Guarantee Arrangements, Pledged Assets and Repurchase Agreements

Guarantee Arrangements As part of our normal operations, we enter into credit derivatives and various off-balance sheet guarantee arrangements with affiliates and third parties. These arrangements arise principally in connection with our lending and client intermediation activities and include standby letters of credit and certain credit derivative transactions. The contractual amounts of these arrangements represent our maximum possible credit exposure in the event that we are required to fulfill the maximum obligation under the contractual terms of the guarantee.

The following table presents total carrying value and contractual amounts of our sell protection credit derivatives and major off-balance sheet guarantee arrangements at September 30, 2016 and December 31, 2015. Following the table is a description of the various arrangements.



	September 30, 2016					December 31, 2015
	Carrying Value			Notional / Maximum Exposure to Loss		Carrying Value			Notional / Maximum Exposure to Loss
	(in millions)
Credit derivatives⁽¹⁾⁽⁴⁾	$	(682	)	$	68,248	$	(2,621	)	$	91,435
Financial standby letters of credit, net of participations⁽²⁾⁽³⁾	—			5,539		—			5,842
Performance standby letters of credit, net of participations⁽²⁾⁽³⁾	—			2,887		—			3,008
Liquidity asset purchase agreements⁽³⁾	—			—		—			3,362
Total	$	(682	)	$	76,674	$	(2,621	)	$	103,647


⁽¹⁾	Includes $38,642 million and $44,130 million of notional issued for the benefit of HSBC affiliates at September 30, 2016 and December 31, 2015, respectively.


⁽²⁾	Includes $1,204 million and $910 million issued for the benefit of HSBC affiliates at September 30, 2016 and December 31, 2015, respectively.


⁽³⁾	For standby letters of credit and liquidity asset purchase agreements, maximum loss represents losses to be recognized assuming the letter of credit and liquidity facilities have been fully drawn and the obligors have defaulted with zero recovery.


⁽⁴⁾	For credit derivatives, the maximum loss is represented by the notional amounts without consideration of mitigating effects from collateral or recourse arrangements.

Credit-Risk Related Guarantees

Credit derivatives Credit derivatives are financial instruments that transfer the credit risk of a reference obligation from the credit protection buyer to the credit protection seller who is exposed to the credit risk without buying the reference obligation. We sell credit protection on underlying reference obligations (such as loans or securities) by entering into credit derivatives, primarily in the form of credit default swaps, with various institutions. We account for all credit derivatives at fair value. Where we sell credit protection to a counterparty that holds the reference obligation, the arrangement is effectively a financial guarantee on the reference obligation. Under a credit derivative contract, the credit protection seller will reimburse the credit protection buyer upon occurrence of a credit event (such as bankruptcy, insolvency, restructuring or failure to meet payment obligations when due) as defined in the derivative contract, in return for a periodic premium. Upon occurrence of a credit event, we will pay the counterparty the stated notional amount of the derivative contract and receive the underlying reference obligation. The recovery value of the reference obligation received could be significantly lower than its notional principal amount when a credit event occurs.

Certain derivative contracts are subject to master netting arrangements and related collateral agreements. A party to a derivative contract may demand that the counterparty post additional collateral in the event its net exposure exceeds certain predetermined limits and when the credit rating falls below a certain grade. We set the collateral requirements by counterparty such that the collateral covers various transactions and products, and is not allocated to specific individual contracts.

We manage our exposure to credit derivatives using a variety of risk mitigation strategies where we enter into offsetting hedge positions or transfer the economic risks, in part or in entirety, to investors through the issuance of structured credit products. We actively manage the credit and market risk exposure in the credit derivative portfolios on a net basis and, as such, retain no or a limited net sell protection position at any time. The following table summarizes our net credit derivative positions at September 30, 2016 and December 31, 2015:



	September 30, 2016					December 31, 2015
	Carrying / Fair Value			Notional		Carrying / Fair Value			Notional
	(in millions)
Sell-protection credit derivative positions	$	(682	)	$	68,248	$	(2,621	)	$	91,435
Buy-protection credit derivative positions	889			75,267		2,789			96,635
Net position⁽¹⁾	$	207		$	7,019	$	168		$	5,200

⁽¹⁾

Positions are presented net in the table above to provide a complete analysis of our risk exposure and depict the way we manage our credit derivative portfolio. The offset of the sell-protection credit derivatives against the buy-protection credit derivatives may not be legally binding in the absence of master netting agreements with the same counterparty. Furthermore, the credit loss triggering events for individual sell protection credit derivatives may not be the same or occur in the same period as those of the buy protection credit derivatives thereby not providing an exact offset.

