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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, 2002
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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2
T A B L E O F C O N T E N T S
Part 1
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Page
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Item 1. Description of Business
History and Development 4
Regulation, Supervision and Capital 4
Competition 7
Business Segments 27
International and Domestic Operations 89
Statistical Disclosure by Bank Holding Companies:
Average Balance Sheets and Interest Earned and Paid 10
Changes in Interest Income and Expense Attributable
to Changes in Rate and Volume 17
Securities Portfolios 38
Loans Outstanding:
Composition and Maturities 38, 40
Risk Elements in the Loan Portfolio 42
Summary of Loan Loss Experience 44
Deposits 71
Short-Term Borrowings 72
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
Part II
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Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 50
Item 8. Financial Statements and Supplementary Data 51
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 95
Part III
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Item 10. Directors and Executive Officers of the Registrant 95
Item 11. Executive Compensation 98
Item 12. Security Ownership of Certain Beneficial Owners
and Management 101
Item 13. Certain Relationships and Related Transactions 101
Item 14. Controls and Procedures 102
Part IV
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Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 103
3
P A R T I
Item 1. Business
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History and Development
HSBC USA Inc. (the Company), incorporated under the laws of Maryland, is a New
York State based bank holding company registered under the Bank Holding Company
Act of 1956, as amended. The Company's origin was in Buffalo, New York in 1850
as The Marine Trust Company, which later became Marine Midland Banks, Inc.
(Marine). In 1980, The Hongkong and Shanghai Banking Corporation (now HSBC
Holdings plc, hereinafter referred to as "HSBC") acquired 51% of the common
stock of Marine and the remaining 49% of common stock in 1987. HSBC is one of
the largest banking and financial services organizations in the world. In
December 1999, HSBC acquired Republic New York Corporation (Republic) and merged
it with the Company. At the merger date, Republic and the Company had total
assets of approximately $47 billion and $43 billion, respectively.
At December 31, 2002, the Company had assets of $89.4 billion and approximately
14,000 full and part time employees. The Company's principal subsidiary is HSBC
Bank USA (the Bank), which had assets of $86.4 billion and deposits of $60.2
billion at December 31, 2002. The Bank is the tenth largest U.S. commercial bank
ranked by assets.
The Company offers a full range of traditional commercial 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. The Bank also has
mortgage banking and retail brokerage operations. The Company is 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, commodity prices and
credit, focusing on structuring of transactions to meet clients' needs.
The Bank's domestic operations are primarily in New York State. It also has
banking branch offices in Pennsylvania, Florida, Oregon, Washington and
California. 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, Australia and Canada.
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 Bank is required to maintain noninterest bearing cash reserves with the
Federal Reserve Bank. The Bank's reserves averaged $394.0 million in 2002 and
$211.0 million in 2001.
4
Item 1. Business Continued
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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 classifications 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.
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. Nothing has occurred since that notification that
would change that category. 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%. The
actual amounts and ratios for the Company and the Bank were as follows.
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2002 2001
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December 31, Amount Ratio Amount Ratio
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in millions
Total capital
(to risk weighted assets)
Company $7,796 14.24% $7,404 13.31%
Bank 6,684 12.44 6,502 11.90
Tier 1 capital
(to risk weighted assets)
Company 5,127 9.36 4,639 8.34
Bank 4,719 8.78 4,493 8.22
Tier 1 capital
(to average assets)
Company 5,127 5.98 4,639 5.48
Bank 4,719 5.66 4,493 5.46
Risk weighted assets
Company 54,763 55,620
Bank 53,752 54,655
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5
Item 1. Business Continued
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The following shows the components of the Company's risk-based capital.
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December 31, 2002 2001
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in millions
Common shareholder's equity $ 6,634 $ 6,450
Preferred stock 375 375
Guaranteed mandatorily redeemable
preferred securities of subsidiaries 1,051 729
Less: Goodwill and identifiable intangibles (2,918) (2,896)
Foreign currency translation adjustment (15) (19)
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Tier 1 capital 5,127 4,639
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Long-term debt and other instruments
qualifying as Tier 2 capital 2,123 2,209
Qualifying aggregate allowance for
credit losses 539 556
Other Tier 2 components 7 -
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Tier 2 capital 2,669 2,765
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Total capital $7,796 $ 7,404
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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.
The Bank is subject to risk-based assessments from the Federal Deposit Insurance
Corporation (FDIC), the U. S. Government agency that insures deposits in the
Bank to a maximum of $100,000 per domestic depositor. Depository institutions
subject to assessment are categorized based on capital ratios and other factors,
with those in the highest rated categories paying no assessments. The Bank was
not assessed by the FDIC in the past three years.
The Deposit Insurance Funds Act (DIFA) of 1996 authorized the Financing
Corporation (FICO), a U.S. Government corporation, to collect funds from FDIC
insured institutions to pay interest on FICO bonds. The current FICO assessment
rate is 1.70 basis points annually for assessable deposits. The FICO assessment
rate is adjusted quarterly. The Bank is subject to a quarterly FICO premium.
The USA Patriot Act (Patriot Act), effective October 26, 2001, imposed
significant record keeping and customer identity requirements, expanded the
government's powers to freeze or confiscate assets and increased the available
penalties that may be assessed against financial institutions for violation of
the requirements of the Patriot Act intended to detect and deter money
laundering. The Patriot Act required the U.S. Treasury Secretary to develop and
adopt final regulations with regard to the anti-money laundering compliance
obligations on financial institutions (a term which includes insured U.S.
depository institutions, U.S. branches and agencies of foreign banks, U.S.
broker-dealers and numerous other entities). The U.S. Treasury Secretary
delegated this authority to a bureau of the U.S. Treasury Department known as
the Financial Crimes Enforcement Network (FinCEN).
Many of the new anti-money laundering compliance requirements of the Patriot
Act, as implemented by FinCEN, are generally consistent with the anti-money
laundering compliance obligations that applied to the Bank under the Bank
Secrecy Act and applicable Federal Reserve Board regulations before the Patriot
Act was adopted. These include requirements to adopt and implement an anti-money
laundering program, report suspicious transactions and implement due diligence
procedures for certain correspondent and private banking accounts. Certain other
specific requirements under the Patriot Act involve new compliance obligations.
The Patriot Act and other recent events have resulted in heightened scrutiny of
Bank Secrecy Act and anti-money laundering compliance programs by the federal
bank examiners. HSBC Bank USA is in the process of implementing a program to
ensure that it is in full compliance with all such requirements.
6
Competition
The Gramm-Leach-Bliley Act of 1999 (GLB Act), effective March 11, 2000,
eliminated many of the regulatory restrictions on providing financial services.
The Act allows for financial institutions and other providers of financial
products to enter into combinations that permit a single organization to offer a
complete line of financial products and services. Therefore, the Company and its
subsidiaries face intense competition in all of the markets they serve,
competing with both other financial institutions and non-banking institutions
such as insurance companies, major retailers, brokerage firms and investment
companies.
Following the enactment of the Gramm-Leach-Bliley Act, the Company elected to be
treated as a financial holding company (FHC). As an FHC, the Company's
activities in the United States have been expanded enabling it to offer a more
complete line of products and services. The Company's ability to engage in
expanded financial activities as an FHC depends upon the Company's meeting
certain criteria, including requirements that its U.S. depository institution
subsidiary, the Bank, and its forty percent owned subsidiary, Wells Fargo HSBC
Trade Bank, N.A., be well capitalized and well managed, and that they have
achieved at least a satisfactory record of meeting community credit needs during
their most recent examination pursuant to the Community Reinvestment Act. In
general, an FHC would be required, upon notice by the Federal Reserve Board, to
enter into an agreement to correct any deficiency in the requirements necessary
to maintain its FHC election. Until such deficiencies are corrected, the Federal
Reserve Board may impose limitations on the conduct or activities of an FHC or
any of its affiliates as it deems appropriate. If such deficiencies are not
timely corrected, the Federal Reserve Board may require an FHC to divest its
control of any subsidiary bank or to cease to engage in certain financial
activities.
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, four branches in California and one branch in Oregon
and one in Washington. Approximately 39% 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 (See Note 22 Litigation)
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Item 4. Submission of Matters to a Vote of Security Holders (Not applicable)
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P A R T II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters (Not applicable)
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7
Item 6. Selected Financial Data (1)
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Year Ended December 31, 2002 2001 2000 1999 1998
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in millions
Net interest income $ 2,376.3 $ 2,265.3 $ 2,118.5 $ 1,225.9 $ 1,165.3
- --------------------------------------------------------------------------------------------------------------------
Total trading revenues 33.1 198.9 140.2 10.0 3.7
Securities transactions 118.2 149.3 28.8 10.1 13.8
Interest on Brazilian tax settlement -- -- -- 13.1 32.7
Other operating income 908.0 747.5 663.4 430.8 409.9
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Total other operating income 1,059.3 1,095.7 832.4 464.0 460.1
- --------------------------------------------------------------------------------------------------------------------
Goodwill amortization -- 176.5 176.1 33.3 37.7
Princeton Note Matter -- 575.0 -- -- --
Operating expenses 1,875.5 1,791.5 1,729.7 794.6 742.5
Provision for credit losses 195.0 238.4 137.6 90.0 80.0
- --------------------------------------------------------------------------------------------------------------------
Income before taxes and cumulative effect
of accounting change 1,365.1 579.6 907.5 772.0 765.2
Applicable income tax expense 509.7 226.0 338.5 308.3 238.1
- --------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of
accounting change 855.4 353.6 569.0 463.7 527.1
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Cumulative effect of accounting change -
implementation of SFAS 133, net of tax -- (0.5) -- -- --
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Net income $ 855.4 $ 353.1 $ 569.0 $ 463.7 $ 527.1
====================================================================================================================
Adjusted net income (2) $ 855.4 $ 529.6 $ 745.1 $ 497.0 $ 564.8
====================================================================================================================
Balances at year end
Total assets $ 89,426 $ 87,114 $ 83,035 $ 87,246 $ 33,944
Goodwill 2,829 2,842 3,172 3,245 333
Long-term debt 4,225 4,491 5,097 5,885 1,748
Common shareholder's equity 6,897 6,549 6,834 6,717 2,228
Total shareholders' equity 7,397 7,049 7,334 7,217 2,228
Ratio of shareholders'
equity to total assets 8.27% 8.09% 8.83% 8.27% 6.56%
- --------------------------------------------------------------------------------------------------------------------
Selected financial data (3)
Rate of return on
Total assets 0.97% 0.41% 0.69% 1.35% 1.60%
Total common shareholder's equity 12.42 4.80 8.22 20.31 24.93
Total shareholders' equity to total assets 8.20 8.50 8.56 6.67 6.44
- --------------------------------------------------------------------------------------------------------------------
(1) 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.
(2) With the adoption of Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (SFAS 142) on January 1, 2002, the
Company is no longer required to amortize goodwill but rather evaluate
goodwill for impairment annually. Accordingly, for prior periods
presented, goodwill amortization has been excluded from the adjusted
amounts for consistency purposes.
(3) Based on average daily balances.
8
Quarterly Results of Operations
2002
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4th Q 3rd Q (1) 2nd Q (1) 1st Q (1)
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in millions
Net interest income $ 625.2 (2) $ 595.1 $ 574.0 $ 582.0
- -------------------------------------------------------------------------------------------------------------------
Total trading revenues 10.1 21.5 (30.4) 31.9
Securities transactions (2.3) 16.2 66.3 38.0
Other operating income 259.3 (3) 211.2 230.3 207.2
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Total other operating income 267.1 248.9 266.2 277.1
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Operating expenses 496.9 457.4 471.2 450.0
Provision for credit losses 26.2 39.0 56.3 73.5
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Income before taxes 369.2 347.6 312.7 335.6
Applicable income tax expense 140.7 130.7 114.1 124.2
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Net income $ 228.5 $ 216.9 $ 198.6 $ 211.4
===================================================================================================================
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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Total trading revenues 22.9 73.8 51.8 50.4
Securities transactions 2.6 20.9 56.6 69.2
Other operating income 233.8 181.1 159.8 172.8
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Total other operating income 259.3 275.8 268.2 292.4
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Goodwill amortization 43.4 43.8 44.2 45.1
Princeton Note Matter -- 575.0 -- -
Operating expenses 467.7 437.9 439.4 446.5
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 (benefit) 96.3 (106.5) 120.4 115.8
- -------------------------------------------------------------------------------------------------------------------
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
===================================================================================================================
(1) Operating expenses for the first three quarters of 2002 were restated in
accordance with the adoption of SFAS 147 during the fourth quarter.
(2) Reflects the impact of growth in the balance sheet, primarily residential
mortgage loans, and wider interest margins on residential mortgage loans
and treasury investments.
(3) Reflects higher levels of fee-based income, including $12.8 million of
revenue earned by the newly formed wealth and tax advisory services
business. Also includes higher levels of mortgage banking revenue as a
result of increased gains on sale of mortgages from higher mortgage
origination volumes.
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.
2002
---------------------------------
Balance Interest Rate
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Assets
Interest bearing deposits with banks $ 1,996 $ 54.7 2.74%
Federal funds sold and securities purchased under resale agreements 5,289 94.7 1.79
Trading assets 10,943 161.3 1.47
Securities 18,541 975.3 5.26
Loans
Domestic
Commercial 16,464 841.5 5.11
Consumer
Residential mortgages 19,346 1,250.0 6.46
Other consumer 2,963 270.5 9.13
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Total domestic 38,773 2,362.0 6.09
International 3,281 160.1 4.88
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Total loans 42,054 2,522.1 6.00
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Other interest * 23.4 *
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Total earning assets 78,823 $ 3,831.5 4.86%
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Allowance for credit losses (533)
Cash and due from banks 2,017
Other assets 7,473
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Total assets $ 87,780
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Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits $ 21,070 $ 211.7 1.00%
Other time deposits 12,170 317.3 2.61
Deposits in foreign offices 18,705 406.7 2.17
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Total interest bearing deposits 51,945 935.7 1.80
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Federal funds purchased and securities sold under repurchase agreements 2,123 53.0 2.50
Other short-term borrowings 9,292 178.5 1.92
Long-term debt 4,610 263.3 5.71
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Total interest bearing liabilities 67,970 $ 1,430.5 2.10%
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Interest rate spread 2.76%
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Noninterest bearing deposits 5,631
Other liabilities 6,979
Total shareholders' equity 7,200
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Total liabilities and shareholders' equity $ 87,780
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Net yield on average earning assets 3.05%
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Net yield on average total assets 2.74
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* Other interest relates to Federal Reserve Bank and Federal Home Loan Bank
stock included in other assets.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest
included fees of $42 million for 2002, $55 million for 2001 and $44 million for
2000.
10
SCHEDULE CONTINUED
2001 2000
- -------------------------------- ----------------------------------
Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------
in millions
$ 4,467 $ 207.2 4.64% $ 4,424 $ 308.7 6.98%
3,588 137.9 3.84 3,260 215.0 6.59
8,429 217.1 2.58 5,504 140.5 2.55
19,808 1,292.3 6.52 21,653 1,572.4 7.26
16,997 1,065.7 6.27 16,436 1,266.3 7.70
17,123 1,247.5 7.29 14,551 1,086.3 7.47
3,186 339.3 10.65 3,189 365.7 11.47
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37,306 2,652.5 7.11 34,176 2,718.3 7.95
4,135 286.1 6.92 4,790 355.5 7.42
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41,441 2,938.6 7.09 38,966 3,073.8 7.89
- --------------------------------------------------------------------------------------------
* 27.9 * * 32.8 *
- --------------------------------------------------------------------------------------------
77,733 $4,821.0 6.20% 73,807 $5,343.2 7.24%
- --------------------------------------------------------------------------------------------
(541) (606)
1,891 1,794
7,193 7,793
- --------------------------------------------------------------------------------------------
$ 86,276 $ 82,788
============================================================================================
$ 17,503 $ 275.7 1.58% $ 15,579 $ 333.2 2.14%
14,069 679.7 4.83 13,796 770.9 5.59
20,263 901.5 4.45 19,594 1,230.0 6.28
- --------------------------------------------------------------------------------------------
51,835 1,856.9 3.58 48,969 2,334.1 4.77
- --------------------------------------------------------------------------------------------
2,553 78.2 3.06 2,082 123.8 5.95
7,341 259.0 3.53 6,574 320.9 4.88
4,835 328.1 6.79 5,771 420.3 7.28
- --------------------------------------------------------------------------------------------
66,564 $2,522.2 3.79% 63,396 $3,199.1 5.05%
- --------------------------------------------------------------------------------------------
2.41% 2.19%
- --------------------------------------------------------------------------------------------
5,596 6,063
6,782 6,246
7,334 7,083
- --------------------------------------------------------------------------------------------
$ 86,276 $ 82,788
============================================================================================
2.96% 2.91%
- --------------------------------------------------------------------------------------------
2.66 2.59
============================================================================================
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 $855.4 million for 2002 compared with $353.1
million in 2001. Return on average common shareholder's equity was 12.42% in
2002 and 4.80% in 2001. Net income in 2001 included a $351.0 million after tax
charge for the Princeton Note Matter and $176.5 million of goodwill
amortization, not included in 2002 earnings under new U.S. GAAP accounting
rules. When 2001 is adjusted for these items, net income decreased by 3 percent
to $855.4 million for the year ended December 31, 2002 from $880.6 million for
the year ended December 31, 2001, although net income before taxes increased by
3 percent year over year.
During 2002, the Company achieved solid growth in income from banking
operations. Net interest income was $2,376.3 million in 2002 compared with
$2,265.3 million in 2001. The increase in net interest income reflects the
impact of growth in the balance sheet, primarily residential mortgage loans, and
wider interest margins in residential mortgage loans and treasury investments.
While total other operating income was down slightly compared to 2001, driven by
lower levels of market sensitive trading revenues, solid growth was achieved in
most categories of fee-based and other operating income. Total operating
expenses were $1,875.5 million for 2002 compared to $2,543.0 million for 2001.
The decrease in expense reflects the discontinuance of goodwill amortization in
2002 as well as the impact of the 2001 charge for the Princeton Note Matter. The
provision for credit losses was $195.0 million for 2002 compared to $238.4
million for 2001, as credit quality improved, as measured by criticized and
nonaccruing loans, during the later part of 2002.
This report includes forward-looking statements. Statements that are not
historical facts, including statements about management's beliefs and
expectations, are forward-looking statements and involve inherent risks and
uncertainties. 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 and challenges; significant changes in accounting, tax or
regulatory requirements; consumer behavior; marketplace perceptions of the
Company's reputation and competition in the geographic and business areas in
which the Company conducts its operations.
A detailed earnings performance review comparing 2002, 2001 and 2000 begins on
page 15. It should be read in conjunction with the consolidated financial
statements of the Company which begin on page 53.
Critical Accounting Estimates
- --------------------------------------------------------------------------------
Provision for Credit Losses
An assessment of the adequacy of the allowance for credit losses is regularly
conducted through a detailed review of the loan portfolio. The allocated portion
of the allowance is based on an evaluation of specific commercial and
residential mortgage problem loans considered "impaired". Reserves against
impaired loans are determined primarily by reference to independent valuations
of underlying loan collateral.
In addition, formula-based reserves are provided for homogeneous categories of
loans where it is deemed probable, based on historical data, that a loss has
been realized even though it has not yet been manifested in a specific loan.
12
In determining formula-based reserves, the Company utilizes historical data to
develop a range of loss factors. These factors are continually updated with
consideration given to specific industry forecasts and concentration risks,
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.
The Company then selects the individual loss factors from within the range based
upon an evaluation of critical data and trends. These loss factors are then
applied to outstanding balances to arrive at formula-based reserve amounts.
At December 31, 2002, there were $345.3 million of formula-based reserves
contained within the total allowance for credit losses. Had the loss factors
been utilized at the high end of the range, formula-based reserves would have
increased by $119.0 million to $464.3 million. In contrast, had the loss factors
been utilized at the low end of the range, formula-based reserves would have
decreased by $201.5 million to $143.8 million.
Changes in credit quality tend to occur over an extended period of time. As
such, movements in selected loss factors within the range tend to be gradual.
The Company does not believe the high or low end of the range would occur for
every segment of the loan portfolio at one point in time. Further the Company
would not expect the allowance for credit losses or associated provision expense
to materially change during any given reporting period strictly as a result of
movements in selected loss factors from within the range. Large movements
primarily result from the significant deterioration of large credits as a result
of factors not previously known.
The Company recognizes however that there is a high degree of subjectivity and
imprecision inherent in the process of estimating losses utilizing historical
data. Accordingly, additional unallocated reserves are provided based upon an
evaluation of certain other critical factors including the impact of the
national economic cycle, migration of loans within non-criticized loan
portfolios, as well as portfolio concentration.
Goodwill
Goodwill is not subject to amortization but must be tested for possible
impairment at least annually or more frequently if events or changes in
circumstances indicate that the asset might be impaired. Impairment testing
requires that the fair value of each reporting unit be compared to its carrying
amount, including the goodwill.
