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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 ______
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
452 Fifth Avenue
New York, New York 10018
(Address of principal executive offices)
Telephone: (212) 525-3735
IRS Employer Identification No.: State of Incorporation:
13-2764867 Maryland
Securities registered pursuant to Section 12(b) of the Act and registered on the
New York Stock Exchange: Depositary Shares, each representing a one-fourth
interest in a share of Adjustable Rate Cumulative
Preferred Stock, Series D
$1.8125 Cumulative Preferred Stock
$2.8575 Cumulative Preferred Stock
7% Subordinated Notes due 2006
8.375% Debentures due 2007
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) had filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. |X|
At February 28, 2005, all voting stock (706 shares of Common Stock $5 par value)
is owned by an indirect wholly owned subsidiary of HSBC Holdings plc.
Indicate by check mark whether the registrant is an accelerated filer as defined
in Rule 12b-2 of the Act.
Yes |_| No |X|
Documents incorporated by reference: None
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HSBC USA Inc.
Form 10-K
TABLE OF CONTENTS
Part I
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Page
Item 1. Business
History .................................................................................................. 4
2004 Developments......................................................................................... 4
Description of Business Segments.......................................................................... 5
Geographic Distribution of Assets and Earnings............................................................ 6
Regulation, Supervision and Capital....................................................................... 6
Competition............................................................................................... 9
Corporate Governance...................................................................................... 9
Cautionary Statement On Forward-Looking Statements........................................................ 10
Statistical Disclosure by Bank Holding Companies:
Average Balance Sheets and Interest Earned and Paid................................................... 66
Changes in Interest Income and Expense Attributable to Changes in Rate and
Volume.............................................................................................. 21
Securities Portfolios................................................................................. 84
Loans Outstanding:
Composition and Maturities........................................................................ 18-19
Risk Elements in the Loan Portfolio............................................................... 37-40
Summary of Loan Loss Experience....................................................................... 41
Deposits.............................................................................................. 90
Short-Term Borrowings................................................................................. 90
Item 2. Properties.................................................................................................... 11
Item 3. Legal Proceedings............................................................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........................................................... 11
Part II
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Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters..................................... 11
Item 6. Selected Financial Data....................................................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview........................................................................................ 13
Critical Accounting Policies.............................................................................. 15
Balance Sheet Review...................................................................................... 18
Results of Operations..................................................................................... 21
Business Segments......................................................................................... 33
Credit Quality............................................................................................ 37
Off-Balance Sheet Arrangements and Contractual Obligations................................................ 43
Risk Management........................................................................................... 45
Glossary of Terms......................................................................................... 60
Reporting to Parent Company in the U.K.................................................................... 62
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................................................... 65
Item 8. Financial Statements and Supplementary Data................................................................... 68
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................... 118
Item 9A. Controls and Procedures....................................................................................... 118
2
Part III
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Page
Item 10. Directors and Executive Officers of the Registrant................................................ 119
Item 11. Executive Compensation............................................................................ 123
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................... 127
Item 13. Certain Relationships and Related Transactions.................................................... 128
Item 14. Principal Accounting Fees and Services............................................................ 129
Part IV
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Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................... 130
3
P A R T I
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Item 1. Business
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History
HSBC USA Inc., incorporated under the laws of Maryland, is a New York State
based bank holding company registered under the Bank Holding Company Act of
1956, as amended. HSBC USA Inc. and its subsidiaries are collectively referred
to as "HUSI". HUSI's origin was in Buffalo, New York in 1850 as The Marine Trust
Company, which later became Marine Midland Banks, Inc. (Marine). In 1980, The
Hongkong and Shanghai Banking Corporation (now HSBC Holdings plc, hereinafter
referred to as "HSBC") acquired 51% of the common stock of Marine and the
remaining 49% of common stock in 1987. In December 1999, HSBC acquired Republic
New York Corporation (Republic) and merged it with HUSI. At the merger date,
Republic and HUSI had total assets of approximately $47 billion and $43 billion
respectively. HSBC is one of the largest banking and financial services
organizations in the world.
Effective January 1, 2004, HSBC created a new North American organizational
structure with HSBC North America Holdings Inc. (HNAH) as the top-tier United
States (U.S.) bank holding company. HNAH's principal subsidiaries include a U.S.
bank holding company, HSBC North America Inc. (HNAI), a Canadian banking
subsidiary, HSBC Bank Canada, a consumer finance holding company, HSBC Finance
Corporation (formerly Household International, Inc.), a holding company for
investment banking and markets subsidiaries, HSBC Markets (USA) Inc. (HSBC
Markets), and a provider of information technology services, HSBC Technology &
Services (USA) Inc. (HTSU). HUSI, a wholly owned subsidiary of HNAI, routinely
conducts transactions with HSBC Finance Corporation, HSBC Markets and HTSU in
the normal course of business.
At December 31, 2004, HUSI had total assets of approximately $141 billion and
approximately 10,800 full and part time employees. HUSI is among the 10 largest
U.S. bank holding companies ranked by assets. HUSI's principal subsidiary is
HSBC Bank USA, National Association (HBUS), which had total assets of
approximately $138 billion and total deposits of approximately $81 billion at
December 31, 2004.
HUSI offers a full range of traditional commercial banking products and services
to individuals, including high net worth individuals, small businesses,
corporations, institutions and governments. Through its affiliation with HSBC,
HUSI also offers its three million customers access to global markets and
services. In turn, HUSI plays a role in the delivery and processing of other
HSBC products. HUSI also has mortgage banking operations, and is an
international dealer in derivative instruments denominated in U.S. dollars and
other currencies, focusing on structuring of transactions to meet clients' needs
as well as for proprietary purposes.
HBUS's domestic operations are primarily in New York State. It also has banking
branch offices and/or representative offices in Florida, California,
Pennsylvania, Oregon, Washington, Delaware, Massachusetts, and Washington, D.C.
In addition to its domestic offices, HBUS maintains foreign branch offices,
subsidiaries and/or representative offices in the Caribbean, Europe, Asia, Latin
America, Australia and Canada.
2004 Developments
On July 1, 2004, HUSI consolidated its banking operations under a single
national charter, following approval from the Office of the Comptroller of the
Currency (the OCC). The national charter enables HBUS to serve its customers
more efficiently and effectively across the U.S., as well as provide an expanded
range of products. It also enables HBUS to operate on the same competitive
footing as other major U.S. banks.
In March 2003, HSBC completed its acquisition of Household International, Inc.
In December 2004, Household International, Inc. changed its legal name to HSBC
Finance Corporation. As a result of the acquisition, HUSI and HSBC Finance
Corporation have been working together to identify synergies in products and
processes. Synergies have been achieved in loan origination and servicing, card
processing, IT contingency rationalization, purchasing, call center cooperation,
the shared use of HSBC's service centers, and the consolidation of certain
administrative
4
functions. In addition, HSBC Finance Corporation's credit scoring and
data-mining technology has been made available to HUSI. HUSI and HSBC Finance
Corporation will continue to work cooperatively on product offerings and
back-office operations.
During 2004, HUSI purchased approximately $17 billion of loans from HSBC Finance
Corporation, and from originating lenders pursuant to HSBC Finance Corporation
correspondent loan programs. The most significant of these transactions was the
acquisition of approximately $12 billion of private label loans and retained
interests in another $3 billion of securitized trusts (the private label loan
portfolio). Details of these and other transactions with HSBC Finance
Corporation are presented in Note 18 of the consolidated financial statements
beginning on page 97 of this Form 10-K.
During 2004, HSBC integrated certain North American and Latin American
operations through changes to its organization structure. These organizational
changes are further described in Note 18 of the consolidated financial
statements beginning on page 97 of this Form 10-K.
2004 was also highlighted by significant growth in residential mortgage loan
balances, which increased approximately 78% to $47 billion at December 31, 2004.
HUSI continued the general strategy begun in 2003 to retain variable rate
residential mortgages on the balance sheet, while selling fixed rate mortgages
to government agencies. Prior to 2004, the interest rate environment generally
caused customers to favor originations of fixed rate loans. In 2004, customers
generally favored variable rate products. In addition, HUSI continues to acquire
residential mortgages from HSBC Finance Corporation and from originating lenders
pursuant to HSBC Finance Corporation correspondent loan programs.
Description of Business Segments
HUSI has four distinct segments that it utilizes for management reporting and
analysis purposes, which are consistent with the line of business groupings used
by HSBC. The segments are based upon customer groupings, as well as products and
services offered. The segments are described in the following paragraphs.
The Personal Financial Services (PFS) Segment
This segment provides a broad range of financial products and services including
installment and revolving term loans, deposits, branch services, mutual funds,
investments and insurance. These products are marketed to individuals primarily
through the branch banking network. Residential mortgage lending provides loan
financing through direct retail and wholesale origination channels. Mortgage
loans are originated through a network of brokers, wholesale agents and retail
origination offices. Servicing is performed for the individual mortgage holder
or on a contractual basis for mortgages owned by third parties.
This segment also includes residential mortgage loans, credit card receivables,
other consumer loans and retained interests in securitized trusts purchased from
HSBC Finance Corporation and from originating lenders pursuant to HSBC Finance
Corporation correspondent loan programs in 2003 and 2004.
The Commercial Banking (CMB) Segment
This segment provides loan and deposit products to small businesses and
middle-market corporations including specialized products such as real estate
financing. Various credit and trade related products are also offered such as
standby facilities, performance guarantees and acceptances. These products and
services are offered through multiple delivery systems, including the branch
banking network.
5
The Corporate, Investment Banking and Markets (CIBM) Segment
This segment is comprised of Corporate/Institutional Banking (CIB) and
Investment Banking and Markets (IBM). CIB provides deposit and lending
functionality to large and multi-national corporations and banks. U.S. dollar
clearing services are offered for domestic and international wire transfer
transactions. Credit and trade related products such as standby facilities,
performance guarantees and acceptances are also provided by CIB to large
corporate entities. The IBM component includes treasury and traded markets. The
treasury function maintains overall responsibility for the investment and
borrowing of funds to ensure liquidity, manage interest rate risk and capital at
risk. Traded markets encompasses the trading and sale of foreign exchange,
banknotes, derivatives, precious metals, securities and emerging markets
instruments, both domestically and internationally.
The Private Banking (PB) Segment
This segment offers a full range of services for high net worth domestic and
foreign individuals including deposit, lending, trading, trust, branch services,
mutual funds, insurance and investment management.
Other Segment
This segment includes equity investments in Wells Fargo HSBC Trade Bank N.A. and
HSBC Republic Bank (Suisse) S.A.
Operating results by business segment are presented on pages 33-36 of this Form
10-K.
Geographic Distribution of Assets and Earnings
HUSI's foreign operations represented less than 7% of HUSI's consolidated total
assets at December 31, 2004 and 2003, and less than 5% of consolidated income
before income tax expense for 2004, 2003 and 2002.
Regulation, Supervision and Capital
Through June 30, 2004, HUSI and HBUS were supervised and routinely examined by
the State of New York Banking Department and the Board of Governors of the
Federal Reserve System (the Federal Reserve). Effective July 1, 2004, HBUS
became a nationally chartered bank and is primarily supervised by the OCC. HUSI,
as a bank holding company, continues to be supervised by the Federal Reserve.
HUSI and HBUS are subject to banking laws and regulations which place various
restrictions on and requirements regarding their operations and administration,
including the establishment and maintenance of branch offices, capital and
reserve requirements, deposits and borrowings, investment and lending
activities, payment of dividends and numerous other matters. The Federal Reserve
Act restricts certain transactions between banks and their nonbank affiliates.
The deposits of HBUS are insured by the Federal Deposit Insurance Corporation
(FDIC) and HBUS is thereby subject to relevant FDIC regulations.
HBUS is required to maintain noninterest bearing cash reserves with the Federal
Reserve Bank. HBUS's reserves averaged $730 million in 2004 and $578 million in
2003.
HUSI and HBUS are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory actions, and possibly additional
discretionary actions by regulators. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, specific capital guidelines
must be met that involve quantitative measures of assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
HUSI's capital resources are summarized on page 20 of this Form 10-K.
6
Quantitative measures established by regulation to ensure capital adequacy
require the maintenance of minimum amounts and ratios of total and Tier 1
capital (as defined in the regulations). The following table presents the
capital ratios of HUSI and HBUS, calculated in accordance with banking
regulations. To be categorized as "well capitalized", 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. Capital amounts and ratios for HUSI and HBUS were as follows.
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2004 2003
------------------------------------------ -------------------------------------------
Capital Well-Capitalized Actual Capital Well-Capitalized Actual
December 31 Amount Minimum Ratio Ratio Amount Minimum Ratio Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Total capital (to risk weighted
assets):
HUSI ......................... $ 13,496 10.00% 12.53% $ 7,816 10.00% 12.42%
HBUS ......................... 13,270 10.00 12.46 7,325 10.00 11.82
Tier 1 capital (to risk weighted
assets):
HUSI ......................... 8,983 6.00 8.34 5,366 6.00 8.53
HBUS ......................... 9,219 6.00 8.66 5,572 6.00 8.99
Tier 1 capital (to average
assets):
HUSI ......................... 8,983 3.00 7.20 5,366 3.00 5.87
HBUS ......................... 9,219 5.00 7.51 5,572 5.00 6.22
Tangible common equity
(to risk weighted assets):
HUSI ......................... 7,611 7.05 4,022 6.39
HBUS ......................... 9,249 8.73 5,621 9.07
Risk weighted assets:
HUSI ......................... 107,696 62,945
HBUS ......................... 106,470 61,973
The following table presents the components of HUSI's risk-based capital.
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December 31 2004 2003
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(in millions)
Tier 1 Capital:
Common shareholder's equity ........................................................ $ 10,366 $ 6,962
Preferred stock..................................................................... 375 375
Minority interest (primarily trust preferred securities) ........................... 1,029 1,025
Goodwill, identifiable intangibles and other direct deductions from capital......... (2,771) (2,881)
Other Tier 1 adjustments............................................................ (16) (115)
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Tier 1 capital...................................................................... 8,983 5,366
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Tier 2 Capital:
Long-term debt and other instruments qualifying as Tier 2 capital................... 3,621 1,993
Qualifying aggregate allowance for credit losses.................................... 872 437
Other Tier 2 components............................................................. 20 20
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Tier 2 capital...................................................................... 4,513 2,450
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Total capital............................................................................. $ 13,496 $ 7,816
========== =========
From time to time, bank regulators propose amendments to or issue
interpretations of risk-based capital guidelines. Such proposals or
interpretations could, upon implementation, affect reported capital ratios and
net risk weighted assets. A new capital adequacy framework has been proposed by
U.S. regulators for implementation by January 1, 2008, as further described
below under "Basel Capital Standards".
7
HBUS is subject to risk-based assessments from the FDIC, the U.S. Government
agency that insures deposits in HBUS to a maximum of $100,000 per domestic
depositor. Depository institutions subject to assessment are categorized based
on capital ratios and other factors, with those in the highest rated categories
paying no assessments. Because of its standing as a "well-capitalized",
financially sound institution, HBUS has not been assessed by the FDIC in the
past three years.
The Deposit Insurance Funds Act (DIFA) of 1996 authorized the Financing
Corporation (FICO), a U.S. Government corporation, to collect funds from FDIC
insured institutions to pay interest on FICO bonds. The FICO assessment rate in
effect at December 31, 2004 was 1.46 percent of assessable deposits. The FICO
assessment rate is adjusted quarterly. HBUS is subject to a quarterly FICO
premium.
The USA Patriot Act (the Patriot Act), effective October 26, 2001, imposed
significant record keeping and customer identity requirements, expanded the
government's powers to freeze or confiscate assets and increased the available
penalties that may be assessed against financial institutions for violation of
the requirements of the Patriot Act intended to detect and deter money
laundering. The Patriot Act required the U.S. Treasury Secretary to develop and
adopt final regulations with regard to the anti-money laundering compliance
obligations on financial institutions (a term which includes insured U.S.
depository institutions, U.S. branches and agencies of foreign banks, U.S.
broker-dealers and numerous other entities). The U.S. Treasury Secretary
delegated certain authority to a bureau of the U.S. Treasury Department known as
the Financial Crimes Enforcement Network (FinCEN).
Many of the new anti-money laundering compliance requirements of the Patriot
Act, as implemented by FinCEN, are generally consistent with the anti-money
laundering compliance obligations that applied to HBUS under the Bank Secrecy
Act and applicable Federal Reserve Board regulations before the Patriot Act was
adopted. These include requirements to adopt and implement an anti-money
laundering program, report suspicious transactions and implement due diligence
procedures for certain correspondent and private banking accounts. Certain other
specific requirements under the Patriot Act involve new compliance obligations.
The Patriot Act and other recent events have resulted in heightened scrutiny of
Bank Secrecy Act and anti-money laundering compliance programs by the federal
and state bank regulators. On April 30, 2003, HBUS entered into a written
agreement with the Federal Reserve Bank of New York and the New York State
Banking Department to enhance its compliance with anti-money laundering
requirements. Due to the change in primary regulators in 2004, this agreement is
now subject to enforcement by the OCC. HBUS has increased compliance staff and
has implemented certain improvements in its compliance, reporting, and review
systems and procedures.
Basel Capital Standards
In June 2004, the Basel Committee on Banking Supervision (Basel) published a
revised capital adequacy framework for complex and internationally active banks.
The framework (Basel II) is now being considered by U.S. regulatory agencies,
including the Federal Reserve and the OCC. The U.S. regulatory agencies expect
to publish a notice of proposed rulemaking regarding new capital adequacy
regulations based on Basel II by mid-year 2005, followed by the final rules
sometime in 2006. The earliest that banks may adopt the new rules is January 1,
2008.
In 2004, HSBC was advised by the U.S. regulatory agencies that HNAH and its
subsidiaries, including HUSI and HBUS, are considered to be mandatory
participants in the new capital framework. HNAH and HUSI have established
comprehensive Basel implementation project teams comprised of risk management
specialists representing all risk disciplines. HUSI currently anticipates full
implementation of Basel standards by January 1, 2008.
Sarbanes-Oxley Act of 2002, Section 404 Compliance
As an SEC registrant of public debt and preferred shares HUSI is required to
comply with the Sarbanes-Oxley Act of 2002 (the Act). Section 404 of the Act
(Section 404) requires registrants and their auditors to assess and report on
internal controls over financial reporting on an annual basis. HUSI is required
to comply with Section 404 of the Act for the fiscal year ending December 31,
2005.
8
HUSI has adopted the framework of financial reporting assertions established by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO) as
the basis for the risk assessment process. Certain other financial reporting
risk assessment factors have been added to the COSO framework to ensure adequate
coverage of safeguarding of assets and anti-fraud risks.
Competition
The Gramm-Leach-Bliley Act of 1999 (GLB Act), effective March 11, 2000,
eliminated many of the regulatory restrictions on providing financial services.
The GLB Act allows for financial institutions and other providers of financial
products to enter into combinations that permit a single organization to offer a
complete line of financial products and services. Therefore, HUSI and its
subsidiaries face intense competition in all of the markets they serve,
competing with both other financial institutions and non-banking institutions
such as insurance companies, major retailers, brokerage firms and investment
companies.
Following the enactment of the GLB Act, HUSI elected to be treated as a
financial holding company (FHC). As an FHC, HUSI's activities in the U.S. have
been expanded enabling it to offer a more complete line of products and
services. HUSI's ability to engage in expanded financial activities as an FHC
depends upon its meeting certain criteria, including requirements that its U.S.
depository institution subsidiary, HBUS, and its forty percent owned subsidiary,
Wells Fargo HSBC Trade Bank N.A., be well capitalized and well managed, and that
they have achieved at least a satisfactory record of meeting community credit
needs during their most recent examination pursuant to the Community
Reinvestment Act. In general, an FHC would be required, upon notice by the
Federal Reserve Board, to enter into an agreement to correct any deficiency in
the requirements necessary to maintain its FHC election. Until such deficiencies
are corrected, the Federal Reserve Board may impose limitations on the conduct
or activities of an FHC or any of its affiliates as it deems appropriate. If
such deficiencies are not timely corrected, the Federal Reserve Board may
require an FHC to divest its control of any subsidiary depository institution or
to cease to engage in certain financial activities. As of December 31, 2004, no
known deficiencies exist, and HUSI is not subject to limitations or penalties
relative to its status as an FHC.
Corporate Governance
HUSI is committed to high standards of corporate governance. Governance
standards, together with the charters of committees of the Board of Directors,
provide the framework for the corporate governance of HUSI. HUSI's Board of
Directors has three primary committees to assist with corporate oversight
responsibilities.
o Audit and Examining Committee - This committee's primary duties are to:
(1) monitor the integrity of HUSI's financial reporting processes and
systems of internal controls regarding finance, accounting, and
legal compliance;
(2) monitor the independence and performance of HUSI's internal and
independent auditor; and
(3) provide an avenue of communication among the independent auditor,
management, the internal auditors, and the Board of Directors.
o Human Resources Committee - This committee's primary duties are to review
and make recommendations with respect to the appointment and compensation
of such officers and employees as the Board by resolution shall from time
to time determine, including incentive compensation programs, and to
counsel management with respect to general human resources related
matters.
o Fiduciary Committee - This committee's primary duties are to review
matters related to HUSI's responsibilities to its customers, employees and
the communities it serves.
The annual report on Form 10-K, quarterly reports on Form 10-Q, and current
reports on Form 8-K, as filed with the Securities and Exchange Commission (the
SEC), are available on HUSI's website at www.us.hsbc.com.
9
Cautionary Statement On Forward-Looking Statements
Certain matters discussed throughout this Form 10-K constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. In addition, certain statements may be made in future filings with the
SEC, in press releases, or in oral or written presentations by representatives
of HUSI that are not statements of historical fact and may also constitute
forward-looking statements. Words such as "believe", "expects", "estimates",
"targeted", "anticipates", "goal" and similar expressions are intended to
identify forward-looking statements but should not be considered as the only
means through which these statements may be made. These matters or statements
will relate to our future financial condition, results of operations, plans,
objectives, performance or business developments and will involve known and
unknown risks, uncertainties and other factors that may cause actual results,
performance or achievements to be materially different from that which was
expressed or implied by such forward-looking statements. Forward-looking
statements are based on current views and assumptions and speak only as of the
date they are made. HUSI undertakes no obligation to update any forward-looking
statement to reflect subsequent circumstances or events.
The important factors, many of which are out of HUSI's control, which could
affect our actual results and could cause results to vary materially from those
expressed in public statements or documents are:
o changes in laws and regulations;
o increased competition which may impact the terms, rates, costs or profits
historically included in the products offered by HUSI;
o changes in accounting or credit policies, practices or standards, as they
may be internally modified from time to time or changes as may be required
by regulatory agencies or the Financial Accounting Standards Board;
o changes to operational practices from time to time or changes to our
customer account management policies and practices and risk
management/collection practices;
o changes in overall economic conditions, including the interest rate
environment in which HUSI operates, the capital markets in which HUSI
funds its operations, the market values of consumer owned real estate
throughout the United States, recession, employment and currency
fluctuations;
o consumer perception of the availability of credit, including price
competition in the market segments targeted and the ramifications or ease
of filing for personal bankruptcy;
o the effectiveness of models or programs to predict loan delinquency or
loss, initiatives to improve collections in all business areas, and
changes made from time to time in these models, programs and initiatives;
o continued consumer acceptance of HUSI's distribution systems and demand
for HUSI's loan or insurance products;
o changes associated with, as well as the difficulty in, integrating
systems, operational functions and cultures, as applicable, of any
organization or portfolio acquired by HUSI;
o a reduction of our debt ratings by any of the nationally recognized
statistical rating organizations that rate these instruments to a level
that is below our current rating;
o the costs, effects and outcomes of regulatory reviews or litigation
relating to the business practices or policies of any of our business
units, including, but not limited to, additional compliance requirements;
o increased funding costs resulting from instability in the capital markets
and risk tolerance of fixed income investors;
o the costs, effects and outcomes of any litigation matter that is
determined adversely to HUSI or its businesses;
o the ability to attract and retain qualified personnel to support the
underwriting, servicing, collection and sales functions of HUSI's
businesses;
o the inability of HUSI to manage any or all of the foregoing risks as well
as anticipated.
10
Item 2. Properties
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The principal executive offices of HUSI are located at 452 Fifth Avenue, New
York, New York 10018, which is owned by HBUS. The main office of HBUS is located
at 1105 N. Market Street, Wilmington, Delaware 19801 and the principal executive
offices of HBUS are located at One HSBC Center, Buffalo, New York 14203, in a
building under a long-term lease. HBUS has more than 380 other banking offices
in New York State located in 46 counties, eleven branches in Florida, eight
branches in California, three branches in Washington, D.C. and one branch each
in Pennsylvania, Oregon, Washington and Delaware. Approximately 39% of these
offices are located in buildings owned by HBUS and the remaining are located in
leased quarters. In addition, there are branch offices and locations for other
activities occupied under various types of ownership and leaseholds in states
other than New York, none of which is materially important to the respective
activities. HBUS also owns properties in: Montevideo, Uruguay; Punta del Este,
Uruguay; and Buenos Aires, Argentina.
Item 3. Legal Proceedings
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HUSI's legal proceedings are summarized in Note 23 of the consolidated financial
statements on page 106 of this Form 10-K.
Item 4. Submission of Matters to a Vote of Security Holders
- --------------------------------------------------------------------------------
Omitted.
P A R T II
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Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
- --------------------------------------------------------------------------------
All 706 shares of HUSI's outstanding stock are owned by HSBC North America Inc.,
an indirect subsidiary of HNAH. Consequently, there is no public market in
HUSI's common stock.
11
Item 6. Selected Financial Data
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Year Ended December 31 2004 2003 2002 2001 2000
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(in millions)
Net interest income................................ $ 2,741 $ 2,510 $ 2,376 $ 2,265 $ 2,119
---------- --------- --------- --------- ---------
Trading revenues .................................. 288 291 130 255 140
Residential mortgage banking revenue
(expense)........................................ (120) (102) 24 33 -
Securities gains, net.............................. 85 48 118 149 29
Other income....................................... 1,066 917 787 659 664
---------- --------- --------- --------- ---------
Total other revenues............................... 1,319 1,154 1,059 1,096 833
---------- --------- --------- --------- ---------
Goodwill amortization.............................. -- -- -- 176 176
Princeton Note Matter.............................. -- -- -- 575 --
Operating expenses................................. 2,101 2,040 1,875 1,792 1,730
Provision for credit losses........................ (17) 113 195 238 138
---------- --------- --------- --------- ---------
Income before income tax expense and
cumulative effect of accounting change........... 1,976 1,511 1,365 580 908
Income tax expense................................. 718 570 510 226 339
---------- --------- --------- --------- ---------
Income before cumulative effect of
accounting change................................ 1,258 941 855 354 569
---------- --------- --------- --------- ---------
Cumulative effect of accounting change -
implementation of SFAS 133, net of tax........... -- -- -- (1) --
---------- --------- --------- --------- ---------
Net income......................................... $ 1,258 $ 941 $ 855 $ 353 $ 569
========== ========= ========= ========= =========
Adjusted net income (1)............................ $ 1,258 $ 941 $ 855 $ 529 $ 745
========== ========= ========= ========= =========
Balances at year end:
Loans:
Commercial................................... $ 23,032 $ 18,704 $ 19,946 $ 19,944 $ 21,450
Residential mortgages........................ 46,715 26,295 20,438 17,595 15,683
Other consumer............................... 15,200 3,475 3,252 3,384 3,285
---------- --------- --------- --------- ---------
Total loans.................................. 84,947 48,474 43,636 40,923 40,418
Allowance for credit losses.................. (788) (399) (493) (506) (525)
---------- --------- --------- --------- ---------
Loans, net................................... 84,159 48,075 43,143 40,417 39,893
Total assets....................................... 141,050 95,562 89,426 87,114 83,035
Total tangible assets.............................. 138,310 92,736 86,544 84,218 79,806
Total deposits..................................... 79,981 63,955 59,830 57,330 56,961
Short-term borrowings.............................. 9,874 6,782 7,392 9,202 8,562
Long-term debt..................................... 23,839 3,814 3,675 3,668 4,178
Common shareholder's equity........................ 10,366 6,962 6,897 6,549 6,834
Tangible common shareholder's equity............... 7,611 4,022 3,737 3,535 3,481
Total shareholders' equity......................... 10,866 7,462 7,397 7,049 7,334
Selected financial ratios:
Total shareholders' equity to total assets......... 7.70% 7.81% 8.27% 8.09% 8.83%
Tangible common shareholder's equity
to total tangible assets......................... 5.50 4.34 4.32 4.20 4.36
Rate of return on (2):
Total assets ................................ 1.12 1.02 .97 .41 .69
Total common shareholder's equity............ 16.35 13.06 12.42 4.80 8.22
Net interest margin to (2):
Earning assets............................... 2.70 3.07 3.03 2.94 2.89
Total assets................................. 2.46 2.76 2.74 2.66 2.59
Total shareholders' equity to total assets (2)..... 7.18 8.20 8.20 8.50 8.56
Cost/income ratio (2).............................. 51.73 55.65 54.59 52.94 55.73
(1) With the adoption of Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets on January 1, 2002, HUSI is no longer
required to amortize goodwill, but rather evaluate goodwill for impairment
annually. Accordingly, for prior periods presented, goodwill amortization
has been excluded from the adjusted amounts for consistency purposes.
(2) Selected financial ratios are defined in the Glossary of Terms beginning
on page 60 of this Form 10-K.
12
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
Executive Overview
- --------------------------------------------------------------------------------
Increased net income for 2004 as compared with 2003 reflects growth in net
interest income, lower provisions for credit losses and increased other
revenues. Partially offsetting these improvements were lower levels of
residential mortgage banking revenue and higher non-salary related operating
expenses.
The increase in net interest income was a net result of:
o the excess of total average earning assets over total average interest
bearing liabilities (net earning assets) increased approximately $3
billion during 2004;
o the net interest rate spread on net earning assets decreased 40 basis
points. The overall decreases in yields earned on assets were greater than
decreases in rates paid on liabilities.
Average total loan balances increased approximately $16 billion (37%) during
2004, primarily in residential mortgage loans. The positive impact of increased
loan balances was partially offset by decreases in average yields earned on
various loan portfolios. Increased assets were funded primarily by increased
interest bearing deposits, short-term borrowings and long-term debt. The average
rate paid on these combined interest bearing liabilities increased during 2004,
despite a decrease in the average rate paid on long-term debt balances. An
analysis of net interest income begins on page 21 of this Form 10-K.
The decreased provision for credit losses during 2004 resulted from 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 balances previously charged off. In addition, the unallocated
component of the allowance for credit losses was reduced as a result of
refinement of the allowance methodology, resulting in an additional reduction in
the provision. An analysis of credit quality begins on page 37 of this Form
10-K.
The 2004 net increase in total other revenues was primarily attributable to the
following transactions and/or activities. An analysis of other revenues begins
on page 23 of this Form 10-K.
o Sale of credit card relationships to HSBC Finance Corporation for a gain
of approximately $99 million.
o Sale of an investment in NYCE Corporation for a gain of approximately $45
million.
o Gains on sales of securities were approximately $37 million higher in
2004, as compared with 2003.
o Residential mortgage banking revenue decreased approximately $18 million
in 2004, compared with 2003.
The 2004 increase in total operating expenses was primarily attributable to the
following transactions and/or activities. An analysis of operating expenses
begins on page 30 of this Form 10-K.
o Additional provisions for off-balance sheet credit exposure, resulting in
increased expense of approximately $53 million in 2004.
o A fourth quarter 2004 provision for U.S. withholding tax costs related to
deficiencies in client tax documentation, resulting in increased expense
of approximately $26 million.
o Increased expenses related to technology services, debt underwriting, and
loan origination and servicing costs paid to HNAH affiliates, which were
offset by decreased salaries and other expenses resulting from
efficiencies gained from integration of certain North American operations,
and from the relationship with HSBC Finance Corporation.
The increase in income tax expense for 2004 was primarily attributable to higher
taxable income, which was partially offset by a release of approximately $51
million of income tax liability during the second quarter related to completion
of outstanding audits. An analysis of income tax expense and deferred income
taxes is provided in Note 13 of the consolidated financial statements beginning
on page 91 of this Form 10-K.
13
HUSI is planning for continued growth in 2005 for all business segments. The
following general initiatives, begun in 2004, will continue to be emphasized in
2005 to achieve overall net revenue growth:
o Additional resources and priority have been focused on HBUS's core retail
banking businesses. Investment in the retail branch network has been, and
will continue to be, expanded and reallocated to ensure coverage of high
potential growth geographic areas.
o Loan and deposit products offered to individuals, small businesses, and
middle-market commercial customers have been expanded, in conjunction with
increased marketing efforts. HUSI plans to build upon its status as the
top ranked small business lender in New York State.
o Various treasury and traded markets activities have been expanded through
increased products offered to customers, increased marketing efforts for
those products, and increased proprietary activities.
o Additional resources have been allocated to expand services provided to
high net worth domestic and foreign individuals.
o HUSI will continue to leverage its relationship with HSBC Finance
Corporation to increase consumer loan assets, to obtain loan origination
and loan servicing, and to centralize and reduce the operating cost of
various administrative services.
The purchase of the private label loan portfolio from HSBC Finance Corporation
in December 2004 will have a significant impact on various components of revenue
and expense in 2005. Overall, 2005 net income will decrease as a result of this
transaction, due to heavy first year amortization of the premium paid at the
purchase date. In subsequent years, net income will increase due to
significantly reduced premium amortization.
Effective October 1, 2004, through its affiliation with HSBC Finance
Corporation, HBUS is the originating lender for a federal tax refund
anticipation loan program for clients of various third party tax preparers.
Although the impact on 2004 net income was minimal, this arrangement will result
in increased other revenues in the first half of 2005.
Despite anticipated increases in costs related to information technology,
compliance and finance functions, HUSI expects to recognize nominal increases in
operating expenses for core support services in 2005, as compared with 2004. The
2005 business plan depends greatly on HUSI's ability to operate efficiently and
cost effectively while supporting new business initiatives.
Primary opportunities and risks associated with achieving HUSI's business goals
in 2005, which are largely dependent upon economic conditions, revolve around
many key factors, including the following:
o Success in achieving overall financial goals in 2005 is predicated upon
continued growth in various consumer and commercial loan and deposit
portfolios. Maximizing deposits as a relatively low-cost funding source
for asset growth will have a positive impact on net interest rate spreads.
Conversely, funding asset growth primarily through higher-cost sources
such as long-term debt will have a negative impact on spreads.
o Credit quality associated with various HUSI commercial lending portfolios
generally improved in 2004, resulting in reduced provisions for credit
losses. The improving economic climate in 2004 resulted in significant
recoveries of loan balances previously charged off. HUSI expects that a
more normalized environment in 2005 will result in lower recoveries and
higher provision expense. Although overall commercial credit quality is
expected to remain stable and well controlled in 2005, any sudden and/or
unexpected adverse economic events or trends could significantly affect
credit quality and increase provisions for credit losses.
o Significant growth in consumer lending portfolios in 2004, primarily
residential mortgages and credit cards acquired from HSBC Finance
Corporation, has changed products offered and customer credit profiles,
and consequently has increased revenues and risks associated with these
portfolios. Certain economic trends, such as unemployment and
underemployment, must be closely scrutinized for their potential impact on
these portfolios.
14
Critical Accounting Policies
- --------------------------------------------------------------------------------
Allowance for Credit Losses
HUSI's reserves for credit losses are regularly assessed for adequacy through a
detailed review of the loan portfolio. Reserves are comprised of two balance
sheet components:
o The allowance for credit losses, which is carried as a reduction to loans
on the balance sheet, includes reserves for anticipated losses associated
with all loans and leases outstanding.
o The reserve for off-balance sheet risk, which is recorded in other
liabilities, includes probable and reasonably estimable losses arising
from off-balance sheet arrangements such as letters of credit and
commitments to lend that have not as yet been drawn by customers.
Both types of reserves include amounts calculated for individual loan balances
and for collective loan portfolios depending on the nature of the exposure and
the manner in which risks inherent in that exposure are managed.
o All loans that exceed five hundred thousand dollars are evaluated
individually for impairment. When a loan is found to be "impaired", a
specific reserve is calculated. Reserves against impaired loans are
determined primarily by an analysis of discounted expected cash flows
expected by HUSI with reference to independent valuations of underlying
loan collateral and also considering secondary market prices for
distressed debt where appropriate.
o Loans which are not individually evaluated for impairment are pooled into
homogeneous categories of loans and evaluated to determine if it is deemed
probable, based on historical data, that a loss has been realized even
though it has not yet been manifested in a specific loan.
For retail credit card receivables, HUSI uses roll rate methodology (statistical
analysis of historical trends used to estimate the probability of continued
delinquency, ultimate charge off, and amount of consequential loss assessed at
each time period for which payments are overdue) to ensure that an acceptable
number of months of anticipated losses are included in the allowance for credit
losses. The resulting loss coverage ratio varies by portfolio based on inherent
risk and regulatory guidance. Historical factors used in the models are modified
as appropriate by an evaluation of current economic conditions and portfolio
trends including behavioral and account management information such as
bankruptcy. Roll rates are regularly updated and benchmarked against actual
outcomes to ensure that they remain appropriate.
In 2004, HUSI implemented a new methodology to support the estimation of losses
inherent in pools of homogeneous commercial loans, leases and off-balance sheet
risk. These measures have been under development at HUSI for over three years to
support more advanced credit risk management, estimation of credit economic
capital, enhanced portfolio management and the requirements of the Basel
framework. This new methodology uses the probability of default from the
customer rating assigned to each counterparty, the "Loss Given Default" rating
assigned to each transaction or facility based on the collateral securing the
transaction, and the measure of exposure based on the transaction. A suite of
models, tools and templates was developed using quantitative and statistical
techniques, which are combined with expert judgement to support the assessment
of each transaction. They were developed using HUSI's internal data and
supplemented by data from external sources which was judged to be consistent
with HUSI's internal credit standards. As some of the requirements under Basel
differ from interpretations of U.S. GAAP requirements for the measurement of
inherent losses in homogeneous pools of loans, these measures are modified to
meet accounting standards. These advanced measures are applied to the
homogeneous credit pools to estimate the reserves required.
The results from the advanced commercial analysis, retail roll rate analysis and
the specific/impairment reserving process is reviewed each quarter by a Credit
Reserve Committee co-chaired by the Chief Financial Officer and Chief Credit
Officer. This committee also considers other observable factors, both internal
to HUSI and external in the general economy, to ensure that the estimates
provided by the various models adequately include all known information at each
reporting period. The Credit Reserve Committee may add to or reduce a general
unallocated
15
reserve to account for any observable factor not considered in the various
models, for small portfolios or period ending manual entries not considered in a
model and to recognize modeling imperfections. The credit reserves and the
results of the Credit Reserve Committee are reviewed with HUSI's Credit Risk
Management Committee and the Board of Directors' Audit and Examining Committee
each quarter.
HUSI recognizes however that there is a high degree of subjectivity and
imprecision inherent in the process of estimating losses utilizing historical
data. Accordingly, a discretionary component of the allowance for credit losses
for unspecified potential losses inherent in the loan portfolios is provided
based upon an evaluation of certain critical factors including the impact of the
national economic cycle, migration of loans within non-criticized loan
portfolios, and loan portfolio concentration. As a result of review and revision
of various assumptions used in the overall methodology for calculating the
allowance for credit losses, the unspecified component was reduced to $13
billion at December 31, 2004.
Additional credit quality related analysis begins on page 37 of this Form 10-K.
