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CONFORMED 1.
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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-7436
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
Maryland
(State of Incorporation)
13-2764867
(IRS Employer Identification No.)
452 Fifth Avenue, New York, New York 10018
(Address of principal executive offices)
(212) 525-3735
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
At October 31, 2004, all voting stock (705 shares of Common Stock, $5 par value)
is owned by an indirect wholly owned subsidiary of HSBC Holdings plc.
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HSBC USA Inc.
Form 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
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Page
----
Item 1. Consolidated Financial Statements
Statement of Income 3
Balance Sheet 4
Statement of Changes in Shareholders' Equity 5
Statement of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (MD&A)
Average Balances and Interest Rates 18
Forward-Looking Statements 20
Executive Overview 20
Basis of Reporting 22
Results of Operations 26
Business Segments 38
Credit Quality 42
Derivative Instruments and Hedging Activities 44
Off-Balance Sheet Arrangements 45
Special Purpose and Variable Interest Entities 46
Capital 46
Risk Management 47
Item 3. Quantitative and Qualitative Disclosures About Market Risk 53
Item 4. Controls and Procedures 53
Part II OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings 54
Item 5. Other Information 54
Item 6. Exhibits and Reports on Form 8-K 54
Signature 55
2
Part I. Financial Information
Item 1. Consolidated Financial Statements
HSBC USA Inc.
- --------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Three months ended September 30, Nine months ended September 30,
2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
in millions
Interest income:
Loans ................................................ $ 779 $ 573 $ 2,060 $ 1,769
Securities ........................................... 220 217 651 669
Trading assets ....................................... 43 30 114 104
Short-term investments ............................... 27 18 63 61
Other ................................................ 5 4 13 18
-------- -------- -------- --------
Total interest income .................................... 1,074 842 2,901 2,621
-------- -------- -------- --------
Interest expense:
Deposits ............................................. 226 150 544 511
Short-term borrowings ................................ 59 13 112 72
Long-term debt ....................................... 91 50 204 155
-------- -------- -------- --------
Total interest expense ................................... 376 213 860 738
-------- -------- -------- --------
Net interest income ...................................... 698 629 2,041 1,883
Provision for credit losses .............................. 27 (1) 7 86
-------- -------- -------- --------
Net interest income after provision for credit losses .... 671 630 2,034 1,797
-------- -------- -------- --------
Other revenues:
Trust income ......................................... 23 24 71 70
Service charges ...................................... 54 54 158 157
Other fees and commissions ........................... 110 110 341 334
Other income ......................................... 200 37 283 129
Residential mortgage banking revenue (expense) ....... (64) (74) (105) (80)
Trading revenues ..................................... 21 52 188 212
Security gains, net .................................. 18 2 59 51
-------- -------- -------- --------
Total other revenues ..................................... 362 205 995 873
-------- -------- -------- --------
Operating expenses:
Salaries and employee benefits ....................... 216 290 707 846
Occupancy expense, net ............................... 38 40 110 115
Other expenses ....................................... 226 193 672 539
-------- -------- -------- --------
Total operating expenses ................................. 480 523 1,489 1,500
-------- -------- -------- --------
Income before income tax expense ......................... 553 312 1,540 1,170
Income tax expense ....................................... 214 114 551 445
-------- -------- -------- --------
Net income ............................................... $ 339 $ 198 $ 989 $ 725
======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC USA Inc.
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CONSOLIDATED BALANCE SHEET
September 30, December 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------
in millions
Assets
Cash and due from banks ................................................ $ 3,457 $ 2,534
Interest bearing deposits with banks ................................... 2,172 843
Federal funds sold and securities purchased under resale agreements .... 6,192 2,446
Trading assets ......................................................... 15,436 14,646
Securities available for sale .......................................... 14,656 14,143
Securities held to maturity (fair value $4,044 and $4,648) ............. 3,898 4,512
Loans .................................................................. 67,040 48,474
Less - allowance for credit losses ..................................... 340 399
---------- ----------
Loans, net ....................................................... 66,700 48,075
Properties and equipment, net .......................................... 606 681
Intangible assets, net ................................................. 381 551
Goodwill ............................................................... 2,699 2,777
Other assets ........................................................... 4,742 4,354
---------- ----------
Total assets ........................................................... $ 120,939 $ 95,562
========== ==========
Liabilities
Deposits in domestic offices:
Noninterest bearing .................................................. $ 7,727 $ 6,093
Interest bearing ..................................................... 45,093 38,995
Deposits in foreign offices:
Noninterest bearing .................................................. 340 453
Interest bearing ..................................................... 21,643 18,414
---------- ----------
Total deposits ................................................... 74,803 63,955
---------- ----------
Trading account liabilities ............................................ 10,345 10,460
Short-term borrowings .................................................. 11,467 6,782
Interest, taxes and other liabilities .................................. 3,653 3,089
Long-term debt ......................................................... 12,118 3,814
---------- ----------
Total liabilities ...................................................... 112,386 88,100
---------- ----------
Shareholders' equity
Preferred stock ........................................................ 500 500
Common shareholder's equity:
Common stock ($5 par; 150,000,000 shares authorized;
705 shares issued) ............................. --(1) --(1)
Capital surplus ...................................................... 6,414 6,027
Retained earnings .................................................... 1,654 807
Accumulated other comprehensive (loss) income ........................ (15) 128
---------- ----------
Total common shareholder's equity ................................ 8,053 6,962
---------- ----------
Total shareholders' equity ............................................. 8,553 7,462
---------- ----------
Total liabilities and shareholders' equity ............................. $ 120,939 $ 95,562
========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
4
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' EQUITY
Nine months ended September 30,
2004 2003
- --------------------------------------------------------------------------------------------------------------------------
in millions
Preferred stock
Balance, January 1 and September 30, ..................................................... $ 500 $ 500
--------- ---------
Common stock
Balance, January 1 and September 30, ..................................................... --(1) --(1)
--------- ---------
Capital surplus
Balance, January 1, ...................................................................... 6,027 6,056
Capital contribution from parent ......................................................... 408 10
Reduction of capital surplus ............................................................. (21) (44)
--------- ---------
Balance, September 30, ................................................................... 6,414 6,022
--------- ---------
Retained earnings
Balance, January 1, ...................................................................... 807 578
Net income ............................................................................... 989 725
Cash dividends declared:
Preferred stock ...................................................................... (17) (17)
Common stock ......................................................................... (125) (255)
--------- ---------
Balance, September 30, ................................................................... 1,654 1,031
--------- ---------
Accumulated other comprehensive (loss) income
Balance, January 1, ...................................................................... 128 262
Net change in unrealized (losses) gains on securities .................................... (45) (128)
Net change in unrealized (losses) gains on derivatives classified as cash flow hedges .... (95) 25
Foreign currency translation adjustments ................................................. (3) 24
--------- ---------
Other comprehensive loss, net of tax ..................................................... (143) (79)
--------- ---------
Balance, September 30, ................................................................... (15) 183
--------- ---------
Total shareholders' equity, September 30, ................................................ $ 8,553 $ 7,736
========= =========
Comprehensive income
Net income ............................................................................... $ 989 $ 725
Other comprehensive loss ................................................................. (143) (79)
--------- ---------
Comprehensive income ..................................................................... $ 846 $ 646
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
5
HSBC USA Inc.
- --------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine months ended September 30,
2004 2003
- --------------------------------------------------------------------------------------------------------
in millions
Cash flows from operating activities
Net income ........................................................ $ 989 $ 725
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation, amortization and deferred taxes ................ 314 321
Provision for credit losses .................................. 7 86
Net change in other accrual accounts ......................... 43 582
Net change in loans originated for sale ...................... 1 (315)
Net change in trading assets and liabilities ................. (534) 970
Other, net ................................................... (366) (268)
---------- ----------
Net cash provided by operating activities ............... 454 2,101
---------- ----------
Cash flows from investing activities
Net change in interest bearing deposits with banks ................ (1,330) (479)
Net change in short-term investments .............................. (3,848) (1,794)
Net change in securities available for sale:
Purchases of securities available for sale ................... (8,971) (11,871)
Proceeds from sales of securities available for sale ......... 4,195 3,461
Proceeds from maturities of securities available for sale .... 4,568 8,827
Net change in securities held to maturity:
Purchases of securities held to maturity ..................... (821) (1,924)
Proceeds from maturities of securities held to maturity ...... 1,437 2,366
Net change in loans:
Net change in credit card receivables ........................ (69) (48)
Net change in other short-term loans ......................... (743) (58)
Net originations and maturities of long-term loans ........... (15,716) (1,319)
Loans purchased .............................................. (3,068) --
Sales of loans/other ......................................... 132 243
Expenditures for properties and equipment ......................... (18) (26)
Net cash provided in acquisitions, net of cash acquired ........... 196 79
Other, net ........................................................ (735) (323)
---------- ----------
Net cash used in investing activities ................... (24,791) (2,866)
---------- ----------
Cash flows from financing activities
Net change in deposits ............................................ 12,275 2,548
Net change in short-term borrowings ............................... 4,926 (1,286)
Net change in long-term debt:
Issuance of long-term debt ................................... 8,542 126
Repayment of long-term debt .................................. (720) (37)
Capital contribution from parent .................................. 400 --
Reduction of capital surplus ...................................... (21) (44)
Dividends paid .................................................... (142) (272)
---------- ----------
Net cash provided by financing activities ............... 25,260 1,035
---------- ----------
Net change in cash and due from banks ................................. 923 270
Cash and due from banks at beginning of period ........................ 2,534 2,081
---------- ----------
Cash and due from banks at end of period .............................. $ 3,457 $ 2,351
========== ==========
Pending settlement receivables/payables related to securities and trading assets
and liabilities are treated as non cash items for cash flows reporting.
The accompanying notes are an integral part of the consolidated financial
statements.
6
Notes to Consolidated Financial Statements
1. Organization and Basis of Presentation
HSBC USA Inc. is an indirect wholly owned subsidiary of HSBC North America
Holdings Inc. (HNAH), which is a wholly owned subsidiary of HSBC Holdings plc
(HSBC). The accompanying unaudited consolidated financial statements of HSBC USA
Inc. and its subsidiaries (collectively, the Company), including its principal
subsidiary, HSBC Bank USA, National Association (the Bank), have been prepared
in accordance with accounting principles generally accepted in the United States
of America (U.S. GAAP) for interim financial information, with the instructions
to Form 10-Q and with Article 10 of Regulation S-X, as well as in accordance
with predominant practices within the banking industry. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments, which are normal and recurring, considered
necessary for a fair presentation of financial position, results of operations
and cash flows for the interim periods, have been made. The unaudited interim
financial information should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended December 31, 2003 (the 2003 Form 10-K).
Certain reclassifications have been made to prior period amounts to conform to
the current period presentations. The accounting and reporting policies of the
Company are consistent, in all material respects, with those used to prepare the
2003 Form 10-K, except for the impact of new accounting pronouncements
summarized in Note 12.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and
disclosures. Actual results could differ from those estimates. Interim results
should not be considered indicative of results in future periods.
Interim financial statement disclosures regarding business segments and
off-balance sheet arrangements are included in the Management's Discussion and
Analysis of Financial Condition and Results of Operations (MD&A) section of this
Form 10-Q.
In June 2004, the Company filed a Form 8-K with the SEC announcing approval by
the Office of the Comptroller of the Currency for the Company to consolidate its
banking operations under a single national charter, effective July 1, 2004. As a
result, on July 1, 2004, the Bank's legal name was changed from HSBC Bank USA to
HSBC Bank USA, National Association. The change to a national charter has not
had a material effect on the existing operations of the Company.
7
2. Securities
At September 30, 2004 and December 31, 2003, 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 following tables provide a summary of the amortized cost and fair value of
the securities available for sale and securities held to maturity portfolios.
- ----------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2004 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ..................... $ 203 $ -- $ 2 $ 201
U.S. Government agency (1) ........ 12,153 119 153 12,119
Asset backed securities ........... 1,228 4 1 1,231
Other domestic debt securities .... 210 1 6 205
Foreign debt securities ........... 775 12 2 785
Equity securities ................. 69 50 4 115
--------- --------- --------- ---------
$ 14,638 $ 186 $ 168 $ 14,656
========= ========= ========= =========
Securities held to maturity:
U.S. Treasury ..................... $ 46 $ -- $ -- $ 46
U.S. Government agency ............ 3,089 127 23 3,193
Obligations of U.S. states and
political subdivisions .......... 485 38 -- 523
Other domestic debt securities .... 254 6 2 258
Foreign debt securities ........... 24 -- -- 24
--------- --------- --------- ---------
$ 3,898 $ 171 $ 25 $ 4,044
========= ========= ========= =========
- ----------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2003 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government agency (1) ........ $ 10,778 $ 155 $ 141 $ 10,792
Asset backed securities ........... 1,785 7 6 1,786
Other domestic debt securities .... 415 1 -- 416
Foreign debt securities ........... 904 12 -- 916
Equity securities ................. 187 50 4 233
--------- --------- --------- ---------
$ 14,069 $ 225 $ 151 $ 14,143
========= ========= ========= =========
Securities held to maturity:
U.S. Treasury ..................... $ 125 $ -- $ -- $ 125
U.S. Government agency ............ 3,513 123 40 3,596
Obligations of U.S. states and
political subdivisions .......... 572 47 -- 619
Other domestic debt securities .... 294 8 2 300
Foreign debt securities ........... 8 -- -- 8
--------- --------- --------- ---------
$ 4,512 $ 178 $ 42 $ 4,648
========= ========= ========= =========
(1) Includes mortgage backed securities issued or guaranteed by U.S.
Government agencies.
8
The following tables provide a summary of gross unrealized losses and related
fair values, classified as to the length of time the losses have existed.
- -------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
--------------------------------------- ----------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
September 30, 2004 Securities Losses of Investment Securities Losses of Investment
- -------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury .................. 1 $ 2 $ 201 -- $ -- $ --
U.S. Government agency (1) ..... 197 65 3,800 176 88 2,029
All other securities ........... 28 9 496 32 4 180
-------- -------- -------- -------- -------- --------
226 $ 76 $ 4,497 208 $ 92 $ 2,209
======== ======== ======== ======== ======== ========
Securities held to maturity:
U.S. Government agency ......... 11 $ 7 $ 195 17 $ 16 $ 316
All other securities ........... 24 2 47 4 -- 10
-------- -------- -------- -------- -------- --------
35 $ 9 $ 242 21 $ 16 $ 326
======== ======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
---------------------------------------- ---------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
December 31, 2003 Securities Losses of Investment Securities Losses of Investment
- -------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government agency (1) ..... 325 $ 141 $ 4,753 39 $ -- $ 66
All other securities ........... 101 5 388 47 5 257
-------- -------- -------- -------- -------- --------
426 $ 146 $ 5,141 86 $ 5 $ 323
======== ======== ======== ======== ======== ========
Securities held to maturity:
U.S. Government agency ......... 40 $ 40 $ 905 -- $ -- $ --
All other securities ........... 8 1 11 8 1 6
-------- -------- -------- -------- -------- --------
48 $ 41 $ 916 8 $ 1 $ 6
======== ======== ======== ======== ======== ========
(1) Includes mortgage backed securities issued or guaranteed by U.S.
Government agencies.
Gross unrealized losses for the available for sale securities portfolio have
increased during the nine months ended September 30, 2004 due to a general
increase in interest rates. The rise in interest rates has also extended the
average durations of the portfolios. The securities are high credit grade (i.e.
AAA or AA), and no permanent impairment is expected to be realized.
9
3. Loans
The following table shows the composition of the loan portfolio.
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Domestic:
Commercial:
Construction and mortgage loans .............. $ 8,003 $ 7,075
Other business and financial ................. 9,891 8,658
Consumer:
Residential mortgages ........................ 42,900 26,294
Credit card receivables ...................... 1,127 1,112
Other consumer loans ......................... 2,086 1,905
International .................................... 3,033 3,430
--------- ---------
$ 67,040 $ 48,474
========= =========
On March 31, 2004, the Company purchased approximately $900 million of domestic
residential mortgage loans at fair value from subsidiaries of Household
International, Inc. (Household), a related HSBC entity. In addition, during the
nine months ended September 30, 2004, approximately $2.2 billion of residential
mortgage loans were purchased from originating lenders pursuant to a Household
correspondent loan program. The remaining net increase in residential mortgages
resulted from growth in the mortgage banking business during the first nine
months of 2004.
4. Allowance for Credit Losses
The following table provides a summary of changes in the allowance for credit
losses.
