FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a - 16 or 15d - 16 of
the Securities Exchange Act of 1934
For the month of November 2005
HSBC Holdings plc
42nd Floor, 8 Canada
Square, London E14 5HQ, England
(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F).
Form 20-F X Form 40-F ......
(Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934).
Yes....... No X
(If "Yes" is marked, indicate below the file number assigned to the registrant
in connection with Rule 12g3-2(b): 82- ..............)
CONFORMED
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-7436
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
Maryland
(State of Incorporation)
13-2764867
(IRS Employer Identification No.)
452 Fifth Avenue, New York, New York 10018
(Address of principal executive offices)
(212) 525-3735
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
At October 31, 2005, all voting stock (706 shares of Common Stock, $5 par value)
is owned by an indirect wholly owned subsidiary of HSBC Holdings plc.
================================================================================
HSBC USA Inc.
Form 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
--------------------------------------------------------------------------------
Page
----
Item 1. Consolidated Financial Statements
Statement of Income ......................................... 3
Balance Sheet ............................................... 4
Statement of Changes in Shareholders' Equity ................ 5
Statement of Cash Flows ..................................... 6
Notes to Consolidated Financial Statements .................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (MD&A)
Average Balances and Interest Rates ......................... 21
Forward-Looking Statements .................................. 23
Executive Overview .......................................... 23
Basis of Reporting .......................................... 29
Results of Operations ....................................... 34
Business Segments ........................................... 46
Credit Quality .............................................. 54
Derivative Instruments and Hedging Activities ............... 58
Off-Balance Sheet Arrangements .............................. 60
Variable Interest Entities (VIEs) ........................... 61
Capital ..................................................... 63
Risk Management ............................................. 63
Item 3. Quantitative and Qualitative Disclosures About Market Risk ....... 68
Item 4. Controls and Procedures .......................................... 68
Part II OTHER INFORMATION
--------------------------------------------------------------------------------
Item 6. Exhibits ......................................................... 69
Signature ................................................................. 70
2
Part I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
--------------------------------------------------------------------------------
HSBC USA Inc.
--------------------------------------------------------------------------------
C O N S O L I D A T E D S T A T E M E N T O F I N C O M E
Three months ended September 30, Nine months ended September 30,
2005 2004 2005 2004
------------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans ................................................ $ 1,192 $ 779 $ 3,377 $ 2,060
Securities ........................................... 225 220 650 651
Trading assets ....................................... 73 43 193 114
Short-term investments ............................... 83 27 202 63
Other ................................................ 9 5 23 13
------- ------- ------- -------
Total interest income .................................... 1,582 1,074 4,445 2,901
------- ------- ------- -------
Interest expense:
Deposits ............................................. 476 226 1,199 544
Short-term borrowings ................................ 87 49 205 100
Long-term debt ....................................... 258 101 720 216
------- ------- ------- -------
Total interest expense ................................... 821 376 2,124 860
------- ------- ------- -------
Net interest income ...................................... 761 698 2,321 2,041
Provision for credit losses .............................. 199 27 476 7
------- ------- ------- -------
Net interest income after provision for credit losses .... 562 671 1,845 2,034
------- ------- ------- -------
Other revenues:
Trust income ......................................... 21 23 65 71
Service charges ...................................... 52 54 158 158
Other fees and commissions ........................... 192 110 481 341
Securitization revenue ............................... 30 -- 99 --
Other income ......................................... 25 200 180 283
Residential mortgage banking revenue (expense) ....... 31 (64) 41 (105)
Trading revenues ..................................... 137 21 268 188
Security gains, net .................................. 17 18 105 59
------- ------- ------- -------
Total other revenues ..................................... 505 362 1,397 995
------- ------- ------- -------
Operating expenses:
Salaries and employee benefits ....................... 257 219 778 714
Occupancy expense, net ............................... 49 42 134 124
Support services from HSBC affiliates ................ 213 99 649 291
Other expenses ....................................... 154 120 451 360
------- ------- ------- -------
Total operating expenses ................................. 673 480 2,012 1,489
------- ------- ------- -------
Income before income tax expense ......................... 394 553 1,230 1,540
Income tax expense ....................................... 142 214 450 551
------- ------- ------- -------
Net income ............................................... $ 252 $ 339 $ 780 $ 989
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC USA Inc.
--------------------------------------------------------------------------------
C O N S O L I D A T E D B A L A N C E S H E E T
September 30, December 31,
2005 2004
-------------------------------------------------------------------------------------------------------
(in millions)
Assets
Cash and due from banks ............................................... $ 4,524 $ 2,682
Interest bearing deposits with banks .................................. 2,132 2,776
Federal funds sold and securities purchased under resale agreements ... 4,311 3,126
Trading assets ........................................................ 20,320 19,815
Securities available for sale ......................................... 15,917 14,655
Securities held to maturity (fair value $3,392 and $4,042) ............ 3,261 3,881
Loans ................................................................. 89,409 84,947
Less - allowance for credit losses .................................... 852 788
-------- --------
Loans, net ...................................................... 88,557 84,159
Properties and equipment, net ......................................... 531 594
Intangible assets, net ................................................ 394 352
Goodwill .............................................................. 2,694 2,697
Other assets .......................................................... 6,248 6,313
-------- --------
Total assets .......................................................... $148,889 $141,050
======== ========
Liabilities
Deposits in domestic offices:
Noninterest bearing ................................................. $ 8,557 $ 7,639
Interest bearing .................................................... 56,155 50,069
Deposits in foreign offices:
Noninterest bearing ................................................. 341 248
Interest bearing .................................................... 22,064 22,025
-------- --------
Total deposits .................................................. 87,117 79,981
-------- --------
Trading account liabilities ........................................... 11,202 12,120
Short-term borrowings ................................................. 9,324 9,874
Interest, taxes and other liabilities ................................. 4,610 4,370
Long-term debt ........................................................ 24,800 23,839
-------- --------
Total liabilities ..................................................... 137,053 130,184
-------- --------
Shareholders' equity
Preferred stock ....................................................... 1,017 500
Common shareholder's equity:
Common stock ($5 par; 150,000,000 shares authorized;
706 shares issued) ............................ -- --
Capital surplus ..................................................... 8,136 8,418
Retained earnings ................................................... 2,668 1,917
Accumulated other comprehensive income .............................. 15 31
Total common shareholder's equity ............................... 10,819 10,366
-------- --------
Total shareholders' equity ............................................ 11,836 10,866
-------- --------
Total liabilities and shareholders' equity ............................ $148,889 $141,050
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
HSBC USA Inc.
--------------------------------------------------------------------------------
C O N S O L I D A T E D S T A T E M E N T O F C H A N G E S
I N S H A R E H O L D E R S' E Q U I T Y
Nine months ended September 30,
2005 2004
---------------------------------------------------------------------------------------------------------------------
(in millions)
Preferred stock
Balance, January 1, ...................................................................... $ 500 $ 500
Preferred stock issuance ................................................................. 517 --
-------- --------
Balance, September 30, ................................................................... 1,017 500
-------- --------
Common stock
Balance, January 1 and September 30, ..................................................... -- --
-------- --------
Capital surplus
Balance, January 1, ...................................................................... 8,418 6,027
Capital contribution from parent ......................................................... 10 408
Preferred stock issuance costs ........................................................... (13) --
Employee benefit plans, including transfers and other .................................... (279) (21)
-------- --------
Balance, September 30, ................................................................... 8,136 6,414
-------- --------
Retained earnings
Balance, January 1, ...................................................................... 1,917 807
Net income ............................................................................... 780 989
Cash dividends declared:
Preferred stock ...................................................................... (29) (17)
Common stock ......................................................................... -- (125)
-------- --------
Balance, September 30, ................................................................... 2,668 1,654
-------- --------
Accumulated other comprehensive income (loss)
Balance, January 1, ...................................................................... 31 128
Net change in unrealized gains (losses) on securities .................................... (110) (45)
Net change in unrealized gains (losses) on derivatives classified as cash flow hedges .... 93 (95)
Net change in unrealized gains on interest only strip receivables ........................ 5 --
Foreign currency translation adjustments ................................................. (4) (3)
-------- --------
Other comprehensive loss, net of tax ..................................................... (16) (143)
-------- --------
Balance, September 30, ................................................................... 15 (15)
-------- --------
Total shareholders' equity, September 30, ................................................ $ 11,836 $ 8,553
======== ========
Comprehensive income
Net income ............................................................................... $ 780 $ 989
Other comprehensive loss ................................................................. (16) (143)
-------- --------
Comprehensive income ..................................................................... $ 764 $ 846
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
5
HSBC USA Inc.
--------------------------------------------------------------------------------
C O N S O L I D A T E D S T A T E M E N T O F C A S H F L O W S
Nine months ended September 30,
2005 2004
------------------------------------------------------------------------------------------------------------------------
(in millions)
Cash flows from operating activities
Net income ...................................................................... $ 780 $ 989
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation, amortization and deferred taxes .............................. 570 314
Provision (credit) for credit losses ....................................... 476 7
Net change in other accrual accounts ....................................... 977 43
Net change in loans held for sale .......................................... (1,844) 1
Net change in trading assets and liabilities ............................... (1,454) (534)
Other, net ................................................................. (595) (366)
-------- --------
Net cash provided by (used in) operating activities ................... (1,090) 454
-------- --------
Cash flows from investing activities
Net change in interest bearing deposits with banks .............................. 638 (1,330)
Net change in short-term investments ............................................ (1,184) (3,848)
Net change in securities available for sale:
Purchases of securities available for sale ................................. (7,790) (8,971)
Proceeds from sales of securities available for sale ....................... 3,299 4,195
Proceeds from maturities of securities available for sale .................. 3,074 4,568
Net change in securities held to maturity:
Purchases of securities held to maturity ................................... (533) (821)
Proceeds from maturities of securities held to maturity .................... 1,159 1,437
Net change in loans:
Net change in credit card receivables ...................................... 11,918 (69)
Net change in other short-term loans ....................................... (293) (743)
Net originations and maturities of long-term loans ......................... (361) (15,716)
Loans purchased from HSBC Finance Corporation .............................. (14,804) (3,068)
Sales of loans and other ................................................... 51 132
Net change in tax refund anticipation loans program:
Originations of loans ...................................................... (24,300) --
Sales of loans to HSBC Finance Corporation, including premium .............. 24,319 --
Net cash provided by (used for) sales (acquisitions) of
properties and equipment ................................................... 41 (18)
Net cash provided by (used for) acquisitions (disposals) of branches and
subsidiaries ............................................................... (90) 196
Other, net ...................................................................... (546) (735)
-------- --------
Net cash used in investing activities ................................. (5,402) (24,791)
-------- --------
Cash flows from financing activities
Net change in deposits .......................................................... 7,202 12,275
Net change in short-term borrowings ............................................. (550) 4,926
Net change in long-term debt:
Issuance of long-term debt ................................................. 1,696 8,542
Repayment of long-term debt ................................................ (505) (720)
Preferred stock issuance ........................................................ 517 --
Capital contribution from parent ................................................ 10 400
Other reductions of capital surplus ............................................. (13) (21)
Dividends paid .................................................................. (23) (142)
-------- --------
Net cash provided by financing activities ............................. 8,334 25,260
-------- --------
Net change in cash and due from banks ............................................... 1,842 923
Cash and due from banks at beginning of period ...................................... 2,682 2,534
-------- --------
Cash and due from banks at end of period ............................................ $ 4,524 $ 3,457
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
6
Notes to Consolidated Financial Statements
Note 1. Organization and Basis of Presentation
--------------------------------------------------------------------------------
HSBC USA Inc. is an indirect wholly owned subsidiary of HSBC North America
Holdings Inc. (HNAH), which is an indirect wholly owned subsidiary of HSBC
Holdings plc (HSBC). HNAH's other principal indirect subsidiaries include:
o HSBC Finance Corporation, a consumer finance company;
o HSBC Markets (USA) Inc. (HSBC Markets), a holding company for investment
banking and markets subsidiaries;
o HSBC Technology & Services (USA) Inc. (HTSU), a provider of information
technology services for HSBC affiliates; and
o HSBC Bank Canada (HBCA), a Canadian banking subsidiary.
The accompanying unaudited consolidated financial statements of HSBC USA Inc.
and its subsidiaries (collectively, HUSI), including its principal subsidiary,
HSBC Bank USA, National Association (HBUS), have been prepared in accordance
with accounting principles generally accepted in the United States of America
(U.S. GAAP) for interim financial information, with the instructions to Form
10-Q and with Article 10 of Regulation S-X, as well as in accordance with
predominant practices within the banking industry. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all normal and recurring adjustments, considered necessary for a
fair presentation of financial position, results of operations and cash flows
for the interim periods have been made. These unaudited interim financial
statements should be read in conjunction with HUSI's Annual Report on Form 10-K
for the year ended December 31, 2004 (the 2004 Form 10-K). Certain
reclassifications have been made to prior period amounts to conform to the
current period presentations. The accounting and reporting policies of HUSI are
consistent, in all material respects, with those used to prepare the 2004 Form
10-K.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and
disclosures. Actual results could differ from those estimates. Interim results
should not be considered indicative of results in future periods.
Interim financial statement disclosures regarding off-balance sheet arrangements
are included in the Management's Discussion and Analysis of Financial Condition
and Results of Operations (MD&A) section of this Form 10-Q.
7
Note 2. Securities
--------------------------------------------------------------------------------
At September 30, 2005 and December 31, 2004, HUSI held no securities of any
single issuer (excluding the U.S. Treasury, U.S. Government agencies, or U.S.
Government sponsored enterprises) with a book value that exceeded 10% of
shareholders' equity.
The following tables provide a summary of the amortized cost and fair value of
the securities available for sale and securities held to maturity portfolios.
---------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2005 Cost Gains Losses Value
---------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ........................................... $ 451 $ -- $ (6) $ 445
U.S. Government sponsored enterprises(1) ................ 8,973 12 (183) 8,802
U.S. Government agency issued or guaranteed ............. 3,929 13 (48) 3,894
Obligations of U.S. states and political subdivisions ... 488 -- (6) 482
Asset backed securities ................................. 1,330 3 (3) 1,330
Other domestic debt securities .......................... 237 5 (1) 241
Foreign debt securities ................................. 662 8 (2) 668
Equity securities ....................................... 49 6 -- 55
-------- -------- -------- --------
$ 16,119 $ 47 $ (249) $ 15,917
======== ======== ======== ========
Securities held to maturity:
U.S. Treasury ........................................... $ 87 $ -- $ -- $ 87
U.S. Government sponsored enterprises(1) ................ 1,859 72 (6) 1,925
U.S. Government agency issued or guaranteed ............. 714 37 (2) 749
Obligations of U.S. states and political subdivisions ... 384 28 -- 412
Other domestic debt securities .......................... 166 3 (1) 168
Foreign debt securities ................................. 51 -- -- 51
-------- -------- -------- --------
$ 3,261 $ 140 $ (9) $ 3,392
======== ======== ======== ========
---------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
---------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ........................................... $ 203 $ -- $ (3) $ 200
U.S. Government sponsored enterprises(1) ................ 8,136 47 (90) 8,093
U.S. Government agency issued or guaranteed ............. 3,029 32 (29) 3,032
Asset backed securities ................................. 1,122 3 (1) 1,124
Other domestic debt securities .......................... 990 6 (2) 994
Foreign debt securities ................................. 1,090 15 (2) 1,103
Equity securities ....................................... 64 49 (4) 109
-------- -------- -------- --------
$ 14,634 $ 152 $ (131) $ 14,655
======== ======== ======== ========
Securities held to maturity:
U.S. Treasury ........................................... $ 122 $ -- $ -- $ 122
U.S. Government sponsored enterprises(1) ................ 2,202 92 (11) 2,283
U.S. Government agency issued or guaranteed ............. 716 40 (2) 754
Obligations of U.S. states and political subdivisions ... 465 37 -- 502
Other domestic debt securities .......................... 231 6 (1) 236
Foreign debt securities ................................. 145 -- -- 145
-------- -------- -------- --------
$ 3,881 $ 175 $ (14) $ 4,042
======== ======== ======== ========
(1) Includes primarily mortgage-backed securities issued by the Federal
National Mortgage Association (FNMA) and the Federal Home Loan Mortgage
Corporation (FHLMC).
8
The following tables provide a summary of gross unrealized losses and related
fair values, classified as to the length of time the losses have existed.
------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
--------------------------------------- ------------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
September 30, 2005 Securities Losses of Investment Securities Losses of Investment
------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government sponsored
enterprises(1) ............ 312 $ (111) $ 5,882 49 $ (72) $ 1,782
U.S. Government agency
issued or guaranteed ...... 294 (28) 2,498 75 (20) 467
All other securities ........ 105 (17) 1,576 25 (1) 85
------- ------- ------- ------- ------- -------
711 $ (156) $ 9,956 149 $ (93) $ 2,334
======= ======= ======= ======= ======= =======
Securities held to maturity:
U.S. Government sponsored
enterprises(1) ............ 15 $ (3) $ 261 3 $ (3) $ 51
U.S. Government agency
issued or guaranteed ...... 131 (2) 74 -- -- --
All other securities ........ -- -- -- 10 (1) 4
------- ------- ------- ------- ------- -------
146 $ (5) $ 335 13 $ (4) $ 55
======= ======= ======= ======= ======= =======
------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
------------------------------------------ ------------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
December 31, 2004 Securities Losses of Investment Securities Losses of Investment
------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government sponsored
enterprises(1) ............ 78 $ (36) $ 3,118 51 $ (54) $ 1,344
U.S. Government agency
issued or guaranteed ...... 62 (11) 646 115 (18) 532
All other securities ........ 32 (9) 687 21 (3) 103
------- ------- ------- ------- ------- -------
172 $ (56) $ 4,451 187 $ (75) $ 1,979
======= ======= ======= ======= ======= =======
Securities held to maturity:
U.S. Government sponsored
enterprises(1) ............ 8 $ (2) $ 163 12 $ (9) $ 247
U.S. Government agency
issued or guaranteed ...... 4 (1) 27 3 (1) 34
All other securities ........ 7 (1) 5 -- -- --
------- ------- ------- ------- ------- -------
19 $ (4) $ 195 15 $ (10) $ 281
======= ======= ======= ======= ======= =======
(1) Includes primarily mortgage-backed securities issued by FNMA and FHLMC.
Gross unrealized losses on securities available for sale increased during the
nine months ended September 30, 2005 due to rising short-term and medium-term
interest rates. Since substantially all of these securities are high credit
grade (i.e., AAA or AA), and HUSI has the ability and intent to hold these
securities until maturity or a market price recovery, these securities are not
considered to be other than temporarily impaired.
9
Note 3. Loans
--------------------------------------------------------------------------------
The following table shows the composition of the loan portfolio.
--------------------------------------------------------------------------------------------------------
September 30, 2005 December 31, 2004
--------------------- ---------------------
Held Held
Total for Sale Total for Sale
--------------------------------------------------------------------------------------------------------
(in millions)
Commercial:
Construction and other real estate ... $ 8,994 $ -- $ 8,281 $ --
Other commercial ..................... 16,136 -- 14,691 --
Consumer:
Residential mortgages ................ 46,793 3,140 46,775 1,352
Credit card receivables .............. 14,285 -- 12,078 --
Other consumer loans ................. 3,201 402 3,122 393
------- ------- ------- -------
Total loans ................................. $89,409 $ 3,542 $84,947 $ 1,745
======= ======= ======= =======
In June 2005, HUSI began acquiring residential mortgage loans from unaffiliated
third parties, with the intent of selling the loans to HSBC Markets. The
increase in held for sale loans from December 31, 2004 to September 30, 2005
primarily resulted from this new activity.
Note 4. Allowance for Credit Losses
--------------------------------------------------------------------------------
The following table provides a summary of changes in the allowance for credit
losses.
--------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2005 2004 2005 2004
--------------------------------------------------------------------------------------------------------------
(in millions)
Beginning balance .......................................... $ 790 $ 347 $ 788 $ 399
Allowance related to acquisitions and (dispositions), net .. -- (11) -- (20)
Charge offs ................................................ 202 43 607 107
Recoveries ................................................. 65 20 195 61
----- ----- ----- -----
Net charge offs ...................................... 137 23 412 46
----- ----- ----- -----
Provision charged to income ................................ 199 27 476 7
----- ----- ----- -----
Ending balance ............................................. $ 852 $ 340 $ 852 $ 340
===== ===== ===== =====
The 2005 provision for credit losses and levels of allowance for credit losses
reflect the impact of the acquisition of domestic private label receivables from
HSBC Finance Corporation in December 2004 as well as the impact of loans and
receivables growth during 2005. Additionally, the provision for the third
quarter of 2005 and overall allowance levels at September 30, 2005 include an
incremental provision of $26 million relating to Hurricane Katrina.
Further analysis of the allowance for credit losses and credit quality begins on
page 54 of this Form 10-Q.
Note 5. Intangible Assets, Net
--------------------------------------------------------------------------------
The following table summarizes the composition of intangible assets.
------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2005 2004
------------------------------------------------------------------------------------------------------------------
(in millions)
Mortgage servicing rights, net of accumulated amortization and valuation allowance ... $346 $309
Other ................................................................................ 48 43
---- ----
Intangible assets, net ............................................................... $394 $352
==== ====
10
Mortgage Servicing Rights (MSRs)
The following table summarizes activity for MSRs and the related valuation
allowance.
