Annual Financial Report - 3 of 41

RNS Number : 8200D

HSBC Holdings PLC

30 March 2011

 



Financial summary

	Page
Reconciliation of reported and underlying profit before tax .........................................................	14
Consolidated income statement ............................	16
Group performance by income and expense item .	18
Net interest income ...........................................	18
Net fee income ..................................................	19
Net trading income ...........................................	20
Net income from financial instruments designated at fair value ..................................................	21
Gains less losses from financial investments ......	22
Net earned insurance premiums .......................	22
Other operating income ...................................	23

	Page
Net insurance claims incurred and movement in liabilities to policyholders .............................	24
Loan impairment charges and other credit risk provisions .....................................................	24
Operating expenses ..........................................	26
Share of profit in associates and joint ventures .	28
Tax expense ......................................................	28
Consolidated balance sheet ...................................	29
Movement in 2010 ...........................................	30
Economic profit ..................................................	32
Critical accounting policies ..................................	33

The management commentary included in the Report of the Directors: 'Overview' and 'Operating and Financial Review', together with the 'Employees' and 'Corporate sustainability' sections of 'Governance' and the 'Directors' Remuneration Report' is presented in compliance with the IFRS Practice Statement Management Commentary issued by the IASB.

Reconciliation of reported and underlying profit before tax

We measure our performance internally on a like-for-like basis by eliminating the effects of foreign currency translation differences, acquisitions and disposals of subsidiaries and businesses, and fair value movements on own debt attributable to credit spread where the net result of such movements will be zero upon maturity of the debt; all of which distort year-on-year comparisons. We refer to this as our underlying performance.

Reported results include the effects of the above items. They are excluded when monitoring progress against operating plans and past results because management believes that the underlying basis more accurately reflects operating performance.

Constant currency

Constant currency comparatives for 2009 referred to in the commentaries are computed by retranslating into US dollars for non-US dollar branches, subsidiaries, joint ventures and associates:

·  the income statements for 2009 at the average rates of exchange for 2010; and

·  the balance sheet at 31 December 2009 at the prevailing rates of exchange on 31 December 2010.

No adjustment has been made to the exchange rates used to translate foreign currency denominated assets and liabilities into the functional currencies of any HSBC branches, subsidiaries, joint ventures or associates. When reference is made to 'constant currency' in tables or commentaries, comparative data reported in the functional currencies of HSBC's operations have been translated at the appropriate exchange rates applied in the current period on the basis described above.

Underlying performance

The tables below compare our underlying performance in 2010 and 2009 with reported profits in those years.

The foreign currency translation differences reflect the relative strengthening of the US dollar against the euro and sterling, which offset its relative weakness against currencies in Asia, Mexico and Brazil during 2010.

The following acquisitions and disposals affected both comparisons:

·     the acquisition of PT Bank Ekonomi Raharja Tbk ('Bank Ekonomi') in May 2009;

·     the gain on sale of our 49% interest in a joint venture for a UK merchant acquiring business in June 2009 of US$280m;

·     the gain of US$62m on reclassification of Bao Viet Holdings ('Bao Viet') from an available-for-sale asset to an associate in January 2010;

·     the gain on sale of our stake in Wells Fargo HSBC Trade Bank in March 2010 of US$66m;

·     the gain on disposal of HSBC Insurance Brokers Limited of US$107m in April 2010;

·     the dilution gain of US$188m which arose on our holding in Ping An Insurance (Group) Company of China, Limited ('Ping An Insurance') following the issue of shares by the company in May 2010;

·     the loss of US$42m on the completion of the sale of our investment in British Arab Commercial Bank plc in October 2010;

·     the gain on sale of Eversholt Rail Group of US$255m in December 2010; and

·     the gain of US$74m on the deconsolidation of private equity funds following the management buy-out of Headland Capital Partners Ltd (formally known as HSBC Private Equity (Asia) Ltd) in November 2010.

Reconciliation of reported and underlying profit before tax

	2010 compared with 2009
HSBC	2009            as reported     US$m	2009       adjust-       ments10        US$m			Currency translation11       US$m		2009    at 2010 exchange       rates12      US$m	2010               as    reported        US$m			2010    adjust-    ments10      US$m		2010    under-      lying     US$m	Re- ported change13         %		Under-  lying change13         %
Net interest income ...........	40,730		(1)		642		41,371		39,441		(31)		39,410		(3)		(5)
Net fee income ...	17,664		(210)		182		17,636		17,355		(3)		17,352		(2)		(2)
Changes in fair value14 ............	(6,533)		6,533		-		-		(63)		63		-		99		-
Other income .....	14,320		(283)		228		14,265		11,514		(719)		10,795		(20)		(24)
Net operating income15 .......	66,181		6,039		1,052		73,272		68,247		(690)		67,557		3		(8)
Loan impairment charges and other credit risk provisions .......	(26,488)		-		(330)		(26,818)		(14,039)		-		(14,039)		47		48
Net operating income ..........	39,693		6,039		722		46,454		54,208		(690)		53,518		37		15
Operating expenses .........	(34,395)		200		(568)		(34,763)		(37,688)		19		(37,669)		(10)		(8)
Operating profit ........................	5,298		6,239		154		11,691		16,520		(671)		15,849		212		36
Income from associates	1,781		(1)		11		1,791		2,517		-		2,517		41		41
Profit before tax ........................	7,079		6,238		165		13,482		19,037		(671)		18,366		169		36
By geographical region
Europe ...............	4,009		2,546		(152)		6,403		4,302		(164)		4,138		7		(35)
Hong Kong .........	5,029		1		(10)		5,020		5,692		(130)		5,562		13		11
Rest of Asia-Pacific ............	4,200		3		205		4,408		5,902		(211)		5,691		41		29
Middle East ........	455		-		(2)		453		892		42		934		96		106
North America ...	(7,738)		3,688		46		(4,004)		454		(208)		246
Latin America ....	1,124		-		78		1,202		1,795		-		1,795		60		49
Profit before tax ........................	7,079		6,238		165		13,482		19,037		(671)		18,366		169		36
By customer group and global business
Personal Financial Services...........	(2,065)		(2)		(70)		(2,137)		3,518		(10)		3,508
Commercial Banking ..........	4,275		(306)		64		4,033		6,090		(133)		5,957		42		48
Global Banking and Markets.....	10,481		13		173		10,667		9,536		(342)		9,194		(9)		(14)
Global Private Banking ..........	1,108		-		1		1,109		1,054		1		1,055		(5)		(5)
Other..................	(6,720)		6,533		(3)		(190)		(1,161)		(187)		(1,348)		83		(609)
Profit before tax ........................	7,079		6,238		165		13,482		19,037		(671)		18,366		169		36

For footnotes, see page 83.

