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 August, 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 June 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|
At July 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 ...................... 17
Forward-Looking Statements ............................... 19
Executive Overview ....................................... 19
Basis of Reporting ....................................... 22
Results of Operations .................................... 22
Business Segments ........................................ 33
Credit Quality ........................................... 39
Derivative Instruments and Hedging Activities ............ 42
Off-Balance Sheet Arrangements ........................... 44
Variable Interest Entities (VIEs) ........................ 44
Capital .................................................. 45
Risk Management .......................................... 45
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 50
Item 4. Controls and Procedures........................................ 50
Part II OTHER INFORMATION
--------------------------------------------------------------------------------
Item 5. Other Information ............................................. 51
Item 6. Exhibits ...................................................... 51
Signature .............................................................. 52
2
Part I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
--------------------------------------------------------------------------------
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Three months ended June 30, Six months ended June 30,
2005 2004 2005 2004
------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans .............................................. $ 1,136 $ 669 $ 2,185 $ 1,282
Securities ......................................... 215 215 425 430
Trading assets ..................................... 60 38 119 71
Short-term investments ............................. 70 18 119 36
Other .............................................. 9 4 15 8
------------ ------------ ----------- -----------
Total interest income ................................. 1,490 944 2,863 1,827
------------ ------------ ----------- -----------
Interest expense:
Deposits ........................................... 396 158 723 318
Short-term borrowings .............................. 67 34 119 52
Long-term debt ..................................... 242 63 461 114
------------ ------------ ----------- -----------
Total interest expense ................................ 705 255 1,303 484
------------ ------------ ----------- -----------
Net interest income ................................... 785 689 1,560 1,343
Provision (credit) for credit losses .................. 170 6 277 (20)
------------ ------------ ----------- -----------
Net interest income after provision (credit) for
credit losses ...................................... 615 683 1,283 1,363
------------ ------------ ----------- -----------
Other revenues:
Trust income ....................................... 22 24 45 48
Service charges .................................... 53 53 105 104
Other fees and commissions ......................... 144 122 289 230
Securitization revenue ............................. 25 -- 69 --
Other income ....................................... 83 35 155 82
Residential mortgage banking revenue (expense) ..... (13) (17) 10 (41)
Trading revenues ................................... 35 78 131 168
Security gains, net ................................ 64 3 87 41
------------ ------------ ----------- -----------
Total other revenues .................................. 413 298 891 632
------------ ------------ ----------- -----------
Operating expenses:
Salaries and employee benefits ..................... 254 242 520 494
Occupancy expense, net ............................. 43 42 85 82
Support services from HSBC affiliates .............. 218 106 436 192
Other expenses ..................................... 169 130 297 240
------------ ------------ ----------- -----------
Total operating expenses .............................. 684 520 1,338 1,008
------------ ------------ ----------- -----------
Income before income tax expense ...................... 344 461 836 987
Income tax expense .................................... 131 130 307 337
------------ ------------ ----------- -----------
Net income ............................................ $ 213 $ 331 $ 529 $ 650
============ ============ =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
June 30, December 31,
2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Assets
Cash and due from banks ................................................. $ 3,098 $ 2,682
Interest bearing deposits with banks .................................... 2,853 2,776
Federal funds sold and securities purchased under resale agreements ..... 3,886 3,126
Trading assets .......................................................... 18,848 19,815
Securities available for sale ........................................... 15,705 14,655
Securities held to maturity (fair value $3,601 and $4,042) .............. 3,408 3,881
Loans ................................................................... 87,847 84,947
Less - allowance for credit losses ...................................... 790 788
------------ -------------
Loans, net ........................................................... 87,057 84,159
Properties and equipment, net ........................................... 539 594
Intangible assets, net .................................................. 334 352
Goodwill ................................................................ 2,694 2,697
Other assets ............................................................ 5,972 6,313
------------ -------------
Total assets ............................................................ $ 144,394 $ 141,050
============ =============
Liabilities
Deposits in domestic offices:
Noninterest bearing .................................................... $ 8,960 $ 7,639
Interest bearing ....................................................... 53,113 50,069
Deposits in foreign offices:
Noninterest bearing .................................................... 423 248
Interest bearing ....................................................... 22,583 22,025
------------ -------------
Total deposits ....................................................... 85,079 79,981
------------ -------------
Trading account liabilities ............................................. 11,020 12,120
Short-term borrowings ................................................... 8,220 9,874
Interest, taxes and other liabilities ................................... 4,548 4,370
Long-term debt .......................................................... 23,885 23,839
------------ -------------
Total liabilities ....................................................... 132,752 130,184
------------ -------------
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 ........................................................ 8,133 8,418
Retained earnings ...................................................... 2,429 1,917
Accumulated other comprehensive income ................................. 63 31
------------ -------------
Total common shareholder's equity .................................... 10,625 10,366
------------ -------------
Total shareholders' equity .............................................. 11,642 10,866
------------ -------------
Total liabilities and shareholders' equity .............................. $ 144,394 $ 141,050
============ =============
The accompanying notes are an integral part of the consolidated financial
statements.
4
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Six months ended June 30,
2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Preferred stock
Balance, January 1 ...................................................... $ 500 $ 500
Preferred stock issuance ................................................ 517 --
------------ -------------
Balance, June 30, ....................................................... 1,017 500
------------ -------------
Common stock
Balance, January 1 and June 30, ......................................... -- --
------------ -------------
Capital surplus
Balance, January 1, ..................................................... 8,418 6,027
Capital contribution from parent ........................................ 7 8
Preferred stock issuance costs .......................................... (13) --
Employee benefit plans and other ........................................ (279) (9)
------------ -------------
Balance, June 30, ....................................................... 8,133 6,026
------------ -------------
Retained earnings
Balance, January 1, ..................................................... 1,917 807
Net income .............................................................. 529 650
Cash dividends declared:
Preferred stock ....................................................... (17) (12)
------------ -------------
Balance, June 30, ....................................................... 2,429 1,445
------------ -------------
Accumulated other comprehensive income (loss)
Balance, January 1, ..................................................... 31 128
Net change in unrealized gains (losses) on securities ................... 6 (222)
Net change in unrealized gains (losses) on derivatives classified as
cash flow hedges ...................................................... 24 (58)
Net change in unrealized gains on interest only strip receivables ....... 5 --
Foreign currency translation adjustments ................................ (3) (4)
------------ -------------
Other comprehensive income (loss), net of tax ........................... 32 (284)
------------ -------------
Balance, June 30, ....................................................... 63 (156)
------------ -------------
Total shareholders' equity, June 30, .................................... $ 11,642 $ 7,815
============ =============
Comprehensive income
Net income .............................................................. $ 529 $ 650
Other comprehensive income (loss) 32 (284)
------------ -------------
Comprehensive income .................................................... $ 561 $ 366
============ =============
The accompanying notes are an integral part of the consolidated financial
statements.
5
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Six months ended June 30,
2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Cash flows from operating activities
Net income .......................................................... $ 529 $ 650
Adjustments to reconcile net income to net cash
provided by (used in ) operating activities
Depreciation, amortization and deferred taxes .................... 380 52
Provision (credit) for credit losses ............................. 277 (20)
Net change in other accrual accounts ............................. 264 (41)
Net change in loans originated for sale .......................... (804) (297)
Net change in trading assets and liabilities ..................... (5) 204
Other, net ....................................................... (446) (261)
------------ -------------
Net cash provided by operating activities ..................... 195 287
------------ -------------
Cash flows from investing activities
Net change in interest bearing deposits with banks .................. (52) (1,174)
Net change in short-term investments ................................ (759) (1,510)
Net change in securities available for sale:
Purchases of securities available for sale ....................... (4,992) (5,919)
Proceeds from sales of securities available for sale ............. 2,360 2,916
Proceeds from maturities of securities available for sale ........ 2,056 3,445
Net change in securities held to maturity:
Purchases of securities held to maturity ......................... (370) (727)
Proceeds from maturities of securities held to maturity .......... 845 1,099
Net change in loans:
Net change in credit card receivables ............................ 7,665 (17)
Net change in other short-term loans ............................. (153) (351)
Net originations and maturities of long-term loans ............... (1,253) (12,266)
Loans purchased from HSBC Finance Corporation .................... (8,917) (870)
Sales of loans/other ............................................. 29 92
Net change in tax refund anticipation loans program:
Originations of loans ............................................ (24,300) --
Sales of loans to HSBC Finance Corporation, including premium .... 24,318 --
Expenditures for properties and equipment ........................... 37 (7)
Net cash provided by (used in) acquisitions (disposals),
net of cash acquired ............................................... (90) 91
Other, net .......................................................... (397) (484)
------------ -------------
Net cash used in investing activities ......................... (3,973) (15,682)
------------ -------------
Cash flows from financing activities
Net change in deposits .............................................. 5,106 10,634
Net change in short-term borrowings ................................. (1,655) 2,976
Net change in long-term debt:
Issuance of long-term debt ....................................... 651 2,687
Repayment of long-term debt ...................................... (412) (329)
Preferred stock issuance ............................................ 517 --
Capital contribution from parent .................................... 7 8
Reduction of capital surplus ........................................ (13) (9)
Dividends paid ...................................................... (7) (11)
------------ -------------
Net cash provided by financing activities ..................... 4,194 15,956
------------ -------------
Net change in cash and due from banks ................................... 416 561
Cash and due from banks at beginning of period .......................... 2,682 2,534
------------ -------------
Cash and due from banks at end of period ................................ $ 3,098 $ 3,095
============ =============
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 business segments and
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 June 30, 2005 and December 31, 2004, HUSI held no securities of any single
issuer (excluding the U.S. Treasury and federal agencies) 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
June 30, 2005 Cost Gains Losses Value
-------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury .......................................... $ 396 $ 9 $ -- $ 405
U.S. Government sponsored enterprises (1) .............. 9,159 44 (54) 9,149
U.S. Government agency issued or guaranteed ............ 3,563 34 (24) 3,573
Obligations of U.S. states and political subdivisions .. 85 -- (3) 82
Asset backed securities ................................ 1,196 4 (1) 1,199
Other domestic debt securities ......................... 220 6 -- 226
Foreign debt securities ................................ 999 19 (1) 1,017
Equity securities ...................................... 49 5 -- 54
---------- ---------- ---------- ----------
$ 15,667 $ 121 $ (83) $ 15,705
========== ========== ========== ==========
Securities held to maturity:
U.S. Treasury .......................................... $ 83 $ -- $ -- $ 83
U.S. Government sponsored enterprises (1) .............. 2,302 128 (3) 2,427
U.S. Government agency issued or guaranteed ............ 380 30 -- 410
Obligations of U.S. states and political subdivisions .. 410 31 -- 441
Other domestic debt securities ......................... 184 7 -- 191
Foreign debt securities ................................ 49 -- -- 49
---------- ---------- ---------- ----------
$ 3,408 $ 196 $ (3) $ 3,601
========== ========== ========== ==========
-------------------------------------------------------------------------------------------------------------------
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
June 30, 2005 Securities Losses of Investment Securities Losses of Investment
------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government sponsored
enterprises (1) ............. 89 $ (29) $ 3,141 34 $ (25) $ 905
U.S. Government agency
issued or guaranteed ........ 74 (6) 858 104 (18) 638
All other securities .......... 26 (5) 451 -- -- --
---------- ---------- ------------- ---------- ---------- -------------
189 $ (40) $ 4,450 138 $ (43) $ 1,543
========== ========== ============= ========== ========== =============
Securities held to maturity:
U.S. Government sponsored
enterprises (1) ............. 6 $ (1) $ 149 3 $ (2) $ 72
---------- ---------- ------------- ---------- ---------- -------------
6 $ (1) $ 149 3 $ (2) $ 72
========== ========== ============= ========== ========== =============
------------------------------------------------------------------------------------------------------------------------
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. Treasury ................. 1 $ (3) $ 200 -- $ -- $ --
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 .......... 31 (6) 487 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.
