HSBC FY05 REL2; Pt4/7

HSBC Holdings PLC 06 March 2006 33. Reconciliation of operating profit to cash generated from operations 2005 2004 Figures in HK$m restated Operating profit 43,344 43,237 Net interest income (43,491) (36,970) Dividend income (368) (163) Depreciation and amortisation 1,983 1,853 Impairment and other credit risk provisions 2,064 (862) Advances written off net of recoveries (3,268) (4,066) Other provisions for liabilities and charges 373 453 Provisions utilised (99) (672) Surplus arising on property revaluation (1,537) (1,038) Profit on disposal of property, plant and equipment (104) (192) Profit on disposal of subsidiaries and associates (53) (342) Gains less losses from financial investments (756) (1,497) Employees' options granted cost free 333 242 Interest received 63,331 45,635 Interest paid (31,956) (18,052) Operating profit before changes in working capital 29,796 27,566 Change in treasury bills with original term to maturity of more than three months 10,704 (49,096) Change in placings with banks maturing after one month 4,139 38,639 Change in certificates of deposit with original term to maturity of more than three months (2,351) (5,422) Change in trading assets (85,741) 13,061 Change in trading liabilities 87,174 8,279 Change in financial assets designated at fair value (1,001) - Change in financial liabilities designated at fair value 673 - Change in derivative assets 15,122 (14,344) Change in derivative liabilities (21,007) 20,630 Change in financial investments held for backing liabilities to long-term policyholders (8,227) (12,137) Change in advances to customers (82,836) (99,508) Change in amounts due from fellow subsidiary companies (20,058) (25,203) Change in deposits by banks 11,147 4,289 Change in other assets 13,558 (16,711) Change in customer accounts 41,993 168,856 Change in amounts due to fellow subsidiary companies 6,438 6,006 Change in amounts due to ultimate holding company 1,949 178 Change in debt securities in issue (2,221) 40,206 Change in liabilities to customers under insurance and investment contracts 17,271 13,445 Change in other liabilities 15,750 898 Exchange adjustments (1,263) 925 Cash generated from operations 31,009 120,557 34. Analysis of cash and cash equivalents a. Changes in cash and cash equivalents during the year 2005 2004 Figures in HK$m restated Balance at 1 January 403,545 314,861 Net cash inflow before the effect of foreign exchange movements 56,138 81,548 Effect of foreign exchange movements (15,169) 7,136 Balance at 31 December 444,514 403,545 b. Analysis of balances of cash and cash equivalents in the consolidated balance sheet 2005 2004 Figures in HK$m restated Cash in hand and current balances with banks 86,882 54,509 Items in the course of collection from other banks 17,782 13,479 Placings with banks 310,396 336,292 Treasury bills 45,484 17,916 Certificates of deposit 4,897 4,801 Less: items in the course of transmission to other banks (20,927) (23,452) 444,514 403,545 The difference between the amounts above and the amounts included in the consolidated balance sheet reflects treasury bills and certificates of deposit with an initial maturity of more than 3 months. c. Analysis of net outflow of cash and cash equivalents in respect of acquisition of and increased shareholding in subsidiary companies 2005 2004 Figures in HK$m restated Cash consideration (2,391) (972) Cash and cash equivalents acquired 747 - (1,644) (972) d. Analysis of net flow of cash and cash equivalents in respect of sale of subsidiary companies Figures in HK$m 2005 2004 Sale proceeds 151 63 Cash and cash equivalents transferred - (24) 151 39 35. Segmental analysis The allocation of earnings reflects the benefits of shareholders' equity to the extent that these are actually allocated to businesses in the segment by way of intra-group capital and funding structures. Common costs are included in segments on the basis of the actual recharges made. Geographical information has been classified by the location of the principal operations of the subsidiary company or, in the case of the bank, by the location of the branch responsible for reporting the results or advancing the funds. Due to the nature of the group structure, the analysis of profits shown below includes intra-group items between geographical regions. Income statement Rest of Americas/ Figures in HK$m Hong Kong Asia-Pacific Europe Total Year ended 31Dec05 Interest income 55,139 29,613 529 85,281 Interest expense (24,149) (17,336) (305) (41,790) Net interest income 30,990 12,277 224 43,491 Fee income 14,237 7,921 2 22,160 Fee expense (2,252) (1,803) (8) (4,063) Net trading income 3,152 4,198 (170) 7,180 Net income from financial instruments designated at fair value (69) 453 - 384 Gains less losses from financial investments 714 42 - 756 Dividend income 350 18 - 368 Net earned insurance premiums 18,140 1,200 - 19,340 Other operating income 6,480 1,131 22 7,633 Total operating income 71,742 25,437 70 97,249 Net insurance claims incurred and movement in policyholder liabilities (16,002) (1,289) - (17,291) Net operating income before loan impairment charges and other credit risk provisions 55,740 24,148 70 79,958 Loan impairment charges and other credit risk provisions (1,161) (915) 12 (2,064) Net operating income 54,579 23,233 82 77,894 Operating expenses (20,514) (13,998) (38) (34,550) Operating profit 34,065 9,235 44 43,344 Share of profit in associates 178 1,727 - 1,905 Profit before tax 34,243 10,962 44 45,249 Tax expense (5,411) (2,634) (6) (8,051) Profit for the year 28,832 8,328 38 37,198 Attributable to shareholders 24,644 8,191 38 32,873 Attributable to minority interests 4,188 137 - 4,325 Income statement Rest of Americas/ Total Figures in HK$m Hong Kong Asia-Pacific Europe restated Year ended 31Dec04 Interest income 38,533 21,777 601 60,911 Interest expense (12,211) (11,255) (475) (23,941) Net interest income 26,322 10,522 126 36,970 Fee income 13,717 6,066 1 19,784 Fee expense (1,913) (1,578) (12) (3,503) Net trading income 4,413 2,590 - 7,003 Net investment income on assets backing policyholder liabilities 669 229 - 898 Gains less losses from financial investments 1,361 135 1 1,497 Dividend income 148 15 - 163 Net earned insurance premiums 13,351 734 - 14,085 Other operating income 4,686 726 8 5,420 Total operating income 62,754 19,439 124 82,317 Net insurance claims incurred and movement in policyholder liabilities (11,098) (627) - (11,725) Net operating income before loan impairment charges and other credit risk provisions 51,656 18,812 124 70,592 Loan impairment charges and other credit risk provisions 1,684 (828) 6 862 Net operating income 53,340 17,984 130 71,454 Operating expenses (17,917) (10,268) (32) (28,217) Operating profit 35,423 7,716 98 43,237 Share of profit in associates 52 247 - 299 Profit before tax 35,475 7,963 98 43,536 Tax expense (4,768) (2,214) (6) (6,988) Profit for the year 30,707 5,749 92 36,548 Attributable to shareholders 26,334 5,722 92 32,148 Attributable to minority interests 4,373 27 - 4,400 Interest income and interest expense include intra-group interest of HK$5,082 million (2004: HK$2,964 million). Fee income and fee expense include intra-group fees of HK$489 million (2004: HK$308 million). Other operating income and operating expenses include intra-group items of HK$2,736 million (2004: HK$1,306 million). 36. Capital adequacy The table below sets out an analysis of regulatory capital and capital adequacy ratios for the group. Figures in HK$m 31Dec05 31Dec04^ Composition of capital Tier 1: Shareholders' funds 97,334 147,495 Less: proposed dividend (4,500) (4,800) property revaluation reserves^^ (7,892) (11,907) available-for-sale investments and equity revaluation reserves^^^ (3,051) (1,609) classified as regulatory reserve^^^^ (1,319) - term preference shares - (3,886) goodwill (3,784) (5,771) others 1,769 - Irredeemable non-cumulative preference shares 51,587 - Minority interests^^^^^ 14,808 14,384 Total qualifying tier 1 capital 144,952 133,906 Tier 2: Property revaluation reserves (@70%) 5,524 7,977 Available-for-sale investments and equity revaluation reserves (@70%) 2,136 1,126 Collective impairment provision and regulatory reserve 5,112 2,447 Perpetual subordinated debt 9,359 9,328 Term subordinated debt 6,117 1,814 Term preference shares 3,877 3,109 Irredeemable cumulative preference shares 16,516 - Total qualifying tier 2 capital 48,641 25,801 Deductions (39,528) (20,251) Total capital 154,065 139,456 Risk-weighted assets 1,238,164 1,173,432 ^ Comparative amounts for 31 December 2004 are as previously reported. ^^ Includes the revaluation surplus on investment properties, which is now reported as part of retained profits. ^^^ Includes adjustments made in accordance with guidelines issued by HKMA. ^^^^ The regulatory reserve is maintained for the purpose of satisfying the Banking Ordinance for prudential supervision. Movements in this reserve are made in consultation with the HKMA. ^^^^^ After deduction of minority interests in unconsolidated subsidiary companies. The group's capital adequacy ratios adjusted for market risks calculated in accordance with the HKMA Guideline on 'Maintenance of Adequate Capital Against Market Risks' are as follows: 31Dec05 31Dec04 Total capital 12.4% 11.9% Tier 1 capital 11.7% 11.4% The group's capital adequacy ratios calculated in accordance with the provisions of the Third Schedule of the Banking Ordinance, which does not take into account market risks, are as follows: Total capital 12.0% 11.9% Tier 1 capital 11.2% 11.4% 37. Liquidity ratio The Banking Ordinance requires banks operating in Hong Kong to maintain a minimum liquidity ratio, calculated in accordance with the provisions of the Fourth Schedule of the Banking Ordinance, of 25 per cent. This requirement applies separately to the Hong Kong branches of the bank and to those subsidiary companies which are Authorised Institutions under the Banking Ordinance in Hong Kong. 2005 2004 The average liquidity ratio for the period was as follows: Hong Kong branches of the bank 48.2% 41.7% 38. Property revaluation The group's premises and investment properties were revalued as at 30 September 2005 and updated for any material changes at 31 December 2005. The basis of valuation was open market value. Premises and investment properties in the Hong Kong SAR, the Macau SAR and mainland China, which represent 95 per cent by value of the group's properties subject to valuation, were valued by DTZ Debenham Tie Leung Limited. The valuations were carried out by independent qualified valuers who are members of the Hong Kong Institute of Surveyors. Properties in 11 other countries, which represent 5 per cent by