CONFORMED 1.
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-7436
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
Maryland
(State of Incorporation)
13-2764867
(IRS Employer Identification No.)
452 Fifth Avenue, New York, New York 10018
(Address of principal executive offices)
(212) 525-3735
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
At April 30, 2005, all voting stock (706 shares of Common Stock, $5 par value)
is owned by an indirect wholly owned subsidiary of HSBC Holdings plc.
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HSBC USA Inc.
Form 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
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Page
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Item 1. Consolidated Financial Statements
Statement of Income .......................................... 3
Balance Sheet ................................................ 4
Statement of Changes in Shareholders' Equity ................. 5
Statement of Cash Flows ...................................... 6
Notes to Consolidated Financial Statements ................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (MD&A)
Average Balances and Interest Rates .......................... 16
Forward-Looking Statements ................................... 17
Executive Overview ........................................... 17
Basis of Reporting ........................................... 20
Results of Operations ........................................ 20
Business Segments ............................................ 27
Credit Quality ............................................... 31
Derivative Instruments and Hedging Activities ................ 34
Off-Balance Sheet Arrangements ............................... 35
Variable Interest Entities (VIEs) ............................ 36
Capital ...................................................... 36
Risk Management .............................................. 37
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........ 41
Item 4. Controls and Procedures ........................................... 41
Part II OTHER INFORMATION
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Item 1. Legal Proceedings ................................................. 42
Item 5. Other Information ................................................. 42
Item 6. Exhibits .......................................................... 42
Signature ................................................................. 43
2
Part I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
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HSBC USA Inc.
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CONSOLIDATED STATEMENT OF INCOME
Three months ended March 31,
2005 2004
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(in millions)
Interest income:
Loans ....................................................... $ 1,049 $ 613
Securities .................................................. 210 215
Trading assets .............................................. 59 33
Short-term investments ...................................... 49 18
Other ....................................................... 6 4
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Total interest income ........................................... 1,373 883
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Interest expense:
Deposits .................................................... 327 160
Short-term borrowings ....................................... 52 18
Long-term debt .............................................. 219 51
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Total interest expense .......................................... 598 229
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Net interest income ............................................. 775 654
Provision (credit) for credit losses ............................ 107 (26)
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Net interest income after provision for credit losses ........... 668 680
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Other revenues:
Trust income ................................................ 23 24
Service charges ............................................. 52 51
Other fees and commissions .................................. 145 108
Securitization revenue ...................................... 44 --
Other income ................................................ 72 47
Residential mortgage banking revenue (expense) .............. 23 (24)
Trading revenues ............................................ 96 90
Security gains, net ......................................... 23 38
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Total other revenues ............................................ 478 334
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Operating expenses:
Salaries and employee benefits .............................. 266 252
Occupancy expense, net ...................................... 42 40
Support services from HSBC affiliates ....................... 218 86
Other expenses .............................................. 128 110
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Total operating expenses ........................................ 654 488
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Income before income tax expense ................................ 492 526
Income tax expense .............................................. 176 207
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Net income ...................................................... $ 316 $ 319
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC USA Inc.
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CONSOLIDATED BALANCE SHEET
March 31, December 31,
2005 2004
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(in millions)
Assets
Cash and due from banks ..................................................... $ 4,277 $ 2,682
Interest bearing deposits with banks ........................................ 3,090 2,776
Federal funds sold and securities purchased under resale agreements ......... 2,855 3,126
Trading assets .............................................................. 16,964 19,815
Securities available for sale ............................................... 15,625 14,655
Securities held to maturity (fair value $3,716 and $4,042) .................. 3,583 3,881
Loans ....................................................................... 86,247 84,947
Less - allowance for credit losses .......................................... 773 788
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Loans, net ............................................................ 85,474 84,159
Properties and equipment, net ............................................... 584 594
Intangible assets, net ...................................................... 362 352
Goodwill .................................................................... 2,696 2,697
Other assets ................................................................ 6,095 6,313
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Total assets ................................................................ $ 141,605 $ 141,050
=========== ===========
Liabilities
Deposits in domestic offices:
Noninterest bearing ....................................................... $ 8,455 $ 7,639
Interest bearing .......................................................... 50,770 50,069
Deposits in foreign offices:
Noninterest bearing ....................................................... 300 248
Interest bearing .......................................................... 23,469 22,025
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Total deposits ........................................................ 82,994 79,981
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Trading account liabilities ................................................. 11,163 12,120
Short-term borrowings ....................................................... 7,152 9,874
Interest, taxes and other liabilities ....................................... 5,486 4,370
Long-term debt .............................................................. 23,925 23,839
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Total liabilities ........................................................... 130,720 130,184
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Shareholders' equity
Preferred stock ............................................................. 500 500
Common shareholder's equity:
Common stock ($5 par; 150,000,000 shares authorized;
706 shares issued) .................................. --(1) --(1)
Capital surplus ........................................................... 8,143 8,418
Retained earnings ......................................................... 2,227 1,917
Accumulated other comprehensive income .................................... 15 31
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Total common shareholder's equity ..................................... 10,385 10,366
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Total shareholders' equity .................................................. 10,885 10,866
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Total liabilities and shareholders' equity .................................. $ 141,605 $ 141,050
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The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
4
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' EQUITY
Three months ended March 31,
2005 2004
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in millions
Preferred stock
Balance, January 1 and March 31, .................................................. $ 500 $ 500
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Common stock
Balance, January 1 and March 31, .................................................. --(1) --(1)
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Capital surplus
Balance, January 1, ............................................................... 8,418 6,027
Capital contribution from parent .................................................. 4 5
Employee benefit plans and other .................................................. (279) (1)
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Balance, March 31, ................................................................ 8,143 6,031
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Retained earnings
Balance, January 1, ............................................................... 1,917 807
Net income ........................................................................ 316 319
Cash dividends declared:
Preferred stock ............................................................... (6) (7)
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Balance, March 31, ................................................................ 2,227 1,119
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Accumulated other comprehensive income
Balance, January 1, ............................................................... 31 128
Net change in unrealized (losses) gains on securities ............................. (120) 48
Net change in unrealized gains on derivatives classified as cash flow hedges ...... 87 12
Net change in unrealized gains on interest only strip receivables ................. 18 --
Foreign currency translation adjustments .......................................... (1) 1
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Other comprehensive (loss) income, net of tax ..................................... (16) 61
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Balance, March 31, ................................................................ 15 189
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Total shareholders' equity, March 31, ............................................. $ 10,885 $ 7,839
============ ============
Comprehensive income
Net income ........................................................................ $ 316 $ 319
Other comprehensive (loss) income ................................................. (16) 61
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Comprehensive income .............................................................. $ 300 $ 380
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
5
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF CASH FLOWS
Three months ended March 31,
2005 2004
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(in millions)
Cash flows from operating activities
Net income ......................................................................... $ 316 $ 319
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation, amortization and deferred taxes ................................. 188 178
Provision (credit) for credit losses .......................................... 107 (25)
Net change in other accrual accounts .......................................... 444 (150)
Net change in loans originated for sale ....................................... (205) (54)
Net change in trading assets and liabilities .................................. 2,094 415
Other, net .................................................................... (235) (287)
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Net cash provided by operating activities ................................ 2,709 396
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Cash flows from investing activities
Net change in interest bearing deposits with banks ................................. (430) (54)
Net change in short-term investments ............................................... 312 (1,568)
Net change in securities available for sale:
Purchases of securities available for sale .................................... (2,823) (2,228)
Proceeds from sales of securities available for sale .......................... 1,659 1,983
Proceeds from maturities of securities available for sale ..................... 1,030 1,741
Net change in securities held to maturity:
Purchases of securities held to maturity ...................................... (189) (465)
Proceeds from maturities of securities held to maturity ....................... 487 340
Net change in loans:
Net change in credit card receivables ......................................... (162) 38
Net change in other short-term loans .......................................... (184) (236)
Net originations and maturities of long-term loans ............................ (1,055) (2,923)
Loans purchased from HSBC Finance Corporation ................................. -- (870)
Sales of loans/other .......................................................... 29 60
Net change in tax refund anticipation loans program:
Net originations of loans ..................................................... (24,300) --
Sales of loans to HSBC Finance Corporation .................................... 24,298 --
Expenditures for properties and equipment .......................................... (11) (3)
Net cash provided (used) in acquisitions (disposals), net of cash acquired ......... (24) 30
Other, net ......................................................................... (156) (536)
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Net cash used in investing activities .................................... (1,519) (4,691)
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Cash flows from financing activities
Net change in deposits ............................................................. 2,990 3,851
Net change in short-term borrowings ................................................ (2,762) (685)
Net change in long-term debt:
Issuance of long-term debt .................................................... 345 1,186
Repayment of long-term debt ................................................... (166) (138)
Capital contribution from parent ................................................... 4 5
Reduction of capital surplus ....................................................... -- (1)
Dividends paid ..................................................................... (6) (7)
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Net cash provided by financing activities ................................ 405 4,211
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Net change in cash and due from banks .................................................. 1,595 (84)
Cash and due from banks at beginning of period ......................................... 2,682 2,534
------------ ------------
Cash and due from banks at end of period ............................................... $ 4,277 $ 2,450
============ ============
Cash paid for: Interest ................................................................ $ 505 $ 195
Income taxes ............................................................ 31 7
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.
6
Notes to Consolidated Financial Statements
Note 1. Organization and Basis of Presentation
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HSBC USA Inc. is an indirect wholly owned subsidiary of HSBC North America
Holdings Inc. (HNAH), which is a wholly owned subsidiary of HSBC Holdings plc
(HSBC). HNAH's other principal indirect subsidiaries include:
o HSBC Finance Corporation, a consumer finance company;
o HSBC Markets (USA) Inc. (HSBC Markets), a holding company for investment
banking and markets subsidiaries;
o HSBC Technology & Services (USA) Inc. (HTSU), a provider of information
technology services; and
o HSBC Bank Canada (HBCA), a Canadian banking subsidiary.
The accompanying unaudited consolidated financial statements of HSBC USA Inc.
and its subsidiaries (collectively, HUSI), including its principal subsidiary,
HSBC Bank USA, National Association (HBUS), have been prepared in accordance
with accounting principles generally accepted in the United States of America
(U.S. GAAP) for interim financial information, with the instructions to Form
10-Q and with Article 10 of Regulation S-X, as well as in accordance with
predominant practices within the banking industry. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all normal and recurring adjustments, considered necessary for a
fair presentation of financial position, results of operations and cash flows
for the interim periods have been made. These unaudited interim financial
statements should be read in conjunction with HUSI's Annual Report on Form 10-K
for the year ended December 31, 2004 (the 2004 Form 10-K). Certain
reclassifications have been made to prior period amounts to conform to the
current period presentations. The accounting and reporting policies of HUSI are
consistent, in all material respects, with those used to prepare the 2004 Form
10-K, except for the impact of new accounting pronouncements summarized in Note
12.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and
disclosures. Actual results could differ from those estimates. Interim results
should not be considered indicative of results in future periods.
Interim financial statement disclosures regarding business segments and
off-balance sheet arrangements are included in the Management's Discussion and
Analysis of Financial Condition and Results of Operations (MD&A) section of this
Form 10-Q.
7
Note 2. Securities
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At March 31, 2005 and December 31, 2004, HUSI held no securities of any single
issuer (excluding the U.S. Treasury and federal agencies) with a book value that
exceeded 10% of shareholders' equity.
The following tables provide a summary of the amortized cost and fair value of
the securities available for sale and securities held to maturity portfolios.
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Gross Gross
Amortized Unrealized Unrealized Fair
March 31, 2005 Cost Gains Losses Value
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(in millions)
Securities available for sale:
U.S. Treasury .................................................... $ 202 $ -- $ 7 $ 195
U.S. Government sponsored enterprises (1) ........................ 9,709 22 203 9,528
U.S. Government agency issued or guaranteed ...................... 3,471 22 75 3,418
Asset backed securities .......................................... 1,196 4 1 1,199
Other domestic debt securities ................................... 201 4 2 203
Foreign debt securities .......................................... 976 5 20 961
Equity securities ................................................ 64 59 2 121
--------- --------- --------- ---------
$ 15,819 $ 116 $ 310 $ 15,625
========= ========= ========= =========
Securities held to maturity:
U.S. Treasury .................................................... $ 84 $ -- $ -- $ 84
U.S. Government sponsored enterprises (1) ........................ 2,060 72 15 2,117
U.S. Government agency issued or guaranteed ...................... 742 41 1 782
Obligations of U.S. states and political subdivisions ............ 443 31 -- 474
Other domestic debt securities ................................... 205 6 1 210
Foreign debt securities .......................................... 49 -- -- 49
--------- --------- --------- ---------
$ 3,583 $ 150 $ 17 $ 3,716
========= ========= ========= =========
(1) Includes primarily mortgage-backed securities issued by the Federal
National Mortgage Association (FNMA) and the Federal Home Loan Mortgage
Corporation (FHLMC).