The gross unrealized losses on securities available for sale decreased during
the six months ended June 30, 2005 due to a decrease in long-term interest
rates, which was partially offset by the impact of increased short-term and
medium-term 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.
-------------------------------------------------------------------------------
June 30, December 31,
2005 2004
-------------------------------------------------------------------------------
(in millions)
Commercial:
Construction and other real estate ............ $ 8,861 $ 8,281
Other commercial .............................. 15,314 14,691
Consumer:
Residential mortgages ......................... 47,634 46,775
Credit card receivables ....................... 12,876 12,078
Other consumer loans .......................... 3,162 3,122
----------- -----------
Total loans ....................................... $ 87,847 $ 84,947
=========== ===========
Note 4. Allowance for Credit Losses
--------------------------------------------------------------------------------
The following provides a summary of changes in the allowance for credit losses.
-------------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
----------------- -----------------
2005 2004 2005 2004
-------------------------------------------------------------------------------------------------
(in millions)
Beginning balance ....................................... $ 773 $ 357 $ 788 $ 399
Allowance related to acquisitions and (dispositions), net -- -- -- (9)
Charge offs ............................................. 206 35 405 64
Recoveries .............................................. 53 19 130 41
------- ------- ------- -------
Net charge offs ................................... 153 16 275 23
------- ------- ------- -------
Provision charged (credited) to income .................. 170 6 277 (20)
------- ------- ------- -------
Ending balance .......................................... $ 790 $ 347 $ 790 $ 347
======= ======= ======= =======
Further analysis of the allowance for credit losses and credit quality begins on
page 39 of this Form 10-Q.
10
Note 5. Intangible Assets, Net
--------------------------------------------------------------------------------
The following table summarizes the composition of intangible assets.
-----------------------------------------------------------------------------------------------------
June 30, December 31,
2005 2004
-----------------------------------------------------------------------------------------------------
(in millions)
Mortgage servicing rights, net of accumulated amortization and valuation
allowance ............................................................. $ 285 $ 309
Other ................................................................... 49 43
----------- -----------
Intangible assets, net .................................................. $ 334 $ 352
=========== ===========
Mortgage Servicing Rights (MSRs)
The following table summarizes activity for MSRs and the related valuation
allowance.
----------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
------------------ ------------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Beginning balance .............................. $ 401 $ 459 $ 416 $ 526
Additions related to loan sales ................ 18 19 31 36
Net MSRs acquisitions (sales) .................. -- 3 -- (54)
Permanent impairment charges ................... (7) (6) (16) (7)
Amortization ................................... (18) (38) (37) (64)
------- ------- ------- -------
Ending balance ................................. 394 437 394 437
------- ------- ------- -------
Valuation allowance for MSRs:
Beginning balance .............................. (81) (81) (107) (23)
Temporary impairment (provision) recovery ...... (35) 75 (18) 13
Permanent impairment charges ................... 7 6 16 7
Release of allowance related to MSRs sold ...... -- -- -- 3
------- ------- ------- -------
Ending balance ................................. (109) -- (109) --
------- ------- ------- -------
MSRs, net of accumulated amortization and valuation
allowance ....................................... $ 285 $ 437 $ 285 $ 437
======= ======= ======= =======
Normal amortization for the current MSRs portfolios is expected to be
approximately $78 million for the year ending December 31, 2005, declining
gradually to approximately $34 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 six 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 six
months ended June 30, 2005 and 2004.
----------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
------------------ ------------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------
Effective tax rate ................................ 38.1% 28.2% 36.7% 34.1%
11
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. Excluding the impact of this adjustment, the
effective tax rate for the six months ended June 30, 2005 would have been 39.2%.
In June 2004, approximately $51 million of income tax liability related to the
anticipated completion of an outstanding audit was released, reducing the
effective tax rate by 10.9% for the second quarter and 5.2% for the first six
months of 2004.
Note 8. Long-Term Debt
--------------------------------------------------------------------------------
The following table presents a summary of long-term debt.
-------------------------------------------------------------------------------
June 30, December 31,
2005 2004
-------------------------------------------------------------------------------
(in millions)
Senior debt........................................ $ 18,870 $ 18,831
Subordinated debt.................................. 4,995 4,988
All other.......................................... 20 20
----------- -----------
Total long-term debt............................... $ 23,885 $ 23,839
=========== ===========
For a discussion of the components of long-term debt refer to the narrative
accompanying Note 14 Long-Term Debt on pages 93 and 94 of the 2004 Form 10-K.
Note 9. Preferred Stock
--------------------------------------------------------------------------------
In April 2005, HUSI issued 20,700,000 shares of floating rate non-cumulative
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.
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.
-----------------------------------------------------------------------------------
June 30, December 31,
2005 2004
-----------------------------------------------------------------------------------
(in millions)
Assets:
Interest bearing deposits with banks ........... $ 225 $ 436
Loans .......................................... 1,142 828
Trading assets ................................. 4,688 3,167
Other .......................................... 122 752
----------- ------------
Total assets ................................... $ 6,177 $ 5,183
=========== ============
Liabilities:
Deposits ....................................... $ 9,426 $ 9,759
Trading account liabilities .................... 4,979 5,704
Short-term borrowings .......................... 1,153 1,089
Other .......................................... 162 77
----------- ------------
Total liabilities .............................. $ 15,720 $ 16,629
=========== ============
12
-----------------------------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
----------------------- -----------------------
2005 2004 2005 2004
-----------------------------------------------------------------------------------------------------------------
(in millions)
Interest income........................................... $ 3 $ 1 $ 4 $ 4
Interest expense ......................................... 69 18 132 39
Trading losses ........................................... (1,430) (137) (1,751) (70)
Other revenues ........................................... 27 14 67 24
Support services from HSBC affiliates:
Fees paid to HTSU for technology services ............. 51 44 100 82
Fees paid to HSBC Finance Corporation ................. 100 8 205 13
Other fees, primarily treasury and traded markets
services ............................................. 67 55 132 99
The following business transactions conducted with HSBC Finance Corporation
impacted operations 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 six months of 2005, approximately $9
billion of additional receivables were acquired from HSBC Finance
Corporation at a premium of $192 million, which is being amortized to
interest income over the estimated life of the receivables purchased.
o During the first six months of 2005, HUSI purchased approximately $1.4
billion of residential mortgage and other consumer loans from originating
lenders pursuant to HSBC Finance Corporation correspondent loan programs.
Total premium paid was $17 million, which is being amortized to interest
income over the estimated life of the loans purchased.
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 credit card customer relationships of HUSI were sold to HSBC
Finance Corporation. 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 six months of
2005, approximately $947 million of receivables associated with these
relationships were purchased from HSBC Finance Corporation at a premium of
approximately $17 million, which is being amortized to interest income
over the estimated life of the receivables purchased. Servicing for the
majority of 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. During the first six months of 2005,
approximately $24 billion of loans were originated by HUSI and immediately
sold to HSBC Finance Corporation, resulting in gains of approximately $19
million and fees paid to HSBC Finance Corporation of $4 million.
o At June 30, 2005, HUSI had a $2 billion line of credit from HSBC Finance
Corporation, of which $600 million was outstanding and included in
short-term borrowings.
13
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. 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, with the change in value on the intercompany
component substantially offset by the mark to market of related contracts
entered into with third parties.
HTSU charges HUSI for technology services pursuant to a master service level
agreement. These charges are included in other expenses as HSBC affiliate
charges.
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
component 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.
At June 30, 2005, HUSI had an unused line of credit from HSBC of $1,500 million.
HUSI has extended loans and lines of credit to various other HSBC affiliates of
$1,295 million, of which $281 million was outstanding at June 30, 2005.
At June 30, 2005 and December 31, 2004, the aggregate notional amounts of all
derivative contracts with other HSBC affiliates were approximately $441 billion
and $302 billion respectively. The net credit risk exposure related to these
contracts was approximately $4 billion at June 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 six months of
2005 and 2004 was $20 million and $36 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.
-----------------------------------------------------------------------------
June 30, December 31,
2005 2004
-----------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks ............ $ 1,075 $ 767
Trading assets .................................. 484 305
Securities available for sale ................... 6,125 6,096
Securities held to maturity ..................... 533 655
Loans ........................................... 6,002 5,971
---------- ----------
Total ........................................... $ 14,219 $ 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 subsidiaries participate in these plans.
14
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 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
Pension Benefits Postretirement Benefits
-------------------- -----------------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Three months ended June 30:
Net periodic benefit cost:
Service cost ......................................... $ 10 $ 9 $ -- $ 1
Interest cost ........................................ 17 20 1 1
Expected return on plan assets ....................... (24) (28) -- --
Prior service cost amortization ...................... -- -- -- --
Actuarial loss ....................................... 1 6 -- --
Transition amount amortization ....................... -- -- -- 1
-------- -------- -------- --------
Net periodic benefit cost ............................ $ 4 $ 7 $ 1 $ 3
======== ======== ======== ========
Amount recorded as pension expense by:
HUSI ................................................. $ 2 $ 4
Other HSBC affiliates ................................ 2 3
-------- --------
$ 4 $ 7
======== ========
----------------------------------------------------------------------------------------------------------
Other
Pension Benefits Postretirement Benefits
-------------------- -----------------------
2005 2004 2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Six months ended June 30:
Net periodic benefit cost:
Service cost ......................................... $ 19 $ 16 $ 1 $ 1
Interest cost ........................................ 33 34 3 4
Expected return on plan assets ....................... (47) (48) -- --
Prior service cost amortization ...................... -- 1 -- --
Actuarial loss ....................................... 2 13 -- --
Transition amount amortization ....................... -- -- 1 2
-------- -------- -------- --------
Net periodic benefit cost ............................ $ 7 $ 16 $ 5 $ 7
======== ======== ======== ========
Amount recorded as pension expense by:
HUSI ................................................. $ 4 $ 9
Other HSBC affiliates ................................ 3 7
-------- --------
$ 7 $ 16
======== ========
HUSI expects to make no contribution for pension benefits and to contribute
approximately $9 million for other postretirement benefits during fiscal year
2005.
15
Note 13. New Accounting Pronouncements
--------------------------------------------------------------------------------
In March 2004, the Financial Accounting Standards Board (FASB) reached a
consensus on Emerging Issues Task Force 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides guidance for determining when an investment is
impaired and whether the impairment is other than temporary. EITF 03-1 also
incorporates into its consensus the required disclosures about unrealized losses
on investments announced by the EITF in late 2003 and adds new disclosure
requirements relating to cost-method investments. The new disclosure
requirements are effective for annual reporting periods ending after June 15,
2004, and the new impairment guidance was to become effective for reporting
periods beginning after June 15, 2004. In September 2004, the FASB delayed the
effective date of EITF 03-1 for measurement and recognition of impairment losses
until implementation guidance is issued. Adoption of the impairment guidance
contained in EITF 03-1 is not expected to have a material impact on HUSI's
financial position or results of operations.