- ----------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
--------------------- ----------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------
(in millions)
Beginning balance ............................................. $ 347 $ 476 $ 399 $ 493
Allowance related to acquisitions and (dispositions), net ..... (12) -- (20) (8)
Provision charged (credited) to income ........................ 27 (1) 7 86
Charge offs:
Commercial .................................................. 17 29 31 104
Consumer .................................................... 24 20 68 58
International ............................................... 1 9 8 12
------- ------- ------- -------
Total charge offs ............................................. 42 58 107 174
------- ------- ------- -------
Recoveries on loans charged off:
Commercial .................................................. 16 10 48 22
Consumer .................................................... 4 3 11 9
International ............................................... -- 5 2 7
------- ------- ------- -------
Total recoveries .............................................. 20 18 61 38
------- ------- ------- -------
Total net charge offs ......................................... 22 40 46 136
------- ------- ------- -------
Ending balance ................................................ $ 340 $ 435 $ 340 $ 435
======= ======= ======= =======
During the first nine months of 2004, the Company sold certain foreign
operations to affiliated HSBC entities resulting in releases of allowance for
credit losses totaling approximately $20 million.
10
5. Intangible Assets, Net
The following table summarizes the composition of intangible assets.
- --------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------------------------------------------
(in millions)
Mortgage servicing rights, net of accumulated amortization and valuation allowance .... $ 337 $ 503
Favorable lease arrangements, net of accumulated depreciation ......................... 44 48
------- -------
Intangible assets, net ................................................................ $ 381 $ 551
======= =======
Mortgage Servicing Rights (MSRs)
The Company recognizes the right to service mortgages as a separate and distinct
asset at the time the related loans are sold, or at the time the MSRs are
purchased. MSRs are 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. The carrying value of MSRs is evaluated for
impairment on an ongoing basis through internal modeling. Results of internally
prepared MSR valuations are periodically compared with external independent
broker valuations. Permanent impairment results in direct write-down of the
gross MSRs balance. Temporary impairment is recorded through use of a valuation
allowance account.
The following table summarizes activity for MSRs and the related valuation
allowance.
- ---------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
-------------------- --------------------
2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Beginning balance .................................. $ 437 $ 459 $ 526 $ 395
Additions related to loan sales .................... 14 102 49 239
Net MSRs acquisitions (sales) ...................... -- 19 (53) 46
Permanent impairment charges ....................... (8) (27) (15) (41)
Amortization ....................................... (19) (44) (83) (130)
------- ------- ------- -------
Ending balance ..................................... 424 509 424 509
------- ------- ------- -------
Valuation allowance for MSRs:
Beginning balance .................................. -- (85) (23) (41)
Temporary impairment (provision) recovery .......... (95) 7 (82) (51)
Permanent impairment charges ....................... 8 27 15 41
Release of allowance related to MSRs sold .......... -- -- 3 --
------- ------- ------- -------
Ending balance ..................................... (87) (51) (87) (51)
------- ------- ------- -------
MSRs, net of accumulated amortization and valuation
allowance .............................................. $ 337 $ 458 $ 337 $ 458
======= ======= ======= =======
The increase in temporary impairment in the third quarter and first nine months
of 2004 resulted primarily from reductions in interest rates, supplemented by
changes resulting from the Company's ongoing review of assumptions used in its
MSRs valuation model.
Normal amortization for the current MSRs portfolios is expected to be
approximately $101 million for the year ending December 31, 2004, declining
gradually to approximately $41 million for the year ending December 31, 2008.
Actual levels of amortization could increase or decrease depending upon changes
in interest rates and loan prepayment activity. Actual levels of amortization
are also dependent upon future levels of MSRs recorded.
Favorable Lease Arrangements
Favorable lease arrangements resulted from various business acquisitions.
Scheduled amortization of favorable lease arrangements will approximate $5
million per year for 2004 through 2008.
11
6. Goodwill
During 2004, the Company sold or transferred certain domestic and foreign
operations to affiliated HSBC entities, resulting in reductions of goodwill of
approximately $78 million.
During the second quarter of 2004, the Company completed its annual impairment
test of goodwill and determined that the fair value of each of the reporting
units exceeded its carrying value. As a result, no impairment loss was required
to be recognized.
7. Long-Term Debt
The following table presents a summary of long-term debt.
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Senior debt .................................. $ 7,969 $ 643
Subordinated debt ............................ 4,128 3,149
All other .................................... 21 22
--------- ---------
Total long-term debt ......................... $ 12,118 $ 3,814
========= =========
Senior Debt
In June 2004, the Bank issued Senior debt for the Euro equivalent of $500
million, which matures in 2044 and provides for quarterly payments of principal
and interest at 3.99%.
In June 2004 the Bank finalized a $10 billion Global Bank Note Program, which
provided for the issuance of subordinated and senior global notes. In September
2004 this program was replaced by a $20 billion Global Bank Note Program. The
new program also replaced the Bank's $4 billion Global Medium-Term Note Program
initiated in June 2000. The following senior debt offerings have been made under
these programs during the first nine months of 2004.
In June the Bank issued $550 million of Floating Rate Senior Notes due
2009. The current interest rate on these notes is 2.01% per annum, payable
on December 10, 2004. The rate resets quarterly based on the three month
LIBOR rate plus .14% per annum until the final interest payment date on
June 10, 2009.
In June the Bank also issued $39 million of Fixed Rate Senior Notes due
2006. Interest is paid semi-annually at an initial rate of 2.75% through
the interest payment period ending on June 27, 2005 and at 4.10% per annum
thereafter. The Bank may redeem these notes, in whole but not in part, on
June 27, 2005.
In July the Bank issued EUR $1 billion (USD $1,241 million) of Floating
Rate Senior Notes due 2008. The initial interest rate on these notes is
2.215% per annum, payable on October 9, 2004. The rate then resets
quarterly based on the three month EURIBOR plus .10% per annum until the
final interest payment date on July 9, 2008.
In September the Bank issued $2,750 million of Floating Rate Senior Notes
due 2007. The initial interest rate on these notes is 1.98% per annum,
payable on December 21, 2004. The rate then resets quarterly based on the
three month LIBOR plus .07% per annum until the final interest payment
date on September 21, 2007.
In September the Bank also issued $1,750 million of 3.875% Senior Notes
due 2009. Interest is paid semi-annually in March and September of each
year, commencing on March 15, 2005 and ending with the final interest
payment date on September 15, 2009.
During the nine months ended September 30, 2004 the Bank made net
medium-term note advances of $804 million, due 2004 to 2016, and bearing
various fixed and variable rates of interest.
12
Subordinated Debt
In March 2004 the Bank issued $1 billion of Global Subordinated Notes, which
bear interest at a fixed rate of 4.625% and mature in April 2014.
8. Income Taxes
The following table presents the effective tax rate for the three months and
nine months ended September 30, 2004 and 2003 respectively.
- --------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
------------------- -------------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------
Effective tax rate ............ 38.7% 36.5% 35.8% 38.0%
In June 2004, as a result of a recently completed tax audit, approximately $51
million of income tax liability was released, reducing the effective tax rate by
3.6% for the first nine months of 2004. Excluding the impact of this adjustment,
moderate increases in the effective tax rate for the three months and nine
months ended September 30, 2004 were due to increased levels of taxable income,
which were taxed at the full corporate rate.
9. Related Party Transactions
In the normal course of business, the Company conducts transactions with HSBC
and its subsidiaries (HSBC group). These transactions occur at prevailing market
rates and terms. All extensions of credit by the Company to other HSBC
affiliates are legally required to be secured by eligible collateral. The
following table presents related party balances and the income and expense
generated by related party transactions.
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Assets:
Interest bearing deposits with banks ........... $ 276 $ 139
Loans .......................................... 576 330
Trading assets ................................. 1,944 1,811
Other .......................................... 76 34
--------- ---------
Total assets ................................. $ 2,872 $ 2,314
========= =========
Liabilities:
Deposits ....................................... $ 9,393 $ 7,512
Trading account liabilities .................... 4,094 3,434
Short-term borrowings .......................... 999 735
Other .......................................... 171 79
--------- ---------
Total liabilities ............................ $ 14,657 $ 11,760
========= =========
- ----------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
-------------------- --------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------
(in millions)
Interest income ................................................ $ -- $ 4 $ 4 $ 14
Interest expense ............................................... 26 23 65 71
Trading (losses) revenues ...................................... (956) 278 (1,307) 374
Other fees and commissions ..................................... 12 3 20 7
Other expenses:
Fees paid to HTSU for technology services .................... 42 -- 124 --
Fees paid to Household for loan origination,
loan servicing and other administrative support ............. 8 -- 19 --
Other fees, primarily treasury and traded markets services ... 49 42 148 103
13
Trading losses for the quarter and nine months ended September 30, 2004,
primarily represent the mark-to-market of the inter-company leg of interest rate
and foreign currency derivative swap transations entered into by Household.
Specifically, Household enters into these swap contracts with the Company in
order to hedge its interest rate positions. The Company, within its Corporate,
Investment Banking and Markets business, accounts for these transactions on a
mark-to-market basis, with the change in value on the inter-company leg
substantially offset by the mark-to-market of related contracts entered into
with third parties. These activities commenced in September of 2003 and had
minimal impact on that quarter.
During 2004, HSBC has integrated certain North American operations through
changes to its organization structure. The following organizational changes have
resulted in changes in the classification of revenues and/or expenses in 2004,
as compared with 2003.
- - Technology services were centralized by the creation of a new HSBC
subsidiary, HSBC Technology and Services (USA) Inc. (HTSU), effective
January 1, 2004. The Company's technology services employees, as well as
technology services employees from other HSBC entities in the United
States, were transferred to HTSU. All technology related assets and
software purchased subsequent to January 1, 2004 are generally purchased
and owned by HTSU. Technology related assets owned by the Company prior to
January 1, 2004 remain in place and were not transferred to HTSU. Pursuant
to a master service level agreement, HTSU charges the Company for its
share of technology services and software development costs. As a result,
HSBC group charges for 2004 include amounts previously recorded as
"salaries and benefits" and "occupancy expense, net" and "other expenses"
on the consolidated statement of income for 2003.
- - The Company obtains certain underwriting, broker-dealer and administrative
support services from an affiliated HSBC entity, HSBC Securities (USA)
Inc. (HSUI) pursuant to various service level agreements. Effective
January 1, 2004, several employees of the Company were transferred to
HSUI. As a result, HSBC group charges for 2004 include amounts previously
recorded as "salaries and benefits" on the consolidated statement of
income for 2003.
- - On June 1, 2004, The Company transferred its wholly owned subsidiary, HSBC
Brokerage (USA) Inc. (HBUI) to a related HSBC entity. The transfer
resulted in a decrease in total assets of approximately $201 million and a
loss on sale of approximately $9 million which has been reported as a
reduction of capital surplus. For the five months ended May 31, 2004, HBUI
contributed approximately $14 million of the Company's income before
taxes.
HSBC group other expenses also include charges by Household under various
service level agreements for certain loan origination and servicing as well as
other operational and administrative support. Amounts reported in the preceding
table do not include fees associated with loan originations that have been
deferred and are being amortized over the life of the related loans.
On March 31, 2004, the Company purchased approximately $900 million of domestic
residential mortgage loan assets at fair value from Household. In addition,
during the first nine months of 2004, approximately $2.2 billion of loans were
purchased from originating lenders pursuant to a Household correspondent loan
program.
On July 1, 2004, in order to centralize the servicing of credit card receivables
within a common HSBC affiliate in the United States, certain consumer credit
card customer relationships were sold to Household, resulting in a third quarter
2004 gain of approximately $99 million. Receivable balances of approximately
$970 million associated with these relationships were not sold as part of the
transaction. Servicing for the majority of these relationships was transferred
to Household in October 2004. Also effective July 1, 2004, new receivable
balances generated by these relationships are purchased at fair value from
Household on a daily basis. Through September 30, 2004, approximately $515
million of receivables have been purchased from Household at a premium of
approximately $10 million. The premium, which is recorded in loans as a
component of credit card receivables, is being amortized to interest income over
the estimated life of the receivables purchased.
It was previously reported that the Company expected to purchase domestic
private label credit card receivables and residual interests in securitized
private label credit card receivable pools from Household during 2004. Household
will maintain the related customer account relationships for the receivables
purchased, and charge the Company for ongoing servicing of the accounts.
Subsequent to the initial transfer, additional credit card receivables generated
from the relationships maintained by Household will be purchased by the Company
on a daily basis. The securitized credit card receivable trusts are expected to
expire at various times until 2007. As the securitized trusts expire,
14
receivables generated from the underlying relationships will also be purchased
from Household.
The Company has filed a formal application seeking regulatory approval to
acquire these receivables in 2004. Subject to regulatory approval, the private
label receivables expected to be purchased from Household by year end will have
a principal balance of approximately $12 billion. Residual interests in
securitized private label credit card receivable pools of approximately $3
billion will also be acquired. The timing of regulatory approval, and therefore
the timing of the asset transfers, cannot be predicted with any degree of
certainty. If regulatory approval is received, a premium of approximately
$675-$700 million is expected to be recorded on the initial transfer date. The
premium will be amortized to interest income over the two year estimated life of
the assets purchased. The purchased credit card receivables are expected to
decrease net income after taxes by approximately $100-$150 million in 2005 due
primarily to year one amortization of the premium paid. For years subsequent to
2005, net income is expected to increase due to decreases in premium
amortization. Net interest income, other operating revenue, service fee expense,
the provision and allowance for credit losses will all be impacted by the
transaction in future periods.
The Company and Household will consider potential transfers of MasterCard and
Visa receivables in the future based upon continuing evaluations of capital and
liquidity at each entity.
At September 30, 2004 and December 31, 2003, the aggregate notional amounts of
all derivative contracts with other HSBC affiliates were approximately $210
billion and $168 billion respectively. The net credit risk exposure related to
these contracts was approximately $2 billion at September 30, 2004 and December
31, 2003.
Employees of the Company participate in one or more stock compensation plans
sponsored by HSBC. The Company's share of the expense of the plans for the first
nine months of 2004 and 2003 was $46 million and $38 million respectively. A
description of these plans is included on pages 91 and 92 of the Company's 2003
Form 10-K.
On July 31, 2004, the Company transferred most of its Panamanian branch
operations to a related HSBC group entity at fair value. Total assets and
deposits transferred were approximately $1.0 billion and $.9 billion,
respectively. The sale resulted in a loss of approximately $11 million which has
been reported as a reduction of capital surplus. For the seven months ended July
31, 2004, the transferred operations contributed approximately $19 million of
the Company's income before taxes.
On September 30, 2004, the Company received a capital contribution of $400
million from its direct parent company, HSBC North America Inc., in exchange for
one share of common stock. Also on September 30, 2004, the Company contributed
$400 million to the Bank in exchange for one share of common stock.
10. Pledged Assets
The following table presents pledged assets included in the consolidated balance
sheet.
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks ............ $ 315 $ 140
Interest bearing deposits with nonbanks ......... 365 500
Trading assets .................................. 343 647
Securities available for sale ................... 6,034 4,171
Securities held to maturity ..................... 644 956
Loans ........................................... 4,293 360
--------- ---------
Total ........................................... $ 11,994 $ 6,774
========= =========
The 2004 increase in pledged assets resulted primarily from collateral
requirements associated with increased short-term borrowings and with increased
derivatives activity.
15
11. Pensions and Other 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 employees who joined the Company
through acquisitions and were participating in a defined benefit plan at the
time of acquisition. 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 tables present the components of net periodic benefit cost.
- ----------------------------------------------------------------------------------------------
Pension Benefits Other Postretirement Benefits
---------------------- -----------------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------
(in millions)
Three Months Ended September 30
Net periodic benefit cost
Service cost ....................... $ 7 $ 7 $ --(1) $ 1
Interest cost ...................... 17 16 1 2
Expected return on plan assets ..... (24) (21) -- --
Prior service cost amortization .... --(1) --(1) -- --
Actuarial loss ..................... 7 8 -- --
Transition amount amortization ..... -- -- --(1) 1
------ ------ ------ ------
Net periodic benefit cost .......... $ 7 $ 10 $ 1 $ 4
====== ====== ====== ======
Nine Months Ended September 30
Net periodic benefit cost
Service cost ....................... $ 23 $ 22 $ 1 $ 2
Interest cost ...................... 51 48 5 5
Expected return on plan assets ..... (72) (65) -- --
Prior service cost amortization .... 1 1 -- --
Actuarial loss ..................... 20 24 -- --
Transition amount amortization ..... -- -- 2 2
------ ------ ------ ------
Net periodic benefit cost .......... $ 23 $ 30 $ 8 $ 9
====== ====== ====== ======
(1) Less than $500 thousand.
The Company expects to make no contribution for pension benefits and contribute
approximately $9 million for other postretirement benefits during fiscal year
2004. On November 9, 2004, sponsorship of the defined benefit pension plan for
employees of the Bank was transferred to HNAH.
12. New Accounting Pronouncements
In December 2003, the American Institute of Certified Public Accountants (AICPA)
released Statement of Position 03-3, Accounting for Certain Loans or Debt
Securities Acquired in a Transfer (SOP 03-3). SOP 03-3 addresses accounting for
differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer if those differences are attributable to credit quality.