Additional information is available on the HSBC website www.hsbc.com.

Consolidated income statement

Five-year summary consolidated income statement

	2010 US$m		2009 US$m		2008 US$m		2007 US$m		2006 US$m
Net interest income ..........................................................	39,441		40,730		42,563		37,795		34,486
Net fee income .................................................................	17,355		17,664		20,024		22,002		17,182
Net trading income ...........................................................	7,210		9,863		6,560		9,834		8,222
Net income/(expense) from financial instruments designated at fair value .................................................	1,220		(3,531)		3,852		4,083		657
Gains less losses from financial investments ......................	968		520		197		1,956		969
Gains arising from dilution of interests in associates ..........	188		-		-		1,092		-
Dividend income ...............................................................	112		126		272		324		340
Net earned insurance premiums .........................................	11,146		10,471		10,850		9,076		5,668
Gains on disposal of French regional banks .......................	-		-		2,445		-		-
Other operating income ....................................................	2,374		2,788		1,808		1,439		2,546
Total operating income .................................................	80,014		78,631		88,571		87,601		70,070
Net insurance claims incurred and movement in liabilities to policyholders ................................................................	(11,767)		(12,450)		(6,889)		(8,608)		(4,704)
Net operating income before loan impairment charges and other credit risk provisions ..............................	68,247		66,181		81,682		78,993		65,366
Loan impairment charges and other credit risk provisions	(14,039)		(26,488)		(24,937)		(17,242)		(10,573)
Net operating income ...................................................	54,208		39,693		56,745		61,751		54,793
Total operating expenses17 ...............................................	(37,688)		(34,395)		(49,099)		(39,042)		(33,553)
Operating profit ............................................................	16,520		5,298		7,646		22,709		21,240
Share of profit in associates and joint ventures .................	2,517		1,781		1,661		1,503		846
Profit before tax ............................................................	19,037		7,079		9,307		24,212		22,086
Tax expense .....................................................................	(4,846)		(385)		(2,809)		(3,757)		(5,215)
Profit for the year .........................................................	14,191		6,694		6,498		20,455		16,871
Profit attributable to shareholders of the parent company	13,159		5,834		5,728		19,133		15,789
Profit attributable to non-controlling interests .................	1,032		860		770		1,322		1,082
Five-year financial information
	US$		US$		US$		US$		US$
Basic earnings per share18 ..................................................	0.73		0.34		0.41		1.44		1.22
Diluted earnings per share18 ...............................................	0.72		0.34		0.41		1.42		1.21
Basic earnings excluding goodwill impairment per share17,18	0.73		0.34		1.19		1.44		1.22
Dividends per share1 .........................................................	0.34		0.34		0.93		0.87		0.76
	%		%		%		%		%
Dividend payout ratio19 ....................................................
- reported16 ......................................................................	46.6		100.0		226.8		60.4		62.3
- excluding goodwill impairment17,18 .................................	46.6		100.0		78.2		60.4		62.3
Post-tax return on average total assets .............................	0.57		0.27		0.26		0.97		1.00
Return on average total shareholders' equity .....................	9.5		5.1		4.7		15.9		15.7
Average foreign exchange translation rates to US$:
US$1: £ ............................................................................	0.648		0.641		0.545		0.500		0.543
US$1: € ............................................................................	0.755		0.719		0.684		0.731		0.797

For footnotes, see page 83.

Reported profit before tax of US$19.0bn in 2010 was 169% higher than in 2009, and 36% higher on an underlying basis. The difference between reported and underlying results is explained on page 14. Except where stated otherwise, the commentaries in the Financial Summary are on an underlying basis and references to HSBC Finance and HSBC Bank USA are on a management basis, rather than a legal entity basis (for details see page 37).

Net operating income before loan impairment charges and other credit risk provisions ('revenue') was lower than in 2009, notably due to a decline in balances in North America, lower trading income from adverse movements on non-qualifying hedges and a fall in revenue from GB&M. In the former, we continued to reposition our core businesses and we remained focused on managing down our run-off portfolios. As a consequence, revenue fell, reflecting declining balances in the run-off portfolios and in the Card and Retail Services business, where revenue was also adversely affected by new regulations. In GB&M, lower revenue was generated in Balance Sheet Management as higher yielding positions matured and funds were invested in lower yielding assets. Trading income declined driven by increased competition and reduced margins across core products, and less favourable market conditions caused by the European sovereign debt crisis. These factors were partly offset by increased CMB revenue from balance sheet growth, particularly in Asia, and higher trade-related fees.

Loan impairment charges were significantly lower than in 2009, with decreases across all regions and customer groups as economic conditions improved. The most significant decline in loan impairment charges was in North America, reflecting lower balances due to increased repayments, an improvement in delinquency rates in Card and Retail Services, and the continued run-off of balances in the Consumer Finance business. There were also marked declines in the Middle East and in Latin America, primarily in Mexico and Brazil, reflecting a reduction in personal lending balances as selected portfolios were managed down, and an improvement in credit quality as origination criteria were tightened and collection practices improved. In GB&M, loan impairment charges were significantly lower, reflecting the improvement in the credit environment which resulted in fewer significant charges than those taken in 2009 in relation to a small number of clients, notably in Europe and other credit risk provisions fell in the available-for-sale asset-backed securities ('ABS') portfolio due to a slowing in the rate of anticipated losses in the underlying collateral pools.

Underlying profit before tax rose by 36% as a significant fall in impairment charges offset a decline in revenue.

Operating expenses were higher than in 2009, in part due to specific one-off items such as a US$0.3bn charge for UK bank payroll tax in 2010 and the non-recurrence of a pension accounting gain of US$0.5bn in 2009 relating to the treatment of staff benefits. Excluding these items, operating expenses rose in support of strategic growth initiatives in our target markets to invest in operational infrastructure and the selective recruitment of customer-facing staff.

Income from associates increased, driven by strong results in Asia which reflected robust economic growth in mainland China.