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.
16
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 June 30,
--------------------------------------------------------------------
2005 2004
--------------------------------- --------------------------------
Balance Interest Rate* Balance Interest Rate*
------------------------------------------------------------------------------------------------------------------------
Assets (in millions)
Interest bearing deposits with banks ..............$ 3,913 $ 29 2.95% $ 2,467 $ 7 1.22%
Federal funds sold and securities purchased under
resale agreements ................................ 5,285 41 3.14 3,682 11 1.17
Trading assets .................................... 18,843 60 1.28 14,550 38 1.04
Securities ........................................ 19,158 218 4.58 17,584 219 5.02
Loans
Commercial ...................................... 23,049 289 5.02 19,101 186 3.92
Consumer:
Residential mortgages ......................... 47,542 581 4.89 34,561 422 4.89
Credit cards .................................. 12,688 200 6.32 1,125 27 9.74
Other consumer ................................ 3,717 66 7.10 2,106 33 6.24
--------- --------- -------- --------- --------- -------
Total consumer .................................. 63,947 847 5.31 37,792 482 5.13
--------- --------- -------- --------- --------- -------
Total loans ..................................... 86,996 1,136 5.24 56,893 668 4.73
--------- --------- -------- --------- --------- -------
Other ............................................. 615 9 5.31 544 4 3.26
--------- --------- -------- --------- --------- -------
Total earning assets .............................. 134,810 $ 1,493 4.44% 95,720 $ 948 3.99%
--------- --------- -------- --------- --------- -------
Allowance for credit losses ....................... (885) (350)
Cash and due from banks ........................... 3,447 3,204
Other assets ...................................... 7,923 7,551
--------- ---------
Total assets ......................................$ 145,295 $ 106,125
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ................................$ 28,530 $ 69 0.97% $ 27,762 $ 45 0.66%
Other time deposits ............................. 23,435 177 3.03 14,846 64 1.72
Deposits in foreign offices ....................... 22,678 150 2.65 21,867 49 0.90
--------- --------- -------- --------- --------- -------
Total interest bearing deposits ................... 74,643 396 2.13 64,475 158 0.98
--------- --------- -------- --------- --------- -------
Short-term borrowings ............................. 13,176 67 2.01 9,464 34 1.44
Long-term debt .................................... 23,889 242 4.07 5,460 63 4.67
--------- --------- -------- --------- --------- -------
Total interest bearing liabilities ................ 111,708 705 2.53 79,399 255 1.29
--------- --------- -------- --------- --------- -------
Net interest income / Interest rate spread ........ $ 788 1.91% $ 693 2.70%
--------- -------- --------- -------
Noninterest bearing deposits ...................... 8,643 7,636
Other liabilities ................................. 13,463 11,298
Total shareholders' equity ........................ 11,481 7,792
--------- ---------
Total liabilities and shareholders' equity ........$ 145,295 $ 106,125
========= =========
Net yield on average earning assets ............... 2.35% 2.91%
-------- ------
Net yield on average total assets ....................... 2.18 2.63
======== ======
* 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
second quarter of 2005 and 2004 included fees of $11 million and $18 million,
respectively.
17
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.
Six Months Ended June 30,
---------------------------------------------------------------------------
2005 2004
----------------------------------- ------------------------------------
Balance Interest Rate* Balance Interest Rate*
------------------------------------------------------------------------------------------------------------------------
Assets (in millions)
Interest bearing deposits with banks ..... $ 3,882 $ 54 2.78% $ 2,022 $ 14 1.36%
Federal funds sold and securities purchased
under resale agreements ................. 4,467 65 2.94 3,842 22 1.16
Trading assets ........................... 18,612 119 1.28 15,129 71 0.94
Securities ............................... 18,741 432 4.65 17,873 440 4.94
Loans
Commercial ........................... 22,777 539 4.77 19,019 380 4.02
Consumer:
Residential mortgages .............. 47,503 1,160 4.88 31,103 780 5.02
Credit cards ....................... 12,430 358 5.81 1,126 56 9.96
Other consumer ..................... 3,681 128 7.02 2,075 66 6.36
--------- --------- -------- --------- ---------- ---------
Total consumer ....................... 63,614 1,646 5.22 34,304 902 5.29
--------- --------- -------- --------- ---------- ---------
Total loans .......................... 86,391 2,185 5.10 53,323 1,282 4.84
--------- --------- -------- --------- ---------- ---------
Other .................................... 599 15 4.87 517 8 3.28
--------- --------- -------- --------- ---------- ---------
Total earning assets ..................... 132,692 $ 2,870 4.36% 92,706 $ 1,837 3.98%
--------- --------- -------- --------- ---------- ---------
Allowance for credit losses .............. (890) (371)
Cash and due from banks .................. 3,729 3,150
Other assets ............................. 8,168 7,396
--------- ---------
Total assets ............................ $ 143,699 $ 102,881
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ...................... $ 28,050 $ 120 0.86% $ 27,199 $ 90 0.67%
Other time deposits ................... 23,220 325 2.83 13,271 117 1.76
Deposits in foreign offices ............. 23,060 278 2.43 21,656 111 1.03
--------- --------- -------- --------- ---------- ---------
Total interest bearing deposits ......... 74,330 723 1.96 62,126 318 1.03
--------- --------- -------- --------- ---------- ---------
Short-term borrowings ................... 11,048 119 2.17 9,002 52 1.15
Long-term debt .......................... 23,880 461 3.90 4,706 114 4.88
--------- --------- -------- --------- ---------- ---------
Total interest bearing liabilities ...... 109,258 1,303 2.41 75,834 484 1.28
--------- --------- -------- --------- ---------- ---------
Net interest income / Interest rate
spread ................................. $ 1,567 1.95% $ 1,353 2.70%
--------- -------- ---------- ---------
Noninterest bearing deposits ............ 9,201 7,413
Other liabilities ....................... 14,027 11,924
Total shareholders' equity .............. 11,213 7,710
--------- ---------
Total liabilities and shareholders'
equity ................................ $ 143,699 $ 102,881
========= =========
Net yield on average earning assets ..... 2.38% 2.93%
--------- ---------
Net yield on average total assets ....... 2.20 2.64
========= =========
* 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 six months of 2005 and 2004 included fees of $19 million and $35 million,
respectively.
18
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. 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 $118 million in the second quarter of 2005 and $121 million
in the first six months of 2005, as compared with the same 2004 periods,
primarily due to:
o the Corporate, Investment Banking and Markets (CIBM) segment's reduced
earnings resulting from the flattening yield curve, difficult trading
markets and increased expenses associated with investment in business
expansion initiatives; and
o negative net earnings resulting from the private label receivable
portfolio acquired in December 2004, caused by amortization of the premium
paid at acquisition, as reflected within the Consumer Finance (CF)
segment.
The first six months of 2005 has been highlighted by a 75% increase in net
earnings in Personal Financial Services (PFS), a 2% increase in net earnings in
Commercial Banking (CMB) and a 107% increase in net earnings in Private Banking
(PB) business segments, due to:
o successful rollout during 2005 of a number of business expansion
initiatives;
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; and
o gains realized on sales of certain assets during 2005.
Further analysis of business segments begins on page 33 of this Form 10-Q.
Private Label Loan Portfolio Purchase
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. Results from this portfolio for the first half of 2005 have been
negatively impacted by significant amortization of the premium paid for the
portfolio, which is heavily front loaded into 2005 in relation to runoff of
receivable balances purchased.
Further analysis regarding this acquired portfolio is included in the analysis
of the CF business segment, beginning on page 36 of this Form 10-Q.
Balance Sheet Review
Asset growth slowed to a more normalized level (less than 3%) during the first
six months of 2005, as compared with calendar year 2004. Total deposit growth of
$5 billion during 2005 was the primary funding source for increased loans and
decreased short-term borrowings balances.
19
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 was approximately $24 billion at June 30, 2005 and December 31,
2004. Total short-term borrowings decreased approximately $2 billion to $8
billion at June 30, 2005. Total deposits and borrowings from HSBC affiliates
were $11 billion at June 30, 2005 and December 31, 2004.
Average earning assets and interest bearing liabilities increased significantly
during the first six months of 2005, as compared with the same 2004 period,
primarily due to:
o increased average residential loan balances from held portfolio growth in
2004;
o increased average credit card and other loan balances resulting from the
private label receivable portfolio acquired in December 2004;
o increased average 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.
In April 2005, HUSI issued 20,700,000 shares of floating rate non-cumulative
preferred stock with a stated value of $25 per share. Refer to Note 9 of the
consolidated financial statements on page 12 of this Form 10-Q for further
information regarding this issuance.
Income Statement Review
Increased net interest income in the first six 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 the premium paid for the private label receivable portfolio.
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 22 of this Form 10-Q.
The provision for credit losses increased during the first six months of 2005,
as compared with the same 2004 period, due mainly to required provision
associated with the private label receivable portfolio acquired in December
2004, and to other loans acquired from HSBC Finance Corporation during 2004 and
2005. Further analysis of credit quality and the allowance for credit losses
begins on page 39 of this Form 10-Q.
Other revenues increased in the first six months of 2005, as compared with 2004,
primarily due to:
o increased fee income and securitization revenue associated with the
acquired private label receivable portfolio;
o increased residential mortgage banking revenue; and
o increased gains on sales of securities, properties and other financial
assets.
Further analysis of other revenues begins on page 25 of this Form 10-Q.
Operating expenses increased in the first six months of 2005, as compared with
2004, primarily due to increased fees charged by HSBC affiliates 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 12 of this Form 10-Q.
Further analysis of operating expenses begins on page 31 of this Form 10-Q.
In June 2004, $51 million of income tax liability related to completion of an
outstanding audit was released. The decrease in income tax expense for the first
half of 2005 is primarily attributable to a $20 million reduction of expense
recorded in the first quarter resulting from the difference between the estimate
of prior year state and local tax liability and the liability per final tax
returns.
20
The following table presents a five quarter summary of selected financial
information.
