HSBC USA 10-Q - Part 2
HSBC Holdings PLC
31 July 2006
PART 2 OF 2
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Increase (Decrease)
-------------------
Six months ended June 30 2006 2005 Amount %
-----------------------------------------------------------------------------------------------------------
($ in millions)
Trust income $ 44 $ 45 $ (1) (2)
Service charges:
HSBC affiliate income 7 8 (1) (13)
Other service charges 97 97 -- --
------- ------- ------- -------
104 105 (1) (1)
------- ------- ------- -------
Credit card fees 261 118 143 121
Other fees and commissions:
Letter of credit fees 36 35 1 3
Wealth and tax advisory services 48 29 19 66
HSBC affiliate income 23 36 (13) (36)
Other fee-based income, net of referral fees 109 71 38 54
------- ------- ------- -------
216 171 45 26
------- ------- ------- -------
Securitization revenue 19 69 (50) (72)
Other income:
Insurance 24 32 (8) (25)
HSBC affiliate income 102 23 79 343
Additional valuation allowance for reductions in market value
of loans held for sale to HMUS (152) -- (152) *
Gains on sale of property and other financial assets 16 46 (30) (65)
Other 89 54 35 65
------- ------- ------- -------
79 155 (76) (49)
------- ------- ------- -------
Residential mortgage banking revenue 50 10 40 400
Trading revenues 548 131 417 318
Securities gains, net 10 87 (77) (89)
------- ------- ------- -------
Total other revenues $ 1,331 $ 891 $ 440 49
======= ======= ======= =======
* Not meaningful.
All increases and decreases referred to below for the second quarter and for the
first six months of 2006 represent comparisons with the same 2005 periods.
Credit Card Fees
Increased credit card fees in the second quarter and in the first six months of
2006 primarily resulted from the following private label credit card portfolio
activity:
o increased number of accounts and average receivable balances associated
with the private label credit card portfolio;
o increased late fees and other fees; and
o lower payments to merchant partners due to terminations and revisions to
certain merchant agreements.
Other Fees and Commissions
Increased wealth and tax advisory services revenue in the second quarter and in
the first six months of 2006 resulted from expansion of services offered to high
net worth individuals within the PB business segment.
The increase in other fee-based income is due to:
o new service fees recorded within the CIBM business segment generated by a
subsidiary transferred to HUSI from HSBC in March 2005, which provides
accounting and valuation services for hedge fund clients; and
o various growth initiatives undertaken in 2005 and 2006, which resulted in
general increases in fee income recorded within the PFS, CMB and CIBM
business segments.
42
Securitization Revenue
Securitization revenue is comprised of servicing revenue and excess servicing
spread from residual interests in securitized private label credit card
receivables. Existing securitized trusts require replenishments of receivables
to support previously issued securities. Receivables will continue to be sold to
these trusts until their revolving periods end, the last of which is expected to
occur in 2007. All collateralized funding transactions have been structured as
secured financings since the third quarter of 2004. Therefore, there were no new
securitization transactions during 2005 or 2006.
The decrease in securitization revenue for the second quarter and for the first
six months of 2006 is attributable to decreased levels of receivables maintained
within existing securitized trusts. As the balance requirements of these trusts
have decreased, receivables maintained on HUSI's consolidated balance sheet have
increased, resulting in increased net interest income.
Additional analysis of securitization activities is provided in Off-Balance
Sheet Arrangements beginning on page 64 of this Form 10-Q.
Other Income
Increased HSBC affiliate income for the second quarter and for the first six
months of 2006 primarily resulted from gains realized from sales of residential
mortgage loans to HMUS. Additional valuation adjustments for reductions in
market value of residential mortgage loans held for resale to HMUS also relate
to this program, which began in the third quarter of 2005. Additional revenues
related to this program are recorded in trading revenues (refer to pages 47-48
of this Form 10-Q). Additional information regarding these loan sales is
provided in the Executive Overview on page 28 of this Form 10-Q.
Gains on sale of property and other financial assets include the following
material transactions for 2006 and 2005:
o gains for the second quarter of 2006 include a $13 million gain from the
redemption of Brady Bonds (refer to commentary on page 29 of this Form
10-Q); and
o gains for the second quarter of 2005 included a gain of $26 million from
the sale of property, as well as additional gains of $6 million from sales
of various branches.
Other includes the following material transactions and/or activity for 2006 and
2005:
o in the second quarter of 2006, MasterCard International, Inc. completed an
initial public offering, which resulted in redemption of shares held by
HUSI and by other financial institutions. Proceeds of $7 million from this
redemption of shares was recorded in other income in the quarter; and
o earnings from various equity investments, which were recorded in the first
quarter of 2006, were $16 million higher than those recorded for 2005.
43
Residential Mortgage Banking Revenue
The following table presents the components of residential mortgage banking
revenue. Net interest income includes interest earned/paid on assets and
liabilities of the residential mortgage banking business as well as an
allocation of the funding cost or benefit associated with these balances. The
net interest income component in the table is included in net interest income in
the consolidated statement of income and reflects actual interest earned, net of
cost of funds, and adjusted for corporate transfer pricing.
----------------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
Three months ended June 30 2006 2005 Amount %
----------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income $ 87 $ 118 $ (31) (26)
----- ----- ------- ------
Servicing related income:
Servicing fee income 24 19 5 26
Changes in fair value of MSRs due to (1):
Changes in valuation inputs or assumptions used in valuation
model 30 -- 30 *
Realization of cash flows (18) -- (18) *
MSRs amortization (2) -- (18) 18 *
MSRs temporary impairment provision (2) -- (35) 35 *
Trading - Derivative instruments used to offset changes in
value of MSRs (23) 24 (47) (196)
----- ----- ------- ------
13 (10) 23 *
----- ----- ------- ------
Originations and sales related income:
Gains on sales of residential mortgages 8 11 (3) (27)
Trading and fair value hedge activity (3) -- (19) 19 *
----- ----- ------- ------
8 (8) 16 *
----- ----- ------- ------
Other mortgage income 6 5 1 20
----- ----- ------- ------
Total residential mortgage banking revenue (expense) included
in other revenues 27 (13) 40 *
----- ----- ------- ------
Total residential mortgage banking related revenue $ 114 $ 105 $ 9 9
===== ===== ======= ======
(1) Based upon adoption of SFAS 156 effective January 1, 2006. Refer to Note 6
of the consolidated financial statements, beginning on page 13 of this
Form 10-Q for further discussion.
(2) Based upon methodology existing prior to adoption of SFAS 156.
(3) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity, which was
discontinued in 2005, and other immaterial activity.
* Not meaningful.
