Fair Value Measurements

3 Months Ended

Mar. 31, 2012

Fair Value Option and Fair Value Measurements [Abstract]

Fair Value Measurements

22.    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 effective in 2012 clarifies that financial instruments do not have alternative use and, as such, the fair value of financial instruments should be determined on an individual instrument basis using an “in-exchange” valuation premise. However, 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 risks 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 elected to make fair value adjustments to a group of derivative instruments with offsetting credit risks and market risks, which include, but are not limited to, interest rate, foreign currency, equity and debt price, and commodity price risks as of the reporting date.

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. The fair value adjustments are broadly categorized by the following types:

Credit risk adjustment – The credit risk adjustment is an adjustment to a group of financial assets and financial liabilities, predominantly derivative assets and derivative 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. A debit valuation adjustment to a financial liability is recorded to reflect the default risk of HUSI. Where applicable, we take into consideration the credit risk mitigating arrangements including collateral agreements and master netting arrangements in estimating the credit risk adjustments.

Liquidity risk adjustment – The liquidity risk adjustment reflects, among other things, (a) the cost that would be incurred to close out the market risks by hedging, disposing or unwinding the actual position (i.e., a bid-offer adjustment), and (b) the illiquid nature, other than the size of the risk position, of a financial instrument.

Input valuation adjustment – Where fair value measurements are determined using internal valuation model based on unobservable inputs, certain valuation inputs may be less readily determinable. There may be a range of possible valuation input that market participants may assume in determining the fair value measurement. The resultant fair value measurement has inherent measurement risk if one or more significant parameters are unobservable and must be estimated. An input valuation adjustment is necessary to reflect the likelihood that market participants may use different input parameters, and to mitigate the possibility of measurement error.

Fair Value Hierarchy  The Fair Value Framework establishes a three-tiered fair value hierarchy as follows:

Level 1 quoted market price – Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 valuation technique using observable inputs – Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are inactive, and measurements determined using valuation models where all significant inputs are observable, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 valuation technique with significant unobservable – Level 3 inputs are unobservable inputs for the asset or liability and include situations where fair values are measured using valuation techniques based on one or more significant unobservable input.

Classification within the fair value hierarchy is based on whether the lowest level input that is significant to the fair value measurement is observable. As such, the classification within the fair value hierarchy is dynamic and can be transferred to other hierarchy levels in each reporting period. Transfers between leveling categories are assessed, determined and recognized at the end of each reporting period.

Valuation Control Framework  We have established a control framework which is designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. To that end, the ultimate responsibility for the determination of fair values rests with Finance. Finance has established an independent price validation process to ensure that the assets and liabilities measured at fair value are properly stated.

A valuation committee, chaired by the Head of Business Finance of Global Banking and Markets, meets monthly to review, monitor and discuss significant valuation matters arising from credit and market risks. The committee is responsible for establishing valuation policies and procedures, approving the internal valuation techniques and models developed by the Quantitative Risk and Valuation Group (QRVG), reviewing and approving valuation adjustments pertaining to, among other things, unobservable inputs, market liquidity, selection of valuation model and counterparty credit risk. Significant valuation risks identified in business activities are corroborated and addressed by the committee members and, where applicable, are escalated to the Chief Financial Officer of HUSI.

Where fair value measurements are determined based on information obtained from independent pricing services or brokers, Finance applies appropriate validation procedures to substantiate fair value. For price validation purposes, quotations from at least two independent pricing sources are obtained for each financial instrument, where possible. The following factors are considered in determining fair values:

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

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

• consistency among different pricing sources;

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

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

• the source of the fair value information.

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 structured such instrument and market consensus pricing based on inputs from a large number of survey participants. Any significant discrepancies among the external quotations are reviewed and adjustments to fair values are recorded where appropriate. Where the transaction volume of a specific instrument has been reduced and the fair value measurement becomes less transparent, Finance will apply more detailed procedures to understand and challenge the appropriateness of the unobservable inputs and the valuation techniques used by the independent pricing service. Where applicable, Finance will develop a fair value estimate using its own pricing model inputs to test reasonableness. Where fair value measurements are determined using internal valuation models, Finance will validate the fair value measurement by either developing unobservable inputs based on the industry consensus pricing surveys in which we participate or back testing by observing the actual settlements occurring soon after the measurement date. Any significant valuation adjustments are reported to and discussed with the valuation committee.

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 quarterly report.

The following table summarizes the carrying value and estimated fair value of our financial instruments at March 31, 2012 and December 31, 2011.

