow models using assumptions we believe are consistent with those that would be used by market participants in valuing such receivables and trading inputs from other market participants which includes observed primary and secondary trades. As a result of our decision during the second quarter of 2015 to expand our receivable sales program, we have added additional pools to our fair value estimation process in line with the new risk characteristics that now exist in the expanded receivables held for sale portfolio.

Valuation inputs include estimates of future interest rates, prepayment speeds, default and loss curves, estimated collateral values (including expenses to be incurred to maintain the collateral) and market discount rates reflecting management's estimate of the rate of return that would be required by investors in the current market given the specific characteristics and inherent credit risk of the receivables and receivables held for sale. Some of these inputs are influenced by collateral value changes and unemployment rates. We perform analytical reviews of fair value changes on a quarterly basis and periodically validate our valuation methodologies and assumptions based on the results of actual sales of such receivables. We also may hold discussions on value directly with potential investors. Since some receivables pools may have features which are unique, the fair value measurement processes use significant unobservable inputs which are specific to the performance characteristics of the various receivable portfolios.

Real estate owned: Fair value is determined based on third party valuations obtained at the time we take title to the property and, if less than the carrying amount of the receivable, the carrying amount of the receivable is adjusted to the fair value less estimated cost to sell. The carrying amount of the property is further reduced, if necessary, at least every 45 days to reflect observable local market data, including local area sales data.

Due from affiliates: Carrying amount approximates fair value because the interest rates on these receivables adjust with changing market interest rates.

Long-term debt and Due to affiliates: Fair value is primarily determined by a third party valuation source. The pricing services source fair value from quoted market prices and, if not available, expected cash flows are discounted using the appropriate interest rate for the applicable duration of the instrument adjusted for our own credit risk (spread). The credit spreads applied to these instruments are derived from the spreads recognized in the secondary market for similar debt as of the measurement date. Where available, relevant trade data is also considered as part of our validation process.

Derivative financial assets and liabilities: Derivative values are defined as the amount we would receive or pay to extinguish the contract using a market participant at the reporting date. The values are determined by management using a pricing system maintained by HSBC Bank USA. In determining these values, HSBC Bank USA uses quoted market prices, when available. For non-exchange traded contracts, such as interest rate swaps, fair value is determined using discounted cash flow modeling techniques. Valuation models calculate the present value of expected future cash flows based on models that utilize independently-sourced market parameters, including interest rate yield curves, option volatilities, and currency rates. Valuations may be adjusted in order to ensure that those values represent appropriate estimates of fair value. These adjustments are generally required to reflect factors such as market liquidity and counterparty credit risk that can affect prices in arms-length transactions with unrelated third parties. Finally, other transaction specific factors such as the variety of valuation models available, the range of unobservable model inputs and other model assumptions can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.

Counterparty credit risk is considered in determining the fair value of a financial asset. The Fair Value Framework specifies that the fair value of a liability should reflect the entity's non-performance risk and accordingly, the effect of our own credit risk (spread) has been factored into the determination of the fair value of our financial liabilities, including derivative instruments. In estimating the credit risk adjustment to the derivative assets and liabilities, we take into account the impact of netting and/or collateral arrangements that are designed to mitigate counterparty credit risk.