44
--------------------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
Six months ended June 30 2006 2005 Amount %
--------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income $ 182 $ 246 $ (64) (26)
------- ------- ------- --------
Servicing related income:
Servicing fee income 48 37 11 30
Changes in fair value of MSRs due to (1):
Changes in valuation inputs or assumptions used in valuation
model 75 -- 75 *
Realization of cash flows (39) -- (39) *
MSRs amortization (2) -- (37) 37 *
MSRs temporary impairment provision (2) -- (18) 18 *
Trading - Derivative instruments used to offset changes in
value of MSRs (57) 19 (76) (400)
------- ------- ------- --------
27 1 26 2,600
------- ------- ------- --------
Originations and sales related income:
Gains on sales of residential mortgages 11 15 (4) (27)
Trading and fair value hedge activity (3) 1 (15) 16 *
------- ------- ------- --------
12 -- 12 *
------- ------- ------- --------
Other mortgage income 11 9 2 22
------- ------- ------- --------
Total residential mortgage banking revenue included in other
revenues 50 10 40 400
------- ------- ------- --------
Total residential mortgage banking related revenue $ 232 $ 256 $ (24) (9)
======= ======= ======= ========
(1) Based upon adoption of SFAS 156 effective January 1, 2006. Refer to Note 6
of the consolidated financial statements, beginning on page 13 of this
Form 10-Q for further discussion.
(2) Based upon methodology existing prior to adoption of SFAS 156.
(3) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity, which was
discontinued in 2005, and other immaterial activity.
* Not meaningful.
All increases and decreases referenced below for the second quarter and for the
first six months of 2006 represent comparisons with the same 2005 periods.
Net Interest Income
Decreased net interest income for the second quarter and for the first six
months of 2006 resulted from the following activity:
o in 2005, HUSI commenced a strategic balance sheet initiative to sell the
majority of new loan production to government sponsored enterprises and
private investors, which continued into 2006, and which decreased average
residential mortgage loan outstandings. The held loan portfolio is
expected to continue to decline for the remainder of 2006 as a result of
this initiative; and
o despite a rising residential mortgage interest rate environment, interest
rate spreads narrowed slightly during 2006 due to higher funding costs.
Additional commentary regarding residential mortgage interest income is provided
on page 37 of this Form 10-Q.
45
Servicing Related Income
Increased net servicing related income for the second quarter and for the first
six months of 2006 resulted from:
o increased volume of loans included within the average serviced loans
portfolio, which increased approximately 25% for the first six months of
2006 due to the following factors:
- HUSI sold a higher proportion of adjustable rate loans in 2005 and
2006, which previously would have been held on the balance sheet;
- in the fourth quarter of 2005, HUSI commenced servicing a portfolio
of loans previously serviced by a third party; and
- also in the fourth quarter of 2005, HUSI completed a sale of loans,
which were previously held in portfolio, to a government agency for
which it continues to provide servicing.
o increased value of MSRs, net of economic hedges. The generally increasing
residential mortgage interest rate environment has resulted in a reduction
in prepayments in 2006, which has increased the long-term value of MSRs.
In addition, HUSI's adoption of SFAS 156 (refer to Note 6 of the
consolidated financial statements, beginning on page 13 of this Form 10-Q)
resulted in the recognition of higher fair market values for MSRs recorded
on the consolidated balance sheet.
Additional commentary regarding risk management associated with the MSRs hedging
program is provided on pages 70-71 of this Form 10-Q.
Originations and Sales Related Income (Expense)
Increased originations and sales related income for the second quarter and for
the first six months of 2006 resulted from:
o higher basis point gains on individual sales of residential mortgages; and
o increased volume of residential mortgages originated with the intention to
sell, which increased 24% for the first six months of 2006.
46
Trading Revenues
Trading revenues are generated by HUSI's participation in foreign exchange,
credit derivative and precious metals markets; from trading derivative
contracts, including interest rate swaps and options; and from trading
securities. During 2005, HUSI's CIBM business segment expanded operations and
products offered to clients, which resulted in increased trading activity and
improved trading results in 2005 and 2006. Decreased net interest income for
2006 was primarily due to steadily rising short-term interest rates during 2005
and 2006, which had an adverse impact on interest rate spreads.
Trading related revenues generated by the CIBM business segment, summarized by
type of product, are provided in the following table. The data in the table
includes interest income earned on trading instruments, net of allocated funding
cost associated with the trading positions. The net interest income component is
included in net interest income on the consolidated statement of income. Trading
revenues related to the residential mortgage banking business are included in
residential mortgage banking revenue.
-------------------------------------------------------------------------------
Increase (Decrease)
-------------------
Three months ended June 30 2006 2005 Amount %
-------------------------------------------------------------------------------
($ in millions)
Trading revenues $ 269 $ 35 $ 234 669
Net interest (expense) income (17) 4 (21) (525)
------- ------- ------- ---------
Trading related revenues $ 252 $ 39 $ 213 546
======= ======= ======= =========
Business:
Derivatives instruments $ 83 $ 18 $ 65 361
Economic hedges of loans held for
sale to HMUS 70 -- 70 *
Treasury (primarily securities) 4 (11) 15 *
Foreign exchange and banknotes 52 26 26 100
Precious metals 36 8 28 350
Other trading 7 (2) 9 *
------- ------- ------- ---------
Trading related revenues $ 252 $ 39 $ 213 546
======= ======= ======= =========
* Not meaningful.
-------------------------------------------------------------------------------
Increase (Decrease)
-------------------
Six months ended June 30 2006 2005 Amount %
-------------------------------------------------------------------------------
($ in millions)
Trading revenues $ 548 $ 131 $ 417 318
Net interest (expense) income (31) 21 (52) (248)
------- ------- ------- ---------
Trading related revenues $ 517 $ 152 $ 365 240
======= ======= ======= =========
Business:
Derivatives instruments $ 173 $ 59 $ 114 193
Economic hedges of loans held for
sale to HMUS 154 -- 154 *
Treasury (primarily securities) 9 3 6 200
Foreign exchange and banknotes 95 63 32 51
Precious metals 71 25 46 184
Other trading 15 2 13 650
------- ------- ------- ---------
Trading related revenues $ 517 $ 152 $ 365 240
======= ======= ======= =========
* Not meaningful.
47
Derivative Instruments
Net interest income related to derivatives businesses decreased $26 million and
$51 million for the second quarter and for the first six months of 2006
respectively, as compared with the same 2005 periods, due to the rising
short-term interest rate environment.
HUSI recognizes gain or loss at the inception of derivative transactions only
when the fair value of the transaction can be verified to market transactions or
if all significant pricing model assumptions can be verified to observable
market data. Gain or loss not recognized at inception is recorded in trading
liabilities and recognized over the term of the derivative contract in
correlation with outstanding risk and valuation characteristics.
In addition, derivatives trading revenues increased during 2006 as a result of
increased revenue from the credit derivatives trading and structured
transactions businesses, which were significantly expanded during 2005.
Economic Hedges of Loans Held for Sale to HMUS
Effective from the third quarter of 2005, HUSI maintains a portfolio of
derivative instruments that are utilized as economic hedges to offset changes in
market values of loans held for sale to HMUS. During the second quarter of 2006,
HUSI realized $52 million of trading revenues and $18 million of net interest
income related to this portfolio. During the first six months of 2006, HUSI
realized $116 million of trading revenues and $38 million of net interest
income. Further analysis and commentary regarding these loans and the associated
hedges is provided on page 28 of this Form 10-Q.
Precious Metals
Precious metals trading income increased due to increased client and proprietary
trading activity from both domestic and foreign trading desks, which resulted
from higher precious metals prices. Partially offsetting increased trading
revenues was decreased net interest income resulting from rising short-term
interest rates.