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Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
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(in millions)
Securities available for sale:
U.S. Treasury .................................................... $ 203 $ -- $ 3 $ 200
U.S. Government sponsored enterprises (1) ........................ 8,136 47 90 8,093
U.S. Government agency issued or guaranteed ...................... 3,029 32 29 3,032
Asset backed securities .......................................... 1,122 3 1 1,124
Other domestic debt securities ................................... 990 6 2 994
Foreign debt securities .......................................... 1,090 15 2 1,103
Equity securities ................................................ 64 49 4 109
--------- --------- --------- ---------
$ 14,634 $ 152 $ 131 $ 14,655
========= ========= ========= =========
Securities held to maturity:
U.S. Treasury .................................................... $ 122 $ -- $ -- $ 122
U.S. Government sponsored enterprises (1) ........................ 2,202 92 11 2,283
U.S. Government agency issued or guaranteed ...................... 716 40 2 754
Obligations of U.S. states and political subdivisions ............ 465 37 -- 502
Other domestic debt securities ................................... 231 6 1 236
Foreign debt securities .......................................... 145 -- -- 145
--------- --------- --------- ---------
$ 3,881 $ 175 $ 14 $ 4,042
========= ========= ========= =========
(1) Includes primarily mortgage-backed securities issued by the Federal
National Mortgage Association (FNMA) and the Federal Home Loan Mortgage
Corporation (FHLMC).
8
The following tables provide a summary of gross unrealized losses and related
fair values, classified as to the length of time the losses have existed.
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Less Than One Year Greater Than One Year
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Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
March 31, 2005 Securities Losses of Investment Securities Losses of Investment
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(in millions)
Securities available for sale:
U.S. Treasury ...................... 1 $ 7 $ 195 -- $ -- $ --
U.S. Government sponsored
enterprises (1) .................. 259 111 5,461 53 92 2,300
U.S. Government agency
issued or guaranteed ............. 220 34 1,548 141 41 1,053
All other securities ............... 44 23 827 1 2 4
------ ------ ------ ------ ------ ------
524 $ 175 $8,031 195 $ 135 $3,357
====== ====== ====== ====== ====== ======
Securities held to maturity:
U.S. Government sponsored
enterprises (1) .................. 10 $ 2 $ 262 10 $ 13 $ 191
U.S. Government agency
issued or guaranteed ............. -- -- -- 3 1 35
All other securities ............... 35 1 14 -- -- --
------ ------ ------ ------ ------ ------
45 $ 3 $ 276 13 $ 14 $ 226
====== ====== ====== ====== ====== ======
(1) Includes primarily mortgage-backed securities issued by FNMA and FHLMC.
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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
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(in millions)
Securities available for sale:
U.S. Treasury ...................... 1 $ 3 $ 200 -- $ -- $ --
U.S. Government sponsored
enterprises (1) .................. 78 36 3,118 51 54 1,344
U.S. Government agency
issued or guaranteed ............. 62 11 646 115 18 532
All other securities ............... 31 6 487 21 3 103
------ ------ ------ ------ ------ ------
172 $ 56 $4,451 187 $ 75 $1,979
====== ====== ====== ====== ====== ======
Securities held to maturity:
U.S. Government sponsored
enterprises (1) .................. 8 $ 2 $ 163 12 $ 9 $ 247
U.S. Government agency
issued or guaranteed ............. 4 1 27 3 1 34
All other securities ............... 7 1 5 -- -- --
------ ------ ------ ------ ------ ------
19 $ 4 $ 195 15 $ 10 $ 281
====== ====== ====== ====== ====== ======
(1) Includes primarily mortgage-backed securities issued by FNMA and FHLMC.
The gross unrealized losses on securities available for sale increased during
the three months ended March 31, 2005 due to the impact of a general increase in
interest rates on fixed rate securities. Since substantially all of these
securities are high credit grade (i.e., AAA or AA), and HUSI has the ability and
intent to hold these securities until maturity or a market price recovery, these
securities are not considered to be other than temporarily impaired.
9
Note 3. Loans
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The following table shows the composition of the loan portfolio.
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March 31, December 31,
2005 2004
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(in millions)
Domestic:
Commercial:
Construction and mortgage loans ........................... $ 8,563 $ 8,281
Other business and financial .............................. 12,015 11,815
Consumer:
Residential mortgages ..................................... 47,610 46,775
Credit card receivables ................................... 12,001 12,078
Other consumer loans ...................................... 3,152 3,122
International ...................................................... 2,906 2,876
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Total loans ........................................................ $ 86,247 $ 84,947
========= =========
Note 4. Allowance for Credit Losses
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The following provides a summary of changes in the allowance for credit losses.
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Quarter ended March 31 2005 2004
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(in millions)
Balance at beginning of quarter .................................... $ 788 $ 399
Allowance related to acquisitions and (dispositions), net .......... -- (9)
Charge offs ........................................................ 199 29
Recoveries ......................................................... 77 22
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Net charge offs .............................................. 122 7
--------- ---------
Provision charged (credited) to income ............................. 107 (26)
--------- ---------
Balance at end of quarter .......................................... $ 773 $ 357
========= =========
Further analysis of credit quality and the allowance for credit losses are
presented on pages 31-33 of this Form 10-Q.
10
Note 5. Intangible Assets, Net
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The following table summarizes the composition of intangible assets.
- ------------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
2005 2004
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(in millions)
Mortgage servicing rights, net of accumulated amortization and valuation allowance ............ $ 320 $ 309
Favorable lease arrangements, net of accumulated depreciation ................................. 42 43
--------- ---------
Intangible assets, net ........................................................................ $ 362 $ 352
========= =========
Mortgage Servicing Rights (MSRs)
The following table summarizes activity for MSRs and the related valuation
allowance.
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Three months ended March 31 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Beginning balance ....................................................................... $ 416 $ 526
Additions related to loan sales ......................................................... 13 16
Net MSRs sales .......................................................................... -- (56)
Permanent impairment charges ............................................................ (9) (1)
Amortization ............................................................................ (19) (26)
--------- ---------
Ending balance .......................................................................... 401 459
--------- ---------
Valuation allowance for MSRs:
Beginning balance ....................................................................... (107) (23)
Temporary impairment (provision) recovery ............................................... 17 (62)
Permanent impairment charges ............................................................ 9 1
Release of allowance related to MSRs sold ............................................... -- 3
--------- ---------
Ending balance .......................................................................... (81) (81)
--------- ---------
MSRs, net of accumulated amortization and valuation allowance ................................. $ 320 $ 378
========= =========
Normal amortization for the current MSRs portfolios is expected to be
approximately $78 million for the year ending December 31, 2005, declining
gradually to approximately $34 million for the year ending December 31, 2009.
Actual levels of amortization could increase or decrease depending upon changes
in interest rates and loan prepayment activity. Actual levels of amortization
are also dependent upon future levels of MSRs recorded.
Favorable Lease Arrangements
Favorable lease arrangements resulted from various business acquisitions.
Scheduled amortization of favorable lease arrangements will approximate $5
million per year for 2005 through 2009.
Note 6. Goodwill
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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. During the first quarter of 2005, there were no events or
transactions which warrant consideration for their impact on recorded book
values assigned to goodwill.
11
Note 7. Income Taxes
- --------------------------------------------------------------------------------
The following table presents HUSI's effective tax rates.
- --------------------------------------------------------------------------------
Three months ended March 31 2005 2004
- --------------------------------------------------------------------------------
Effective tax rate ............................... 35.8% 39.4%
In the first quarter of 2005, HUSI finalized certain prior year state and local
tax returns and recorded a $20 million reduction of income tax expense, which
represents the difference between its previous estimate of tax liability and the
liability per the tax returns.
During the first quarter of 2005, the prepaid pension asset previously carried
on the balance sheet of HUSI was transferred to HNAH. The related deferred tax
liability of approximately $203 million was also transferred to HNAH resulting
in a significantly lower deferred tax liability as of March 31, 2005.
Note 8. Long-Term Debt
- --------------------------------------------------------------------------------
The following table presents a summary of long-term debt.
- --------------------------------------------------------------------------------
March 31, December 31,
2005 2004
- --------------------------------------------------------------------------------
(in millions)
Senior debt ...................................... $ 18,929 $ 18,831
Subordinated debt ................................ 4,976 4,988
All other ........................................ 20 20
--------- ---------
Total long-term debt ............................. $ 23,925 $ 23,839
========= =========
Note 9. Related Party Transactions
- --------------------------------------------------------------------------------
In the normal course of business, HUSI conducts transactions with HSBC and its
subsidiaries (HSBC affiliates). These transactions occur at prevailing market
rates and terms. All extensions of credit by HUSI to other HSBC affiliates are
legally required to be secured by eligible collateral. The following table
presents related party balances and the income and expense generated by related
party transactions.
- --------------------------------------------------------------------------------
March 31, December 31,
2005 2004
- --------------------------------------------------------------------------------
(in millions)
Assets:
Interest bearing deposits with banks ....... $ 97 $ 436
Loans ...................................... 1,537 828
Trading assets ............................. 3,096 3,167
Other ...................................... 159 752
--------- ---------
Total assets ............................... $ 4,889 $ 5,183
========= =========
Liabilities:
Deposits ................................... $ 11,113 $ 9,759
Trading account liabilities ................ 4,865 5,704
Short-term borrowings ...................... 1,139 1,089
Other ...................................... 180 77
--------- ---------
Total liabilities .......................... $ 17,297 $ 16,629
========= =========
12
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Three months ended March 31 2005 2004
- -------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income ............................................................. $ 1 $ 3
Interest expense ............................................................ 63 21
Trading losses .............................................................. (321) (127)
Other revenues .............................................................. 36 10
Support services from HSBC affiliates:
Fees paid to HTSU for technology services ............................. 48 39
Fees paid to HSBC Finance Corporation ................................. 106 4
Other fees, primarily treasury and traded markets services ............ 64 43
The following business transactions conducted with HSBC Finance Corporation
impacted operations during the first quarter of 2005.
o Trading losses primarily represent the mark to market of the intercompany
components of interest rate and foreign currency derivative swap
transactions entered into with HSBC Finance Corporation. Specifically,
HSBC Finance Corporation enters into these swap contracts with HUSI in
order to hedge its interest rate positions. HUSI, within its Corporate,
Investment Banking and Markets business, accounts for these transactions
on a mark to market basis, with the change in value on the intercompany
component substantially offset by the mark to market of related contracts
entered into with HSBC affiliates and third parties.
o In December of 2004, approximately $12 billion of loans, primarily private
label credit card receivables, were purchased from HSBC Finance
Corporation. Residual interests in securitized private label credit card
receivable pools of approximately $3 billion were also acquired. HSBC
Finance Corporation retained the customer relationships and continues to
service the loans. By agreement, HUSI is purchasing additional receivables
generated under current and future private label accounts at fair value on
a daily basis. During the first quarter of 2005, approximately $4 billion
of additional receivables were acquired from HSBC Finance Corporation at a
premium of $103 million, which is being amortized to interest income over
the estimated life of the receivables purchased.
o During the quarter ended March 31, 2005, HUSI purchased approximately $781
million of consumer loans, primarily domestic residential mortgage loans,
at fair value from originating lenders pursuant to HSBC Finance
Corporation correspondent loan programs.
o In July of 2004, in order to centralize the servicing of credit card
receivables within a common HSBC affiliate in the United States, certain
consumer credit card customer relationships of HUSI were sold to HSBC
Finance Corporation. Receivable balances associated with these
relationships were not sold as part of the transaction. New receivable
balances generated by these relationships are purchased at fair value from
HSBC Finance Corporation on a daily basis. During the quarter ended March
31, 2005, approximately $467 million of receivables associated with these
relationships were purchased from HSBC Finance Corporation at a premium of
approximately $8 million, which is being amortized to interest income over
the estimated life of the receivables purchased. Servicing for the
majority of these relationships was also transferred to HSBC Finance
Corporation.
o Support services from HSBC affiliates includes charges by HSBC Finance
Corporation under various service level agreements for loan origination
and servicing as well as other operational and administrative support.
o Effective October 1, 2004, HBUS is the originating lender for a federal
income tax refund anticipation loan program for clients of various third
party tax preparers, which is managed by HSBC Finance Corporation. By
agreement, HBUS processes applications, funds and subsequently sells these
loans to HSBC Finance Corporation. During the quarter ended March 31,
2005, approximately $24 billion of loans were originated by HUSI and sold
to HSBC Finance Corporation, resulting in gains of approximately $17
million and fees paid to HSBC Finance Corporation of $3 million.
o At March 31, 2005, HUSI had a $2 billion line of credit with HSBC Finance
Corporation, of which $600 million was outstanding and included in
short-term borrowings.