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Beginning balance ............................... $ 394 $ 437 $ 416 $ 526
Additions related to loan sales ................. 30 14 62 49
Net MSRs acquisitions (sales) ................... -- -- -- (53)
Permanent impairment charges .................... (4) (8) (21) (15)
Amortization .................................... (18) (19) (55) (83)
----- ----- ----- -----
Ending balance .................................. 402 424 402 424
----- ----- ----- -----
Valuation allowance for MSRs:
Beginning balance ............................... (109) -- (107) (23)
Temporary impairment recovery (provision) ....... 49 (95) 30 (82)
Permanent impairment charges .................... 4 8 21 15
Release of allowance related to MSRs sold ....... -- -- -- 3
----- ----- ----- -----
Ending balance .................................. (56) (87) (56) (87)
----- ----- ----- -----
MSRs, net of accumulated amortization and valuation
allowance ........................................... $ 346 $ 337 $ 346 $ 337
===== ===== ===== =====
Normal amortization for the current MSRs portfolios is expected to be
approximately $72 million for the year ending December 31, 2005, declining
gradually to approximately $36 million for the year ending December 31, 2009.
Actual levels of amortization could increase or decrease depending upon changes
in interest rates and loan prepayment activity. Actual levels of amortization
are also dependent upon future levels of MSRs recorded.
Note 6. Goodwill
--------------------------------------------------------------------------------
During the second quarter of 2005, HUSI completed its annual impairment test of
goodwill and determined that the fair value of each of the reporting units
exceeded its carrying value. As a result, no impairment loss was required to be
recognized. During the first nine months of 2005, there were no significant
events or transactions which warranted specific consideration for their impact
on recorded book values assigned to goodwill.
Note 7. Income Taxes
--------------------------------------------------------------------------------
The following table presents the effective tax rate for the three months and
nine months ended September 30, 2005 and 2004 respectively.
--------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
-------------------- --------------------
2005 2004 2005 2004
--------------------------------------------------------------------------------
Effective tax rate ...... 36.0% 38.6% 36.6% 35.8%
In the first quarter of 2005, HUSI finalized certain prior year state and local
tax returns and recorded a $20 million reduction of income tax expense, which
represents the difference between its previous estimate of tax liability and the
liability per the tax returns. In addition, during the third quarter of 2005,
HUSI revised its estimate of certain tax credits and recorded the effect of
certain audit adjustments that resulted in a $9 million reduction in income tax
expense. Excluding the impact of these adjustments, the effective tax rate for
the third quarter and the first nine months of 2005 would have been 38.4% and
39.0% respectively.
In June 2004, as a result of a recently completed tax audit, approximately $51
million of income tax liability was released, reducing the effective tax rate by
3.6% for the first nine months of 2004.
11
Note 8. Long-Term Debt
--------------------------------------------------------------------------------
The following table presents a summary of long-term debt.
--------------------------------------------------------------------------------
September 30, December 31,
2005 2004
--------------------------------------------------------------------------------
(in millions)
Senior debt .................................. $19,062 $18,831
Subordinated debt ............................ 5,719 4,988
All other .................................... 19 20
------- -------
Total long-term debt ......................... $24,800 $23,839
======= =======
For a discussion of the components of long-term debt refer to Note 14, beginning
on page 93 of HUSI's 2004 Form 10-K.
In August 2005, HBUS issued $750 million of subordinated debt from its $20
billion Global Bank Note Program. The newly issued debt matures in August 2035
and pays interest at 5.625% per annum.
Note 9. Preferred Stock
--------------------------------------------------------------------------------
In April 2005, HUSI issued 20,700,000 shares of Series F, Floating Rate
Non-Cumulative Perpetual Preferred stock with a stated value of $25 per share.
Dividends are payable quarterly, beginning July 1, 2005 at .75% above
three-month LIBOR, but not less than 3.50% per annum. The shares may be redeemed
at the option of HUSI on or after April 7, 2010 at $25 per share, plus accrued
dividends. Related issuance costs of $13 million have been recorded as a
reduction of capital surplus.
In October 2005, HUSI issued 373,750 shares of Floating Rate Non-Cumulative
Perpetual Preferred Stock, represented by 14,950,000 depositary shares. Total
proceeds, net of issuance costs, were approximately $365 million.
12
Note 10. Related Party Transactions
--------------------------------------------------------------------------------
In the normal course of business, HUSI conducts transactions with HSBC and its
subsidiaries (HSBC affiliates). These transactions occur at prevailing market
rates and terms. All extensions of credit by HUSI to other HSBC affiliates are
legally required to be secured by eligible collateral. The following table
presents related party balances and the income and expense generated by related
party transactions.
---------------------------------------------------------------------------------------------------------------
September 30, December 31,
2005 2004
---------------------------------------------------------------------------------------------------------------
(in millions)
Assets:
Cash and due from banks ................................................ $ 119 $ 182
Interest bearing deposits with banks ................................... 77 283
Federal funds sold and securities purchased under resale agreements .... 147 47
Trading assets ......................................................... 5,490 3,167
Loans .................................................................. 1,158 1,378
Other .................................................................. 129 126
-------- --------
Total assets ........................................................... $ 7,120 $ 5,183
======== ========
Liabilities:
Deposits ............................................................... $ 9,036 $ 9,764
Trading account liabilities ............................................ 4,433 5,749
Short-term borrowings .................................................. 1,596 1,089
Long-term debt ......................................................... (31) (31)
Other .................................................................. 98 58
-------- --------
Total liabilities ...................................................... $ 15,132 $ 16,629
======== ========
------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
----------------------- -----------------------
2005 2004 2005 2004
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income .......................................... $ 9 $ 6 $ 29 $ 13
Interest expense ......................................... 73 26 207 65
Trading losses ........................................... (285) (956) (2,039) (1,037)
Other revenues ........................................... 19 118 79 141
Support services from HSBC affiliates:
Fees paid to HTSU for technology services .......... 48 42 148 124
Fees paid to HSBC Finance Corporation .............. 102 8 307 19
Other fees, primarily treasury and traded markets services . 63 49 194 148
The following business transactions were conducted with HSBC Finance Corporation
during 2005.
o In December of 2004, approximately $12 billion of private label
receivables and other loans were purchased from HSBC Finance Corporation.
Retained interests in securitized private label credit card receivable
pools of approximately $3 billion were also acquired. HSBC Finance
Corporation retained the customer relationships and continues to service
the loans. By agreement, HUSI is purchasing additional receivables
generated under current and future private label accounts at fair value on
a daily basis. During the first nine months of 2005, underlying customer
balances included within the private label portfolio have revolved, and
new relationships have been added, bringing the total private label
portfolio balance to approximately $14 billion at September 30, 2005.
Private label receivables were acquired from HSBC Finance Corporation at a
total premium of $312 million during the first nine months of the year.
13
o During the first nine months of 2005, HUSI purchased approximately $1.5
billion of residential mortgage loans from originating lenders pursuant to
HSBC Finance Corporation correspondent loan programs. Total premiums paid
to correspondents totaled $33 million, which is being amortized to
interest income over the estimated life of the loans purchased. Purchases
of residential mortgage loans from HSBC Finance Corporation correspondents
were discontinued effective September 1, 2005 due to HUSI's increasing
ability to originate similar products.
o In July of 2004, in order to centralize the servicing of credit card
receivables within a common HSBC affiliate in the United States, certain
consumer MasterCard(1)/Visa(2) credit card customer relationships of HUSI
were sold to HSBC Finance Corporation. A gain on this transaction was
reported in other revenues in the third quarter of 2004. Receivable
balances associated with these relationships were not sold as part of the
transaction. New receivable balances generated by these relationships are
purchased at fair value from HSBC Finance Corporation on a daily basis.
During the first nine months of 2005, approximately $1.5 million of
receivables associated with these relationships were purchased from HSBC
Finance Corporation at a premium of approximately $25 million, which is
being amortized to interest income over the estimated life of the
receivables purchased. Servicing for these relationships was also
transferred to HSBC Finance Corporation.
o Support services from HSBC affiliates includes charges by HSBC Finance
Corporation under various service level agreements for loan origination
and servicing as well as other operational and administrative support.
o Effective October 1, 2004, HBUS is the originating lender for loans
initiated for HSBC Finance Corporation's Taxpayer Financial Services
business for clients of various third party tax preparers. By agreement,
HBUS processes applications, funds and subsequently sells these loans to
HSBC Finance Corporation. Approximately $24 billion of loans were
originated by HBUS and immediately sold to HSBC Finance Corporation during
the first nine months of 2005, primarily during the first two quarters,
resulting in gains of approximately $19 million and fees paid to HSBC
Finance Corporation of $4 million.
o At September 30, 2005, HUSI had a $2 billion line of credit from HSBC
Finance Corporation, of which $1 billion was outstanding and included in
short-term borrowings. The interest rate is comparable to third party
rates for a line of credit with similar terms.
o Trading losses primarily represent the mark to market of the intercompany
components of interest rate and foreign currency derivative swap
transactions entered into with HSBC Finance Corporation, which are
substantially offset by the mark to market of related contracts entered
into with third parties that are not reflected in the table on the
preceding page. Specifically, HSBC Finance Corporation enters into these
swap contracts with HUSI in order to hedge its interest rate positions.
HUSI, within its Corporate, Investment Banking and Markets business,
accounts for these transactions on a mark to market basis.
HTSU charges HUSI for technology services pursuant to a master service level
agreement. These charges are included in other expenses as HSBC affiliate
charges.
The following business transactions were conducted with HSBC Markets during
2005.
o HUSI utilizes HSBC Markets for debt underwriting, customer referrals and
for other treasury and traded markets related services, pursuant to
service level agreements. Debt underwriting fees charged by HSBC Markets
are deferred as a reduction of long-term debt and amortized to interest
expense over the life of the related debt. Customer referral fees paid to
HSBC Markets are netted against customer fee income, which is included in
other fees and commissions. All other fees charged by HSBC Markets are
included in support services from HSBC affiliates.
----------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated.
(2) Visa is a registered trademark of Visa USA, Inc.
14
o In June 2005, HUSI began acquiring residential mortgage loans, excluding
servicing, from unaffiliated third parties and subsequently selling these
acquired loans to HSBC Markets. HUSI maintains no ownership interest in
the residential mortgage loans after sale, and maintains no beneficial
interest in the securitization vehicle. Since inception of this program,
HUSI has acquired approximately $2 billion of residential mortgage loans,
which it subsequently sold to HSBC Markets for total gains on sale of
approximately $2 million.
At September 30, 2005, HUSI had an unused line of credit from HSBC of $1,500
million. The interest rate is comparable to third party rates for a line of
credit with similar terms.
HUSI has extended loans and lines of credit to various other HSBC affiliates of
$1,295 million, of which $288 million was outstanding at September 30, 2005.
Interest rates are comparable to third party rates for lines of credit with
similar terms.
At September 30, 2005 and December 31, 2004, the aggregate notional amounts of
all derivative contracts with other HSBC affiliates were approximately $479
billion and $302 billion respectively. The net credit risk exposure related to
these contracts was approximately $4 billion at September 30, 2005 and $2
billion at December 31, 2004.
Employees of HUSI participate in one or more stock compensation plans sponsored
by HSBC. HUSI's share of the expense of the plans for the first nine months of
2005 and 2004 was $31 million and $46 million respectively. HUSI's share of
expense has been reduced during 2005, resulting from a change in the
amortization period utilized for share-based compensation in the CIBM business
segment. A description of these plans begins on page 99 of HUSI's 2004 Form
10-K.
Note 11. Pledged Assets
--------------------------------------------------------------------------------
The following table presents pledged assets included in the consolidated balance
sheet.
--------------------------------------------------------------------------------
September 30, December 31,
2005 2004
--------------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks ............. $ 1,062 $ 767
Trading assets ................................... 1,255 305
Securities available for sale .................... 5,648 6,096
Securities held to maturity ...................... 399 655
Loans ............................................ 6,034 5,971
------- -------
Total ............................................ $14,398 $13,794
======= =======
Securities available for sale are primarily pledged against various short-term
borrowings. Loans are primarily residential mortgage loans pledged against
long-term borrowings from the Federal Home Loan Bank.
Note 12. Pensions and Other Postretirement Benefits
--------------------------------------------------------------------------------
Through December 31, 2004, HUSI maintained noncontributory defined benefit
pension plans covering substantially all of their employees hired prior to
January 1, 1997 and those employees who joined HUSI through acquisitions and
were participating in a defined benefit plan at the time of acquisition. Certain
other HSBC affiliates participate in these plans.
In addition, through December 31, 2004, HUSI also maintained unfunded
noncontributory health and life insurance coverage for all employees who retired
from HUSI and were eligible for immediate pension benefits from HUSI's
retirement plan. Employees retiring after 1992 will absorb a portion of the cost
of these benefits. Employees hired after that same date are not eligible for
these benefits. A premium cap has been established for HUSI's share of retiree
medical cost.
In November 2004, sponsorship of the U.S. defined benefit pension plans and the
health and life insurance plan of HUSI and HSBC Finance Corporation were
transferred to HNAH. Effective January 1, 2005, the separate U.S. defined
benefit pension plans were merged into a single defined benefit pension plan
which facilitates the development of a unified employee benefit policy and
unified employee benefit plan administration for HSBC
15
affiliates operating in the U.S. As a result, HUSI's prepaid pension asset of
$482 million, and a related deferred tax liability of $203 million, were
transferred to HNAH. The net transfer amount of $279 million is reflected as a
reduction of capital surplus on the consolidated statement of changes in
shareholders' equity.
The following table presents the components of net periodic benefit cost as
allocated to HUSI from HNAH.
---------------------------------------------------------------------------------------
Other
Postretirement
Pension Benefits Benefits
---------------- ---------------
2005 2004 2005 2004
---------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net periodic benefit cost:
Service cost ...................... $ 7 $ 7 $ -- $ --
Interest cost ..................... 16 17 2 1
Expected return on plan assets .... (22) (24) -- --
Prior service cost amortization ... -- -- -- --
Actuarial loss .................... 1 7 -- --
Transition amount amortization .... -- -- 1 --
---- ---- ---- ----
Net periodic benefit cost ......... $ 2 $ 7 $ 3 $ 1
==== ==== ==== ====
Nine months ended September 30:
Net periodic benefit cost:
Service cost ...................... $ 20 $ 23 $ 1 $ 1
Interest cost ..................... 47 51 5 5
Expected return on plan assets .... (68) (72) -- --
Prior service cost amortization ... 1 1 -- --
Actuarial loss .................... 4 20 -- --
Transition amount amortization .... -- -- 2 2
---- ---- ---- ----
Net periodic benefit cost ......... $ 4 $ 23 $ 8 $ 8
==== ==== ==== ====
HUSI expects to make no contribution for pension benefits and to contribute
approximately $12 million for other postretirement benefits during fiscal year
2005.
Note 13. Business Segments
--------------------------------------------------------------------------------
HUSI has five distinct segments that it utilizes for management reporting and
analysis purposes, which are consistent with the line of business groupings used
by HSBC. The segments are based upon customer groupings, as well as products and
services offered. The segments are described in the following paragraphs.
The Personal Financial Services (PFS) Segment
This segment provides a broad range of financial products and services including
installment and revolving term loans, deposits, branch services, mutual funds,
investments and insurance. These products are marketed to individuals primarily
through the branch banking network. Residential mortgage lending provides loan
financing through direct retail and wholesale origination channels. Mortgage
loans are originated through a network of brokers, wholesale agents and retail
origination offices. Servicing is performed for the individual mortgage holder
or on a contractual basis for mortgages owned by third parties.
The PFS segment continues to include MasterCard/Visa credit card receivables
acquired on a daily basis, related to account relationships which HUSI sold to
HSBC Finance Corporation in 2004.
The Consumer Finance (CF) Segment
Effective for the first quarter of 2005, HUSI formed a new business segment,
Consumer Finance (CF), which was reported as a component of PFS in prior
periods. The CF segment includes point of sale and other lending activities
primarily to meet the financial needs of individuals. Specifically, operating
activity within the CF segment relates to various consumer loans, private label
credit card receivables, and retained interests in securitized receivable trusts
purchased from HSBC Finance Corporation, as well as consumer loans purchased
from originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs.
16
The Commercial Banking (CMB) Segment
This segment provides loan and deposit products to small businesses and
middle-market corporations including specialized products such as real estate
financing. Various credit and trade related products are also offered such as
standby facilities, performance guarantees and acceptances. These products and
services are offered through multiple delivery systems, including the branch
banking network.
The Corporate, Investment Banking and Markets (CIBM) Segment
This segment is comprised of Corporate/Institutional Banking (CIB) and
Investment Banking and Markets (IBM). CIB provides deposit and lending
functionality to large and multi-national corporations and banks. U.S. dollar
clearing services are offered for domestic and international wire transfer
transactions. Credit and trade related products such as standby facilities,
performance guarantees and acceptances are also provided by CIB to large
corporate entities. The IBM component includes treasury and traded markets. The
treasury function maintains overall responsibility for the investment and
borrowing of funds to ensure liquidity, manage interest rate risk and capital at
risk. Traded markets encompasses the trading and sale of foreign exchange,
banknotes, derivatives, precious metals, securities and emerging markets
instruments, both domestically and internationally.
The Private Banking (PB) Segment
This segment offers a full range of services for high net worth domestic and
foreign individuals including deposit, lending, trading, trust, branch services,
mutual funds, insurance and investment management.
Other Segment
This segment includes equity investments in Wells Fargo HSBC Trade Bank N.A. and
HSBC Republic Bank (Suisse) S.A.
17
The following table summarizes the results for each segment. The net interest
income component in the table reflects actual interest earned, net of cost of
funds as determined by corporate transfer pricing methodology. Effective January
2005, HUSI enhanced its funds transfer pricing methodology to better approximate
current external market pricing and valuation, resulting in additional internal
charges to the residential mortgage banking business, included in PFS, from
CIBM. For comparability purposes, 2004 segment results were also restated,
increasing CIBM revenues by $57 million for the third quarter and by $143
million for the first nine months of 2004, with the offsetting decrease to PFS
revenues.
Analysis of operating results for each segment begins on page 47 of this Form
10-Q.
-----------------------------------------------------------------------------------------------------------------------
PFS CF CMB CIBM PB Other Total
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended
September 30:
2005
Net interest income(1) .. $ 300 $ 140 $ 172 $ 107 $ 45 $ (3) $ 761
Other revenues .......... 124 102 52 176 45 6 505
-------- -------- -------- -------- -------- -------- --------
Total revenues .......... 424 242 224 283 90 3 1,266
Operating expenses(2) ... 257 101 93 153 69 -- 673
-------- -------- -------- -------- -------- -------- --------
Working contribution .... 167 141 131 130 21 3 593
Provision for credit
losses(3) ............. 23 176 7 (8) 1 -- 199
-------- -------- -------- -------- -------- -------- --------
Income (loss) before
income tax expense .... $ 144 $ (35) $ 124 $ 138 $ 20 $ 3 $ 394
======== ======== ======== ======== ======== ======== ========
Average assets .......... $ 48,655 $ 19,764 $ 16,200 $ 58,736 $ 4,999 $ 330 $148,684
Average liabilities/
equity(4) ............. 42,081 343 18,302 78,290 9,674 (6) 148,684
Goodwill at September 30 (5). 1,164 -- 471 631 428 -- 2,694
2004
Net interest income(1) .. $ 274 $ 49 $ 145 $ 200 $ 33 $ (3) $ 698
Other revenues .......... 168 -- 41 104 44 5 362
-------- -------- -------- -------- -------- -------- --------
Total revenues .......... 442 49 186 304 77 2 1,060
Operating expenses(2) ... 239 4 75 106 56 -- 480
-------- -------- -------- -------- -------- -------- --------
Working contribution .... 203 45 111 198 21 2 580
Provision for credit
losses(3) ............. 20 3 (5) 7 2 -- 27
-------- -------- -------- -------- -------- -------- --------
Income before income
tax expense ........... $ 183 $ 42 $ 116 $ 191 $ 19 $ 2 $ 553
======== ======== ======== ======== ======== ======== ========
Average assets .......... $ 44,731 $ 4,777 $ 13,783 $ 47,342 $ 4,265 $ 300 $115,198
Average liabilities/
equity(4) ............. 34,072 (5) 14,180 58,229 8,722 -- 115,198
Goodwill at September 30 (5). 1,167 -- 473 631 428 -- 2,699
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses. Credit loss
reserves are established at a level sufficient to absorb the losses
considered to be inherent in the portfolio.
(4) Common shareholder's equity and earnings on common shareholder's equity
are allocated back to the segments based on the percentage of capital
assigned to the business.
(5) The reduction in goodwill from September 30, 2004 to September 30, 2005
resulted from the sale of branches during 2004.
18
-----------------------------------------------------------------------------------------------------------------------
PFS CF CMB CIBM PB Other Total
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Nine months ended
September 30:
2005
Net interest income(1) ... $ 902 $ 436 $ 481 $ 384 $ 127 $ (9) $ 2,321
Other revenues ........... 339 249 139 441 206 23 1,397
-------- -------- -------- -------- -------- -------- --------
Total revenues .......... 1,241 685 620 825 333 14 3,718
Operating expenses(2) ... 757 318 281 459 197 -- 2,012
-------- -------- -------- -------- -------- -------- --------
Working contribution .... 484 367 339 366 136 14 1,706
Provision for credit
losses(3) ............. 67 437 6 (33) (1) -- 476
-------- -------- -------- -------- -------- -------- --------
Income (loss) before
income tax expense .... $ 417 $ (70) $ 333 $ 399 $ 137 $ 14 $ 1,230
======== ======== ======== ======== ======== ======== ========
Average assets .......... $ 49,824 $ 18,890 $ 15,614 $ 55,777 $ 4,956 $ 318 $145,379
Average liabilities/
equity(4) ............. 43,465 506 17,226 74,652 9,528 2 145,379
2004
Net interest income(1) .. $ 803 $ 135 $ 434 $ 582 $ 95 $ (8) $ 2,041
Other revenues .......... 308 -- 126 387 157 17 995
-------- -------- -------- -------- -------- -------- --------
Total revenues .......... 1,111 135 560 969 252 9 3,036
Operating expenses(2) ... 709 10 249 345 176 -- 1,489
-------- -------- -------- -------- -------- -------- --------
Working contribution .... 402 125 311 624 76 9 1,547
Provision for credit
losses(3) ............. 63 6 (8) (54) -- -- 7
-------- -------- -------- -------- -------- -------- --------
Income before income
tax expense ........... $ 339 $ 119 $ 319 $ 678 $ 76 $ 9 $ 1,540
======== ======== ======== ======== ======== ======== ========
Average assets .......... $ 38,877 $ 3,928 $ 13,504 $ 46,510 $ 3,899 $ 298 $107,016
Average liabilities/
equity(4) ............. 33,063 (3) 14,131 50,806 9,019 -- 107,016
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses. Credit loss
reserves are established at a level sufficient to absorb the losses
considered to be inherent in the portfolio.