Securities Gains, Net
HUSI maintains various securities portfolios as part of its strategies for
overall liquidity, balance sheet diversification and risk management. The
following tables summarize net securities gains resulting from various
strategies.
-------------------------------------------------------------------------------
2006 2005
-------------------------------------------------------------------------------
(in millions)
Three months ended June 30
Balance sheet diversity and reduction of risk $ -- $ 15
Sale of foreign equity fund -- 48
Other 6 1
------- -------
Total securities gains, net $ 6 $ 64
======= =======
Six months ended June 30
Balance sheet diversity and reduction of risk $ 4 $ 27
Reduction of Latin American exposure -- 10
Sale of foreign equity fund -- 48
Other 6 2
------- -------
Total securities gains, net $ 10 $ 87
======= =======
48
Operating Expenses
The following table presents the components of operating expenses.
------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
Three months ended June 30 2006 2005 Amount %
------------------------------------------------------------------------------------------------
($ in millions)
Salaries and employee benefits:
Salaries $ 218 $ 185 $ 33 18
Employee benefits 103 69 34 49
-------- --------- --------- -------
321 254 67 26
-------- --------- --------- -------
Occupancy expense, net 57 43 14 33
Support services from HSBC affiliates:
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support 109 100 9 9
Treasury and traded markets services and other
fees 89 67 22 33
Fees paid to HTSU for technology services 49 51 (2) (4)
-------- --------- --------- -------
247 218 29 13
-------- --------- --------- -------
Other expenses:
Equipment and software 18 22 (4) (18)
Marketing 25 18 7 39
Outside services 31 30 1 3
Professional fees 14 15 (1) (7)
Telecommunications 5 5 -- --
Postage, printing and office supplies 9 7 2 29
Insurance business 6 3 3 100
Other 42 69 (27) (39)
-------- --------- --------- -------
150 169 (19) (11)
-------- --------- --------- -------
Total operating expenses $ 775 $ 684 $ 91 13
======== ========= ========= =======
Personnel - average number 12,313 11,134 1,179 11
------------------------------------------------------------------------------------------------
Increase (Decrease)
-------------------
Six months ended June 30 2006 2005 Amount %
------------------------------------------------------------------------------------------------
($ in millions)
Salaries and employee benefits:
Salaries $ 437 $ 368 $ 69 19
Employee benefits 199 152 47 31
-------- --------- --------- -------
636 520 116 22
-------- --------- --------- -------
Occupancy expense, net 108 85 23 27
Support services from HSBC affiliates:
Fees paid to HSBC Finance Corporation for loan
servicing and other administrative support 225 204 21 10
Treasury and traded markets services and other
fees 180 132 48 36
Fees paid to HTSU for technology services 106 100 6 6
-------- --------- --------- -------
511 436 75 17
-------- --------- --------- -------
Other expenses:
Equipment and software 38 46 (8) (17)
Marketing 46 33 13 39
Outside services 60 55 5 9
Professional fees 31 29 2 7
Telecommunications 10 10 -- --
Postage, printing and office supplies 16 13 3 23
Insurance business 11 9 2 22
Other 93 102 (9) (9)
-------- --------- --------- -------
305 297 8 3
-------- --------- --------- -------
Total operating expenses $ 1,560 $ 1,338 $ 222 17
======== ========= ========= =======
Personnel - average number 12,224 10,982 1,242 11
49
All increases and decreases referred to below for the second quarter and for the
first six months of 2006 represent comparisons with the same 2005 periods.
Overview
Increased expenses for the second quarter and for the first six months of 2006
were driven largely by the rollout of various business growth initiatives
affecting all business segments, and by increased fees charged by HSBC
affiliates for various services.
Salaries and Employee Benefits
Increased salary expense for the second quarter and for the first six months of
2006 was primarily due to the increased number of personnel employed to support
various business growth initiatives within the PFS, CMB, CIBM and PB business
segments.
Increased employee benefits expenses primarily resulted from increased salary
expense and staff counts. In addition, in light of impressive and sustained
performance and shareholder returns by the consolidated HSBC group over the
three years covered by 2003 awards granted under the HSBC Group Share Option
Plan (refer to page 126 of HUSI's 2005 Form 10-K for a description of this
plan), HSBC's Remuneration Committee has exercised its discretion to waive the
Total Shareholder Return performance condition, as permitted by the plan. This
modification resulted in an additional charge to operating expenses of $9
million during the first six months of 2006. This is a non-cash item and
economically has no impact on shareholders.
Support Services from HSBC Affiliates
Fees are charged by various HSBC affiliates for technology services, for
underwriting and broker-dealer services, for treasury and traded markets
services, for loan origination and servicing, and for other operational and
administrative support functions. The overall increases in HSBC affiliate
charges for the second quarter and for the first six months of 2006 are due
primarily to the following activity:
o fees charged by HMUS and other HSBC affiliates for treasury and traded
markets services have increased in 2006 due primarily to business
expansion initiatives within the CIBM segment; and
o fees charged by HSBC Finance Corporation for loan origination and
servicing have increased as a result of an increased number of accounts
and increased balances associated with various loan portfolios and other
loan balances serviced by HSBC Finance Corporation on behalf of HUSI. Fees
charged by HSBC Finance Corporation for various administrative services
have also increased as a result of continued initiatives to centralize
administrative functions.
Other Expenses
For the first six months of 2006, business expansion initiatives within PFS,
CMB, CIBM and PB business segments have resulted in general increases in various
expense categories.
Increased marketing and promotional expenses resulted from investment in HSBC
brand activities, promotion of the internet savings account and marketing
support for branch expansion initiatives.
Other expenses includes the following material activity for 2006 and 2005:
o during the second quarter of 2006, HUSI settled certain prior year income
tax liabilities. Taxes and interest related to this settlement were fully
reserved for prior to December 31, 2005. As a result of this settlement,
approximately $13 million of accrued interest was released and reversed
from other expenses; and
o errors and losses decreased $14 million and $21 million for the second
quarter and for the first six months of 2006 respectively. Unusual losses
associated with the private label receivable portfolio were recorded in
2005.
50
Efficiency Ratio
--------------------------------------------------------------------------------
Three months ended Six months ended
June 30 June 30
--------------------- --------------------
2006 2005 2006 2005
--------------------------------------------------------------------------------
Efficiency ratio (1) 53.49% 57.11% 54.91% 54.59%
(1) Represents the ratio of total operating expenses, reduced by minority
interests and certain non-recurring expense items, to the sum of net
interest income and other revenues.
Improvement in the efficiency ratio for the second quarter of 2006 was primarily
due to increased trading revenues (refer to commentary beginning on page 47 of
this Form 10-Q), which was partially offset by increased operating expenses
(refer to commentary on the preceding page). For the first six months of 2006,
the efficiency ratio was relatively unchanged, as increased trading revenues
were offset by increased operating expenses and decreased net interest income.
51
SEGMENT RESULTS
--------------------------------------------------------------------------------
HUSI has five distinct segments that are utilized for management reporting and
analysis purposes. The segments, which are based upon customer groupings, as
well as products and services offered, are described in Note 13 of the
consolidated financial statements, beginning on page 19 of this Form 10-Q.