HUSI's approach toward credit risk management begins on page 47 of this Form
10-K.
Goodwill
Goodwill is not subject to amortization but must be tested for possible
impairment at least annually or more frequently if events or changes in
circumstances indicate that the asset might be impaired. Impairment testing
requires that the fair value of each reporting unit be compared to its carrying
amount, including the goodwill.
Reporting units were identified based upon an analysis of each of HUSI's
individual operating segments. A reporting unit is defined as any distinct,
separately identifiable component of an operating segment for which complete,
discrete financial information is available that management regularly reviews.
Goodwill was allocated to the carrying value of each reporting unit based on its
relative fair value.
Determining the fair value of a reporting unit requires a high degree of
subjective management assumption. Discounted cash flow valuation models are
utilized that incorporate such variables as revenue growth rates, expense
trends, interest rates and terminal values. Based upon an evaluation of key data
and market factors, management selects from a range the specific variables to be
incorporated into the valuation model.
HUSI has established April 30 of each year as the date for conducting its annual
goodwill impairment assessment. The variables are selected as of that date and
the valuation models are run to determine the fair value of each reporting unit.
See Business Segments beginning on page 33 of this Form 10-K for an allocation
of recorded book value of goodwill by segment. At April 30, 2004, there were no
individual reporting units with a fair value less than carrying value, including
goodwill. In aggregate, fair value of all the reporting units exceeded carrying
value, including goodwill, by more than $6 billion. Fair value exceeded carrying
value by at least $300 million for all business units. The fair value
calculations were tested for sensitivity to reflect reasonable variations,
including keeping all other variables constant and assuming no future expense
savings are achieved; and keeping other variables constant while cutting
projected revenue growth rates in half. In both of these cases there was no
impairment identified in any reporting unit.
Mortgage Servicing Rights
HUSI recognizes the right to service mortgage loans as a separate and distinct
asset at the time the loans are sold. Servicing rights are then amortized in
proportion to net servicing income and carried on the balance sheet at the lower
of their initial carrying value, adjusted for amortization, or fair value.
As interest rates decline, prepayments generally accelerate, thereby reducing
future net servicing cash flows from the serviced mortgage loan portfolio. The
carrying value of the mortgage servicing rights (MSRs) is periodically evaluated
for impairment based on the difference between the carrying value of such rights
and their current fair value. For purposes of measuring impairment, MSRs are
stratified based upon interest rates and whether such rates
16
are fixed or variable and other loan characteristics. Fair value is determined
based upon the application of pricing valuation models incorporating portfolio
specific prepayment assumptions. These assumptions involve a high degree of
subjectivity that is dependent on future interest rate movements. The
reasonableness of these pricing models is periodically substantiated by
reference to external independent broker valuations and industry surveys.
Note 9 of the consolidated financial statements, which begins on page 88 of this
Form 10-K, contains information regarding the factors that were used in
determining the fair value of the MSRs at December 31, 2004.
HUSI manages its exposure to declines in the fair value of the MSRs by reference
to the interest rate environment. However, in evaluating the impact of the
interest rate changes, the effect of various financial instruments, including
investment securities and derivatives, that are used to offset changes in the
economic value of the MSRs, are considered. Modeling techniques are used to
monitor certain interest rate scenarios for their impact on the economic value
of net hedged MSRs. These modeling scenarios are summarized beginning on page 55
of this Form 10-K.
17
Balance Sheet Review
- --------------------------------------------------------------------------------
Overview
Balance sheet growth during 2004 was highlighted by significant increases in
residential mortgages and credit card receivables, and moderate increases in
other consumer and commercial loans. Acquisitions of loans from HSBC Finance
Corporation contributed significantly to the overall increases. Transactions
with HSBC Finance Corporation are described in Note 18 of the consolidated
financial statements on page 97 of this Form 10-K.
HUSI and HBUS periodically issue debt instruments to fund balance sheet growth,
to meet cash and capital needs, or to fund investments in subsidiaries. HUSI's
shelf registration statement filed with the U.S. Securities and Exchange
Commission has $825 million available under which it may issue debt and equity
securities and have ready access to the capital markets for long-term funding
through the issuance of registered debt. In 2004, HBUS completed a $20 billion
Global Bank Note Program for the issuance of subordinated and senior global
notes. Through December 31, 2004, approximately $14 billion of debt has been
issued from this program. HBUS also issued $1 billion of subordinated debt in
March 2004.
As of December 31, 2004, HUSI had borrowings from the Federal Home Loan Bank
(FHLB) of approximately $5 billion and access to a potential secured borrowing
facility as a member of the FHLB. Off-balance sheet special purpose vehicles or
other off-balance sheet mechanisms are not used as a significant source of
liquidity or funding.
As of December 31, 2004, HUSI had deposits and borrowings from HSBC affiliates
of approximately $6 billion, and an unused $750 million line of credit with
HSBC.
Anticipated balance sheet growth in 2005, can be funded through a variety of
sources, including new deposit growth, asset securitizations, borrowings from
other affiliates, borrowings from the FHLB, debt issuances from the Global Bank
Note Program, and short-term wholesale markets.
Loans Outstanding
The following table provides a breakdown of major loan categories.
- ----------------------------------------------------------------------------------------------------------------------------
December 31 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
(in millions)
Domestic:
Commercial:
Construction and other real estate $ 8,341 $ 7,075 $ 6,350 $ 5,954 $ 5,646
Other commercial ................. 11,815 8,658 11,025 10,920 12,704
Consumer:
Residential mortgage loans ....... 46,715 26,295 20,438 17,595 15,683
Credit card receivables .......... 12,078 1,112 1,101 1,148 1,232
Other consumer loans ............. 3,122 1,904 1,693 1,770 1,640
------- ------- ------- ------- -------
82,071 45,044 40,607 37,387 36,905
------- ------- ------- ------- -------
International:
Government and official institutions . 167 168 184 169 302
Banks and other financial institutions 202 186 139 314 852
Commercial and industrial ............ 2,507 2,617 2,248 2,587 1,946
Consumer ............................. -- 459 458 466 413
------- ------- ------- ------- -------
2,876 3,430 3,029 3,536 3,513
------- ------- ------- ------- -------
Total loans ................................ $84,947 $48,474 $43,636 $40,923 $40,418
======= ======= ======= ======= =======
18
2004 Compared to 2003
Commercial Loans
The increase in commercial loans in 2004 primarily reflects targeted growth in
middle market, commercial real estate and small business lending portfolios.
Specific programs were implemented in 2004 to expand these portfolios.
Residential Mortgage Loans
The increase in residential mortgage loans partially reflects 2004 purchases of
approximately $4 billion from HSBC Finance Corporation and from originating
lenders pursuant to an HSBC Finance Corporation correspondent loan program. The
remaining net increase resulted from continued growth in the held mortgage loan
portfolio.
Credit Card Receivables and Other Consumer Loans
On December 29, 2004, HUSI acquired a $12 billion private label loan portfolio
from HSBC Finance Corporation, which consisted primarily of credit card
receivables.
2003 Compared to 2002
Commercial Loans
The exit of less profitable relationships, including equipment finance, U.S.
factoring and commercial finance resulted in a decrease in other business and
financial commercial loans. Partially offsetting this decrease was business
growth in commercial middle market loans in the New York City area. The increase
in commercial construction and mortgage loans reflects business growth in New
York State based commercial real estate lending businesses.
Residential Mortgage Loans
The increase in residential mortgage loans includes the December 31, 2003
purchase of approximately $3 billion of residential mortgage loan assets from
HSBC Finance Corporation. The increase also was a result of loan growth
attributed to the low interest rate environment which continued to stimulate
consumers to refinance mortgages and purchase residential property.
Commercial Loan Maturities and Sensitivity to Changes in Interest Rates
The following table presents the contractual maturity and interest sensitivity
of domestic commercial and international loans at December 31, 2004.
- ---------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five Total
December 31, 2004 or Less Five Years Years Loans
- ---------------------------------------------------------------------------------------------------------
(in millions)
Domestic:
Construction and other real estate $ 2,557 $ 4,212 $ 1,572 $ 8,341
Other commercial ................. 7,518 3,542 755 11,815
International .......................... 2,211 564 101 2,876
------- ------- ------- -------
Total .................................. $12,286 $ 8,318 $ 2,428 $23,032
======= ======= ======= =======
Loans with fixed interest rates ........ $ 4,279 $ 2,370 $ 1,308 $ 7,957
Loans having variable interest rates ... 8,007 5,948 1,120 15,075
------- ------- ------- -------
Total .................................. $12,286 $ 8,318 $ 2,428 $23,032
======= ======= ======= =======
19
Capital Resources
A summary of changes in common shareholder's equity is presented in the
following table.
- --------------------------------------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------------------------
(in millions)
Balance, January 1 ........................... $ 6,962 $ 6,896 $ 6,550
Increases (decreases) due to:
Net income ............................. 1,258 941 855
Dividends paid to common shareholder ... (125) (690) (670)
Dividends paid to preferred shareholders (23) (22) (23)
Change in other comprehensive income ... (97) (134) 163
Capital contribution from parent (1) ... 2,411 15 21
Reductions of capital surplus .......... (20) (44) --
-------- ------- -------
Total net increase ..................... 3,404 66 346
-------- ------- -------
Balance, December 31 ......................... $ 10,366 $ 6,962 $ 6,896
======== ======= =======
(1) Capital contribution from parent includes amounts related to an HSBC stock
option plan in which almost all of HUSI's employees are eligible to
participate ($11 million, $15 million and $21 million for 2004, 2003 and
2002 respectively).
Year end common shareholder's equity ratios are presented in the following
table.
- -----------------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------
Common shareholder's equity to total assets........................... 7.35% 7.28% 7.71%
Tangible common shareholder's equity to total tangible assets......... 5.50 4.34 4.32
HUSI periodically pays dividends to its parent company, HNAI. Dividends paid to
HNAI were significantly reduced in 2004 in order to conserve funds for the
December 2004 acquisition of private label loans from HSBC Finance Corporation.
The capital contribution from parent includes $2.4 billion received to provide
additional funding for the private label loan acquisition.
Reductions of capital surplus in 2004 resulted from sales or transfers of
subsidiaries to affiliated HSBC entities.
HUSI and HBUS are required to meet minimum capital requirements by their
principal regulators. Risk-based capital amounts and ratios are presented on
page 7 of this Form 10-K.
20
Results of Operations
- --------------------------------------------------------------------------------
Net Interest Income
- --------------------------------------------------------------------------------
Net interest income is the total interest income on earning assets less the
total interest expense on deposits and borrowed funds. In the discussion that
follows, interest income and rates are presented and analyzed on a taxable
equivalent basis, in order to permit comparisons of yields on tax-exempt and
taxable assets.
The following table presents changes in the components of net interest income
according to "volume" and "rate". Specific categories and amounts for interest
income and interest expense agree with the "Consolidated Average Balances and
Interest Rates" tables on pages 66-67 of this Form 10-K.
- ----------------------------------------------------------------------------------------------------------------------------------
2004 Compared to 2003 2003 Compared to 2002
Increase/(Decrease) Increase/(Decrease)
Year Ended December 31 2004 Volume Rate 2003 Volume Rate 2002
- ----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Interest bearing deposits with banks .. $ 41 $ 13 $ 3 $ 25 $ (8) $ (22) $ 55
Federal funds sold and securities
purchased under resale agreements ... 74 2 17 55 (13) (27) 95
Trading assets ........................ 165 35 (7) 137 20 (45) 162
Securities ............................ 885 (40) 17 908 27 (94) 975
Loans
Domestic
Commercial .................. 732 (24) (49) 805 8 (44) 841
Consumer
Residential mortgages .. 1,795 779 (155) 1,171 116 (195) 1,250
Other consumer ......... 286 42 (4) 248 7 (30) 271
International .................. 99 12 (39) 126 -- (34) 160
Other interest ....................... 18 2 (4) 20 -- (3) 23
--------- ------- -------- --------- ------ ------- -------
Total interest income ................ 4,095 821 (221) 3,495 157 (494) 3,832
--------- ------- -------- --------- ------ ------- -------
Interest expense:
Deposits in domestic offices
Savings deposits ............... 179 17 (27) 189 34 (57) 212
Other time deposits ............ 365 121 21 223 (54) (78) 355
Deposits in foreign offices .......... 281 31 (4) 254 16 (169) 407
Short-term borrowings ................ 132 3 38 91 (44) (97) 232
Long-term debt ....................... 380 247 (73) 206 (9) (10) 225
--------- ------- -------- --------- ------ ------- -------
Total interest expense ............... 1,337 419 (45) 963 (57) (411) 1,431
--------- ------- -------- --------- ------ ------- -------
Net interest income -
taxable equivalent basis ........... 2,758 $ 402 $ (176) 2,532 $ 214 $ (83) 2,401
======= ======== ====== =======
Tax equivalent adjustment ............ 17 22 25
--------- --------- -------
Net interest income -
non taxable equivalent basis ....... $ 2,741 $ 2,510 $ 2,376
========= ========= =======
2004 Compared to 2003
Net interest income increased approximately $231 million (9%) in 2004, compared
with the prior year. Increased average loan balances, primarily residential
mortgage loans, were partially offset by increased long-term debt and deposit
balances, and by a reduction in the net interest rate spread during 2005.
Residential mortgage interest income increased approximately $624 million (53%)
in 2004, compared with 2003. Average residential mortgages increased
approximately $16 billion (74%) in 2004. The low interest rate environment of
2003 and 2004 continued to stimulate consumers to refinance mortgages and
purchase residential property. In addition, HUSI continued to purchase
residential mortgage loans from HSBC Finance Corporation and
21
from originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs. HUSI generally sells higher fixed rate residential mortgages under
Federal loan programs, and retains low adjustable rate mortgages on the balance
sheet. The increase in variable rate mortgages relative to the entire
residential mortgage portfolio has caused a decline in average residential
mortgage interest rates of approximately 66 basis points for 2004.
Commercial loan interest income decreased approximately $73 million (9%) in
2004. Average commercial loans decreased approximately $.5 billion (3%).
Targeted growth in middle-market, commercial real estate and small business
lending portfolios increased commercial loan balances in 2004. However, during
2002 and 2003, certain equipment finance, commercial finance and U.S. factoring
businesses were exited or restructured resulting in office closings and sales of
customer relationships. In addition, certain receivables associated with these
businesses were retained, but have been decreasing throughout 2003 and 2004 as
balances have run off. These transactions more than offset the positive impact
of 2004 loan growth on interest income.
Interest expense associated with time deposits in domestic and foreign offices
increased a combined $159 million (24%) in 2004. An increase in average time
deposit balances of approximately $10 billion (19%), coupled with an increase in
the average rate paid on time deposits, were the primary drivers of the overall
interest expense increase.
Interest expense on short-term borrowings increased approximately $41 million
(45%) in 2004, due primarily to increases in the federal funds borrowing rate
during the year.
Interest expense on long-term debt increased approximately $174 million (84%) in
2004. Debt issued from HUSI's expanded global notes program and advances from
the Federal Home Loan Bank with maturities greater than one year were primary
funding sources for the purchase of $12 billion of private label receivables
from HSBC Finance Corporation in December 2004, thus increasing average
long-term debt balances by approximately $6 billion (158%) during the year. The
average rate paid on long-term debt decreased significantly during 2004, due to
rates on new debt which are lower than rates on debt that existed in 2003.
The purchase of the $12 billion private label loan portfolio from HSBC Finance
Corporation in December 2004, as well as the ongoing purchases of receivables
associated with the portfolio relationships in 2005, will have a significant
impact on net interest income in 2005. Additional consumer loans will also be
purchased from HSBC Finance Corporation and from originating lenders pursuant to
HSBC Finance Corporation correspondent loan programs. Increased interest earned
on these receivables will be offset by amortization of premiums paid and
additional interest expense associated with related funding sources.
HUSI also plans for organic growth of various loan and deposit portfolios during
2005. Emphasis will be placed on enhancing and improving core retail banking
businesses. Investment in the retail branch network is planned. Loan and deposit
products offered to individuals, small businesses, and middle-market commercial
customers were expanded in 2004, and will continue to be expanded in 2005, in
conjunction with increased marketing efforts.
2003 Compared to 2002
An improved mix of loans, securities and deposits on the balance sheet and a
continued steep yield curve all contributed to the increase in net interest
income as compared to 2002. Also contributing to the increase in net interest
income was a larger balance sheet, primarily from residential mortgages and
growth in lower cost savings deposits.
Average residential mortgages outstanding grew approximately $2 billion compared
with 2002, as the low interest rate environment continued to stimulate consumers
to refinance mortgages and purchase residential property. Although total average
commercial loans were essentially unchanged from 2002, HUSI benefited from
efforts to improve its loan mix. Less profitable relationships, including
equipment finance, U.S. factoring and commercial finance relationships were
exited, while more profitable commercial middle market and commercial real
estate loans
22
grew. This improved loan mix and higher levels of commercial loan prepayment
fees helped to maintain the gross rate earned on commercial loans during a
period of declining rates. The securities portfolio also increased as longer
term fixed rate instruments were purchased to replace matured variable rate
securities. This strategy helped to improve the net yield as funding costs
dropped more than the gross rate earned on these securities.
HUSI experienced almost $4 billion of growth in average savings deposits as
compared to 2002. Due to the low rate environment and the uncertainty of the
equity markets, many of HUSI's personal financial services customers showed
preference to place funds in more liquid savings deposits as opposed to time
deposits or mutual funds. This savings deposit growth has been achieved
primarily in the New York City market. Higher levels of savings deposits also
permitted HUSI to reduce its reliance on short-term borrowings as a funding
source. The almost $1 billion increase in average noninterest bearing deposits
was due to commercial deposit growth and the increased usage of compensating
balances to pay for services provided to commercial customers.
Other Revenues
- --------------------------------------------------------------------------------
The following table presents the components of other revenues.
- ----------------------------------------------------------------------------------------------------------------------------------
2004 Compared to 2003 Compared to
2003 2002
Increase/(Decrease) Increase/(Decrease)
-------------------- ----------------------
Year Ended December 31 2004 2003 2002 Amount % Amount %
- ----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Trust income ................... $ 95 $ 94 $ 94 $ 1 1 $ -- --
Service charges:
HSBC affiliate income .... 17 16 15 1 6 1 7
Other service charges .... 196 196 191 -- -- 5 3
Other fees and commissions:
Letter of credit fees .... 70 71 66 (1) (1) 5 8
Credit card fees ......... 82 76 72 6 8 4 6
Investment product fees .. 36 75 89 (39) (52) (14) (16)
Wealth and tax advisory
services ............... 45 39 15 6 15 24 160
HSBC affiliate income .... 27 26 8 1 4 18 225
Other fee-based income ... 165 159 148 6 4 11 7
------- ------- ------- ------- ------- ------- -------
Total other fees and
commissions ............ 425 446 398 (21) (5) 48 12
------- ------- ------- ------- ------- ------- -------
Other income:
Insurance ................ 63 65 46 (2) (3) 19 41
Interest on tax settlement 17 22 -- (5) (23) 22 --
Other .................... 253 78 43 175 224 35 81
------- ------- ------- ------- ------- ------- -------
Total other income ....... 333 165 89 168 102 76 85
------- ------- ------- ------- ------- ------- -------
Residential mortgage banking
revenue (expense) ............ (120) (102) 24 (18) (18) (126) (525)
Trading revenues ............... 288 291 130 (3) (1) 161 124
Securities gains, net .......... 85 48 118 37 77 (70) (59)
------- ------- ------- ------- ------- ------- -------
Total other revenues ........... $ 1,319 $ 1,154 $ 1,059 $ 165 14 $ 95 9
======= ======= ======= ======= ======= ======= =======
23
2004 Compared to 2003
Other Fees and Commissions
The overall decrease in other fees and commissions during 2004 was attributable
to the June 2004 transfer of a brokerage subsidiary of HUSI to an HSBC
affiliate. As a result, income received directly from customers and recorded as
investment product fees prior to the transfer, was replaced by lower net
referral fees received from HSBC affiliates.
On December 29, 2004, HUSI acquired $12 billion of private label loans from HSBC
Finance Corporation, which consisted primarily of credit card receivables. These
additional receivables will result in a significant increase in credit card fees
in 2005.
Other Income
The 2004 increase in other income was primarily the result of the following
significant non-recurring transactions and/or other activities:
o HUSI sold certain consumer credit card relationships to HSBC Finance
Corporation at a gain of approximately $99 million, which was recorded as
other income. Further analysis of transactions with HSBC Finance
Corporation is provided in Note 18 of the consolidated financial
statements beginning on page 97 of this Form 10-K.
o HUSI sold its non-marketable minority investment in NYCE Corporation for a
gain of approximately $45 million. HUSI had held its investment since 1985
and was obligated to sell its investment by the majority shareholder in
accordance with the terms of the shareholder agreement.
o HUSI recorded higher earnings from a foreign equity investment, resulting
in an increase in other income of approximately $13 million in 2004, as
compared with 2003.
o Various bank branches and other properties were sold during 2004, with
combined gains on sale of approximately $9 million being recorded as other
income.
2003 Compared to 2002
Other Fees and Commissions
The year to year increase in credit card fees was primarily due to higher levels
of credit card interchange fees, the result of an increase in purchase volume
per account. An increase in merchant fee income, the result of increased sales
and marketing efforts, also contributed to this increase. The decrease in
investment product fees for 2003 as compared to 2002 was due to lower sales and
customer demand for annuity based products, which historically have had a higher
commission structure. Uncertainties affecting the stock market reduced customer
demand for equity mutual fund products, while sales of fixed income securities
were higher in 2003. The increased revenue from the wealth and tax advisory
services business reflects 12 months of activity for 2003 versus 4 months of
activity for 2002 (the business commenced activity during the third quarter of
2002). Higher levels of fees earned by International Private Banking, Investment
Banking and Markets and by HUSI's U.S. dollar clearing business account for the
majority of the year to year increase in other fee-based income.
Other Income
Increased sales, marketing and employee training efforts resulted in substantial
growth in insurance income for 2003 as compared to 2002. Commissions from retail
insurance products (life, disability and elder care) as well as credit and
annuity reinsurance premiums grew at a double digit rate. During the second
quarter of 2003 HUSI received $21 million from the Internal Revenue Service for
settlement of additional interest related to a corporate tax refund for prior
years. Included in other is a $12 million increase related to equity investments
primarily from the investment in HSBC Republic Bank (Suisse) S.A.
24
Residential Mortgage Banking Revenue
The following table presents the components of residential mortgage banking
revenue. Net interest income includes interest earned/paid on assets and
liabilities of the residential mortgage banking business as well as an
allocation of the funding benefit or cost associated with these balances. The
net interest income component of the table is included in net interest income in
the consolidated statement of income and reflects actual interest earned, net of
interest expense and corporate transfer pricing cost of funds.
- -------------------------------------------------------------------------------------------------------------------------------
2004 Compared to 2003 Compared to
2003 2002
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2004 2003 2002 Amount % Amount %
- -------------------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ...................... $ 667 $ 430 $ 286 $ 237 55 $ 144 50
----- ----- ----- ----- ---- ----- ------
Servicing related income (expense):
Servicing fee income ............... 78 72 72 6 8 -- --
MSRs amortization .................. (101) (158) (77) 57 36 (81) (105)
MSRs temporary impairment
(provision) recovery ............. (102) (27) (56) (75) (278) 29 52
Trading - Derivative instruments
used to offset changes in value
of MSRs .......................... 8 (135) 44 143 106 (179) (407)
Gains on sales of available for sale
securities ....................... 8 22 1 (14) (64) 21 2,100
----- ----- ----- ----- ---- ----- ------
Total net servicing related income
(expense) .............................. (109) (226) (16) 117 52 (210) (1,312)
----- ----- ----- ----- ---- ----- ------
Originations and sales related income
(expense):
Gains (losses) on sales of mortgages (4) 117 164 (121) (103) (47) (29)
Trading - Forward loan sale
commitments ........... (2) 35 (189) (37) (106) 224 119
- Interest rate lock
commitments ........... (13) (40) 47 27 68 (87) (185)
Fair value hedge activity (1) ...... (2) -- 8 (2) -- (8) (100)
----- ----- ----- ----- ---- ----- ------
Total net originations and sales related
income (expense) ....................... (21) 112 30 (133) (119) 82 273
----- ----- ----- ----- ---- ----- ------
Other mortgage income .................... 10 12 10 (2) (17) 2 20
----- ----- ----- ----- ---- ----- ------
Total residential mortgage banking
revenue (expense) included in other
revenues ............................... (120) (102) 24 (18) (18) (126) (525)
----- ----- ----- ----- ---- ----- ------
Total residential mortgage banking
related revenue ........................ $ 547 $ 328 $ 310 $ 219 67 $ 18 6
===== ===== ===== ===== ==== ===== ======
(1) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity.
25
2004 Compared to 2003
Overview
Increased residential mortgage banking related revenue for full year 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.
Net Interest Income
Increased net interest income in 2004 resulted from the significant increase in
residential mortgage loans during the year, primarily due to the following
factors:
o Approximately $4 billion of residential mortgage loans were acquired from
HSBC Finance Corporation and from originating lenders pursuant to an HSBC
Finance Corporation correspondent loan program.
o Increased origination volumes in the held loan portfolio. In 2004 HUSI
continued the general strategy to retain variable rate mortgage loans in
the held portfolio, while selling fixed rate loans to government agencies.
Consumer demand for variable rate products increased significantly in
2004.
Residential mortgage loan portfolio increases were partially offset by lower
interest rate spreads on originated loans and by lower income on loans held for
sale due to reduced levels of loans originated for sale. Commentary regarding
residential mortgage interest income is presented on pages 21-22 of this Form
10-K.
Servicing Related Income (Expense)
Decreased net servicing related expense for full year 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 $57 million
for full year 2004.
The recorded net book value of MSRs, as well as related amortization expense,
are directly impacted by levels of residential mortgage prepayments. Higher
levels of prepayments generally increase amortization expense and decrease the
net book value of MSRs. 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. 30 year fixed rate
mortgage rates generally rose in the second quarter of 2004 from the
historically low rates experienced in 2003, declined again through the third
quarter, and leveled off in the fourth quarter. Loan refinance activity
represented 50% of total originations in 2004, as compared with 74% in 2003. The
reduction in amortization is also partially due to lower MSRs balances in 2004,
as compared with 2003.
The positive impacts of amortization and trading revenue for 2004 were partially
offset by increases in the temporary impairment valuation allowance for the
MSRs. The net servicing related expense amounts in the tables do not reflect
approximately $4 million of unrealized losses, recorded as other comprehensive
income, on available for sale securities used to offset changes in the economic
value of MSRs, or net interest income of $19 million on these securities.
Additional commentary regarding risk management associated with the MSRs hedging
program is presented on pages 55-56 of this Form 10-K.
26
Originations and Sales Related Income (Expense)
Originations and sales related income in 2004 reflects a small amount of net
losses realized on sales of residential mortgage loans, as compared with net
gains of $117 million for 2003. Significantly lower volume of loans originated
with the intention to sell in 2004 were coupled with lower gains recorded on
each sale transaction. During 2004, residential mortgages originated with the
intention to sell declined 64% from 2003 levels, despite an overall increase in
residential mortgage loan originations. This was attributable to lower mortgage
refinancings and a larger proportion of adjustable rate mortgage originations in
2004, which are generally held on HBUS'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.
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, resulted in deferral of originations and sales
related income of approximately $22 million in 2004. This income will be
realized in future reporting periods.
2003 Compared to 2002
The increases in net interest income reflected growth in the residential
mortgage portfolio in combination with widening interest rate spreads. Average
residential mortgages outstanding grew approximately $2 billion in 2003 and
2002. During 2003, the mortgage industry experienced the lowest mortgage rates
in forty years, with the rate on a 30 year fixed rate mortgage reaching a low of
4.99% in June. The unusually low interest rate environment in 2003 encouraged
consumers to refinance mortgages and purchase residential property in
unprecedented numbers, as HUSI originated approximately $32 billion in
mortgages. The steep yield curve and historically low interest rates contributed
to increased interest margins in the mortgage banking business.
Total servicing related income decreased $210 million in 2003, primarily driven
by accelerated amortization and large write-downs of mortgage servicing rights
(MSRs) as customers refinanced mortgages in record numbers due to the low rate
environment. The decrease in servicing related income also reflected significant
losses on derivative instruments used to protect the economic value of MSRs. The
June/July 2003 time period was one of the more difficult periods related to
derivatives used to hedge the change in economic value of MSRs. Specifically, as
mortgage rates continued to fall in June, additional derivative instrument
positions were taken to further reduce the exposure to losses in a continuing
declining rate environment. Extreme interest rate volatility ensued during July
when there was a significant rise in interest rates resulting in a substantial
loss in value of the derivative instruments and resultant mark to market losses.
Subsequent falls in rates only modestly recovered part of these losses which
compounded the impact of large MSRs write-downs recorded in prior months.
Partially offsetting these reductions were gains related to the sale of certain
mortgage backed securities available for sale that were used as "on-balance
sheet" economic hedges of MSRs.
While the values of MSRs generally decline in a falling rate environment as
mortgages prepay, the effect of this decline is often mitigated to some degree
by increases in originations and thus income from increases in mortgage loan
refinancings. Total loan volumes originated for sale in 2003 were $20 billion
compared to $12 billion for 2002. Market conditions during 2003 also permitted
favorable pricing which allowed HUSI to earn a significantly higher gain on sale
percentage per salable loan dollar. Total originations and sales related income
for 2003 therefore increased approximately $82 million compared to 2002.
27
Trading Revenues
Trading revenues are generated by HUSI's participation in the foreign exchange,
credit derivative and precious metal markets; from trading derivative contracts,
including interest rate swaps and options; from trading securities; and as a
result of certain residential mortgage banking activities.
The following table presents trading related revenues by business. The data in
the table includes net interest income earned on trading instruments, as well as
an allocation of the funding benefit or cost associated with the trading
positions. The trading related net interest income component is not included in
other revenues, but it is included in net interest income. Trading revenues
related to the mortgage banking business are included in residential mortgage
banking revenue. See analysis of residential mortgage banking revenue for
details.
- -----------------------------------------------------------------------------------------------------------------------------
2004 Compared to 2003 Compared to
2003 2002
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2004 2003 2002 Amount % Amount %
- -----------------------------------------------------------------------------------------------------------------------------
(in millions)
Trading revenues ................... $ 288 $ 291 $ 130 $ (3) (1) $ 161 124
Net interest income ................ 76 81 74 (5) (6) 7 9
------ ------ ------ ------ ------ ------ ------
Trading related revenues ........... $ 364 $ 372 $ 204 $ (8) (2) $ 168 82
====== ====== ====== ====== ====== ====== ======
Business:
Derivatives and treasury ..... $ 149 $ 190 $ 71 $ (41) (22) $ 119 168
Foreign exchange and banknotes 143 102 39 41 40 63 162
Precious metals .............. 49 59 70 (10) (17) (11) (16)
Other trading ................ 23 21 24 2 10 (3) (13)
------ ------ ------ ------ ------ ------ ------
Trading related revenues ........... $ 364 $ 372 $ 204 $ (8) (2) $ 168 82
====== ====== ====== ====== ====== ====== ======
2004 Compared to 2003
Derivatives and treasury revenue decreased in 2004, due primarily to a lower
interest rate environment which decreased customer activity and reduced
proprietary gains.
Increased foreign exchange revenues resulted from improved performance for
foreign currency and banknotes trading activities. 2003 banknotes trading
results were negatively impacted by the SARS scare and by the war in Iraq. 2004
activity reflected a recovery of customer activity levels and improved
proprietary results.
Decreased precious metals trading revenue was primarily due to a significant
default by a customer in Australia, which was partially offset by slightly
improved results in other domestic and foreign locations.
2003 Compared to 2002
The increase in foreign exchange and banknotes revenues was due to increased
client activity and improved trading results relative to 2002, when a
challenging market environment in emerging markets currencies impacted
performance. The increase in foreign exchange client activity can be attributed
to significant investment in marketing and trading personnel, as part of a
targeted effort to improve client business. Banknotes revenue in 2003 benefited
from an improving global economy.
Derivative and treasury revenue increases in 2003 were primarily the result of
mark to market gains on economic hedges of HUSI's investment portfolio. HUSI
also had higher proprietary trading revenue in corporate and other securities,
offset by lower proprietary trading revenues in credit and interest rate
derivatives. Revenue from client activity in interest and credit derivatives
increased in 2003 due to an expanded customer base and a continued focus on
servicing client business.
The decrease in precious metals trading revenues was a result of losses in risk
taking activities in precious metals options and the impact of adverse movements
in precious metals interest rates on other proprietary metal trading positions.
28
Security Gains, Net
2004 Overview
The following table presents realized security gains and losses included in the
consolidated statement of income for 2004.
- ---------------------------------------------------------------------------------------------------------
Gross Realized Gross Realized Net Realized
Year Ended December 31, 2004 Gains (Losses) Gains (Losses)
- ---------------------------------------------------------------------------------------------------------
(in millions)
Net gains included in:
Residential mortgage banking revenue (1). $ 8 $ -- $ 8
Security gains, net...................... 93 (8) 85
------ ------ ------
$ 101 $ (8) $ 93
====== ====== ======
(1) Securities gains related to available for sale securities used to offset
charges in the economic value of MSRs are included in residential mortgage
banking revenue.
HUSI continued to manage its credit risk exposure related to investment in Latin
American securities, resulting in net gains on sales of securities of
approximately $30 million. Ongoing review and diversification of securities
portfolios to adjust for interest rate changes and changes in credit risk
profiles resulted in an additional $48 million of net gains.
2003 Overview
The following table presents realized security gains and losses included in the
consolidated statement of income for 2003.
- ---------------------------------------------------------------------------------------------------------
Gross Realized Gross Realized Net Realized
Year Ended December 31, 2003 Gains (Losses) Gains (Losses)
- ---------------------------------------------------------------------------------------------------------
(in millions)
Net gains included in:
Residential mortgage banking revenue (1) $ 22 $ -- $ 22
Security gains, net..................... 59 (11) 48
------ ------- ------
$ 81 $ (11) $ 70
====== ======= ======
(1) Securities gains related to available for sale securities used to offset
charges in the economic value of MSRs are included in residential mortgage
banking revenue.
Certain Latin American securities were sold during 2003 in order to reduce the
credit risk of HUSI, resulting in approximately $18 million of gains. The
remainder of the security gains in 2003 primarily related to transactions that
adjusted the average life and interest rate profile of HUSI's available for sale
securities holdings.
2002 Overview
The following table presents realized security gains and losses included in the
consolidated statement of income for 2002.
- -------------------------------------------------------------------------------------------------------
Gross Realized Gross Realized Net Realized
Year Ended December 31, 2002 Gains (Losses) Gains (Losses)
- -------------------------------------------------------------------------------------------------------
(in millions)
Net gains included in:
Residential mortgage banking revenue (1) $ 1 $ -- $ 1
Security gains, net..................... 190 (72) 118
------ ------- ------
$ 191 $ (72) $ 119
====== ======= ======
(1) Securities gains related to available for sale securities used to offset
charges in the economic value of MSRs are included in residential mortgage
banking revenue.
29
Security gains for 2002 included gains on sales of mortgage backed, U.S.
Treasury and Latin American securities. HUSI sold the securities to adjust to
interest rate changes and/or reduce its credit risk.
Operating Expenses
- --------------------------------------------------------------------------------
2004 Compared to 2003 Compared to
2003 2002
Increase/(Decrease) Increase/(Decrease)
------------------- --------------------
Year Ended December 31 2004 2003 2002 Amount % Amount %
- ---------------------------------------------------------------------------------------------------------------------------------
(in millions)
Salaries and employee benefits ... $ 947 $ 1,138 $ 1,036 $ (191) (17) $ 102 10
Occupancy expense, net ........... 176 164 165 12 7 (1) (1)
Other expenses:
Equipment and software ..... 108 145 141 (37) (26) 4 3
Marketing .................. 44 39 38 5 13 1 3
Outside services ........... 103 116 106 (13) (11) 10 9
Professional fees .......... 55 69 43 (14) (20) 26 60
Telecommunications ......... 17 42 43 (25) (60) (1) (2)
Postage, printing and office
supplies ................. 25 29 32 (4) (14) (3) (9)
Insurance business ......... 22 31 24 (9) (29) 7 29
HSBC affiliate charges ..... 420 159 98 261 164 61 62
Other ...................... 184 108 149 76 70 (41) (28)
------- ------- ------- ------- ------- ------- -------
Total other expenses ..... 978 738 674 240 33 64 9
------- ------- ------- ------- ------- ------- -------
Total operating expenses ......... $ 2,101 $ 2,040 $ 1,875 $ 61 3 $ 165 9
======= ======= ======= ======= ======= ======= =======
Personnel - average number ....... 11,416 13,486 13,856 (2,070) (15) (370) (3)
2004 Compared to 2003
Total operating expenses increased 3% in 2004, as compared with 2003, primarily
due to increased charges by HSBC affiliates for technology related services,
broker-dealer, loan origination and servicing and other administrative services,
offset by related salary decreases as described below, and to increased
provisions for off-balance sheet credit exposures.
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 HSBC affiliates at fair value. These
transactions decreased various operating expense lines by an approximate
combined amount of $97 million in 2004.
HSBC affiliate charges include amounts 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
affiliates in North America. These other HSBC affiliates 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"
on the consolidated statement of income for 2003 and 2002 are now recorded in
"other expenses" for 2004. In the preceding table, the increase in HSBC
affiliate charges, as well as the decreases for salaries and employee benefits,
equipment and software, telecommunications and outside services expenses,
primarily resulted from these organizational changes. Additional details
regarding HSBC affiliate charges are presented in Note 18 of the consolidated
financial statements beginning on page 97 of this Form 10-K.
30
Salaries and Employee Benefits
The decrease in salaries and employee benefits in 2004 was primarily due to the
transfer of employees to HSBC affiliates, 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 HSBC Finance
Corporation. As a result of the organizational changes and other efforts, the
average number of personnel employed directly by HUSI has decreased 15% during
2004, as compared with 2003. During 2003, severance costs of $48 million were
recorded as a result of various expense reduction, global resourcing, and HSBC
Finance Corporation integration efforts. These initiatives were generally
completed in 2003 resulting in expense decreases in 2004.
Partially offsetting the above salary decreases were increased expenses
associated with expanded residential mortgage lending and CIBM operations.
HSBC Affiliate Charges
As previously noted, a significant number of employees were transferred to HSBC
affiliates 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. Total
technology related expenses, net of related salary line decreases, increased
during 2004 as HUSI has continued to upgrade its automated technology
environment. Origination and servicing expenses have increased due to increased
services provided by HSBC Finance Corporation related to residential mortgages
and other consumer loans.
The purchase of the private label loan portfolio from HSBC Finance Corporation
in December 2004 will result in a significant increase in servicing fees paid to
HSBC Finance Corporation and included in HSBC affiliate charges.
Other Expense
The 2004 increase in other expense was primarily due to the following factors:
o HUSI refined its methodology for calculating its reserve for off-balance
sheet exposure, resulting in an increase in the provision for off-balance
sheet exposure of approximately $53 million.
o In the fourth quarter of 2004, HUSI recorded a provision of approximately
$26 million for U.S. withholding tax costs related to deficiencies in
client tax documentation through a charge to other expense.