value of the group's properties, were valued by different, independent, professionally qualified valuers. The September property revaluation, together with the revaluation of Hong Kong properties undertaken in June 2005, has resulted in an increase in the group's revaluation reserves of HK$1,017 million, net of deferred taxation of HK$307 million, and a credit to the income statement of HK$1,537 million, of which HK$1,167 million represents the surplus on the revaluation of investment properties and HK$370 million relates to the reversal of previous revaluation deficits that had arisen when the value of certain premises fell below depreciated historical cost. 39. Transition to new Hong Kong Financial Reporting Standards and comparative figures The group has adopted new and revised Hong Kong Financial Reporting Standards and Hong Kong Accounting Standards ('new HKFRS') which are broadly equivalent to International Financial Reporting Standards, and are effective for accounting periods beginning on or after 1 January 2005. The adoption of the new HKFRS has resulted in changes to the group's accounting policies which have affected the amounts reported for the current and prior year. Comparative numbers have been restated to conform with the new accounting policies, except for those applicable to financial instruments (HKAS 39). Included in the appendix to this news release is the reconciliation of the consolidated income statement for 2004 and of the consolidated balance sheet at 31 December 2004, as previously reported and as restated, showing the effects of the adoption of the new HKFRS (except HKAS 39). Also included in the appendix is the restatement of the opening consolidated balance sheet at 1 January 2005, showing the effects of the adoption of HKAS 39. 40. Accounting policies The accounting policies adopted in 2005 and 2004, and a summary of the effects of the significant changes, are detailed in the appendix to this news release. 41. Statutory accounts The information in this news release is not audited and does not constitute statutory accounts. Certain financial information in this news release is extracted from the statutory accounts for the year ended 31 December 2005 which were approved by the Board of Directors on 6 March 2006 and will be delivered to the Registrar of Companies and the Hong Kong Monetary Authority. The Auditors expressed an unqualified opinion on those statutory accounts in their report dated 6 March 2006. The Annual Report and Accounts for the year ended 31 December 2005, which include the statutory accounts, can be obtained on request from Group Public Affairs, The Hongkong and Shanghai Banking Corporation Limited, 1 Queen's Road Central, Hong Kong, and may be viewed on our website: www.hsbc.com.hk on or after 4 April 2006. 42. Ultimate holding company The Hongkong and Shanghai Banking Corporation Limited is an indirectly-held, wholly-owned subsidiary of HSBC Holdings plc. Appendix 1. Accounting policies a Interest income and expense From 1 January 2005 Interest income and expense for all interest-bearing financial instruments, except those classified as held-for-trading or designated at fair value, are recognised in 'Interest income' and 'Interest expense' in the income statement using the effective interest rates of the financial assets or financial liabilities to which they relate. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the group estimates cash flows considering all contractual terms of the financial instrument but not future credit losses. The calculation includes all amounts paid or received by the group that are an integral part of the effective interest rate, including transaction costs and all other premiums or discounts. Interest on impaired financial assets is recognised at the original effective interest rate of the financial asset applied to the impaired carrying amount. The accounting policy for recognising impairment of loans and advances is set out in Note (d) below. From 1 January 2004 to 31 December 2004 Interest income was recognised in the income statement as it accrued, except in the case of impaired loans and advances. Interest on impaired loans was not recognised in the income statement, but was credited to an interest suspense account in the balance sheet which was netted against the relevant loan. b Non-interest income (i) Fee income From 1 January 2005 The group earns fee income from a diverse range of services it provides to its customers. Fee income is accounted for as follows: - if the income is earned on the execution of a significant act, it is recognised as revenue when the significant act has been completed (for example, fees arising from negotiating, or participating in the negotiation of, a transaction for a third party, such as the arrangement for the acquisition of shares or other securities); - if the income is earned as services are provided, it is recognised as revenue as the services are provided (for example, asset management, portfolio and other management advisory and service fees); and - if the income is an integral part of the effective interest rate of a financial instrument, it is recognised as an adjustment to the effective interest rate (for example, loan commitment fees) and recorded in 'Interest income' (see Note (a) above). From 1 January 2004 to 31 December 2004 Fee income