Reporting units were identified based upon an analysis of each of the Company's
individual operating segments. A reporting unit is defined as any distinct,
separately identifiable component of an operating segment for which complete,
discrete financial information is available that management regularly reviews.
Goodwill was allocated to the carrying value of each reporting unit based on its
relative fair value.
Determining the fair value of a reporting unit requires a high degree of
subjective management assumption. Discounted cash flow valuation models are
utilized that incorporate such variables as revenue growth rates, expense
trends, interest rates and terminal values. Based upon an evaluation of key data
and market factors, management selects from a range the specific variables to be
incorporated into the valuation model.
The Company has established April 30 of each year as the date for conducting its
annual goodwill impairment assessment. The variables are selected as of that
date and the valuation models are run to determine the fair value of each
reporting unit. At April 30, 2002, the Company did not identify any
13
individual reporting unit where fair value was less than carrying value,
including goodwill. In aggregate, fair value of all the reporting units exceeded
carrying value, including goodwill, by more than $4 billion. Only if the most
severely negative assumptions relative to these variables were incorporated into
the model, which in the opinion of management are not appropriate assumptions in
the current environment, would any individual reporting unit indicate
impairment.
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. These
assumptions involve a high degree of subjectivity that is dependent on future
interest rate movements. The reasonableness of these pricing models is
periodically substantiated by reference to independent broker price quotations
and actual market sales.
Note 6 to the consolidated financial statements contains information regarding
the factors (prepayment rate, discount rate, etc.) that were used in determining
the fair value of the MSRs at December 31, 2002. It also contains the isolated
impacts on fair value resulting from hypothetical changes in those factors, as
required by GAAP.
The Company manages its exposure to declines in the fair value of the MSRs by
reference to the interest rate environment. For instance, at December 31, 2002,
the Company estimates that the fair value of the MSRs would be approximately $63
million higher if intermediate term rates were to immediately increase by 100
basis points. Similarly, if there were an immediate decrease of 100 basis
points, the value would be approximately $114 million lower. However, in
evaluating the impact of rate changes, the effect of the various financial
instruments, including derivatives, that are used to protect the economic value
of the MSRs, is considered. After considering that effect, the adjusted positive
impact on operations of a 100 basis point increase in rates is $5 million. The
negative impact of a 100 basis point decrease is approximately $17 million.
14
E A R N I N G S P E R F O R M A N C E R E V I E W
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.
- -----------------------------------------------------------------------------------------------------------------
Increase/(Decrease) Increase/(Decrease)
2002 Amount % 2001 Amount % 2000
- -----------------------------------------------------------------------------------------------------------------
in millions
Interest income $3,831.5 $ (989.5) (20.5) $4,821.0 $(522.2) (9.8) $5,343.2
Interest expense 1,430.5 (1,091.7) (43.3) 2,522.2 (676.9) (21.2) 3,199.1
- -----------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent
basis 2,401.0 102.2 4.4 2,298.8 154.7 7.2 2,144.1
Less: taxable
equivalent adjustment 24.7 (8.8) (26.2) 33.5 7.9 30.8 25.6
- -----------------------------------------------------------------------------------------------------------------
Net interest income $2,376.3 $ 111.0 4.9 $2,265.3 $ 146.8 6.9 $2,118.5
- -----------------------------------------------------------------------------------------------------------------
Average earning assets $ 78,823 $ 1,090 1.4 $ 77,733 $ 3,926 5.3 $ 73,807
Average nonearning
assets 8,957 414 4.9 8,543 (438) (4.9) 8,981
- -----------------------------------------------------------------------------------------------------------------
Average total assets $ 87,780 $ 1,504 1.7 $ 86,276 $ 3,488 4.2 $ 82,788
- -----------------------------------------------------------------------------------------------------------------
Net yield on:
Average earning assets 3.05% .09% 3.0 2.96% .05% 1.7 2.91%
Average total assets 2.74 .08 3.0 2.66 .07 2.7 2.59
=================================================================================================================
2002 Compared to 2001
Net interest income was $2,376.3 million in 2002 compared with $2,265.3 million
in 2001. The 4.9% increase in net interest income for 2002 reflects the impact
of a larger balance sheet and a wider net interest margin in a declining rate
environment.
Average residential mortgages grew $2.2 billion for 2002 as the mortgage banking
division experienced record levels of production driven by the low rate
environment which began in 2001. Average investment securities decreased $1.3
billion compared to 2001 as the Company sold securities, including mortgage
backed, U.S. Treasury and Latin American securities to adjust to interest rate
changes and to reduce its credit risk. The Company invested additional amounts
in shorter term trading assets. A more profitable funding mix consisting of
higher levels of savings deposits and lower levels of certificate of deposit
products also contributed to the increase in net interest income for 2002 as
compared to 2001.
The Federal Reserve reductions in short-term rates in 2001 and the fourth
quarter of 2002 led to lower gross yields earned on assets and lower gross rates
paid on liabilities compared to 2001. The short-term rate cuts led to wider
interest margins in the residential mortgage business, treasury investment
operations and certain commercial lending businesses.
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 reflected the impact
of a larger balance sheet and a wider interest margin.
15
Average residential mortgages grew $2.6 billion for 2001 as the mortgage banking
division experienced increased levels of production driven by a low rate
environment. Average investment securities decreased $1.8 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 on assets 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.
Forward Outlook
The Company will continue to pursue modest growth in high quality commercial
loans and residential mortgages. Some less profitable commercial lending
relationships are expected to be exited. We expect continuing weakness in the
U.S. economy and the uncertain world wide political environment to encourage our
corporate customers to adopt a cautious approach towards revenue growth and
capital spending plans, and this will undoubtedly dampen future loan demand. The
ultimate level of activity in the residential mortgage portfolio will depend on
the rate environment and the Company's appetite for additional mortgage products
on the balance sheet. Lending activity should benefit from HSBC Group
initiatives, specifically our cross-border business is expected to benefit from
the HSBC Group's new North American alignment initiative. The goal of this
initiative is to increase HSBC brand awareness and to provide seamless North
American service propositions to customers of the Company and HSBC Bank Canada.
The acquisition of Household International, Inc. by HSBC, which is expected to
be completed during the first quarter of 2003, may also provide an opportunity
for future growth.
The Company expects to fund balance sheet growth with personal and commercial
deposits and some wholesale market funding. The Company is expected to continue
to benefit from the steep yield curve established in the later part of 2002 into
the early part of 2003. A continuing low level of interest rates means less
money will be earned by the Company on deposits. The lower rate environment may
also lead to further movements of customer funds from certificate of deposit
products and other investments into saving accounts, thus helping to sustain
current interest margins. However, if rates drop and the yield curve flattens in
2003, interest margins are likely to shrink. (See Quantitative and Qualitative
Disclosures About Market Risk). This margin shrinkage may be dampened by balance
sheet growth or other management actions.
16
The following table presents net interest income components on a taxable
equivalent basis, using tax rates approximating 35%, and quantifies the changes
in the components according to "volume and rate".
Net Interest Income Components Including Volume/Rate Analysis
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
2002 Compared to 2001 2001 Compared to 2000
Increase(Decrease) Increase(Decrease)
2002 Volume Rate 2001 Volume Rate 2000
- -----------------------------------------------------------------------------------------------------------
in millions
Interest income:
Interest bearing
deposits with banks $ 54.7 $ (87.7) $ (64.8) $ 207.2 $ 2.9 $ (104.4) $ 308.7
Federal funds sold and
securities purchased
under resale agreements 94.7 49.0 (92.2) 137.9 19.9 (97.0) 215.0
Trading assets 161.3 53.4 (109.2) 217.1 75.4 1.2 140.5
Securities 975.3 (78.7) (238.3) 1,292.3 (127.7) (152.4) 1,572.4
Loans
Domestic
Commercial 841.5 (32.5) (191.7) 1,065.7 41.9 (242.5) 1,266.3
Consumer
Residential
mortgages 1,250.0 152.1 (149.6) 1,247.5 188.0 (26.8) 1,086.3
Other consumer 270.5 (22.6) (46.2) 339.3 (.5) (25.9) 365.7
International 160.1 (51.9) (74.1) 286.1 (46.4) (23.0) 355.5
Other interest * 23.4 (4.5) -- 27.9 (4.9) -- 32.8
- -----------------------------------------------------------------------------------------------------------
Total interest income 3,831.5 (23.4) (966.1) 4,821.0 148.6 (670.8) 5,343.2
- -----------------------------------------------------------------------------------------------------------
Interest expense:
Deposits in domestic
offices
Savings deposits 211.7 48.9 (112.9) 275.7 37.7 (95.2) 333.2
Other time deposits 317.3 (82.2) (280.2) 679.7 15.0 (106.2) 770.9
Deposits in foreign
offices 406.7 (64.7) (430.1) 901.5 40.7 (369.2) 1,230.0
Federal funds purchased
and securities sold
under repurchase
agreements 53.0 (12.0) (13.2) 78.2 23.7 (69.3) 123.8
Other short-term
borrowings 178.5 57.3 (137.8) 259.0 34.3 (96.2) 320.9
Long-term debt 263.3 (14.7) (50.1) 328.1 (64.9) (27.3) 420.3
- -----------------------------------------------------------------------------------------------------------
Total interest expense 1,430.5 (67.4) (1,024.3) 2,522.2 86.5 (763.4) 3,199.1
- -----------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis $2,401.0 $ 44.0 $ 58.2 $2,298.8 $ 62.1 $ 92.6 $2,144.1
- -----------------------------------------------------------------------------------------------------------
* Other interest income relates to Federal Reserve Bank and Federal Home
Loan Bank stock included in other assets.
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.
17
Other Operating Income
- --------------------------------------------------------------------------------
Other operating income was $1,059.3 million in 2002 compared with $1,095.7
million in 2001 and $832.4 million in 2000.
- ----------------------------------------------------------------------------------------------------------------------
Increase/(Decrease) Increase/(Decrease)
2002 Amount % 2001 Amount % 2000
- ----------------------------------------------------------------------------------------------------------------------
in millions
Trust income $ 94.4 $ 6.8 7.8 $ 87.6 $ 2.7 3.2 $ 84.9
Service charges 206.5 17.5 9.2 189.0 16.7 9.7 172.3
Mortgage banking revenue 110.1 30.7 38.7 79.4 46.9 144.3 32.5
Letter of credit fees 66.4 5.4 8.8 61.0 7.5 13.9 53.5
Credit card fees 72.3 8.2 12.7 64.1 8.1 14.5 56.0
Other fee-based income 175.3 38.7 28.3 136.6 4.8 3.7 131.8
Investment product fees 89.1 21.3 31.5 67.8 8.8 14.8 59.0
Other income 93.9 31.9 51.5 62.0 (11.4) (15.5) 73.4
- -------------------------------------------------------------------------------------------------------------------
Nontrading income 908.0 160.5 21.5 747.5 84.1 12.7 663.4
- -------------------------------------------------------------------------------------------------------------------
Trading revenues
Treasury business and
other 130.1 (135.9) (51.1) 266.0 125.8 89.7 140.2
Residential mortgage
related (97.0) (29.9) (44.5) (67.1) (67.1) -- --
- -------------------------------------------------------------------------------------------------------------------
Total trading revenues 33.1 (165.8) (83.3) 198.9 58.7 41.9 140.2
- -------------------------------------------------------------------------------------------------------------------
Securities transactions 118.2 (31.1) (20.8) 149.3 120.5 417.6 28.8
- -------------------------------------------------------------------------------------------------------------------
Total other operating
income $1,059.3 $ (36.4) (3.3) $1,095.7 $ 263.3 31.6 $ 832.4
===================================================================================================================
Nontrading Income
- --------------------------------------------------------------------------------
2002 Compared to 2001
Nontrading income was $908.0 million in 2002 compared with $747.5 million in
2001. The increase in service charges for 2002 is due to growth in personal and
commercial deposit service charges, reflecting business growth in the New York
City region as well as fee increases instituted during 2002. The increase in
other fee-based income includes $15.1 million of revenue earned by the newly
formed wealth and tax advisory services business which commenced activity during
the third quarter of 2002. Also, increases in fee income were noted in the
International Private Banking, Treasury and Traded Markets businesses. The
growth in investment product fees was driven by increases in brokerage revenues
due primarily to the sale of annuity products. Revenues related to the sale of
annuity products increased $22.5 million compared with 2001. The increase in
other income reflects higher levels of insurance revenues. Insurance revenues
increased $13.8 million or 42.5% compared to 2001. Over 1,500 professionals are
now licensed to sell insurance and certain annuity products through our retail
network. The $24.3 million increase in earnings on investments, accounted for
under the equity method of accounting also contributed to the growth in other
income for 2002. These improved earnings related primarily to the equity
investment in HSBC Republic Bank (Suisse) S.A.
18
The following table presents the components of mortgage banking revenue for the
past three years.
- --------------------------------------------------------------------------------
2002 2001 2000(3)
- --------------------------------------------------------------------------------
in millions
Servicing fee income $72.4 $ 70.9 $ 71.1
MSRs amortization (133.6)(1) (58.1) (45.6)
Gain on sale of mortgages 163.7 66.6 7.0
Fair value hedge activity 7.6(2) -- --
- --------------------------------------------------------------------------------
Total mortgage banking revenue (4) $ 110.1 $ 79.4 $ 32.5
- --------------------------------------------------------------------------------
(1) Includes a $56.3 million provision for impairment. $40.6 million of the
provision is included in a valuation reserve at December 31, 2002.
(2) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity. Effective December
2002, the Company established a qualifying hedge strategy using forward
sales contracts to offset the fair value changes of conventional closed
mortgage loans originated for sale.
(3) Prior to the adoption of SFAS 133 on January 1, 2001, 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.
After the adoption of SFAS 133, these instruments were marked to market as
a component of residential mortgage business related trading revenue.
(4) Does not include residential mortgage business related trading revenue or
net interest income impact of the mortgage business.
Mortgage banking revenue increased $30.7 million compared to 2001 as a result of
higher gains on the sale of mortgages from higher mortgage origination volumes.
This increase was partially offset by higher levels of mortgage servicing rights
(MSRs) amortization which included a provision for impairment of $56.3 million
associated with higher prepayment activity during 2002 due to the low rate
environment. The provision for impairment was partially offset by increased
market value of derivative instruments used to protect the value of MSRs. This
was recorded in residential mortgage business related trading revenue. The
residential mortgage business related trading revenue and the net interest
income impact of the mortgage business should also be considered when evaluating
overall profitability of the mortgage business.
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 2000. Offsetting
the increase in mortgage banking revenue were losses in residential mortgage
related trading revenue.
19
Forward Outlook
During 2003, the Company will utilize its strong retail distribution network,
its HSBC Group linkage and its high quality sales and service culture to pursue
revenue growth despite an uncertain economy. The Company will continue to focus
on growth in brokerage, insurance, mortgage banking, trust, asset management,
private banking and trade service related fees. Maximization of the "cross-sell"
potential of the existing customer base will be a key business development theme
for the upcoming year. The Company is expecting to earn increased fee income
from the newly formed wealth and tax advisory service business, which commenced
activity during the third quarter of 2002. Expansion of the Company's
reinsurance business will be a strategic initiative for the upcoming year.
Mortgage banking will continue to leverage its strong New York and national
presence and multiple, well developed origination channels to position the
business to maximize production opportunities and maintain continuity in
different markets and rate environments. The Company will continue to utilize
its well developed secondary market strategy to sell loans to the "Agencies"
(FNMA, FHLMC and GNMA), private investors and conduits on a services retained
basis.
Trading Revenues
- --------------------------------------------------------------------------------
Trading revenues are generated by the Company's participation in the foreign
exchange, credit derivative 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 because trading activities are managed to maximize total
revenue. The trading related net interest income component is not included in
other operating income; it is included in net interest income.
- ----------------------------------------------------------------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
in millions
Trading revenues - treasury business and other $130.1 $266.0 $140.2
Net interest income * 74.3 38.6 52.1
- ----------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $204.4 $304.6 $192.3
==========================================================================================================
Business:
Derivatives and treasury $ 70.8 $120.2 $ 44.9
Foreign exchange 39.5 93.1 74.4
Precious metals 70.2 52.6 49.1
Other trading 23.9 38.7 23.9
- ----------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $204.4 $304.6 $192.3
==========================================================================================================
Trading revenues (loss) - residential mortgage business related $(97.0) $(67.1) $ --
==========================================================================================================
* Included in net interest income on the consolidated income statement.
20
Treasury Business and Other: 2002 Compared to 2001
Total treasury business and other trading related revenues were $204.4 million
in 2002 compared to $304.6 million for 2001. The decline in derivatives and
treasury trading revenue in 2002 results from mark to market losses on
derivative instruments used to protect against rising interest rates and also
from widening spread relationships that took place at various times during the
year. Offsetting these declines were increased trading revenues in credit and
interest rate derivatives resulting from increased customer activity and
proprietary trading positions, which profited from movements in credit and
interest rate spreads. The reduction in foreign exchange trading revenue for
2002 compared to 2001 reflects lower levels of proprietary trading revenue due
to reduced volatility in the foreign exchange markets and adverse rate exchange
movements. The increase in precious metals trading revenue for 2002 compared to
2001 is due to increased customer activity and proprietary trading positions,
which benefited from movement in precious metals spreads and prices.
Treasury Business and Other: 2001 Compared to 2000
Trading related revenues for 2001 increased 58% compared with 2000. 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 was a direct result
of that decision as trading volumes with clients and proprietary trading revenue
increased markedly over 2000. 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 reflected 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.
Treasury Business and Other: Forward Outlook
The Company expects to continue to build on its capabilities in foreign
exchange, credit and interest rate derivatives and precious and base metals to
expand its client franchise and grow related revenues. However, these revenues
are subject to market factors, among other things, and may vary significantly
from reporting period to reporting period.
Residential Mortgage Business Related
In conjunction with the adoption of Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133)
on January 1, 2001, certain derivatives including loan commitments granted to
customers, forward loan sales commitments (FLSC) 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 components of trading revenue (loss) related to these instruments
were as follows.
- ------------------------------------------------------------------------------
2002 2001
- ------------------------------------------------------------------------------
in millions
SFAS 133 FLSC/Rate locks $(141.6) $(27.4)
Derivative instruments used to
protect value of MSRs 44.6 (39.7)
- ------------------------------------------------------------------------------
Trading revenues (loss) - residential
mortgage business related $ (97.0) $(67.1)
==============================================================================
21
As a result of the adoption of SFAS 133, higher gains on sale of mortgages,
included in mortgage banking revenue (see other operating income), have been
recognized in 2002 and 2001 as compared to 2000. In periods prior to the
adoption of SFAS 133, 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 MSRs were considered in assessing whether or
not impairment needed to be recognized. Both were reported as a component of
mortgage banking revenue for 2000.
The increase in the market value of the servicing hedges of $44.6 million
through the trading account does not include mortgage backed securities (MBS's)
on the balance sheet that provide additional economic protection against a
decline in the value of MSRs. As the MBS's are classified as investment
securities available for sale, the increase in their market value is reflected
in the equity section of the balance sheet through other comprehensive income.
The change in market value of these securities is not recognized in income until
they are sold.
Mortgage banking revenue included in other operating income and the net interest
impact of the mortgage business should also be considered when evaluating
overall profitability of the mortgage business.
Forward Outlook
The Company will continue to employ a well developed risk management strategy to
reduce interest rate and prepayment risk by utilizing derivative instruments to
hedge both (a) the mortgage pipeline and (b) MSRs values through different
economic cycles and rate environments and within established guidelines.
The Company is pursuing hedge accounting treatment under SFAS 133 for additional
closed loans in the pipeline (primarily jumbo loans) that are currently on the
lower of cost or market basis and not subject to a mark to market treatment.
This would eliminate additional earnings volatility and timing differences
associated with this portion of the mortgage pipeline.
Securities Transactions
- --------------------------------------------------------------------------------
2002
Security gains for 2002 included gains on sales of mortgage backed, U.S.
Treasury and Latin American securities. The Company sold the securities to
adjust to interest rate changes and/or reduce its credit risk.
2001
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 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. The Company also recognized losses in 2001 of $38.2
million as it significantly reduced its holdings of Brazilian securities.