SOP 03-3 is effective for loans acquired in fiscal years beginning after
December 15, 2004. Adoption is not expected to have a material impact on the
Company's financial position or results of operations.
In December 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 132 (revised), Employers'
Disclosures about Pensions and Other Postretirement Benefits (SFAS 132
(revised)). SFAS 132 (revised) revises employers' disclosures about pension
plans and other postretirement benefit plans. It does not change the measurement
or recognition of those plans. SFAS 132 (revised) revises certain
16
disclosure requirements contained in the original SFAS 132. It also requires
additional disclosures about the assets, obligations, cash flows, and net
periodic benefit cost of defined benefit pension plans and other postretirement
benefit plans. The annual disclosure requirements for SFAS 132 (revised) were
adopted in the 2003 Form 10-K and the interim period disclosure requirements
were adopted in the Form 10-Q beginning with the quarter ended March 31, 2004.
In January 2004, the FASB issued FASB Staff Position 106-1, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FSP 106-1). FSP 106-1 was issued in response to a
new Medicare bill that provides prescription drug coverage to Medicare-eligible
retirees and was signed into law in December 2003. FSP 106-1 allowed plan
sponsors the option of accounting for the effects of this new law in financial
statements for periods that cover the date of enactment or making a one-time
election to defer the accounting for the effects of the new law. The Company
elected to defer the accounting for the effects of the new law.
In May 2004, the FASB issued FASB Staff Position FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FSP 106-2), which superceded FSP 106-1. FSP 106-2
is effective for the first interim period beginning after June 15, 2004. For
companies that elected deferral under FSP 106-1, and for which enactment is
deemed to be a "significant event", FSP 106-2 provides two methods of transition
- - retroactive application or prospective application from the date of adoption.
The effects of the new law were not deemed to be a "significant event" by the
Company. Accordingly, the effects of the new law will be incorporated into the
next measurement date following the effective date. Adoption of FSP 106-2 is not
expected to have a material impact on the accumulated postretirement benefit
obligation or the net periodic benefit cost.
In March 2004, the FASB reached a consensus on EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides guidance for determining when an investment is
impaired and whether the impairment is other than temporary. EITF 03-1 also
incorporates into its consensus the required disclosures about unrealized losses
on investments announced by the EITF in late 2003 and adds new disclosure
requirements relating to cost-method investments. The impairment accounting
guidance is effective for reporting periods beginning after June 15, 2004 and
the new disclosure requirements for annual reporting periods ending after June
15, 2004. The adoption of the impairment guidance contained in EITF 03-1 is not
expected to have a material impact on the financial position or results of
operations of the Company.
In September 2004, the FASB issued FASB Staff Position EITF 03-1-1, Effective
Date of Paragraphs 10-20 of EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments",
(FSP 03-1-1). FSP 03-1-1 delays the effective date for the measurement and
recognition guidance contained in paragraphs 10-20 of EITF 03-1, previously
defined as annual reporting periods ending after June 15, 2004. This delay does
not suspend the requirement to recognize other-than-temporary impairments as
required by existing authoritative literature, nor the disclosure guidance
effective for annual reporting periods ending after June 15, 2004. The
disclosure requirements for FSP 03-1-1 were adopted for the quarter ended
September 30, 2004.
In December 2003, the FASB issued Interpretation No. 46 Revised, Consolidation
of Variable Interest Entities (FIN 46R). The Company has adopted all of the
provisions of FIN 46R. All required disclosures are included in the MD&A section
of this Form 10-Q or in the Company's 2003 Form 10-K under "Special Purpose and
Variable Interest Entities".
In March 2004, the SEC released Staff Accounting Bulletin No. 105, Application
of Accounting Principles to Loan Commitments (SAB 105) which provides guidance
regarding commitments related to loans to be held for sale, and accounted for as
derivative instruments. The guidance indicates that, for commitments issued
after March 31, 2004, expected future cash flows from servicing may not be
considered in valuing the derivatives and may only be recorded upon sale of the
related loans. The Company previously recorded those cash flows as assets and
income upon the issuance of the commitment. Commentary regarding the impact of
SAB 105 on residential mortgage banking revenue is presented on page 33 of this
Form 10-Q.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
HSBC USA Inc.
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES (Taxable Equivalent Basis)
Three Months Ended September 30,
-------------------------------------------------------------------------
2004 2003
----------------------------------- -----------------------------------
Balance Interest Rate * Balance Interest Rate *
- ----------------------------------------------------------------------------------------------------------------------------
in millions
Assets
Interest bearing deposits with banks .......... $ 2,642 $ 11 1.60% $ 1,910 $ 7 1.38%
Federal funds sold and securities
purchased under resale agreements ......... 4,132 16 1.56 4,088 11 1.09
Trading assets ................................ 14,778 43 1.16 11,892 30 1.01
Securities .................................... 18,566 224 4.80 19,448 222 4.53
Loans
Domestic
Commercial ................................ 16,376 196 4.77 16,647 204 4.85
Consumer
Residential mortgages ................ 41,118 494 4.81 20,441 276 5.40
Other consumer ....................... 3,561 67 7.45 3,076 62 8.01
--------- -------- ------- --------- -------- -------
Total domestic .......................... 61,055 757 4.93 40,164 542 5.35
International ............................... 3,473 22 2.44 3,408 32 3.75
--------- -------- ------- --------- -------- -------
Total loans ............................. 64,528 779 4.80 43,572 574 5.22
--------- -------- ------- --------- -------- -------
Other ......................................... 546 5 3.60 485 4 3.20
--------- -------- ------- --------- -------- -------
Total earning assets .......................... 105,192 $ 1,078 4.07% 81,395 $ 848 4.13%
--------- -------- ------- --------- -------- -------
Allowance for credit losses ................... (339) (474)
Cash and due from banks ....................... 3,290 2,648
Other assets .................................. 7,055 8,260
--------- ---------
Total assets .................................. $ 115,198 $ 91,829
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits .......................... $ 27,350 $ 44 0.64% $ 25,602 $ 44 0.69%
Other time deposits ....................... 17,935 111 2.47 9,665 50 2.06
Deposits in foreign offices ................... 22,197 71 1.27 19,374 56 1.14
--------- -------- ------- --------- -------- -------
Total interest bearing deposits ............... 67,482 226 1.33 54,641 150 1.09
--------- -------- ------- --------- -------- -------
Short-term borrowings ......................... 12,568 59 1.85 8,149 13 0.62
Long-term debt ................................ 7,905 91 4.58 3,725 50 5.28
--------- -------- ------- --------- -------- -------
Total interest bearing liabilities ............ 87,955 376 1.70% 66,515 213 1.27%
--------- -------- ------- --------- -------- -------
Net interest income / Interest rate spread .... $ 702 2.37% $ 635 2.86%
-------- ------- -------- -------
Noninterest bearing deposits .................. 7,584 6,628
Other liabilities ............................. 11,646 11,116
Total shareholders' equity .................... 8,013 7,570
--------- ---------
Total liabilities and shareholders' equity .... $ 115,198 $ 91,829
========= =========
* Rates are calculated on unrounded numbers
18
HSBC USA Inc.
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES (Taxable Equivalent Basis)
Nine Months Ended September 30,
------------------------------------------------------------------------
2004 2003
---------------------------------- ----------------------------------
Balance Interest Rate * Balance Interest Rate *
- -------------------------------------------------------------------------------------------------------------------------
in millions
Assets
Interest bearing deposits with banks .......... $ 2,230 $ 24 1.46% $ 1,668 $ 19 1.55%
Federal funds sold and securities
purchased under resale agreements ......... 3,940 38 1.30 4,359 42 1.27
Trading assets ................................ 15,011 114 1.01 12,445 104 1.12
Securities .................................... 18,106 664 4.89 19,091 685 4.80
Loans
Domestic
Commercial ................................ 15,646 520 4.44 16,563 613 4.95
Consumer
Residential mortgages ................ 34,391 1,258 4.88 20,667 874 5.64
Other consumer ....................... 3,396 205 8.04 3,011 188 8.34
--------- -------- ------- --------- -------- -------
Total domestic .......................... 53,433 1,983 4.96 40,241 1,675 5.56
International ............................... 3,652 78 2.86 3,198 95 3.97
--------- -------- ------- --------- -------- -------
Total loans ............................. 57,085 2,061 4.82 43,439 1,770 5.45
--------- -------- ------- --------- -------- -------
Other ......................................... 526 13 3.39 482 18 4.87
--------- -------- ------- --------- -------- -------
Total earning assets .......................... 96,898 $ 2,914 4.02% 81,484 $ 2,638 4.33%
--------- -------- ------- --------- -------- -------
Allowance for credit losses ................... (360) (493)
Cash and due from banks ....................... 3,197 2,452
Other assets .................................. 7,281 7,423
--------- ---------
Total assets .................................. $ 107,016 $ 90,866
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits .......................... $ 27,250 $ 134 0.66% $ 24,414 $ 144 0.79%
Other time deposits ....................... 14,837 228 2.05 10,553 172 2.17
Deposits in foreign offices ................... 21,837 182 1.11 19,208 195 1.36
--------- -------- ------- --------- -------- -------
Total interest bearing deposits ............... 63,924 544 1.14 54,175 511 1.26
--------- -------- ------- --------- -------- -------
Short-term borrowings ......................... 10,305 112 1.44 9,207 72 1.04
Long-term debt ................................ 5,675 204 4.80 3,714 155 5.59
--------- -------- ------- --------- -------- -------
Total interest bearing liabilities ............ 79,904 860 1.44% 67,096 738 1.47%
--------- -------- ------- --------- -------- -------
Net interest income / Interest rate spread .... $ 2,054 2.58% $ 1,900 2.86%
-------- ------- -------- -------
Noninterest bearing deposits .................. 7,470 6,261
Other liabilities ............................. 11,831 10,035
Total shareholders' equity .................... 7,811 7,474
--------- ---------
Total liabilities and shareholders' equity .... $ 107,016 $ 90,866
========= =========
* Rates are calculated on unrounded numbers
19
FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company's results may
differ materially from those noted in the forward-looking statements. Words such
as "believe", "expects", "estimates", "targeted", "anticipates", "goal" and
similar expressions are intended to identify forward-looking statements but
should not be considered as the only means through which these statements are
made. Statements that are not historical facts, including statements about
management's beliefs and expectations, are forward-looking statements and
involve inherent risks and uncertainties and are based on current views and
assumptions. 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. For a list of important factors that may affect
the Company's actual results, see Forward-Looking Statements in Part I, Item 7
of the Company's 2003 Form 10-K.
EXECUTIVE OVERVIEW
Net income increased $141 million in the third quarter of 2004, and increased
$264 million in the first nine months of 2004, as compared with the same 2003
periods. Third quarter and year-to-date 2004 operating performance has been
highlighted by a significant increase in net interest income, primarily from
residential mortgage loans, and by non-recurring transaction gains and other
income amounts recorded as other revenues. Despite a third quarter 2004
increase, the provision for credit losses has also decreased significantly in
the first nine months of 2004.
During 2002 and 2003, certain equipment finance, commercial finance, and U.S.
factoring business lines were exited or restructured, resulting in office
closings and sales of customer relationships. Certain receivables associated
with these businesses were retained, and have been decreasing throughout 2003
and 2004 as balances have run off. As a result of these transactions, average
loan balances associated with these business lines have been steadily
decreasing, and reported 2003 year-to-date amounts for net interest income,
provision for credit losses, and operating expenses exceeded 2004 year-to-date
amounts by approximately $49 million, $20 million and $28 million, respectively.
During the first nine months of 2004, the Company sold or transferred certain
foreign and domestic subsidiaries, at fair value, to affiliated HSBC group
entities. As a result of these transactions, the Company reported 2003
year-to-date amounts for net interest income, other revenues and operating
expenses that exceeded 2004 year-to-date amounts by approximately $8 million,
$20 million and $24 million, respectively. Further discussion of these related
party transactions is presented in Note 9 to the consolidated financial
statements on pages 13 through 15 of this Form 10-Q.
Balance Sheet Review
Balance sheet growth during the third quarter and first nine months of 2004 was
highlighted by significant growth in residential mortgage loans, and moderate
growth in other consumer and commercial loans. Loan growth was primarily funded
by relatively low cost interest bearing deposits and by long-term debt.
Short-term investments, such as deposits placed with other banks and securities
purchased under resale agreements, have also increased during the third quarter
and the first nine months of 2004. In anticipation of the private label credit
card portfolio transfer (see Note 9 to the consolidated financial statements on
pages 13 through 15 of this Form 10-Q), the Bank has been raising funds through
long-term debt issuances and through short-term borrowings. These accumulated
funds are invested in the short-term assets noted above.
Balance sheet funding needs and sources are further addressed under Liquidity
Management in the Risk Management section on page 47 of this Form 10-Q.
20
Income Statement Review
Net interest income increased $69 million in the third quarter of 2004, and
increased $158 million in the first nine months of 2004, as compared with the
same 2003 periods. For both reporting periods, a significant increase in total
interest income was primarily due to volume growth in various consumer loan
portfolios, especially residential mortgage loans. Smaller increases in total
interest expense were due to general increases in deposits, short-term
borrowings, and long-term debt balances.
Net interest rate spreads for the third quarter and the first nine months of
2004 have been negatively impacted by a continuing trend of lower interest rates
earned from loans, primarily residential mortgage loans. Higher average rates
paid on the growing short-term borrowing balances also contributed to tightening
interest spreads. Further analysis of net interest income is presented on pages
26 through 29 of this Form 10-Q.
The provision for credit losses has decreased $79 million during the first nine
months of 2004, as compared with the same 2003 periods. The Company has
experienced a continuing trend of improved credit quality within the commercial
lending portfolios, as evidenced by decreased charge offs of commercial loan
balances, and by increased recoveries of commercial loan balances previously
charged off. Changes in the allowance for credit losses are summarized in Note 4
to the consolidated financial statements on page 10 of this Form 10-Q. An
analysis of credit quality is presented on pages 42 and 43 of this Form 10-Q.
Other revenues increased $157 million in the third quarter of 2004 and increased
$122 million in the first nine months of 2004, as compared with the same 2003
periods. During the third quarter of 2004, the Company recorded the following
significant non-recurring transactions:
- - Sale of credit card account relationships to a related HSBC entity for a
gain of approximately $99 million. This transaction is further described
in Note 9 of the financial statements on pages 13 through 15 of this Form
10-Q.
- - Sale of an investment in NYCE Corporation for a gain of approximately $45
million. This transaction is further described in the "Other Revenues"
section on pages 29 through 31 of this Form 10-Q.
- - Refund of interest previously paid to the Internal Revenue Service of
approximately $17 million. This transaction is further described in the
"Other Revenues" section on pages 29 through 31 of this Form 10-Q.
The net 2004 comparative increases in other revenues also reflect activity from
non-interest residential mortgage banking performance, non-interest trading
revenues and gains on the sale of available for sale securities. Quarterly and
year-to-date results for these areas are presented on pages 31 through 35 of
this Form 10-Q.
Operating expenses decreased $43 million in the third quarter of 2004 and
decreased $11 million in the first nine months of 2004, as compared with the
same 2003 periods. The expense decreases were primarily attributable to sales or
transfers of various subsidiaries and commercial lending lines of business in
2003 and 2004, which were partially offset by increased technology-related fees
and increases in other fees charged by affiliated HSBC entities. An analysis of
operating expenses is presented on pages 35 through 37 of this Form 10-Q.
Income tax expense increased $100 million in the third quarter of 2004, and
increased $106 million during the first nine months of 2004, as compared with
the same 2003 periods. In June 2004, approximately $51 million of income tax
liability related to the anticipated completion of an outstanding audit was
released. Excluding the impact of this adjustment, increased income tax expense
for the third quarter and the first nine months of 2004 was a direct result of
increased taxable income, which is taxed at the full corporate rate. An analysis
of the Company's effective tax rate is presented in Note 8 to the financial
statements on page 13 of this Form 10-Q.
21
The following table presents a five quarter summary of selected financial
information.