13
Effective January 1, 2004, HUSI's technology services employees, as well as
technology services employees from other HSBC affiliates in North America, were
transferred to HTSU. HTSU charges HUSI for technology services pursuant to a
master service level agreement. These charges are included in other expenses as
HSBC affiliate charges.
HUSI utilizes HSBC Markets primarily for debt underwriting and for other
treasury and traded markets related services, pursuant to service level
agreements. Debt underwriting fees charged by HSBC Markets are deferred as a
component of long-term debt and amortized to interest expense over the life of
the related debt. All other fees charged by HSBC Markets are included in support
services from HSBC affiliates.
At March 31, 2005, HUSI had an unused line of credit with HSBC of $1,500
million.
At March 31, 2005 and December 31, 2004, the aggregate notional amounts of all
derivative contracts with other HSBC affiliates were approximately $355 billion
and $302 billion respectively. The net credit risk exposure related to these
contracts was approximately $2 billion at both March 31, 2005 and December 31,
2004.
Employees of HUSI participate in one or more stock compensation plans sponsored
by HSBC. HUSI's share of the expense of the plans for the first three months of
2005 and 2004 was $9 million and $19 million respectively. A description of
these plans begins on page 99 of HUSI's 2004 Form 10-K.
Note 10. Pledged Assets
- --------------------------------------------------------------------------------
The following table presents pledged assets included in the consolidated balance
sheet.
- --------------------------------------------------------------------------------
March 31, December 31,
2005 2004
- --------------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks .......... $ 1,047 $ 767
Trading assets ................................ 283 305
Securities available for sale ................. 5,813 6,096
Securities held to maturity ................... 577 655
Loans ......................................... 6,041 5,971
--------- ---------
Total ......................................... $ 13,761 $ 13,794
========= =========
Note 11. Pensions and Other Postretirement Benefits
- --------------------------------------------------------------------------------
Through December 31, 2004, HUSI maintained noncontributory defined benefit
pension plans covering substantially all of their employees hired prior to
January 1, 1997 and those employees who joined HUSI through acquisitions and
were participating in a defined benefit plan at the time of acquisition. Certain
other HSBC subsidiaries participate in these plans.
In addition, through December 31, 2004, HUSI also maintained unfunded
noncontributory health and life insurance coverage for all employees who retired
from HUSI and were eligible for immediate pension benefits from HUSI's
retirement plan. Employees retiring after 1992 will absorb a portion of the cost
of these benefits. Employees hired after that same date are not eligible for
these benefits. A premium cap has been established for HUSI's share of retiree
medical cost.
In November 2004, sponsorship of the U.S. defined benefit pension plans and the
health and life insurance plan of HUSI and HSBC Finance Corporation were
transferred to HNAH. Effective January 1, 2005, the separate U.S. defined
benefit pension plans were merged into a single defined benefit pension plan
which facilitates the development of a unified employee benefit policy and
unified employee benefit plan administration for HSBC affiliates operating in
the U.S. As a result, HUSI's prepaid pension asset of $482 million, and a
related deferred tax liability of $203 million, were transferred to HNAH. The
net transfer amount of $279 million is reflected as a reduction of capital
surplus on the consolidated statement of changes in shareholders' equity.
14
The following table presents the components of net periodic benefit cost as
allocated to HUSI from HNAH.
- ------------------------------------------------------------------------------------------------------------------
Other
Postretirement
Pension Benefits Benefits
---------------------- ---------------------
Three months ended March 31 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
(in millions)
Net periodic benefit cost:
Service cost ................................. $ 11 $ 7 $ 1 $ 1
Interest cost ................................ 17 15 2 2
Expected return on plan assets ............... (25) (20) -- --
Prior service cost amortization .............. -- -- -- --
Actuarial loss ............................... 1 7 -- --
Transition amount amortization ............... -- -- 1 1
------ ------ ------ ------
Net periodic benefit cost .................... $ 4 $ 9 $ 4 $ 4
====== ====== ====== ======
Amount recorded as pension expense by:
HUSI ......................................... $ 1 $ 3
Other HSBC affiliates ........................ 3 6
------ ------
$ 4 $ 9
====== ======
HUSI expects to make no contribution for pension benefits and to contribute
approximately $10 million for other postretirement benefits during fiscal year
2005.
Note 12. New Accounting Pronouncements
- --------------------------------------------------------------------------------
In March 2004, the Financial Accounting Standards Board (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 annual reporting periods
ending after June 15, 2004, and the new impairment guidance was to become
effective for reporting periods beginning after June 15, 2004. In September
2004, the FASB delayed the effective date of EITF 03-1 for measurement and
recognition of impairment losses until implementation guidance is issued.
Adoption of the impairment guidance contained in EITF 03-1 is not expected to
have a material impact on HUSI's financial position or results of operations.
In December 2004, FASB issued Statement of Financial Accounting Standards No.
123 (Revised), Share-Based Payment (SFAS 123R). SFAS 123R requires public
entities to measure the cost of stock-based compensation based on the grant date
fair value of the award, as well as other disclosure requirements. On March 28,
2005, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin 107 which amended the compliance date to allow public companies to
comply with the provisions of SFAS 123R at the beginning of their next fiscal
year that begins after June 15, 2005, instead of the next reporting period as
originally required by SFAS 123R. HUSI was substantially in compliance with SFAS
123R as of December 31, 2004, and will be entirely compliant by the required
adoption date. The adoption of SFAS 123R therefore will not have a significant
effect on operating results.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (MD&A)
- --------------------------------------------------------------------------------
HSBC USA Inc.
- --------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES
The following table shows the average balances of the principal components of
assets, liabilities and shareholders' equity, together with their respective
interest amounts and rates earned or paid, presented on a taxable equivalent
basis.
Three Months Ended March 31,
---------------------------------------------------------------------------
2005 2004
----------------------------------- -----------------------------------
Balance Interest Rate* Balance Interest Rate*
- ------------------------------------------------------------------------------------------------------------------------------------
Assets (in millions)
Interest bearing deposits with banks ............... $ 3,850 $ 25 2.61% $ 1,577 $ 6 1.59%
Federal funds sold and securities purchased
under resale agreements .......................... 3,639 24 2.66 4,002 11 1.15
Trading assets ..................................... 18,379 59 1.28 15,708 33 0.85
Securities ......................................... 18,318 214 4.73 18,162 220 4.86
Loans
Domestic
Commercial ..................................... 19,167 229 4.84 15,061 165 4.40
Consumer
Residential mortgages ..................... 47,463 579 4.88 27,645 358 5.18
Credit cards .............................. 12,169 158 5.26 1,126 29 10.19
Other consumer ............................ 3,645 62 6.93 2,045 33 6.49
--------- --------- ----- --------- --------- -----
Total domestic ............................... 82,444 1,028 5.06 45,877 585 5.12
International .................................... 3,336 21 2.58 3,876 29 3.05
--------- --------- ----- --------- --------- -----
Total loans .................................. 85,780 1,049 4.96 49,753 614 4.96
--------- --------- ----- --------- --------- -----
Other .............................................. 583 6 4.40 490 4 3.31
--------- --------- ----- --------- --------- -----
Total earning assets ............................... 130,549 $ 1,377 4.28% 89,692 $ 888 3.98%
--------- --------- ----- --------- --------- -----
Allowance for credit losses ........................ (894) (391)
Cash and due from banks ............................ 4,013 3,095
Other assets ....................................... 8,416 7,240
--------- ---------
Total assets ....................................... $ 142,084 $ 99,636
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ................................. $ 27,090 $ 51 0.76% $ 26,636 $ 45 0.68%
Other time deposits .............................. 23,478 148 2.56 11,696 53 1.82
Deposits in foreign offices ........................ 23,445 128 2.21 21,445 62 1.17
--------- --------- ----- --------- --------- -----
Total interest bearing deposits .................... 74,013 327 1.79 59,777 160 1.08
--------- --------- ----- --------- --------- -----
Short-term borrowings .............................. 8,896 52 2.40 8,540 18 0.83
Long-term debt ..................................... 23,870 219 3.72 3,952 51 5.17
--------- --------- ----- --------- --------- -----
Total interest bearing liabilities ................. 106,779 598 2.27 72,269 229 1.27
--------- --------- ----- --------- --------- -----
Net interest income / Interest rate spread ......... $ 779 2.01% $ 659 2.71%
--------- ----- --------- -----
Noninterest bearing deposits ....................... 9,766 7,190
Other liabilities .................................. 14,596 12,550
Total shareholders' equity ......................... 10,943 7,627
--------- ---------
Total liabilities and shareholders' equity ......... $ 142,084 $ 99,636
========= =========
Net yield on average earning assets ................ 2.42% 2.96%
----- -----
Net yield on average total assets .................. 2.22 2.66
===== =====
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest for the
first quarter of 2005 and first quarter of 2004 included fees of $8 million and
$17 million, respectively.
16
FORWARD-LOOKING STATEMENTS
- --------------------------------------------------------------------------------
The MD&A should be read in conjunction with the consolidated financial
statements, notes and tables included elsewhere in this Form 10-Q and with
HUSI's 2004 Form 10-K. The MD&A may contain certain statements that may be
forward-looking in nature within the meaning of the Private Securities
Litigation Reform Act of 1995. HUSI's results may differ materially from those
noted in the forward-looking statements. Words such as "believe", "expects",
"estimates", "targeted", "anticipates", "goal" and similar expressions are
intended to identify forward-looking statements but should not be considered as
the only means through which these statements may be made. Statements that are
not historical facts, including statements about management's beliefs and
expectations, are forward-looking statements which involve inherent risks and
uncertainties and are based on current views and assumptions. A number of
factors could cause actual results to differ materially from those contained in
any forward-looking statements. For a list of important factors that may affect
HUSI's actual results, see Cautionary Statement on Forward-Looking Statements in
Part I, Item 1 of HUSI's 2004 Form 10-K.
EXECUTIVE OVERVIEW
- --------------------------------------------------------------------------------
Net income decreased $3 million in the first quarter of 2005, as compared with
the same 2004 period. Increased interest income and other revenues
associated with the private label loan portfolio acquired from HSBC Finance
Corporation in December 2004 were more than offset by amortization of the
premium paid for the portfolio, and by increased provision for credit losses
associated with the acquired portfolio. This resulted in reduced pre-tax income
for HUSI's Consumer Finance business segment. Strong revenue growth within other
business units materially offset the reduced Consumer Finance results.
Although total assets grew less than 1% during the first quarter of 2005,
average assets increased 43% in the quarter, as compared with the same 2004
period, reflecting the significant loans growth experienced during calendar year
2004.
Private Label Loan Portfolio Purchase
In December of 2004, HUSI acquired approximately $12 billion of loans, primarily
private label credit card receivables, from HSBC Finance Corporation at fair
value, without recourse. The resulting increase in interest income for the first
quarter of 2005 was significantly reduced by amortization of the initial premium
paid for the portfolios. Although the amortization period for the initial
premium paid is two years, amortization is heavily "front loaded" for 2005 in
relation to expected runoff of the loan balances. Credit card interest income
was especially impacted by this portfolio acquisition, as addressed on page 21
of this Form 10-Q.
Residual interests in securitized credit card receivable pools of approximately
$3 billion were also acquired, from which approximately $44 million of
securitization revenue was recorded in the first quarter of 2005. Refer to Other
Revenues on page 23 of this Form 10-Q for further discussion of this revenue.
Potential acquisitions of Mastercard and Visa receivables from HSBC Finance
Corporation will be considered in the future based upon continuing evaluation of
capital and liquidity at each entity.
Balance Sheet Review
Asset growth slowed to more normalized levels during the first quarter of 2005,
as compared with calendar year 2004. Total deposit growth of $3 billion during
the quarter was the primary funding source for increased loans and decreased
short-term borrowings.