2003 Compared to 2002
Higher costs related to certain volume driven and revenue driven incentive
compensation programs contributed approximately $23 million to the year to year
increase in personnel costs. Fringe benefit costs increased approximately $48
million compared to the prior year, primarily due to higher pension and health
care costs. Offsetting these higher incentive and fringe benefit costs was a $26
million increase in personnel expense deferrals of direct costs associated with
the origination of loans, primarily residential mortgage loans. HUSI had almost
a $9 billion increase in loan originations during 2003. During 2003 severance
costs of $48 million were recorded for expense reduction initiatives, global
resourcing moves and HSBC Finance Corporation integration efforts, a $28 million
increase over the prior year. Personnel costs related to the wealth and tax
advisory services business, which commenced activity during the third quarter of
2002, increased approximately $34 million over 2002. Included in these costs are
severance costs related to the closure of certain offices of the business.
The increase in outside services included incremental costs of approximately $8
million supporting new business initiatives and products in treasury (derivative
and structured products) and wealth management (brokerage self-clearing).
Increased residential mortgages origination activity for 2003 also resulted in
an over $2 million increase in outside services.
31
Professional fees for 2003 included $13 million related to consulting and other
professional fees incurred by HUSI to enhance its compliance with anti-money
laundering requirements and an increase of approximately $7 million supporting
new business initiatives and products in wealth management (brokerage
self-clearing) and treasury (derivative and structured products).
The increase in insurance business expense reflected higher claim expenses
associated with continued growth in the reinsurance businesses and was more than
offset by increases in insurance related other income. See comments related to
other revenues.
The increase in HSBC affiliate charges was primarily due to increased costs
supporting continued growth in our treasury and traded markets businesses.
Provision for Credit Losses
- --------------------------------------------------------------------------------
Provisions for credit losses are recorded to adjust the allowance for credit
losses to the level that management deems adequate to absorb losses inherent in
the loan and lease portfolio. Such provisions decreased $130 million in 2004, as
compared with 2003, due primarily to the following factors.
o The overall credit quality of HUSI's commercial lending portfolios
continued to improve during 2004, as evidenced by decreased nonaccruing
loan balances, decreased criticized asset balances, decreased commercial
loan charge offs, and increased recoveries of balances previously charged
off. Specific reserves on impaired commercial loans decreased
approximately $69 million during 2004, while formula reserves on
criticized commercial loans decreased approximately $20 million.
o The unallocated component of the allowance for credit losses was
significantly reduced due to refinement of the allowance for credit losses
methodology, resulting in an overall reduction in provision expense of
approximately $51 million.
On December 29, 2004, HUSI purchased the $12 billion private label loan
portfolio from HSBC Finance Corporation, including an allowance for credit
losses associated with the purchased portfolio of approximately $505 million.
The purchased portfolio is considered to be prime credit quality, with
historical credit losses ranging from 5%-6% over the past few years.
Analysis of the loan portfolios is presented within the Balance Sheet Review
section on pages 18-19 of this Form 10-K. Analysis of credit quality associated
with loan portfolios begins on page 37 of this Form 10-K.
Income Taxes
- --------------------------------------------------------------------------------
Income tax expense increased $148 million (26%) in 2004, as compared with 2003,
due principally to an increase in pretax income. Analysis of income tax expense,
the effective tax rate, and the net deferred tax position is provided in Note 13
of the consolidated financial statements beginning on page 91 of this Form 10-K.
32
Business Segments
- --------------------------------------------------------------------------------
HUSI's business segments are described beginning on page 5 of this Form 10-K.
Results for each segment are summarized in the following table and commentary.
Prior period disclosures previously reported for 2003 and 2002 have been
conformed herein to the presentation of current segments, including methodology
changes related to the transfer pricing of assets and liabilities.
- ----------------------------------------------------------------------------------------------------------------------
PFS CMB CIBM PB Other Total
- ----------------------------------------------------------------------------------------------------------------------
(in millions)
2004
- ----
Net interest income (1) ......... $ 1,478 $ 585 $ 558 $ 130 $ (10) $ 2,741
Other revenues .................. 382 170 536 204 27 1,319
------- -------- -------- ------- ----- ---------
Total revenues .................. 1,860 755 1,094 334 17 4,060
Operating expenses (2) .......... 961 352 525 263 -- 2,101
------- -------- -------- ------- ----- ---------
Working contribution ............ 899 403 569 71 17 1,959
Provision for credit losses (3) . 103 (26) (95) 1 -- (17)
------- -------- -------- ------- ----- ---------
Income before income tax expense $ 796 $ 429 $ 664 $ 70 $ 17 $ 1,976
======= ======== ======== ======= ===== =========
Average assets .................. $45,460 $ 13,750 $ 48,687 $ 4,029 $ 300 $ 112,226
Average liabilities/equity (4) .. 34,165 14,670 54,440 8,951 -- 112,226
Goodwill at December 31, 2004 (5) 1,170 468 631 428 -- 2,697
2003
- ----
Net interest income (1) ......... $ 1,193 $ 592 $ 619 $ 123 $ (17) $ 2,510
Other revenues .................. 250 158 526 195 25 1,154
------- -------- -------- ------- ----- ---------
Total revenues .................. 1,443 750 1,145 318 8 3,664
Operating expenses (2) .......... 930 402 442 265 1 2,040
------- -------- -------- ------- ----- ---------
Working contribution ............ 513 348 703 53 7 1,624
Provision for credit losses (3) . 68 55 (8) (2) -- 113
------- -------- -------- ------- ----- ---------
Income before income tax expense $ 445 $ 293 $ 711 $ 55 $ 7 $ 1,511
======= ======== ======== ======= ===== =========
Average assets .................. $28,601 $ 14,236 $ 45,738 $ 2,936 $ 314 $ 91,825
Average liabilities/equity (4) .. 31,066 13,281 38,917 8,561 -- 91,825
Goodwill at December 31, 2003 (5) 1,223 495 631 428 -- 2,777
2002
- ----
Net interest income (1) ......... $ 1,106 $ 588 $ 566 $ 127 $ (11) $ 2,376
Other revenues .................. 369 133 411 127 20 1,060
------- -------- -------- ------- ----- ---------
Total revenues .................. 1,475 721 977 254 9 3,436
Operating expenses (2) .......... 897 406 371 202 -- 1,876
------- -------- -------- ------- ----- ---------
Working contribution ............ 578 315 606 52 9 1,560
Provision for credit losses (3) . 68 97 21 9 -- 195
------- -------- -------- ------- ----- ---------
Income before income tax expense $ 510 $ 218 $ 585 $ 43 $ 9 $ 1,365
======= ======== ======== ======= ===== =========
Average assets .................. $26,475 $ 14,413 $ 43,990 $ 2,813 $ 89 $ 87,780
Average liabilities/equity (4) .. 29,872 13,239 35,645 9,006 18 87,780
Goodwill at December 31, 2002 ... 1,223 543 635 428 -- 2,829
(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 December 31, 2003 to December 31, 2004
resulted from the sale or transfer of certain domestic and foreign
operations during 2004. The reduction in goodwill from December 31, 2002
to December 31, 2003 includes goodwill associated with the sale of the
domestic factoring business on December 31, 2003.
33
Personal Financial Services (PFS)
2004 Compared to 2003
During 2004, HUSI sold or transferred certain foreign subsidiaries to HSBC
affiliates. As a result of these transactions, HUSI reported 2003 PFS amounts
associated with these sold subsidiaries, for net interest income, other
revenues, and operating expenses that exceeded 2004 amounts.
Excluding the effects of sales of the foreign subsidiaries noted above:
o Net interest income increased $292 million, primarily due to higher
interest income from residential mortgage lending activity. Growth in
residential mortgage loans continued to result from the low interest rate
environment, especially for variable rate loans, which HUSI maintains in
its held portfolio. Increased loan balances were partially offset by a
decline in the average interest rate earned on the held mortgage loan
portfolio during the year.
o Other revenues increased $171 million in 2004, primarily as a result of a
$99 million gain on sale of credit card relationships to HSBC Finance
Corporation, and a $45 million gain from sale of an investment in NYCE
Corporation. Residential mortgage banking revenue decreased $18 million in
2004, as a reduction in gains on sales of mortgage loans, coupled with an
increase in temporary impairment expense associated with MSRs, which was
partially offset by decreased MSRs amortization expense and improved
trading performance related to derivative instruments used to offset
changes in the value of MSRs. Other general increases in various fees and
other revenues resulted from expansion of retail lending and deposit
activities.
o Operating expenses increased $70 million in 2004, due to growth in
residential mortgage operations to accommodate increased loan production,
increased technology costs due to conversions of consumer loan systems to
platforms that are shared with HSBC Finance Corporation, and a provision
for U.S. withholding tax costs related to deficiencies in client tax
documentation.
o The provision for credit losses increased $31 million in 2004, as a direct
result of increases in residential mortgage loan and other consumer loan
portfolios.
2003 Compared to 2002
Income before income tax expense for the segment decreased $65 million in 2003
due to lower levels of other revenues and higher levels of operating expenses
partially offset by an increase in net interest income. The decrease in other
revenues was due to a reduction in residential mortgage banking revenue, driven
by accelerated amortization of MSRs and losses on hedges used to offset changes
in the economic value of MSRs. That decrease was partially offset by increases
in residential mortgage originations and sales related income. Wealth management
fees were also lower, reflecting reduced demand for retail investment products,
weaker consumer confidence and volatile equity markets. The increase in
operating expenses reflected higher personnel costs (pension, health care
insurance costs and severance), professional fees associated with enhanced
compliance with anti-money laundering requirements and higher technology related
infrastructure expenses. The increase in net interest income was driven by
continued growth in residential mortgage activity, an improved mix of loans and
savings deposits and lower funding costs. Average residential mortgages grew $2
billion as the low interest rate environment continued to stimulate consumers to
refinance mortgages and purchase residential property.
Commercial Banking (CMB)
2004 Compared to 2003
During 2002 and 2003, certain equipment finance, commercial finance and U.S.
factoring businesses were exited or restructured resulting in office closings
and sales of customer relationships. Certain receivables associated with these
businesses were retained, but have been decreasing throughout 2003 and 2004 as
balances have run off. During 2004, HUSI sold or transferred certain foreign
subsidiaries to HSBC affiliates. As a result of these transactions, reported CMB
amounts for 2003 associated with these exited businesses, for net interest
income, other revenues and expenses all exceeded 2004 amounts.
34
Excluding the effect of the business sale and transfer transactions:
o Net interest income increased $73 million, due to growth in net interest
income from loan and deposit activity with middle-market, commercial real
estate and small business customers in the second half of the year.
o Revenue growth was achieved in 2004 while maintaining a stable operating
expense base, due to focused cost containment efforts.
o The provision for credit losses decreased $58 million, due primarily to
continued improvement in commercial credit quality, as evidenced by
decreased nonaccruing loan balances, decreased criticized assets,
decreased charge offs, and increased recoveries of commercial loans
previously charged off. A reduction in the unallocated portion of the
allowance for credit losses also contributed to the overall decrease in
provision expense.
2003 Compared to 2002
Income before income tax expense for this segment increased 34% over 2002
reflecting a decrease in the provision for credit losses and an increase in
other revenues. The decrease in the provision for credit losses was driven by
continued improvement in the overall credit quality of HUSI's commercial lending
portfolio as evidenced by a significant decline in the level of criticized
assets. The increase in other revenues includes growth in fees earned by the
commercial real estate lending business and commercial service charges from the
New York City region as well as this segment's share of the $21 million interest
on a tax settlement for 2003. An increase in commercial loan prepayment fees
earned by the Commercial Real Estate Lending business contributed to the year to
year increase in net interest income. The restructuring of the commercial
finance receivables and equipment financing units led to lower operating
expenses. These cost savings were partially offset by higher pension, health
care insurance and severance related costs.
Corporate, Investment Banking and Markets (CIBM)
2004 Compared to 2003
The decrease in income before income tax expense in 2004 primarily resulted from
decreased net interest income and increased operating expenses, offset by
decreased provision for credit losses.
Net interest income decreased $61 million in 2004, due partly to a significant
increase in short-term borrowings and long-term debt balances during the second
half of the year, and partly to a flattening yield curve, which tightened the
interest spread earned on net earning assets. Short-term and long-term debt
issuances reported in CIBM were the primary sources of funds for PFS balance
sheet growth, and increases in these debt balances significantly outpaced
increases in net treasury and traded markets assets included in CIBM during
2004.
The 2004 increase in other revenues was due to increased net gains on sales of
securities, which was partially offset by decreased trading revenues.
Operating expenses increased $83 million in 2004 due primarily to expansion
initiatives related to various treasury and traded markets products. These
initiatives resulted in higher salaries and benefits expenses, higher
information technology expenses, and increased administrative and other fees
charged by HSBC and other affiliated entities.
The provision for credit losses decreased $87 million in 2004 due to general
improvement of commercial credit quality. Significant loan paydowns and
recoveries of amounts previously charged off were received during 2004. In
addition, there were upgrades of classification of certain large criticized
credits during the year. A reduction in the unallocated portion of the allowance
for credit losses also contributed to the overall decrease in provision expense.
35
2003 Compared to 2002
Income before income tax expense for this segment increased 22% over 2002 due to
higher levels of trading revenue and net interest income. The year to year
improvement in trading revenue primarily related to derivatives and treasury
trading and foreign exchange trading revenue. The increase in derivatives and
treasury trading revenue for 2003 was due to increased client activity in
interest rate and credit derivatives, higher proprietary trading revenue and
mark to market gains on economic hedges of HUSI's investment portfolio.
Increased client activity and improved trading results relative to 2002, when a
challenging market environment in emerging markets currencies impacted
performance, drove the improvement in foreign exchange trading revenue. The
increases in trading revenue were partially offset by lower profits from the
sale of available for sale investment securities. The net interest income growth
in this segment was driven by a larger balance sheet and improved interest
spreads resulting from historically low interest rates and a steep yield curve,
particularly during the first half of the year. The increase in operating
expenses reflected higher levels of performance driven incentive compensation
and higher fringe benefit costs. Recoveries on several large credits in the
Corporate Banking unit and improved overall credit quality drove the year to
year improvement in provision for credit losses.
Private Banking (PB)
2004 Compared to 2003
Income before income tax expense increased 27% in 2004 due to increased equity
investment revenue, increased wealth and tax advisory service revenues, and
increased gains on sales of investment securities. Operating expenses were flat
in 2004, as compared with 2003, as a provision for U.S. withholding tax costs
related to deficiencies in client tax documentation was offset by decreases in
other expenses.
2003 Compared to 2002
Income before income tax expense for this segment increased 28% over 2002
reflecting increases in other revenues and a reduced provision for credit
losses. Increased wealth and tax advisory services, higher levels of investment
sales and increases in trust income all contributed to the year to year increase
in other revenues. Other revenues also includes $24 million of additional
revenues from wealth and tax advisory services, a business that commenced
activity during the third quarter of 2002. The lower provision for credit losses
reflected the improvement in the overall credit quality of the segment including
fewer problem credits related to South American risk. The increase in operating
expenses was due to a $39 million increase in expenses related to the wealth and
tax advisory services business, which commenced activity in the third quarter of
2002. Also contributing to the expense increase were higher levels of
performance related incentive compensation for certain businesses, agency
recruitment fees and fringe benefit costs.
36
Credit Quality
- --------------------------------------------------------------------------------
Regional Concentrations of Credit Risk
HUSI enters into a variety of transactions in the normal course of business that
involve both on and off-balance sheet credit risk. Principal among these
activities is lending to various commercial, institutional, governmental and
individual customers. HUSI participates in lending activity throughout the U.S.
and, on a limited basis, internationally.
The following is a summary of the regional exposure HUSI has at December 31,
2004 for the following secured loan portfolios.
- ------------------------------------------------------------------------------
Commercial, Residential
Construction and Mortgage
December 31, 2004 Mortgage Loans Loans
- ------------------------------------------------------------------------------
New York State............................. 61% 22%
North Central United States................ 3 12
North Eastern United States................ 9 12
Southern United States..................... 10 24
Western United States...................... 17 28
Other...................................... -- 2
----- -----
Total...................................... 100% 100%
===== =====
In general, HUSI controls the varying degrees of credit risk involved in on and
off-balance sheet transactions through specific credit policies. These policies
and procedures provide for a strict approval, monitoring and reporting process.
It is HUSI's policy to require collateral when it is deemed appropriate. Varying
degrees and types of collateral are secured depending upon management's credit
evaluation.
Cross-Border Net Outstandings
Cross-border net outstandings, as calculated in accordance with Federal
Financial Institutions Examination Council (FFIEC) guidelines, are amounts
payable to HUSI by residents of foreign countries regardless of the currency of
claim and local country claims in excess of local country obligations.
Cross-border net outstandings include deposits in other banks, loans,
acceptances, securities available for sale, trading securities, revaluation
gains on foreign exchange and derivative contracts and accrued interest
receivable. Excluded from cross-border net outstandings are, among other things,
the following: local country claims funded by non-local country obligations
(U.S. dollar or other non-local currencies), principally certificates of deposit
issued by a foreign branch, where the providers of funds agree that, in the
event of the occurrence of a sovereign default or the imposition of currency
exchange restrictions in a given country, they will not be paid until such
default is cured or currency restrictions lifted or, in certain circumstances,
they may accept payment in local currency or assets denominated in local
currency (hereinafter referred to as constraint certificates of deposit); and
cross-border claims that are guaranteed by cash or other external liquid
collateral.
There were no cross-border net outstandings which exceeded .75% of total assets
at December 31, 2004, 2003 and 2002.
Problem Loan Management
Nonaccruing Loans
Borrowers who experience difficulties in meeting the contractual payment terms
of their loans receive special attention. Depending on circumstances, decisions
may be made to cease accruing interest on such loans.
37
Commercial loans are designated as nonaccruing when, in the opinion of
management, reasonable doubt exists with respect to collectibility of all
interest and principal based on certain factors, including adequacy of
collateral. However, HUSI complies with regulatory requirements, which mandate
that interest not be accrued on commercial loans with principal or interest past
due for a period of ninety days, unless the loan is both adequately secured and
in process of collection.
Residential mortgage interest accruals are suspended when principal or interest
payments are more than three months contractually past due. Loans to credit card
customers that are past due more than ninety days are designated as nonaccruing
only if the customer has agreed to credit counseling; otherwise they are charged
off in accordance with a predetermined schedule. Other consumer loans are
generally not designated as nonaccruing and are charged off against the
allowance for credit losses according to an established delinquency schedule.
Interest that has been accrued but unpaid on loans placed on nonaccruing status
generally is reversed and reduces current income at the time loans are so
categorized. Interest income on these loans may be recognized to the extent of
cash payments received. In those instances where there is doubt as to
collectibility of principal, any cash interest payments received are applied as
principal reductions. Loans are not reclassified as accruing until interest and
principal payments are brought current and future payments are reasonably
assured.
In certain situations where the borrower is experiencing temporary cash flow
problems, and after careful examination by management, the interest rate and
payment terms may be adjusted from the original contractual agreement. When this
occurs and the revised terms at the time of renegotiations are less than HUSI
would be willing to accept for a new loan with comparable risk, the loan is
separately identified as restructured.
HUSI has commitments to lend additional funds to borrowers whose loans are
classified as nonaccruing. A significant portion of these commitments includes
clauses that provide for cancellation in the event of a material adverse change
in the financial position of the borrower.
Impaired Loans
In accordance with HUSI's credit policy, a loan is considered to be impaired
when it is deemed probable that all principal and interest amounts due,
according to the contractual terms of the loan agreement, will not be collected.
Probable losses from impaired loans are quantified and recorded as a component
of the overall allowance for credit losses. Generally, impaired loans include
loans in nonaccruing status, loans which have been assigned a specific allowance
for credit losses, loans which have been partially or wholly charged off, and
loans designated as troubled debt restructures.
Criticized Loans
Problem loans are assigned various criticized facility grades under the
allowance for credit losses methodology.
Special Mention Loans are generally protected by collateral and/or the credit
worthiness of the customer, but are potentially weak based upon economic or
market circumstances which, if not checked or corrected, could weaken HUSI's
credit position at some future date.
Substandard Loans are inadequately protected by the underlying collateral and/or
general credit worthiness of the customer. These loans present a distinct
possibility that HUSI will sustain some loss if the deficiencies are not
corrected.
Doubtful Loans have all the weaknesses exhibited by substandard loans, with the
added characteristic that the weaknesses make collection or liquidation in full
of the recorded loan highly improbable. However, although the possibility of
loss is extremely high, certain pending factors exist which may strengthen the
credit at some future date, and therefore the decision to charge off the loan is
deferred. Loans graded as doubtful are required to be placed in nonaccruing
status.
38
Credit Quality Statistics
A summary of nonaccruing loan information is presented in the following table.
- -------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
(in millions)
Nonaccruing loans
Balance at end of period:
Domestic:
Commercial loans:
Construction and other real estate ....... $ 33 $ 30 $ 29 $ 28 $ 35
Other commercial ......................... 103 205 200 237 252
---- ---- ---- ---- ----
Total commercial ......................... 136 235 229 265 287
Consumer loans ............................... 114 93 102 118 105
---- ---- ---- ---- ----
Total domestic ............................... 250 328 331 383 392
International .................................... 14 38 56 34 31
---- ---- ---- ---- ----
Total nonaccruing loans .......................... $264 $366 $387 $417 $423
==== ==== ==== ==== ====
As a percent of loans:
Domestic:
Commercial loans:
Construction and other real estate ....... .40% .42% .46% .47% .62%
Other commercial ......................... .87 2.37 1.81 2.17 1.98
---- ---- ---- ---- ----
Total commercial ......................... .67 1.49 1.32 1.57 1.56
Consumer loans ............................... .18 .32 .44 .58 .57
---- ---- ---- ---- ----
Total domestic ............................... .30 .73 .82 1.02 1.06
International .................................... .49 1.11 1.85 .96 .88
---- ---- ---- ---- ----
Total ............................................ .31% .76% .89% 1.02% 1.05%
==== ==== ==== ==== ====
Commitments to lend additional funds to borrowers
whose loans are classified as nonaccruing (Balance
at end of period):
Other commercial ................................. $ 1 $ 4 $ 12 $ 10 $ 46
Interest income on nonaccruing loans (Year ended
December 31):
Amount which would have been recorded had the
associated loans been current in accordance with
their original terms ........................... $ 23 $ 28 $ 37 $ 31 $ 28
Amount actually recorded ......................... 17 12 9 19 24
2004 growth in consumer loans resulted primarily from residential mortgage loan
originations and from the $12 billion private label loan portfolio purchased
from HSBC Finance Corporation. 2004 loan growth did not result in significantly
increased nonaccruing loan balances, and therefore resulted in a significant
reduction in consumer nonaccruing loan balances as a percentage of total
consumer loans, as reflected in the above table.
39
Additional credit quality information is presented in the following table.
- ------------------------------------------------------------------------------------------------------------------------
December 31 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
(in millions)
Accruing loans contractually past due 90 days
or more as to principal or interest:
Commercial ................................. $ 13 $ 24 $ 31 $ 12 $ 29
Consumer ................................... 246 12 5 10 13
International .............................. -- 1 5 -- --
------- ------- ------- ------- -------
Total accruing loans contractually past
due 90 days or more ...................... $ 259 $ 37 $ 41 $ 22 $ 42
======= ======= ======= ======= =======
Criticized assets (Balance at end of period):
Special mention ............................ $ 784 $ 618 $ 1,099 $ 1,146 $ 1,383
Substandard ................................ 590 682 996 946 540
Doubtful ................................... 46 128 115 108 118
------- ------- ------- ------- -------
Total ...................................... $ 1,420 $ 1,428 $ 2,210 $ 2,200 $ 2,041
======= ======= ======= ======= =======
Impaired loans
Balance at end of period ................... $ 236 $ 267 $ 288 $ 243 $ 224
Amount with impairment reserve ............. 210 179 170 151 109
Impairment reserve ......................... 18 86 89 83 46
Other real estate and owned assets
Balance at end of period ................... $ 15 $ 17 $ 17 $ 18 $ 21
Ratio of total nonaccruing loans, other real
estate assets to total assets ............ .20% .40% .45% .50% .53%
The increase in accruing loans contractually past due 90 days was a direct
result of credit card receivables growth during 2004. Receivables included in
the $12 billion private label loan portfolio acquired from HSBC Finance
Corporation are generally maintained in accruing status until being charged off
after six months of delinquency.
40
Allowance for Credit Losses
HUSI's methodology and accounting policies related to its allowance for credit
losses are presented in Critical Accounting Policies on page 15 and in Note 2 of
the consolidated financial statements beginning on page 75 of this Form 10-K.
An analysis of changes in the allowance for credit losses and related allowance
ratios is presented in the following table.
- ---------------------------------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Total loans at year end .................... $ 84,947 $ 48,474 $ 43,636 $ 40,923 $ 40,418
Average total loans ........................ 60,328 44,187 42,054 41,441 38,966
Allowance for credit losses:
Balance at beginning of year ......... $ 399 $ 493 $ 506 $ 525 $ 638
Allowance related to acquisitions and
(dispositions), net ................ 485 (15) (2) (19) (11)
Charge offs:
Commercial:
Construction and other real estate 2 2 8 7 11
Other commercial ................. 51 147 126 181 173
Consumer:
Residential mortgages ............ 10 2 3 3 5
Credit card receivables .......... 65 58 61 66 71
Other consumer loans ............. 22 18 14 11 11
International ........................ 7 16 29 13 2
-------- -------- -------- -------- --------
Total charge offs .......................... 157 243 241 281 273
-------- -------- -------- -------- --------
Recoveries on loans charged off:
Commercial:
Construction and other real estate 4 2 9 -- 3
Other commercial ................. 56 26 11 29 15
Consumer:
Residential mortgages ............ 1 1 1 1 1
Credit card receivables .......... 8 7 8 9 11
Other consumer loans ............. 6 5 4 4 4
International ........................ 3 10 2 -- --
-------- -------- -------- -------- --------
Total recoveries ........................... 78 51 35 43 34
-------- -------- -------- -------- --------
Total net charge offs ...................... 79 192 206 238 239
-------- -------- -------- -------- --------
Translation adjustment ..................... -- -- -- -- (1)
-------- -------- -------- -------- --------
Provision charged to income ................ (17) 113 195 238 138
-------- -------- -------- -------- --------
Balance at end of year ..................... $ 788 $ 399 $ 493 $ 506 $ 525
======== ======== ======== ======== ========
Allowance ratios:
Total net charge offs to average loans .13% .43% .49% .57% .61%
Year-end allowance to:
Year-end total loans ............. .93% .82% 1.13% 1.24% 1.30%
Year-end total nonaccruing loans . 298.48% 109.02% 127.39% 121.34% 124.11%
41
During 2004, total nonaccruing loans decreased approximately $102 million while
the allowance for credit losses increased approximately $389 million, resulting
in a significant increase in the ratio of year-end allowance to total
nonaccruing loans in the preceding table. The increased allowance for credit
losses resulted from the acquisition of the private label loan portfolio from
HSBC Finance Corporation on December 29, 2004. As these receivable balances are
typically maintained as accruing until charged off, there were no loan balances
included in this portfolio which were classified as nonaccruing at December 31,
2004.
An allocation of the allowance for credit losses by major loan categories is
presented in the following table. The decrease in the unallocated portion noted
in the table is due to refinement in the allowance methodology during 2004.
- -----------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------------- ------------------ ------------------- ------------------- --------------------
% of % of % of % of % of
Loans Loans Loans Loans Loans
to to to to to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- -----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Domestic:
Commercial:
Construction and
other real estate.. $ 42 10 $ 29 15 $ 27 15 $ 25 14 $ 28 14
Other commercial..... 78 14 148 18 226 25 224 27 163 31
Consumer:
Residential
mortgages........... 20 55 12 54 11 47 11 43 10 39
Credit card
receivables........ 560 14 48 2 51 2 53 3 62 3
Other consumer....... 25 4 22 4 27 4 29 4 31 4
International............. 50 3 75 7 93 7 105 9 117 9
Unallocated reserve....... 13 -- 65 -- 58 -- 59 -- 114 --
---- --- ---- --- ---- --- ---- --- ---- ---
Total..................... $788 100 $399 100 $493 100 $506 100 $525 100
==== === ==== === ==== === ==== === ==== ===
Reserve For Off-Balance Sheet Exposures
HUSI maintains a separate reserve for credit risk associated with certain
off-balance sheet exposures including letters of credit, unused commitments to
extend credit and financial guarantees. This reserve, included in other
liabilities, was approximately $90 million and $44 million at December 31, 2004
and 2003 respectively. In 2004, HUSI refined its methodology for calculating its
reserve for off-balance sheet exposure.
Descriptions and financial information for various off-balance sheet
arrangements begin on page 43 of this Form 10-K.
42
Off-Balance Sheet Arrangements and Contractual Obligations
- --------------------------------------------------------------------------------
Off-Balance Sheet Arrangements
The following table presents maturity information related to various off-balance
sheet arrangements. Descriptions of the various arrangements follow the table.
- ------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2004 or Less Five Years Years Total
- ------------------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations .. $ 3,564 $ 1,521 $ 110 $ 5,195(1)
Commercial letters of credit, net of participations 584 200 76 860
Recourse on sold loans ............................ -- 1 9 10(2)
Securities lending indemnifications ............... 4,534 -- -- 4,534
Credit derivative contracts ....................... 990 51,435 12,990 65,415(3)
Commitments to extend credit:
Commercial .................................. 19,808 18,879 1,944 40,631
Consumer .................................... 5,582 -- -- 5,582
Commitments to deliver mortgage backed securities . 1,627 -- -- 1,627
-------- -------- -------- --------
Total ............................................. $ 36,689 $ 72,036 $ 15,129 $123,854
======== ======== ======== ========
(1) Includes $383 million issued for the benefit of related parties.
(2) $8 million of this amount is indemnified by third parties.
(3) Includes $9,912 million issued for the benefit of related parties.
Letters of Credit
HUSI may issue a letter of credit for the benefit of a customer, authorizing a
third party to draw on the letter for specified amounts under certain terms and
conditions. The issuance of a letter of credit is subject to HUSI's credit
approval process and collateral requirements. HUSI issues two types of letters
of credit, commercial and standby.
o A commercial letter of credit is drawn down on the occurrence of an
expected underlying transaction, such as the delivery of goods. Upon the
occurrence of the transaction, a commercial letter of credit is recorded
as a customer acceptance in other assets and other liabilities until
settled.
o A standby letter of credit is issued to third parties for the benefit of a
customer and is essentially a guarantee that the customer will perform, or
satisfy some obligation, under a contract. It irrevocably obligates HUSI
to pay a third party beneficiary when a customer either: (1) in the case
of a performance standby letter of credit, fails to perform some
contractual non-financial obligation, or (2) in the case of a financial
standby letter of credit, fails to repay an outstanding loan or debt
instrument.
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Included in other
liabilities are deferred fees on standby letters of credit, representing the
fair value of HUSI's "stand ready obligation to perform" under these guarantees,
amounting to $15 million and $12 million at December 31, 2004 and 2003
respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit, of $28 million and $25 million at
December 31, 2004 and 2003 respectively.
Loan Sales with Recourse
HUSI securitizes and sells assets, generally without recourse. In prior years,
HUSI's mortgage banking subsidiary sold residential mortgage loans with recourse
upon borrower default, with partial indemnification from third parties.
43
Credit Derivatives
HUSI enters into credit derivative contracts both for its own benefit and to
satisfy the needs of its customers. Credit derivatives are arrangements that
provide for one party (the "beneficiary") to transfer the credit risk of a
"reference asset" to another party (the "guarantor"). Under this arrangement the
guarantor assumes the credit risk associated with the reference asset without
directly purchasing it. The beneficiary agrees to pay to the guarantor a
specified fee. In return, the guarantor agrees to pay the beneficiary an agreed
upon amount if there is a default during the term of the contract.
In accordance with its policy, HUSI offsets virtually all of the market risk it
assumes in selling credit guarantees through a credit derivative contract with
another counterparty. Credit derivatives, although having characteristics of a
guarantee, are accounted for as derivative instruments and are carried at fair
value. The commitment amount included in the table on the preceding page is the
maximum amount that HUSI could be required to pay, without consideration of the
approximately equal amount receivable from third parties and any associated
collateral.
Securities Lending Indemnifications
HUSI may lend securities of customers, on a fully collateralized basis, as an
agent to third party borrowers. HUSI indemnifies the customers against the risk
of loss and obtains collateral from the borrower with a market value exceeding
the value of the loaned securities. At December 31, 2004, the fair value of that
collateral was approximately $4,625 million.
Commitments to Extend Credit
Commitments include arrangements whereby HUSI is contractually obligated to
extend credit in the form of loans, participations in loans, lease financing
receivables, or similar transactions. Consumer commitments are comprised of
unused credit card lines and commitments to extend credit secured by residential
properties. HUSI has the right to change or terminate any terms or conditions of
a customer's credit card or home equity line of credit account, upon
notification to the customer.
Contractual Obligations
Obligations to make future payments under contracts are presented in the
following table.
- -----------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2004 or Less Five Years Years Total
- -----------------------------------------------------------------------------------------------------------------------
(in millions)
Subordinated long-term debt and perpetual capital notes (1) . $ -- $ 1,094 $ 3,894 $ 4,988
Other long-term debt, including capital lease obligations (1) 80 17,872 899 18,851
Pension and other postretirement benefit obligations (2) .... 49 237 407 693
Minimum future rental commitments on operating leases (3) ... 65 174 134 373
Purchase obligations (4) .................................... 57 31 -- 88
------- ------- ------- -------
Total ....................................................... $ 251 $19,408 $ 5,334 $24,993
======= ======= ======= =======
(1) Future payments are based on the recorded book value of debt instruments
included in Note 14 of the consolidated financial statements beginning on
page 93 of this Form 10-K.
(2) Represents estimated future employee service expected to be paid based on
assumptions used to measure HUSI's benefit obligation at December 31,
2004. See Note 20 of the consolidated financial statements beginning on
page 101 of this Form 10-K.
(3) Represents expected minimum lease payments under noncancellable operating
leases for premises and equipment included in Note 22 of the consolidated
financial statements beginning on page 105 of this Form 10-K.
(4) Represents binding agreements for facilities management and maintenance
contracts, custodial account processing services, internet banking
services and other services.
44
Risk Management
- --------------------------------------------------------------------------------
Overview
Some degree of risk is inherent in virtually all of HUSI's activities. For the
principal activities undertaken by HUSI, the most important types of risks are
considered to be credit, interest rate, market, liquidity, operational,
fiduciary and reputational. Market risk broadly refers to price risk inherent in
mark to market positions taken on trading and non-trading instruments.
Operational risk technically includes legal and compliance risk. However, since
compliance risk, including anti-money laundering (AML) risk, has such broad
scope within HUSI's businesses, it is addressed below as a separate functional
discipline.
The objective of HUSI's risk management system is to identify, measure and
monitor risks so that:
o the potential costs can be weighed against the expected rewards from
taking the risks;
o unexpected losses can be minimized;
o appropriate disclosures can be made to all concerned parties;
o adequate protections, capital and other resources can be put in place to
weather all significant risks; and
o compliance with all relevant laws, regulations and regulatory requirements
is ensured through staff education, adequate processes and controls, and
ongoing monitoring efforts.
Historically, HUSI's approach toward risk management has emphasized a culture of
business line responsibility combined with central requirements for
diversification of customers and businesses. Extensive centrally determined
requirements for controls, limits, reporting and the escalation of issues have
been detailed in HUSI's and HSBC's policies and procedures. In addition, HUSI
has a formal independent compliance function, the staff of which has been
aligned with, and has advised, each business and support function.
As a result of an increasingly complex business environment, increased
regulatory scrutiny, and the evolution of improved risk management tools and
standards, HUSI has significantly upgraded, and continues to upgrade, its
methodologies and systems. New practices and techniques have been developed that
involve data development, modeling, simulation and analysis, management
information systems development, self-assessment, and staff education programs.
A senior leadership structure has been introduced at HUSI, under the direction
of the Chief Risk Officer, which includes dedicated independent risk specialists
for operational, AML and fiduciary risk, in addition to the existing specialists
for managing other risks. Staffing has been expanded, including a three-fold
increase of compliance/AML specialists to approximately 200 persons, to
accommodate an extensive compliance/AML monitoring and testing program.
Risk management oversight begins with HUSI's Board of Directors and its various
committees, principally the Audit and Examining Committee. Specific oversight of
various risk management processes is provided by the Risk Management Committee,
which is chaired by the Chief Risk Officer, and its five principal
subcommittees:
o the Credit Risk Committee;
o the Asset and Liability Policy Committee;
o the Operational Risk Management Committee;
o the Fiduciary Risk Management Committee; and
o the Compliance Risk Management Committee.
The Risk Management Committee and each sub-committee have charters established
by the Board of Directors. While the charters are tailored to reflect the roles
and responsibilities of each committee, they all have the following common
themes:
o defining risk appetites, policies and limits;
o monitoring and assessing exposures, trends and the effectiveness of risk
management;
o reporting to the Board of Directors; and
o promulgating a suitable risk taking, risk management, and compliance
culture.
45
Day-to-day management of credit risk is centralized under the Chief Credit
Officer. For retail consumer loan portfolios, such as credit cards, installment
loans, and residential mortgages, the Chief Credit Officer leverages off the
consumer credit management skills and tools of HSBC Finance Corporation.
Day-to-day management of interest rate and market risk is centralized
principally under the Treasurer. Operational, fiduciary, and compliance risk is
decentralized and is the responsibility of each business and support unit.
However, for all risk types, there are independent risk specialists that set
standards, develop new risk methodologies, maintain central risk databases, and
conduct reviews and analysis. The Chief Risk Officer and the Executive Vice
Presidents for Compliance and Anti-Money Laundering provide day-to-day oversight
of these activities and work closely with Internal Audit, and senior risk
officers and specialists at HNAH and HSBC.
Economic and Regulatory Capital
Economic Capital
Economic capital is defined as the amount of capital required to sustain a
business through a complete business cycle, enabling the business to absorb
unexpected losses and thus minimize the probability of insolvency. Economic
capital is measured at the business unit level based on four categories of risk:
o Credit risk
o Operational risk
o Market risk
o Interest rate risk
Whereas regulatory capital is traditionally only calculated at the total bank
level as a measure of the minimum capital needed for regulatory compliance and
is based on the amount of capital maintained in relation to risk-weighted assets
at a specific point in time, economic capital is actually a measure of risk that
can be assigned to each business unit according to its risk characteristics. As
a result, economic capital can be used to establish business performance
measures, make pricing decisions or set portfolio guidelines.
Economic capital is an internal measure developed by HUSI based on its unique
set of diverse businesses, risk appetites, and management practices. In 2004,
HUSI began to calculate economic capital from statistical analyses of possible
losses related to credit, market, interest rate and operational risk. HUSI
calculates economic capital sufficient to cover losses over a one year time
horizon at a 99.95% confidence level. This is consistent with HBUS's "AA"
rating, as "AA" rated credits have historically defaulted at a rate of about
..05% per year. The one year time horizon is also consistent with traditional
planning and budgeting time horizons. Quantification of possible losses related
to other risks, such as fiduciary and reputational risk, are broadly covered
under the credit, market and operational risk measurements.
Basel Capital Standards
The status of HNAH's and HUSI's preparations relative to Basel II is summarized
on page 8 of this Form 10-K. Only the most advanced approaches toward
implementation of the Basel II framework are expected to be adopted by U.S.
regulators. For credit risk and operational risk, bank holding companies must
adopt the Advanced Internal Ratings Based approach and the Advanced Measurement
Approach, respectively, as described in the Basel framework. Market risk
assessment will continue to be based on the same value at risk calculations used
under current regulation.