In 2010, taxable profits were achieved in the US, principally as the result of a gain from an internal reorganisation that was not recognised for accounting purposes which increased the effective tax rate by 6.4 percentage points. If this were excluded, the effective tax rate would be 19.1% which is in line with our geographical range of business activities. Reported profit after tax was US$7.5bn higher than in 2009.

Group performance by income and expense item

Net interest income

	2010		2009		2008
	US$m		US$m		US$m
Interest income ............................................................................................	58,345		62,096		91,301
Interest expense ...........................................................................................	(18,904)		(21,366)		(48,738)
Net interest income20 ...................................................................................	39,441		40,730		42,563
Average interest-earning assets .....................................................................	1,472,294		1,384,705		1,466,622
Gross interest yield21 ....................................................................................	3.96%		4.48%		6.23%
Net interest spread22 .....................................................................................	2.55%		2.90%		2.87%
Net interest margin23 ....................................................................................	2.68%		2.94%		2.90%

Summary of interest income by type of asset

	2010						2009						2008
	Average balance		Interest income		Yield		Average     balance		Interest income		Yield		Average     balance		Interest income		Yield
	US$m		US$m		%		US$m		US$m		%		US$m		US$m		%
Short-term funds and loans and advances to banks ............................................	236,742		4,555		1.92		192,578		4,199		2.18		240,111		9,646		4.02
Loans and advances to customers ..........	858,499		44,186		5.15		870,057		48,301		5.55		943,662		68,722		7.28
Financial investments ...........................	378,971		9,375		2.47		322,880		9,425		2.92		264,396		12,618		4.77
Other interest-earning assets24 ..............	(1,918)		229		(11.94)		(810)		171		(21.11)		18,453		315		1.71
Total interest-earning assets .................	1,472,294		58,345		3.96		1,384,705		62,096		4.48		1,466,622		91,301		6.23
Trading assets25 .....................................	332,511		6,027		1.81		357,504		7,614		2.13		428,539		16,742		3.91
Financial assets designated at fair value26	52,692		1,033		1.96		62,143		1,032		1.66		37,303		1,108		2.97
Impairment provisions ..........................	(22,905)						(26,308)						(20,360)
Non-interest-earning assets ...................	664,308						667,942						596,885
Total assets and interest income ...........	2,498,900		65,405		2.62		2,445,986		70,742		2.89		2,508,989		109,151		4.35

Summary of interest expense by type of liability and equity

	2010						2009						2008
	Average balance		Interest expense		Cost		Average     balance		Interest expense		Cost		Average     balance		Interest expense		Cost
	US$m		US$m		%		US$m		US$m		%		US$m		US$m		%
Deposits by banks27 ...............................	111,443		1,136		1.02		117,847		1,659		1.41		135,747		4,959		3.65
Financial liabilities designated at fair value - own debt issued28 ...................	66,706		1,271		1.91		60,221		1,558		2.59		63,835		3,133		4.91
Customer accounts29 .............................	962,613		10,778		1.12		940,918		11,346		1.21		950,854		27,989		2.94
Debt securities in issue ...........................	189,898		4,931		2.60		225,657		5,901		2.62		286,827		11,982		4.18
Other interest-bearing liabilities ............	8,730		788		9.03		8,640		902		10.44		14,579		675		4.63
Total interest-bearing liabilities .............	1,339,390		18,904		1.41		1,353,283		21,366		1.58		1,451,842		48,738		3.36
Trading liabilities ..................................	258,348		3,497		1.35		205,670		3,987		1.94		277,940		11,029		3.97
Financial liabilities designated at fair value (excluding own debt issued) ................	17,456		283		1.62		15,688		293		1.87		21,266		345		1.62
Non-interest bearing current accounts ...	142,579						123,271						98,193
Total equity and other non-interest bearing liabilities ................................	741,127						748,074						659,747
Total equity and liabilities .....................	2,498,900		22,684		0.91		2,445,986		25,646		1.05		2,508,988		60,112		2.40

For footnotes, see page 83.

Reported net interest income fell by 3% to US$39bn; the decline was 5% on an underlying basis. This was driven by the exceptionally low interest rate environment and by the effect of repositioning our customer assets towards secured lending as we reduced our higher risk and higher yielding portfolios.

Revenues in Balance Sheet Management decreased, as expected, from the strong levels of 2009 as higher yielding positions taken in prior years matured and opportunities for reinvestment at equivalent yields were limited by the prevailing low interest rates and flatter yield curves.

The fall in income from interest-earning assets was driven by declining yields on loans and advances to customers following the Group's decision to reposition the lending portfolio towards higher quality assets. Higher yielding unsecured lending balances decreased, particularly in North America, where the run-off portfolios continued to diminish and credit card balances fell as the number of active accounts declined and repayments by customers increased. Certain higher risk portfolios were also managed down in Latin America, Asia and the Middle East. This reduction was partly offset by commercial lending growth in CMB and GB&M, and growth in secured lending in the UK in residential mortgages.

The interest expense on debt issued by the Group fell, largely due to a decline in average balances in debt securities in issue as HSBC Finance's funding requirements continued to decrease in line with the run‑off of the residual

balances in Mortgage Services and Consumer Lending and the sale of the vehicle finance portfolios.

Net interest income includes the expense of the internal funding of trading assets, while related revenue is reported in trading income. The cost of funding these assets declined as a result of the low interest rates. In reporting our customer group results, this cost is included within net trading income.

Net interest spread decreased due to lower yields on loans and advances to customers, partly as a result of the greater focus on secured lending. In addition, returns on financial investments and deposit spreads remained constrained due to low interest rates. Our net interest margin fell by a lesser amount due to the benefit from an increase in net free funds as customers held more funds in liquid non-interest bearing current accounts in the current low interest rate environment.