22
Operating Expenses
- --------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
2002 Amount % 2001 Amount % 2000
- ----------------------------------------------------------------------------------------------------------------------------
in millions
Salaries and employee
benefits $ 1,029.3 $ 28.9 2.9 $ 1,000.4 $ 25.0 2.6 $ 975.4
Net occupancy 155.7 .2 .1 155.5 (11.7) (7.0) 167.2
Equipment and software 141.6 12.2 9.4 129.4 14.4 12.5 115.0
Goodwill amortization -- (176.5) -- 176.5 .3 .2 176.2
Marketing 38.1 (1.8) (4.5) 39.9 5.6 16.3 34.3
Outside services 112.7 (2.2) (1.9) 114.9 9.6 9.1 105.3
Professional fees 42.7 1.5 3.5 41.2 2.9 7.6 38.3
Telecommunications 42.5 .8 2.0 41.7 6.5 18.5 35.2
Postage, printing and
office supplies 32.0 (.9) (2.8) 32.9 (.6) (1.9) 33.5
Princeton Note Matter -- (575.0) -- 575.0 575.0 -- --
Other 280.9 45.3 19.2 235.6 10.2 4.5 225.4
- ----------------------------------------------------------------------------------------------------------------------------
Total operating expenses $ 1,875.5 $ (667.5) (26.2) $ 2,543.0 $ 637.2 33.4 $ 1,905.8
- ----------------------------------------------------------------------------------------------------------------------------
Personnel - average number 13,856 (585) (4.1) 14,441 26 .2 14,415
============================================================================================================================
2002 Compared to 2001
Operating expenses were $1,875.5 million in 2002 compared with $2,543.0 million
for 2001. The decrease reflects the $575.0 million charge taken in 2001 by the
Company to reflect the resolution of the majority of the litigation in the
Princeton Note Matter. See Note 22 Litigation, for additional information on the
Princeton Note Matter. The decrease in operating expenses for 2002 also reflects
the adoption of SFAS 142. See Note 7 Goodwill and Intangible Assets for a
discussion of SFAS 142. Under SFAS 142, goodwill is no longer being amortized
through operating expenses. The increase in salaries and employee benefits
reflects cost of living increases, production driven increases in incentive
compensation for certain businesses and higher fringe benefit costs, primarily
related to health care and pension costs. Also contributing to this increase are
personnel costs related to the newly formed wealth and tax advisory services
business which commenced activity during the third quarter of 2002. The increase
in equipment and software expense reflects higher levels of depreciation on
infrastructure investments made during the past three years. The increase in
other expenses for 2002 as compared to 2001 is primarily due to the second
quarter 2002 charge related to reserves for letters of credit and for a
leveraged lease.
23
2001 Compared to 2000
Operating expenses were $2,543.0 million in 2001 compared with $1,905.8 million
in 2000. The increase in operating expenses reflected a $575.0 million third
quarter charge taken by the Company to reflect the resolution of the majority of
the litigation in 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. 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 compared to $85.0 million for 2000. The integration costs did 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, 2001, airlines 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.
Forward Outlook
The Company is anticipating higher fringe benefit costs related to pension and
health care and corporate insurance. The Company continues to actively take
steps necessary to reduce the impact of higher health care costs which are
rapidly rising for both the Company and its employees. The Company continues to
position itself to operate in an uncertain economy. Improving efficiencies,
lowering the cost of traditional delivery channels and maintaining strict cost
disciplines will be a priority. Limited incremental costs will be incurred for
new business initiatives during 2003. Increased costs are expected relative to
the wealth and tax advisory service business, which commenced activity during
the third quarter of 2002. To a lesser extent, additional costs are anticipated
to support growth in the Company's reinsurance business. Other business
initiatives are expected to be funded by cost savings elsewhere in the
organization.
As a member of a global organization, the Company has the opportunity to gain
cost advantages through the utilization of human, technological and operational
resources in low cost environments. The HSBC Group currently operates global
processing centers in India and China and plans to open additional sites in Asia
this year. The Company has commenced the migration of certain operational and
customer service activities to India and intends to continue to do so over the
next few years. A qualified team is in place to manage the transition of the
work ensuring no negative customer impact and the sensitive handling of affected
employees.
The Company is also expected to realize cost savings as a result of the HSBC
Group's new North American alignment initiative. The Company and HSBC Bank
Canada, the HSBC Group's Canadian based bank, are actively seeking opportunities
to better leverage their collective infrastructures and best business practices.
These efforts are expected to improve cost efficiencies of both organizations.
24
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 2002 were $195.0 million,
compared with $238.4 million in 2001, representing a decrease of $43.4 million.
This decrease reflects improvement in the overall quality of the Company's loan
portfolios as evidenced by a declining level of nonaccruals, reduced charge offs
and a stabilization of criticized asset totals. The Company's outlook remains
cautious given continued weakness in the U.S. economy and uncertainty as to the
outcome of certain significant world events.
Criticized assets, which include loans credit graded "special mention",
"substandard" or "doubtful", are a key indicator of credit quality. Criticized
asset totals remained relatively stable increasing by just $10.2 million to
$2,210.2 million at December 31, 2002 from $2,200.0 million at December 31,
2001. In 2001, criticized assets totals increased by $158.5 million.
Consumer and commercial nonaccruing loans decreased by a total $29.4 million to
$387.4 million at December 31, 2002 from $416.8 million at December 31, 2001.
This decrease reflects the migration of $312.4 million of loans into nonaccrual
status offset by $341.7 million of payoffs and pay downs, charge offs, returns
to accrual and other movements. In 2001, $507.5 million of loans migrated to
nonaccrual status.
Total net charge offs were $205.7 million for the year ended December 31, 2002,
a $32.0 million decrease from $237.7 million for the year ended December 31,
2001. The significantly slower pace of migration to criticized and nonaccrual
status, coupled with a lower level of net charge offs reflect the improvement in
the Company's overall credit quality profile.
Overall key coverage statistics have remained strong as the allowance for credit
losses at December 31, 2002 represented 1.13% of total loans as compared with
1.24% at December 31, 2001 and 127.3% of total nonaccruing loans at December 31,
2002, compared with 121.5% at December 31, 2001.
The Company also maintains a separate reserve for credit losses associated with
certain off-balance sheet exposures including letters of credit, unused
commitments to extend credit and financial guarantees. This reserve increased by
$2.0 million to $51.4 million at December 31, 2002 from $49.4 million at
December 31, 2001. The net result was an increase in the reserves held against
certain criticized letters of credit, offset by the settlement of the exposure
on a specific financial performance guarantee in 2002, and $22.0 million of new
provisions which are recorded as a charge to other expense. This represents an
increase of $12.4 million from the previous year.
Although criticized letters of credit increased by $55.0 million to $369.2
million at December 31, 2002 from $314.2 million at December 31, 2001, this was
primarily the result of the credit downgrade of two large corporate exposures.
The Company does not believe these specific downgrades to be indicative of a
trend toward deterioration in the overall quality of the off balance sheet
portfolio.
25
Forward Outlook
Although the credit quality of both the consumer and commercial portfolios has
been relatively stable, there have been signs of improvement. As credit quality
in all portfolios remains a concern, the Company will continue to monitor
closely key economic indicators and trends including governmental and corporate
spending priorities, consumer confidence and the general business climate, and
will take decisive action to quickly identify and address problem situations.
An analysis of the allowance for credit losses and the provision for credit
losses begins on page 44.
Income Taxes
- --------------------------------------------------------------------------------
The Company recognized income tax expense of $509.7 million and $226.0 million
in 2002 and 2001, respectively. The increase in income tax expense for 2002 is
principally due to an increase 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, 2002, the Company had a
net deferred tax liability of $209.2 million, as compared with a net deferred
tax asset of $328.1 million at December 31, 2001. The change from a net deferred
tax asset position to a net deferred tax liability position is primarily
attributable to settlement payments made during the first quarter of 2002
related to the Princeton Note litigation, tax deductible pension contributions
and the tax effect of items accounted for on a mark to market basis.
26
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 the business segments that it used in 2002 to
reflect the movement of certain domestic private banking activities from the
Personal Financial Services Segment to the Private Banking Segment. Also
activity related to selected commercial customers was moved from the Commercial
Banking Segment to the Corporate, Investment Banking and Markets Segment. Prior
year disclosures have been conformed herein to the presentation of current
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.
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 since they 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 Personal Financial Services Segment provides an extensive array of products
and services including installment and revolving term loans, deposits, branch
services, mutual funds and insurance. These products are marketed to individuals
primarily through the branch banking network. Residential mortgage lending
provides loan financing through direct retail and wholesale origination
channels. Mortgage loans are originated through a network of brokers, wholesale
agents and retail originations offices. Servicing is performed for the
individual mortgage holder or on a contractual basis for mortgages owned by
third parties.
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
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. 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,
manages interest rate risk and capital at risk. Traded markets encompasses the
trading and sale of foreign exchange, banknotes, derivatives, precious metals,
securities and emerging markets instruments, both domestically and
internationally.
27
The Private Banking Segment offers a full range of services for high net worth
individuals including deposit, lending, trading, trust and investment
management.
Other Segment for 2001 included the expense associated with the Princeton Note
settlement and related liabilities recorded in September of 2001 and paid in
January of 2002.
The following summarizes the results for each segment.
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate,
Personal Investment
Financial Commercial Banking and Private
Services Banking Markets Banking Other Total
- ------------------------------------------------------------------------------------------------------------------------------------
in millions
2002
Net interest income (1) $ 1,192 $ 643 $ 412 $ 129 $ -- $ 2,376
Other operating income 371 161 401 127 -- 1,060
- ------------------------------------------------------------------------------------------------------------------------------------
Total income 1,563 804 813 256 -- 3,436
Operating expenses (2) 893 407 375 201 -- 1,876
- ------------------------------------------------------------------------------------------------------------------------------------
Working contribution 670 397 438 55 -- 1,560
Provision for credit losses (3) 72 92 22 9 -- 195
- ------------------------------------------------------------------------------------------------------------------------------------
CMBT 598 305 416 46 -- 1,365
- ------------------------------------------------------------------------------------------------------------------------------------
Average assets 27,133 15,229 42,631 2,787 -- 87,780
Average liabilities/equity (4) 32,818 13,093 33,115 8,736 18 87,780
- ------------------------------------------------------------------------------------------------------------------------------------
2001
Net interest income (1) $ 1,066 $ 588 $ 469 $ 142 $ -- $ 2,265
Other operating income 325 170 489 112 -- 1,096
- ------------------------------------------------------------------------------------------------------------------------------------
Total income 1,391 758 958 254 -- 3,361
Operating expenses (2) * 817 435 365 175 575 2,367
- ------------------------------------------------------------------------------------------------------------------------------------
Working contribution 574 323 593 79 (575) 994
Provision for credit losses (3) 71 76 80 11 -- 238
- ------------------------------------------------------------------------------------------------------------------------------------
CMBT * 503 247 513 68 (575) 756
- ------------------------------------------------------------------------------------------------------------------------------------
Average assets 23,763 15,663 42,418 4,432 -- 86,276
Average liabilities/equity (4) 29,856 11,884 32,170 12,222 144 86,276
- ------------------------------------------------------------------------------------------------------------------------------------
2000
Net interest income (1) $ 955 $ 592 $ 447 $ 125 $ -- $ 2,119
Other operating income 306 150 247 129 -- 832
- ------------------------------------------------------------------------------------------------------------------------------------
Total income 1,261 742 694 254 -- 2,951
Operating expenses (2) * 822 406 327 174 -- 1,729
- ------------------------------------------------------------------------------------------------------------------------------------
Working contribution 439 336 367 80 -- 1,222
Provision for credit losses (3) 38 66 35 (1) -- 138
- ------------------------------------------------------------------------------------------------------------------------------------
CMBT * 401 270 332 81 -- 1,084
- ------------------------------------------------------------------------------------------------------------------------------------
Average assets 21,099 16,045 41,562 4,082 -- 82,788
Average liabilities/equity (4) 31,821 12,197 27,311 11,459 -- 82,788
- ------------------------------------------------------------------------------------------------------------------------------------
* Contribution margin before tax (CMBT) represents pretax income (loss)
excluding goodwill amortization in 2001 and 2000.
(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.
28
Personal Financial Services: 2002 Compared to 2001
This segment contributed $598 million to CMBT in 2002. Growth in CMBT over 2001
was $95 million or 19%. The increase in net interest income for 2002 reflects
the impact of a larger balance sheet, a wider interest margin earned on
residential mortgages and a more profitable funding mix consisting of higher
levels of savings deposits and lower levels of certificate of deposit products.
Average residential mortgages grew $2.2 billion for 2002, as the mortgage
banking division experienced record levels of production driven by a low rate
environment. Other operating income has increased over the previous year
reflecting growth in brokerage, primarily due to higher annuity sales, and
insurance related income. Expense increases are attributable to performance
related incentive compensation programs in brokerage, mortgage and branch
banking.
Commercial Banking: 2002 Compared to 2001
This segment contributed $305 million to CMBT in 2002 compared to $247 million
in 2001. The increase in net interest income reflects improved margins in
middle-market commercial banking as well as a larger overall balance sheet. The
Company continues to exit less profitable commercial lending relationships. The
lower level of operating expenses are due to decreases in support/infrastructure
costs for regional middle-market commercial banking. The higher provision for
credit losses for 2002 is due to a small number of problem loans. The credit
quality deterioration that began late in 2001 and continued in early 2002, began
to improve in the later part of the year.
Corporate, Investment Banking and Markets: 2002 Compared to 2001
This segment contributed $416 million to CMBT in 2002 compared to $513 million
in 2001. The reduction in other operating income reflects a decline in trading
related revenues. Derivatives and treasury trading revenue declined due to mark
to market losses on derivative instruments used to protect against rising
interest rates and also from widening spread relationships that took place at
various times during the year. A reduction in foreign exchange trading revenue
for 2002 compared to 2001 reflects lower levels of proprietary trading revenue
due to reduced volatility in the foreign exchange markets and adverse rate
exchange movements. The higher provision for credit losses in 2001 reflects
losses related to a single large corporate customer in the energy sector.
Private Banking: 2002 Compared to 2001
This segment contributed $46 million to CMBT in 2002 compared to $68 million in
2001. The reduction in net interest income and average liabilities compared to
2001 reflects the migration of customers from deposit products to mutual funds
and annuities due to the lower rate environment. Reduced net interest income and
average assets and liabilities also reflect the continuing migration of
customers in Asia to other HSBC Group members. The increase in other operating
income is due to increased levels of fee income earned on wealth management
products and revenue earned by the newly formed wealth and tax advisory service
business. The increase in operating expenses relates to costs associated with
the newly formed wealth and tax advisory service business.
Other: 2002 Compared to 2001
This segment for 2001 included the expenses associated with the Princeton Note
settlement and related liabilities recorded in September 2001 and paid in
January of 2002.
29
Personal Financial Services: 2001 Compared to 2000
The increase in net interest income for 2001 reflected 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 higher
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 reflected
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. The increased provision for credit losses reflected a weaker economy
and higher delinquency rates on consumer loans.
Commercial Banking: 2001 Compared to 2000
Increased fees for commercial loans and deposit servicing/cash management were
the principal factors behind the growth in other operating income. The operating
expense increase for 2001 was principally due to the full year impact of the
Panama branch acquisitions. Higher provisions for credit losses reflected the
weaker economic conditions during 2001, with losses concentrated in receivable
and inventory lending portfolios.
Corporate, Investment Banking and Markets: 2001 Compared to 2000
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 reflected 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
reflected losses related to a single large corporate in the energy sector.
Private Banking: 2001 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 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 the
noted migration of Asian business.
Other: 2001 Compared to 2000
This segment for 2001 included the expenses associated with the Princeton Note
settlement and related liabilities recorded in September 2001 and paid in
January of 2002.
30
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 Policy Committee manages the
details of liquidity and interest rate risk. The management of credit risk is
further discussed on page 39.
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 Policy 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 48.
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
31
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. 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 shareholders' 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.
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.
Effective December 2002, the Company established a SFAS 133 qualifying hedge
strategy using forward sales contracts to offset the change in the fair value of
conventional closed residential mortgage loans originated for sale.
Some earnings volatility results from the 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 continues to pursue its overall asset
and liability risk management objectives using a combination of derivatives and
cash instruments.
32
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 and Liability Policy Committee is responsible for the development 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 and Liability Policy 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, 2002, 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 issued $300 million of floating rate senior notes in September 2002.
The Company's shelf registration statement filed with the Securities and
Exchange Commission has $825 million available under which it may issue 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 Bank plc, 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 source of liquidity or funding.
Assets, principally consisting of a portfolio of highly rated investment
securities in excess of $19 billion, approximately $8 billion of which is
scheduled to mature within the next twelve months, a liquid trading portfolio of
approximately $13 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 would be used to
supplement liquidity derived from liabilities only in a crisis scenario.
33
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.
The Company projects, as part of normal ongoing contingency planning, that in
the event of a severe liquidity problem there would be sources of cash exceeding
projected uses of cash by over $10 billion. This also assumes that the Company
no longer has access to the wholesale funds market. In addition, the Company
maintains residential mortgages and eligible collateral at the Federal Reserve
that could provide additional liquidity if needed.
Off-Balance Sheet Arrangements
- --------------------------------------------------------------------------------
Letters of Credit
The Company may issue a letter of credit for the benefit of a customer,
authorizing a third party to draw on the letter for specified amounts under
certain terms and conditions. The issuance of a letter of credit is subject to
the Company's credit approval process and collateral requirements. The Company
issues two types of letters of credit, commercial and standby.
A commercial letter of credit is drawn down on the occurrence of an expected
underlying transaction, such as the delivery of goods. Upon the occurrence of
the transaction, a commercial letter of credit is recorded as a customer
acceptance in other assets and other liabilities until settled.
A standby letter of credit may be either performance or financial. A standby
letter of credit is also issued to third parties for the benefit of a customer
and is essentially a guarantee that the customer will perform, or satisfy some
obligation, under a contract. It irrevocably obligates the Company to pay a
third party beneficiary when a customer either: (1) in the case of a performance
standby letter of credit, fails to perform some contractual non-financial
obligation, or (2) in the case of a financial standby letter of credit, fails to
repay an outstanding loan or debt instrument.
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Deferred fees on standby
letters of credit included in other liabilities at December 31, 2002 and 2001
were $3.7 million and $4.2 million, respectively.
Loan Sales with Recourse
The Company securitizes and sells loans, generally without recourse. In prior
years, the Company's mortgage banking subsidiary has sold residential mortgage
loans with recourse to it upon borrower default, with partial indemnification
from third parties.
Credit Derivatives
The Company enters into credit derivative contracts to provide value-added
solutions to the risk management and investment needs of its customers. Credit
derivatives are arrangements that allow one party (the "beneficiary") to
transfer the credit risk of a "reference asset" to another party (the
"guarantor"). This arrangement allows the guarantor to assume the credit risk
34
associated with the reference asset without directly purchasing it. The
beneficiary agrees to pay to the guarantor a specified fee while in return, the
guarantor agrees to pay the beneficiary an agreed upon amount if there is a
default during the term of the contract.
In accordance with its policy, the Company offsets virtually all of the market
risk it assumes in selling credit guarantees through a credit derivative
contract with another counterparty. Credit derivatives, although having
characteristics of a guarantee, are accounted for in accordance with Statement
of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133) and are carried at fair value. The commitment
amount included in the table below is the maximum amount that the Company could
be required to pay, without consideration of the approximately equal amount
receivable from third parties.
Commitments to Extend Credit
Loan commitments are agreements to make or acquire a loan as long as the agreed
upon terms are met.
The following table provides information at December 31, 2002 related to the
off-balance sheet arrangements and lending and sales commitments.
- -----------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2002 or Less Five Years Years Total
- -----------------------------------------------------------------------------------------------------
in millions
Standby letters of credit, net of
participations $ 3,144 $ 999 $ 78 $ 4,221(1)
Commercial letters of credit,
net of participations 656 -- -- 656
Recourse on sold loans -- 3 23 26(2)
Credit derivative contracts 331 5,399 -- 5,730(3)
Commitments to extend credit 17,294 8,061 990 26,345
Commitments to deliver mortgage
backed securities 3,206 -- -- 3,206
- -----------------------------------------------------------------------------------------------------
Total $24,631 $14,462 $1,091 $40,184
=====================================================================================================
(1) Includes $302 million issued for the benefit of related parties.
(2) $17 million of this amount is indemnified by third parties.
(3) Includes $71 million issued for the benefit of related parties.
At December 31, 2001, the Company had standby letters of credit and financial
guarantees (net of risk participations) and commitments to extend credit of
$5,583 million and $28,722 million, respectively. The Company also had $2,122
million of commitments to deliver mortgage backed securities at December 31,
2001.
The Company also has unused credit card and home equity lines of $7,033 million
and $6,331 million at December 31, 2002 and 2001, respectively. 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.
35
Special Purpose and Variable Interest Entities
Commercial Paper Conduit
An affiliated member of the HSBC Group (HSBC affiliate) supports the financing
needs of customers by facilitating their access to the commercial paper markets.
These markets provide an attractive, lower-cost financing alternative for these
customers. Specifically, a customer's assets such as high-grade trade or other
receivables are sold to a commercial paper financing entity, which in turn
issues high-grade short-term commercial paper that is collateralized by such
assets. The HSBC affiliate facilitates these transactions and bills and collects
fees from the financing entity for the services it provides.
In its role as administrator of this independently rated specialized financing
entity, the HSBC affiliate structures financing transactions for customers such
that the receivables financed through the financing entity are appropriately
diversified and credit enhanced to support the issuance of asset backed
commercial paper. Neither the HSBC affiliate nor the Company service the assets
or transfer their own receivables into the financing entity.
