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Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2001
Commission file number 1-7436
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
452 Fifth Avenue
New York, New York 10018
(Address of principal executive offices)
Telephone: (212) 525-3735
IRS Employer Identification No.: State of Incorporation:
13-2764867 Maryland
Securities registered on the New York Stock Exchange pursuant to Section 12(b)
of the Act:
Depositary Shares, each representing a one-fourth interest in a
share of Adjustable Rate Cumulative Preferred Stock, Series D
$1.8125 Cumulative Preferred Stock
$2.8575 Cumulative Preferred Stock
7% Subordinated Notes due 2006
8.375% Debentures due 2007
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) had 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [X]
All voting stock (704 shares of Common Stock $5 par value) is owned by HSBC
North America Inc., an indirect wholly owned subsidiary of HSBC Holdings plc.
Documents incorporated by reference: None
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This page is intentionally left blank.
2
T A B L E O F C O N T E N T S
Page
Part I
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1. Business 4
2. Properties 6
3. Legal Proceedings 6
4. Submission of Matters to a Vote of Security Holders 7
Part II
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5. Market for the Registrant's Common Equity and
Related Stockholder Matters 7
6 Selected Financial Data 8
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
7A. Quantitative and Qualitative Disclosures About
Market Risk 36
8. Financial Statements and Supplementary Data 41
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 93
Part III
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10. Directors and Executive Officers of the Registrant 93
11. Executive Compensation 97
12. Security Ownership of Certain Beneficial Owners
and Management 100
13. Certain Relationships and Related Transactions 100
Part IV
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14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 101
3
PART I
Item 1. Business
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Overview
HSBC USA Inc. (the Company) is a New York State based bank holding company
registered under the Bank Holding Company Act of 1956, as amended. At December
31, 2001, the Company had assets of $87.1 billion and employed approximately
14,100 full and part time employees.
All of the Company's common stock is owned by HSBC North America Inc. (HNAI), an
indirect wholly owned subsidiary of HSBC Holdings plc (HSBC). HSBC, the ultimate
parent company of HSBC Bank plc, The Hongkong and Shanghai Banking Corporation
Limited (HongkongBank), and other financial services companies, is an
international banking and financial services organization with major commercial
and investment banking franchises operating in the Asia-Pacific region, Europe,
the Americas, the Middle East and Africa. The principal executive offices of
HSBC are located in London, England. HSBC, with assets of $696 billion at
December 31, 2001, is one of the world's largest banking and financial services
organizations.
The Company's principal subsidiary HSBC Bank USA (the Bank), had assets of $84.2
billion and deposits of $58.2 billion at December 31, 2001. The Company also is
a participant in a joint venture, Wells Fargo HSBC Trade Bank.
The Bank's domestic operations encompass the State of New York as well as two
branches in Pennsylvania, eight branches in Florida and three branches in
California. Selected commercial and consumer banking products are offered on a
national basis. The Bank is engaged in a general commercial banking business,
offering a full range of banking products and services to individuals, including
high-net-worth individuals, corporations, institutions and governments. Through
its affiliation with HSBC, the Bank offers its customers access to global
markets and services. In turn, the Bank plays a role in the delivery and
processing of other HSBC products. In addition to its domestic offices, the Bank
maintains foreign branch offices, subsidiaries and/or representative offices in
the Caribbean, Europe, Panama, Asia, Latin America and Australia.
Acquisitions and Divestitures
On April 1, 2001, the Bank acquired approximately a 5 percent interest in the
voting shares of HSBC Republic Bank (Suisse) S.A. (Swiss Bank), an affiliate
wholly owned by the HSBC Group, in exchange for the contribution to the Swiss
Bank of private banking businesses conducted by the Bank's Singapore and Hong
Kong branches. The 5 percent interest represents the fair value estimate of the
businesses transferred to the Swiss Bank and is being accounted for using the
equity method of accounting. The Bank retained its banknotes activities in
Singapore and its banknotes and foreign currency businesses in Hong Kong, and
maintained its branch licenses in both locations.
The transaction was another step in an internal reorganization of the HSBC
Group's global private banking operations, which began late last year. The Swiss
Bank, a Switzerland based banking affiliate, will manage much of the HSBC
Group's worldwide private banking business. Swiss Bank is a foreign bank
chartered and regulated under the banking laws of Switzerland.
4
PART I
Item 1. Business Continued
================================================================================
On January 1, 2001, the Bank acquired the Panama branches of HSBC Bank plc for
approximately $22 million in cash. The purchase included two branches in Panama
City, one in the Colon Free Trade Zone, one in Colon and one in Aguadulce. The
Bank acquired approximately $500 million in assets and assumed $450 million in
customer and bank deposits. The acquisition was accounted for as a transfer of
assets between companies under common control at HSBC Bank plc's historical
cost.
On August 1, 2000, the Company purchased the banking operations of Chase
Manhattan Bank, Panama (Chase Panama). The transaction was accounted for as a
purchase. Accordingly, the results of Chase Panama are included with those of
the Company for the period subsequent to the date of acquisition. The branch
operations had over $750 million in assets and $720 million in deposit
liabilities.
On December 31, 1999, HSBC acquired Republic New York Corporation (Republic),
which it subsequently merged with the Company, and Safra Republic Holdings S.A.,
subsequently renamed HSBC Republic Holdings (Luxembourg) S.A. (HRH). Certain
operations of non-U.S. branches and subsidiaries of the Company have been
transferred to foreign operations of HSBC, such as the sale of a branch in Tokyo
to the Asia Pacific operations of HSBC.
The Bank had a 49% investment in HRH, a holding company, principally engaged in
international private banking and commercial banking with assets of $24.4
billion at December 31, 1999. HSBC held the remaining 51% ownership interest in
HRH. In connection with HSBC's internal international private banking operations
reorganization in December 2000, the Company distributed its interest in HRH to
HNAI, its parent. The distribution, in the form of a return of capital in the
amount of $2.8 billion, included its investment in a Bahamian subsidiary in
addition to the $2.5 billion investment in HRH.
Regulation, Supervision and Capital
The Bank is supervised and routinely examined by the State of New York Banking
Department and the Board of Governors of the Federal Reserve System (the Federal
Reserve), and it is subject to banking laws and regulations which place various
restrictions on and requirements regarding its operations and administration,
including the establishment and maintenance of branch offices, capital and
reserve requirements, deposits and borrowings, investment and lending
activities, payment of dividends and numerous other matters. The Federal Reserve
Act restricts certain transactions between banks and their nonbank affiliates.
The deposits of the Bank are insured by the Federal Deposit Insurance
Corporation (FDIC) and subject to relevant FDIC regulations.
The enactment of the Gramm-Leach-Bliley Act of 1999 (GLB Act), effective
March 11, 2000, provides expanded opportunities for banks, other depository
institutions, insurance companies and securities firms to enter into
combinations that permit a single financial services organization to offer a
more complete line of financial products and services. Further competitive
pressures are anticipated from industry consolidations in the wake of the
passage of the GLB Act. The GLB Act also required banks, securities firms and
insurance companies to adopt written privacy policies, designed to safeguard
5
PART I
Item 1. Business Continued
================================================================================
consumers' privacy, and to provide copies of those policies to their customers
on or before July 1, 2001. The Company devoted significant resources in 2001 to
this endeavor and successfully complied with the GLB Act in a timely manner.
The Company and the Bank are subject to risk-based capital and leverage
guidelines issued by the Federal Reserve. The Federal Reserve is required by law
to take specific prompt actions with respect to financial institutions that do
not meet minimum capital standards. For banks, five capital categories have been
identified, the highest of which is well-capitalized. A well-capitalized bank
must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based
capital ratio of at least 10% and a leverage ratio of at least 5% and not be
subject to a capital directive order. For bank holding companies, regulators
also have guidelines regarding the leverage ratios to be applied to banking
organizations in conjunction with the risk-based capital framework. Under these
guidelines, strong bank holding companies must maintain a minimum leverage ratio
of Tier 1 capital to quarterly average assets of 3%. The Company's and the
Bank's ratios at December 31, 2001 exceeded all ratios required for the
well-capitalized banks and strong bank holding companies.
Competition
The Company and its subsidiaries face competition in all the markets they serve,
competing with other financial institutions, including commercial banks,
investment banks, savings and loan associations, credit unions, consumer finance
companies, money market funds and other non-banking institutions such as
insurance companies, major retailers, brokerage firms and investment companies.
Many of these institutions are not subject to the same laws and regulations
imposed on the Company and its subsidiaries.
Item 2. Properties
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The principal executive offices of the Company are located at 452 Fifth Avenue,
New York, New York 10018, which is owned by the Bank. The principal executive
offices of the Bank are located at One HSBC Center, Buffalo, New York 14203, in
a building under a long-term lease. The Bank has more than 400 other banking
offices in New York State located in 49 counties, two branches in Pennsylvania,
eight branches in Florida and three branches in California. Approximately 40% of
these offices are located in buildings owned by the Bank and the remaining are
located in leased quarters. In addition, there are branch offices and locations
for other activities occupied under various types of ownership and leaseholds in
states other than New York, none of which is materially important to the
respective activities. The Bank owns properties in: Buenos Aires, Argentina;
Santiago, Chile; Panama City, Panama; Montevideo, Uruguay; Punta del Este,
Uruguay and Mexico City, Mexico.
Item 3. Legal Proceedings
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The information contained in Note 26 to the Financial Statements on page 81 of
this report is incorporated herein by reference.
6
PART I
Item 4. Submission of Matters to a Vote of Security Holders
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Reference is made to Item 5.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
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Since all common stock of the Company is owned by HSBC North America Inc.,
shares of the Company's common stock are not listed or traded on a securities
exchange.
7
Item 6. Selected Financial Data
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Year Ended December 31, 2001 2000 (1) 1999 (1) 1998 1997
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in millions
Net interest income $ 2,265.3 $ 2,118.5 $ 1,225.9 $ 1,165.3 $ 1,173.4
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Securities transactions 149.3 28.8 10.1 13.8 17.4
Interest on Brazilian tax settlement -- -- 13.1 32.7 --
Other operating income 946.4 803.6 440.8 413.6 342.0
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Total other operating income 1,095.7 832.4 464.0 460.1 359.4
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Princeton Note Matter 575.0 -- -- -- --
Other operating expenses 1,968.0 1,905.8 827.9 780.2 781.4
Provision for credit losses 238.4 137.6 90.0 80.0 87.4
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Income before taxes and cumulative effect
of accounting change 579.6 907.5 772.0 765.2 664.0
Applicable income tax expense 226.0 338.5 308.3 238.1 193.0
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Income before cumulative effect of
accounting change 353.6 569.0 463.7 527.1 471.0
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Cumulative effect of accounting change -
implementation of SFAS 133, net of tax (0.5) -- -- -- --
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Net income $ 353.1 $ 569.0 $ 463.7 $ 527.1 $ 471.0
=================================================================================================================================
Balances at year end
Total assets $ 87,114 $ 83,035 $ 87,246 $ 33,944 $ 31,518
Goodwill and other acquisition intangibles 2,896 3,229 3,307 335 370
Long-term debt 4,491 5,097 5,885 1,748 1,708
Common shareholder's equity 6,549 6,834 6,717 2,228 2,039
Total shareholders' equity 7,049 7,334 7,217 2,228 2,039
Ratio of shareholders' equity to total assets 8.09% 8.83% 8.27% 6.56% 6.47%
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Selected financial data (2)
Rate of return on
Total assets 0.41% 0.69% 1.35% 1.60% 1.62%
Total common shareholder's equity 4.80 8.22 20.31 24.93 22.93
Total shareholders' equity to total assets 8.50 8.56 6.67 6.44 7.14
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(1) Results of operations and balances for 2000 and 1999 were restated to
exclude an investment in an entity transferred to HSBC North America Inc.
during 2001.
(2) Based on average daily balances.
HSBC acquired Republic New York Corporation (Republic) and merged it with the
Company on December 31, 1999. The acquisition was accounted for as a purchase by
the Company so that the fair value of the assets and liabilities of Republic are
included in balances as of year end 1999. Accordingly, the results of operations
of Republic are included with those of the Company for the periods subsequent to
the acquisition.
8
Quarterly Results of Operations
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2001
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4th Q 3rd Q 2nd Q 1st Q
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in millions
Net interest income $ 595.0 $ 554.7 $ 571.8 $ 543.8
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Securities transactions 2.6 20.9 56.6 69.2
Other operating income 256.7 254.9 211.6 223.2
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Total other operating income 259.3 275.8 268.2 292.4
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Princeton Note Matter -- 575.0 -- --
Other operating expenses 511.1 481.7 483.6 491.6
Provision for credit losses 95.4 47.5 48.0 47.5
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Income (loss) before taxes and cumulative effect
of accounting change 247.8 (273.7) 308.4 297.1
Applicable income tax expense (credit) 96.3 (106.5) 120.4 115.8
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Income (loss) before cumulative effect of
accounting change 151.5 (167.2) 188.0 181.3
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Cumulative effect of accounting change -
implementation of SFAS 133, net of tax -- -- -- (0.5)
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Net income (loss) $ 151.5 $ (167.2) $ 188.0 $ 180.8
==============================================================================================================================
2000(1)
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4th Q 3rd Q 2nd Q 1st Q
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in millions
Net interest income $ 523.7 $ 539.4 $ 527.4 $ 528.0
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Securities transactions 18.4 9.1 3.7 (2.4)
Other operating income 194.0 202.5 193.8 213.3
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Total other operating income 212.4 211.6 197.5 210.9
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Other operating expenses 488.2 472.4 473.6 471.6
Provision for credit losses 31.0 50.6 28.0 28.0
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Income before taxes 216.9 228.0 223.3 239.3
Applicable income tax expense 81.6 84.4 83.1 89.4
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Net income $ 135.3 $ 143.6 $ 140.2 $ 149.9
==============================================================================================================================
(1) The 2000 quarterly results of operations as reported in the respective Form
10-Q's were restated to exclude an investment in an entity transferred to
HSBC North America Inc. during 2001.
9
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS
The following table shows the average balances of the principal components of
assets, liabilities and shareholders' equity, together with their respective
interest amounts and rates earned or paid on a taxable equivalent basis. Average
balances for 2000 were restated to exclude an investment in an entity
transferred to HSBC North America Inc. during 2001.
2001
---------------------------------------
Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------
Assets
Interest bearing deposits with banks $ 4,467 $ 207.2 4.64%
Federal funds sold and securities purchased under resale agreements 3,588 137.9 3.84
Trading assets 8,429 217.1 2.58
Securities 20,281 1,320.2 6.51
Loans
Domestic
Commercial 16,997 1,060.2 6.24
Consumer
Residential mortgages 17,123 1,247.5 7.29
Other consumer 3,186 344.8 10.83
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Total domestic 37,306 2,652.5 7.11
International 4,135 286.1 6.92
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Total loans 41,441 2,938.6 7.09
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Total earning assets 78,206 $4,821.0 6.16%
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Allowance for credit losses (541)
Cash and due from banks 1,891
Other assets 6,720
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Total assets $ 86,276
=============================================================================================================================
Liabilities and Shareholders' Equity
Interest bearing demand deposits $ 367 $ 2.3 0.61%
Consumer savings deposits 13,158 243.3 1.85
Other consumer time deposits 11,125 503.3 4.52
Commercial, public savings and other time deposits 6,921 222.9 3.22
Deposits in foreign offices 20,264 885.1 4.37
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Total interest bearing deposits 51,835 1,856.9 3.58
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Federal funds purchased and securities sold under repurchase agreements 2,553 78.2 3.06
Other short-term borrowings 7,341 259.0 3.53
Long-term debt 4,835 328.1 6.79
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Total interest bearing liabilities 66,564 $2,522.2 3.79%
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Interest rate spread 2.37%
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Noninterest bearing deposits 5,596
Other liabilities 6,782
Total shareholders' equity 7,334
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Total liabilities and shareholders' equity $ 86,276
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Net yield on average earning assets 2.94%
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Net yield on average total assets 2.66
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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 fees included
were $55 million for 2001, $44 million for 2000 and $36 million for 1999.
10
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS (CONTINUED)
2000 1999
----------------------------------------------- ------------------------------------
Balance Interest Rate Balance Interest Rate
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in millions
Assets
Interest bearing deposits with banks $ 4,425 $ 308.7 6.98% $ 1,795 $ 97.0 5.40%
Federal funds sold and securities
purchased under resale agreements 3,260 215.0 6.59 2,238 116.5 5.21
Trading assets 5,504 140.5 2.55 919 50.8 5.52
Securities 22,158 1,605.2 7.24 3,654 214.7 5.88
Loans
Domestic
Commercial 16,444 1,265.8 7.70 9,927 784.4 7.90
Consumer
Residential mortgages 14,543 1,086.3 7.47 9,382 656.9 7.00
Other consumer 3,189 366.2 11.48 2,432 286.4 11.78
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Total domestic 34,176 2,718.3 7.95 21,741 1,727.7 7.95
International 4,790 355.5 7.42 1,644 115.5 7.02
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Total loans 38,966 3,073.8 7.89 23,385 1,843.2 7.88
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Total earning assets 74,313 $ 5,343.2 7.19% 31,991 $ 2,322.2 7.26%
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Allowance for credit losses (606) (379)
Cash and due from banks 1,794 1,046
Other assets 7,287 1,572
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Total assets $ 82,788 $ 34,230
================================================================================================================================
Liabilities and Shareholders' Equity
Interest bearing demand deposits $ 676 $ 8.0 1.18% $ 248 $ 2.3 0.91%
Consumer savings deposits 12,462 313.5 2.52 7,620 172.9 2.27
Other consumer time deposits 9,048 467.0 5.16 6,808 308.4 4.53
Commercial, public savings and other
time deposits 7,188 358.3 4.98 4,265 153.3 3.59
Deposits in foreign offices 19,595 1,187.3 6.06 4,584 216.0 4.71
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Total interest bearing deposits 48,969 2,334.1 4.77 23,525 852.9 3.63
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Federal funds purchased and securities
sold under repurchase agreements 2,082 123.8 5.95 951 45.2 4.75
Other short-term borrowings 6,574 320.9 4.88 1,618 84.4 5.21
Long-term debt 5,771 420.3 7.28 1,867 111.7 5.98
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Total interest bearing liabilities 63,396 $ 3,199.1 5.05% 27,961 $ 1,094.2 3.91%
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Interest rate spread 2.14% 3.35%
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Noninterest bearing deposits 6,063 3,111
Other liabilities 6,246 873
Total shareholders' equity 7,083 2,285
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Total liabilities and shareholders' equity $ 82,788 $34,230
================================================================================================================================
Net yield on average earning assets 2.89% 3.84%
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Net yield on average total assets 2.59 3.59
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11
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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The Company reported net income of $353.1 million for 2001 compared with $569.0
million in 2000. Return on average common shareholder's equity was 4.80% in 2001
and 8.22% in 2000. The decrease in net income for 2001 was driven by the $575.0
million charge taken by the Company related to the Princeton Note Matter. See
Note 26, Litigation, for additional information on the Princeton Note Matter.
During 2001, the Company achieved solid growth in income from banking
operations. Net interest income was $2,265.3 million in 2001 compared with
$2,118.5 million in 2000. The increase in net interest income for 2001 reflects
the impact of a larger balance sheet and a wider interest margin. Other
operating income was $1,095.7 million in 2001 compared with $832.4 million in
2000. This increase was driven by growth in wealth management, insurance and
bankcard fees. Also, trading related revenues increased significantly,
reflecting strategic decisions to strengthen trading capabilities, as well as
favorable market conditions for treasury related trading. The results for 2001
benefited from $149.3 million in securities gains. Other operating expenses
excluding the Princeton Note Matter were $1,968.0 million in 2001 compared with
$1,905.8 million in 2000. The increase in other operating expenses reflects
higher costs due to business expansion in trading and treasury, wealth
management and e-commerce, and increased marketing expenses. The provision for
credit losses for 2001 was $238.4 million compared with $137.6 million for 2000.
This increase reflects the general weakness in the U.S. economy coupled with
specific deterioration in markets and business sectors served by the Company.
This report includes forward-looking statements that involve inherent risks and
uncertainties. Statements that are not historical facts, including statements
about management's beliefs and expectations, are forward-looking statements. A
number of important factors could cause actual results to differ materially from
those contained in any forward-looking statements. Such factors include, but are
not limited to: sharp and/or rapid changes in interest rates; significant
changes in the economic conditions which could materially change anticipated
credit quality trends and the ability to generate loans; technology changes;
significant changes in accounting, tax or regulatory requirements; and
competition in the geographic and business areas in which the Company conducts
its operations.
A detailed review comparing 2001 operations with 2000 and 1999 follows. It
should be read in conjunction with the consolidated financial statements of the
Company which begin on page 44.
12
EARNINGS PERFORMANCE REVIEW
Net Interest Income
================================================================================
Net interest income is the total interest income on earning assets less the
interest expense on deposits and borrowed funds. In the discussion that follows,
interest income and rates are presented and analyzed on a taxable equivalent
basis, in order to permit comparisons of yields on tax-exempt and taxable
assets.
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Increase(Decrease) Increase(Decrease)
2001 Amount % 2000 Amount % 1999
- ------------------------------------------------------------------------------------------------------------------------------------
in millions
Interest income $ 4,821.0 $ (522.2) (9.8) $ 5,343.2 $ 3,021.0 130.1 $ 2,322.2
Interest expense 2,522.2 (676.9) (21.2) 3,199.1 2,104.9 192.4 1,094.2
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis 2,298.8 154.7 7.2 2,144.1 916.1 74.6 1,228.0
Less: taxable equivalent
adjustment 33.5 7.9 30.8 25.6 23.5 1,102.6 2.1
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 2,265.3 $ 146.8 6.9 $ 2,118.5 $ 892.6 72.8 $ 1,225.9
- ------------------------------------------------------------------------------------------------------------------------------------
Average earning assets $ 78,206 $ 3,893 5.2 $ 74,313 $ 42,322 132.3 $ 31,991
Average nonearning assets 8,070 (405) (4.8) 8,475 6,236 278.5 2,239
- ------------------------------------------------------------------------------------------------------------------------------------
Average total assets $ 86,276 $ 3,488 4.2 $ 82,788 $ 48,558 141.9 $ 34,230
- ------------------------------------------------------------------------------------------------------------------------------------
Net yield on:
Average earning assets 2.94% .05% 1.7 2.89% (.95)% (24.7) 3.84%
Average total assets 2.66 .07 2.7 2.59 (1.00) (27.9) 3.59
====================================================================================================================================
2001 Compared to 2000
Net interest income was $2,265.3 million in 2001 compared with $2,118.5 million
in 2000. The 6.9% increase in net interest income for 2001 reflects the impact
of a larger balance sheet and a wider interest margin.
Average residential mortgages grew $2.6 billion for 2001 as the mortgage banking
division experienced record levels of production driven by a low rate
environment. Average investment securities decreased $1.9 billion for 2001 as
the Company sold securities, including mortgage backed securities, to adjust to
interest rate changes and to reconfigure exposure to residential mortgages.
Balance sheet growth for 2001 was funded largely by increased levels of consumer
savings and time deposits.
The Federal Reserve lowered short-term interest rates eleven times during 2001.
For the year 2001, the average annual prime rate decreased 2.3% and the average
three month LIBOR rate decreased by 2.8%. The declining interest rate
environment in 2001 led to lower gross yields earned and lower gross rates paid
on liabilities. In addition to the benefit of an increased level of lower cost
personal and commercial deposits, short-term rate cuts led to wider interest
margins in certain commercial businesses, the residential mortgage business and
treasury.
2000 Compared to 1999
The Republic acquisition was the principal factor contributing to the increase
in net interest income and average assets in 2000 as compared to 1999. The
decrease in net yield in 2000 from 1999 was primarily due to a higher
concentration of lower yielding treasury assets and higher costing foreign
deposits as a result of the Republic acquisition. The favorable volume variance
for residential mortgages also reflected loan growth achieved for
13
2000. The overall rate environment for 2000 was higher than 1999, with an
approximate 1.2% increase in average prime rate and a 1.1% increase in the
average three month LIBOR rate year to year. The unfavorable rate variances for
trading assets, domestic commercial loans and credit card receivables for 2000
compared to 1999 reflected the impact of lower yielding Republic assets. The
rate variance for short-term borrowings for 2000 compared to 1999 similarly
reflected the impact of lower rate Republic liabilities.
Forward Outlook
In 2002, the Company will pursue modest growth in high quality commercial loans,
residential mortgages and core personal and commercial deposits, despite a
continuing weak economy. The steeper yield curve which benefited the Company in
the later part of 2001 is expected to continue into the early part of 2002. As
the anticipated economic recovery emerges, the yield curve should be less steep
and interest margins will tighten.
The following table presents net interest income components on a taxable
equivalent basis, using marginal tax rates of 35%, and quantifies the changes in
the components according to "volume and rate".
Net Interest Income Components Including Volume/Rate Analysis
================================================================================
2001 Compared to 2000 2000 Compared to 1999
Increase(Decrease) Increase(Decrease)
2001 Volume Rate 2000 Volume Rate 1999
- ----------------------------------------------------------------------------------------------------------------------------------
in millions
Interest income:
Interest bearing deposits
with banks $ 207.2 $ 2.9 $ (104.4) $ 308.7 $ 176.6 $ 35.1 $ 97.0
Federal funds sold and
securities purchased under
resale agreements 137.9 19.9 (97.0) 215.0 62.1 36.4 116.5
Trading assets 217.1 75.4 1.2 140.5 130.3 (40.6) 50.8
Securities 1,320.2 (129.7) (155.3) 1,605.2 1,329.4 61.1 214.7
Loans
Domestic
Commercial 1,060.2 41.4 (247.0) 1,265.8 502.2 (20.8) 784.4
Consumer
Residential mortgages 1,247.5 188.6 (27.4) 1,086.3 382.8 46.6 656.9
Credit card receivables 162.5 (11.8) (5.8) 180.1 (1.3) (5.5) 186.9
Other consumer 182.3 7.5 (11.3) 186.1 72.4 14.2 99.5
International 286.1 (46.4) (23.0) 355.5 233.1 6.9 115.5
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest income 4,821.0 147.8 (670.0) 5,343.2 2,887.6 133.4 2,322.2
- ----------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest bearing demand deposits 2.3 (2.8) (2.9) 8.0 4.9 .8 2.3
Consumer savings and
other time deposits 746.6 93.5 (127.4) 780.5 253.8 45.4 481.3
Commercial and public savings
and other time deposits 222.9 (12.9) (122.5) 358.3 131.1 73.9 153.3
Deposits in foreign offices 885.1 39.4 (341.6) 1,187.3 893.4 77.9 216.0
Short-term borrowings 337.2 57.2 (164.7) 444.7 312.6 2.5 129.6
Long-term debt 328.1 (64.9) (27.3) 420.3 279.5 29.1 111.7
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 2,522.2 109.5 (786.4) 3,199.1 1,875.3 229.6 1,094.2
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis $ 2,298.8 $ 38.3 $ 116.4 $ 2,144.1 $ 1,012.3 $ (96.2) $ 1,228.0
==================================================================================================================================
The changes in interest income and interest expense due to both rate and volume
have been allocated in proportion to the absolute amounts of the change in each.
14
Other Operating Income
================================================================================
Other operating income was $1,095.7 million in 2001 compared with $832.4 million
in 2000 and $464.0 million in 1999.
- ------------------------------------------------------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
2001 Amount % 2000 Amount % 1999
- ------------------------------------------------------------------------------------------------------------------------------
in millions
Trust income $ 87.6 $ 2.7 3.2 $ 84.9 $ 32.7 62.6 $ 52.2
Service charges 189.0 16.7 9.7 172.3 43.7 33.9 128.6
Mortgage banking revenue 79.4 46.9 144.3 32.5 2.0 6.7 30.5
Letter of credit fees 61.0 7.5 13.9 53.5 21.0 64.6 32.5
Credit card fees 64.1 8.1 14.5 56.0 9.4 20.4 46.6
Other fee-based income 136.6 4.8 3.7 131.8 75.7 134.8 56.1
Investment product fees 67.8 8.8 14.8 59.0 26.6 82.1 32.4
Interest on Brazilian
tax settlement -- -- -- -- (13.1) -- 13.1
Other income 62.0 (11.4) (15.5) 73.4 21.5 41.5 51.9
- ------------------------------------------------------------------------------------------------------------------------------
Nontrading income 747.5 84.1 12.7 663.4 219.5 49.5 443.9
- ------------------------------------------------------------------------------------------------------------------------------
Trading revenues
Treasury business and other 266.0 125.8 89.7 140.2 130.2 1,300.0 10.0
Residential mortgage related (67.1) (67.1) -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Total trading revenues 198.9 58.7 41.9 140.2 130.2 1,300.0 10.0
- ------------------------------------------------------------------------------------------------------------------------------
Securities transactions 149.3 120.5 417.6 28.8 18.7 185.6 10.1
- ------------------------------------------------------------------------------------------------------------------------------
Total other operating income $ 1,095.7 $ 263.3 31.6 $ 832.4 $ 368.4 79.4 $ 464.0
==============================================================================================================================
Nontrading Income
================================================================================
2001 Compared to 2000
Nontrading income was $747.5 million in 2001 compared with $663.4 million in
2000. Wealth management, insurance and bankcard fees all grew during 2001 as
former Republic customers were introduced to new products. Despite a turbulent
equity and fixed income market, brokerage revenues were up $16.3 million or over
25% year to year due in part to higher levels of annuities sales. Insurance
revenues increased $10.1 million or 44% compared to 2000 as sales of life,
property and casualty, and disability insurance through the branch network were
strong. Within the commercial segment, harmonization of HSBC and the former
Republic product lines led to increases in deposit, cash management and loan
related fees. Mortgage banking revenue increased significantly due to higher
levels of gains on sales of mortgages resulting from a mortgage refinancing wave
and the adoption of SFAS 133 on January 1, 2001 which required interest rate
locks and forward sales commitments, previously part of mortgage banking
revenue, to be marked to market through trading revenue. The total dollar amount
of residential mortgages originated for sale was over three times greater than
last year. Offsetting the increase in mortgage banking revenue were losses in
residential mortgage related trading revenue. See trading revenue discussion in
the following section.