- -----------------------------------------------------------------------------------------------------------------------
September 30 June 30 March 31 December 31 September 30
Three months ended 2004 2004 2004 2003 2003
- -----------------------------------------------------------------------------------------------------------------------
(in millions)
Income statement data:
Net interest income ........................... $ 698 $ 689 $ 655 $ 627 $ 629
Provision for credit losses ................... 27 6 (25) 27 (1)
Other revenues ................................ 362 298 334 280 205
Operating expenses ............................ 480 520 489 539 523
Income tax expense ............................ 214 130 207 125 114
Net income .................................... 339 331 318 216 198
Balance sheet data (period end balances):
Cash and short-term investments ............... $ 11,821 $ 8,490 $ 7,111 $ 5,823 $ 8,406
Loans, net .................................... 66,700 61,719 52,075 48,075 44,473
Total assets .................................. 120,939 112,791 102,502 95,562 92,718
Total deposits ................................ 74,803 74,534 67,994 63,955 62,098
Short-term borrowings ......................... 11,467 9,499 5,906 6,782 6,466
Long-term debt ................................ 12,118 6,135 4,871 3,814 3,740
Total shareholders' equity .................... 8,553 7,815 7,839 7,462 7,736
Total tangible common shareholder's equity .... 5,336 4,673 4,341 4,022 4,196
Financial performance:
Net yield on average earning assets ........... 2.65% 2.91% 2.96% 2.95% 3.09%
Net yield on average total assets ............. 2.42 2.63 2.66 2.65 2.74
BASIS OF REPORTING
HSBC reports results in accordance with accounting principles generally accepted
in the United Kingdom (U.K. GAAP). Therefore, management separately monitors net
income and earnings excluding goodwill amortization under U.K. GAAP (non-GAAP
financial measures). The following table reconciles net income of the Company on
a U.S. GAAP basis to net income on a U.K. GAAP basis.
- -------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30 Ended September 30
--------------------- ---------------------
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------
(in millions)
Net income - U.S. GAAP basis .................................. $ 339 $ 198 $ 989 $ 725
Deferred loan origination fees and costs ...................... (1) -- (18) --
Derivative financial instruments .............................. 6 3 -- 3
Deferred taxation ............................................. (26) 4 (12) 22
Depreciation .................................................. 4 4 12 12
Software amortization ......................................... 2 (1) 7 (2)
Other ......................................................... -- (1) -- (2)
------- ------- ------- -------
Earnings excluding goodwill amortization - U.K. GAAP basis .... 324 207 978 758
Goodwill amortization ......................................... (34) (54) (105) (135)
------- ------- ------- -------
Net income - U.K. GAAP basis .................................. $ 290 $ 153 $ 873 $ 623
======= ======= ======= =======
Differences between U.S. and U.K. GAAP are as follows:
Deferred loan origination fees and costs
U.K. GAAP
- - Fee and commission income is accounted for in the period when receivable,
except when it is charged to cover the costs of a continuing service to,
or risk borne for, the customer, or is interest in nature. In these cases,
it is recognized on an appropriate basis over the relevant period.
22
- - Loan origination costs are generally expensed as incurred. As permitted by
U.K. GAAP, HSBC applies a restricted definition of the incremental,
directly attributable origination expenses that are deferred and
subsequently amortized over the life of the loans.
U.S. GAAP
- - In accordance with Statement of Financial Accounting Standards No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases (SFAS 91), certain loan
fee income and direct loan origination costs are amortized to the profit
and loss account over the life of the loan as an adjustment to interest
income.
Derivative financial instruments
U.K. GAAP
- - Non-trading derivatives are those which are held for hedging purposes as
part of our risk management strategy against cash flows, assets,
liabilities, or positions measured on an accruals basis. Non-trading
transactions include qualifying hedges and positions that synthetically
alter the characteristics of specified financial instruments.
- - Non-trading derivatives are accounted for on an equivalent basis to the
underlying assets, liabilities or net positions. Any profit or loss
arising is recognized on the same basis as that arising from the related
assets, liabilities or positions.
- - To qualify as a hedge, a derivative must effectively reduce the price,
foreign exchange or interest rate risk of the asset, liability or
anticipated transaction to which it is linked and be designated as a hedge
at inception of the derivative contract. Accordingly, changes in the
market value of the derivative must be highly correlated with changes in
the market value of the underlying hedged item at inception of the hedge
and over the life of the hedge contract. If these criteria are met, the
derivative is accounted for on the same basis as the underlying hedged
item. Derivatives used for hedging purposes include swaps, forwards and
futures.
- - Interest rate swaps are also used to alter synthetically the interest rate
characteristics of financial instruments. In order to qualify for
synthetic alteration, a derivative instrument must be linked to specific
individual, or pools of similar, assets or liabilities by the notional
principal and interest rate risk of the associated instruments, and must
achieve a result that is consistent with defined risk management
objectives. If these criteria are met, accrual based accounting is
applied, i.e. income or expense is recognized and accrued to the next
settlement date in accordance with the contractual terms of the agreement.
- - Any gain or loss arising on the termination of a qualifying derivative is
deferred and amortized to earnings over the original life of the
terminated contract. Where the underlying asset, liability or position is
sold or terminated, the qualifying derivative is immediately
marked-to-market through the profit and loss account.
- - Derivatives that do not qualify as hedges or synthetic alterations at
inception are marked-to-market through the profit and loss account, with
gains and losses included within "other income".
U.S. GAAP
- - All derivatives must be recognized as either assets or liabilities in the
balance sheet and be measured at fair value, in accordance with Statement
of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133).
- - The accounting for changes in the fair value of a derivative (that is,
gains and losses) depends on the intended use of the derivative and the
resulting designation as described below:
o For a derivative designated as hedging exposure to changes in the
fair value of a recognized asset or liability or a firm commitment,
the gain or loss is recognized in earnings in the period of change
together with the associated loss or gain on the hedged item
attributable to the risk being hedged. Any resulting net gain or
loss represents the ineffective portion of the hedge.
o For a derivative designated as hedging exposure to variable cash
flows of a recognized asset or liability, or of a forecast
transaction, the derivative's gain or loss associated with the
effective portion of the hedge is initially reported as a component
of other comprehensive income and subsequently reclassified into
earnings when the forecast transaction affects earnings. The
ineffective portion is reported in earnings immediately.
23
o For net investment hedges in which derivatives hedge the foreign currency
exposure of a net investment in a foreign operation, the change in fair
value of the derivative associated with the effective portion of the hedge
is included as a component of other comprehensive income, together with
the associated loss or gain on the hedged item. The ineffective portion is
reported in earnings immediately.
o In order to apply hedge accounting it is necessary to comply with
documentation requirements and to demonstrate the effectiveness of the
hedge on an ongoing basis.
o For a derivative not designated as a hedging instrument, the gain or loss
is recognized in earnings in the period of change in fair value.
Deferred taxation
U.K. GAAP
- - Deferred tax is generally recognized for all timing differences subject to
exceptions in FRS 19, Deferred Tax, and the assessment of the
recoverability of deferred tax assets.
- - Fair value adjustments on acquisition are treated as if they were timing
differences arising in the acquired entity's own accounts. Deferred tax is
recognized on fair value adjustments where they give rise to deferral or
acceleration of taxable cash flows.
U.S. GAAP
- - In accordance with Statement of Financial Accounting Standards No. 109,
Accounting For Income Taxes (SFAS 109), deferred tax liabilities and
assets are recognized for all temporary differences. A valuation allowance
is raised against any deferred tax asset where it is more likely than not
that the asset, or a part thereof, will not be realized (SFAS 109
'Accounting for Income Taxes').
- - The deferred taxation impact of all temporary differences arising from
fair value adjustments on acquisition is recognized as part of the
purchase accounting adjustment.
Depreciation
U.K. GAAP
- - HSBC revalues its properties on an annual basis. HSBC depreciates
non-investment properties based on their cost or revalued amounts. No
depreciation is charged on investment properties, other than leaseholds,
with useful lives of 20 years or less.
U.S. GAAP
- - U.S. GAAP does not permit revaluation of property, although it requires
recognition of asset impairment. Depreciation is recognized on all
properties, based on cost, over the useful lives of the assets.
Software amortization
U.K. GAAP
- - HSBC generally expenses costs of software developed for internal use. If
it can be shown that conditions for capitalization are met under FRS 10,
Goodwill and Intangible Assets, or FRS 15, Tangible Fixed Assets, the
software is capitalized and amortized over its useful life. Website design
and content development costs are capitalized only to the extent that they
lead to the creation of an enduring asset delivering benefits at least as
great as the amount capitalized.
U.S. GAAP
- - The American Institute of Certified Public Accountants' (AICPA) Statement
of Position 98-1, Accounting For the Costs of Computer Software Developed
or Obtained For Internal Use, requires that all costs incurred in the
preliminary project and post implementation stages of internal software
development be expensed. Costs incurred in the application development
stage must be capitalized and amortized over their estimated useful life.
Website design costs are capitalized and website content development costs
are expensed as they are incurred.
24
Goodwill amortization
U.K. GAAP
- - Goodwill arising on acquisitions of subsidiary undertakings, associates or
joint ventures prior to 1998 was charged against reserves in the year of
acquisition.
- - For acquisitions made on or after January 1, 1998, goodwill is included in
the balance sheet and amortized over its estimated useful life on a
straight-line basis. U.K. GAAP allows goodwill previously eliminated
against reserves to be reinstated, but does not require it.
- - Goodwill included in the balance sheet is tested for impairment when
necessary by comparing the recoverable amount of an entity with the
carrying value of its net assets, including attributable goodwill. The
recoverable amount of an entity is the higher of its value in use,
generally the present value of the expected future cash flows from the
entity, and its net realizable value.
- - At the date of disposal of subsidiaries, associates or joint ventures, any
unamortized goodwill or goodwill charged directly against reserves is
included in the share of the undertakings' total net assets in the
calculation of the gain or loss on disposal.
- - Where quoted securities are issued as part of the purchase consideration
in an acquisition, the fair value of those securities for the purpose of
determining the cost of acquisition is the market price at the date of
completion.
U.S. GAAP
- - Goodwill acquired up to June 30, 2001 was capitalized and amortized over
its useful life but not more than 25 years. The amortization of previously
acquired goodwill ceased from December 31, 2001.
- - Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142) requires that goodwill should not be
amortized but should be tested for impairment annually at the reporting
unit level by applying a fair-value-based test.
- - The goodwill of a reporting unit should be tested for impairment between
annual tests in response to events or changes in circumstance which could
result in an impairment.
- - Where quoted securities are issued as part of the purchase consideration
in an acquisition, the fair value of those securities for the purpose of
determining the cost of acquisition is the average market price of the
securities for a reasonable period before and after the date that the
terms of the acquisition are agreed and announced.
Other
- - Includes various immaterial items.
25
RESULTS OF OPERATIONS
Net Interest Income
The following table presents a five quarter summary of net interest income for
the Company.
- -------------------------------------------------------------------------------------------------------
September 30 June 30 March 31 December 31 September 30
Three months ended 2004 2004 2004 2003 2003
- -------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans ......................... $ 779 $ 669 $ 613 $ 580 $ 573
Securities .................... 220 215 215 218 217
Trading assets ................ 43 38 33 32 30
Short-term investments ........ 27 18 18 19 18
Other ......................... 5 4 4 3 4
-------- -------- -------- -------- --------
Total interest income ...... 1,074 944 883 852 842
-------- -------- -------- -------- --------
Interest expense:
Deposits ...................... 226 158 160 155 150
Short-term borrowings ......... 59 35 17 20 13
Long-term debt ................ 91 62 51 50 50
-------- -------- -------- -------- --------
Total interest expense ..... 376 255 228 225 213
-------- -------- -------- -------- --------
Net interest income ............. $ 698 $ 689 $ 655 $ 627 $ 629
======== ======== ======== ======== ========
In the discussion that follows, interest income and rates are presented and
analyzed on a taxable equivalent basis to permit comparisons of yields on
tax-exempt and taxable assets. An analysis of consolidated average balances and
interest rates on a taxable equivalent basis is presented on pages 18-19 of this
Form 10-Q.
All increases and decreases referred to below for the third quarter and for the
first nine months of 2004 represent comparisons with the same 2003 periods.
Interest Income - Loans
Total interest income on loans increased $205 million (36%) in the third quarter
of 2004 and increased $291 million (16%) in the first nine months of 2004.
Increased interest income from residential mortgage and other consumer loans
were partially offset by decreased interest income from commercial and
international loans.
Residential Mortgage Loans
Interest income earned from residential mortgage loans increased $218 million
(79%) in the third quarter of 2004, and increased $384 million (44%) in the
first nine months of 2004. The Company has significantly expanded the volume of
adjustable rate residential mortgage loans originated during 2003 and 2004. As a
result, average residential mortgage loans held increased $21 billion (101%) in
the third quarter of 2004, and increased $14 billion (66%) in the first nine
months of 2004.
On December 31, 2003, approximately $2.8 billion of domestic residential
mortgage loan assets were purchased from Household at fair value. On March 31,
2004, approximately $900 million of additional mortgages were purchased from
Household. During 2004, approximately $2.2 billion of residential mortgages have
been purchased from originating lenders pursuant to a Household correspondent
loan program. Originations of other residential mortgage loans during the first
nine months of 2004 continued to be strong, due to competitive pricing, an
expanded sales force, development of a correspondent network, and increased
marketing efforts.
The increased loan balances, and their positive effect on earnings, were
partially offset by continued decreases in the average yield earned on
residential mortgages during the third quarter and first nine months of 2004, as
consumers continued to take advantage of lower coupon adjustable rate products.
Competitive pricing in a contracting national mortgage originations market
contributed to a general trend toward declining mortgage rates in 2004, as
compared with 2003. The lower level of refinancings in 2004, and a reduction in
loans originated for sale, also resulted in lower interest income on mortgages
held for sale.
26
Residential mortgage growth is expected to continue at a moderate level through
the remainder of 2004 by continuing to increase loans originated for various
product offerings, including, jumbo (mortgages greater than Government Sponsored
Enterprise limits), other prime (adjustable rate mortgages not sold to
Government Sponsored Enterprises) and limited documentation products. Loan
originations from the relationship with Household are also expected to provide
some level of growth.
Other Consumer Loans
Interest earned from various other consumer lending programs increased $5
million (8%) in the third quarter of 2004, and $17 million (9%) in the first
nine months of 2004. These increases resulted directly from growth in average
loan balances, especially in automobile and other installment lending programs.
Moderate expansion of these programs is expected to continue for the remainder
of 2004, driven mainly by increased consumer loan originations arising from the
relationship with Household.
These average balance increases were partially offset by a decrease in the
average yield earned on consumer loans, as new loans are being originated with
lower interest rates than loans that are maturing.
Subject to regulatory approval, certain private label credit card receivables
are expected to be purchased from Household by year end. Residual interests in
certain securitized private label credit card receivable pools will also be
acquired. The timing of regulatory approval, and therefore the timing of the
asset transfers, cannot be predicted with any degree of certainty.
Commercial Loans
Interest income earned from commercial loans decreased $8 million (4%) in the
third quarter of 2004, and decreased $93 million (15%) in the first nine months
of 2004. The decreases are due to slightly lower average loan balances and to
lower average yields earned on the commercial lending portfolios, resulting from
an increasingly competitive rate environment.
Average commercial loan balances decreased $.3 billion (2%) in the third quarter
of 2004 and decreased $1 billion (6%) in the first nine months of 2004. Loan
decreases resulting from decisions made to exit or restructure certain business
lines during 2003, including equipment finance, commercial finance and domestic
receivables factoring businesses, and from significant pay downs of certain
nonaccruing and charged off loans, were partially offset by general growth in
the remaining commercial loan portfolios during 2004.
Operating and financial performance continue to stabilize and improve for large
corporate clients, leading to a generally improving credit profile within most
industry sectors. Demand for ongoing credit support for these customers during
the first nine months of 2004 was comparable to the same 2003 period. This
stability is expected to continue for the remainder of 2004.
The Company will continue to improve its commercial loan mix as well as grow
certain commercial banking businesses. Additional resources are being allocated
to commercial middle market, real estate and small business lending,
particularly in the New York City, California and Florida markets. Overall
commercial loan growth will continue to be limited, however, due to the 2003
sale of the U.S. factoring business, and planned run-off of equipment financing
and commercial finance portfolios.
The supply of credit in the overall commercial lending market is increasing. The
increased credit supply is partially offset, however, by marginal credit supply
restrictions stemming from ongoing bank industry consolidation. The overall
increase in credit supply is placing downward competitive pressure on pricing
and fees. This trend may continue throughout the balance of the year, absent a
material change in economic conditions.
27
Interest Income - Trading Assets
Interest income from trading assets increased $13 million (43%) in the third
quarter of 2004 and increased $10 million (10%) in the first nine months of
2004. During the third quarter of 2004, the Company increased average trading
asset balances, and experienced an increase in the average yield earned on these
balances. For the first nine months of 2004, increased average balances were
offset by a decrease in the average yield earned. Increased balances are
primarily due to planned growth initiatives related to derivative structured
products, and temporary growth in anticipation of the planned purchase of credit
card receivables from Household.
Interest Income - Short-Term Investments
Short-term investments include interest bearing deposits with banks, federal
funds sold and securities purchased under resale agreements.
Interest income from short-term investments increased $9 million (50%) in the
third quarter of 2004 and increased $1 million (2%) in the first nine months of
2004. Short-term investment balances have grown significantly during 2004, as
funds generated from borrowings have been invested in short-term, liquid assets
in anticipation of the planned credit card portfolio purchase from Household
(see Interest Income - Other Consumer Loans). Average rates earned on these
balances have also increased during 2004, primarily due to increases in the
federal funds rate.