HUSI will continue to leverage the internal economic capital development program
begun in 2002 in its preparations for the new capital adequacy standards. Many
of the practices related to the calculation of economic capital will be used to
satisfy regulatory requirements. HUSI expects to qualify to use the new
approaches in time to meet the January 1, 2008 implementation date.
46
Credit Risk Management
Credit risk is the potential that a borrower or counterparty will default on a
credit obligation, as well as the impact on the value of credit instruments due
to changes in the probability of borrower default.
For HUSI, credit risk is inherent in various on and off-balance sheet
instruments and arrangements:
o in loan portfolios;
o in investment portfolios;
o in unfunded commitments such as letters of credit and lines of credit that
customers can draw upon; and
o in treasury instruments, such as interest rate swaps which, if more
valuable today than when originally contracted, may represent an exposure
to the counterparty to the contract.
While credit risk exists widely within HUSI, diversification among various
commercial and consumer portfolios helps HUSI to lessen risk exposure.
HUSI assesses, monitors and controls credit risk with formal standards, policies
and procedures. An independent Credit Risk function is maintained under the
direction of the Chief Credit Officer, who reports directly to the Chief
Executive Officer of HUSI, and indirectly to the Chief Risk Officer of HNAH and
to the Group General Manager, Head of Credit and Risk for HSBC.
The responsibilities of the Credit Risk function include:
o Formulating credit policies - HUSI's policies are designed to ensure that
various retail and commercial business units operate within clear
standards of acceptable credit risk. HUSI's policies ensure that the HSBC
standards are consistently implemented across all businesses and that all
regulatory requirements are also considered. Credit policies are reviewed
and approved annually by the Audit and Examining Committee.
o Approving new commercial and financial institution credit exposures and
reviewing large exposures annually - The Chief Credit Officer delegates
credit authority to various lending units throughout HUSI. However, most
large credits are reviewed and approved centrally through a dedicated
Credit Approval Unit that reports directly to the Chief Credit Officer. In
addition, the Chief Credit Officer coordinates the approval of material
credits with HSBC Group Credit and Risk which, subject to certain
agreed-upon limits, will review and concur on material new and renewal
transactions.
o Monitoring portfolio performance - HUSI has implemented a credit data
warehouse to centralize the reporting of its credit risk, support the
analysis of risk using tools such as economic capital, and to calculate
its credit loss reserves. This data warehouse will also support HSBC's
wider effort to meet the requirements of Basel II and to generate credit
reports for management and the Board of Directors.
o Establishing counterparty and portfolio limits - HUSI monitors and limits
its exposure to individual counterparties and to the combined exposure of
related counterparties. In addition, selected industry portfolios, such as
real estate, telecommunications, aviation, and shipping, are subject to
caps that are established by the Chief Credit Officer and reviewed where
appropriate by management committees and the Board of Directors.
Counterparty credit exposure related to derivative activities is also
managed under approved limits. Since the exposure related to derivatives
is variable and uncertain, HUSI uses internal risk management
methodologies to calculate the 95% worst-case potential future exposure
for each customer. These methodologies take into consideration, among
other factors, cross-product close-out netting, collateral received from
customers under Collateral Support Annexes (CSAs), termination clauses,
and off-setting positions within the portfolio.
o Managing problem commercial loans - Special attention is paid to problem
loans. When appropriate, HUSI's Special Credits Unit provides customers
with intensive management and control support in order to help them avoid
default wherever possible and maximize recoveries.
47
o Overseeing retail credit risk - Each retail business unit is supported by
dedicated advanced risk analytics units. The Chief Credit Officer provides
independent oversight of credit risk associated with these retail
portfolios and is supported by expertise from HNAH's Retail Credit
Management unit, under the direction of the HNAH's Chief Risk Officer.
o Chairing the Credit Risk Management Committee - The Chief Credit Officer
chairs the Credit Risk Management Committee and is responsible for
strategic and collective oversight of the scope of risk taken, the
adequacy of the tools used to measure it, and the adequacy of reporting.
During 2004, HUSI introduced a new two dimensional credit risk rating system to
replace its previous single dimensional, seven level system. Under the new
system, the first "dimension" is measurement of customer or counterparty credit
risk through a probability of default based "Customer Rating". The second
"dimension" is measurement of loss severity through a facility level "Loss Given
Default" assessment.
Customer Rating entails a 22 level grading system. Each grade has its own
specified probability of default calibrated to the performance of Standard and
Poor's and Moody's Long-Term Debt Ratings across an economic cycle. A suite of
models, tools and templates developed using quantitative and statistical
techniques, as well as expert judgement, supports the estimation of the
probability of default. This suite of tools has been developed using a
combination of internal and external resources and data and aims at following
what has been determined to be best practice in the industry. To estimate the
probable loss in the event of default, HUSI is working with other members of the
HSBC Group in building a significant database of historical internal credit
losses which will be supplemented by data from external sources, and has
implemented other tools and models to support this effort.
The Customer Rating and Loss Given Default measures are also leveraged to
support the calculation of HUSI's commercial credit loss reserves beginning with
year-end 2004. These measures are modified from their Basel II definitions to
ensure that the calculation will comply with U.S. accounting and regulatory
standards for credit reserves.
In 2004, HUSI implemented the first stage of its credit economic capital risk
measurement system, using the measure in certain internal and Board of Directors
reporting. A simulation model is used to determine the amount of unexpected
losses, beyond expected losses, that HUSI must be prepared to support with
capital given its targeted debt rating. Monthly credit economic capital reports
are generated and reviewed with management and the business units. Efforts
continue to refine both the inputs and assumptions used in the credit economic
capital model to increase its usefulness in pricing and the evaluation of large
and small commercial and retail customer portfolio products and business unit
return on risk. HUSI intends to continue to refine its calculation of economic
capital related to credit risk and begin to integrate the new credit risk
modeling tools into the credit risk and portfolio management processes as
appropriate.
Asset/Liability Management
Asset and liability management includes management of liquidity, interest rate,
and market risk. Liquidity risk is the potential that an instit1ution will be
unable to meet its obligations as they become due or fund its customers because
of inadequate cash flow or the inability to liquidate assets or obtain funding
itself. Market risk includes both interest rate and trading risk. Interest rate
risk is the potential impairment of net interest income due to mismatched
pricing between assets and liabilities and off-balance sheet instruments. Market
risk is the potential for losses in daily mark to market positions (mostly
trading) due to adverse movements in money, foreign exchange, equity or other
markets. In managing these risks, HUSI seeks to protect both its income stream
and the value of its assets.
HUSI has substantial, but historically well controlled, interest rate risk in
large part as a result of its large portfolio of residential mortgages and
mortgage backed securities, which consumers can prepay without penalty, and to a
lesser extent the result of its large base of demand and savings deposits. These
deposits can be withdrawn by consumers at will, but historically they have been
a stable source of funds. Market risk exists principally in treasury businesses
and to a lesser extent in the residential mortgage business where mortgage
servicing rights and the
48
pipeline of forward mortgage sales are hedged. HUSI has little foreign exchange
exposure from investments in overseas operations, which are limited in scope,
and total equity investments, excluding stock owned in the Federal Reserve and
New York Federal Home Loan Bank, which are less than 2% of total available for
sale securities.
The management of liquidity, interest rate and most market risk is centralized
in treasury and mortgage banking operations. In all cases, the valuation of
positions and tracking of positions against limits is handled independently by
HUSI's finance units. Oversight of all liquidity, interest rate and market risks
is provided by the Asset and Liability Policy Committee (ALCO) which is chaired
by the Chief Financial Officer. Subject to the approval of the HUSI Board of
Directors and HSBC, ALCO sets the limits of acceptable risk, monitors the
adequacy of the tools used to measure risk, and assesses the adequacy of
reporting. ALCO also conducts contingency planning with regard to liquidity.
Liquidity Risk Management
Liquidity risk is the risk that an institution will be unable to meet its
obligations as they become due because of an inability to liquidate assets or
obtain adequate funding. Liquidity is managed to provide the ability to generate
cash to meet lending, deposit withdrawal and other commitments at a reasonable
cost in a reasonable amount of time, while maintaining routine operations and
market confidence. HUSI is planning its funding and liquidity management in
conjunction with HSBC Finance Corporation, as the markets increasingly view debt
issuances from the separate companies within the context of their common parent
company. Liquidity management is performed at HUSI and at HBUS. Each entity is
required to have sufficient liquidity for a crisis situation. ALCO is
responsible for the development and implementation of related policies and
procedures to ensure that the minimum liquidity ratios and a strong overall
liquidity position are maintained.
In carrying out this responsibility, ALCO projects cash flow requirements and
determines the optimal level of liquid assets and available funding sources to
have at HUSI's disposal, with consideration given to anticipated deposit and
balance sheet growth, contingent liabilities, and the ability to access
wholesale funding markets. Our liquidity management approach has been
supplemented by increased long-term debt issuances to third parties, and
potential asset sales/securitizations (i.e. residential mortgage loans) in
liquidity contingency plans. In addition, ALCO monitors the overall mix of
deposit and funding concentrations to avoid undue reliance on individual funding
sources and large deposit relationships. It must also maintain a liquidity
management contingency plan, which identifies certain potential early indicators
of liquidity problems, and actions that can be taken both initially and in the
event of a liquidity crisis, to minimize the long-term impact on HUSI's business
and customer relationships. In the event of a cash flow crisis (e.g. no access
to wholesale funding for one year), the objective of crisis cash flow
contingency plans is for sources of cash to exceed uses by a ratio of 1.1 or
greater in 12 months. Contingency funding needs will be satisfied primarily
through the sale of the investment portfolio and liquidation of the residential
mortgage portfolio. Securities may be sold or used as collateral in a repurchase
agreement depending on the scenario. Portions of the mortgage portfolio may be
sold, securitized, or used for collateral at the FHLB to increase borrowings.
Deposit accounts from a diverse mix of "core" retail, commercial and public
sources represent a significant, cost-effective source of liquidity under normal
operating conditions. HUSI's ability to regularly attract wholesale funds at a
competitive cost is enhanced by strong ratings from the major credit ratings
agencies. At December 31, 2004, HUSI and HBUS maintained the following long and
short-term debt ratings:
Short-Term Debt Long-Term Debt
------------------------------------------- -------------------------------------------
Moody's S&P Fitch Moody's S&P Fitch
HSBC USA Inc. P-1 A-1 F1+ A1 A+ A+
HSBC Bank USA, N.A. P-1 A-1+ F1+ Aa3 AA- A+
Our continued success and prospects for growth are dependent upon access to the
global capital markets. Numerous factors, internal and external, may impact our
access to and the costs associated with issuing debt in these markets. These
factors include our debt ratings, overall economic conditions, overall capital
markets volatility and the effectiveness of our management of credit risks
inherent in our customer base.
49
The following assets are primary sources of liquidity to the extent that they
can be sold or used as collateral for borrowing:
o a portfolio of highly rated investment securities in excess of $18
billion, approximately $5 billion of which, based on anticipated cash
flows, is scheduled to mature within the next twelve months;
o a liquid trading portfolio in excess of $19 billion; and
o residential mortgage loans.
The economics and long-term business impact of obtaining liquidity from assets
must be weighed against the economics of obtaining liquidity from liabilities,
along with consideration given to the associated capital ramifications of these
two alternatives. Currently, assets would be used to supplement liquidity
derived from liabilities only in a crisis scenario.
It is the policy of HBUS to maintain both primary and secondary collateral in
order to ensure precautionary borrowing availability from the Federal Reserve.
Primary collateral is that which is physically maintained at the Federal
Reserve, and serves as a safety net against any unexpected funding shortfalls
that may occur. Secondary collateral is collateral that is acceptable to the
Federal Reserve, but is not maintained there. If unutilized borrowing capacity
were to be low, secondary collateral would be identified and maintained as
necessary.
50
Interest Rate Risk Management
HUSI is subject to interest rate risk associated with the repricing
characteristics of its balance sheet assets and liabilities. Specifically, as
interest rates change, amounts of interest earning assets and liabilities
fluctuate, and interest earning assets reprice at intervals that do not
correspond to the maturities or repricing patterns of interest bearing
liabilities. This mismatch between assets and liabilities in repricing
sensitivity results in shifts in net interest income as interest rates move. To
help manage the risks associated with changes in interest rates, and to optimize
net interest income within ranges of interest rate risk that management
considers acceptable, HUSI uses derivative instruments such as interest rate
swaps, options, futures and forwards as hedges to modify the repricing
characteristics of specific assets, liabilities, forecasted transactions or firm
commitments.
The following table shows the repricing structure of assets and liabilities as
of December 31, 2004. 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. Data shown is as of year end, and one-day
figures can be distorted by temporary swings in assets or liabilities.
- ----------------------------------------------------------------------------------------------------------------------------
Within After One After Five After
One But Within But Within Ten
December 31, 2004 Year Five Years Ten Years Years Total
- ----------------------------------------------------------------------------------------------------------------------------
(in millions)
Commercial loans (including international) . $ 19,253 $ 2,460 $ 915 $ 404 $ 23,032
Residential mortgages ...................... 17,760 24,051 4,070 834 46,715
Credit card receivables .................... 8,576 3,340 162 -- 12,078
Other loans ................................ 1,770 1,206 134 12 3,122
--------- -------- -------- ------- --------
Total loans .......................... 47,359 31,057 5,281 1,250 84,947
--------- -------- -------- ------- --------
Securities available for sale and securities
held to maturity ......................... 6,115 6,546 3,541 2,334 18,536
Other assets ............................... 32,327 2,358 2,882 -- 37,567
--------- -------- -------- ------- --------
Total assets ......................... 85,801 39,961 11,704 3,584 141,050
--------- -------- -------- ------- --------
Domestic deposits (1)
Savings and demand ................... 17,445 8,372 9,106 -- 34,923
Certificates of deposit .............. 9,824 1,582 130 211 11,747
Long-term debt ............................. 18,389 3,158 1,269 1,023 23,839
Other liabilities/equity ................... 60,394 4,114 6,033 -- 70,541
--------- -------- -------- ------- --------
Total liabilities and equity ......... 106,052 17,226 16,538 1,234 141,050
--------- -------- -------- ------- --------
Total balance sheet gap .............. (20,251) 22,735 (4,834) 2,350 --
--------- -------- -------- ------- --------
Effect of derivative contracts ............. 12,753 (11,660) (1,053) (40) --
--------- -------- -------- ------- --------
Total gap position ................... $ (7,498) $ 11,075 $ (5,887) $ 2,310 $ --
========= ======== ======== ======= ========
(1) Does not include purchased or wholesale treasury deposits. The placement
of administered deposits such as savings and demand for interest rate risk
purposes reflects behavioral expectations associated with these balances.
Long term core balances are differentiated from more fluid balances in an
effort to reflect anticipated shifts of non-core balances to other deposit
products or equities over time.
Various techniques are utilized to quantify and monitor risks associated with
the repricing characteristics of HUSI's assets, liabilities, and derivative
contracts. During 2004, there were no significant changes in policies or
approach for managing interest rate risk.
51
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.
The assessment techniques discussed below 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 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 limit ranges will result in consideration of adjustment of the risk
position, or consideration of temporary dispensation from making adjustments.
Present Value of a Basis Point (PVBP)
PVBP 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 December 31, 2004.
- --------------------------------------------------------------------------------
December 31, 2004
Values
- --------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit ...................... +/- $ 6.5
PVBP position at period end............................. (2.3)
Capital at Risk
Capital at risk is the change in base case valuation of the balance sheet for
either a 200 basis point gradual rate increase or a 100 basis point gradual rate
decrease. The following table reflects the capital at risk position at December
31, 2004.
- -------------------------------------------------------------------------------------------------------------------------
December 31, 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....... (6.0)
Projected change in value resulting from a gradual 100 basis point decrease in interest rates....... (2.0)
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.
52
Dynamic Simulation Modeling
In addition to the previously mentioned limits, ALCO uses additional modeling to
monitor a number of interest rate scenarios for their impact on net interest
income. The following table reflects the impact on net interest income of the
scenarios utilized by these modeling techniques.
- -----------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 Values
-----------------------------
Amount %
- -----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net interest income (reflects projected rate movements on January 1, 2005):
Institutional base earnings movement limit.................................................... +/- 10
Change resulting from a gradual 200 basis point increase in the yield curve .................. $ (71) (2)
Change resulting from a gradual 200 basis point decrease in the yield curve .................. 351 10
Other significant scenarios monitored (reflects projected rate movements on January 1, 2005):
Change resulting from an immediate 100 basis point increase in the yield curve ............... (48)
Change resulting from an immediate 100 basis point decrease in the yield curve ............... 61
Change resulting from an immediate 200 basis point increase in the yield curve ............... (201)
Change resulting from an immediate 200 basis point decrease in the yield curve ............... 20
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........................................... (13)
Change resulting from an immediate 100 basis point increase in short-term rates............... (122)
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, except for some changes in residential
mortgage loans and various types of personal deposits. Therefore, although this
provides a reasonable estimate of interest rate sensitivity, actual results will
vary from these estimates, possibly by significant amounts.
Capital Risk/Sensitivity of Other Comprehensive Income
Large movements of interest rates could directly affect some reported capital
and capital ratios. The mark to market valuation of available for sale
securities is credited on a tax effective basis to accumulated other
comprehensive income. 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 December 31, 2004, HUSI had an
available for sale securities portfolio of approximately $15 billion with a net
positive mark to market of $21 million included in tangible common equity of $8
billion. An increase of 25 basis points in interest rates of all maturities
would lower the mark to market by approximately $112 million to a net loss of
$91 million with the following results on the tangible capital ratios.
- -----------------------------------------------------------------------------------------------------------------
Proforma - Reflecting
25 Basis Points
December 31, 2004 Actual Increase in Rates
- -----------------------------------------------------------------------------------------------------------------
Tangible common equity to tangible assets........................... 5.50% 5.46%
Tangible common equity to risk weighted assets...................... 7.05 6.99
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. As it
relates to net interest income, VAR looks at a historical observation period and
shows the potential loss from unfavorable market conditions during a "given
period" with a certain confidence level (99% for HUSI). HUSI uses a one-day
"given period" or "holding period" for setting limits and measuring results. At
a 99% confidence level for a two year observation period, HUSI is setting as its
limit the fifth worse loss performance in the last 500 business days.
The predominant VAR methodology used by HUSI, "historical simulation", has a
number of limitations, including the use of historical data as a proxy for the
future, the assumption that position adjustments can be made within the holding
period specified, and the use of a 99% confidence level, which does not take
into account potential losses that might occur beyond that level of confidence.
53
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 and 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 Statement of Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities (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 a two year observation period and a 10 day "holding period".
- -------------------------------------------------------------------------------------------------------------------------------
Full Year 2004
December 31, --------------------------------------- December 31,
2004 Minimum Maximum Average 2003
- -------------------------------------------------------------------------------------------------------------------------------
(in millions)
Total trading................................... $ 41 $ 34 $ 74 $ 47 $ 23
Commodities..................................... 11 -- 11 3 1
Credit derivatives.............................. 9 4 32 11 4
Equities........................................ 1 -- 1 1 1
Foreign exchange................................ 1 1 11 5 11
Interest rate................................... 27 19 61 33 16
54
Trading Volatility
The following table summarizes the frequency distribution of daily market
risk-related revenues for Treasury trading activities during calendar year 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 2004 gain (loss) data shows that the
largest daily gain was $13 million and the largest daily loss was $11 million.
- --------------------------------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue Below $(2) to $0 to $2 to $4 to Over
earned from market risk-related activities $(2) $0 $2 $4 $6 $6
- --------------------------------------------------------------------------------------------------------------------------
(in millions)
Number of trading days market risk-related
revenue was within the stated range................ 12 48 92 58 26 14
Trading Activities - Mortgage Banking
Trading occurs in Mortgage Banking as a result of an economic hedging program
intended to offset changes in value of mortgage servicing rights and the salable
loan pipeline. Economic hedging may include, for example, forward contracts to
sell residential mortgages and derivative contracts used to protect the value of
MSRs which, while economically viable, may not satisfy the hedge requirements of
SFAS 133.
MSRs are assets that represent the present value of net servicing income
(servicing fees, ancillary income, escrow and deposit float, 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 HUSI'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.
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 Values
----------------------------
Amount %
- --------------------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects projected rate
movements on January 1, 2005):
Value of hedged MSRs portfolio........................................................... $ 309
Change resulting from an immediate 50 basis point decrease in the yield curve:
Change limit (no worse than) ........................................................ - 4
Calculated change in net market value................................................ (2) - 1
Change resulting from an immediate 50 basis point increase in the yield curve:
Change limit (no worse than) ........................................................ - 2
Calculated change in net market value................................................ 4 + 1
Change resulting from an immediate 100 basis point increase in the yield curve:
Change limit (no worse than) ........................................................ - 3
Calculated change in net market value................................................ 6 + 2
55
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
The following table summarized the frequency distribution of the weekly economic
value of the MSR asset during calendar year 2004. This includes the change in
the market value of the MSR asset net of changes in the market value of the
underlying hedging positions used to hedge the asset. The changes in economic
value are adjusted for changes in MSR valuation assumptions that were made
during the course of the year.
- ---------------------------------------------------------------------------------------------------------------------------------
Ranges of mortgage economic value from Below $(5) to $0 to $5 to Over
market risk-related activities $(5) $0 $5 $10 $10
- ---------------------------------------------------------------------------------------------------------------------------------
(in millions)
Number of weeks market risk-related
revenue was within the stated range......................... 9 17 20 3 3
Operational Risk
Operational risk is the risk of loss resulting from inadequate or failed
internal processes, people, systems or from external events. It is inherent in
every business organization and covers a wide spectrum of issues, including
fraud, unauthorized activities, errors, omissions, inefficiency, systems failure
and various issues/events outside of the direct control of HUSI.
HUSI has established an independent Operational Risk Management discipline. The
Operational Risk Management Committee, chaired by the Executive Vice
President-Operations and including the Chief Risk Officer, is responsible for
oversight of the operational risks being taken, the analytic tools used to
monitor those risks, and reporting. Results from this Committee are communicated
to the Risk Management Committee and subsequently to the Audit and Examining
Committee of the Board of Directors. Business unit line management is
responsible for managing and controlling all risks and for communicating and
implementing all control standards. A Corporate Operational Risk Coordinator
provides functional oversight by coordinating the following activities:
o maintaining a network of business line Operational Risk Coordinators;
o developing quantitative tools and databases;
o providing training and developing awareness; and
o independently reviewing and reporting the assessments of operational
risks.
Management of operational risk includes identification, assessment, monitoring,
control and mitigation, rectification and reporting of the results of risk
events and compliance with local regulatory requirements. These key components
of the Operational Risk Management process have been communicated by issuance of
a high level standard. Key features within the standard that have been addressed
in HUSI's Operational Risk Management program include:
o each business and support department is responsible for the identification
and management of their operational risks;
o each risk is evaluated and scored by its likelihood to occur; its
potential impact on shareholder value; and by exposure - based on the
effectiveness of current controls to prevent or mitigate losses. An
operational risk automated database is used to record risk assessments and
track risk mitigation action plans. The risk assessments are reviewed at
least annually, or as business conditions change;
o key risk indicators are established in the automated database where
appropriate, and tracked monthly; and
o the database is also used to track operational losses for analysis of root
causes, comparison with risk assessments and lessons learned.
56
Management practices include standard monthly reporting to business line
managers, senior management and the Operational Risk Management Committee of
high risks, risk mitigation action plan exceptions, losses and key risk
indicators. Monthly certification of internal controls includes an operational
risk attestation. Operational Risk Management is an integral part of the new
product development process and the management performance measurement process.
Analysis of primary types of operational risks reflects a greater than 40%
concentration in process risk. The remaining 60% is divided fairly equally
between the other three primary operational risk types - systems, people and
external events. The same percent distribution of primary operational risk types
applies for the higher or more critical operational risks. Within the process
risk type greater than 70% of risk is concentrated within internal and external
reporting and payment/settlement/delivery risk.
Internal audits, including audits by specialist teams in information technology
and treasury, provide an important check on controls and test institutional
compliance with the Operational Risk Management policy.
An annual review of internal controls is conducted by internal audit as part of
HUSI's compliance with the Federal Deposit Insurance Corporation Improvement Act
(FDICIA) and its comprehensive examination and documentation of controls across
HUSI involving all business and support units.
Compliance Risk
Compliance Risk is the risk arising from failure to comply with relevant laws,
regulations, and regulatory requirements governing the conduct of specific
businesses. It is a composite risk that can result in regulatory sanctions,
financial penalties, litigation exposure and loss of reputation. Compliance risk
is inherent throughout the HUSI organization.
Consistent with HSBC's commitment to ensure adherence with applicable regulatory
requirements for all of its world-wide affiliates, HUSI has implemented a
multi-faceted Compliance Risk Management Program. This program addresses the
following priorities, among other issues:
o anti-money laundering (AML) regulations
o fair lending laws
o dealings with affiliates
o the Community Reinvestment Act
o permissible activities
o conflicts of interest
Oversight of the Compliance Risk Management Program is provided by the Audit and
Examining Committee of the Board of Directors through the Risk Management
Committee and its Compliance Risk Management Subcommittee. This subcommittee is
chaired by the Chief Executive Officer and comprised of representatives from key
business and support areas having significant compliance risk, the Chief Risk
Officer, the General Counsel and executive compliance management. It was
established in 2004 and is responsible for overseeing the effectiveness of the
overall compliance program and providing counsel to line and compliance
management on major potential issues, strategic policy-making decisions and
reputational risk matters. Group Audit USA, through continuous monitoring and
periodic internal audits, tests the effectiveness of the overall Compliance Risk
Management Program.
57
The independent Corporate Compliance function is comprised of separate Corporate
Compliance units focusing on General Compliance and Anti-Money Laundering (AML)
compliance, as well as various compliance teams supporting specific business
units. The Corporate Compliance function is responsible for the following
activities:
o advising management on compliance matters;
o providing independent assessment and monitoring; and
o reporting compliance issues to HUSI senior management and Board of
Directors, as well as to HSBC Group Compliance.
The overall Corporate Compliance program elements include identification,
assessment, monitoring, control and mitigation of the risk and timely resolution
of the results of risk events. These functions are generally performed by line
management, with oversight provided by Corporate Compliance. Controls for
mitigating compliance risk are incorporated into business operating policies and
procedures. Processes are in place to ensure controls are appropriately updated
to reflect changes in regulatory requirements as well as changes in business
practices, including new or revised products, services and marketing programs. A
wide range of compliance training is provided to relevant staff, including
mandated programs for such areas as anti-money laundering, fair lending and
privacy.
HUSI took the following steps during 2004 to enhance its Corporate Compliance
program:
o compliance staffing was significantly increased to accommodate expansion
of compliance monitoring and testing and to respond to the changing
regulatory requirements and business strategies.
o independent AML and General Compliance teams were enhanced to support
existing and new business initiatives.
o the Corporate Compliance function created a new centralized compliance
testing unit to supplement testing performed by the business compliance
teams. This testing unit conducts AML testing throughout HUSI as well as
certain general compliance testing programs.
o new AML procedures were written and implemented for each business unit.
o an automated transaction monitoring program was implemented within retail
banking and existing transaction monitoring systems enhanced for private
and correspondent banking and assessments performed for the purpose of
implementing further automated monitoring tools.
o the existing Operational Risk methodology was leveraged to develop a new
compliance self-assessment tool for business units. A common database is
used for compliance, operational and fiduciary risk management.
o initial business Compliance Self Assessments were completed by all
businesses in 2004 and the self assessment program will be further
expanded and modified in 2005 to include additional regulatory
requirements and further development of key risk indicators.
58
Fiduciary Risk
Fiduciary risk is the risk associated with offering services honestly and
properly to clients in a fiduciary capacity in accordance with Regulation 12 CFR
9, Fiduciary Activity of National Banks. Fiduciary capacity is defined in the
regulation as:
o serving traditional fiduciary duties such as trustee, executor,
administrator, registrar of stocks and bonds, guardian, receiver or
assignee, or
o providing investment advice for a fee, or
o processing investment discretion on behalf of another.
Fiduciary risks reside in Private Banking businesses (including Investment
Management, Personal Trust, Custody, Trust Operations) and in several other
business lines outside of Private Banking (including Retirement Financial
Services, Corporate Trust and Asset Management). These risks almost always occur
where HUSI is entrusted to handle and execute client business affairs and
transactions in a fiduciary capacity. HUSI's policies and procedures for
addressing fiduciary risks generally address the following risk categories:
o placing a client in unsuitable investments, or in investments that do not
meet stated investment objectives;
o improper asset allocation or mix, portfolio performance, and lack of
adherence to investment policy;
o untimely or improper execution of client instructions, especially in a
trustee or custodial role;
o failure to handle uninvested cash or overdrafts properly;
o noncompliance with AML procedures or account documentation requirements;
o failure to disburse funds properly, either by wire or check;
o providing imprudent or unsound financial and asset safekeeping advice;
o creating conflicts of interest between employee incentives and client
objectives.
Oversight for the Fiduciary Risk Management function falls to the Fiduciary Risk
Management Committee of the Risk Management Committee. This committee is chaired
by the Senior Executive Vice President - Private Banking and Wealth Management
and includes the Chief Risk Officer and the Senior Vice President - Fiduciary
Risk. The Senior Vice President - Fiduciary Risk is responsible for an
independent Fiduciary Risk Management Unit that is responsible for day to day
oversight of the Fiduciary Risk Management function. The main goals and
objectives of this unit include:
o development and implementation of control self assessments, which have
been completed for all fiduciary businesses;
o developing, tracking and collecting rudimentary key risk indicators (KRI),
and collecting data regarding errors associated with these risks. KRIs for
each fiduciary business are in process of being expanded:
o designing, developing and implementing risk monitoring tools, approaches
and programs for the relevant business lines and senior management that
will facilitate the identification, evaluation, monitoring, measurement,
management and reporting of fiduciary risks. In this regard, a common
database is used for compliance, operational and fiduciary risks;
o ongoing development and implementation of more robust and enhanced key
risk indicator/key performance indicator process with improved risk
focused reporting.
Business Continuity Planning
HUSI is committed to the protection of employees, customers and shareholders by
a quick response to all threats to the organization, whether they are of a
physical or financial nature. For this purpose, HUSI has established a Business
Continuity Event Management (EM) process. EM provides an enterprise-wide
response and communication framework for managing major business continuity
events or incidents. It is designed to be flexible and is scaled to the scope
and magnitude of the event or incident.
59
The EM process works in tandem with HUSI's business continuity policy, plans and
key business continuity committees to manage events. HUSI's Crisis Management
Committee, a 24/7 standing committee, is activated to manage the EM process in
concert with senior HUSI management. This committee provides critical strategic
and tactical management of business continuity crisis issues, risk management,
communication, coordination and recovery management. HUSI also has designated an
Institutional Manager for Business Continuity who plays a key role on the Crisis
Management Committee. All major business and support functions have a senior
representative assigned to HUSI's Business Continuity Planning Committee chaired
by the Institutional Manager.
HUSI has dedicated certain work areas as hot and warm backup sites, which serve
as primary business recovery locations. HUSI also has concentrations of major
operations in both upstate and downstate New York. This geographic split of
major operations is leveraged to provide secondary business recovery sites for
many critical business and support areas of HUSI.
HUSI has built its own data center with the intention of developing the highest
level of resiliency for disaster recovery as defined by industry standards. Data
is mirrored synchronously to the disaster recovery site across duplicate dark
fiber loops. A high level of network backup resiliency has been established. In
a disaster situation, HUSI is positioned to bring main systems and server
applications online within predetermined timeframes.
HUSI tests business continuity and disaster recovery resiliency and capability
through routine contingency tests and actual events. Business continuity and
disaster recovery programs have been strengthened in numerous areas as a result
of these tests or actual events. There is a continuing effort to enhance the
program well beyond the traditional business resumption and disaster recovery
model.
In 2003, HUSI determined the applicability of the Interagency Paper on "Sound
Practices to Strengthen the Resiliency of the U.S. Financial System". HUSI is
committed to meeting or exceeding the requirements of the paper for the
businesses impacted by the compliance due date.
Glossary of Terms
- --------------------------------------------------------------------------------
Cost/Income Ratio - Ratio of total operating expenses, reduced by minority
interests and certain non-recurring expense items, to the sum of net interest
income and other revenues.
Federal Reserve - the Federal Reserve Bank; the principal regulator for HBUS.
Global Bank Note Program - $20 billion note program, under which HBUS issues
senior and subordinated debt.
Goodwill - Represents the purchase price over the fair value of identifiable
assets acquired, reduced by liabilities assumed, for business combinations.
HBUS - HSBC Bank USA, National Association; a wholly-owned U.S. banking
subsidiary of HUSI.
HNAH - HSBC North America Holdings Inc.; a wholly-owned subsidiary of HSBC and
HSBC's top-tier bank holding company in North America.
HNAI - HSBC North America Inc.; an indirect wholly-owned subsidiary of HNAH.
HSBC - HSBC Holdings plc.; HNAH's U.K. parent company.
HSBC Affiliate - any direct or indirect subsidiary of HSBC outside of the HUSI
consolidated group of entities.
60
HSBC Finance Corporation - an indirect wholly-owned finance company subsidiary
of HNAH.
HTSU - HSBC Technology & Services (USA) Inc.; an indirect wholly-owned
subsidiary of HNAH which provides information technology services to all
subsidiaries of HNAH and to other subsidiaries of HSBC.
HUSI - HSBC USA Inc.; the registrant, and a wholly-owned subsidiary of HNAI.
Intangible Assets - Assets (not including financial assets) that lack physical
substance. HUSI's acquired intangible assets include mortgage servicing rights
and favorable lease arrangements.
Mortgage Servicing Rights - Intangible assets representing the right to service
mortgage loans, which are recognized at the time the related loans are sold.
Net Interest Margin to Earning Assets - Net interest income divided by average
interest-earning assets for a given period.
Net Interest Margin to Total Assets - Net interest income divided by average
total assets for a given period.
Nonaccruing Loans - Loans for which interest is no longer accrued because
ultimate collection is unlikely.
OCC - the Office of the Comptroller of the Currency; the principal regulator for
HUSI.
Private Label Loan Portfolio - Loan and credit card receivable portfolio
acquired from HSBC Finance Corporation on December 29, 2004.
Rate of Return on Common Shareholder's Equity - Net income, reduced by preferred
dividends, divided by average common shareholder's equity for a given period.
Rate of Return on Total Assets - Net income after taxes divided by average total
assets for a given period.
Total Average Shareholders' Equity to Total Assets - Average total shareholders'
equity divided by average total assets as of a given date.
Total Period End Shareholders' Equity to Total Assets - Total shareholders'
equity divided by total assets as of a given date.
61
Reporting to Parent Company in the U.K.
- --------------------------------------------------------------------------------
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 HUSI on a U.S.
GAAP basis to net income on a U.K. GAAP basis.
- -----------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002
- -----------------------------------------------------------------------------------------------------
(in millions)
Net income - U.S. GAAP basis ............................. $ 1,258 $ 941 $ 855
Adjustments, net of tax:
Deferred loan origination fees and costs ........... (20) -- --
Derivative financial instruments ................... 13 8 (3)
Deferred taxation .................................. (10) 45 (8)
Depreciation ....................................... 16 16 15
Software amortization .............................. 8 (5) (4)
Securitizations .................................... (1) -- --
Other .............................................. (10) (2) 9
------- ------- -------
Earnings excluding goodwill amortization - U.K. GAAP basis 1,254 1,003 864
Goodwill amortization .................................... (140) (152) (151)
------- ------- -------
Net income - U.K. GAAP basis ............................. $ 1,114 $ 851 $ 713
======= ======= =======
Differences between U.S. and U.K. GAAP are as follows:
Deferred loan origination fees and costs
U.K. GAAP
o 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.
o 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
o 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. Prepayment and delinquency estimates are regularly monitored and
cost amortization rates adjusted accordingly.
o Credit card annual fees are netted with direct lending costs, deferred,
and amortized on a straight-line basis over one year.
Derivative financial instruments
U.K. GAAP
o Non-trading derivatives are those which are held for hedging purposes as
part of HUSI's 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.
o 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.
62
o 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.
o 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.
o 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.
o 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
o 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).
o 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:
- 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.
- 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.
- 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.
- 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.
- 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
o 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.
o 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.
63
U.S. GAAP
o 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').
o 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
o 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
o 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
o 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.
o 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
o 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.
Securitizations
U.K. GAAP
o FRS 5, "Reporting the Substance of Transactions," requires that the
accounting for securitized receivables is governed by whether the
originator has access to the benefits of the securitized assets and
exposure to the risks inherent in those benefits and whether the
originator has a liability to repay the proceeds of the note issue:
- The securitized assets should be derecognized in their entirety and
a gain or loss on sale recorded where the originator retains no
significant benefits and no significant risks relating to those
securitized assets.
- The securitized assets and the related finance should be
consolidated under a linked presentation where the originator
retains significant benefits and significant risks relating to those
securitized assets but where the downside exposure is limited to a
fixed monetary amount and certain other conditions are met.
- The securitized assets and the related finance should be
consolidated on a gross basis where the originator retains
significant benefits and significant risks relating to those
securitized assets and does not meet the conditions required for
linked presentation.
U.S. GAAP
o SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," requires that receivables that are sold
to a special purpose entity and securitized can only be derecognized and a
gain or loss on sale recognized if the originator has surrendered control
over those securitized assets.
64
o Control has been surrendered over transferred assets if and only if all of
the following conditions are met:
- The transferred assets have been put presumptively beyond the reach
of the transferor and its creditors, even in bankruptcy or other
receivership.
- Each holder of interests in the transferee (i.e., holder of issued
notes) has the right to pledge or exchange their beneficial
interests, and no condition constrains this right and provides more
than a trivial benefit to the transferor.
- The transferor does not maintain effective control over the assets
through either an agreement that obligates the transferor to
repurchase or to redeem them before their maturity or through the
ability to unilaterally cause the holder to return specific assets,
other than through a clean-up call.
- If these conditions are not met the securitized assets should
continue to be consolidated.
o Where we retain an interest in the securitized assets, such as a servicing
right or the right to residual cash flows from the special purpose entity,
we recognize this interest at fair value on sale of the assets.
o There are no provisions for linked presentation of securitized assets and
the related finance.
Goodwill amortization
U.K. GAAP
o Goodwill arising on acquisitions of subsidiary undertakings, associates or
joint ventures prior to 1998 was charged against reserves in the year of
acquisition.
o 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. In common with
many other U.K. companies, HSBC elected not to reinstate such goodwill on
the grounds that it would not materially assist the understanding of
readers of its accounts who were already familiar with U.K. GAAP.
o 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.
o 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.
o 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
o 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.
o 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.
o 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.
o 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------------------
Refer to the disclosure in Item 7 of the Management's Discussion and Analysis of
Financial Condition and Results of Operations under the captions "Interest Rate
Risk Management" and "Trading Activities".
65
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS
The following table shows the major consolidated assets, liabilities and
shareholders' equity, together with their respective interest amounts and rates
earned or paid on a taxable equivalent basis.