	March 31, 2012										December 31, 2011
	Carrying Value		Fair Value		Level 1		Level 2		Level 3		Carrying Value		Fair Value
	(in millions)
Financial assets:
Short-term financial assets	$	25,092	$	25,092	$	1,573	$	23,038	$	481	$	27,534	$	27,534
Federal funds sold and securities purchased under resale agreements		8,439		8,439		-		8,439		-		3,109		3,104
Non-derivative trading assets		27,791		27,791		704		24,366		2,721		30,028		30,028
Derivatives		9,419		9,419		19		9,172		228		9,826		9,826
Securities		55,458		55,714		27,908		27,806		-		55,316		55,579
Commercial loans, net of allowance for credit losses		35,243		35,837		-		-		35,837		33,207		33,535
Commercial loans designated under fair value option and held for sale		410		410		-		410		-		378		378
Commercial loans held for sale		550		550		-		-		550		587		587
Consumer loans, net of allowance for credit losses		18,023		14,417		-		-		14,417		17,917		14,301
Consumer loans held for sale:
Residential mortgages		1,833		1,840		-		-		1,840		2,058		2,071
Credit cards		388		388		-		-		388		416		416
Other consumer		212		212		-		-		212		231		231
Financial liabilities:
Short-term financial liabilities	$	10,259	$	10,259	$	-	$	10,259	$	-	$	18,497	$	18,497
Deposits:
Without fixed maturities		122,018		122,018		-		122,018		-		123,720		122,710
Fixed maturities		5,531		5,548		-		5,548		-		6,210		6,232
Deposits designated under fair value option		10,018		10,018		-		7,054		2,964		9,799		9,799
Non-derivative trading liabilities		8,436		8,436		383		8,053		-		7,342		7,342
Derivatives		10,738		10,738		13		10,588		137		8,440		8,440
Long-term debt		13,627		14,048		-		14,048		-		11,666		11,653
Long-term debt designated under fair value option		6,042		6,042		-		5,882		160		5,043		5,043

Loan 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 value we believe would be received in a sale as of the balance sheet date (i.e. exit price). The secondary market demand and estimated value for our loans has been heavily influenced by the prevailing economic conditions during the past few years, including house price depreciation, rising unemployment, changes in consumer behavior, and changes in discount rates. Many investors are non-bank financial institutions or hedge funds with high equity levels and a high cost of debt. For certain consumer loans, investors incorporate numerous assumptions in predicting cash flows, such as higher charge-off levels and/or slower voluntary prepayment speeds than we, as the servicer of these loans, believe will ultimately be the case. The investor discount rates reflect this difference in overall cost of capital 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 March 31, 2012 and December 31, 2011 reflect these market conditions.

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 as of March 31, 2012 and December 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

	Fair Value Measurements on a Recurring Basis
	Level 1		Level 2		Level 3		Gross Balance		Netting(1)			Net Balance
	(in millions)
March 31, 2012:
Assets:
Trading securities, excluding derivatives:
U.S. Treasury, U.S. Government agencies and sponsored enterprises	$	704	$	216	$	-	$	920	$	-		$	920
Collateralized debt obligations		-		93		661		754		-			754
Asset-backed securities:
Residential mortgages		-		273		-		273		-			273
Home equity		-		1		-		1		-			1
Student loans		-		-		-		-		-			-
Corporate and other domestic debt securities		-		241		1,753		1,994		-			1,994
Debt securities issued by foreign entities:
Corporate		-		1,668		294		1,982		-			1,982
Government		-		5,581		-		5,581		-			5,581
Equity securities		-		24		13		37		-			37
Precious metals trading		-		16,249		-		16,249		-			16,249
Derivatives(2):
Interest rate contracts		133		55,905		9		56,047		-			56,047
Foreign exchange contracts		3		13,253		198		13,454		-			13,454
Equity contracts		-		1,051		171		1,222		-			1,222
Precious metals contracts		26		632		24		682		-			682
Credit contracts		-		9,037		1,581		10,618		-			10,618
Other contracts		-		-		-		-		-			-
Derivatives netting		-		-		-		-		(72,604	)		(72,604	)
Total derivatives		162		79,878		1,983		82,023		(72,604	)		9,419
Securities available-for-sale:
U.S. Treasury, U.S. Government agencies and sponsored enterprises		27,867		17,242		-		45,109		-			45,109
Obligations of U.S. states and political subdivisions		-		584		-		584		-			584
Asset-backed securities:
Residential mortgages		-		5		-		5		-			5
Commercial mortgages		-		365		-		365		-			365
Home equity		-		265		-		265		-			265
Student loans		-		9		-		9		-			9
Other		-		85		-		85		-			85
Corporate and other domestic debt securities		-		243		-		243		-			243
Debt securities issued by foreign entities:
Corporate		-		1,319		-		1,319		-			1,319
Government		41		5,333		-		5,374		-			5,374
Equity securities		-		151		-		151		-			151
Loans(3)		-		410		-		410		-			410
Intangible(4)		-		-		228		228		-			228
Total assets	$	28,774	$	130,255	$	4,932	$	163,961	$	(72,604	)	$	91,357
Liabilities:
Deposits in domestic offices(5)	$	-	$	7,054	$	2,964	$	10,018	$	-		$	10,018
Trading liabilities, excluding derivatives		383		8,053		-		8,436		-			8,436
Derivatives(2):
Interest rate contracts		55		56,551		-		56,606		-			56,606
Foreign exchange contracts		17		13,068		203		13,288		-			13,288
Equity contracts		-		723		224		947		-			947
Precious metals contracts		24		847		24		895		-			895
Credit contracts		-		9,818		597		10,415		-			10,415
Derivatives netting		-		-		-		-		(71,413	)		(71,413	)
Total derivatives		96		81,007		1,048		82,151		(71,413	)		10,738
Long-term debt(6)		-		5,882		160		6,042		-			6,042
Total liabilities	$	479	$	101,996	$	4,172	$	106,647	$	(71,413	)	$	35,234