(4) Common shareholder's equity and earnings on common shareholder's equity
are allocated back to the segments based on the percentage of capital
assigned to the business.
19
Note 14. New Accounting Pronouncements
--------------------------------------------------------------------------------
In December 2004, FASB issued Statement of Financial Accounting Standards No.
123 (Revised), Share-Based Payment (SFAS 123R). SFAS 123R requires public
entities to measure the cost of stock-based compensation based on the grant date
fair value of the award, as well as other disclosure requirements. On March 28,
2005, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin 107 which amended the compliance date to allow public companies to
comply with the provisions of SFAS 123R at the beginning of their next fiscal
year that begins after June 15, 2005, instead of the next reporting period as
originally required by SFAS 123R. HUSI was substantially in compliance with SFAS
123R as of December 31, 2004, and will be entirely compliant by the required
adoption date. The adoption of SFAS 123R therefore will not have a significant
effect on operating results or cash flows.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, Accounting Changes and Error Corrections: a replacement of APB Opinion No.
20 and FASB Statement 3 (SFAS No. 154) which requires companies to apply
voluntary changes in accounting principles retrospectively whenever it is
practicable. The retrospective application requirement replaces APB 20's
requirement to recognize most voluntary changes in accounting principle by
including the cumulative effect of the change in net income during the period
the change occurs. Retrospective application will be the required transition
method for new accounting pronouncements in the event that a newly-issued
pronouncement does not specify transition guidance. SFAS No. 154 is effective
for accounting changes made in fiscal years beginning after December 15, 2005.
In November 2005, the Financial Accounting Standards Board (FASB) issued Staff
Position Nos. FAS 115-1 and FAS 124-1 (FSP 115-1 and FSP 124-1), The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, in
response to Emerging Issues Task Force 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments (EITF 03-1). FSP 115-1 and
FSP 124-1 provide guidance regarding the determination as to when an investment
is considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. FSP 115-1 and FSP 124-1 also include
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than
temporary-impairments. These requirements are effective for annual reporting
periods beginning after December 15, 2004. Adoption of the impairment guidance
contained in FSP 115-1 and FSP 124-1 is not expected to have a material impact
on HUSI's financial position or results of operations.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (MD&A)
--------------------------------------------------------------------------------
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES
The following table shows the quarterly average balances of the principal
components of assets, liabilities and shareholders' equity, together with their
respective interest amounts and rates earned or paid, presented on a taxable
equivalent basis.
Three Months Ended September 30,
--------------------------------------------------------------
2005 2004
----------------------------- ----------------------------
Balance Interest Rate* Balance Interest Rate*
-----------------------------------------------------------------------------------------------------------------------
Assets (in millions)
Interest bearing deposits with banks ................ $ 2,912 $ 25 3.42% $ 2,642 $ 11 1.60%
Federal funds sold and securities purchased under
resale agreements ................................... 6,375 58 3.61 4,132 16 1.56
Trading assets ...................................... 19,846 73 1.48 14,778 43 1.16
Securities .......................................... 19,309 230 4.73 18,566 224 4.80
Loans
Commercial ...................................... 24,333 328 5.35 19,849 218 4.36
Consumer:
Residential mortgages ...................... 47,250 580 4.91 41,250 504 4.89
Credit cards ............................... 14,020 216 6.11 1,129 23 7.99
Other consumer ............................. 3,416 68 7.87 2,300 34 5.92
--------- ------ ---- --------- ------ ----
Total consumer ................................ 64,686 864 5.30 44,679 561 4.99
--------- ------ ---- --------- ------ ----
Total loans ................................... 89,019 1,192 5.31 64,528 779 4.80
--------- ------ ---- --------- ------ ----
Other ............................................... 644 9 5.18 546 5 3.60
--------- ------ ---- --------- ------ ----
Total earning assets ................................ 138,105 $1,587 4.56% 105,192 $1,078 4.07%
--------- ------ ---- --------- ------ ----
Allowance for credit losses ......................... (892) (339)
Cash and due from banks ............................. 3,516 3,290
Other assets ........................................ 7,955 7,055
--------- ---------
Total assets ........................................ $ 148,684 $ 115,198
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits .................................. $ 29,082 $ 91 1.24% $ 27,350 $ 44 0.64%
Other time deposits ............................... 26,168 226 3.43 17,935 111 2.47
Deposits in foreign offices ......................... 22,218 159 2.84 22,197 71 1.27
--------- ------ ---- --------- ------ ----
Total interest bearing deposits ..................... 77,468 476 2.44 67,482 226 1.33
--------- ------ ---- --------- ------ ----
Short-term borrowings ............................... 12,520 87 2.74 10,019 49 1.92
Long-term debt ...................................... 24,307 258 4.21 10,454 101 3.85
--------- ------ ---- --------- ------ ----
Total interest bearing liabilities .................. 114,295 821 2.85 87,955 376 1.70
--------- ------ ---- --------- ------ ----
Net interest income / Interest rate spread .......... $ 766 1.71% $ 702 2.37%
------ ---- ------ ----
Noninterest bearing deposits ........................ 8,833 7,584
Other liabilities ................................... 13,779 11,646
Total shareholders' equity .......................... 11,777 8,013
--------- ---------
Total liabilities and shareholders' equity .......... $ 148,684 $ 115,198
========= =========
Net yield on average earning assets ................. 2.20% 2.65%
---- ----
Net yield on average total assets ................... 2.04 2.42
==== ====
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest for the
third quarter of 2005 and 2004 included fees of $14 million and $21 million
respectively.
21
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES
The following table shows the year to date average balances of the principal
components of assets, liabilities and shareholders' equity, together with their
respective interest amounts and rates earned or paid, presented on a taxable
equivalent basis.
Nine Months Ended September 30,
--------------------------------------------------------------
2005 2004
----------------------------- ----------------------------
Balance Interest Rate* Balance Interest Rate*
-----------------------------------------------------------------------------------------------------------------------
Assets (in millions)
Interest bearing deposits with banks ................ $ 3,555 $ 79 2.96% $ 2,230 $ 25 1.46%
Federal funds sold and securities purchased under
resale agreements ................................... 5,110 123 3.22 3,940 38 1.30
Trading assets ...................................... 19,028 193 1.35 15,011 114 1.01
Securities .......................................... 18,932 662 4.68 18,106 664 4.89
Loans
Commercial ...................................... 23,302 867 4.97 19,298 598 4.14
Consumer:
Residential mortgages ...................... 47,418 1,740 4.89 34,510 1,284 4.96
Credit cards ............................... 12,965 574 5.92 1,126 78 9.30
Other consumer ............................. 3,592 196 7.29 2,151 100 6.20
--------- ------ ---- --------- ------ ----
Total consumer ................................ 63,975 2,510 5.25 37,787 1,462 5.17
--------- ------ ---- --------- ------ ----
Total loans ................................... 87,277 3,377 5.17 57,085 2,060 4.82
--------- ------ ---- --------- ------ ----
Other ............................................... 614 23 4.98 526 13 3.39
--------- ------ ---- --------- ------ ----
Total earning assets ................................ 134,516 $4,457 4.43% 96,898 $2,914 4.02%
--------- ------ ---- --------- ------ ----
Allowance for credit losses ......................... (890) (360)
Cash and due from banks ............................. 3,657 3,197
Other assets ........................................ 8,096 7,281
--------- ---------
Total assets ........................................ $ 145,379 $ 107,016
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits .................................. $ 28,398 $ 211 0.99% $ 27,250 $ 134 0.66%
Other time deposits ............................... 24,214 551 3.04 14,837 228 2.05
Deposits in foreign offices ......................... 22,776 437 2.57 21,837 182 1.11
--------- ------ ---- --------- ------ ----
Total interest bearing deposits ..................... 75,388 1,199 2.13 63,924 544 1.14
--------- ------ ---- --------- ------ ----
Short-term borrowings ............................... 11,544 205 2.38 9,344 100 1.43
Long-term debt ...................................... 24,023 720 4.00 6,636 216 4.33
--------- ------ ---- --------- ------ ----
Total interest bearing liabilities .................. 110,955 2,124 2.56 79,904 860 1.44
--------- ------ ---- --------- ------ ----
Net interest income / Interest rate spread .......... $2,333 1.87% $2,054 2.58%
====== ==== ====== ====
Noninterest bearing deposits ........................ 9,077 7,470
Other liabilities ................................... 13,944 11,831
Total shareholders' equity .......................... 11,403 7,811
--------- ---------
Total liabilities and shareholders' equity .......... $ 145,379 $ 107,016
========= =========
Net yield on average earning assets ................. 2.32% 2.83%
---- ----
Net yield on average total assets ................... 2.15 2.56
==== ====
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest for the
first nine months of 2005 and 2004 included fees of $33 million and $56 million
respectively.
22
FORWARD-LOOKING STATEMENTS
--------------------------------------------------------------------------------
The MD&A should be read in conjunction with the consolidated financial
statements, notes and tables included elsewhere in this Form 10-Q and with
HUSI's 2004 Form 10-K. The MD&A may contain certain statements that may be
forward-looking in nature within the meaning of the Private Securities
Litigation Reform Act of 1995. HUSI's results may differ materially from those
noted in the forward-looking statements. Words such as "believe", "expects",
"estimates", "targeted", "anticipates", "goal" and similar expressions are
intended to identify forward-looking statements but should not be considered as
the only means through which these statements may be made. Statements that are
not historical facts, including statements about management's beliefs and
expectations, are forward-looking statements which involve inherent risks and
uncertainties and are based on current views and assumptions. A number of
factors could cause actual results to differ materially from those contained in
any forward-looking statements, such as the impact of natural disasters on the
collectibility of receivables in the affected areas. For a list of important
factors that may affect HUSI's actual results, see Cautionary Statement on
Forward-Looking Statements in Part I, Item 1 of HUSI's 2004 Form 10-K.
EXECUTIVE OVERVIEW
--------------------------------------------------------------------------------
Net income decreased $87 million in the third quarter of 2005 and decreased $209
million in the first nine months of 2005 as compared with the same 2004 periods,
primarily due to:
o losses before taxes from the private label receivable portfolio acquired
from HSBC Finance Corporation in December 2004, and from additional
private label receivables acquired in 2005, caused by amortization of
premiums paid, as reflected within the Consumer Finance (CF) segment.
Amortization of these premiums were $180 million and $538 million for the
third quarter and the first nine months of 2005 respectively;
o an incremental third quarter provision for credit losses of $26 million
within the CF segment related to Hurricane Katrina;
o reduced income before taxes in the Corporate, Investment Banking and
Markets (CIBM) segment resulting from the flattening yield curve and
increased expenses associated with investment in business expansion
initiatives; and
o excluding the impact of Hurricane Katrina and the private label receivable
portfolio acquired in December 2004, credit loss provisions increased
modestly in the first nine months of 2005.
Excluding the impact of the items noted above, 2005 has been highlighted by
increases in year to date income before taxes in the Personal Financial Services
(PFS), Commercial Banking (CMB) and Private Banking (PB) segments, due to:
o successful rollout during 2005 of an enhanced deposit growth strategy;
o significant expansion of residential mortgage, other consumer and
commercial loan portfolios in 2004 and 2005 which, net of associated
funding costs, have had a positive impact on 2005 earnings;
o improvement in residential mortgage banking revenue, driven by increased
values of mortgage servicing rights; and
o gains realized on sales of certain assets during 2005.
Further analysis of business segments begins on page 46 of this Form 10-Q.
Private Label Loan Portfolio Purchases
In December of 2004, HUSI acquired approximately $12 billion of private label
receivables and other loans from HSBC Finance Corporation at fair value, without
recourse. By agreement, HUSI is purchasing additional receivables generated
under current and future private label credit card accounts at fair value on a
daily basis. During 2005, underlying customer balances included within the
private label portfolio have revolved, and new relationships have been added,
bringing the total private label portfolio balance to $14 billion at September
30, 2005. Losses before income tax expense of $47 million and $175 million were
realized from this portfolio for the three months and nine months ended
September 30, 2005 respectively. Results have been negatively impacted by
23
significant amortization of the premium paid for these receivables. Further
analysis regarding this acquired portfolio is included in the analysis of the CF
segment, beginning on page 49 of this Form 10-Q.
Hurricane Katrina
In August 2005, Hurricane Katrina (Katrina) caused destruction and loss to
individuals, businesses and public infrastructure. As of September 30, 2005,
HUSI had $292 million (.3% of total loans) of credit card receivables and other
loans outstanding with customers living in the Federal Emergency Management
Agency (FEMA) designated Individual Assistance disaster areas(1) with
approximately $99 million of these receivables secured by real estate.
Assessment of the impact of Katrina on the collectibility of these receivables
is continuing, but is complicated by the number of customers that have been
displaced from their primary residence. Preliminary estimates of the potential
impact to HUSI's businesses take into account a number of factors on which
information is still being gathered such as:
o how the current and long-term financial impact of the disaster on
customers will affect future payment patterns;
o the condition and value of any collateral supporting the amounts
outstanding; and
o the availability of insurance to cover losses on the underlying
collateral.
Based on the information currently available, HUSI has recorded an incremental
provision for credit losses of $26 million at September 30, 2005, representing
the best estimate of Katrina's impact on HUSI's loan portfolio. As these
estimates are influenced by factors outside of HUSI's control, there is
uncertainty inherent in these estimates, making it reasonably probable that they
will change. As more information becomes available relating to the financial
condition of HUSI's affected customers, the physical condition of the collateral
for loans which are secured by real estate and the resultant impact on customer
payment patterns, the estimate of credit loss exposure relating to Katrina will
continue to be reviewed and any adjustments will be reported in earnings when
they become known. In an effort to assist customers affected by the disaster,
various programs have been initiated including extended payment arrangements and
interest and fee waivers for up to 60 days for certain products depending upon
customer circumstances. These interest and fee waivers totaled $4 million during
the quarter. Additional interest and fee waivers of approximately $3 million are
anticipated for the fourth quarter of 2005.
Deposit Strategy and Growth
Beginning in 2004, the deposit strategy for HUSI's retail network included a
shifting emphasis toward building a deposit engine capable of generating
significant balance growth over a three to five year period, across multiple
markets and segments, utilizing multiple delivery systems. Specifically, the
following were initiated:
o full deployment of new personal and business checking and savings
products;
o emphasis on more competitive pricing with the introduction of high
yielding products beginning in 2004;
o retail branch expansion into new geographic markets;
o improving delivery systems, including use of internet capabilities;
o refining targeting of the affluent consumer population;
o maintaining strong customer relationships; and
o increasing deposits from, and improving retention of, existing customers.
HUSI has experienced a successful rollout of its deposit strategy during 2005.
Total deposits in domestic offices have increased $2.4 billion (7%) in the first
nine months of the year across HUSI's retail network.
----------
(1) Customers in the Individual Assistance Counties, as defined by FEMA on the
list last updated and published on September 9, 2005.
24
Balance Sheet Review
Asset growth was managed to a more normalized level (less than 6%) during the
first nine months of 2005, as compared with calendar year 2004. Total deposit
growth of $7 billion during 2005 was the primary funding source for increased
loans and short-term investments balances.
Total loan growth of $4.5 billion during the first nine months of 2005 was
highlighted by:
o targeted growth in small business, middle market and real estate
commercial lending portfolios; and
o growth in private label credit card receivables, due partially to the
addition of new private label relationships to the portfolio, and
partially to declining balances required to be maintained in off-balance
sheet securitized receivable trusts.
HUSI utilizes borrowings from various sources to fund balance sheet growth, to
meet cash and capital needs, and to fund investments in subsidiaries. Total
long-term debt increased approximately $1 billion during the first nine months
of 2005 to $25 billion at September 30, 2005. In August 2005, HBUS issued $750
million of subordinated debt from its $20 billion Global Bank Note Program.
Total short-term borrowings decreased by less than $1 billion to $9 billion at
September 30, 2005. Total deposits and borrowings from HSBC affiliates were $11
billion at September 30, 2005 and December 31, 2004.
In April 2005, HUSI issued 20,700,000 shares of Series F, Floating Rate
Non-Cumulative Perpetual Preferred stock with a stated value of $25 per share.
In October 2005, HUSI issued 373,750 shares of Floating Rate Non-Cumulative
Perpetual Preferred stock, represented by 14,950,000 depositary shares.
Average earning assets and interest bearing liabilities increased significantly
during the first nine months of 2005, as compared with the same 2004 period,
primarily due to:
o increased average residential mortgage loan balances from held portfolio
growth in 2004; increased average credit card and other loan balances
resulting from the private label receivable portfolio acquired in December
2004;
o increased average commercial loan and deposit balances resulting from
targeted growth in small business and middle-market commercial customers;
and
o increased average deposits, long-term debt and short-term borrowings
balances, which were the primary funding sources for asset growth during
2004.
Income Statement Review
Increased net interest income in the first nine months of 2005 was primarily due
to significantly increased average loan balances, the impact of which was
partially offset by increased average deposits and long-term debt balances, and
by amortization of premiums paid for acquiring private label receivables in 2004
and 2005. In addition, a flattening yield curve has resulted in tightening
interest rate spreads associated with certain businesses, particularly within
the CIBM segment. Further analysis of the components of net interest income
begins on page 34 of this Form 10-Q.
The provision for credit losses increased during the first nine months of 2005,
as compared with the same 2004 period, due mainly to an additional provision
associated with the private label receivable portfolios acquired in 2004 and
2005. During the third quarter of 2005, an incremental provision for credit
losses related to Hurricane Katrina was also recorded. New bankruptcy
legislation became effective in October 2005. As a result of changes in
bankruptcy legislation, consumers nationwide filed bankruptcies in record
numbers in recent months. HUSI's provision for the third quarter and allowance
for credit losses at September 30, 2005 have not been materially impacted by the
changed legislation. Further analysis of credit quality and the allowance for
credit losses begins on page 54 of this Form 10-Q.
25
Other revenues increased in the first nine months of 2005, as compared with
2004, primarily due to:
o new fee income and new securitization revenue associated with the acquired
private label receivable portfolio;
o increased residential mortgage banking revenue;
o increased trading revenues; and
o increased gains on sales of securities.
Further analysis of other revenues begins on page 37 of this Form 10-Q.
Operating expenses increased in the first nine months of 2005, as compared with
2004, primarily due to new fees charged by HSBC Finance Corporation for loan
origination and servicing related to the private label receivable portfolio and
other loans acquired from HSBC Finance Corporation in 2004 and 2005. Fees
charged by HSBC affiliates for technology services, for broker-dealer services,
and for other operational and administrative support functions have also
increased. Increased expenses have also resulted from investment in expansion
initiatives in various business segments, particularly CIBM. Further commentary
regarding support services from HSBC affiliates is provided in Note 10 of the
consolidated financial statements beginning on page 13 of this Form 10-Q.
Further analysis of operating expenses begins on page 44 of this Form 10-Q.
For the first nine months of 2005, income tax expense was reduced by the
following items:
o a $20 million reduction of expense recorded in the first quarter resulting
from the difference between the previous estimate of tax liability for the
prior year and the liability per the final tax returns;
o a $9 million reduction of expense resulting from revised estimates of
certain tax credits and the effect of certain audit adjustments; and
o a reduction of taxable income for 2005.
26
The following tables present a summary of selected financial information for
2005 and 2004.
----------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
-----------------------
Three months ended September 30: 2005 2004 Amount %
----------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ......................................... $ 761 $ 698 $ 63 9
--------- --------- --------- ---------
Trading revenues ............................................ 137 21 116 552
Residential mortgage banking revenue (expense) .............. 31 (64) 95 148
Securities gains, net ....................................... 17 18 (1) (6)
Other income ................................................ 320 387 (67) (17)
--------- --------- --------- ---------
Total other revenues ........................................ 505 362 143 40
--------- --------- --------- ---------
Operating expenses .......................................... 673 480 193 40
Provision (credit) for credit losses ........................ 199 27 172 637
--------- --------- --------- ---------
Income before income tax expense ............................ 394 553 (159) (29)
Income tax expense .......................................... 142 214 (72) (34)
--------- --------- --------- ---------
Net income .................................................. $ 252 $ 339 $ (87) (26)
========= ========= ========= =========
Balances at period end:
Loans:
Commercial loans ...................................... $ 25,130 $ 20,869 $ 4,261 20
Residential mortgages ................................. 46,793 42,958 3,835 9
Credit card receivables ............................... 14,285 1,127 13,158 1,168
Other consumer loans .................................. 3,201 2,086 1,115 53
--------- --------- --------- ---------
Total loans ........................................... 89,409 67,040 22,369 33
Allowance for credit losses ........................... (852) (340) (512) (151)
--------- --------- --------- ---------
Loans, net of allowance ............................... 88,557 66,700 21,857 33
Total assets ................................................ 148,889 120,939 27,950 23
Total tangible assets ....................................... 146,146 118,195 27,951 24
Total deposits .............................................. 87,117 74,803 12,314 16
Short-term borrowings ....................................... 9,324 7,967 1,357 17
Long-term debt .............................................. 24,800 15,618 9,182 59
Common shareholder's equity ................................. 10,819 8,053 2,766 34
Tangible common shareholder's equity ........................ 8,074 5,336 2,738 51
Total shareholders' equity .................................. 11,836 8,553 3,283 38
Selected financial ratios:
Total shareholders' equity to total assets, at period end ... 7.95% 7.07%
Tangible common shareholder's equity to total
tangible assets, at period end ............................. 5.52 4.51
Rate of return on average(1):
Total assets .......................................... .67 1.17
Total common shareholder's equity ..................... 8.83 17.68
Net interest margin to average(1):
Earning assets ........................................ 2.20 2.65
Total assets .......................................... 2.04 2.42
Average total shareholders' equity to average total
assets(1) .................................................. 7.92 6.96
Cost:income ratio(1) ........................................ 53.15 45.28
(1) Selected financial ratios are defined in the Glossary of Terms beginning
on page 60 of the 2004 Form 10-K.