Standby letters of credit A standby letter of credit is issued to a third party for the benefit of a customer and is a guarantee that the customer will perform or satisfy certain obligations under a contract. It irrevocably obligates us to pay a specified amount to the third party beneficiary if the customer fails to perform the contractual obligation. We issue two types of standby letters of credit: performance and financial. A performance standby letter of credit is issued where the customer is required to perform some non-financial contractual obligation, such as the performance of a specific act, whereas a financial standby letter of credit is issued where the customer's contractual obligation is of a financial nature, such as the repayment of a loan or debt instrument. At September 30, 2016, the total amount of outstanding financial standby letters of credit (net of participations) and performance guarantees (net of participations) were $5,539 million and $2,887 million, respectively. At December 31, 2015, the total amount of outstanding financial standby letters of credit (net of participations) and performance guarantees (net of participations) were $5,842 million and $3,008 million, respectively.

The issuance of a standby letter of credit is subject to our credit approval process and collateral requirements. We charge fees for issuing letters of credit commensurate with the customer's credit evaluation and the nature of any collateral. Included in other liabilities are deferred fees on standby letters of credit amounting to $49 million and $54 million at September 30, 2016 and December 31, 2015, respectively. Also included in other liabilities is an allowance for credit losses on unfunded standby letters of credit of $38 million and $19 million at September 30, 2016 and December 31, 2015, respectively.

The following table summarizes the credit ratings related to guarantees including the ratings of counterparties against which we sold credit protection and financial standby letters of credit at September 30, 2016 as an indicative proxy of payment risk:



	Average Life (in years)	Credit Ratings of the Obligors or the Transactions
Notional/Contractual Amounts	Average Life (in years)	Investment Grade		Non-Investment Grade		Total
		(dollars are in millions)
Sell-protection Credit Derivatives⁽¹⁾
Single name credit default swaps ("CDS")	2.3	$	35,310	$	18,357	$	53,667
Structured CDS	0.8	3,719		491		4,210
Index credit derivatives	3.3	4,077		3,107		7,184
Total return swaps	2.6	2,837		351		3,188
Subtotal		45,943		22,306		68,249
Standby Letters of Credit⁽²⁾	1.0	5,597		2,829		8,426
Total		$	51,540	$	25,135	$	76,675


⁽¹⁾	The credit ratings in the table represent external credit ratings for classification as investment grade and non-investment grade.


⁽²⁾	External ratings for most of the obligors are not available. Presented above are the internal credit ratings which are developed using similar methodologies and rating scale equivalent to external credit ratings for purposes of classification as investment grade and non-investment grade.

Our internal credit ratings are determined based on HSBC's risk rating systems and processes which assign a credit grade based on a scale which ranks the risk of default of a customer. The credit grades are assigned and used for managing risk and determining level of credit exposure appetite based on the customer's operating performance, liquidity, capital structure and debt service ability. In addition, we also incorporate subjective judgments into the risk rating process concerning such things as industry trends, comparison of performance to industry peers and perceived quality of management. We compare our internal risk ratings to outside external rating agency benchmarks, where possible, at the time of formal review and regularly monitor whether our risk ratings are comparable to the external ratings benchmark data.

A non-investment grade rating of a referenced obligor has a negative impact to the fair value of the credit derivative and increases the likelihood that we will be required to perform under the credit derivative contract. We employ market-based parameters and, where possible, use the observable credit spreads of the referenced obligors as measurement inputs in determining the fair value of the credit derivatives. We believe that such market parameters are more indicative of the current status of payment/performance risk than external ratings by the rating agencies which may not be forward-looking in nature and, as a result, lag behind those market-based indicators.

Non Credit-Risk Related Guarantees and Other Arrangements

Liquidity asset purchase agreements Prior to the third quarter of 2016, we provided liquidity facilities to Regency, a multi-seller ABCP conduit consolidated by an HSBC affiliate. Regency financed the purchase of individual assets by issuing commercial paper to third party investors. Each liquidity facility was transaction specific and had a maximum limit. Pursuant to the liquidity agreements, we were obligated, subject to certain limitations, to advance funds in an amount not to exceed the face value of the commercial paper in the event Regency was unable or unwilling to refinance its commercial paper. A liquidity asset purchase agreement is economically a conditional written put option issued to the conduit where the exercise price is the face value of the commercial paper. At December 31, 2015 we had issued $3,362 million of liquidity facilities to provide liquidity support to Regency. During the third quarter of 2016, Regency was restructured and these liquidity facilities were terminated. See Note 17, "Variable Interest Entities," for further discussion.