Interest Expense - Deposits
Total interest expense on deposits increased $76 million (51%) in the third
quarter of 2004, and increased $33 million (6%) in the first nine months of
2004. Interest expense increases were noted from both domestic and foreign
deposits.
Deposits in Domestic Offices
Interest expense on interest bearing deposits in domestic offices increased $61
million (65%) in the third quarter of 2004, and increased $46 million (15%) in
the first nine months of 2004. General increases in average deposit balances and
increased expense associated with interest rate swaps used to hedge deposit
liabilities were the primary drivers of the overall interest expense increase.
Decreases in average interest rates paid to customers during 2004 partially
offset overall expense increases.
Total average interest bearing deposits in domestic offices increased $10
billion (28%) in the third quarter of 2004, and increased $7 billion (20%) in
the first nine months of 2004. General increases were noted for commercial and
personal interest bearing deposit balances. Increased marketing efforts have
also resulted in increased noninterest bearing demand deposit balances.
Interest rates paid on deposits generally decreased in the third quarter and the
first nine months of 2004. The low interest rate environment, combined with
continued uncertainty of the equity markets, continues to cause many personal
and commercial customers to show preference for highly liquid but low yielding
demand and savings deposits as opposed to longer term time deposits and mutual
funds. This accounts for the significant increase in deposit balances, and also
effectively continues to reduce the overall rate paid on liabilities.
Balance sheet growth will continue to be partially funded by domestic deposit
growth for the remainder of 2004, as marketing of deposit products will
continue.
Deposits in Foreign Offices
Interest expense on deposits in foreign offices increased $15 million (27%) in
the third quarter of 2004, due to a combination of increased average balances
outstanding and an increase in the average interest rate paid.
Interest expense decreased $13 million (7%) in the first nine months of 2004, as
a decrease in the average interest rate paid was partially offset by increased
average balances outstanding.
28
Interest Expense - Short-Term Borrowings
Interest expense on short-term borrowings increased $46 million (354%) in the
third quarter of 2004 and $40 million (56%) in the first nine months of 2004.
Average short-term borrowings balances increased in the third quarter and in the
first nine months of 2004, due to Bank funding activity in anticipation of the
purchase of private label credit card receivables from Household, and to
increased expense associated with interest rate swaps used to hedge short-term
liabilities. The average interest rate paid on short-term borrowings increased
during the third quarter and the first nine months of 2004, due primarily to
increases in the federal funds rate.
Interest Expense - Long-Term Debt
Interest expense on long-term debt increased $41 million (82%) in the third
quarter of 2004 and $49 million (32%) in the first nine months of 2004, due
mainly to new debt issued during 2004, which was partially offset by a decrease
in the average interest rate paid on long-term debt. Long-term debt will
continue to be a primary funding source for balance sheet growth for the
remainder of 2004, and into 2005. For further details regarding long-term debt,
refer to Note 7 of the financial statements on pages 12 through 13 of this Form
10-Q.
Other Revenues
The following tables present the components of other revenues for the three
months and nine months ended September 30, 2004 and 2003.
- --------------------------------------------------------------------------------------------------------
Increase (Decrease)
Three months ended September 30 2004 2003 Amount %
- --------------------------------------------------------------------------------------------------------
(in millions)
Trust income ...................................... $ 23 $ 24 $ (1) (4.2)
Service charges ................................... 54 54 -- --
Other fees and commissions:
Letter of credit fees ........................... 18 18 -- --
Credit card fees ................................ 20 19 1 5.3
Investment product fees ......................... -- 18 (18) (100.0)
Wealth and tax advisory services ................ 10 9 1 11.1
Other fee-based income .......................... 50 43 7 16.3
HSBC group income ............................... 12 3 9 300.0
------- ------- ------- -------
Total other fees and commissions ................ 110 110 -- --
------- ------- ------- -------
Other income:
Insurance ....................................... 16 17 (1) (5.9)
Other ........................................... 167 20 147 735.0
Interest on tax settlement ...................... 17 -- 17 --
------- ------- ------- -------
Total other income .............................. 200 37 163 440.5
------- ------- ------- -------
Residential mortgage banking revenue (expense) .... (64) (74) 10 13.5
Trading revenues .................................. 21 52 (31) (59.6)
Securities gains, net ............................. 18 2 16 800.0
------- ------- ------- -------
Total other revenues .............................. $ 362 $ 205 $ 157 76.6
======= ======= ======= =======
29
- --------------------------------------------------------------------------------------------------------
Increase (Decrease)
Nine months ended September 30 2004 2003 Amount %
- --------------------------------------------------------------------------------------------------------
(in millions)
Trust income ...................................... $ 71 $ 70 $ 1 1.4
Service charges ................................... 158 157 1 .6
Other fees and commissions:
Letter of credit fees ........................... 53 53 -- --
Credit card fees ................................ 61 58 3 5.2
Investment product fees ......................... 36 58 (22) (37.9)
Wealth and tax advisory services ................ 34 31 3 9.7
Other fee-based income .......................... 137 127 10 7.9
HSBC group income ............................... 20 7 13 185.7
------- ------- ------- -------
Total other fees and commissions ................ 341 334 7 2.1
------- ------- ------- -------
Other income:
Insurance ....................................... 48 50 (2) (4.0)
Other ........................................... 218 58 160 275.9
Interest on tax settlement ...................... 17 21 (4) (19.0)
------- ------- ------- -------
Total other income .............................. 283 129 154 119.4
------- ------- ------- -------
Residential mortgage banking revenue (expense) .... (105) (80) (25) (31.3)
Trading revenues .................................. 188 212 (24) (11.3)
Securities gains, net ............................. 59 51 8 15.7
------- ------- ------- -------
Total other revenues .............................. $ 995 $ 873 $ 122 14.0
======= ======= ======= =======
Other Fees and Commissions
The 2004 increase in other fee-based income, and the partially offsetting
decrease in investment product fees, are attributable to the June 1, 2004
transfer of a brokerage subsidiary of the Company to a related HSBC group
entity. As a result of the transfer, income received directly from customers and
recorded as investment product fees prior to June 1, 2004, has been partially
replaced by fees received from an affiliated HSBC group entity, and recorded as
HSBC group income. Refer to Note 9 of the financial statements on pages 13
through 15 of this Form 10-Q for further discussion.
Ongoing efforts to maximize the "cross-sell" potential of the existing customer
base and of the relationship with Household will continue to be a key business
development theme for the remainder of 2004. Further growth in fees and
commissions income is expected to continue from these efforts.
Other Income
Other income for 2004 includes the following items:
- - During the first quarter of 2004, equity investment revenue increased
approximately $13 million, as compared with the same 2003 period, due to
higher than expected earnings from a foreign investment.
- - In July 2004, certain consumer credit card relationships were sold to
Household at a gain of approximately $99 million. This transaction is
further described in Note 9 to the financial statements on pages 13
through 15 of this Form 10-Q.
- - In July 2004, the Company sold an investment in NYCE Corporation for a
gain of approximately $45 million. The Company had held its non-marketable
minority investment since 1985, at a recorded cost of approximately $2
million. The Company was obliged to sell its investment by the majority
shareholder in accordance with the terms of the shareholder agreement.
- - In July 2004, the Company recorded a $17 million refund of interest
previously paid to the Internal Revenue Service related to a prior year
tax audit. The settlement included a $14 million refund of interest
previously paid, plus accrued interest on the refunded amount.
30
Other income for 2003 included $21 million of interest on an income tax refund.
Excluding the effect of these items, other income for the first nine months of
2004, as compared with the same 2003 period, remained relatively constant.
Subject to regulatory approval, certain private label credit card receivables
are expected to be purchased from Household by year end. Residual interests in
certain securitized private label credit card receivable pools will also be
acquired. The timing of regulatory approval, and therefore the timing of the
asset transfers, cannot be predicted with any degree of certainty.
Residential Mortgage Banking Revenue
The following tables present the components of residential mortgage banking
revenue for the three months and nine months ended September 30, 2004 and 2003.
The tables include net interest income earned on assets and liabilities of the
mortgage banking business as well as an allocation of the funding benefit or
cost associated with these balances. The net interest income component is
included in net interest income in the consolidated statement of income.
- -----------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
Three months ended September 30 2004 2003 Amount %
- -----------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ............................................... $ 179 $ 104 $ 75 72.1
------- ------- ------- -------
Servicing related income (expense):
Servicing fee income ............................................ 20 15 5 33.3
MSRs amortization ............................................... (19) (44) 25 56.8
MSRs temporary impairment (provision) recovery .................. (95) 7 (102) (1,457.1)
Trading - Derivative instruments used to offset changes in
value of MSRs ................................................. 33 (98) 131 133.7
Gains on sales of available for sale securities ................. -- 7 (7) (100.0)
------- ------- ------- -------
Total net servicing related expense .......................... (61) (113) 52 46.0
------- ------- ------- -------
Originations and sales related income (expense):
(Losses) gains on sales of mortgages ............................ 1 (18) 19 105.6
Trading - Forward loan sale commitments ........................ (4) 55 (59) (107.3)
- Interest rate lock commitments ....................... (3) (2) (1) (50.0)
Fair value hedge activity (1) ................................... (1) 1 (2) (200.0)
------- ------- ------- -------
Total net originations and sales related income (expense) .... (7) 36 (43) (119.4)
------- ------- ------- -------
Other mortgage income ............................................. 4 3 1 33.3
------- ------- ------- -------
Total residential mortgage banking expense included in
other revenues ................................................... (64) (74) 10 13.5
------- ------- ------- -------
Total residential mortgage banking related revenue ................ $ 115 $ 30 $ 85 283.3
======= ======= ======= =======
(1) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity.
31
- -----------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
Nine months ended September 30 2004 2003 Amount %
- -----------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ............................................... $ 485 $ 320 $ 165 51.6
------- ------- ------- -------
Servicing related income (expense):
Servicing fee income ............................................ 60 50 10 20.0
MSRs amortization ............................................... (82) (129) 47 36.4
MSRs temporary impairment (provision) recovery .................. (82) (51) (31) (60.8)
Trading - Derivative instruments used to offset changes in
value of MSRs ................................................. 9 (83) 92 110.8
Gains on sales of available for sale securities ................. 8 22 (14) (63.6)
------- ------- ------- -------
Total net servicing related expense .......................... (87) (191) 104 54.5
------- ------- ------- -------
Originations and sales related income (expense):
(Losses) gains on sales of mortgages ............................ (7) 93 (100) (107.5)
Trading - Forward loan sale commitments ........................ (1) 33 (34) (103.0)
- Interest rate lock commitments ....................... (13) (24) 11 45.8
Fair value hedge activity (1) ................................... (2) -- (2) --
------- ------- ------- -------
Total net originations and sales related income (expense) .... (23) 102 (125) (122.5)
------- ------- ------- -------
Other mortgage income ............................................. 5 9 (4) (44.4)
------- ------- ------- -------
Total residential mortgage banking expense included in
other revenues ................................................... (105) (80) (25) (31.3)
------- ------- ------- -------
Total residential mortgage banking related revenue ................ $ 380 $ 240 $ 140 58.3
======= ======= ======= =======
(1) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity.
Overview
Increased residential mortgage banking related revenue for the third quarter and
for the first nine months of 2004 was primarily due to increased net interest
income and decreased net servicing related expense, which were partially offset
by decreased net originations and sales related income.
All increases and decreases referred to below for the third quarter and the
first nine months of 2004 represent comparisons with the same 2003 periods.
Net Interest Income
Increased net interest income for the third quarter and for the first nine
months of 2004 resulted from the mortgage loans acquired from Household and from
originating lenders pursuant to a Household correspondent loan program, and from
increased origination volumes in the held loan portfolio. Other mortgage
portfolio increases were partially offset by lower interest rate spreads on
originated mortgages and lower income on loans held for sale due to reduced
levels of loans originated for sale. Refer to "Originations and Sales Related
Income (Expense)" for further discussion of market factors. Commentary regarding
residential mortgage interest income is presented on pages 26 through 27 of this
Form 10-Q.
Servicing Related Income (Expense)
Decreased net servicing related expense for the third quarter and for the first
nine months of 2004 resulted from increased servicing fee income, decreased MSRs
amortization expense and increased income associated with derivative instruments
used to offset changes in the economic value of MSRs. These were partially
offset by increases in temporary impairment reserves. Normal amortization of
MSRs decreased $25 million for the third quarter and decreased $47 million for
the first nine months of 2004.
32
The recorded net book value of MSRs, as well as related MSRs amortization
expense, are directly impacted by levels of residential mortgage prepayments.
Higher levels of prepayments generally increase amortization expense and
decrease the net book value of MSRs. Conversely, lower levels of prepayments
generally decrease amortization expense and increase the net book value of MSRs.
During 2004, prepayments of residential mortgages, mostly in the form of loan
refinancings, have decreased in comparison with 2003 levels. Mortgage rates
generally rose in the second quarter of 2004 from the historically low rates
experienced in 2003, but declined in the third quarter of 2004. Loan refinance
activity represented 52% of total originations through the first nine months of
2004, as compared with 78% in the first nine months of 2003. The reduction in
amortization is also partially due to lower MSRs balances in 2004, as compared
with 2003.
The positive impacts on amortization and trading revenue for 2004 were offset by
increases in the temporary impairment valuation allowance, which resulted from a
combination of lower interest rates and changes resulting from the Company's
ongoing review of assumptions used in its MSRs valuation model. The net
servicing related expense amounts in the tables do not reflect approximately $6
million of unrealized losses, recorded as other comprehensive income, on
available for sale securities used to offset changes in the economic value of
MSRs as well as net interest income of $16 million on these securities.
Additional commentary regarding risk management associated with the MSRs hedging
program is presented on pages 51 through 52 of this Form 10-Q.
Originations and Sales Related Income (Expense)
The overall decrease in originations and sales related income in the first nine
months of 2004 reflects decreased gains realized on sales of mortgages due
mainly to significantly lower volume of loans originated with the intention to
sell as well as lower gains recorded on each sale transaction. During the first
nine months of 2004, residential mortgages originated with the intention to sell
declined 66% from the same 2003 period, as a direct result of lower mortgage
refinancings and a larger proportion of adjustable rate mortgage originations in
2004, which are generally held on the Bank's balance sheet. In the low interest
rate environment that existed prior to 2004, customers tended to refinance with
fixed rate loans, which are generally sold. As interest rates have risen during
2004, and refinancing activity has decreased, origination of fixed rate loans
originated for sale also has decreased.
General market conditions and industry factors have affected the ability of
lenders to recognize the same level of gains in 2004 when compared to 2003.
During 2003, the market demand for residential mortgages far outweighed the
supply of such mortgages originated by lenders, which drove up pricing and
associated gains recorded on the sales. During 2004, due to lower mortgage
refinancings and a contracting national mortgage originations market, the demand
has weakened relative to supply, which in turn has returned pricing to more
normalized levels and net gains associated with sales of mortgages. Secondary
market gains on sales now reflect a more normalized environment when compared
with unusually high levels of 2003.
The adoption of Securities and Exchange Commission (SEC) Staff Accounting
Bulletin No. 105, Applications of Accounting Principles to Loan Commitments (SAB
105), effective April 1, 2004, also decreased originations and sales related
income by approximately $22 million in the first nine months of 2004. This
income is expected to be realized in future reporting periods.
Trading Revenues
Trading revenues are generated by the Company's participation in the foreign
exchange, credit derivative and precious metals markets; from trading derivative
contracts, including interest rate swaps and options; and from trading
securities. Trading revenues related to the mortgage banking business are
included in residential mortgage banking revenue. See analysis of residential
mortgage banking revenue for details.
The following tables present trading related revenues by business for the three
months and nine months ended September 30, 2004 and 2003. The data in the table
includes interest income earned on trading instruments, net of allocated funding
cost associated with the trading positions. The net interest income component is
included in net interest income on the consolidated statement of income.
33
- --------------------------------------------------------------------------------
Increase (Decrease)
Three months ended September 30 2004 2003 Amount %
- -------------------------------------------------------------------------------
(in millions)
Trading revenues ............... $ 21 $ 52 $ (31) (59.6)
Net interest income ............ 24 18 6 33.3
------- ------- ------- -------
Trading related revenues ....... $ 45 $ 70 $ (25) (35.7)
======= ======= ======= =======
Business:
Derivatives and treasury ..... $ 2 $ 23 $ (21) (91.3)
Foreign exchange ............. 27 32 (5) (15.6)
Precious metals .............. 11 13 (2) (15.3)
Other trading ................ 5 2 3 150.0
------- ------- ------- -------
Trading related revenues ....... $ 45 $ 70 $ (25) (35.7)
======= ======= ======= =======
- --------------------------------------------------------------------------------
Increase (Decrease)
Nine months ended September 30 2004 2003 Amount %
- -------------------------------------------------------------------------------
(in millions)
Trading revenues ............... $ 188 $ 212 $ (24) (11.3)
Net interest income ............ 61 64 (3) (4.7)
------- ------- ------- -------
Trading related revenues ....... $ 249 $ 276 $ (27) (9.8)
======= ======= ======= =======
Business:
Derivatives and treasury ..... $ 103 $ 138 $ (35) (25.4)
Foreign exchange ............. 90 70 20 28.6
Precious metals .............. 39 52 (13) (25.0)
Other trading ................ 17 16 1 6.3
------- ------- ------- -------
Trading related revenues ....... $ 249 $ 276 $ (27) (9.8)
======= ======= ======= =======
All increases and decreases referred to below for the third quarter and the
first nine months of 2004 represent comparisons with the same 2003 periods.