All increases and decreases referenced below for the second quarter and for the
first six months of 2006 represent comparisons to the same 2005 periods.
Personal Financial Services (PFS)
Overview
Additional resources and investment continue to be directed towards expansion of
the core retail banking business, including investment in the HSBC brand,
expansion of the core branch network in existing and new geographic areas, and
continued rollout of the internet savings business. As expected during the
build-out phase, these initiatives have resulted in growth of expenses during
the first six months of 2006 that has outpaced growth in revenues.
Balance sheet growth during the first six months of 2006 was highlighted by a
significant increase in deposits resulting from successful rollout of a strategy
to build deposits across multiple markets and business segments, utilizing
multiple delivery systems.
Operating Results
The following table summarizes results for the PFS segment.
-------------------------------------------------------------------------------
2006 Compared to 2005
Increase (Decrease)
---------------------
2006 2005 Amount %
-------------------------------------------------------------------------------
($ in millions)
Three months ended June 30
Net interest income $ 311 $ 302 $ 9 3
Other revenues 99 86 13 15
--------- --------- --------- ---------
Total revenues 410 388 22 6
Operating expenses 276 248 28 11
--------- --------- --------- ---------
134 140 (6) (4)
Provision for credit losses 12 22 (10) (45)
--------- --------- --------- ---------
Income before income tax expense $ 122 $ 118 $ 4 3
========= ========= ========= =========
Six months ended June 30
Net interest income $ 620 $ 602 $ 18 3
Other revenues 234 214 20 9
--------- --------- --------- ---------
Total revenues 854 816 38 5
Operating expenses 581 499 82 16
--------- --------- --------- ---------
273 317 (44) (14)
Provision for credit losses 28 44 (16) (36)
--------- --------- --------- ---------
Income before income tax expense $ 245 $ 273 $ (28) (10)
========= ========= ========= =========
Increased net interest income in 2006 was primarily due to higher interest rate
spreads on a growing personal deposit base, which was partially offset by a
migration by customers toward higher yielding deposit products, and by lower net
interest income from a decreasing residential mortgage loan portfolio.
Increased other revenues for 2006 is primarily due to increased non-interest
residential mortgage banking revenues. Additional commentary regarding
residential mortgage banking revenue begins on page 44 of this Form 10-Q.
52
Operating expenses increased for the second quarter of 2006 due to:
o increased personnel, marketing and other direct costs associated with
expansion of the core banking network and other consumer lending
operations have resulted in additional expenses of approximately $34
million for the first six months of 2006;
o increased fees paid to HSBC Finance Corporation, as HUSI continued to
leverage its relationship to centralize various loan servicing and
administrative support functions; and
o allocations to the PFS business segment of various increased expenses,
including share option costs.
Consumer Finance (CF)
Overview
The CF segment includes the private label receivable portfolio (the PLRP)
acquired from HSBC Finance Corporation and its correspondents. Results of the CF
segment have been positively impacted by growth of private label credit card
receivables included within the PLRP and by decreased amortization of premiums
paid to HSBC Finance Corporation for those receivables.
Refer to commentary regarding the PLRP on page 27 of this Form 10-Q.
Operating Results
The following table summarizes results for the CF segment.
-------------------------------------------------------------------------------------
2006 Compared to 2005
Increase (Decrease)
---------------------
2006 2005 Amount %
-------------------------------------------------------------------------------------
($ in millions)
Three months ended June 30
Net interest income $ 190 $ 166 $ 24 14
Other revenues 117 67 50 75
-------- -------- -------- ----------
Total revenues 307 233 74 32
Operating expenses 106 110 (4) (4)
-------- -------- -------- ----------
201 123 78 63
Provision for credit losses 155 152 3 2
-------- -------- -------- ----------
Income (loss) before income tax expense $ 46 $ (29) $ 75 *
======== ======== ======== ==========
Six months ended June 30
Net interest income $ 343 $ 296 $ 47 16
Other revenues 236 147 89 61
-------- -------- -------- ----------
Total revenues 579 443 136 31
Operating expenses 216 217 (1) --
-------- -------- -------- ----------
363 226 137 61
Provision for credit losses 290 261 29 11
-------- -------- -------- ----------
Income (loss) before income tax expense $ 73 $ (35) $ 108 *
======== ======== ======== ==========
* Not meaningful.
53
The following table summarizes the impact of the PLRP on earnings for the CF
segment in comparison with the other portfolios.
---------------------------------------------------------------------------
Three months ended June 30 PLRP Other Total
---------------------------------------------------------------------------
(in millions)
2006
Net interest income $ 153 $ 37 $ 190
Other revenues 117 -- 117
-------- -------- --------
Total revenues 270 37 307
Operating expenses 103 3 106
-------- -------- --------
167 34 201
Provision for credit losses 150 5 155
-------- -------- --------
Income before income tax expense $ 17 $ 29 $ 46
======== ======== ========
2005
Net interest income $ 110 $ 56 $ 166
Other revenues 67 -- 67
-------- -------- --------
Total revenues 177 56 233
Operating expenses 106 4 110
-------- -------- --------
71 52 123
Provision for credit losses 139 13 152
-------- -------- --------
(Loss) income before income tax expense $ (68) $ 39 $ (29)
======== ======== ========
---------------------------------------------------------------------------
Six months ended June 30 PLRP Other Total
---------------------------------------------------------------------------
(in millions)
2006
Net interest income $ 263 $ 80 $ 343
Other revenues 236 -- 236
-------- -------- --------
Total revenues 499 80 579
Operating expenses 208 8 216
-------- -------- --------
291 72 363
Provision for credit losses 278 12 290
-------- -------- --------
Income before income tax expense $ 13 $ 60 $ 73
======== ======== ========
2005
Net interest income $ 181 $ 115 $ 296
Other revenues 147 -- 147
-------- -------- --------
Total revenues 328 115 443
Operating expenses 208 9 217
-------- -------- --------
120 106 226
Provision for credit losses 248 13 261
-------- -------- --------
(Loss) income before income tax expense $ (128) $ 93 $ (35)
======== ======== ========
Increased net interest income for the PLRP is due to increased average credit
card receivable balances for the quarter, and to decreased amortization of
premiums paid for purchases of receivables from HSBC Finance Corporation (refer
to page 38 of this Form 10-Q).
Increased other revenues for the PLRP are directly related to increased credit
card fees (refer to page 42 of this Form 10-Q), which were partially offset by
decreased securitization revenue (refer to page 43 of this Form 10-Q).
Increased provision for credit losses for the PLRP portfolio resulted from
increased average credit card receivable balances as well as from increased past
due balances (refer to page 40 of this Form 10-Q).
54
New domestic private label credit card receivables are acquired from HSBC
Finance Corporation on a daily basis. In accordance with Federal Financial
Institutions Examination Council (FFIEC) guidance, HUSI adopted a plan to phase
in changes to the required minimum monthly payment amount for domestic private
label credit card accounts. The implementation of these new requirements began
in the fourth quarter of 2005 and was completed in the first quarter of 2006,
resulting in an immaterial impact on second quarter and six month results.
Estimates of the potential impact to the business are based on numerous
assumptions and take into account a number of factors which are difficult to
predict such as changes in customer behavior, which will not be fully known or
understood until the changes have been in place for a period of time. The impact
of these changes, if any, is not expected to be material to HUSI's consolidated
results.