	Fair Value Measurements on a Recurring Basis
	Level 1		Level 2		Level 3		Gross Balance		Netting(1)			Net Balance
	(in millions)
December 31, 2011:
Assets:
Trading securities, excluding derivatives:
U.S. Treasury, U.S. Government agencies and sponsored enterprises	$	259	$	38	$	-	$	297	$	-		$	297
Collateralized debt obligations		-		52		703		755		-			755
Asset-backed securities:
Residential mortgages		-		274		-		274		-			274
Home equity		-		1		-		1		-			1
Student loans		-		2		-		2		-			2
Corporate and other domestic debt securities		-		226		1,679		1,905		-			1,905
Debt securities issued by foreign entities:
Corporate		-		1,958		253		2,211		-			2,211
Government		-		7,461		-		7,461		-			7,461
Equity securities		-		27		13		40		-			40
Precious metals trading		-		17,082		-		17,082		-			17,082
Derivatives(2):
Interest rate contracts		135		61,565		9		61,709		-			61,709
Foreign exchange contracts		4		15,440		221		15,665		-			15,665
Equity contracts		-		1,047		169		1,216		-			1,216
Precious metals contracts		171		1,641		30		1,842		-			1,842
Credit contracts		-		12,297		2,093		14,390		-			14,390
Derivatives netting		-		-		-		-		(84,996	)		(84,996	)
Total derivatives		310		91,990		2,522		94,822		(84,996	)		9,826
Securities available-for-sale:
U.S. Treasury, U.S. Government agencies and sponsored enterprises		22,467		22,142		-		44,609		-			44,609
Obligations of U.S. states and political subdivisions		-		600		-		600		-			600
Asset-backed securities:
Residential mortgages		-		5		-		5		-			5
Commercial mortgages		-		451		-		451		-			451
Home equity		-		270		-		270		-			270
Student loans		-		12		-		12		-			12
Other		-		80		-		80		-			80
Corporate and other domestic debt securities		-		544		-		544		-			544
Debt securities issued by foreign entities:
Corporate		-		1,235		-		1,235		-			1,235
Government		40		5,295		-		5,335		-			5,335
Equity securities		-		140		-		140		-			140
Loans(3)		-		367		11		378		-			378
Intangible(4)		-		-		220		220		-			220
Total assets	$	23,076	$	150,252	$	5,401	$	178,729	$	(84,996	)	$	93,733
Liabilities:
Deposits in domestic offices(5)	$	-	$	6,932	$	2,867	$	9,799	$	-		$	9,799
Trading liabilities, excluding derivatives		321		7,021		-		7,342		-			7,342
Derivatives(2):
Interest rate contracts		66		62,702		-		62,768		-			62,768
Foreign exchange contracts		13		15,191		222		15,426		-			15,426
Equity contracts		-		999		252		1,251		-			1,251
Precious metals contracts		32		1,186		30		1,248		-			1,248
Credit contracts		-		13,553		740		14,293		-			14,293
Derivatives netting		-		-		-		-		(86,546	)		(86,546	)
Total derivatives		111		93,631		1,244		94,986		(86,546	)		8,440
Long-term debt(6)		-		4,957		86		5,043		-			5,043
Total liabilities	$	432	$	112,541	$	4,197	$	117,170	$	(86,546	)	$	30,624

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

⁽²⁾  Includes trading derivative assets of $8.3 billion and $8.8 billion and trading derivative liabilities of $9.7 billion and $6.8 billion as of March 31, 2012 and December 31, 2011, respectively, as well as derivatives held for hedging and commitments accounted for as derivatives.

⁽³⁾  Includes leveraged acquisition finance and other commercial loans held for sale or risk-managed on a fair value basis for which we have elected to apply the fair value option. See Note 8, “Loans Held for Sale,” for further information.

⁽⁴⁾  Represents residential mortgage servicing rights. See Note 9, “Intangible Assets,” for further information on residential mortgage servicing rights.

⁽⁵⁾  Represents structured deposits risk-managed on a fair value basis for which we have elected to apply the fair value option.

⁽⁶⁾  Includes structured notes and own debt issuances which we have elected to measure on a fair value basis.

Transfers between leveling categories are recognized at the end of each reporting period.

Transfers into/out of Levels 1 and 2  During the three months ended March 31, 2012 and 2011, there were no transfers between Level 1 and Level 2 measurements.

Information on Level 3 assets and liabilities  The following table summarizes additional information about changes in the fair value of Level 3 assets and liabilities during three months ended March 31, 2012 and 2011. As a risk management practice, we may risk manage the Level 3 assets and liabilities, in whole or in part, using securities and derivative positions that are classified as Level 1 or Level 2 measurements within the fair value hierarchy. Since those Level 1 and Level 2 risk management positions are not included in the table below, the information provided does not reflect the effect of such risk management activities related to the Level 3 assets and liabilities.