Derivatives and Treasury
Derivatives trading revenue decreased significantly in the third quarter and in
the first nine months of 2004. Derivatives business lines were negatively
impacted by decreased customer activity due primarily to a lower interest rate
environment.
Foreign Exchange
Although revenue decreased slightly in the third quarter of 2004, the first nine
months of 2004 was highlighted by improved foreign currency and banknotes
trading results. 2003 trading activity was negatively impacted by the SARS scare
and by the war in Iraq. 2004 activity reflects increased levels of customer
activity and improved proprietary results.
Precious Metals
Decreased precious metals trading revenue in the third quarter and the first
nine months of 2004 was primarily due to a significant default by a customer in
Australia. Partially offsetting the loss in Australia were improved results in
other domestic and foreign locations, driven by higher customer activity
resulting from enhanced marketing efforts, and by higher proprietary revenue.
34
Security Gains, Net
The following tables present realized security gains and losses included in the
income statement for the three months and nine months ended September 30, 2004
and 2003.
- --------------------------------------------------------------------------------------------------------------
2004 2003
---------------------------------- ----------------------------------
Gross Gross Net Gross Gross Net
Realized Realized Realized Realized Realized Realized
Gains (Losses) Gains Gains (Losses) Gains
- --------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30
Net security gains included in:
Residential mortgage banking
related revenue ................. $ -- $ -- $ -- $ 7 $ -- $ 7
Security gains, net .............. 19 (1) 18 2 -- 2
------ ------ ------ ------ ------ ------
$ 19 $ (1) $ 18 $ 9 $ -- $ 9
====== ====== ====== ====== ====== ======
Nine months ended September 30
Net security gains included in:
Residential mortgage banking
related revenue ................. $ 8 $ -- $ 8 $ 22 $ -- $ 22
Security gains, net .............. 66 (7) 59 57 (6) 51
------ ------ ------ ------ ------ ------
$ 74 $ (7) $ 67 $ 79 $ (6) $ 73
====== ====== ====== ====== ====== ======
Net realized gains on sales of available for sale securities increased $9
million in the third quarter and decreased $6 million in the first nine months
of 2004, as compared to the same 2003 periods. Third quarter 2004 activity was
highlighted by gains from sale of various debt, equity and asset backed
securities, in anticipation of a downturn in long term interest rates. Proceeds
of these sales were generally reinvested in U.S. Government agency sponsored
securities.
In the first nine months of 2004, security sales volume was significantly lower
than the same 2003 period, due to the rising interest rate environment.
Operating Expenses
The following table presents the components of operating expenses for the three
and nine months ended September 30, 2004 and 2003. For presentation purposes,
amounts paid to HSBC group entities have been excluded from functional expense
categories as included within the consolidated statement of income, and are
presented as "HSBC group charges" in the table below.
- -------------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
Three months ended September 30 2004 2003 Amount %
- -------------------------------------------------------------------------------------------
(in millions)
Salaries and employee benefits ............. $ 219 $ 291 $ (72) (24.7)
Occupancy expense, net ..................... 43 42 1 2.4
Other expenses:
Equipment and software ................... 26 38 (12) (31.6)
Marketing ................................ 13 10 3 30.0
Outside services ......................... 24 30 (6) (20.0)
Professional fees ........................ 14 18 (4) (22.2)
Telecommunications ....................... 4 11 (7) (63.6)
Postage, printing and office supplies .... 6 7 (1) (14.3)
Insurance business ....................... 6 9 (3) (33.3)
HSBC group charges ....................... 99 42 57 135.7
Other .................................... 26 25 1 4.0
------- ------- ------- -------
Total other expenses ..................... 218 190 28 14.7
------- ------- ------- -------
Total operating expenses ................... $ 480 $ 523 $ (43) (8.2)
======= ======= ======= =======
Personnel - average number ................. 11,108 13,466 (2,358) (17.5)
35
- --------------------------------------------------------------------------------------------
Increase (Decrease)
---------------------
Nine months ended September 30 2004 2003 Amount %
- --------------------------------------------------------------------------------------------
(in millions)
Salaries and employee benefits ............. $ 714 $ 851 $ (137) (16.1)
Occupancy expense, net ..................... 124 121 3 2.5
Other expenses:
Equipment and software ................... 83 106 (23) (21.7)
Marketing ................................ 34 30 4 13.3
Outside services ......................... 74 81 (7) (8.6)
Professional fees ........................ 35 41 (6) (14.6)
Telecommunications ....................... 13 30 (17) (56.7)
Postage, printing and office supplies .... 18 22 (4) (18.2)
Insurance business ....................... 17 25 (8) (32.0)
HSBC group charges ....................... 291 103 188 182.5
Other .................................... 86 90 (4) (4.4)
------- ------- ------- -------
Total other expenses ..................... 651 528 123 23.3
------- ------- ------- -------
Total operating expenses ................... $ 1,489 $ 1,500 $ (11) (.7)
======= ======= ======= =======
Personnel - average number ................. 11,634 13,513 (1,879) (13.9)
All increases and decreases referred to below for the third quarter and the
first nine months of 2004 represent comparisons with the same 2003 periods.
Overview
Total operating expenses decreased $43 million (8%) in the third quarter and
decreased $11 million (1%) in the first nine months of 2004. Increases in
various HSBC group charges were offset by a decrease in salaries and employee
benefits, and by general decreases in several other expense categories.
During 2003, certain equipment finance, commercial finance and U.S. factoring
businesses were sold. In addition, during 2004, certain domestic and foreign
operations were sold or transferred to affiliated HSBC group entities at fair
value. These transactions effectively decreased operating expenses by
approximately $36 million and $52 million in the third quarter and the first
nine months of 2004, respectively.
HSBC group charges include amounts paid to various HSBC group entities for
information technology, loan origination and servicing, administrative and other
operational support. During 2003 and into 2004, HSBC instituted certain
organizational changes that resulted in employees and other aspects of
operations being transferred to other HSBC group entities in North America.
These other HSBC group entities in turn charge for services in accordance with
service level agreements. These organizational changes have impacted the amounts
recorded in various functional expense categories included in operating expenses
on the consolidated statement of income. Direct expenses previously recorded in
"salaries and employee benefits" and "occupancy expense, net" on the
consolidated statement of income for 2003 are now recorded in "other expenses"
for 2004. As a result, in the preceding table, the increase in HSBC group
charges, as well as the decreases for salaries and employee benefits, equipment
and software, and telecommunications expenses, primarily resulted from these
organizational changes. Additional details regarding HSBC group charges are
presented in Note 9 of the consolidated financial statements on pages 13 through
15 of this Form 10-Q.
Total other expenses have increased in the first nine months of 2004 primarily
due to increased charges by affiliated HSBC group entities for technology
related, debt underwriting, broker-dealer, loan origination and servicing and
other administrative services.
During the remainder of 2004, the Company plans to maintain a relatively flat
operating expense base while supporting new business initiatives and developing
information systems conversions/upgrades. Continued benefit is expected from
expense reduction initiatives, begun in 2003, including Household related
synergies and global resourcing.
36
Ongoing business initiatives for the remainder of 2004 include:
- - hiring relationship managers and staff and opening new offices to support
commercial middle market, small business and commercial real estate
expansion
- - growing the emerging markets derivatives business
- - supporting planned expansion of our corporate investment banking business
- - opening new retail branches in selected growth markets
Increased costs for independent audit fees and costs for implementing a
Sarbanes-Oxley Section 404 compliance environment have been recorded in the
first nine months of 2004 and are expected to continue through year end.
Salaries and Employee Benefits
The decrease in salaries and employee benefits in the third quarter and in the
first nine months of 2004 was primarily due to the transfer of employees to
affiliated HSBC group entities, to sales of various commercial lending business
units in 2003, and to the sales or transfers of various subsidiaries to
affiliated HSBC entities during 2004, as previously described. Additional
decreases in salaries have resulted from ongoing efforts to integrate and
centralize operations of various departments with those of Household. As a
result of the organizational changes and other efforts, the average number of
personnel employed directly by the Company has decreased during 2004, as
compared with 2003.
HSBC Group Charges
Fees are charged by various related HSBC group entities for technology services,
for underwriting and broker-dealer services, for loan origination and servicing,
and for other operational and administrative support functions. As noted above,
a significant number of employees were transferred to these entities during
2004. Fees charged by these entities in accordance with various service level
agreements either began on January 1, 2004, or have increased during the year
due to expansion of the services they provide. Technology related expenses have
increased during 2004 as the Company has continued to upgrade its automated
technology environment. Debt underwriting expenses have increased in 2004 due to
a significant increase in debt issuances from the Company's new Global Bank Note
Program. Origination and servicing expenses have increased due to increased
services provided by Household related to residential mortgages and other
consumer loans.
Subject to regulatory approval, certain private label credit card receivables
are expected to be purchased from Household by year end. Residual interests in
certain securitized private label credit card receivable pools will also be
acquired. Household will maintain the related customer relationships for the
receivables purchased, and charge the Company for ongoing servicing of the
accounts. The timing of regulatory approval, and therefore the timing of the
asset transfers, cannot be predicted with any degree of certainty.
37
BUSINESS SEGMENTS
Business segments are managed consistently with the line of business groupings
used by HSBC. The segments are based upon customer groupings and products and
services offered. These segments are described on page 30 of the 2003 Form 10-K.
Prior period disclosures previously reported for 2003 have been conformed herein
to the presentation of current segments, including methodology changes related
to the transfer pricing of assets and liabilities.
The following tables summarize the results for each segment for the three months
and nine months ended September 30, 2004 and 2003.
- --------------------------------------------------------------------------------------------------------------------------
Corporate,
Personal Investment
Financial Commercial Banking and Private
Services Banking Markets Banking Other Total
- --------------------------------------------------------------------------------------------------------------------------
(in millions)
Three months ended September 30
2004
Net interest income (1) ............... $ 379 $ 148 $ 140 $ 34 $ (3) $ 698
Other revenues ........................ 168 42 102 44 6 362
--------- --------- --------- --------- --------- ---------
Total revenues ........................ 547 190 242 78 3 1,060
Operating expenses (2) ................ 240 79 106 55 -- 480
--------- --------- --------- --------- --------- ---------
Working contribution .................. 307 111 136 23 3 580
Provision for credit losses (3) ....... 24 (13) 6 10 -- 27
--------- --------- --------- --------- --------- ---------
Income before income tax expense ...... $ 283 $ 124 $ 130 $ 13 $ 3 $ 553
========= ========= ========= ========= ========= =========
Average assets ........................ $ 49,490 $ 13,855 $ 47,294 $ 4,261 $ 298 $ 115,198
Average liabilities/equity (4) ........ 34,116 14,608 57,682 8,792 -- 115,198
Goodwill at September 30, 2004 (5) .... 1,155 485 631 428 -- 2,699
2003
Net interest income (1) ............... $ 296 $ 146 $ 162 $ 29 $ (4) $ 629
Other revenues ........................ 16 38 90 55 6 205
--------- --------- --------- --------- --------- ---------
Total revenues ........................ 312 184 252 84 2 834
Operating expenses (2) ................ 234 117 109 63 -- 523
--------- --------- --------- --------- --------- ---------
Working contribution .................. 78 67 143 21 2 311
Provision for credit losses (3) ....... 17 (2) (10) (6) -- (1)
--------- --------- --------- --------- --------- ---------
Income before income tax expense ...... $ 61 $ 69 $ 153 $ 27 $ 2 $ 312
========= ========= ========= ========= ========= =========
Average assets ........................ $ 28,051 $ 14,403 $ 46,140 $ 2,954 $ 281 $ 91,829
Average liabilities/equity (4) ........ 31,376 13,483 38,690 8,280 -- 91,829
Goodwill at September 30, 2003 (5) .... 1,223 534 631 428 -- 2,816
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses. Credit loss
reserves are established at a level sufficient to absorb the losses
considered to be inherent in the portfolio.
(4) Common shareholder's equity and earnings on common shareholder's equity
are allocated back to the segments based on the percentage of capital
assigned to the business.
(5) The reduction in goodwill from September 30, 2003 to September 30, 2004
resulted from the sale or transfer of certain domestic and foreign
operations during the fourth quarter of 2003 and the first nine months of
2004.
38
- -------------------------------------------------------------------------------------------------------------------
Corporate,
Personal Investment
Financial Commercial Banking and Private
Services Banking Markets Banking Other Total
- -------------------------------------------------------------------------------------------------------------------
(in millions)
Nine months ended September 30
2004
Net interest income (1) ............. $ 1,081 $ 434 $ 439 $ 95 $ (8) $ 2,041
Other revenues ...................... 308 126 387 157 17 995
-------- -------- -------- -------- -------- --------
Total revenues ...................... 1,389 560 826 252 9 3,036
Operating expenses (2) .............. 718 249 346 176 -- 1,489
-------- -------- -------- -------- -------- --------
Working contribution ................ 671 311 480 76 9 1,547
Provision for credit losses (3) ..... 69 (8) (54) -- -- 7
-------- -------- -------- -------- -------- --------
Income before income tax expense .... $ 602 $ 319 $ 534 $ 76 $ 9 $ 1,540
======== ======== ======== ======== ======== ========
Average assets ...................... $ 42,805 $ 13,500 $ 46,514 $ 3,899 $ 298 $107,016
Average liabilities/equity (4) ...... 33,060 14,128 50,809 9,019 -- 107,016
2003
Net interest income (1) ............. $ 892 $ 447 $ 467 $ 89 $ (12) $ 1,883
Other revenues ...................... 188 117 397 152 19 873
-------- -------- -------- -------- -------- --------
Total revenues ...................... 1,080 564 864 241 7 2,756
Operating expenses (2) .............. 692 316 311 181 -- 1,500
-------- -------- -------- -------- -------- --------
Working contribution ................ 388 248 553 60 7 1,256
Provision for credit losses (3) ..... 51 34 7 (6) -- 86
-------- -------- -------- -------- -------- --------
Income before income tax expense .... $ 337 $ 214 $ 546 $ 66 $ 7 $ 1,170
======== ======== ======== ======== ======== ========
Average assets ...................... $ 27,950 $ 14,225 $ 45,538 $ 2,872 $ 281 $ 90,866
Average liabilities/equity (4) ...... 30,913 13,251 38,598 8,104 -- 90,866
(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.
All increases and decreases referred to below for the third quarter and the
first nine months of 2004 represent comparisons with the same 2003 periods.
Personal Financial Services
Income before income tax expense increased $222 million (364%) in the third
quarter and increased $265 million (79%) in the first nine months of 2004. For
both reporting periods, significant increases in net interest income and other
revenues were partially offset by increases in operating expenses and provision
for credit losses.
Net interest income increased $83 million (28%) in the third quarter and
increased $189 million (21%) in the first nine months of 2004, primarily due to
increased residential mortgage and other consumer loan balances. Further
analysis of increases in residential mortgage loans and other consumer loans is
presented on pages 26-27 of this Form 10-Q.
Other revenues increased $152 million (950%) in the third quarter and increased
$120 million (64%) in the first nine months of 2004. Third quarter and nine
month 2004 activity was highlighted by a $99 million gain on sale of certain
credit card relationships to an affiliated HSBC entity, and a $45 million gain
on sale of an equity investment.
39
Other revenues also include non-interest mortgage banking revenue, which
increased by $10 million in the third quarter of 2004 and decreased by $25
million in the first nine months of 2004. Analysis of residential mortgage
banking related revenue is presented on pages 31-33 of this Form 10-Q.
Operating expenses increased $6 million (3%) in the third quarter and increased
$26 million (4%) in the first nine months of 2004, primarily due to increased
salary costs associated with the expansion of the residential mortgage business.
The loan origination and servicing workforces have been increased during 2004 to
accommodate business growth. Increased technology related costs also have
contributed to overall expense increases. Decreases in expenses resulting from
sales or transfers of certain subsidiaries to affiliated HSBC group entities
during 2004 partially offset the overall expense increases.
The provision for credit losses increased $7 million (41%) in the third quarter
and increased $18 million (35%) in the first nine months of 2004, primarily due
to increases in the allowance and provision for credit losses associated with
the growing residential mortgage portfolio.
