Fair Value Option

9 Months Ended

Sep. 30, 2013

We report our results to HSBC in accordance with its reporting basis, International Financial Reporting Standards (“IFRSs”). We typically have elected to apply fair value option accounting to selected financial instruments to align the measurement attributes of those instruments under U.S. GAAP and IFRSs and to simplify the accounting model applied to those financial instruments. We elected to apply fair value option (“FVO”) reporting to commercial leveraged acquisition finance loans held for sale and related unfunded commitments, certain fixed rate long-term debt issuances and hybrid instruments which include all structured notes and structured deposits. Changes in fair value for these assets and liabilities are reported as gain (loss) on instruments designated at fair value and related derivatives in the consolidated statement of income (loss).

Loans We elected to apply FVO to all commercial leveraged acquisition finance loans held for sale and related unfunded commitments. The election allows us to account for these loans and commitments at fair value which is consistent with the manner in which the instruments are managed. During the first quarter of 2013, we completed the sale of substantially all of our remaining leveraged acquisition finance syndicated loans which we had been holding since the financial crisis.

These loans are included in loans held for sale in the consolidated balance sheet. Interest from these loans is recorded as interest income in the consolidated statement of income (loss). Because a substantial majority of the loans elected for the fair value option are floating rate assets, changes in their fair value are primarily attributable to changes in loan-specific credit risk factors. The components of gain (loss) related to loans designated at fair value are summarized in the table below. As of September 30, 2013 and December 31, 2012, no loans for which the fair value option has been elected are 90 days or more past due or on nonaccrual status.

Long-Term Debt (Own Debt Issuances) We elected to apply FVO for certain fixed-rate long-term debt for which we had applied or otherwise would elect to apply fair value hedge accounting. The election allows us to achieve a similar accounting effect without having to meet the hedge accounting requirements. We measure the fair value of these debt issuances based on inputs observed in the secondary market. Changes in fair value of these instruments are attributable to changes of our own credit risk and interest rates. Interest on the fixed-rate debt accounted for under FVO is recorded as interest expense in the consolidated statement of income (loss). The components of gain (loss) related to long-term debt designated at fair value are summarized in the table below.

Hybrid Instruments We elected to apply fair value option accounting to all of our hybrid instruments, inclusive of structured notes and structured deposits, issued after January 1, 2006. Interest on this debt is recorded as interest expense in the consolidated statement of income (loss). The components of gain (loss) related to hybrid instruments designated at fair value which reflect the instruments described above are summarized in the table below.

The following table summarizes the fair value and unpaid principal balance for items we account for under FVO:



	Fair Value		Unpaid Principal Balance
	(in millions)
September 30, 2013
Commercial leveraged acquisition finance loans	$	1	$	1
Fixed rate long-term debt	1,845		1,750
Hybrid instruments:
Interest bearing deposits in domestic offices	7,851		7,693
Structured notes	5,002		4,852
December 31, 2012
Commercial leveraged acquisition finance loans	$	465	$	486
Fixed rate long-term debt	2,016		1,750
Hybrid instruments:
Interest bearing deposits in domestic offices	8,692		8,399
Structured notes	5,264		5,030

Components of Gain on Instruments at Fair Value and Related Derivatives Gain (loss) on instruments designated at fair value and related derivatives includes the changes in fair value related to interest, credit and other risks as well as the mark-to-market adjustment on derivatives related to the financial instrument designated at fair value and net realized gains or losses on these derivatives. The following table summarizes the components of gain (loss) on instruments designated at fair value and related derivatives related to the changes in fair value of the financial instrument accounted for under FVO:



	Loans			Long-Term Debt			Hybrid Instruments			Total
	(in millions)
Three Months Ended September 30, 2013
Interest rate and other components⁽¹⁾	$	—		$	40		$	(280	)	$	(240	)
Credit risk component	—			(63		)	39			(24		)
Total mark-to-market on financial instruments designated at fair value	—			(23		)	(241		)	(264		)
Mark-to-market on the related derivatives	—			(39		)	280			241
Net realized gain on the related long-term debt derivatives	—			17			—			17
Gain (loss) on instruments designated at fair value and related derivatives	$	—		$	(45	)	$	39		$	(6	)