Net fee income

	2010 US$m		2009 US$m		2008 US$m
Cards ............................................................................................................	3,801		4,625		5,844
Account services ..........................................................................................	3,632		3,592		4,353
Funds under management ..............................................................................	2,511		2,172		2,757
Broking income ............................................................................................	1,789		1,617		1,738
Credit facilities .............................................................................................	1,635		1,479		1,313
Insurance ......................................................................................................	1,147		1,421		1,771
Imports/exports ...........................................................................................	991		897		1,014
Global custody ..............................................................................................	700		988		1,311
Remittances .................................................................................................	680		613		610
Underwriting ................................................................................................	623		746		325
Unit trusts ....................................................................................................	560		363		502
Corporate finance ........................................................................................	440		396		381
Trust income ................................................................................................	291		278		325
Mortgage servicing .......................................................................................	118		124		120
Maintenance income on operating leases ......................................................	99		111		130
Taxpayer financial services ..........................................................................	73		87		168
Other ...........................................................................................................	2,027		1,894		2,102
Fee income ...................................................................................................	21,117		21,403		24,764
Less: fee expense ..........................................................................................	(3,762)		(3,739)		(4,740)
Net fee income .............................................................................................	17,355		17,664		20,024

Net fee income marginally decreased compared with 2009 on both a reported and an underlying basis. The significant decrease in fee income in North America, primarily in Card and Retail Services, was mostly offset by higher investment-related fees in Asia and Europe and an increase in trade-related fee income in Asia.

The significant fall in fee income from cards occurred primarily in North America, driven by lower volumes, improved delinquency rates and the revision to charging practices following the implementation of the Credit Card Accountability, Responsibility and Disclosure Act ('CARD Act').

Insurance fee income was markedly down. In the US, the decline resulted from lower sales of credit protection products associated with the cards business. In the UK, income was lower on a reported basis due to the sale of the insurance brokerage business in the first half of 2010.

Overall, underwriting fee income declined, particularly in Europe as a result of reduced capital market activity in the uncertain economic environment, although in Asia underwriting fees increased following several notable transactions.

Net fee income from sales of investment products in Asia and Europe increased, driven by a stronger investment performance in funds and improved customer sentiment which led to higher volumes.

Credit facilities fees also rose, notably in Asia, as a result of an increase in loan syndication transactions completed during the year.

Net fee income from trade finance also increased, particularly in Asia, reflecting a rise in trade activity.

Net trading income

	2010 US$m		2009 US$m		2008 US$m
Trading activities .........................................................................................	5,708		5,312		2,988
Net interest income on trading activities ......................................................	2,530		3,627		5,713
Other trading income - hedge ineffectiveness:
- on cash flow hedges ...............................................................................	(9)		90		(40)
- on fair value hedges ...............................................................................	38		(45)		5
Non-qualifying hedges ..................................................................................	(1,057)		951		(1,122)
Losses on Bernard L. Madoff Investment Securities LLC fraud .....................	-		(72)		(984)
Net trading income30,31 .................................................................................	7,210		9,863		6,560

For footnotes, see page 83.

Reported net trading income was US$7.2bn, 27% lower than in 2009. On an underlying basis, net trading income declined by 28% due to adverse movements on non-qualifying hedges and lower income from trading activities.

A US$1.1bn adverse fair value movement was reported on non-qualifying hedges compared with a favourable fair value movement of US$954m in 2009. These instruments are derivatives entered into as part of a documented interest rate management strategy for which hedge accounting was not, or could not be, applied. They are principally cross-currency and interest rate swaps used to economically hedge fixed rate debt issued by HSBC Holdings, floating rate debt issued by HSBC Finance and certain operating leased assets. The loss recognised on non-qualifying hedges was a result of fair value losses on these instruments, driven by the decrease in long-term US interest rates relative to sterling and euro rates. In HSBC Finance, the volume of non-qualifying hedge positions also increased as the duration of the mortgage book lengthened and swaps were used to align more closely the duration of the funding liabilities. The size and direction of the changes in fair value of non-qualifying hedges which are recognised in the income statement can be volatile from year to year, but do not alter the cash flows expected as part of the documented interest rate management strategy for both the instruments and the underlying economically hedged assets and liabilities.

The remaining decline in net trading income was driven by increased competition and reduced margins across core products. European sovereign debt concerns and increased economic uncertainty resulted in less favourable market conditions compared with 2009.

In the Credit business, corporate bond trading volumes remained robust following investment in electronic trading capabilities, though revenues were affected as margins declined and credit spread movements were more favourable in 2009. This was partly offset by gains on the legacy portfolio which included a net release of write-downs on legacy positions and monoline credit exposures of US$429m. This compared with a reported write‑down of US$331m in 2009.

Rates income decreased, reflecting reduced margins and increased risk aversion from customers due to economic uncertainty. Turmoil in the eurozone led to sovereign debt downgrades and falling asset prices in certain European countries, leading to lower revenues in the trading portfolio. These factors were partly offset by a small favourable fair value movement on structured liabilities, compared with an adverse movement in 2009.

Lower net trading income was driven by a US$2.0bn adverse movement on non-qualifying hedges from 2009.

Performance in the Foreign Exchange business remained strong, although was affected by a competitive trading environment and tighter bid-offer spreads as competitors sought to rebuild their businesses. In addition, revenues fell as market volatility declined from the exceptional levels seen in early 2009.

The Equities business continued to increase market share in its target markets, following investment in the equities platform. However, core revenues fell, as overall market volumes and margins declined.

Trading income benefited from foreign exchange gains on trading assets held as economic hedges of foreign currency debt designated at fair value compared with losses on these instruments in 2009. These gains were largely offset by corresponding losses reported in 'Net income from financial instruments designated at fair value'.

Net interest income earned on trading activities decreased by 30%, driven by reduced holdings of debt securities. The cost of internally funding these assets also declined, but this interest expense is reported under 'Net interest income' and excluded from net trading income.

Net income/(expense) from financial instruments designated at fair value

	2010 US$m		2009 US$m		2008 US$m
Net income/(expense) arising from:
- financial assets held to meet liabilities under insurance and investment contracts .............................................................................	2,349		3,793		(5,064)
- liabilities to customers under investment contracts ................................	(946)		(1,329)		1,751
- HSBC's long-term debt issued and related derivatives ............................	(258)		(6,247)		6,679
Change in own credit spread on long-term debt .................................	(63)		(6,533)		6,570
Other changes in fair value32 .............................................................	(195)		286		109
- other instruments designated at fair value and related derivatives ..........	75		252		486
Net income/(expense) from financial instruments designated at fair value ....	1,220		(3,531)		3,852

Assets and liabilities from which net income/(expense) from financial instruments designated at fair value arose

	2010 US$m		2009 US$m		2008 US$m
Financial assets designated at fair value at 31 December ...............................	37,011		37,181		28,533
Financial liabilities designated at fair value at 31 December ..........................	88,133		80,092		74,587
Including:
Financial assets held to meet liabilities under:
- insurance contracts and investment contracts with DPF33 ......................	7,167		6,097		5,556
- unit-linked insurance and other insurance and investment contracts .......	19,725		16,982		12,758
Long-term debt issues designated at fair value ...............................................	69,906		62,641		58,686

For footnotes, see page 83.