2000 Compared to 1999
The Republic acquisition was the principal factor contributing to the increase
in nontrading income in 2000 compared to 1999. In addition, increases in trust
income, investment product fees and insurance income reflect growth achieved in
our domestic wealth management business. Mortgage banking revenue for 2000
increased only slightly as a result of lower gains on sale of mortgages due to
the higher interest rate environment and competitive pricing pressures. The
Company received interest of $13.1 million in 1999 as a result
15
of the settlement of previously disallowed income tax credits on Brazilian debt.
Other income in 1999 included a gain on the sale of a student loan business of
$15.0 million.
Forward Outlook
In 2002, the Company will focus on growth in brokerage, insurance, trust, asset
management and trade service related fees. The Company will utilize its strong
retail distribution network, its improving brand visibility in the United States
as well as its HSBC Group linkage to pursue revenue growth despite a weak
economy. The Company continues to face strong competitive challenges from other
banks and financial service providers to maintain and grow market share in key
customer segments.
Trading Revenues
================================================================================
Trading revenues are generated by the Company's participation in the foreign
exchange and precious metal markets, from trading derivative contracts,
including interest rate swaps and options, from trading securities, and as a
result of certain residential mortgage banking activities classified as trading
revenue due to the adoption of SFAS 133 effective January 1, 2001. The following
table presents trading revenues by business. The data in the table includes net
interest income earned/(paid) on trading instruments, as well as an allocation
by management to reflect the funding benefit or cost associated with the trading
positions.
- ----------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
in millions
Trading revenues - treasury business and other $266.0 $140.2 $10.0
Net interest income 38.6 52.1 4.6
- ----------------------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $304.6 $192.3 $14.6
======================================================================================================================
Business:
Derivatives and treasury $120.2 $ 44.9 $10.0
Foreign exchange 93.1 74.4 4.6
Precious metals 52.6 49.1 --
Other trading 38.7 23.9 --
- ----------------------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $304.6 $192.3 $14.6
======================================================================================================================
Trading revenues - residential mortgage business related $(67.1) $ -- $ --
======================================================================================================================
Treasury Business and Other: 2001 Compared to 2000
Trading related revenues for 2001 increased 58% compared with the prior year.
Foreign exchange trading revenue increased $18.7 million or 25% as the Company
made a strategic decision to strengthen its capabilities in foreign exchange in
the U.S. market. The increase in foreign exchange trading income is a direct
result of that decision as trading volumes with clients and proprietary trading
revenue increased markedly over the prior year. Trading revenue in the Company's
banknote business, included in foreign exchange business results, also increased
in 2001. The Company also decided to expand its derivative capabilities in 2001.
The increased derivatives related trading revenues reflects increased client
activity and expanded product offerings. The Company was able to take advantage
of falling U.S. interest rates and price volatility to more than double its
domestic treasury business related trading revenue in 2001. Precious metals
trading revenue increased 7% in 2001 as the Company capitalized on interest rate
movements in those markets as well as profiting from precious metals option
trading.
16
Treasury Business and Other: 2000 Compared to 1999
The Republic acquisition was the principal factor contributing to the increase
for 2000 as compared to 1999. Overall market conditions for 2000 were stable.
During the second half of 2000, the flatter yield curve reduced opportunities in
some markets.
Treasury Business and Other: Forward Outlook
The Company expects to build on its expanded capabilities in foreign exchange
and interest rate derivatives to grow dealing related revenues during 2002.
However, these revenues will be under pressure from low economic growth on a
global basis. Downward pressure on U.S. interest rates is anticipated until
signs of economic recovery emerge, at which time the yield curve is expected to
be less steep. Net interest margins in treasury will decline reflecting
higher-margin securities sold in 2001 and the flatter yield curve as the economy
begins to improve.
Residential Mortgage Business Related
In conjunction with the adoption of the Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133) on January 1, 2001, certain derivative financial instruments
including interest rate lock commitments granted to customers, forward sales
commitments associated with originated mortgage loans held for sale, and
instruments used to protect against the decline in economic value of mortgage
servicing rights, are recorded as trading positions. The mark to market of these
instruments recognized during 2001 was a loss of $39.7 million relating to
mortgage servicing rights and a loss of $27.4 million relating to mortgage loans
held for sale. In prior periods, the value of the interest rate lock commitments
and forward sale commitments were considered in the determination of the lower
of cost or market for loans held for sale and the ultimate gain or loss on sale
of mortgages. The economic hedges on mortgage servicing rights were considered
in assessing whether or not impairment needed to be recognized. Both were
reported as a component of mortgage banking revenue.
Securities Transactions
================================================================================
Gains for 2001 resulted from the sale of investments classified as available for
sale and from the redemption of certain held to maturity securities. Securities
transactions during 2001 resulted in net gains of $149.3 million compared with
net gains of $28.8 million in 2000. Gains for 2001 were primarily realized from
securities sales to adjust to interest rate changes and to reconfigure exposure
to residential mortgages. The gains for 2001 included a first quarter one-time
gain of $19.3 million on the sale of shares in Canary Wharf, a retail/office
development investment project in London, England. Gains for 2001 also included
$11.2 million on the sale of investment securities acquired to help protect
against the decline in economic value of mortgage servicing rights. During the
fourth quarter of 2001, the Company recognized losses of $38.2 million as it
significantly reduced its holdings of Brazilian securities.
17
Other Operating Expenses
===========================================================================================================================
Increase(Decrease) Increase(Decrease)
2001 Amount % 2000 Amount % 1999
- ---------------------------------------------------------------------------------------------------------------------------
in millions
Salaries and employee benefits $ 1,000.4 $ 25.0 2.6 $ 975.4 $ 554.1 131.5 $ 421.3
Net occupancy 155.5 (11.7) (7.0) 167.2 78.2 88.0 89.0
Equipment and software 129.4 14.4 12.5 115.0 61.3 114.3 53.7
Goodwill amortization 176.5 .3 .2 176.2 142.9 428.6 33.3
Marketing 39.9 5.6 16.3 34.3 9.9 40.9 24.4
Outside services 114.9 9.6 9.1 105.3 56.2 114.6 49.1
Professional fees 41.2 2.9 7.6 38.3 16.2 73.2 22.1
Telecommunications 41.7 6.5 18.5 35.2 18.0 104.8 17.2
Postage, printing and office
supplies 32.9 (.6) (1.9) 33.5 12.3 57.9 21.2
Princeton Note Matter 575.0 575.0 -- -- -- -- --
Other 235.6 10.2 4.5 225.4 128.8 133.3 96.6
- ---------------------------------------------------------------------------------------------------------------------------
Total other operating expenses $ 2,543.0 $ 637.2 33.4 $ 1,905.8 $ 1,077.9 130.2 $ 827.9
- ---------------------------------------------------------------------------------------------------------------------------
Personnel - average number 14,441 26 .2 14,415 5,509 61.9 8,906
===========================================================================================================================
2001 Compared to 2000
Other operating expenses were $2,543.0 million in 2001 compared with $1,905.8
million in 2000. The increase in other operating expenses reflects a $575.0
million third quarter charge taken by the Company to reflect the resolution of
the Princeton Note Matter as well as higher costs due to business expansion in
trading and treasury, wealth management and e-commerce, and increased marketing
expenses. See Note 26, Litigation, for additional information on the Princeton
Note Matter. Incentive compensation tied to performance also increased primarily
in the investment, banking and markets business. Average staffing levels (full
time equivalents) were 14,441 in 2001 compared with 14,415 in 2000. Republic
integration related costs for 2001 were $12.1 million. The integration costs do
not include the higher level of equipment and software depreciation incurred
during 2001 on infrastructure investments made during 2000 related to the
Republic acquisition. Caused by the weaker U.S. economy as well as the response
to the events of September 11, airlines have posted large losses, and the
Company made the decision to recognize a charge of $12.0 million for an
off-balance sheet airline exposure, included in other expenses above.
2000 Compared to 1999
The increase in other operating expenses for 2000 over 1999 was due primarily to
the Republic acquisition. Included in total other operating expenses for 2000
was $85.0 million of integration costs related to the Republic acquisition. See
Note 2, Acquisitions for further discussion. Additional expenses were also
incurred in 2000 to support growth in our domestic wealth management business,
as well as information technology related initiatives including a comprehensive
internet banking product for personal banking customers.
Forward Outlook
The Company is positioning itself to operate in a continuing weak economy.
Improving efficiencies and maintaining strict cost disciplines will be a
priority for 2002. Limited infrastructure and personnel related expansion are
anticipated to support continued growth in wealth management and selected
trading related businesses.
18
Provision for Credit Losses
================================================================================
The provision for credit losses is recorded to adjust the allowance for credit
losses to the level that management deems adequate to absorb losses inherent in
the loan and lease portfolio. Such provisions in 2001 were $238.4 million,
compared with $137.6 million in 2000, representing an increase of $100.8
million. This increase reflects the general weakness in the U.S. economy coupled
with specific deterioration in markets and business sectors served by the
Company including large corporate and middle market commercial business,
international sites, as well as the continued concerns over the consumer sector.
The Company experienced a decline in the overall quality of both its commercial
and consumer loan portfolios during the year although it is not directly evident
by analysis of the key credit statistics. In fact, total nonaccruing loans
decreased by $6.4 million to $416.8 million at December 31, 2001 from $423.2
million at December 31, 2000. This decrease however reflects the Company's
decision to liquidate certain problem credits which resulted in the sale of
$84.9 million of nonaccruing commercial loans during the year. Consumer loan
nonaccruals increased by $13.7 million to $118.1 million at December 31, 2001
from $104.4 million a year earlier, primarily attributable to weaknesses in the
residential mortgage sector. Overall key coverage statistics have remained
strong as the allowance for credit losses at December 31, 2001 represented 1.24%
of total loans as compared with 1.30% at December 31, 2000 and 121.5% of total
nonaccruing loans at December 31, 2001, compared with 124.1% at December 31,
2000.
Although total charge offs net of recoveries were $1.0 million less during 2001
compared to 2000, gross charge offs during the same period increased by $7.5
million. This reflects the decision to charge off certain large domestic problem
credits including specific exposure to the energy sector, as well as exposures
in certain international sites, primarily Panama and Argentina.
Criticized assets are loans that the Company has credit-graded either "special
mention", "substandard" or "doubtful". A key indicator of deterioration in
credit quality, criticized assets increased by $158.5 million during the year.
The Company anticipates that the impact of recent world events and the overall
weakness in the domestic and world economies will continue to have a significant
long-term effect on general economic conditions, governmental and corporate
spending priorities, consumer confidence and the general business climate.
Credit quality in all portfolios is a concern and the Company has and will
continue to take decisive action to quickly identify and address problem
situations.
Although the deterioration in the credit portfolios that manifested itself
during the year would be considered modest, a thorough review of the adequacy of
the allowance for credit losses, with consideration given to specific credits
and more general facts and circumstances, was performed during the year. The
provision for credit losses recognized during 2001 was the amount, based upon
the results of this review and in the judgment of management, deemed necessary
to provide for losses inherent in the portfolio.
In 2000, the provision for credit losses was $137.6 million compared with $90.0
million in 1999. Net charge offs in the credit card portfolio were $60.2 million
and $74.9 million in 2000 and 1999, respectively. Commercial loan net charge
offs were $166.3 million in 2000 compared with $8.7 million in 1999. Although
the overall credit quality of the portfolio remained sound, there was some
deterioration in the quality of highly leverage credits in 2000. These
constituted a small portion of total loans.
19
An analysis of the allowance for credit losses and the provision for credit
losses begins on page 33.
Income Taxes
================================================================================
The Company recognized income tax expense of $226.0 million and $338.5 million
in 2001 and 2000, respectively. The reduction in income tax expense for 2001 is
principally due to the decrease in pretax income.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss carryforwards. At December 31, 2001, the Company had a
net deferred tax asset of $328.1 million, as compared with a net deferred tax
asset of $92.4 million at December 31, 2000. The increase in the net deferred
tax asset for 2001 is primarily due to the Princeton Note Matter.
Business Segments
================================================================================
The Company reports and manages its business segments consistently with the line
of business groupings used by HSBC. As a result of HSBC line of business
changes, the Company altered its business segments that it uses in 2001. Prior
year disclosures have been conformed to the presentation of current segments.
The Company has four distinct segments that it uses for management reporting:
commercial banking; corporate, investment banking and markets; personal
financial services; and private banking. A description of each segment and the
methodologies used to measure financial performance are included in Note 24,
Business Segments, to the financial statements. The following summarizes the
results for each segment.
20
Corporate,
Investment Personal
Commercial Banking and Financial Private
Banking Markets Services Banking Other Total
- -------------------------------------------------------------------------------------------------------------------------
in millions
2001
Net interest income (1) $ 646 $ 426 $ 1,099 $ 94 $ -- $ 2,265
Other operating income 191 455 393 57 -- 1,096
- -------------------------------------------------------------------------------------------------------------------------
Total income 837 881 1,492 151 -- 3,361
Operating expenses (2) 452 349 871 120 575 2,367
- -------------------------------------------------------------------------------------------------------------------------
Working contribution 385 532 621 31 (575) 994
Provision for credit losses (3) 90 80 62 6 -- 238
- -------------------------------------------------------------------------------------------------------------------------
CMBT* 295 452 559 25 (575) 756
- -------------------------------------------------------------------------------------------------------------------------
Average assets 17,562 41,485 23,944 3,285 -- 86,276
Average liabilities/equity (4) 13,124 30,010 31,703 11,295 144 86,276
- -------------------------------------------------------------------------------------------------------------------------
2000
Net interest income (1) $ 598 $ 447 $ 971 $ 103 $ -- $ 2,119
Other operating income 151 235 376 70 -- 832
- -------------------------------------------------------------------------------------------------------------------------
Total income 749 682 1,347 173 -- 2,951
Operating expenses (2) 415 311 882 121 -- 1,729
- -------------------------------------------------------------------------------------------------------------------------
Working contribution 334 371 465 52 -- 1,222
Provision for credit losses (3) 68 34 37 (1) -- 138
- -------------------------------------------------------------------------------------------------------------------------
CMBT* 266 337 428 53 -- 1,084
Average assets 16,147 41,911 21,325 3,405 -- 82,788
Average liabilities/equity (4) 12,249 28,441 31,234 10,864 -- 82,788
- -------------------------------------------------------------------------------------------------------------------------
1999
Net interest income (1) $ 369 $ 165 $ 692 $ -- $ -- $ 1,226
Other operating income 104 77 283 -- -- 464
- -------------------------------------------------------------------------------------------------------------------------
Total income 473 242 975 -- -- 1,690
Operating expenses (2) 183 73 539 -- -- 795
- -------------------------------------------------------------------------------------------------------------------------
Working contribution 290 169 436 -- -- 895
Provision for credit losses (3) 21 12 57 -- -- 90
- -------------------------------------------------------------------------------------------------------------------------
CMBT* 269 157 379 -- -- 805
- -------------------------------------------------------------------------------------------------------------------------
Average assets 9,141 9,692 15,397 -- -- 34,230
Average liabilities/equity (4) 6,983 8,846 18,401 -- -- 34,230
- -------------------------------------------------------------------------------------------------------------------------
*Contribution margin before tax represents pretax income (loss) excluding
goodwill amortization.
(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.
Commercial Banking
This segment contributed $295 million to CMBT in 2001. Growth in CMBT over 2000
was $29 million or 11%. The increase in net interest income for 2001 reflects
growth achieved in commercial deposits and real estate lending, an improved
margin in real estate lending and the impact of the Panama branch acquisitions.
Increased fees for commercial loans and deposit servicing/cash management were
the principal factors behind the growth in other operating
21
income. The expense increase for 2001 was principally due to the full year
impact of the Panama branch acquisitions. Higher provisions for credit losses
reflect the weaker economic conditions during 2001, with losses concentrated in
receivable and inventory lending portfolios.
Corporate, Investment Banking and Markets
This segment contributed $452 million to CMBT in 2001. Growth in CMBT over 2000
was $115 million or 34%. The increase in CMBT was driven by higher levels of
other operating income. Higher levels of trading revenues were earned as the
Company expanded its capabilities in foreign exchange, derivatives and other
trading. The Company was also able to take advantage of falling U.S. interest
rates as well as price volatility to significantly increase treasury related
trading revenue. Other operating income was up significantly year to year due to
gains realized from securities sales to adjust to interest rate changes and to
reconfigure exposure to residential mortgages. These security sales contributed
to the lower level of net interest income earned for 2001 in this business
segment. The increase in operating expenses reflects the higher costs associated
with the previously noted business expansions in traded markets as well as
increases in incentive compensation tied to performance. The higher provision
for credit losses reflects losses related to a single large corporate in the
energy sector.
Personal Financial Services
This segment contributed $559 million to CMBT in 2001. Growth in CMBT over 2000
was $131 million or 31%. The increase in net interest income for 2001 reflects
the impact of a larger balance sheet and a wider interest margin. Average
residential mortgages grew $2.6 billion for 2001, as the mortgage banking
division experienced record levels of production driven by a low rate
environment. Wider interest margins earned on residential mortgages and customer
deposits also contributed to increased net interest income. The growth in other
operating income reflects growth in wealth management fees, deposit service
charges and insurance. In conjunction with the adoption of SFAS 133 on January
1, 2001, mark to market losses were recognized in other operating income in the
residential mortgage business. Mark to market losses of $39.7 million related to
mortgage servicing rights and $27.4 million related to mortgage loans held for
sale were recorded in 2001. The increased provision for credit losses reflects a
weaker economy and higher delinquency rates on consumer loans.
Private Banking
This segment contributed $25 million to CMBT in 2001. CMBT decreased $28 million
or 53% compared to 2000. The lower level of other operating income was driven by
losses on sale of securities, as the Company significantly reduced its holdings
of Brazilian securities. The migration of international private banking business
in Asia to other HSBC Group members also contributed to lower revenues. Higher
operating expenses required to build the business were offset by lower costs
associated with above noted migration of Asian business.
Other
This segment for 2001 includes the expenses associated with the Princeton Note
settlement.
22
BALANCE SHEET REVIEW
Risk Management
================================================================================
The Company's organizational structure includes a Risk Management Committee
comprised of senior officers to oversee the risk management process. This
committee is charged with the review of the internal control framework which
identifies, measures, monitors and controls the risks undertaken by the various
business and support units and the Company as a whole. It is responsible for the
review of all risks associated with significant new products and activities and
their primary internal controls prior to implementation. The spectrum of risks
includes, but is not limited to, liquidity, market, credit, operational, legal
and reputational risk. The Asset and Liability Management Committee manages the
details of liquidity and interest rate risk. The management of credit risk is
further discussed on page 29.
Asset/Liability Management
================================================================================
The principal objectives of asset/liability management are to ensure adequate
liquidity and to manage exposure to interest rate, currency and other market
risks. In managing these risks, the Company seeks to protect both its income
stream and the value of its assets.
Liquidity management requires maintaining funds to meet customers' borrowing and
deposit withdrawal requirements as well as funding anticipated growth. Interest
rate exposure management seeks to control both the near term and longer term
effects of interest rate movements on net interest income and other correlated
income.
The Company has a variety of available techniques for implementing asset/
liability management decisions. Overall balance sheet strategy is centralized
under the Asset and Liability Management Committee, comprised of senior
officers. Authority and responsibility for implementation of the Committee's
broad strategy is controlled under a framework of defined balance sheet position
limits.
The Company employs a combination of market rate risk assessment techniques,
principally dynamic simulation modeling, capital at risk analysis, gap analysis
and Value at Risk (VaR) to assess the sensitivity of its earnings and capital
positions to changes in interest rates. In addition, VaR, stress testing and
other analyses are used for trading activities. In dynamic simulation modeling,
the primary technique currently used, reactions to a range of possible future
positive and negative interest rate movements are projected with consideration
given to known activities and to the behavioral patterns of specific pools of
assets and liabilities in the corresponding rate environments. The optionality
of some instruments such as mortgage backed securities and the mortgage loan
portfolio is taken into consideration. VaR attempts to capture the potential
loss resulting from unfavorable market developments within a given time horizon
(typically 10 days) and given a certain confidence level (99%). Management of
market risk is further discussed on page 36.
Diversification is also a principle employed in asset/liability management. The
Company is an active participant in international banking markets. Managing this
activity requires diversification of the risks among many countries and
counterparties throughout the world. Liabilities, which are
23
primarily interest bearing deposits and other purchased funds, are obtained from
both domestic and international sources. These sources of funds represent a wide
range of depositors, mostly individuals, and product types. The stability of the
funding base is enhanced by the diversification of the funding sources.
On January 1, 2001 the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133) as amended by SFAS 137 and SFAS 138. As further described in the
Summary of Significant Accounting Policies beginning on page 49, SFAS 133
requires that all derivative financial instruments be recognized at fair value
on the balance sheet. To the extent these derivatives qualify for special hedge
accounting under SFAS 133, changes in their value may be offset by the
corresponding mark to market of hedged assets, liabilities, firm commitments or
for forecasted transactions, deferred as a component of shareholder's equity
until the transaction occurs. The ineffective portion of the change in value of
a derivative in a qualifying hedge relationship and derivative contracts that do
not qualify for hedge accounting under SFAS 133 are recognized currently in
earnings. Although the adoption of SFAS 133 resulted in the liquidation of
certain derivative contracts previously identified as qualifying hedges and the
mark to market as trading positions of many others, the Company pursues several
SFAS 133 qualifying hedge strategies.
Specifically, within the context of its overall balance sheet risk management
strategy, interest rate swap and futures contracts are utilized to protect
against changes in fair values and cash flows associated with certain balance
sheet assets, liabilities, forecasted transactions and firm commitments in order
to maintain net interest margin within a range that management considers
acceptable. Additionally, forward contracts are utilized to hedge the foreign
currency risk associated with available for sale debt securities. To achieve
this objective, the Company has identified and currently pursues several
qualifying SFAS 133 hedge strategies.
Interest rate swaps that call for the receipt of a variable market rate and the
payment of a fixed rate are utilized under fair value strategies to hedge the
risk associated with changes in the risk free rate component of the value of
certain fixed rate investment securities. Interest rate swaps that call for the
receipt of a fixed rate and payment of a variable market rate are utilized to
hedge the risk associated with changes in the risk free rate component of
certain fixed rate debt obligations.
Similarly, interest rate swaps that call for the receipt of a variable market
rate and the payment of a fixed rate are utilized under the cash flow strategy
to hedge the forecasted repricing of certain deposit liabilities.
Increased earnings volatility will result from the on-going mark to market of
certain economically viable derivative contracts that do not satisfy the
qualifying hedge requirements of SFAS 133, as well as from the hedge
ineffectiveness associated with the qualifying contracts. The Company expects
however that it will be able to continue to pursue its overall asset and
liability risk management objectives using a combination of derivatives and cash
instruments.
Liquidity Management
================================================================================
Liquidity is managed to provide the ability to generate cash to meet lending,
deposit withdrawal and other commitments at a reasonable cost in a reasonable
amount of time, while maintaining routine operations and market confidence. The
Asset Liability Management Committee is responsible for the development
24
and implementation of related policies and procedures to ensure that the minimum
liquidity ratios and a strong overall liquidity position are maintained.
In carrying out this responsibility, the Asset Liability Management Committee
projects cash flow requirements and determines the optimal level of liquid
assets and available funding sources to have at the Company's disposal, with
consideration given to anticipated deposit and balance sheet growth, contingent
liabilities, and the ability to access short-term wholesale funding markets. In
addition, the Committee must monitor deposit and funding concentrations in terms
of overall mix and to avoid undue reliance on individual funding sources and
large deposit relationships. They must also maintain a liquidity management
contingency plan, which identifies certain potential early indicators of
liquidity problems, and actions which can be taken both initially and in the
event of a liquidity crisis to minimize the long-term impact on the Company's
business and customer relationships.
Deposit accounts from a diverse mix of "core" retail, commercial and public
sources represent a significant, cost-effective source of liquidity under normal
operating conditions. The Company's ability to regularly attract wholesale funds
at a competitive cost is enhanced by strong ratings from the major credit
ratings agencies. As of December 31, 2001, the Company and its principal
operating subsidiary, HSBC Bank USA, 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+ A1 A+ AA-
HSBC Bank USA P-1 A-1+ F1+ Aa3 AA- AA-
The Company has filed a shelf registration statement with the Securities and
Exchange Commission under which it may issue up to $1.1 billion in debt and
equity securities and has ready access to the capital markets for long-term
funding through the issuance of registered debt. In addition, the Company
maintains an unused $500 million bank line of credit with HSBC, and as member of
the New York Federal Home Loan Bank, a secured borrowing facility in excess of
$5 billion collateralized by residential mortgage loan assets. Off-balance sheet
special purpose vehicles or other off-balance sheet mechanisms are not utilized
as a material source of liquidity or funding.
Assets, principally consisting of a portfolio of highly rated investment
securities in excess of $20 billion, approximately $2 billion of which is
scheduled to mature during 2002, a liquid trading portfolio of approximately $9
billion, and residential mortgages are a primary source of liquidity to the
extent that they can be sold or used as collateral for borrowing. The economics
and long-term business impact of obtaining liquidity from assets must be weighed
against the economics of obtaining liquidity from liabilities, along with
consideration given to the associated capital ramifications of these two
alternatives. Currently, assets supplement liquidity derived from liabilities,
only in a crisis scenario.
It is the policy of the Bank to maintain both primary and secondary collateral
in order to ensure precautionary borrowing availability from the Federal
Reserve. Primary collateral is that which is physically maintained at the
Federal Reserve, and serves as a safety net against any unexpected funding
shortfalls that may occur. Secondary collateral is collateral that is acceptable
to the Federal Reserve, but is not maintained there. If unutilized borrowing
capacity were to be low, secondary collateral would be identified and maintained
as necessary.
25
With over $15 billion of available wholesale short-term funding at its disposal,
the Company has ample liquidity to handle almost any crisis scenario. For
example, in the event that the Company had no ability to access the wholesale
liability markets and additional funding of commercial credit lines and letters
of credit totaling up to $5 billion were to occur, there would still be more
than $5 billion of surplus cash to meet any additional withdrawals or funding
requirements.
Contractual Obligations and Commercial Commitments
================================================================================
As disclosed in the notes to the consolidated financial statements, the Company
has certain obligations and commitments to make future payments under contracts.
The following table provides information related to contractual obligations.
- ------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2001 or Less Five Years Years Total
- ------------------------------------------------------------------------------------------------------------------
in millions
Subordinated long-term debt and
perpetual capital notes $ 646 $ 300 $1,753 $ 2,699
Guaranteed mandatorily redeemable
securities -- -- 750 750
Other long-term debt, including
capital lease obligations 191 240 602 1,033
Minimum future rental commitments
on operating leases 62 188 97 347
- ------------------------------------------------------------------------------------------------------------------
Total $ 899 $ 728 $3,202 $ 4,829
==================================================================================================================
The following table provides information related to commercial commitments.
- ------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2001 or Less Five Years Years Total
- ------------------------------------------------------------------------------------------------------------------
in millions
Standby letters of credit,
other letters of credit and
financial guarantees $ 4,452 $ 991 $ 140 $ 5,583
Commitments to extend credit 19,897 7,766 981 28,644
Commitments to deliver mortgage-
backed securities 2,122 -- -- 2,122
- ------------------------------------------------------------------------------------------------------------------
Total $26,471 $8,757 $1,121 $36,349
==================================================================================================================
Interest Rate Sensitivity
================================================================================
The Company is subject to interest rate risk associated with the repricing
characteristics of its balance sheet assets and liabilities. Specifically, as
interest rates change, interest earning assets reprice at intervals that do not
correspond to the maturities or repricing patterns of interest bearing
liabilities. This mismatch between assets and liabilities in repricing
sensitivity results in shifts in net interest income as interest rates move.
To help manage the risks associated with changes in interest rates, and to
optimize net interest income within ranges of interest rate risk that management
considers acceptable, the Company uses derivative instruments such as interest
rate swaps, options, futures and forwards as hedges to modify the repricing
characteristics of specific assets, liabilities, forecasted transactions or firm
commitments.
The following table shows the repricing structure of assets and liabilities as
of December 31, 2001. For assets and liabilities whose cash flows are subject
26
to change due to movements in interest rates, such as the sensitivity of
mortgage loans to prepayments, data is reported based on the earlier of expected
repricing or maturity. The resulting "gaps" are reviewed to assess the potential
sensitivity to earnings with respect to the direction, magnitude and timing of
changes in market interest rates. Data shown is as of one day, and one day
figures can be distorted by temporary swings in assets or liabilities.
- -----------------------------------------------------------------------------------------------------------------------
Interest Bearing Funds
Noninterest ------------------------------------------------
Bearing 0-90 91-180 181-365 Over 1
December 31, 2001 Funds Days Days Days Year Total
- -----------------------------------------------------------------------------------------------------------------------
in millions
Assets $ 9,399 $ 39,366 $ 2,582 $ 5,197 $ 30,570 $87,114
Liabilities and shareholders'
equity 18,974 42,609 3,918 5,010 16,603 87,114
- -----------------------------------------------------------------------------------------------------------------------
(9,575) (3,243) (1,336) 187 13,967 --
Effect of derivative contracts -- 3,809 100 (3,060) (849) --
- -----------------------------------------------------------------------------------------------------------------------
Gap position $ (9,575) $ 566 $(1,236) $ (2,873) $ 13,118 $ --
=======================================================================================================================
Liabilities and shareholders' equity at year-end 2001 include time deposits of
$100,000 or more with maturity dates as follows: $2,987.8 million, 0-90 days;
$545.1 million, 91-180 days; $412.6 million, 181-365 days, and $210.4 million
over 1 year.