was accounted for as follows: - income earned on the execution of a significant act and income earned as services were provided, were recognised as revenue on the same basis as described above for 2005; - if the income was clearly interest in nature, it was recognised on an appropriate basis over the relevant period and recorded in 'Interest income' (see Note (a) above). (ii) Dividend income Dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for equity securities. (iii) Net income from financial instruments designated at fair value From 1 January 2005 Net income from financial instruments designated at fair value comprises all gains and losses from changes in the fair value (net of accrued coupon) of such financial assets and financial liabilities, together with interest income and expense and dividend income attributable to those financial instruments. There was no such category for financial instruments prior to 1 January 2005. (iv) Net trading income From 1 January 2005 Net trading income comprises interest income and expense and dividend income attributable to trading financial assets and liabilities, together with all gains and losses from changes in fair value. Income and expense arising from economic hedging activities which do not qualify for hedge accounting under HKAS 39, as well as from the ineffective portion of qualifying hedges, are also included in 'Net trading income'. From 1 January 2004 to 31 December 2004 Net trading income comprised all gains and losses from changes in fair value (net of accrued coupons) of trading financial assets and financial liabilities. Interest income and expense, and dividend income, were recognised in 'Net interest income' or 'Dividend income' as appropriate. c Advances to customers and placings with banks From 1 January 2005 Advances to customers and placings with banks are loans and advances originated by the group, which have not been classified as held for trading or designated at fair value. Loans and advances are recognised when cash is advanced to borrowers. They are initially recorded at fair value plus any transaction costs, and are subsequently measured at amortised cost using the effective interest method, less impairment losses. Loans and advances classified as held for trading or designated at fair value are reported as 'Trading assets' or 'Financial assets designated at fair value' respectively (see Notes (e) and (f) below). From 1 January 2004 to 31 December 2004 Advances to customers and placings with banks included loans and advances originated by the group, which were not intended to be sold in the short term and had not been classified as held for trading. Loans and advances were recognised when cash was advanced to borrowers. They were measured at cost plus or minus amortisation of discounts or premiums as appropriate, less provisions for impaired loans and advances. d Loan impairment From 1 January 2005 It is the group's policy to make provisions for impaired loans and advances promptly where there is objective evidence that impairment of a loan or portfolio of loans has occurred. Impairment losses are assessed for all credit exposures. Loans that are individually significant are assessed and where impairment is identified, impairment losses are recognised. Loans that have been subject to individual assessment, but for which no impairment has been identified, are then assessed collectively to estimate the amount of impairment at the reporting date, which has not been specifically identified. Loans which are not individually significant, but which can be aggregated into groups of exposures sharing similar characteristics, are then assessed collectively to identify and calculate impairment losses which have occurred by the reporting date. This methodology is explained in greater detail below. Impairment losses are only recognised when there is evidence that they have been incurred prior to the reporting date. Losses which may be expected as a result of future events, no matter how likely, are not recognised. (i) Individually significant loans Impairment losses on individually significant accounts are assessed by an evaluation of the exposures on a case-by-case basis. The group assesses at each reporting date whether there is any objective evidence that a loan is impaired. This procedure is applied to all accounts that are considered individually significant. In determining the impairment losses on individually assessed accounts, the following factors are considered: - the group's aggregate exposure to the customer; - the viability of the customer's business model and capability to trade successfully out of financial difficulties and generate sufficient cash flow to service their debt obligations; - the amount and timing of expected receipts and recoveries; - the likely dividend available on liquidation or bankruptcy; - the extent of other creditors' commitments ranking ahead of, or pari passu with, HSBC and the likelihood of other creditors continuing to support the company; - the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident; - the realisable value of security (or other credit mitigants) and likelihood of successful repossession; - the likely deduction of any costs involved in recovery of amounts outstanding; - the ability of the borrower to obtain and make payments in the relevant