	Jan. 1, 2012			Total Gains and (Losses) Included in(1)							Purch- ases		Issu- ances			Settle- ments			Transfers Into Level 3			Transfers Out of Level 3			Mar. 31, 2012			Current Period Unrealized Gains (Losses)
				Trading Revenue (Loss)			Other Revenue		Other Comprehensive Income
	(in millions)
Assets:
Trading assets, excluding derivatives:
Collateralized debt obligations	$	703		$	39		$	-	$	-	$	1	$	-		$	(82	)	$			$			$	661		$	33
Corporate and other domestic debt securities		1,679			20			-		-		82		-			(28	)		-			-			1,753			20
Corporate debt securities issued by foreign entities		253			41			-		-		-		-			-			-			-			294			41
Equity securities		13			-			-		-		-		-			-			-			-			13			-
Derivatives(2):
Interest rate contracts		9			-			-		-		-		-			-			-			-			9			-
Foreign exchange contracts		(1	)		(1	)		-		-		-		-			-			(3	)		-			(5	)		(1	)
Equity contracts		(83	)		50			-		-		-		-			(19	)		-			(1	)		(53	)		27
Credit contracts		1,353			(375	)		-		-		-		-			6			-			-			984			(346	)
Loans(3)		11			-			-		-		-		-			-			-			(11	)		-			(12	)
Mortgage servicing rights(4)		220			-			-		-		-		8			-			-			-			228			-
Total assets	$	4,157		$	(226	)	$	-	$	-	$	83	$	8		$	(123	)	$	(3	)	$	(12	)	$	3,884		$	(238	)
Liabilities:
Deposits in domestic offices	$	(2,867	)	$	(56	)	$	-	$	-	$	-	$	(287	)	$	82		$	3		$	161		$	(2,964	)	$	(41	)
Long-term debt		(86	)		(1	)		-		-		-		(89	)		3			-			13			(160	)		-
Total liabilities	$	(2,953	)	$	(57	)	$	-	$	-	$	-	$	(376	)	$	85		$	3		$	174		$	(3,124	)	$	(41	)

	Jan. 1, 2011			Total Gains and (Losses) Included in(1)								Purch- ases		Issua- nces			Settle- ments			Transfers Into Level 3			Transfers Out of Level 3			Mar. 31, 2011			Current Period Unrealized Gains (Losses)
				Trading Revenue (Loss)			Other Revenue			Other Comprehensive Income
	(in millions)
Assets:
Trading assets, excluding derivatives:
Collateralized debt obligations	$	793		$	11		$	-		$	-	$	-	$	-		$	(4	)	$	-		$	-		$	800		$	4
Corporate and other domestic debt securities		833			12			-			-		21		-			-			-			-			866			12
Corporate debt securities issued by foreign entities		243			26			-			-		-		-			-			-			-			269			26
Equity securities		17			(1	)		-			-		-		-			-			-			-			16			(1	)
Derivatives(2):
Interest rate contracts		(1	)		-			5			-		-		-			-			-			-			4			5
Foreign exchange contracts		(4	)		1			-			-		-		-			-			-			-			(3	)		1
Equity contracts		12			24			-			-		-		-			(71	)		-			(10	)		(45	)		(35	)
Credit contracts		1,202			(159	)		-			-		-		-			(28	)		-			62			1,077			(193	)
Loans(3)		11			-			-			-		-		-			1			-			-			12			-
Mortgage servicing rights(4)		394			-			(14	)		-		-		16			-			-			-			396			(14	)
Total assets	$	3,500		$	(86	)	$	(9	)	$	-	$	21	$	16		$	(102	)	$	-		$	52		$	3,392		$	(195	)
Liabilities:
Deposits in domestic offices	$	(3,612	)	$	(18	)	$	-		$	-	$	-	$	(553	)	$	98		$	(8	)	$	15			(4,078	)	$	(13	)
Long-term debt		(301	)		(9	)		-			-		-		(74	)		115			-			73			(196	)		2
Total liabilities	$	(3,913	)	$	(27	)	$	-		$	-	$	-	$	(627	)	$	213		$	(8	)	$	88		$	(4,274	)	$	(11	)

⁽¹⁾  Includes realized and unrealized gains and losses.

⁽²⁾  Level 3 net derivatives included derivative assets of $2.0 billion and $2.2 billion and derivative liabilities of $1.0 billion and $1.1 billion as of March 31, 2012 and 2011, respectively.

⁽³⁾  Includes Level 3 corporate lending activities risk-managed on a fair value basis for which we have elected the fair value option.

⁽⁴⁾  See Note 9, “Intangible Assets,” for additional information.

The following table presents quantitative information about recurring fair value measurements of assets and liabilities classified with Level 3 of the fair value hierarchy as of March 31, 2012.

Financial Instrument Type	Fair Value (in millions)			Valuation Technique(s)	Significant Unobservable Inputs	Range of Inputs
Collateralized debt obligations	$	661		Broker quotes or consensus pricing and, where applicable, discounted cash flows	Prepayment rates	0% - 35%
					Constant default rates	4% - 14%
					Loss severity rates	50% - 90%
Corporate and other domestic debt securities		1,753		Option adjusted discounted cash flows	Option adjusted spread	292 - 486 basis points
				Discounted cash flows	Spread volatility on collateral assets	1.7% - 4.2%
					Correlation between insurance claim shortfall and collateral value	80%
Corporate debt securities issued by foreign entities		294		Discounted cash flows	Correlations of default among a portfolio of credit names of embedded credit derivatives	12% - 17%
Equity securities (investments in hedge funds)		13		Net asset value of hedge funds	Range of fair value adjustments to reflect restrictions on timing and amount of redemption and realization risks	0% - 90%
Interest rate derivative contracts		9		Market comparable adjusted for probability to fund	Probability to fund for rate lock commitments	NM(1)
Foreign exchange derivative contracts		(5	)	Option pricing model	Foreign exchange volatility and correlation of a basket of currencies	NM(2) (3)
Equity derivative contracts		(53	)	Option pricing model	Price volatility of underlying equity and correlations of equities with a basket or index	NM(2) (3)
Credit derivative contracts		984		Option pricing model	Correlation of defaults of a portfolio of reference credit names	31% - 63%
					Industry by industry correlation of defaults	43% - 73%
Mortgage servicing right		228		Option adjusted discounted cash flow	Constant prepayment rates	8.8% - 35.8%
					Option adjusted spread	8.1% - 19.1
					Estimated annualized costs to service	$98 - $263 per account
Deposits in domestic offices (Structured deposits)		(2,964	)	Option adjusted discounted cash flows	Foreign exchange volatility and correlations of a currency basket within the embedded derivative feature	NM(3)
					Equity price volatility and correlations of equity baskets or index within the embedded derivative feature
Long-term debt (Structured notes)		(160	)	Option adjusted discounted cash flows	Foreign exchange volatility and correlations of a currency basket within the embedded derivative feature	NM(3)
					Equity price volatility and correlations of equity baskets or index within the embedded derivative feature

⁽¹⁾  Insignificant Level 3 measurement. Disclosure is not meaningful to users.