The Company does not use the static "gap" measurement of interest rate risk
reflected in the table above as a primary management tool. See pages 36 through
38 for further description of earnings at risk measurements and dynamic
simulation modeling employed by the Company to manage interest rate risk.
Commercial Loan Maturities and Sensitivity to Changes in Interest Rates
================================================================================
The following table presents the contractual maturity and interest sensitivity
of domestic commercial and international loans at year end 2001.
- -------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2001 or Less Five Years Years
- -------------------------------------------------------------------------------------------------------
in millions
Domestic:
Construction and mortgage loans $ 1,169 $2,832 $1,953
Other business and financial 7,025 3,452 87
International 2,448 821 267
- -------------------------------------------------------------------------------------------------------
Total $10,642 $7,105 $2,307
=======================================================================================================
Loans with fixed interest rates $ 4,028 $2,759 $2,013
Loans having variable interest rates 6,614 4,346 294
- -------------------------------------------------------------------------------------------------------
Total $10,642 $7,105 $2,307
=======================================================================================================
Securities Portfolios
================================================================================
Debt securities that the Company has the ability and intent to hold to maturity
are reported at amortized cost. Securities acquired principally for the purpose
of selling them in the near term are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings.
All other securities are classified as available for sale and carried at fair
value, with unrealized gains and losses included in accumulated other
comprehensive income and reported as a separate component of shareholders'
equity.
27
The following table is an analysis of the carrying values of the securities
portfolios at the end of each of the last three years.
- ----------------------------------------------------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------ ----------------
December 31, 2001 2000 1999 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
in millions
U.S. Treasury $ 372 $ 323 $ 1,522 $ -- $ -- $ --
U.S. Government agency 8,068 9,119 16,383 3,882 3,530 4,092
Obligations of U.S. states and
political subdivisions -- -- -- 769 730 678
Asset backed securities 3,485 3,166 3,017 -- -- --
Other domestic debt securities 739 1,487 1,418 -- -- --
Foreign debt securities 2,435 2,555 1,805 -- -- --
Equity securities 646 687 472 -- -- --
- ----------------------------------------------------------------------------------------------------------------------
Total $15,745 $17,337 $24,617 $4,651 $4,260 $4,770
======================================================================================================================
Equity securities in the table above include Federal Reserve Bank and Federal
Home Loan Bank stock totaling $478 million at December 31, 2001, $463 million at
December 31, 2000 and $238 million at December 31, 1999.
The following table reflects the distribution of maturities of debt securities
held at year-end 2001 together with the approximate taxable equivalent yield of
the portfolio. The yields shown are calculated by dividing annual interest
income, including the accretion of discounts and the amortization of premiums,
by the amortized cost of securities outstanding at December 31, 2001. Yields on
tax-exempt obligations have been computed on a taxable equivalent basis using
applicable statutory tax rates.
Securities - Contractual Final Maturities and Yield
================================================================================
Within After One After Five After
Taxable One but Within but Within Ten
equivalent Year Five Years Ten Years Years
basis Amount Yield Amount Yield Amount Yield Amount Yield
- -------------------------------------------------------------------------------------------------------------------------
in millions
Available for sale:
U.S. Treasury $ 2 -% $ 196 2.76% $ 160 3.69% $ 8 .37%
U.S. Government agency 8 6.37 1,191 6.19 636 6.19 6,129 6.12
Asset backed securities 4 2.31 1,222 3.85 1,100 2.84 1,125 2.78
Other domestic debt
securities 333 1.67 109 5.20 44 4.75 192 4.08
Foreign debt securities 160 5.49 977 5.34 753 5.65 525 7.37
- -------------------------------------------------------------------------------------------------------------------------
Total amortized cost $ 507 2.95% $3,695 4.98% $2,693 4.00% $7,979 5.68%
- -------------------------------------------------------------------------------------------------------------------------
Total fair value $ 515 $3,788 $2,714 $8,082
=========================================================================================================================
Held to maturity:
U.S. Government agency $ 17 7.44% $ 143 7.25% $ 319 7.19% $3,403 7.13%
Obligations of U.S.
states and political
subdivisions 5 10.50 39 10.81 144 9.08 581 8.89
- -------------------------------------------------------------------------------------------------------------------------
Total amortized cost $ 22 8.10% $ 182 8.01% $ 463 7.78% $3,984 7.38%
- -------------------------------------------------------------------------------------------------------------------------
Total fair value $ 23 $ 191 $ 484 $4,142
=========================================================================================================================
The maturity distribution of U.S. Government agency obligations and other
securities which include asset backed securities, primarily mortgages, are based
on the contractual due date of the final payment. These securities have
28
an anticipated cash flow that includes contractual principal payments and
estimated prepayments generally resulting in shorter average lives than those
based on contractual maturities.
Credit Risk Management
================================================================================
The credit approval and policy function is centralized under the control of the
Chief Credit Officer. The structure is designed to emphasize credit decision
accountability, optimize credit quality, facilitate control of credit policies
and procedures and encourage consistency in the approach to, and management of,
the credit process throughout the Company.
The Risk Management Committee is responsible for oversight of the credit risk
profile of the loan portfolio. The Chief Credit Officer is responsible for the
design and management of the credit function including monitoring and making
changes, where appropriate, to written credit policies.
In addition to active supervision and evaluation by lending officers, periodic
reviews of the loan portfolio are made by internal auditors, independent
auditors, the Board of Directors and regulatory agency examiners. These reviews
cover selected borrowers' current financial position, past and prospective
earnings and cash flow, and realizable value of collateral and guarantees. These
reviews also serve as an early identification of problem credits.
Loans Outstanding
================================================================================
The following table provides a breakdown of major loan categories as of year end
for the past five years.
- -------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
in millions
Domestic:
Commercial:
Construction and mortgage loans $ 5,954 $ 5,646 $ 5,648 $ 3,096 $ 2,235
Other business and financial 10,564 12,551 12,002 7,803 5,811
Consumer:
Residential mortgages 17,951 15,836 13,241 9,467 10,008
Credit card receivables 1,148 1,232 1,290 1,291 1,780
Other consumer loans 1,770 1,640 1,231 1,319 1,179
- -------------------------------------------------------------------------------------------------------------------
37,387 36,905 33,412 22,976 21,013
- -------------------------------------------------------------------------------------------------------------------
International:
Government and official institutions 169 302 444 331 345
Banks and other financial institutions 314 852 727 622 65
Commercial and industrial 2,587 1,946 3,747 120 199
Consumer 466 413 -- -- --
- -------------------------------------------------------------------------------------------------------------------
3,536 3,513 4,918 1,073 609
- -------------------------------------------------------------------------------------------------------------------
Total loans $40,923 $40,418 $38,330 $24,049 $21,622
===================================================================================================================
2001
The decrease in other business and financial commercial loans for 2001 compared
to 2000 reflects the intentional unwinding of marginally profitable
relationships in Corporate Institutional Banking as well as lower levels of
shorter term money market loans. Residential mortgages increased during 2001 as
the mortgage banking division experienced record levels of production driven by
a low rate environment. On January 1, 2001, the Bank acquired approximately $346
million in commercial and consumer loans as a result of the acquisition of the
Panama branches of HSBC Bank plc.
29
2000
In the third quarter of 2000, HSBC acquired Credit Commercial de France. As part
of the consolidation of HSBC's commercial banking activities in the U.S., the
Company acquired a commercial loan portfolio of approximately $500 million of
the New York office of Credit Commercial de France. Additionally, $2.4 billion
of commitments to lend were assumed as part of the acquisition.
In 2000, certain operations of non-U.S. branches and subsidiaries of the Company
were transferred to foreign operations of HSBC. Over $1 billion of international
loans were transferred or sold to other HSBC entities.
In the third quarter of 2000, the Company purchased the banking operations of
Chase Manhattan Bank, Panama. Approximately $390 million of consumer and $220
million of commercial loans were acquired from Chase Panama.
1999
As a result of the Republic acquisition, loans increased approximately $14
billion at December 31, 1999 comprised of $6 billion commercial loans, $4
billion residential mortgages and $4 billion international loans.
1998
In 1998, the Company acquired $1.7 billion of commercial loans from the U.S.
corporate banking unit of the HongkongBank completing the consolidation of
HSBC's commercial banking activities in the U.S. Credit card portfolios of
approximately $370 million were sold in 1998.
1997
Acquisitions in 1997 included a commercial mortgage portfolio of approximately
$400 million and a residential mortgage portfolio of $5.1 billion.
Total loans outstanding included $577 million and $783 million at year ends 2001
and 2000, respectively, to HSBC Group members. With respect to other business
and financial commercial loans, no single industry group's aggregate borrowings
from the Company exceeded 10% of the total loan portfolio at December 31, 2001.
Problem Loan Management
================================================================================
Borrowers who experience difficulties in meeting the contractual payment terms
of their loans receive special attention. Depending on circumstances, decisions
may be made to cease accruing interest on such loans.
The Company complies with regulatory requirements which mandate that interest
not be accrued on commercial loans with principal or interest past due for a
period of ninety days unless the loan is both adequately secured and in process
of collection. In addition, commercial loans are designated as nonaccruing when,
in the opinion of management, reasonable doubt exists with respect to
collectibility of all interest and principal based on certain factors, including
adequacy of collateral.
Interest that has been recorded but unpaid on loans placed on nonaccruing status
generally is reversed and reduces current income at the time loans are so
categorized. Interest income on these loans may be recognized to the extent of
cash payments received. In those instances where there is doubt as
30
to collectibility of principal, any cash interest payments received are applied
as principal reductions. Loans are not reclassified as accruing until interest
and principal payments are brought current and future payments are reasonably
assured.
Risk Elements in the Loan Portfolio at Year End
=================================================================================================================
2001 2000 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------
in millions
Nonaccruing loans:
Domestic:
Construction and other commercial
real estate $ 28 $ 35 $ 83 $104 $129
Other commercial loans 238 253 160 141 74
Consumer loans 118 104 95 92 107
- -----------------------------------------------------------------------------------------------------------------
Subtotal 384 392 338 337 310
International 33 31 6 -- 1
- -----------------------------------------------------------------------------------------------------------------
Total nonaccruing loans 417 423 344 337 311
Other real estate and owned assets 18 21 14 9 12
- -----------------------------------------------------------------------------------------------------------------
Total nonaccruing loans, other real estate
and owned assets $435 $444 $358 $346 $323
=================================================================================================================
Ratios:
Nonaccruing loans to total loans 1.02% 1.05% .90% 1.40% 1.44%
Nonaccruing loans, other real estate
and owned assets to total assets .50 .53 .41 1.02 1.02
- -----------------------------------------------------------------------------------------------------------------
Accruing loans contractually past due
90 days or more as to principal or
interest (all domestic):
Residential real estate mortgages $ 1 $ -- $ 13 $ 2 $ 1
Credit card receivables -- 1 1 5 33
Other consumer loans 9 12 3 10 10
All other 12 29 23 13 13
- -----------------------------------------------------------------------------------------------------------------
Total accruing loans contractually past
due 90 days or more $ 22 $ 42 $ 40 $ 30 $ 57
=================================================================================================================
In certain situations where the borrower is experiencing temporary cash flow
problems, and after careful examination by management, the interest rate and
payment terms may be adjusted from the original contractual agreement. When this
occurs and the revised terms at the time of renegotiation are less than the
Company would be willing to accept for a new loan with comparable risk, the loan
is separately identified as restructured.
Nonaccruing loans at December 31, 2001 totaled $417 million compared with $423
million a year ago. Of the nonaccruing loans at December 31, 2001 over 35% are
less than 30 days past due as to cash payment of principal and interest.
Nonaccruing loans that have been restructured but remain on nonaccruing status
amounted to $3 million, $8 million and $32 million at December 31, 2001, 2000
and 1999, respectively. During 2001, $84.9 million of nonaccruing commercial
loans were sold. Cash payments received on loans on nonaccruing status during
2001, or since loans were placed on nonaccruing status, whichever was later,
totaled $51 million, $19 million of which was recorded as interest income and
$32 million as reduction of loan principal.
Residential mortgages are generally designated as nonaccruing when delinquent
for more than ninety days. Loans to credit card customers that are past due more
than ninety days are designated as nonaccruing if the customer has agreed to
credit counseling. Other consumer loans are generally not designated as
nonaccruing and are charged off against the allowance for credit losses
according to an established delinquency schedule.
31
The Company identified impaired loans totaling $243 million at December 31, 2001
of which $151 million had an allocation from the allowance of $83 million. At
December 31, 2000, identified impaired loans were $224 million, of which $109
million had an allocation from the allowance of $46 million.
Cross-Border Net Outstandings
================================================================================
The following table presents total cross-border net outstandings in accordance
with Federal Financial Institutions Examination Council (FFIEC) guidelines.
Cross-border net outstandings are amounts payable to the Company by residents of
foreign countries regardless of the currency of claim and local country claims
in excess of local country obligations. Excluded from cross-border net
outstandings are, among other things, the following: local country claims funded
by non-local country obligations (U.S. dollar or other non-local currencies),
principally certificates of deposits issued by a foreign branch, where the
providers of funds agree that, in the event of the occurrence of a sovereign
default or the imposition of currency exchange restrictions in a given country,
they will not be paid until such default is cured or currency restrictions
lifted or, in certain circumstances, they may accept payment in local currency
or assets denominated in local currency (hereinafter referred to as constraint
certificates of deposits); and cross-border claims that are guaranteed by cash
or other external liquid collateral. The Company's cross-border net outstandings
at December 31, 2000 excluded $682 million of Brazilian assets funded by
constraint certificates of deposit.
Cross-border net outstandings include deposits in other banks, loans,
acceptances, securities available for sale, trading securities, revaluation
gains on foreign exchange and derivative contracts and accrued interest
receivable.
Cross-Border Net Outstandings Which Exceed .75% of Total Assets at Year End
=====================================================================================================
Banks and Other Government and Commercial
Financial Official and
Institutions Institutions Industrial(1) Total
- -----------------------------------------------------------------------------------------------------
in millions
December 31, 2001:
Germany $1,145 $35 $ 56 $1,236
December 31, 2000:
France 500 15 135 650
Germany 889 6 77 972
United Kingdom 443 8 208 659
December 31, 1999:
Germany 853 15 60 928
United Kingdom 523 1 265 789
=====================================================================================================
(1) Includes excess of local country claims over local country obligations.
32
Allowance for Credit Losses and Charge Offs
================================================================================
At year end 2001, the allowance was $506 million, or 1.24% of total loans,
compared with $525 million, or 1.30% of total loans, a year ago. The ratio of
the allowance to nonaccruing loans was 121.50% at December 31, 2001 compared
with 124.06% a year earlier.
- --------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
in millions
Total loans at year end $ 40,923 $ 40,418 $ 38,330 $ 24,049 $ 21,622
Average total loans 41,441 38,966 23,385 21,392 20,049
Allowance for credit losses:
Balance at beginning of year $ 525.0 $ 638.0 $ 379.7 $ 409.4 $ 418.2
Allowance related to acquisitions,
net/other (19.0) (11.3) 268.6 -- 40.3
Charge offs:
Commercial:
Construction and mortgage loans 6.7 11.2 -- -- --
Other business and financial 181.3 173.0 27.0 27.9 28.3
Consumer:
Residential mortgages 3.2 5.2 12.1 10.2 7.7
Credit card receivables 65.6 70.9 86.5 105.0 137.2
Other consumer loans 11.2 10.9 9.5 9.5 13.5
International 12.5 1.8 -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Total charge offs 280.5 273.0 135.1 152.6 186.7
- --------------------------------------------------------------------------------------------------------------------------
Recoveries on loans charged off:
Commercial:
Construction and mortgage loans .2 3.3 -- -- --
Other business and financial 28.8 14.6 18.3 22.9 31.3
Consumer:
Residential mortgages 1.0 1.0 1.0 .8 1.0
Credit card receivables 9.1 10.7 11.6 14.9 14.1
Other consumer loans 3.6 4.5 3.9 4.3 3.8
International .1 .2 -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Total recoveries 42.8 34.3 34.8 42.9 50.2
- --------------------------------------------------------------------------------------------------------------------------
Total net charge offs 237.7 238.7 100.3 109.7 136.5
- --------------------------------------------------------------------------------------------------------------------------
Translation adjustment (.3) (.6) -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Provision charged to income 238.4 137.6 90.0 80.0 87.4
- --------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 506.4 $ 525.0 $ 638.0 $ 379.7 $ 409.4
- --------------------------------------------------------------------------------------------------------------------------
Allowance ratios:
Total net charge offs to
average loans .57% .61% .43% .51% .68%
Year-end allowance to:
Year-end total loans 1.24 1.30 1.66 1.58 1.89
Year-end total nonaccruing loans 121.50 124.06 185.72 112.74 131.62
==========================================================================================================================
As described in more detail in the Summary of Significant Accounting Policies
beginning on page 51, the allowance for credit losses is the amount that in the
judgment of management is adequate to absorb estimated losses inherent in the
loan portfolio at the balance sheet date. It includes both an allocated and an
unallocated component.
Management regularly performs an assessment of the adequacy of the allowance by
conducting a detailed review of the loan portfolio. The allocated portion of the
allowance is based upon an evaluation of individual commercial and residential
mortgage loan problem credits resulting in the establishment of specific
reserves against loans that are considered "impaired". In addition,
formula-based reserves are provided against categories of loans where it is
33
deemed probable, based upon analysis of historical data, that a loss will be
incurred at a future date even though it has not yet manifested itself in
specific loan assets.
The Company regularly reviews its loss experience and assesses its loss factors
utilizing current data, to ensure that the allowance for credit losses is
adequate to cover both the estimated but not yet realized losses, and inherent,
historically measurable but yet unidentified losses in its commercial and
consumer loan portfolios. The estimation of inherent losses involves the
determination of formula-based loss factors. These loss factors are developed
and continually updated with consideration given to specific industry forecasts,
concentration risks, and internal audit findings along with trends in
delinquency, nonaccruals and credit classifications. For purposes of this
analysis, commercial loan portfolios are segregated by specific business unit
while consumer loans are segregated by product type.
Management recognizes that there is a high degree of subjectivity and
imprecision inherent in the process of estimating future losses utilizing
historical data. Accordingly, the Company provides additional unallocated
reserves based upon an evaluation of certain other factors including the impact
of the national economic cycle, loss experience within non-criticized loan
portfolios, as well as the concentration of loans to individual counterparties.
As a result of continued economic uncertainty and a weakening overall credit
climate, the Company conducted a thorough review and evaluation of its process
for determining the allowance for credit losses and related provision for credit
losses during the year. Although this resulted in the revision of certain of its
loss reserve factors in light of concerns with regard to specific industry and
business segments, as well as a comprehensive re-evaluation of the adequacy of
the overall unallocated reserve, the overall process for estimating losses
inherent in the credit portfolios was deemed sound. The Company intends to
continually review and update its loss estimation models and techniques, refresh
historical data elements, closely monitor both general economic and specific
business trends and take quick and decisive action, to ensure the overall
adequacy of the allowance for credit losses.
An allocation of the allowance by major loan categories follows.
Allocation of Allowance for Credit Losses
===============================================================================================================================
2001 2000 1999 1998 1997
---------------- ----------------- ---------------- ---------------- ----------------
% of % of % of % of % of
Loans Loans Loans Loans Loans
to to to to to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- -------------------------------------------------------------------------------------------------------------------------------
in millions
Domestic:
Commercial:
Construction and
mortgage loans $ 25 14.6 $ 28 14.0 $ 45 14.8 $ 23 12.8 $ 31 10.4
Other business 224 25.8 163 31.0 163 31.3 62 32.4 53 26.9
Consumer:
Residential mortgages 11 43.9 10 39.2 43 34.5 12 39.4 30 46.3
Credit card receivables 53 2.8 62 3.0 40 3.4 45 5.4 60 8.2
Other consumer 29 4.3 31 4.1 17 3.2 12 5.5 17 5.4
International 105 8.6 117 8.7 116 12.8 31 4.5 26 2.8
Unallocated reserve 59 -- 114 -- 214 -- 195 -- 192 --
- -------------------------------------------------------------------------------------------------------------------------------
Total $ 506 100.0 $ 525 100.0 $ 638 100.0 $ 380 100.0 $ 409 100.0
===============================================================================================================================
34
The allocations in the table are based on management's current allocation
methodologies. The use of other methods to allocate the allowance would change
the assigned allocation.
Management concludes that the allowance for credit losses, including the
unallocated component, is adequately stated at December 31, 2001.
Capital Resources
================================================================================
Total common shareholder's equity at year end 2001 was $6,549 million, compared
with $6,834 million at year end 2000. The equity base increased by $353 million
from net income and reduced by $525 million for common shareholder dividends
paid to HNAI and $25 million for dividends to preferred stock shareholders. The
equity base also decreased by $18 million from the change in other comprehensive
income. The other capital contribution from the parent of $15 million relates
principally to an HSBC stock option plan in which almost all of the Company's
employees are eligible to participate. During 2001, the Company returned $84.9
million of capital to a related entity.
The ratio of common shareholder's equity to total year-end assets was 7.52% at
December 31, 2001 compared with 8.23% at December 31, 2000.
Capital Adequacy
================================================================================
The Federal Reserve Board (FRB) has Risk-Based Capital Guidelines for assessing
the capital adequacy of U.S. banking organizations. The guidelines place balance
sheet assets into four categories of risk weights, primarily based on the
relative credit risk of the counterparty. Some off-balance sheet items such as
letters of credit and loan commitments are taken into account by applying
different categories of "credit conversion factors" to arrive at
credit-equivalent amounts, which are then weighted in the same manner as balance
sheet assets involving similar counterparties. For derivative financial
instruments such as those relating to interest rate and foreign exchange rate
contracts, the credit-equivalent amounts are arrived at by estimating both the
current exposure, positive mark to market value, and the potential exposure over
the remaining life of each contract. The credit-equivalent amount is similarly
assigned to the risk weight category appropriate to the counterparty.
The guidelines include a measure for market risk inherent in the trading
portfolio. Under the market risk requirements, capital is allocated to support
the amount of market risk that relates to the Company's trading activities
including derivative contracts associated with trading activities.
The guidelines include the concept of Tier 1 capital and total capital. The
guidelines establish a minimum standard risk-based target ratio of 8%, of which
at least 4% must be in the form of Tier 1 capital. The following table shows the
components of the Company's risk-based capital.
35
- ---------------------------------------------------------------------------
December 31, 2001 2000
- ---------------------------------------------------------------------------
in millions
Common shareholder's equity $ 6,450 $ 6,726
Preferred stock 375 375
Guaranteed mandatorily redeemable
preferred securities of subsidiaries 729 712
Less: Goodwill and identifiable intangibles (2,896) (3,233)
Foreign currency translation adjustment (19) (7)
- ---------------------------------------------------------------------------
Tier 1 capital 4,639 4,573
- ---------------------------------------------------------------------------
Long-term debt and other instruments
qualifying as Tier 2 capital 2,209 2,285
Qualifying aggregate allowance for
credit losses 556 525
45% of pretax unrealized gains on available
for sale equity securities -- 10
- ---------------------------------------------------------------------------
Tier 2 capital 2,765 2,820
- ---------------------------------------------------------------------------
Total capital $ 7,404 $ 7,393
===========================================================================
The capital adequacy guidelines establish a limit on the amount of certain
deferred tax assets that may be included in (that is, not deducted from) Tier 1
capital for risk-based and leverage capital purposes. The deferred tax asset
recognized by the Company meets the criteria for capital recognition and has
been included in the calculation of the Company's capital ratios.
The Company's total risk weighted assets were approximately $55.6 billion and
$54.5 billion at December 31, 2001 and 2000, respectively. Risk based capital
ratios were 8.34% at the Tier 1 level and 13.31% at the total capital level at
December 31, 2001. These ratios compared with 8.39% at the Tier 1 level and
13.56% at the total capital level at December 31, 2000. At December 31, 2001,
the Company had a 5.48% leverage ratio compared with 5.73% at December 31, 2000
based on quarterly average assets.
From time to time, the bank regulators propose amendments to or issue
interpretations of risk-based capital guidelines. Such proposals or
interpretations could, upon implementation, affect reported capital ratios and
net risk weighted assets.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
================================================================================
In consideration of the degree of interest rate risk inherent in the banking
industry, the Company has interest rate risk management policies designed to
meet performance objectives within defined risk/safety parameters. In the course
of managing interest rate risk, a combination of risk assessment techniques,
including dynamic simulation modeling, gap analysis, Value at Risk (VaR) and
capital at risk analysis are employed. The combination of these tools enables
management to identify and assess the potential impact of interest rate
movements and take appropriate action.
Certain limits and benchmarks that serve as guidelines in determining the
appropriate levels of interest rate risk for the institution have been
established. One such limit is expressed in terms of the Present Value of a
Basis Point (PVBP), which reflects the change in value of the balance sheet for
a one basis point movement in all interest rates. The institutional PVBP limit
as of December 31, 2001 was plus or minus $4.7 million, which includes distinct
limits associated with trading portfolio activities and financial instruments.
Thus, for a one basis point change in interest rates, the policy dictates that
the value of the balance sheet shall not change by more than
36
+/- $4.7 million. As of December 31, 2001, the Company had a position of $(3.3)
million PVBP reflecting the impact of a one basis point increase in interest
rates. Mortgage servicing rights are excluded from the PVBP determination as
their interest rate risk is significantly different from other balance sheet
items. The mortgage servicing rights risk is to lower interest rates, which is
managed through the purchase of various financial instruments including interest
rate floors and mortgage backed securities.
The Company also monitors changes in value of the balance sheet for large
movements in interest rates with an overall limit of +/- 10%, after tax, change
from the base case valuation for a 200 basis point gradual rate movement. As of
December 31, 2001, for a gradual 200 basis point increase in rates, the value
was projected to drop by 3.8% and for a 200 basis point gradual decrease in
rates, value was projected to drop by 17.4% if there were no management actions
taken to manage exposures to the changing environment.
In addition to the above mentioned limits, the Company's Asset and Liability
Management Committee particularly monitors the simulated impact of a number of
interest rate scenarios on net interest income. These scenarios include both
rate shock scenarios which assume immediate market rate movements of 200 basis
points, as well as rate change scenarios in which rates rise or fall by 200
basis points over a twelve month period. The individual limit for such gradual
200 basis point movements is currently +/- 10%, pretax, of base case earnings
over a twelve month period. Simulations are also performed for other relevant
interest rate scenarios including immediate rate movements and changes in the
shape of the yield curve or in competitive pricing policies. Net interest income
under the various scenarios is reviewed over a twelve month period, as well as
over a three year period. The simulations capture the effects of the timing of
the repricing of all assets and liabilities, including derivative instruments
such as interest rate swaps, futures and option contracts. Additionally, the
simulations incorporate any behavioral aspects such as prepayment sensitivity
under various scenarios.
For purposes of simulation modeling, base case earnings reflect the existing
balance sheet composition, with balances generally maintained at current levels
by the anticipated reinvestment of expected runoff. These balance sheet levels
will however, factor in specific known or likely changes including material
increases, decreases or anticipated shifts in balances due to management
actions. Current rates and spreads are then applied to produce base case
earnings estimates on both a twelve month and three year time horizon. Rate
shocks are then modeled and compared to base earnings (earnings at risk), and
include behavioral assumptions as dictated by specific scenarios relating to
such factors as prepayment sensitivity and the tendency of balances to shift
among various products in different rate environments. It is assumed that no
management actions are taken to manage exposures to the changing environment
being simulated.
Utilizing these modeling techniques, a gradual 200 basis point parallel rise or
fall in the yield curve on January 1, 2002 would cause projected net interest
income for the next twelve months to decrease by $44 million and increase by $13
million, respectively. This +/- 2% change is well within the Company's +/- 10%
limit. An immediate 100 basis point parallel rise or fall in the yield curve on
January 1, 2002, would cause projected net interest income for the next twelve
months to decrease by $43 million and $78 million, respectively. An immediate
200 basis point parallel rise or fall would decrease projected net interest
income for the next twelve months by $95 million and $134 million, respectively.
37
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.
Management of Primary Market Risk Exposures
================================================================================
The primary market risk to the Company's earnings associated with its investing,
lending and borrowing activities historically lies in exposure to sudden and
drastic shifts in interest rates. Management of these risks is undertaken with
the overall objective of meeting the Company's overall performance objectives
within defined risk and safety parameters. The strategies employed reflect the
goal of minimizing exposure to sudden and drastic upward and downward movements
in rates. These strategies entail the use of various instruments to effectively
mitigate the risk inherent in the balance sheet.
In addition to interest rate risk, the Company has an exposure to certain other
market risks including fluctuations in foreign currency exchange rates and
changes in global commodity and precious metals prices. Risk management
practices reflect these changes in balance sheet positions.
Trading Activities
================================================================================
The trading portfolios of the Company 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.
The Company relies upon Value at Risk (VaR) analysis as a basis for quantifying
and managing risks associated with the trading portfolios. Such analysis is
based upon the following two general principles:
(i) VaR applies to all trading positions across all risk classes including
interest rate, equity, commodity, optionality and global/foreign exchange risks
and
(ii) VaR is based on the concept of independent valuations, with all
transactions being repriced by an independent risk management function using
separate models prior to being stressed against VaR parameters.
VaR attempts to capture the potential loss resulting from unfavorable market
developments within a given time horizon (typically ten days) and given a
certain confidence level (99%). VaR calculations are performed for all material
trading and investment portfolios and for market risk-related treasury
activities. The VaR is calculated using the historical simulation or the
variance/covariance (parametric) method.