Commercial Banking
Income before income tax expense increased $55 million (80%) in the third
quarter and increased $105 million (49%) in the first nine months of 2004.
During 2002 and 2003, certain equipment finance, commercial finance and U.S.
factoring business lines were exited or restructured resulting in office
closings and sales of customer relationships. Certain receivables associated
with these businesses were retained and have been decreasing throughout 2003 and
2004 as balances have run off. As a result of these transactions, reported
amounts for the first nine months of 2003 for net interest income, operating
expenses, and provision for credit losses all exceeded 2004 amounts.
Net interest income increased $2 million in the third quarter and decreased $13
million in the first nine months of 2004. Excluding the effect of the commercial
business sale transactions noted above, net interest income associated with the
remaining commercial loan portfolios increased moderately in the third quarter
and in the first nine months of 2004. 2004 has been highlighted by increases in
commercial loan balances in remaining portfolios as well as increased commercial
core deposit balances, especially in downstate New York. More favorable interest
spreads associated with growing commercial loans and related core deposit
balances also contributed to the overall increase in net interest income.
Operating expenses decreased $38 million (32%) in the third quarter and
decreased $67 million (21%) in the first nine months of 2004. Excluding the
impact of the commercial business sale transactions noted above, operating
expenses associated with remaining commercial lending operations decreased
approximately $26 million in the third quarter and decreased approximately $39
million in the first nine months of 2004. The first nine months of 2004 has been
highlighted by lower corporate cost allocations for employee benefits and
restructuring expenses, and lower allocation of expenses from central units
including credit and deposit services.
The provision for credit losses decreased $11 million in the third quarter and
decreased $42 million in the first nine months of 2004. Excluding the effect of
the commercial business sale transactions noted above, the provision for credit
losses associated with the remaining commercial loan portfolios decreased
approximately $10 million in the third quarter and decreased approximately $22
million in the first nine months of 2004. The decrease in the provision for
credit losses is due to general improvement in commercial credit quality, as
evidenced by decreased nonaccruing loan balances, decreased criticized asset
balances, decreased charge offs of commercial loan balances, and increased
recoveries of commercial loans previously charged off.
40
Corporate, Investment Banking and Markets
Income before income tax expense decreased $23 million (15%) in the third
quarter and decreased $12 million (2%) in the first nine months of 2004.
Net interest income decreased $22 million (14%) in the third quarter and
decreased $28 million (6%) in the first nine months of 2004, primarily due to
significantly increased interest paid on growing short-term borrowing and
long-term debt balances for both reporting periods. Net interest rate spreads
associated with earning assets and paying liabilities also tightened during the
third quarter of 2004, contributing to the overall quarter and year-to-date
decreases.
Other revenues increased $12 million (13%) in the third quarter of 2004, as
increased net gains on sales of available for sale investment securities, and
increases in various credit-related and other fees, were partially offset by
decreased non-interest trading revenues.
Other revenues decreased $10 million (3%) in the first nine months of 2004.
Decreased trading revenues were partially offset by increased gains on sales of
securities, and increases in various credit-related and other fees.
Operating expenses decreased $3 million (3%) in the third quarter and increased
$35 million (11%) in the first nine months of 2004. Expense increases in the
first nine months of 2004 reflect increased technology related costs, increased
incentive compensation expenses and increased fees charged by affiliated HSBC
group entities for brokerage and underwriting services. Third quarter expenses
reflected lower technology expenses and incentive compensation expenses, as
compared to previous 2004 quarters, as well as a decrease in the provision for
off-balance sheet credit exposures, as compared with the same 2003 quarter.
The provision for credit losses increased $16 million (160%) in the third
quarter, but decreased $61 million (871%) in the first nine months of 2004. The
year-to-date decrease in the provision reflects continuation of improvement in
credit quality associated with commercial loan portfolios, as evidenced by
decreased charge offs of loans and increased recoveries of loans previously
charged off.
Private Banking
Income before income tax expense decreased $14 million (52%) in the third
quarter, and increased $10 million (15%) in the first nine months of 2004.
During the third quarter of 2003, a one time gain was recognized on the sale of
private banking operations in a foreign subsidiary of the Bank. In addition,
specific loan charge offs increased in the third quarter of 2004, leading to an
increase in provision expense.
41
CREDIT QUALITY
The following table provides a summary of credit quality statistics for the past
five quarters.
- -----------------------------------------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30,
2004 2004 2004 2003 2003
- -----------------------------------------------------------------------------------------------------------------
(in millions)
Nonaccruing loans
Balance at end of period:
Commercial ....................... $ 160 $ 185 $ 231 $ 235 $ 222
Consumer ......................... 114 99 87 93 96
International .................... 16 15 11 38 30
-------- -------- -------- -------- --------
Total ............................ $ 290 $ 299 $ 329 $ 366 $ 348
======== ======== ======== ======== ========
As a percent of loans:
Commercial ....................... .89% 1.11% 1.44% 1.49% 1.29%
Consumer ......................... .25 .24 .26 .32 .40
International .................... .53 .44 .31 1.11 .82
Total ............................ .43 .48 .63 .76 .77
Criticized assets
Balance at end of period:
Special mention .................. $ 734 $ 673 $ 707 $ 618 $ 637
Substandard ...................... 383 532 632 682 676
Doubtful ......................... 67 66 87 128 129
-------- -------- -------- -------- --------
Total ............................ $ 1,184 $ 1,271 $ 1,426 $ 1,428 $ 1,442
======== ======== ======== ======== ========
Impaired loans
Balance at end of period ......... $ 252 $ 281 $ 314 $ 267 $ 240
Amount with impairment reserve ... 233 263 296 179 161
Impairment reserve ............... 38 38 61 86 91
Overview
Unless otherwise noted, all increases and decreases referred to below for the
third quarter and the first nine months of 2004 represent comparisons with the
same 2003 periods.
The allowance for credit losses was $340 million at September 30, 2004. The
allowance has decreased $59 million (15%) from December 31, 2003, and has
decreased $95 million (22%) from September 30, 2003. Reductions in the allowance
attributable to domestic commercial loans and loans recorded in foreign offices
were partially offset by moderate increases in the allowance attributed to
domestic consumer loans. Changes in the allowance for credit losses are
summarized in Note 4 of the consolidated financial statements on page 10 of this
Form 10-Q.
The provision for credit losses increased $28 million in the third quarter of
2004. Increased provisions were recorded during the quarter for domestic
commercial and consumer loan portfolios, as well as for loans in foreign
offices.
The provision for credit losses decreased $79 million in the first nine months
of 2004. Significantly reduced provisions associated with domestic commercial
loan portfolios were partially offset by increases in provisions associated with
domestic consumer loan portfolios.
The third quarter and the first nine months of 2004 were highlighted by
continued improvement in commercial credit quality, as evidenced by decreased
commercial loan charge offs and increased recoveries of commercial loan balances
previously charged off.
42
Commercial Credit Quality
The allowance for credit losses associated with commercial loan portfolios
remained relatively constant during the third quarter of 2004, and has decreased
significantly from December 31, 2003 and September 30, 2003 amounts. The
provision for credit losses associated with commercial loans also has decreased
significantly in the first nine months of 2004. The overall 2004 decreases in
the allowance and in the provision for credit losses are due to continued
improvement of credit quality associated with commercial loan portfolios, as
evidenced by decreased nonaccruing loan balances, decreased criticized asset
balances, decreased charge offs of commercial loan balances, and increased
recoveries of balances previously charged off. These improvements resulted
partially from the strategy to exit various commercial lending relationships,
which have not provided acceptable levels of profitability to offset associated
credit risk, and partially from continued improvement in economic conditions,
which have resulted in pay downs on problem loans and upgrades of criticized
assets. The improving economic environment also presented opportunities to sell
certain criticized assets during 2004 at favorable prices to third parties
resulting in the release of certain loan loss reserves and recoveries of
previously recorded charge offs.
Although there are numerous economic and geopolitical factors that can impact
credit quality, it is anticipated that the recent trend of improved credit
quality will continue throughout the remainder of 2004. Key economic indicators,
consumer confidence, and corporate performance, as well as governmental and
private sector spending priorities and political events will continue to be
closely monitored.
Consumer Credit Quality
The allowance for credit losses associated with domestic consumer loan
portfolios increased slightly during the third quarter of 2004, continuing a
recent trend toward moderate growth in the allowance balance. Increases in the
allowance for credit losses and in the provision for credit losses during 2004
were directly attributable to increasing consumer loan balances, particularly
residential mortgages. Although nonaccruing consumer loans have increased during
2004, the percentage of nonaccruing loans to total consumer loans has decreased,
indicating that the additional loans have not had a significant impact on
overall credit quality.
On December 31, 2003 $2.8 billion of residential mortgage loan assets were
purchased at fair value from Household. On March 31, 2004, approximately $900
million of additional residential mortgage loan assets at fair value were also
purchased from Household. In addition, approximately $2.2 billion of loans have
been purchased from originating lenders during the first nine months of 2004
pursuant to a Household correspondent loan program. The purchase of these loans
effectively increased the allowance for credit losses by approximately $6
million as of September 30, 2004. Continued utilization of Household services
for origination of residential mortgage loans is planned for the remainder of
2004. The credit quality of all such loans will be closely monitored.
Subject to regulatory approval, certain private label credit card receivables
are expected to be purchased from Household by year end. Residual interests in
certain securitized private label credit card receivable pools will also be
acquired. The portfolio to be purchased is considered to be prime credit
quality, with receivables originated through more than 60 merchant
relationships. Credit losses associated with the portfolio have ranged from
5%-6% over the past few years. Credit losses are expected to improve modestly in
future periods due to new credit management initiatives recently implemented by
Household. The timing of regulatory approval, and therefore the timing of the
asset transfers, cannot be predicted with any degree of certainty. On the date
of the transfer, the allowance for credit losses to be transferred from
Household will be considered adequate to cover expected losses on the purchased
portfolio.
International Credit Quality
During the first nine months of 2004, the allowance for credit losses, the
provision for credit losses, and total nonaccruing loans associated with foreign
operations of the Company have all decreased. The transfer of certain foreign
operations in Uruguay and Panama to affiliated companies, combined with payments
received from customers on certain foreign nonaccruing loans, contributed to the
overall decreases.
43
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company is party to various derivative financial instruments as an end user,
as an international dealer in derivative instruments, and for purely trading
purposes in order to realize profits from short-term movements in interest
rates, commodity prices, foreign exchange rates and credit spreads. Additional
information regarding the use of various derivative instruments is included on
pages 98 and 99 of the 2003 Form 10-K.
Notional Values of Derivative Contracts
The following table summarizes the notional values of derivative contracts.
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards ......................... $ 92,743 $ 107,646
Swaps ........................................ 979,301 625,670
Options written .............................. 126,996 161,824
Options purchased ............................ 105,272 197,081
----------- -----------
1,304,312 1,092,221
----------- -----------
Foreign exchange:
Swaps, futures and forwards .................. 205,386 147,741
Options written .............................. 42,002 16,583
Options purchased ............................ 42,804 16,769
Spot ......................................... 35,443 14,320
----------- -----------
325,635 195,413
----------- -----------
Commodities, equities and precious metals:
Swaps, futures and forwards .................. 40,640 33,897
Options written .............................. 9,751 7,048
Options purchased ............................ 9,018 7,081
Credit derivatives ........................... 97,991 31,302
----------- -----------
157,400 79,328
----------- -----------
Total .......................................... $ 1,787,347 $ 1,366,962
=========== ===========
Credit and Market Risk Associated with Derivative Contracts
The notional value of derivative contracts only provides an indicator of the
transaction volume in these types of instruments. It does not represent exposure
to market or credit risks under these contracts.
Credit (or repayment) risk in derivative instruments is minimized by entering
into transactions with high quality counterparties including other HSBC group
entities. Counterparties include financial institutions, government agencies,
both foreign and domestic, corporations, funds (mutual funds, hedge funds,
etc.), insurance companies and private clients. These counterparties are subject
to regular credit review by the credit risk management department. Most
derivative contracts are governed by an International Swaps and Derivatives
Association Master Agreement. Depending on the type of counterparty and the
level of expected activity, bilateral collateral arrangements may be required as
well.
The following table presents credit risk exposure and net fair value associated
with derivative contracts. Total fair value of derivative receivables reflects
revaluation gains from the "marking to market" of derivative contracts held for
trading purposes, for all counterparties with an International Swaps and
Derivatives Association Master Agreement in place. The net fair value of all
derivative contracts represents the total fair value described above, less the
net liability balance representing revaluation losses from the "marking to
market" of derivative contracts held for trading purposes.
44
- ------------------------------------------------------------------------------------------------
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(in millions)
Credit risk exposure associated with derivative contracts:
Total fair value of derivative receivables ................... $ 7,164 $ 7,653
Collateral held against exposure ............................. (2,027) (2,580)
--------- ---------
Net credit risk exposure ....................................... $ 5,137 $ 5,073
========= =========
Net fair value of all derivative contracts ..................... $ (1,165) $ (566)
--------- ---------
OFF-BALANCE SHEET ARRANGEMENTS
The following table provides information at September 30, 2004 related to the
off-balance sheet arrangements and lending and sales commitments. Descriptions
of these arrangements are found on pages 44-45 of the 2003 Form 10-K.
- --------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
September 30, 2004 or Less Five Years Years Total
- --------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations .... $ 3,381 $ 1,623 $ 104 $ 5,108(1)
Loan sales with recourse ............................ -- 2 10 12(2)
Credit derivative contracts ......................... 1,886 45,410 7,567 54,863(3)
Securities lending indemnifications ................. 3,717 -- -- 3,717
--------- --------- --------- ---------
Total ............................................... $ 8,984 $ 47,035 $ 7,681 $ 63,700
========= ========= ========= =========
(1) Includes $370 million issued for the benefit of related parties.
(2) $9 million of this amount is indemnified by third parties.
(3) Includes $7,529 million issued for the benefit of related parties.
Standby Letters of Credit
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Included in other
liabilities are deferred fees on standby letters of credit, representing the
fair value of the "stand ready obligation to perform" under these guarantees,
amounting to $14 million and $12 million at September 30, 2004 and December 31,
2003 respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit of $19 million and $25 million at
September 30, 2004 and December 31, 2003 respectively.
Credit Derivative Contracts
The Company enters into credit derivative contracts both for its own benefit and
to satisfy the needs of our customers. Credit derivatives are arrangements that
provide for one party (the "beneficiary") to transfer the credit risk of a
"reference asset" to another party (the "guarantor"). Under this arrangement the
guarantor assumes the credit risk associated with the reference asset without
directly purchasing it. The beneficiary agrees to pay to the guarantor a
specified fee. In return, the guarantor agrees to pay the beneficiary an agreed
upon amount if there is a default during the term of the contract.
Virtually all of the market risk assumed in selling credit guarantees through
credit derivative contracts is offset with another counterparty. Credit
derivatives, although having characteristics of a guarantee, are accounted for
as derivative instruments and are carried at fair value. The commitment amount
included in the table above is the maximum amount that the Company could be
required to pay, without consideration of the approximately equal amount
receivable from third parties and any associated collateral.
45
Securities Lending Indemnifications
The Company may lend securities of customers, on a fully collateralized basis,
as an agent to third party borrowers. Customers are indemnified against the risk
of loss, and collateral is obtained from the borrower with a market value
exceeding the value of the loaned securities. At September 30, 2004, the fair
value of that collateral was approximately $3,803 million.
SPECIAL PURPOSE AND VARIABLE INTEREST ENTITIES
The provisions of Financial Accounting Standards Board issued Interpretation No.
46 Revised, Consolidation of Variable Interest Entities (FIN 46R) were adopted
as of March 31, 2004. At September 30, 2004, none of the Variable Interest
Entities (VIEs) that the Company is involved with are required to be
consolidated under FIN 46R.
The following table provides information for unconsolidated VIEs at September
30, 2004. Descriptions of these VIE relationships are included in pages 45-47 of
the 2003 Form 10-K. During 2004, the Company revised the descriptive titles
associated with various VIEs. In the following table, the former titles, as
described in the 2003 Form 10-K, are presented parenthetically.
- -------------------------------------------------------------------------------------------------------------
Maximum
Total Exposure
Assets to Loss
- -------------------------------------------------------------------------------------------------------------
(in millions)
Asset backed commercial paper conduit (formerly, commercial paper conduit) ......... $ 2,524 $ 3,900
Securitization vehicles (formerly, trust certificates) ............................. 1,092 556
Investment funds (formerly, hedge funds) ........................................... 3,949 103
Capital funding vehicles (formerly, trust preferred securities) .................... 1,105 32
Low income housing tax credits (formerly, investments in limited partnerships) ..... 882 71
-------- --------
Total .............................................................................. $ 9,552 $ 4,662
======== ========
CAPITAL
The following table presents the capital ratios of the Company and the Bank
calculated in accordance with banking regulations. To be categorized as
"well-capitalized" under the Federal Reserve Board and Federal Deposit Insurance
Corporation guidelines, a banking institution must have the minimum ratios
reflected in the table, and must not be subject to a directive, order, or
written agreement to meet and maintain specific capital levels.