2004
--------------------------------------
Balance Interest Rate*
- ---------------------------------------------------------------------------------------------------------------
Assets
Interest bearing deposits with banks .............................. $ 2,499 $ 41 1.66%
Federal funds sold and securities purchased under resale agreements 4,682 74 1.58
Trading assets .................................................... 15,816 165 1.04
Securities ........................................................ 18,224 885 4.86
Loans
Domestic
Commercial ...................................................... 16,114 732 4.54
Consumer
Residential mortgages ......................................... 37,014 1,795 4.85
Other consumer ................................................ 3,567 286 8.00
--------- ------ ----
Total domestic ................................................. 56,695 2,813 4.96
International .................................................... 3,633 99 2.72
--------- ------ ----
Total loans .................................................... 60,328 2,912 4.83
--------- ------ ----
Other ............................................................. 533 18 3.46
--------- ------ ----
Total earning assets .............................................. 102,082 $4,095 4.01%
--------- ------ ----
Allowance for credit losses ....................................... (359)
Cash and due from banks ........................................... 3,276
Other assets ...................................................... 7,227
---------
Total assets ...................................................... $ 112,226
=========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ................................................. $ 27,220 $ 179 0.66%
Other time deposits .............................................. 16,085 365 2.27
Deposits in foreign offices ....................................... 21,899 281 1.28
--------- ------ ----
Total interest bearing deposits ................................... 65,204 825 1.27
--------- ------ ----
Short-term borrowings ............................................. 9,320 132 1.42
Long-term debt .................................................... 9,655 380 3.93
--------- ------ ----
Total interest bearing liabilities ................................ 84,179 1,337 1.59
--------- ------ ----
Net interest income / Interest rate spread ........................ $2,758 2.42%
------ ----
Noninterest bearing deposits ...................................... 7,649
Other liabilities ................................................. 12,341
Total shareholders' equity ........................................ 8,057
---------
Total liabilities and shareholders' equity ........................ $ 112,226
=========
Net yield on average earning assets ............................... 2.70%
----
Net yield on average total assets ................................. 2.46
----
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest
included fees of $78 million for 2004, $68 million for 2003 and $47 million for
2002.
66
2003 2002
- -------------------------------------------------------------------------------------
Balance Interest Rate* Balance Interest Rate*
- -------------------------------------------------------------------------------------
(in millions)
$ 1,682 $ 25 1.46% $ 1,996 $ 55 2.74%
4,521 55 1.22 5,289 95 1.79
12,427 137 1.10 10,943 162 1.47
19,051 908 4.76 18,541 975 5.26
16,612 805 4.85 16,464 841 5.11
21,245 1,171 5.51 19,346 1,250 6.46
3,049 248 8.15 2,963 271 9.13
-------- -------- ---- ------- ------ ----
40,906 2,224 5.44 38,773 2,362 6.09
3,281 126 3.83 3,281 160 4.88
-------- -------- ---- ------- ------ ----
44,187 2,350 5.32 42,054 2,522 6.00
-------- -------- ---- ------- ------ ----
482 20 4.28 476 23 4.91
-------- -------- ---- ------- ------ ----
82,350 $ 3,495 4.24% 79,299 $3,832 4.83%
-------- -------- ---- ------- ------ ----
(476) (533)
2,513 2,017
7,438 6,997
-------- -------
$ 91,825 $87,780
======== =======
$ 24,822 $ 189 0.76% $21,070 $ 212 1.00%
10,691 223 2.09 12,879 355 2.76
19,490 254 1.30 18,705 407 2.17
-------- -------- ---- ------- ------ ----
55,003 666 1.21 52,654 974 1.85
-------- -------- ---- ------- ------ ----
8,885 91 1.03 11,415 232 2.03
3,738 206 5.50 3,901 225 5.78
-------- -------- ---- ------- ------ ----
67,626 963 1.42 67,970 1,431 2.10
-------- -------- ---- ------- ------ ----
$ 2,532 2.82% $2,401 2.73%
-------- ---- ------ ----
6,464 5,631
10,203 6,979
7,532 7,200
-------- --------
$ 91,825 $ 87,780
======== ========
3.07% 3.03%
---- ----
2.76 2.74
==== ====
67
Item 8. Financial Statements and Supplementary Data
- --------------------------------------------------------------------------------
Page
Report of Independent Registered Public Accounting Firm................... 69
HSBC USA Inc.:
Consolidated Statement of Income.................................. 70
Consolidated Balance Sheet........................................ 71
Consolidated Statement of Changes in Shareholders' Equity......... 72
Consolidated Statement of Cash Flows.............................. 73
HSBC Bank USA, N.A.:
Consolidated Balance Sheet...................................... 74
Notes to Financial Statements............................................. 75
68
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
HSBC USA Inc.:
We have audited the accompanying consolidated balance sheets of HSBC USA Inc.
and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the years in the three year period ended December 31, 2004,
and the accompanying consolidated balance sheets of HSBC Bank USA, National
Association (formerly HSBC Bank USA) and subsidiaries (the Bank) as of December
31, 2004 and 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2004 and 2003, and the results of their operations and their cash
flows for each of the years in the three year period ended December 31, 2004,
and the financial position of the Bank as of December 31, 2004 and 2003, in
conformity with United States generally accepted accounting principles.
/s/ KPMG LLP
February 25, 2005
New York, New York
69
HSBC USA Inc.
- --------------------------------------------------------------------------------
C O N S O L I D A T E D S T A T E M E N T O F I N C O M E
Year Ended December 31, 2004 2003 2002
- -----------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans ........................................... $ 2,912 $ 2,350 $ 2,521
Securities ...................................... 868 887 952
Trading assets .................................. 165 136 161
Short-term investments .......................... 115 80 150
Other ........................................... 18 20 23
------- ------- -------
Total interest income ............................... 4,078 3,473 3,807
------- ------- -------
Interest expense:
Deposits ........................................ 825 666 974
Short-term borrowings ........................... 132 91 232
Long-term debt .................................. 380 206 225
------- ------- -------
Total interest expense .............................. 1,337 963 1,431
------- ------- -------
Net interest income ................................. 2,741 2,510 2,376
Provision (credit) for credit losses ................ (17) 113 195
------- ------- -------
Net interest income after provision for credit losses 2,758 2,397 2,181
------- ------- -------
Other revenues:
Trust income .................................... 95 94 94
Service charges ................................. 213 212 206
Other fees and commissions ...................... 425 446 398
Other income .................................... 333 165 89
Residential mortgage banking revenue (expense) .. (120) (102) 24
Trading revenues ................................ 288 291 130
Security gains, net ............................. 85 48 118
------- ------- -------
Total other revenues ................................ 1,319 1,154 1,059
------- ------- -------
Operating expenses:
Salaries and employee benefits .................. 937 1,131 1,029
Occupancy expense, net .......................... 157 156 156
Other expenses .................................. 1,007 753 690
------- ------- -------
Total operating expenses ............................ 2,101 2,040 1,875
------- ------- -------
Income before income tax expense .................... 1,976 1,511 1,365
Income tax expense .................................. 718 570 510
------- ------- -------
Net income .......................................... $ 1,258 $ 941 $ 855
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
70
HSBC USA Inc.
- --------------------------------------------------------------------------------
C O N S O L I D A T E D B A L A N C E S H E E T
December 31, 2004 2003
- -------------------------------------------------------------------------------------------------
(in millions)
Assets
Cash and due from banks ............................................ $ 2,682 $ 2,534
Interest bearing deposits with banks ............................... 2,776 843
Federal funds sold and securities purchased under resale agreements 3,126 2,446
Trading assets ..................................................... 19,815 14,646
Securities available for sale ...................................... 14,655 14,143
Securities held to maturity (fair value $4,042 and $4,648) ......... 3,881 4,512
Loans .............................................................. 84,947 48,474
Less - allowance for credit losses ................................. 788 399
-------- --------
Loans, net ................................................... 84,159 48,075
Properties and equipment, net ...................................... 594 681
Intangible assets, net ............................................. 352 551
Goodwill ........................................................... 2,697 2,777
Other assets ....................................................... 6,313 4,354
-------- --------
Total assets ....................................................... $141,050 $ 95,562
======== ========
Liabilities
Deposits in domestic offices:
Noninterest bearing .............................................. $ 7,639 $ 6,093
Interest bearing ................................................. 50,069 38,995
Deposits in foreign offices:
Noninterest bearing .............................................. 248 453
Interest bearing ................................................. 22,025 18,414
-------- --------
Total deposits ............................................... 79,981 63,955
-------- --------
Trading account liabilities ........................................ 12,120 10,460
Short-term borrowings .............................................. 9,874 6,782
Interest, taxes and other liabilities .............................. 4,370 3,089
Long-term debt ..................................................... 23,839 3,814
-------- --------
Total liabilities .................................................. 130,184 88,100
-------- --------
Shareholders' equity
Preferred stock .................................................... 500 500
Common shareholder's equity:
Common stock ($5 par; 150,000,000 shares authorized;
706 and 704 shares issued) --(1) --(1)
Capital surplus .................................................. 8,418 6,027
Retained earnings ................................................ 1,917 807
Accumulated other comprehensive income ........................... 31 128
-------- --------
Total common shareholder's equity ............................ 10,366 6,962
-------- --------
Total shareholders' equity ......................................... 10,866 7,462
-------- --------
Total liabilities and shareholders' equity ......................... $141,050 $ 95,562
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
71
HSBC USA Inc.
- --------------------------------------------------------------------------------
C O N S O L I D A T E D S T A T E M E N T O F C H A N G E S
I N S H A R E H O L D E R S' E Q U I T Y
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
(in millions)
Preferred stock
Balance, January 1 and December 31, ............................................. $ 500 $ 500 $ 500
-------- -------- --------
Common stock
Balance, January 1 and December 31, ............................................. --(1) --(1) --(1)
-------- -------- --------
Capital surplus
Balance, January 1, ............................................................. 6,027 6,056 6,035
Capital contribution from parent ................................................ 2,411 15 21
Reductions of capital surplus ................................................... (20) (44) --
-------- -------- --------
Balance, December 31, ........................................................... 8,418 6,027 6,056
-------- -------- --------
Retained earnings
Balance, January 1, ............................................................. 807 578 416
Net income ...................................................................... 1,258 941 855
Cash dividends declared:
Preferred stock ............................................................. (23) (22) (23)
Common stock ................................................................ (125) (690) (670)
-------- -------- --------
Balance, December 31, ........................................................... 1,917 807 578
-------- -------- --------
Accumulated other comprehensive income
Balance, January 1, ............................................................. 128 262 99
Net change in unrealized (losses) gains on securities ........................... (40) (175) 80
Net change in unrealized (losses) gains on derivatives classified as cash
flow hedges ................................................................... (58) 11 79
Foreign currency translation adjustments ........................................ 1 30 4
-------- -------- --------
Other comprehensive (loss) income, net of tax ................................... (97) (134) 163
-------- -------- --------
Balance, December 31, ........................................................... 31 128 262
-------- -------- --------
Total shareholders' equity, December 31, ........................................ $ 10,866 $ 7,462 $ 7,396
======== ======== ========
Comprehensive income
Net income ...................................................................... $ 1,258 $ 941 $ 855
Other comprehensive (loss) income ............................................... (97) (134) 163
-------- -------- --------
Comprehensive income ............................................................ $ 1,161 $ 807 $ 1,018
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
72
HSBC USA Inc.
- --------------------------------------------------------------------------------
C O N S O L I D A T E D S T A T E M E N T O F C A S H F L O W S
Year Ended December 31, 2004 2003 2002
- ---------------------------------------------------------------------------------------------------------------
(in millions)
Cash flows from operating activities
Net income ................................................... $ 1,258 $ 941 $ 855
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation, amortization and deferred taxes ........... 459 399 811
Provision (credit) for credit losses .................... (17) 113 195
Net change in other accrual accounts .................... (66) (960) (694)
Net change in loans originated for sale ................. (423) 1,033 (775)
Net change in trading assets and liabilities ............ (2,974) 448 (408)
Other, net .............................................. (623) (485) (586)
-------- -------- --------
Net cash provided by (used in) operating activities (2,386) 1,489 (602)
-------- -------- --------
Cash flows from investing activities
Net change in interest bearing deposits with banks ........... (2,126) (396) 2,512
Net change in short-term investments ......................... (909) 494 (95)
Net change in securities available for sale:
Purchases of securities available for sale .............. (11,306) (13,827) (13,110)
Proceeds from sales of securities available for sale .... 6,129 3,637 7,032
Proceeds from maturities of securities available for sale 5,578 10,752 5,306
Net change in securities held to maturity:
Purchases of securities held to maturity ................ (1,190) (2,678) (1,556)
Proceeds from maturities of securities held to maturity . 1,826 3,004 1,596
Net change in loans:
Net change in credit card receivables ................... 1,416 (86) (15)
Net change in other short-term loans .................... (828) 245 (374)
Net originations and maturities of long-term loans ...... (21,632) (3,131) (1,561)
Loans purchased from HSBC Finance Corporation ........... (16,227) (2,847) --
Sales of loans/other .................................... 466 669 190
Expenditures for properties and equipment .................... (29) (65) (83)
Net cash provided in acquisitions, net of cash acquired ...... 196 403 23
Other, net ................................................... (849) (366) 10
-------- -------- --------
Net cash used in investing activities .............. (39,485) (4,192) (125)
-------- -------- --------
Cash flows from financing activities
Net change in deposits ....................................... 17,030 4,405 2,399
Net change in short-term borrowings .......................... 3,333 (661) (979)
Net change in long-term debt:
Issuance of long-term debt .............................. 20,481 271 979
Repayment of long-term debt ............................. (1,068) (118) (1,022)
Capital contribution from parent ............................. 2,411 15 21
Reduction of capital surplus ................................. (20) (44) --
Dividends paid ............................................... (148) (712) (693)
-------- -------- --------
Net cash provided by financing activities .......... 42,019 3,156 705
-------- -------- --------
Net change in cash and due from banks ............................ 148 453 (22)
Cash and due from banks at beginning of year ..................... 2,534 2,081 2,103
-------- -------- --------
Cash and due from banks at end of year ........................... $ 2,682 $ 2,534 $ 2,081
======== ======== ========
Cash paid for: Interest ......................................... $ 1,195 $ 990 $ 1,484
Income taxes ..................................... 569 331 211
The accompanying notes are an integral part of the consolidated financial
statements.
Pending settlement receivables/payables related to securities and trading assets
and liabilities are treated as non cash items for cash flows reporting.
73
HSBC Bank USA, National Association
- --------------------------------------------------------------------------------
C O N S O L I D A T E D B A L A N C E S H E E T
December 31, 2004 2003
- -----------------------------------------------------------------------------------------------
(in millions)
Assets
Cash and due from banks ........................................... $ 2,624 $ 2,534
Interest bearing deposits with banks .............................. 2,698 555
Federal funds sold and securities purchased under resale agreements 3,123 2,446
Trading assets .................................................... 19,240 14,487
Securities available for sale ..................................... 14,539 13,529
Securities held to maturity (fair value $3,879 and $4,458) ........ 3,729 4,335
Loans ............................................................. 84,419 48,390
Less - allowance for credit losses ................................ 787 398
-------- --------
Loans, net .................................................. 83,632 47,992
Properties and equipment, net ..................................... 591 676
Intangible assets, net ............................................ 350 548
Goodwill .......................................................... 2,092 2,173
Other assets ...................................................... 5,678 3,693
-------- --------
Total assets ...................................................... $138,296 $ 92,968
======== ========
Liabilities
Deposits in domestic offices:
Noninterest bearing ............................................. $ 7,589 $ 6,065
Interest bearing ................................................ 50,069 38,995
Deposits in foreign offices:
Noninterest bearing ............................................. 248 453
Interest bearing ................................................ 23,373 19,034
-------- --------
Total deposits .............................................. 81,279 64,547
-------- --------
Trading account liabilities ....................................... 12,075 10,442
Short-term borrowings ............................................. 7,305 5,517
Interest, taxes and other liabilities ............................. 3,985 2,719
Long-term debt .................................................... 22,279 1,812
-------- --------
Total liabilities ................................................. 126,923 85,037
-------- --------
Shareholder's equity
Common shareholder's equity
Common stock ($100 par; 50,000 shares authorized;
20,002 and 20,000 shares issued) ....... 2 2
Capital surplus ................................................. 9,527 7,133
Retained earnings ............................................... 1,839 700
Accumulated other comprehensive income .......................... 5 96
-------- --------
Total shareholder's equity ........................................ 11,373 7,931
-------- --------
Total liabilities and shareholder's equity ........................ $138,296 $ 92,968
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
74
N O T E S T O F I N A N C I A L S T A T E M E N T S
Note 1. Organization and Basis of Presentation
- --------------------------------------------------------------------------------
HSBC USA Inc. is a New York State based bank holding company, and is an indirect
wholly owned subsidiary of HSBC Holdings plc (HSBC). HSBC USA Inc. and its
subsidiaries are collectively referred to as "HUSI". Effective January 1, 2004,
HSBC created a new North American organizational structure with HSBC North
America Holdings Inc. (HNAH) as the top-tier bank holding company parent. HNAH's
principal subsidiaries include a top tier U.S. bank holding company, HSBC North
America Inc. (HNAI), a consumer finance company, HSBC Finance Corporation
(formerly Household International Inc.), a holding company for investment
banking and markets, HSBC Markets (USA) Inc. (HSBC Markets), and a provider of
information technology services, HSBC Technology & Services (USA) Inc. (HTSU).
HUSI, a wholly owned subsidiary of HNAI, routinely conducts transactions with
HSBC Finance Corporation, HSBC Markets and HTSU in the normal course of
business.
On July 1, 2004, HUSI consolidated its banking operations under a single
national charter, following approval from the Office of the Comptroller of the
Currency.
The accounting and reporting policies of HUSI, including its principal
subsidiary, HSBC Bank USA, National Association (HBUS), conform to accounting
principles generally accepted in the United States of America and to predominant
practice within the banking industry. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires the use of estimates and assumptions that affect reported
amounts and disclosures. Actual results could differ from those estimates.
Certain reclassifications have been made to prior year amounts to conform with
current year presentations.
Note 2. Summary of Significant Accounting Policies and New Accounting
Pronouncements
- --------------------------------------------------------------------------------
Significant Accounting Policies and Practices
Principles of Consolidation
The financial statements of HUSI and HBUS are consolidated with those of their
respective wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated. Investments in companies in which the percentage
of ownership is at least 20%, but not more than 50%, are generally accounted for
under the equity method and reported as equity investments.
Foreign Currency Translation
The accounts of HUSI's foreign operations are measured using local currency as
the functional currency. Assets and liabilities are translated into United
States dollars at period end exchange rates. Income and expense accounts are
translated at average monthly exchange rates. Net exchange gains or losses
resulting from such translation are included in accumulated other comprehensive
income and reported as a separate component of shareholders' equity. Foreign
currency denominated transactions in other than the local functional currency
are translated using the period end exchange rate with any foreign currency
transaction gain or loss recognized currently in income.
Resale and Repurchase Agreements
HUSI enters into purchases of securities under agreements to resell ("resale
agreements") and sales of securities under agreements to repurchase ("repurchase
agreements") of substantially identical securities. Resale agreements and
repurchase agreements are generally accounted for as secured lending and secured
borrowing transactions respectively.
The amounts advanced under resale agreements and the amounts borrowed under
repurchase agreements are carried on the consolidated balance sheet at the
amount advanced or borrowed. Interest earned on resale agreements and interest
paid on repurchase agreements are reported as interest income and interest
expense respectively. HUSI offsets resale and repurchase agreements executed
with the same counterparty under legally enforceable netting
75
agreements that meet the applicable netting criteria. HUSI's policy is to take
possession of securities purchased under resale agreements. The market value of
the securities subject to the resale and repurchase agreements is regularly
monitored to ensure appropriate collateral coverage of these secured financing
transactions.
Investment Securities
Debt securities that HUSI has the ability and intent to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of
discounts. Securities acquired principally for the purpose of selling them in
the near term are classified as trading assets and reported at fair value, with
unrealized gains and losses included in earnings. All other securities are
classified as available for sale and carried at fair value, with unrealized
gains and losses, net of related income taxes, included in accumulated other
comprehensive income and reported as a separate component of shareholders'
equity.
The fair value of securities is based on current market quotations, where
available or internal valuation models that approximate market pricing. The
validity of internal pricing models is regularly substantiated by reference to
actual market prices realized upon sale or liquidation of these instruments. If
quoted market prices are not available, fair value is estimated based on the
quoted price of similar instruments.
Realized gains and losses on sales of securities are computed on a specific
identified cost basis and are reported within other revenues in the consolidated
statement of income. Adjustments of trading assets to fair value and gains and
losses on the sale of such securities are recorded in trading revenues.
HUSI regularly evaluates its securities portfolios to identify losses in value
that are deemed other than temporary. To the extent such losses are identified,
a loss is recognized in other revenues.
Loans
Loans are stated at amortized cost. Loans held for sale are carried at the lower
of aggregate cost or market value and remain presented as loans in the
consolidated balance sheet. Interest income is recorded using the effective
yield method as adjusted for amortization of purchase premiums and discounts,
and deferred fees and costs.
Commercial loans are categorized as nonaccruing when, in the opinion of
management, reasonable doubt exists with respect to the ultimate collectibility
of interest or principal based on certain factors including period of time past
due (principally ninety days) and adequacy of collateral. At the time a loan is
classified as nonaccruing, any accrued interest recorded on the loan is
generally reversed and charged against income. Interest income on these loans is
recognized only to the extent of cash received. In those instances where there
is doubt as to collectibility of principal, any interest payments received are
applied to principal. Loans are not reclassified as accruing until interest and
principal payments are brought current and future payments are reasonably
assured.
Residential mortgage interest income accruals are suspended when principal or
interest payments are more than three months contractually past due. Loans to
credit card customers that are past due more than ninety days are designated as
nonaccruing if the customer has agreed to credit counseling; otherwise they are
charged off in accordance with a predetermined schedule. Other consumer loans
are generally not designated as nonaccruing and are charged off against the
allowance for credit losses according to an established delinquency schedule.
Loans, other than those included in large groups of smaller balance homogenous
loans, are considered impaired when, based on current information, it is
probable that HUSI will be unable to collect all amounts due according to the
contractual terms of the loan agreement. Impaired loans are valued at the
present value of expected future cash flows, discounted at the loan's original
effective interest rate or, as a practical expedient, at the loan's observable
market price or the fair value of the collateral if the loan is collateral
dependent.
Restructured loans are loans for which the original contractual terms have been
modified to provide for terms that are less than HUSI would be willing to accept
for new loans with comparable risk because of a deterioration in the borrowers'
financial condition. Interest on these loans is accrued at the renegotiated
rates.
76
Loan Fees
Nonrefundable fees and related direct costs associated with the origination or
purchase of loans are deferred and netted against outstanding loan balances. The
amortization of net deferred fees and costs are recognized in interest income,
generally by the interest method, based on the estimated lives of the loans.
Nonrefundable fees related to lending activities other than direct loan
origination are recognized as other revenues over the period the related service
is provided. This includes fees associated with the issuance of loan commitments
where the likelihood of the commitment being exercised is considered remote. In
the event of the exercise of the commitment, the remaining unamortized fee is
recognized in interest income over the loan term using the interest method.
Other credit-related fees, such as standby letter of credit fees, loan
syndication and agency fees and annual credit card fees are recognized as other
revenues over the period the related service is performed.
Allowance for Credit Losses
HUSI maintains an allowance for credit losses that is, in the judgment of
management, adequate to absorb estimated losses inherent in its commercial and
consumer loan portfolios. A separate reserve for credit losses associated with
certain off-balance sheet exposures, such as letters of credit and commitments
to lend, is also maintained and included in other liabilities. The adequacy of
the allowance and the separate off-balance sheet reserve is assessed within the
context of both Statement of Financial Accounting Standards No. 114, Accounting
by Creditors for Impairment of a Loan (SFAS 114), and Statement of Financial
Accounting Standards No. 5, Accounting for Contingencies (SFAS 5), and is based
upon an evaluation of various factors including an analysis of individual
exposures, current and historical loss experience, changes in the overall size
and composition of the portfolio, specific adverse situations, and general
economic conditions. Provisions for all credit losses are recorded to earnings
based upon HUSI's periodic review of these and other pertinent factors. Actual
loan losses are charged and recoveries are credited to the allowance.
For commercial and select consumer loan assets, HUSI conducts a periodic
assessment of losses it believes to be inherent in the loan portfolio. When it
is deemed probable, based upon known facts and circumstances, that full
contractual interest and principal on an individual loan will not be collected,
the asset is considered impaired. In accordance with SFAS 114, a "specific loss"
impairment reserve is established based upon the present value of expected
future cash flows, discounted at the loan's original effective interest rate, or
as a practical expedient, at the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent.
Formula-based reserves are also established against commercial loans and
off-balance sheet credit exposures in accordance with SFAS 5, based upon an
analysis of relevant data, when it is probable that a loss has been incurred and
will be realized and the amount of that loss can be reasonably estimated, even
though it has yet to manifest itself in a specifically identifiable loan asset.
These reserves are determined by reference to continuously monitored and updated
historical loss rates or factors, derived from a migration analysis which
considers net charge off experience by loan and industry type, in relation to
internal credit grading.
Homogeneous pools of loans including consumer installment and residential
mortgage loans are not assigned specific loan grades. Formula-based reserves are
generally determined based upon historical loss experience by loan type or in
certain instances, by reference to specific collateral values.
For retail credit card receivables, HUSI uses roll rate methodology (statistical
analysis of historical trends used to estimate the probability of continued
delinquency, ultimate charge off, and amount of consequential loss assessed at
each time period for which payments are overdue) to ensure that an acceptable
number of months of anticipated losses are included in the allowance for credit
losses. The resulting loss coverage ratio varies by portfolio based on inherent
risk and regulatory guidance. Historical factors used in the models are modified
as appropriate by an evaluation of current economic conditions and portfolio
trends including behavioral and account management information such as
bankruptcy. Roll rates are regularly updated and benchmarked against actual
outcomes to ensure that they remain appropriate.
77
Although the calculation of required formula-based reserves is a mechanical
process incorporating historical data, the ultimate selection of reserve factors
and the assessment of the overall adequacy of the allowance to provide for
credit losses inherent in the loan portfolio involves a high degree of
subjective management judgment. With recognition to the imprecision in
estimating credit losses, and with consideration given to probable losses
associated with factors including the impact of the national economic cycle,
migration trends within non-criticized portfolios of loans, as well as portfolio
concentration, HUSI therefore also maintains an "unallocated reserve".
HUSI gathers and analyzes historical data, updates assumptions relative to
expected loss experience and reviews individual and portfolio loan assets on a
quarterly basis. In December 2004, HUSI implemented a new advanced methodology
for estimation of losses inherent in pools of homogeneous commercial loans,
leases and off-balance sheet risk. Conversion to the new methodology, which is
further described in Critical Accounting Policies on page 15 of this Form 10-K,
resulted in a reduction in the allowance for credit losses and an increase in
the reserve for off-balance sheet exposures.
Properties and Equipment, Net
Properties and equipment are recorded at cost, net of accumulated depreciation
and amortization. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets. Leasehold improvements are amortized over
the lesser of the economic useful life of the improvement or the term of the
lease. Costs of maintenance and repairs are expensed as incurred.
Mortgage Servicing Rights
HUSI recognizes the right to service mortgages as a separate and distinct asset
at the time the loans are sold. Servicing rights are then amortized in
proportion to net servicing income and carried on the balance sheet in other
assets at the lower of their initial carrying value, adjusted for amortization,
or fair value.
As interest rates decline, prepayments generally accelerate, thereby reducing
future net servicing cash flows from the mortgage portfolio. The carrying value
of the mortgage servicing rights (MSRs) is periodically evaluated for impairment
through internal modeling based on the difference between the carrying value of
such rights and their current fair value. For purposes of measuring impairment
which, if temporary is recorded through the use of a valuation reserve or, if
permanent as a direct write-down, MSRs are stratified based upon interest rates
and whether such rates are fixed or variable and other loan characteristics.
Fair value is determined based upon the application of pricing valuation models
incorporating portfolio specific prepayment assumptions. The reasonableness of
these pricing models is periodically substantiated by reference to external
independent broker valuations and industry surveys.
If the carrying value of the servicing rights exceeds fair value, the asset is
deemed impaired and impairment is recognized by recording a balance sheet
valuation reserve with a corresponding charge to income.
HUSI uses certain derivative financial instruments including options and
interest rate swaps, to protect against the decline in economic value of
servicing rights. These instruments have not been designated as qualifying
hedges under SFAS 133 and are therefore recorded as trading instruments that are
marked to market through earnings.
Goodwill and Other Acquisition Intangibles
Goodwill, representing the excess of purchase price over the fair value of net
assets acquired, results from purchase acquisitions made by HUSI. HUSI has
adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142), which requires that goodwill, including previously
existing goodwill, and intangible assets with indefinite useful lives, not be
amortized but rather tested for impairment at least annually. Under SFAS 142,
all recorded goodwill must be assigned to one or more reporting units of the
entity and evaluated for impairment at that level. Impairment testing requires
that the fair value of each reporting unit be compared to its carrying amount,
including the goodwill.
78
Income Taxes
HNAH files a consolidated federal income tax return which includes HUSI.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as the estimated future tax consequences attributable to net
operating loss and tax credit carryforwards. A valuation allowance is
established if, based on available evidence, it is more likely than not that
some portion or all of the deferred tax asset will not be realized. Foreign
taxes paid are applied as credits to reduce federal income taxes payable.
Derivative Financial Instruments
Derivative financial instruments are recognized on the balance sheet at fair
value in accordance with Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities (SFAS 133). On the
date the derivative contract is entered into, HUSI designates it as either (1) a
qualifying SFAS 133 hedge of the fair value of a recognized asset or liability
or of an unrecognized firm commitment ("fair value" hedge); or (2) a qualifying
SFAS 133 hedge of a forecasted transaction of the variability of cash flows to
be received or paid related to a recognized asset or liability ("cash flow"
hedge); or (3) as a trading position.
Changes in the fair value of a derivative that has been designated and qualifies
as a fair value hedge, along with the changes in the fair value of the hedged
asset or liability that is attributable to the hedged risk (including losses or
gains on firm commitments), are recorded in current period earnings. Changes in
the fair value of a derivative that has been designated and qualifies as a cash
flow hedge are recorded in other comprehensive income to the extent of its
effectiveness, until earnings are impacted by the variability of cash flows from
the hedged item. Changes in the fair value of derivatives held for trading
purposes are reported in current period earnings.
At the inception of each hedge, it is HUSI's policy to formally document all
relationships between hedging instruments and hedged items, as well as its risk
management objective and strategy for undertaking various hedge transactions.
This process includes linking all derivatives that are designated as fair value
or cash flow hedges to specific assets and liabilities on the balance sheet or
to specific firm commitments or forecasted transactions.
Increased earnings volatility may result from the on-going mark to market of
certain economically viable derivative contracts that do not satisfy the hedging
requirements of SFAS 133, as well as from the hedge ineffectiveness associated
with the qualifying contracts. HUSI expects however that it will be able to
continue to pursue its overall asset and liability risk management objectives
using a combination of derivatives and cash instruments.
Embedded Derivatives
HUSI may acquire or originate a financial instrument that contains a derivative
instrument "embedded" within it. Upon origination or acquisition of any such
instrument, HUSI assesses whether the economic characteristics of the embedded
derivative are clearly and closely related to the economic characteristics of
the principal component of the financial instrument (i.e., the "host contract")
and whether a separate instrument with the same terms as the embedded instrument
would meet the definition of a derivative instrument.
When it is determined that (1) the embedded derivative possesses economic
characteristics that are not clearly and closely related to the economic
characteristics of the host contract; and (2) a separate instrument with the
same terms would qualify as a derivative instrument, the embedded derivative is
separated from the host contract, carried at fair value, and designated a
trading instrument.
79
Hedge Discontinuation
HUSI formally assesses, both at the hedge's inception and on an on-going basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged items and
whether they are expected to continue to be highly effective in future periods.
If it is determined that a derivative is not highly effective as a hedge, or
that in the future it ceases to be a highly effective hedge, HUSI discontinues
hedge accounting prospectively, as discussed below.
HUSI discontinues hedge accounting prospectively when (1) the derivative is no
longer effective in offsetting changes in the fair value or cash flows of a
hedged item (including firm commitments or forecasted transactions); (2) the
derivative expires or is sold, terminated, or exercised; (3) it is unlikely that
a forecasted transaction will occur; (4) the hedged firm commitment no longer
meets the definition of a firm commitment; or (5) the designation of the
derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value or cash flow hedge,
the derivative will continue to be carried on the balance sheet at its fair
value, and the hedged item will no longer be adjusted for changes in fair value
or changes in the fair value of the derivative reclassified to other
comprehensive income. If the hedged item was a firm commitment or forecasted
transaction that is not expected to occur, any amounts recorded on the balance
sheet related to the hedged item, including any amounts recorded in other
comprehensive income, are reclassified to current period earnings. In all other
situations in which hedge accounting is discontinued, the derivative will be
carried at its fair value on the balance sheet, with changes in its fair value
recognized in current period earnings unless redesignated as a qualifying SFAS
133 hedge.
Day One Profit (Loss) Recognition
HUSI recognizes profit and loss at the inception of derivative transactions only
when the fair value of the transaction can be verified to market transactions or
if all significant pricing model assumptions can be verified to observable
market data. Profit or loss not recognized at inception is recognized over the
term of the derivative contract in correlation with outstanding risk and
valuation characteristics.
Receivables Sold With Limited Recourse and Securitization Revenue
Certain private label credit card receivables have been securitized and sold to
investors with limited recourse. Servicing rights to these receivables was
retained. Recourse is limited to the rights to future cash flow and any
subordinated interest retained by HUSI. Upon sale, the receivables are removed
from the balance sheet and a gain on sale is recognized for the difference
between the carrying value of the receivables and the adjusted sales proceeds.
The adjusted sales proceeds include cash received and the present value estimate
of future cash flows to be received over the life of the sold receivables.
Future cash flows are based on estimates of prepayments, the impact of interest
rate movements on yields of receivables and securities issued, delinquency of
receivables sold, servicing fees and other factors. The resulting gain is also
adjusted by a provision for estimated probable losses under the recourse
provision. This provision and the related reserve for receivables serviced with
limited recourse are established at the time of sale to cover all probable
credit losses over the life of the receivables sold based on historical
experience and estimates of expected future performance. The methodology uses
historical monthly net charge off rates applied to the expected balances to be
received over the remaining life of the receivable. The reserves are reviewed
periodically by evaluating the estimated future cash flows of each securitized
pool to ensure that there is sufficient remaining cash flow to cover estimated
future credit losses. Any changes to the estimates for the reserve for
receivables serviced with limited recourse are made in the period they became
known. Servicing income and excess spread relating to securitized receivables
are reported in the accompanying consolidated statement of income as other
revenues.
In connection with these transactions, an interest-only strip receivable has
been recorded representing HUSI's contractual right to receive interest and
other cash flows from securitization trusts. Interest-only strip receivables are
reported at fair value using discounted cash flow estimates as a component of
other assets net of the estimate of probable losses under the recourse
provisions. Cash flow estimates include estimates of prepayments, the impact of
80
interest rate movements on yields of receivables and securities issued,
delinquency of receivables sold, servicing fees and estimated probable losses
under the recourse provisions. Interest-only strip receivables are reviewed for
impairment quarterly or earlier if events indicate that the carrying value may
not be recovered. Any decline in the fair value of the interest-only strip
receivable which is deemed to be other than temporary is charged against current
earnings.
Other subordinated interests have also been retained in these securitizations.
Neither the interest-only strip receivables nor the other subordinated interests
are in the form of securities.
In order to align the accounting treatment with that of HSBC under U.K. GAAP
(and beginning in 2005, International Financial Reporting Standards), all new
funding utilizing securitization is being structured as secured financings.
However, because existing transactions were structured as sales to revolving
trusts that require replenishments to support previously issued securities,
receivables will continue to be sold to these trusts until the revolving periods
end.
Transactions With Related Parties
In the normal course of business, HUSI enters into transactions with HSBC and
its subsidiaries. These transactions include purchases and sales of receivables
and/or account relationships, loan origination and servicing arrangements,
information technology services, administrative and operational support, debt
underwriting, and other miscellaneous services. Transactions with related
parties are generally on terms comparable to those that would be made with
unaffiliated parties.
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 assets acquired in fiscal years beginning after
December 15, 2004. Adoption is not expected to have a material impact on HUSI's
financial position or results of operations.
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 allows 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. HUSI elected to
defer the accounting for the effects of the new law. In May 2004, the Financial
Accounting Standards Board (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 provides two methods of transition - retroactive
application or prospective application from the date of adoption. If the effects
of the new law are deemed to be a "significant event" the effect can be
incorporated into the next measurement date following the effective date. Based
on information currently available, the effects of the new law are not
considered to be a "significant event", and therefore the effects of the new law
have been accounted for in the measurement of pension liability at December 31,
2004.
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 new disclosure
requirements are effective for reporting periods beginning after June 15, 2004,
and the new impairment guidance was to become effective for reporting periods
beginning after June 15, 2004. In September 2004, the FASB delayed the effective
81
date of EITF 03-1 for measurement and recognition of impairment losses until
implementation guidance is issued. In December 2004, the FASB decided to
reconsider in its entirety all guidance on disclosing, measuring and recognizing
other-than-temporary impairments of debt and equity securities and requires
companies to continue to comply with existing accounting literature. Until the
new guidance is finalized, the impact on financial position and results of
operations cannot be determined.
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. HUSI 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 provided on page 27 of this Form
10-K.
In December 2004, FASB issued Statement No. 123 (Revised), Share-Based Payment
(SFAS 123R). SFAS 123R requires public entities to measure the cost of
stock-based compensation based on the grant date fair value of the award, and is
effective for interim or annual reporting periods beginning after June 15, 2005.
HUSI was substantially in compliance with SFAS 123R as of December 31, 2004, and
will be entirely compliant by the required adoption date. The adoption of SFAS
123R therefore will not have a significant effect on operating results.
82
Note 3. Acquisitions and Divestitures
- --------------------------------------------------------------------------------
2004
The following acquisitions from affiliated HSBC entities are described in
greater detail in Note 18 of the consolidated financial statements beginning on
page 97 of this Form 10-K:
o On December 29, 2004, HUSI purchased approximately $12 billion of private
label loans, primarily credit card receivables, from HSBC Finance
Corporation at fair value.
o On March 31, 2004, HUSI purchased approximately $1 billion of domestic
residential mortgage loans asset at fair value from HSBC Finance
Corporation. In addition, approximately $3 billion of consumer loans were
purchased from originating lenders pursuant to HSBC Finance Corporation
correspondent loan programs.
The following transfers and sales to affiliated HSBC entities are described in
greater detail in Note 18 of the consolidated financial statements beginning on
page 97 of this Form 10-K:
o On June 1, 2004, HUSI transferred a wholly owned domestic brokerage
subsidiary to HSBC Markets at fair value.
o On July 31, 2004, HUSI transferred most of its Panamanian branch
operations to an HSBC affiliate at fair value.
o On February 29, 2004, HUSI sold its banking subsidiary in Uruguay to an
HSBC affiliate at fair value.
2003
On December 31, 2003 approximately $3 billion of residential mortgage loan
assets were purchased from HSBC Finance Corporation.
On December 31, 2003 HUSI sold its domestic factoring business to CIT Group Inc.
Approximately $1 billion of gross loans and over $.7 billion of liabilities were
sold. The transaction did not have a material effect on the 2003 results of
HUSI.
Note 4. Trading Assets and Liabilities
- --------------------------------------------------------------------------------
The composition of trading assets and liabilities is presented in the following
table.