--------------------------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
Quarter ended 2005 2005 2004 2004 2004
--------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ......................... $ 785 $ 775 $ 700 $ 698 $ 689
---------- ---------- ----------- ----------- ----------
Trading revenues ............................ 35 96 99 21 78
Residential mortgage banking revenue
(expense) ................................. (13) 23 (14) (65) (17)
Securities gains, net ....................... 64 23 26 18 3
Other income ................................ 327 336 214 388 234
---------- ---------- ----------- ----------- ----------
Total other revenues ........................ 413 478 325 362 298
---------- ---------- ----------- ----------- ----------
Operating expenses .......................... 684 654 613 480 520
Provision (credit) for credit losses ........ 170 107 (24) 27 6
---------- ---------- ----------- ----------- ----------
Income before income tax expense ............ 344 492 436 553 461
Income tax expense .......................... 131 176 167 214 130
---------- ---------- ----------- ----------- ----------
Net income .................................. $ 213 $ 316 $ 269 $ 339 $ 331
========== ========== =========== =========== ==========
Balances at quarter end:
Loans:
Commercial loans ..................... $ 24,175 $ 23,484 $ 22,972 $ 20,869 $ 19,556
Residential mortgages ................ 47,634 47,610 46,775 42,958 39,342
Credit card receivables .............. 12,876 12,001 12,078 1,127 1,144
Other consumer loans ................. 3,162 3,152 3,122 2,086 2,024
---------- ---------- ----------- ----------- ----------
Total loans .......................... 87,847 86,247 84,947 67,040 62,066
Allowance for credit losses .......... (790) (773) (788) (340) (347)
---------- ---------- ----------- ----------- ----------
Loans, net ........................... 87,057 85,474 84,159 66,700 61,719
Total assets ................................ 144,394 141,605 141,050 120,939 112,791
Total tangible assets ....................... 141,650 138,866 138,310 118,195 109,982
Total deposits .............................. 85,079 82,994 79,981 74,803 74,534
Short-term borrowings ....................... 8,220 7,152 9,874 7,967 8,499
Long-term debt .............................. 23,885 23,925 23,839 15,618 7,135
Common shareholder's equity ................. 10,625 10,385 10,366 8,053 7,315
Tangible common shareholder's equity ........ 7,831 7,646 7,611 5,336 4,673
Total shareholders' equity .................. 11,642 10,885 10,866 8,553 7,815
Selected financial ratios:
Total shareholders' equity to total assets,
at period end ............................. 8.06% 7.69% 7.70% 7.07% 6.93%
Tangible common shareholder's equity
to total tangible assets, at period end ... 5.53 5.51 5.50 4.51 4.25
Annualized rate of return on average (1):
Total assets ......................... .59 .90 .84 1.17 1.26
Total common shareholder's equity .... 7.87 12.05 12.62 17.68 17.96
Net interest margin to average (1):
Earning assets ....................... 2.35 2.42 2.38 2.65 2.91
Total assets ......................... 2.18 2.22 2.19 2.42 2.63
Average total shareholders' equity to average
total assets (1) .......................... 7.90 7.70 6.88 6.96 7.34
Cost:income ratio (1) ....................... 57.11 52.17 59.70 45.28 52.63
(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 unusually 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 in relation
to runoff of receivables acquired. As amortization of the initial premium
decreases over the remainder of 2005 and 2006, these ratios are expected to
return to levels consistent with prior reporting periods. Commentary regarding
the private label receivable portfolio acquired, and the related premiums, is
provided on pages 23 and 36 of this Form 10-Q.
21
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)
Prior to January 1, 2005, HSBC reported results in accordance with accounting
principles generally accepted in the United Kingdom (U.K. GAAP). The European
Union has determined that all European listed companies will be required to
prepare their consolidated financial statements using IFRS by 2005. As a result,
HSBC began reporting its financial results under IFRS rather than U.K. GAAP
beginning with the release of its interim financial results for the six months
ended June 30, 2005. HUSI previously reported that it would begin presenting a
reconciliation of U.S. GAAP net income to IFRS net income in the second quarter
of 2005. The Securities and Exchange Commission (SEC) has since adopted revised
disclosure rules for foreign private issuers for the first year of reporting
under IFRS, which became effective in May 2005. HSBC has elected to follow a
provision that allows foreign private issuers to delay disclosure of the
reconciliation between U.S. GAAP net income and IFRS net income for the six
months ended June 30, 2005 until the third quarter of 2005. In line with HSBC's
decision, HUSI expects to report IFRS net income and present a reconciliation of
U.S. GAAP net income to IFRS net income for the nine months ended September 30,
2005 and on a quarterly basis thereafter.
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Net Interest Income
The following table presents a five quarter summary of net interest income.
-------------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
Three months ended 2005 2005 2004 2004 2004
-------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans ................ $ 1,136 $ 1,049 $ 851 $ 779 $ 669
Securities ........... 215 210 218 220 215
Trading assets ....... 60 59 51 43 38
Short-term investments 70 49 52 27 18
Other ................ 9 6 5 5 4
-------- -------- -------- -------- ---------
Total interest income 1,490 1,373 1,177 1,074 944
-------- -------- -------- -------- ---------
Interest expense:
Deposits ............. 396 327 281 226 158
Short-term borrowings 67 52 32 49 34
Long-term debt ....... 242 219 164 101 63
-------- -------- -------- -------- ---------
Total interest expense 705 598 477 376 255
-------- -------- -------- -------- ---------
Net interest income ......... $ 785 $ 775 $ 700 $ 698 $ 689
======== ======== ======== ======== =========
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 17-18 of this
Form 10-Q.
All increases and decreases referenced on the following pages for the second
quarter and six months of 2005 represent comparisons with the same 2004 periods.
22
Interest Income - Loans
Total interest income on loans increased $467 million (70%) in the second
quarter of 2005 and increased $903 million (70%) in the first six months of
2005. Average total loan balances increased approximately $33 billion (62%) for
the first six 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, loans and
receivables acquired directly from HSBC Finance Corporation, and from
originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs, 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 from HSBC
Finance Corporation in December 2004.
Credit Card Receivables
Interest earned from credit card receivables increased $173 million (641%) in
the second quarter of 2005, and increased $302 million (539%) in the first half
of 2005. Average credit card receivable balances were $11 billion higher for the
first six months of 2005.
In December of 2004, HUSI acquired $12 billion of private label receivables and
other loans from HSBC Finance Corporation. HUSI continues to purchase additional
credit card receivables on a daily basis from HSBC Finance Corporation, which
continues to own these customer relationships. Also during 2004, HUSI sold
certain credit card relationships to HSBC Finance Corporation. HUSI purchases
receivables associated with these relationships from HSBC Finance Corporation on
a daily basis.
During the second quarter and first six months of 2005, the increase in interest
income associated with the acquired portfolio was offset by approximately $118
million and $285 million respectively, of amortization of the initial premium
paid for the private label receivable portfolio, and by $44 million and $73
million respectively, of amortization of premiums paid on daily purchases from
HSBC Finance Corporation. The overall average yield for credit card receivables
was significantly reduced in 2005 as a result of premium amortization.
Residential Mortgage Loans
Interest income earned from residential mortgage loans increased $158 million
(37%) in the second quarter of 2005, and increased $380 million (49%) in the
first half 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 were
approximately $16 billion (53%) higher for the first six months of 2005.
Since the beginning of 2004, approximately $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. 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 continued decreases in the average yield earned on
residential mortgages during the first six months of 2005, as 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 variable
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 domestic consumer lending programs increased
$33 million (100%) in the second quarter of 2005, and increased $62 million
(94%) in the first six months of 2005. Average balances increased
23
approximately $2 billion (77%) in the first six months of 2005, primarily due to
automobile and other consumer loans purchased from originating lenders pursuant
to HSBC Finance Corporation correspondent loan programs.
Commercial Loans
Interest income from commercial loans increased $103 million (55%) in the second
quarter of 2005, and increased $159 million (42%) in the first six months of
2005. Average commercial loan balances increased $4 billion (20%) in the first
six months of 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 $22 million (58%) in the second
quarter of 2005, and increased $48 million (68%) in the first six months of
2005. In the first six months of 2005, average trading assets increased
approximately $3 billion (23%) mainly as a result of various business expansion
initiatives, while the average yield earned on these balances also increased 34
basis points (36%).
Interest Income - Short-Term Investments
Short-term investments include interest bearing deposits with banks, 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 $52 million (289%) in the
second quarter of 2005, and increased $83 million (231%) in the first six months
of 2005. Average short-term investment balances grew approximately $2 billion
(42%) the first six months of 2005, while average rates earned also increased
significantly, primarily due to increases in the federal funds rate.
Interest Expense - Deposits
Total interest expense on interest bearing deposits increased $238 million
(151%) in the second quarter of 2005, and increased $405 million (127%) in the
first six months of 2005. Interest expense increases were noted from both
domestic and foreign deposits. Average interest bearing deposits increased $12
billion (20%) in the first six months of 2005. Average interest rates paid to
these customers also increased significantly, due primarily to increases in
short-term interest rates.
Additional resources and priority have been focused on expansion of core retail
banking businesses, as well as high net worth individuals. Additional deposit
products have been developed and offered in recent months, in conjunction with
increased marketing efforts to individuals, small businesses, and middle market
commercial customers. Investment in the retail branch network has been, and will
continue to be, expanded and reallocated to ensure coverage of high potential
growth geographic areas.
Interest Expense - Short-Term Borrowings
Interest expense on short-term borrowings increased $33 million (97%) in the
second quarter of 2005, and increased $67 million (129%) in the first six months
of 2005. Average short-term borrowings balances increased $2 billion (23%) in
the first six 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 $179 million (284%) in the second
quarter of 2005, and increased $347 million (304%) in the first six months of
2005. Average long-term debt balances increased $19 billion (407%) in the first
six months of 2005, due primarily to new debt issued during 2004 to fund balance
sheet growth. A decrease in the average interest rate paid on long-term debt,
which resulted from new debt being issued at significantly lower rates than
existing debt, partially offset the average balance increases.
24
Other Revenues
The following table presents the components of other revenues.
------------------------------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
2005 2004 Amount %
------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended June 30:
Trust income ............................................ $ 22 $ 24 $ (2) (8)
Service charges:
HSBC affiliate income ............................... 4 5 (1) (20)
Other service charges ............................... 49 48 1 2
------- ------- ------- --------
Total service charges ............................... 53 53 -- --
------- ------- ------- --------
Other fees and commissions:
Letter of credit fees ............................... 18 18 -- --
Credit card fees .................................... 61 23 38 165
Wealth and tax advisory services .................... 16 13 3 23
HSBC affiliate income ............................... 20 8 12 150
Other fee-based income .............................. 29 60 (31) (52)
------- ------- ------- --------
Total other fees and commissions .................... 144 122 22 18
------- ------- ------- --------
Securitization revenue .................................. 25 -- 25 --
Other income:
Insurance ........................................... 16 21 (5) (24)
HSBC affiliate income ............................... 3 1 2 200
Gains on sale of property and other financial assets 32 3 29 967
Other ............................................... 32 10 22 220
------- ------- ------- --------
Total other income .................................. 83 35 48 137
------- ------- ------- --------
Residential mortgage banking (expense) revenue .......... (13) (17) 4 24
Trading revenues ........................................ 35 78 (43) (55)
Securities gains, net ................................... 64 3 61 2,033
------- ------- ------- --------
Total other revenues .................................... $ 413 $ 298 $ 115 39
======= ======= ======= ========
Six months ended June 30:
Trust income ........................................... $ 45 $ 48 $ (3) (6)
Service charges:
HSBC affiliate income .............................. 8 10 (2) (20)
Other service charges .............................. 97 94 3 3
------- ------- ------- --------
Total service charges .............................. 105 104 1 1
------- ------- ------- --------
Other fees and commissions:
Letter of credit fees .............................. 35 35 -- --
Credit card fees ................................... 118 41 77 188
Wealth and tax advisory services ................... 29 23 6 26
HSBC affiliate income .............................. 36 12 24 200
Other fee-based income ............................. 71 119 (48) (40)
------- ------- ------- --------
Total other fees and commissions ................... 289 230 59 26
------- ------- ------- --------
Securitization revenue ................................. 69 -- 69 --
Other income:
Insurance .......................................... 32 31 1 3
HSBC affiliate income .............................. 23 2 21 1,050
Gains on sale of property and other financial assets 46 6 40 667
Other .............................................. 54 43 11 26
------- ------- ------- --------
Total other income ................................. 155 82 73 89
------- ------- ------- --------
Residential mortgage banking revenue (expense) ......... 10 (41) 51 124
Trading revenues ....................................... 131 168 (37) (22)
Securities gains, net .................................. 87 41 46 112
------- ------- ------- --------
Total other revenues ................................... $ 891 $ 632 $ 259 41
======= ======= ======= ========
All increases and decreases referenced on the following pages for the second
quarter and first six months of 2005 represent comparisons with the same 2004
periods.