The accounting policies for the designation of financial instruments at fair value and the treatment of the associated income and expenses are described in Notes 2i and 2b on the Financial Statements, respectively.

The majority of the financial liabilities designated at fair value relate to certain fixed-rate long-term debt issues whose rate profile has been changed to floating through interest rate swaps as part of a documented interest rate management strategy. The movement in fair value of these long-term debt issues includes the effect of our credit spread changes and any ineffectiveness in the economic relationship between the related swaps and own debt. As credit spreads widen or narrow, accounting profits or losses, respectively, are booked. The size and direction of the changes in the credit spread on our debt and ineffectiveness, which are recognised in the income statement, can be volatile from year to year, but do not alter the cash flows envisaged as part of the documented interest rate management strategy. As a consequence, fair value movements arising from changes in our own credit spread on long-term debt and other fair value movements on the debt and related derivatives are not regarded internally as part of managed performance and are therefore not allocated to customer groups, but are reported in 'Other'. Credit spread movements on own debt are excluded from underlying results, and related fair value movements are not included in the calculation of regulatory capital.

We reported net income from financial instruments designated at fair value of US$1.2bn in 2010 compared with a net expense of US$3.5bn in 2009. On an underlying basis, the equivalent figures were income of US$1.3bn in 2010 and US$2.9bn in 2009. The difference between the reported and underlying results arises from the exclusion from the latter of the credit spread-related movements in the fair value of our own long-term debt, on which we reported adverse fair value movements of US$63m in 2010 and US$6.5bn in 2009. In North America, a small favourable fair value movement was reported

in 2010 as credit spreads widened marginally, in contrast with a significant adverse fair value movement in 2009. In Europe, significantly lower adverse fair value movements were reported in 2010 as credit spreads tightened, but to a lesser extent than in the previous year.

Income arising from financial assets held to meet liabilities under insurance and investment contracts reflected lower investment gains as the growth in equity markets was less than that of 2009. This predominantly affected the value of assets held to support unit-linked contracts in the UK, Hong Kong, Singapore and Brazil and participating contracts in France.

For investment gains or losses related to assets held to back investment contracts, the corresponding movement in liabilities to customers is also recorded under 'Net income from financial instruments designated at fair value'.

Investment gains or losses related to assets held to back insurance contracts or investment contracts with discretionary participation features ('DPF') are offset by a corresponding change in 'Net insurance claims incurred and movement in liabilities to policyholders' to reflect the extent to which unit-linked policyholders, in particular, participate in the investment performance of the associated asset portfolios.

Gains less losses from financial investments

	2010 US$m		2009 US$m		2008 US$m
Net gains/(losses) from disposal of:
- debt securities ........................................................................................	564		463		19
- equity securities .....................................................................................	516		407		1,216
- other financial investments ...................................................................	(7)		8		4
	1,073		878		1,239
Impairment of available-for-sale equity securities .........................................	(105)		(358)		(1,042)
Gains less losses from financial investments .................................................	968		520		197

Reported gains less losses from financial investments increased by US$448m to US$968m. On an underlying basis, excluding an accounting gain arising from the reclassification of Bao Viet as an associate following our purchase of additional shares, they increased by 69%. This was driven by a decrease in the level of impairments on available-for-sale equity investments as market values improved, along with an increase in gains on the disposal of equity and debt securities.

Impairments on equity investments declined markedly compared with 2009 as the improving economic situation resulted in a reduction in the level of write-downs required on private equity and other strategic equity investments.

Higher net gains were reported in Balance Sheet Management on disposals of available-for-sale debt securities, mainly in Europe and Asia. These were partly offset by a decrease in North America, where net gains realised from the sale of mortgage-backed securities and other ABSs in 2009 did not recur.

Net gains on the disposal of equity securities increased, primarily in our private equity portfolio in Europe, as the market offered greater opportunities for divestment. This was partly offset by the non-recurrence of the gain on disposal of our holdings of Visa Inc. shares in 2009.

Net earned insurance premiums

	2010 US$m		2009 US$m		2008 US$m
Gross insurance premium income ..................................................................	11,609		10,991		12,547
Reinsurance premiums ..................................................................................	(463)		(520)		(1,697)
Net earned insurance premiums ....................................................................	11,146		10,471		10,850

Net earned insurance premiums increased by 6% to US$11.1bn on both a reported and an underlying basis.

Growth was largely attributable to the continued strong performance of life insurance products in Asia. Successful sales campaigns and the recruitment of additional insurance sales managers increased net earned premiums in Hong Kong, particularly from deferred annuity and unit-linked

products, and a life insurance product designed for high net worth individuals. Higher sales were also reported in Malaysia, Taiwan and mainland China, primarily from successful product launches and marketing campaigns.

Net earned premiums in Latin America increased marginally in the improved economic conditions, driven by higher sales in Brazil, Argentina and Mexico and repricing initiatives in Argentina.

In France, an increase in sales of investment contracts with DPF drove higher net earned premiums. Strong sales activity also led to higher net earned premiums in our UK life insurance business.

This growth was partly offset by a reduction in non-life insurance premiums, primarily due to the run-off of the legacy motor book in the UK, which was closed during the second half of 2009, and the decision taken during 2010 not to renew certain contracts in the Irish business.

Net earned premiums in North America also decreased, reflecting a decline in sales of payment protection products following the discontinuation of mortgage originations in HSBC Finance.