27
----------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
-----------------------
Nine months ended September 30: 2005 2004 Amount %
----------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ......................................... $ 2,321 $ 2,041 $ 280 14
--------- --------- --------- ---------
Trading revenues ............................................ 268 188 80 43
Residential mortgage banking revenue (expense) .............. 41 (105) 146 139
Securities gains, net ....................................... 105 59 46 78
Other income ................................................ 983 853 130 15
--------- --------- --------- ---------
Total other revenues ........................................ 1,397 995 402 40
--------- --------- --------- ---------
Operating expenses .......................................... 2,012 1,489 523 35
Provision (credit) for credit losses ........................ 476 7 469 6,700
--------- --------- --------- ---------
Income before income tax expense ............................ 1,230 1,540 (310) (20)
Income tax expense .......................................... 450 551 (101) (18)
--------- --------- --------- ---------
Net income .................................................. $ 780 $ 989 $ (209) (21)
========= ========= ========= =========
Balances at period end:
Loans:
Commercial loans ...................................... $ 25,130 $ 20,869 $ 4,261 20
Residential mortgages ................................. 46,793 42,958 3,835 9
Credit card receivables ............................... 14,285 1,127 13,158 1,168
Other consumer loans .................................. 3,201 2,086 1,115 53
--------- --------- --------- ---------
Total loans ........................................... 89,409 67,040 22,369 33
Allowance for credit losses ........................... (852) (340) (512) (151)
--------- --------- --------- ---------
Loans, net of allowance ............................... 88,557 66,700 21,857 33
Total assets ................................................ 148,889 120,939 27,950 23
Total tangible assets ....................................... 146,146 118,195 27,951 24
Total deposits .............................................. 87,117 74,803 12,314 16
Short-term borrowings ....................................... 9,324 7,967 1,357 17
Long-term debt .............................................. 24,800 15,618 9,182 59
Common shareholder's equity ................................. 10,819 8,053 2,766 34
Tangible common shareholder's equity ........................ 8,074 5,336 2,738 51
Total shareholders' equity .................................. 11,836 8,553 3,283 38
Selected financial ratios:
Total shareholders' equity to total assets, at period end ... 7.95% 7.07%
Tangible common shareholder's equity to total
tangible assets, at period end ............................. 5.52 4.51
Rate of return on average(1):
Total assets .......................................... .72 1.23
Total common shareholder's equity ..................... 9.50 17.76
Net interest margin to average(1):
Earning assets ........................................ 2.32 2.83
Total assets .......................................... 2.15 2.56
Average total shareholders' equity to average total
assets(1) .................................................. 7.84 7.30
Cost:income ratio(1) ........................................ 54.10 49.04
(1) Selected financial ratios are defined in the Glossary of Terms beginning
on page 60 of the 2004 Form 10-K.
The annualized rate of return and net interest margin ratios in the table above
reflect high amortization of premiums associated with private label receivables
acquired from HSBC Finance Corporation in December 2004. The initial premium
paid for these receivables is heavily front loaded into 2005. Commentary
regarding the private label receivable portfolio acquired, and the related
premiums, is provided on pages 23-24 of this Form 10-Q.
28
BASIS OF REPORTING
--------------------------------------------------------------------------------
HUSI's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States (U.S. GAAP).
International Financial Reporting Standards (IFRS)
Because HSBC reports results in accordance with IFRS and IFRS results are used
in measuring and rewarding performance of employees, HUSI management also
separately monitors net income under IFRS (a non-U.S. GAAP financial measure).
The following table reconciles HUSI's net income on a U.S. GAAP basis to net
income on an IFRS basis:
-----------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Net income - U.S. GAAP basis ............................................... $ 252 $ 780
Adjustments, net of tax:
Securitizations .................................................... (1) 5
Derivatives and hedge accounting (including fair value adjustments) ... 5 15
Loan origination ...................................................... (5) (15)
Loan impairment ....................................................... (2) (11)
Stock-based compensation .............................................. (3) (11)
Property .............................................................. (4) (15)
Pension costs ......................................................... 2 3
Designation of financial assets through profit and loss ............... 1 2
----- -----
Net income - IFRS basis ....................................................... $ 245 $ 753
===== =====
Differences between U.S. GAAP and IFRS are as follows:
Securitizations
IFRS
o The recognition of securitized assets is governed by a three-step process.
The process may be applied to the whole asset, or a part of an asset:
- If the rights to the cash flows have been transferred to a third
party, those securitized assets should be derecognized.
- If the rights to the cash flows are retained but there is a
contractual obligation to pay the cash flows to another party, the
securitized assets should be derecognized if certain conditions are
met, for example, where there is no obligation to pay amounts to the
eventual recipient unless an equivalent amount is collected from the
original asset.
- If it is determined that some significant risks and rewards of
ownership have been transferred, but some significant risks and
rewards have also been retained, it must be determined whether or
not control has been retained. If it has not been retained, the
asset should be derecognized. If control has been retained, an
entity shall continue to recognize the asset to the extent of its
continuing involvement.
U.S. GAAP
o SFAS 140 "Accounting for Transfers and Servicing of Finance Assets and
Extinguishments of Liabilities" requires that receivables that are sold to
a special purpose entity and securitized can only be derecognized and a
gain or loss on sale recognized if the originator has surrendered control
over those securitized assets.
o Control has been surrendered over transferred assets if and only if all of
the following conditions are met:
- The transferred assets have been put presumptively beyond the reach
of the transferor and its creditors, even in bankruptcy or other
receivership.
- Each holder of interests in the transferee (i.e. holder of issued
notes) has the right to pledge or exchange their beneficial
interests, and no condition constrains this right and provides more
than a trivial benefit to the transferor.
29
- The transferor does not maintain effective control over the assets
through either an agreement that obligates the transferor to
repurchase or to redeem them before their maturity or through the
ability to unilaterally cause the holder to return specific assets,
other than through a clean-up call.
- If these conditions are not met the securitized assets should
continue to be consolidated.
o Where HSBC retains an interest in the securitized assets, such as a
servicing right or the right to residual cash flows from the special
purpose entity, HSBC recognizes this interest at fair value on sale of the
assets.
Derivatives and hedge accounting
IFRS
o Derivatives are recognized initially, and are subsequently remeasured, at
fair value. Fair values are obtained from quoted market prices in active
markets, or by using valuation techniques, including recent market
transactions, where an active market does not exist. Valuation techniques
include discounted cash flow models and option pricing models as
appropriate. All derivatives are classified as assets when their fair
value is positive, or as liabilities when their fair value is negative.
o In the normal course of business, the fair value of a derivative on
initial recognition is considered to be the transaction price (i.e. the
fair value of the consideration given or received). However, in certain
circumstances the fair value of an instrument will be evidenced by
comparison with other observable current market transactions in the same
instrument (i.e. without modification or repackaging) or based on a
valuation technique whose variables include only data from observable
markets, including interest rate yield curves, option volatilities and
currency rates. When such evidence exists, HSBC recognizes a trading
profit or loss on inception of the derivative. If observable market data
are not available, the initial increase in fair value indicated by the
valuation model, but based on unobservable inputs, is not recognized
immediately in the income statement but is recognized over the life of the
transaction on an appropriate basis, or recognized in the income statement
when the inputs become observable, or when the transaction matures or is
closed out.
o Certain derivatives embedded in other financial instruments, such as the
conversion option in a convertible bond, are treated as separate
derivatives when their economic characteristics and risks are not clearly
and closely related to those of the host contract, the terms of the
embedded derivative are the same as those of a stand-alone derivative, and
the combined contract is not designated at fair value through profit and
loss. These embedded derivatives are measured at fair value with changes
in fair value recognized in the income statement.
o Derivative assets and liabilities on different transactions are only
netted if the transactions are with the same counterparty, a legal right
of set-off exists, and the cash flows are intended to be settled on a net
basis.
o The method of recognizing the resulting fair value gains or losses depends
on whether the derivative is held for trading, or is designated as a
hedging instrument, and if so, the nature of the risk being hedged. All
gains and losses from changes in the fair value of derivatives held for
trading are recognized in the income statement. Where derivatives are
designated as hedges, HSBC classifies them as either: (i) hedges of the
change in fair value of recognized assets or liabilities or firm
commitments ("fair value hedge"); (ii) hedges of the variability in highly
probable future cash flows attributable to a recognized asset or
liability, or a forecast transaction ("cash flow hedge"); or (iii) hedges
of net investments in a foreign operation ("net investment hedge"). Hedge
accounting is applied to derivatives designated as hedging instruments in
a fair value, cash flow or net investment hedge provided certain criteria
are met.
Hedge Accounting:
o It is HSBC's policy to document, at the inception of a hedging
relationship, the relationship between the hedging instruments and hedged
items, as well as its risk management objective and strategy for
undertaking the hedge. Such policies also require documentation of the
assessment, both at hedge inception and on an ongoing basis, of whether
the derivatives that are used in hedging transactions are highly effective
in offsetting changes in fair values or cash flows of hedged items
attributable to the hedged risks. Interest on designated qualifying hedges
is included in "Net interest income".
Fair value hedge:
o Changes in the fair value of derivatives that are designated and qualify
as fair value hedging instruments are recorded in the income statement,
together with changes in the fair value of the asset or liability or group
thereof that are attributable to the hedged risk.
30
o If the hedging relationship no longer meets the criteria for hedge
accounting, the cumulative adjustment to the carrying amount of a hedged
item for which the effective interest method is used is amortized to the
income statement over the residual period to maturity.
Cash flow hedge:
- The effective portion of changes in the fair value of derivatives
that are designated and qualify as cash flow hedges are recognized
in equity. Any gain or loss relating to an ineffective portion is
recognized immediately in the income statement.
- Amounts accumulated in equity are recycled to the income statement
in the periods in which the hedged item will affect profit or loss.
However, when the forecast transaction that is hedged results in the
recognition of a non-financial asset or a non-financial liability,
the gains and losses previously deferred in equity are transferred
from equity and included in the initial measurement of the cost of
the asset or liability.
- When a hedging instrument expires or is sold, or when a hedge no
longer meets the criteria for hedge accounting, any cumulative gain
or loss existing in equity at that time remains in equity until the
forecast transaction is ultimately recognized in the income
statement. When a forecast transaction is no longer expected to
occur, the cumulative gain or loss that was reported in equity is
immediately transferred to the income statement.
Net investment hedge:
- Hedges of net investments in foreign operations are accounted for
similarly to cash flow hedges. Any gain or loss on the hedging
instrument relating to the effective portion of the hedge is
recognized in equity; the gain or loss relating to the ineffective
portion is recognized immediately in the income statement. Gains and
losses accumulated in equity are included in the income statement on
the disposal of the foreign operation.
Hedge effectiveness testing:
- To qualify for hedge accounting, IAS 39 requires that at the
inception of the hedge and throughout its life, each hedge must be
expected to be highly effective (prospective effectiveness). Actual
effectiveness (retrospective effectiveness) must also be
demonstrated on an ongoing basis.
- The documentation of each hedging relationship sets out how the
effectiveness of the hedge is assessed. The method an HSBC entity
adopts for assessing hedge effectiveness will depend on its risk
management strategy.
- For fair value hedge relationships, HSBC entities utilize the
cumulative dollar offset method or regression analysis as
effectiveness testing methodologies. For cash flow hedge
relationships, HSBC entities utilize the change in variable cash
flow method or the cumulative dollar offset method using the
hypothetical derivative approach.
- For prospective effectiveness, the hedging instrument must be
expected to be highly effective in achieving offsetting changes in
fair value or cash flows attributable to the hedged risk during the
period for which the hedge is designated. For actual effectiveness,
the changes in fair value or cash flows must offset each other in
the range of 80 per cent to 125 per cent for the hedge to be deemed
effective.
Derivatives that do not qualify for hedge accounting:
- All gains and losses from changes in the fair value of any
derivatives that do not qualify for hedge accounting are recognized
immediately in the income statement. These gains and losses are
reported in "Trading income", except where derivatives are managed
in conjunction with financial instruments designated at fair value,
in which case gains and losses are reported in "Net income from
financial instruments designated at fair value".
U.S. GAAP
o The accounting under SFAS 133 "Accounting for Derivative Instruments and
Hedging Activities" is generally consistent with that under IAS 39 as
described above (from January 1, 2005). However, see below for discussion
of the designation of financial assets and liabilities at fair value.
o SFAS 133 permits the "shortcut method" of hedge effectiveness testing for
certain transactions. Under this method, it may be assumed, at inception
of the hedge, there is no ineffectiveness in the hedging of interest rate
risk with an interest rate swap provided specific criteria are met.
31
Loan origination
IFRS
o Certain loan fee income and incremental directly attributable loan
origination costs are amortized to the profit and loss account over the
life of the loan as part of the effective interest calculation under IAS
39.
U.S. GAAP
o Certain loan fee income and direct but not necessarily incremental loan
origination costs, including an apportionment of overheads, are amortized
to the profit and loss account over the life of the loan as an adjustment
to interest income (SFAS 91 "Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases".)
Loan impairment
IFRS
o Where there is evidence of impairment, based on statistical models using
historic loss rates adjusted for economic conditions, portfolios of loans
are written down to their net recoverable amount. The net recoverable
amount is the present value of the estimated future recoveries discounted
at the portfolio's original effective interest rate and includes
reasonably estimable recoveries on loans individually identified for
write-off pursuant to HSBC's credit guidelines.
U.S. GAAP
o Where the delinquency status of loans in a portfolio is such that there is
no realistic prospect of recovery of these amounts, the loans are written
off in full, or to recoverable value where collateral exists. The
delinquency status, for example, the number of days payment is overdue,
where write-off occurs is applied consistently across similar loan
products as described in HSBC's credit guidelines. Where local regulators
mandate the delinquency status at which write-off must occur for different
retail products and these reasonably reflect estimable recoveries on
individual loans, this basis of measuring impairment is reflected in U.S.
GAAP accounting. Cash recoveries relating to pools of such written-off
loans, if any, are reported as loan recoveries upon collection.
Stock-based compensation
IFRS
o IFRS 2 "Share-based Payment" requires that where annual bonuses are paid
in restricted shares, whereby the employee must remain with HSBC for a
fixed period in order to receive the shares, the award is expensed over
that period.
U.S. GAAP
o In its U.S. GAAP reporting, under SFAS 123 "Accounting for Stock Based
Compensation", HSBC has interpreted the service period as being the period
to which the bonus relates.
o For 2005 bonuses, awarded in early 2006, HSBC will follow SFAS 123
(revised 2004) "Share-Based Payment" ("SFAS 123R"). SFAS 123R is
consistent with IFRS 2, requiring restricted bonuses be expensed over the
period the employee must remain with HSBC. However, SFAS 123R only applies
to awards made after the date of adoption, which HSBC has elected as July
1, 2005.
Property
IFRS
o Under the transition rules of IFRS 1, HSBC has elected to freeze the value
of its properties at their January 1, 2004 valuations. These are the
"deemed cost" of properties under IFRSs and will not be revalued in the
future. Properties held at historical or deemed cost are depreciated
except for freehold land and leasehold leases greater than 500 years.
Investment properties are not depreciated.
o Investment properties are recognized at current market value with gains or
losses recognized in net income for the period.
32
U.S. GAAP
o U.S. GAAP does not permit revaluations of property, including investment
property, although it requires recognition of asset impairment. Any
realized surplus or deficit is, therefore, reflected in income on disposal
of the property. Depreciation is charged on all properties based on cost.
Pension costs
IFRS
o IAS 19, "Employee Benefits" requires pension liabilities to be assessed
based on current actuarial assumptions and methods and pension assets to
be measured at fair value. The net pension surplus or deficit,
representing the difference between plan assets and liabilities, is
recognized on the balance sheet.
o As permitted by IAS 19 (revised 2004), HSBC elects to record all actuarial
gains and losses on the pension surplus or deficit in the year they occur
within the Statement of Recognized Income and Expense.
U.S. GAAP
o SFAS 87 "Employers' Accounting for Pensions" prescribes a similar method
of actuarial valuation for pension liabilities and measurement of plan
assets at fair value as IAS 39.
o Where the accumulated benefit obligation (the value of benefits accrued
based on employee service up to the balance sheet date) exceeds the value
of plan assets, HSBC recognizes an additional minimum pension liability
equal to this excess, as long as the excess is greater than any accrual
already established for unfunded pension costs.
o SFAS 87 does not permit recognition of all actuarial gains and losses in a
performance statement other than the primary income statement. Under U.S.
GAAP, HSBC elects to use the "corridor method", whereby actuarial gains
and losses outside a certain range are recognized in the income statement,
in equal amounts over the remaining service lives of current employees.
That range is equal to 10% of the greater of plan assets and plan
liabilities. The remaining additional minimum pension liability is
recognized directly in other comprehensive income.
Designation of financial assets and liabilities at fair value through profit and
loss
IFRS
o Under IAS 39, a financial instrument, other than one held for trading, is
classified in this category if it meets the criteria set out below, and is
so designated by management. An entity may designate financial instruments
at fair value where the designation:
- eliminates or significantly reduces a measurement or recognition
inconsistency that would otherwise arise from measuring financial
assets or financial liabilities or recognizing the gains and losses
on them on different bases; or
- applies to a group of financial assets, financial liabilities or
both that is managed and its performance evaluated on a fair value
basis, in accordance with a documented risk management or investment
strategy, and where information about that group of financial
instruments is provided internally on that basis to key management
personnel; or
- relates to financial instruments containing one or more embedded
derivatives that significantly modify the cash flows resulting from
those financial instruments.
o Financial assets and financial liabilities so designated are recognized
initially at fair value, with transaction costs taken directly to the
income statement, and are subsequently remeasured at fair value. This
designation, once made, is irrevocable in respect of the financial
instruments to which it is made. Financial assets and financial
liabilities are recognized using trade date accounting.
o Gains and losses from changes in the fair value of such assets and
liabilities are recognized in the income statement as they arise, together
with related interest income and expense and dividends, within "Net income
from financial instruments designated at fair value".
U.S. GAAP
o There are no provisions to make such an election in U.S. GAAP similar to
that in IAS 39.
- Generally, for financial assets to be measured at fair value with
gains and losses recognized immediately in the income statement
under U.S. GAAP, they must meet the definition of trading securities
in SFAS 115 "Accounting for Certain Investments in Debt and Equity
Securities". Financial liabilities are generally reported at
amortized cost under U.S. GAAP.
33
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Net Interest Income
The following table presents a summary of net interest income.
--------------------------------------------------------------------------------
Increase (Decrease)
-------------------
2005 2004 Amount %
--------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Interest income:
Loans ....................... $ 1,192 $ 779 $ 413 53
Securities .................. 225 220 5 2
Trading assets .............. 73 43 30 70
Short-term investments ...... 83 27 56 207
Other ....................... 9 5 4 80
------- ------- ------- -------
Total interest income ... 1,582 1,074 508 47
------- ------- ------- -------
Interest expense:
Deposits .................... 476 226 250 111
Short-term borrowings ....... 87 49 38 78
Long-term debt .............. 258 101 157 155
------- ------- ------- -------
Total interest expense .. 821 376 445 118
------- ------- ------- -------
Net interest income ............... $ 761 $ 698 $ 63 9
======= ======= ======= =======
Nine months ended September 30:
Interest income:
Loans ....................... $ 3,377 $ 2,060 $ 1,317 64
Securities .................. 650 651 (1) --
Trading assets .............. 193 114 79 69
Short-term investments ...... 202 63 139 221
Other ....................... 23 13 10 77
------- ------- ------- -------
Total interest income ... 4,445 2,901 1,544 53
------- ------- ------- -------
Interest expense:
Deposits .................... 1,199 544 655 120
Short-term borrowings ....... 205 100 105 105
Long-term debt .............. 720 216 504 233
------- ------- ------- -------
Total interest expense .. 2,124 860 1,264 147
------- ------- ------- -------
Net interest income ............... $ 2,321 $ 2,041 $ 280 14
======= ======= ======= =======
In the discussion that follows, interest income and rates are presented and
analyzed on a taxable equivalent basis to permit comparisons of yields on
tax-exempt and taxable assets. An analysis of consolidated average balances and
interest rates on a taxable equivalent basis is presented on pages 21-22 of this
Form 10-Q.
All increases and decreases referenced on the following pages for the third
quarter and nine months of 2005 represent comparisons with the same 2004
periods.
Interest Income - Loans
Total interest income on loans increased $413 million (53%) in the third quarter
of 2005 and increased $1,317 million (64%) in the first nine months of 2005.
Average total loan balances increased 38% for the third quarter and 53% for the
first nine months of 2005, resulting from significant increases in various
consumer and commercial loan portfolios during 2004.
In addition to significant organic residential mortgage loan growth during 2004,
loans and receivables acquired directly from HSBC Finance Corporation, from
originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs, and from unrelated third parties have had a significant impact on
interest income during 2005. Increases in average loan balances, and the
resulting increases in interest income, were offset by significant amortization
of premiums paid for the specific portfolios, most notably private label
receivables acquired
34
from HSBC Finance Corporation in December 2004. Purchases of residential
mortgage loans from HSBC Finance Corporation correspondents were discontinued
effective September 1, 2005 due to HUSI's increasing ability to originate
similar products.