A VaR report broken down by trading business and on a consolidated basis is
distributed daily to management. To measure the accuracy of the VaR model
output, the daily VaR is compared to the actual result from trading activities.
38
The trading VaR at December 31, 2001 was $19.2 million compared with $20.3
million at December 31, 2000. The maximum trading VaR during 2001 was $43.1
million, the minimum $11.1 million and the average $24.1 million. The following
table shows the components of trading VaR by risk category.
- -------------------------------------------------------------------------------------------------------------------
December 31, 2001
- -------------------------------------------------------------------------------------------------------------------
in millions
Commodities $ .3
Equities 2.0
Foreign exchange 4.6
Interest rate 21.5
- -------------------------------------------------------------------------------------------------------------------
The following summary illustrates the Company's daily revenue earned from market
risk-related activities during 2001. Market risk-related revenues include
realized and unrealized gains (losses) related to treasury and trading
activities but excludes the related net interest income. The analysis of the
frequency distribution of daily market risk-related revenues shows that there
were 66 days with negative revenue during 2001. The most frequent result was a
daily revenue of between zero and $2 million with 113 occurrences. The highest
daily revenue was $9.5 million and the largest daily loss was $4.8 million.
- -------------------------------------------------------------------------------------------------------------------
Ranges of daily revenue
earned from market risk-
related activities
(in millions) Below $(4) $(4) to $(2) $(2) to $0 $0 to $2 $2 to $4 $4 to $6 Over $6
- -------------------------------------------------------------------------------------------------------------------
Number of trading days
market risk-related
revenue was within the
stated range 2 8 56 113 51 13 8
- -------------------------------------------------------------------------------------------------------------------
39
Critical Accounting Policies
================================================================================
In the course of maintaining its books and records and in the process of
preparing its periodic financial statements, the Company has adopted and follows
numerous accounting policies. A Summary of Significant Accounting Policies is
provided beginning on page 49.
Policies that are considered most important to the portrayal of the Company's
financial condition and results, and that require management's most difficult,
subjective or complex judgments, are considered to be "critical". Management has
deemed the policy which relates to the determination of the allowance for credit
losses and related provision for credit losses as well as the policy relative to
accounting for mortgage servicing rights to be critical. Detailed information
with respect to the allowance and provision for credit losses policy is included
in the Summary of Significant Accounting Policies on page 51, as well as on page
19 and pages 30 through 35 of this Management Discussion and Analysis of
Financial Condition and Results of Operation.
Detailed information with respect to mortgage servicing rights policy is
included in the Summary of Significant Accounting Policies on pages 52 through
53. With respect to this policy, a high degree of subjective assumptions are
involved in the estimation of the speed at which borrowers will prepay mortgage
loan obligations. As prepayments occur, the associated mortgage servicing rights
which have been capitalized on the balance sheet as an asset must be written
off. Interest rates are the primary factor which impact prepayments.
Specifically, as rates fall borrowers pay off existing mortgage loans and
refinance into new lower rate mortgage loans. The Company uses historical,
portfolio specific data to estimate prepayments and determine the appropriate
carrying value of mortgage servicing rights. If interest rates rise as expected
during 2002, the potential for write-off will lessen.
Management, in conjunction with the external auditors, has focused particular
attention on the selection, development, and disclosure of these critical
accounting policies and feels confident that they are both reasonably formulated
and applied. Management has also reviewed the selection and application of these
policies with the Company's audit committee.
40
Item 8. Financial Statements and Supplementary Data
================================================================================
Page
Report of Management 42
Report of Independent Auditors 43
HSBC USA Inc.:
Consolidated Balance Sheet 44
Consolidated Statement of Income 45
Consolidated Statement of Changes in
Shareholders' Equity 46
Consolidated Statement of Cash Flows 47
HSBC Bank USA:
Consolidated Balance Sheet 48
Summary of Significant Accounting Policies 49
Notes to Financial Statements 56
41
REPORT OF MANAGEMENT
Management of HSBC USA Inc. is responsible for the integrity of the financial
information presented in this annual report. Management has prepared the
financial statements in conformity with accounting principles generally accepted
in the United States of America. In preparing the financial statements,
management makes judgments and estimates of the expected effect of unsettled
transactions and events that are accounted for or disclosed.
The Company's systems of internal accounting control are designed to provide
reasonable but not absolute assurance that assets are safeguarded against loss
from unauthorized acquisition, use or disposition and that the financial records
are reliable for preparing financial statements. The selection and training of
qualified personnel and the establishment and communication of accounting and
administrative policies and procedures are elements of these control systems.
Management believes that the systems of internal control, which are subject to
close scrutiny by management and by internal auditors, support the integrity and
reliability of the financial statements.
The Board of Directors or their committees meet regularly with management,
internal auditors and the independent auditors to discuss internal control,
internal auditing and financial reporting matters, and also the scope of the
annual audit and interim reviews. Both the internal auditors and the independent
auditors have direct access to the Board of Directors.
42
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders of HSBC USA Inc.
We have audited the accompanying consolidated balance sheets of HSBC USA Inc.
and subsidiaries (the Company) as of December 31, 2001 and 2000, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the years in the three year period ended December 31, 2001,
and the accompanying consolidated balance sheets of HSBC Bank USA and
subsidiaries (the Bank) as of December 31, 2001 and 2000. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the years in the three year period ended December 31, 2001,
and the financial position of the Bank as of December 31, 2001 and 2000, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ KPMG LLP
February 1, 2002
New York, New York
43
HSBC USA Inc. 2001
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31, 2001 2000*
- ------------------------------------------------------------------------------------------------------------------------------------
Assets in thousands
Cash and due from banks $ 2,102,756 $ 1,860,713
Interest bearing deposits with banks 3,560,873 5,129,490
Federal funds sold and securities purchased under resale agreements 3,744,624 1,895,492
Trading assets 9,088,905 5,770,972
Securities available for sale (incl. $1,825,283 pledged to creditors at Dec. 31, 2001) 15,745,323 17,336,832
Securities held to maturity (fair value $4,839,705 and $4,417,251) 4,651,329 4,260,492
Loans 40,923,298 40,417,847
Less - allowance for credit losses 506,366 524,984
- ------------------------------------------------------------------------------------------------------------------------------------
Loans, net 40,416,932 39,892,863
Premises and equipment 750,041 777,610
Accrued interest receivable 416,545 785,286
Equity investments 271,402 55,596
Goodwill and other acquisition intangibles 2,895,714 3,229,479
Other assets 3,469,132 2,040,325
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $87,113,576 $83,035,150
====================================================================================================================================
Liabilities
Deposits in domestic offices
Noninterest bearing $ 5,432,106 $ 5,114,668
Interest bearing 31,695,955 30,631,511
Deposits in foreign offices
Noninterest bearing 428,252 282,737
Interest bearing 18,951,096 20,013,588
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits 56,507,409 56,042,504
- ------------------------------------------------------------------------------------------------------------------------------------
Trading account liabilities 3,799,817 2,766,825
Short-term borrowings 9,202,086 8,562,363
Interest, taxes and other liabilities 6,064,462 3,232,886
Subordinated long-term debt and perpetual capital notes 2,711,549 3,027,014
Guaranteed mandatorily redeemable securities 728,341 711,737
Other long-term debt 1,050,882 1,357,904
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 80,064,546 75,701,233
- ------------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity
Preferred stock 500,000 500,000
Common shareholder's equity
Common stock, $5 par; Authorized -150,000,000 shares
Issued - 704 shares 4 4
Capital surplus 6,034,598 6,104,264
Retained earnings 415,821 612,798
Accumulated other comprehensive income 98,607 116,851
- ------------------------------------------------------------------------------------------------------------------------------------
Total common shareholder's equity 6,549,030 6,833,917
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 7,049,030 7,333,917
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $87,113,576 $83,035,150
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
* Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
44
HSBC USA Inc. 2001
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Year Ended December 31, 2001 2000* 1999
- ------------------------------------------------------------------------------------------------------------------------------------
in thousands
Interest income
Loans $ 2,937,052 $3,072,830 $1,841,396
Securities 1,288,292 1,580,606 214,480
Trading assets 217,007 140,455 50,627
Other short-term investments 345,150 523,693 213,536
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income 4,787,501 5,317,584 2,320,039
- ------------------------------------------------------------------------------------------------------------------------------------
Interest expense
Deposits 1,856,893 2,334,036 852,875
Short-term borrowings 337,205 444,718 129,604
Long-term debt 328,111 420,298 111,654
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 2,522,209 3,199,052 1,094,133
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 2,265,292 2,118,532 1,225,906
Provision for credit losses 238,400 137,600 90,000
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income, after provision for credit losses 2,026,892 1,980,932 1,135,906
- ------------------------------------------------------------------------------------------------------------------------------------
Other operating income
Trust income 87,600 84,906 52,212
Service charges 189,025 172,257 128,598
Mortgage banking revenue 79,369 32,484 30,455
Other fees and commissions 329,509 300,388 167,595
Trading revenues:
Treasury business and other 266,010 140,192 10,014
Residential mortgage business related (67,091) -- --
---------- -------- ---------
Total trading revenues 198,919 140,192 10,014
Security gains, net 149,267 28,839 10,098
Interest on Brazilian tax settlement -- -- 13,143
Other income 61,993 73,372 51,854
- ------------------------------------------------------------------------------------------------------------------------------------
Total other operating income 1,095,682 832,438 463,969
- ------------------------------------------------------------------------------------------------------------------------------------
3,122,574 2,813,370 1,599,875
- ------------------------------------------------------------------------------------------------------------------------------------
Other operating expenses
Salaries and employee benefits 1,000,409 975,391 421,334
Occupancy expense, net 155,436 167,202 88,950
Goodwill amortization 176,482 176,162 33,328
Princeton Note Matter 575,000 -- --
Other expenses 635,658 587,083 284,251
- ------------------------------------------------------------------------------------------------------------------------------------
Total other operating expenses 2,542,985 1,905,838 827,863
- ------------------------------------------------------------------------------------------------------------------------------------
Income before taxes and cumulative effect of accounting change 579,589 907,532 772,012
Applicable income tax expense 226,000 338,573 308,300
- ------------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of accounting change 353,589 568,959 463,712
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative effect of accounting change - implementation
of SFAS 133, net of tax (451) -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 353,138 $ 568,959 $ 463,712
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
*Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
45
HSBC USA Inc. 2001
- ----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' EQUITY
2001 2000** 1999
- ----------------------------------------------------------------------------------------------------------------------------------
in thousands
Preferred stock
Balance, January 1, $ 500,000 $ 500,000 $ --
Stock assumed in acquisition -- -- 500,000
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 500,000 500,000 500,000
- ---------------------------------------------------------------------------------------------------------------------------------
Common stock
Balance, January 1, 4 4 5
Redemption of stock -- -- (1)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 4 4 4
- ---------------------------------------------------------------------------------------------------------------------------------
Capital surplus
Balance, January 1, 6,104,264 6,096,318 1,806,563
Capital contribution from parent
Related to Republic acquisition -- -- 7,077,888*
Related to other merger -- -- 22,145
Return of capital (84,939) -- (2,813,575)*
Other 15,273 7,946 3,297
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 6,034,598 6,104,264 6,096,318
- ---------------------------------------------------------------------------------------------------------------------------------
Retained earnings
Balance, January 1, 612,798 671,578 377,179
Net income 353,138 568,959 463,712
Accumulated deficit assumed in other merger -- -- (14,313)
Cash dividends declared:
Preferred stock (25,115) (27,739) --
Common stock (525,000) (600,000) (155,000)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 415,821 612,798 671,578
- ---------------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income (loss)
Balance, January 1, 116,851 (50,534) 44,506
Net change in unrealized gains on securities 31,100 174,874 (95,040)
Net change in unrealized loss on derivatives classified as cash
flow hedges (37,503) -- --
Unrealized net transitional gain related to initial adoption of SFAS 133 2,853 -- --
Amortization of unrealized net transitional SFAS 133 gains
credited to current income (2,853) -- --
Foreign currency translation adjustment (11,841) (7,489) --
- ---------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax (18,244) 167,385 (95,040)
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 98,607 116,851 (50,534)
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity, December 31, $ 7,049,030 $ 7,333,917 $ 7,217,366
=================================================================================================================================
Comprehensive income
Net income $ 353,138 $ 568,959 $ 463,712
Other comprehensive income (loss) (18,244) 167,385 (95,040)
- ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 334,894 $ 736,344 $ 368,672
=================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
*See Notes 1 and 2 for further discussion.
**Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
46
HSBC USA Inc. 2001
- --------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31, 2001 2000* 1999*
- --------------------------------------------------------------------------------------------------------------------------
in thousands
Cash flows from operating activities
Net income $ 353,138 $ 568,959 $ 463,712
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation, amortization and deferred taxes 119,831 368,102 68,063
Provision for credit losses 238,400 137,600 90,000
Net change in other accrual accounts 897,893 32,240 118,406
Net change in loans originated for sale (665,273) 115,652 698,978
Net change in trading assets and liabilities (1,752,622) (913,266) (193,731)
Other, net (348,128) (114,171) (92,693)
- --------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities (1,156,761) 195,116 1,152,735
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Net change in interest bearing deposits with banks 1,389,943 (813,245) 653,135
Net change in short-term investments (751,850) 422,869 (2,571,317)
Purchases of securities held to maturity (545,874) (58,720) --
Proceeds from maturities of securities held to maturity 1,175,902 580,539 --
Purchases of securities available for sale (15,600,472) (14,624,091) (2,437,512)
Proceeds from sales of securities available for sale 12,395,593 8,795,549 2,061,740
Proceeds from maturities of securities available for sale 4,820,044 13,042,069 1,160,406
Payment to shareholders of acquired company -- (7,091,209) --
Net change in credit card receivables (11,937) 24,768 (25,200)
Net change in other short-term loans 616,194 201,634 168,130
Net originations and maturities of long-term loans (551,253) (1,665,707) (298,541)
Sales of loans 79,666 169,234 --
Expenditures for premises and equipment (76,810) (108,157) (30,898)
Net cash provided (used) in acquisitions, net of cash acquired (21,547) (585,756) 810,714
Other, net 111,474 589,337 (53,579)
- --------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities 3,029,073 (1,120,886) (562,922)
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Net change in deposits 17,423 (1,113,124) 964,029
Net change in short-term borrowings (339,348) 3,351,655 (692,644)
Issuance of long-term debt 549,464 659,338 400,407
Repayment of long-term debt (1,222,013) (1,448,855) (409,815)
Return of capital (84,939) -- --
Dividends paid (550,856) (621,744) (155,000)
- --------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (1,630,269) 827,270 106,977
- --------------------------------------------------------------------------------------------------------------------------
Net change in cash and due from banks 242,043 (98,500) 696,790
Cash and due from banks at beginning of year 1,860,713 1,959,213 1,262,423
- --------------------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of year $ 2,102,756 $ 1,860,713 $ 1,959,213
==========================================================================================================================
Cash paid for: Interest $ 2,721,880 $ 3,238,257 $ 1,115,201
Income taxes 259,387 444,058 222,765
Non-cash activities:
Fair value of assets acquired $ 482,000 $ 851,930 $ 48,328,158
Fair value of liabilities assumed 460,000 764,438 44,033,905
- --------------------------------------------------------------------------------------------------------------------------
Net assets acquired $ 22,000 $ 87,492 $ 4,294,253
- --------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements. Transfers of securities which occurred in 2001 are disclosed in the
notes.
*Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
47
HSBC Bank USA 2001
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31, 2001 2000*
- ------------------------------------------------------------------------------------------------------------------------------------
in thousands
Assets
Cash and due from banks $ 2,102,271 $ 1,856,376
Interest bearing deposits with banks 3,104,501 4,402,725
Federal funds sold and securities purchased under resale agreements 3,744,624 1,895,492
Trading assets 9,010,203 5,468,281
Securities available for sale (incl. $1,752,902 pledged to creditors at Dec. 31, 2001) 14,839,974 16,372,529
Securities held to maturity (fair value $4,523,696 and $4,252,601) 4,341,263 4,102,701
Loans 40,801,836 40,209,326
Less - allowance for credit losses 481,706 499,234
- ------------------------------------------------------------------------------------------------------------------------------------
Loans, net 40,320,130 39,710,092
Premises and equipment 748,470 777,153
Accrued interest receivable 408,082 777,765
Equity investments 241,219 22,618
Goodwill and other acquisition intangibles 2,291,212 2,530,111
Other assets 3,078,431 2,131,161
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $84,230,380 $80,047,004
====================================================================================================================================
Liabilities
Deposits in domestic offices
Noninterest bearing $ 5,371,379 $ 4,903,846
Interest bearing 31,695,955 30,631,511
Deposits in foreign offices
Noninterest bearing 428,252 282,737
Interest bearing 20,724,657 21,042,297
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits 58,220,243 56,860,391
- ------------------------------------------------------------------------------------------------------------------------------------
Trading account liabilities 3,800,987 2,780,237
Short-term borrowings 7,494,796 7,799,277
Interest, taxes and other liabilities 5,328,008 2,723,558
Subordinated long-term debt and perpetual capital notes 1,540,229 1,539,070
Other long-term debt 947,321 1,253,641
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 77,331,584 72,956,174
- ------------------------------------------------------------------------------------------------------------------------------------
Shareholder's equity
Common shareholder's equity
Common stock, $100 par; Authorized - 2,250,000 shares
Issued - 2,050,001 shares 205,000 205,000
Capital surplus 6,432,902 6,412,569
Retained earnings 165,520 368,405
Accumulated other comprehensive income 95,374 104,856
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholder's equity 6,898,796 7,090,830
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholder's equity $84,230,380 $80,047,004
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
*Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
48
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
HSBC USA Inc. (the Company), is a New York State based bank holding company. All
of the common stock of the Company is owned by HSBC North America Inc. (HNAI),
an indirect wholly owned subsidiary of HSBC Holdings plc (HSBC).
The accounting and reporting policies of the Company and its subsidiaries,
including its principal subsidiary, HSBC Bank USA (the Bank), conform to
accounting principles generally accepted in the United States of America and to
predominant practice within the banking industry. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires the use of estimates and assumptions that
affect reported amounts and disclosures. Actual results could differ from those
estimates. The Company maintains no significant relationships with off-balance
sheet special purpose entities.
The following is a description of the significant policies and practices.
Principles of Consolidation
================================================================================
The financial statements of the Company and the Bank are consolidated with those
of their respective wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated. Investments in companies in
which the percentage of ownership is at least 20%, but not more than 50%, are
generally accounted for under the equity method and reported as equity
investments.
Foreign Currency Translation
================================================================================
The accounts of the Company's foreign operations are measured using local
currency as the functional currency. Assets and liabilities are translated into
United States dollars at period end exchange rates. Income and expense accounts
are translated at average monthly exchange rates. Net exchange gains or losses
resulting from such translation are included in accumulated other comprehensive
income and reported as a separate component of shareholders' equity. Foreign
currency denominated transactions in other than the local functional currency
are translated using the period end exchange rate with any foreign currency
translation gain or loss recognized currently in income.
Resale and Repurchase Agreements
================================================================================
The Company enters into purchases of securities under agreements to resell
("resale agreements") and sales of securities under agreements to repurchase
("repurchase agreements") of substantially identical securities. Resale
agreements and repurchase agreements are generally accounted for as secured
lending and secured borrowing transactions, respectively.
The amounts advanced under resale agreements and the amounts borrowed under
repurchase agreements are carried on the consolidated balance sheet at the
amount advanced or borrowed. Interest earned on resale agreements and interest
paid on repurchase agreements are reported as interest income and interest
expense, respectively. The Company offsets resale and repurchase agreements
executed with the same counterparty under legally enforceable netting agreements
that meet the applicable netting criteria. The Company takes possession of
securities purchased under resale agreements. The market
49
value of the securities subject to the resale and repurchase agreements are
regularly monitored to ensure appropriate collateral coverage of these secured
financing transactions.
Securities
================================================================================
Debt securities that the Company has the ability and intent to hold to maturity
are reported at cost, adjusted for amortization of premiums and accretion of
discounts. Securities acquired principally for the purpose of selling them in
the near term are classified as trading assets and reported at fair value, with
unrealized gains and losses included in earnings. All other securities are
classified as available for sale and carried at fair value, with unrealized
gains and losses, net of related income taxes, included in accumulated other
comprehensive income and reported as a separate component of shareholders'
equity.
Realized gains and losses on sales of securities are computed on a specific
identified cost basis and are reported within other operating income in the
consolidated statement of income. Adjustments of trading assets to fair value
and gains and losses on the sale of such securities are recorded in trading
revenues.
The Company regularly evaluates its securities portfolios to identify losses in
value that are deemed other than temporary. To the extent such losses are
identified, the security is considered permanently impaired and a loss is
recognized in current other operating income.
Loans
================================================================================
Loans are stated at their principal amount outstanding, net of unearned income,
purchase premium or discount, unamortized nonrefundable fees and related direct
loan origination costs. Loans held for sale are carried at the lower of
aggregate cost or market value. Interest income is recorded based on methods
that result in level rates of return over the terms of the loans.
Commercial loans are categorized as nonaccruing when, in the opinion of
management, reasonable doubt exists with respect to the ultimate collectibility
of interest or principal based on certain factors including period of time past
due (principally ninety days) and adequacy of collateral. At the time a loan is
classified as nonaccruing, any accrued interest recorded on the loan is
generally reversed and charged against income. Interest income on these loans is
recognized only to the extent of cash received. In those instances where there
is doubt as to collectibility of principal, any interest payments received are
applied to principal. Loans are not reclassified as accruing until interest and
principal payments are brought current and future payments are reasonably
assured.
Residential mortgages are generally designated as nonaccruing when delinquent
for more than ninety days. Loans to credit card customers that are past due more
than ninety days are designated as nonaccruing if the customer has agreed to
credit counseling. Other consumer loans are generally not designated as
nonaccruing and are charged off against the allowance for credit losses
according to an established delinquency schedule.
Loans, other than those included in large groups of smaller balance homogenous
loans, are considered impaired when, based on current information, it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. Impaired loans are valued at
50
the present value of expected future cash flows, discounted at the loan's
original effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent.
Restructured loans are loans for which the original contractual terms have been
modified to provide for terms that are less than the Company would be willing to
accept for new loans with comparable risk because of a deterioration in the
borrowers' financial condition. Interest on these loans is accrued at the
renegotiated rates.
Loan Fees
================================================================================
Nonrefundable fees and related direct costs associated with the origination or
purchase of loans are deferred and netted against outstanding loan balances. The
amortization of net deferred fees and costs are recognized in interest income,
generally by the interest method, based on the estimated lives of the loans.
Nonrefundable fees related to lending activities other than direct loan
origination are recognized as other operating income over the period the related
service is provided. This includes fees associated with the issuance of loan
commitments where the likelihood of the commitment being exercised is considered
remote. In the event of the exercise of the commitment, the remaining
unamortized fee is recognized in interest income over the loan term using the
interest method. Other credit-related fees, such as standby letter of credit
fees, loan syndication and agency fees and annual credit card fees are
recognized as other operating income over the period the related service is
performed.
Allowance for Credit Losses
================================================================================
The Company maintains an allowance for credit losses that is, in the judgment of
management, adequate to absorb estimated losses inherent in the loan portfolio.
This is based upon an evaluation of various factors including an analysis of
individual credits, current and historical loss experience, changes in the
overall size and composition of the portfolio, specific adverse situations, and
general economic conditions. Provisions for credit losses are recorded to
earnings based upon the Company's periodic review of these and other pertinent
factors. Actual losses are charged and recoveries are credited to the allowance.
For commercial loan assets, the Company conducts a periodic assessment of losses
it believes to be inherent in the loan portfolio, within the context of both
Statement of Financial Accounting Standards No. 114, Accounting by Creditors for
Impairment of a Loan (SFAS 114), and Statement of Financial Accounting Standards
No. 5, Accounting for Contingencies (SFAS 5). When it is deemed probable, based
upon known facts and circumstances, that full contractual interest and principal
on an individual loan will not be collected, the asset is considered impaired.
In accordance with SFAS 114, an "impairment reserve" is established based upon
the expected present value of expected future cash flows, discounted at the
loan's original effective interest rate, or as a practical expedient, at the
loan's observable market price or the fair value of the collateral if the loan
is collateral dependent.
Reserves are also established against commercial loans where based upon an
analysis of relevant data, it is probable that a loss has been incurred and will
be realized in the future and the amount of that loss can be reasonably
estimated, even though it has yet to manifest itself in a specifically
identifiable loan asset. Commonly referred to as "formula reserves", these
51
amounts are determined by reference to continuously monitored and updated
historical loss rates or factors, derived from a migration analysis which
considers net charge off experience by loan and industry type, in relation to
internal credit grading.
Homogeneous pools of loans including consumer installment, residential mortgage
and credit cards are not assigned specific loan grades. Formula reserves are
generally determined based upon historical loss experience by loan type or in
certain instances, by reference to specific collateral values.
Although the calculation of required formula reserves is a mechanical process
incorporating historical data, the ultimate selection of reserve factors and the
assessment of the overall adequacy of the allowance to provide for credit losses
inherent in the loan portfolio involves a high degree of subjective management
judgment. With recognition to the imprecision in estimating credit losses, and
with consideration given to probable losses associated with factors including
the impact of the national economic cycle, loss experience within non-criticized
portfolios of loans, as well as the concentration of loans to individual
counterparties, the Company therefore also maintains an "unallocated reserve".
The Company gathers and analyzes historical data, updates assumptions relative
to expected loss experience and reviews individual and portfolio loan assets on
a quarterly basis. There have been no material changes in estimation techniques
or loss reserve methodology during the year.
Mortgage Servicing Rights
================================================================================
The Company recognizes the right to service mortgages as a separate and distinct
asset at the time the loans are sold. Servicing rights are then amortized in
proportion to net servicing income and carried on the balance sheet at the lower
of their initial carrying value, adjusted for amortization, or fair value.
As interest rates decline, prepayments generally accelerate, thereby reducing
future net servicing cash flows from the mortgage portfolio. The carrying value
of the mortgage servicing rights (MSRs) is periodically evaluated for impairment
based on the difference between the carrying value of such rights and their
current fair value. For purposes of measuring impairment, which is recorded
through the use of a valuation reserve, MSRs are stratified based upon interest
rates and whether such rates are fixed or variable and other loan
characteristics. Fair value is determined based upon the application of pricing
valuation models incorporating portfolio specific prepayment assumptions. The
reasonableness of these pricing models is periodically substantiated by
reference to independent broker price quotations and actual market sales.
If the carrying value of the servicing rights exceeds fair value, the asset is
deemed impaired and impairment is recognized by recording a balance sheet
valuation reserve with a corresponding charge to income.
The Company uses certain derivative financial instruments including constant
maturity U.S. Treasury floors and interest rate swaps, to protect against the
decline in economic value of servicing rights. These instruments have not been
designated as qualifying hedges under SFAS 133 and are therefore recorded as
trading instruments that are marked to market through earnings. In addition,
interest rate lock commitments granted to mortgage customers at the time of
application and forward commitments to sell originated and closed loans are
considered derivative instruments under SFAS 133 and are likewise accounted for
as trading instruments.
52
Prior to the adoption of SFAS 133, the value of economic hedges against
servicing rights were considered a component of market value of servicing rights
for purposes of assessing impairment. Interest rate lock commitments and forward
sales were not specifically recognized until such time as related mortgages were
sold at which time they were considered in the determination of the gain or loss
on sale.
Goodwill and Other Acquisition Intangibles
================================================================================
Goodwill, representing the excess of purchase price over the fair value of net
assets acquired, results from purchase acquisitions made by the Company.
Goodwill and other acquisition intangibles are amortized over the estimated
periods to be benefited, under the straight-line method, not exceeding 20 years.
The Company reviews its goodwill and other acquisition intangibles periodically
for other than temporary impairment. If such impairment is indicated,
recoverability of the asset is assessed based on expected undiscounted net cash
flows.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 142
requires that goodwill, including previously existing goodwill, and intangible
assets with indefinite useful lives, not be amortized but rather tested for
impairment at least annually. Under SFAS 142, all recorded goodwill must be
assigned to one or more reporting units of the entity and evaluated for
impairment at that level.
Income Taxes
================================================================================
The Company and its subsidiaries file a consolidated federal income tax return.
Taxes of each subsidiary of the Company are generally determined on the basis of
filing separate returns.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as the estimated future tax consequences attributable to net
operating loss and tax credit carryforwards. A valuation allowance is
established if, based on available evidence, it is more likely than not that
some portion or all of the deferred tax asset will not be realized. Foreign
taxes paid are applied as credits to reduce federal income taxes payable.
Derivative Financial Instruments
================================================================================
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133). All derivatives are now recognized on the balance sheet at their
fair value. On the date the derivative contract is entered into (January 1, 2001
for all derivatives in place at that date) the Company designates it as (1) a
qualifying SFAS 133 hedge of the fair value of a recognized asset or liability
or of an unrecognized firm commitment ("fair value" hedge); or (2) a qualifying
SFAS 133 hedge of a forecasted transaction of the variability of cash flows to
be received or paid related to a recognized asset or liability ("cash flow"
hedge); or (3) as a trading position.
53
Changes in the fair value of a derivative that has been designated and qualifies
as a fair value hedge, along with the changes in the fair value of the hedged
asset or liability that is attributable to the hedged risk (including losses or
gains on firm commitments), are recorded in current period earnings. Changes in
the fair value of a derivative that has been designated and qualifies as a cash
flow hedge are recorded in other comprehensive income to the extent of its
effectiveness, until earnings are impacted by the variability of cash flows from
the hedged item. Changes in the fair value of derivatives held for trading
purposes are reported in current period earnings.