⁽²⁾  We are the client-facing entity and we enter into identical but opposite derivatives to transfer the resultant risks to our affiliates. With the exception of counterparty credit risks, we are market neutral. As a result, the range of significant unobservable inputs is not meaningful as the net risk positions are not significant.

⁽³⁾  The structured notes and structured deposits contain embedded equity or foreign currency derivatives. For financial reporting purposes, we measure the financial instruments at fair value in entirety with changes in fair value recorded in the income statement. For the presentation of this table, we have separated the embedded derivatives from the financial instruments and included them in the equity derivative and foreign currency derivative categories to reflect the underlying risks are managed through identical but offsetting derivatives with affiliates (also see note (2) above).

Sensitivity of Level 3 Inputs to Fair Value Measurements

Collateralized Debt Obligations – Probability of default, prepayment speed and loss severity rate are significant unobservable inputs. Significant increase (decrease) in these inputs will result in a lower (higher) fair value measurement of a collateralized debt obligation. A change in assumption for default probability is often accompanied by a directionally similar change in loss severity, and a directionally opposite change in prepayment speed.

Corporate and Domestic Debt Securities – The fair value measurements of certain corporate debt securities are affected by the fair value of the underlying portfolios of investments used as collateral and the make-whole guarantee provided by third party guarantors. The probability that the collateral fair value declines below the collateral call threshold concurrent with the guarantors failure to perform its make whole obligation is unobservable. The increase (decrease) in the probability the collateral value falls below the collateral call threshold is often accompanied by a directionally similar change in default probability of the guarantor.

Credit derivatives – Correlation of default among a basket of reference credit names is a significant unobservable input if the credit attributes of the portfolio are not within the parameters of relevant standardized CDS indices. Significant increase (decrease) in the unobservable input will result in a lower (higher) fair value measurement of the credit derivative. A change in assumption for default correlation is often accompanied by a directionally similar change in default probability and loss rates of other credit names in the basket.

Equity and foreign currency derivatives – The fair value measurement of a structured equity or foreign currency derivative is primarily affected by the implied volatility of the underlying equity price or exchange rate of the paired foreign currencies. The implied volatility is not observable. Significant increase (decrease) in the implied volatility will result in a higher (lower) fair value of a long position in the derivative contract.

Material Additions to and Transfers Into (Out of) Level 3 Measurements  During the three months ended March 31, 2012, we transferred $161 million of deposits in domestic offices, which we have elected to carry at fair value, from Level 3 to Level 2 as a result of the embedded derivative no longer being unobservable as the derivative option is closer to maturity and there is more observability in short term volatility.

During the three months ended March 31, 2011, we transferred $62 million of credit derivatives from Level 3 to Level 2 as a result of a qualitative analysis of the foreign exchange and credit correlation attributes of our model used for certain credit default swaps.

Assets and Liabilities Recorded at Fair Value on a Non-recurring Basis  Certain financial and non-financial assets are measured at fair value on a non-recurring basis and therefore, are not included in the tables above. These assets include (a) mortgage and consumer loans classified as held for sale reported at the lower of amortized cost or fair value and (b) impaired loans or assets that are written down to fair value based on the valuation of underlying collateral during the period. These instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustment in certain circumstances (e.g., impairment). The following table presents the fair value hierarchy level within which the fair value of the financial and non-financial assets has been recorded as of March 31, 2012 and 2011. The gains (losses) during the three months ended March 31, 2012 and 2011 are also included.

	Non-Recurring Fair Value Measurements as of March 31, 2012								Total Gains (Losses) For the Three Months Ended Mar. 31, 2012
	Level 1		Level 2		Level 3		Total
	(in millions)
Residential mortgage loans held for sale (1)	$	-	$	20	$	186	$	206	$	(2	)
Other consumer loans held for sale (1)		-		-		68		68		-
Impaired loans (2)		-		-		273		273		(11	)
Real estate owned (3)		-		56		-		56		2
Commercial loans held for sale		-		53		-		53		-
Total assets at fair value on a non-recurring basis	$	-	$	129	$	527	$	656	$	(11	)

	Non-Recurring Fair Value Measurements as of March 31, 2011								Total Gains (Losses) For the Three Months Ended Mar. 31, 2011
	Level 1		Level 2		Level 3		Total
	(in millions)
Residential mortgage loans held for sale (1)	$	-	$	175	$	328	$	503	$	5
Other consumer loans held for sale (1)		-		-		80		80		-
Impaired loans (2)		-		-		457		457		1
Real estate owned (3)		-		73		-		73		(3	)
Commercial loans held for sale		-		33		-		33		-
Impairment of certain previously capitalized software development costs (4)		-		-		-		-		(78	)
Building held for use		-		-		13		13		-
Total assets at fair value on a non-recurring basis	$	-	$	281	$	878	$	1,159	$	(75	)

⁽¹⁾  As of March 31, 2012 and 2011, the fair value of the loans held for sale was below cost. Certain residential mortgage loans held for sale have been classified as a Level 3 fair value measurement within the fair value hierarchy as the underlying real estate properties which determine fair value are illiquid assets as a result of market conditions and significant inputs in estimating fair value were unobservable. Additionally, the fair value of these properties is affected by, among other things, the location, the payment history and the completeness of the loan documentation.