Credit Card Receivables
Interest earned from credit card receivables increased $193 million (839%) in
the third quarter of 2005, and increased $496 million (636%) in the first nine
months of 2005. Average credit card receivable balances were $12 billion higher
for the first nine months of 2005.
In December 2004, HUSI acquired $12 billion of private label receivables and
other loans from HSBC Finance Corporation. Total premiums paid for these
receivables, which are being amortized against interest income over the
estimated life of the related receivables, totaled $639 million. During the
first nine months of 2005, underlying customer balances included within the
private label portfolio have revolved, and new relationships have been added,
bringing the total private label portfolio balance to $14 billion at September
30, 2005. By agreement, new receivables generated from these private label
relationships are being acquired from HSBC Finance Corporation on a daily basis.
Total premiums paid, which are being amortized against interest income over the
estimated life of the related receivables, totaled $312 million for the first
nine months of the year.
HUSI continues to purchase additional private label credit card receivables on a
daily basis from HSBC Finance Corporation, which continues to own the private
label customer relationships noted above.
During 2004, HUSI sold certain MasterCard/Visa credit card relationships to HSBC
Finance Corporation. HUSI purchases receivables associated with these
MasterCard/Visa relationships from HSBC Finance Corporation on a daily basis.
Total premiums paid for these new receivables, which are being amortized against
interest income over the estimated life of the related receivables, totaled $25
million.
The average yields for credit card receivables and total loans were reduced in
2005 as a result of amortization of premiums paid for various credit card
portfolios, as follows:
------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
------------------ ------------------
Amount Rate Amount Rate
------------------------------------------------------------------------------------------------------
(in millions)
Credit card receivables:
Interest income, before premium amortization ......... $ 396 11.58% $ 1,112 11.94%
Premium amortization ................................. (180) (5.47) (538) (6.02)
------- ----- ------- -----
Interest income, adjusted for premium amortization ... $ 216 6.11% $ 574 5.92%
======= ===== ======= =====
Total loans:
Interest income, before premium amortization ......... $ 1,372 6.15% $ 3,915 6.03%
Premium amortization ................................. (180) (.84) (538) (.86)
------- ----- ------- -----
Interest income, adjusted for premium amortization ... $ 1,192 5.31% $ 3,377 5.17%
======= ===== ======= =====
Residential Mortgage Loans
Interest income earned from residential mortgage loans increased $76 million
(15%) in the third quarter of 2005, and increased $456 million (36%) in the
first nine months of 2005. HUSI significantly expanded the volume of adjustable
rate residential mortgage loans originated during 2004, which were retained on
the balance sheet. As a result, average residential mortgage loans held
increased by approximately 37% for the first nine months of 2005.
35
Since the beginning of 2004, approximately $5.5 billion of residential mortgages
have been purchased from HSBC Finance Corporation and from originating lenders
pursuant to an HSBC Finance Corporation correspondent loan program. Purchases
from these correspondents were discontinued effective September 1, 2005 due to
HUSI's increasing ability to originate similar products. Originations of
residential mortgage loans have decreased in 2005 as compared with 2004, due to
the contracting national originations market.
The increased average loan balances, and their positive effect on earnings, were
partially offset by a year to date decrease in the average yield earned on
residential mortgages during the first nine months of 2005. Despite rising
interest rates, consumers continued to take advantage of lower coupon adjustable
rate products, resulting in lower overall average yields.
The residential mortgage loan portfolio is expected to remain relatively
constant through the remainder of 2005. Loan originations of various adjustable
rate products that previously would have been retained in the held loan
portfolio are now being sold in the secondary market.
Other Consumer Loans
Interest earned from various other consumer lending programs increased $34
million (100%) in the third quarter of 2005, and increased $96 million (96%) in
the first nine months of 2005. Average loan balances increased by 67% in the
first nine months of 2005, primarily due to consumer loans purchased from
originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs. The average yield earned on consumer loans also increased due to the
rising rate environment.
Commercial Loans
Interest income from commercial loans increased $110 million (50%) in the third
quarter of 2005, and increased $269 million (45%) in the first nine months of
2005. Average commercial loan balances increased by 21% in the first nine months
of 2005. The average yield earned on commercial loans also increased due to
increases in HBUS's prime lending rate during 2005.
Targeted growth in small business, middle market and real estate lending
portfolios, which began in 2004, has continued to increase loan balances in
2005. HUSI plans to continue to build upon its status as the top small business
lender in New York State.
Interest Income - Trading Assets
Interest income from trading assets increased $30 million (70%) in the third
quarter of 2005, and increased $79 million (69%) in the first nine months of
2005. In the first nine months of 2005, average trading assets increased by 27%
mainly as a result of various business expansion initiatives. Average yields
earned on these balances also increased for the first nine months of 2005.
Interest Income - Short-Term Investments
Short-term investments include interest bearing deposits with banks and federal
funds sold and securities purchased under resale agreements. Fluctuations in
short-term investments directly result from the relationship between HUSI's
excess liquidity position and its funding needs at any given point in time.
Interest income from short-term investments increased $56 million (207%) in the
third quarter of 2005, and increased $139 million (221%) in the first nine
months of 2005. Average short-term investment balances grew by 40% the first
nine months of 2005, while average rates earned also increased significantly,
primarily due to increases in the federal funds rate.
36
Interest Expense - Deposits
Total interest expense on interest bearing deposits increased $250 million
(111%) in the third quarter of 2005, and increased $655 million (120%) in the
first nine months of 2005. Interest expense increased for both domestic and
foreign deposits. Average interest bearing deposits increased by 18% in the
first nine months of 2005. Average interest rates paid to these customers also
increased significantly, due to increases in short-term interest rates and to
introduction of more competitively priced consumer and commercial products.
An overview of deposit growth initiatives is provided on page 24 of this Form
10-Q.
Interest Expense - Short-Term Borrowings
Interest expense on short-term borrowings increased $38 million (78%) in the
third quarter of 2005, and increased $105 million (105%) in the first nine
months of 2005. Average short-term borrowings balances increased by 24% in the
first nine months of 2005, while the average interest rate paid also increased
significantly, due primarily to increases in the federal funds rate.
Interest Expense - Long-Term Debt
Interest expense on long-term debt increased $157 million (155%) in the third
quarter of 2005, and increased $504 million (233%) in the first nine months of
2005. Average long-term debt balances increased by 262% in the first nine months
of 2005, due primarily to new debt issued during the second half of 2004 to fund
balance sheet growth. A decrease in the average interest rate paid on long-term
debt in the first nine months of 2005, which resulted from new debt being
issued at significantly lower rates than existing debt, partially offset the
average balance increases.
Other Revenues
The following table presents the components of other revenues.
------------------------------------------------------------------------------------------------------------
Increase
(Decrease)
----------------
2005 2004 Amount %
------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Trust income .............................................. $ 21 $ 23 $ (2) (9)
Service charges:
HSBC affiliate income ................................. 4 4 -- --
Other service charges ................................. 48 50 (2) (4)
----- ----- ----- -----
Total service charges ................................. 52 54 (2) (4)
----- ----- ----- -----
Other fees and commissions:
Letter of credit fees ................................. 18 18 -- --
Credit card fees ...................................... 93 20 73 365
Wealth and tax advisory services ...................... 15 10 5 50
HSBC affiliate income ................................. 12 14 (2) (14)
Other fee-based income, net of referral fees .......... 54 48 6 13
----- ----- ----- -----
Total other fees and commissions ...................... 192 110 82 75
----- ----- ----- -----
Securitization revenue .................................... 30 -- 30 --
Other income:
Insurance ............................................. 6 16 (10) (63)
HSBC affiliate income ................................. 3 100 (97) (97)
Interest on tax settlement ............................ -- 17 (17) (100)
Gains on sale of property and other financial assets .. 22 50 (28) (56)
Other ................................................. (6) 17 (23) (135)
----- ----- ----- -----
Total other income .................................... 25 200 (175) (88)
----- ----- ----- -----
Residential mortgage banking revenue (expense) ............ 31 (64) 95 148
Trading revenues .......................................... 137 21 116 552
Securities gains, net ..................................... 17 18 (1) (6)
----- ----- ----- -----
Total other revenues ...................................... $ 505 $ 362 $ 143 40
===== ===== ===== =====
37
------------------------------------------------------------------------------------------------------------
Increase
(Decrease)
----------------
2005 2004 Amount %
------------------------------------------------------------------------------------------------------------
(in millions)
Nine months ended September 30:
Trust income .............................................. $ 65 $ 71 $ (6) (8)
Service charges:
HSBC affiliate income ................................. 11 14 (3) (21)
Other service charges ................................. 147 144 3 2
------ ------ ------ ------
Total service charges ................................. 158 158 -- --
------ ------ ------ ------
Other fees and commissions:
Letter of credit fees ................................. 53 53 -- --
Credit card fees ...................................... 211 60 151 252
Wealth and tax advisory services ...................... 44 34 10 29
HSBC affiliate income ................................. 42 25 17 68
Other fee-based income, net of referral fees .......... 131 169 (38) (22)
------ ------ ------ ------
Total other fees and commissions ...................... 481 341 140 41
------ ------ ------ ------
Securitization revenue .................................... 99 -- 99 --
Other income:
Insurance ............................................. 37 47 (10) (21)
HSBC affiliate income ................................. 26 102 (76) (75)
Interest on tax settlement ............................ -- 17 (17) (100)
Gains on sale of property and other financial assets .. 68 56 12 21
Other ................................................. 49 61 (12) (20)
------ ------ ------ ------
Total other income .................................... 180 283 (103) (36)
------ ------ ------ ------
Residential mortgage banking revenue (expense) ............ 41 (105) 146 139
Trading revenues .......................................... 268 188 80 43
Securities gains, net ..................................... 105 59 46 78
------ ------ ------ ------
Total other revenues ...................................... $1,397 $ 995 $ 402 40
====== ====== ====== ======
All increases and decreases referenced on the following pages for the third
quarter and first nine months of 2005 represent comparisons with the same 2004
periods.
Other Fees and Commissions
Increased credit card fees in the third quarter and first nine months of 2005
primarily resulted from the private label receivables acquired from HSBC Finance
Corporation in 2004 and 2005.
Other fee-based income increased in the third quarter of 2005. New fees
generated by a subsidiary transferred from HSBC in March 2005, which provides
accounting and valuation services for hedge fund clients, were partially offset
by referral fees paid to other HSBC affiliates under new referral arrangements
in 2005, which are netted against related fee revenues received from customers.
In June 2004, HUSI transferred an investment brokerage subsidiary to an HSBC
affiliate. Fees received from brokerage customers prior to the transfer date are
reported as other fee-based income in the preceding tables, while fees received
pursuant to an ongoing arrangement with the HSBC affiliate since the transfer
date are reported as HSBC affiliate income. Therefore, for the first nine months
of 2005, HSBC affiliate income increased, while other fee-based income
decreased.
38
Securitization Revenue
Securitization revenue results directly from the purchase of residual interests
in securitized private label credit card receivables from HSBC Finance
Corporation in December 2004. Securitization revenue is comprised of the
following activity:
---------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
---------------------------------------------------------------------------------------------------------
(in millions)
Net replenishment gains, net of provision for credit losses ..... $24 $66
Servicing revenue and excess spread ............................. 6 33
--- ---
Total ........................................................... $30 $99
=== ===
The securitized trusts require replenishments of receivables to support
previously issued securities. Receivables will continue to be sold to these
trusts until their revolving periods end, the last of which is expected to occur
in 2008. The replenishment gains result from these receivable sales to the
trusts. Third quarter servicing revenue and excess spread was comparable to the
second quarter, but has decreased when compared with previous periods, due to
declining receivable balances in the securitized trusts. There have been no new
securitization transactions during 2005.
Other Income
HSBC affiliate income for the third quarter of 2004 included a gain of $99
million related to the sale of certain credit card relationships to HSBC Finance
Corporation. HSBC affiliate income during the first nine months of 2005 was
primarily attributable to HBUS's new role, effective October 2004, as
originating lender for HSBC Finance Corporation's Taxpayer Financial Services
business. This revenue is further described in Note 10 of the consolidated
financial statements beginning on page 13 of this Form 10-Q.
In July 2004, HUSI recorded a $17 million refund of interest previously paid to
the Internal Revenue Service related to a prior year tax audit.
Gains on sale of property and other financial assets primarily include the
following significant activity and/or transactions for 2005 and 2004:
2005
o $17 million gain from the sale of property in July 2005;
o $26 million gain from the sale of property in May 2005;
o $16 million of gains from the sales of various branches and from the sale
of a portion of HUSI's personal trust business during the first nine
months of 2005; and
o In June 2005, HUSI began acquiring residential mortgage loans from
unaffiliated third parties and subsequently selling these loans to HSBC
Markets. Since the inception of this program, HUSI has acquired
approximately $2 billion of residential mortgage loans, which it
subsequently sold to HSBC Markets for total gains of approximately $2
million.
2004
o $45 million gain on the sale of an investment in NYCE Corporation in July
2004.
Other includes the following significant activity and/or transactions for 2005:
o In June 2005, HUSI began acquiring residential mortgage loans from
unaffiliated third parties and subsequently selling these acquired loans
to HSBC Markets. At September 30, 2005, HUSI had approximately $1.5
billion of residential mortgage loans held for sale on its consolidated
balance sheet, which are reported at the lower of cost or market value. A
mark to market loss of $24 million was included in other income related to
these loans; and
39
o miscellaneous fees have also increased as a direct result of the private
label receivable portfolio purchased from HSBC Finance Corporation in
December 2004, and from other private label portfolios acquired from
unrelated third parties during 2005.
Residential Mortgage Banking Revenue
The following table presents the components of residential mortgage banking
revenue. Net interest income includes interest earned/paid on assets and
liabilities of the residential mortgage banking business as well as an
allocation of the funding benefit or cost associated with these balances. The
net interest income component in the table is included in net interest income in
the consolidated statement of income and reflects actual interest earned, net of
cost of funds, and adjusted for corporate transfer pricing. Corporate transfer
pricing methodology was revised in the first quarter of 2005 resulting in
additional internal charges to the residential mortgage banking business from
the CIBM segment. Net interest income for the third quarter and the first nine
months of 2004 has been adjusted in the table to facilitate comparison.
-------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net interest income ................................................ $ 103 $ 121 $ (18) (15)
------ ------ ------ ------
Servicing related income (expense):
Servicing fee income ......................................... 19 20 (1) (5)
MSRs amortization ............................................ (18) (19) 1 5
MSRs temporary impairment (provision) recovery ............... 49 (95) 144 152
Trading - Derivative instruments used to offset changes in
value of MSRs .............................................. (14) 33 (47) (142)
------ ------ ------ ------
Total net servicing related income (expense) ................. 36 (61) 97 159
------ ------ ------ ------
Originations and sales related income (expense):
Gains (losses) on sales of mortgages ......................... (12) 1 (13) (1,300)
Trading - Forward loan sale commitments ...................... -- (4) 4 100
- Interest rate lock commitments ..................... -- (3) 3 100
- Euro interest rate contracts ....................... 2 -- 2 --
Fair value hedge activity(1) ................................. -- (1) 1 100
------ ------ ------ ------
Total net originations and sales related income (expense) .... (10) (7) (3) (43)
------ ------ ------ ------
Other mortgage income .............................................. 5 4 1 25
------ ------ ------ ------
Total residential mortgage banking revenue (expense) included
in other revenues ................................................ 31 (64) 95 148
------ ------ ------ ------
Total residential mortgage banking related revenue ................. $ 134 $ 57 $ 77 135
====== ====== ====== ======
40
-------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------------------------------
(in millions)
Nine months ended September 30:
Net interest income ................................................ $ 349 $ 342 $ 7 2
------ ------ ------ ------
Servicing related income (expense):
Servicing fee income ......................................... 56 60 (4) (7)
MSRs amortization ............................................ (54) (82) 28 34
MSRs temporary impairment (provision) recovery ............... 30 (82) 112 137
Trading - Derivative instruments used to offset changes in
value of MSRs .............................................. 5 9 (4) (44)
Gains on sales of available for sale securities .............. -- 8 (8) (100)
------ ------ ------ ------
Total net servicing related income (expense) ................. 37 (87) 124 143
------ ------ ------ ------
Originations and sales related income (expense):
Gains (losses) on sales of mortgages ......................... 3 (7) 10 143
Trading - Forward loan sale commitments ...................... (9) (1) (8) (800)
- Interest rate lock commitments ..................... (4) (13) 9 69
Fair value hedge activity(1) ................................. -- (2) 2 100
------ ------ ------ ------
Total net originations and sales related income (expense) .... (10) (23) 13 57
------ ------ ------ ------
Other mortgage income .............................................. 14 5 9 180
------ ------ ------ ------
Total residential mortgage banking revenue (expense) included
in other revenues ................................................ 41 (105) 146 139
------ ------ ------ ------
Total residential mortgage banking related revenue ................. $ 390 $ 237 $ 153 65
====== ====== ====== ======
(1) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity.
All increases and decreases referenced below for the third quarter and the first
nine months of 2005 represent comparisons with the same 2004 periods.
Overview
Residential mortgage banking related revenue increased $77 million and $153
million for the third quarter and the first nine months of 2005 respectively.
Net interest income for the first nine months of 2005 was consistent with 2004
levels. The decrease for the third quarter of 2005 was attributable to a
narrowing of interest rate spreads on the core mortgage portfolio. Commentary
regarding residential mortgage interest income is presented on pages 35-36 of
this Form 10-Q.
Servicing Related Income (Expense)
Increased net servicing related income (expense) for the third quarter and for
the first nine months of 2005 was primarily attributable to recovery of the
temporary impairment valuation allowance during 2005 compared with provisions
for impairment recorded for 2004, which was partially offset by decreases in
income associated with derivative instruments used to offset changes in the
economic value of MSRs. The overall increase for the first nine months of 2005
was also partially attributable to decreased MSR amortization expense.
The recorded net book value of MSRs and related amortization expense, are
directly impacted by interest rate fluctuations, which in turn affect levels of
residential mortgage prepayments. During 2005, interest rates generally rose and
prepayments of residential mortgages, mostly in the form of loan refinancings,
have subsequently decreased in comparison with 2004 levels, resulting in
decreased MSR amortization expense compared with amounts recorded in prior
periods. Loan refinance activity represented 43% of total originations in the
first nine months of 2005, as compared with 52% in the first nine months of
2004.
41
The net servicing related income amounts in the tables do not reflect
approximately $4 million of unrealized losses, recorded as other comprehensive
income, on available for sale securities used to offset changes in the economic
value of MSRs as well as net interest income of $7 million on these securities.
Additional commentary regarding risk management associated with the MSRs
economic hedging program begins on page 67 of this Form 10-Q.
Originations and Sales Related Income (Expense)
The increase in originations and sales related income for the first nine months
of 2005 was attributable to a higher basis point gain on each individual sale
driven by less market volatility as compared with 2004 as well as a higher
volume of originated loans sold. During the first nine months of 2005,
residential mortgages originated with the intention to sell increased 27% from
the same 2004 period. A greater proportion of adjustable rate residential
mortgage loans were sold in 2005, which previously would have been held on
HUSI's balance sheet.
Trading Revenues
Trading revenues are generated by HUSI's participation in the foreign exchange,
credit derivative and precious metals markets; from trading derivative
contracts, including interest rate swaps and options; and from trading
securities. Trading revenues related to the mortgage banking business are
included in residential mortgage banking revenue.
The following table presents trading related revenues by business. The data in
the table includes interest income earned on trading instruments, net of
allocated funding cost associated with the trading positions. The net interest
income component is included in net interest income on the consolidated
statement of income.
-----------------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
-----------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Trading revenues ........................ $ 137 $ 21 $ 116 552
Net interest income ..................... -- 24 (24) (100)
------ ------ ------ ------
Trading related revenues ................ $ 137 $ 45 $ 92 204
====== ====== ====== ======
Business:
Derivative instruments ............ $ 44 $ (3) $ 47 1,567
Treasury (primarily securities) ... 39 5 34 680
Bank notes ........................ 19 16 3 19
Foreign exchange .................. 20 11 9 82
Precious metals ................... 9 11 (2) (18)
Other trading ..................... 6 5 1 20
------ ------ ------ ------
Trading related revenues ................ $ 137 $ 45 $ 92 204
====== ====== ====== ======
Nine months ended September 30:
Trading revenues ........................ $ 268 $ 188 $ 80 43
Net interest income ..................... 21 61 (40) (66)
------ ------ ------ ------
Trading related revenues ................ $ 289 $ 249 $ 40 16
====== ====== ====== ======
Business:
Derivative instruments ............ $ 103 $ 83 $ 20 24
Treasury (primarily securities) ... 42 20 22 110
Bank notes ........................ 49 42 7 17
Foreign exchange .................. 52 48 4 8
Precious metals ................... 35 39 (4) (10)
Other trading ..................... 8 17 (9) (53)
------ ------ ------ ------
Trading related revenues ................ $ 289 $ 249 $ 40 16
====== ====== ====== ======
42
Improved trading markets during the third quarter of 2005 offset the difficult
markets encountered during the first two quarters. Overall, non-interest client
and propriety trading revenues increased during the third quarter and the first
nine months of 2005 as a result of the following factors:
o improved trading markets for the third quarter associated with the credit
derivatives trading desk;
o successful rollout of a new structured transactions business within the
CIBM segment, which has increased derivatives related revenues in the
third quarter and the first nine months of 2005; and
o increased Treasury related revenues for the third quarter associated with
a new whole loan structuring business initiated during 2005.
The yield curve continued to flatten during the third quarter, which resulted in
significant decreases in quarter and year to date interest rate margins
associated with various trading assets.
Security Gains, Net
The following table presents gains and losses on securities portfolios included
in the consolidated statement of income.