At the inception of each hedge (January 1, 2001 for all derivatives in place at
that date), the Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair value or cash flow hedges to
specific assets and liabilities on the balance sheet or to specific firm
commitments or forecasted transactions.
Increased earnings volatility may result from the on-going mark to market of
certain economically viable derivative contracts that do not satisfy the hedging
requirements of SFAS 133, as well as from the hedge ineffectiveness associated
with the qualifying contracts. The Company expects however that it will be able
to continue to pursue its overall asset and liability risk management objectives
using a combination of derivatives and cash instruments.
Embedded Derivatives
The Company may acquire or originate a financial instrument that contains a
derivative instrument "embedded" within it. Upon origination or acquisition of
any such instrument, the Company assesses whether the economic characteristics
of the embedded derivative are clearly and closely related to the economic
characteristics of the principal component of the financial instrument (i.e.,
the "host contract") and whether a separate instrument with the same terms as
the embedded instrument would meet the definition of a derivative instrument.
When it is determined that (1) the embedded derivative possesses economic
characteristics that are not clearly and closely related to the economic
characteristics of the host contract; and (2) a separate instrument with the
same terms would qualify as a derivative instrument, the embedded derivative is
separated from the host contract, carried at fair value, and designated a
trading instrument.
Hedge Discontinuation
The Company formally assesses, both at the hedge's inception and on an on-going
basis, whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged items and
whether they are expected to continue to be highly effective in future periods.
If it is determined that a derivative is not highly effective as a hedge or that
it has ceased to be a highly effective hedge, the Company discontinues hedge
accounting prospectively, as discussed below.
The Company discontinues hedge accounting prospectively when (1) the derivative
is no longer effective in offsetting changes in the fair value or cash flows of
a hedged item (including firm commitments or forecasted
54
transactions); (2) the derivative expires or is sold, terminated, or exercised;
(3) it is unlikely that a forecasted transaction will occur; (4) the hedged firm
commitment no longer meets the definition of a firm commitment; or (5) the
designation of the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value or cash flow hedge,
the derivative will continue to be carried on the balance sheet at its fair
value, and the hedged item will no longer be adjusted for changes in fair value
or changes in the fair value of the derivative reclassified to other
comprehensive income. If the hedged item was a firm commitment or forecasted
transaction that is not expected to occur, any amounts recorded on the balance
sheet related to the hedged item, including any amounts recorded in other
comprehensive income, are reversed to current period earnings. In all other
situations in which hedge accounting is discontinued, the derivative will be
carried at its fair value on the balance sheet, with changes in its fair value
recognized in current period earnings unless redesignated as a qualifying SFAS
133 hedge.
Pre-SFAS 133 Derivative Accounting Policy
================================================================================
Prior to the implementation of SFAS 133 on January 1, 2001, the Company used
derivative financial instruments for asset/liability management purposes. Such
instruments were accounted for using either the synthetic alteration or hedge
model of accounting. Under the synthetic alteration accounting model, accrual
based accounting was applied to derivative instruments that altered the
repricing characteristics of identified balance sheet assets or liabilities.
Under the hedge accounting model, to the extent derivatives met the correlation
testing requirements set forth, the derivatives were accounted for on a basis
consistent with the underlying hedged items. Derivative instruments that failed
to qualifying under these two methods of accounting were marked to market
through earnings. Derivative instruments that were entered into for the purpose
of generating trading revenues were accounted for on a mark to market basis with
the associated income and expense recognized in trading revenue.
55
NOTES TO FINANCIAL STATEMENTS
Note 1. Divestitures
================================================================================
In December 2000, as part of an internal international reorganization of the
HSBC Group's global private banking operations, the Company distributed its 49%
interest in HSBC Republic Holdings (Luxembourg) S.A. (HRH) from the Bank to its
parent HSBC North America Inc. (HNAI). The distribution, in the form of a return
of capital of $2.8 billion, included its investment in HSBC Investments
(Bahamas) Limited in addition to the $2.5 billion investment in HRH. The assets
transferred were acquired as a part of the acquisition and merger of Republic
New York Corporation (Republic) on December 31, 1999. See Note 2, Acquisitions.
The divestitures were accounted for as transfers of assets between companies
under common control at historical cost.
Note 2. Acquisitions
================================================================================
2001
On April 1, 2001, the Bank acquired approximately a 5 percent interest in the
voting shares of HSBC Republic Bank (Suisse) S.A. (Swiss Bank), an affiliate
wholly owned by the HSBC Group, in exchange for the contribution to the Swiss
Bank of private banking businesses conducted by the Bank's Singapore and Hong
Kong branches acquired as part of the Republic acquisition. The 5 percent
interest represents the fair value estimate of the businesses transferred to the
Swiss Bank and is being accounted for using the equity method of accounting due
to the common control relationship of the entities. The Bank retained its
banknotes activities in Singapore and its banknotes and foreign currency
businesses in Hong Kong, and maintained its branch licenses in both locations.
The transaction was another step in an internal reorganization of the HSBC
Group's global private banking operations, which began late last year. The Swiss
Bank, a Switzerland based banking affiliate, will manage much of the HSBC
Group's worldwide private banking business. Swiss Bank is a foreign bank
chartered and regulated under the banking laws of Switzerland.
On January 1, 2001, the Bank acquired the Panama branches of HSBC Bank plc for
approximately $22 million in cash. The purchase included two branches in Panama
City, one in the Colon Free Trade Zone, one in Colon and one in Aguadulce. The
Bank acquired approximately $500 million in assets and assumed $450 million in
customer and bank deposits. The acquisition was accounted for as a transfer of
assets between companies under common control at HSBC Bank plc's historical
cost.
2000
In the third quarter of 2000, HSBC acquired Credit Commercial de France. As part
of the consolidation of HSBC's commercial banking activities in the U.S., the
Company acquired in a cash purchase the commercial loan portfolio of
approximately $500 million of the New York office of Credit Commercial de
France. Additionally, $2.4 billion of commitments to lend were assumed as part
of the acquisition.
56
On August 1, 2000, the Company purchased the banking operations of Chase
Manhattan Bank, Panama (Chase Panama). The transaction was accounted for as a
purchase. Accordingly, the results of operations of Chase Panama are included
with those of the Company for the period subsequent to the date of the
acquisition. The branch operations had over $750 million in assets and $720
million in deposit liabilities. The excess of cost over acquired net
identifiable assets (goodwill) was $60 million amortized on a straight-line
basis using a 20 year life. See Note 19, Impact of Recently Issued Accounting
Standards.
1999
On December 31, 1999, HSBC acquired Republic. Also on December 31, 1999,
following the acquisition, HSBC merged Republic with the Company. The purchase
price of the transaction was approximately $7.1 billion and was paid to
Republic's shareholders on January 7, 2000. Republic had consolidated total
assets of $46.9 billion, deposits of $29.9 billion and common shareholders'
equity of $2.9 billion on December 31, 1999.
The merger was accounted for as a purchase transaction. Accordingly, the results
of operations of Republic are included with those of the Company for the period
subsequent to the date of acquisition. Assets acquired and liabilities assumed
were recorded at their estimated fair values. The fair value of net identifiable
assets acquired was $4.1 billion. The purchase price allocation resulted in an
excess of cost over acquired net identifiable assets (goodwill) of approximately
$2.9 billion, which prior to January 1, 2002, was amortized on a straight-line
basis using a 20 year life.
The following table is an analysis of Republic's goodwill through 2001,
reflecting adjustments for transferred and liquidated companies as well as the
finalization of items estimated at December 31, 1999, as permitted by accounting
principles generally accepted in the United States of America.
- -------------------------------------------------------------------
in thousands
Balance December 31, 1999 $2,922,863
Adjustments 43,196
Less: amortization expense 146,143
- -------------------------------------------------------------------
Balance December 31, 2000 2,819,916
Adjustments (162,383)
Less: amortization expense 144,727
- -------------------------------------------------------------------
Balance December 31, 2001 $2,512,806
- -------------------------------------------------------------------
As a result of the Republic acquisition, the Company recognized certain
liabilities associated with merging Republic's operations with those of the
Company and recognized integration costs relating to the planned severance of
employees and exiting of businesses of the Company.
57
The following table presents the activity in these reserves through December 31,
2001.
Severance
Related Premises Other Total
- ----------------------------------------------------------------------------------------
in millions
Liabilities assumed $133.9 $ 9.7 $ 14.0 $157.6
Restructuring charges 5.7 21.0 -- 26.7
- ----------------------------------------------------------------------------------------
Balance December 31, 1999 139.6 30.7 14.0 184.3
Change in estimates 83.7 (17.8) 2.5 68.4
Less: Payments 71.5 2.1 11.2 84.8
- ----------------------------------------------------------------------------------------
Balance December 31, 2000 151.8 10.8 5.3 167.9
Change in estimates (1.7) (2.6) (2.5) (6.8)
Less: Payments 96.8 6.8 2.6 106.2
- ----------------------------------------------------------------------------------------
Balance December 31, 2001 $ 53.3 (1) $ 1.4 $ .2 $ 54.9
- ----------------------------------------------------------------------------------------
(1) The severance related balances relate to employees who have elected to
receive their termination payments over an extended period of time. The
payments will be made during the next two years.
During 2001, $12.1 million of integration costs were expensed compared with
$85.0 million in 2000. The integration costs do not include the higher level of
equipment and software depreciation incurred during 2001 on infrastructure
investments made during 2000 related to the Republic acquisition. All
restructuring related to the acquisition from a customer perspective is
complete.
Note 3. Cash and Due from Banks
================================================================================
The Bank is required to maintain noninterest bearing balances at Federal Reserve
Banks as part of its membership requirements in the Federal Reserve System.
These balances averaged $211.0 million in 2001 and $224.6 million in 2000.
Note 4. Trading Assets and Liabilities
================================================================================
An analysis of trading assets and liabilities follows.
- --------------------------------------------------------------------------------
December 31, 2001 2000
- --------------------------------------------------------------------------------
in thousands
Trading assets:
U.S. Treasury $ 375,689 $ 244,933
U.S. Government agency 583,558 471,490
Asset backed securities 2,212,220 1,373,280
Other securities 1,262,978 978,226
Fair value of derivatives 2,542,793 1,876,732
Precious metals 2,111,667 826,311
- --------------------------------------------------------------------------------
$9,088,905 $5,770,972
- --------------------------------------------------------------------------------
Trading account liabilities:
Securities sold, not yet purchased $ 544,498 $ 217,830
Payables for precious metals 1,243,428 487,905
Fair value of derivatives 2,011,891 2,061,090
- --------------------------------------------------------------------------------
$3,799,817 $2,766,825
- --------------------------------------------------------------------------------
Trading revenues are generated by the Company's participation in the foreign
exchange and precious metals markets, trading activities in other derivative
contracts, including interest rate swaps and options, from trading securities,
and as a result of certain residential mortgage banking activities classified as
trading revenue due to the adoption of SFAS 133 effective January 1, 2001.
58
The following table presents trading revenues by business. The Company reports
the net revenues from these activities, which include mark to market adjustments
and any related direct trading expenses, as trading revenues - treasury business
and other in the consolidated statement of income. The data in the table below
includes net interest income earned/(paid) on trading instruments, as well as an
allocation by management to reflect the funding benefit or cost associated with
the trading positions.
- -------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------
in thousands
Trading revenues - treasury business and other $ 266,010 $140,192 $10,014
Net interest income 38,620 52,137 4,600
- -------------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $ 304,630 $192,329 $14,614
=============================================================================================================
Business:
Derivatives and treasury $ 120,210 $ 44,916 $10,017
Foreign exchange 93,145 74,399 4,597
Precious metals 52,548 49,137 --
Other trading 38,727 23,877 --
- -------------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $ 304,630 $192,329 $14,614
=============================================================================================================
Trading revenues - residential mortgage business related $ (67,091) $ -- $ --
=============================================================================================================
Note 5. Securities
================================================================================
At December 31, 2001, the Company 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 amortized cost and fair value of the securities available for sale and
securities held to maturity portfolios follow.
- --------------------------------------------------------------------------------------------------------------------------
2001 2000
------------------------------------------------------ ------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair Amortized Fair
December 31, Cost Gains Losses Value Cost Value
- --------------------------------------------------------------------------------------------------------------------------
in thousands
U.S. Treasury $ 365,924 $ 8,083 $ 2,444 $ 371,563 $ 318,378 $ 322,587
U.S. Government agency 7,963,852 144,806 40,943 8,067,715 8,943,188 9,119,190
Asset backed securities 3,450,797 38,485 4,175 3,485,107 3,158,113 3,166,218
Other domestic debt
securities 678,042 66,804 5,564 739,282 1,515,374 1,486,570
Foreign debt securities 2,415,076 47,341 27,048 2,435,369 2,542,658 2,555,301
Equity securities 644,944 7,945 6,602 646,287 665,648 686,966
- --------------------------------------------------------------------------------------------------------------------------
Securities available
for sale $15,518,635 $313,464 $86,776 $15,745,323 $17,143,359 $17,336,832
- --------------------------------------------------------------------------------------------------------------------------
U.S. Government agency $ 3,882,621 $166,271 $ 8,724 $ 4,040,168 $ 3,530,285 $ 3,657,386
Obligations of U.S.
states and political
subdivisions 768,708 32,229 1,400 799,537 730,207 759,865
- --------------------------------------------------------------------------------------------------------------------------
Securities held to
maturity $ 4,651,329 $198,500 $10,124 $ 4,839,705 $ 4,260,492 $ 4,417,251
- --------------------------------------------------------------------------------------------------------------------------
At December 31, 2000, with regard to securities available for sale, the Company
had gross unrealized gains of $5.6 million, $242.4 million and $89.7 million and
gross unrealized losses of $1.4 million, $66.4 million and $76.4 million related
to U.S. Treasury, U.S. Government agency and other securities,
59
respectively. At December 31, 2000, with regard to securities held to maturity,
the Company had gross unrealized gains of $127.2 million and $30.7 million and
gross unrealized losses of $.1 million and $1.0 million related to U.S.
Government agency and obligations of U.S. states and political subdivisions.
The following table presents realized gains and losses on investment securities
transactions attributable to securities available for sale and securities held
to maturity.
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Gross Net Gross Net Gross Net
------------------- Gains ------------------ Gains ------------------ Gains
Gains (Losses) (Losses) Gains (Losses) (Losses) Gains (Losses) (Losses)
- ------------------------------------------------------------------------------------------------------------------------------------
in thousands
Securities available
for sale $ 250,381 $(102,671) $147,710 $ 54,030 $(27,189) $26,841 $ 19,532 $ (9,434) $10,098
Securities held
to maturity:
Maturities,
calls and
mandatory
redemptions 1,578 (21) 1,557 2,205 (207) 1,998 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
$ 251,959 $(102,692) $149,267 $ 56,235 $(27,396) $28,839 $ 19,532 $ (9,434) $10,098
====================================================================================================================================
The amortized cost and fair values of securities available for sale and
securities held to maturity at December 31, 2001, by contractual maturity are
shown in the following table. Expected maturities differ from contractual
maturities because borrowers have the right to prepay obligations without
prepayment penalties in certain cases. The amounts exclude $645 million cost
($646 million fair value) of equity securities that do not have maturities.
- ---------------------------------------------------------------------------------------------------
Amortized Fair
December 31, 2001 Cost Value
- ---------------------------------------------------------------------------------------------------
in thousands
Within one year $ 506,570 $ 515,571
After one but within five years 3,695,866 3,788,143
After five but within ten years 2,692,379 2,713,673
After ten years 7,978,876 8,081,649
- ---------------------------------------------------------------------------------------------------
Securities available for sale $14,873,691 $15,099,036
- ---------------------------------------------------------------------------------------------------
Within one year $ 22,098 $ 22,716
After one but within five years 182,165 190,587
After five but within ten years 462,654 484,113
After ten years 3,984,412 4,142,289
- ---------------------------------------------------------------------------------------------------
Securities held to maturity $ 4,651,329 $ 4,839,705
- ---------------------------------------------------------------------------------------------------
During 2001, Brady bonds with a carrying value of $189.9 million issued by the
government of Mexico were transferred from loans to securities available for
sale, as permitted by the transition provisions of SFAS 133. Mortgage backed
securities with a carrying value of $1,041.9 million were transferred from
available for sale to held to maturity during 2001. Brazilian debt securities
with a carrying value of $98.3 million were transferred from available for sale
to trading during 2001.
60
Note 6. Loans
================================================================================
A distribution of the loan portfolio follows.
- --------------------------------------------------------------------------------
December 31, 2001 2000
- --------------------------------------------------------------------------------
in thousands
Domestic:
Commercial:
Construction and mortgage loans $ 5,953,751 $ 5,645,641
Other business and financial 10,564,340 12,550,766
Consumer:
Residential mortgages 17,951,119 15,835,374
Credit card receivables 1,147,998 1,232,054
Other consumer loans 1,769,576 1,640,260
International 3,536,514 3,513,752
- --------------------------------------------------------------------------------
$40,923,298 $40,417,847
- --------------------------------------------------------------------------------
Residential mortgages include $1,150.0 million and $413.0 million of mortgages
held for sale at December 31, 2001 and 2000, respectively. Other consumer loans
include $368.0 million and $368.5 million of higher education loans also held
for sale at December 31, 2001 and 2000, respectively.
International loans include certain bonds issued by the government of Venezuela
as part of debt renegotiations (Brady bonds). These bonds had an aggregate
carrying value of $165.9 million (face value $177.5 million) and an aggregate
fair value of $130.7 million at year end 2001. The Company's intent is to hold
these instruments until maturity. The bonds are fully secured as to principal by
zero-coupon U.S. Treasury securities with face value equal to that of the
underlying bonds. During 2001, Brady bonds with a carrying value of $189.9
million issued by the government of Mexico were transferred to securities
available for sale, as permitted by the transition provisions of SFAS 133.
At December 31, 2001 and 2000, the Company's nonaccruing loans were $416.8
million and $423.2 million, respectively. At December 31, 2001 and 2000, the
Company had commitments to lend additional funds of $10.0 million and $45.8
million, respectively, to borrowers whose loans are classified as nonaccruing. A
significant portion of these commitments include clauses that provide for
cancellation in the event of a material adverse change in the financial position
of the borrower.
- --------------------------------------------------------------------------------
Year Ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------
in thousands
Interest income on nonaccruing loans which
would have been recorded had they been
current in accordance with their original terms $30,565 $28,004 $22,879
Interest income recorded on nonaccruing loans 18,677 23,986 29,084
- --------------------------------------------------------------------------------
Other real estate and owned assets included in other assets amounted to $17.7
million and $20.6 million at December 31, 2001 and 2000, respectively.
The Company identified impaired loans totaling $242.6 million at December 31,
2001, of which $150.7 million had an allocation from the allowance of $83.0
million. At December 31, 2000, the Company had identified impaired loans of
$223.5 million of which $108.7 million had an allocation from the allowance of
$46.3 million. The average recorded investment in such impaired loans was $215.5
million, $192.2 million and $184.9 million in 2001, 2000 and 1999, respectively.
61
The Company has loans outstanding to certain executive officers and directors.
The loans were made on substantially the same terms, including interest rates
and collateral, as those prevailing at the same time for comparable transactions
with other persons and do not involve more than normal risk of collectibility.
The aggregate amount of such loans did not exceed 5% of shareholders' equity at
December 31, 2001 and 2000.
Note 7. Allowance for Credit Losses
================================================================================
An analysis of the allowance for credit losses follows.
- ----------------------------------------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------------
in thousands
Balance at beginning of year $ 524,984 $ 637,995 $ 379,652
Allowance related to acquisitions, net/other (18,987) (11,302) 268,617
Provision charged to income 238,400 137,600 90,000
Recoveries on loans charged off 42,821 34,248 34,825
Loans charged off (280,500) (272,975) (135,099)
Translation adjustment (352) (582) --
- ----------------------------------------------------------------------------------------------
Balance at end of year $ 506,366 $ 524,984 $ 637,995
- ----------------------------------------------------------------------------------------------
Note 6 provides information on impaired loans and the related specific credit
loss allowance.
Included in the December 31, 2001 allowance for credit losses is $70.5 million
of non-United States transfer risk reserves.
Note 8. Mortgage Servicing Rights
================================================================================
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The outstanding principal balances of these loans
were $23.12 billion and $20.02 billion at December 31, 2001 and 2000,
respectively. Custodial balances maintained in connection with the foregoing
loan servicing, and included in noninterest bearing deposits in domestic offices
were $547.1 million and $304.8 million at December 31, 2001 and 2000,
respectively.
An analysis of MSRs, reported in other assets, follows.
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
in thousands
Balance at beginning of year $ 267,065 $ 269,774 $ 133,804
Additions 109,035 39,695 166,179
Amortization (59,725) (42,404) (30,209)
- --------------------------------------------------------------------------------
Balance at end of year $ 316,375 $ 267,065 $ 269,774
- --------------------------------------------------------------------------------
Additions to MSRs in 1999 include $115.1 million obtained in the acquisition of
Republic. No valuation reserve has been established against MSRs. The fair value
of MSRs as of December 31, 2001 and 2000 was approximately $364.1 million and
$357.1 million, respectively.
62
Note 9. Deposits
================================================================================
The aggregate amount of time deposit accounts (primarily certificates of
deposits) each with a minimum of $100,000 included in domestic office deposits
were $4.16 billion and $4.82 billion at December 31, 2001 and 2000,
respectively. The scheduled maturities of all domestic time deposits at December
31, 2001 follows.
- --------------------------------------------------------------------------------
in thousands
2002 $10,437,972
2003 880,454
2004 236,216
2005 117,032
2006 18,376
Later years 35,881
- --------------------------------------------------------------------------------
$11,725,931
- --------------------------------------------------------------------------------
Note 10. Short-Term Borrowings
================================================================================
The following table shows detail relating to short-term borrowings in 2001, 2000
and 1999. Average interest rates during each year are computed by dividing total
interest expense by the average amount borrowed.
- -------------------------------------------------------------------------------------------------------------------
2001 2000 1999
------------------ ---------------- ---------------------
Amount Rate Amount Rate Amount Rate
- -------------------------------------------------------------------------------------------------------------------
in thousands
Federal funds purchased
(day to day):
At December 31 $ 133,640 1.18% $1,974,589 4.90% $ 368,089 5.08%
Average during year 1,436,449 3.78 985,215 6.31 502,595 4.87
Maximum month-end balance 2,919,576 2,122,030 840,849
Securities sold under repurchase agreements:
At December 31 377,059 1.25 893,567 5.13 1,046,984 6.23
Average during year 1,116,434 2.13 1,096,989 5.62 448,745 4.62
Maximum month-end balance 2,280,180 1,746,506 1,046,984
Commercial paper:
At December 31 1,634,559 2.05 1,472,586 6.70 1,121,377 5.42
Average during year 1,218,242 3.77 1,131,819 6.36 838,739 5.18
Maximum month-end balance 1,642,520 1,629,704 1,121,377
Precious metals:
At December 31 2,208,527 1.39 1,899,747 .95 1,679,118 2.45
Average during year 2,157,762 1.15 2,127,067 1.32 4,600 --
Maximum month-end balance 2,503,772 2,684,805 1,679,118
All other short-term borrowings:
At December 31 4,848,301 2.31 2,321,874 7.44 995,141 5.56
Average during year 3,187,795 4.90 3,137,950 6.83 718,570 5.29
Maximum month-end balance 5,817,136 6,789,254 1,225,000
- -------------------------------------------------------------------------------------------------------------------
At December 31, 2001, the Company had unused lines of credit with HSBC
aggregating $500 million. These lines of credit do not require compensating
balance arrangements and commitment fees are not significant. In addition, the
Company, as a member of the New York Federal Home Loan Bank, has a secured
borrowing facility in excess of $5 billion collateralized by residential
mortgage loan assets.
63
Note 11. Income Taxes
================================================================================
Total income taxes were allocated as follows.
- ------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
in thousands
To income before income taxes $ 226,000 $338,573 $308,300
To shareholders' equity as tax charge (benefit):
Net unrealized gains and losses on
securities available for sale 20,638 95,322 (51,546)
Foreign currency translation, net (6,383) (4,033) --
Unrealized loss on derivatives classified
as cash flow hedges (20,194) -- --
- ------------------------------------------------------------------------------------------------------------------
$ 220,061 $429,862 $256,754
- ------------------------------------------------------------------------------------------------------------------
The components of income tax expense follow.
- ------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
in thousands
Current:
Federal $ 384,849 $217,683 $240,180
State and local 60,987 12,000 59,017
Foreign 24,127 26,151 --
- ------------------------------------------------------------------------------------------------------------------
Total current 469,963 255,834 299,197
Deferred, primarily federal (243,963) 82,739 9,103
- ------------------------------------------------------------------------------------------------------------------
Total income taxes $ 226,000 $338,573 $308,300
- ------------------------------------------------------------------------------------------------------------------
The following table is an analysis of the difference between effective rates
based on the total income tax provision attributable to pretax income and the
statutory U.S. Federal income tax rate.
- ------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
Increase (decrease) due to:
State and local income taxes 1.8 .9 4.7
Goodwill amortization 9.8 6.3 .9
Change in valuation allowance
for deferred tax assets (4.9) -- --
Tax exempt interest income (2.6) (1.5) (.2)
Other items (.1) (3.4) (.5)
- ------------------------------------------------------------------------------------------------------------------
Effective income tax rate 39.0% 37.3% 39.9%
- ------------------------------------------------------------------------------------------------------------------
64
The components of the net deferred tax asset are summarized below.
- --------------------------------------------------------------------------------
December 31, 2001 2000
- --------------------------------------------------------------------------------
in thousands
Deferred tax assets:
Allowance for credit losses $197,792 $181,919
Deferred charge offs 11,305 11,305
Accrued expenses not currently deductible 145,571 134,825
Investment securities 141,839 108,655
Princeton Note Matter settlement/other 284,864 107,928
- --------------------------------------------------------------------------------
781,371 544,632
Less valuation allowance -- 28,329
- --------------------------------------------------------------------------------
Total deferred tax assets 781,371 516,303
- --------------------------------------------------------------------------------
Less deferred tax liabilities:
Lease financing income accrued 45,464 48,319
Accrued pension cost 60,105 46,093
Accrued income on foreign bonds 16,161 20,094
Deferred net operating loss recognition 90,018 90,018
Depreciation and amortization 116,361 81,052
Interest and discount income 57,846 82,062
Other 67,284 56,229
- --------------------------------------------------------------------------------
Total deferred tax liabilities 453,239 423,867
- --------------------------------------------------------------------------------
Net deferred tax asset $328,132 $ 92,436
- --------------------------------------------------------------------------------
Realization of deferred tax assets is contingent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carryback period. Based upon the level of historical taxable income and the
scheduled reversal of the deferred tax liabilities over the periods which the
deferred tax assets are deductible, management believes it is more likely than
not the Company will realize the benefits of these deductible differences.
Note 12. Subordinated Long-Term Debt and Perpetual Capital Notes
================================================================================
The following is a summary of subordinated long-term debt and perpetual capital
notes. Interest rates shown are based on the face values of the instruments.
- -----------------------------------------------------------------------------------------------------
Face Value Book Value
------------------ ------------------
December 31, 2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------------
in thousands
7.875-8.875% Subordinated notes due 2001 $ -- $ 350,000 $ -- $ 351,727
7.25-7.75% Subordinated notes due 2002 400,000 400,000 399,912 399,889
Floating rate subordinated notes due 2002
(5.00%) 245,700 245,700 244,927 243,798
7% Subordinated notes due 2006 300,000 300,000 298,782 298,530
5.875% Subordinated notes due 2008 250,000 250,000 226,280 222,766
6.625-9.70% Subordinated notes due 2009 550,000 550,000 583,990 565,198
Floating rate subordinated notes due 2009
(5.25%) 124,320 124,320 124,320 124,320
7% Subordinated notes due 2011 100,000 100,000 105,376 94,038
9.50% Subordinated debentures due 2014 150,000 150,000 165,406 166,663
9.125-9.30% Subordinated notes due 2021 200,000 200,000 217,587 218,494
7.20% Subordinated debentures due 2097 250,000 250,000 214,812 214,443
Perpetual Capital Notes (4.00%) 129,000 129,000 130,157 127,148
- -----------------------------------------------------------------------------------------------------
$2,699,020 $3,049,020 $2,711,549 $3,027,014
- -----------------------------------------------------------------------------------------------------
The above table excludes $1,550 million of debt issued by the Bank or its
subsidiaries payable to the Company. Of this amount, the earliest note to mature
is in 2006 and the latest note to mature is in 2097.
65
Interest rates on floating rate notes are determined periodically by formulas
based on certain money market rates or, in certain instances, by minimum
interest rates as specified in the agreements governing the issues. Interest
rates on the floating rate notes in effect at December 31, 2001 are shown in
parentheses.
The Perpetual Capital Notes (PCNs) are a component of total qualifying capital
under applicable risk-based capital rules. The PCNs may be exchanged for
securities that constitute permanent primary capital securities for regulatory
purposes. The principal amount of each PCN will be payable as follows: (1) at
the option of the holder on the put date in each year commencing in 2012, (2) at
the option of the Company on 90 days prior notice, the PCNs may be either (i)
redeemed on the specified redemption date, in whole, for cash and at par, but
only with the proceeds of a substantially concurrent sale of capital securities
issued for the purpose of such redemption or (ii) exchanged, in whole, for
capital securities having a market value equal to the principal amount of the
PCNs, and, in each case, the payment of accrued interest in cash or (3) in the
event that the sum of the Company's retained earnings and surplus accounts
becomes less than zero, the PCNs will automatically be exchanged, in whole, for
capital securities having a market value equal to the principal amount of the
PCNs and the payment of accrued interest in cash.
Contractual scheduled maturities for the subordinated debt over the next five
years are as follows: 2002, $646 million; none in 2003, 2004 or 2005; and $300
million in 2006.