The Company and other banks provide liquidity facilities, which mature within
one year, in the form of either loan or asset purchase commitments, in support
of each transaction in the financing entity. In addition, the Company provides a
standby letter of credit as a program wide credit enhancement to the financing
entity. The Company collects fees from the financing entity for both the
liquidity facility and the standby letter of credit. Credit risk is managed on
these commitments by subjecting them to normal underwriting and risk management
processes. Although the analysis has yet to be completed, it is reasonably
possible that the Company may have to consolidate the financing entity under the
new accounting requirements of FIN 46.
At December 31, 2002 and 2001, the financing entity had total commitments to
customers of $1,250.0 million and $350.0 million, and total investments of
$792.0 million and $120.0 million, respectively. At December 31, 2002 and 2001,
the Company had liquidity commitments and standby letters of credit to the
financing entity of $685.0 million and $175.0 million, respectively. Assets in
the financing entity are principally trade receivables, auto loans and credit
card receivables.
Trust Certificates
The HSBC affiliate also organizes trusts that are special purpose entities
(SPEs) that issue floating rate certificates backed by the underlying assets of
the trusts, which the SPEs purchase primarily from insurance companies. The
Company's relationship with the SPE is solely as a counterparty to derivative
transactions (interest rate swaps) with it. The derivative transactions are
accounted for in accordance with SFAS 133 and are carried at fair value. At
December 31, 2002 and 2001, the SPEs had total assets of $412.0 million and
$230.0 million, respectively. Currently, these SPEs are not consolidated with
the Company and although the analysis has yet to be completed, the Company does
not believe it is reasonably possible that the SPEs will be consolidated under
the new accounting requirements of FIN 46.
Investments in Limited Partnerships
The Company has investments of less than 20% in limited partnerships, primarily
Low Income Housing Tax Credit Partnerships. Currently, these partnerships are
not consolidated and are being evaluated for consolidation under FIN 46.
36
Contractual Obligations
- --------------------------------------------------------------------------------
Obligations to make future payments under contracts are as follows.
- ----------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2002 or Less Five Years Years Total
- ----------------------------------------------------------------------------------------
in millions
Subordinated long-term debt and
perpetual capital notes $ -- $300 $1,753 $2,053
Guaranteed mandatorily redeemable
securities -- -- 1,050 1,050
Other long-term debt, including
capital lease obligations 61 520 481 1,062
Minimum future rental commitments
on operating leases 66 176 81 323
- ----------------------------------------------------------------------------------------
Total $127 $996 $3,365 $4,488
========================================================================================
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, 2002. For assets and liabilities whose cash flows are subject 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, 2002 Funds Days Days Days Year Total
- -----------------------------------------------------------------------------------------------------------
in millions
Assets $ 9,268 $45,455 $5,094 $6,202 $23,407 $89,426
Liabilities and shareholders'
equity 16,948 50,810 3,717 2,430 15,521 89,426
- -----------------------------------------------------------------------------------------------------------
Effect of derivative contracts -- (1,373) (250) 23 1,600 --
- -----------------------------------------------------------------------------------------------------------
Gap position $(7,680) $(6,728) $1,127 $3,795 $ 9,486 $ --
===========================================================================================================
Liabilities and shareholders' equity at year end 2002 include domestic time
deposits of $100,000 or more with maturity dates as follows: $2,977 million,
0-90 days; $1,647 million, 91-180 days; $508 million, 181-365 days, and $463
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 46 and 47
for further description of earnings at risk measurements and dynamic simulation
modeling employed by the Company to manage interest rate risk.
37
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 2002.
- --------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2002 or Less Five Years Years
- --------------------------------------------------------------------------------
in millions
Domestic:
Construction and mortgage loans $ 2,261 $2,512 $1,577
Other business and financial 7,227 2,888 506
International 2,018 872 139
- --------------------------------------------------------------------------------
Total $11,506 $6,272 $2,222
================================================================================
Loans with fixed interest rates $ 5,060 $2,351 $1,332
Loans having variable interest rates 6,446 3,921 890
- --------------------------------------------------------------------------------
Total $11,506 $6,272 $2,222
================================================================================
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.
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, 2002 2001 2000 2002 2001 2000
- ------------------------------------------------------------------------------------------------
in millions
U.S. Treasury $ 266 $ 372 $ 323 $ 14 $ -- $ --
U.S. Government agency 9,597 8,068 9,119 3,903 3,882 3,530
Obligations of U.S. states and
political subdivisions -- -- -- 673 769 730
Asset backed securities 2,935 3,485 3,166 -- -- --
Other domestic debt securities 705 739 1,487 31 -- --
Foreign debt securities 887 2,435 2,555 7 -- --
Equity securities 304 169 224 -- -- --
- ------------------------------------------------------------------------------------------------
Total $14,694 $15,268 $16,874 $ 4,628 $ 4,651 $ 4,260
================================================================================================
The following table reflects the distribution of maturities of debt securities
held at year end 2002 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, 2002. Yields on
tax-exempt obligations have been computed on a taxable equivalent basis using
applicable statutory tax rates.
38
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 $ -- --% $ * 6.28% $ 202 3.97% $ 62 4.32%
U.S. Government agency 73 7.20 941 4.39 680 5.39 7,599 4.62
Asset backed securities 35 1.78 792 2.68 909 2.15 1,188 2.11
Other domestic debt
securities 513 .26 148 2.52 15 1.73 27 2.35
Foreign debt securities 115 4.72 491 5.72 215 6.14 48 3.88
- -------------------------------------------------------------------------------------------------------------------------
Total amortized cost $ 736 1.72% $2,372 3.98% $2,021 3.84% $8,924 4.28%
- -------------------------------------------------------------------------------------------------------------------------
Total fair value $ 739 $2,400 $2,070 $9,181
=========================================================================================================================
Held to maturity:
U.S. Treasury $ 14 1.15% $ -- --% $ * 5.65% $ -- --%
U.S. Government agency * 8.36 188 7.23 193 7.15 3,522 6.71
Obligations of U.S.
states and political
subdivisions 9 12.76 45 9.36 130 8.87 489 8.82
Other domestic debt
securities -- -- -- -- -- -- 31 6.09
Foreign debt securities 7 2.63 -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------------------
Total amortized cost $ 30 5.07% $ 233 7.65% $ 323 7.84% $4,042 6.96%
- -------------------------------------------------------------------------------------------------------------------------
Total fair value $ 30 $ 240 $ 347 $4,288
=========================================================================================================================
* Less than $500 thousand
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 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.
39
Loans Outstanding
- --------------------------------------------------------------------------------
The following table provides a breakdown of major loan categories as of year end
for the past five years.
- ------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------
in millions
Domestic:
Commercial:
Construction and mortgage loans $ 6,350 $ 5,954 $ 5,646 $ 5,648 $ 3,096
Other business and financial 10,621 10,564 12,551 12,002 7,803
Consumer:
Residential mortgages 20,842 17,951 15,836 13,241 9,467
Credit card receivables 1,101 1,148 1,232 1,290 1,291
Other consumer loans 1,693 1,770 1,640 1,231 1,319
- ------------------------------------------------------------------------------------------------------
40,607 37,387 36,905 33,412 22,976
- ------------------------------------------------------------------------------------------------------
International:
Government and official institutions 184 169 302 444 331
Banks and other financial institutions 139 314 852 727 622
Commercial and industrial 2,248 2,587 1,946 3,747 120
Consumer 458 466 413 -- --
- ------------------------------------------------------------------------------------------------------
3,029 3,536 3,513 4,918 1,073
- ------------------------------------------------------------------------------------------------------
Total loans $43,636 $40,923 $40,418 $38,330 $24,049
======================================================================================================
2002
The increase in construction and mortgage loan reflects growth achieved in New
York State based real estate lending business. The increase in residential
mortgage loans was the result of record levels of production driven by the low
rate environment which began in 2001. The decrease in international loans
reflects the continuing migration of customers in Asia to other HSBC Group
members.
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 higher 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.
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.
40
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.
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.
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. However, 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.
Interest that has been accrued 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 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.
41
Risk Elements in the Loan Portfolio at Year End
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------
in millions
Nonaccruing loans:
Domestic:
Construction and other commercial
real estate $ 29 $ 28 $ 35 $ 83 $104
Other commercial loans 200 238 253 160 141
Consumer loans 116 118 104 95 92
- ------------------------------------------------------------------------------
Subtotal 345 384 392 338 337
International 42 33 31 6 --
- ------------------------------------------------------------------------------
Total nonaccruing loans 387 417 423 344 337
Other real estate and owned assets 17 18 21 14 9
- ------------------------------------------------------------------------------
Total nonaccruing loans, other real
estate and owned assets $404 $435 $444 $358 $346
==============================================================================
Ratios:
Nonaccruing loans to total loans .89% 1.02% 1.05% .90% 1.40%
Nonaccruing loans, other real estate
and owned assets to total assets .45 .50 .53 .41 1.02
- ------------------------------------------------------------------------------
Accruing loans contractually past due
90 days or more as to principal or
interest:
Consumer $ 5 $ 10 $ 13 $ 17 $ 18
Commercial 31 12 29 23 12
International 5 -- -- -- --
- ------------------------------------------------------------------------------
Total accruing loans contractually past
due 90 days or more $ 41 $ 22 $ 42 $ 40 $ 30
==============================================================================
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, 2002 totaled $387 million compared with $417
million a year ago. Of the nonaccruing loans at December 31, 2002 over 34% 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 $4 million, $3 million and $8 million at December 31, 2002, 2001 and
2000, respectively. During 2002, $6 million of nonaccruing commercial loans were
sold. Cash payments received on loans on nonaccruing status during 2002, or
since loans were placed on nonaccruing status, whichever was later, totaled $30
million, $9 million of which was recorded as interest income and $21 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 only if the customer has agreed
to credit counseling; otherwise they are charged off in accordance with a
predetermined schedule. 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.
The Company identified impaired loans totaling $288 million at December 31, 2002
of which $170 million had a related impairment reserve of $89 million. At
December 31, 2001, identified impaired loans were $243 million, of which $151
million had a related impairment reserve of $83 million.
42
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 deposit 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 deposit); 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. There were no cross-border net outstandings which exceeded .75% of
total assets at December 31, 2002.
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
==============================================================================================
(1) Includes excess of local country claims over local country obligations.
43
Allowance for Credit Losses and Charge Offs
- -------------------------------------------
At year end 2002, the allowance was $493 million, or 1.13% of total loans,
compared with $506 million, or 1.24% of total loans, a year ago. The ratio of
the allowance to nonaccruing loans was 127.28% at December 31, 2002 compared
with 121.50% a year earlier.
- -----------------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
in millions
Total loans at year end $ 43,636 $ 40,923 $ 40,418 $ 38,330 $ 24,049
Average total loans 42,054 41,441 38,966 23,385 21,392
Allowance for credit losses:
Balance at beginning of year $ 506.4 $ 525.0 $ 638.0 $ 379.7 $ 409.4
Allowance related to acquisitions,
net/other (2.2) (19.0) (11.3) 268.6 --
Charge offs:
Commercial:
Construction and mortgage loans 8.0 6.7 11.2 -- --
Other business and financial 141.4 181.3 173.0 27.0 27.9
Consumer:
Residential mortgages 2.8 3.2 5.2 12.1 10.2
Credit card receivables 61.0 65.6 70.9 86.5 105.0
Other consumer loans 13.8 11.2 10.9 9.5 9.5
International 13.9 12.5 1.8 -- --
- -----------------------------------------------------------------------------------------------------------------------------
Total charge offs 240.9 280.5 273.0 135.1 152.6
- -----------------------------------------------------------------------------------------------------------------------------
Recoveries on loans charged off:
Commercial:
Construction and mortgage loans 9.4 .2 3.3 -- --
Other business and financial 11.2 28.8 14.6 18.3 22.9
Consumer:
Residential mortgages .8 1.0 1.0 1.0 .8
Credit card receivables 8.0 9.1 10.7 11.6 14.9
Other consumer loans 3.7 3.6 4.5 3.9 4.3
International 2.1 .1 .2 -- --
- -----------------------------------------------------------------------------------------------------------------------------
Total recoveries 35.2 42.8 34.3 34.8 42.9
- -----------------------------------------------------------------------------------------------------------------------------
Total net charge offs 205.7 237.7 238.7 100.3 109.7
- -----------------------------------------------------------------------------------------------------------------------------
Translation adjustment (.4) (.3) (.6) -- --
- -----------------------------------------------------------------------------------------------------------------------------
Provision charged to income 195.0 238.4 137.6 90.0 80.0
- -----------------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 493.1 $ 506.4 $ 525.0 $ 638.0 $ 379.7
- -----------------------------------------------------------------------------------------------------------------------------
Allowance ratios:
Total net charge offs to average loans .49% .57% .61% .43% .51%
Year-end allowance to:
Year-end total loans 1.13 1.24 1.30 1.66 1.58
Year-end total nonaccruing loans 127.28 121.50 124.06 185.72 112.74
=============================================================================================================================
In addition, the Company also maintains a separate reserve for credit losses
associated with certain off-balance sheet exposures including letters of credit,
unused commitments to extend credit and financial guarantees. This reserve,
included in other liabilities, was $51.4 million at December 31, 2002 and $49.4
million at December 31, 2001.
As described in more detail in the Summary of Significant Accounting Policies
beginning on page 60, 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 specific reserves,
formula-based reserves 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 specific loss portion of
the allowance includes reserves that are calculated based upon an evaluation of
individual commercial and residential mortgage loan problem credits that are
considered "impaired" as well as formula-based reserves
44
against loans where it is deemed probable, based upon analysis of historical
data, that a loss is inherent in the loan portfolio even though it has not yet
manifested itself in individual 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 losses inherent and 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 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, migration trends in the non-criticized loan
portfolios, as well as the concentration of loans to individual counterparties.
The Company continually reviews and updates its loss estimation models and
techniques, refreshing historical data elements and closely monitoring both
general economic and specific business trends.
An allocation of the allowance by major loan categories follows.
Allocation of Allowance for Credit Losses
- --------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- --------------- --------------- -------------- --------------
% 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 $ 27 14.6 $ 25 14.6 $ 28 14.0 $ 45 14.8 $ 23 12.8
Other business 226 24.3 224 25.8 163 31.0 163 31.3 62 32.4
Consumer:
Residential mortgages 11 47.8 11 43.9 10 39.2 43 34.5 12 39.4
Credit card
receivables 51 2.5 53 2.8 62 3.0 40 3.4 45 5.4
Other consumer 27 3.9 29 4.3 31 4.1 17 3.2 12 5.5
International 93 6.9 105 8.6 117 8.7 116 12.8 31 4.5
Unallocated reserve 58 -- 59 -- 114 -- 214 -- 195 --
- --------------------------------------------------------------------------------------------------------------------
Total $493 100.0 $506 100.0 $525 100.0 $638 100.0 $380 100.0
====================================================================================================================
45
Capital Resources
- --------------------------------------------------------------------------------
Total common shareholder's equity at year end 2002 was $6,897 million, compared
with $6,549 million at year end 2001. The equity base increased by $855 million
from net income and reduced by $670 million for common shareholder dividends
paid to HNAI and $23 million for dividends to preferred stock shareholders. The
equity base also increased by $164 million from the change in other
comprehensive income. The other capital contribution from the parent of $22
million includes $16 million relating to an HSBC stock option plan in which
almost all of the Company's employees are eligible to participate and $6 million
relating to other activity.
The ratio of common shareholder's equity to total year-end assets was 7.71% at
December 31, 2002 compared with 7.52% at December 31, 2001.
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, 2002 was plus or minus $4.0 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 +/- $4.0 million.
As of December 31, 2002, the Company had a position of $2.1 million PVBP
reflecting the impact of a one basis point increase in interest rates.
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 either a 200 basis point gradual rate increase
or a 100 basis point gradual rate decrease. As of December 31, 2002, for a
gradual 200 basis point increase in rates, the value was projected to drop by
0.1% and for a 100 basis point gradual decrease in rates, value was projected to
drop by 4.4%. The projected drop in value is primarily related to changes in the
value of balance sheet products with ascribed maturities beyond three years and
assumes no management actions to either manage exposures to the changing
interest rate environment or reinvesting the proceeds from any maturing assets
or liabilities.
In addition to the above mentioned limits, the Company's Asset and Liability
Policy 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%, after tax, of base case earnings
over a twelve month period. Simulations are also performed for
46
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, 2003 would cause projected net interest
income for the next twelve months to decrease by $56 million and increase by $2
million, respectively. This 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, 2003, would cause projected net interest income for the next twelve months to
decrease by $64 million and $194 million, respectively. An immediate 200 basis
point parallel rise or fall would decrease projected net interest income for the
next twelve months by $127 million and $298 million, respectively. In addition,
simulations are performed to analyze the impact associated with various twists
and shapes of the yield curve. If the yield curve continues to flatten
significantly (i.e. long end of the yield curve down) in 2003, the projected
margin could shrink by approximately 5 to 10%, assuming no management actions.
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.
47
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), given a certain
confidence level (99%) and based upon a two year observation period. 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.
The following table summarizes trading VAR of the Company.
- -------------------------------------------------------------------------------------------------
Full year 2002
December 31, ----------------------------------- December 31,
2002 Minimum Maximum Average 2001
- -------------------------------------------------------------------------------------------------
in millions
Total trading $11.4 $6.7 $38.3 $16.6 $19.2
Commodities 2.6 .1 8.2 1.8 .3
Credit derivatives 2.1 .3 9.1 1.5 -
Equities 1.0 .1 8.0 1.7 2.0
Foreign exchange 3.1 .4 16.1 5.6 4.6
Interest rate 8.6 4.1 35.6 14.8 21.5
- -------------------------------------------------------------------------------------------------
48
The following summary illustrates the Company's daily revenue earned from market
risk-related activities during 2002. 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 101 days with negative revenue during 2002. The most frequent result was a
daily revenue of between zero and $2 million with 101 occurrences. The highest
daily revenue was $25.9 million and the largest daily loss was $5.6 million.
- ----------------------------------------------------------------------------------------------------------
Ranges of daily revenue
earned from market risk-
related activities
- ----------------------------------------------------------------------------------------------------------
Below $(4) to $(2) to $0 to $2 to $4 to Over
in millions $(4) $(2) $0 $2 $4 $6 $6
- ----------------------------------------------------------------------------------------------------------
Number of trading days
market risk-related
revenue was within the
stated range 3 17 81 101 33 9 7
- ----------------------------------------------------------------------------------------------------------
Recently Issued Accounting Standards
- --------------------------------------------------------------------------------
In June 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 (e.g. an owned office
building or an operating facility).
SFAS 143 requires the fair value of a liability for an asset retirement
obligation be recognized through a charge to earnings 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 netted against the carrying amount of the associated asset
and this adjusted carrying amount is depreciated over the life of the asset. The
liability is accreted at the end of each period through credits 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 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.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 146, Accounting for Costs Associated with Exit or
Disposal Activities (SFAS 146) in June 2002, which prescribes the way in which
costs associated with exit or disposal activities are to be determined and the
timing of their recognition. These activities include the sale or termination of
a line of business and the closure of business activities at a particular
location. The statement also provides guidance for the reporting and disclosure
of these costs. The Company is currently reviewing the prospective impact of
applying the statement, which will be effective for disposal activities
initiated after December 31, 2002.
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. The Interpretation
expands on the accounting guidance of Statements No. 5, 57, and 107 and
incorporates without change the provisions of FASB Interpretation No. 34, which
is being superseded.
49
The Interpretation elaborates on the existing disclosure requirements for most
guarantees, including loan guarantees such as standby letters of credit. It also
clarifies that at the time a company issues a guarantee, the company must
recognize an initial liability for the fair value, or market value, of the
obligations it assumes under that guarantee and must disclose that information
in its interim and annual financial statements.
The Company is currently reviewing the impact of applying the initial
recognition and initial measurement provisions. These apply on a prospective
basis to guarantees issued or modified after December 31, 2002, regardless of
the guarantor's fiscal year end. Adoption is not expected to have a material
impact on the consolidated financial statements of the Company.
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46, Consolidation of Variable Interest Entities. Until now, one company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. The Interpretation
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. The Interpretation increases required disclosures by companies
consolidating a variable interest entity. The Interpretation also requires
disclosures about variable interest entities that the company is not required to
consolidate but in which it has a significant variable interest.
The Company is currently reviewing the impact of the consolidation requirements
of Interpretation No. 46. These apply immediately to variable interest entities
created after January 31, 2003. The requirements apply to pre-January 31
entities in the first fiscal year or interim period beginning after June 15,
2003. The disclosure requirements apply in all financial statements issued after
January 31, 2003, regardless of when the variable interest entity was
established.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------------------
Refer to the disclosure in Item 7 of the Management's Discussion and Analysis of
Financial Condition and Results of Operations under the caption "Market Risk".