⁽²⁾  Represents impaired commercial loans. Certain commercial loans have undergone troubled debt restructurings and are considered impaired. As a matter of practical expedient, we measure the credit impairment of a collateral-dependent loan based on the fair value of the collateral asset. The collateral often involves real estate properties that are illiquid due to market conditions. As a result, these commercial loans are classified as a Level 3 fair value measurement within the fair value hierarchy.

⁽³⁾  Real estate owned are 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 unadjusted for transaction costs.

⁽⁴⁾  In the first quarter of 2011 it was determined that certain previously capitalized software development costs were no longer realizable as a result of the decision to cancel certain projects and, therefore, we recorded an impairment charge of $78 million representing the full amount of the developed software capitalized associated with these projects. The impairment charge was recorded in other expenses in our consolidated statement of income and is included in the results of our RBWM and CMB segment.

The following table presents quantitative information about non-recurring fair value measurements of assets and liabilities classified with Level 3 of the fair value hierarchy as of March 31, 2012.

Financial Instrument Type	Fair Value (in millions)		Valuation Technique(s)	Significant Unobservable Inputs	Range of Inputs
Residential mortgage loans held for sale	$	186	Valuation of third party appraisal on underlying collateral	Loss severity rates	30% -70%
Impaired loans		273	Valuation by third party appraisal on underlying collateral	Loss severity rates	3% - 100%

Valuation Techniques  Following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for those financial instruments not recorded at fair value for which fair value disclosure is required.

Short-term financial assets and liabilities – The carrying amount of certain financial assets and liabilities recorded at cost is considered to approximate fair value because they are short-term in nature, bear interest rates that approximate market rates, and generally have negligible credit risk. These items include cash and due from banks, interest bearing deposits with banks, accrued interest receivable, customer acceptance assets and liabilities and short-term borrowings.

Federal funds sold and purchased and securities purchased and sold under resale and repurchase agreements – Federal funds sold and purchased and securities purchased and sold under resale and repurchase agreements are recorded at cost. A significant majority of these transactions are short-term in nature and, as such, the recorded amounts approximate fair value. For transactions with long-dated maturities, fair value is based on dealer quotes for instruments with similar terms and collateral.

Loans – Except for leveraged loans, selected residential mortgage loans and certain foreign currency denominated commercial loans, we do not record loans at fair value on a recurring basis. From time to time, we record on a non-recurring negative basis adjustment to loans. The write-downs can be based on observable market price of the loan or the underlying collateral value. In addition, fair value estimates are determined based on the product type, financial characteristics, pricing features and maturity.

• Mortgage Loans Held for Sale – Certain residential mortgage loans are classified as held for sale and are recorded at the lower of amortized cost or fair value. The fair value of these mortgage loans is determined based on the valuation information observed in alternative exit markets, such as the whole loan market, adjusted for portfolio specific factors. These factors include the location of the collateral, the loan-to-value ratio, the estimated rate and timing of default, the probability of default or foreclosure and loss severity if foreclosure does occur.

• Leveraged Loans – We record leveraged loans and revolvers held for sale at fair value. Where available, market consensus pricing obtained from independent sources is used to estimate the fair value of the leveraged loans and revolvers. In determining the fair value, we take into consideration the number of participants submitting pricing information, the range of pricing information and distribution, the methodology applied by the pricing services to cleanse the data and market liquidity. Where consensus pricing information is not available, fair value is estimated using observable market prices of similar instruments or inputs, including bonds, credit derivatives, and loans with similar characteristics. Where observable market parameters are not available, fair value is determined based on contractual cash flows, adjusted for the probability of default and estimated recoveries where applicable, discounted at the rate demanded by market participants under current market conditions. In those cases, we also consider the loan specific attributes and inherent credit risk and risk mitigating factors such as collateral arrangements in determining fair value.

• Commercial Loans – Commercial loans and commercial real estate loans are valued by discounting the contractual cash flows, adjusted for prepayments and the borrower’s credit risk, using a discount rate that reflects the current rates offered to borrowers of similar credit standing for the remaining term to maturity and our own estimate of liquidity premium.

• Commercial impaired loans – Fair value is determined primarily by an analysis of discounted expected cash flows with a reference to independent valuations of underlying loan collateral and considering secondary market prices for distressed debt, where applicable.

• Consumer Loans – The estimated fair value of our consumer loans were determined by developing an approximate range of value from a mix of various sources as appropriate for the respective pool of assets. These sources included, among other things, value estimates from an HSBC affiliate which reflect over-the-counter trading activity, forward looking discounted cash flow models using assumptions we believe are consistent with those which would be used by market participants in valuing such receivables; trading input from other market participants which includes observed primary and secondary trades; where appropriate, the impact of current estimated rating agency credit tranching levels with the associated benchmark credit spreads; and general discussions held directly with potential investors. For revolving products, the estimated fair value excludes future draws on the available credit line as well as other items and, therefore, does not include the fair value of the entire relationship.