25
Other Fees and Commissions
Increased credit card fees in the second quarter and the first six months of
2005 directly resulted from the private label receivable portfolio acquired from
HSBC Finance Corporation in December 2004.
The increases in HSBC affiliate income for the second quarter and for the first
half of 2005 were attributable to the following:
o in June 2004, HUSI transferred a brokerage subsidiary to an HSBC
affiliate. As a result of the transfer, income from customers, reported as
other fees and commissions prior to June 2004, has been partially replaced
by fees received from the HSBC affiliate; and
o business expansion and centralization initiatives among HSBC entities in
North America have resulted in general increases in fees from HSBC
affiliates for various businesses, including the PFS and CIBM segments.
Decreased other fee-based income in the second quarter and the first six months
of 2005 primarily resulted from:
o new customer referral arrangements with HSBC affiliates, which resulted in
referral fees paid, which are netted against related fee revenues received
from customers;
o reduced investment product fees received, resulting from the 2004 transfer
of an investment brokerage subsidiary to an HSBC affiliate; and
o offset partially by new service fees generated by a subsidiary transferred
from HSBC in March 2005, which provides accounting and valuation services
for hedge fund clients.
Securitization Revenue
Securitization revenue results directly from the purchase of residual interests
in securitized credit card receivables from HSBC Finance Corporation in December
2004. Securitization revenue is comprised of the following activity:
-----------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
-----------------------------------------------------------------------------------------------------------
(in millions)
Net replenishment gains, net of provision for credit losses .... $ 22 $ 42
Servicing revenue and excess spread ............................ 3 27
------------ -------------
Total .......................................................... $ 25 $ 69
============ =============
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. Servicing revenue and excess spread decreased approximately $21 million
in the second quarter of 2005, as compared with the previous quarter, due to
declining receivable balances in the securitized trusts. There have been no new
securitization transactions during 2005.
Other Income
The increase in HSBC affiliate income for the first six months of 2005 was
primarily due 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 12 of this Form 10-Q.
Gains on sale of property and other financial assets includes the following
significant activity and/or transactions for 2005:
o $26 million gain on sale of property in May 2005; and
o $16 million of gains on sales of various branches and a portion of HUSI's
personal trust business during the first six months of 2005.
26
Other includes the following significant activity and/or transactions for 2005:
o non-recurring fees received from a loan customer and a Brady Bond issuer
totaled approximately $7 million for the second quarter of 2005;
o HUSI holds investments related to key officer insurance policies. Mark to
market gains related to these investments, recorded in other income, are
offset by hedging activity included in trading revenue. Total gains
recorded on these investments were approximately $9 million for the second
quarter and $4 million for the first half of 2005; and
o miscellaneous fees have also increased as a direct result of the private
label receivable portfolio purchased from HSBC Finance Corporation in
December 2004.
For 2004, other included $21 million of interest revenue on an income tax
refund.
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 second quarter and the first six
months of 2004 has been adjusted in the table to facilitate comparison.
27
-------------------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
2005 2004 Amount %
-------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended June 30:
Net interest income ............................................. $ 118 $ 111 $ 7 6
------- ------- -------- -------
Servicing related income (expense):
Servicing fee income ..................................... 19 18 1 6
MSRs amortization ........................................ (18) (38) 20 53
MSRs temporary impairment (provision) recovery ........... (35) 75 (110) (147)
Trading - Derivative instruments used to offset changes in
value of MSRs .......................................... 24 (61) 85 139
------- ------- -------- -------
Total net servicing related (expense) .................... (10) (6) (4) (67)
------- ------- -------- -------
Originations and sales related income (expense):
Gains (losses) on sales of mortgages ..................... 11 (8) 19 238
Trading - Forward loan sale commitments .................. (17) 6 (23) (383)
- Interest rate lock commitments ................. -- (9) 9 100
- Euro currency contracts ........................ (2) -- (2) --
Fair value hedge activity (1) ............................ -- (2) 2 100
------- ------- -------- -------
Total net originations and sales related income (expense) (8) (13) 5 38
------- ------- -------- -------
Other mortgage income ........................................... 5 2 3 150
------- ------- -------- -------
Total residential mortgage banking revenue (expense) included
in other revenues ............................................. (13) (17) 4 24
------- ------- -------- -------
Total residential mortgage banking related revenue .............. $ 105 $ 94 $ 11 12
======= ======= ======== =======
Six months ended June 30:
Net interest income ............................................. $ 246 $ 221 $ 25 11
------- ------- -------- -------
Servicing related income (expense):
Servicing fee income ..................................... 37 40 (3) (8)
MSRs amortization ........................................ (37) (64) 27 42
MSRs temporary impairment (provision) recovery ........... (18) 13 (31) (238)
Trading - Derivative instruments used to offset changes in
value of MSRs .......................................... 19 (25) 44 176
Gains on sales of available for sale securities .......... -- 8 (8) (100)
------- ------- -------- -------
Total net servicing related income (expense) ............. 1 (28) 29 104
------- ------- -------- -------
Originations and sales related income (expense):
Gains (losses) on sales of mortgages ..................... 15 (7) 22 314
Trading - Forward loan sale commitments .................. (9) 3 (12) (400)
- Interest rate lock commitments ................. (4) (10) 6 60
- Euro currency contracts ........................ (2) -- (2) --
Fair value hedge activity (1) ............................ -- (1) 1 100
------- ------- -------- -------
Total net originations and sales related income (expense) -- (15) 15 100
------- ------- -------- -------
Other mortgage income ........................................... 9 2 7 350
------- ------- -------- -------
Total residential mortgage banking revenue (expense) included
in other revenues ............................................. 10 (41) 51 124
------- ------- -------- -------
Total residential mortgage banking related revenue .............. $ 256 $ 180 $ 76 42
======= ======= ======== =======
(1) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity.
28
All increases and decreases referenced below for the second quarter and the
first six months of 2005 represent comparisons with the same 2004 periods.
Overview
Residential mortgage banking related revenue for the second quarter and the
first six months of 2005 increased $11 million and $76 million respectively.
Increased net interest income for 2005 resulted from overall growth in the held
residential mortgage portfolio. Throughout 2004 there was a significant increase
in the held portfolio as strong consumer demand for variable rate residential
mortgage loans continued. Commentary regarding residential mortgage interest
income is presented on page 23 of this Form 10-Q.
Servicing Related Income (Expense)
Net servicing related income (expense) decreased for the second quarter, but
increased for the first six months of 2005. For both periods decreased MSR
amortization expense and increased income associated with derivative instruments
used to offset changes in the economic value of MSRs were offset by increases in
the temporary impairment valuation allowance.
The recorded net book value of MSRs, as well as related amortization expense,
are directly impacted by levels of residential mortgage prepayments. Higher
levels of prepayments generally increase amortization expense and decrease the
net book value of MSRs. During 2005, interest rates generally rose and
prepayments of residential mortgages, mostly in the form of loan refinancings,
have decreased in comparison with 2004 levels, resulting in decreased MSR
amortization expense compared with amounts recorded in prior periods. Loan
refinance activity represented 42% of total originations in the first half of
2005, as compared with 59% in the first half of 2004.
During the second quarter of 2005 however, long-term rates declined, which
caused temporary impairment of the value of MSRs.
The net servicing related income amounts in the tables do not reflect
approximately $14 million of unrealized gains, 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 $4 million on these securities.
Additional commentary regarding risk management associated with the MSRs
economic hedging program is presented on pages 48-49 of this Form 10-Q.
Originations and Sales Related Income (Expense)
The increase in originations and sales related income for both the second
quarter and first six months of 2005 was attributable to a higher basis point
gain on each individual sale driven by less market volatility as compared with
2004. During 2005, residential mortgages originated with the intention to sell
was consistent with 2004, although a greater proportion of adjustable rate
residential mortgage loans is being sold in 2005, which previously would have
been held on HUSI's balance sheet.
29
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 June 30:
Trading revenues ..................... $ 35 $ 78 $ (43) (55)
Net interest income .................. 4 20 (16) (80)
------- ------- ------- -------
Trading related revenues ............. $ 39 $ 98 $ (59) (60)
======= ======= ======= =======
Business:
Derivative instruments ........ $ 18 $ 42 $ (24) (57)
Treasury (primarily securities) (11) 15 (26) (173)
Foreign exchange .............. 26 29 (3) (10)
Precious metals ............... 8 11 (3) (27)
Other trading ................. (2) 1 (3) (300)
------- ------- ------- -------
Trading related revenues ............. $ 39 $ 98 $ (59) (60)
======= ======= ======= =======
Six months ended June 30:
Trading revenues ..................... $ 131 $ 168 $ (37) (22)
Net interest income .................. 21 36 (15) (42)
------- ------- ------- -------
Trading related revenues ............. $ 152 $ 204 $ (52) (25)
======= ======= ======= =======
Business:
Derivative instruments ........ $ 59 $ 85 $ (26) (31)
Treasury (primarily securities) 3 16 (13) (81)
Foreign exchange .............. 63 63 -- --
Precious metals ............... 25 28 (3) (11)
Other trading ................. 2 12 (10) (83)
------- ------- ------- -------
Trading related revenues ............. $ 152 $ 204 $ (52) (25)
======= ======= ======= =======
Decreased trading related revenues during the second quarter of 2005 was a
direct result of the following factors:
o difficult trading markets during the quarter had a significant negative
impact on proprietary results associated with credit derivatives and
treasury trading businesses;
o a rising interest rate environment resulted in negative mark to market
adjustments associated with U.S. Treasury securities held for trading
purposes; and
o a flattening yield curve during the quarter resulted in tightening
interest rate margins associated with treasury trading assets.
30
Security Gains, Net
The following table presents realized security gains and losses 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 June 30:
Net security gains included in:
Security gains, net ........................ $ 65 $ (1) $ 64 $ 3 $ -- $ 3
======== ======= ======== ======== ======= ========
Six months ended June 30:
Net security gains included in:
Residential mortgage banking
related revenue .......................... $ -- $ -- $ -- $ 8 $ -- $ 8
Security gains, net ........................ 88 (1) 87 47 (6) 41
-------- ------- -------- -------- ------- --------
$ 88 $ (1) $ 87 $ 55 $ (6) $ 49
======== ======= ======== ======== ======= ========
HUSI maintains various securities portfolios as part of its overall liquidity,
balance sheet diversification and risk management strategy. During the first six
months of 2005, approximately $27 million of gains were realized on securities
sold to address interest rate sensitivity and balance sheet diversification
needs, as compared with gains of $30 million for the same 2004 period. Also
during 2005, HUSI reduced its exposure in Latin American securities, resulting
in gains of $10 million, as compared with $16 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.
Operating Expenses
The following table presents the components of operating expenses.