Note 13. Guaranteed Mandatorily Redeemable Securities
================================================================================
The following table presents the guaranteed mandatorily redeemable securities
outstanding. Interest rates shown are based on the face values of the
instruments.
- --------------------------------------------------------------------------------
Face Value Book Value
---------- ----------------------
December 31, 2001/2000 2001 2000
- --------------------------------------------------------------------------------
in thousands
7.808% Capital Securities due 2026 $200,000 $200,000 $200,000
8.38% Capital Securities due 2027 200,000 200,000 200,000
7.75% Capital Securities due 2026 150,000 136,339 135,789
7.53% Capital Securities due 2026 200,000 192,002 175,948
- --------------------------------------------------------------------------------
$750,000 $728,341 $711,737
- --------------------------------------------------------------------------------
The guaranteed mandatorily redeemable securities (Capital Securities) are issued
by trusts all of whose outstanding common securities are owned by the Company.
The Capital Securities represent preferred beneficial interests in the assets of
the trusts and are guaranteed by the Company. The sole assets of the trusts
consist of junior subordinated debentures of the Company. The Capital Securities
qualify as Tier 1 capital under the risk-based capital guidelines of the Federal
Reserve Board.
The Capital Securities are redeemable at the option of the Company in the case
of a tax event or regulatory capital event at the prepayment price equal to the
greater of (i) 100% of the principal amount of the Capital Securities or (ii)
the sum of the present values of the stated percentage of the principal amount
of the Capital Securities plus the remaining scheduled payments of interest
thereon from the prepayment date. Tax event refers to notice that the interest
payable on the Capital Securities would not be deductible. Regulatory capital
event refers to notice that the Capital Securities would not qualify as Tier 1
capital.
66
In the absence of a tax or regulatory capital event, the Capital Securities are
redeemable at the option of the Company. The 7.808% Capital Securities are
redeemable on December 15, 2006 at a premium of 3.904% in the first twelve
months after December 15, 2006 and varying lesser amounts thereafter and without
premium if redeemed after December 15, 2016. The 8.38% Capital Securities are
redeemable on May 15, 2007 at a premium of 4.19% in the first twelve months
after May 15, 2007 and varying lesser amounts thereafter and without premium if
redeemed after May 15, 2017. The 7.75% Capital Securities are redeemable on
November 15, 2006 at a premium of 3.66% in the first twelve months after
November 15, 2006 and varying lesser amounts thereafter and without premium if
redeemed after November 15, 2016. The 7.53% Capital Securities are redeemable on
December 4, 2006 at a premium of 3.765% in the first twelve months after
December 4, 2006 and varying lesser amounts thereafter and without premium if
redeemed after December 4, 2016.
Note 14. Other Long-Term Debt
================================================================================
The following table reports other long-term debt. Interest rates shown are based
on the face values of the instruments.
- ----------------------------------------------------------------------------------------------------------------
Face Value Book Value
------------------- -----------------------
December 31, 2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------
in thousands
Issued or acquired by the Company
or subsidiaries other than the Bank:
8.375% Debentures due 2007 $ 100,000 $ 100,000 $ 103,561 $ 104,262
- ----------------------------------------------------------------------------------------------------------------
Issued or acquired by the Bank or its subsidiaries:
Medium-Term Floating Rate Note
due 2040 (1.75%) 24,999 24,999 24,999 24,999
Fixed rate Federal Home Loan Bank of
New York advances 12,531 232,838 12,531 232,838
Collateralized mortgage obligations 1,497 2,343 1,497 2,343
Collateralized repurchase agreements 838,724 936,205 838,724 936,205
Other 55,597 57,196 69,570 57,257
- ----------------------------------------------------------------------------------------------------------------
933,348 1,253,581 947,321 1,253,642
- ----------------------------------------------------------------------------------------------------------------
$1,033,348 $1,353,581 $1,050,882 $1,357,904
- ----------------------------------------------------------------------------------------------------------------
The Medium-Term Floating Rate Note due 2040 was issued under the Bank's Global
Medium-Term Note Program which provides for the issuance of up to $4 billion of
notes having maturities of 7 days or more from the date of issue.
The fixed rate Federal Home Loan Bank of New York advances have interest rates
ranging from 2.67% to 7.24%.
The mortgage bonds are collateralized by a pledge of FHLMC mortgage-backed
securities. All payments received on the pledged mortgage-backed securities, net
of certain costs, must be applied to repay the bonds. The stated maturity and
stated rate for the bonds are: September, 2002 at 7.89% and October, 2006 at
7.27%. It is expected that the actual life of the bonds will be less than their
stated maturity.
The collateralized repurchase agreements consist of securities repurchase
agreements with initial maturities exceeding one year. The repurchase agreements
have fixed rates ranging from 1.75% to 7.40% and floating rates of 2.18% and
4.05%.
Contractual scheduled maturities for the debt over the next five years are as
follows: 2002, $191 million; 2003, $96 million; 2004, $84 million; 2005, $42
million and $18 million in 2006.
67
Note 15. Preferred Stock
================================================================================
The following table presents information related to the issues of preferred
stock outstanding.
- ----------------------------------------------------------------------------------------------------------
Amount
Shares Dividend Outstanding
Outstanding Rate ------------------------
December 31, 2001 2001 2001 2000
- ----------------------------------------------------------------------------------------------------------
in thousands
$1.8125 Cumulative Preferred Stock
($25 stated value) 3,000,000 7.25% $ 75,000 $ 75,000
6,000,000 Depositary shares each representing
a one-fourth interest in a share of Adjustable
Rate Cumulative Preferred Stock, Series D
($100 stated value) 1,500,000 4.549 150,000 150,000
Dutch Auction Rate Transferable Securities(TM)
Preferred Stock (DARTS)
Series A ($100,000 stated value) 625 3.51 62,500 62,500
Series B ($100,000 stated value) 625 3.34 62,500 62,500
$2.8575 Cumulative Preferred Stock
($50 stated value) 3,000,000 5.715 150,000 150,000
CTUS Inc. Preferred Stock 100 -- -- --
- ----------------------------------------------------------------------------------------------------------
$ 500,000 $ 500,000
- ----------------------------------------------------------------------------------------------------------
The $1.8125 Cumulative Preferred Stock may be redeemed, at the option of the
Company, at $25 per share plus dividends accrued and unpaid to the redemption
date.
The dividend rate on the Adjustable Rate Cumulative Preferred Stock, Series D
(Series D Stock) is determined quarterly, by reference to a formula based on
certain benchmark market interest rates, but will not be less than 4 1/2% or
more than 10 1/2% per annum for any applicable dividend period. The Series D
Stock is redeemable by the Company at $100 per share (or $25 per depositary
share), plus accrued and unpaid dividends to the redemption date.
DARTS of each series are redeemable at the option of the Company, at $100,000
per share, plus accrued and unpaid dividends to the redemption date. Dividend
rates for each dividend period are set pursuant to an auction procedure. The
maximum applicable dividend rates on the shares of DARTS range from 110% to 150%
of the 60 day "AA" composite commercial paper rate. DARTS are also redeemable,
at the option of the Company, on any dividend payment date for such series, at a
redemption price of $100,000 per share plus the payment of accrued and unpaid
dividends, if the applicable rate for such series fixed with respect to the
dividend period for such series ending on such dividend payment date equals or
exceeds the 60 day "AA" composite commercial paper rate on the date of
determination of such rate.
The outstanding shares of $2.8575 Cumulative Preferred Stock have an aggregate
stated value of $150 million. The Cumulative Preferred Stock may be redeemed at
the option of the Company on or after October 1, 2007, at $50 per share, plus
dividends accrued and unpaid to the redemption date.
The Company acquired CTUS Inc., a unitary thrift holding company in 1997 from CT
Financial Services Inc. (the Seller). CTUS owned First Federal Savings and Loan
Association of Rochester (First Federal). The acquisition agreement provided
that the Company issue preferred shares to the Seller. The preferred shares
provide for, and only for, a contingent dividend or redemption equal to the
amount of recovery, net of taxes and costs, if any, by First Federal resulting
from the pending action against the United States government
68
alleging breaches by the government of contractual obligations to First Federal
following passage of the Financial Institutions Reform, Recovery and Enforcement
Act of 1989. The Company issued 100 preferred shares at a par value of $1.00 per
share in connection with the acquisition.
Note 16. Common Stock
================================================================================
All of the common stock of the Company is owned by HSBC North America Inc., an
indirect wholly owned subsidiary of HSBC. Common shares authorized are
150,000,000 with a par value of $5.00. Shares issued were 704 at December 31,
2001 and 2000.
Note 17. Retained Earnings
================================================================================
Bank dividends are a major source of funds for payment by the Company of
shareholder dividends and along with interest earned on investments, cover the
Company's operating expenses which consist primarily of interest on outstanding
debt. The approval of the Federal Reserve Board is required if the total of all
dividends declared by the Bank in any year exceed the net profits for that year,
combined with the retained profits for the two preceding years. Under a separate
restriction, payment of dividends is prohibited in amounts greater than
undivided profits then on hand, after deducting actual losses and bad debts. Bad
debts are debts due and unpaid for a period of six months unless well secured,
as defined, and in the process of collection.
Under the more restrictive of the above rules the Bank can pay dividends to the
Company as of December 31, 2001 of approximately $38 million, adjusted by the
effect of its net income (loss) for 2002 up to the date of such dividend
declaration.
69
Note 18. Accumulated Other Comprehensive Income
================================================================================
Accumulated other comprehensive income includes net income as well as certain
items that are reported directly within a separate component of shareholders'
equity. The following table presents changes in accumulated other comprehensive
income balances.
- ------------------------------------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------------------------------------
in thousands
Accumulated other comprehensive income (loss)
at beginning of year $ 116,851 $ (50,534) $ 44,506
Fair value adjustments on securities
available for sale:
Increase(decrease) in fair value, net of
taxes of $72,307, $104,717, and $(48,012)
in 2001, 2000 and 1999, respectively 127,141 192,318 (88,476)
Reclassification adjustment for (gains)
losses included in net income, net of
taxes of $51,669, $9,395, and $3,534
in 2001, 2000 and 1999, respectively (96,041) (17,444) (6,564)
- ------------------------------------------------------------------------------------------------------
31,100 174,874 (95,040)
- ------------------------------------------------------------------------------------------------------
Adjustments related to SFAS 133:
Change in unrealized loss on derivatives
classified as cash flow hedges, net of
taxes of $(20,194) (37,503) -- --
Unrealized net transitional gain related
to initial adoption of SFAS 133 2,853 -- --
Amortization of unrealized transitional
SFAS 133 gains credited to current income (2,853) -- --
- ------------------------------------------------------------------------------------------------------
(37,503) -- --
- ------------------------------------------------------------------------------------------------------
Accumulated foreign currency translation adjustments:
Translation losses, net of taxes of $(6,383)
and $(4,033) in 2001 and 2000, respectively (11,841) (7,489) --
- ------------------------------------------------------------------------------------------------------
(11,841) (7,489) --
- ------------------------------------------------------------------------------------------------------
Net change in accumulated other
comprehensive income (loss) (18,244) 167,385 (95,040)
- ------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive
income (loss) at end of year $ 98,607 $ 116,851 $ (50,534)
- ------------------------------------------------------------------------------------------------------
Note 19. Impact of Recently Issued Accounting Standards
================================================================================
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations (SFAS 141). The
Statement is effective for all business combinations initiated after June 30,
2001 and for all business combinations accounted for by the purchase method that
are completed after June 30, 2001. SFAS 141 prohibits the pooling-of-interests
method of accounting for business combinations and prescribes the initial
recognition and measurement of goodwill and other intangible assets, accounting
for negative goodwill and the required disclosures in respect of business
combinations.
In July 2001, the Financial Accounting Standards Board also issued Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets
(SFAS 142). The Statement is effective for fiscal years beginning after December
15, 2001 and may not be retroactively applied to financial statements of prior
periods. SFAS 142 requires that goodwill, including previously existing
goodwill, and intangible assets with indefinite useful lives should not be
amortized but should be tested for impairment annually.
70
SFAS 142 does not carry forward the concept of corporate or enterprise-wide
goodwill found in previous accounting literature. Under SFAS 142, all goodwill
must be assigned to one or more reporting units of the entity and evaluated for
impairment at that level. This represents a significant departure from previous
accounting guidance which generally applied an acquisition-specific or an
enterprise-wide basis for evaluating goodwill for impairment.
The Company was required to adopt the provisions of SFAS 141 immediately and
SFAS 142 with effect from January 1, 2002. At January 1, 2002, the Company will
have unamortized goodwill of approximately $2.8 billion. Amortization expense
related to goodwill was $176.5 million and $176.2 million for the years ended
December 31, 2001 and 2000, respectively. Because of the extensive effort needed
to comply with adopting SFAS 141 and SFAS 142, it is not practicable to estimate
reasonably the impact of adopting these Statements on the Company's financial
statements at the date of this report, including whether any transitional
impairment losses will be required to be recognized as the cumulative effect of
a change in accounting principles.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations (SFAS 143), which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The standard applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) normal use of the asset.
SFAS 143 requires the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The fair value of the liability is added to
the carrying amount of the associated asset and this additional carrying amount
is depreciated over the life of the asset. The liability is accreted at the end
of each period through charges to operating expense. If the obligation is
settled for other than the carrying amount of the liability, the Company will
recognize a gain or loss on settlement.
The Company is required and plans to adopt the provisions of SFAS 143 for the
quarter ending March 31, 2003. Adoption of this standard is not expected to have
a material effect on the consolidated financial statements of the Company.
In October 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS 144). The statement supersedes SFAS 121 and
is effective for fiscal years beginning after June 15, 2002 although early
adoption is encouraged. SFAS 144 retains many of the fundamental principles of
SFAS 121 but differs from it in that it excludes goodwill and intangible assets
from its provisions and provides greater direction relating to the
implementation of its principles. Adoption is not expected to have a material
impact on the financial statements of the Company.
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133) as amended by SFAS 137 and SFAS 138. SFAS 133 standardizes the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts. Under SFAS 133, entities
71
are required to carry all derivatives in the consolidated balance sheet at fair
value. The accounting for changes in fair value (i.e. gains or losses) of a
derivative depends on whether it has been designated and qualifies as part of a
hedging relationship and, if so, the type of hedge.
In accordance with the transition provisions of SFAS 133, the Company recorded a
net of tax cumulative effect adjustment charge of $.5 million in earnings for
the year ended December 31, 2001 representing the difference between the fair
value of derivatives that were designated as fair value hedging instruments at
the date of adoption and the related mark to market of the previously hedged
assets and liabilities.
The Company also recorded a net of tax cumulative effect gain of $2.9 million in
accumulated other comprehensive income representing the fair value of
derivatives that were designated as cash flow hedging instruments at the date of
adoption, all of which was recognized in earnings during the current year as the
hedged items impacted operating results. Gains and losses on derivatives that
were previously deferred as adjustments to the carrying amount of hedged items
were not affected and continue to be amortized over the life of the previously
hedged items.
See Summary of Significant Accounting Policies for further discussion of
derivative financial instruments and SFAS 133.
In September 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities (SFAS 140). SFAS 140
replaced Statement of Financial Accounting Standards No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS 125). It revised the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carried over most of SFAS 125's provisions without change.
SFAS 140 was effective for transfers and servicing of financial assets and
extinguishments of liabilities of the Company occurring after March 31, 2001.
Adoption of this standard has not had a material effect on the consolidated
financial statements of the Company.
Note 20. Regulatory Matters
================================================================================
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, specific capital
guidelines must be met that involve quantitative measures of assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the maintenance of minimum amounts and ratios of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined) of
8% and 4%, respectively. Also required are ratios of Tier 1 capital (as defined)
to average assets (as defined) of 4% at the Bank level and 3% at the Company
level as long as the Company has a strong supervisory rating.
72
As of December 31, 2001 the most recent notification from the Federal Reserve
Board (FRB) categorized the Company and the Bank as well-capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, a banking institution must have a minimum total risk-based ratio of
at least 10%, a Tier 1 risk-based ratio of at least 6%, and a Tier 1 leverage
ratio of at least 5%. There are no conditions or events since that notification
that management believes have changed the categories. The capital amounts and
ratios are presented in the table.
- --------------------------------------------------------------------------------
2001 2000
------------------- --------------------
December 31, Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------
in millions
Total capital
(to risk weighted assets)
Company $7,404 13.31% $7,393 13.56%
Bank 6,502 11.90 6,458 12.01
Tier 1 capital
(to risk weighted assets)
Company 4,639 8.34 4,573 8.39
Bank 4,493 8.22 4,420 8.22
Tier 1 capital
(to average assets)
Company 4,639 5.48 4,573 5.73
Bank 4,493 5.46 4,420 5.69
- --------------------------------------------------------------------------------
Note 21. Transactions with Principal Shareholder and Related Parties
================================================================================
The Company's common stock is owned by HSBC North America Inc., an indirect
wholly owned subsidiary of HSBC. In the normal course of business, the Company
conducts transactions with HSBC, including its 25% or more owned subsidiaries
(HSBC Group). These transactions occur at prevailing market rates and terms and
include deposits taken and placed, short-term borrowings and interest rate
contracts and do not have a significant impact on reported results.
At December 31, 2001 and 2000 assets of $738.8 million and $981.5 million,
respectively, and liabilities of $4,834.1 million and $3,721.4 million,
respectively, related to such transactions with the HSBC Group were included in
the Company's balance sheet. Interest income on transactions with HSBC Group
members was $46.3 million and $82.0 million for 2001 and 2000, respectively.
Interest expense on transactions with HSBC Group members was $159.6 million and
$285.7 million for 2001 and 2000, respectively.
Derivative contracts entered into with the HSBC Group are used for various
purposes. See Note 28 for a discussion of derivative instruments. At December
31, 2001 and 2000, the notional amounts of all derivative contracts with members
of the HSBC Group were $39.09 billion and $20.05 billion, respectively.
Legal restrictions on extensions of credit by the Bank to the HSBC Group require
that such extensions be secured by eligible collateral. At December 31, 2001 and
2000, outstanding extensions of credit secured by eligible collateral were
$1,208.2 million and $950.4 million, respectively.
Refer to Notes 1 and 2 for discussions of the Company's divestitures and
acquisition transactions with other HSBC Group members.
73
On April 1, 2001, the Bank acquired approximately a 5 percent interest in the
voting shares of HSBC Republic Bank (Suisse) S.A. (Swiss Bank), an affiliate
wholly owned by the HSBC Group, in exchange for the contribution to the Swiss
Bank of private banking businesses conducted by the Bank's Singapore and Hong
Kong branches acquired as part of the Republic acquisition. The 5 percent
interest represents the fair value estimate of the businesses transferred to the
Swiss Bank and is being accounted for using the equity method of accounting due
to the common control relationship of the entities. The Bank retained its
banknotes activities in Singapore and its banknotes and foreign currency
businesses in Hong Kong, and maintained its branch licenses in both locations.
In the third quarter of 2000, HSBC acquired Credit Commercial de France. As part
of the consolidation of HSBC's commercial banking activities in the U.S., the
Company acquired in a cash purchase the commercial loan portfolio of
approximately $500 million of the New York office of Credit Commercial de
France. Additionally, $2.4 billion of commitments to lend were assumed as part
of the acquisition.
Note 22. Stock Option Plans and Restricted Share Plan
================================================================================
Options have been granted to employees of the Company under the HSBC Holdings
Group Share Option Plan (the Group Share Option Plan), the HSBC Holdings
Executive Share Option Scheme (the Executive Share Option Plan) and under the
HSBC Savings Related Share Option Contribution Program (the Savings Related
Share Option Plans).
Group Share Option Plan
The Group Share Option Plan is a long-term incentive compensation plan available
to certain Company employees with grants usually made each year. Options are
granted at market value and are normally exercisable between the third and tenth
anniversaries of the date of grant, subject to vesting conditions. This plan was
adopted during 2001. An analysis of the Group Share Option Plan follows.
- --------------------------------------------------------------------------------
2001
- --------------------------------------------------------------------------------
Number Weighted Average
of Options Exercise Price
- --------------------------------------------------------------------------------
Balance at beginning of year -- $ --
Granted 4,084,220 12.67
(Forfeited) (109,350) 12.67
- --------------------------------------------------------------------------------
Balance at end of year 3,974,870 $12.67
- --------------------------------------------------------------------------------
The fair value of options granted was $3.38 per option in 2001. Compensation
expense recognized amounted to $3.0 million in 2001.
Executive Share Option Plan
The Executive Share Option Plan is a long-term incentive compensation plan
available to certain Company employees with grants usually made each year.
Options are granted at market value and are normally exercisable between the
third and tenth anniversaries of the date of grant, subject to vesting
conditions. No further grants have been made under this plan since the adoption
of the Group Share Option Plan.
74
As of December 31, 2001, there were 4,202,842 shares outstanding under this plan
primarily as a result of grants issued in 2000 of 2,758,075 shares with an
exercise price of $10.85 per share and 1999 of 1,078,542 shares with an exercise
price of $9.27 per share. The exercise price of the options ranges from $3.16
per share to $14.03 per share.
The fair value of options granted was $4.55 and $3.34 per option in 2000 and
1999, respectively. Compensation expense recognized related to this plan
amounted to $4.9 million in 2001, $4.0 million in 2000 and $1.1 million in 1999.
Savings Related Share Option Plans
The Savings Related Share Option Plans invite eligible employees to enter into
savings contracts to save up to $400 per month, with the option to use the
savings to acquire shares. There are currently two types of plans offered which
allow the participant to select savings contracts of either a 5 year or 3 year
length. The options are exercisable within six months following the third or
fifth year, respectively of the commencement of the related savings contract, at
a 20 percent discount for options granted in 2001 or 15 percent discount for
options granted in 2000.
- -------------------------------------------------------------------------------------------------------
Five Year Contract 2001 2000
- -------------------------------------------------------------------------------------------------------
Number Weighted Average Number Weighted Average
of Options Exercise Price of Options Exercise Price
- -------------------------------------------------------------------------------------------------------
Balance at beginning of year 2,906,518 $ 9.82 -- $ --
Granted 494,524 8.77 3,343,348 9.82
(Forfeited) (6,642) (436,830)
- -------------------------------------------------------------------------------------------------------
Balance at end of year 3,394,400 $ 9.67 2,906,518 $ 9.82
- -------------------------------------------------------------------------------------------------------
The fair value of options granted was $3.84 and $4.30 per option in 2001 and
2000, respectively. Compensation expense recognized amounted to $2.7 million and
$1.4 million in 2001 and 2000, respectively.
- -------------------------------------------------------------------------------------------------------
Three Year Contract 2001
- -------------------------------------------------------------------------------------------------------
Number Weighted Average
of Options Exercise Price
- -------------------------------------------------------------------------------------------------------
Balance at beginning of year -- $ --
Granted 803,352 8.77
(Forfeited) (36,921)
- -------------------------------------------------------------------------------------------------------
Balance at end of year 766,431 $8.77
- -------------------------------------------------------------------------------------------------------
The fair value of options granted was $3.60 per option in 2001. Compensation
expense recognized amounted to $.5 million.
Prior to the Savings Related Share Option Plans being offered to employees in
its present form, eligible employees could elect to participate through the
Company's 401(k) plan and acquire contributions based on HSBC stock at 85% of
market value on the date of grant. An employee's agreement to participate was a
five year commitment. At the end of each five year period employees receive the
appreciation of the HSBC stock over the initial exercise price in the form of
stock of HSBC. Eligibility for this plan was discontinued after 1999 with the
adoption of the Savings Related Share Option Plans. Compensation expense related
to this plan amounted to $2.4 million in 2001, $2.5 million in 2000 and $2.2
million in 1999.
75
Fair values of share options are calculated at the date of grant using a
binomial model which produces similar results to the Black-Scholes model. The
significant assumptions used to estimate the fair value of options granted is as
follows.
- -------------------------------------------------------------------------------------------------------------------
Savings Related Savings Related
Group Share Share Option Share Option
2001 Option Plan Plan - 5 Year Plan - 3 Year
- -------------------------------------------------------------------------------------------------------------------
Risk free interest rate 5.65% 5.50% 5.40%
Expected life (years) 10 5.5 3.5
Expected volatility 30% 30% 30%
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Savings Related
Group Share Executive Share Share Option
2000 Option Plan Option Plan Plan - 5 Year
- -------------------------------------------------------------------------------------------------------------------
Risk free interest rate 6.15% 6.20% 6.60%
Expected life (years) 10 10 5.5
Expected volatility 29% 32% 32%
- -------------------------------------------------------------------------------------------------------------------
Restricted Share Plan
The Company provides awards to key employees in the form of restricted shares.
These awards require the achievement of certain performance targets and vest
from one to three years from the date of the award. The cost of shares awarded
amounted to $23.7 million in 2001.
Republic Plans
Republic had benefit plans including: (1) the Long Term Incentive Stock Plan
which provided for the award of incentive stock options, non-qualified stock
options, stock appreciation rights, restricted stock and other stock-based
awards; (2) the Restricted Stock Election Plan which allowed certain officers
who had earned deferred compensation to elect to receive payment in the form of
restricted stock; (3) the Performance Based Incentive Compensation Plan which
was designed to provide an incentive to officers who served on the Management
Executive Committee and were in a position to make a material contribution to
Republic for which certain awards were paid out in the form of restricted stock
under the Long Term Incentive Plan; and (4) the Long Term Incentive Compensation
Plan which granted deferred restricted cash awards to certain employees.
Employees vested in the assets awarded under the Plans based on the terms of
each Plan. Employees will continue to vest in these Plans under the original
terms of the Plans unless they are terminated, at which time they will become
fully vested. As part of the acquisition, liabilities of $240.3 million were
assumed in connection with the Plans. As a result of the Company's purchase of
100% of Republic's outstanding common stock, amounts earned under these various
Plans will be satisfied through future payments of cash rather than the issuance
of shares of Republic common stock.
Note 23. Postretirement Benefits
================================================================================
The Company, the Bank and certain other subsidiaries maintain noncontributory
pension plans covering substantially all of their employees hired prior to
January 1, 1997 and those who joined the Company through acquisitions. Certain
other HSBC subsidiaries participate in these plans.
The Company also maintains unfunded noncontributory health and life insurance
coverage for all employees who retired from the Company and were eligible for
immediate pension benefits from the Company's retirement plan. Employees
76
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 the Company's share of retiree medical
cost.
The following table provides data concerning the Company's benefit plans.
- ---------------------------------------------------------------------------------------------------------------
Other
Pension Benefits Postretirement Benefits
---------------- -----------------------
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------
in thousands
Change in benefit obligation
Benefit obligation, January 1 $ 756,038 $ 687,731 $ 118,556 $ 107,214
Service cost 25,232 26,820 2,228 2,130
Interest cost 55,523 53,090 6,579 8,778
Participant contributions -- -- 282 267
Plan amendment 2,100 -- -- --
Actuarial (gain) loss 12,712 14,829 (18,839) 10,602
Benefits paid (27,023) (26,432) (8,203) (10,435)
- ---------------------------------------------------------------------------------------------------------------
Benefit obligation, December 31 $ 824,582 $ 756,038 $ 100,603 $ 118,556
===============================================================================================================
Change in plan assets
Fair value of plan assets, January 1 $ 850,759 $ 916,470 $ -- $ --
Actual return on plan assets (49,609) (39,279) -- --
Company contribution -- -- 7,921 10,168
Participant contributions -- -- 282 267
Benefits paid (27,023) (26,432) (8,203) (10,435)
- ---------------------------------------------------------------------------------------------------------------
Fair value of plan assets, December 31 $ 774,127 $ 850,759 $ -- $ --
===============================================================================================================
Funded status of plan
Funded status, December 31 $ (50,455) $ 94,721 $(100,603) $(118,556)
Unrecognized actuarial (gain) loss 169,007 26,997 (11,297) 7,015
Unrecognized prior service cost 6,161 5,005 -- --
Unrecognized net transition obligation -- -- 35,718 38,965
- ---------------------------------------------------------------------------------------------------------------
Recognized amount $ 124,713 $ 126,723 $ (76,182) $ (72,576)
===============================================================================================================
Amount recognized in the consolidated
balance sheet
Prepaid benefit cost $ 124,713 $ 126,723 $ -- $ --
Accrued benefit liability -- -- (76,182) (72,576)
- ---------------------------------------------------------------------------------------------------------------
Recognized amount $ 124,713 $ 126,723 $ (76,182) $ (72,576)
===============================================================================================================
77
Operating expenses for 2001, 2000 and 1999 included the following components.
- ---------------------------------------------------------------------------------------------------------------------
Other
Pension Benefits Postretirement Benefits
---------------- -----------------------
2001 2000 1999 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
in thousands
Net periodic benefit
cost (credit)
Service cost $ 25,232 $ 26,820 $ 17,900 $ 2,228 $ 2,130 $ 2,060
Interest cost 55,523 53,090 31,080 6,579 8,778 5,479
Expected return on plan
assets (79,689) (85,965) (48,748) -- -- --
Prior service cost
amortization 944 944 959 -- -- --
Actuarial gain -- (3,087) -- (527) -- --
Transition amount
amortization -- -- -- 3,247 3,247 3,247
- ---------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost
(credit) $ 2,010 $ (8,198) $ 1,191 $ 11,527 $14,155 $10,786
=====================================================================================================================
Weighted-average assumptions
as of December 31
Discount rate 7.25% 7.75% 8.00% 6.75% 7.25% 7.75%
Expected return on plan
assets 9.50 9.50 9.50 -- -- --
Rate of compensation
increase 4.00 5.15 5.15 4.65(1) 5.15(1) 5.15(1)
- ---------------------------------------------------------------------------------------------------------------------
(1) Applicable to life insurance only.