Valuation inputs include estimates of future interest rates, prepayment speeds, default and loss curves, estimated collateral value and market discount rates reflecting management’s estimate of the rate that would be required by investors in the current market given the specific characteristics and inherent credit risk of the receivables. Some of these inputs are influenced by collateral value changes and unemployment rates. To the extent available, such inputs are derived principally from or corroborated by observable market data by correlation and other means. 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. In addition, from time to time, we may engage a third party valuation specialist to measure the fair value of a pool of receivables. Portfolio risk management personnel provide further validation through discussions with third party brokers and other market participants. Since an active market for these receivables does not exist, the fair value measurement process uses unobservable significant inputs specific to the performance characteristics of the various receivable portfolios.

Lending-related commitments – The fair value of commitments to extend credit, standby letters of credit and financial guarantees are not included in the table. The majority of the lending related commitments are not carried at fair value on a recurring basis nor are they actively traded. These instruments generate fees, which approximate those currently charged to originate similar commitments, which are recognized over the term of the commitment period. Deferred fees on commitments and standby letters of credit totaled $49 million and $44 million at March 31, 2012 and December 31, 2011, respectively.

Precious metals trading – Precious metals trading primarily include physical inventory which are valued using spot prices.

Securities – Where available, debt and equity securities are valued based on quoted market prices. If a quoted market price for the identical security is not available, the security is valued based on quotes from similar securities, where possible. For certain securities, internally developed valuation models are used to determine fair values or validate quotes obtained from pricing services. The following summarizes the valuation methodology used for our major security classes:

• U.S. Treasury, U.S. Government agency issued or guaranteed and Obligations of U.S. state and political subdivisions – As these securities transact in an active market, fair value measurements are based on quoted prices for the identical security or quoted prices for similar securities with adjustments as necessary made using observable inputs which are market corroborated.

• U.S. Government sponsored enterprises – For certain government sponsored mortgage-backed securities which transact in an active market, fair value measurements are based on quoted prices for the identical security or quoted prices for similar securities with adjustments as necessary made using observable inputs which are market corroborated. For government sponsored mortgage-backed securities which do not transact in an active market, fair value is determined primarily based on pricing information obtained from pricing services and is verified by internal review processes.

• Asset-backed securities, including collateralized debt obligations – Fair value is primarily determined based on pricing information obtained from independent pricing services adjusted for the characteristics and the performance of the underlying collateral.

Additional information relating to asset-backed securities and collateralized debt obligations is presented in the following tables:

Trading asset-backed securities and related collateral:

		Prime				Alt-A				Sub-prime
Rating of Securities:	Collateral Type:	Level 2		Level 3		Level 2		Level 3		Level 2		Level 3		Total
		(in millions)
AAA -A	Residential mortgages	$	-	$	-	$	62	$	-	$	207	$	-	$	269
	Home equity		-		-		-		-		-		-		-
	Student loans		-		-		-		-		-		-		-
	Other		-		-		-		-		-		-		-
	Total AAA -A		-		-		62		-		207		-		269
BBB -B	Residential mortgages		-		-		1		-		-		-		1
	Home equity		-		-		-		-		-		-		-
	Total BBB -B		-		-		1		-		-		-		1
CCC-Unrated	Residential mortgages		-		-		-		-		4		-		4
	Home equity		-		-		-		-		-		-		-
	Other		-		-		-		-		-		-		-
	Total CCC -Unrated		-		-		-		-		4		-		4
		$	-	$	-	$	63	$	-	$	211	$	-	$	274

Trading collateralized debt obligations and related collateral:

Rating of Securities:	Collateral Type:	Level 2		Level 3
	(in millions)
AAA -A	Commercial mortgages	$	-	$	-
	Residential mortgages		-		-
	Student loans		53		-
	Other		-		-
	Total AAA -A		53		-
BBB -B	Commercial mortgages		-		156
	Corporate loans		-		351
	Other		-		133
	Total BBB -B		-		640
CCC -Unrated	Commercial mortgages		-		61
	Corporate loans		-		-
	Other		-		-
	Total CCC -Unrated		-		61
		$	53	$	701

Available-for-sale securities backed by collateral:

		Commercial Mortgages				Prime				Alt-A				Sub-prime
Rating of Securities:	Collateral Type:	Level 2		Level 3		Level 2		Level 3		Level 2		Level 3		Level 2		Level 3		Total
		(in millions)
AAA -A	Residential mortgages	$	-	$	-	$	-	$	-	$	3	$	-	$	-	$	-	$	3
	Commercial mortgages		365		-		-		-		-		-		-		-		365
	Home equity		-		-		-		-		116		-		-		-		116
	Student loans		-		-		-		-		9		-		-		-		9
	Other		-		-		-		-		85		-		-		-		85
	Total AAA -A		365		-		-		-		213		-		-		-		578
BBB -B	Residential mortgages		-		-		-		-		-		-		-		-		-
	Home equity		-		-		-		-		82		-		1		-		83
	Total BBB -B		-		-		-		-		82		-		1		-		83
CCC -Unrated	Residential mortgages		-		-		-		-		2		-		-		-		2
	Home equity		-		-		-		-		66		-		-		-		66
	Total CCC -Unrated		-		-		-		-		68		-		-		-		68
		$	365	$	-	$	-	$	-	$	363	$	-	$	1	$	-	$	729

• Other domestic debt and foreign debt securities (corporate and government) – Except for certain structured securities, substantially all of the domestic and foreign securities are classified as Level 3 measurements. For non-callable corporate securities, a credit spread scale is created for each issuer. These spreads are then added to the equivalent maturity U.S. Treasury yield to determine current pricing. Credit spreads are obtained from the new market, secondary trading levels and dealer quotes. For securities with early redemption features, an option adjusted spread (“OAS”) model is incorporated to adjust the spreads determined above. Additionally, we survey the broker/dealer community to obtain relevant trade data including benchmark quotes and updated spreads.