Commercial Banking (CMB)
Overview
Improved operating results for 2006, which resulted from the continued rollout
of planned expansion initiatives, were offset by increased provisions for credit
losses in the second quarter of 2006 as compared with unusually low provisions
in 2005. Office locations and staffing levels were expanded in 2005 and 2006, as
were loan and deposit products offered to small businesses and middle-market
commercial customers, in conjunction with increased marketing efforts. HUSI
continues to leverage its status as one of the top ranked small business lenders
in New York State.
Operating Results
The following table summarizes results for the CMB segment.
-------------------------------------------------------------------------------------
2006 Compared to 2005
Increase (Decrease)
---------------------
2006 2005 Amount %
-------------------------------------------------------------------------------------
($ in millions)
Three months ended June 30
Net interest income $ 178 $ 155 $ 23 15
Other revenues 77 51 26 51
-------- -------- -------- ----------
Total revenues 255 206 49 24
Operating expenses 135 90 45 50
-------- -------- -------- ----------
120 116 4 3
Provision for credit losses 26 4 22 550
-------- -------- -------- ----------
Income before income tax expense $ 94 $ 112 $ (18) (16)
======== ======== ======== ==========
Six months ended June 30
Net interest income $ 356 $ 309 $ 47 15
Other revenues 126 91 35 38
-------- -------- -------- ----------
Total revenues 482 400 82 21
Operating expenses 245 188 57 30
-------- -------- -------- ----------
237 212 25 12
Provision (credit) for credit losses 30 (1) 31 *
-------- -------- -------- ----------
Income before income tax expense $ 207 $ 213 $ (6) (3)
======== ======== ======== ==========
* Not meaningful.
Increased net interest income and other revenues for the second quarter of 2006
resulted from the successful rollout of planned expansion of various small
business, middle-market and real estate commercial lending programs, which
resulted in increased actual and average commercial loan balances. Net interest
income growth was partially offset by narrowing deposit spreads, as customers
migrated to higher yielding deposit products in 2006.
Higher operating expenses primarily resulted from branch expansion initiatives
and new lending offices and, to a lesser extent, to allocation to CMB of various
increased expenses, such as share option costs.
55
Increased provision for credit losses for 2006 resulted from growth in
commercial loan portfolio balances and from increased allowance requirements
associated with small business lending portfolios. In addition, unusually low
net charge offs were recorded during 2005. Further commentary regarding credit
quality begins on page 58 of this Form 10-Q.
Corporate, Investment Banking and Markets (CIBM)
Overview
Various treasury and traded markets activities were expanded in 2005 and 2006.
Increased products offered to customers, increased marketing efforts for those
products, and an expanded infrastructure to support growth initiatives have
resulted in increased non-interest revenues and income before income tax expense
during 2006.
The CIBM segment has recorded strong trading results in 2006, which were
partially offset by steadily rising short-term interest rates, which limited
opportunities to profit from placing funds generated from operations. While
increased short-term rates have a positive impact on interest rate spreads for
deposit generating businesses, such as the PFS and CMB segments, they have an
adverse impact on the CIBM segment, which does not generate significant low cost
deposit funding.
Operating Results
The following table summarizes results for the CIBM segment.
-------------------------------------------------------------------------------
2006 Compared to 2005
Increase (Decrease)
---------------------
2006 2005 Amount %
-------------------------------------------------------------------------------
($ in millions)
Three months ended June 30
Net interest income $ 49 $ 123 $ (74) (60)
Other revenues 313 98 215 219
--------- --------- --------- ---------
Total revenues 362 221 141 64
Operating expenses 184 172 12 7
--------- --------- --------- ---------
178 49 129 263
Provision (credit) for credit
losses -- (7) 7 *
--------- --------- --------- ---------
Income before income tax expense $ 178 $ 56 $ 122 218
========= ========= ========= =========
Six months ended June 30
Net interest income $ 102 $ 277 $ (175) (63)
Other revenues 586 265 321 121
--------- --------- --------- ---------
Total revenues 688 542 146 27
Operating expenses 368 306 62 20
--------- --------- --------- ---------
320 236 84 36
Provision (credit) for credit
losses 2 (25) 27 *
--------- --------- --------- ---------
Income before income tax expense $ 318 $ 261 $ 57 22
========= ========= ========= =========
* Not meaningful.
Decreased net interest income primarily resulted from steadily rising short-term
interest rates during 2005 and 2006, which had an adverse impact on CIBM
interest rate spreads. Net interest income from balance sheet management
activity decreased approximately $66 million and $169 million for the second
quarter and for the first six months of 2006 respectively. Rising interest rates
also tightened interest rate spreads related to higher trading activity, which
contributed to lower net interest income.
Increased other revenues mainly resulted from:
o increased trading revenues (refer to page 47 of this Form 10-Q);
o new service fees generated by a subsidiary transferred to HUSI from HSBC
in March 2005, which provides accounting and valuation services for hedge
fund clients; and
o increased fee-based income within the transaction banking business,
resulting from business expansion initiatives.
56
Partially offsetting these increases were decreased realized gains on sales of
securities (refer to page 48 of this Form 10-Q).
Operating expenses growth slowed in the second quarter, as evidenced by expenses
increasing 20% for the first half of 2006, but increasing only 8% for the second
quarter. Increases in operating expenses resulted from:
o increased direct expenses associated with foreign exchange, risk
management products, and transaction banking businesses; and
o increased expenses associated with development of an infrastructure to
support the growing complexity of the CIBM business.
The net provision credit for 2005 resulted from continuation of relatively low
charge offs and higher than normal recoveries of amounts previously charged off.
Although recoveries have decreased during 2006, charge offs remain low and
credit quality remains good and well managed.
Private Banking (PB)
Overview
During 2005 and 2006, additional resources have been allocated to expand
products and services provided to high net worth customers served by this
business segment, resulting in increased net interest income, service fee income
and operating expenses associated with core PB operations. 2006 results were
negatively impacted by increased provision expense. 2005 other revenues included
a one-time gain on sale of an investment.
Operating Results
The following table summarizes results for the PB segment.
--------------------------------------------------------------------------------
2006 Compared to 2005
Increase (Decrease)
---------------------
2006 2005 Amount %
--------------------------------------------------------------------------------
($ in millions)
Three months ended June 30
Net interest income $ 48 $ 42 $ 6 14
Other revenues 60 103 (43) (42)
--------- --------- --------- ---------
Total revenues 108 145 (37) (26)
Operating expenses 74 64 10 16
--------- --------- --------- ---------
34 81 (47) (58)
Provision (credit) for credit
losses 29 (1) 30 *
--------- --------- --------- ---------
Income before income tax expense $ 5 $ 82 $ (77) (94)
========= ========= ========= =========
Six months ended June 30
Net interest income $ 96 $ 82 $ 14 17
Other revenues 136 161 (25) (16)
--------- --------- --------- ---------
Total revenues 232 243 (11) (5)
Operating expenses 150 128 22 17
--------- --------- --------- ---------
82 115 (33) (29)
Provision (credit) for credit
losses 29 (2) 31 *
--------- --------- --------- ---------
Income before income tax expense $ 53 $ 117 $ (64) (55)
========= ========= ========= =========
* Not meaningful.