50
Item 8. Financial Statements and Supplementary Data
- --------------------------------------------------------------------------------
Page
----
Report of Independent Auditors 52
HSBC USA Inc.:
Consolidated Balance Sheet 53
Consolidated Statement of Income 54
Consolidated Statement of Changes in
Shareholders' Equity 55
Consolidated Statement of Cash Flows 56
HSBC Bank USA:
Consolidated Balance Sheet 57
Summary of Significant Accounting Policies 58
Notes to Financial Statements 65
51
R E P O R T O F I N D E P E N D E N T A U D I T O R S
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, 2002 and 2001, 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, 2002,
and the accompanying consolidated balance sheets of HSBC Bank USA and
subsidiaries (the Bank) as of December 31, 2002 and 2001. 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, 2002 and 2001, and the results of their operations and their cash
flows for each of the years in the three year period ended December 31, 2002,
and the financial position of the Bank as of December 31, 2002 and 2001, in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 7, the Company adopted prospectively the provisions of
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, in 2002.
/s/ KPMG LLP
February 5, 2003
New York, New York
52
HSBC USA Inc. 2002
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31, 2002 2001
- --------------------------------------------------------------------------------------------------------------------
in thousands
Assets
Cash and due from banks $ 2,081,279 $ 2,102,756
Interest bearing deposits with banks 1,048,294 3,560,873
Federal funds sold and securities purchased under resale agreements 2,742,943 3,744,624
Trading assets 13,408,215 9,088,905
Securities available for sale 14,694,115 15,267,790
Securities held to maturity (fair value $4,905,162 and $4,839,705) 4,628,482 4,651,329
Loans 43,635,872 40,923,298
Less - allowance for credit losses 493,125 506,366
- --------------------------------------------------------------------------------------------------------------------
Loans, net 43,142,747 40,416,932
Premises and equipment 726,457 750,041
Accrued interest receivable 328,595 416,545
Equity investments 278,270 271,402
Goodwill 2,829,074 2,842,083
Other assets 3,517,730 4,000,296
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 89,426,201 $ 87,113,576
====================================================================================================================
Liabilities
Deposits in domestic offices
Noninterest bearing $ 5,731,442 $ 5,432,106
Interest bearing 34,352,307 31,695,955
Deposits in foreign offices
Noninterest bearing 397,743 428,252
Interest bearing 18,798,723 18,951,096
- --------------------------------------------------------------------------------------------------------------------
Total deposits 59,280,215 56,507,409
- --------------------------------------------------------------------------------------------------------------------
Trading account liabilities 7,710,010 3,799,817
Short-term borrowings 7,392,368 9,202,086
Interest, taxes and other liabilities 3,422,047 6,064,462
Subordinated long-term debt and perpetual capital notes 2,109,163 2,711,549
Guaranteed mandatorily redeemable securities 1,050,942 728,341
Other long-term debt 1,064,863 1,050,882
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 82,029,608 80,064,546
- --------------------------------------------------------------------------------------------------------------------
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 6,056,307 6,034,598
Retained earnings 578,083 415,821
Accumulated other comprehensive income 262,199 98,607
- --------------------------------------------------------------------------------------------------------------------
Total common shareholder's equity 6,896,593 6,549,030
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 7,396,593 7,049,030
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 89,426,201 $ 87,113,576
====================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
53
HSBC USA Inc. 2002
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Year Ended December 31, 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
in thousands
Interest income
Loans $ 2,521,200 $ 2,937,052 $ 3,072,830
Securities 951,542 1,260,439 1,547,868
Trading assets 161,262 217,007 140,455
Short-term investments 149,400 345,150 523,693
Other interest income 23,366 27,853 32,738
- ----------------------------------------------------------------------------------------------------------
Total interest income 3,806,770 4,787,501 5,317,584
- ----------------------------------------------------------------------------------------------------------
Interest expense
Deposits 935,663 1,856,893 2,334,036
Short-term borrowings 231,567 337,205 444,718
Long-term debt 263,264 328,111 420,298
- ----------------------------------------------------------------------------------------------------------
Total interest expense 1,430,494 2,522,209 3,199,052
- ----------------------------------------------------------------------------------------------------------
Net interest income 2,376,276 2,265,292 2,118,532
Provision for credit losses 195,000 238,400 137,600
- ----------------------------------------------------------------------------------------------------------
Net interest income, after provision for credit losses 2,181,276 2,026,892 1,980,932
- ----------------------------------------------------------------------------------------------------------
Other operating income
Trust income 94,419 87,600 84,906
Service charges 206,423 189,025 172,257
Mortgage banking revenue 110,115 79,369 32,484
Other fees and commissions 403,076 329,509 300,388
Trading revenues:
Treasury business and other 130,080 266,010 140,192
Residential mortgage business related (96,935) (67,091) --
----------- ----------- -----------
Total trading revenues 33,145 198,919 140,192
Security gains, net 118,169 149,267 28,839
Other income 93,917 61,993 73,372
- ----------------------------------------------------------------------------------------------------------
Total other operating income 1,059,264 1,095,682 832,438
- ----------------------------------------------------------------------------------------------------------
3,240,540 3,122,574 2,813,370
- ----------------------------------------------------------------------------------------------------------
Operating expenses
Salaries and employee benefits 1,029,254 1,000,409 975,391
Occupancy expense, net 155,655 155,436 167,202
Goodwill amortization -- 176,482 176,162
Princeton Note Matter -- 575,000 --
Other expenses 690,558 635,658 587,083
- ----------------------------------------------------------------------------------------------------------
Total operating expenses 1,875,467 2,542,985 1,905,838
- ----------------------------------------------------------------------------------------------------------
Income before taxes and cumulative effect of accounting change 1,365,073 579,589 907,532
Applicable income tax expense 509,629 226,000 338,573
- ----------------------------------------------------------------------------------------------------------
Income before cumulative effect of accounting change 855,444 353,589 568,959
- ----------------------------------------------------------------------------------------------------------
Cumulative effect of accounting change - implementation
of SFAS 133, net of tax -- (451) --
- ----------------------------------------------------------------------------------------------------------
Net income $ 855,444 $ 353,138 $ 568,959
==========================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
54
HSBC USA Inc. 2002
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
in thousands
Preferred stock
Balance, January 1, $ 500,000 $ 500,000 $ 500,000
- -----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 500,000 500,000 500,000
- -----------------------------------------------------------------------------------------------------------------------
Common stock
Balance, January 1, 4 4 4
- -----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 4 4 4
- -----------------------------------------------------------------------------------------------------------------------
Capital surplus
Balance, January 1, 6,034,598 6,104,264 6,096,318
Return of capital -- (84,939) --
Other 21,709 15,273 7,946
- -----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 6,056,307 6,034,598 6,104,264
- -----------------------------------------------------------------------------------------------------------------------
Retained earnings
Balance, January 1, 415,821 612,798 671,578
Net income 855,444 353,138 568,959
Cash dividends declared:
Preferred stock (23,182) (25,115) (27,739)
Common stock (670,000) (525,000) (600,000)
- -----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 578,083 415,821 612,798
- -----------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income (loss)
Balance, January 1, 98,607 116,851 (50,534)
Net change in unrealized gains on securities 80,508 31,100 174,874
Net change in unrealized gain (loss) on derivatives classified as cash
flow hedges 78,968 (37,503) --
Foreign currency translation adjustment 4,116 (11,841) (7,489)
- -----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 163,592 (18,244) 167,385
- -----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 262,199 98,607 116,851
- -----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity, December 31, $ 7,396,593 $ 7,049,030 $ 7,333,917
=======================================================================================================================
Comprehensive income
Net income $ 855,444 $ 353,138 $ 568,959
Other comprehensive income (loss) 163,592 (18,244) 167,385
- -----------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 1,019,036 $ 334,894 $ 736,344
=======================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
55
HSBC USA Inc. 2002
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31, 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------
in thousands
Cash flows from operating activities
Net income $ 855,444 $ 353,138 $ 568,959
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation, amortization and deferred taxes 810,810 119,831 368,102
Provision for credit losses 195,000 238,400 137,600
Net change in other accrual accounts (693,559) 897,893 32,240
Net change in loans originated for sale (775,464) (665,273) 115,652
Net change in trading assets and liabilities (379,398) (1,752,622) (913,266)
Other, net (581,851) (348,128) (114,171)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities (569,018) (1,156,761) 195,116
- -----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Net change in interest bearing deposits with banks 2,512,579 1,389,943 (813,245)
Net change in short-term investments (95,601) (751,850) 422,869
Purchases of securities held to maturity (1,556,240) (545,874) (58,720)
Proceeds from maturities of securities held to maturity 1,595,747 1,175,902 580,539
Purchases of securities available for sale (13,109,951) (15,585,510) (14,304,302)
Proceeds from sales of securities available for sale 7,032,407 12,395,526 8,701,959
Proceeds from maturities of securities available for sale 5,305,988 4,820,044 13,042,069
Payment to shareholders of acquired company -- -- (7,091,209)
Net change in credit card receivables (15,316) (11,937) 24,768
Net change in other short-term loans (374,180) 616,194 201,634
Net originations and maturities of long-term loans (1,561,311) (551,253) (1,665,707)
Sales of loans 189,905 79,666 169,234
Expenditures for premises and equipment (82,821) (76,810) (108,157)
Net cash provided (used) in acquisitions, net of cash acquired 23,221 (21,547) (585,756)
Other, net (3,426) 96,890 363,897
- -----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities (138,999) 3,029,384 (1,120,127)
- -----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Net change in deposits 2,671,510 17,112 (1,113,883)
Net change in short-term borrowings (978,648) (339,348) 3,351,655
Issuance of long-term debt 1,352,338 549,464 659,338
Repayment of long-term debt (1,672,093) (1,222,013) (1,448,855)
Contribution (return) of capital 6,500 (84,939) --
Dividends paid (693,067) (550,856) (621,744)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 686,540 (1,630,580) 826,511
- -----------------------------------------------------------------------------------------------------------------
Net change in cash and due from banks (21,477) 242,043 (98,500)
Cash and due from banks at beginning of year 2,102,756 1,860,713 1,959,213
- -----------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of year $ 2,081,279 $ 2,102,756 $ 1,860,713
=================================================================================================================
Cash paid for: Interest $ 1,484,348 $ 2,721,880 $ 3,238,257
Income taxes 210,610 259,387 444,058
The accompanying notes are an integral part of the consolidated financial
statements.
56
HSBC Bank USA 2002
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31, 2002 2001
- -----------------------------------------------------------------------------------------------
in thousands
Assets
Cash and due from banks $ 2,079,940 $ 2,102,271
Interest bearing deposits with banks 707,840 3,104,501
Federal funds sold and securities purchased under resale agreements 2,742,943 3,744,624
Trading assets 13,243,465 9,010,203
Securities available for sale 13,701,218 14,362,591
Securities held to maturity (fair value $4,639,939 and $4,523,696) 4,372,512 4,341,263
Loans 43,528,280 40,801,836
Less - allowance for credit losses 491,801 481,706
- -----------------------------------------------------------------------------------------------
Loans, net 43,036,479 40,320,130
Premises and equipment 723,647 748,470
Accrued interest receivable 322,297 408,082
Equity investments 245,614 241,219
Goodwill 2,224,573 2,237,582
Other assets 3,015,241 3,609,444
- -----------------------------------------------------------------------------------------------
Total assets $86,415,769 $84,230,380
===============================================================================================
Liabilities
Deposits in domestic offices
Noninterest bearing $ 5,682,618 $ 5,371,379
Interest bearing 34,352,307 31,695,955
Deposits in foreign offices
Noninterest bearing 397,743 428,252
Interest bearing 19,731,918 20,724,657
- -----------------------------------------------------------------------------------------------
Total deposits 60,164,586 58,220,243
- -----------------------------------------------------------------------------------------------
Trading account liabilities 7,696,329 3,800,987
Short-term borrowings 5,907,951 7,494,796
Interest, taxes and other liabilities 3,147,260 5,328,008
Subordinated long-term debt and perpetual capital notes 1,549,034 1,540,229
Other long-term debt 662,002 947,321
- -----------------------------------------------------------------------------------------------
Total liabilities 79,127,162 77,331,584
- -----------------------------------------------------------------------------------------------
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 6,454,612 6,432,902
Retained earnings 384,408 165,520
Accumulated other comprehensive income 244,587 95,374
- -----------------------------------------------------------------------------------------------
Total shareholder's equity 7,288,607 6,898,796
- -----------------------------------------------------------------------------------------------
Total liabilities and shareholder's equity $86,415,769 $84,230,380
===============================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
57
S U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S
HSBC USA Inc. (the Company), is a New York State based bank holding company, and
is 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.
Certain reclassifications have been made to prior year amounts to conform with
current year presentations.
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
transaction gain or loss recognized currently in income.
Statement of Cash Flows
- --------------------------------------------------------------------------------
For the Company's consolidated statement of cash flows, cash and cash
equivalents is defined as those amounts included in cash and due from banks.
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
58
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's policy is to
take possession of securities purchased under resale agreements. The market
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.
The fair value of securities and derivative contracts is based on current market
quotations, where available or internal valuation models that approximate market
pricing. The validity of internal pricing models is regularly substantiated by
reference to actual market prices realized upon sale or liquidation of these
instruments. If quoted market prices are not available, fair value is estimated
based on the quoted price of similar instruments.
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, 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 and remain presented as loans in the consolidated
balance sheet. 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.
59
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; otherwise they are charged off in accordance with a
predetermined schedule. 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 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 its commercial and
consumer loan portfolios. A separate reserve for credit losses associated with
certain off-balance sheet exposures including letters of credit, guarantees to
extend credit and financial guarantees is also maintained and included in other
liabilities. The adequacy of the allowance and this reserve is assessed 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), and
is based upon an evaluation of various factors including an analysis of
individual exposures, current and historical loss experience, changes in the
overall size and composition of the portfolio, specific adverse situations, and
general economic conditions. Provisions for all credit losses are recorded to
earnings based upon the Company's periodic review of these and other pertinent
factors. Actual loan losses are charged and recoveries are credited to the
allowance.
60
For commercial and select consumer loan assets, the Company conducts a periodic
assessment of losses it believes to be inherent in the loan portfolio. 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, a "specific loss"
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.
Formula-based reserves are also established against commercial loans and off
balance sheet credit exposures in accordance with SFAS 5, when based upon an
analysis of relevant data, it is probable that a loss has been incurred and will
be realized and the amount of that loss can be reasonably estimated, even though
it has yet to manifest itself in a specifically identifiable loan asset. These
reserves 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 based 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, migration trends within
non-criticized portfolios of loans, as well as portfolio concentration, 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 in other
assets 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.
61
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.
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.
Goodwill and Other Acquisition Intangibles
- --------------------------------------------------------------------------------
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. Impairment testing requires that the fair value of
each reporting unit be compared to its carrying amount, including the goodwill.
Goodwill, representing the excess of purchase price over the fair value of net
assets acquired, results from purchase acquisitions made by the Company. Prior
to the adoption of SFAS 142, goodwill and other acquisition intangibles were
amortized over the estimated periods to be benefited, under the straight-line
method, not exceeding 20 years.
Income Taxes
- --------------------------------------------------------------------------------
The Company and its subsidiaries are members of a larger group which files a
consolidated federal income tax return.
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.
62
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 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.
63
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 reclassified 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 qualify 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.
Off-Balance Sheet Arrangements
- --------------------------------------------------------------------------------
In addition to lending commitments, the Company has a variety of other
arrangements that are not reflected in the consolidated balance sheet.
Descriptions of such arrangements, including disclosures required by FASB
Interpretation No. 45 and FASB Interpretation No. 46, are set forth in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations section under the heading "Off-Balance Sheet Arrangements".
Regulation
- --------------------------------------------------------------------------------
A description of bank regulatory matters affecting the Company is included in
the Description of Business section under "Regulation, Supervision and Capital"
on page 5 until the second table on page 6.
64
NOTES TO FINANCIAL STATEMENTS
Note 1. Acquisitions/Divestitures
- --------------------------------------------------------------------------------
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 represented 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 in 2000. The Swiss
Bank, a Switzerland based banking affiliate, manages 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.
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.
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. This divestiture was
accounted for as transfers of assets between companies under common control at
historical cost.
65
Note 2. Trading Assets and Liabilities
- --------------------------------------------------------------------------------
An analysis of trading assets and liabilities follows.
- ----------------------------------------------------------------------------
December 31, 2002 2001
- ----------------------------------------------------------------------------
in thousands
Trading assets:
U.S. Treasury $ 523,908 $ 375,689
U.S. Government agency 711,000 581,642
Asset backed securities 1,870,750 2,212,219
Corporate bonds 1,236,953 630,042
Other securities 693,986 634,854
Fair value of derivatives 5,418,705 2,546,149
Precious metals 2,952,913 2,108,310
- ----------------------------------------------------------------------------
$13,408,215 $ 9,088,905
- ----------------------------------------------------------------------------
Trading account liabilities:
Securities sold, not yet purchased $ 1,481,788 $ 544,498
Payables for precious metals 1,183,243 1,243,428
Fair value of derivatives 5,044,979 2,011,891
- ----------------------------------------------------------------------------
$ 7,710,010 $ 3,799,817
- ----------------------------------------------------------------------------
Note 3. Securities
- --------------------------------------------------------------------------------
At December 31, 2002, 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.
- -------------------------------------------------------------------------------------------------------------------
2002 2001
------------------------------------------------------ ------------------------
Gross Gross
Amortized Unrealized Unrealized Fair Amortized Fair
December 31, Cost Gains Losses Value Cost Value
- ------------------------------------------------------------------------------------------------------------------
in thousands
U.S. Treasury $ 263,765 $ 2,001 $ -- $ 265,766 $ 365,924 $ 371,563
U.S. Government agency 9,293,270 306,772 2,873 9,597,169 7,963,852 8,067,715
Asset backed securities 2,924,183 15,454 4,750 2,934,887 3,450,797 3,485,107
Other domestic debt
securities 703,062 2,571 20 705,613 678,042 739,282
Foreign debt securities 869,076 20,798 2,909 886,965 2,415,076 2,435,369
Equity securities 289,485 27,293 13,063 303,715 167,411 168,754
- -------------------------------------------------------------------------------------------------------------------
Securities available
for sale $14,342,841 $ 374,889 $ 23,615 $14,694,115 $15,041,102 $15,267,790
- -------------------------------------------------------------------------------------------------------------------
U.S. Treasury $ 14,444 $ 6 $ -- $ 14,450 $ -- $ --
U.S. Government agency 3,903,397 233,942 1,319 4,136,020 3,882,621 4,040,168
Obligations of U.S.
states and political
subdivisions 672,787 44,452 746 716,493 768,708 799,537
Other domestic debt
securities 31,379 525 180 31,724 -- --
Foreign debt securities 6,475 -- -- 6,475 -- --
- -------------------------------------------------------------------------------------------------------------------
Securities held to
maturity $ 4,628,482 $ 278,925 $ 2,245 $ 4,905,162 $ 4,651,329 $ 4,839,705
- -------------------------------------------------------------------------------------------------------------------
At December 31, 2001, with regard to securities available for sale, the Company
had gross unrealized gains of $8.1 million, $144.8 million and $160.6 million
and gross unrealized losses of $2.4 million, $40.9 million and $43.5 million
related to U.S. Treasury, U.S. Government agency and other securities,
respectively. At December 31, 2001, with regard to securities held to
66
maturity, the Company had gross unrealized gains of $166.3 million and $32.2
million and gross unrealized losses of $8.7 million and $1.4 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.
- --------------------------------------------------------------------------------
Gross Net
--------------------------- Gains
Year Ended December 31, Gains (Losses) (Losses)
- --------------------------------------------------------------------------------
in thousands
2002
Securities available for sale $187,021 $ (69,903) $117,118
Securities held to maturity:
Maturities, calls and mandatory
redemptions 3,412 (2,361) 1,051
- --------------------------------------------------------------------------------
$190,433 $ (72,264) $118,169
================================================================================
2001
Securities available for sale $250,381 $(102,671) $147,710
Securities held to maturity:
Maturities, calls and mandatory
redemptions 1,578 (21) 1,557
- --------------------------------------------------------------------------------
$251,959 $(102,692) $149,267
================================================================================
2000
Securities available for sale $ 54,030 $ (27,189) $ 26,841
Securities held to maturity:
Maturities, calls and mandatory
redemptions 2,205 (207) 1,998
- --------------------------------------------------------------------------------
$ 56,235 $ (27,396) $ 28,839
================================================================================
The amortized cost and fair values of securities available for sale and
securities held to maturity at December 31, 2002, 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 $289 million cost
($304 million fair value) of equity securities that do not have maturities.
- --------------------------------------------------------------------------------
Amortized Fair
December 31, 2002 Cost Value
- --------------------------------------------------------------------------------
in thousands
Within one year $ 736,324 $ 739,187
After one but within five years 2,372,041 2,400,406
After five but within ten years 2,021,314 2,069,864
After ten years 8,923,677 9,180,943
- --------------------------------------------------------------------------------
Securities available for sale $14,053,356 $14,390,400
- --------------------------------------------------------------------------------
Within one year $ 29,822 $ 29,956
After one but within five years 232,664 240,361
After five but within ten years 323,867 347,086
After ten years 4,042,129 4,287,759
- --------------------------------------------------------------------------------
Securities held to maturity $ 4,628,482 $ 4,905,162
- --------------------------------------------------------------------------------
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. There were no transfers of securities during 2002.