------------------------------------------------------------------------------------------------------------------
2005 2004
---------------------------------- ----------------------------------
Gross Gross Net Gross Gross Net
Realized Realized Realized Realized Realized Realized
Gains (Losses) Gains Gains (Losses) Gains
------------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net security gains included in:
Security gains, net ............ $ 17 $ -- $ 17 $ 19 $ (1) $ 18
===== ===== ===== ===== ===== =====
Nine months ended September 30:
Net security gains included in:
Residential mortgage banking
related revenue .............. $ -- $ -- $ -- $ 8 $ -- $ 8
Security gains, net ............ 106 (1) 105 66 (7) 59
----- ----- ----- ----- ----- -----
$ 106 $ (1) $ 105 $ 74 $ (7) $ 67
===== ===== ===== ===== ===== =====
HUSI maintains various securities portfolios as part of its overall liquidity,
balance sheet diversification and risk management strategy. During the first
nine months of 2005, approximately $33 million of gains were realized on
securities sold to address interest rate sensitivity and balance sheet
diversification needs, which was consistent with similar gains for the same 2004
period. Also during 2005, HUSI reduced its exposure in Latin American
securities, resulting in gains of $20 million, as compared with $27 million for
the same 2004 period.
In June 2005, HUSI sold shares in a foreign equity fund to an HSBC affiliate for
a gain of $48 million.
43
Operating Expenses
The following table presents the components of operating expenses.
-------------------------------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Salaries and employee benefits ............................. $ 257 $ 219 $ 38 17
Occupancy expense, net ..................................... 49 42 7 17
Support services from HSBC affiliates:
Fees paid to HTSU for technology services ............ 48 42 6 14
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support ......... 102 8 94 1,175
Other fees, primarily treasury and traded markets
services ........................................... 63 49 14 29
------- ------- ------- -------
213 99 114 115
------- ------- ------- -------
Other expenses:
Equipment and software ............................... 22 26 (4) (15)
Marketing ............................................ 22 14 8 57
Outside services ..................................... 29 24 5 21
Professional fees .................................... 15 14 1 7
Telecommunications ................................... 5 4 1 25
Postage, printing and office supplies ................ 6 6 -- --
Insurance business ................................... 6 6 -- --
Other ................................................ 49 26 23 88
------- ------- ------- -------
Total other expenses ................................. 154 120 34 28
------- ------- ------- -------
Total operating expenses ................................... $ 673 $ 480 $ 193 40
======= ======= ======= =======
Personnel - average number ................................. 11,378 11,108 270 2
-------------------------------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------------------------
(in millions)
Nine months ended September 30:
Salaries and employee benefits ............................. $ 778 $ 714 $ 64 9
Occupancy expense, net ..................................... 134 124 10 8
Support services from HSBC affiliates:
Fees paid to HTSU for technology services ............ 148 124 24 19
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support ......... 307 19 288 1,516
Other fees, primarily treasury and traded markets
services ........................................... 194 148 46 31
------- ------- ------- -------
649 291 358 123
------- ------- ------- -------
Other expenses:
Equipment and software ............................... 68 83 (15) (18)
Marketing ............................................ 55 34 21 62
Outside services ..................................... 84 74 10 14
Professional fees .................................... 44 35 9 26
Telecommunications ................................... 14 13 1 8
Postage, printing and office supplies ................ 19 18 1 6
Insurance business ................................... 15 17 (2) (12)
Other ................................................ 152 86 66 77
------- ------- ------- -------
Total other expenses ................................. 451 360 91 25
------- ------- ------- -------
Total operating expenses ................................... $ 2,012 $ 1,489 $ 523 35
======= ======= ======= =======
Personnel - average number ................................. 11,114 11,634 (520) (4)
All increases and decreases referred to for the third quarter and for the first
nine months of 2005 represent comparisons with the same 2004 periods.
44
Overview
Total operating expenses increased 40% in the third quarter of 2005, and
increased 35% in the first nine months of 2005. Increases in various HSBC
affiliate charges and in salaries and employee benefits were the primary drivers
of increased expenses.
Salaries and Employee Benefits
Salaries increased $21 million (12%) for the third quarter and increased $26
million (5%) for the first nine months of 2005.
During the first half of 2004, HUSI transferred its brokerage subsidiary and
most of its branch operations in Panama to other HSBC affiliates, resulting in a
significant reduction in average personnel. Excluding these subsidiary
transfers, the average number of personnel increased for the third quarter and
the first nine months of 2005. Expansion initiatives in various businesses were
the primary drivers of increased staff counts and salaries expense. In addition,
in March 2005, HSBC transferred a subsidiary to HUSI that provides accounting
and valuation services to hedge fund clients, which also increased salaries
expense.
Employee benefits expenses increased $17 million (43%) in the third quarter and
$38 million (22%) in the first nine months of 2005, due to:
o increased employer share of payroll taxes and other benefit costs
associated with the overall increases noted above for salaries;
o HUSI's employer matching of employee retirement savings contributions have
increased, due to changes in matching program provisions which took effect
during 2004; and
o increased staffing levels noted above.
Support Services From HSBC Affiliates
Fees are charged by various HSBC affiliates for technology services, for
underwriting and broker-dealer services, for loan origination and servicing, and
for other operational and administrative support functions. Transactions with
HSBC affiliates are presented in Note 10 of the consolidated financial
statements beginning on page 13 of this Form 10-Q.
The overall increases in HSBC affiliate charges are due primarily to the
following activity:
o fees charged by HSBC Finance Corporation for loan origination and
servicing expenses have increased significantly due to increased services
related to the private label receivable portfolio and other loans acquired
from HSBC Finance Corporation and from their correspondents. Fees charged
by HSBC Finance Corporation for various administrative services have also
increased as a result of specific initiatives to centralize administrative
functions;
o fees charged by HTSU for technology services expenses have increased in
2005, as HUSI continued to upgrade its automated technology environment.
Equipment and software costs included in other expenses have decreased in
2005, as these costs are now included in the charges by HTSU; and
o fees charged by HSBC Markets and other HSBC affiliates for treasury and
traded markets services provided to HUSI's CIBM business segment have also
increased in 2005 due primarily to business expansion initiatives.
Other Expenses
Other includes external fraud losses of $4 million in the third quarter of 2005,
and $26 million in the first nine months of 2005, which are related primarily to
the private label receivable portfolio acquired from HSBC Finance Corporation in
December 2004.
HUSI maintains a separate reserve for credit risk associated with certain
off-balance sheet exposures, including letters of credit, unused commitments to
extend credit and financial guarantees. The provision for losses associated with
these off-balance sheet exposures increased $9 million in the third quarter of
2005 and $15 million for the first nine months of 2005. Additional analysis of
off-balance sheet exposures begins on page 60 of this Form 10-Q.
45
Various business expansion initiatives within the PFS, CMB and CIBM segments
have also resulted in general increases in other expenses during 2005.
BUSINESS SEGMENTS
--------------------------------------------------------------------------------
HUSI has five distinct segments that it utilizes for management reporting and
analysis purposes, which are consistent with the line of business groupings used
by HSBC. The segments are based upon customer groupings, as well as products and
services offered. The segments are described in the following paragraphs.
The Personal Financial Services (PFS) Segment
This segment provides a broad range of financial products and services including
installment and revolving term loans, deposits, branch services, mutual funds,
investments and insurance. These products are marketed to individuals primarily
through the branch banking network. Residential mortgage lending provides loan
financing through direct retail and wholesale origination channels. Mortgage
loans are originated through a network of brokers, wholesale agents and retail
origination offices. Servicing is performed for the individual mortgage holder
or on a contractual basis for mortgages owned by third parties.
The PFS segment continues to include MasterCard/Visa credit card receivables
acquired on a daily basis, related to account relationships which HUSI sold to
HSBC Finance Corporation in 2004.
The Consumer Finance (CF) Segment
Effective for the first quarter of 2005, HUSI formed a new business segment,
Consumer Finance (CF), which was reported as a component of PFS in prior
periods. The CF segment includes point of sale and other lending activities
primarily to meet the financial needs of individuals. Specifically, operating
activity within the CF segment relates to various consumer loans, private label
credit card receivables, and retained interests in securitized receivable trusts
purchased from HSBC Finance Corporation, as well as consumer loans purchased
from originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs. Purchases from these correspondents were discontinued effective
September 1, 2005 due to HUSI's increasing ability to originate similar
products.
The Commercial Banking (CMB) Segment
This segment provides loan and deposit products to small businesses and
middle-market corporations including specialized products such as real estate
financing. Various credit and trade related products are also offered such as
standby facilities, performance guarantees and acceptances. These products and
services are offered through multiple delivery systems, including the branch
banking network.
The Corporate, Investment Banking and Markets (CIBM) Segment
This segment is comprised of Corporate/Institutional Banking (CIB) and
Investment Banking and Markets (IBM). CIB provides deposit and lending
functionality to large and multi-national corporations and banks. U.S. dollar
clearing services are offered for domestic and international wire transfer
transactions. Credit and trade related products such as standby facilities,
performance guarantees and acceptances are also provided by CIB to large
corporate entities. The IBM component includes treasury and traded markets. The
treasury function maintains overall responsibility for the investment and
borrowing of funds to ensure liquidity, manage interest rate risk and capital at
risk. Traded markets encompasses the trading and sale of foreign exchange,
banknotes, derivatives, precious metals, securities and emerging markets
instruments, both domestically and internationally.
The Private Banking (PB) Segment
This segment offers a full range of services for high net worth domestic and
foreign individuals including deposit, lending, trading, trust, branch services,
mutual funds, insurance and investment management.
46
Other Segment
This segment includes equity investments in Wells Fargo HSBC Trade Bank N.A. and
HSBC Republic Bank (Suisse) S.A.
The net interest income component in the following tables reflects actual
interest earned, net of cost of funds as determined by corporate transfer
pricing methodology. Effective January 2005, HUSI enhanced its funds transfer
pricing methodology to better approximate current external market pricing and
valuation, resulting in additional internal charges to the residential mortgage
banking business, included in PFS, from CIBM. For comparability purposes, 2004
segment results were also restated, increasing CIBM revenues by $57 million for
the third quarter and $143 million for the first nine months of 2004, with the
offsetting decrease to PFS revenues.
All increases and decreases referred to on the following pages for the third
quarter 2005 and for the first nine months of 2005 represent comparisons with
the same 2004 periods.
The term "interest rate spread", as used in the following commentary, refers to
either:
o the percentage difference between the interest rate earned on earning
assets, net of amortized premiums and loan fees, and the cost of funds
utilized to fund those assets, as calculated using corporate transfer
pricing methodology; or
o the percentage difference between the interest rate paid on deposits
specifically assigned to a business segment and the associated value of
funds as calculated using corporate transfer pricing methodology.
Personal Financial Services (PFS)
Overview
Excluding certain one-time transactions that occurred in 2005 and 2004, earnings
improved for the PFS segment during the first nine months of 2005. Additional
resources and priority have been focused on core retail banking businesses.
Investment in the retail branch network continues to be expanded and reallocated
to ensure coverage of high potential growth geographic areas. Loan and deposit
products offered to individuals have been expanded in conjunction with increased
marketing efforts. HUSI has also continued to leverage its relationship with
HSBC Finance Corporation to increase consumer loan assets and earnings, to
obtain loan origination and servicing, and to reduce overall operating costs of
various administrative services.
Operating Results
The following table summarizes the results for the Personal Financial Services
(PFS) segment.
------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net interest income ............... $ 300 $ 274 $ 26 9
Other revenues .................... 124 168 (44) (26)
------- ------- ------- -------
Total revenues .................... 424 442 (18) (4)
Operating expenses ................ 257 239 18 8
------- ------- ------- -------
Working contribution .............. 167 203 (36) (18)
Provision for credit losses ....... 23 20 3 15
------- ------- ------- -------
Income before income tax expense .. $ 144 $ 183 $ (39) (21)
======= ======= ======= =======
Average assets .................... $48,655 $44,731
Average liabilities/equity ........ 42,081 34,072
Goodwill at September 30 .......... 1,164 1,167
47
------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
------------------------------------------------------------------------------------
(in millions)
Nine months ended September 30:
Net interest income ............... $ 902 $ 803 $ 99 12
Other revenues .................... 339 308 31 10
------- ------- ------- -------
Total revenues .................... 1,241 1,111 130 12
Operating expenses ................ 757 709 48 7
------- ------- ------- -------
Working contribution .............. 484 402 82 20
Provision for credit losses ....... 67 63 4 6
------- ------- ------- -------
Income before income tax expense .. $ 417 $ 339 $ 78 23
======= ======= ======= =======
Average assets .................... $49,824 $38,877
Average liabilities/equity ........ 43,465 33,063
Increased net interest income for the third quarter and the first nine months of
2005, was due to:
o significant growth in average consumer loan balances, particularly
adjustable rate residential mortgage loans, partially offset by the lower
average yields on the adjustable rate loans;
o more favorable interest rate spreads on a growing personal deposits base
during 2005; and
o offset by $24 million of amortization of premium paid during the first
nine months of 2005 for MasterCard/Visa credit card receivables acquired
on a daily basis from HSBC Finance Corporation.
Other revenues includes the following significant activity for 2005 and 2004,
which affects the comparability of reported amounts:
2005
o non-interest residential mortgage banking revenue increased $95 million in
the third quarter and increased $146 million in the first nine months of
2005. Commentary regarding residential mortgage banking revenue begins on
page 40 of this Form 10-Q;
o during 2005, HUSI sold certain properties to unaffiliated third parties.
Approximately $26 million of the gains realized on these transactions were
recorded in the PFS segment; and
o effective in October 2004, HBUS is the originating lender for HSBC Finance
Corporation's Taxpayer Financial Services program. Gains recognized for
tax refund anticipation loans sold to HSBC Finance Corporation were
approximately $19 million in the first nine months of 2005, most of which
was recorded in the first quarter of the year.
2004
o during the third quarter of 2004, HUSI recorded a $99 million gain on sale
of certain credit card relationships to HSBC Finance Corporation; and
o also during the third quarter, HUSI recorded a $45 million gain on sale of
an equity investment.
Increased operating expenses for the third quarter and the first nine months of
2005, were due to:
o increased personnel, marketing and other direct expenses associated with
expanded consumer lending and retail banking operations; and
o increased fees paid to HTSU, as HUSI has continued to upgrade its
technology environment.
48
Consumer Finance (CF)
Overview
Results of this segment, which was initiated in 2005, have been negatively
impacted by significant amortization of premiums paid for private label credit
card receivables acquired from HSBC Finance Corporation in 2004 and 2005.
Residential mortgage loans and other consumer loans acquired from HSBC Finance
Corporation and their correspondents, which began in 2003, have had a positive
impact on income before taxes.
Operating Results
The following table summarizes the results for the Consumer Finance (CF)
segment.
-------------------------------------------------------------------------------------------------------
Increase (Decrease)
----------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net interest income ............................ $ 140 $ 49 $ 91 186
Other revenues ................................. 102 -- 102 --
-------- -------- -------- --------
Total revenues ................................. 242 49 193 394
Operating expenses ............................. 101 4 97 2,425
-------- -------- -------- --------
Working contribution ........................... 141 45 96 213
Provision for credit losses .................... 176 3 173 5,767
-------- -------- -------- --------
Income (loss) before income tax expense ........ $ (35) $ 42 $ (77) (183)
======== ======== ======== ========
Average assets ................................. $ 19,764 $ 4,777
Average liabilities/equity ..................... 343 (5)
Nine months ended September 30:
Net interest income ............................ $ 436 $ 135 $ 301 223
Other revenues ................................. 249 -- 249 --
-------- -------- -------- --------
Total revenues ................................. 685 135 550 407
Operating expenses ............................. 318 10 308 3,080
-------- -------- -------- --------
Working contribution ........................... 367 125 242 194
Provision for credit losses .................... 437 6 431 7,183
-------- -------- -------- --------
Income (loss) before income tax expense ........ $ (70) $ 119 $ (189) (159)
======== ======== ======== ========
Average assets ................................. $ 18,890 $ 3,928
Average liabilities/equity ..................... 506 (3)
This segment includes receivables associated with the private label receivable
portfolio (the PLRP) acquired in December 2004 from HSBC Finance Corporation and
other consumer loans acquired from HSBC Finance Corporation and their
correspondents. The following table summarizes the impact of the PLRP on
earnings for this segment for the third quarter and first nine months of 2005 in
comparison with the other portfolios.
--------------------------------------------------------------------------------
PLRP Other Total
--------------------------------------------------------------------------------
(in millions)
Three months ended September 30, 2005:
Net interest income ............................ $ 102 $ 38 $ 140
Other revenues ................................. 102 -- 102
----- ----- -----
Total revenues ................................. 204 38 242
Operating expenses ............................. 98 3 101
----- ----- -----
Working contribution ........................... 106 35 141
Provision for credit losses .................... 153 23 176
----- ----- -----
Income (loss) before income tax expense ........ $ (47) $ 12 $ (35)
===== ===== =====
49
--------------------------------------------------------------------------------
PLRP Other Total
--------------------------------------------------------------------------------
(in millions)
Nine months ended September 30, 2005:
Net interest income ............................ $ 283 $ 153 $ 436
Other revenues ................................. 249 -- 249
----- ----- -----
Total revenues ................................. 532 153 685
Operating expenses ............................. 306 12 318
----- ----- -----
Working contribution ........................... 226 141 367
Provision for credit losses .................... 401 36 437
----- ----- -----
Income (loss) before income tax expense ........ $(175) $ 105 $ (70)
===== ===== =====
Interest income for the PLRP has been partially offset by approximately $370
million of amortization of the initial premium paid for the portfolio. In
addition, amortization of premium paid for additional PLRP receivables acquired
from HSBC Finance Corporation during 2005 was $168 million for the first nine
months of 2005.
Other revenues for the PLRP for the first nine months of 2005 is primarily
comprised of the following:
o approximately $150 million of credit card and other fees from customers;
and
o approximately $99 million of securitization revenue from residual
interests in securitized private label credit card receivables acquired as
part of the PLRP purchase.
Operating expenses for the PLRP are primarily fees paid to HSBC Finance
Corporation for loan servicing. Additional direct expenses for management of the
portfolio, including technology services and fraud losses, have also been
incurred.
The provision for credit losses includes an incremental provision of $25 million
for Hurricane Katrina (see further commentary on page 24 of this Form 10-Q).
Excluding this incremental provision, the provision for credit losses for the
first nine months of 2005 is consistent with historical experience for this
portfolio. Commentary regarding credit quality begins on page 54 of this Form
10-Q.
New domestic private label credit card receivable originations are purchased
from HSBC Finance Corporation on a daily basis. In accordance with Federal
Financial Institutions Examination Council (FFIEC) guidance, in the first
quarter of 2006, the required minimum monthly payment amounts for domestic
private label credit card accounts will change. Preliminary estimates of the
potential impact to the business are based on numerous assumptions and take into
account a number of factors, such as changes in customer behavior, which are
difficult to predict. The impact of these factors will not be fully known or
understood until the changes are fully implemented. It is anticipated that the
changes will reduce the premium associated with these daily purchases beginning
in 2006. Although these changes are not expected to have a material impact on
HUSI's consolidated results, the impact will be material to the CF segment in
2006.
Commercial Banking (CMB)
Overview
Improved results for 2005 resulted from successful rollout of planned expansion
initiatives. Loan and deposit products offered to small businesses, and
middle-market commercial customers have been expanded, beginning in 2004, in
conjunction with increased marketing efforts. HUSI has also leveraged its status
as the top ranked small business lender in New York State.
50
Operating Results
The following table summarizes the results for the Commercial Banking (CMB)
segment.
-----------------------------------------------------------------------------------------
Increase (Decrease)
---------------------
2005 2004 Amount %
-----------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net interest income ................ $ 172 $ 145 $ 27 19
Other revenues ..................... 52 41 11 27
-------- -------- -------- --------
Total revenues ..................... 224 186 38 20
Operating expenses ................. 93 75 18 24
-------- -------- -------- --------
Working contribution ............... 131 111 20 18
Provision for credit losses ........ 7 (5) 12 240
-------- -------- -------- --------
Income before income tax expense ... $ 124 $ 116 $ 8 7
======== ======== ======== ========
Average assets ..................... $ 16,200 $ 13,783
Average liabilities/equity ......... 18,302 14,180
Goodwill at September 30 ........... 471 473
Nine months ended September 30:
Net interest income ................ $ 481 $ 434 $ 47 11
Other revenues ..................... 139 126 13 10
-------- -------- -------- --------
Total revenues ..................... 620 560 60 11
Operating expenses ................. 281 249 32 13
-------- -------- -------- --------
Working contribution ............... 339 311 28 9
Provision for credit losses ........ 6 (8) 14 175
-------- -------- -------- --------
Income before income tax expense ... $ 333 $ 319 $ 14 4
======== ======== ======== ========
Average assets ..................... $ 15,614 $ 13,504
Average liabilities/equity ......... 17,226 14,131
Increased net interest income and other revenues for the third quarter and the
first nine months of 2005 resulted from the successful rollout of planned
expansion of various small business, middle-market and real estate commercial
lending programs. CMB also benefited from more favorable interest rate spreads
on a growing deposit base during 2005.
During the second quarter of 2004, HUSI transferred its Panamanian operations to
an HSBC affiliate. As a result, commercial loans, deposits and related net
interest income, included in the CMB segment, have decreased in 2005, partially
offsetting the increases from business expansion initiatives noted above.
During 2005, HUSI sold certain properties to unaffiliated third parties.
Approximately $14 million of the gains realized on these transactions were
recorded in other revenues within the CMB segment.
Increased operating expenses resulted from the business expansion initiatives
noted above and from increased fees paid to HTSU for technology services as HUSI
has continued to upgrade its technology environment.
Corporate, Investment Banking and Markets (CIBM)
Overview
Decreased income for 2005 is primarily the result of significant recent
increases in short-term interest rates. While increased short-term rates have a
positive impact on interest rate spreads for deposit generating businesses, such
as the PFS and CMB segments, they have an adverse impact on CIBM which does not
generate significant low cost deposit funding. Improved market conditions
resulted in increased trading revenues in the third quarter of 2005, which
partially offset difficult markets encountered during the first two quarters of
the year.