foreign currency if loans are not in local currency; and - where available, the secondary market price for the debt. The impairment loss is calculated by comparing the present value of the expected future cash flows, discounted at the original effective interest rate of the loan, with its current carrying value and the amount of any loss is charged to the income statement. The carrying amount of impaired loans is reduced through the use of an allowance account. (ii) Collectively assessed loans Impairment losses are calculated on a collective basis in two different scenarios: - in respect of losses which have been incurred but have not yet been identified on loans subject to individual assessment for impairment (see section (i) above); and - for homogeneous groups of loans that are not considered individually significant. Incurred but not yet identified impairment Where loans have been individually assessed and no evidence of loss has been identified, these loans are grouped together on the basis of similar credit risk characteristics for the purpose of calculating a collective impairment loss. The loss calculated by this method represents impairments that have occurred at the balance sheet date but which will not be individually identified as such until some time in the future. The collective impairment loss is determined after taking into account: - historical loss experience in portfolios of similar risk characteristics (for example, by industry and geographical sectors, loan grade or product); - the estimated period between a loss occurring and the establishment of an allowance against the loss on an individual loan; and - management's experienced judgement as to whether the current economic and credit conditions are such that the actual level of inherent losses is likely to be greater or less than that suggested by historical experience. The estimated period between a loss occurring and its identification is determined by management for each identified portfolio. Homogeneous groups of loans For homogeneous groups of loans that are not considered individually significant, two alternative methods are used to calculate allowances on a portfolio basis. - When appropriate empirical information is available, the group utilises roll rate methodology. This methodology utilises a statistical analysis of historical trends of the probability of default and amount of consequential loss, assessed for each time period during which the customer's contractual payments are overdue. The amount of loss is based on the present value of expected future cash flows, discounted at the original effective interest rate of the portfolio. Other historical data and an evaluation of current economic conditions are also considered to calculate the appropriate level of impairment allowance based on inherent loss. - In other cases, when the portfolio size is small or when information is insufficient or not sufficiently reliable to adopt a roll rate methodology, the group adopts a formulaic approach which allocates loss rates having regard to the period of time for which a customer's loan is overdue. Loss rates are based on the discounted expected future cash flows from a portfolio. - Roll rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure they remain appropriate. (iii) Loan write-offs Loans (and the related impairment allowance accounts) are normally written off, either partially or in full, when there is no realistic prospect of recovery of these amounts and, for collateralised loans, when the proceeds from the realisation of security have been received. (iv) Reversals of impairment If the amount of an impairment loss decreases in a subsequent period and the decrease can be related objectively to an event occurring after the impairment was recognised, the previously recognised impairment loss is reduced accordingly. The reduction of an impairment loss under these circumstances is recognised in the income statement in the period in which it occurs. (v) Assets acquired in exchange for loans Non-financial assets acquired in exchange for loans in order to achieve an orderly realisation are recorded as assets held for sale and reported in 'Other assets'. The asset acquired is recorded at the lower of its fair value less costs to sell and the carrying amount of the loan, net of impairment allowance amounts, at the date of exchange. No depreciation is provided in respect of assets held for sale. Any subsequent write-down of the acquired asset to fair value less costs to sell is recorded as an impairment loss and included within 'Other operating income' in the income statement. Any subsequent increase in the fair value less costs to sell, to the extent this does not exceed the cumulative impairment loss, is recognised as a gain in 'Other operating income' in the income statement. Debt securities or equities acquired in debt-to-debt/equity swaps are included in 'Financial investments' and are classified as available-for-sale. (vi) Renegotiated loans Loans that have been individually identified as impaired and whose terms have been subsequently renegotiated and which have been performing satisfactorily for a certain period are no longer treated as impaired. This information is provided by RNS The company news service from the London Stock Exchange

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