-----------------------------------------------------------------------------------------------
Increase (Decrease)
-----------------------------------------------------------------------------------------------
2005 2004 Amount %
-----------------------------------------------------------------------------------------------
(in millions)
Three months ended June 30:
Salaries and employee benefits ...................... $ 254 $ 242 $ 12 5
Occupancy expense, net .............................. 43 42 1 2
Support services from HSBC affiliates:
Fees paid to HTSU for technology services ..... 51 44 7 16
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support .. 100 7 93 1,329
Other fees, primarily treasury and traded
markets services ............................ 67 55 12 22
------- ------- ------- --------
218 106 112 106
------- ------- ------- --------
Other expenses:
Equipment and software ........................ 22 29 (7) (24)
Marketing ..................................... 18 9 9 100
Outside services .............................. 30 27 3 11
Professional fees ............................. 15 12 3 25
Telecommunications ............................ 5 5 -- --
Postage, printing and office supplies ......... 7 6 1 17
Insurance business ............................ 3 8 (5) (63)
Other ......................................... 69 34 35 103
------- ------- ------- --------
Total other expenses .......................... 169 130 39 30
------- ------- ------- --------
Total operating expenses ............................ $ 684 $ 520 $ 164 32
======= ======= ======= ========
Personnel - average number .......................... 11,134 11,776 (642) (5)
31
----------------------------------------------------------------------------------------------
Increase (Decrease)
----------------------------------------------------------------------------------------------
2005 2004 Amount %
----------------------------------------------------------------------------------------------
(in millions)
Six months ended June 30:
Salaries and employee benefits ..................... $ 520 $ 494 $ 26 5
Occupancy expense, net ............................. 85 82 3 4
Support services from HSBC affiliates:
Fees paid to HTSU for technology services .... 100 82 18 22
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support . 204 11 193 1,755
Other fees, primarily treasury and traded
markets services ............................ 132 99 33 33
------- ------- ------- --------
436 192 244 127
------- ------- ------- --------
Other expenses:
Equipment and software ....................... 46 57 (11) (19)
Marketing .................................... 33 21 12 57
Outside services ............................. 55 51 4 8
Professional fees ............................ 29 20 9 45
Telecommunications ........................... 10 8 2 25
Postage, printing and office supplies ........ 13 12 1 8
Insurance business ........................... 9 11 (2) (18)
Other ........................................ 102 60 42 70
------- ------- ------- --------
Total other expenses ......................... 297 240 57 24
------- ------- ------- --------
Total operating expenses ........................... $ 1,338 $ 1,008 $ 330 33
======= ======= ======= ========
Personnel - average number ......................... 10,982 11,897 (915) (8)
All increases and decreases referred to below for the second quarter and for the
first six months of 2005 represent comparisons with the same 2004 periods.
Overview
Total operating expenses increased $164 million (32%) in the second quarter of
2005, and increased $330 million in the first six 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 and employee benefits increased approximately 5% in the second quarter
and the first six months of 2005. Increased payroll taxes and fringe benefit
expenses were partially offset by the impact on salaries of a decrease in the
average number of personnel employed and by decreased incentive compensation
expenses, primarily in CIBM.
In March 2005, HSBC transferred a subsidiary to HUSI that provides accounting
and valuation services to hedge fund clients. During the second quarter and the
first half of 2005, this new business resulted in $6 million and $8 million
respectively, of salaries and employee benefits expenses.
During 2004, HUSI transferred its brokerage subsidiary and most of its branch
operations in Panama to HSBC affiliates, resulting in decreased salaries and
related expenses, which were partially offset by expansion in regional banking,
which is included in the PFS segment and in the treasury and traded markets
businesses, which are included in the CIBM segment.
Support Services From HSBC Affiliates
Fees are charged by various related HSBC affiliate entities for technology
services, for underwriting and broker-dealer services, for loan origination and
servicing, and for other operational and administrative support functions. The
increase for 2005 primarily relates to origination and servicing of various
receivables acquired from HSBC Finance Corporation. Additional details regarding
HSBC affiliate charges are presented in Note 10 of the consolidated financial
statements beginning on page 12 of this Form 10-Q.
32
The overall increases in HSBC affiliate charges are due primarily to the
following activity:
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;
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; 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 fraud losses of $7 million in the second quarter of 2005, and $14
million in the first six months of 2005, which are directly related 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 $12 million in the second quarter of
2005 and $6 million for the first six months of 2005. Additional analysis of
off-balance sheet exposures begins on page 44 of this Form 10-Q.
Various business expansion initiatives have resulted in general increases in
other expenses during 2005.
BUSINESS SEGMENTS
--------------------------------------------------------------------------------
The Personal Financial Services (PFS), Commercial Banking (CMB), Corporate,
Investment Banking and Markets (CIBM), Private Banking (PB) and Other segments
are described on pages 5-6 of HUSI's 2004 Form 10-K.
Effective for the first quarter of 2005, the following table reflects 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 and
retained interests in securitized receivable trusts purchased from HSBC Finance
Corporation, and consumer loans purchased from originating lenders pursuant to
HSBC Finance Corporation correspondent loan programs, begun in 2003.
The PFS segment continues to include credit card receivables acquired on a daily
basis, related to account relationships which HUSI sold to HSBC Finance
Corporation in 2004.
The net interest income component in the following 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 $84 million for
the first six months of 2004, with the offsetting decrease to PFS revenues.
33
The following table summarizes the results for each segment.
-------------------------------------------------------------------------------------------------------------------
PFS CF CMB CIBM PB Other Total
-------------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended June 30:
2005
Net interest income (1) $ 302 $ 166 $ 155 $ 123 $ 42 $ (3) $ 785
Other revenues ......... 86 67 48 98 104 10 413
--------- --------- --------- --------- --------- --------- ---------
Total revenues ......... 388 233 203 221 146 7 1,198
Operating expenses (2) . 248 110 90 172 64 -- 684
--------- --------- --------- --------- --------- --------- ---------
Working contribution ... 140 123 113 49 82 7 514
Provision for credit
losses (3) ........... 22 152 4 (7) (1) -- 170
--------- --------- --------- --------- --------- --------- ---------
Income before income
tax expense .......... $ 118 $ (29) $ 109 $ 56 $ 83 $ 7 $ 344
========= ========= ========= ========= ========= ========= =========
Average assets ......... $ 50,088 $ 18,608 $ 15,708 $ 55,430 $ 5,146 $ 315 $ 145,295
Average liabilities/
equity (4) ........... 44,598 644 17,176 73,357 9,508 12 145,295
Goodwill at June 30 (5) 1,167 -- 468 631 428 -- 2,694
2004
Net interest income (1). $ 261 $ 49 $ 147 $ 203 $ 31 $ (2) $ 689
Other revenues ......... 76 -- 48 117 52 5 298
--------- --------- --------- --------- --------- --------- ---------
Total revenues ......... 337 49 195 320 83 3 987
Operating expenses (2) . 239 4 93 126 58 -- 520
--------- --------- --------- --------- --------- --------- ---------
Working contribution ... 98 45 102 194 25 3 467
Provision for credit
losses (3) ........... 26 1 6 (27) -- -- 6
--------- --------- --------- --------- --------- --------- ---------
Income before income
tax expense .......... $ 72 $ 44 $ 96 $ 221 $ 25 $ 3 $ 461
========= ========= ========= ========= ========= ========= =========
Average assets ......... $ 38,755 $ 4,203 $ 13,657 $ 45,399 $ 3,814 $ 297 $ 106,125
Average liabilities/
equity (4) ........... 33,484 (3) 15,556 48,097 8,991 -- 106,125
Goodwill at June 30 (5) 1,209 -- 495 631 428 -- 2,763
(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 June 30, 2004 to June 30, 2005 resulted
from the sale or transfer of certain domestic and foreign operations
during 2004.
34
-------------------------------------------------------------------------------------------------------------------
PFS CF CMB CIBM PB Other Total
-------------------------------------------------------------------------------------------------------------------
(in millions)
Six months ended June 30:
2005
Net interest income (1) $ 602 $ 296 $ 309 $ 277 $ 82 $ (6) $ 1,560
Other revenues ........ 214 147 86 265 162 17 891
--------- --------- --------- --------- --------- --------- ---------
Total revenues ........ 816 443 395 542 244 11 2,451
Operating expenses (2) 499 217 188 306 128 -- 1,338
--------- --------- --------- --------- --------- --------- ---------
Working contribution .. 317 226 207 236 116 11 1,113
Provision for credit
losses (3) .......... 44 261 (1) (25) (2) -- 277
--------- --------- --------- --------- --------- --------- ---------
Income before income
tax expense ......... $ 273 $ (35) $ 208 $ 261 $ 118 $ 11 $ 836
========= ========= ========= ========= ========= ========= =========
Average assets ........ $ 50,418 $ 18,446 $ 15,316 $ 54,273 $ 4,934 $ 312 $ 143,699
Average liabilities/
equity (4) .......... 44,168 589 16,679 72,803 9,454 6 143,699
2004
Net interest income (1) $ 529 $ 86 $ 289 $ 382 $ 62 $ (5) $ 1,343
Other revenues ........ 139 -- 85 283 113 12 632
--------- --------- --------- --------- --------- --------- ---------
Total revenues ........ 668 86 374 665 175 7 1,975
Operating expenses (2) 469 6 174 239 120 -- 1,008
--------- --------- --------- --------- --------- --------- ---------
Working contribution .. 199 80 200 426 55 7 967
Provision for credit
losses (3) .......... 43 3 (3) (61) (2) -- (20)
--------- --------- --------- --------- --------- --------- ---------
Income before income
tax expense ......... $ 156 $ 77 $ 203 $ 487 $ 57 $ 7 $ 987
========= ========= ========= ========= ========= ========= =========
Average assets ........ $ 35,919 $ 3,499 $ 13,363 $ 46,089 $ 3,714 $ 297 $ 102,881
Average liabilities/
equity (4) .......... 32,554 (2) 14,106 47,054 9,169 -- 102,881
(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 June 30, 2004 to June 30, 2005 resulted
from the sale or transfer of certain domestic and foreign operations
during 2004.
All increases and decreases referred to on the following pages for the second
quarter 2005 and for the first six 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.
35
Personal Financial Services (PFS)
Net interest income increased $41 million (16%) in the second quarter and
increased $73 million (14%) in the first half of 2005, due primarily to:
o significant growth in average balances for residential mortgage loans,
particularly adjustable rate products, partially offset by the lower
average yields on the adjustable rate loans;
o more favorable interest rate spreads on personal deposits; and
o offset by $16 million of amortization of premium paid during the first
half of 2005 for credit card receivables acquired on a daily basis from
HSBC Finance Corporation. These receivables are related to various credit
card relationships sold to HSBC Finance Corporation in 2004.
Other revenues increased $10 million (13%) in the second quarter and increased
$75 million (54%) in the first half of 2005, due primarily to the following:
o non-interest residential mortgage banking revenue increased $4 million in
the second quarter and increased $51 million in the first half of 2005.
Commentary regarding residential mortgage banking revenue begins on page
27 of this Form 10-Q;
o in May 2005, HUSI sold property to an unaffiliated third party.
Approximately $14 million of the gain realized on this sale was 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 half of 2005.
Operating expenses increased $9 million (4%) in the second quarter and increased
$30 million (6%) for the first half of 2005, due primarily 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.
Consumer Finance (CF)
This segment includes the $12 billion private label receivable portfolio (PLRP)
acquired in December 2004 from HSBC Finance Corporation, and other consumer
loans acquired from HSBC Finance Corporation and their correspondents beginning
in 2003. The following table summarizes the impact of the PLRP on earnings for
this segment for the first half of 2005.