Net periodic pension cost includes $1.1 million, none, and $1.7 million for
2001, 2000 and 1999, respectively, recognized in the financial statements of
other HSBC subsidiaries participating in the Company's pension plan.
For purposes of determining its obligation for other postretirement benefits,
the Company has assumed a health care cost trend rate of 8% for 2001, decreasing
to 7% in the year 2002. The assumed health care cost trend rate has an effect on
the amounts reported. For example, increasing the assumed health care cost trend
by 1% would increase the aggregate service and interest cost component by $.2
million and the accumulated postretirement benefit obligation by $2.0 million.
Decreasing the health care cost trend rate by 1% would decrease the aggregate
service and interest cost components by $.2 million and the accumulated post
retirement benefit obligation by $1.9 million.
Employees hired after December 31, 1996 become participants in a defined
contribution plan after one year of service. Contributions to the plan are based
on a percentage of employees' compensation. Total expense recognized for the
plan was $3.0 million in 2001, $2.4 million in 2000, and $1.3 million in 1999.
The Company maintains a 401(k) plan covering substantially all employees.
Contributions to the plan by the Company are based on employee contributions.
Total expense recognized for the plan was $15.1 million in 2001, $11.7 million
in 2000 and $8.9 million for 1999.
Note 24. Business Segments
================================================================================
The Company has four distinct segments that it utilizes for management reporting
and analysis purposes. These segments are based upon products and services
offered and are identified in a manner consistent with the requirements outlined
in Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information (SFAS 131). The segment
results show the financial performance of the major business units.
78
These results are determined based on the Company's management accounting
process, which assigns balance sheet, revenue and expense items to each
reportable business unit on a systematic basis. Management does not analyze
depreciation and amortization expense or expenditures for additions to
long-lived assets which are not considered significant. As such, these amounts
are included in other expenses and average assets, respectively, in the table.
The following describes the four reportable segments.
The Commercial Banking Segment provides a diversified range of financial
products and services. This segment provides loan and deposit products to small
and middle-market corporations including specialized products such as equipment
and real estate financing. These products and services are offered through
multiple delivery systems, including the branch banking network. In addition,
various credit and trade related products are offered such as standby
facilities, performance guarantees, acceptances and accounts receivable
factoring.
The Corporate, Investment Banking and Markets Segment is comprised of two
reporting units/components: Corporate/Institutional Banking (CIB) and Investment
Banking and Markets (IB&M). CIB provides deposit and lending functionality to
large corporate and multi-national corporations and banks. U.S. dollar clearing
services are offered for domestic and international wire transfer transactions.
Corporate trust provides various trustee, agency and custody products and
services for both corporate and municipal customers. Credit and trade related
products such as standby facilities, performance guarantees and acceptances are
also provided to large corporate entities. The IB&M component includes treasury
and traded markets. The treasury function maintains overall responsibility for
the investment and borrowing of funds to ensure liquidity, maximize return and
manage interest rate risk. Traded markets encompasses the trading and sale of
foreign exchange, banknotes, derivatives, precious metals, securities and
emerging markets instruments, both domestically and internationally.
The Personal Financial Services Segment provides an extensive array of products
and services including installment and revolving term loans, deposits, branch
services, mutual funds, insurance, estate planning and other investment
management services. These products are marketed to individuals through the
branch banking network. Residential mortgage lending provides loan financing
through direct retail and wholesale origination channels. Mortgage loans are
originated through a network of brokers, wholesale agents and retail
originations offices. Servicing is performed for the individual mortgage holder
or on a contractual basis for mortgages owned by third parties.
The Private Banking Segment offers a full range of services for high net worth
individuals throughout the world including deposit, lending, trading, trust and
investment management.
Other consists of the charge for the Princeton Note settlement.
The Company reports and manages its business segments consistently with the line
of business groupings used by HSBC. As a result of HSBC line of business
changes, the Company altered its business segments that it uses during 2001.
Prior year disclosures have been conformed to the presentation of current
segments.
79
- --------------------------------------------------------------------------------------------------------------------------------
Corporate,
Investment Personal
Commercial Banking and Financial Private
Banking Markets Services Banking Other Total
- --------------------------------------------------------------------------------------------------------------------------------
in millions
2001
- ----
Net interest income (1) $ 646 $ 426 $ 1,099 $ 94 $ -- $ 2,265
Other operating income 191 455 393 57 -- 1,096
- --------------------------------------------------------------------------------------------------------------------------------
Total income 837 881 1,492 151 -- 3,361
Operating expenses (2) 452 349 871 120 575 2,367
- --------------------------------------------------------------------------------------------------------------------------------
Working contribution 385 532 621 31 (575) 994
Provision for credit losses (3) 90 80 62 6 -- 238
- --------------------------------------------------------------------------------------------------------------------------------
CMBT * 295 452 559 25 (575) 756
- --------------------------------------------------------------------------------------------------------------------------------
Average assets 17,562 41,485 23,944 3,285 -- 86,276
Average liabilities/equity (4) 13,124 30,010 31,703 11,295 144 86,276
- --------------------------------------------------------------------------------------------------------------------------------
2000
- ----
Net interest income (1) $ 598 $ 447 $ 971 $ 103 $ -- $ 2,119
Other operating income 151 235 376 70 -- 832
- --------------------------------------------------------------------------------------------------------------------------------
Total income 749 682 1,347 173 -- 2,951
Operating expenses (2) 415 311 882 121 -- 1,729
- --------------------------------------------------------------------------------------------------------------------------------
Working contribution 334 371 465 52 -- 1,222
Provision for credit losses (3) 68 34 37 (1) -- 138
- --------------------------------------------------------------------------------------------------------------------------------
CMBT * 266 337 428 53 -- 1,084
- --------------------------------------------------------------------------------------------------------------------------------
Average assets 16,147 41,911 21,325 3,405 -- 82,788
Average liabilities/equity (4) 12,249 28,441 31,234 10,864 -- 82,788
- --------------------------------------------------------------------------------------------------------------------------------
1999
- ----
Net interest income (1) $ 369 $ 165 $ 692 $ -- $ -- $ 1,226
Other operating income 104 77 283 -- -- 464
- --------------------------------------------------------------------------------------------------------------------------------
Total income 473 242 975 -- -- 1,690
Operating expenses (2) 183 73 539 -- -- 795
- --------------------------------------------------------------------------------------------------------------------------------
Working contribution 290 169 436 -- -- 895
Provision for credit losses (3) 21 12 57 -- -- 90
- --------------------------------------------------------------------------------------------------------------------------------
CMBT * 269 157 379 -- -- 805
- --------------------------------------------------------------------------------------------------------------------------------
Average assets 9,141 9,692 15,397 -- -- 34,230
Average liabilities/equity (4) 6,983 8,846 18,401 -- -- 34,230
- --------------------------------------------------------------------------------------------------------------------------------
* Contribution margin before tax represents pretax income (loss) excluding
goodwill amortization.
(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.
80
Note 25. Collateral, Commitments and Contingent Liabilities
================================================================================
At December 31, 2001 securities, loans and other assets carried in the
consolidated balance sheet at $8.6 billion were pledged as collateral for
borrowings, to secure governmental and trust deposits and for other purposes.
In accordance with the Statement of Financial Accounting Standards No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities (SFAS 140), debt securities pledged as collateral that can be
sold or repledged by the secured party continue to be reported on the
consolidated balance sheet. The following table provides the fair value of
collateral that can be sold or repledged.
- --------------------------------------------------------------------------------
December 31, 2001 2000
- --------------------------------------------------------------------------------
in millions
Trading assets $ -- $223
Securities available for sale 1,825 404
- --------------------------------------------------------------------------------
The fair value of collateral accepted by the Company not reported on the
consolidated balance sheet that can be sold or repledged at December 31, 2001
and 2000 was $1,402 million and $715 million, respectively. This collateral was
obtained under security resale agreements. Of this collateral, $583 million at
December 31, 2001 has been sold or repledged as collateral under repurchase
agreements or to cover short sales compared with $326 million at December 31,
2000.
The Company and its subsidiaries are obligated under a number of noncancellable
leases for premises and equipment. Certain leases contain renewal options and
escalation clauses. Rental expense under all operating leases, net of sublease
rentals, was $60.1 million, $72.7 million and $47.9 million in 2001, 2000 and
1999, respectively. Minimum future rental commitments on operating leases in
effect at December 31, 2001 were as follows: 2002, $62 million; 2003, $59
million; 2004, $52 million; 2005, $45 million; 2006, $32 million and $97 million
thereafter.
Note 26. Litigation
================================================================================
The Company is named in and is defending legal actions in various jurisdictions
arising from its normal business. None of these proceedings is regarded as
material litigation.
On December 17, 2001, the Company announced that it had settled civil law suits
brought by 51 of the 53 Japanese plaintiffs who have asserted claims arising
from the involvement of its subsidiary, Republic New York Securities Corporation
(RNYSC), with its customers Princeton Global Management Ltd. and affiliated
entities and their Chairman Martin Armstrong (the Princeton Note Matter). It
also announced that it had resolved all of the previously reported regulatory
and criminal investigations arising from the Princeton Note Matter. The
Princeton Note Matter came to light prior to HSBC's acquisition of Republic New
York Corporation, RNYSC's parent, in December 1999.
As part of the resolution, RNYSC, now a dormant subsidiary, pleaded guilty in
federal court in Manhattan to two federal criminal charges arising from the
misconduct of certain of its former executives in assisting Martin Armstrong's
scheme to defraud numerous purchasers of Princeton Notes, which Armstrong
offered for sale in Japan. Following the acquisition by HSBC, RNYSC ceased
active business during 2000, and the employment of all the RNYSC executives
associated with RNYSC's misconduct was terminated.
81
The United States Attorney's Office in its public filing acknowledged HSBC's
exemplary cooperation and recommended to the Court that no criminal fine be
imposed on RNYSC. Instead, RNYSC agreed to the imposition of a restitution order
requiring it to make payments totaling approximately $569 million to Princeton
noteholders, as compensation for their out-of-pocket losses. Since RNYSC's
capital was about $81 million, the Company agreed to pay the remaining amount of
compensation due to the noteholders in exchange for their termination of the
pending civil litigation against the Company and RNYSC, and in connection with
the United States Attorney's Office commitment not to pursue any claims against
RNYSC's parent company or its banking affiliate. In addition, the settling
Princeton noteholders can expect to receive payments totaling approximately $72
million from assets held by Princeton's court-appointed receiver.
At hearings held on January 7 and January 9, 2002 the Court entered the
restitution order agreed to by RNYSC and the United States Attorney's Office and
also approved the related settlement between HSBC and the Princeton Receiver.
Promptly thereafter 17 lawsuits filed in the federal court in Manhattan by 51
Princeton noteholders against the Company, RNYSC and others were dismissed
pursuant to the previously announced settlements, terminating the plaintiffs'
claims for damages arising from unpaid Princeton Notes with face amounts
totaling approximately $1 billion. RNYSC has also reached settlements with seven
additional Princeton noteholders who did not file suit.
The after tax cost to date of the settlement is within the range of the price
reduction taken by Republic's largest stockholders, companies controlled by the
late Mr. Edmond Safra, at the time of HSBC's acquisition of Republic. Two of the
noteholders, whose civil suits seek damages arising from unpaid Princeton Notes
with face amounts totaling approximately $125 million, are not included in the
settlement and their civil suits will continue. The U.S. Government excluded one
of them from the restitution order because that noteholder is being criminally
prosecuted in Japan for its conduct relating to its Princeton Notes, and
excluded the other because the sum it is likely to recover from the Princeton
Receiver exceeds its losses attributable to its funds transfers with RNYSC as
calculated by the U.S. Government.
Under the regulatory settlements RNYSC agreed with the Securities and Exchange
Commission to the revocation of its broker-dealer registration and with the
Commodity Futures Trading Commission to the revocation of various
commodities-related licenses and the payment of a $5 million civil monetary
penalty. It is also expected that RNYSC will shortly reach an agreement with the
New York Mercantile Exchange resolving Princeton-related matters.
Note 27. Financial Instruments With Off-Balance Sheet Risk
================================================================================
The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers, to
reduce its own exposure to fluctuations in interest rates and to realize
profits. These financial instruments involve, to varying degrees, elements of
credit and market risk in excess of the amount recognized in the consolidated
balance sheet. Credit risk represents the possibility of loss resulting from the
failure of another party to perform in accordance with the terms of a contract.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for balance sheet instruments.
Market risk represents the exposure to future loss resulting from the decrease
in value of an on- or off-balance sheet financial instrument caused by changes
in interest rates. Market risk is a function of the type of financial
82
instrument involved, transaction volume, tenor and terms of the agreement and
the overall interest rate environment. The Company controls market risk by
managing the mix of the aggregate financial instrument portfolio and by entering
into offsetting positions.
A summary of off-balance sheet and derivative financial instruments follows.
- ----------------------------------------------------------------------------------------------------------------
December 31, 2001 2000
- ----------------------------------------------------------------------------------------------------------------
in millions
Financial instruments whose contractual amounts represent the associated risk:
Standby letters of credit and financial guarantees (net of risk
participations of $1,012 and $369) and other letters of credit $ 5,583 $ 5,501
Unused credit card and home equity lines 6,331 5,972
Commitments to extend credit 28,722 23,957
Commitments to deliver mortgaged-backed securities 2,122 409
Financial instruments whose notional or contractual amounts do not represent
the associated risk:
Interest rate contracts 244,083 145,599
Foreign exchange contracts 157,877 128,423
Commodity, equity and other contracts 6,236 4,549
- ----------------------------------------------------------------------------------------------------------------
Credit card and home equity lines allow consumers to purchase goods or services
and to obtain cash advances. However, the Company has the right to change or
terminate any terms or conditions of a customer's account, upon notification to
the customer. Loan commitments are agreements to make or acquire a loan as long
as the agreed upon terms are met.
Standby letters of credit, financial guarantees and other letters of credit are
issued in connection with agreements made by customers with counterparties. If
the customer fails to comply with the agreement, the counterparty may enforce
the letter of credit or the guarantee as a remedy.
For commitments to extend credit, standby letters of credit and guarantees, the
Company's exposure to credit loss, in the event of non-performance by the
counterparty to the financial instrument, is represented by the contractual
amount of those instruments. Management has an allowance for credit loss related
to these instruments of $49.4 million and $39.2 million included in interest,
taxes and other liabilities on the consolidated balance sheet at December 31,
2001 and 2000, respectively.
For those financial instruments whose contractual or notional amount does not
represent the amount exposed to credit loss, risk at any point in time
represents the cost, on a present value basis, of replacing these existing
instruments at current interest and exchange rates. Based on this measurement,
$3.4 billion and $2.8 billion was at risk at December 31, 2001 and 2000,
respectively. See Note 28 for further discussion of activities in derivative
financial instruments. The Company controls the credit risk associated with
derivative financial instruments established for each counterparty through the
normal credit approval process. See Note 21 for contracts entered into with the
HSBC Group. Collateral is maintained on these positions, the amount of which is
consistent with the measurement of exposure used in the risk-based capital ratio
calculations under the banking regulators' guidelines.
Note 28. Derivative Instruments and Hedging Activities
================================================================================
The Company is party to various derivative financial instruments as an end user
(1) for asset and liability management purposes; (2) in order to offset the risk
associated with changes in the value of various assets and liabilities accounted
for in the trading account; (3) to protect against
83
changes in value of its mortgage servicing rights portfolio, and (4) for
speculative trading in its own account. The Company is also an international
dealer in derivative instruments denominated in U.S. dollars and other
currencies which include futures, forwards, swaps and options related to
interest rates, foreign exchange rates, equity indices and commodity prices,
focusing on structuring of transactions to meet clients' needs.
Types of Derivatives
Derivative instruments are contracts whose value is derived from that of an
underlying instrument, physical commodity or market index and generally do not
involve the exchange of principal but may involve the payment of a fee or
receipt of a premium at inception of a contract. Certain instruments such as
futures and forward contracts commit the Company to buy or sell a specified
financial instrument, currency, precious metal or other commodity at a future
date. Futures contracts are exchange-trading instruments that settle through an
independent clearing house and require daily cash settlement. Forward contracts
are customized transactions that require no cash settlement until the end of the
contract.
Other contracts, such as interest rate swaps, involve commitments to make
periodic cash settlements based upon the differential between specified rates or
indices applied to a stated notional amount. Purchased option contracts give the
right, but do not obligate the holder, to acquire or sell for a limited time a
financial instrument, precious metal or commodity at a designated price upon
payment for assuming the risk of unfavorable changes in the price of the
underlying instrument or index.
Within the context of its overall balance sheet risk management strategy,
derivatives are utilized to protect against changes in fair values and cash
flows associated with certain balance sheet assets, liabilities, forecasted
transactions and firm commitments in order to maintain net interest margin
within a range that management considers acceptable. To achieve this objective,
the Company has identified and currently pursues several qualifying SFAS 133
hedge strategies.
Fair Value Hedges
Specifically, interest rate swaps that call for the receipt of a variable market
rate and the payment of a fixed rate are utilized under fair value strategies to
hedge the risk associated with changes in the risk free rate component of the
value of certain fixed rate investment securities. Interest rate swaps that call
for the receipt of a fixed rate and payment of a variable market rate are
utilized to hedge the risk associated with changes in the risk free rate
component of certain fixed rate debt obligations. Additionally, forward
contracts are utilized to hedge the foreign currency risk associated with
available for sale debt securities.
For the year ended December 31, 2001, the Company recognized a net loss of $.6
million (reported as a component of other income in the consolidated statement
of income), which represented the ineffective portion of all fair value hedges.
Only the time value component of these derivative contracts has been excluded
from the assessment of hedge effectiveness.
Cash Flow Hedges
Similarly, interest rate swaps and futures contracts that call for the payment
of a fixed rate are utilized under the cash flow strategy to hedge the
forecasted repricing of certain deposit liabilities.
84
For the year ended December 31, 2001, the Company recognized a net gain of $8.5
million (reported as a component of other income in the consolidated statement
of income), which represented the total ineffectiveness of all cash flow hedges.
Only the time value component of the change in the fair value of these
derivative contracts has been excluded from the assessment of hedge
effectiveness.
Gains or losses on derivative contracts that are reclassified from accumulated
other comprehensive income to current period earnings pursuant to this strategy,
are included in interest expense on deposit liabilities during the periods that
net income is impacted by the repricing.
Trading and Other Activities
The Company enters into certain derivative contracts for purely speculative
trading purposes in order to realize profits from short-term movements in
interest rates, commodity prices and foreign exchange rates. In addition,
certain contracts do not qualify as SFAS 133 hedges and are accounted for on a
full mark to market basis through current earnings even though they were not
acquired for trading purposes.
For example, in conjunction with managing the risks associated with its mortgage
banking business, the Company purchases interest rate floors. Although these
derivative contracts do not qualify as hedges under SFAS 133, they have the
economic impact of largely offsetting the erosion in value of the mortgage
servicing rights portfolio in declining rate environments. The changes in value
of these and all such "economic hedges" are recognized in current period
earnings as if they were trading positions.
Credit and Market Risks
By using derivative instruments, the Company is exposed to credit and market
risk. If the counterparty fails to perform, credit risk is equal to the fair
value gain in a derivative. When the fair value of a derivative contract is
positive, this generally indicates that the counterparty owes the Company, and,
therefore, creates a repayment risk for the Company. When the fair value of a
derivative contract is negative, the Company owes the counterparty and,
therefore, it has no repayment risk.
The Company minimizes the credit (or repayment) risk in derivative instruments
by entering into transactions with high quality counterparties including other
members of the HSBC Group. Exposures are reviewed periodically by the Company's
credit committee. Counterparties generally include financial institutions
including banks, other government agencies, both foreign and domestic, and
insurance companies. The Company also maintains a policy of requiring that all
derivative contracts be governed by an International Swaps and Derivatives
Association Master Agreement; depending on the nature of the derivative
transaction, bilateral collateral arrangements may be required as well.
When the Company has more than one outstanding derivative transaction with a
counterparty, and there exists a legally enforceable master netting agreement,
the "net" mark to market exposure represents the netting of the positive and
negative exposure with the same counterparty. When there is a net negative
exposure, the Company considers its exposure to be zero.
85
The net mark to market position with a particular counterparty represents a
reasonable measure of credit risk when there is a legally enforceable master
netting agreement (i.e., a legal right of set off of receivable and payable
derivative contracts) between the Company and a counterparty. The Company's
policy is to use master netting agreements with all counterparties.
Market risk is the adverse effect that a change in interest rates, currency, or
implied volatility rates has on the value of a financial instrument. The Company
manages the market risk associated with interest rate and foreign exchange
contracts by establishing and monitoring limits as to the types and degree of
risk that may be undertaken. The Company periodically measures this risk by
using a value at risk methodology.
The Company's Asset and Liability Management Committee is responsible for
implementing various hedging strategies that are developed through its analysis
of data from financial simulation models and other internal and industry
sources. The resulting hedge strategies are then incorporated into the Company's
overall interest rate risk management and trading strategies.
As discussed in Note 19, Impact of Recently Issued Accounting Standards, SFAS
133 was adopted effective January 1, 2001. Under SFAS 133, entities are required
to carry all derivatives in the consolidated balance sheet at fair value. See
Summary of Significant Accounting Policies for additional information on SFAS
133, as well as the pre-SFAS 133 derivative accounting policy.
The following information summarizes the notional amounts of derivative
instruments used for both trading and asset/liability management purposes at
December 31, 2000 (pre-implementation of SFAS 133). These amounts serve as
volume indicators to denote the level of activity and include contracts that
have both favorable and unfavorable value to the Company. These notional amounts
did not represent the amounts to be exchanged by the Company, nor did they
measure the exposure to credit or market risk. These trading positions and
asset/liability management positions included intercompany transactions that
were established between independent trading departments of the Company that
acted as counterparties. The exposure may have been limited by offsetting asset
or liability positions held by the Company or by the use of master netting
agreements.
At December 31, 2000, the notional amount outstanding of interest rate contracts
for trading and asset/liability management positions were $115.6 billion and
$30.0 billion, respectively. The notional amount outstanding at December 31,
2000 of foreign exchange contracts for trading and asset/liability management
positions were $124.7 billion and $3.8 billion, respectively.
The net fair value of derivative financial instruments was $495 million and $198
million at December 31, 2001 and 2000, respectively.
86
Note 29. Concentrations of Credit Risk
================================================================================
The Company enters into a variety of transactions in the normal course of
business that involve both on- and off-balance sheet credit risk. Principal
among these activities is lending to various commercial, institutional,
governmental and individual customers. The Company participates in lending
activity throughout the United States and on a limited basis internationally
with credit risk concentrated in the Northeastern United States. A real estate
portfolio, concentrated in the New York metropolitan area, is secured by
multi-family, commercial and residential properties. See Note 30 for a
geographic distribution of year-end assets.
The ability of individual borrowers to repay is generally linked to the economic
stability of the regions from where the loans originate, as well as the
creditworthiness of the borrower. With emphasis on the Western, Central and
Metropolitan regions of New York State, the Company maintains a diversified
portfolio of loan assets. At December 31, 2001 40% of residential mortgages and
88% of commercial construction and mortgage loans were located within the
Northeastern United States.
In general, the Company controls the varying degrees of credit risk involved in
on- and off-balance sheet transactions through specific credit policies. These
policies and procedures provide for a strict approval, monitoring and reporting
process. It is the Company's policy to require collateral when it is deemed
appropriate. Varying degrees and types of collateral are secured depending upon
management's credit evaluation.
Note 30. International and Domestic Operations
================================================================================
In the following table, international loans are distributed geographically
primarily on the basis of the location of the head office or residence of the
borrowers or, in the case of certain guaranteed loans, the guarantors. Interest
bearing deposits with banks are grouped by the location of the head office of
the bank. Investments and acceptances are distributed on the basis of the
location of the issuers or borrowers.
- --------------------------------------------------------------------------------
International Assets by Geographic Distribution and Domestic Assets
December 31, 2001 2000
- --------------------------------------------------------------------------------
in millions
International:
Asia/Pacific $ 1,079 $ 876
Europe/Middle East/Africa 5,517 4,282
Other Western Hemisphere 1,775 2,078
- --------------------------------------------------------------------------------
Total international 8,371 7,236
Domestic 78,743 75,799
- --------------------------------------------------------------------------------
Total international/domestic $87,114 $83,035
- --------------------------------------------------------------------------------
The following table presents income statement information relating to the
international and domestic operations of the Company. Geographical information
has been classified by the location of the principal operations of the
subsidiary, or in the case of the Bank, by the location of the branch office. As
a result of the Republic acquisition, the Company altered the methodology used
to report international income statement information beginning with 2000. Due to
the nature of the Company's structure, the following analysis includes
intra-Company items between geographic regions. Under this methodology, the
international components for 1999 were not significant and therefore are not
disclosed.
87
- --------------------------------------------------------------------------------------------------------------------------
Revenues and Earnings - International and Domestic
Total Total Income
Revenue (1) Expenses (2) Before Taxes
------------------- -------------------- ------------------
Year Ended December 31, 2001 2000 2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
in millions
International:
Asia/Pacific $ 206.6 $ 339.7 $ 174.3 $ 290.3 $ 32.3 $ 49.4
Europe 110.8 254.4 55.4 129.4 55.4 125.0
Other Western Hemisphere 224.7 158.7 208.9 147.8 15.8 10.9
- --------------------------------------------------------------------------------------------------------------------------
Total international 542.1 752.8 438.6 567.5 103.5 185.3
Domestic (3) 5,487.5 5,661.4 5,011.4 4,939.2 476.1 722.2
- --------------------------------------------------------------------------------------------------------------------------
Total international/domestic $ 6,029.6 $ 6,414.2 $ 5,450.0 $ 5,506.7 $ 579.6 $ 907.5
- --------------------------------------------------------------------------------------------------------------------------
(1) Includes interest income and other operating income. Total revenue includes
intra-Company income of $146.4 million and $264.2 million for 2001 and
2000, respectively.
(2) Includes interest expense, operating expenses and provision for credit
losses. Total expenses include intra-Company expenses of $146.4 million and
$264.2 million for 2001 and 2000, respectively.
(3) Includes the Caribbean and Canada.
Note 31. Fair Value of Financial Instruments
================================================================================
The following disclosures represent the Company's best estimate of the fair
value of on-balance sheet financial instruments. The following methods and
assumptions have been used to estimate the fair value of each class of financial
instrument for which it is practicable to do so.
Financial instruments with carrying value equal to fair value - The carrying
value of certain financial assets including cash and due from banks, interest
bearing deposits with banks, federal funds sold and securities purchased under
resale agreements, accrued interest receivable, and customers' acceptance
liability and certain financial liabilities including short-term borrowings,
interest, taxes and other liabilities and acceptances outstanding, as a result
of their short-term nature, are considered to be equal to fair value.
Securities and trading assets and liabilities - The fair value of securities and
derivatives contracts have been based upon current market quotations, where
available. If quoted market prices are not available, fair value has been
estimated based upon the quoted price of similar instruments.
Loans - The fair value of the performing loan portfolio has been determined
principally based upon a discounted analysis of the anticipated cash flows,
adjusted for expected credit losses. The loans have been grouped to the extent
possible, into homogeneous pools, segregated by maturity and the weighted
average maturity and average coupon rate of the loans within each pool.
Depending upon the type of loan involved, maturity assumptions have been based
on either contractual or expected maturity.
Credit risk has been factored into the present value analysis of cash flows
associated with each loan type, by allocating the allowance for credit losses.
The allocated portion of the allowance, adjusted by a present value factor based
upon the timing of expected losses, has been deducted from the gross cash flows
prior to calculating the present value.
As a result of the allocation of the allowance to adjust the anticipated cash
flows for credit risk, a published interest rate that equates as closely as
possible to a "risk-free" or "low-risk" loan has been selected for the purpose
of discounting the commercial loan portfolio, adjusted for a liquidity factor
where appropriate.
88
Consumer loans have been discounted at the estimated rate of return an investor
would demand for the product, without regard to credit risk. This rate has been
formulated based upon reference to current market rates. The fair value of the
residential mortgage portfolio has been determined by reference to quoted market
prices for loans with similar characteristics and maturities.
Intangible assets - The Company has elected not to specifically disclose the
fair value of certain intangible assets. In addition, the Company has not
estimated the fair value of unrecorded intangible assets associated with its own
portfolio such as core deposits.
Deposits - The fair value of demand, savings and certain money market deposits
is equal to the amount payable on demand at the reporting date. For deposits
with fixed maturities, fair value has been estimated based upon interest rates
currently being offered on deposits with similar characteristics and maturities.
Long-term debt - Fair value has been estimated based upon interest rates
currently available to the Company for borrowings with similar characteristics
and maturities.
The following, which is provided for disclosure purposes only, provides a
comparison of the carrying value and fair value of the Company's financial
instruments. Fair values have been determined based on applicable requirements
and do not necessarily represent the amount that would be realized upon their
liquidation.
- ----------------------------------------------------------------------------------------------------
2001 2000
---------------------- ---------------------------
Carrying Fair Carrying Fair
December 31, Value Value Value Value
- ----------------------------------------------------------------------------------------------------
in millions
Financial assets:
Instruments with carrying value
equal to fair value $ 9,921 $ 9,921 $ 9,910 $ 9,910
Trading assets 9,089 9,089 5,771 5,771
Securities available for sale 15,745 15,745 17,337 17,337
Securities held to maturity 4,651 4,840 4,260 4,417
Loans, net of allowance 40,417 41,163 39,893 40,406
Derivative instruments included
in other assets (1) 49 49 -- --
Derivative instruments -
Pre SFAS 133 (2) -- -- (9) (6)
Financial liabilities:
Instruments with carrying value
equal to fair value 9,493 9,493 9,191 9,191
Deposits:
Without fixed maturities 46,099 46,099 42,805 42,805
Fixed maturities 10,408 10,468 13,238 13,258
Trading account liabilities 3,800 3,800 2,767 2,767
Long-term debt 4,491 4,861 5,097 5,248
Derivative instruments included
in other liabilities (1) 79 79 -- --
Derivative instruments -
Pre SFAS 133 (2) -- -- 105 146
- ----------------------------------------------------------------------------------------------------
(1) At December 31, 2001, the amounts reported relate to derivative contracts
that qualify for hedge accounting treatment as defined by SFAS 133.