HUSI utilizes borrowings from various sources to fund balance sheet growth, to
meet cash and capital needs, and to fund investments in subsidiaries. Total
long-term debt was approximately $24 billion at March 31, 2005 and December 31,
2004. Total deposits and borrowings from HSBC affiliates were $12 billion and
$11 billion at March 31, 2005 and December 31, 2004 respectively.
17
Average earning assets and interest bearing liabilities increased significantly
during the first quarter of 2005, as compared with the same 2004 period,
primarily due to:
o increased average residential loan balances from held portfolio growth in
2004;
o increased average loan balances resulting from the private label loan
portfolio purchase previously noted;
o increased average loan and deposit balances resulting from targeted growth
in small business and middle-market commercial customers; and
o increased average balances for deposits, long-term debt and short-term
borrowings, which were the primary funding sources for asset growth during
2004.
Income Statement Review
Increased net interest income in the first quarter of 2005, as compared with
2004, was primarily due to significantly increased interest income associated
with increased average loan balances noted above, partially offset by increased
interest expense associated with increased average balances for deposits and
long-term debt.
The provision for credit losses increased during the first quarter of 2005, as
compared with the same 2004 period, primarily due to additional provision for
credit losses associated with the loans acquired in December 2004 from HSBC
Finance Corporation.
Other revenues increased in the first quarter of 2005, as compared with 2004,
primarily due to:
o increased credit card and other fee income associated with the acquired
private label loan portfolio;
o increased securitization revenue associated with securitized trusts
acquired as part of the private label loan portfolio;
o increased residential mortgage banking revenue; and
o gains on sale of tax refund anticipation loans to HSBC Finance
Corporation's Taxpayer Financial Services business.
Operating expenses increased in the first quarter of 2005, as compared with
2004, primarily due to increased fees charged by various HSBC affiliates for
technology services, for broker-dealer services, for loan origination and
servicing, and for other operational and administrative support functions.
Further commentary regarding support services from HSBC affiliates is provided
in Note 9 of the consolidated financial statements beginning on page 12 of this
Form 10-Q.
Decreased income tax expense is primarily attributable to a $20 million
reduction of expense resulting from the difference between the estimate of
prior year state and local tax liability and the liability per final tax
returns.
18
The following table presents a five quarter summary of selected financial
information.
- ------------------------------------------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
Quarter ended 2005 2004 2004 2004 2004
- ------------------------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ............................ $ 775 $ 700 $ 698 $ 689 $ 654
--------- --------- --------- --------- ---------
Trading revenues ............................... 96 99 21 78 90
Residential mortgage banking revenue
(expense) .................................... 23 (14) (65) (17) (24)
Securities gains, net .......................... 23 26 18 3 38
Other income ................................... 336 214 388 234 230
--------- --------- --------- --------- ---------
Total other revenues ........................... 478 325 362 298 334
--------- --------- --------- --------- ---------
Operating expenses ............................. 654 613 480 520 488
Provision (credit) for credit losses ........... 107 (24) 27 6 (26)
--------- --------- --------- --------- ---------
Income before income tax expense ............... 492 436 553 461 526
Income tax expense ............................. 176 167 214 130 207
--------- --------- --------- --------- ---------
Net income ..................................... $ 316 $ 269 $ 339 $ 331 $ 319
========= ========= ========= ========= =========
Balances at quarter end:
Loans:
Commercial loans ......................... $ 23,484 $ 22,972 $ 20,869 $ 19,557 $ 19,072
Residential mortgages .................... 47,610 46,775 42,958 38,982 29,953
Credit card receivables .................. 12,001 12,078 1,127 1,093 1,052
Other consumer loans ..................... 3,152 3,122 2,086 2,434 2,355
--------- --------- --------- --------- ---------
Total loans .............................. 86,247 84,947 67,040 62,066 52,432
Allowance for credit losses .............. (773) (788) (340) (347) (357)
--------- --------- --------- --------- ---------
Loans, net ............................... 85,474 84,159 66,700 61,719 52,075
Total assets ................................... 141,605 141,050 120,939 112,791 102,502
Total tangible assets .......................... 138,866 138,310 118,195 109,982 99,678
Total deposits ................................. 82,994 79,981 74,803 74,534 67,994
Short-term borrowings .......................... 7,152 9,874 7,967 8,499 5,906
Long-term debt ................................. 23,925 23,839 15,618 7,135 4,871
Common shareholder's equity .................... 10,385 10,366 8,053 7,315 7,339
Tangible common shareholder's equity ........... 7,646 7,611 5,336 4,673 4,341
Total shareholders' equity ..................... 10,885 10,866 8,553 7,815 7,839
Selected financial ratios:
Total shareholders' equity to total
assets ......................................... 7.69% 7.70% 7.07% 6.93% 7.65%
Tangible common shareholder's equity
to total tangible assets ..................... 5.51 5.50 4.51 4.25 4.36
Rate of return on (1):
Total assets ............................. .90 .84 1.17 1.26 1.29
Total common shareholder's equity ........ 12.05 12.62 17.68 17.96 17.65
Net interest margin to (1):
Earning assets ........................... 2.42 2.38 2.65 2.91 2.96
Total assets ............................. 2.22 2.19 2.42 2.63 2.66
Total shareholders' equity to total
assets (1) ................................... 7.70 6.88 6.96 7.34 7.65
Cost:income ratio (1) .......................... 52.17 59.70 45.28 52.63 49.48
(1) Selected financial ratios are defined in the Glossary of Terms beginning
on page 60 of the 2004 Form 10-K.
19
BASIS OF REPORTING
- --------------------------------------------------------------------------------
HUSI's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States (U.S. GAAP).
International Financial Reporting Standards (IFRS)
Prior to January 1, 2005, HSBC reported results in accordance with accounting
principles generally accepted in the United Kingdom (U.K. GAAP). The European
Union has determined that all European listed companies will be required to
prepare their consolidated financial statements using IFRS by 2005. As a result,
HSBC has announced that it will begin reporting its financial results under IFRS
rather than U.K. GAAP beginning with its release of interim financial results
for the six months ended June 30, 2005. Therefore, beginning in the second
quarter of 2005, HUSI will present a reconciliation of U.S. GAAP net income to
IFRS net income for the six months ended June 30, 2005 and on a quarterly basis
thereafter.
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Net Interest Income
- -------------------
The following table presents a five quarter summary of net interest income.
- --------------------------------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
Three months ended 2005 2004 2004 2004 2004
- --------------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans ................................... $ 1,049 $ 851 $ 779 $ 669 $ 614
Securities .............................. 210 218 220 215 215
Trading assets .......................... 59 51 43 38 33
Short-term investments .................. 49 52 27 18 17
Other ................................... 6 5 5 4 4
-------- -------- -------- -------- --------
Total interest income ................... 1,373 1,177 1,074 944 883
-------- -------- -------- -------- --------
Interest expense:
Deposits ................................ 327 281 226 158 160
Short-term borrowings ................... 52 20 59 35 18
Long-term debt .......................... 219 176 91 62 51
-------- -------- -------- -------- --------
Total interest expense .................. 598 477 376 255 229
-------- -------- -------- -------- --------
Net interest income ........................... $ 775 $ 700 $ 698 $ 689 $ 654
======== ======== ======== ======== ========
In the discussion that follows, interest income and rates are presented and
analyzed on a taxable equivalent basis to permit comparisons of yields on
tax-exempt and taxable assets. An analysis of consolidated average balances and
interest rates on a taxable equivalent basis is presented on page 16 of this
Form 10-Q.
All increases and decreases referenced below for the first quarter of 2005
represent comparisons with the same 2004 period.
Interest Income - Loans
Total interest income on loans increased $435 million (71%) in the first quarter
of 2005. Average total loan balances increased approximately $36 billion (72%)
in the quarter, resulting from significant increases in various consumer and
commercial loan portfolios during 2004.
In addition to significant organic residential mortgage loan growth, loans and
receivables acquired directly from HSBC Finance Corporation, and from
originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs, have had a significant impact on interest income for the first quarter
of 2005. Increases in average
20
loan balances, and the resulting increases in interest income, were reduced by
significant amortization of premiums paid for the specific portfolios, most
notably private label credit card receivables acquired from HSBC Finance
Corporation in December 2004.
Residential Mortgage Loans
Interest income earned from residential mortgage loans increased $221 million
(62%) in the first quarter of 2005. HUSI significantly expanded the volume of
adjustable rate residential mortgage loans originated during 2004, which were
retained in its held loan portfolio. As a result, average residential mortgage
loans held increased approximately $20 billion (72%) in the first quarter of
2005.
Since the beginning of 2004, approximately $4 billion of residential mortgages
have been purchased from HSBC Finance Corporation and from originating lenders
pursuant to an HSBC Finance Corporation correspondent loan program. Originations
of residential mortgage loans have decreased to more moderate levels in 2005 as
compared with 2004, due to the contracting national originations market.
The increased average loan balances, and their positive effect on earnings, were
partially offset by continued decreases in the average yield earned on
residential mortgages during the first quarter of 2005, as consumers continued
to take advantage of lower coupon adjustable rate products, resulting in lower
overall average yields.
The residential mortgage loan portfolio is expected to remain relatively
constant through the remainder of 2005. Loan originations, including those
resulting from the relationship with HSBC Finance Corporation, are expected to
be offset by the fact that HUSI has begun selling a significant portion of
variable rate residential mortgage originations, which previously would have
been retained in the held loan portfolio.
Credit Card Receivables
Interest earned from credit card receivables increased $129 million (445%) in
the first quarter of 2005. Average credit card receivable balances increased $11
billion (981%) for the quarter.
In December of 2004, HUSI acquired the $12 billion private label loan portfolio
from HSBC Finance Corporation, which consisted primarily of credit card
receivables. HUSI continues to purchase additional credit card receivables on a
daily basis from customer relationships owned by HSBC Finance Corporation. For
the first quarter of 2005, these additional purchased receivables were offset by
customer payments and net charge offs of customer balances, resulting in minimal
additional change in total credit card receivables.
During the first quarter of 2005, the increase in interest income associated
with the acquired portfolio was offset by approximately $166 million of
amortization of the premium paid, which significantly reduced the overall
average yield for credit card receivables in the quarter.
Other Consumer Loans
Interest earned from various other domestic consumer lending programs increased
$29 million (88%) in the first quarter of 2005. Average balances increased
approximately $1.6 billion (78%) in the first quarter of 2005, primarily due to
automobile and other consumer loans purchased directly from HSBC Finance
Corporation, or from originating lenders pursuant to HSBC Finance Corporation
correspondent loan programs.
Commercial Loans
Interest income from commercial loans increased $64 million (39%) in the first
quarter of 2005. Average commercial loan balances increased $4 billion (27%) in
the quarter.
Targeted growth in small business, middle market and real estate lending
portfolios, which began in 2004, has continued to increase loan balances in
2005. HUSI plans to continue to build upon its status as the top small business
lender in New York State.
21
Approximately $200 million of commercial loans were purchased directly from HSBC
Finance Corporation in December 2004. After amortization of purchase premium,
this acquired portfolio had a nominal impact on interest income for the first
quarter of 2005.
Interest Income - Trading Assets
Interest income from trading assets increased $26 million (79%) in the first
quarter of 2005. During the quarter, average trading assets increased
approximately $3 billion (17%), while the average yield earned on these balances
also increased 43 basis points (51%).
Interest Income - Short-Term Investments
Short-term investments include interest bearing deposits with banks, federal
funds sold and securities purchased under resale agreements.
Interest income from short-term investments increased $32 million (188%) in the
first quarter of 2005. Average short-term investment balances grew $2 billion
(34%) in the quarter, while average rates earned also increased significantly,
primarily due to increases in the federal funds rate.
Interest Expense - Deposits
Total interest expense on interest bearing deposits increased $167 million
(104%) in the first quarter of 2005. Interest expense increases were noted from
both domestic and foreign deposits. Average interest bearing deposits increased
$14 billion (24%) in the quarter. Average interest rates paid to these customers
also increased significantly in the first quarter of 2005, due to increases in
short-term interest rates.
Additional resources and priority have been focused on core retail banking
businesses, as well as high net worth individuals. Additional deposit products
have been developed and offered in recent months, in conjunction with increased
marketing efforts, to individuals, small businesses, and middle market
commercial customers. Investment in the retail branch network has been, and will
continue to be, expanded and reallocated to ensure coverage of high potential
growth geographic areas. Continuation of these programs, coupled with additional
product expansion and marketing efforts, are key growth initiatives for 2005.