----------------------------------------------------------------
Six months ended June 30, 2005 PLRP Other Total
----------------------------------------------------------------
(in millions)
Net interest income ................... $ 181 $ 115 $ 296
Other revenues ........................ 147 -- 147
----- ----- -----
Total revenues ........................ 328 115 443
Operating expenses .................... 208 9 217
----- ----- -----
Working contribution .................. 120 106 226
Provision for credit losses ........... 248 13 261
----- ----- -----
Income (loss) before income tax expense $(128) $ 93 $ (35)
===== ===== =====
Interest income for the PLRP has been partially offset by approximately $285
million of amortization of the initial premium paid for the portfolio. Although
the amortization period for the initial premium is two years, amortization is
heavily front loaded for 2005 in relation to runoff of the receivable balances
purchased.
Other revenues for the PLRP for the first half of 2005 is comprised of the
following:
o approximately $78 million of credit card and other fees from customers;
and
o approximately $69 million of securitization revenue from residual
interests in securitized credit card receivables acquired as part of the
PLRP purchase.
36
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 of $248 million for the PLRP for the first half
of 2005 is consistent with historical experience for this portfolio. Commentary
regarding credit quality begins on page 39 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, HSBC Finance Corporation's domestic private label business will
change the required minimum monthly payment amounts for their domestic private
label credit card accounts. Preliminary estimates of the potential impact to the
CF segment are based on numerous assumptions and take into account a number of
factors that are difficult to predict, such as changes in customer behavior,
which will not be fully known or understood until the changes are implemented.
It is anticipated that the changes, which will reduce the premium associated
with these daily purchases, reduce fee income, and increase the provision for
credit losses beginning in 2006, will not have a material impact on consolidated
results. However, this change may have a material impact on the results of the
CF segment in 2006.
Commercial Banking (CMB)
Net interest income increased $8 million (5%) in the second quarter and $20
million (7%) in the first half of 2005, resulting from 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 deposits during 2005.
During the third 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 expansions noted above.
Operating expenses increased $14 million (8%) for the first half of 2005 as a
direct result of business expansion initiatives and increased fees paid to HTSU
for technology services as HUSI has continued to upgrade its technology
environment.
Corporate, Investment Banking and Markets (CIBM)
Net interest income decreased $80 million (39%) in the second quarter and
decreased $105 million (27%) in the first half of 2005. Recent increases in
short-term interest rates, which have favorably impacted interest rate spreads
for deposit generating businesses such as PFS and CMB, have had an adverse
impact on CIBM funding costs in 2005.
Other revenues decreased $19 million (16%) in the second quarter and decreased
$18 million (6%) in the first half of 2005. Decreased trading revenues resulting
from difficult market conditions in the second quarter of 2005 were partially
offset by increased fee-based income and increased gains on the sale of
securities. Commentary regarding trading revenues and securities gains begins on
page 30 of this Form 10-Q.
Operating expenses increased $46 million (37%) in the second quarter and
increased $67 million (28%) in the first half of 2005, due to:
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.
37
The provision for credit losses increased $20 million (74%) in the second
quarter and increased $36 million (59%) in the first half of 2005. The net
provision credit of $61 million for the first half of 2004 reflected a period of
unusually low loan charge offs and relatively high recoveries of amounts
previously charged off. The net provision credit of $25 million for the first
half of 2005 resulted from continuation of relatively low charge offs, and a
specific $17 million recovery of a loan previously charged off.
Private Banking (PB)
Net interest income increased $11 million (35%) in the second quarter and
increased $20 million (32%) in the first half of 2005. Average earning assets
associated with this segment, primarily commercial loans, increased
approximately 39% for the first half of the year. Operating expenses have also
increased as additional resources have been allocated to this segment to expand
the services provided to high net worth domestic and foreign individuals.
Other revenues includes the following transactions 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, which was recorded in
other revenues; 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.
38
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
six months of 2005.
The following table provides an analysis of changes in the allowance for credit
losses and related ratios.
----------------------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
Quarter ended 2005 2005 2004 2004 2004
----------------------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of quarter ............. $ 773 $ 788 $ 340 $ 347 $ 357
Allowance related to acquisitions and
(dispositions), net ........................ -- -- 505 (11) --
Charge offs:
Commercial .......................... 17 6 22 18 11
Consumer:
Residential mortgages ........... 6 4 5 2 3
Credit card receivables ......... 160 159 17 17 16
Other consumer loans ............ 23 30 6 6 5
-------- --------- ------------ ------------- ---------
Total consumer loans ............ 189 193 28 25 24
-------- --------- ------------ ------------- ---------
Total charge offs ................... 206 199 50 43 35
-------- --------- ------------ ------------- ---------
Recoveries on loans charged off:
Commercial .......................... 7 23 12 16 14
Consumer:
Residential mortgages ........... -- -- 1 -- 1
Credit card receivables ......... 37 44 2 2 2
Other consumer loans ............ 9 10 2 2 2
-------- --------- ------------ ------------- ---------
Total consumer loans ............ 46 54 5 4 5
-------- --------- ------------ ------------- ---------
Total recoveries .................... 53 77 17 20 19
-------- --------- ------------ ------------- ---------
Total net charge offs ................... 153 122 33 23 16
-------- --------- ------------ ------------- ---------
Provision charged (credited) to income:
Commercial .......................... (1) (25) (45) 3 (19)
Consumer:
Residential mortgages ........... 12 (1) 11 3 4
Credit card receivables ......... 141 108 9 14 18
Other consumer loans ............ 18 25 1 7 3
-------- --------- ------------ ------------- ---------
Total consumer loans ........ 171 132 21 24 25
-------- --------- ------------ ------------- ---------
Total provision ..................... 170 107 (24) 27 6
-------- --------- ------------ ------------- ---------
Balance at end of quarter ............... $ 790 $ 773 $ 788 $ 340 $ 347
======== ========= ============ ============= =========
Allowance ratios:
Annualized net charge offs to average
loans .............................. .71% .58% .19% .14% .11%
Quarter-end allowance to:
Quarter-end total loans ......... .90% .90% .93% .51% .56%
Quarter-end total nonaccruing
loans .......................... 351.11% 318.11% 298.48% 117.24% 116.05%
39
The following table provides a summary of credit quality statistics.
------------------------------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
2005 2005 2004 2004 2004
------------------------------------------------------------------------------------------------------------------------
(in millions)
Nonaccruing loans
Balance at end of period:
Commercial:
Construction and other real
estate ........................... $ 29 $ 28 $ 33 $ 24 $ 33
Other commercial .................. 81 99 117 152 161
--------- --------- ------------ ------------ --------
Total commercial .................. 110 127 150 176 194
--------- --------- ------------ ------------ --------
Consumer:
Residential mortgages ............. 115 116 113 94 82
Credit card receivables ........... -- -- -- 19 20
Other consumer loans .............. -- -- 1 1 3
--------- --------- ------------ ------------ --------
Total consumer loans .............. 115 116 114 114 105
--------- --------- ------------ ------------ --------
Total nonaccruing loans ..................... $ 225 $ 243 $ 264 $ 290 $ 299
========= ========= ============ ============ ========
As a percent of loans:
Commercial:
Construction and other real
estate ........................... .33% .33% .40% .30% .43%
Other commercial .................. .53 .66 .80 1.18 1.35
--------- --------- ------------ ------------ --------
Total commercial .................. .46 .54 .65 .84 .99
--------- --------- ------------ ------------ --------
Consumer:
Residential mortgages ............. .24 .24 .24 .22 .21
Credit card receivables ........... -- -- -- 1.69 1.75
Other consumer loans .............. -- -- .03 .05 .15
--------- --------- ------------ ------------ --------
Total consumer loans .............. .18 .18 .18 .25 .25
--------- --------- ------------ ------------ --------
Total ....................................... .26% .28% .31% .43% .48%
========= ========= ============ ============ ========
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 ....... $ 7 $ 5 $ 6 $ 5 $ 5
Amount actually recorded .................... 1 3 5 5 4
Accruing loans contractually past due 90 days
or more as to principal or interest:
Total commercial ............................ $ 7 $ 13 $ 13 $ 15 $ 6
--------- --------- ------------ ------------ --------
Residential mortgages ....................... -- 1 1 2 1
Credit card receivables ..................... 206 210 223 3 2
Other consumer loans ........................ 14 15 22 16 13
--------- --------- ------------ ------------ --------
Total consumer loans ................... 220 226 246 21 16
--------- --------- ------------ ------------ --------
Total accruing loans contractually past due
90 days or more ............................ $ 227 $ 239 $ 259 $ 36 $ 22
========= ========= ============ ============ ========
Criticized assets (balance at end of period):
Special mention ............................. $ 706 $ 728 $ 784 $ 734 $ 673
Substandard ................................. 761 535 590 383 532
Doubtful .................................... 28 34 46 67 66
--------- --------- ------------ ------------ --------
Total ....................................... $ 1,495 $ 1,297 $ 1,420 $ 1,184 $ 1,271
========= ========= ============ ============ ========
Impaired loans:
Balance at end of period .................... $ 102 $ 119 $ 236 $ 252 $ 281
Amount with impairment reserve .............. 79 96 210 233 263
Impairment reserve .......................... 19 21 18 38 38
Other real estate and owned assets:
Balance at end of period .................... $ 25 $ 20 $ 15 $ 14 $ 17
Ratio of total nonaccruing loans, other real
estate and owned assets to total assets .... .17% .19% .20% .25% .28%
40
Overview
The allowance for credit losses increased $17 million (2%) during the second
quarter of 2005 and increased $2 million (less than 1%) during the first six
months of 2005. Total provision for credit losses of $277 million for the first
six months of 2005 was offset by total net charge offs of $275 million.
The allowance for credit losses increased $443 million from June 30, 2004 to
June 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.
Commercial Loan Credit Quality
The allowance for credit losses associated with commercial loan portfolios
decreased $11 million during the second quarter and decreased $20 million during
the first six months of 2005. For the first six months of 2005 net recoveries of
$7 million were more than offset by a $27 million credit in the provision for
credit losses associated with commercial loans.
General improvement of commercial loan credit quality continued during the
second quarter, as evidenced by decreased nonaccruing loan balances, and
decreased impaired loans balances.
Criticized assets classified as "substandard" increased $226 million during the
quarter, 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 in 2005 among all classifications.
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.
41
Credit Card Receivable Credit Quality
The allowance for credit losses associated with credit card receivables
increased $18 million in the second quarter and increased $11 million during the
first six months of 2005. Net charge offs of $238 million in the first six
months of 2005 were more than offset by provision for credit losses expense of
$249 million. This activity is a direct result of the private label receivable
portfolio acquired from HSBC Finance Corporation in December 2004, which
primarily consisted of credit card receivables. The acquired portfolio is
considered to be prime credit quality, with historical credit losses ranging
from 5%-6% over the past few years.
The following table provides certain credit quality data for credit card
receivables. Credit card credit quality was generally stable in the first six
months of 2005. The June 30, 2004 data pertains to HUSI's credit card portfolio
held prior to acquisition of the private label receivable portfolio.
---------------------------------------------------------------------------------------------------------------
June 30, March 31, December 31, June 30,
2005 2005 2004 2004
---------------------------------------------------------------------------------------------------------------
(in millions)
Accruing credit card receivables contractually past due
90 days or more:
Balance at end of quarter ............................. $ 206 $ 210 $ 223 $ 2
As a percent of total credit card receivables ......... 1.60% 1.75% 1.85% .17%
Allowance for credit losses associated with credit card
receivables:
Balance at end of quarter ............................. $ 559 $ 541 $ 548 $ 50
As a percent of total credit card receivables ......... 4.34% 4.51% 4.54% 4.37%
Net charge offs of credit card receivables:
Total for the quarter ended ........................... $ 123 $ 115 $ 15 $ 14
Annualized net charge offs as a percent of
average credit card receivables for the quarter ..... 3.89% 3.83% 4.05% 4.98%
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 $10 million in the second quarter and in the first six
months of 2005. Provision for credit losses expense of $54 million for the first
six months of 2005, primarily associated with various installment lending
portfolios, was partially offset by net charge offs of $44 million, also
primarily from installment lending portfolios.