Clearinghouses and exchanges We are a member of various exchanges and clearinghouses that trade and clear securities and/or derivatives contracts. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, members of a clearinghouse may be required to contribute to a guaranty fund to backstop members' obligations to the clearinghouse. As a member, we may be required to pay a proportionate share of the financial obligations of another member who defaults on its obligations to the exchange or the clearinghouse. Our guarantee obligations would arise only if the exchange or clearinghouse had exhausted its resources. Any potential contingent liability under these membership agreements cannot be estimated.

Securitization Activity In addition to the repurchase risk described above, we have also been involved as a sponsor/seller of loans used to facilitate whole loan securitizations underwritten by our affiliate, HSI. In this regard, we began acquiring residential mortgage loans in 2005 which were warehoused on our balance sheet with the intent of selling them to HSI to facilitate HSI’s whole loan securitization program which was discontinued in 2007. During 2005-2007, we purchased and sold $24 billion of such loans to HSI which were subsequently securitized and sold by HSI to third parties. See "Mortgage Securitization Matters" in Note 27, "Litigation and Regulatory Matters," in our 2015 Form 10-K and in Note 20, "Litigation and Regulatory Matters," in our Form 10-Q for the three month period ended March 31, 2016 for additional discussion of related exposure. There have been no significant changes with regards to this exposure since March 31, 2016. The outstanding principal balance on these loans was approximately $4.8 billion and $5.2 billion at September 30, 2016 and December 31, 2015, respectively.

Mortgage Loan Repurchase Obligations Historically, we originated and sold mortgage loans, primarily to government sponsored entities, and provided various representations and warranties related 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, we may be obligated to repurchase the loans with identified defects or to indemnify the buyers. Our contractual obligation arises only when the breach of representations and warranties are discovered and repurchase is demanded. As a result of settlements with FNMA and FHLMC during 2013 and 2014, the repurchase exposure associated with these sales has been substantially resolved. In addition, with the conversion of our mortgage processing and servicing operations to PHH Mortgage in 2013, new agency eligible originations are sold directly to PHH Mortgage and PHH Mortgage is responsible for origination representations and warranties for all loans purchased.

In estimating our repurchase liability arising from breaches of representations and warranties, we consider historical losses on residual risks not covered by settlement agreements adjusted for any risk factors not captured in the historical losses as well as the level of outstanding repurchase demands received. Outstanding repurchase demands received totaled $9 million and $5 million at September 30, 2016 and December 31, 2015, respectively.

The following table summarizes the change in our estimated repurchase liability during the three and nine months ended September 30, 2016 and 2015 for obligations arising from the breach of representations and warranties associated with mortgage loans sold:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
	(in millions)
Balance at beginning of period	$	13		$	21		$	17		$	27
Decrease in liability recorded through earnings	—			(2		)	(3		)	(7		)
Realized losses	(1		)	—			(2		)	(1		)
Balance at end of period	$	12		$	19		$	12		$	19

Our remaining repurchase liability of $12 million at September 30, 2016 represents our best estimate of the loss that has been incurred, including interest, arising from breaches of representations and warranties associated with mortgage loans sold. Because the level of mortgage loan repurchase losses is dependent upon economic factors, investor demand strategies and other external risk factors such as housing market trends that may change, the level of the liability for mortgage loan repurchase losses requires significant judgment. We continue to evaluate our methods of determining the best estimate of loss based on recent trends. As these estimates are influenced by factors outside our control, there is uncertainty inherent in these estimates making it reasonably possible that they could change. The range of reasonably possible losses in excess of our recorded repurchase liability is between zero and $25 million at September 30, 2016. This estimated range of reasonably possible losses was determined based upon modifying the assumptions utilized in our best estimate of probable losses to reflect what we believe to be reasonably possible adverse assumptions.