• Equity securities – Except for those legacy investments in hedge funds, since most of our securities are transacted in active markets, fair value measurements are determined based on quoted prices for the identical security. For mutual fund investments, we receive monthly statements from the investment manager with the estimated fair value.

Derivatives – Derivatives are recorded at fair value. Asset and liability positions in individual derivatives that are covered by legally enforceable master netting agreements, including cash collateral are offset and presented net in accordance with accounting principles which allow the offsetting of amounts relating to certain contracts.

Derivatives traded on an exchange are valued using quoted prices. OTC derivatives, which comprise a majority of derivative contract positions, are valued using valuation techniques. The fair value for the majority of our derivative instruments are determined based on internally developed models that utilize independently corroborated market parameters, including interest rate yield curves, option volatilities, and currency rates. For complex or long-dated derivative products where market data is not available, fair value may be affected by the choice of valuation model and the underlying assumptions about, among other things, the timing of cash flows and credit spreads. The fair values of certain structured derivative products are sensitive to unobservable inputs such as default correlations of the referenced credit and volatilities of embedded options. These estimates are susceptible to significant change in future periods as market conditions change.

Significant inputs related to derivative classes are broken down as follows:

• Credit Derivatives – Use credit default curves and recovery rates which are generally provided by broker quotes and various pricing services. Certain credit derivatives may also use correlation inputs in their model valuation. Correlation is derived using market quotes from brokers and various pricing services.

• Interest Rate Derivatives – Swaps use interest rate curves based on currency that are actively quoted by brokers and other pricing services. Options will also use volatility inputs which are also quoted in the broker market.

• Foreign Exchange (“FX”) Derivatives – FX transactions use spot and forward FX rates which are quoted in the broker market.

• Equity Derivatives – Use listed equity security pricing and implied volatilities from equity traded options position.

• Precious Metal Derivative – Use spot and forward metal rates which are quoted in the broker market.

We may adjust valuations derived using the methods described above in order to ensure that those values represent appropriate estimates of fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors such as bid-ask spreads and counterparty credit risk that can affect prices in arms-length transactions with unrelated third parties. Such adjustments are based on management judgment and may not be observable.

Real estate owned – Fair value is determined based on third party appraisals obtained at the time we take title to the property and, if less than the carrying amount of the loan, the carrying amount of the loan is adjusted to the fair value. The carrying amount of the property is further reduced, if necessary, not less than once every 45 days to reflect observable local market data including local area sales data.

Mortgage servicing rights – We elected to measure residential mortgage servicing rights, which are classified as intangible assets, at fair value. The fair value for the residential mortgage servicing rights is determined based on an option adjusted approach which involves discounting servicing cash flows under various interest rate projections at risk-adjusted rates. The valuation model also incorporates our best estimate of the prepayment speed of the mortgage loans, current cost to service and discount rates which are unobservable. As changes in interest rates is a key factor affecting the prepayment speed and hence the fair value of the mortgage servicing rights, we use various interest rate derivatives and forward purchase contracts of mortgage-backed securities to risk-manage the mortgage servicing rights.

Structured notes – Certain structured notes were elected to be measured at fair value in their entirety under fair value option accounting principles. As a result, derivative features embedded in the structured notes are included in the valuation of fair value. The valuation of embedded derivatives may include significant unobservable inputs such as correlation of the referenced credit names or volatility of the embedded option. Other significant inputs include interest rates (yield curve), time to maturity, expected loss and loss severity.

Cash flows of the funded notes are discounted at the appropriate rate for the applicable duration of the instrument adjusted for our own credit spreads. The credit spreads applied to these instruments are derived from the spreads at which institutions of similar credit standing would offer for issuing similar structured instruments as of the measurement date. The market spreads for structured notes are generally lower than the credit spreads observed for plain vanilla debt or in the credit default swap market.

Long-term debt – We elected to apply fair value option to certain own debt issuances for which fair value hedge accounting otherwise would have been applied. These own debt issuances elected under FVO are traded in secondary markets and, as such, the fair value is determined based on observed prices for the specific instrument. The observed market price of these instruments reflects the effect of our own credit spreads. The credit spreads applied to these instruments were derived from the spreads recognized in the secondary market for similar debt as of the measurement date.

For long-term debt recorded at cost, fair value is determined based on quoted market prices where available. If quoted market prices are not available, fair value is based on dealer quotes, quoted prices of similar instruments, or internally developed valuation models adjusted for own credit risks.

Deposits – For fair value disclosure purposes, the carrying amount of deposits with no stated maturity (e.g., demand, savings, and certain money market deposits), which represents the amount payable upon demand, is considered to approximate fair value. For deposits with fixed maturities, fair value is estimated by discounting cash flows using market interest rates currently offered on deposits with similar characteristics and maturities.