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.
42
The following table presents credit risk exposure and net fair value associated
with derivative contracts. Total fair value of derivative receivables reflects
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. The net fair value of all
derivative contracts represents the total fair value previously described, less
the net liability balance representing revaluation losses from the marking to
market of derivative contracts held for trading purposes.
------------------------------------------------------------------------------------------------
June 30, December 31,
2005 2004
------------------------------------------------------------------------------------------------
(in millions)
Credit risk exposure associated with derivative contracts:
Total fair value of derivative receivables ................. $ 7,523 $ 9,607
Collateral held against exposure ........................... (2,234) (4,091)
----------- ------------
Net credit risk exposure ......................................... $ 5,289 $ 5,516
=========== ============
Net fair value of all derivative contracts ....................... $ (18) $ (249)
=========== ============
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.
------------------------------------------------------------------------------------------------
June 30, December 31,
2005 2004
------------------------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards ....................................... $ 75,679 $ 79,830
Swaps ...................................................... 1,527,997 1,219,657
Options written ............................................ 133,899 105,582
Options purchased .......................................... 124,805 90,635
----------- ------------
1,862,380 1,495,704
----------- ------------
Foreign exchange:
Swaps, futures and forwards ................................ 272,722 234,424
Options written ............................................ 37,232 42,719
Options purchased .......................................... 38,344 43,200
Spot ....................................................... 50,691 21,927
----------- ------------
398,989 342,270
----------- ------------
Commodities, equities and precious metals:
Swaps, futures and forwards ................................ 55,538 40,876
Options written ............................................ 12,200 10,648
Options purchased .......................................... 13,790 11,729
----------- ------------
81,528 63,253
----------- ------------
Credit derivatives ............................................... 286,161 135,937
----------- ------------
Total ............................................................ $ 2,629,058 $ 2,037,164
=========== ============
43
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
June 30, 2005 or Less Five Years Years Total
--------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations .. $ 3,796 $ 1,854 $ 129 $ 5,779 (1)
Commercial letters of credit ...................... 911 38 -- 949
Loan sales with recourse .......................... -- 1 8 9 (2)
Credit derivative contracts ....................... 2,263 137,007 13,478 152,748 (3)
Commitments to extend credit:
Commercial .................................. 18,673 22,694 3,572 44,939
Consumer .................................... 6,346 -- -- 6,346
Commitments to deliver mortgage backed securities . 2,827 -- -- 2,827
Securities lending indemnifications ............... 4,547 -- -- 4,547
--------- ---------- --------- ----------
Total ............................................. $ 39,363 $ 161,594 $ 17,187 $ 218,144
========= ========== ========= ==========
(1) Includes $460 million issued for the benefit of related parties.
(2) $7 million of this amount is indemnified by third parties.
(3) Includes $19,211 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 $18 million and $15 million at June 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 $26 million and $28 million at
June 30, 2005 and December 31, 2004 respectively.
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. At June 30, 2005, the fair value of that
collateral was approximately $4,636 million.
VARIABLE INTEREST ENTITIES (VIEs)
--------------------------------------------------------------------------------
The following table provides information for unconsolidated VIEs. Descriptions
of these VIE relationships are included in pages 111-112 of HUSI's 2004 Form
10-K.
--------------------------------------------------------------------------------------------------------
June 30, 2005 December 31, 2004
----------------------- -----------------------
Maximum Maximum
Total Exposure Total Exposure
Assets to Loss Assets to Loss
--------------------------------------------------------------------------------------------------------
(in millions)
Asset backed commercial paper conduits ............ $ 8,640 $ 5,969 $ 5,657 $ 5,867
Securitization vehicles ........................... 1,080 546 1,062 552
Investment funds .................................. 2,257 -- 2,832 36
Capital funding vehicles .......................... 1,093 32 1,093 32
Low income housing tax credits .................... 1,112 110 994 88
--------- ---------- --------- ----------
Total ............................................. $ 14,182 $ 6,657 $ 11,638 $ 6,575
========= ========== ========= ==========
44
Asset Backed Commercial Paper Conduits
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 its own receivables into the financing entity, has no ownership
interest, 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 $1.3 billion at June 30, 2005. These facilities
are excluded from the table summarizing HUSI's involvement in VIEs.
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" June 30, December 31,
Minimum 2005 2004
-------------------------------------------------------------------------------------------------------------
Total capital (to risk weighted assets)
HUSI .................................................... 10.00% 12.67% 12.53%
HBUS .................................................... 10.00 12.65 12.46
Tier 1 capital (to risk weighted assets)
HUSI .................................................... 6.00 8.74 8.34
HBUS .................................................... 6.00 8.99 8.66
Tier 1 capital (to average assets)
HUSI .................................................... 3.00 6.84 7.20
HBUS .................................................... 5.00 7.10 7.51
Tangible common equity (to risk weighted assets)
HUSI .................................................... 7.03 7.07
HBUS .................................................... 9.01 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 six months of 2005, there have been no significant
changes in policies or approach for managing various types of risk.
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 June 30,
2005, HUSI and HBUS maintained the following long and short-term debt ratings:
--------------------------------------------------------------------------------------------------------
Short-Term Debt Long-Term Debt
----------------------------------- -----------------------------------
Moody's S&P Fitch Moody's S&P Fitch
------- ---- ----- ------- --- -----
HSBC USA Inc. P-1 A-1 F1+ Aa3 A+ AA
HSBC Bank USA, N.A. P-1 A-1+ F1+ Aa2 AA- AA
45
HUSI periodically issues capital instruments to fund balance sheet growth, to
meet cash and capital needs, or to fund investments in subsidiaries. In April
2005, HUSI issued 20,700,000 floating rate non-cumulative preferred shares.
Total proceeds of this issuance, net of transaction fees, were approximately
$500 million.
Commentary regarding growth and composition of the consolidated balance sheet is
provided on pages 19-20 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 six 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 June 30, 2005.
--------------------------------------------------------------------------------
June 30, 2005
--------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit ............................. $ 7.5
PVBP position at period end ................................... 1.0
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 June 30,
2005.
-----------------------------------------------------------------------------------------------------------------
June 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 .. (4)
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.
46
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.
---------------------------------------------------------------------------------------------------------------------
June 30, 2005
----------------------
Amount %
---------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net interest income (reflects projected rate movements on July 1, 2005):
Institutional base earnings movement limit ........................................... (10)
Change resulting from a gradual 200 basis point increase in the yield curve .......... $ (144) (4)
Change resulting from a gradual 200 basis point decrease in the yield curve .......... 328 9
Change resulting from a gradual 100 basis point increase in the yield curve .......... (27)
Change resulting from a gradual 100 basis point decrease in the yield curve .......... 243
Other significant scenarios monitored (reflects projected rate movements on July 1, 2005):
Change resulting from an immediate 100 basis point increase in the yield curve ....... (96)
Change resulting from an immediate 100 basis point decrease in the yield curve ....... 76
Change resulting from an immediate 200 basis point increase in the yield curve ....... (282)
Change resulting from an immediate 200 basis point decrease in the yield curve ....... 55
Change resulting from an immediate 100 basis point increase in short-term rates ...... (159)
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 two important accounting based capital ratios: the tangible common
equity to tangible assets and the tangible common equity to risk weighted
assets. As of June 30, 2005, HUSI had an available for sale securities portfolio
of approximately $16 billion with a net positive mark to market of $38 million
included in tangible common equity of $8 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 $141 million to a net loss of $103 million
with the following results on the tangible capital ratios.
-------------------------------------------------------------------------------
Proforma - Reflecting
25 Basis Points
June 30, 2005 Actual Increase in Rates
-------------------------------------------------------------------------------
Tangible common equity to tangible assets ...... 5.53% 5.48%
Tangible common equity to risk weighted assets . 7.03 6.96
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.
47
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 June 30, 2005
June 30, -------------------------------- December 31,
2005 Minimum Maximum Average 2004
-------------------------------------------------------------------------------------------------------------
(in millions)
Total trading ............................. $ 16 $ 15 $ 46 $ 25 $ 41
Commodities ............................... 2 1 16 4 11
Credit derivatives ........................ 9 5 23 10 9
Equities .................................. 1 -- 2 1 1
Foreign exchange .......................... 5 2 21 10 1
Interest rate ............................. 22 14 48 27 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 six months of 2005 shows that the
largest daily gain was $13 million and the largest daily loss was $9 million.
----------------------------------------------------------------------------------------------------
Three months ended June 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 ..... 11 13 10 16 8 6
----------------------------------------------------------------------------------------------------
Six months ended June 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 ..... 11 23 37 30 14 10
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 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.
48
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.
---------------------------------------------------------------------------------------------------------------------
June 30, 2005 Values
----------------------
Amount %
---------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects
projected rate movements on July 1, 2005):
Value of hedged MSRs portfolio ....................................................... $ 285
Change resulting from an immediate 50 basis point decrease in the yield curve:
Change limit (no worse than) ...................................................... (4)
Calculated change in net market value ............................................. (4) (1)
Change resulting from an immediate 50 basis point increase in the yield curve:
Change limit (no worse than) ...................................................... (2)
Calculated change in net market value ............................................. 7 2
Change resulting from an immediate 100 basis point increase in the yield curve:
Change limit (no worse than) ...................................................... (3)
Calculated change in net market value ............................................. 12 4
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 June 30, 2005
------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(4) to $(2) to $0 to Over
(in millions) $(4) $(2) $0 $2 $2
Number of trading weeks market risk-related
revenue was within the stated range....... -- 2 4 4 3
------------------------------------------------------------------------------------------------
Six months ended June 30, 2005
------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(4) to $(2) to $0 to Over
(in millions) $(4) $(2) $0 $2 $2
Number of trading weeks market risk-related
revenue was within the stated range....... 1 4 6 9 6
49
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 46 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. The
disclosure controls and procedures are designed to ensure that information
required to be disclosed by HUSI in the reports we file 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 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 control 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 subsidiary
of a foreign registrant, HUSI is required to comply with Section 404 of the Act
for the fiscal year ending December 31, 2006.
50
Part II - OTHER INFORMATION
--------------------------------------------------------------------------------
Item 5 - Other Information
As approved by the Audit and Examining Committee of the Board of
Directors, HUSI has engaged KPMG to perform certain non-audit
services during 2005, including tax compliance and consultation
services, litigation support services and general accounting
consultation services.
Item 6 - Exhibits
3(i) Registrant's Restated Certificate of Incorporation and
Amendments thereto, Exhibit 3(i) to HUSI's March 31, 2005
Report on Form 10-Q, incorporated herein by reference.
(ii) Registrant's By-Laws, as Amended and Restated, Exhibit
3(ii) to HUSI's March 31, 2005 Report on Form 10-Q,
incorporated herein by reference.
4 Instruments Defining the Rights of Security Holders,
including Indentures, incorporated by reference to
previously filed periodic reports.
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.
51
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: August 1, 2005 /s/ Joseph R. Simpson
-------------------------------------------
Joseph R. Simpson
Chief Accounting Officer
(On behalf of Registrant)
52
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: 01 August 2005