Pledged Assets

Pledged assets included in the consolidated balance sheet consisted of the following:



	September 30, 2016		December 31, 2015
	(in millions)
Interest bearing deposits with banks	$	1,274	$	676
Trading assets⁽¹⁾	3,323		3,802
Securities available-for-sale⁽²⁾	10,417		11,092
Securities held-to-maturity	3,718		3,293
Loans⁽³⁾	18,135		17,880
Other assets⁽⁴⁾	644		1,765
Total	$	37,511	$	38,508


⁽¹⁾	Trading assets are primarily pledged against liabilities associated with repurchase agreements.


⁽²⁾	Securities available-for-sale are primarily pledged against derivatives, public fund deposits, trust deposits and various short-term and long term borrowings, as well as providing capacity for potential secured borrowings from the Federal Home Loan Bank of New York ("FHLB") and the Federal Reserve Bank of New York.


⁽³⁾	Loans are primarily residential mortgage loans pledged against current and potential borrowings from the FHLB and the Federal Reserve Bank of New York.


⁽⁴⁾	Other assets represent cash on deposit with non-banks related to derivative collateral support agreements.

Debt securities pledged as collateral that can be sold or repledged by the secured party continue to be reported on the consolidated balance sheet. The fair value of securities available-for-sale that could be sold or repledged was $658 million and $1,000 million at September 30, 2016 and December 31, 2015, respectively. The fair value of trading assets that could be sold or repledged was $3,323 million and $3,797 million at September 30, 2016 and December 31, 2015, respectively.

The fair value of collateral we accepted under security resale agreements but not reported on the consolidated balance sheet was $32,118 million and $25,058 million at September 30, 2016 and December 31, 2015, respectively, discussed further below. Of this collateral, $26,478 million and $19,558 million could be sold or repledged at September 30, 2016 and December 31, 2015, respectively, of which $1,409 million and $3,400 million, respectively, had been sold or repledged as collateral under repurchase agreements or to cover short sales.

Repurchase Agreements

We enter into purchases of securities under agreements to resell (resale agreements) and sales of securities under agreements to repurchase (repurchase agreements) identical or substantially the same securities. Resale and repurchase agreements are accounted for as secured lending and secured borrowing transactions, respectively.

Repurchase agreements may require us to deposit cash or other collateral with the lender. In connection with resale agreements, it is our policy to obtain possession of collateral, which may include the securities purchased, with market value in excess of the principal amount loaned. The market value of the collateral subject to the resale and repurchase agreements is regularly monitored, and additional collateral is obtained or provided when appropriate, to ensure appropriate collateral coverage of these secured financing transactions.

The following table provides information about resale and repurchase agreements that are subject to offset at September 30, 2016 and December 31, 2015:



							Gross Amounts Not Offset in the Balance Sheet
	Gross Amounts Recognized		Gross Amounts Offset in the Balance Sheet⁽¹⁾		Net Amounts Presented in the Balance Sheet		Financial Instruments ⁽²⁾		Cash Collateral Received / Pledged		Net Amount ⁽³⁾
	(in millions)
At September 30, 2016:
Assets:
Securities purchased under resale agreements	$	32,118	$	1,404	$	30,714	$	30,680	$	—	$	34
Liabilities:
Securities sold under repurchase agreements	$	5,390	$	1,404	$	3,986	$	3,986	$	—	$	—

At December 31, 2015:
Assets:
Securities purchased under resale agreements	$	25,058	$	5,211	$	19,847	$	19,845	$	—	$	2
Liabilities:
Securities sold under repurchase agreements	$	8,197	$	5,211	$	2,986	$	2,954	$	—	$	32


⁽¹⁾	Represents recognized amount of resale and repurchase agreements with counterparties subject to legally enforceable netting agreements that meet the applicable netting criteria as permitted by generally accepted accounting principles.


⁽²⁾	Represents securities received or pledged to cover financing transaction exposures.


⁽³⁾	Represents the amount of our exposure that is not collateralized / covered by pledged collateral.

The following table provides the class of collateral pledged and remaining contractual maturity of repurchase agreements accounted for as secured borrowings at September 30, 2016 and December 31, 2015:



	Overnight and Continuous		Up to 30 Days		31 to 90 Days		91 Days to One Year		Greater Than One Year		Total
	(in millions)
At September 30, 2016:
U.S. Treasury, U.S. Government agency and sponsored entity securities	$	1,404	$	311	$	—	$	368	$	3,307	$	5,390

At December 31, 2015:
U.S. Treasury, U.S. Government agency and sponsored entity securities	$	1,764	$	3,457	$	—	$	—	$	2,976	$	8,197