(2) The amounts reported at December 31, 2000 relate to derivative contracts
hedging assets and liabilities, respectively, prior to the implementation
of SFAS 133.
89
The fair value of commitments to extend credit, standby letters of credit and
financial guarantees, is not included in the previous table. These instruments
generate fees which approximate those currently charged to originate similar
commitments.
Note 32. Financial Statements of HSBC USA Inc. (parent)
================================================================================
Condensed parent company financial statements follow.
- --------------------------------------------------------------------------------------------
Balance Sheet
December 31, 2001 2000(1)
- --------------------------------------------------------------------------------------------
in thousands
Assets:
Cash and due from subsidiary bank $ 4,809 $ 3,600
Interest bearing deposits with banks (including
$1,594,250 and $775,499 in banking subsidiary) 1,659,251 840,499
Trading assets 85,870 182,482
Securities available for sale 63,658 299,260
Securities held to maturity (fair value $221,173
and $163,742) 214,130 156,903
Loans (net of allowance for credit losses of
$24,643 and $25,732) 96,191 114,053
Receivable from subsidiaries 1,628,845 1,815,197
Investment in subsidiaries at amount of their
net assets
Banking 6,898,797 7,091,423
Other 1,197,890 1,235,343
Goodwill and other acquisition intangibles 604,501 699,368
Other assets 661,807 259,921
- --------------------------------------------------------------------------------------------
Total assets $13,115,749 $12,698,049
- --------------------------------------------------------------------------------------------
Liabilities:
Interest, taxes and other liabilities $ 831,970 $ 555,527
Short-term borrowings 1,634,559 892,586
Long-term debt (2) 2,824,398 3,140,736
Long-term debt due to subsidiary (2) 775,792 775,283
- --------------------------------------------------------------------------------------------
Total liabilities 6,066,719 5,364,132
Shareholders' equity * 7,049,030 7,333,917
- --------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $13,115,749 $12,698,049
- --------------------------------------------------------------------------------------------
*See Consolidated Statement of Changes in Shareholders' Equity, page 46.
(1) Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
(2) Contractual scheduled maturities for the debt over the next five years are
as follows: 2002, $646 million and none for 2003, 2004 and 2005 and $300
million for 2006.
90
- ------------------------------------------------------------------------------------------------------------
Statement of Income
Year Ended December 31, 2001 2000(1) 1999
- ------------------------------------------------------------------------------------------------------------
in thousands
Income:
Dividends from banking subsidiaries $ 950,000 $ 400,000 $ 450,000
Dividends from other subsidiaries 3,801 7,501 1,001
Interest from banking subsidiaries 138,254 187,925 96,836
Interest from other subsidiaries 1,938 1,047 --
Other interest income 34,910 69,652 15,469
Securities transactions 5,868 6,542 7,800
Other income 9,612 13,218 4,014
- ------------------------------------------------------------------------------------------------------------
Total income 1,144,383 685,885 575,120
- ------------------------------------------------------------------------------------------------------------
Expenses:
Interest (including $61,172, $61,338,
and $33,378 paid to subsidiaries) 312,902 378,101 123,920
Goodwill amortization 39,381 28,396 --
Princeton Note Matter 575,000 -- --
Other expenses 25,799 72,788 13,831
- ------------------------------------------------------------------------------------------------------------
Total expenses 953,082 479,285 137,751
- ------------------------------------------------------------------------------------------------------------
Income before taxes, equity in undistributed
income of subsidiaries and cumulative
effect of accounting change 191,301 206,600 437,369
Income tax benefit (311,757) (92,762) (4,360)
- ------------------------------------------------------------------------------------------------------------
Income before equity in undistributed
income of subsidiaries and cumulative
effect of accounting change 503,058 299,362 441,729
Equity in undistributed income (loss)
of subsidiaries (143,721) 269,597 21,983
- ------------------------------------------------------------------------------------------------------------
Income before cumulative effect of
accounting change 359,337 568,959 463,712
- ------------------------------------------------------------------------------------------------------------
Cumulative effect of accounting change-
implementation of SFAS 133, net of tax (6,199) -- --
- ------------------------------------------------------------------------------------------------------------
Net income $ 353,138 $ 568,959 $ 463,712
============================================================================================================
(1) Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
91
- ----------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
Year Ended December 31, 2001 000(1) 1999
- ----------------------------------------------------------------------------------------------------------------
in thousands
Cash flows from operating activities:
Net income $ 353,138 $ 568,959 $ 463,712
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation, amortization and
deferred taxes (70,270) 96,797 (58,960)
Net change in other accrued accounts 110,215 44,326 33,788
Undistributed (income) loss of
subsidiaries 143,722 (269,597) (21,983)
Other, net 79,599 (60,344) 46,934
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by operating
activities 616,404 380,141 463,491
- ----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net change in interest bearing
deposits with banks (818,752) 1,530,982 (298,400)
Purchases of securities (89,798) (3,632,912) --
Sales and maturities of securities 293,632 10,163,473 13,198
Payment to shareholders of acquired
company -- (7,091,209) --
Net originations and maturities of loans 263,044 (25,175) (38,912)
Other, net (105,179) (61,629) (19,937)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by
investing activities (457,053) 883,530 (344,051)
- ----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net change in short-term borrowings 741,973 (243,235) (64,125)
Issuance of long-term debt -- -- 200,000
Repayment of long-term debt (350,000) (400,000) (100,000)
Dividends paid (550,115) (621,744) (155,000)
Other, net -- 4,593 --
- ----------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (158,142) (1,260,386) (119,125)
- ----------------------------------------------------------------------------------------------------------------
Net change in cash and due from banks 1,209 3,285 315
Cash and due from banks at beginning of year 3,600 315 --
- ----------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of year $ 4,809 $ 3,600 $ 315
- ----------------------------------------------------------------------------------------------------------------
Cash paid for:
Interest $ 322,014 $ 384,883 $ 120,963
Non-cash activities related to acquisitions:
Preferred stock assumed -- -- 500,000
Capital contributed principally in the form
of treasury securities -- -- 7,088,108
- ----------------------------------------------------------------------------------------------------------------
(1) Restated to exclude an investment in an entity transferred to HSBC North
America Inc. during 2001.
The Bank is subject to legal restrictions on certain transactions with its
nonbank affiliates in addition to the restrictions on the payment of dividends
to the Company. See Note 17 for further discussion.
92
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
================================================================================
There were no disagreements on accounting and financial disclosure matters
between the Company and its independent accountants during 2001.
PART III
Item 10. Directors and Executive Officers of the Registrant
================================================================================
Directors
Set forth below is certain biographical information relating to the members of
the Company's Board of Directors. Each director is elected annually. There are
no family relationships among the directors.
Sal H. Alfiero, age 64, Chairman and Chief Executive Officer, Protective
Industries, LLC. Mr. Alfiero has been a director of the Bank since 1996. He is
also a director of Phoenix Companies, Inc., Southwire Company, Niagara Mohawk
Holdings Inc., National Health Care Affiliates, Inc., Kaleida Health System and
a trustee for the University of Buffalo Foundation. Elected January, 2000.
Sir John R. H. Bond, age 60, Chairman of the Company and the Bank since 1997 and
Group Chairman of HSBC since 1998. Formerly President and Chief Executive
Officer of the Company and the Bank from 1991 through 1992. Previously Executive
Director Banking, The Hongkong and Shanghai Banking Corporation Limited from
1990 to 1991 and Executive Director Americas from 1988 to 1990. Sir John is
director and Chairman of HSBC Finance (Netherlands), Chairman of HSBC Bank plc,
Chairman of HSBC Bank Middle East and a director of The Hongkong and Shanghai
Banking Corporation Limited, and Ford Motor Company. Elected in 1987.
James H. Cleave, age 59, formerly President and Chief Executive Officer of the
Company and the Bank from 1993 through 1997 and formerly Executive Director from
June 1992 through December 1992. Previously Director, President and Chief
Executive Officer of HSBC Bank Canada since 1987. Mr. Cleave is also a director
and Chairman of HSBC Bank Canada. Elected in 1991.
Frances D. Fergusson, age 57, President, Vassar College since 1986. Formerly
Provost and Vice President for Academic Affairs, Bucknell University. Dr.
Fergusson is a director of C H Energy Group. She was a director of the Company
from 1990 through 1995 and has been a director of the Bank since 1990. Reelected
January, 2000.
Douglas J. Flint, age 46, Group Finance Director, HSBC and an Executive Director
of HSBC since 1995. A director of HSBC Investment Bank Holdings plc, HSBC Bank
Malaysia Berhad and a director of the Bank since 1998. Mr. Flint is a member of
the UK Accounting Standards Board and a former partner in KPMG. Elected January,
2000.
Martin J. G. Glynn, age 50, Director, President and Chief Executive Officer,
HSBC Bank Canada and Group General Manager. He joined HSBC Bank Canada in 1982.
He is also a director of the Bank and Husky Energy Inc. Elected January, 2000.
93
Stephen K. Green, age 53, Executive Director Investment Banking and Markets,
HSBC and an Executive Director of HSBC since 1998. Joined HSBC in 1982. Group
Treasurer from 1992 to 1998. Mr. Green is Chairman of HSBC Investment Bank
Holdings plc and a director of HSBC Bank plc, Credit Commercial de France S.A.,
HSBC Guyerzeller Bank AG, HSBC Private Banking Holdings (Suisse) S.A. and HSBC
Trinkaus & Burkhardt KGaA. A director of the Bank and the Company since January,
2000.
Richard A. Jalkut, age 57, Executive Chairman and director of Birch Telecom,
Inc. Formerly President and Chief Executive of Pathnet. Previously President and
Group Executive, NYNEX Telecommunications and Executive Vice President and Chief
Operating Officer of New England Telephone and New York Telephone. He was a
director of the Company from 1992 through 1995 and has been a director of the
Bank since 1992. He is also a director of IKON Office Solution. Reelected
January, 2000.
Peter Kimmelman, age 57, Private Investor. Formerly a director of Republic and
Republic Bank since 1976. A director of the Bank and the Company since January,
2000.
Charles G. Meyer, Jr., age 64, President of Cord Meyer Development Company.
Formerly a director of Republic Bank. A director of the Bank and the Company
since January, 2000.
James L. Morice, age 64, Sole member, The JLM Group, LLC, a management
consulting firm. Formerly a director of Republic and Republic Bank since 1987. A
director of the Bank and the Company since January, 2000.
Youssef A. Nasr, age 47, President and Chief Executive Officer of the Company
and the Bank since January, 2000 and a director of the Company and the Bank
since 1998. Mr. Nasr is a director of HSBC Bank Canada and was President and
Chief Executive Officer of HSBC Bank Canada from 1998 through 1999. He joined
HSBC in 1976 and was appointed a Group General Manager in 1998. Elected in 1998.
Jonathan Newcomb, age 55, Principal, Leeds Weld & Co. Formerly Chairman & CEO,
Simon & Schuster, Inc. He is a director of the Bank, Edison Schools and The
Bureau of National Affairs Inc. He is also a member of the Board of Trustees of
Dartmouth College and the Board of Overseers for Dartmouth's Amos Tuck School of
Business Administration. Elected January, 2000.
Henry J. Nowak, age 66, Attorney, Consultant and a member of the U.S. House of
Representatives from 1974 through 1992. Prior to his service in the U.S. House
of Representatives, he was elected to the office and served as Comptroller of
the County of Erie. Mr. Nowak is a director of A&G Resources Corporation and is
a member of the New York State and Erie County Bar Associations. He was a
director of the Company from 1993 through 1995 and has been a director of the
Bank since 1993. Reelected January, 2000.
Carole S. Taylor, age 56, Chair of the Canadian Broadcasting Corporation and
Chair of the Vancouver Board of Trade. Also a director of Fairmont Hotels and
Canfor. Formerly a director of HSBC Bank Canada. Elected a director of the Bank
and the Company with effect from April 11, 2002.
94
Keith R. Whitson, age 58, Group Chief Executive Officer of HSBC Holdings plc
since 1998 and a director since 1994. Deputy Chairman of HSBC Bank plc since
1998 and Chief Executive Officer from 1994 to 1998. Director of the Bank from
1990 to 1992 and from 2000 to present. He is Chairman of Merrill Lynch HSBC and
of HSBC Bank AS. He is also a director of The Hongkong and Shanghai Banking
Corporation Limited, HSBC Bank Canada and Deputy Chairman, Supervisory Board
HSBC Trinkaus and Burkhardt KGaA. He has been with HSBC since 1961. Elected in
1998.
Directors' Compensation
================================================================================
For their services as directors of both the Company and the Bank, all
nonemployee directors receive an annual retainer of $35,000, plus a fee of
$1,000 for each Board meeting attended. Directors who are employees of HSBC or
other Group affiliates do not receive annual retainers or fees. In addition,
nonemployee directors who are members of any committee of the Board of Directors
other than the Audit and Examining Committee also receive a fee of $1,000 for
attendance at committee meetings except, when a meeting is held on the same day
as a Board meeting or if participation is by conference telephone, the fee is
$500. Additionally, committee chairmen receive annual fees of $2,500 for acting
in that capacity. Members of the Audit and Examining Committee receive an annual
fee which is $9,000 for the chairman and $6,000 for the other members and $500
per meeting for special meetings. Directors are reimbursed for their expenses
incurred in attending meetings. The Company and the Bank have standard
arrangements pursuant to which directors may defer all or part of their fees.
The Directors' Retirement Plan covers nonemployee directors elected prior to
1998 and excludes those serving as directors at the request of HSBC. Eligible
directors with at least five years of service will receive quarterly retirement
benefit payments commencing at the later of age 65 or retirement from the Board,
and continuing for ten years. The annual amount of the retirement benefit is a
percent of the annual retainer in effect at the time of the last Board meeting
the director attended. The percentage is 50 percent after five years of service
and increases by five percent for each additional year of service to 100 percent
upon completion of 15 years of service. If a director who has at least five
years of service dies before the retirement benefit has commenced, the
director's beneficiary will receive a death benefit calculated as if the
director had retired on the date of death. If a retired director dies before
receiving retirement benefit payments for the ten year period, the balance of
the payments will be continued to the director's beneficiary. The Plan is
unfunded and payment will be made out of the general funds of the Company or the
Bank.
95
Executive Officers
================================================================================
The table below shows the names and ages of all executive officers of the
Company and the positions held by them as of March 15, 2002 and the dates when
elected an executive officer of the Company or the Bank.
- -------------------------------------------------------------------------------------
Year
Name Age Elected Present Position with the Company
- -------------------------------------------------------------------------------------
Youssef A. Nasr 47 2000 President and Chief Executive Officer
Leslie E. Bains 58 2000 Senior Executive Vice President
Niall S. K. Booker 43 2001 Senior Executive Vice President
Robert M. Butcher 58 1988 Senior Executive Vice President
and Chief Financial Officer
Alexander A. Flockhart 50 1999 Senior Executive Vice President
Paul L. Lee 55 2000 Senior Executive Vice President
and General Counsel
Vincent J. Mancuso 55 1996 Senior Executive Vice President
and Group Audit Executive, USA
Robert H. Muth 49 1993 Senior Executive Vice President
Joseph M. Petri 49 2001 Senior Executive Vice President
Gerald A. Ronning 54 1991 Executive Vice President and Controller
Iain A. Stewart 43 2000 Senior Executive Vice President
Philip S. Toohey 58 1990 Senior Executive Vice President
and Secretary
George T. Wendler 57 2000 Senior Executive Vice President
and Chief Credit Officer
- -------------------------------------------------------------------------------------
Youssef A. Nasr has been a Director of the Company since 1998. From 1998 through
1999, he had been President and Chief Executive Officer of HSBC Bank Canada. He
has been a member of the HSBC Group since 1976.
Leslie E. Bains managed domestic private banking and investments at Republic.
Ms. Bains joined Republic in 1993.
Niall S. K. Booker previously was Chief Executive Officer of HSBC Thailand from
1997 to 2001. Mr. Booker has been with the HSBC Group for over twenty years.
Alexander A. Flockhart previously was HSBC's Managing Director of the Saudi
British Bank. From 1992 to 1994, he served as the Chief Executive Officer of
HSBC Thailand. He joined HSBC in 1974.
Joseph M. Petri was Executive Managing Director and head of sales for HSBC's
Investment Banking and Markets, Americas from 1999 to 2000. He was President and
Senior Partner of Summit Capital Advisors LLC, a New Jersey based hedge fund
from 1995 to 1998. Prior to that, Mr. Petri held a variety of management
positions with Merrill Lynch.
Iain A. Stewart is an HSBC International Manager who was Group Treasurer in
London from 1994 to 1999 and formerly manager of Group Market Risk. He joined
HSBC in 1981 and was Treasurer USA from 1989 to 1993.
Messrs. Lee and Wendler each served Republic or Republic Bank in executive
capacities for more than five years. Messrs. Butcher, Mancuso, Muth, Ronning and
Toohey each served the Company or the Bank in executive capacities for more than
five years. There are no family relationships among the above officers.
96
Item 11. Executive Compensation
================================================================================
The following table sets forth information as to the compensation earned through
December 31, 2001 by the President and Chief Executive Officer and by the four
most highly compensated officers of the Company and the Bank for their services
on behalf of the Company. Principal position indicates capacity served in 2001.
Summary Compensation Table
================================================================================
Annual Compensation Long Term Compensation
----------------------------------- ----------------------
Restricted All
Name and Stock LTIP Other
Principal Position Year Salary Bonus Other Awards Payouts Compensation
- ------------------------------------------------------------------------------------------------------------------------------
Youssef A. Nasr 2001 $784,614 $1,500,000 $324,920 $ 578,000 $ -- $ 6,800
President and 2000 738,461 1,100,000 145,172 441,000 -- 423,706
Chief Executive Officer
Joseph M. Petri 2001 284,615 2,185,000 540 2,015,000 -- 5,547
Senior Executive Vice President
Investment Banking and Markets
Iain A. Stewart 2001 514,727 1,600,000 293,723 2,760,000 -- --
Senior Executive Vice President 2000 569,288 2,000,000 80,664 1,466,000 -- 243,351
Investment Banking and Markets
Robert H. Muth 2001 567,308 700,000 2,070 200,000 -- 16,800
Senior Executive Vice President 2000 550,000 550,000 117,241 150,000 -- 118,859
Administration 1999 296,596 275,000 1,469 152,000 -- 110,175
Paul L. Lee 2001 400,000 700,000 1,806 150,000 283,151 --
Senior Executive Vice President 2000 200,000 550,000 965 150,000 254,036 8,877
and General Counsel
- ------------------------------------------------------------------------------------------------------------------------------
Prior to 2000 Messrs. Nasr and Stewart were compensated by HSBC entities other
than the Company and prior to 2001, Mr. Petri was compensated by an HSBC entity
other than the Company. Prior to 2000, Mr. Lee was compensated by Republic. Mr.
Muth's 1999 compensation reflects only the amounts paid by the Company and does
not include compensation received while on secondment to another HSBC entity.
Other Annual Compensation for Mr. Nasr includes reimbursement of rental expenses
and related tax gross ups amounting to $322,108 in 2001 and $142,119 in 2000.
Other Annual Compensation for Mr. Stewart includes a housing allowance of
$218,793 in 2001 and an executive travel allowance, including related tax
gross-ups, of $51,221 in 2000. Mr. Muth's Other Annual Compensation in 2000
includes tax gross-ups of $96,448. Other Annual Compensation for the other named
executives includes health and insurance benefits.
The Restricted Stock Awards represent the monetary value at grant date of awards
made under the HSBC Restricted Share Plan for performance in the year indicated.
The number of shares of HSBC Holdings plc common stock corresponding to the 2001
awards will not be known until HSBC actually purchases the shares, which is
expected to occur in the first quarter of 2002. Dividends are paid on all
restricted shares and are reinvested in additional restricted shares. The
aggregate number and value at December 31, 2001 of restricted share holdings for
each of the named executives was: Mr. Nasr: 81,043 shares ($950,157); Mr. Petri:
68,103 shares ($798,450); Mr. Stewart: 207,920 shares ($2,437,668); Mr. Muth:
38,697 shares ($453,684); and Mr. Lee: 11,094 shares ($130,071). Of Mr.
Stewart's restricted share holdings at December 31, 2001, 44,613 shares
represent the accumulated balance of shares originally granted in 2000, 50% of
which will vest in 2002 and 50% in 2003. Of Mr. Petri's restricted share
holdings at December 31, 2001, 62,556 shares represent the accumulated balance
of shares granted in 2001, 50% of which will
97
vest in 2002 and 50% in 2003. The aggregate restricted share holdings of Messrs.
Nasr and Stewart at December 31, 2001 include shares granted for performance
while employed by HSBC entities other than the Company of 48,192 and 76,404
respectively.
No stock options on HSBC Holdings plc common stock were granted under the HSBC
Executive Share Option Plan to any of the named executives for the performance
years indicated.
The Long-Term Incentive Plan payouts to Mr. Lee represent payments made under
Republic's Long-Term Incentive Plan.
All Other Compensation in 2001 for Messrs. Nasr and Petri represents the
Company's matching 401(k) plan contribution. Mr. Muth's All Other Compensation
in 2001 represents the Company's matching 401(k) plan contribution and a four
percent credit on salary deferred under the Company's deferred salary plan.
Since deferred salary is not eligible for the company matching contributions
under the 401(k) plan, salary deferrals are increased by four percent, the
maximum matching contribution available under the 401(k) plan.
- ------------------------------------------------------------------------------------------------------------------
Aggregated Stock Options Exercised in 2001 and Option Values as of Year End 2001
Number of Securities Value of Unexercised
Underlying Unexercised Options In-the-Money Options
as of December 31, 2001 as of December 31, 2001 (2)
Shares Acquired Value ---------------------------- ---------------------------
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------
Youssef A. Nasr -- $ -- 126,000 -- $612,242 $ --
Joseph M. Petri -- -- -- -- -- --
Iain A. Stewart -- -- 106,500 -- 470,734 --
Robert H. Muth (1) 19,500 152,905 39,000 -- 136,925 --
Paul L. Lee -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------
(1) The aggregate dollar value realized by Mr. Muth upon the exercise of his
stock options on April 24, 2001 is based upon the difference between the
fair market value of HSBC Holdings plc common stock on the date of exercise
and the exercise price of the options, converted to U.S. dollars at the
April 24, 2001 exchange rate of 1.4344 per GBP.
(2) The value of unexercised in-the-money options is based on the December 31,
2001 closing price per share of 8.06 GBP for HSBC Holdings plc common stock
as quoted on the London Stock Exchange and the December 31, 2001 U.S.
dollar exchange rate of 1.4546 per GBP.
The unexercised stock options included above on HSBC Holdings plc common stock
were granted under the HSBC Holdings Executive Share Option Scheme for
performance years 1997 and prior. The option awards for Messrs. Nasr and Stewart
are for performance while employed by other HSBC entities.
The following table shows the estimated annual retirement benefit payable upon
normal retirement on a straight life annuity basis to participating employees,
including officers, in the compensation and years of service classifications
indicated under the Company's retirement plans which cover most officers and
employees on a non-contributory basis. The amounts shown are before application
of social security reductions. Years of service credited for benefit purposes is
limited to 30 years in the aggregate.
98
- ---------------------------------------------------------------------------------------------
Estimated Annual Retirement Benefits for
Five Year Average Representative Years of Credited Service
Compensation 15 20 25 30 35
- ---------------------------------------------------------------------------------------------
$125,000 $ 36,688 $ 49,188 $ 61,688 $ 74,188 $ 74,500
150,000 44,025 59,025 74,025 89,025 89,400
175,000 51,363 68,863 86,363 103,863 104,300
200,000 58,700 78,700 98,700 118,700 119,200
225,000 66,038 88,538 111,038 133,538 134,100
250,000 73,375 98,375 123,375 148,375 149,000
300,000 88,050 118,050 148,050 178,050 178,800
350,000 102,725 137,725 172,725 207,725 208,600
400,000 117,400 157,400 197,400 237,400 238,400
450,000 132,075 177,075 222,075 267,075 268,200
500,000 146,750 196,750 246,750 296,750 298,000
600,000 176,100 236,100 296,100 356,100 357,600
700,000 205,450 275,450 345,450 415,450 417,200
800,000 234,800 314,800 394,800 474,800 476,800
- ---------------------------------------------------------------------------------------------
The Pension Plan is a non-contributory defined benefit pension plan under which
the Bank and other participating subsidiaries of the Company make contributions
in actuarially determined amounts. Compensation covered by the Pension Plan
includes regular basic earnings (including salary reduction contributions to the
401(k) plan), but not incentive awards, bonuses, special payments or deferred
salary. The Company maintains supplemental benefit plans which provide for the
difference between the benefits actually payable under the Pension Plan and
those that would have been payable if certain other awards, special payments and
deferred salaries were taken into account and if compensation in excess of the
limitations set by the Internal Revenue Code could be counted. Payments under
these plans are unfunded and will be made out of the general funds of the Bank
or other participating subsidiaries. The calculation of retirement benefits is
based on the highest five-consecutive year compensation.
Members of the Senior Management Committee of the Bank receive two times their
normal credited service for each year and fraction thereof served as a committee
member in determining pension and severance benefits to a maximum of 30 years of
credited service in total. This additional service accrual is unfunded and
payments will be made from the general funds of the Bank or other subsidiaries.
As of December 31, 2001, the individuals listed in the Summary Compensation
Table, have total years of credited service in determining benefits payable
under the plans as follows: Mr. Nasr, 15.25; Mr. Muth, 17.5 and Mr. Lee, 9.75.
Mr. Petri participates in the Company's defined contribution retirement plan
covering employees hired after 1996 and therefore does not receive the special
credited service for Senior Management Committee members, applicable to the
Company's defined benefit retirement plan. Since Mr. Stewart is an HSBC
International Manager, he does not participate in the Company's retirement
plans.
In addition to the pension benefits payable under the Company plan, Messrs. Nasr
and Muth are also entitled to receive pension benefits under the plan of HSBC
Bank Canada. Under terms of employment with the Company, they may receive
additional pension benefits which take into account their combined total years
of service with HSBC. Payments under these arrangements are unfunded and any
additional amounts due would be paid out of the general funds of the Bank.
99
Item 12. Security Ownership of Certain Beneficial Owners and Management
================================================================================
Principal Holder of Securities
The Company is 100 percent owned by HSBC North America Inc. HSBC North America
Inc., is an indirect wholly owned subsidiary of HSBC Holdings plc.
Messrs. Bond, Flint, Green and Whitson are officers and directors of HSBC.
None of the directors or executive officers owned any of the Company's common
stock at December 31, 2001.
Item 13. Certain Relationships and Related Transactions
================================================================================
Directors and officers of the Company, members of their immediate families and
HSBC and its affiliates were customers of, and had transactions with, the
Company, the Bank and other subsidiaries of the Company in the ordinary course
of business during 2001. Similar transactions in the ordinary course of business
may be expected to take place in the future.
All loans to executive officers and directors and members of their immediate
families and to HSBC and its affiliates were made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other persons and did not involve more than
normal risk of collectibility or present other unfavorable features.
100
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
================================================================================
A
================================================================================
1. and 2. Financial Statements and Schedules
The following financial statements and schedules of the Company and its
subsidiaries are included in Item 8:
Report of Independent Auditors
HSBC USA Inc.:
Consolidated Balance Sheet
Consolidated Statement of Income
Consolidated Statement of Changes in Shareholders' Equity
Consolidated Statement of Cash Flows
HSBC Bank USA:
Consolidated Balance Sheet
Summary of Significant Accounting Policies
Notes to Financial Statements
3. Exhibits
3 a Registrant's Restated Certificate of Incorporation and Amendments
Thereto
b Registrant's By-Laws, as Amended to Date
4 Instruments Defining the Rights of Security Holders, Including
Indentures
12.01 Computation of Ratio of Earnings to Fixed Charges (filed
herewith)
12.02 Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Dividends (filed herewith)
22 Subsidiaries of the Registrant
The Company's only significant subsidiary, as defined, is HSBC Bank
USA, a state bank organized under the laws of New York State.
23 Consent of Independent Accountants
B
================================================================================
Reports on Form 8-K
1. On December 31, 2001 a report on Form 8-K was filed announcing that a
resolution was reached in the Princeton Note Matter.
101
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
/s/ Philip S. Toohey
- --------------------
Philip S. Toohey
Senior Executive Vice President
and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed on March 15, 2002 by the following persons on behalf of the
Registrant and in the capacities indicated:
Sal H. Alfiero* Director
/s/ Robert M. Butcher John R. H. Bond*
- --------------------- Chairman of the Board
Robert M. Butcher James H. Cleave* Director
Senior Executive Vice President Frances D. Fergusson* Director
and Chief Financial Officer Douglas J. Flint* Director
(Principal Financial Officer) Martin J. G. Glynn* Director
Stephen K. Green* Director
Richard A. Jalkut* Director
/s/ Gerald A. Ronning Peter Kimmelman* Director
- --------------------- Charles G. Meyer, Jr.* Director
Gerald A. Ronning James L. Morice* Director
Executive Vice President Youssef A. Nasr*
and Controller Director, President
(Principal Accounting Officer) and Chief Executive Officer
Jonathan Newcomb* Director
Henry J. Nowak* Director
Keith R. Whitson* Director
*
/s/ Philip S. Toohey
--------------------
Philip S. Toohey
Attorney-in-fact
102