- --------------------------------------------------------------------------------------------------------
"Well-Capitalized" September 30, December 31,
Minimum 2004 2003
- --------------------------------------------------------------------------------------------------------
Total capital (to risk weighted assets)
Company........................................... 10.00% 11.87% 12.42%
Bank.............................................. 10.00 11.69 11.82
Tier 1 capital (to risk weighted assets)
Company........................................... 6.00 8.00 8.53
Bank.............................................. 6.00 8.49 8.99
Tier 1 capital (to average assets)
Company........................................... 3.00 5.96 5.87
Bank.............................................. 5.00 6.36 6.22
Tangible common equity (to risk weighted assets)
Company........................................... 6.37 6.39
Bank.............................................. 8.53 9.07
Capital ratios have generally declined in relation to risk-weighted assets
during 2004, due primarily to increases in consumer loan balances, off-balance
sheet unused loan commitments, and derivatives activity. Tier 1 capital of $400
million was contributed to the Company and the Bank during the third quarter of
2004 in support of continuing growth in risk-weighted assets. Capital ratios are
expected to remain substantially in excess of "well-capitalized" minimums in
support of continued on-balance sheet and off-balance sheet growth planned for
the remainder of 2004 and for 2005.
46
RISK MANAGEMENT
Liquidity Management
The approach to address liquidity risk and to meet funding requirements is
summarized on pages 51-53 of the 2003 Form 10-K. During 2004, the Company's
liquidity management approach was supplemented by increased long-term debt
issuances to third parties, and potential asset sales (i.e. residential mortgage
loans) in liquidity contingency plans. In addition, the Company is now planning
its funding and liquidity management in conjunction with Household, as the
markets increasingly view debt issuances from the separate companies within the
context of their common parent company.
In October 2004, Moody's Investors Service (Moody's) raised the long-term credit
rating for the Company from A1 to Aa3. During the third quarter, Moody's raised
the long-term credit rating for the Bank from Aa3 to Aa2 and Fitch Ratings
raised the long-term credit rating from AA- to AA for both the Company and Bank.
The long-term credit ratings from Standard & Poors are unchanged from December
31, 2003.
The Company and the Bank periodically issue debt instruments to fund balance
sheet growth, to meet cash and capital needs, or to fund investments in
subsidiaries. See Note 7 to the financial statements on pages 12 and 13 of this
Form 10-Q for an analysis of 2004 long-term debt activity. In June 2004, the
Bank finalized a $10 billion Global Bank Note Program for the issuance of
subordinated and senior global notes. In September 2004, this program was
expanded to $20 billion to allow for further opportunity to access the market
for longer term funding of anticipated balance sheet growth. Through September
30, 2004, approximately $6.5 billion of debt has been issued from this program.
In October 2004, an additional $209 million of senior notes and $1 billion of
subordinated notes were issued under the program.
During the third quarter of 2004, the Company increased its short-term
borrowings from affiliated HSBC entities and from the Federal Home Loan Bank
(FHLB) by approximately $1.6 billion and $2.5 billion, respectively.
Subject to regulatory approvals, private label credit card receivables of
approximately $12 billion are expected to be purchased from Household by year
end. Residual interests in securitized private label credit card receivables
pools of approximately $3 billion will also be acquired. The timing of
regulatory approval, and therefore the timing of the asset transfers, cannot be
predicted with any degree of certainty. The portfolio purchase will be funded
through a variety of sources, including new deposit growth, asset
securitizations, borrowings from other Group affiliates, borrowings from the
FHLB, debt issuances from the Global Bank Note Program, and short-term wholesale
markets.
Interest Rate Risk Management
Various techniques are utilized to quantify and monitor risks associated with
the repricing characteristics of the Company's assets, liabilities, and
derivative contracts. The approach toward managing interest rate risk is
summarized on pages 53-56 of the 2003 Form 10-K. During the first nine months of
2004, there were no significant changes in policies or approach for managing
interest rate risk.
Static "gap" measurement of interest rate risk is not used as a primary
management tool. In the course of managing interest rate risk, Present Value of
a Basis Point (PVBP) analysis is utilized in conjunction with a combination of
other risk assessment techniques, including capital at risk, dynamic simulation
modeling, capital risk and Value at Risk (VAR) analyses. The combination of
these tools enables management to identify and assess the potential impact of
interest rate movements and take appropriate action.
Institutional movement limits are established at the beginning of each fiscal
year for each of the assessment techniques discussed below. These limits act as
a guide for managing interest rate risk associated with balance sheet
composition and off-balance sheet hedging strategy (the risk position).
Calculated values within movement limit ranges reflect an acceptable risk
position, although an unfavorable trend may prompt consideration to adjust on or
off-balance sheet exposure. Calculated values outside of movement limit ranges
will result in consideration of adjustment of the risk position, or
consideration of temporary dispensation from making adjustments.
47
PVBP Analysis
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 and reflects anticipated prepayments based on the current rate
environment. 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.
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 PVBP, which is the
change in value of the balance sheet for a one basis point upward movement in
all interest rates.
The following table reflects the PVBP position at September 30, 2004.
- -------------------------------------------------------------------------------
September 30, 2004
Values
- -------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit ....................... +/- $ 5.0
PVBP position at period end.............................. (.1)
In November 2004, the institutional PVBP movement limit was increased to $6.5
million.
Capital at Risk
The Company also monitors capital at risk, which is the change in base case
valuation of the balance sheet for either a 200 basis point gradual rate
increase or a 100 basis point gradual rate decrease.
The following table reflects the capital at risk position at September 30, 2004.
- ------------------------------------------------------------------------------------------------------------------------
September 30, 2004
Values
- ------------------------------------------------------------------------------------------------------------------------
Institutional capital at risk movement limit........................................................ +/- 10.0%
Projected change in value resulting from a gradual 200 basis point increase in interest rates....... (6.5)
Projected change in value resulting from a gradual 100 basis point decrease in interest rates....... (5.3)
The projected drop in value for a 100 basis point gradual decrease in rates is
primarily related to the anticipated acceleration of prepayments for the held
mortgage and mortgage backed securities portfolios in this lower rate
environment. This assumes that no management actions are taken to manage
exposures to the changing interest rate environment.
48
Dynamic Simulation Modeling
In addition to the previously mentioned limits, the Asset and Liability Policy
Committee (ALCO) uses various modeling techniques to monitor a number of
interest rate scenarios for their impact on net interest income. These
techniques include both rate shock scenarios which assume immediate market rate
movements of 200 basis points, as well as scenarios in which rates rise or fall
by 200 basis points over a twelve month period.
The following table reflects the impact on net interest income of the scenarios
utilized by these modeling techniques.
- ----------------------------------------------------------------------------------------------------------------------------
September 30, 2004 Values
---------------------------
Amount %
- ----------------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net interest income (reflects projected rate movements on
October 1, 2004):
Institutional base earnings movement limit.................................................. +/- 10
Change resulting from a gradual 200 basis point increase in the yield curve ................ $ (2) (3)
Change resulting from a gradual 200 basis point decrease in the yield curve ................ 182 (7)
Other significant scenarios monitored (reflects projected rate movements on October 1, 2004):
Change resulting from an immediate 100 basis point increase in the yield curve ............. (22)
Change resulting from an immediate 100 basis point decrease in the yield curve ............. (59)
Change resulting from an immediate 200 basis point increase in the yield curve ............. (96)
Change resulting from an immediate 200 basis point decrease in the yield curve ............. (211)
Change resulting from an immediate 75-100 basis point decrease in long term rates, and
a decrease of 50 basis points in short-term rates.......................................... (102)
Change resulting from an immediate 100 basis point increase in short-term rates............. (120)
The projections do not take into consideration possible complicating factors
such as the effect of changes in interest rates on the credit quality, size and
composition of the balance sheet. Therefore, although this provides a reasonable
estimate of interest rate sensitivity, actual results will vary from these
estimates, possibly by significant amounts.
Capital Risk
Large movements of interest rates could directly affect some reported capital
and capital ratios. The mark to market valuation of available for sale
securities is credited on a tax effective basis through other comprehensive
income in the consolidated statement of changes in shareholders' equity. This
valuation mark is excluded from Tier 1 and Tier 2 capital ratios but it would be
included in two important accounting based capital ratios: the tangible common
equity to tangible assets and the tangible common equity to risk weighted
assets. As of September 30, 2004, the Company had an available for sale
securities portfolio of approximately $15 billion with a net positive mark to
market of $18 million included in tangible common equity of $5 billion. An
increase of 25 basis points in interest rates of all maturities would lower the
mark to market by approximately $105 million to a net loss of $87 million with
the following results on the tangible capital ratios.
- ------------------------------------------------------------------------------------------
Proforma - Reflecting
25 Basis Points
September 30, 2004 Actual Increase in Rates
- ------------------------------------------------------------------------------------------
Tangible common equity to tangible assets............ 4.51% 4.46%
Tangible common equity to risk weighted assets....... 6.37 6.28
Value at Risk (VAR)
VAR analysis is also used to measure interest rate risk and to calculate the
economic capital required to cover potential losses due to interest risk. The
approach toward using VAR to measure interest rate risk is summarized on pages
55-56 of the Company's 2003 Form 10-K.
49
Trading Activities
Trading portfolios reside primarily in the Treasury and mortgage banking areas
and include foreign exchange, derivatives, precious metals (gold, silver,
platinum), commodities, equities, money market instruments including "repos" and
securities. Trading occurs as a result of customer facilitation, proprietary
position taking, and economic hedging. In this context, economic hedging may
include, for example, forward contracts to sell residential mortgages and
derivative contracts which, while economically viable, may not satisfy the hedge
requirements of SFAS 133.
The trading portfolios have defined limits pertaining to items such as
permissible investments, risk exposures, loss review, balance sheet size and
product concentrations. "Loss review" refers to the maximum amount of loss that
may be incurred before senior management intervention is required.
Trading Activities - Treasury
Value at Risk
Value at Risk (VAR) analysis is relied upon as a basis for quantifying and
managing risks associated with the Treasury 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 on 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.
The following table summarizes trading VAR for 2004, assuming a 99% confidence
level for 500 business days and a 10 day "holding period".
- ----------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2004
September 30, ------------------------------------- December 31,
2004 Minimum Maximum Average 2003
- ----------------------------------------------------------------------------------------------------
(in millions)
Total trading .......... $ 62 $ 26 $ 69 $ 43 $ 23
Commodities ............ 1 1 14 4 --
Credit derivatives ..... 20 3 20 4 4
Equities ............... -- -- 1 1 1
Foreign exchange ....... 10 1 11 4 11
Interest rate .......... 36 8 61 37 16
Trading Volatility
The following tables summarize the frequency distribution of daily market
risk-related revenues for Treasury trading activities during 2004. Market
risk-related Treasury trading revenues include realized and unrealized gains
(losses) related to Treasury trading activities, but exclude the related net
interest income. Analysis of the third quarter of 2004 gain (loss) data shows
that the largest daily gain was $6 million and the largest daily loss was $11
million. Analysis of the first nine months of 2004 gain (loss) data shows that
the largest daily gain was $12 million and the largest daily loss was $11
million.
50
- -------------------------------------------------------------------------------------------------------------
Three months ended September 30, 2004
- -------------------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue
earned from market risk-related activities
Below $(2) to $0 to $2 to $4 to Over
(in millions) $(2) $0 $2 $4 $6 $6
Number of trading days market risk-related
revenue was within the stated range............ 4 11 28 13 7 1
- -------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2004
- -------------------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue
earned from market risk-related activities
Below $(2) to $0 to $2 to $4 to Over
(in millions) $(2) $0 $2 $4 $6 $6
Number of trading days market risk-related
revenue was within the stated range............ 8 39 66 43 23 9`
Trading Activities - Mortgage Banking
Mortgage servicing rights (MSRs) are assets that represent the present value of
net servicing income (servicing fees, ancillary income, escrow and deposit
float, and net of servicing costs). MSRs are recognized upon the sale of the
underlying loans or at the time that servicing rights are purchased. MSRs are
subject to interest rate risk, in that their value will decline as a result of
actual and expected acceleration of prepayment of the underlying loans in a
falling interest rate environment.
Interest rate risk is mitigated through an active hedging program that uses
available for sale (AFS) securities and derivative instruments to offset changes
in value of MSRs. Since the hedging program involves trading activity, risk is
quantified and managed using a number of risk assessment techniques.
A review of the Company's MSRs hedging program was conducted in light of the
unprecedented market conditions of 2003. This was to ensure that a program is in
place to support anticipated business growth while at the same time limiting
volatility in the mortgage banking results. Existing risk limits were revised
and additional risk limits were established for hedging of economic losses.
Rate Shock Analysis
Modeling techniques are used to monitor certain interest rate scenarios for
their impact on the economic value of net hedged MSRs, as reflected in the
following table.
- -----------------------------------------------------------------------------------------------------------
September 30, 2004 Values
-------------------------
Amount %
- ----------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects
projected rate movements on October 1, 2004):
Value of hedged MSRs portfolio.............................................. $ 336
Change resulting from an immediate 50 bp decrease in the yield curve:
Change limit............................................................ <- 4
Calculated change in net market value................................... 2 + 1
Change resulting from an immediate 50 bp increase in the yield curve:
Change limit............................................................ <- 2
Calculated change in net market value................................... 3 + 1
Change resulting from an immediate 100 bp increase in the yield curve:
Change limit............................................................ <- 3
Calculated change in net market value................................... 6 + 2
51
Economic Value of MSRs
The economic value of the net, hedged MSRs portfolio is monitored on a daily
basis for interest rate sensitivity. If the economic value declines by more than
established limits for one day or one month, various levels of management
review, intervention and/or corrective actions are required.
Hedge Volatility
During 2004, there was volatility in the trading positions in derivative
instruments used to protect the economic value of the MSRs portfolio. The
following tables summarize the frequency distribution of weekly market
risk-related revenues during 2004 associated with mortgage trading positions.
- -------------------------------------------------------------------------------------------------------
Three months ended September 30, 2004
- -------------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(5) to $0 to $5 to Over
(in millions) $(5) $0 $5 $10 $10
Number of trading weeks market risk-related
revenue was within the stated range.............. 2 4 3 5 1
- -------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2004
- -------------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(5) to $0 to $5 to Over
(in millions) $(5) $0 $5 $10 $10
Number of trading weeks market risk-related
revenue was within the stated range.............. 10 11 11 8 3
52
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Refer to the disclosure in Item 2 of the Management's Discussion and Analysis of
Financial Condition and Results of Operations under the captions "Interest Rate
Risk Management" and "Trading Activities".
Item 4. Controls and Procedures
Under the direction of the Company's Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), the Company has reviewed its "disclosure controls and
procedures". That term means controls and other procedures designed to ensure
that information required to be disclosed in the Company's reports filed with
the United States Securities and Exchange Commission (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 directly supports the CEO and
CFO certifications included as exhibits to this report.
Since 1993, the CEO and CFO have reported on the Bank's internal controls over
financial reporting pursuant to Federal Deposit Insurance Corporation
Improvement Act (FDICIA) regulations. The Company's independent registered
public accounting firm has annually attested, without qualification, to the
reports. Thus management is well acquainted with the process underlying the
attestation to financial reporting controls. The current review process is built
on the annual review at the Bank in accordance with FDICIA as well as various
other internal control processes and procedures, which management has
established and monitors. The review is conducted quarterly and includes all
subsidiaries of the Company.
To monitor the Company's compliance with the 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 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 including the development of appropriate 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
September 30, 2004 and that those controls and procedures support the
disclosures in this document. During the nine months ended September 30, 2004,
there were no material changes in the Company's internal controls over financial
reporting.
53
Part II - OTHER INFORMATION
Item 1 - Legal Proceedings
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 Note Matter, as disclosed in the
Company's 2003 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 during September 2002 of various criminal
charges related to the sale of the Princeton Notes. 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
HSBC USA Inc., the Bank, and Republic New York Securities
Corporation as defendants. HSBC USA Inc. and the Bank 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.
Item 5 - Other Information
As approved by the Audit and Examining Committee of the Board of
Directors, the Company has engaged KPMG to perform certain non-audit
services during 2004, including tax compliance and consultation
services, litigation support services and general accounting
consultation services.
Item 6 - Exhibits and Reports on Form 8-K
(a) 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.
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.0 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed by the Company during
the quarter ended September 30, 2004.
54
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC USA Inc.
(Registrant)
Date: November 15, 2004 /s/ Joseph R. Simpson
--------------------------------------
Joseph R. Simpson
Senior Vice President & Controller
(On behalf of Registrant and
as Chief Accounting Officer)
55