- --------------------------------------------------------------------------------
December 31 2004 2003
- --------------------------------------------------------------------------------
(in millions)
Trading assets:
U.S. Treasury .............................. $ 181 $ 115
U.S. Government agency ..................... 677 875
Asset backed securities .................... 1,144 1,505
Corporate bonds ............................ 1,771 848
Other securities ........................... 3,263 1,344
Precious metals ............................ 3,172 2,306
Fair value of derivatives .................. 9,607 7,653
------- -------
$19,815 $14,646
======= =======
Trading account liabilities:
Securities sold, not yet purchased ......... $ 951 $ 914
Payables for precious metals ............... 1,134 1,181
Fair value of derivatives .................. 10,035 8,365
------- -------
$12,120 $10,460
======= =======
83
Note 5. Securities
- --------------------------------------------------------------------------------
At December 31, 2004 and 2003, HUSI held no securities of any single issuer
(excluding the U.S. Treasury and U.S. Government agencies) with a book value
that exceeded 10% of shareholders' equity.
The amortized cost and fair value of the available for sale and held to maturity
securities portfolios are presented in the following table.
- ----------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ....................................... $ 203 $ -- $ 3 $ 200
U.S. Government agency (1) .......................... 11,165 79 119 11,125
Asset backed securities ............................. 1,122 3 1 1,124
Other domestic debt securities ...................... 990 6 2 994
Foreign debt securities ............................. 1,090 15 2 1,103
Equity securities ................................... 64 49 4 109
------- ------- ------- -------
Securities available for sale ....................... $14,634 $ 152 $ 131 $14,655
======= ======= ======= =======
Securities held to maturity:
U.S. Treasury ....................................... $ 122 $ -- $ -- $ 122
U.S. Government agency (1) .......................... 2,918 132 13 3,037
Obligations of U.S. states and political subdivisions 465 37 -- 502
Other domestic debt securities ...................... 231 6 1 236
Foreign debt securities ............................. 145 -- -- 145
------- ------- ------- -------
Securities held to maturity ......................... $ 3,881 $ 175 $ 14 $ 4,042
======= ======= ======= =======
(1) Includes mortgage backed securities issued or guaranteed by U.S.
Government agencies.
- ----------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2003 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ....................................... $ -- $ -- $ -- $ --
U.S. Government agency (1) .......................... 10,778 155 141 10,792
Asset backed securities ............................. 1,784 8 6 1,786
Other domestic debt securities ...................... 415 1 -- 416
Foreign debt securities ............................. 904 13 -- 917
Equity securities ................................... 187 49 4 232
------- ------- ------- -------
Securities available for sale ....................... $14,068 $ 226 $ 151 $14,143
======= ======= ======= =======
Securities held to maturity:
U.S. Treasury ....................................... $ 125 $ -- $ -- $ 125
U.S. Government agency (1) .......................... 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
------- ------- ------- -------
Securities held to maturity ......................... $ 4,512 $ 178 $ 42 $ 4,648
======= ======= ======= =======
(1) Includes mortgage backed securities issued or guaranteed by U.S.
Government agencies.
84
A summary of gross unrealized losses and related fair values, classified as to
the length of time the losses have existed, is presented in the following table.
The unrealized losses that have existed for more than one year related to asset
backed securities are due to interest rate market conditions. The securities in
question are high credit grade (i.e. AAA or AA) and impairment is expected to be
temporary.
- ----------------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
------------------------------------------- ---------------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
December 31, 2004 Securities Losses of Investment Securities Losses of Investment
- ----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ................. 1 $ 3 $ 200 -- $ -- $ --
U.S. Government agency......... 140 47 3,764 166 72 1,876
All other securities........... 31 6 487 21 3 103
--- ------ -------- --- ------- ---------
Securities available for sale.. 172 $ 56 $ 4,451 187 $ 75 $ 1,979
=== ====== ======== === ======= =========
Securities held to maturity:
U.S. Government agency......... 12 $ 3 $ 190 15 $ 10 $ 281
All other securities........... 7 1 5 -- -- --
--- ------ -------- --- ------- ---------
Securities held to maturity.... 19 $ 4 $ 195 15 $ 10 $ 281
=== ====== ======== === ======= =========
The following table presents realized gains and losses on investment securities
transactions attributable to available for sale and held to maturity securities.
Amounts in the table include net realized gains of $8 million, $22 million and
$1 million reported in residential mortgage banking revenue in the consolidated
statement of income for 2004, 2003 and 2002 respectively.
- ---------------------------------------------------------------------------------------------------------
Net
Gross Gross Realized
Realized Realized Gains
Year Ended December 31 Gains (Losses) (Losses)
- ---------------------------------------------------------------------------------------------------------
(in millions)
2004
- ----
Securities available for sale ......................... $ 100 $ (8) $ 92
Securities held to maturity:
Maturities, calls and mandatory redemptions ..... 1 -- 1
------- ------- ------
$ 101 $ (8) $ 93
======= ======= ======
2003
- ----
Securities available for sale ......................... $ 81 $ (11) $ 70
======= ======= ======
2002
- ----
Securities available for sale ......................... $ 188 $ (70) $ 118
Securities held to maturity:
Maturities, calls and mandatory redemptions ..... 3 (2) 1
------- ------- ------
$ 191 $ (72) $ 119
======= ======= ======
The amortized cost and fair values of securities available for sale and
securities held to maturity at December 31, 2004, by contractual maturity are
presented in the following table. Expected maturities differ from contractual
maturities because borrowers have the right to prepay obligations without
prepayment penalties in certain cases. The amounts exclude $64 million cost
($109 million fair value) of equity securities that do not have maturities.
85
The following table also reflects the distribution of maturities of debt
securities held at December 31, 2004 together with the approximate taxable
equivalent yield of the portfolio. The yields shown are calculated by dividing
annual interest income, including the accretion of discounts and the
amortization of premiums, by the amortized cost of securities outstanding at
December 31, 2004. Yields on tax-exempt obligations have been computed on a
taxable equivalent basis using applicable statutory tax rates.
- --------------------------------------------------------------------------------------------------------------------------------
Within After One After Five After
Taxable One But Within But Within Ten
Equivalent Year Five Years Ten Years Years
Basis Amount Yield Amount Yield Amount Yield Amount Yield
- --------------------------------------------------------------------------------------------------------------------------------
(in millions)
Available for sale:
U.S. Treasury ......... $ -- --% $ -- --% $ 203 4.00% $ -- --%
U.S. Government agency 431 3.14 392 2.94 879 4.62 9,463 4.14
Asset backed securities 32 2.42 263 2.62 425 2.84 402 2.57
Other domestic debt
securities .......... 36 4.59 116 3.45 -- -- 838 3.80
Foreign debt securities 126 3.52 349 5.37 391 6.62 224 6.59
------- ------- ------- ------- ------- ------- ------- -------
Total amortized cost ........ $ 625 3.26% $ 1,120 3.67% $ 1,898 4.57% $10,927 4.11%
------- ------- ------- ------- ------- ------- ------- -------
Total fair value ............ $ 623 $ 1,116 $ 1,903 $10,904
======= ======= ======= =======
Held to maturity:
U.S. Treasury ......... $ 122 1.66% $ -- --% $ -- --% $ -- --%
U.S. Government agency -- -- 90 7.14 169 6.53 2,659 6.34
Obligations of U.S.
states and political
subdivisions ........ 9 6.85 49 6.26 86 5.55 321 5.31
Other domestic debt
securities .......... -- -- -- -- -- -- 231 5.93
Foreign debt securities 145 2.49 -- -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- -------
Total amortized cost ........ $ 276 2.28% $ 139 6.83% $ 255 6.20% $ 3,211 6.21%
------- ------- ------- ------- ------- ------- ------- -------
Total fair value ............ $ 277 $ 145 $ 275 $ 3,345
======= ======= ======= =======
Note 6. Loans
- --------------------------------------------------------------------------------
A distribution of the loan portfolio, including loans held for sale, is
presented in the following table.
- ----------------------------------------------------------------------------------------------------------
December 31 2004 2003
- ----------------------------------------------------------------------------------------------------------
Total Held for Sale Total Held for Sale
- ----------------------------------------------------------------------------------------------------------
(in millions)
Domestic:
Commercial:
Construction and other real estate $ 8,341 $ -- $ 7,075 $ --
Other commercial ................. 11,815 -- 8,658 --
Consumer:
Residential mortgage ............. 46,715 1,352 26,295 946
Credit card receivables .......... 12,078 -- 1,112 --
Other consumer ................... 3,122 393 1,904 385
International .............................. 2,876 -- 3,430 --
------- ------- ------- -------
$84,947 $ 1,745 $48,474 $ 1,331
======= ======= ======= =======
On December 29, 2004, HUSI acquired a $12 billion private label loan portfolio
from HSBC Finance Corporation. The portfolio consisted of approximately $11
billion of credit card receivables and $1 billion of other consumer loans.
86
During 2004, HUSI purchased approximately $1 billion of residential mortgage
loans from HSBC Finance Corporation. In addition, approximately $4 billion of
additional consumer loans, primarily residential mortgage loans, were purchased
from originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs. The remaining net increase in residential mortgage loans resulted from
organic growth, primarily in variable rate loans, as customers continued to take
advantage of the low interest rate environment.
International loans includes certain bonds issued by the government of Venezuela
as part of debt renegotiations (Brady Bonds). HUSI's intent is to hold these
instruments until maturity. The Brady Bonds are fully secured as to principal by
zero-coupon U.S. Treasury securities with a face value equal to that of the
underlying bonds. The following table presents information regarding Brady
Bonds.
- --------------------------------------------------------------------------------
December 31 2004 2003
- --------------------------------------------------------------------------------
(in millions)
Balance at end of year:
Face value ............................. $178 $178
Aggregate carrying value ............... 166 166
Aggregate fair value ................... 177 164
Information regarding credit quality of loans, including analysis of nonaccruing
loans, criticized loans, impaired loans, and other real estate and owned assets,
is presented in Item 7 beginning on page 37 of this Form 10-K.
HUSI has loans outstanding to certain executive officers and directors. The
loans were made on substantially the same terms, including interest rates and
collateral, as those prevailing at the same time for comparable transactions
with other persons and do not involve more than normal risk of collectibility.
The aggregate amount of such loans did not exceed 5% of shareholders' equity at
December 31, 2004 and 2003.
Note 7. Allowance for Credit Losses
- --------------------------------------------------------------------------------
An analysis of the allowance for credit losses is presented in the following
table.
- ----------------------------------------------------------------------------------------------------
2004 2003 2002
- ----------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of year ............................ $ 399 $ 493 $ 506
Allowance related to acquisitions and (dispositions), net 485 (15) (2)
Provision (credited) charged to income .................. (17) 113 195
Recoveries on loans charged off ......................... 78 51 35
Loans charged off ....................................... (157) (243) (241)
----- ----- -----
Balance at end of year .................................. $ 788 $ 399 $ 493
===== ===== =====
On December 29, 2004, HUSI acquired approximately $12 billion of private label
loans from HSBC Finance Corporation, including an allowance for credit losses of
approximately $505 million associated with the purchased loans.
Included in the December 31, 2004 and December 31, 2003 allowance for credit
losses are approximately $14 million and $33 million respectively, of non-United
States transfer risk reserves.
87
Note 8. Properties and Equipment, Net
- --------------------------------------------------------------------------------
The following table presents the composition of properties and equipment, net of
accumulated depreciation and amortization.
- --------------------------------------------------------------------------------------------
Depreciable
December 31 Life (Years) 2004 2003
- --------------------------------------------------------------------------------------------
(in millions)
Land .......................................... -- $ 99 $ 102
Buildings ..................................... 5-40 711 721
Furniture and equipment ....................... 3-7 483 504
------- -------
Total ......................................... 1,293 1,327
------- -------
Less: accumulated depreciation and amortization (699) (646)
------- -------
Properties and equipment, net ................. $ 594 $ 681
======= =======
Depreciation and amortization expense was approximately $98 million and $99
million in 2004 and 2003 respectively.
Note 9. Intangible Assets, Net
- --------------------------------------------------------------------------------
The following table summarizes the composition of intangible assets.
- ------------------------------------------------------------------------------------------------------------
December 31 2004 2003
- ------------------------------------------------------------------------------------------------------------
(in millions)
Mortgage servicing rights, net of accumulated amortization and valuation allowance $309 $503
Favorable lease arrangements, net of accumulated depreciation of $24 and $19 ..... 43 48
---- ----
Intangible assets, net ........................................................... $352 $551
==== ====
Mortgage Servicing Rights (MSRs)
HUSI 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.
Fair value is based on the present value of future cash flows which, at December
31, 2004, was calculated using a constant prepayment rate (CPR) of 19.8%
annualized, a constant discount rate of 9.64%, and a weighted average life of
4.5 years.
88
The following table summarizes activity for MSRs and the related valuation
allowance.
- ---------------------------------------------------------------------------------------------
2004 2003 2002
- ---------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Balance, January 1, ........................... $ 526 $ 395 $ 316
Additions related to loan sales ............... 62 283 169
Net MSRs acquisitions (sales) ................. (54) 51 3
Permanent impairment charges .................. (15) (44) (16)
Amortization .................................. (103) (159) (77)
----- ----- -----
Balance, December 31, ......................... 416 526 395
----- ----- -----
Valuation allowance for MSRs:
Balance, January 1, ........................... (23) (40) --
Temporary impairment (provision) recovery ..... (102) (27) (56)
Permanent impairment charges .................. 15 44 16
Release of allowance related to MSRs sold ..... 3 -- --
----- ----- -----
Balance, December 31, ......................... (107) (23) (40)
----- ----- -----
MSRs, net of accumulated amortization and valuation
allowance at December 31, ....................... $ 309 $ 503 $ 355
===== ===== =====
The increase in temporary impairment in 2004 resulted primarily from reductions
in interest rates, supplemented by changes resulting from HUSI's normal ongoing
review of assumptions used in its MSRs valuation model.
Residential mortgage loans serviced for others are not included in the
accompanying consolidated balance sheets. The outstanding principal balances of
these loans were $28 billion and $34 billion at December 31, 2004 and 2003
respectively. Custodial balances maintained in connection with the foregoing
loan servicing, and included in noninterest bearing deposits in domestic
offices, were approximately $546 million and $643 million at December 31, 2004
and 2003 respectively.
Normal amortization for the current MSRs portfolios is expected to be
approximately $88 million for the year ending December 31, 2005, declining
gradually to approximately $34 million for the year ending December 31, 2009.
Actual levels of amortization could increase or decrease depending upon changes
in interest rates and loan prepayment activity. Actual levels of amortization
are also dependent upon future levels of MSRs recorded.
Favorable Lease Arrangements
Intangible assets have been recorded for favorable lease arrangements, which
resulted from various business acquisitions. Scheduled amortization of favorable
lease arrangements will approximate $5 million per year for 2005 through 2009.
Note 10. Goodwill
- --------------------------------------------------------------------------------
During 2004, HUSI sold or transferred certain domestic and foreign operations to
affiliated HSBC entities, resulting in reductions of goodwill of approximately
$80 million.
During the second quarter of 2004, HUSI completed its annual impairment test of
goodwill and determined that the fair value of each of the reporting units
exceeded its carrying value. As a result, no impairment loss was required to be
recognized.
89
Note 11. Deposits
- --------------------------------------------------------------------------------
The aggregate amount of time deposit accounts (primarily certificates of
deposits) each with a minimum of $100,000 included in domestic office deposits
were approximately $19 billion and $7 billion at December 31, 2004 and 2003
respectively. The scheduled maturities of all time deposits at December 31, 2004
follows.
- --------------------------------------------------------------------------------
Time Deposits In
-------------------------
Domestic Foreign
Offices Offices Total
- --------------------------------------------------------------------------------
(in millions)
2005 ..................... $18,081 $12,460 $30,541
2006 ..................... 4,112 11 4,123
2007 ..................... 291 3 294
2008 ..................... 243 4 247
2009 ..................... 91 -- 91
Later years .............. 300 -- 300
------- ------- -------
$23,118 $12,478 $35,596
======= ======= =======
Note 12. Short-Term Borrowings
- --------------------------------------------------------------------------------
The following table presents selected information for short-term borrowings.
Average interest rates during each year are computed by dividing total interest
expense by the average amount borrowed.
- ----------------------------------------------------------------------------------------------------------------------
2004 2003 2002
------------------- ------------------- ------------------
Amount Rate Amount Rate Amount Rate
- ----------------------------------------------------------------------------------------------------------------------
(in millions)
Federal funds purchased (day to day):
At December 31 ....................... $2,152 2.31% $1,718 .95% $ 656 1.29%
Average during year .................. 958 1.30 915 1.11 1,402 1.62
Maximum month-end balance ............ 2,612 2,563 2,788
Securities sold under repurchase agreements:
At December 31 ....................... 1,733 2.69 357 1.45 553 1.52
Average during year .................. 1,008 3.38 638 1.97 834 3.64
Maximum month-end balance ............ 2,597 1,475 1,054
Commercial paper:
At December 31 ....................... 1,879 2.22 1,730 1.08 1,484 1.53
Average during year .................. 1,735 1.40 1,406 1.21 1,496 1.79
Maximum month-end balance ............ 1,911 1,730 1,787
Precious metals:
At December 31 ....................... 3,163 .41 2,808 .78 3,083 .42
Average during year .................. 3,017 .42 3,437 .33 3,275 .51
Maximum month-end balance ............ 3,338 3,735 3,865
All other short-term borrowings:
At December 31 ....................... 947 2.76 169 .97 1,616 1.46
Average during year .................. 766 4.28 1,044 1.80 2,781 2.76
Maximum month-end balance ............ 2,187 2,103 6,669
At December 31, 2004, HUSI had a $2 billion line of credit with HSBC Finance
Corporation, of which $600 million was outstanding and included in all other
short-term borrowings in the above table.
At December 31, 2004, HUSI had unused lines of credit with HSBC Bank plc
aggregating $750 million. These lines of credit do not require compensating
balance arrangements and commitment fees are not significant.
As a member of the New York Federal Home Loan Bank, HUSI has a secured borrowing
facility which is collateralized by residential mortgage loan assets.
90
Note 13. Income Taxes
- --------------------------------------------------------------------------------
Total income taxes were allocated as follows.
- --------------------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002
- --------------------------------------------------------------------------------------------------------------
(in millions)
To income before income taxes ............................................ $ 718 $ 570 $ 510
To shareholders' equity as tax charge (benefit):
Net unrealized gains (losses) on securities available for sale ..... (20) (99) 41
Unrealized gain (loss) on derivatives classified as cash flow hedges (30) 6 43
Foreign currency translation, net .................................. 4 16 2
----- ----- -----
$ 672 $ 493 $ 596
===== ===== =====
The components of income tax expense follow.
- --------------------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002
- --------------------------------------------------------------------------------------------------------------
(in millions)
Current:
Federal ............................................................ $ 452 $ 365 $ (31)
State and local .................................................... 153 48 10
Foreign ............................................................ 17 24 19
----- ----- -----
Total current ............................................................ 622 437 (2)
Deferred, primarily federal .............................................. 96 133 512
----- ----- -----
Total income taxes ....................................................... $ 718 $ 570 $ 510
===== ===== =====
The following table is an analysis of the difference between effective rates
based on the total income tax provision attributable to pretax income and the
statutory U.S. Federal income tax rate.
- --------------------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002
- --------------------------------------------------------------------------------------------------------------
(in millions)
Statutory rate ........................................................... 35.0% 35.0% 35.0%
Increase (decrease) due to:
State and local income taxes ....................................... 5.6 3.1 4.2
Goodwill ........................................................... -- .9 --
Release of tax reserves ............................................ (2.9) -- --
Tax exempt interest income ......................................... (.5) (.8) (1.0)
Other items ........................................................ (.9) (.5) (.9)
----- ----- -----
Effective income tax rate ................................................ 36.3% 37.7% 37.3%
===== ===== =====
91
The components of the net deferred tax position are presented in the following
table.
- -------------------------------------------------------------------------------
December 31 2004 2003
- -------------------------------------------------------------------------------
(in millions)
Deferred tax assets:
Allowance for credit losses ..................... $ 308 $ 176
Benefit accruals ................................ 97 93
Accrued expenses not currently deductible ....... 47 41
Investment securities ........................... (12) (38)
Net purchase discount on acquired companies ..... 40 58
Premium on purchased receivables ................ 44 --
----- -----
Total deferred tax assets ................... 524 330
----- -----
Less deferred tax liabilities:
Unrealized gains on securities available for sale 11 30
Lease financing income accrued .................. 26 36
Accrued pension cost ............................ 197 212
Accrued income on foreign bonds ................. 10 11
Deferred gain recognition ....................... 40 --
Depreciation and amortization ................... 41 50
Interest and discount income .................... 230 47
Deferred fees/costs ............................. 106 (2)
Mortgage servicing rights ....................... 116 185
Other ........................................... 21 29
----- -----
Total deferred tax liabilities .............. 798 598
----- -----
Net deferred tax asset (liability) .......... $(274) $(268)
===== =====
Realization of deferred tax assets is contingent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carryback period. Based upon the level of historical taxable income and the
scheduled reversal of the deferred tax liabilities over the periods which the
deferred tax assets are deductible, management believes that it is more likely
than not HUSI would realize the benefits of these deductible differences.
92
Note 14. Long-Term Debt
- --------------------------------------------------------------------------------
The composition of long-term debt is presented in the following table. Interest
rates on floating rate notes are determined periodically by formulas based on
certain money market rates or, in certain instances, by minimum interest rates
as specified in the agreements governing the issues. Interest rates in effect at
December 31, 2004 are shown in parentheses.
- ----------------------------------------------------------------------------------------------------
December 31 2004 2003
- ----------------------------------------------------------------------------------------------------
(in millions)
Issued or acquired by HUSI or subsidiaries other than HBUS:
Non-subordinated debt:
Floating Rate Senior Notes due 2004 ............................... $ -- $ 300
8.375% Debentures due 2007 ........................................ 101 102
------- -------
101 402
Subordinated debt:
7% Subordinated Notes due 2006 .................................... 300 299
Fixed Rate Subordinated Notes due 2008-2097 (5.88% - 9.70%) ....... 1,523 1,544
Floating Rate Subordinated Notes due 2009 ......................... -- 124
Perpetual Capital Notes (2.25%) ................................... 125 125
Junior Subordinated Debentures due 2026-2032 (7.53% - 8.38%) ...... 1,060 1,057
------- -------
3,008 3,149
------- -------
Issued or acquired by HBUS or its subsidiaries:
Non-subordinated debt:
Global Bank Note Program:
Medium-Term Floating Rate Notes due 2005-2040 (2.22%-2.56%) ....... 890 175
Fixed Rate Senior Global Bank Notes due 2006-2009 (2.75%-3.88%) ... 1,977 --
Floating Rate Senior Global Bank Notes due 2006-2009 (2.09%-2.62%) 8,884 --
Floating Rate Non-USD Global Bank Notes due 2008-2009 (1.46%-2.25%) 1,362 --
Federal Home Loan Bank of New York (FHLB) advances:
Fixed Rate FHLB advances due 2005-2033 (2.01%-7.24%) .............. 12 17
Floating Rate FHLB advances due 2006-2008 (2.02%-2.48%) ........... 5,000 --
Other:
Floating Rate Note due 2019 (1.68%) ............................... 10 10
Senior Notes due 2036 (1.33%) ..................................... 10 10
Floating Rate Notes due 2036 (.96%) ............................... 10 10
3.99% Non-USD Senior Debt due 2044 ................................ 557 --
Collateralized repurchase agreements .............................. 18 19
------- -------
18,730 241
------- -------
Subordinated debt:
Global Bank Note Program:
Global Bank Notes due 2014-2034 (4.63%-5.88%) ..................... 1,980 --
Obligations under capital leases ........................................ 20 22
------- -------
Total long-term debt .................................................... $23,839 $ 3,814
======= =======
The above table excludes $1,550 million of debt issued by HBUS or its
subsidiaries payable to HUSI. Of this amount, the earliest note to mature is in
2006 and the latest note to mature is in 2097.
93
The Perpetual Capital Notes (PCNs) may be exchanged for securities that
constitute permanent primary capital securities for regulatory purposes. The
principal amount of each PCN will be payable as follows: (1) at the option of
the holder on the put date in each year commencing in 2012, (2) at the option of
HUSI on 90 days prior notice, the PCNs may be either (i) redeemed on the
specified redemption date, in whole, for cash and at par, but only with the
proceeds of a substantially concurrent sale of capital securities issued for the
purpose of such redemption or (ii) exchanged, in whole, for capital securities
having a market value equal to the principal amount of the PCNs, and, in each
case, the payment of accrued interest in cash or (3) in the event that the sum
of HUSI's retained earnings and surplus accounts becomes less than zero, the
PCNs will automatically be exchanged, in whole, for capital securities having a
market value equal to the principal amount of the PCNs and the payment of
accrued interest in cash.
Prior to HUSI's adoption of FIN 46 at December 31, 2003, the statutory business
trusts (issuer trusts) that issued guaranteed mandatorily redeemable securities
(Capital Securities) were considered consolidated subsidiaries of HUSI. The
$1,050 million of Capital Securities issued by these trusts to third party
investors, along with $32 million of common securities of the trusts (Common
Securities) issued to HUSI, were invested in Junior Subordinated Debentures of
HUSI. The Capital Securities were included in long-term debt on HUSI's
consolidated balance sheet and the Common Securities and Junior Subordinated
Debentures were eliminated in consolidation. Upon adoption of FIN 46, HUSI
deconsolidated the issuer trusts. As a result, the Junior Subordinated
Debentures issued by HUSI to the trusts are reflected in total long-term debt on
HUSI's consolidated balance sheet at December 31, 2004 and 2003.
In June 2004, HBUS finalized a $10 billion Global Bank Note Program, which
provided for 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 replaced HBUS's $4 billion Global Medium-Term Note Program initiated
in June 2000.
Prior to June 2004 the Medium-Term Floating Rate Notes due 2004-2010 represented
equity linked notes issued under HBUS's Global Medium-Term Note Program, which
provided for the issuance of up to $4 billion of notes having maturities of 7
days or more from the date of issuance. The Medium-Term Floating Rate Note due
2040 was also issued under this Program.
The collateralized repurchase agreements consist of securities repurchase
agreements with initial maturities exceeding one year.
Contractual scheduled maturities for total long-term debt over the next five
years are as follows.
- --------------------------------------------------------------------------------
(in millions)
2005 ............................................................. $ 80
2006 ............................................................. 5,712
2007 ............................................................. 5,581
2008 ............................................................. 3,214
2009 ............................................................. 4,459
94
Note 15. Preferred Stock
- --------------------------------------------------------------------------------
The following table presents information related to the issues of preferred
stock outstanding.
- ---------------------------------------------------------------------------------------------------------------------------
Amount
Shares Dividend Outstanding
Outstanding Rate ------------------
2004 2004 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------
(in millions)
$1.8125 Cumulative Preferred Stock ($25 stated value) .................. 3,000,000 7.250% $ 75 $ 75
6,000,000 Depositary shares each representing a one-fourth
interest in a share of Adjustable Rate Cumulative
Preferred Stock, Series D ($100 stated value) ........................ 1,500,000 4.563 150 150
Dutch Auction Rate Transferable Securities(TM) Preferred
Stock (DARTS)
Series A ($100,000 stated value) ................................. 625 1.560 63 63
Series B ($100,000 stated value) ................................. 625 1.537 62 62
$2.8575 Cumulative Preferred Stock ($50 stated value) .................. 3,000,000 5.715 150 150
CTUS Inc. Preferred Stock .............................................. 100 --(1) --(1)
----- -----
$ 500 $ 500
===== =====
(1) Less than $500 thousand
The $1.8125 Cumulative Preferred Stock may be redeemed, as a whole or in part,
at the option of HUSI at $25 per share plus dividends accrued and unpaid to the
redemption date.
The dividend rate on the Adjustable Rate Cumulative Preferred Stock, Series D
(Series D Stock) is determined quarterly, by reference to a formula based on
certain benchmark market interest rates, but will not be less than 4 1/2% or
more than 10 1/2% per annum for any applicable dividend period. The Series D
Stock is redeemable, as a whole or in part, at the option of HUSI at $100 per
share (or $25 per depositary share), plus accrued and unpaid dividends to the
redemption date.
DARTS of each series are redeemable at the option of HUSI, as a whole or in part
on any dividend payment date, at $100,000 per share, plus accrued and unpaid
dividends to the redemption date. Dividend rates for each dividend period are
set pursuant to an auction procedure. The maximum applicable dividend rates on
the shares of DARTS range from 110% to 150% of the 60 day "AA" composite
commercial paper rate. DARTS are also redeemable at the option of HUSI, as a
whole but not in part, on any dividend payment date at a redemption price of
$100,000 per share plus the payment of accrued and unpaid dividends, if the
applicable rate for such series fixed with respect to the dividend period for
such series ending on such dividend payment date equals or exceeds the 60 day
"AA" composite commercial paper rate in effect on the date of determination of
such rate.
The outstanding shares of $2.8575 Cumulative Preferred Stock have an aggregate
stated value of $150 million. The shares may be redeemed at the option of HUSI,
as a whole or in part, on or after October 1, 2007 at $50 per share, plus
dividends accrued and unpaid to the redemption date.
HUSI acquired CTUS Inc., a unitary thrift holding company in 1997 from CT
Financial Services Inc. (the Seller). CTUS owned First Federal Savings and Loan
Association of Rochester (First Federal). The acquisition agreement provided
that HUSI issue preferred shares to the Seller. The preferred shares provide
for, and only for, a contingent dividend or redemption equal to the amount of
recovery, net of taxes and costs, if any, by First Federal resulting from the
pending action against the United States government alleging breaches by the
government of contractual obligations to First Federal following passage of the
Financial Institutions Reform, Recovery and Enforcement Act of 1989. HUSI issued
100 preferred shares at a par value of $1.00 per share in connection with the
acquisition.
95
Note 16. Retained Earnings
- --------------------------------------------------------------------------------
Bank dividends are a major source of funds for payment by HUSI of shareholder
dividends and along with interest earned on investments, cover HUSI's operating
expenses which consist primarily of interest on outstanding debt. The approval
of the Federal Reserve Board is required if the total of all dividends declared
by HBUS in any year exceeds the net profits for that year, combined with the
retained profits for the two preceding years. Under a separate restriction,
payment of dividends is prohibited in amounts greater than undivided profits
then on hand, after deducting actual losses and bad debts. Bad debts are debts
due and unpaid for a period of six months unless well secured, as defined, and
in the process of collection.
Under the more restrictive of the above rules HBUS can pay dividends to HUSI as
of December 31, 2004 of approximately $1.7 billion, adjusted by the effect of
its net income (loss) for 2005 up to the date of such dividend declaration.
Note 17. Accumulated Other Comprehensive Income
- --------------------------------------------------------------------------------
Accumulated other comprehensive income includes certain items that are reported
directly within a separate component of shareholders' equity. The following
table presents changes in accumulated other comprehensive income balances.
- ------------------------------------------------------------------------------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------
(in millions)
Unrealized gains (losses) on available for sale securities:
Balance, January 1, ........................................................... $ 61 $ 236 $ 156
Increase (decrease) in fair value, net of taxes of $19, $(75), and $82 in
2004, 2003 and 2002 respectively ...................................... 14 (129) 156
Net gains on sale of securities reclassified to net income, net of taxes
of $39, $25 and $41 in 2004, 2003 and 2002 respectively ............... (54) (46) (76)
---- ----- -----
Net change .............................................................. (40) (175) 80
---- ----- -----
Balance, December 31, ......................................................... 21 61 236
---- ----- -----
Unrealized gains (losses) on derivatives classified as cash flow hedges:
Balance, January 1, ........................................................... 52 41 (38)
Change in unrealized gain (loss) net of taxes of $(30), $11 and $43 in
2004, 2003 and 2002 respectively ...................................... (58) 11 79
---- ----- -----
Net change .............................................................. (58) 11 79
---- ----- -----
Balance, December 31, ......................................................... (6) 52 41
---- ----- -----
Foreign currency translation adjustments:
Balance, January 1, ........................................................... 15 (15) (19)
Translation gains net of taxes of $4, $16 and $2 in 2004, 2003 and 2002
respectively ............................................................ 1 30 4
---- ----- -----
Net change .............................................................. 1 30 4
---- ----- -----
Balance, December 31, ......................................................... 16 15 (15)
---- ----- -----
Total accumulated other comprehensive income at December 31, .................. $ 31 $ 128 $ 262
==== ===== =====
96
Note 18. Related Party Transactions
- --------------------------------------------------------------------------------
In the normal course of business, HUSI conducts transactions with HSBC
and its affiliates (HSBC affiliates). These transactions occur at prevailing
market rates and terms. All extensions of credit by HUSI to other HSBC
affiliates are legally required to be secured by eligible collateral. The
following table presents related party balances and the income and expense
generated by related party transactions.
- ----------------------------------------------------------------------------------
December 31 2004 2003 2002
- ----------------------------------------------------------------------------------
(in millions)
Assets:
Interest bearing deposits with banks $ 436 $ 139 $ 130
Loans .............................. 828 330 338
Trading assets ..................... 3,167 1,811 991
Other .............................. 752 34 38
------- ------- -------
Total assets ................... $ 5,183 $ 2,314 $ 1,497
======= ======= =======
Liabilities:
Deposits ........................... $ 9,759 $ 7,512 $ 6,140
Trading account liabilities ........ 5,704 3,434 1,145
Short-term borrowings .............. 1,089 735 267
Other .............................. 77 79 349
------- ------- -------
Total liabilities .............. $16,629 $11,760 $ 7,901
======= ======= =======
- -----------------------------------------------------------------------------------------------------------
December 31 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------
(in millions)
Interest income ................................................. $ (6) $ 17 $ 28
Interest expense ................................................ 119 91 87
Trading (losses) revenues ....................................... (2,821) 428 21
Other revenues .................................................. 44 42 23
Other expenses:
Fees paid to HTSU for technology services ................. 172 -- --
Fees paid to HSBC Finance Corporation for loan origination,
loan servicing and other administrative support ......... 35 -- --
Other fees, primarily treasury and traded markets services 213 159 98
Trading losses for the year ended December 31, 2004 primarily represent the mark
to market of the intercompany components of interest rate and foreign currency
derivative swap transactions entered into by HSBC Finance Corporation.
Specifically, HSBC Finance Corporation enters into these swap contracts with
HUSI in order to hedge its interest rate positions. HUSI, within its Corporate,
Investment Banking and Markets business, accounts for these transactions on a
mark to market basis, with the change in value on the intercompany component
substantially offset by the mark to market of related contracts entered into
with third parties.
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 HUSI's revenues and/or expenses in
2004, as compared with 2003.
o Technology services were centralized by the creation of a new HSBC
subsidiary, HSBC Technology & Services (USA) Inc. (HTSU), effective
January 1, 2004. HUSI's technology services employees, as well as
technology services employees from other HSBC affiliates 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 HUSI prior to
January 1, 2004 remain in place and were not transferred to HTSU. Pursuant
to a master service level agreement, HTSU charges HUSI for technology
services and software development. As a result, HSBC affiliate charges
included in other expenses for 2004 include amounts previously recorded as
"salaries and benefits" and "occupancy expense, net" and "other expenses"
on HUSI's consolidated statement of income for 2003.
97
o HUSI 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 HUSI were transferred to HSUI. As a
result, HSBC affiliate charges included in other expenses for 2004 include
amounts previously recorded as "salaries and benefits" on HUSI's
consolidated statement of income for 2003.
o On June 1, 2004, HUSI 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 HUSI's income before income tax
expense.
The following business transactions were conducted with HSBC Finance Corporation
during 2004:
o On December 29, 2004, approximately $12 billion of private label loans,
primarily credit card receivables, and related assets were purchased from
HSBC Finance Corporation at fair value, without recourse. The purchase
price was determined based upon an independent valuation opinion. Residual
interests in securitized private label credit card receivable pools of
approximately $3 billion were also acquired. Total premium of
approximately $639 million was recorded on the acquisition date. The
premium will be amortized to interest income over the estimated life of
the assets purchased. This transaction did not have a material impact on
net income in 2004. HSBC Finance Corporation retained the customer
relationships associated with this portfolio. By agreement, HUSI will
purchase additional receivables generated under current and future private
label accounts at fair value. HUSI and HSBC Finance Corporation will
consider potential transfers of MasterCard and Visa receivables in the
future based upon continuing evaluations of capital and liquidity at each
entity.
o During 2004, HUSI purchased approximately $5 billion of consumer loans,
primarily domestic residential mortgage loans, at fair value from HSBC
Finance Corporation and from originating lenders pursuant to HSBC Finance
Corporation correspondent loan programs.
o 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 of HUSI were sold to HSBC
Finance Corporation, resulting in a gain of approximately $99 million.
Receivable balances of approximately $1 billion associated with these
relationships were not sold as part of the transaction. Also effective
July 1, 2004, new receivable balances generated by these relationships are
purchased at fair value from HSBC Finance Corporation on a daily basis.
Through December 31, 2004, approximately $1 billion of receivables
associated with these relationships have been purchased from HSBC Finance
Corporation at a premium of approximately $20 million, which is being
amortized to interest income over the estimated life of the receivables
purchased. Total premium amortized in 2004 was approximately $9 million.
Servicing for the majority of these relationships was transferred to HSBC
Finance Corporation in October 2004, resulting in service expense paid to
HSBC Finance Corporation of $2 million through December 31, 2004.
o HSBC affiliate expenses, included in other expenses, include charges by
HSBC Finance Corporation under various service level agreements for 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.
o Effective October 1, 2004, HBUS is the originating lender for a federal
tax refund anticipation loan (RAL) program for clients of various third
party tax preparers, which is managed by HSBC Finance Corporation. By
agreement, HBUS will process applications, fund and subsequently sell RALs
to HSBC Finance Corporation.
o At December 31, 2004, HUSI had a $2 billion line of credit with HSBC
Finance Corporation, of which $600 million was outstanding and included in
short-term borrowings.
98
At December 31, 2004 and December 31, 2003, the aggregate notional amounts of
all derivative contracts with HSBC affiliates were approximately $302 billion
and $168 billion respectively. The net credit risk exposure related to these
contracts was approximately $2 billion at December 31, 2004 and December 31,
2003.
Employees of HUSI participate in one or more stock compensation plans sponsored
by HSBC. HUSI's share of the expense of the plans for the year ended 2004 and
2003 was $61 million and $60 million respectively. A description of these plans
is included in Note 19 of the consolidated financial statements below.
At December 31, 2004, HUSI had an unused line of credit with HSBC of $750
million. Deposits from affiliated HSBC entities were approximately $6 billion at
December 31, 2004.
On July 31, 2004, HUSI transferred most of its Panamanian branch operations to
an affiliated HSBC entity at fair value. Total assets and deposits transferred
were each approximately $1 billion. 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 HUSI's income before income tax expense.
During 2004, HUSI received capital contributions of $2.4 billion from its direct
parent company, HNAI, in exchange for two shares of common stock. HUSI also
contributed $2.4 billion to HBUS in exchange for two shares of common stock.
HUSI periodically pays dividends to its parent company, HNAI. Dividends paid in
2004 and 2003 were $125 million and $690 million respectively.
Note 19. Stock Option Plans and Restricted Share Plans
- --------------------------------------------------------------------------------
Options have been granted to employees of HUSI under the HSBC Holdings Group
Share Option Plan (the Group Share Option Plan), the HSBC Holdings Executive
Share Option Scheme (the Executive Share Option Plan) and under the HSBC
Holdings Savings-Related Share Option Plan: Overseas Section (the Sharesave
Plans). Since the shares and contribution commitment have been granted directly
by HSBC, the offset to compensation expense was a credit to capital surplus,
representing a contribution of capital from HSBC.