Increased net interest income for the second quarter of 2006 resulted from
increased average interest earning assets, primarily loans.
57
In the second quarter of 2005, shares in a foreign equity fund were sold to an
HSBC affiliate, resulting in a gain of approximately $48 million. Decreased
other revenues for the second quarter and for the first six months of 2006 was a
direct result of this 2005 activity. Excluding this transaction, other revenues
have increased during 2006, due to:
o increased fee income from wealth and tax advisory services provided to
high net worth individuals; and
o increased equity earnings from a foreign equity investment.
Increased operating expenses for the second quarter and for the first six months
of 2006 resulted from additional resources being allocated to this segment to
expand the services provided.
Increased provision for credit losses during 2006 directly relates to a specific
commercial real estate investment loan relationship for which a combination of
charge offs and increased allowances for credit losses resulted in a $29 million
provision.
CREDIT QUALITY
--------------------------------------------------------------------------------
Overview
The allowance for credit losses increased $32 million (4%) during the second
quarter and increased $23 million (3%) during the first six months of 2006, due
to:
o increased allowance requirements associated with increased balances within
various commercial loan portfolios;
o increased allowance requirements associated with specific small business
commercial loan portfolios within the CMB business segment (refer to
additional commentary below); and
o an additional allowance requirement for a specific commercial real estate
investment loan relationship within the PB business segment.
The allowance for credit losses increased $79 million (10%) from June 30, 2005
to June 30, 2006 due to:
o increased allowance requirements associated with increased balances within
the private label credit card receivable portfolio;
o increased allowance requirements associated with increased balances within
various commercial loan portfolios; and
o increased allowance requirements associated with small business commercial
loan portfolios within the CMB business segment and a specific commercial
real estate investment loan relationship within the PB business segment.
The provision for credit losses increased $52 million (31%) for the second
quarter of 2006 and increased $102 million (37%) for the first six months of
2006, as compared with the same 2005 periods. Increased provisions related to
various commercial loan portfolios and, to a lesser extent, to the private label
credit card portfolio were the primary drivers of the overall increase. The
provision for credit losses associated with various loan portfolios is
summarized on page 40 of this Form 10-Q.
Policies and critical estimates associated with the allowance for credit losses
are summarized on pages 23-24 and 57-60 of HUSI's 2005 Form 10-K. There have
been no material revisions to policies or methodologies during the first six
months of 2006.
Credit quality statistics are summarized in Note 4 of the consolidated financial
statements, beginning on page 10 of this Form 10-Q.
58
The following table provides an analysis of changes in the allowance for credit
losses and related ratios.
-----------------------------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30,
Quarter ended 2006 2006 2005 2005 2005
-----------------------------------------------------------------------------------------------------------------------
($ in millions)
Balance at beginning of quarter $ 837 $ 846 $ 852 $ 790 $ 773
Allowance related to disposition of certain
credit card relationships -- (6) -- -- --
Charge offs:
Commercial 44 20 36 16 17
Consumer:
Residential mortgages 7 11 8 6 6
Credit card receivables 165 170 186 154 160
Other consumer loans 23 29 34 26 23
-------- --------- ------------ ------------- --------
Total consumer loans 195 210 228 186 189
-------- --------- ------------ ------------- --------
Total charge offs 239 230 264 202 206
-------- --------- ------------ ------------- --------
Recoveries on loans charged off:
Commercial 6 15 15 26 7
Consumer:
Residential mortgages -- -- -- 1 --
Credit card receivables 28 46 35 30 37
Other consumer loans 15 9 10 8 9
-------- --------- ------------ ------------- --------
Total consumer loans 43 55 45 39 46
-------- --------- ------------ ------------- --------
Total recoveries 49 70 60 65 53
-------- --------- ------------ ------------- --------
Total net charge offs 190 160 204 137 153
-------- --------- ------------ ------------- --------
Provision charged to income 222 157 198 199 170
-------- --------- ------------ ------------- --------
Balance at end of quarter $ 869 $ 837 $ 846 $ 852 $ 790
======== ========= ============ ============= ========
Allowance ratios:
Annualized net charge offs to average loans:
Commercial .55% .08% .33% (.16)% .17%
Consumer:
Residential mortgages .07 .10 .07 .04 .05
Credit card receivables 3.61 3.32 4.02 3.51 3.87
Other consumer loans 1.04 2.50 2.82 2.09 1.51
-------- --------- ------------ ------------- --------
Total consumer 1.00 1.01 1.13 .90 .90
-------- --------- ------------ ------------- --------
Total loans .86% .73% .90% .61% .71%
======== ========= ============ ============= ========
Quarter-end allowance to:
Quarter-end total loans .95% .94% .94% .95% .90%
Quarter-end total nonaccruing loans 330.42% 341.63% 351.04% 362.55% 351.11%
59
An analysis of 2006 changes in the allowance for credit losses by general loan
categories, is provided in the following tables.
-------------------------------------------------------------------------------------------------------------
Residential Credit Other
Commercial Mortgage Card Consumer Unallocated Total
-------------------------------------------------------------------------------------------------------------
(in millions)
Quarter ended June 30, 2006
Balance at beginning of period $ 171 $ 30 $ 589 $ 32 $ 15 $ 837
---------- ----------- ------ -------- ----------- -----
Allowance related to dispositions -- -- -- -- -- --
Charge offs 44 7 165 23 -- 239
Recoveries 6 -- 28 15 -- 49
---------- ----------- ------ -------- ----------- -----
Net charge offs 38 7 137 8 -- 190
---------- ----------- ------ -------- ----------- -----
Provision charged to income 59 8 148 5 2 222
---------- ----------- ------ -------- ----------- -----
Balance at end of period $ 192 $ 31 $ 600 $ 29 $ 17 $ 869
========== =========== ====== ======== =========== =====
Six months ended June 30, 2006
Balance at beginning of period $ 162 $ 34 $ 600 $ 36 $ 14 $ 846
---------- ----------- ------ -------- ----------- -----
Allowance related to dispositions -- -- (6) -- -- (6)
Charge offs 64 18 335 52 -- 469
Recoveries 21 -- 74 24 -- 119
---------- ----------- ------ -------- ----------- -----
Net charge offs 43 18 261 28 -- 350
---------- ----------- ------ -------- ----------- -----
Provision charged to income 73 15 267 21 3 379
---------- ----------- ------ -------- ----------- -----
Balance at end of period $ 192 $ 31 $ 600 $ 29 $ 17 $ 869
========== =========== ====== ======== =========== =====
Commercial Loan Credit Quality
Components of the commercial allowance for credit losses are summarized in the
following table.