Three Months Ended September 30, 2012
Interest rate and other components⁽¹⁾	$	1		$	14		$	(389	)	$	(374	)
Credit risk component	14			(179		)	(39		)	(204		)
Total mark-to-market on financial instruments designated at fair value	15			(165		)	(428		)	(578		)
Net realized loss on financial instruments	1			—			—			1
Mark-to-market on the related derivatives	—			(21		)	396			375
Net realized gain on the related long-term debt derivatives	—			15			—			15
Gain (loss) on instruments designated at fair value and related derivatives	$	16		$	(171	)	$	(32	)	$	(187	)

Nine Months Ended September 30, 2013
Interest rate and other components⁽¹⁾	$	—		$	223		$	(392	)	$	(169	)
Credit risk component	21			(52		)	126			95
Total mark-to-market on financial instruments designated at fair value	21			171			(266		)	(74		)
Net realized loss on financial instruments	(8		)	—			—			(8		)
Mark-to-market on the related derivatives	—			(229		)	344			115
Net realized gain on the related long-term debt derivatives	—			49			—			49
Gain (loss) on instruments designated at fair value and related derivatives	$	13		$	(9	)	$	78		$	82

Nine Months Ended September 30, 2012
Interest rate and other components⁽¹⁾	$	2		$	(26	)	$	(744	)	$	(768	)
Credit risk component	48			(269		)	(62		)	(283		)
Total mark-to-market on financial instruments designated at fair value	50			(295		)	(806		)	(1,051		)
Mark-to-market on the related derivatives	—			6			741			747
Net realized gain on the related long-term debt derivatives	—			46			—			46
Gain (loss) on instruments designated at fair value and related derivatives	$	50		$	(243	)	$	(65	)	$	(258	)


⁽¹⁾	As it relates to hybrid instruments, interest rate and other components includes interest rate, foreign exchange and equity contract risks.

- Definition

The entire disclosure for a company's election to apply the fair value option for measurement and reporting of eligible financial assets and liabilities (as defined), as well as certain other eligible items (as defined) included in the statement of financial position, whether such option is elected for a single eligible item or a group of similar eligible items and is in addition to other disclosures concerning fair value which the company may be required to provide. Such disclosure might be expected to include: (1) for items included in the statement of financial position: (a) the reasons for electing a fair value option for each eligible item or group of similar eligible items; (b) if the fair value option is elected for some but not all eligible items within a group of similar eligible items: (i) a description of those similar items and the reasons for partial election and (ii) information of how the group of similar items relates to individual balance sheet line items; (c) for each line item in the statement of financial position that includes an item or items for which the fair value option has been elected: (i) information of how each line item in the statement of financial position relates to major categories of assets and liabilities presented in accordance with other fair value disclosures and (ii) the aggregate carrying amount of ineligible items included in each line item in the balance sheet, if any; (d) the difference between the aggregate fair value and the aggregate unpaid principal balance (assuming contractual principal amounts and fair value option elected) of: (i) loans and long-term receivables (other than securities otherwise reported at fair value) and (ii) long-term debt instruments; (e) for loans held as assets for which the fair value option has been elected: (i) the aggregate fair value of loans that are 90 days or more past due, (ii) if the policy is to recognize interest income separately from other changes in fair value, the aggregate fair value of loans in nonaccrual status, and (iii) the difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due, in nonaccrual status, or both; (f) for investments that would have been accounted for under the equity method if the entity had not chosen to apply the fair value option, the information required for such investments, if material either individually or in the aggregate; (2) for items included in the income statement: (a) the amounts of gains and losses from fair value changes included in earnings and in which line in the income statement those gains and losses are reported whether or not combined with gains and losses from items required to be accounted for at fair value; (b) a description of how interest and dividends are measured and where they are reported in the income statement; (c) for loans and other receivables held as assets: (i) the estimated amount of gains or losses included in earnings attributable to changes in instrument-specific credit risk and (ii) how the gains or losses attributable to changes in instrument-specific credit risk were determined; (d) for liabilities with fair values that have been significantly affected during the reporting period by changes in the instrument-specific credit risk: (i) the estimated amount of gains and losses from fair value changes included in earnings that are attributable to changes in the instrument-specific credit risk, (ii) qualitative information about the reasons for those changes, and (iii) how the gains and losses attributable to changes in instrument-specific credit risk were determined; and (3) certain other disclosures as required or determined to be provided.

+ References+ Details