Interest Expense - Short-Term Borrowings
Interest expense on short-term borrowings increased $34 million (189%) in the
first quarter of 2005. Average short-term borrowings balances increased
nominally (4%) in the quarter, while the average interest rate paid increased
significantly, due primarily to increases in the federal funds rate.
Interest Expense - Long-Term Debt
Interest expense on long-term debt increased $168 million (329%) in the first
quarter of 2005. Average long-term debt balances increased $20 billion (504%) in
the quarter, due primarily to new debt issued during 2004 to fund balance sheet
growth. A decrease in the average interest rate paid on long-term debt, which
resulted from new debt being issued at significantly lower rates than existing
debt, partially offset the average balance increases. For a summary of long-term
debt outstanding, refer to Note 8 of the consolidated financial statements on
page 12 of this Form 10-Q.
22
Other Revenues
- --------------
The following table presents the components of other revenues.
- --------------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
------------------------
Three months ended March 31 2005 2004 Amount %
- --------------------------------------------------------------------------------------------------------------------------
(in millions)
Trust income .......................................... $ 23 $ 24 $ (1) (4)
Service charges:
HSBC affiliate income ........................... 4 5 (1) (20)
Other service charges ........................... 48 46 2 4
------ ------ ------ ------
Total service charges ........................... 52 51 1 2
------ ------ ------ ------
Other fees and commissions:
Letter of credit fees ........................... 17 17 -- --
Credit card fees ................................ 57 18 39 217
Wealth and tax advisory services ................ 13 10 3 30
HSBC affiliate income ........................... 12 4 8 200
Other fee-based income .......................... 46 59 (13) (22)
------ ------ ------ ------
Total other fees and commissions ................ 145 108 37 34
------ ------ ------ ------
Securitization revenue ................................ 44 -- 44 --
Other income:
Insurance ....................................... 16 10 6 60
HSBC affiliate income ........................... 20 1 19 1,900
Other ........................................... 36 36 -- --
------ ------ ------ ------
Total other income .............................. 72 47 25 53
------ ------ ------ ------
Residential mortgage banking revenue (expense) ........ 23 (24) 47 196
Trading revenues ...................................... 96 90 6 7
Securities gains, net ................................. 23 38 (15) (39)
------ ------ ------ ------
Total other revenues .................................. $ 478 $ 334 $ 144 43
====== ====== ====== ======
Other Fees and Commissions
The increase in other fees and commissions in the first quarter of 2005
primarily resulted from credit card fees generated by the private label loan
portfolio acquired from HSBC Finance Corporation in December 2004.
Other Income
Securitization revenue in the first quarter of 2005 resulted directly from the
purchase of residual interests in securitized credit card receivables from HSBC
Finance Corporation in December 2004. Securitization revenue is comprised of the
following activity during the quarter:
- ------------------------------------------------------------------------------------
(in millions)
Net replenishment gains, net of provision for credit losses ........... $ 20
Servicing revenue and excess spread ................................... 24
-------
Total ................................................................. $ 44
=======
The securitized trusts require replenishments of receivables to support
previously issued securities. Receivables will continue to be sold to these
trusts until their revolving periods end, the last of which is expected to occur
in 2008. The replenishment gains result from these receivable sales to the
trusts.
The increase in HSBC affiliate income was primarily due to HBUS's new role,
effective October 2004, as originating lender for HSBC Finance Corporation's
Taxpayer Financial Services program.
HUSI has agreed to sell property to an unaffiliated third party for a gain of
approximately $29 million. It is anticipated that this sale will be completed
sometime during the second quarter of 2005.
23
Residential Mortgage Banking Revenue
The following table presents the components of residential mortgage banking
revenue. Net interest income includes interest earned/paid on assets and
liabilities of the residential mortgage banking business as well as an
allocation of the funding benefit or cost associated with these balances. The
net interest income component in the table is included in net interest income in
the consolidated statement of income and reflects actual interest earned, net of
cost of funds, and adjusted for corporate transfer pricing. Corporate transfer
pricing methodology was revised in the first quarter of 2005 resulting in
additional internal charges to the residential mortgage banking business from
the Corporate, Investment Banking and Markets business segment. Net interest
income for the first quarter of 2004 has been adjusted in the table to
facilitate an accurate comparison.
- -----------------------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
--------------------
Three months ended March 31 2005 2004 Amount %
- -----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Net interest income ............................................................ $ 129 $ 110 $ 19 17
------- ------- ------- -------
Servicing related income (expense):
Servicing fee income ..................................................... 19 22 (3) (14)
MSRs amortization ........................................................ (19) (26) 7 27
MSRs temporary impairment (provision) recovery ........................... 17 (62) 79 127
Trading - Derivative instruments used to offset changes in
value of MSRs .......................................................... (5) 36 (41) (114)
Gains on sales of available for sale securities .......................... -- 8 (8) (100)
------- ------- ------- -------
Total net servicing related income (expense) ............................. 12 (22) 34 155
------- ------- ------- -------
Originations and sales related income (expense):
Gains on sales of mortgages .............................................. 3 1 2 200
Trading - Forward loan sale commitments .................................. 8 (3) 11 367
- Interest rate lock commitments ................................. (4) (1) (3) (300)
Fair value hedge activity (1) ............................................ -- 1 (1) (100)
------- ------- ------- -------
Total net originations and sales related income (expense) ................ 7 (2) 9 450
------- ------- ------- -------
Other mortgage income .......................................................... 4 -- 4 --
------- ------- ------- -------
Total residential mortgage banking revenue (expense) included
in other revenues ............................................................ 23 (24) 47 196
------- ------- ------- -------
Total residential mortgage banking related revenue ............................. $ 152 $ 86 $ 66 77
======= ======= ======= =======
(1) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity.
Overview
Residential mortgage banking related revenue for the first three months of 2005
increased $66 million compared with the same 2004 period.
All increases and decreases referenced below for the first quarter of 2005
represent comparisons with the same 2004 period.
Net Interest Income
Increased net interest income for the first quarter of 2005 resulted from
overall growth in the held residential mortgage portfolio. Throughout 2004 there
was a significant increase in the held portfolio as strong consumer demand for
variable rate residential mortgage loans continued. Commentary regarding
residential mortgage interest income is presented on page 21 of this Form 10-Q.
24
Servicing Related Income (Expense)
Increased net servicing related income (expense) for the first three months of
2005 was attributable to decreased MSR amortization expense and increased
recoveries of the temporary impairment valuation allowance. These were partially
offset by decreases in income associated with derivative instruments used to
offset changes in the economic value of MSRs.
The recorded net book value of MSRs, as well as related amortization expense,
are directly impacted by levels of residential mortgage prepayments. Higher
levels of prepayments generally increase amortization expense and decrease the
net book value of MSRs. During the first three months of 2005, prepayments of
residential mortgages, mostly in the form of loan refinancings, have decreased
in comparison with 2004 levels, resulting in decreased MSR amortization expense
and increased recoveries of temporary MSR impairment compared with amounts
recorded in prior periods. Mortgage rates generally rose through the first
quarter of 2005 with loan refinance activity representing 45% of total
originations in the quarter, as compared with 58% in the first three months of
2004 when rates declined.
The positive impacts on MSR amortization and recoveries of the temporary
impairment valuation allowance resulting from higher interest rates were offset
by decreases in the value of derivative instruments used to offset changes in
the economic value of MSRs. The net servicing related income amounts in the
tables do not reflect approximately $11 million of unrealized losses, recorded
as other comprehensive income, on available for sale securities used to offset
changes in the economic value of MSRs as well as net interest income of $2
million on these securities.
Additional commentary regarding risk management associated with the MSRs hedging
program is presented on pages 39-40 of this Form 10-Q.
Originations and Sales Related Income (Expense)
The overall increase in originations and sales related income in the first three
months of 2005 was attributable to an increase in the volume of loans originated
for sale, and a higher basis point gain on each individual sale driven by less
market volatility as compared with 2004. During the first three months of 2005,
residential mortgages originated with the intention to sell increased 13% from
the same 2004 period. A larger volume of adjustable rate residential mortgage
loans is being sold in 2005, which previously would have been held on HUSI's
balance sheet.
Trading Revenues
Trading revenues are generated by HUSI's participation in the foreign exchange,
credit derivative and precious metals markets; from trading derivative
contracts, including interest rate swaps and options; and from trading
securities. Trading revenues related to the mortgage banking business are
included in residential mortgage banking revenue.
The following table presents trading related revenues by business. The data in
the table includes interest income earned on trading instruments, net of
allocated funding cost associated with the trading positions. The net interest
income component is included in net interest income on the consolidated
statement of income.
- ----------------------------------------------------------------------------------------------------------------
Increase (Decrease)
------------------------
Three months ended March 31 2005 2004 Amount %
- ----------------------------------------------------------------------------------------------------------------
(in millions)
Trading revenues .................................. $ 96 $ 90 $ 6 7
Net interest income ............................... 17 17 -- --
-------- -------- -------- --------
Trading related revenues .......................... $ 113 $ 107 $ 6 6
======== ======== ======== ========
Business:
Derivatives instruments ..................... $ 41 $ 43 $ (2) (5)
Treasury (primarily securities) ............. 14 1 13 1300
Foreign exchange ............................ 37 34 3 9
Precious metals ............................. 17 17 -- --
Other trading ............................... 4 12 (8) (67)
-------- -------- -------- --------
Trading related revenues .......................... $ 113 $ 107 $ 6 6
======== ======== ======== ========
25
Improved trading results in the first quarter of 2005 were primarily driven by
increased securities trading activity. In recent months, HUSI's CIBM business
segment has expanded operations and securities products offered to clients,
which has resulted in increased activity and improved results.
Security Gains, Net
The following table presents realized security gains and losses included in the
consolidated statement of income.
- ----------------------------------------------------------------------------------------------------------------------------
2005 2004
-------------------------------- ----------------------------------
Gross Gross Net Gross Gross Net
Realized Realized Realized Realized Realized Realized
Three months ended March 31 Gains (Losses) Gains Gains (Losses) Gains
- ----------------------------------------------------------------------------------------------------------------------------
(in millions)
Net security gains included in:
Residential mortgage banking
related revenue .......................... $ -- $ -- $ -- $ 8 $ -- $ 8
Security gains, net ........................ 23 -- 23 44 (6) 38
------- ------- ------- ------- ------- -------
$ 23 $ -- $ 23 $ 52 $ (6) $ 46
======= ======= ======= ======= ======= =======
HUSI maintains various securities portfolios as part of its overall liquidity,
balance sheet diversification and risk management strategy. During the first
quarter of 2005, approximately $12 million of gains were realized on securities
sold to address interest rate sensitivity and balance sheet diversification
needs, as compared with gains of $30 million for the same 2004 period. Also in
the first quarter of 2005, HUSI realized $10 million of gains on Latin American
securities, which were sold in order to reduce its foreign credit risk, as
compared with $16 million for the first quarter of 2004.
Operating Expenses
- ------------------
The following table presents the components of operating expenses.
- ----------------------------------------------------------------------------------------------------------------------------
Increase (Decrease)
------------------------
Three months ended March 31 2005 2004 Amount %
- ----------------------------------------------------------------------------------------------------------------------------
(in millions)
Salaries and employee benefits ............................ $ 266 $ 252 $ 14 6
Occupancy expense, net .................................... 42 40 2 5
Support services from HSBC affiliates:
Fees paid to HTSU for technology services ........... 48 39 9 23
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support ........ 106 4 102 2,550
Other fees, primarily treasury and traded
markets services .................................. 64 43 21 49
------- ------- ------- -------
218 86 132 153
------- ------- ------- -------
Other expenses:
Equipment and software .............................. 24 29 (5) (17)
Marketing ........................................... 14 11 3 27
Outside services .................................... 26 24 2 8
Professional fees ................................... 14 8 6 75
Telecommunications .................................. 5 4 1 25
Postage, printing and office supplies ............... 6 6 -- --
Insurance business .................................. 6 3 3 100
Other ............................................... 33 25 8 32
------- ------- ------- -------
Total other expenses ................................ 128 110 18 16
------- ------- ------- -------
Total operating expenses .................................. $ 654 $ 488 $ 166 34
======= ======= ======= =======
Personnel - average number ................................ 10,830 12,018 (1,188) (10)
All increases and decreases referred to below for the first quarter of 2005
represent comparisons with the same 2004 periods.
26
Overview
Total operating expenses increased $166 million (34%) in the first quarter of
2005. Increases in various HSBC affiliate charges and in salaries and employee
benefits were the primary drivers of increased expenses.