Fair values of Group Share Option and Sharesave Plan awards made in 2004,
measured at the date of grant, are calculated using a binomial lattice
methodology that is based on the underlying assumptions of the Black-Scholes
model. When modeling awards with vesting dependent on performance targets, these
performance targets are incorporated into the model using Monte-Carlo
simulation. The expected life of options depends on the behavior of option
holders, which is incorporated into the option model consistent with historic
observable data. Prior to 2004, options were valued using a simpler methodology,
which was also based on the Black-Scholes model.
99
The following table presents information for each plan. Descriptions of each
plan follow the table.
- ---------------------------------------------------------------------------------------------------------------
December 31 2004 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Group Share Option Plan:
Total options granted ............................... 4,574,000 4,076,000 4,615,000
Fair value per option granted ....................... $ 2.83 $ 3.01 $ 2.33
Total compensation expense recognized (in millions) . $ 10 $ 11 $ 7
Significant assumptions used to calculate fair value:
Risk free interest rate .......................... 4.90% 4.68% 5.57%
Expected life (years) ............................ 6.9 5 5.25
Expected volatility .............................. 25% 30% 25%
Sharesave Plans (5 year vesting period):
Total options granted ............................... 207,000 737,000 524,000
Fair value per option granted ....................... $ 3.80 $ 3.29 $ 3.53
Total compensation expense recognized (in millions) . $ -- $ 1 $ 3
Significant assumptions used to calculate fair value:
Risk free interest rate .......................... 5.0% 4.24% 5.57%
Expected life (years) ............................ 5 5 5.25
Expected volatility .............................. 25% 30% 30%
Sharesave Plans (3 year vesting period):
Total options granted ............................... 407,000 910,000 691,000
Fair value per option granted ....................... $ 3.44 $ 3.20 $ 3.63
Total compensation expense recognized (in millions) . $ 1 $ 1 $ 1
Significant assumptions used to calculate fair value:
Risk free interest rate .......................... 4.9% 4.01% 5.46%
Expected life (years) ............................ 3 3 3.25
Expected volatility .............................. 25% 30% 30%
Restricted Share Plan:
Total compensation expense recognized (in millions) . $ 50 $ 46 $ 28
Executive Share Option Plan:
Total compensation expense recognized (in millions) . $ -- $ 1 $ 4
Group Share Option Plan
The Group Share Option Plan is a discretionary long-term incentive compensation
plan available to certain HUSI employees, based on performance criteria and
potential, with grants usually made each year. Options are granted at market
value and are normally exercisable between the third and tenth anniversaries of
the date of grant, subject to vesting conditions. This plan was adopted by HUSI
during 2001.
Beginning in 2005, no further Group Share options will be granted to employees
although existing stock option grants will remain in effect subject to the same
conditions as before. Instead employees will receive grants of shares of HSBC
stock subject to certain vesting conditions.
Sharesave Plans
The Sharesave Plans invite eligible employees to enter into savings contracts to
save up to $400 per month, with the option to use the savings to acquire shares.
There are currently two types of plans offered which allow the participant to
select savings contracts of either a 5 year or 3 year length. The options are
exercisable within six months following the third or fifth year respectively of
the commencement of the related savings contract, at a 20 percent discount for
options granted in 2004, 2003 and 2002.
100
Prior to the Sharesave Plans being offered to employees in its present form,
eligible employees could elect to participate through HUSI's 401(k) plan and
acquire contributions based on HSBC stock at 85% of market value on the date of
grant. An employee's agreement to participate was a five year commitment. At the
end of each five year period employees receive the appreciation of the HSBC
stock over the initial exercise price credited to their 401(k) account.
Eligibility for this plan was discontinued after 1999 with the adoption of the
Sharesave Plans. Compensation expense related to this plan amounted to
approximately $0.1 million in 2004, $0.3 million in 2003 and $2 million in 2002.
Restricted Share Plans
Awards are granted to key individuals in the form of performance and
non-performance restricted shares. The awards are based on an individual's
demonstrated performance and future potential. Performance related restricted
shares generally vest after three years from date of grant, based on HSBC's
Total Shareholder Return (TSR) relative to a benchmark TSR during the
performance period. TSR is defined as the growth in share value and declared
dividend income during the period and the benchmark is composed of HSBC's peer
group of financial institutions. If the performance conditions are met, the
shares vest and are released to the recipients two years later. Non-performance
restricted shares are released to the recipients based on continued service,
typically at the end of a three year vesting period.
Executive Share Option Plan
The Executive Share Option Plan is a discretionary long-term incentive
compensation plan available to certain HUSI employees, based on performance
criteria and potential, with grants usually made each year. Options are granted
at market value and are normally exercisable between the third and tenth
anniversaries of the date of grant, subject to vesting conditions. No further
grants have been made under this plan since the adoption of the Group Share
Option Plan in 2001, and no further compensation expense is expected to be
recognized beginning in 2004.
Note 20. Pension and Other Postretirement Benefits
- --------------------------------------------------------------------------------
HUSI maintains noncontributory defined benefit pension plans covering
substantially all of their employees hired prior to January 1, 1997 and those
employees who joined HUSI through acquisitions and were participating in a
defined benefit plan at the time of acquisition. Certain other HSBC subsidiaries
also participate in these plans.
In November 2004, sponsorship of the U.S. defined benefit pension plans of HBUS
and HSBC Finance Corporation were transferred to HNAH. Effective January 1,
2005, the two separate plans were merged into a single defined benefit pension
plan which facilitates the development of a unified employee benefit policy and
unified employee benefit plan administration for HSBC affiliates operating in
the U.S.
HUSI also maintains unfunded noncontributory health and life insurance coverage
(other postretirement benefits) for all employees who retired from HUSI and were
eligible for immediate pension benefits from HUSI's retirement plan. Employees
retiring after 1992 will absorb a portion of the cost of these benefits.
Employees hired after that same date are not eligible for these benefits. A
premium cap has been established for HUSI's share of retiree medical cost.
101
Plan Data and Assumptions
The measurement date for all plans described is December 31. The following table
provides data concerning HUSI's qualified defined benefit plan and other
postretirement benefits.
- -----------------------------------------------------------------------------------------------------------
Qualified Defined Other Postretirement
Benefit Plan Benefits
--------------------- ---------------------
2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------------
(in millions)
Change in benefit obligation:
Benefit obligation, January 1 ................ $ 1,102 $ 952 $ 124 $ 127
Service cost ................................. 31 29 2 2
Interest cost ................................ 69 64 6 7
Participant contributions .................... -- -- 1 1
Plan amendment ............................... -- -- -- (2)
Actuarial (gain) loss ........................ 9 91 -- (2)
Benefits paid ................................ (38) (34) (11) (9)
------- ------- ------- -------
Benefit obligation, December 31 .............. $ 1,173 $ 1,102 $ 122 $ 124
======= ======= ======= =======
Change in plan assets:
Fair value of plan assets, January 1 ......... $ 1,222 $ 878 $ -- $ --
Actual return on plan assets ................. 120 203 -- --
HUSI contribution ............................ -- 175 10 8
Participant contributions .................... -- -- 1 1
Benefits paid ................................ (38) (34) (11) (9)
------- ------- ------- -------
Fair value of plan assets, December 31 ....... $ 1,304 $.1,222 $ -- $ --
======= ======= ======= =======
Funded status of plan:
Funded status, December 31 ................... $ 130 $ 119 $ (122) $ (124)
Unrecognized actuarial loss .................. 348 390 12 12
Unrecognized prior service cost .............. 4 4 -- --
Unrecognized net transition obligation ....... -- -- 24 27
------- ------- ------- -------
Recognized amount ............................ $ 482 $ 513 $ (86) $ (85)
======= ======= ======= =======
Amount recognized in the consolidated balance sheet:
Prepaid benefit cost ......................... $ 482 $ 513 $ -- $ --
Accrued benefit liability .................... -- -- (86) (85)
------- ------- ------- -------
Recognized amount ............................ $ 482 $ 513 $ (86) $ (85)
======= ======= ======= =======
The accumulated benefit obligation for the defined benefit pension plan was
approximately $1,027 million and $942 million at December 31, 2004 and 2003
respectively.
102
Total net periodic benefit cost included the following components.
- -------------------------------------------------- --------------------------------------------------
Qualified Defined Other Postretirement
Benefit Plan Benefits
-------------------------- ------------------------
2004 2003 2002 2004 2003 2002
- -------------------------------------------------- --------------------------------------------------
(in millions)
Net periodic benefit cost:
Service cost ................... $ 31 $ 29 $ 26 $ 2 $ 3 $ 2
Interest cost .................. 69 64 60 7 7 8
Expected return on plan assets . (96) (87) (84) -- -- --
Prior service cost amortization 1 1 1 -- -- --
Actuarial loss ................. 26 32 9 -- -- --
Transition amount amortization . -- -- -- 3 3 3
---- ---- ---- ---- ---- ----
$ 31 $ 39 $ 12 $ 12 $ 13 $ 13
==== ==== ==== ==== ==== ====
Amount recorded as pension expense by:
HUSI ........................... $ 25 $ 37 $ 10
Other HSBC affiliates .......... 6 2 2
---- ---- ----
$ 31 $ 39 $ 12
==== ==== ====
The assumptions used in determining projected benefit obligation and net
periodic benefit cost are as follows:
- -------------------------------------------------------------------------------------------------------------------
Qualified Defined Other Postretirement
Benefit Plan Benefits
------------------------------ -------------------------------------
2004 2003 2002 2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Weighted-average assumptions to
determine projected benefit
obligation at December 31:
Discount rate ................ 6.00% 6.25% 6.75% 6.00% 5.75% 6.25%
Rate of compensation increase 3.75 3.75 3.75 3.75(1) 3.75(1) 3.75(1)
Weighted-average assumptions to
determine net cost for years ended
December 31:
Discount rate ................ 6.25% 6.75% 7.25% 5.75% 6.25% 6.75%
Expected return on plan assets 8.00 8.75 9.50 -- -- --
Rate of compensation increase 3.75 3.75 4.00 3.75 3.75 4.00
(1) Applicable to life insurance only.
HUSI determines its expected long-term rate of return based upon historical
market returns of equities and fixed income investments adjusted for the mix
between these instruments. Additional factors are considered such as the rate of
inflation and interest rates. The expected long-term rate of return is validated
by comparison to independent sources, which include actuarial consultants and
investment advisors.
103
Assumed Health Care Cost Trend Rates
- --------------------------------------------------------------------------------
December 31 2004 2003
- --------------------------------------------------------------------------------
Health care cost trend rate assumed for next year pre-65 10% 7%
Health care cost trend rate assumed for next year post-65 9% --%
Rate that the cost trend rate gradually declines to ..... 5% 7%
Year that the rate reaches the ultimate rate ............ 2009 2003
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one percentage point change in assumed
health care cost trend rates would have the following effects.
- -------------------------------------------------------------------------------------------
One Percentage One Percentage
Point Increase Point Decrease
- -------------------------------------------------------------------------------------------
(in millions)
Effect on total service and interest cost ............... $ .1 $(.1)
Effect on postretirement benefits obligation ............ 1.9 (1.8)
Plan Assets
HUSI's qualified defined benefit pension plan's weighted-average asset
allocation at December 31, 2004 and 2003 by asset category are as follows.
- -------------------------------------------------------------------------------------
Percentage of Plan Assets
--------------------------
December 31 2004 2003
- -------------------------------------------------------------------------------------
Equity securities ....................................... 61% 62%
Debt securities ......................................... 36 38
Cash and cash equivalents ............................... 3 --
---- ----
Total ............................................. 100% 100%
==== ====
HUSI strives to maximize the possibility of having sufficient funds to meet the
long-term liabilities of the pension plan. To do so, HUSI must achieve a fine
balance between the goals of growing the assets of the plan and keeping risk at
an acceptable level. A key factor in shaping HUSI's attitude towards risk is the
long-term investment horizon of the pension fund. The long-term horizon enables
the plan to tolerate the risk of somewhat volatile investment returns in the
short run with the expectation of higher returns in the long run.
HUSI's Investment Committee has developed an asset allocation policy based on
the plan's objectives, characteristics of the pension liabilities, and asset
projections. In addition, the Investment Committee considered industry
practices, the current market environment, and practical investment issues. HUSI
is cognizant of the fact that diversification is necessary to reduce unnecessary
risk. Therefore the pension fund is diversified across several asset classes and
securities. The Investment Committee discussed "traditional" asset classes
(i.e., publicly traded securities) as well as "alternative" asset classes (e.g.,
private equity, hedge funds, real estate, etc.), but decided it was not
comfortable with alternative asset classes at this time.
- --------------------------------------------------------------------------------
Asset Class Target Allocation Percentage
- --------------------------------------------------------------------------------
Equity securities ................................ 60%
Debt securities .................................. 40
---
Total ...................................... 100%
===
The Investment Committee has examined the plan's risk tolerance from the
perspective of participant demographic characteristics, funding characteristics
and business/financial characteristics. Based on its assessment of these
characteristics and risk preference, HUSI believes that its overall risk posture
is average relative to the typical pension plan. Consequently, HUSI believes an
average equity exposure is appropriate for its pension fund.
104
Expected Benefit Payments
Estimated employee benefit payments expected to be paid in each of the next five
fiscal years, and in the aggregate for the five fiscal years thereafter, based
upon the same assumptions used to measure HUSI's benefit obligation at December
31, 2004 is summarized as follows:
- ------------------------------------------------------------------------------
Other
Pension Postretirement
Years Benefits Benefits
- ------------------------------------------------------------------------------
(in millions)
2005 ................................. $ 38 $11
2006 ................................. 42 11
2007 ................................. 46 11
2008 ................................. 50 11
2009 ................................. 55 11
2010-2014 ............................ 356 51
Cash Flows
HUSI does not expect to make employer contributions to the qualified defined
benefit plan and expects to contribute $10 million for other postretirement
benefits during fiscal year 2005.
Defined Contribution Plans
Employees hired after December 31, 1996 become participants in a defined
contribution plan after one year of service. Contributions to the plan are based
on a percentage of employees' compensation. Total expense recognized for the
plan was approximately $6 million in 2004, $8 million in 2003 and $3 million in
2002.
HUSI maintains a 401(k) plan covering substantially all employees. Contributions
to the plan by HUSI are based on employee contributions. Total expense
recognized for the plan was approximately $18 million in 2004, $18 million in
2003 and $16 million in 2002.
Note 21. Business Segments
- --------------------------------------------------------------------------------
HUSI reports and manages its business segments consistently with the line of
business groupings used by HSBC. HUSI has four distinct segments that it
utilizes for management reporting and analysis purposes. Descriptions of HUSI's
business segments are presented in Item 1 on pages 5-6 of this Form 10-K.
Analysis of Business Segments results and geographic distribution of assets and
earnings are presented on pages 33-36 of this Form 10-K.
Note 22. Collateral, Commitments and Contingent Liabilities
- --------------------------------------------------------------------------------
The following table presents pledged assets included in the consolidated balance
sheet.
- --------------------------------------------------------------------------------
December 31 2004 2003
- --------------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks ................ $ 767 $ 140
Trading assets ...................................... 305 647
Securities available for sale ....................... 6,096 4,171
Securities held to maturity ......................... 655 956
Loans ............................................... 5,971 360
------- ------
Total ............................................... $13,794 $6,274
======= ======
105
In accordance with the Statement of Financial Accounting Standards No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities (SFAS 140), debt securities pledged as collateral that can be
sold or repledged by the secured party continue to be reported on the
consolidated balance sheet. The fair value of securities available for sale that
can be sold or repledged at December 31, 2004 and 2003 was approximately $1,320
million and $349 million respectively.
The fair value of collateral accepted by HUSI not reported on the consolidated
balance sheet that can be sold or repledged at December 31, 2004 and 2003 was
approximately $2,834 million and $1,655 million respectively. This collateral
was obtained under security resale agreements. Of this collateral, approximately
$2,081 million at December 31, 2004 has been sold or repledged as collateral
under repurchase agreements or to cover short sales compared with $1,138 million
at December 31, 2003.
The 2004 increase in pledged assets resulted from collateral requirements
associated with increased short-term borrowings and with increased derivatives
activity.
HUSI and its subsidiaries are obligated under a number of noncancellable leases
for premises and equipment. Certain leases contain renewal options and
escalation clauses. The following table presents actual and expected minimum
lease payments under noncancellable operating leases, net of sublease rentals.
- ------------------------------------------------------------------
December 31 2004 2003 2002
- ------------------------------------------------------------------
(in millions)
Actual annual rental expense .... $ 81 $ 63 $ 58
==== ===== =====
Minimum expected future payments:
2005 ...................... $ 65
2006 ...................... 53
2007 ...................... 49
2008 ...................... 37
2009 ...................... 35
Thereafter ................ 134
----
$373
====
Note 23. Litigation
- --------------------------------------------------------------------------------
HUSI 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 HUSI's 2002 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 HUSI, HBUS,
and Republic New York Securities Corporation as defendants. HUSI and HBUS 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.
106
Note 24. Derivative Instruments and Hedging Activities
- --------------------------------------------------------------------------------
HUSI is party to various derivative financial instruments as an end user (1) for
asset and liability management purposes; (2) in order to offset the risk
associated with changes in the value of various assets and liabilities accounted
for in the trading account; (3) to protect against changes in value of its
mortgage servicing rights portfolio; and (4) for trading in its own account.
HUSI is also an international dealer in derivative instruments denominated in
U.S. dollars and other currencies which include futures, forwards, swaps and
options related to interest rates, foreign exchange rates, equity indices,
commodity prices and credit, focusing on structuring of transactions to meet
clients' needs.
Fair Value Hedges
Specifically, interest rate swaps that call for the receipt of a variable market
rate and the payment of a fixed rate are utilized under fair value strategies to
hedge the risk associated with changes in the risk free rate component of the
value of certain fixed rate investment securities. Interest rate swaps that call
for the receipt of a fixed rate and payment of a variable market rate are
utilized to hedge the risk associated with changes in the risk free rate
component of certain fixed rate debt obligations. Additionally, beginning in
December 2002, HUSI established a qualifying hedge strategy using forward sales
contracts to offset the fair value changes of certain conventional closed
mortgage loans originated for sale.
Where the critical terms of the hedge instrument are identical at hedge
inception, the short-cut method of accounting is utilized. As a result, no
retrospective or prospective assessment of effectiveness is required and no
hedge ineffectiveness is recognized. However, in instances where the short-cut
method of accounting cannot be applied, the cumulative dollar offset method is
utilized in order to satisfy the retrospective and prospective assessment of
hedge effectiveness for SFAS 133.
HUSI recognized net (losses) gains of approximately $(2) million, $0.2 million
and $8 million for the years ended December 31, 2004, 2003 and 2002
respectively, (reported as residential mortgage banking revenue and/or other
income in the consolidated statement of income), which represented the
ineffective portion of all fair value hedges. Only the time value component of
these derivative contracts has been excluded from the assessment of hedge
effectiveness.
Cash Flow Hedges
Similarly, interest rate swaps and futures contracts that call for the payment
of a fixed rate are utilized under the cash flow strategy to hedge the
forecasted repricing of certain deposit liabilities and commercial loan assets.
In order to initially qualify for hedge accounting, assessment of hedge
effectiveness is demonstrated on a prospective basis utilizing both regression
analysis and the cumulative dollar offset method. In order to satisfy the
retrospective assessment of hedge effectiveness, the cumulative dollar offset
method is utilized and ineffectiveness is recorded to the income statement on a
monthly basis.
HUSI recognized net (losses) gains of approximately $(1) million, $3 million and
$13 million for the years ended December 31, 2004, 2003 and 2002 respectively,
(reported as a component of other income in the consolidated statement of
income), which represented the total ineffectiveness of all cash flow hedges.
Only the time value component of these derivative contracts has been excluded
from the assessment of hedge effectiveness.
Gains or losses on derivative contracts that are reclassified from accumulated
other comprehensive income to current period earnings pursuant to this strategy,
are included in interest expense on deposit liabilities during the periods that
net income is impacted by the repricing. As of December 31, 2004, approximately
$12 million of deferred net losses on derivative instruments accumulated in
other comprehensive income are expected to be charged to earnings during 2005.
107
Trading and Other Activities
HUSI enters into certain derivative contracts for purely trading purposes in
order to realize profits from short-term movements in interest rates, commodity
prices, foreign exchange rates and credit spreads. In addition, certain
derivative contracts are accounted for on a full mark to market basis through
current earnings even though they were acquired for the purpose of protecting
the economic value of certain assets and liabilities.
Notional Values of Derivative Contracts
The following table summarizes the notional values of derivative contracts.
- --------------------------------------------------------------------------------
December 31 2004 2003
- --------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards ................... $ 79,830 $ 107,646
Swaps .................................. 1,219,657 625,670
Options written ........................ 105,582 161,824
Options purchased ...................... 90,635 197,081
---------- ----------
1,495,704 1,092,221
---------- ----------
Foreign exchange:
Swaps, futures and forwards ............ 234,424 147,741
Options written ........................ 42,719 16,583
Options purchased ...................... 43,200 16,769
Spot ................................... 21,927 14,320
---------- ----------
342,270 195,413
---------- ----------
Commodities, equities and precious metals:
Swaps, futures and forwards ............ 40,876 33,897
Options written ........................ 10,648 7,048
Options purchased ...................... 11,729 7,081
Credit derivatives ..................... 135,937 31,302
---------- ----------
199,190 79,328
---------- ----------
Total ........................................ $2,037,164 $1,366,962
========== ==========
Credit and Market Risks Associated with Derivative Contracts
By using derivative instruments, HUSI is exposed to credit and market risks. If
the counterparty fails to perform, credit risk is equal to the fair value gain
in the derivative. When the fair value of the derivative contract is positive,
this generally indicates that the counterparty owes HUSI, and, therefore,
creates a repayment risk for HUSI. When the fair value of a derivative contract
is negative, HUSI owes the counterparty and, therefore, it has no repayment
risk.
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
affiliates. 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.
108
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, less the net liability
balance representing revaluation losses from the "marking to market" of
derivative contracts held for trading purposes.
- --------------------------------------------------------------------------------------
December 31 2004 2003
- --------------------------------------------------------------------------------------
(in millions)
Credit risk exposure associated with derivative contracts:
Total fair value of derivative receivables ......... $ 9,607 $ 7,653
Collateral held against exposure ................... (4,091) (2,580)
------- -------
Net credit risk exposure ................................. $ 5,516 $ 5,073
======= =======
Net fair value of all derivative contracts ............... $ (249) $ (566)
======= =======
The table below summarizes the risk profile of the counterparties of HUSI's on
balance sheet exposure to derivative contracts, net of cash and other highly
liquid collateral as of December 31, 2004.
- --------------------------------------------------------------------------------
Percent of
Net Credit Exposure Net
Rating equivalent Risk Exposure of Collateral
- --------------------------------------------------------------------------------
(in millions)
AAA to AA- ............................. $1,756 32%
A+ to A- ............................... 2,572 47
BBB+ to BBB- ........................... 629 11
BB+ to B- .............................. 351 6
CCC+ and below ......................... 208 4
------ ---
Total .................................. $5,516 100%
====== ===
Market risk is the adverse effect that a change in interest rates, currency, or
implied volatility rates has on the value of a financial instrument. HUSI
manages the market risk associated with interest rate and foreign exchange
contracts by establishing and monitoring limits as to the types and degree of
risk that may be undertaken. HUSI also manages the market risk associated with
the trading derivatives through hedging strategies that correlate the rates,
price and spread movements. HUSI measures this risk daily by using Value at Risk
(VAR) and other methodologies.
HUSI's Asset and Liability Policy Committee is responsible for monitoring and
defining the scope and nature of various strategies utilized to manage interest
rate risk that are developed through its analysis of data from financial
simulation models and other internal and industry sources. The resulting hedge
strategies are then incorporated into HUSI's overall interest rate risk
management and trading strategies.
109
Note 25. Securitizations and Variable Interest Entities
- --------------------------------------------------------------------------------
Securitizations
On December 29, 2004, HUSI acquired a domestic private label loan portfolio from
HSBC Finance Corporation, without recourse, which included a consumer private
label credit card portfolio, securitized receivables related to this portfolio,
and other retained interest assets related to these securitizations. HUSI
purchased all trusts and retained interests associated with these
securitizations. Total receivables and delinquencies for the purchased consumer
private label credit card portfolio are summarized in the following table:
- --------------------------------------------------------------------------------------
(in millions)
Private label credit card receivables at December 31, 2004:
Reported in loans ................................................ $10,935
Add: Securitized amounts ......................................... 3,490
-------
Total managed private label credit card receivables .............. $14,425
=======
Retained interest reported in other assets at December 31, 2004:
Interest-only strip receivables .................................. $ 50
Over collateralization ........................................... 126
Subordinated tranche ............................................. 163
Subordinated interest in accrued interest and fees ............... 37
-------
Total retained interests ......................................... $ 376
=======
Private label credit card receivable delinquencies at December 31, 2004:
Included in credit card receivables reported as loans ............ $ 206
Add: Securitized amounts acquired from HSBC Finance Corporation .. 58
-------
Total private label credit card receivable delinquencies ......... $ 264
=======
Structure of Credit Card Securitizations
These credit card securitization transactions are structured to receive sale
treatment under Statement of Financial Accounting Standards No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, a replacement of FASB Statement No. 125, (SFAS 140). In a
securitization, a designated pool of private label credit card receivables is
removed from the balance sheet and transferred to an unaffiliated trust. This
unaffiliated trust is a qualifying special purpose entity ("QSPE") as defined by
SFAS 140 and, therefore, is not consolidated. The QSPE funds its receivable
purchase through the issuance of securities to investors, entitling them to
receive specified cash flows during the life of the securities. The securities
are collateralized by the underlying receivables transferred to the QSPE.
The credit card securitization trusts are established at fixed levels and, due
to the revolving nature of the underlying receivables, require the sale of new
receivables into the trust to replace runoff so that the principal dollar amount
of the investors' interest remains unchanged. This activity is referred to as
replenishment. Once the revolving period ends, the amortization period begins
and the trust distributes principal payments to the investors.
To help ensure that adequate funds are available to meet the cash needs of the
QSPE, various forms of interests in securitized assets may be retained including
interest-only strip receivables, over collateralization, subordinated tranches,
interest in accrued interest and fees, or other retained interests which provide
credit enhancement to investors. Interest-only strip receivables are rights to
future cash flows arising from the securitized receivables after the investors
receive their contractual return, and are recorded at fair value, net of related
loss reserves. Investors and the securitization trusts have only limited
recourse to HUSI's assets for failure of debtors to pay. That recourse is
limited to the rights to future cash flows and any other subordinated interest
that HUSI may retain. Cash flows related to the interest-only strip receivables
are collected over the life of the underlying securitized receivables.
110
The retained securitization interests are not in the form of securities and are
included in other assets on the consolidated balance sheet. In addition to the
subordinated retained interests previously described, credit card securitization
trusts require HUSI to maintain a minimum undivided interest in the trusts,
representing HUSI's interest in the receivables transferred to the trust that
have not been securitized. This interest in the trust, which is not subordinated
to the interest of other investors, amounted to approximately $6 billion at
December 31, 2004, and is carried at historical cost and classified as loans on
the consolidated balance sheet.
Securitization Cash Flows
HUSI receives various fees and other revenues from the securitization trusts,
which were minimal for 2004. HUSI outsources the servicing to HSBC Finance
Corporation, for which minimal servicing fees were expensed for 2004.
As the securitized portfolio was purchased in late December 2004, there was no
replenishment activity related to the securitization trusts in 2004.
Variable Interest Entities (VIEs)
The provisions of Financial Accounting Standards Board Interpretation No. 46
Revised, Consolidation of Variable Interest Entities (FIN 46R) were adopted
effective March 31, 2004. HUSI is not the primary beneficiary of any of the VIEs
it is involved with.
At December 31, 2004 and 2003, none of the VIEs that HUSI is involved with were
required to be consolidated under FIN 46R. Information for unconsolidated VIEs
is presented in the following table.
- --------------------------------------------------------------------------------
Maximum
Total Exposure
December 31, 2004 Assets to Loss
- --------------------------------------------------------------------------------
(in millions)
Asset backed commercial paper conduits .......... $ 5,657 $5,867
Securitization vehicles ......................... 1,062 552
Investment funds ................................ 3,722 36
Capital funding vehicles ........................ 1,093 32
Low income housing tax credits .................. 994 88
------- ------
Total ........................................... $12,528 $6,575
======= ======
Asset Backed Commercial Paper Conduits
HSBC affiliates support the financing needs of customers by facilitating their
access to the commercial paper markets. Specifically, pools of customers'
assets, typically trade receivables, are sold to an independently rated,
commercial paper financing entity, which in turn issues short-term, asset backed
commercial paper that is collateralized by such assets. Neither the HSBC
affiliates nor HUSI service the assets or transfer their own receivables into
the financing entities.
HUSI and other banks provide one year liquidity facilities, in the form of
either loan or asset purchase commitments, in support of each transaction in the
financing entity. HUSI does not provide any program wide enhancements to the
financing entities. In the table above, the total notional amount of the
liquidity facilities represents HUSI's maximum exposure to loss.
In the normal course of business, HUSI provides liquidity facilities to asset
backed commercial paper conduits sponsored by unrelated third parties. HUSI does
not transfer their own receivables into the financing entity, has no ownership
interest, no administrative duties, and does not service any assets of these
conduits. The only interest HUSI has in these entities are liquidity facilities
in the amount of approximately $1.3 billion at December 31, 2004. These
facilities are excluded from the table summarizing HUSI's involvement in VIEs.
111
Credit risk is managed on these commitments by subjecting them to HUSI's normal
underwriting and risk management processes.
Securitization Vehicles
An HSBC affiliate and third parties organize trusts that are special purpose
entities (SPEs) that issue fixed or floating rate debt backed by the assets of
the trusts. Neither the HSBC affiliate nor HUSI transfer their own assets into
the trusts. HUSI's relationship with the SPEs is primarily as a counterparty to
the SPEs' derivative transactions (interest rate, credit default and currency
swaps). HUSI's maximum exposure to loss from the unconsolidated trust entities
is comprised of investments in the trust and the market risk on the derivative
transactions.
Investment Funds
HUSI is an investor in and derivative counterparty (total return swap) with
hedge funds established by unrelated third parties. HUSI has credit exposure
with the funds in respect to the replacement costs (fair value) of the
derivative contract. At December 31, 2004, the fair value of the total return
swap is negative, hence the replacement cost is zero. At December 31, 2004,
HUSI's maximum exposure to loss is its investment in the fund.
HUSI is a sub-investment advisor to mutual funds structures as trusts managed by
an HSBC affiliate. As sub-advisor, HUSI receives a variable fee based on value
of funds. HUSI has no ownership interest in or credit exposure resulting from
its duty as sub-advisor. HUSI's maximum exposure to loss is zero at December 31,
2004.
HUSI is the investment manager of other vehicles that were determined to be
VIE's. HUSI has no ownership interest in or credit exposure resulting from its
duties as investment advisor.
Capital Funding Vehicles
At December 31, 2004, HUSI owned all of the common equity of five trusts. The
trusts have issued "Capital Securities", guaranteed by HUSI, representing
preferred beneficial interests in the trusts' assets, which consist of Company
debt. HUSI's maximum exposure to loss is its equity ownership interest in the
trusts.
Low Income Housing Tax Credits
HUSI participates as a limited partner in Low Income Housing Tax Credit
Partnerships. The amount HUSI has agreed to invest in these limited partnerships
represents HUSI's maximum exposure to loss.
Note 26. Fair Value of Financial Instruments
- --------------------------------------------------------------------------------
HUSI is required to disclose the estimated fair value of its financial
instruments in accordance with Statement of Financial Accounting Standards No.
107, Disclosures about Fair Value of Financial Instruments (SFAS 107). The
disclosures do not attempt to estimate or represent the fair value of HUSI as a
whole. The disclosures exclude assets and liabilities that are not financial
instruments, including intangible assets, such as goodwill. The estimation
methods and assumptions used by HUSI to value individual classifications of
financial instruments are described below. Different assumptions could
significantly affect the estimates. Accordingly, the net realizable values upon
liquidation of the financial instruments could be materially different from the
estimates presented below.
Financial instruments with carrying value equal to fair value - The carrying
value of certain financial assets and liabilities is considered to be equal to
fair value as a result of their short term nature. These include cash and due
from banks, interest bearing deposits with banks, federal funds sold and
securities purchased under resale agreements, accrued interest receivable,
customers' acceptance liability and certain financial liabilities including
acceptances outstanding, short-term borrowings and interest, taxes, and other
liabilities.
112
Securities and trading assets and liabilities - The fair value of securities and
derivative contracts is based on current market quotations, where available. If
quoted market prices are not available, fair value is estimated based on the
quoted price of similar instruments or internal valuation models that
approximate market pricing.
Loans - The fair value of the performing loan portfolio is determined primarily
by calculating the present value of expected cash flows using a discount rate as
noted below. The loans are grouped, to the extent possible, into homogeneous
pools, segregated by maturity, weighted average maturity, and average coupon
rate. Depending upon the type of loan involved, maturity assumptions are based
on either the contractual or expected maturity date.
For commercial loans, the allowance for credit losses is allocated to the
expected cash flows to provide for credit risk. A published interest rate that
equates closely to a "risk free" or "low-risk" loan rate is used as the discount
rate. The interest rate is adjusted for a liquidity factor, as appropriate.
The discount rate used to calculate the fair value of consumer loans is computed
using the estimated rate of return an investor would demand for the product
without regard to credit risk. The discount rate is formulated by reference to
current market rates.
The discount rate used to calculate the fair value of residential mortgages is
determined by reference to quoted market prices for loans with similar
characteristics and maturities.
Deposits - The fair value of demand, savings, and money market deposits with
variable maturities is equal to the carrying value. For deposits with fixed
maturities, fair value is estimated using market interest rates currently
offered on deposits with similar characteristics and maturities.
Long-term debt - Fair value is estimated using interest rates currently
available to HUSI for borrowings with similar characteristics and maturities.
The summarized carrying values and estimated fair values of financial
instruments as of December 31, 2004 and 2003 follows.
- ------------------------------------------------------------------------------------------------------------------
2004 2003
--------------------- ---------------------
Carrying Fair Carrying Fair
December 31 Value Value Value Value
- ------------------------------------------------------------------------------------------------------------------
(in millions)
Financial assets:
Instruments with carrying value equal to fair value .... $ 9,845 $ 9,845 $ 6,185 $ 6,185
Trading assets ......................................... 19,815 19,815 14,646 14,646
Securities available for sale .......................... 14,655 14,655 14,143 14,143
Securities held to maturity ............................ 3,881 4,042 4,512 4,648
Loans, net of allowance ................................ 84,159 84,216 48,075 48,871
Derivative instruments included in other assets (1) .... 217 217 194 194
Financial liabilities:
Instruments with carrying value equal to fair value .... 10,200 10,200 6,960 6,960
Deposits:
Without fixed maturities ........................... 68,234 68,234 54,304 54,304
Fixed maturities ................................... 11,747 11,749 9,651 9,675
Trading account liabilities ............................ 12,120 12,120 10,460 10,460
Long-term debt ......................................... 23,839 24,589 3,814 4,500
Derivative instruments included in other liabilities (1) 176 176 53 53
(1) At December 31, 2004 and 2003, the amounts reported relate to derivative
contracts that qualify for hedge accounting treatment as defined by SFAS
133.
The fair value of commitments to extend credit, standby letters of credit and
financial guarantees, is not included in the previous table. These instruments
generate fees, which approximate those currently charged to originate similar
commitments.
113
Note 27. Financial Statements of HSBC USA Inc. (parent)
- --------------------------------------------------------------------------------
Condensed parent company financial statements follow.
- -----------------------------------------------------------------------------------------------------------------
Balance Sheet
December 31 2004 2003
- -----------------------------------------------------------------------------------------------------------------
(in millions)
Assets:
Cash and due from subsidiary bank .................................................... $ -- $ --
Interest bearing deposits with banks (including $1,286 and $548 in banking subsidiary) 1,351 613
Trading assets ....................................................................... 279 179
Securities purchased under resale agreements ......................................... 3 --
Securities available for sale ........................................................ 20 44
Securities held to maturity (fair value $162 and $180) ............................... 151 167
Loans (net of allowance for credit losses of $1 and $1) .............................. 533 104
Receivable from subsidiaries ......................................................... 1,766 1,682
Investment in subsidiaries at amount of their net assets:
Banking ........................................................................ 11,373 7,931
Other .......................................................................... 362 1,244
Goodwill ............................................................................. 604 605
Other assets ......................................................................... 179 335
------- -------
Total assets ......................................................................... $16,621 $12,904
======= =======
Liabilities:
Interest, taxes and other liabilities ................................................ $ 180 $ 163
Short-term borrowings ................................................................ 2,480 1,746
Long-term debt (1) ................................................................... 3,092 3,530
Long-term debt due to subsidiary (1) ................................................. 3 3
------- -------
Total liabilities .................................................................... 5,755 5,442
Shareholders' equity * ............................................................... 10,866 7,462
------- -------
Total liabilities and shareholders' equity ........................................... $16,621 $12,904
======= =======
* See Consolidated Statement of Changes in Shareholders' Equity, page 72.
(1) Contractual scheduled maturities for the debt over the next five years are
as follows: none for 2005; 2006, $300 million; 2007, $100 million; 2008,
$250 million and 2009, $100 million.
114
- ------------------------------------------------------------------------------------------------------------
Statement of Income
Year Ended December 31 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------
(in millions)
Income:
Dividends from banking subsidiaries ............................ $ 125 $ 690 $ 670
Dividends from other subsidiaries .............................. 2 34 3
Interest from banking subsidiaries ............................. 105 99 106
Interest from other subsidiaries ............................... 1 1 --
Other interest income .......................................... 18 16 17
Securities transactions ........................................ 4 (2) (1)
Other income ................................................... 91 49 23
------- ----- -----
Total income ......................................................... 346 887 818
------- ----- -----
Expenses:
Interest (including $86, $64 and $65 paid to subsidiaries) ..... 240 229 241
Provision (credit) for credit losses ........................... 3 36 (24)
Other expenses ................................................. 20 24 23
------- ----- -----
Total expenses ....................................................... 263 289 240
------- ----- -----
Income before taxes and equity in undistributed income of subsidiaries 83 598 578
Income tax benefit ................................................... (21) (64) (54)
------- ----- -----
Income before equity in undistributed income of subsidiaries ......... 104 662 632
Equity in undistributed income of subsidiaries ....................... 1,154 279 223
------- ----- -----
Net income ........................................................... $ 1,258 $ 941 $ 855
======= ===== =====
115
- ------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
Year Ended December 31 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------
(in millions)
Cash flows from operating activities:
Net income ................................................ $ 1,258 $ 941 $ 855
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, amortization and deferred taxes ......... 13 13 132
Provision (credit) for credit losses .................. 3 36 (24)
Net change in other accrued accounts .................. 137 25 (540)
Undistributed income of subsidiaries .................. (1,154) (279) (223)
Other, net ............................................ (80) (63) (136)
------- ------- -------
Net cash provided by operating activities ......... 177 673 64
------- ------- -------
Cash flows from investing activities:
Net change in interest bearing deposits with banks ........ (738) 306 741
Purchases of securities ................................... (11) (1) (5)
Sales and maturities of securities ........................ 41 31 47
Net originations and maturities of loans .................. (435) (32) (70)
Net change in investments in and advances to subsidiaries . (1,510) (539) (19)
Other, net ................................................ (65) 56 96
------- ------- -------
Net cash provided by (used in) investing activities (2,718) (179) 790
------- ------- -------
Cash flows from financing activities:
Net change in short-term borrowings ....................... 733 261 (150)
Issuance of long-term debt ................................ (424) -- 609
Repayment of long-term debt ............................... -- -- (624)
Dividends paid ............................................ (148) (712) (693)
Reductions of capital surplus ............................. (20) (44) --
Capital contribution from HNAI ............................ 2,400 -- --
------- ------- -------
Net cash provided by (used in) financing activities ............. 2,541 (495) (858)
------- ------- -------
Net change in cash and due from banks ........................... -- (1) (4)
Cash and due from banks at beginning of year .................... -- 1 5
------- ------- -------
Cash and due from banks at end of year .......................... $ -- $ -- $ 1
======= ======= =======
Cash paid for:
Interest .................................................. $ 237 $ 228 $ 250
======= ======= =======
HBUS is subject to legal restrictions on certain transactions with its nonbank
affiliates in addition to the restrictions on the payment of dividends to HUSI.