67
Note 4. Loans
- --------------------------------------------------------------------------------
A distribution of the loan portfolio follows.
- --------------------------------------------------------------------------------
December 31, 2002 2001
- --------------------------------------------------------------------------------
in thousands
Domestic:
Commercial:
Construction and mortgage loans $ 6,350,036 $ 5,953,751
Other business and financial 10,620,784 10,564,340
Consumer:
Residential mortgages 20,841,485 17,951,119
Credit card receivables 1,101,067 1,147,998
Other consumer loans 1,693,224 1,769,576
International 3,029,276 3,536,514
- --------------------------------------------------------------------------------
$43,635,872 $40,923,298
- --------------------------------------------------------------------------------
Included in commercial loans for 2002 are $249.5 million of commercial mortgages
and other commercial loans held for sale. Residential mortgages include $1,838.1
million and $1,150.0 million of mortgages held for sale at December 31, 2002 and
2001, respectively. Other consumer loans include $372.8 million and $368.0
million of higher education loans also held for sale at December 31, 2002 and
2001, 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) at year end 2002
and 2001, and an aggregate fair value of $141.9 million and $130.7 million at
year end 2002 and 2001, respectively. 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, 2002 and 2001, the Company's nonaccruing loans were $387.4
million and $416.8 million, respectively. At December 31, 2002 and 2001, the
Company had commitments to lend additional funds of $12.3 million and $10.0
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, 2002 2001 2000
- --------------------------------------------------------------------------------
in thousands
Interest income on nonaccruing loans which
would have been recorded had they been
current in accordance with their original terms $36,826 $30,565 $28,004
Interest income recorded on nonaccruing loans 9,354 18,677 23,986
- --------------------------------------------------------------------------------
Other real estate and owned assets included in other assets amounted to $16.6
million and $17.7 million at December 31, 2002 and 2001, respectively.
The Company identified impaired loans totaling $288.1 million at December 31,
2002, of which $170.3 million had a related impairment reserve of $88.9 million.
At December 31, 2001, the Company had identified impaired loans of $242.6
million of which $150.7 million had a related impairment reserve of $83.0
million. The average recorded investment in such impaired loans was $288.2
million, $215.5 million and $192.2 million in 2002, 2001 and 2000, respectively.
68
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, 2002 and 2001.
Note 5. Allowance for Credit Losses
- --------------------------------------------------------------------------------
An analysis of the allowance for credit losses follows.
- ---------------------------------------------------------------------------------------------------
2002 2001 2000
- ---------------------------------------------------------------------------------------------------
in thousands
Balance at beginning of year $ 506,366 $ 524,984 $ 637,995
Allowance related to acquisitions, net/other (2,249) (18,987) (11,302)
Provision charged to income 195,000 238,400 137,600
Recoveries on loans charged off 35,301 42,821 34,248
Loans charged off (240,926) (280,500) (272,975)
Translation adjustment (367) (352) (582)
- ---------------------------------------------------------------------------------------------------
Balance at end of year $ 493,125 $ 506,366 $ 524,984
- ---------------------------------------------------------------------------------------------------
Note 4 provides information on impaired loans and the related impairment
reserve.
Included in the December 31, 2002 and December 31, 2001 allowance for credit
losses are $40.8 million and $70.5 million, respectively, of non-United States
transfer risk reserves.
Note 6. 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 $27.06 billion and $23.12 billion at December 31, 2002 and 2001,
respectively. Custodial balances maintained in connection with the foregoing
loan servicing, and included in noninterest bearing deposits in domestic offices
were $845.2 million and $547.1 million at December 31, 2002 and 2001,
respectively.
An analysis of MSRs, reported in other assets, follows.
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
in thousands
Balance at beginning of year $316,375 $267,065 $269,774
Additions 172,433 109,035 39,695
Amortizations (77,639) (59,725) (42,404)
Provision for impairment * (56,340) -- --
- --------------------------------------------------------------------------------
Balance at end of year $354,829 $316,375 $267,065
- --------------------------------------------------------------------------------
* $40.6 million of the provision for impairment included in a valuation reserve
at December 31, 2002.
The fair value of MSRs as of December 31, 2002 and 2001 was approximately $354.8
million and $364.1 million, respectively.
In 2002, 2001 and 2000, the Company realized net gains from the sale of
residential mortgages in securitizations, including those through agencies such
as FHLMC, of $163.7 million, $66.6 million and $7.0 million, respectively.
69
At December 31, 2001, the fair value of the MSRs exceeded their carrying value
by approximately $48 million. At December 31, 2002, the carrying value of the
MSRs was written down to their fair value of $354.8 million. That fair value was
based on the present value of future cash flows, using a constant prepayment
rate (CPR) of 28% annualized, a constant discount rate of 8.9% and a weighted
average life of 3.6 years. The following table illustrates the negative impacts
that adverse changes in those factors, without consideration of any interrelated
effects, would have on the 2002 fair value.
- -------------------------------------------------------------------------------
Adverse Change Adverse Change
of 10% of 20%
- -------------------------------------------------------------------------------
in millions
Prepayment speed assumption (CPR annualized) $22.0 $42.0
Discount rate 15.0 35.0
- -------------------------------------------------------------------------------
These impacts are hypothetical and isolated from the counter strategies that
management implements to offset such negative trends. As indicated, interrelated
effects are not reflected in the impacts; however, in actuality there would be
such effects. Therefore, this information should be used cautiously.
Note 7. Goodwill and Intangible Assets
- --------------------------------------------------------------------------------
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), on January
1, 2002. Under SFAS 142, goodwill is no longer amortized, but is reviewed for
impairment at least annually at the reporting unit level. Identifiable
intangible assets acquired in a business combination are amortized over their
useful lives unless their useful lives are indefinite, in which case those
intangible assets are tested for impairment annually. In accordance with SFAS
142, the Company has completed its transitional goodwill impairment test and its
annual impairment test and determined that the fair value of each of the
reporting units exceeded its carrying value at both test dates. As a result, no
impairment loss was recognized as of January 1, 2002 and December 31, 2002.
In October 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 147, Acquisitions of Certain Financial
Institutions (SFAS 147), an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. This statement removes acquisitions of financial
institutions from the scope of both Statement No. 72 and Interpretation No. 9
and requires that those transactions, which constitute a business, be accounted
for in accordance with SFAS No. 141 and SFAS No. 142. Thus, the requirement in
paragraph 5 of Statement No. 72 to recognize (and subsequently amortize) any
excess of the fair value of liabilities assumed over the fair value of tangible
and identifiable intangible assets acquired as an unidentifiable intangible
asset no longer applies to acquisitions within the scope of SFAS 147.
SFAS 147 is effective for acquisitions on or after October 1, 2002 with
mandatory implementation effective January 1, 2002 for existing intangibles. The
Company concluded that its acquisition of East River Savings Bank was within the
scope of SFAS 147. As of December 31, 2001, the unamortized amount of
unidentifiable intangible assets (i.e. excess premium SFAS 72) was $64.6
million. During the fourth quarter, this intangible asset was reclassified
retroactively to January 1, 2002 to goodwill and no longer amortized but subject
to annual impairment testing. The amortization previously recorded for the first
three quarters of 2002 was reversed in accordance with SFAS 147.
70
The following table presents the consolidated results of operations adjusted as
though the adoption of SFAS 142 occurred as of January 1, 2000.
- ------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------
in thousands
Reported net income $855,444 $353,138 $568,959
Goodwill amortization add-back -- 176,482 176,162
- ------------------------------------------------------------------------------
Adjusted net income $855,444 $529,620 $745,121
- ------------------------------------------------------------------------------
The following table presents the changes in the carrying amount of goodwill for
each of the reported business segments for the year ended December 31, 2002.
- ------------------------------------------------------------------------------------------------------------
Goodwill
- ------------------------------------------------------------------------------------------------------------
Corporate,
Personal Investment
Financial Commercial Banking & Private
Services Banking Markets Banking Total
- ------------------------------------------------------------------------------------------------------------
in thousands
Balance December 31, 2001 $1,221,817 $575,333 $637,627 $407,306 $2,842,083
Goodwill adjustments and other (34,782) 3,356 (2,568) 20,985 (13,009)
- ------------------------------------------------------------------------------------------------------------
Balance December 31, 2002 $1,187,035 $578,689 $635,059 $428,291 $2,829,074
- ------------------------------------------------------------------------------------------------------------
The following table presents all intangible assets of the Company that are being
amortized. Annual amortization of mortgage servicing rights is expected to be
approximately $72 million for the years ended December 31, 2003 through 2006. At
December 31, 2002 intangible assets are as follows.
- -----------------------------------------------------------------------------------------------------
Intangible Assets
- -----------------------------------------------------------------------------------------------------
Amortization
Gross Carrying Accumulated Expense
Amount Amortization 2002
- -----------------------------------------------------------------------------------------------------
in thousands
Mortgage servicing rights $558,038 $203,209* $133,251**
Favorable lease arrangements 66,519 13,604 4,468
- -----------------------------------------------------------------------------------------------------
Total $624,557 $216,813 $137,719
- -----------------------------------------------------------------------------------------------------
* Includes a $40.6 million impairment valuation reserve.
** Includes $56.3 million of provision for impairment.
Note 8. 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 $5.60 billion and $4.16 billion at December 31, 2002 and 2001,
respectively. The scheduled maturities of all domestic time deposits at December
31, 2002 follows.
- --------------------------------------------------------------------------------
in thousands
2003 $ 9,662,505
2004 1,005,193
2005 658,373
2006 222,878
2007 63,221
Later years 35,178
- --------------------------------------------------------------------------------
$11,647,348
- --------------------------------------------------------------------------------
71
Note 9. Short-Term Borrowings
- --------------------------------------------------------------------------------
The following table shows detail relating to short-term borrowings in 2002, 2001
and 2000. Average interest rates during each year are computed by dividing total
interest expense by the average amount borrowed.
- ------------------------------------------------------------------------------------------------------------
2002 2001 2000
---------------- ----------------- ------------------
Amount Rate Amount Rate Amount Rate
- ------------------------------------------------------------------------------------------------------------
in thousands
Federal funds purchased (day to day):
At December 31 $ 656,181 1.29% $ 133,640 1.18% $1,974,589 4.90%
Average during year 1,401,672 1.62 1,436,449 3.78 985,215 6.31
Maximum month-end balance 2,788,010 2,919,576 2,122,030
Securities sold under
repurchase agreements:
At December 31 552,583 1.52 377,059 1.25 893,567 5.13
Average during year 834,470 3.64 1,116,434 2.13 1,096,989 5.62
Maximum month-end balance 1,053,540 2,280,180 1,746,506
Commercial paper:
At December 31 1,484,417 1.53 1,634,559 2.05 1,472,586 6.70
Average during year 1,496,367 1.79 1,218,242 3.77 1,131,819 6.36
Maximum month-end balance 1,787,276 1,642,520 1,629,704
Precious metals:
At December 31 3,083,397 .42 2,300,704 1.37 1,899,747 .95
Average during year 3,274,783 .51 2,200,346 1.13 2,127,067 1.32
Maximum month-end balance 3,865,153 2,544,318 2,684,805
All other short-term borrowings:
At December 31 1,615,790 1.46 4,756,124 2.32 2,321,874 7.44
Average during year 2,780,541 2.76 3,145,211 4.97 3,137,922 6.83
Maximum month-end balance 6,669,263 5,817,136 6,790,231
- -------------------------------------------------------------------------------------------------------------
At December 31, 2002, the Company had unused lines of credit with HSBC Bank plc
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.
Note 10. Income Taxes
- --------------------------------------------------------------------------------
Total income taxes were allocated as follows.
- ----------------------------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
in thousands
To income before income taxes $509,629 $226,000 $338,573
To shareholders' equity as tax charge (benefit):
Net unrealized gains on securities
available for sale 41,407 20,638 95,322
Unrealized gain (loss) on derivatives
classified as cash flow hedges 42,521 (20,194) --
Foreign currency translation, net 2,216 (6,383) (4,033)
- ----------------------------------------------------------------------------------------------------
$595,773 $220,061 $429,862
- ----------------------------------------------------------------------------------------------------
72
The components of income tax expense follow.
- --------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
in thousands
Current:
Federal $(31,657) $ 384,849 $217,683
State and local 10,393 60,987 12,000
Foreign 19,218 24,127 26,151
- --------------------------------------------------------------------------------
Total current (2,046) 469,963 255,834
Deferred, primarily federal 511,675 (243,963) 82,739
- --------------------------------------------------------------------------------
Total income taxes $509,629 $ 226,000 $338,573
- --------------------------------------------------------------------------------
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, 2002 2001 2000
- --------------------------------------------------------------------------------
Statutory rate 35.0% 35.0% 35.0%
Increase (decrease) due to:
State and local income taxes 4.2 1.8 .9
Goodwill amortization -- 9.8 6.3
Change in valuation allowance
for deferred tax assets -- (4.9) --
Tax exempt interest income (1.0) (2.6) (1.5)
Other items (.9) (.1) (3.4)
- --------------------------------------------------------------------------------
Effective income tax rate 37.3% 39.0% 37.3%
- --------------------------------------------------------------------------------
The components of the net deferred tax position are summarized below.
- --------------------------------------------------------------------------------
December 31, 2002 2001
- --------------------------------------------------------------------------------
in thousands
Deferred tax assets:
Allowance for credit losses $ 177,680 $197,792
Benefit accruals 128,620 131,618
Accrued expenses not currently deductible 88,785 81,886
Investment securities 49,256 101,735
Net purchase discount on acquired companies 68,245 110,454
Princeton Note settlement -- 224,883
Other 35,590 35,795
- --------------------------------------------------------------------------------
Total deferred tax assets 548,176 884,163
- --------------------------------------------------------------------------------
Less deferred tax liabilities:
Unrealized gains on securities available for sale 129,751 88,345
Lease financing income accrued 62,405 60,105
Accrued pension cost 133,766 45,464
Accrued income on foreign bonds 16,161 16,161
Deferred net operating loss recognition 113,468 90,018
Depreciation and amortization 118,484 116,361
Interest and discount income 42,901 42,901
Mortgage servicing rights 140,492 96,676
- --------------------------------------------------------------------------------
Total deferred tax liabilities 757,428 556,031
- --------------------------------------------------------------------------------
Net deferred tax asset (liability) $(209,252) $328,132
- --------------------------------------------------------------------------------
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 that it is more likely
than not the Company would realize the benefits of these deductible differences.
73
Note 11. 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, 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------
in thousands
7.25-7.75% Subordinated notes due 2002 $ -- $ 400,000 $ -- $ 399,912
Floating rate subordinated notes due 2002 -- 245,700 -- 244,927
7% Subordinated notes due 2006 300,000 300,000 299,034 298,782
5.875% Subordinated notes due 2008 250,000 250,000 229,794 226,280
6.625-9.70% Subordinated notes due 2009 550,000 550,000 619,594 583,990
Floating rate subordinated notes due
2009 (5.25%) 124,320 124,320 124,320 124,320
7% Subordinated notes due 2011 100,000 100,000 116,279 105,376
9.50% Subordinated debentures due 2014 150,000 150,000 164,148 165,406
9.125-9.30% Subordinated notes due 2021 200,000 200,000 216,680 217,587
7.20% Subordinated debentures due 2097 250,000 250,000 215,181 214,812
Perpetual Capital Notes (2.125%) 129,000 129,000 124,133 130,157
- ---------------------------------------------------------------------------------------------------
$2,053,320 $2,699,020 $2,109,163 $2,711,549
- ---------------------------------------------------------------------------------------------------
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.
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, 2002 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: none in 2003, 2004, or 2005; $300 million in 2006 and none
in 2007.
74
Note 12. 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, 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------
in thousands
7.808% Capital Securities due 2026 $ 200,000 $200,000 $ 200,000 $200,000
8.38% Capital Securities due 2027 200,000 200,000 200,000 200,000
7.75% Capital Securities due 2026 150,000 150,000 136,832 136,339
7.53% Capital Securities due 2026 200,000 200,000 214,110 192,002
7.85% Capital Securities due 2032 300,000 -- 300,000 --
- --------------------------------------------------------------------------------------------------
$1,050,000 $750,000 $1,050,942 $728,341
- --------------------------------------------------------------------------------------------------
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.
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.
The 7.85% Capital Securities are the result of a transaction between the Company
and HSBC Holdings B.V., a subsidiary of HSBC. These Capital Securities are
redeemable at the option of the Company on October 15, 2012 at a premium of
3.925% in the first twelve months after October 15, 2012 and varying lesser
amounts thereafter and without premium if redeemed after October 15, 2022.
75
Note 13. 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, 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------
in thousands
Issued or acquired by the Company
or subsidiaries other than the Bank:
Floating Rate Senior Notes
due 2004 (1.55%) $ 300,000 $ -- $ 300,000 $ --
8.375% Debentures due 2007 100,000 100,000 102,861 103,561
- -------------------------------------------------------------------------------------------------------
400,000 100,000 402,861 103,561
- -------------------------------------------------------------------------------------------------------
Issued or acquired by the Bank or its subsidiaries:
Medium-Term Floating Rate Note
due 2040 (1.23%) 24,999 24,999 24,999 24,999
Fixed rate Federal Home Loan Bank of
New York advances 14,128 12,531 14,128 12,531
Collateralized repurchase agreements 568,901 838,724 568,901 852,637
Other 54,000 57,094 53,974 57,154
- -------------------------------------------------------------------------------------------------------
662,028 933,348 662,002 947,321
- -------------------------------------------------------------------------------------------------------
$1,062,028 $1,033,348 $1,064,863 $1,050,882
- -------------------------------------------------------------------------------------------------------
The Floating Rate Senior Notes due 2004 represent unsecured obligations of the
Company bearing interest at the 3-month U.S. Dollar London Interbank offered
rate plus 15 basis points. The notes are not redeemable prior to maturity in
September 2004.
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 2.10% to 7.24%.
The collateralized repurchase agreements consist of securities repurchase
agreements with initial maturities exceeding one year. The repurchase agreements
have fixed rates ranging from 1.60% to 7.40% and floating rates of 1.87% and
3.00%.
Contractual scheduled maturities for the debt over the next five years are as
follows: 2003, $61 million; 2004, $373 million; 2005, $11 million; 2006, $27
million and $109 million in 2007.
76
Note 14. Preferred Stock
- --------------------------------------------------------------------------------
The following table presents information related to the issues of preferred
stock outstanding.
- ---------------------------------------------------------------------------------------------------
Amount
Shares Dividend Outstanding
Outstanding Rate ----------------------
December 31, 2002 2002 2002 2001
- ---------------------------------------------------------------------------------------------------
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 4.50 150,000 150,000
Dutch Auction Rate Transferable Securities(TM)
Preferred Stock (DARTS)
Series A ($100,000 stated value) 625 1.865 62,500 62,500
Series B ($100,000 stated value) 625 2.01 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 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.
77
Note 15. 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, 2002 of approximately $257 million, adjusted by the
effect of its net income (loss) for 2003 up to the date of such dividend
declaration.
Note 16. 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.
- ------------------------------------------------------------------------------------------------------
Year Ended December 31, 2002 2001 2000
- ------------------------------------------------------------------------------------------------------
in thousands
Accumulated other comprehensive income (loss)
at beginning of year $ 98,607 $116,851 $(50,534)
Fair value adjustments on securities
available for sale:
Increase in fair value, net of taxes of
$82,398, $72,307, and $104,717, in 2002,
2001 and 2000, respectively 156,635 127,141 192,318
Reclassification adjustment for (gains)
losses included in net income, net of
taxes of $40,991, $51,669, and $9,395
in 2002, 2001 and 2000, respectively (76,127) (96,041) (17,444)
- ------------------------------------------------------------------------------------------------------
80,508 31,100 174,874
- ------------------------------------------------------------------------------------------------------
Adjustments related to SFAS 133:
Change in unrealized gain(loss) on
derivatives classified as cash flow hedges,
net of taxes of $42,521 and $(20,194) in
2002 and 2001, respectively 78,968 (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) --
- ------------------------------------------------------------------------------------------------------
78,968 (37,503) --
- ------------------------------------------------------------------------------------------------------
Accumulated foreign currency translation adjustments:
Translation gains(losses) net of taxes
of $2,216, $(6,383) and $(4,033) in
2002, 2001 and 2000, respectively 4,116 (11,841) (7,489)
- ------------------------------------------------------------------------------------------------------
4,116 (11,841) (7,489)
- ------------------------------------------------------------------------------------------------------
Net change in accumulated other
comprehensive income (loss) 163,592 (18,244) 167,385
- ------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive
income at end of year $262,199 $ 98,607 $116,851
- ------------------------------------------------------------------------------------------------------
78
Note 17. Related Party Transactions
- --------------------------------------------------------------------------------
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. The following table presents related
party transactions balances at year end and the total income and expense
generated by those transactions.