Other operating income

	2010 US$m		2009 US$m		2008 US$m
Rent received ...............................................................................................	535		547		606
Losses recognised on assets held for sale .......................................................	(263)		(115)		(130)
Valuation gains/(losses) on investment properties .........................................	93		(24)		(92)
Gain on disposal of property, plant and equipment, intangible assets and non-financial investments ........................................................................	889		1,033		881
Change in present value of in-force long-term insurance business .................	705		605		286
Other ...........................................................................................................	603		742		257
Other operating income ...............................................................................	2,562		2,788		1,808

Reported other operating income of US$2.6bn was 8% lower than in 2009. Income in 2010 included gains of US$188m following the dilution of our holding in Ping An Insurance, US$107m from the sale of HSBC Insurance Brokers, US$66m from the disposal of our interest in the Wells Fargo HSBC Trade Bank and US$255m from the sale of Eversholt Rail Group. In addition, we reported a gain of US$74m resulting from the sale of HSBC Private Equity (Asia) Ltd, partly offset by a loss of US$42m on the disposal of our shareholding in British Arab Commercial Bank plc. Reported results in 2009 included a gain of US$280m from the sale of the remaining stake in the card merchant-acquiring business in the UK.

On an underlying basis, excluding the items referred to above, other operating income decreased by 23%, primarily because gains on the sale of properties in London and Hong Kong in 2009 did not recur.

Net losses recognised on assets held for sale increased, reflecting a US$207m loss on the sale of the US vehicle finance servicing operation and associated US$5.3bn loan portfolio.

Net investment valuation gains on investment properties contrasted with losses in 2009. This reflected improvements in the property markets in Hong Kong and the UK which led to net valuation gains on investment properties, compared with net valuation losses in 2009.

A loss on sale of the US vehicle finance business contributed to a fall in Other operating income.

We recognised gains of US$194m and US$56m in 2010 on the sale and leaseback of our Paris and New York headquarters buildings, respectively. These compared with more substantial underlying gains of US$667m (US$686m as reported) on the sale and leaseback of 8 Canada Square and the sale of a property in Hong Kong in 2009.

Strong sales of life insurance products, notably in Hong Kong, resulted in favourable movements in the present value of in-force ('PVIF') long-term insurance business. These were offset in part by the non-recurrence of gains recognised in 2009 following the refinement of the income recognition methodology in HSBC Finance.

Net insurance claims incurred and movement in liabilities to policyholders

	2010 US$m		2009 US$m		2008 US$m
Insurance claims incurred and movement in liabilities to policyholders:
-  gross .....................................................................................................	11,969		12,560		9,206
-  reinsurers' share ....................................................................................	(202)		(110)		(2,317)
-  net34 .....................................................................................................	11,767		12,450		6,889

For footnote, see page 83.

Net insurance claims incurred and movement in liabilities to policyholders decreased by 5% and 4% on a reported and an underlying basis, respectively.

Lower investment returns than in 2009, particularly in Asia, Europe and Brazil, led to a decrease in the movement in liabilities to policyholders on unit-linked insurance contracts and, to a certain extent, participating contracts, whose policyholders share in the investment performance of the assets supporting their policies. The gains or losses experienced on the financial assets designated at fair value held to support insurance contract liabilities and investment contracts with DPF are reported in 'Net income from financial instruments designated at fair value'.

In Asia, the effect of the lower investment returns was more than offset by additional reserves established for new business written, consistent with the increase in net insurance premiums earned, particularly in Hong Kong, as a result of successful sales campaigns and the recruitment of additional insurance sales managers.

In addition, the increase in reserves in 2009 on the now closed UK motor insurance book, which reflected the rising incidence and severity of claims at that time, did not recur. The decision taken in 2010 not to renew certain contracts in our Irish business resulted in a further decrease in net insurance claims incurred and movement in liabilities to policyholders. 

Loan impairment charges and other credit risk provisions

	2010 US$m		2009 US$m		2008 US$m
Loan impairment charges
New allowances net of allowance releases ..................................................	14,568		25,832		24,965
Recoveries of amounts previously written off ...........................................	(1,020)		(890)		(834)
	13,548		24,942		24,131
Individually assessed allowances ....................................................................	2,625		4,458		2,064
Collectively assessed allowances ...................................................................	10,923		20,484		22,067
Impairment of available-for-sale debt securities ............................................	472		1,474		737
Other credit risk provisions ..........................................................................	19		72		69
Loan impairment charges and other credit risk provisions ............................	14,039		26,488		24,937
	%		%		%
-  as a percentage of net operating income excluding the effect of fair value movements in respect of credit spread on own debt and before loan impairment charges and other credit risk provisions .................................	20.6		36.4		33.2
Impairment charges on loans and advances to customers as a percentage of gross average loans and advances to customers ..........................................	1.5		2.8		2.5
	US$m		US$m		US$m
Customer impaired loans ..............................................................................	28,091		30,606		25,352
Customer loan impairment allowances ..........................................................	20,083		25,542		23,909

On a reported basis, loan impairment charges and other credit risk provisions were US$14bn, a decline of 47% compared with 2009 and 48% on an underlying basis. There was improvement across all regions and in all customer groups.

At 31 December 2010, the aggregate balance of customer loan impairment allowances was US$20.1bn. This represented 2.2% of gross loans and advances to customers (net of reverse repos and settlement accounts) compared with 3.0% at 31 December 2009.

We actively managed down some of our higher risk portfolios in all regions and enhanced credit quality through tighter underwriting and increased focus on the sale of secured products to customers where we already held a banking relationship. Loan impairment charges in our CMB and GB&M businesses fell as economic conditions improved and we recognised fewer large loan impairment charges against specific clients than in 2009.

Loan impairment charges and other credit risk provisions of US$14bn were 48% or US$12.8bn lower than in 2009.

Impairments on available-for-sale debt securities declined markedly to US$472m from the US$1.5bn reported in 2009, mainly reflecting a slowing in the rate of anticipated losses in the underlying collateral pools.

The most significant decline in loan impairment charges was in our HSBC Finance portfolios in the US, where lending balances reduced and delinquency levels improved.

Loan impairment charges and other credit risk provisions in the US declined by 48% to US$7.9bn, the lowest level since 2006, representing 57% of the Group's total reduction compared with 2009. This mainly occurred in the US PFS business, where loan impairment charges declined by US$6.1bn to US$8.0bn, primarily in the Card and Retail Services business of HSBC Finance and, to a lesser extent, in the run-off consumer finance portfolios.

In Cards and Retail Services, loan impairment charges declined by 57% to US$2.2bn. This improvement reflected the continuing effects of additional steps taken from the fourth quarter of 2007 to manage risk, including tightening underwriting criteria, lowering credit limits and reducing the number of active cards. An increased focus by our customers on reducing outstanding credit card debt helped improve delinquency levels.