See Note 13 for further discussion.
116
Quarterly Results of Operations (Unaudited)
- --------------------------------------------------------------------------------
The following table presents a quarterly summary of selected financial
information.
- -----------------------------------------------------------------------------------------------------------
Quarter Ended December 31 September 30 June 30 March 31
- -----------------------------------------------------------------------------------------------------------
(in millions)
2004
- ----
Net interest income .......................... $ 700 $ 698 $ 689 $ 654
------ ------ ------ ------
Trading revenues ............................. 99 21 78 90
Residential mortgage banking revenue (expense) (14) (65) (17) (24)
Securities gains, net ........................ 26 18 3 38
Other income ................................. 214 388 234 230
------ ------ ------ ------
Total other revenues ......................... 325 362 298 334
------ ------ ------ ------
Operating expenses ........................... 613 480 520 488
Provision (credit) for credit losses ......... (24) 27 6 (26)
------ ------ ------ ------
Income before income tax expense ............. 436 553 461 526
Income tax expense ........................... 167 214 130 207
------ ------ ------ ------
Net income ................................... $ 269 $ 339 $ 331 $ 319
====== ====== ====== ======
2003
- ----
Net interest income .......................... $ 627 $ 629 $ 610 $ 644
------ ------ ------ ------
Trading revenues ............................. 78 52 91 70
Residential mortgage banking revenue (expense) (22) (74) (14) 8
Securities (losses) gains, net ............... (3) 2 33 16
Other income ................................. 227 225 248 217
------ ------ ------ ------
Total other revenues ......................... 280 205 358 311
------ ------ ------ ------
Operating expenses ........................... 539 523 492 486
Provision (credit) for credit losses ......... 27 (1) 31 56
------ ------ ------ ------
Income before income tax expense ............. 341 312 445 413
Income tax expense ........................... 125 114 172 159
------ ------ ------ ------
Net income ................................... $ 216 $ 198 $ 273 $ 254
====== ====== ====== ======
117
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
- --------------------------------------------------------------------------------
There were no disagreements on accounting and financial disclosure matters
between HUSI and its independent accountants during 2004.
Item 9A. Controls and Procedures
- --------------------------------------------------------------------------------
Under the direction of HUSI's Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), HUSI has reviewed its controls and other procedures designed to
ensure that information required to be disclosed in HUSI's reports filed with
the SEC is recorded, processed, summarized and reported by the due dates
specified by the SEC's rules (disclosure controls and procedures). This process
is the support for the certifications of the CEO and CFO included as Exhibit 31
to this report.
Since 1993, the CEO and CFO have reported on HBUS's disclosure controls and
procedures pursuant to FDICIA regulations. HUSI's independent auditors have
annually attested, without qualification, to the reports. Thus, management is
well acquainted with the process underlying the attestation to financial
reporting controls. The current review process is built on the annual review at
HBUS for FDICIA purposes 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 HUSI.
To monitor HUSI's compliance with disclosure controls and procedures, HUSI has
formed a Disclosure Committee chaired by its CFO. The Disclosure Committee is
comprised of key members of senior management, who have knowledge of significant
portions of HUSI's internal control system as well as the business and
competitive environment in which HUSI operates. The Disclosure Committee covers
all of HUSI's significant business and administrative functions. One of the key
responsibilities of each Disclosure Committee member is to review the document
to be filed with the SEC as it progresses through the preparation process. Open
lines of communication to financial reporting management exist for Disclosure
Committee members to convey comments and suggestions.
The Disclosure Committee has designated a preparation working group that is
responsible for providing and/or reviewing the detail supporting financial
disclosures including the development of appropriate forward-looking
disclosures.
HUSI's CEO and CFO have concluded that, based on the deliberations of the
Disclosure Committee and input received from senior business and financial
managers, HUSI's disclosure controls and procedures were effective as of
December 31, 2004 and that those controls and procedures support the disclosures
in this document. During 2004 there were no material changes in HUSI's internal
controls over financial reporting.
118
P A R T III
Item 10. Directors and Executive Officers of the Registrant
- --------------------------------------------------------------------------------
Directors
Set forth below is certain biographical information relating to the members of
HUSI's Board of Directors. Each director is elected annually. There are no
family relationships among the directors.
William F. Aldinger III, age 57, Chairman of HUSI and HBUS since January 2004.
Mr. Aldinger has been Chairman and Chief Executive Officer of HSBC Finance
Corporation since 1996 and has been an Executive Director of HSBC since 2003. He
is also a director of AT&T, Illinois Tool Works, Inc. and MasterCard
International. He has been a director of HBUS and HUSI since 2003.
Under an agreement with management and the Board of Directors of HSBC, Mr.
Aldinger acts as Chairman and Director of the principal U.S. operating
subsidiaries of HSBC.
Salvatore H. Alfiero, age 67, Chairman and Chief Executive Officer, Protective
Industries, LLC. He is also a director of Phoenix Companies, Inc., Southwire
Company, Fresh Del Monte Produce Company and National Health Care Affiliates. He
has been a director of HBUS since 1996 and a director of HUSI since 2000.
Donald K. Boswell, age 53, President and Chief Executive Officer, Western New
York Public Broadcasting Association since 1998. Mr. Boswell has been in public
broadcasting since 1977. He has been a director of HBUS and HUSI since 2002.
James H. Cleave, age 62, formerly President and Chief Executive Officer of HUSI
and HBUS from 1993 through 1997. Prior to that Mr. Cleave was President and
Chief Executive Officer of HSBC Bank Canada and he is currently a director and
Vice Chairman of HSBC Bank Canada. He has been a director of HBUS and HUSI since
1991.
Frances D. Fergusson, age 60, President, Vassar College since 1986. Dr.
Fergusson was formerly Provost and Vice President for Academic Affairs, Bucknell
University. Dr. Fergusson is also a director of Wyeth Pharmaceuticals and a
member of the Board of Overseers of Harvard University. She has been a director
of HBUS since 1990 and a director of HUSI since 2000.
Martin J. G. Glynn, age 53, Director of HUSI and HBUS since 2000, and President
and Chief Executive Officer of HUSI and HBUS since 2003. Mr. Glynn also has been
a Group General Manager for HSBC since 2001 and Chairman of HSBC Bank Canada
since 2004. He has been a director of HSBC Bank Canada since 1999 and was
formerly President and Chief Executive Officer of HSBC Bank Canada from 1999 to
2003. He is also a director of AEA Investors LLC and Husky Energy Inc.
Richard A. Jalkut, age 60, President and Chief Executive Officer, Telepacific
Communications and Chairman of Birch Telecom, Inc. Mr. Jalkut was formerly
President and Chief Executive of Pathnet and previously President and Group
Executive, NYNEX Telecommunications. He is also a director of IKON Office
Solutions and Covad Communications. He has been a director of HBUS since 1992
and a director of HUSI since 2000.
Peter Kimmelman, age 60, private investor. Mr. Kimmelman was formerly a director
of Republic New York Corporation and Republic National Bank of New York from
1976 until 1999. He has been a director of HBUS and HUSI since 2000.
Charles G. Meyer, Jr., age 67, Director and former President of Cord Meyer
Development Company. Mr. Meyer was formerly a director of Republic National Bank
of New York from 1987 until 1999. He has been a director of HBUS and HUSI since
2000.
119
James L. Morice, age 67, Executive Vice President and Director of
NationsBuilders Insurance Services, Inc. and concurrently President and Chief
Executive Officer of the JLM Group LLC, a management consulting firm. Mr. Morice
is also a member of the University of New Haven Board of Governor's Human
Resources Committee. He was formerly a director of Republic New York Corporation
and Republic National Bank of New York from 1987 until 1999. He has been a
director of HBUS and HUSI since 2000.
Executive Officers
- --------------------------------------------------------------------------------
Information regarding the executive officers of HUSI as of February 28, 2005 is
presented in the following table.
- ------------------------------------------------------------------------------------------------------------------------------------
Year
Name Age Elected Present Position with HUSI
- ------------------------------------------------------------------------------------------------------------------------------------
Martin J. G. Glynn 53 2003 President and Chief Executive Officer
Brendan McDonagh 46 2002 Chief Operating Officer
Gerard Aquilina 53 2002 Senior Executive Vice President, Private Banking and Wealth Management
Janet L. Burak 49 2004 Senior Executive Vice President, General Counsel and Secretary
Robert M. Butcher 61 1988 Senior Executive Vice President and Chief Risk Officer
Vincent J. Mancuso 58 1996 Senior Executive Vice President and Group Audit Executive, USA
Joseph M. Petri 52 2001 Senior Executive Vice President, Treasurer and Co-Head, CIBM Americas
George T. Wendler 60 2000 Senior Executive Vice President and Chief Credit Officer
Paulette M. Crooke 51 2004 Executive Vice President, Operations
Jeanne G. Ebersole 43 2004 Executive Vice President, Human Resources
Roger K. McGregor 56 2003 Executive Vice President and Chief Financial Officer
Seamus McMahon 45 2004 Executive Vice President, Strategy and Corporate Development
Linda Stryker-Luftig 61 2004 Executive Vice President, Head of Group Public Affairs
Teresa A. Pesce 45 2005 Executive Vice President, AML Compliance
Carolyn M. Wind 51 2005 Executive Vice President, Compliance
Anthony J. Murphy 45 2005 Co-Head, CIBM Americas
Michael P. Ebbs 45 2005 Managing Director, Chief Information Officer
Joseph R. Simpson 43 2003 Chief Accounting Officer
- ------------------------------------------------------------------------------------------------------------------------------------
Martin J. G. Glynn was appointed President and Chief Executive Officer of HUSI
and HBUS in October 2003. Prior to joining HUSI, he was President and Chief
Executive Officer of HSBC Bank Canada. Mr. Glynn was appointed a Group General
Manager in 2001 and has been with the HSBC Group since 1982.
Brendan McDonagh was appointed Chief Operating Officer, HBUS effective October
22, 2004. Mr. McDonagh is an HSBC International Manager who has been with the
HSBC Group for over twenty years. He has extensive commercial and retail
management experience and prior to joining HUSI in 2002 served as Senior
Executive, Strategy Implementation, at HSBC Group Headquarters.
Gerard Aquilina assumed responsibilities for Private Banking and Wealth
Management Services for HSBC in North America in 2003. He previously held
various management positions with Merrill Lynch from 1984 to 2002 including
Global Head of Marketing and Wealth Management for their International Private
Client Group.
Janet L. Burak was appointed HUSI General Counsel and Secretary effective April
1, 2004. She had served as an attorney with HSBC Finance Corporation for twelve
years and most recently as their Group General Counsel. Prior to joining HSBC
Finance Corporation, she was an associate with Shearman & Sterling and an
attorney with Citigroup.
Robert M. Butcher was appointed Chief Risk Officer for HUSI and HBUS in May
2003. Prior to that he held the position of Chief Financial Officer from 1990 to
May 2003. He joined HBUS's predecessor, Marine Midland Bank, in 1988. Prior to
that he was with Citicorp for 15 years where he held various senior officer
positions in the corporate finance department.
Vincent J. Mancuso was appointed Group Audit Executive USA in 1996. Prior to
this role he held a variety of management positions in HBUS's corporate offices,
including head of the commercial finance division and senior officer positions
in credit. He has been with HBUS since 1965.
120
Joseph M. Petri, Head of Global Markets, Americas, was appointed Co-Head of
Corporate, Investment Banking and Markets (CIBM) Americas in November 2004. Mr.
Petri joined HUSI in April 2000 as Executive Managing Director and head of sales
for HSBC's Investment Banking and Markets, Americas division. From 1995 to 1998,
he was President and Senior Partner of Summit Capital Advisors LLC, a New Jersey
based hedge fund. Prior to that, Mr. Petri held a variety of management
positions with Merrill Lynch.
George T. Wendler was appointed Chief Credit Officer of HUSI in 2000. Mr.
Wendler was Chief Credit Officer and a member of the Senior Management Committee
for Republic New York Corporation when it was acquired by HSBC in December 1999.
He was also a director and Vice Chairman of Republic New York Corporation from
1997 to 1999.
Paulette M. Crooke was appointed Executive Vice President, Operations for HUSI
and HBUS in July 2004. She has previously held various management positions
within HBUS including Human Resources and various retail banking markets, most
recently directing PFS activities in Manhattan. Ms. Crooke has been with HBUS
for 31 years.
Jeanne G. Ebersole joined HUSI from HSBC Finance Corporation in May 2004 as
Executive Vice President, Human Resources. She held a variety of human resources
roles since joining HSBC Finance Corporation in 1980 and had overall human
resources responsibility for HSBC Finance Corporation's retail services,
insurance services and refund lending businesses since August 2002.
Roger K. McGregor was appointed Chief Financial Officer in 2003 and was
previously Chief Financial Officer, HSBC Bank Canada from 2000 to 2003. From
1995 to 2000, he was Head of International Financial Control, HSBC Bank plc. Mr.
McGregor has been with the HSBC Group since 1977.
Seamus McMahon was appointed Executive Vice President in charge of strategic
planning, corporate development and acquisitions, and ongoing integration
initiatives in May 2004. In October 2004, Mr. McMahon was appointed Regional
President Atlantic Region. Mr. McMahon has more than twenty years of experience
in the financial services industry, most recently serving as President and CEO
of TD Bank, USA, a wholly owned subsidiary of Toronto Dominion Bank. Previously,
he led the retail financial services practices at First Manhattan Consulting
Group and Booz Allen & Hamilton, and worked for Chase Manhattan in New York and
Accenture (then Andersen Consulting) in Europe.
Linda Stryker-Luftig was appointed head of Group Public Affairs USA in 1998.
Prior to that she was Vice President, Corporate Communications at First Union
Corporation following its acquisition of CoreStates Financial Corp. in 1998.
From 1990 to 1998 she held various positions in corporate communications,
marketing and public relations with CoreStates Financial Corp.
Teresa A. Pesce joined HUSI in September 2003 as Executive Vice President and
Anti-Money Laundering (AML) Director and in 2004 became the AML Director for all
HSBC businesses in North America. Ms. Pesce joined HSBC from the United States
Attorney's Office, Southern District of New York. In that office she was Senior
Trial Counsel, White Plains Division and previously Chief of the Major Crimes
Unit and Deputy Chief of the Criminal Division. From 1992 to 1999 she served as
a Line Assistant in the Major Crimes, Narcotics, and General Crimes Units.
Carolyn M. Wind, Executive Vice President, Compliance was the Chief Compliance
Officer for Republic New York Corporation when it was acquired by HSBC in
December 1999. Prior to joining Republic New York Corporation, she was a senior
national bank examiner with the Office of the Comptroller of the Currency (OCC).
Anthony J. Murphy, CEO, HSBC Securities (USA) Inc., was appointed Co-Head, CIBM
Americas in November 2004. Mr. Murphy has been employed with the HSBC Group
since 1990. Prior to his appointment as CEO, HSBC Securities (USA) Inc. in April
2003, he served as Chief Strategic Officer, CIBM Americas from 2000. Prior to
that he was Head of Market Risk Management for HSBC Bank plc and HSBC Investment
Bank in London from 1996.
121
Michael P. Ebbs was appointed Managing Director and Chief Information Officer -
HBUS Banking Systems in January 2005. Mr. Ebbs was Head of Information
Technology at the Bank of Bermuda Ltd., which was acquired by HSBC in February
2004. Prior to his thirteen years at the Bank of Bermuda, he held senior
technology positions at The Putnam Companies and the Bank of New England.
Joseph R. Simpson was appointed Chief Accounting Officer for HUSI and HBUS in
2003. Prior to that he held the position of Manager of External Financial
Reporting and previous to that, Manager of Accounting Policy. Mr. Simpson has
been with HBUS for 16 years.
Audit and Examining Committee
- --------------------------------------------------------------------------------
The Audit and Examining Committee of HUSI's Board of Directors is comprised of
Messrs.: Alfiero (Chairman), Cleave, Jalkut and Kimmelman. Messrs. Alfiero and
Cleave have been determined by HUSI's Board of Directors to be audit committee
financial experts, each having the attributes prescribed by the SEC, and are
independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the
Exchange Act.
Code of Ethics
- --------------------------------------------------------------------------------
HUSI has adopted a code of ethics applicable to its chief executive officer, its
chief financial officer, and its chief accounting officer and is included herein
as Exhibit 14.
122
Item 11. Executive Compensation
- --------------------------------------------------------------------------------
The following table presents the compensation earned for the three years ending
December 31, 2004 by the President and Chief Executive Officer of HUSI and HBUS,
the four most highly compensated Executive Officers of HUSI and HBUS, who were
serving as such on December 31, 2004, and by a former Executive Officer, who
would have been among the four most highly compensated Executive Officers had he
not been appointed to another position within the HSBC group prior to December
31, 2004 (the named executive officers). Principal position indicates capacity
served in 2004.
Summary Compensation Table
- --------------------------------------------------------------------------------
Long Term
Annual Compensation Compensation
----------------------------------------- -------------
Restricted All Other
Name and Principal Position Year Salary Bonus Other Stock Awards Compensation
- ----------------------------------------------------------------------------------------------------------------------------------
Martin J. G. Glynn (1) 2004 $ 600,000 $ 1,500,000 $ 299,312 (2) $ 1,200,000 $ 7,738 (8)
President and 2003 103,846 1,000,000 70,449 (2) 526,693 1,846
Chief Executive Officer
Joseph M. Petri 2004 325,000 3,210,000 69,355 (3) 2,790,000 7,175 (8)
Senior Executive Vice President, 2003 325,000 3,750,000 246,553 (3) 3,750,000 7,000
Treasurer and Co-Head, Corporate, 2002 325,000 1,800,000 -- 2,700,000 7,000
Investment Banking and Markets,
Americas
Gerard Aquilina 2004 490,173 875,000 -- 775,000 5,381 (8)
Senior Executive Vice President, 2003 465,000 750,000 -- 700,000 781
Private Banking and Wealth 2002 304,038 513,000 -- 1,412,000 --
Management
George T. Wendler 2004 566,500 700,194 -- 150,000 --
Senior Executive Vice President 2003 566,500 475,000 -- -- --
and Chief Credit Officer 2002 566,500 450,000 -- 56,000 --
Brendan McDonagh (4) 2004 529,796 475,500 401,871 (5) 376,000 164,041 (9)
Chief Operating Officer 2003 470,333 219,598 464,264 (5) 228,000 93,174
2002 112,900 91,641 73,602 (5) 150,000 21,298
Brian Robertson (6) 2004 635,869 483,500 230,292 (7) 522,180 143,245 (9)
Former Senior Executive Vice 2003 492,487 435,176 517,303 (7) 431,153 85,113
President and CEO, Corporate,
Investment Banking and Markets
(1) Mr. Glynn was appointed President and Chief Executive Officer of HUSI and
HBUS effective October 22, 2003.
(2) Mr. Glynn's Other Annual Compensation for 2004 and 2003 includes
reimbursements and tax gross-ups related to rental expenses of $272,115
and $69,222 respectively.
(3) Mr. Petri's Other Annual Compensation for 2004 and 2003 principally
represents imputed interest income from the investment of deferred bonus
amounts from previous years.
(4) Mr. McDonagh, an HSBC International Manager, joined HUSI in 2002.
(5) Mr. McDonagh's Other Annual Compensation for 2004 includes reimbursements
and tax gross-ups related to rental expenses of $135,501, a tax gross-up
of $132,329 on an HSBC paid pension contribution and $103,205 of
children's educational expenses. Mr. McDonagh's 2003 Other Annual
Compensation includes $169,283 of rental related expenses and $124,149 of
children's educational expenses. His 2002 Other Annual Compensation
includes $46,766 of rental related expenses and a tax gross-up of $19,193
on an HSBC paid pension contribution.
(6) Mr. Robertson, an HSBC International Manager, joined HUSI in 2003. In
November 2004 Mr. Robertson left HUSI when he was appointed Group General
Manager, Credit and Risk.
(7) Mr. Robertson's 2004 Other Annual Compensation includes a housing
allowance benefit of $288,393 and a tax gross-up of $144,280 on an HSBC
paid pension contribution, and is net of a $320,422 charge for a tax
reimbursement received on employer paid income taxes. His 2003 Other
Annual Compensation includes a $228,019 housing allowance and a rent
reimbursement of $145,878.
(8) All Other Compensation in 2004 for Messrs. Glynn, Petri and Aquilina
represents HUSI's matching 401(k) plan contribution.
(9) All Other Compensation in 2004 for Messrs. McDonagh and Robertson
represents pension contributions made by HSBC on their behalf.
123
The restricted stock awards included in the prior table represent the monetary
value of awards made under the HSBC Restricted Share Plan for performance in the
year indicated. The actual number of shares of HSBC Holdings plc common stock
corresponding to the 2004 awards will not be known until the shares are
purchased, which is expected to occur late in the first quarter of 2005.
Dividends are paid on all restricted shares and are reinvested in additional
restricted shares.
The prior table includes the monetary value of restricted stock awards granted
to the named executive officers for the three years ending December 31, 2004.
The following table includes the number and value of restricted share holdings
as of December 31, 2004, accumulated for all years of service.
- --------------------------------------------------------------------------------
Number of
December 31, 2004 Shares Value
- --------------------------------------------------------------------------------
Martin J. G. Glynn .............................. 109,175 $ 1,857,015
Joseph M. Petri (1) ............................. 461,040 7,842,067
Gerard Aquilina ................................. 180,853 3,076,231
George T. Wendler ............................... 23,667 402,567
Brendan McDonagh ................................ 63,862 1,086,261
Brian Robertson (2) ............................. 81,419 1,384,904
(1) Mr. Petri's restricted share holdings at December 31, 2004 include 184,320
shares, which represent the net accumulated balance of shares originally
granted in March 2003, one third of which vested in 2004 and two thirds of
which will vest equally in 2005 and 2006. Mr. Petri's restricted share
holdings at December 31, 2004 also include 243,249 shares that were
granted in March 2004. These shares will vest in equal increments on the
date HSBC publishes its annual results in 2005, 2006 and in 2007.
(2) Mr. Robertson's restricted share holdings at December 31, 2004 include
3,244 shares from a March 2004 grant and 2,141 shares from a June 2004
grant. Both of these grants vest equally on the date HSBC publishes its
annual results in 2005, 2006 and in 2007.
No stock options on HSBC Holdings plc common stock were granted during 2004 to
any of the named executives under the HSBC Holdings Group Share Option Plan and
none of the named executives exercised any previously awarded stock options
during 2004.
The unexercised stock options included in the following table on HSBC Holdings
plc common stock were granted under the HSBC Holdings Executive Share Option
Scheme for performance years 1998 and prior. The option awards for Messrs.
McDonagh and Robertson are for performance while employed by other HSBC
entities.
- ------------------------------------------------------------------------------------------------------------------------------------
Aggregated Stock Options Exercised in 2004 and Option Values as of Year End 2004
Number of Securities Value of Unexercised
Underlying Unexercised Options In-the-Money Options
Shares as of December 31, 2004 as of December 31, 2004 (2)
Acquired on Value --------------------------------- ----------------------------------
Name Exercise (#) Realized ($) Exercisable (1) Unexercisable Exercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------------------------
Martin J. G. Glynn.. -- $ -- -- -- $ -- $ --
Joseph M. Petri..... -- -- -- -- -- --
Gerard Aquilina..... -- -- -- -- -- --
George T. Wendler... -- -- -- -- -- --
Brendan McDonagh.... -- -- 33,900 -- 176,128 --
Brian Robertson..... -- -- 37,500 -- 226,527 --
(1) Although the performance conditions have been met on the above unexercised
options, HSBC Staff Dealing Rules prohibit the exercise of these options
until the 2004 financial results of HSBC Holdings plc have been publicly
announced.
(2) The value of unexercised in-the-money options is based on the December 31,
2004 closing price per share of 8.795 GBP for HSBC Holdings plc common
stock and a U.S. dollar exchange rate of 1.9340 per GBP.
124
The following table shows the estimated annual retirement benefit payable upon
normal retirement on a straight life annuity basis to participating employees,
including officers, in the compensation and years of service classifications
indicated under the HSBC Bank USA Pension Plan (the Pension Plan) and
non-qualified supplemental benefit plans, which cover most officers and
employees on a noncontributory basis. The amounts shown are before application
of social security reductions. Years of service credited for benefit purposes is
limited to 30 years in the aggregate.
- -----------------------------------------------------------------------------------------
Five Year
Average
Compensation 15 20 25 30 35
- -----------------------------------------------------------------------------------------
$ 300,000 $ 87,750 $ 117,600 $ 147,600 $ 177,600 $ 178,350
400,000 117,000 156,800 196,800 236,800 237,800
500,000 146,250 196,000 246,000 296,000 297,250
600,000 175,500 235,200 295,200 355,200 356,700
700,000 204,750 274,400 344,400 414,400 416,150
800,000 234,000 313,600 393,600 473,600 475,600
900,000 263,250 352,800 442,800 532,800 535,050
1,000,000 292,500 392,000 492,000 592,000 594,500
- -----------------------------------------------------------------------------------------
The Pension Plan is a noncontributory defined benefit pension plan under which
HBUS and other participating subsidiaries of HUSI make contributions in
actuarially determined amounts. Compensation covered by the Pension Plan
includes regular basic earnings (including salary reduction contributions to the
401(k) plan), but not incentive awards, bonuses, special payments or deferred
salary. HUSI maintains supplemental benefit plans which provide for the
difference between the benefits actually payable under the Pension Plan and
those that would have been payable if certain other awards, special payments and
deferred salaries were taken into account and if compensation in excess of the
limitations set by the Internal Revenue Code could be counted. Payments under
these plans are unfunded and will be made out of the general funds of HBUS or
other participating subsidiaries. The calculation of retirement benefits is
based on the highest five-consecutive year compensation.
Mr. Wendler is the only named executive officer who participates in the Pension
Plan and is also a member of the Senior Management Committee of HBUS.
Individuals who were members of the Senior Management Committee prior to
July 1, 2004, and who participate in the Pension Plan receive two times
their normal credited service for each year and fraction thereof served as a
committee member in determining pension and severance benefits to a maximum of
30 years of credited service in total. This additional service accrual is
unfunded and payments will be made from the general funds of HBUS or other
subsidiaries. As of December 31, 2004, Mr. Wendler had 21.76 total years of
credited service in determining benefits payable under the Pension Plan and
other non-qualified supplemental benefit plans.
Mr. Glynn's pension benefits will be provided through the HSBC Bank Canada plan.
Mr. Petri and Mr. Aquilina participate in the HSBC Bank USA Retirement Plan, a
defined contribution retirement plan covering employees hired after 1996. Since
Mr. McDonagh and Mr. Robertson are HSBC International Managers, they
participate in HSBC's International Staff Retirement Benefits Scheme.
125
Directors' Compensation
- --------------------------------------------------------------------------------
For their services as directors of both HUSI and HBUS, all nonemployee directors
receive an annual retainer of $50,000. Directors who are employees of HSBC or
other Group affiliates do not receive annual retainers or fees. Committee
chairmen receive an additional annual fee of $2,500 for acting in that capacity.
Members of the Audit and Examining Committee receive an annual fee which is
$10,000 for the chairman and $6,000 for the other members. Directors are
reimbursed for their expenses incurred in attending meetings. HUSI and HBUS have
standard arrangements pursuant to which directors elected prior to June 1999 may
defer all or part of their fees.
The Directors' Retirement Plan covers nonemployee directors elected prior to
1998 and excludes those serving as directors at the request of HSBC. Eligible
directors with at least five years of service will receive quarterly retirement
benefit payments commencing at the later of age 65 or retirement from the Board,
and continuing for ten years. The annual amount of the retirement benefit is a
percent of the annual retainer in effect at the time of the last Board meeting
the director attended. The percentage is 50 percent after five years of service
and increases by five percent for each additional year of service to 100 percent
upon completion of 15 years of service. If a director who has at least five
years of service dies before the retirement benefit has commenced, the
director's beneficiary will receive a death benefit calculated as if the
director had retired on the date of death. If a retired director dies before
receiving retirement benefit payments for the ten year period, the balance of
the payments will be continued to the director's beneficiary. The plan is
unfunded and payment will be made out of the general funds of HUSI or HBUS.
Employment Contracts
- --------------------------------------------------------------------------------
Mr. Joseph M. Petri has an agreement with HUSI whereby he will give six months
notice before leaving and sign a non-compete agreement in order to receive all
restricted stock granted to him at that time. There are no other employment
contracts between HUSI and any of its other named executive officers.
Compensation Committee Interlocks and Insider Participation
- --------------------------------------------------------------------------------
The current members of the Human Resources Committee of HUSI's Board of
Directors are: nonemployee director Dr. Frances D. Fergusson, Chair; Mr. Martin
J. G. Glynn, President and Chief Executive Officer of HUSI and HBUS; nonemployee
director Mr. James L. Morice and nonemployee director Mr. Donald K. Boswell.
Other Committee members during 2004 were former Board members: Mr. Stephen K.
Green, Group Chief Executive of HSBC and nonemployee director Ms. Carole S.
Taylor. There are no interlocking relationships.
126
Item 12. Security Ownership of Certain Beneficial Owners and Management
- --------------------------------------------------------------------------------
Security Ownership of Certain Beneficial Owners
HUSI's common stock is 100% owned by HSBC North America Inc. (HNAI). HNAI is an
indirect wholly owned subsidiary of HSBC.
Security Ownership by Management
The following table shows the beneficial ownership of HSBC $0.50 ordinary shares
as of December 31, 2004 by each of HUSI's directors, the named executive
officers in the Summary Compensation Table on page 123 and by all of HUSI's
directors and executive officers as a group. Each of the individuals listed
below and all directors and executive officers as a group own less than 1% of
the outstanding shares of stock.
- -----------------------------------------------------------------------------------------------------------------------
Shares That
Shares May Be Acquired Within Total
Beneficially 60 Days By Beneficially Owned
Directors Owned (1) Exercise of Options (2) Shares
- -----------------------------------------------------------------------------------------------------------------------
William F. Aldinger III (3)(5) 6,667,662 (6) 8,586,750 (7) 15,254,412
Salvatore H. Alfiero 244,000 -- 244,000
Donald K. Boswell 220 -- 220
James H. Cleave 216,919 -- 216,919
Frances D. Fergusson 100 -- 100
Martin J. G. Glynn (4) 136,451 -- 136,451
Richard A. Jalkut 250 -- 250
Peter Kimmelman 16,485 -- 16,485
Charles G. Meyer, Jr. 500 -- 500
James L. Morice 500 -- 500
- -----------------------------------------------------------------------------------------------------------------------
Named executive officers
- -----------------------------------------------------------------------------------------------------------------------
Joseph M. Petri 461,040 -- 461,040
Gerard Aquilina 180,853 -- 180,853
George T. Wendler 23,667 -- 23,667
Brendan McDonagh 80,984 33,900 114,884
Brian Robertson 156,911 37,500 194,411
- -----------------------------------------------------------------------------------------------------------------------
All directors and executive officers
as a group 8,616,286 8,887,050 17,503,336
- -----------------------------------------------------------------------------------------------------------------------
(1) Beneficially owned shares include restricted stock awards which do not
carry voting rights.
(2) HSBC Staff Dealing Rules prohibit the exercise of these options until the
2004 financial results of HSBC have been publicly announced.
(3) Mr. Aldinger is an Executive Director of HSBC.
(4) As the President and CEO of HUSI and HBUS, Mr. Glynn is also one of the
named executive officers.
(5) The majority of Mr. Aldinger's beneficially owned shares and options
resulted from the conversion of beneficially owned HSBC Finance
Corporation common stock and options into HSBC ordinary shares and options
following HSBC's March 2003 acquisition of HSBC Finance Corporation. The
conversion was in the same ratio as the offer for HSBC Finance
Corporation, 2.675 HSBC ordinary shares for each HSBC Finance Corporation
common share. Exercise prices per share were adjusted accordingly.
(6) Includes: 4,025,850 HSBC ordinary shares held by an employee benefit trust
of which Mr. Aldinger is a beneficiary; 1,363,849 shares held either
personally, through partnerships and trusts, or as a result of exercising
restricted stock rights; 1,050,053 shares held under the HSBC Restricted
Share Plan; 212,785 shares resulting from the vesting of an HSBC
Restricted Share Plan award; and 15,125 shares held in a charitable
foundation of which Mr. Aldinger disclaims beneficial ownership.
(7) Represents exercisable options for HSBC ordinary shares. Total options
held at December 31, 2004 amounted to 9,656,750.
127
At December 31, 2004 Salvatore H. Alfiero beneficially owned 225,000 shares, or
7.50% of the outstanding non-voting shares, of HUSI's $1.8125 Cumulative
Preferred Stock. No other director or executive officer of HUSI owned any of
HUSI's outstanding preferred stock at December 31, 2004.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------------------------------
Directors and officers of HUSI, members of their immediate families and HSBC and
its affiliates were customers of, and had transactions with, HUSI, HBUS and
other subsidiaries of HUSI in the ordinary course of business during 2004.
Similar transactions in the ordinary course of business may be expected to take
place in the future.
Of particular note are certain business transactions between HUSI and HSBC
Finance Corporation, of which Mr. Aldinger is Chairman and Chief Executive
Officer. The following transactions are further described in Note 18 of the
consolidated financial statements beginning on page 97 of this Form 10-K.
o On December 29, 2004, approximately $12 billion of private label loans,
primarily credit card receivables, and residual interests in approximately
$3 billion of securitized private label credit card receivable pools were
purchased from HSBC Finance Corporation.
o During 2004, HUSI purchased approximately $5 billion of consumer loans,
primarily residential mortgage loans, from HSBC Finance Corporation and
from originating lenders pursuant to HSBC Finance Corporation
correspondent loan programs.
o On July 1, 2004, HUSI sold certain consumer credit card customer
relationships to HSBC Finance Corporation.
o Pursuant to various service level agreements, HSBC Finance Corporation
charges HUSI for loan origination and servicing, and other operational and
administrative support.
o Effective October 1, 2004, HBUS is the originating lender for a federal
tax refund anticipation program which is managed by HSBC Finance
Corporation.
o At December 31, 2004, HUSI had a $2 billion line of credit with HSBC
Finance Corporation, of which $600 million was outstanding.
All loans to executive officers and directors and members of their immediate
families and to HSBC and its affiliates were made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other persons and did not involve more than
normal risk of collectibility or present other unfavorable features.
128
Item 14. Principal Accounting Fees and Services
- --------------------------------------------------------------------------------
Fees billed to HUSI by its auditing firm, KPMG LLP, were as follows.
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Audit fees:
Auditing of financial statements, quarterly reviews, statutory audits, preparation of comfort
letters, consents and review of registration statements ................................... $4,310 $3,476
Audit related fees:
Employee benefit plan audits, due diligence assistance, internal control review assistance,
and audit or attestation services not required by statute or regulation ................... 1,478 598
Tax fees:
Tax related research, general tax services in connection with transactions and legislation,
and review of federal and state tax accounts for possible over-assessment of interest
and/or penalties .......................................................................... 1,762 168
All other fees .................................................................................... 46 1,544
------ ------
Total KPMG LLP fees ............................................................................... $7,596 $5,786
====== ======
Audit and Examining Committee Pre-approval Policies and Procedures
It is the practice of the Audit and Examining Committee of HUSI's Board of
Directors to approve the annual audit fees, including those covering audit
services beyond HUSI's financial statements, before any audit procedures are
undertaken. Prior to 2003, management had the implicit pre-approval of the Audit
and Examining Committee to engage KPMG LLP, or any other professional service
firm, to perform tax and other services. Any such services provided by KPMG LLP
were reported to the Audit and Examining Committee after the fact. Beginning in
2003, the Audit and Examining Committee assumed responsibility for pre-approving
all auditing services and permitted non-auditing services, including the related
fees and terms thereof.
129
P A R T I V
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- --------------------------------------------------------------------------------
(a) (1) Financial Statements
HSBC USA Inc.:
Consolidated Balance Sheet
Consolidated Statement of Income
Consolidated Statement of Changes in Shareholders' Equity
Consolidated Statement of Cash Flows
HSBC Bank USA, N.A.:
Consolidated Balance Sheet
Notes to Financial Statements
(2) Financial Statement Schedules
All required schedules are omitted since they are either not
applicable or the information is presented elsewhere in this
document.
(3) Exhibits
3(i) Registrant's Restated Certificate of Incorporation and
Amendments thereto, Exhibit 3(a) to HUSI's 1999 Annual
Report on Form 10-K incorporated herein by reference
3(ii) Registrant's By-Laws, as Amended and Restated effective
January 20, 2005
4 Instruments Defining the Rights of Security Holders,
Including Indentures, incorporated by reference to
previously filed periodic reports
12.01 Computation of Ratio of Earnings to Fixed Charges
12.02 Computation of Ratio of Earnings to Combined Fixed
Charges and Preferred Dividends
14 Code of Ethics for Senior Financial Officers
21 Subsidiaries of the Registrant:
HUSI's only significant subsidiary, as defined, is HBUS,
a state bank organized under the laws of New York State.
23 Consent of Independent Registered Public Accounting Firm
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
A current report on Form 8-K was filed with the Securities and Exchange
Commission on March 25, 2004 announcing HUSI's intention to apply with the
OCC to consolidate its banking operations under a single national charter.
A subsequent current report on Form 8-K was filed on June 28, 2004
announcing approval by the OCC.
A current report on Form 8-K was filed with the Securities and Exchange
Commission on January 5, 2005 announcing that HBUS had purchased the $12
billion domestic private label loan portfolio from HSBC Finance
Corporation on December 29, 2004.
130
S I G N A T U R E S
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HSBC USA Inc.
Registrant
- -----------------------------------
/s/ Janet L. Burak
- -----------------------------------
Janet L. Burak
Senior Executive Vice President, General Counsel
and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed on February 28, 2005 by the following persons on behalf of the
registrant and in the capacities indicated:
/s/ Roger K. McGregor William F. Aldinger III*
- ------------------------------------ Chairman of the Board
Roger K. McGregor Salvatore H. Alfiero* Director
Executive Vice President and Donald K. Boswell* Director
Chief Financial Officer James H. Cleave* Director
(Principal Financial Officer) Frances D. Fergusson* Director
Martin J. G. Glynn*
Director, President and Chief
Executive Officer
Richard A. Jalkut* Director
Peter Kimmelman* Director
/s/ Joseph R. Simpson Charles G. Meyer, Jr.* Director
- ------------------------------------ James L. Morice* Director
Joseph R. Simpson
Chief Accounting Officer
(Principal Accounting Officer) * /s/ Janet L. Burak
--------------------------------------
Janet L. Burak
Attorney-in-fact
131