- --------------------------------------------------------------------------------
December 31, 2002 2001 2000
- --------------------------------------------------------------------------------
in millions
Assets:
Interest bearing deposits with banks $ 130 $ 564 $ 27
Loans 338 142 783
Other 38 33 172
- --------------------------------------------------------------------------------
Total assets $ 506 $ 739 $ 982
- --------------------------------------------------------------------------------
Liabilities
Deposits $6,140 $4,686 $3,647
Short-term borrowings 267 114 11
Other 349 34 63
- --------------------------------------------------------------------------------
Total liabilities $6,756 $4,834 $3,721
- --------------------------------------------------------------------------------
Interest income $ 28 $ 46 $ 82
Interest expense 87 160 286
- --------------------------------------------------------------------------------
At December 31, 2002 and 2001, the aggregate notional amounts of all derivative
contracts with other HSBC affiliates were $88 billion and $39 billion,
respectively.
Extensions of credit by the Company to other HSBC affiliates are legally
required to be secured by eligible collateral.
Refer to Note 1 for discussions of the Company's acquisition and divestiture
transactions with other HSBC Group members.
79
Note 18. 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 Sharesave Contribution Program (the Sharesave Plans). Since the shares and
contribution commitment have been granted directly by HSBC, the offset to
compensation expense was a credit to capital surplus, representing a
contribution of capital from HSBC.
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.
Total options granted were 4,615,000 in 2002 and 4,084,000 in 2001. The fair
value of options granted was $2.33 per option in 2002 and $3.38 per option in
2001. Compensation expense recognized amounted to $6.6 million and $3.0 million
in 2002 and 2001, respectively.
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.
Total options granted were 2,758,000 in 2000. The fair value of options granted
was $4.55 in 2000. Compensation expense recognized related to this plan amounted
to $3.9 million, $4.9 million and $4.0 million in 2002, 2001 and 2000,
respectively.
Sharesave Plans
The Sharesave Plans (formerly known as 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 2002 and 2001.
Total options granted under the 5 year vesting period were 524,000 in 2002,
495,000 in 2001 and 3,343,000 in 2000. The fair value of options granted was
$3.53 per option in 2002, $3.84 per option in 2001, and $4.30 per option in
2000. Compensation expense recognized amounted to $2.6 million, $2.7 million and
$1.4 million in 2002, 2001 and 2000, respectively.
Total options granted under the 3 year vesting period were 691,000 in 2002 and
803,000 in 2001. The fair value of options was $3.63 per option in 2002 and
$3.60 per option in 2001. Compensation expense recognized amounted to $1.4
million in 2002 and $.5 million in 2001.
80
Prior to the Sharesave 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 Sharesave
Plans. Compensation expense related to this plan amounted to $2.1 million in
2002, $2.4 million in 2001 and $2.5 million in 2000.
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.
- --------------------------------------------------------------------------------
Group Share Sharesave Plan Sharesave Plan
2002 Option Plan 5 Year 3 Year
- --------------------------------------------------------------------------------
Risk free interest rate 5.57% 5.57% 5.46%
Expected life (years) 5.25 5.25 3.25
Expected volatility 25% 30% 30%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Group Share Sharesave Plan Sharesave Plan
2001 Option Plan 5 Year 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%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Group Share Executive Share Sharesave Plan
2000 Option Plan Option 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. Total expense recognized for
the plan for 2002 and 2001 was $24.4 million and $23.7 million, respectively.
81
Note 19. Postretirement Benefits
- --------------------------------------------------------------------------------
The Company, the Bank and certain other subsidiaries maintain noncontributory
defined benefit 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
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
---------------------- ------------------------
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------
in thousands
Change in benefit obligation
Benefit obligation, January 1 $ 824,582 $ 756,038 $ 100,603 $ 118,556
Service cost 25,826 25,232 2,274 2,228
Interest cost 59,862 55,523 7,388 6,579
Participant contributions -- -- 349 282
Plan amendment 639 2,100 -- --
Actuarial (gain) loss 70,973 12,712 24,629 (18,839)
Benefits paid (29,445) (27,023) (8,591) (8,203)
- ---------------------------------------------------------------------------------------------
Benefit obligation, December 31 $ 952,437 $ 824,582 $ 126,652 $ 100,603
=============================================================================================
Change in plan assets
Fair value of plan assets, January 1 $ 774,127 $ 850,759 $ -- $ --
Actual return on plan assets (132,060) (49,609) -- --
Company contribution 265,000 -- 8,242 7,921
Participant contributions -- -- 349 282
Benefits paid (29,445) (27,023) (8,591) (8,203)
- ---------------------------------------------------------------------------------------------
Fair value of plan assets, December 31 $ 877,622 $ 774,127 $ -- $ --
=============================================================================================
Funded status of plan
Funded status, December 31 $ (74,815) $ (50,455) $(126,652) $(100,603)
Unrecognized actuarial (gain) loss 446,855 169,007 13,332 (11,297)
Unrecognized prior service cost 5,613 6,161 -- --
Unrecognized net transition obligation -- -- 32,471 35,718
- ---------------------------------------------------------------------------------------------
Recognized amount $ 377,653 $ 124,713 $ (80,849) $ (76,182)
=============================================================================================
Amount recognized in the consolidated
balance sheet
Prepaid benefit cost $ 377,653 $ 124,713 $ -- $ --
Accrued benefit liability -- -- (80,849) (76,182)
- ---------------------------------------------------------------------------------------------
Recognized amount $ 377,653 $ 124,713 $ (80,849) $ (76,182)
=============================================================================================
82
Operating expenses for 2002, 2001 and 2000 included the following components.
- ------------------------------------------------------------------------------------------------------------------
Other
Pension Benefits Postretirement Benefits
------------------------------ -------------------------------------------
2002 2001 2000 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
in thousands
Net periodic benefit
cost (credit)
Service cost $ 25,826 $ 25,232 $ 26,820 $ 2,274 $ 2,228 $ 2,130
Interest cost 59,862 55,523 53,090 7,388 6,579 8,778
Expected return on
plan assets (83,974) (79,689) (85,965) -- -- --
Prior service cost
amortization 1,187 944 944 -- -- --
Actuarial
(gain)/loss 9,159 -- (3,087) -- (527) --
Transition amount
amortization -- -- -- 3,247 3,247 3,247
- ------------------------------------------------------------------------------------------------------------------
Net periodic benefit
cost (credit) $ 12,060 $2,010 $ (8,198) $12,909 $11,527 $14,155
==================================================================================================================
Weighted-average
assumptions as of
December 31
Discount rate 6.75% 7.25% 7.75% 6.25% 6.75% 7.25%
Expected return on
plan assets 9.50 9.50 9.50 -- -- --
Rate of compensation
increase 3.75 4.00 4.50 3.75 (1) 4.00 (1) 4.50 (1)
- ------------------------------------------------------------------------------------------------------------------
(1) Applicable to life insurance only.
Net periodic pension cost includes $1.6 million, $1.1 million, and none for
2002, 2001 and 2000 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 7% for 2002 and 2003.
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 $3.2 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 $3.3 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 2002, $3.0 million in 2001, and $2.4 million in 2000.
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 $16.3 million in 2002, $15.1 million
in 2001 and $11.7 million in 2000.
83
Note 20. 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 the business segments that it used in 2002 to
reflect the movement of certain domestic private banking activities from the
Personal Financial Services Segment to the Private Banking Segment. Also
activity related to selected commercial customers was moved from the Commercial
Banking Segment to the Corporate, Investment Banking and Markets Segment. Prior
year disclosures have been conformed herein to the presentation of current
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). See the Business
Segments sections for additional disclosure regarding the Company's operating
segments: Business Segments on page 27 and segment results table on page 28.
Note 21. Collateral, Commitments and Contingent Liabilities
- --------------------------------------------------------------------------------
The following table presents pledged assets included in the consolidated balance
sheet.
- --------------------------------------------------------------------------------
December 31, 2002 2001
- --------------------------------------------------------------------------------
in millions
Interest bearing deposits with banks $ 65 $ 65
Trading assets 1,770 136
Securities available for sale 6,083 5,939
Securities held to maturity 1,607 2,112
Loans 343 343
- --------------------------------------------------------------------------------
Total $9,868 $8,595
- --------------------------------------------------------------------------------
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 fair value of securities available for sale that
can be sold or repledged at December 31, 2002 and 2001 was $1,936 million and
$1,825 million, respectively.
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, 2002
and 2001 was $3,011 million and $1,402 million, respectively. This collateral
was obtained under security resale agreements. Of this collateral, $2,428
million at December 31, 2002 has been sold or repledged as collateral under
repurchase agreements or to cover short sales compared with $583 million at
December 31, 2001.
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 $58.1 million, $60.1 million and $72.7 million in 2002, 2001 and
2000, respectively. Minimum future rental commitments on operating leases in
effect at December 31, 2002 were as follows: 2003, $66 million; 2004, $59
million; 2005, $50 million; 2006, $37 million; 2007, $30 million and $81 million
thereafter.
84
Note 22. 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. In addition, there are certain proceedings related to the
"Princeton Note Matter" that are described below.
In relation to the Princeton Notes Matter, as disclosed in the Company's 2001
Annual Report on Form 10-K, two of the noteholders were not included in the
settlement and their civil suits are continuing. The U.S. Government excluded
one of them from the restitution order (Yakult Honsha Co., Ltd.) because a
senior officer of the noteholder was being criminally prosecuted in Japan for
his conduct relating to its Princeton Notes. The senior officer in question was
convicted of various criminal charges related to the sale of the Princeton Notes
during September 2002. The U.S. Government excluded the other noteholder
(Maruzen Company, Limited) because the sum it is likely to recover from the
Princeton Receiver exceeds its losses attributable to its funds transfers with
Republic New York Securities Corporation as calculated by the U.S. Government.
Both of these civil suits seek compensatory, punitive, and treble damages
pursuant to RICO and assorted fraud and breach of duty claims arising from
unpaid Princeton Notes with face amounts totaling approximately $125 million. No
amount of compensatory damages is specified in either complaint. These two
complaints name the Company, HSBC Bank USA, and Republic New York Securities
Corporation as defendants. The Company and HSBC Bank USA have moved to dismiss
both complaints. The motion is fully briefed and sub judice. Mutual production
of documents took place in 2001, but additional discovery proceedings have been
suspended pending the Court's resolution of the motions to dismiss.
As previously reported, a purported class action entitled Ravens v. Republic New
York Corporation, et al., was filed in the United States District Court for the
Eastern District of Pennsylvania on October 7, 1999 on behalf of former
shareholders of Republic New York Corporation (Republic) who acquired common
stock between May 10, 1999 (when the signing of the merger agreement between
Republic and HSBC was announced) and September 15,1999. On October 16, 2000, the
plaintiff in that action filed an amended complaint, alleging that the
defendants violated the federal securities laws in the merger transaction
between Republic and HSBC by failing to disclose certain facts relating to
potential liabilities with respect to the Princeton Note Matter in a timely
manner. The amended complaint seeks unspecified damages on behalf of the class.
On January 16, 2001, defendants filed a motion to dismiss the Ravens action. On
April 24, 2002, the court denied in part the Company's motion to dismiss. On May
24, 2002, the plaintiff filed a motion for class certification, which the
Company opposed. Following a refusal by the plaintiff to produce documents to
the Company and disclosure by the plaintiff that she desired to cease being a
named plaintiff in the action, the Company moved on October 21, 2002 to dismiss
the action. The counsel for the proposed class opposed that motion and sought
leave to provide notice to the class. The plaintiff's motion for class
certification and the Company's motion to dismiss both remain pending. The
Company intends to continue to defend this action vigorously.
85
Note 23. 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 changes in value of its
mortgage servicing rights portfolio, and (4) for 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, commodity prices and credit, focusing on structuring of
transactions to meet clients' needs.
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, beginning in
December 2002, the Company established a qualifying hedge strategy using forward
sales contracts to offset the fair value changes of certain conventional closed
mortgage loans originated for sale.
For the year ended December 31, 2002, the Company recognized a net gain of $7.5
million compared with a net loss of $.6 million for the year ended December 31,
2001 (reported as mortgage banking revenue and/or 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.
For the year ended December 31, 2002, the Company recognized a net gain of $12.7
million compared with a net gain of $8.5 million for the year ended December 31,
2001 (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 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. As of December 31, 2002, $35.6 million
of deferred net losses on derivative instruments accumulated in other
comprehensive income are expected to be charged to earnings during 2003.
Trading and Other Activities
The Company enters into certain derivative contracts for purely trading purposes
in order to realize profits from short-term movements in interest rates,
commodity prices, foreign exchange rates and credit spreads. In
86
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. Counterparties generally include financial
institutions including banks, other government agencies, both foreign and
domestic, and insurance companies. These counterparties are subject to regular
credit review by the Company's credit risk management department. 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.
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 measures this risk daily by using Value
at Risk (VAR) and other methodologies.
The Company's Asset and Liability Policy Committee is responsible for monitoring
and defining the scope and nature of various strategies utilized to manage
interest rate risk 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.
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.
87
A summary of the notional amount of the Company's derivative financial
instruments follows.
- -------------------------------------------------------------------------------
December 31, 2002 2001
- -------------------------------------------------------------------------------
in millions
Interest rate:
Futures and forwards $ 73,640 $ 42,666
Swaps 277,803 131,481
Options written 110,518 39,769
Options purchased 118,065 29,887
Other 1,887 521
- -------------------------------------------------------------------------------
$581,913 $244,324
===============================================================================
Foreign exchange:
Swaps, futures and forwards $126,253 $125,027
Options written 10,945 8,654
Options purchased 11,751 10,220
Spot 8,867 13,975
- -------------------------------------------------------------------------------
$157,816 $157,876
===============================================================================
Other (1):
Swaps, futures and forwards $ 18,546 $5,405
Options written 913 383
Options purchased 878 389
Other 2,310 239
- -------------------------------------------------------------------------------
$ 22,647 $6,416
===============================================================================
(1) Other includes credit derivatives, commodities, equity and precious
metals.
The net fair value of derivative financial instruments was $576 million and $495
million at December 31, 2002 and 2001, respectively.
Note 24. 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 New York State, is secured by multi-family,
commercial and residential properties. See Note 25 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, 2002 46% of residential mortgages and
79% 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.
88
Note 25. 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, 2002 2001
- -----------------------------------------------------------------------------------------------
in millions
International:
Asia/Pacific $ 970 $ 1,079
Europe/Middle East/Africa 3,515 5,517
Other Western Hemisphere 1,195 1,775
- -----------------------------------------------------------------------------------------------
Total international 5,680 8,371
Domestic 83,746 78,743
- -----------------------------------------------------------------------------------------------
Total international/domestic $89,426 $87,114
- -----------------------------------------------------------------------------------------------
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.
Due to the nature of the Company's structure, the following analysis includes
intra-Company items between geographic regions.
- --------------------------------------------------------------------------------
Revenues and Earnings - International and Domestic
Income(Loss)
Total Total Before
Year Ended December 31, Revenue(1) Expenses(2) Taxes
- --------------------------------------------------------------------------------
in millions
2002
International:
Asia/Pacific $ 43.0 $ 17.1 $ 25.9
Europe 31.9 22.7 9.2
Other Western Hemisphere 103.7 112.6 (8.9)
- -------------------------------------------------------------------------------
Total international 178.6 152.4 26.2
Domestic (3) 3,262.5 1,923.6 1,338.9
- -------------------------------------------------------------------------------
Total international/domestic $3,441.1 $2,076.0 $1,365.1
- -------------------------------------------------------------------------------
2001
International:
Asia/Pacific $ 62.7 $ 30.4 $ 32.3
Europe 77.3 21.9 55.4
Other Western Hemisphere 108.2 92.4 15.8
- -------------------------------------------------------------------------------
Total international 248.2 144.7 103.5
Domestic (3) 3,113.5 2,637.4 476.1
- -------------------------------------------------------------------------------
Total international/domestic $3,361.7 $2,782.1 $ 579.6
- -------------------------------------------------------------------------------
2000
International:
Asia/Pacific $ 113.1 $ 63.7 $ 49.4
Europe 162.3 37.3 125.0
Other Western Hemisphere 60.7 49.8 10.9
- -------------------------------------------------------------------------------
Total international 336.1 150.8 185.3
Domestic (3) 2,614.8 1,892.6 722.2
- -------------------------------------------------------------------------------
Total international/domestic $2,950.9 $2,043.4 $ 907.5
- -------------------------------------------------------------------------------
(1) Includes net interest income and other operating income. Total revenue
includes intra-Company income of $5.5 million, $.7 million and none for
2002, 2001 and 2000, respectively.
(2) Includes operating expenses and provision for credit losses. Total
expenses include intra-Company expenses of $5.5 million, $.7 million and
none for 2002, 2001 and 2000, respectively.
(3) Includes the Caribbean and Canada.
89
Note 26. Fair Value of Financial Instruments
- --------------------------------------------------------------------------------
The Company is required to disclose the estimated fair value of its financial
instruments in accordance with Statement of Financial Accounting Standards No.
107, Disclosures about Fair Value of Financial Instruments (SFAS 107). The
disclosures do not attempt to estimate or represent the fair value of the
Company as a whole. The disclosures exclude assets and liabilities that are not
financial instruments, including intangible assets, such as goodwill. The
estimation methods and assumptions used by the Company to value individual
classifications of financial instruments are described below. Different
assumptions could significantly affect the estimates. Accordingly, the net
realizable values upon liquidation of the financial instruments could be
materially different from the estimates presented below.
Financial instruments with carrying value equal to fair value - The carrying
value of certain financial assets and liabilities is considered to be equal to
fair value as a result of their short term nature. These include cash and due
from banks, interest bearing deposits with banks, federal funds sold and
securities purchased under resale agreements, accrued interest receivable,
customers' acceptance liability and certain financial liabilities including
acceptances outstanding, short-term borrowings and interest, taxes, and other
liabilities.
Securities and trading assets and liabilities - The fair value of securities and
derivative contracts is based on current market quotations, where available. If
quoted market prices are not available, fair value is estimated based on the
quoted price of similar instruments.
Loans - The fair value of the performing loan portfolio is determined primarily
by calculating the present value of expected cash flows using a discount rate as
noted below. The loans are grouped, to the extent possible, into homogeneous
pools, segregated by maturity, weighted average maturity, and average coupon
rate. Depending upon the type of loan involved, maturity assumptions are based
on either the contractual or expected maturity date.
For commercial loans, the allowance for credit losses is allocated to the
expected cash flows to provide for credit risk. A published interest rate that
equates closely to a "risk free" or "low-risk" loan rate is used as the discount
rate. The interest rate is adjusted for a liquidity factor as appropriate.
The discount rate used to calculate the fair value of consumer loans is computed
using the estimated rate of return an investor would demand for the product
without regard to credit risk. The discount rate is formulated by reference to
current market rates.
The discount rate used to calculate the fair value of residential mortgages is
determined by reference to quoted market prices for loans with similar
characteristics and maturities.
Deposits - The fair value of demand, savings, and money market deposits with
variable maturities is equal to the carrying value. For deposits with fixed
maturities, fair value is estimated using market interest rates currently
offered on deposits with similar characteristics and maturities.
Long-term debt - Fair value is estimated using interest rates currently
available to the Company for borrowings with similar characteristics and
maturities.
90
The summarized carrying values and estimated fair values of financial
instruments as of December 31, 2002 and 2001 follows.
- --------------------------------------------------------------------------------
2002 2001
------------------ ------------------
Carrying Fair Carrying Fair
December 31, Value Value Value Value
- -------------------------------------------------------------------------------
in millions
Financial assets:
Instruments with carrying value
equal to fair value $ 6,300 $ 6,300 $ 9,921 $ 9,921
Trading assets 13,408 13,408 9,089 9,089
Securities available for sale 14,694 14,694 15,268 15,268
Securities held to maturity 4,628 4,905 4,651 4,840
Loans, net of allowance 43,143 43,940 40,417 41,163
Derivative instruments included
in other assets (1) 267 267 49 49
Financial liabilities:
Instruments with carrying value
equal to fair value 7,632 7,632 9,493 9,493
Deposits:
Without fixed maturities 51,262 51,262 46,099 46,099
Fixed maturities 8,018 8,083 10,408 10,468
Trading account liabilities 7,710 7,710 3,800 3,800
Long-term debt 4,225 4,974 4,491 4,861
Derivative instruments included
in other liabilities (1) 100 100 79 79
- --------------------------------------------------------------------------------
(1) At December 31, 2002 and 2001, the amounts reported relate to derivative
contracts that qualify for hedge accounting treatment as defined by SFAS
133.
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.
91
Note 27. Financial Statements of HSBC USA Inc. (parent)
- --------------------------------------------------------------------------------
Condensed parent company financial statements follow.