Loan impairment charges in our Consumer Lending and Mortgage Services businesses declined by 29% to US$5.7bn, due to the continued run-off of lending balances in these portfolios and lower delinquency balances. Total loss severities on foreclosed loans improved compared with 2009, reflecting an increase in the number of properties for which we accepted a deed in lieu of foreclosure or a short sale, both of which result in lower losses compared with loans which are subject to a formal foreclosure process.

During 2010, state and federal prosecutors announced investigations into foreclosure practices of certain mortgage service providers. As a result, we expect that the scrutiny of documents will increase, and in some states additional verification of information will be required. If these trends continue there may be delays in their processing. See page 83 for more information on the investigation into US foreclosure practices.

In HSBC Bank USA, loan impairment charges in PFS fell by 92% to US$50m, reflecting lower lending balances and improved credit quality in the residential mortgage portfolio.

In GB&M in the US, a net release of loan impairment charges and other credit risk provisions reflected the improved credit environment and a release of impairments of available-for-sale ABSs as mentioned previously. In CMB, loan impairment charges declined by US$194m as the improved economic conditions resulted in credit upgrades on certain accounts, and fewer downgrades across all business lines.

In the UK, loan impairment charges in PFS and CMB declined as economic conditions improved and interest rates remained at low levels, resulting in an improvement in delinquency levels. In PFS, loan impairment charges fell by 35% to US$1.1bn as we actively reduced our exposure to unsecured lending, while collections increased mainly due to programmes implemented to improve performance. In the UK secured lending book, credit quality continued to be high and loan impairment charges remained at low levels. In CMB, loan impairment charges declined by US$159m due to strengthened credit risk management and improved collections, notably in the UK property, retail and service sectors.

Loan impairment charges and other credit provisions fell markedly in GB&M, reflecting the improved credit outlook, loan restructuring activity and the non-recurrence of significant charges against a small number of clients in the financial and property sectors. Credit risk provisions on certain available-for-sale ABSs also reduced.

Loan impairment charges and other credit risk provisions in Latin America declined by 44% to US$1.5bn. In PFS, loan impairment charges of US$1.2bn were 45% lower, mainly in Mexico due to a reduction in balances and improved delinquency rates in our credit card portfolio. In Brazil, they also declined as we managed down the size of certain consumer finance portfolios and economic conditions improved. In 2010, initiatives taken in the region to improve the quality of the loan portfolios continued. These steps included the tightening of underwriting criteria, reducing and, in some

instances, eliminating the use of higher risk, non-branch sales channels, and continued investment in our collections infrastructure. In our CMB portfolios, loan impairment charges and other credit risk provisions declined by 50% to US$293m, as improved economic conditions and credit quality resulted in lower specific impairment charges in all sectors.

In the Middle East, loan impairment charges and other credit risk provisions fell by 53% to US$627m as lower loan impairment charges in both PFS and CMB were partly offset by an increase in GB&M following restructuring activities. In our PFS business, loan impairment charges declined by 61% to US$227m, reflecting a marked decline in delinquency levels and lower lending balances, particularly in our credit card and unsecured personal lending book, as a result of managing down higher risk portfolios. Credit limits were tightened and our customer acquisition strategy was revised in the region to concentrate on Premier and Advance customers. This resulted in an improvement in credit quality. In CMB, lower loan impairment charges reflected a reduction in collective impairment charges and fewer specific loan impairment charges as economic conditions improved.

In Rest of Asia-Pacific, loan impairment charges declined as the credit environment improved. In India, loan impairment charges fell by 83% to US$82m, mainly in PFS as certain unsecured lending portfolios and the higher risk elements of the credit card portfolio were managed down, and economic conditions improved. Impairment charges also declined in CMB, due to the non-recurrence of charges against specific technology-related exposures in 2009. Partly offsetting these increases were higher specific loan impairment charges in GB&M.

In Hong Kong, loan impairment charges fell by 77% to US$114m, as economic conditions improved and fewer large specific loan impairment charges were reported against the CMB and GB&M portfolios. Loan impairment charges fell in PFS too, mainly on unsecured lending as unemployment and bankruptcy levels reduced.

Operating expenses

	2010		2009		2008
	US$m		US$m		US$m
By expense category
Employee compensation and benefits ...........................................................	19,836		18,468		20,792
Premises and equipment (excluding depreciation and impairment) ................	4,348		4,099		4,305
General and administrative expenses .............................................................	10,808		9,293		10,955
Administrative expenses ...............................................................................	34,992		31,860		36,052
Depreciation and impairment of property, plant and equipment ...................	1,713		1,725		1,750
Amortisation and impairment of intangible assets ........................................	983		810		733
Goodwill impairment ....................................................................................	-		-		10,564
Operating expenses ......................................................................................	37,688		34,395		49,099

Staff numbers (full time equivalents)

	At 31 December
	2010		2009		2008
Europe .........................................................................................................	75,698		76,703		82,093
Hong Kong ...................................................................................................	29,171		27,614		29,330
Rest of Asia-Pacific ......................................................................................	91,607		87,141		89,706
Middle East ..................................................................................................	8,676		8,281		8,453
North America .............................................................................................	33,865		35,458		44,725
Latin America ..............................................................................................	56,044		54,288		58,559
Staff numbers ...............................................................................................	295,061		289,485		312,866

Operating expenses increased by 10% to US$37.7bn on a reported basis and by 8% on an underlying basis. Significant one-off items included aggregate payroll taxes of US$324m levied on 2009 bonuses in the UK and France, and the curtailment of certain benefits delivered through pension schemes, which generated accounting credits of US$148m in the US and US$480m (US$499m as reported) in the UK in 2010 and 2009, respectively. Excluding these items, expenses grew by 6% as we continued to invest in our operational infrastructure, customer-facing and support staff, and GB&M's capabilities and platforms.

Employee compensation and benefits increased by 7%, partly due to the net effect of the curtailment gains and the payroll tax referred to above.

Excluding these items, staff costs rose by 3%. Performance-related costs increased, primarily in Asia, reflecting improved business performance and increased staff numbers. While year-end staff numbers increased as the pace of recruitment accelerated in the second half of the year, average staff numbers remained below 2009 levels. The growth in staff numbers in Asia encompassed both customer‑facing and back-office staff supporting business growth and increased operational capacity. In Latin America, staff costs grew following union-agreed salary increases and the recruitment of customer-facing and regional support staff, primarily in the latter part of the year. We also increased resources in our Global Service Centres as we continued to move processes there.