51
Various treasury and traded markets activities have been expanded in 2005
resulting in increased products offered to customers, increased marketing
efforts for those products, increased proprietary activities, and increased
infrastructure expenses for the CIBM segment.
Operating Results
The following table summarizes the results for the Corporate, Investment Banking
and Markets (CIBM) segment.
-------------------------------------------------------------------------------------------
Increase (Decrease)
----------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net interest income ................ $ 107 $ 200 $ (93) (47)
Other revenues ..................... 176 104 72 69
-------- -------- -------- --------
Total revenues ..................... 283 304 (21) (7)
Operating expenses ................. 153 106 47 44
-------- -------- -------- --------
Working contribution ............... 130 198 (68) (34)
Provision for credit losses ........ (8) 7 (15) (214)
-------- -------- -------- --------
Income before income tax expense ... $ 138 $ 191 $ (53) (28)
======== ======== ======== ========
Average assets ..................... $ 58,736 $ 47,342
Average liabilities/equity ......... 78,290 58,229
Goodwill at September 30 ........... 631 631
Nine months ended September 30:
Net interest income ................ $ 384 $ 582 $ (198) (34)
Other revenues ..................... 441 387 54 14
-------- -------- -------- --------
Total revenues ..................... 825 969 (144) (15)
Operating expenses ................. 459 345 114 33
-------- -------- -------- --------
Working contribution ............... 366 624 (258) (41)
Provision for credit losses ........ (33) (54) 21 39
-------- -------- -------- --------
Income before income tax expense ... $ 399 $ 678 $ (279) (41)
======== ======== ======== ========
Average assets ..................... $ 55,777 $ 46,510
Average liabilities/equity ......... 74,652 50,806
Decreased net interest income for the third quarter and for the first nine
months of 2005 was primarily due to recent increases in short-term interest
rates, which have had an adverse impact on CIBM interest rate spreads.
Increased other revenues for the third quarter and for the first nine months of
2005 was primarily due to increased trading revenues resulting from more
favorable market conditions as compared with previous quarters. Increased
fee-based income and increased gains on the sale of securities also contributed
to the overall increase in other revenues. Commentary regarding trading revenues
and securities gains begins on page 42 of this Form 10-Q.
Increased operating expenses resulted from:
o increased direct expenses associated with expanded operations in foreign
exchange, risk management products, and transaction banking business;
o increased expenses associated with development of an infrastructure to
support the growing complexity of the CIBM business;
o increased fees paid to HTSU for technology services, as CIBM required
additional information technology resources to support system conversions
and business expansion; and
o partially offsetting the above increases was a decrease in incentive
compensation expense resulting from a change in the amortization period
utilized for share-based compensation.
52
The provision for credit losses increased for the first nine months of 2005
despite a decrease for the third quarter. The net provision credit for the first
nine months of 2004 reflected a period of unusually low loan charge offs and
relatively high recoveries of amounts previously charged off. The net provision
credit for the first nine months of 2005 resulted from continuation of
relatively low charge offs, but lower recoveries of amounts previously charged
off.
Private Banking (PB)
Overview
During 2005, additional resources have been allocated to expand services
provided to high net worth customers served by this segment resulting in
increased revenues partially offset by increased expenses.
Operating Results
The following table summarizes the results for the Private Banking (PB) segment.
--------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
--------------------------------------------------------------------------------------
(in millions)
Three months ended September 30:
Net interest income ................ $ 45 $ 33 $ 12 36
Other revenues ..................... 45 44 1 2
------- ------- ------- -------
Total revenues ..................... 90 77 13 17
Operating expenses ................. 69 56 13 23
------- ------- ------- -------
Working contribution ............... 21 21 -- --
Provision for credit losses ........ 1 2 (1) (50)
------- ------- ------- -------
Income before income tax expense ... $ 20 $ 19 $ 1 5
======= ======= ======= =======
Average assets ..................... $ 4,999 $ 4,265
Average liabilities/equity ......... 9,674 8,722
Goodwill at September 30 ........... 428 428
Nine months ended September 30:
Net interest income ................ $ 127 $ 95 $ 32 34
Other revenues ..................... 206 157 49 31
------- ------- ------- -------
Total revenues ..................... 333 252 81 32
Operating expenses ................. 197 176 21 12
------- ------- ------- -------
Working contribution ............... 136 76 60 79
Provision for credit losses ........ (1) -- (1) --
------- ------- ------- -------
Income before income tax expense ... $ 137 $ 76 $ 61 80
======= ======= ======= =======
Average assets ..................... $ 4,956 $ 3,899
Average liabilities/equity ......... 9,528 9,019
Increased net interest income for the third quarter and for the first nine
months of 2005 resulted from increased average earning assets, primarily loans.
Operating expenses have also increased as additional resources have been
allocated to this segment to expand the services provided.
Other revenues includes the following significant non-recurring transactions
which affect comparability of results for 2005 and 2004:
o in June 2005, shares in a foreign equity fund were sold to an HSBC
affiliate, resulting in a gain of approximately $48 million;
o during the first quarter of 2005, HUSI recognized a nominal gain on the
sale of a portion of its personal trust business; and
o during the first quarter of 2004, HUSI realized higher revenue from a
foreign equity investment, as compared with the first quarter of 2005.
53
CREDIT QUALITY
--------------------------------------------------------------------------------
HUSI's policies and critical estimates associated with its allowance for credit
losses are summarized on pages 15-16, 37-38 and 77-78 of HUSI's 2004 Form 10-K.
There have been no material revisions to policies or methodologies in the first
nine months of 2005.
The following table provides an analysis of changes in the allowance for credit
losses and related ratios.
-------------------------------------------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
Quarter ended 2005 2005 2005 2004 2004
-------------------------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of quarter ........... $ 790 $ 773 $ 788 $ 340 $ 347
Allowance related to acquisitions and
(dispositions), net ..................... -- -- -- 505 (11)
Charge offs:
Commercial ....................... 16 17 6 22 18
Consumer:
Residential mortgages ......... 6 6 4 5 2
Credit card receivables ....... 154 160 159 17 17
Other consumer loans .......... 26 23 30 6 6
------- ------- ------- ------- -------
Total consumer loans .......... 186 189 193 28 25
------- ------- ------- ------- -------
Total charge offs ................ 202 206 199 50 43
------- ------- ------- ------- -------
Recoveries on loans charged off:
Commercial ....................... 26 7 23 12 16
Consumer:
Residential mortgages ......... 1 -- -- 1 --
Credit card receivables ....... 30 37 44 2 2
Other consumer loans .......... 8 9 10 2 2
------- ------- ------- ------- -------
Total consumer loans .......... 39 46 54 5 4
------- ------- ------- ------- -------
Total recoveries ................ 65 53 77 17 20
------- ------- ------- ------- -------
Total net charge offs ............... 137 153 122 33 23
------- ------- ------- ------- -------
Provision charged (credited) to
income:
Commercial ....................... 5 (1) (25) (45) 3
Consumer:
Residential mortgages ......... 12 12 (1) 11 3
Credit card receivables ....... 162 141 108 9 14
Other consumer loans .......... 20 18 25 1 7
------- ------- ------- ------- -------
Total consumer loans .......... 194 171 132 21 24
------- ------- ------- ------- -------
Total provision .................. 199 170 107 (24) 27
------- ------- ------- ------- -------
Balance at end of quarter ........... $ 852 $ 790 $ 773 $ 788 $ 340
======= ======= ======= ======= =======
Allowance ratios:
Annualized net charge offs to
average loans .................. .61% .71% .58% .19% .14%
Quarter-end allowance to:
Quarter-end total loans ....... .95% .90% .90% .93% .51%
Quarter-end total
nonaccruing loans ........... 362.55% 351.11% 318.11% 298.48% 117.24%
54
The following table provides a summary of credit quality statistics.
---------------------------------------------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
2005 2005 2005 2004 2004
---------------------------------------------------------------------------------------------------------------------
(in millions)
Nonaccruing loans
Balance at end of period:
Commercial:
Construction and other real
estate ....................... $ 32 $ 29 $ 28 $ 33 $ 24
Other commercial ............... 77 81 99 117 152
------- ------- ------- ------- -------
Total commercial ............... 109 110 127 150 176
------- ------- ------- ------- -------
Consumer:
Residential mortgages .......... 126 115 116 113 94
Credit card receivables ........ -- -- -- -- 19
Other consumer loans ........... -- -- -- 1 1
------- ------- ------- ------- -------
Total consumer loans ........... 126 115 116 114 114
------- ------- ------- ------- -------
Total nonaccruing loans ................ $ 235 $ 225 $ 243 $ 264 $ 290
======= ======= ======= ======= =======
As a percent of loans:
Commercial:
Construction and other
real estate .................. .36% .33% .33% .40% .30%
Other commercial ............... .48 .53 .66 .80 1.18
------- ------- ------- ------- -------
Total commercial ............... .43 .46 .54 .65 .84
------- ------- ------- ------- -------
Consumer:
Residential mortgages .......... .27 .24 .24 .24 .22
Credit card receivables ........ -- -- -- -- 1.69
Other consumer loans ........... -- -- -- .03 .05
------- ------- ------- ------- -------
Total consumer loans ........... .20 .18 .18 .18 .25
------- ------- ------- ------- -------
Total .................................. .26% .26% .28% .31% .43%
======= ======= ======= ======= =======
Interest income on nonaccruing loans
(quarterly total):
Amount which would have been
recorded had the associated loans
been current in accordance with
their original terms ................. $ 5 $ 7 $ 5 $ 6 $ 5
Amount actually recorded ............... 3 1 3 5 5
Accruing loans contractually past due 90
days or more as to principal or interest:
Total commercial ....................... $ 4 $ 7 $ 13 $ 13 $ 15
------- ------- ------- ------- -------
Residential mortgages .................. 1 -- 1 1 2
Credit card receivables ................ 237 206 210 223 3
Other consumer loans ................... 15 14 15 22 16
------- ------- ------- ------- -------
Total consumer loans ............... 253 220 226 246 21
------- ------- ------- ------- -------
Total accruing loans contractually
past due 90 days or more ............. $ 257 $ 227 $ 239 $ 259 $ 36
======= ======= ======= ======= =======
Criticized assets (balance at end of
period):
Special mention ........................ $ 735 $ 706 $ 728 $ 784 $ 734
Substandard ............................ 736 761 535 590 383
Doubtful ............................... 29 28 34 46 67
------- ------- ------- ------- -------
Total .................................. $ 1,500 $ 1,495 $ 1,297 $ 1,420 $ 1,184
======= ======= ======= ======= =======
Impaired loans:
Balance at end of period ............... $ 115 $ 102 $ 119 $ 236 $ 252
Amount with impairment reserve ......... 51 79 96 210 233
Impairment reserve ..................... 8 19 21 18 38
Other real estate and owned assets:
Balance at end of period ............... $ 31 $ 25 $ 20 $ 15 $ 14
Ratio of total nonaccruing loans,
other real estate and owned assets
to total assets ...................... .18% .17% .19% .20% .25%
55
Overview
The allowance for credit losses increased $62 million (8%) during the third
quarter of 2005 and increased $64 million (8%) during the first nine months of
2005. Total provision for credit losses of $476 million for the first nine
months of 2005 was offset by total net charge offs of $412 million.
The allowance for credit losses increased $512 million from September 30, 2004
to September 30, 2005, primarily due to the addition of reserves associated with
the acquisition of approximately $12 billion of private label receivables from
HSBC Finance Corporation in December of 2004.
The provision for credit losses for the third quarter of 2005 includes an
incremental provision of $26 million for Hurricane Katrina. See discussion of
Hurricane Katrina beginning on page 24 of this Form 10-Q.
As a result of changes in bankruptcy legislation, consumers nationwide filed
bankruptcies in record numbers in recent months. HUSI's provision for the third
quarter and allowance for credit losses at September 30, 2005 have not been
materially impacted by the changed legislation. Higher levels of personal
bankruptcy filings and higher charge offs of private label credit card
receivables are expected in the fourth quarter of 2005.
Commercial Loan Credit Quality
The allowance for credit losses associated with commercial loan portfolios
increased $15 million during the third quarter and decreased $4 million during
the first nine months of 2005. For the first nine months of 2005, net recoveries
of $17 million were offset by a $21 million credit in the provision for credit
losses associated with commercial loans.
Credit quality was relatively stable during the third quarter of 2005, and has
generally improved during the first nine months 2005, as evidenced by decreased
nonaccruing loan balances and decreased impaired loans balances.
Criticized assets classified as "substandard" have increased $146 million during
the first nine months of 2005, primarily due to the addition of non-investment
grade securities to the calculation of these assets. Excluding these securities,
criticized assets, primarily commercial loans, have declined among all
categories during the first nine months of 2005.
HUSI expects that a more normalized commercial credit environment for the
remainder of 2005 will result in lower recoveries and higher provision expense.
Although overall commercial credit quality is expected to remain stable and well
controlled, any sudden and/or unexpected adverse economic events or trends could
significantly affect credit quality and increase provisions for credit losses.
56
Credit Card Receivable Credit Quality
The allowance for credit losses associated with credit card receivables
increased $38 million in the third quarter and increased $49 million during the
first nine months of 2005. Net charge offs of $362 million in the first nine
months of 2005 were more than offset by provision for credit losses of $411
million. The provision for the third quarter of 2005 includes an incremental
provision of $23 million for Hurricane Katrina. Excluding the provision for
Hurricane Katrina, allowance activity reflects normal portfolio experience for
the private label receivables acquired from HSBC Finance Corporation.
The following table provides select credit quality data for credit card
receivables. Excluding the impact of Hurricane Katrina, credit quality was
generally stable in the first nine months of 2005. The September 30, 2004 data
pertains to HUSI's credit card portfolio held prior to acquisition of the
private label receivable portfolio.
-----------------------------------------------------------------------------------------------------------------------
September 30, June 30, December 31, September 30,
2005 2005 2004 2004
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Accruing credit card receivables contractually past due
90 days or more:
Balance at end of quarter ........................ $ 237 $ 206 $ 223 $ 3
As a percent of total credit card
receivables ...................................... 1.66% 1.60% 1.85% .27%
Allowance for credit losses associated with credit card
receivables:
Balance at end of quarter ........................ $ 597 $ 559 $ 548 $ 49
As a percent of total credit card
receivables ...................................... 4.18% 4.34% 4.54% 4.35%
Net charge offs of credit card receivables:
Total for the quarter ended ...................... $ 124 $ 123 $ 15 $ 15
Annualized net charge offs as a percent of
average credit card receivables for the
quarter .......................................... 3.51% 3.89% 4.05% 5.31%
Receivables included in the private label receivable portfolio are generally
maintained in accruing status until being charged off six months after
delinquency.
Other Consumer Loan Credit Quality
The allowance for credit losses associated with residential mortgage and other
consumer loans increased approximately $9 million in the third quarter and in
the first nine months of 2005. Provision for credit losses of $86 million for
the first nine months of 2005, primarily associated with various installment
lending portfolios, was partially offset by net charge offs of $67 million, also
primarily from installment lending portfolios. The provision for the third
quarter of 2005 includes an incremental provision of $3 million for Hurricane
Katrina, primarily for residential mortgage loans.
57
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
--------------------------------------------------------------------------------
HUSI is party to various derivative financial instruments as an end user, as an
international dealer in derivative instruments, and for purely trading purposes
in order to realize profits from short-term movements in interest rates,
commodity prices, foreign exchange rates and credit spreads. Additional
information regarding the use of various derivative instruments is included on
pages 79-80 and pages 107-109 of HUSI's 2004 Form 10-K.
Credit and Market Risk Associated with Derivative Contracts
Credit (or repayment) risk in derivative instruments is minimized by entering
into transactions with high quality counterparties including other HSBC group
entities. Counterparties include financial institutions, government agencies,
both foreign and domestic, corporations, funds (mutual funds, hedge funds,
etc.), insurance companies and private clients. These counterparties are subject
to regular credit review by the credit risk management department. Most
derivative contracts are governed by an International Swaps and Derivatives
Association Master Agreement. Depending on the type of counterparty and the
level of expected activity, bilateral collateral arrangements may be required as
well.
The total risk in a derivative contract is a function of a number of variables,
such as:
o whether counterparties exchange notional principal;
o volatility of interest rates, currencies, equity or corporate reference
entity used as the basis for determining contract payments;
o maturity and liquidity of contracts;
o credit worthiness of the counterparties in the transaction; and
o existence and value of collateral received from counterparties to secure
exposures.
The following table presents credit risk exposure and net fair value associated
with derivative contracts. In the table, current credit risk exposure is the
recorded fair value of derivative receivables, which represents revaluation
gains from the marking to market of derivative contracts held for trading
purposes, for all counterparties with an International Swaps and Derivatives
Association Master Agreement in place.
Future credit risk exposure in the following table is measured using rules
contained in the risk-based capital guidelines published by U.S. banking
regulatory agencies. The risk exposure calculated in accordance with the risk
based capital guidelines potentially overstates actual credit exposure, because:
o the risk-based capital guidelines ignore collateral that may have been
received from counterparties to secure exposures, and
o the risk-based capital guidelines compute exposures over the life of
derivative contracts. However, many contracts contain provisions that
allow a bank to close out the transaction if the counterparty fails to
post required collateral. As a result, these contracts have potential
future exposures that are often much smaller that the future exposures
derived from the risk-based capital guidelines.
The net credit risk exposure amount in the following table does not reflect the
impact of bilateral netting (i.e., netting with a single counterparty when a
bilateral netting agreement is in place). However, the risk-based capital
guidelines recognize that bilateral netting agreements reduce credit risk and
therefore allow for reductions of risk-weighted assets when netting requirements
have been met. In addition, risk-based capital rules require that netted
exposures of various counterparties be assigned risk-weightings, which result in
risk-weighted amounts for regulatory capital purposes that are a fraction of the
original netted exposures.
-------------------------------------------------------------------------------
September 30, December 31,
2005 2004
-------------------------------------------------------------------------------
(in millions)
Risk associated with derivative contracts:
Current credit risk exposure ................. $ 8,552 $ 9,607
Future credit risk exposure .................. 60,164 29,538
-------- --------
Total risk exposure .......................... 68,716 39,145
Less: collateral held against exposure ....... (2,097) (4,091)
-------- --------
Net credit risk exposure ..................... $ 66,619 $ 35,054
======== ========
58
Notional Values of Derivative Contracts
The notional value of derivative contracts only provides an indicator of the
transaction volume in these types of instruments. It does not represent exposure
to market or credit risks under these contracts.
The following table summarizes the notional values of derivative contracts.
--------------------------------------------------------------------------------
September 30, December 31,
2005 2004
--------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards ................... $ 128,764 $ 79,830
Swaps .................................. 1,562,785 1,219,657
Options written ........................ 170,839 105,582
Options purchased ...................... 182,777 90,635
---------- ----------
2,045,165 1,495,704
---------- ----------
Foreign exchange:
Swaps, futures and forwards ............ 307,098 234,424
Options written ........................ 37,244 42,719
Options purchased ...................... 37,646 43,200
Spot ................................... 41,187 21,927
---------- ----------
423,175 342,270
---------- ----------
Commodities, equities and precious metals:
Swaps, futures and forwards ............ 68,933 40,876
Options written ........................ 14,120 10,648
Options purchased ...................... 16,164 11,729
---------- ----------
99,217 63,253
---------- ----------
Credit derivatives ........................... 378,303 135,937
---------- ----------
Total ........................................ $2,945,860 $2,037,164
========== ==========
At September 30, 2005 and December 31, 2004, the aggregate notional amounts of
all derivative contracts with other HSBC affiliates were approximately $479
million and $302 million respectively.
59
OFF-BALANCE SHEET ARRANGEMENTS
--------------------------------------------------------------------------------
The following table provides maturity information related to off-balance sheet
arrangements and lending and sales commitments. Descriptions of these
arrangements are found on pages 43-44 of HUSI's 2004 Form 10-K.
---------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
September 30, 2005 or Less Five Years Years Total
---------------------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations ..... $ 3,795 $ 1,878 $ 78 $ 5,751(1)
Commercial letters of credit ......................... 809 35 -- 844
Loan sales with recourse ............................. -- 1 8 9(2)
Credit derivative contracts .......................... 2,731 162,037 41,754 206,522(3)
Commitments to extend credit:
Commercial ..................................... 18,163 27,794 3,004 48,961
Consumer ....................................... 6,885 -- -- 6,885
Commitments to deliver mortgage backed securities .... 3,293 -- -- 3,293
Securities lending indemnifications .................. 3,801 -- -- 3,801
-------- -------- -------- --------
Total ................................................ $ 39,477 $191,745 $ 44,844 $276,066
======== ======== ======== ========
(1) Includes $526 million issued for the benefit of related parties.
(2) $7 million of this amount is indemnified by third parties.
(3) Includes $27,408 million issued for the benefit of related parties.
---------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2004 or Less Five Years Years Total
---------------------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations ..... $ 3,564 $ 1,521 $ 110 $ 5,195(1)
Commercial letters of credit ......................... 584 200 76 860
Loan sales with recourse ............................. -- 1 9 10(2)
Credit derivative contracts .......................... 990 51,435 12,990 65,415(3)
Commitments to extend credit:
Commercial ..................................... 19,808 18,879 1,944 40,631
Consumer ....................................... 5,582 -- -- 5,582
Commitments to deliver mortgage backed securities .... 1,627 -- -- 1,627
Securities lending indemnifications .................. 4,534 -- -- 4,534
-------- -------- -------- --------
Total ................................................ $ 36,689 $ 72,036 $ 15,129 $123,854
======== ======== ======== ========
(1) Includes $383 million issued for the benefit of related parties.
(2) $8 million of this amount is indemnified by third parties.
(3) Includes $9,912 million issued for the benefit of related parties.