Salaries and Employee Benefits
Salaries and employee benefits increased approximately 6% in the first quarter
of 2005. Increased payroll taxes and fringe benefit expenses were partially
offset by the impact on salaries of a decrease in the average number of
personnel employed and by decreased incentive compensation expenses.
During 2004, HUSI transferred its brokerage subsidiary and most of its branch
operations in Panama to HSBC affiliates, resulting in decreased salaries and
related expenses, which were offset by business unit expansions in regional
banking, residential mortgage banking, and treasury and traded markets
businesses.
Support Services From HSBC Affiliates
Fees are charged by various related HSBC affiliate entities for technology
services, for underwriting and broker-dealer services, for loan origination and
servicing, and for other operational and administrative support functions.
Additional details regarding HSBC affiliate charges are presented in Note 9 of
the consolidated financial statements beginning on page 12 of this Form 10-Q.
The overall increases in HSBC affiliate charges are due primarily to the
following activity:
o fees charged by HTSU for technology services expenses increased in the
first quarter of 2005, as HUSI continued to upgrade its automated
technology environment;
o fees charged by HSBC Finance Corporation for loan origination and
servicing expenses have increased significantly due to increased services
related to various loan portfolios and other loan balances acquired from
HSBC Finance Corporation, and from their correspondents, in 2004. Fees
charged by HSBC Finance Corporation for various administrative services
have also increased as a result of specific initiatives to centralize
administrative functions; and
o increased fees charged by HSBC Markets and other HSBC affiliates for
treasury and traded markets services provided to HUSI's CIBM business
segment.
BUSINESS SEGMENTS
- --------------------------------------------------------------------------------
Business segments are managed consistently with the line of business groupings
used by HSBC. The segments are based upon customer groupings, products and
services offered.
The Personal Financial Services (PFS), Commercial Banking (CMB), Corporate,
Investment Banking and Markets (CIBM), Private Banking (PB) and Other segments
are described on pages 5-6 of HUSI's 2004 Form 10-K. Effective for the first
quarter of 2005, the table below reflects a new business segment, Consumer
Finance (CF), which was reported as a component of PFS in prior periods. The CF
segment includes point of sale and other lending activities primarily to meet
the financial needs of individuals. Specifically, operating activity within the
CF segment relates to various consumer loans and retained interests in
securitized receivable trusts purchased from HSBC Finance Corporation, and from
originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs, begun in 2003.
The net interest income component in the following table reflects actual
interest earned, net of cost of funds as determined by corporate transfer
pricing methodology. The corporate transfer pricing methodology was revised in
the first quarter of 2005 resulting in additional internal charges to the
residential mortgage banking business, included in PFS, from CIBM. Net interest
income for the first quarter of 2004 has been adjusted in the table to
facilitate an accurate comparison. As a result, net interest income for CIBM and
PFS have been increased and decreased, respectively, by approximately $39
million for the quarter ended March 31, 2004.
27
The following table summarizes the results for each segment.
- ------------------------------------------------------------------------------------------------------------------------
Three months ended
March 31 PFS CF CMB CIBM PB Other Total
- ------------------------------------------------------------------------------------------------------------------------
(in millions)
2005
Net interest income (1) ..... $ 300 $ 130 $ 154 $ 154 $ 40 $ (3) $ 775
Other revenues .............. 128 80 38 167 58 7 478
------- ------- ------- ------- ------- ------- -------
Total revenues .............. 428 210 192 321 98 4 1,253
Operating expenses (2) ...... 251 107 98 134 64 -- 654
------- ------- ------- ------- ------- ------- -------
Working contribution ........ 177 103 94 187 34 4 599
Provision for credit losses (3) 22 109 (5) (18) (1) -- 107
------- ------- ------- ------- ------- ------- -------
Income before income
tax expense ............... $ 155 $ (6) $ 99 $ 205 $ 35 $ 4 $ 492
======= ======= ======= ======= ======= ======= =======
Average assets .............. $50,752 $18,282 $14,920 $53,101 $ 4,720 $ 309 $142,084
Average liabilities/
equity (4) ................ 43,733 533 16,176 72,243 9,399 -- 142,084
Goodwill at March 31 (5) .... 1,169 -- 468 631 428 -- 2,696
2004
Net interest income (1) ..... $ 268 $ 37 $ 142 $ 179 $ 31 $ (3) $ 654
Other revenues .............. 63 -- 37 166 61 7 334
------- ------- ------- ------- ------- ------- -------
Total revenues .............. 331 37 179 345 92 4 988
Operating expenses (2) ...... 230 2 86 108 62 -- 488
------- ------- ------- ------- ------- ------- -------
Working contribution ........ 101 35 93 237 30 4 500
Provision for credit
losses (3) ................ 17 2 (9) (34) (2) -- (26)
------- ------- ------- ------- ------- ------- -------
Income before income
tax expense ............... $ 84 $ 33 $ 102 $ 271 $ 32 $ 4 $ 526
======= ======= ======= ======= ======= ======= =======
Average assets .............. $33,082 $ 2,795 $13,069 $46,779 $ 3,614 $ 297 $99,636
Average liabilities/
equity (4) ................ 31,623 (1) 12,656 46,011 9,347 -- 99,636
Goodwill at March 31 (5) .... 1,223 -- 495 631 428 -- 2,777
(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 March 31, 2004 to March 31, 2005 resulted
from the sale or transfer of certain domestic and foreign operations
during 2004.
All increases and decreases referred to below for the first quarter 2005
represent comparisons with the same 2004 period.
The term "interest rate spread", as used in the following commentary, refers to
either:
o the percentage difference between the interest rate earned on earning
assets, net of amortized premiums and loan fees, and the cost of funds
utilized to fund those assets, as calculated using corporate transfer
pricing methodology; or
o the percentage difference between the interest rate paid on deposits
specifically assigned to a business segment and the associated value of
funds as calculated using corporate transfer pricing methodology.
28
Personal Financial Services (PFS)
Net interest income increased $32 million (12%) in the first quarter of 2005,
due primarily to:
o significant growth in average balances for residential mortgage and other
consumer loan portfolios; and
o a more favorable net interest rate spread on deposits.
Other revenues increased $65 million (103%) in the first quarter of 2005, due
primarily to the following:
o non-interest residential mortgage banking revenue increased $47 million in
the quarter. See commentary regarding residential mortgage banking revenue
beginning on page 24 of this Form 10-Q; and
o effective in October 2004, HBUS is the originating lender for HSBC Finance
Corporation's Taxpayer Financial Services program. Gains recognized for
tax refund anticipation loans sold to HSBC Finance Corporation were
approximately $17 million in the first quarter of 2005.
Operating expenses increased $21 million in the first quarter of 2005, due
primarily to:
o increased direct expenses associated with expanded residential mortgage
banking, other consumer lending and retail banking operations; and
o increased fees paid to HTSU, as HUSI has continued to upgrade its
technology environment.
Consumer Finance (CF)
Net interest income increased $93 million (251%) in the first quarter of 2005,
due primarily to average loan growth associated with loans and receivables
acquired in 2004 from HSBC Finance Corporation, and from originating lenders
pursuant to HSBC Finance Corporation correspondent loan programs. Refer to the
Executive Overview on page 17 of this Form 10-Q for further discussion.
Other revenues increased $80 million in the first quarter of 2005, due primarily
to:
o additional credit card and other fees from loans and receivables acquired
from HSBC Finance Corporation; and
o securitization revenue from residual interests in securitized credit card
receivables acquired from HSBC Finance Corporation in December 2004.
Operating expenses increased $105 million in the first quarter of 2005, due
primarily to increased fees paid to HSBC Finance Corporation for loan
origination and servicing.
The provision for credit losses increased $107 million, which resulted from the
private label loan portfolio acquired from HSBC Finance Corporation in December
2004. Refer to commentary regarding credit quality beginning on page 31 of this
Form 10-Q.
As previously discussed, new domestic private label credit card receivable
originations are purchased from HSBC Finance Corporation on a daily basis. In
the second half of 2005, the required minimum monthly payment amounts for these
accounts will be revised, in accordance with Federal Financial Institutions
Examination Council guidance. Changes to the minimum monthly payment amounts
will likely reduce the premiums associated with the daily purchases of
receivables, beginning in 2006. The magnitude of the impact is currently being
assessed and will depend on the actual payment patterns of customers after the
change and other factors that are difficult to predict or quantify.
Commercial Banking (CMB)
Net interest income and operating expenses increased $12 million (8%) and $12
million (14%) respectively, in the first quarter of 2005. These increases
resulted from planned expansion of various small business, middle-market and
real estate commercial lending programs. CMB also benefited from more favorable
interest rate spreads on deposits during the quarter. Increased expenses also
resulted from increased fees paid to HTSU for technology services as HUSI has
continued to upgrade its technology environment.
29
Corporate, Investment Banking and Markets (CIBM)
Net interest income decreased $25 million (14%) in the first quarter of 2005.
Recent increases in short-term interest rates, which have favorably impacted
interest rate spreads for deposit generating businesses such as PFS and CMB, had
an adverse impact on CIBM funding costs in the first quarter of 2005.
Increased trading revenues and other fee-based income were offset by reduced
gains on sale of securities, resulting in a nominal net change in other
revenues.
Operating expenses increased $26 million (24%) in the first quarter of 2005, due
to:
o increased direct expenses associated with expanded operations in foreign
exchange, risk management products, and transaction banking business;
o increased expenses associated with development of an infrastructure to
support the growing complexity of the CIBM business;
o increased fees paid to HTSU for technology services, as CIBM required
additional information technology resources to support system conversions
and business expansion; and
o partially offsetting the above increases was a decrease in compensation
expense resulting from a change in the amortization period utilized for
share-based compensation.
The provision for credit losses increased $16 million in the first quarter of
2005. The net provision credit of $34 million for the first quarter of 2004
reflected a period of unusually low loan charge offs and relatively high
recoveries of amounts previously charged off. The net provision credit of $18
million for the first quarter of 2005 resulted from continuation of relatively
low charge offs, and a specific $17 million recovery of a loan previously
charged off.
Private Banking (PB)
Net interest income increased $9 million (29%) in the first quarter of 2005.
Average earning assets associated with this segment, primarily domestic earning
assets, increased approximately 38% for the quarter. Nominal increases in
operating expenses and provision for credit losses were also noted for the
quarter. Additional priority and resources have been allocated to this segment
to expand services provided to high net worth domestic and foreign individuals.
During the first quarter of 2005, HUSI recognized a nominal gain on the sale of
a portion of its personal trust business which was recorded in other revenues.
During the first quarter of 2004, HUSI realized higher revenue from a foreign
equity investment, recorded in other revenues, as compared with the first
quarter of 2005.
30
CREDIT QUALITY
- --------------------------------------------------------------------------------
HUSI's policies and critical estimates associated with its allowance for credit
losses are summarized on pages 15, 37-38 and 77-78 of HUSI's 2004 Form 10-K.
There have been no material revisions to policies or methodologies in the first
quarter of 2005.
The following table provides an analysis of changes in the allowance for credit
losses and related ratios.
- ------------------------------------------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
Quarter ended 2005 2004 2004 2004 2004
- ------------------------------------------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of quarter ........................... $ 788 $ 340 $ 347 $ 357 $ 399
Allowance related to acquisitions and
(dispositions), net ..................................... -- 505 (11) -- (9)
Charge offs:
Commercial ....................................... 6 22 18 11 3
Consumer:
Residential mortgages ......................... 4 5 2 3 6
Credit card receivables ....................... 159 17 17 16 15
Other consumer loans .......................... 30 6 6 5 5
-------- -------- -------- -------- --------
Total consumer loans .......................... 193 28 25 24 26
-------- -------- -------- -------- --------
Total charge offs ................................ 199 50 43 35 29
-------- -------- -------- -------- --------
Recoveries on loans charged off:
Commercial ....................................... 23 12 16 14 18
Consumer:
Residential mortgages ......................... -- 1 -- 1 --
Credit card receivables ....................... 44 2 2 2 2
Other consumer loans .......................... 10 2 2 2 2
-------- -------- -------- -------- --------
Total consumer loans .......................... 54 5 4 5 4
-------- -------- -------- -------- --------
Total recoveries ................................ 77 17 20 19 22
-------- -------- -------- -------- --------
Total net charge offs ............................... 122 33 23 16 7
-------- -------- -------- -------- --------
Provision charged (credited) to income .............. 107 (24) 27 6 (26)
-------- -------- -------- -------- --------
Balance at end of quarter ........................... $ 773 $ 788 $ 340 $ 347 $ 357
======== ======== ======== ======== ========
Allowance ratios:
Annualized net charge offs to average
loans .......................................... .58% .19% .14% .11% .06%
Quarter-end allowance to:
Quarter-end total loans ....................... .90% .93% .51% .56% .68%
Quarter-end total nonaccruing loans ........... 318.11% 298.48% 117.24% 116.05% 108.51%
31
The following table provides a summary of credit quality statistics.