Staff costs declined in the US due to the non-recurrence of restructuring costs associated with the closure of the Consumer Lending branch network in 2009. Also, headcount fell due to the sale of the vehicle finance portfolio and related servicing platform. Similarly, reported staff numbers fell in Europe due to the sale of the insurance broking business in the UK and business reorganisation in France, though this was partly offset by higher numbers of customer-facing staff in the UK and Turkey.

Premises and equipment costs increased as rental costs in the UK, the US and France rose following the sale and leaseback of 8 Canada Square, London and our headquarters buildings in the US and France, combined with business expansion in Asia and Europe and refurbishment costs in Europe and Latin America. This was partly offset by lower costs in the US following the closure of the Consumer Lending branch offices and the non-recurrence of the related restructuring costs.

General and administrative expenses rose, reflecting in part higher marketing and advertising costs. These grew in North America in Card and Retail Services, partly from complying with the CARD Act. Marketing costs also rose in Asia and Latin America in support of the launch of Advance and sales campaigns for credit cards and investment products. Project costs increased from various initiatives to enhance operational capabilities, in connection with which consultancy and contractors' fees rose, primarily in the UK as GB&M continued to invest in strategic initiatives to drive future revenue growth. These included the development of Prime Services and equity market capabilities, and the expansion of the Rates and foreign exchange e‑commerce platforms.

Travel costs increased as we increased our focus on international connectivity and business growth. Costs also increased due to litigation provisions in North America and Europe.

Cost efficiency ratios

	2010 %		2009 %		2008 %
HSBC .........................................................................................................	55.2		52.0		60.1
Personal Financial Services ....................................................................	57.7		51.7		76.4
Europe .........................................................................................................	67.4		68.7		62.7
Hong Kong ...................................................................................................	35.3		34.9		32.2
Rest of Asia-Pacific ......................................................................................	85.1		81.2		81.5
Middle East ..................................................................................................	62.2		53.5		53.2
North America .............................................................................................	46.9		38.1		106.8
Latin America ..............................................................................................	72.1		66.7		59.7
Commercial Banking ...............................................................................	49.4		46.4		43.0
Europe .........................................................................................................	51.9		47.4		44.2
Hong Kong ...................................................................................................	32.2		33.7		26.2
Rest of Asia-Pacific ......................................................................................	49.2		47.0		45.9
Middle East ..................................................................................................	36.4		33.8		32.0
North America .............................................................................................	46.6		47.7		46.1
Latin America ..............................................................................................	65.7		57.0		55.0
Global Banking and Markets ..................................................................	49.9		39.1		67.3
Global Private Banking ...........................................................................	65.8		60.5		58.3

Our cost efficiency ratio worsened by 3.2 percentage points on a reported basis and by 8.4 percentage points to 55.8% on an underlying basis.

In PFS, there was a deterioration of 5.7 percentage points in the cost efficiency ratio. Operating expenses remained broadly unchanged as a rise in costs in

Asia in support of business expansion was broadly offset by strict cost control across the Group and lower costs in the US. Revenue fell, largely in the run-off portfolio and in Card and Retail Services in North America.

In CMB, the cost efficiency ratio deteriorated by 2.9 percentage points as we continued to invest for future revenue growth in those markets that we see as central to international connectivity. Revenue grew in all regions, albeit at a slower pace, resulting in a deterioration in the cost efficiency ratio, with the exception of Hong Kong where strong revenue growth led to an improvement of 1.5 percentage points.

In GB&M, the cost efficiency ratio deteriorated by 12.1 percentage points reflecting the one-off payroll and bonus taxes in the UK and France. Excluding them, the ratio deteriorated by 10.5 percentage points following a rise in costs related to higher support costs and continued investment in strategic initiatives being undertaken to drive future revenue growth. Revenue fell during 2010 mainly due to lower net interest income in Balance Sheet Management and lower trading income.

In GPB, the cost efficiency ratio deteriorated by 5.3 percentage points as costs increased, reflecting the hiring of front-line staff, investment in systems and higher compliance costs coupled with lower revenue in the low interest rate environment.

Share of profit in associates and joint ventures

	2010 US$m		2009 US$m		2008 US$m
Associates
Bank of Communications Co., Limited .....................................................	987		754		741
Ping An Insurance (Group) Company of China, Limited ...........................	848		551		324
Industrial Bank Co., Limited .....................................................................	327		216		221
The Saudi British Bank .............................................................................	161		172		251
Other ........................................................................................................	156		42		63
Share of profit in associates ..........................................................................	2,479		1,735		1,600
Share of profit in joint ventures ...................................................................	38		46		61
Share of profit in associates and joint ventures .............................................	2,517		1,781		1,661

The share of profit from associates and joint ventures increased by 41% to US$2.5bn on both a reported and an underlying basis as our associates in mainland China capitalised on the improved economic conditions in region.

Our share of profits in Ping An Insurance increased due to strong insurance sales performance, while fee income and lending growth resulted in higher profits from the Bank of Communications Co., Limited ('Bank of Communciations') and from Industrial Bank Co., Limited ('Industrial Bank').

These results were partly offset by a decrease in our share of profits from The Saudi British Bank as revenue declined amidst challenging economic conditions.

Tax expense

	2010 US$m		2009 US$m		2008 US$m
Profit before tax ..........................................................................................	19,037		7,079		9,307
Tax expense .................................................................................................	(4,846)		(385)		(2,809)
Profit after tax .............................................................................................	14,191		6,694		6,498
Effective tax rate .........................................................................................	25.5%		5.4%		30.2%

The most significant factor influencing the year on year changes to the effective tax rate is the changing geographical split of profits, including the relative proportion of tax on the share of profits in associates and joint ventures included within profit before tax. The impact of the tax on profit on associates and joint ventures included within pre-tax profits was a reduction in the effective tax rate of 3.7% in 2010 and 7.1% in 2009.

In 2010 HSBC's US operations achieved taxable profits, principally as a result of realising a taxable gain from an internal reorganisation which increased the effective tax rate by 6.4%. If this was excluded the effective tax rate would be 19.1% which is in line with the geographic profile of the Group.

 

END

 

 

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