-----------------------------------------------------------------------------
June 30, December 31, June 30,
Balance at 2006 2005 2005
-----------------------------------------------------------------------------
(in millions)
On-balance sheet allowance:
Specific $ 16 $ 9 $ 16
Collective 176 149 143
Transfer risk -- 4 3
-------- ------------ --------
192 162 162
Unallocated 17 14 14
-------- ------------ --------
Total on-balance sheet allowance 209 176 176
Off-balance sheet allowance 85 88 91
-------- ------------ --------
Total commercial allowances $ 294 $ 264 $ 267
======== ============ ========
Continuing with the trend of growth over the past few reporting periods in the
size and complexity of HUSI's commercial loan portfolio, commercial loans
increased $1.9 billion from December 31, 2005 to June 30, 2006. In addition, as
certain segments of the economy show signs of slowing, there has been a net
increase in credit downgrades in 2006, reflecting higher probabilities of
default, a key driver of the commercial loan collective allowance. As a result,
the collective allowance has increased $30 million (11%) during the first six
months of 2006. Increased allowances are spread across a number of industries,
notably commercial real estate, auto and small business.
Criticized assets increased during the second quarter of 2006 (refer to Note 4
of the consolidated financial statements, beginning on page 12 of this Form
10-Q), primarily within the special mention category. Several specific real
estate, auto industry and other commercial credits, as well as loans in the
small business portfolio which were not previously criticized, were downgraded
to special mention, substandard and doubtful categories, as appropriate, during
the quarter based on recent credit assessments. These recently criticized
credits were partially offset by credits which were previously criticized but
were no longer considered to be criticized at June 30, 2006.
60
During the second quarter of 2006, commercial net charge offs increased $33
million from the previous quarter, and increased $28 million from the second
quarter of 2005. The increase resulted primarily from a specific private banking
commercial real estate investment loan relationship that was charged off during
the quarter. Excluding this specific activity, net charge offs continued to run
at levels consistent with those experienced for several recent quarters dating
back to 2004, which is well below historical experience for years prior to 2004.
Increased provisions and allowances for credit losses are expected in the near
term due to growing portfolio risk resulting from:
o HUSI's continued geographic expansion;
o increased borrower concentrations;
o increased number and complexity of products offered; and
o continued signs of stress within certain segments of the economy.
HUSI management continues to monitor and reduce exposures to those industries
considered to be higher risk. During the second quarter of 2006, HUSI management
began to make more extensive use of available tools to more actively manage net
exposure within its corporate loan portfolios with an increased syndication
capacity as well as increased use of credit default swaps to reduce certain
exposures.
Any sudden and/or unexpected adverse economic events or trends could
significantly affect credit quality and increase provisions for credit losses.
For example, HUSI management is monitoring rising interest rates and record-high
energy prices, which could potentially lead to a deceleration of U.S. economic
activity. Recent events in the Middle East may also worsen the overall energy
picture.
Credit Card Receivable Credit Quality
The allowance for credit losses associated with credit card receivables
increased $11 million (2%) during the second quarter of 2006, and was unchanged
for the six months ended June 30, 2006. The net charge off and provision
activity during the second quarter of 2006, as well as the allowance balance at
June 30, 2006, which primarily relates to the private label credit card
portfolio, are generally consistent with recent trends for this portfolio.
Receivables included in the private label credit card portfolio are generally
maintained in accruing status until being charged off six months after
delinquency. The following table provides credit quality data for credit card
receivables.
--------------------------------------------------------------------------------
June 30, December 31, June 30,
2006 2005 2005
--------------------------------------------------------------------------------
(in millions)
Accruing balances contractually past
due 90 days or more:
Balance at end of quarter $ 283 $ 248 $ 206
As a percent of total credit card
receivables 1.85% 1.60% 1.60%
Allowance for credit losses associated
with credit card receivables:
Balance at end of quarter $ 600 $ 600 $ 565
As a percent of total credit card
receivables 3.92% 3.87% 4.39%
Net charge offs of credit card receivables:
Total for the quarter ended $ 137 $ 151 $ 123
Annualized net charge offs as a
percent of average credit card
receivables 3.61% 4.02% 3.89%
61
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
--------------------------------------------------------------------------------
HUSI is party to various derivative financial instruments as an end user, as an
international dealer in derivative instruments, and for purely trading purposes
in order to realize profits from short-term movements in interest rates,
commodity prices, foreign exchange rates and credit spreads. Additional
information regarding the use of various derivative instruments is included on
page 26 and pages 95-97 of HUSI's 2005 Form 10-K.
Credit and Market Risk Associated with Derivative Contracts
Credit (or repayment) risk in derivative instruments is minimized by entering
into transactions with high quality counterparties, including other HSBC group
entities. Counterparties include financial institutions, government agencies,
both foreign and domestic, corporations, funds (mutual funds, hedge funds,
etc.), insurance companies and private clients. These counterparties are subject
to regular credit review by the credit risk management department. Most
derivative contracts are governed by an International Swaps and Derivatives
Association Master Agreement. Depending on the type of counterparty and the
level of expected activity, bilateral collateral arrangements may be required as
well.
The total risk in a derivative contract is a function of a number of variables,
such as:
o whether counterparties exchange notional principal;
o volatility of interest rates, currencies, equity or corporate reference
entity used as the basis for determining contract payments;
o maturity and liquidity of contracts;
o credit worthiness of the counterparties in the transaction; and
o existence and value of collateral received from counterparties to secure
exposures.
The following table presents credit risk exposure associated with derivative
contracts. In the table, current credit risk exposure is the recorded fair value
of derivative receivables, which represents revaluation gains from the marking
to market of derivative contracts held for trading purposes, for all
counterparties with an International Swaps and Derivatives Association Master
Agreement in place.
Future credit risk exposure in the following table is measured using rules
contained in the risk-based capital guidelines published by U.S. banking
regulatory agencies. The risk exposure calculated in accordance with the
risk-based capital guidelines potentially overstates actual credit exposure,
because:
o the risk-based capital guidelines ignore collateral that may have been
received from counterparties to secure exposures; and
o the risk-based capital guidelines compute exposures over the life of
derivative contracts. However, many contracts contain provisions that
allow a bank to close out the transaction if the counterparty fails to
post required collateral. As a result, these contracts have potential
future exposures that are often much smaller than the future exposures
derived from the risk-based capital guidelines.
The net credit risk exposure amount in the following table does not reflect the
impact of bilateral netting (i.e., netting with a single counterparty when a
bilateral netting agreement is in place). However, the risk-based capital
guidelines recognize that bilateral netting agreements reduce credit risk and
therefore allow for reductions of exposures when netting requirements have been
met. In addition, risk-based capital rules require that netted exposures of
various counterparties be assigned risk-weightings, which result in
risk-weighted amounts for regulatory capital purposes that are a fraction of the
original netted exposures.
-------------------------------------------------------------------------------
June 30, December 31,
2006 2005
-------------------------------------------------------------------------------
(in millions)
Risk associated with derivative contracts:
Current credit risk exposure $ 11,955 $ 8,155
Future credit risk exposure 58,721 61,548
------------ ------------
Total risk exposure 70,676 69,703
Less: collateral held against exposure (3,699) (1,850)
------------ ------------
Net credit risk exposure $ 66,977 $ 67,853
============ ============
62
Notional Values of Derivative Contracts
The following table summarizes the notional values of derivative contracts.