- ---------------------------------------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
2005 2004 2004 2004 2004
- ---------------------------------------------------------------------------------------------------------------------------------
(in millions)
Nonaccruing loans
Balance at end of period:
Domestic:
Construction and other real estate .............. $ 28 $ 33 $ 24 $ 32 $ 30
Other commercial ................................ 87 103 136 153 200
------- ------- ------- ------- -------
Total commercial ................................ 115 136 160 185 230
------- ------- ------- ------- -------
Residential mortgages ........................... 116 113 94 77 66
Credit card receivables ......................... -- -- 19 20 20
Other consumer loans ............................ -- 1 1 2 2
------- ------- ------- ------- -------
Total consumer loans ............................ 116 114 114 99 88
------- ------- ------- ------- -------
Total domestic ..................................... 231 250 274 284 318
------- ------- ------- ------- -------
International ...................................... 12 14 16 15 11
------- ------- ------- ------- -------
Total nonaccruing loans ............................... $ 243 $ 264 $ 290 $ 299 $ 329
======= ======= ======= ======= =======
As a percent of loans:
Domestic:
Construction and other real estate .............. .33% .40% .30% .42% .41%
Other commercial ................................ .72 .87 1.37 1.71 2.33
------- ------- ------- ------- -------
Total commercial ................................ .56 .68 .90 1.11 1.44
------- ------- ------- ------- -------
Residential mortgages ........................... .24 .24 .22 .20 .22
Credit card receivables ......................... -- -- 1.69 1.83 1.90
Other consumer loans ............................ -- .03 .05 .10 .11
------- ------- ------- ------- -------
Total consumer loans ............................ .18 .18 .25 .24 .27
------- ------- ------- ------- -------
Total domestic ..................................... .28 .30 .43 .48 .65
International ...................................... .41 .49 .53 .44 .31
------- ------- ------- ------- -------
Total ................................................. .28% .31% .43% .48% .63%
======= ======= ======= ======= =======
Interest income on nonaccruing loans
(quarterly total):
Amount which would have been recorded
had the associated loans been current in
accordance with their original terms ................ $ 5 $ 6 $ 5 $ 5 $ 7
Amount actually recorded .............................. 3 5 5 4 3
Accruing loans contractually past due 90 days
or more as to principal or interest:
Total commercial ...................................... $ 13 $ 13 $ 15 $ 6 $ 12
------- ------- ------- ------- -------
Residential mortgages ................................. 1 1 2 1 1
Credit card receivables ............................... 210 223 3 2 --
Other consumer loans .................................. 15 22 16 13 10
------- ------- ------- ------- -------
Total consumer loans ............................... 226 246 21 16 11
Total accruing loans contractually past due
90 days or more ...................................... $ 239 $ 259 $ 36 $ 22 $ 23
======= ======= ======= ======= =======
Criticized assets (balance at end of period):
Special mention ....................................... $ 728 $ 784 $ 734 $ 673 $ 707
Substandard ........................................... 535 590 383 532 632
Doubtful .............................................. 34 46 67 66 87
------- ------- ------- ------- -------
Total ................................................. $ 1,297 $ 1,420 $ 1,184 $ 1,271 $ 1,426
======= ======= ======= ======= =======
Impaired loans:
Balance at end of period .............................. $ 119 $ 236 $ 252 $ 281 $ 314
Amount with impairment reserve ........................ 96 210 233 263 296
Impairment reserve .................................... 21 18 38 38 61
Other real estate and owned assets:
Balance at end of period .............................. $ 20 $ 15 $ 14 $ 17 $ 16
Ratio of total nonaccruing loans, other real
estate and owned assets to total assets ............. .19% .20% .25% .28% .34%
32
Overview
The allowance for credit losses decreased $15 million during the first quarter
of 2005. The provision for credit losses of $107 million was more than offset by
total net charge offs of $122 million during the quarter.
The allowance for credit losses increased $416 million from March 31, 2004 to
March 31, 2005, primarily due to the addition of reserves associated with the
acquisition of approximately $12 billion of loans, primarily private label
credit card receivables, from HSBC Finance Corporation in December of 2004.
Commercial Loan Credit Quality
The allowance for credit losses associated with commercial loan portfolios
decreased $9 million during the first quarter of 2005. Net recoveries of $17
million during the quarter were more than offset by a $26 million credit in the
provision for loan losses associated with commercial loans.
General improvement of commercial loan credit quality continued during the first
quarter, as evidenced by decreased nonaccruing loan balances, decreased
criticized asset balances, decreased impaired loans balances, a relatively low
level of charge offs, and a relatively high level of recoveries of balances
previously charged off.
HUSI expects that a more normalized commercial credit environment for the
remainder of 2005 will result in lower recoveries and higher provision expense.
Although overall commercial credit quality is expected to remain stable and well
controlled, any sudden and/or unexpected adverse economic events or trends could
significantly affect credit quality and increase provisions for credit losses.
Credit Card Receivable Credit Quality
The allowance for credit losses associated with credit card receivables
decreased $7 million during the first quarter of 2005. Net charge offs of $115
million were substantially offset by provision expense for the quarter of $108
million. This activity is a direct result of the $12 billion private label loan
portfolio acquired from HSBC Finance Corporation in December of 2004, which
primarily consisted of credit card receivables. The acquired portfolio is
considered to be prime credit quality, with historical credit losses ranging
from 5%-6% over the past few years.
The following table provides credit quality data for credit card receivables.
The March 31, 2004 data pertains to HUSI's credit card portfolio held prior to
acquisition of the private label portfolio.
- ---------------------------------------------------------------------------------------------------------------------------------
March 31, December 31, March 31,
2005 2004 2004
- ---------------------------------------------------------------------------------------------------------------------------------
(in millions)
Accruing balances contractually past due 90 days or more:
Balance at end of quarter ................................................... $ 210 $ 223 $ --
As a percent of total credit card receivables ............................... 1.74% 1.85% --%
Allowance for credit losses associated with credit card receivables:
Balance at end of quarter ................................................... $ 541 $ 548 $ 46
As a percent of total credit card receivables ............................... 4.51% 4.54% 4.37%
Net charge offs of credit card receivables:
Total for the quarter ended ................................................. $ 115 $ 15 $ 13
As a percent of average credit card receivables for the quarter ............. .95% 1.01% 1.15%
Receivables included in the private label credit card portfolio are generally
maintained in accruing status until being charged off six months after
delinquency.
Other Consumer Loan Credit Quality
The allowance for credit losses associated with residential mortgage and other
consumer loans was unchanged for the first quarter of 2005, as net charge offs
of $24 million were offset by the same amount of provision expense. Net charge
offs and the provision for credit losses increased $15 million and $11 million
respectively, as compared with the prior quarter, due to activity associated
with loans acquired from HSBC Finance Corporation during 2004.
33
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
- --------------------------------------------------------------------------------
HUSI is party to various derivative financial instruments as an end user, as an
international dealer in derivative instruments, and for purely trading purposes
in order to realize profits from short-term movements in interest rates,
commodity prices, foreign exchange rates and credit spreads. Additional
information regarding the use of various derivative instruments is included on
pages 79-80 and pages 107-109 of HUSI's 2004 Form 10-K.
Notional Values of Derivative Contracts
The following table summarizes the notional values of derivative contracts.
- --------------------------------------------------------------------------------
March 31, December 31,
2005 2004
- --------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards ..................... $ 74,626 $ 79,830
Swaps .................................... 1,361,052 1,219,657
Options written .......................... 131,469 105,582
Options purchased ........................ 153,886 90,635
---------- ----------
1,721,033 1,495,704
---------- ----------
Foreign exchange:
Swaps, futures and forwards .............. 268,420 234,424
Options written .......................... 33,053 42,719
Options purchased ........................ 34,254 43,200
Spot ..................................... 38,836 21,927
---------- ----------
374,563 342,270
---------- ----------
Commodities, equities and precious metals:
Swaps, futures and forwards .............. 50,932 40,876
Options written .......................... 11,814 10,648
Options purchased ........................ 13,193 11,729
Credit derivatives ....................... 187,372 135,937
---------- ----------
263,311 199,190
---------- ----------
Total .......................................... $2,358,907 $2,037,164
========== ==========
Credit and Market Risk Associated with Derivative Contracts
The notional value of derivative contracts only provides an indicator of the
transaction volume in these types of instruments. It does not represent exposure
to market or credit risks under these contracts.
Credit (or repayment) risk in derivative instruments is minimized by entering
into transactions with high quality counterparties including other HSBC group
entities. Counterparties include financial institutions, government agencies,
both foreign and domestic, corporations, funds (mutual funds, hedge funds,
etc.), insurance companies and private clients. These counterparties are subject
to regular credit review by the credit risk management department. Most
derivative contracts are governed by an International Swaps and Derivatives
Association Master Agreement. Depending on the type of counterparty and the
level of expected activity, bilateral collateral arrangements may be required as
well.
34
The following table presents credit risk exposure and net fair value associated
with derivative contracts. Total fair value of derivative receivables reflects
revaluation gains from the marking to market of derivative contracts held for
trading purposes, for all counterparties with an International Swaps and
Derivatives Association Master Agreement in place. The net fair value of all
derivative contracts represents the total fair value previously described, less
the net liability balance representing revaluation losses from the marking to
market of derivative contracts held for trading purposes.
- -----------------------------------------------------------------------------------------------------------
March 31, December 31,
2005 2004
- -----------------------------------------------------------------------------------------------------------
(in millions)
Credit risk exposure associated with derivative contracts:
Total fair value of derivative receivables ...................... $ 8,246 $ 9,607
Collateral held against exposure ................................ (3,366) (4,091)
---------- ----------
Net credit risk exposure .............................................. $ 4,880 $ 5,516
========== ==========
Net fair value of all derivative contracts ............................ $ (476) $ (249)
========== ==========
OFF-BALANCE SHEET ARRANGEMENTS
- --------------------------------------------------------------------------------
The following table provides maturity information related to off-balance sheet
arrangements and lending and sales commitments. Descriptions of these
arrangements are found on pages 43-44 of HUSI's 2004 Form 10-K.
- -------------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
March 31, 2005 or Less Five Years Years Total
- -------------------------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations ......... $ 3,521 $ 1,857 $ 155 $ 5,533(1)
Commercial letters of credit ............................. 881 27 -- 908
Loan sales with recourse ................................. -- 1 9 10(2)
Credit derivative contracts .............................. 1,844 88,530 10,866 101,240(3)
Commitments to extend credit:
Commercial ......................................... 21,558 18,219 2,532 42,309
Consumer ........................................... 5,962 -- -- 5,962
Commitments to deliver mortgage backed securities ........ 2,832 -- -- 2,832
Securities lending indemnifications ...................... 5,101 -- -- 5,101
--------- --------- --------- ---------
Total .................................................... $ 41,699 $ 108,634 $ 13,562 $ 163,895
========= ========= ========= =========
(1) Includes $398 million issued for the benefit of related parties.
(2) $8 million of this amount is indemnified by third parties.
(3) Includes $12,546 million issued for the benefit of related parties.
Letters of Credit
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Included in other
liabilities are deferred fees on standby letters of credit, representing the
fair value of the "stand ready obligation to perform" under these guarantees,
amounting to $18 million and $15 million at March 31, 2005 and December 31, 2004
respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit of $22 million and $28 million at
March 31, 2005 and December 31, 2004 respectively.
Securities Lending Indemnifications
HUSI may lend securities of customers, on a fully collateralized basis, as an
agent to third party borrowers. Customers are indemnified against the risk of
loss, and collateral is obtained from the borrower with a market value exceeding
the value of the loaned securities. At March 31, 2005, the fair value of that
collateral was approximately $5,206 million.
35
VARIABLE INTEREST ENTITIES (VIEs)
- --------------------------------------------------------------------------------
The following table provides information for unconsolidated VIEs at March 31,
2005. Descriptions of these VIE relationships are included in pages 111-112 of
HUSI's 2004 Form 10-K.