- ---------------------------------------------------------------------------------------------------------
Balance Sheet
December 31, 2002 2001
- ---------------------------------------------------------------------------------------------------------
in thousands
Assets:
Cash and due from subsidiary bank $ 882 $ 4,809
Interest bearing deposits with banks (including
$853,261 and $1,594,250 in banking subsidiary) 918,261 1,659,251
Trading assets 177,448 85,870
Securities available for sale 49,045 63,658
Securities held to maturity (fair value $192,889
and $221,173) 185,784 214,130
Loans (net of allowance for credit losses of
$1,329 and $24,643) 107,452 96,191
Receivable from subsidiaries 1,660,589 1,628,845
Investment in subsidiaries at amount of their
net assets:
Banking 7,288,607 6,898,796
Other 1,265,839 1,197,891
Goodwill 604,501 604,501
Other assets 334,495 661,807
- ---------------------------------------------------------------------------------------------------------
Total assets $12,592,903 $13,115,749
- ---------------------------------------------------------------------------------------------------------
Liabilities:
Interest, taxes and other liabilities $ 142,918 $ 831,970
Short-term borrowings 1,484,417 1,634,559
Long-term debt (1) 2,483,620 2,824,398
Long-term debt due to subsidiary (1) 1,085,355 775,792
- ---------------------------------------------------------------------------------------------------------
Total liabilities 5,196,310 6,066,719
Shareholders' equity * 7,396,593 7,049,030
- ---------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $12,592,903 $13,115,749
- ---------------------------------------------------------------------------------------------------------
* See Consolidated Statement of Changes in Shareholders' Equity, page 55.
(1) Contractual scheduled maturities for the debt over the next five years are
as follows: none for 2003, 2004, 2005; 2006 $300 million; and 2007 $100
million.
92
- ----------------------------------------------------------------------------------------
Statement of Income
Year Ended December 31, 2002 2001 2000
- ----------------------------------------------------------------------------------------
in thousands
Income:
Dividends from banking subsidiaries $ 670,000 $ 950,000 $ 400,000
Dividends from other subsidiaries 2,954 3,801 7,501
Interest from banking subsidiaries 105,973 138,254 187,925
Interest from other subsidiaries 392 1,938 1,047
Other interest income 17,264 34,910 69,652
Securities transactions (894) 5,868 6,542
Other income 23,087 9,612 13,218
- ----------------------------------------------------------------------------------------
Total income 818,776 1,144,383 685,885
- ----------------------------------------------------------------------------------------
Expenses:
Interest (including $65,263, $61,172,
and $61,338 paid to subsidiaries) 241,043 312,902 378,101
Goodwill amortization -- 39,381 28,396
Princeton Note Matter -- 575,000 --
Provision for credit losses (23,500) -- 14,898
Other expenses 22,638 25,799 57,890
- ----------------------------------------------------------------------------------------
Total expenses 240,181 953,082 479,285
- ----------------------------------------------------------------------------------------
Income before taxes, equity in undistributed
income of subsidiaries and cumulative
effect of accounting change 578,595 191,301 206,600
Income tax benefit (54,081) (311,757) (92,762)
- ----------------------------------------------------------------------------------------
Income before equity in undistributed
income of subsidiaries and cumulative
effect of accounting change 632,676 503,058 299,362
Equity in undistributed income (loss)
of subsidiaries 222,768 (143,721) 269,597
- ----------------------------------------------------------------------------------------
Income before cumulative effect of
accounting change 855,444 359,337 568,959
- ----------------------------------------------------------------------------------------
Cumulative effect of accounting change-
implementation of SFAS 133, net of tax -- (6,199) --
- ----------------------------------------------------------------------------------------
Net income $ 855,444 $ 353,138 $ 568,959
========================================================================================
93
- -------------------------------------------------------------------------------------------
Statement of Cash Flows
Year Ended December 31, 2002 2001 2000
- -------------------------------------------------------------------------------------------
in thousands
Cash flows from operating activities:
Net income $ 855,444 $ 353,138 $ 568,959
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation, amortization and
deferred taxes 131,685 (42,277) 96,797
Provision for credit losses (23,500) -- 14,898
Net change in other accrued accounts (539,887) 96,003 44,326
Undistributed (income) loss of
subsidiaries (222,768) 143,721 (269,597)
Other, net (136,182) 97,207 (75,242)
- -------------------------------------------------------------------------------------------
Net cash provided by operating
activities 64,792 647,792 380,141
- -------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net change in interest bearing
deposits with banks 740,990 (818,752) 1,530,982
Purchases of securities (5,106) (89,798) (3,632,912)
Sales and maturities of securities 46,787 293,632 10,163,473
Payment to shareholders of acquired
company -- -- (7,091,209)
Net originations and maturities of loans (70,022) 263,044 (25,175)
Other, net 76,882 (50,887) (61,629)
- -------------------------------------------------------------------------------------------
Net cash provided (used) by
investing activities 789,531 (402,761) 883,530
- -------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net change in short-term borrowings (150,142) 741,973 (243,235)
Issuance of long-term debt 609,279 -- --
Repayment of long-term debt (624,320) (350,000) (400,000)
Dividends paid (693,067) (550,856) (621,744)
Return of capital -- (84,939) --
Other, net -- -- 4,593
- -------------------------------------------------------------------------------------------
Net cash used by financing activities (858,250) (243,822) (1,260,386)
- -------------------------------------------------------------------------------------------
Net change in cash and due from banks (3,927) 1,209 3,285
Cash and due from banks at beginning of year 4,809 3,600 315
- -------------------------------------------------------------------------------------------
Cash and due from banks at end of year $ 882 $ 4,809 $ 3,600
===========================================================================================
Cash paid for:
Interest $ 250,098 $ 322,014 $ 384,883
- -------------------------------------------------------------------------------------------
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 15 for further discussion.
94
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 2002.
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 65, 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, Fresh Del Monte
Produce Company and a trustee for the University of Buffalo Foundation. Elected
January, 2000.
John R. H. Bond, age 61, 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. He is director
and Chairman of HSBC Bank Canada, 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.
Donald K. Boswell, age 51, President and Chief Executive Officer, Western New
York Public Broadcasting Association since 1998. He has been in public
broadcasting since 1977. A director of the Bank and the Company since April,
2002.
James H. Cleave, age 60, 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 Vice Chairman of HSBC Bank Canada. Elected in 1991.
Frances D. Fergusson, age 58, President, Vassar College since 1986. Formerly
Provost and Vice President for Academic Affairs, Bucknell University. Dr.
Fergusson is a member of the Board of Overseers of Harvard University. 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 47, Group Finance Director, HSBC and an Executive Director
of HSBC since 1995. A director of 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 LLP. Elected January, 2000.
Martin J. G. Glynn, age 51, 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.
95
Stephen K. Green, age 54, 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 HSBC Private Banking Holdings (Suisse) S.A. and a director of
HSBC Bank plc, CCF S.A., HSBC Guyerzeller Bank AG and HSBC Trinkaus & Burkhardt
KGaA. A director of the Bank and the Company since January, 2000.
Richard A. Jalkut, age 58, President and Chief Executive Officer, Telepacific
Communications and Chairman of Birch Telecom, Inc. Formerly President and Chief
Executive of Pathnet. Previously President and Group Executive, NYNEX
Telecommunications. 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
Solutions and Covad Communications. Reelected January, 2000.
Peter Kimmelman, age 58, 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 65, 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 65, 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 48, 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. Previously 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. He is also a director of HSBC Bank Canada and Grupo Financiero
Bital. Elected in 1998.
Jonathan Newcomb, age 56, Principal, Leeds Weld & Co. Formerly Chairman & CEO,
Simon & Schuster, Inc. He is a director of the Bank, The Bureau of National
Affairs Inc. and United Business Media. 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 67, 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. 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 57, Chair of the Canadian Broadcasting Corporation and
Past Chair of the Vancouver Board of Trade. Also a director of HSBC Holdings
plc, Fairmont Hotels & Resorts and Canfor. Formerly a director of HSBC Bank
Canada. A director of the Bank and the Company since April, 2002.
Keith R. Whitson, age 59, 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. Appointed Vice Chairman of the
Corporation and the Bank in April 2002. He is Chairman of HSBC Bank AS, Turkey.
He is also a director of The Hongkong and Shanghai Banking Corporation Limited
and Grupo Financiero Bital, Vice Chairman of HSBC Bank Canada and Deputy
Chairman, Supervisory Board HSBC Trinkaus and Burkhardt KGaA. He has been with
HSBC since 1961. Elected in 1998.
96
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.
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 3, 2003 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 48 2000 President and Chief Executive Officer
Gerard Aquilina 51 2002 Senior Executive Vice President
Leslie E. Bains 59 2000 Senior Executive Vice President
Robert M. Butcher 59 1988 Senior Executive Vice President
and Chief Financial Officer
Paul L. Lee 56 2000 Senior Executive Vice President
and General Counsel
Vincent J. Mancuso 56 1996 Senior Executive Vice President
and Group Audit Executive, USA
Brendan McDonagh 44 2002 Senior Executive Vice President
Robert H. Muth 50 1993 Senior Executive Vice President
Joseph M. Petri 50 2001 Senior Executive Vice President
Brian Robertson 48 2002 Senior Executive Vice President
Gerald A. Ronning 55 1991 Executive Vice President and Controller
Iain A. Stewart 44 2000 Senior Executive Vice President
Philip S. Toohey 59 1990 Senior Executive Vice President
and Secretary
George T. Wendler 58 2000 Senior Executive Vice President
and Chief Credit Officer
- --------------------------------------------------------------------------------
97
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.
Gerard Aquilina held various management positions with Merrill Lynch from 1984
to 2002. Most recently he was Global Head of Marketing and Wealth Management for
their International Private Client Group.
Leslie E. Bains managed domestic private banking and investments at Republic.
Ms. Bains joined Republic in 1993.
Brendan McDonagh is an HSBC International Manager who has been with the HSBC
Group for over 20 years. He has extensive commercial and retail management
experience, and most recently served as Senior Executive, Strategy
Implementation, at HSBC Group Headquarters.
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.
Brian Robertson has been appointed Group General Manager and Head of Corporate
Investment Banking and Markets, effective March 2003. From 1991 to 1994 he
served the Company as Senior Executive Vice President and Chief Credit Officer
and as Executive Vice President and Manager, Special Credits. Mr. Robertson has
been employed by HSBC since 1975.
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. Effective March 2003, Mr.
Stewart has been appointed Group General Manager and Head of Transaction
Banking, Corporate Investment Banking and Markets, HSBC Group Headquarters.
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.
Item 11. Executive Compensation
- --------------------------------------------------------------------------------
The following table sets forth information as to the compensation earned through
December 31, 2002 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 2002.
98
Summary Compensation Table
- --------------------------------------------------------------------------------
Long Term
Annual Compensation Compensation
-------------------------------- -----------------------
Restricted All
Stock LTIP Other
Name and Principal Position Year Salary Bonus Other Awards Payouts Compensation
- ---------------------------------------------------------------------------------------------------------------------
Youssef A. Nasr 2002 $ 800,000 $2,250,000 $ 271,134 $ 700,425 $ -- $ 7,346
President and 2001 784,614 1,500,000 324,920 578,000 -- 6,800
Chief Executive Officer 2000 738,461 1,100,000 145,172 441,000 -- 423,706
Joseph M. Petri 2002 325,000 1,800,000 1,080 2,700,000 -- 5,250
Senior Executive Vice President 2001 284,615 2,185,000 540 2,015,000 -- 5,547
Investment Banking and Markets
Robert H. Muth 2002 575,000 830,000 97,250 220,000 -- 18,346
Senior Executive Vice President 2001 567,308 700,000 2,070 200,000 -- 16,800
Administration 2000 550,000 550,000 117,241 150,000 -- 118,859
Iain A. Stewart 2002 492,180 800,000 640,707 1,589,125 -- 88,298
Senior Executive Vice President 2001 514,727 1,600,000 293,723 2,760,000 -- --
Investment Banking and Markets 2000 569,288 2,000,000 80,664 1,466,000 -- 243,351
Paul L. Lee 2002 400,000 700,000 3,870 150,000 179,714 --
Senior Executive Vice President 2001 400,000 700,000 1,806 150,000 283,151 --
and General Counsel 2000 200,000 550,000 965 150,000 254,036 8,877
- ---------------------------------------------------------------------------------------------------------------------
Prior to 2001 Mr. Petri was compensated by an HSBC entity other than the
Company.
Other Annual Compensation for Mr. Nasr includes reimbursement of rental expenses
and related tax gross-ups amounting to $260,535 in 2002, $322,108 in 2001 and
$142,119 in 2000. Mr. Muth's Other Annual Compensation in 2002 includes an
automobile allowance of $26,287 and imputed income and tax gross-ups amounting
to $43,296 related to an executive relocation package. Mr. Muth's 2001 Other
Annual Compensation included imputed insurance benefits and in 2000 it included
tax gross-ups of $96,448. Other Annual Compensation in 2002 for Mr. Stewart
includes a housing allowance of $224,073 and $210,507 in tax gross-ups. In 2001
Mr. Stewart's Other Annual Compensation included a housing allowance of $218,793
and in 2000 it included an executive travel allowance and related tax gross-ups
of $51,221. Other Annual Compensation for Mr. Petri and Mr. Lee represent
imputed insurance benefits for each of the years presented.
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 2002
awards will not be known until HSBC actually purchases the shares, which is
expected to occur in the second quarter of 2003. Dividends are paid on all
restricted shares and are reinvested in additional restricted shares. The
aggregate number and value at December 31, 2002 of restricted share holdings for
each of the named executives was: Mr. Nasr: 138,432 shares ($1,530,516); Mr.
Petri: 223,353 shares ($2,469,409); Mr. Muth: 60,788 shares ($672,077); Mr.
Stewart: 439,443 shares ($4,858,518); and Mr. Lee: 25,107 shares ($277,585).
Of Mr. Stewart's restricted share holdings at December 31, 2002, 211,045 shares
represent the accumulated balance of shares originally granted on March 19,
2002, 50% of which will vest in 2003 and 50% in 2005. Of Mr. Petri's restricted
share holdings at December 31, 2002, 32,644 shares represent the accumulated
balance of shares originally granted on February 28, 2001 which will vest in
2003. Mr. Petri's restricted share holdings also include 177,189 shares
accumulated from a March 19, 2002 grant which will vest 50% in 2003 and 50% in
2004. The aggregate restricted share holdings of Messrs. Nasr and Stewart at
December 31, 2002 include shares granted for performance while employed by HSBC
entities other than the Company of 53,706 and 59,612 respectively.
99
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 2002 for Messrs. Nasr and Petri represents the
Company's matching 401(k) plan contribution. Mr. Muth's All Other Compensation
in 2002 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. All Other
Compensation in 2002 for Mr. Stewart represents pension contributions made by
HSBC on his behalf.
- ---------------------------------------------------------------------------------------------------------------------
Aggregated Stock Options Exercised in 2002 and Option Values as of Year End 2002
Number of Securities Value of Unexercised
Underlying Unexercised Options In-the-Money Options
Shares as of December 31, 2002 as of December 31, 2002 (2)
Acquired Value --------------------------------- ---------------------------
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------
Youssef A. Nasr (1) 18,000 $-- 108,000 -- $299,343 $--
Joseph M. Petri -- -- -- -- -- --
Robert H. Muth -- -- 39,000 -- 76,543 --
Iain A. Stewart -- -- 106,500 -- 316,207 --
Paul L. Lee -- -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
(1) On March 8, 2002 Mr. Nasr exercised his right to purchase 18,000
shares of HSBC Holdings plc common stock at an exercise price of
2.1727 GBP per share. No monetary value was realized upon exercise
because Mr. Nasr continues to hold these shares.
(2) The value of unexercised in-the-money options is based on the
December 31, 2002 closing price per share of 6.865 GBP for HSBC
Holdings plc common stock as quoted on the London Stock Exchange and
the December 31, 2002 U.S. dollar exchange rate of 1.6105 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 noncontributory 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.
- --------------------------------------------------------------------------------------------------------------------
Five Year Average Representative Years of Credited Service
Compensation 15 20 25 30 35
- --------------------------------------------------------------------------------------------------------------------
$200,000 $ 58,600 $ 78,600 $ 98,600 $118,600 $119,100
250,000 73,250 98,250 123,250 148,250 148,875
300,000 87,900 117,900 147,900 177,900 178,650
350,000 102,550 137,550 172,550 207,550 208,425
400,000 117,200 157,200 197,200 237,200 238,200
450,000 131,850 176,850 221,850 266,850 267,975
500,000 146,500 196,500 246,500 296,500 297,750
600,000 175,800 235,800 295,800 355,800 357,300
700,000 205,100 275,100 345,100 415,100 416,850
800,000 234,400 314,400 394,400 474,400 476,400
- --------------------------------------------------------------------------------------------------------------------
The Pension Plan is a noncontributory 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
100
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, 2002, 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, 17.25; Mr. Muth, 19.50 and Mr. Lee, 11.75.
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.
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, 2002.
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 2002. 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.
101
Item 14. Controls and Procedures
- --------------------------------------------------------------------------------
Under the direction of the Company's Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), the Company has enhanced its process of reviewing
internal controls to include and emphasize "disclosure controls and procedures"
as defined by the U. S. Securities and Exchange Commission (SEC). Under that
definition the term means controls and other procedures designed to ensure that
information required to be disclosed in the Company's reports filed with the SEC
is recorded, processed, summarized and reported by the due dates specified by
the SEC's rules. Such controls and procedures must be designed to ensure that
information required to be disclosed in reports filed with the SEC, is
accumulated and communicated to the Company's management personnel to allow
timely decisions regarding required disclosure. Also, this process is the
support for the certifications of the CEO and CFO included in this report.
Since 1993, the CEO and CFO have reported on the Bank's internal controls over
financial reporting pursuant to FDICIA regulations. The Company's independent
auditors have annually attested, without qualification, to the reports. Thus
management is well acquainted with the process underlying the attestation to
financial reporting controls. The current enhancement of the review process is
building on the annual review at the Bank for FDICIA purposes as well as various
other internal control processes and procedures which management has established
and monitors. The review will be conducted quarterly and include all
subsidiaries of the Company.
To monitor the Company's compliance with the new SEC rules regarding disclosure
controls and procedures, the Company has formed a Disclosure Committee chaired
by its CFO. The Disclosure Committee is composed of key members of senior
management, who have knowledge of significant portions of the Company's internal
control system as well as the business and competitive environment in which the
Company operates. The Disclosure Committee covers all of the Company's
significant business and administrative functions. One of the key
responsibilities of each Disclosure Committee member is to review the document
to be filed with the SEC as it progresses through the preparation process. Open
lines of communication to financial reporting management exist for Disclosure
Committee members to convey comments and suggestions.
The Disclosure Committee has designated a preparation-working group that is
responsible for providing and/or reviewing the detail supporting financial
disclosures. The Disclosure Committee also has designated a business issues
working group that is responsible for the development of forward-looking
disclosures.
The Company's CEO and CFO have concluded that, based on the deliberations of the
Disclosure Committee and input received from senior business and financial
managers, the Company's disclosure controls and procedures were effective as of
December 31, 2002 (the disclosure control evaluation date) and that those
controls and procedures support the disclosures in this document. Subsequent to
December 31, 2002 through the date hereof, there were no significant changes in
the aforementioned controls or in other factors that affect them.
102
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- --------------------------------------------------------------------------------
(a) (1) Financial Statements
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
(2) Financial Statement Schedules
All required schedules are omitted since they are either not applicable or
the information is presented elsewhere in this document.
(3) Exhibits
3 (i) Registrant's Restated Certificate of Incorporation and
Amendments thereto, Exhibit 3(a) to the Company's 1999 Annual Report
on Form 10-K incorporated herein by reference.
(ii) Registrant's By-Laws, as Amended to Date, Exhibit 3 to the Company's
Form 10-Q for the quarter ended June 30, 2002 incorporated herein by
reference.
4 Instruments Defining the Rights of Security Holders, Including
Indentures, incorporated by reference to previously filed periodic
reports.
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)
21 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
A current report on Form 8-K was filed with the Securities and Exchange
Commission November 4, 2002 announcing that HSBC USA Inc. had submitted
the certification required pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 in connection with its Form 10-Q for the quarterly period
ended September 30, 2002.
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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 3, 2003 by the following persons on behalf of
the Registrant and in the capacities indicated:
/s/ Robert M. Butcher Sal H. Alfiero* Director
- ---------------------------------- John R. H. Bond*
Robert M. Butcher Chairman of the Board
Senior Executive Vice President Donald K. Boswell* Director
and Chief Financial Officer James H. Cleave* Director
(Principal Financial Officer) Frances D. Fergusson* Director
Douglas J. Flint* Director
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
Carole S. Taylor* Director
Keith R. Whitson* Director
* /s/ Philip S. Toohey
--------------------------------------
Philip S. Toohey
Attorney-in-fact
104
CERTIFICATIONS
I, Youssef A. Nasr, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC USA Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
105
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 3, 2003 /s/ Youssef A. Nasr
---------------------------------------
Youssef A. Nasr
President and Chief Executive Officer
106
I, Robert M. Butcher, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC USA Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
107
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 3, 2003 /s/ Robert M. Butcher
---------------------------------------------
Robert M. Butcher
Senior Executive Vice President and
Chief Financial Officer
108