Letters of Credit
Fees are charged 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, representing the
fair value of the "stand ready obligation to perform" under these guarantees,
amounting to $16 million and $15 million at September 30, 2005 and December 31,
2004 respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit of $21 million and $28 million at
September 30, 2005 and December 31, 2004 respectively.
Credit Derivatives
HUSI enters into credit derivative contracts both for its own benefit and to
satisfy the needs of its customers. Credit derivatives are arrangements that
provide for one party (the "beneficiary") to transfer the credit risk of a
"reference asset" to another party (the "guarantor"). Under this arrangement the
guarantor assumes the credit risk associated with the reference asset without
directly purchasing it. The beneficiary agrees to pay to the guarantor a
specified fee. In return, the guarantor agrees to pay the beneficiary an agreed
upon amount if there is a default during the term of the contract.
60
In accordance with its policy, HUSI offsets virtually all of the market risk it
assumes in selling credit guarantees through a credit derivative contract with
another counterparty. Credit derivatives, although having characteristics of a
guarantee, are accounted for as derivative instruments and are carried at fair
value. The commitment amount included in the table is the maximum amount that
HUSI could be required to pay, without consideration of the approximately equal
amount receivable from third parties and any associated collateral.
Securities Lending Indemnifications
HUSI may lend securities of customers, on a fully collateralized basis, as an
agent to third party borrowers. Customers are indemnified against the risk of
loss, and collateral is obtained from the borrower with a market value exceeding
the value of the loaned securities. The fair value of that collateral was
approximately $3,887 million and $4,625 million at September 30, 2005 and
December 31, 2004 respectively.
VARIABLE INTEREST ENTITIES (VIEs)
--------------------------------------------------------------------------------
HUSI, in the ordinary course of business, makes use of VIE structures in a
variety of business activities, primarily to facilitate client needs. VIE
structures are utilized after careful consideration of the most appropriate
structure needed to achieve HUSI's control and risk management objectives and to
help ensure an efficient structure from a taxation and regulatory perspective.
Consolidated VIEs
During the third quarter of 2005, HUSI entered into a series of transactions
with VIEs organized by HSBC affiliates and unrelated third parties. These VIEs
were structured as trusts or corporations that issue fixed or floating rate
instruments backed by the assets of the issuing entities. HUSI sold trading
assets to the VIEs and subsequently entered into total return swaps with the
VIEs whereby HUSI receives the total return on the transferred assets and, in
return, pays a market rate of return to its counterparties. HUSI has determined
that it is the primary beneficiary of these VIEs under the applicable accounting
literature and, accordingly, consolidated $819 million in trading assets at
September 30, 2005. These assets are pledged as collateral for obligations of
the VIEs. The holders of the instruments issued by the VIEs have no recourse to
the general credit of HUSI beyond the assets sold to the VIEs and pledged as
collateral.
Unconsolidated VIEs
HUSI also holds variable interests in various other VIEs which are not
consolidated at September 30, 2005. HUSI is not the primary beneficiary of these
VIE structures. Information for unconsolidated VIEs is presented in the
following table and commentary. Descriptions of these VIE relationships are
included in pages 111-112 of HUSI's 2004 Form 10-K.
------------------------------------------------------------------------------------------------
September 30, 2005 December 31, 2004
-------------------- --------------------
Maximum Maximum
Total Exposure Total Exposure
Assets to Loss Assets to Loss
------------------------------------------------------------------------------------------------
(in millions)
Asset backed commercial paper conduits ..... $ 7,858 $ 6,346 $ 5,657 $ 5,867
Securitization vehicles .................... 1,678 549 1,062 552
Investment funds ........................... 2,429 -- 2,832 36
Capital funding vehicles ................... 1,114 32 1,093 32
Low income housing tax credits ............. 1,406 200 994 88
------- ------- ------- -------
Total ...................................... $14,485 $ 7,127 $11,638 $ 6,575
======= ======= ======= =======
61
Asset Backed Commercial Paper Conduits
HSBC affiliates support the financing needs of customers by facilitating their
access to the commercial paper markets. Specifically, pools of customers'
assets, typically trade receivables, are sold to an independently rated,
commercial paper financing entity, which in turn issues short-term, asset backed
commercial paper that is collateralized by such assets. Neither the HSBC
affiliates nor HUSI service the assets or transfer their own receivables into
the financing entities.
HUSI and other banks provide one year liquidity facilities, in the form of
either loan or asset purchase commitments, in support of each transaction in the
financing entity. HUSI does not provide any program wide enhancements to the
financing entities. In the table on the preceding page, the total notional
amount of the liquidity facilities represents HUSI's maximum exposure to loss.
In the normal course of business, HUSI provides liquidity facilities to asset
backed commercial paper conduits sponsored by unrelated third parties. HUSI does
not transfer their own receivables into the financing entity, has no ownership
interest in, no administrative duties, and does not service any assets of these
conduits. The only interest HUSI has in these entities are liquidity facilities
in the amount of approximately $1.7 billion at September 30, 2005. These
facilities are excluded from the table summarizing HUSI's involvement in VIEs.
Credit risk is managed on these commitments by subjecting them to HUSI's normal
underwriting and risk management processes.
Securitization Vehicles
An HSBC affiliate and third parties organize trusts that are special purpose
entities (SPEs) that issue fixed or floating rate debt backed by the assets of
the trusts. Neither the HSBC affiliate nor HUSI transfer their own assets into
the trusts. HUSI's relationship with the SPEs is primarily as counterparty to
the SPE's derivative transactions (interest rate, credit default and currency
swaps). HUSI's maximum exposure to loss from the unconsolidated trust entities
is comprised of investments in the trust and the market risk on the derivative
transactions.
Investment Funds
HUSI is a derivative counterparty (total return swap) with a hedge fund
established by an unrelated third party. The total return swap creates a
variable interest in the fund for HUSI. HUSI does not hold shares in or have any
other involvement with the fund. As such, HUSI is not the primary beneficiary.
HUSI is also an investor in a hedge fund established by an unrelated third
party. The shares owned by HUSI do not have voting rights but do participate in
profits and losses based on percentage of share ownership. HUSI does not hold
sufficient beneficial interests in the fund to be considered the primary
beneficiary.
HUSI is a sub-investment advisor to mutual funds structured as trusts and
managed by an HSBC affiliate. As sub-investment advisor, HUSI receives a
variable fee based on the value of funds. HUSI has no ownership interest in or
credit exposure resulting from its duties as investment advisor.
Capital Funding Vehicles
Prior to 2005, HUSI established five Capital Trust entities. These trusts issue
preferred securities and common stock. HUSI purchased all of the common equity
issued by the trusts, which equates to approximately 3% of the total assets of
the trusts. HUSI does not own any of the preferred securities issued by the
trusts. It has been determined that the majority of the benefit of profit and/or
risk of loss lies with the preferred security holders. Thus, HUSI is not the
primary beneficiary of the trusts and is not required to consolidate these
entities.
62
Low Income Housing Tax Credits
HUSI participates as a limited partner in Low Income Housing Tax Credit
Partnerships. These investments are recorded as other assets on the consolidated
balance sheet using the equity method of accounting. HUSI also receives tax
benefits over a period of time specified in the investment contracts. HUSI's
investment is reduced over time for its share of any operating losses incurred
by the partnership as well as for any amortization over the time period in which
tax credits are received. Tax credits may be subject to recapture if the
underlying properties do not remain in compliance with certain conditions. Some
of these partnerships have been determined to be VIEs. HUSI's maximum exposure
to loss shown in the table above represents the net assets recorded on the
balance sheet, estimated expected reduction of future tax liabilities, and
potential recapture of tax credits allowed in prior years.
CAPITAL
--------------------------------------------------------------------------------
The following table presents the capital ratios of HUSI and HBUS calculated in
accordance with banking regulations. To be categorized as "well-capitalized"
under the Federal Reserve Board and Federal Deposit Insurance Corporation
guidelines, a banking institution must have the minimum ratios reflected in the
table, and must not be subject to a directive, order, or written agreement to
meet and maintain specific capital levels.
-------------------------------------------------------------------------------------------------------------
"Well-Capitalized" September 30, December 31,
Minimum 2005 2004
-------------------------------------------------------------------------------------------------------------
Total capital (to risk weighted assets)
HUSI ............................................ 10.00% 12.88% 12.53%
HBUS ............................................ 10.00 12.89 12.46
Tier 1 capital (to risk weighted assets)
HUSI ............................................ 6.00 8.48 8.34
HBUS ............................................ 6.00 8.74 8.66
Tier 1 capital (to average assets)
HUSI ............................................ 3.00 6.85 7.20
HBUS ............................................ 5.00 7.12 7.51
Tangible common equity (to risk weighted assets)
HUSI ............................................ 6.87 7.07
HBUS ............................................ 8.77 8.69
RISK MANAGEMENT
--------------------------------------------------------------------------------
Overview
Some degree of risk is inherent in virtually all of HUSI's activities. For the
principal activities undertaken by HUSI, the most important types of risks are
considered to be credit, interest rate, market, liquidity, operational,
fiduciary and reputational. Market risk broadly refers to price risk inherent in
mark to market positions taken on trading and non-trading instruments.
Operational risk technically includes legal and compliance risk. However, since
compliance risk, including anti-money laundering (AML) risk, has such broad
scope within HUSI's businesses, it is addressed as a separate functional
discipline. During the first nine months of 2005, there have been no significant
changes in policies or approach for managing various types of risk.
63
Liquidity Management
HUSI's approach to address liquidity risk is summarized on pages 49-50 of HUSI's
2004 Form 10-K.
HUSI's ability to regularly attract wholesale funds at a competitive cost is
enhanced by strong ratings from the major credit rating agencies. At September
30, 2005, HUSI and HBUS maintained the following debt and preferred stock
ratings.
--------------------------------------------------------------------------------
At September 30, 2005 Moody's S&P Fitch
--------------------------------------------------------------------------------
HUSI:
Short-term borrowings ........................ P-1 A-1 F1+
Long-term debt ............................... Aa3 A+ AA
Preferred stock .............................. A2 A- AA-
HBUS:
Short-term borrowings ........................ P-1 A-1+ F1+
Long-term debt ............................... Aa2 AA- AA
HUSI periodically issues capital instruments to fund balance sheet growth, to
meet cash and capital needs, or to fund investments in subsidiaries.
In October 2005, HUSI issued 373,750 shares of Floating Rate Non-Cumulative
Perpetual Preferred Stock represented by 14,950,000 depositary shares. Total
proceeds, net of issuance costs, were approximately $365 million.
Commentary regarding growth and composition of the consolidated balance sheet is
provided on pages 24-25 of this Form 10-Q.
Interest Rate Risk Management
Various techniques are utilized to quantify and monitor risks associated with
the repricing characteristics of HUSI's assets, liabilities, and derivative
contracts. The approach toward managing interest rate risk is summarized on
pages 51-56 of HUSI's 2004 Form 10-K. During the first nine months of 2005,
there were no significant changes in policies or approach for managing interest
rate risk.
Present Value of a Basis Point (PVBP) Analysis
PVBP is the change in value of the balance sheet for a one basis point upward
movement in all interest rates. In June 2005, HUSI's institutional PVBP movement
limit was increased from $6.5 million to $7.5 million. The following table
reflects the PVBP position at September 30, 2005.
--------------------------------------------------------------------------------
September 30, 2005
--------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit ......................... $7.5
PVBP position at period end ............................... 2.6
Capital at Risk
Capital at risk is the change in base case valuation of the balance sheet for
either a 200 basis point gradual rate increase or a 100 basis point gradual rate
decrease. The projected changes in valuation are reflected on an after tax
basis. The following table reflects the capital at risk position at September
30, 2005.
--------------------------------------------------------------------------------------------------------------------
September 30, 2005
--------------------------------------------------------------------------------------------------------------------
Institutional capital at risk movement limit ................................................... +/- 10%
Projected change in value resulting from a gradual 200 basis point increase in interest rates .. (2)
Projected change in value resulting from a gradual 100 basis point decrease in interest rates .. (3)
64
The projected drop in value for a 100 basis point gradual decrease in rates is
primarily related to the anticipated acceleration of prepayments for the held
mortgage and mortgage backed securities portfolios in this lower rate
environment. This assumes that no management actions are taken to manage
exposures to the changing interest rate environment.
Capital at risk valuations are currently calculated using discounted cash flows
anticipated for specific rate environments. A market based calculation, which
relies less on discounted cash flows in favor of actual market valuations, is
currently under development.
Dynamic Simulation Modeling
Various modeling techniques are utilized to monitor a number of interest rate
scenarios for their impact on net interest income. These techniques include both
rate shock scenarios which assume immediate market rate movements of 200 basis
points, as well as scenarios in which rates rise or fall by as much as 200 basis
points over a twelve month period. The following table reflects the impact on
net interest income of the scenarios utilized by these modeling techniques.
---------------------------------------------------------------------------------------------------------------------
September 30, 2005
------------------
Amount %
---------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net interest income (reflects projected rate movements on
October 1, 2005):
Institutional base earnings movement limit ......................................... (10)
Change resulting from a gradual 200 basis point increase in the yield curve ........ $(170) (5)
Change resulting from a gradual 200 basis point decrease in the yield curve ........ 372 12
Change resulting from a gradual 100 basis point increase in the yield curve ........ (43)
Change resulting from a gradual 100 basis point decrease in the yield curve ........ 251
Other significant scenarios monitored (reflects projected rate movements on
October 1, 2005):
Change resulting from an immediate 100 basis point increase in the yield curve ..... (132)
Change resulting from an immediate 100 basis point decrease in the yield curve ..... 172
Change resulting from an immediate 200 basis point increase in the yield curve ..... (345)
Change resulting from an immediate 200 basis point decrease in the yield curve ..... 291
Change resulting from an immediate 100 basis point increase in short-term rates .... (190)
The projections do not take into consideration possible complicating factors
such as the effect of changes in interest rates on the credit quality, size and
composition of the balance sheet. Therefore, although this provides a reasonable
estimate of interest rate sensitivity, actual results will vary from these
estimates, possibly by significant amounts.
Capital Risk/Sensitivity of Other Comprehensive Income
Large movements of interest rates could directly affect reported capital and
some capital ratios. The mark to market valuation of available for sale
securities is credited on a tax effected basis through other comprehensive
income in the consolidated statement of changes in shareholders' equity. This
valuation mark is excluded from Tier 1 and Tier 2 capital ratios but it would be
included in the ratio of total shareholders' equity to total assets. As of
September 30, 2005, HUSI had an available for sale securities portfolio of
approximately $16 billion with a net negative mark to market of $202 million
included in total equity of $12 billion. An increase of 25 basis points in
interest rates of all maturities of available for sale securities would lower
the mark to market by approximately $158 million to a net pre-tax loss of $360
million with the following effect on the total equity to total assets ratio.
-----------------------------------------------------------------------------------------------
Proforma - Reflecting
25 Basis Points
September 30, 2005 Actual Increase in Rates
-----------------------------------------------------------------------------------------------
Total shareholders' equity to total assets ............ 7.95% 7.89%
65
Value at Risk (VAR)
VAR analysis is also used to measure interest rate risk and to calculate the
economic capital required to cover potential losses due to interest risk. The
approach toward using VAR to measure interest rate risk is summarized on pages
53-54 of HUSI's 2004 Form 10-K.
Trading Activities
Trading portfolios reside primarily in the CIBM and residential mortgage banking
areas and include foreign exchange, derivatives, precious metals (gold, silver,
platinum), commodities, equities and money market instruments. The trading
portfolios have defined limits pertaining to items such as permissible
investments, risk exposures, loss review, balance sheet size and product
concentrations. Loss review refers to the maximum amount of loss that may be
incurred before senior management intervention is required.
Trading Activities - Treasury
Value at Risk
The following table summarizes trading VAR, assuming a 99% confidence level for
a two year observation period and a 10 day holding period.
----------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2005
September 30, ------------------------------------- December 31,
2005 Minimum Maximum Average 2004
----------------------------------------------------------------------------------------------------
(in millions)
Total trading ........... $50 $17 $53 $27 $41
Commodities ............. 7 1 9 4 11
Credit derivatives ...... 24 14 25 17 9
Equities ................ -- -- 2 -- 1
Foreign exchange ........ 7 1 14 5 1
Interest rate ........... 62 17 62 30 27
Trading Volatility
The following tables summarize the frequency distribution of daily market
risk-related revenues for Treasury trading activities. Market risk-related
Treasury trading revenues include realized and unrealized gains (losses) related
to Treasury trading activities, but exclude the related net interest income.
Analysis of gain (loss) data for the first nine months of 2005 shows that the
largest daily gain was $13 million and the largest daily loss was $9 million.
-----------------------------------------------------------------------------------------------------------------------
Three months ended September 30, 2005
-----------------------------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue
earned from market risk-related activities
Below $(2) to $0 to $2 to $4 to Over
(in millions) $(2) $0 $2 $4 $6 $6
Number of trading days market risk-related
revenue was within the stated range ........... 3 9 21 16 8 7
-----------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2005
-----------------------------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue
earned from market risk-related activities
Below $(2) to $0 to $2 to $4 to Over
(in millions) $(2) $0 $2 $4 $6 $6
Number of trading days market risk-related
revenue was within the stated range ........... 14 32 58 45 24 16
66
Trading Activities - Mortgage Banking
HUSI's MSRs hedging program is designed to minimize long-term economic
volatility as opposed to short-term earnings volatility. The program is actively
monitored to ensure that it supports anticipated business growth while at the
same time limiting economic volatility in the mortgage banking results. The
economic value of the net hedged MSRs portfolio is monitored on a daily basis
for interest rate sensitivity. If the economic value declines by more than
established limits for one day or one month, various levels of management
review, intervention and/or corrective actions are required.
Rate Shock Analysis
Modeling techniques are used to monitor certain interest rate scenarios for
their impact on the economic value of net hedged MSRs, as reflected in the
following table.
---------------------------------------------------------------------------------------------------------
September 30, 2005 Values
---------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects projected rate
movements on October 1, 2005):
Value of hedged MSRs portfolio ..................................................... $ 342
Change resulting from an immediate 50 basis point decrease in the yield curve:
Change limit (no worse than) ................................................... (16)
Calculated change in net market value .......................................... (3)
Change resulting from an immediate 50 basis point increase in the yield curve:
Change limit (no worse than) ................................................... (8)
Calculated change in net market value .......................................... 5
Change resulting from an immediate 100 basis point increase in the yield curve:
Change limit (no worse than) ................................................... (12)
Calculated change in net market value .......................................... 9
Hedge Volatility
The following tables summarize the frequency distribution of the weekly economic
value of the MSR asset, net of changes in the market value of the related hedge
positions.
------------------------------------------------------------------------------------------------------------
Three months ended September 30, 2005
------------------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(2) to $0 to $2 to Over
(in millions) $(2) $0 $2 $4 $4
Number of trading weeks market risk-related
revenue was within the stated range ............ 1 1 5 4 2
------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2005
------------------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(2) to $0 to $2 to Over
(in millions) $(2) $0 $2 $4 $4
Number of trading weeks market risk-related
revenue was within the stated range ............ 6 7 14 8 4
67
Item 3. Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------------------
Refer to Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations, under the captions "Interest Rate Risk Management" and
"Trading Activities", beginning on page 64 of this Form 10-Q.
Item 4. Controls and Procedures
--------------------------------------------------------------------------------
Disclosure Controls
An evaluation was conducted, with the participation of the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of HUSI's disclosure
controls and procedures as of the end of the period covered by this report.
HUSI's disclosure controls and procedures are designed to ensure that
information required to be disclosed by HUSI in the reports filed under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded,
processed, summarized and reported on a timely basis. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that HUSI's disclosure controls and procedures were effective as of the end of
the period covered by this report so as to alert them in a timely fashion to
material information required to be disclosed in reports filed under the
Exchange Act.
Internal Controls
There have not been any changes in HUSI's internal controls over financial
reporting during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, HUSI's
internal controls over financial reporting.
Sarbanes-Oxley Section 404 Compliance
As an SEC registrant of public debt and preferred shares, HUSI is required to
comply with the Sarbanes-Oxley Act of 2002 (the Act). Section 404 of the Act
(Section 404) requires registrants and their auditors to assess and report on
internal controls over financial reporting on an annual basis. As a foreign
registrant, HSBC is required to comply with Section 404 of the Act beginning in
the fiscal year ending December 31, 2006. As a subsidiary of a foreign
registrant, HUSI will support HSBC with its Section 404 compliance. Under the
SEC's current rules for non-accelerated filers, HUSI will be required to comply
with Section 404 of the Act for the fiscal year ending December 31, 2007.
68
Part II - OTHER INFORMATION
--------------------------------------------------------------------------------
Item 6 - Exhibits
3(i) Registrant's Articles of Incorporation and amendments and
supplements thereto (incorporated by reference to Exhibit 3.3
to HUSI's Annual Report on Form 10-K for the year ended
December 31, 1999, filed with the Securities and Exchange
Commission on March 30, 2000, Exhibit 3 to HUSI's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2000,
filed with the Securities and Exchange Commission on November
9, 2000, Exhibits 3.2 and 3.3 to HUSI's Current Report on Form
8-K dated March 30, 2005, filed with the Securities and
Exchange Commission on April 4, 2005, and Exhibit 3.2 to
HUSI's Current Report on Form 8-K dated October 11, 2005 and
filed with the Securities and Exchange Commission on October
14, 2005).
(ii) Registrant's By-Laws (incorporated by reference to Exhibit
3(ii) to HUSI's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2005, filed with the Securities and Exchange
Commission on May 16, 2005).
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.0 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
69
SIGNATURE
--------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC USA Inc.
-------------
(Registrant)
Date: November 14, 2005 /s/ Joseph R. Simpson
----------------------------------------
Joseph R. Simpson
Chief Accounting Officer
(On behalf of Registrant)
70
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC Holdings plc
By:
Name: P A Stafford
Title: Assistant Group Secretary
Date: 14 November 2005