- --------------------------------------------------------------------------------
Maximum
Total Exposure
March 31, 2005 Assets to Loss
- --------------------------------------------------------------------------------
(in millions)
Asset backed commercial paper conduits ............. $ 6,869 $ 5,339
Securitization vehicles ............................ 1,034 551
Investment funds ................................... 3,908 109
Capital funding vehicles ........................... 1,115 32
Low income housing tax credits ..................... 986 134
--------- ---------
Total .............................................. $ 13,912 $ 6,165
========= =========
Asset Backed Commercial Paper Conduits
In the normal course of business, HUSI provides liquidity facilities to asset
backed commercial paper conduits sponsored by unrelated third parties. HUSI does
not transfer 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 March 31, 2005. These facilities
are excluded from the table summarizing HUSI's involvement in VIEs.
CAPITAL
- --------------------------------------------------------------------------------
The following table presents the capital ratios of HUSI and HBUS calculated in
accordance with banking regulations. To be categorized as "well-capitalized"
under the Federal Reserve Board and Federal Deposit Insurance Corporation
guidelines, a banking institution must have the minimum ratios reflected in the
table, and must not be subject to a directive, order, or written agreement to
meet and maintain specific capital levels.
- -----------------------------------------------------------------------------------------------------------------
"Well-Capitalized" March 31, December 31,
Minimum 2005 2004
- -----------------------------------------------------------------------------------------------------------------
Total capital (to risk weighted assets)
HUSI ............................................... 10.00% 12.47% 12.53%
HBUS ............................................... 10.00 12.51 12.46
Tier 1 capital (to risk weighted assets)
HUSI ............................................... 6.00 8.37 8.34
HBUS ............................................... 6.00 8.72 8.66
Tier 1 capital (to average assets)
HUSI ............................................... 3.00 6.48 7.20
HBUS ............................................... 5.00 6.78 7.51
Tangible common equity (to risk weighted assets)
HUSI ............................................... 7.11 7.07
HBUS ............................................... 8.75 8.69
36
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Overview
Some degree of risk is inherent in virtually all of HUSI's activities. For the
principal activities undertaken by HUSI, the most important types of risks are
considered to be credit, interest rate, market, liquidity, operational,
fiduciary and reputational. Market risk broadly refers to price risk inherent in
mark to market positions taken on trading and non-trading instruments.
Operational risk technically includes legal and compliance risk. However, since
compliance risk, including anti-money laundering (AML) risk, has such broad
scope within HUSI's businesses, it is addressed as a separate functional
discipline. During the first three months of 2005, there have been no
significant changes in policies or approach for managing various types of risk.
Liquidity Management
HUSI's approach to address liquidity risk is summarized on pages 49-50 of HUSI's
2004 Form 10-K.
HUSI's ability to regularly attract wholesale funds at a competitive cost is
enhanced by strong ratings from the major credit ratings agencies. Long-term
credit ratings are unchanged from December 31, 2004.
HUSI periodically issues capital instruments to fund balance sheet growth, to
meet cash and capital needs, or to fund investments in subsidiaries. In April
2005, HUSI issued 20,700,000 floating rate non-cumulative preferred shares.
Total proceeds of this issuance, net of transaction fees, were approximately
$500 million.
Commentary regarding growth and composition of the consolidated balance sheet is
provided on pages 17-18 of this Form 10-Q.
Interest Rate Risk Management
Various techniques are utilized to quantify and monitor risks associated with
the repricing characteristics of HUSI's assets, liabilities, and derivative
contracts. The approach toward managing interest rate risk is summarized on
pages 51-56 of HUSI's 2004 Form 10-K. During the first quarter of 2005, there
were no significant changes in policies or approach for managing interest rate
risk.
Present Value of a Basis Point (PVBP) Analysis
PVBP is the change in value of the balance sheet for a one basis point upward
movement in all interest rates. The following table reflects the PVBP position
at March 31, 2005.
- -------------------------------------------------------------------------------------------------------------------
March 31, 2005
Values
- -------------------------------------------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit ................................................................ +/- $ 6.5
PVBP position at period end ...................................................................... (3.4)
Capital at Risk
Capital at risk is the change in base case valuation of the balance sheet for
either a 200 basis point gradual rate increase or a 100 basis point gradual rate
decrease. The projected changes in valuation are reflected on an after tax
basis. The following table reflects the capital at risk position at March 31,
2005.
- -------------------------------------------------------------------------------------------------------------------
March 31, 2005
Values
- -------------------------------------------------------------------------------------------------------------------
Institutional capital at risk movement limit ..................................................... +/- 10%
Projected change in value resulting from a gradual 200 basis point increase in interest rates .... (7)
Projected change in value resulting from a gradual 100 basis point decrease in interest rates .... (2)
37
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.
Dynamic Simulation Modeling
Various modeling techniques are utilized to monitor a number of interest rate
scenarios for their impact on net interest income. These techniques include both
rate shock scenarios which assume immediate market rate movements of 200 basis
points, as well as scenarios in which rates rise or fall by as much as 200 basis
points over a twelve month period. The following table reflects the impact on
net interest income of the scenarios utilized by these modeling techniques.
- -----------------------------------------------------------------------------------------------------------------------------
March 31, 2005 Values
-----------------------
Amount %
- -----------------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net interest income (reflects projected rate movements on April 1, 2005):
Institutional base earnings movement limit ................................................. - 10
Change resulting from a gradual 200 basis point increase in the yield curve ................ $ (72) (2)
Change resulting from a gradual 200 basis point decrease in the yield curve ................ 464 15
Other significant scenarios monitored (reflects projected rate movements on April 1, 2005):
Change resulting from an immediate 100 basis point increase in the yield curve ............. (6)
Change resulting from an immediate 100 basis point decrease in the yield curve ............. 218
Change resulting from an immediate 200 basis point increase in the yield curve ............. (120)
Change resulting from an immediate 200 basis point decrease in the yield curve ............. 431
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 ........................................ 117
Change resulting from an immediate 100 basis point increase in short-term rates ............ (97)
The projections do not take into consideration possible complicating factors
such as the effect of changes in interest rates on the credit quality, size and
composition of the balance sheet. Therefore, although this provides a reasonable
estimate of interest rate sensitivity, actual results will vary from these
estimates, possibly by significant amounts.
Capital Risk/Sensitivity of Other Comprehensive Income
Large movements of interest rates could directly affect some reported capital
and capital ratios. The mark to market valuation of available for sale
securities is credited on a tax effective basis through other comprehensive
income in the consolidated statement of changes in shareholders' equity. This
valuation mark is excluded from Tier 1 and Tier 2 capital ratios but it would be
included in two important accounting based capital ratios: the tangible common
equity to tangible assets and the tangible common equity to risk weighted
assets. As of March 31, 2005, HUSI had an available for sale securities
portfolio of approximately $16 billion with a net negative mark to market of
$194 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 $165 million to a net loss of $359 million with the following
results on the tangible capital ratios.
- --------------------------------------------------------------------------------------------------------------
Proforma -
Reflecting
25 Basis Points
March 31, 2005 Actual Increase in Rates
- --------------------------------------------------------------------------------------------------------------
Tangible common equity to tangible assets ................................. 5.51% 5.44%
Tangible common equity to risk weighted assets ............................ 7.11 7.02
Value at Risk (VAR)
VAR analysis is also used to measure interest rate risk and to calculate the
economic capital required to cover potential losses due to interest risk. The
approach toward using VAR to measure interest rate risk is summarized on pages
53-54 of HUSI's 2004 Form 10-K.
38
Trading Activities
Trading portfolios reside primarily in the CIBM and residential mortgage banking
areas and include foreign exchange, derivatives, precious metals (gold, silver,
platinum), commodities, equities and money market instruments. The trading
portfolios have defined limits pertaining to items such as permissible
investments, risk exposures, loss review, balance sheet size and product
concentrations. Loss review refers to the maximum amount of loss that may be
incurred before senior management intervention is required.
Trading Activities - Treasury
Value at Risk
The following table summarizes trading VAR, assuming a 99% confidence level for
a two year observation period and a 10 day holding period.
- --------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2005
March 31, ----------------------------------- December 31,
2005 Minimum Maximum Average 2004
- --------------------------------------------------------------------------------------------------------
(in millions)
Total trading ..................... $ 44 $ 16 $ 51 $ 31 $ 41
Commodities ....................... 3 1 10 3 11
Credit derivatives ................ 23 5 29 11 9
Equities .......................... -- -- 3 1 1
Foreign exchange .................. 6 1 13 5 1
Interest rate ..................... 36 17 48 25 27
Trading Volatility
The following tables summarize the frequency distribution of daily market
risk-related revenues for Treasury trading activities. Market risk-related
Treasury trading revenues include realized and unrealized gains (losses) related
to Treasury trading activities, but exclude the related net interest income.
Analysis of gain (loss) data for the first three months of 2005 shows that the
largest daily gain was $13 million and the largest daily loss was $2 million.
- --------------------------------------------------------------------------------------------------------
Three months ended March 31, 2005
- --------------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue
earned from market risk-related activities
$(2) to $0 to $2 to $4 to Over
(in millions) $0 $2 $4 $6 $6
Number of trading days market risk-related
revenue was within the stated range ............ 10 27 14 6 4
Trading Activities - Mortgage Banking
HUSI's MSRs hedging program is constantly monitored to ensure that the program
in place supports anticipated business growth while at the same time limiting
volatility in the mortgage banking results. The economic value of the net hedged
MSRs portfolio is monitored on a daily basis for interest rate sensitivity. If
the economic value declines by more than established limits for one day or one
month, various levels of management review, intervention and/or corrective
actions are required.
39
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.
- ------------------------------------------------------------------------------------------------------------------------
March 31, 2005 Values
----------------------
Amount %
- ------------------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects
projected rate movements on April 1, 2005):
Value of hedged MSRs portfolio ......................................................... $ 320
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 ............................................... (3) - 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 ............................................... 8 + 2
Hedge Volatility
The following tables summarize the frequency distribution of the weekly economic
value of the MSR asset, net of changes in the market value of the related hedge
positions.
- -------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2005
- -------------------------------------------------------------------------------------------------------------------
Ranges of mortgage trading revenue earned
from market risk-related activities
Below $(4) to $(2) to $0 to Over
(in millions) $(4) $(2) $0 $2 $2
Number of trading weeks market risk-related
revenue was within the stated range ....................... 1 2 1 6 2
40
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------------------
Refer to Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations, under the captions "Interest Rate Risk Management" and
"Trading Activities", beginning on page 37 of this Form 10-Q.
Item 4. Controls and Procedures
- --------------------------------------------------------------------------------
Disclosure Controls
With the participation of the Chief Executive Officer and Chief Financial
Officer, the effectiveness of HUSI's disclosure controls and procedures was
evaluated as of the end of the period covered by this report. The disclosure
controls and procedures are designed to ensure that information required to be
disclosed by HUSI in the reports we file under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), is recorded, processed, summarized and
reported on a timely basis. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that disclosure controls and
procedures were effective as of the end of the period covered by this report so
as to alert them in a timely fashion to material information required to be
disclosed in reports filed under the Exchange Act.
Internal Controls
There have not been any changes in HUSI's internal control over financial
reporting during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, HUSI's
internal controls over financial reporting.
Sarbanes-Oxley Section 404 Compliance
As an SEC registrant of public debt and preferred shares HUSI is required to
comply with the Sarbanes-Oxley Act of 2002 (the Act). Section 404 of the Act
(Section 404) requires registrants and their auditors to assess and report on
internal controls over financial reporting on an annual basis. As a subsidiary
of a foreign registrant, HUSI is required to comply with Section 404 of the Act
for the fiscal year ending December 31, 2006.
41
Part II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1 - Legal Proceedings
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.
Item 5 - Other Information
As approved by the Audit and Examining Committee of the Board of
Directors, HUSI has engaged KPMG to perform certain non-audit
services during 2005, including tax compliance and consultation
services, litigation support services and general accounting
consultation services.
Item 6 - Exhibits
3(i) Registrant's Restated Certificate of Incorporation and
Amendments thereto, effective March 30, 2005.
(ii) Registrant's By-Laws, as Amended and Restated, effective
April 21, 2005.
4 Instruments Defining the Rights of Security Holders,
including Indentures, incorporated by reference to
previously filed periodic reports.
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.0 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
42
SIGNATURE
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC USA Inc.
-------------
(Registrant)
Date: May 16, 2005 /s/ Joseph R. Simpson
-------------------------------
Joseph R. Simpson
Chief Accounting Officer
(On behalf of Registrant)
43