-------------------------------------------------------------------------------
June 30, December 31,
2006 2005
-------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards $ 125,028 $ 106,826
Swaps 1,881,843 1,674,091
Options written 343,910 199,676
Options purchased 391,968 217,095
------------ ------------
2,742,749 2,197,688
------------ ------------
Foreign exchange:
Swaps, futures and forwards 361,436 308,264
Options written 37,698 40,213
Options purchased 38,739 40,959
Spot 46,501 21,099
------------ ------------
484,374 410,535
------------ ------------
Commodities, equities and precious metals:
Swaps, futures and forwards 51,838 48,702
Options written 14,910 14,378
Options purchased 17,797 16,127
------------ ------------
84,545 79,207
------------ ------------
Credit derivatives 621,874 391,814
------------ ------------
Total $ 3,933,542 $ 3,079,244
============ ============
63
OFF-BALANCE SHEET ARRANGEMENTS
--------------------------------------------------------------------------------
The following table provides maturity information related to off-balance sheet
arrangements. Descriptions of these arrangements are found on pages 60-62 of
HUSI's 2005 Form 10-K.
------------------------------------------------------------------------------------------------
Balance at June 30, 2006
-------------------------------------------
One Over One Over Balance at
Year Through Five December 31,
or Less Five Years Years Total 2005
------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of
participations (1) $ 4,111 $ 2,461 $ 129 $ 6,701 $ 6,114
Commercial letters of credit 1,034 57 -- 1,091 806
Loan sales with recourse (2) -- 1 8 9 9
Credit derivative contracts (3) 10,277 199,889 122,451 332,617 222,419
Commitments to extend credit:
Commercial 19,180 30,871 4,180 54,231 51,284
Consumer 8,698 -- -- 8,698 8,305
Securities lending indemnifications -- -- -- -- 4,135
-------- ---------- -------- -------- ------------
Total $ 43,300 $ 233,279 $126,768 $403,347 $ 293,072
======== ========== ======== ======== ============
(1) Includes $528 million and $523 million issued for the benefit of related
parties at June 30, 2006 and December 31, 2005 respectively.
(2) $8 million and $7 million is indemnified by third parties at June 30, 2006
and December 31, 2005 respectively.
(3) Includes $60,267 million and $51,202 million issued for the benefit of
related parties at June 30, 2006 and December 31, 2005 respectively.
Letters of Credit
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Included in other
liabilities are deferred fees on standby letters of credit, representing the
fair value of the "stand ready obligation to perform" under these guarantees,
amounting to $23 million and $19 million at June 30, 2006 and December 31, 2005
respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit of $19 million and $20 million at
June 30, 2006 and December 31, 2005 respectively.
Credit Derivatives
HUSI enters into credit derivative contracts primarily to satisfy the needs of
its customers and, in certain cases, for its own benefit. Credit derivatives are
arrangements that provide for one party (the "protection buyer") to transfer the
credit risk of a "reference asset" to another party (the "protection seller").
Under this arrangement the protection seller assumes the credit risk associated
with the reference asset without directly purchasing it. The protection buyer
agrees to pay a specified fee to the protection seller. In return, the
protection seller agrees to pay the protection buyer an agreed upon amount if
there is a default during the term of the contract.
In accordance with its policy, HUSI offsets most of the risk it assumes in
selling credit protection through a credit derivative contract with another
counterparty. Credit derivatives are recorded at fair value. The commitment
amount included in the table is the maximum amount that HUSI could be required
to pay, without consideration of the approximately equal amount receivable from
third parties and any associated collateral.
Securities Lending Indemnifications
Through December 31, 2005, HUSI occasionally lent securities of customers, on a
fully collateralized basis, as an agent to third party borrowers. Customers were
indemnified against the risk of loss, and collateral was obtained from the
borrower with a market value exceeding the value of the loaned securities.
Securities lending activities were terminated during the first quarter of 2006.
64
Securitizations and Secured Financings
On December 29, 2004, HUSI acquired a domestic private label loan portfolio from
HSBC Finance Corporation, without recourse, which included securitized private
label credit card receivables, and retained interest assets related to these
securitizations. These credit card securitization transactions were structured
to receive sale treatment under Statement of Financial Accounting Standards No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, a replacement of FASB Statement No. 125, (SFAS
140).
In a securitization, a designated pool of receivables is removed from the
balance sheet and transferred to an unaffiliated revolving trust. This
unaffiliated revolving trust is a qualifying special purpose entity (QSPE) as
defined by SFAS 140 and, therefore, is not consolidated. The QSPE funds its
receivable purchase through the issuance of securities to investors, entitling
them to receive specified cash flows during the life of the securities. The
securities are collateralized by the underlying receivables transferred to the
QSPE. These revolving securitization trusts require replenishments of
receivables to support previously issued securities. HUSI will continue to sell
receivables to securitization trusts until their revolving periods end, the last
of which is expected in 2007. Balance requirements of HUSI's securitized trusts
continue to decrease as they near the end of their revolving periods.
Under IFRS, HUSI's securitizations are treated as secured financings. In order
to align its accounting treatment with that of HSBC, all of HUSI's
collateralized funding transactions have been structured as secured financings
since the third quarter of 2004. In a secured financing, a designated pool of
receivables are conveyed to a wholly owned limited purpose subsidiary, which in
turn transfers receivables to a trust that sells interests to investors.
Repayment of the debt issued by the trust is secured by the receivables
transferred. The transactions are structured as secured financings under SFAS
140. Therefore, the receivables and the underlying debt of the trust remain on
HUSI's balance sheet. HUSI does not recognize a gain in a secured financing
transaction. Because the receivables and debt remain on the balance sheet,
revenues and expenses are reported consistent with the owned balance sheet
portfolio. There have been no new secured financing transactions in the first
six months of 2006.
HUSI's securitized receivables and secured financings are summarized in the
following table.
-------------------------------------------------------------------------------
June 30, December 31,
2006 2005
-------------------------------------------------------------------------------
(in millions)
Securitized private label credit card receivables
at period end $ 738 $ 1,343
========= ============
Secured financings included in long-term debt:
Balance at period end $ 988 $ 1,500
========= ============
Private label credit card receivables
collaterizing secured financings at period end $ 1,972 $ 2,221
========= ============
65
RISK MANAGEMENT
--------------------------------------------------------------------------------
Overview
Some degree of risk is inherent in virtually all of HUSI's activities. For the
principal activities undertaken by HUSI, the most important types of risks are
considered to be credit, interest rate, market, liquidity, operational,
fiduciary and reputational. Market risk broadly refers to price risk inherent in
mark to market positions taken on trading and non-trading instruments.
Operational risk technically includes legal and compliance risk. However, since
compliance risk, including anti-money laundering (AML) risk, has such broad
scope within HUSI's businesses, it is addressed as a separate functional
discipline. During the first six months of 2006, there have been no significant
changes in policies or approach for managing various types of risk.
Regulatory Capital
Basel Capital Standards (Basel II)
The status of HNAH's and HUSI's preparations relative to Basel II as of December
31, 2005 was summarized on pages 10 and 64 of HUSI's 2005 Form 10-K. In its 2005
Form 10-K, HUSI reported that it must have in place, by January 1, 2008, a Basel
II framework meeting the requirements of HSBC's principal regulator, the
Financial Services Authority in the United Kingdom. However, U.S. requirements
for HUSI and other U.S. mandatory banks have continued to evolve in 2006. A
Notice of Proposed Rulemaking by U.S. regulators is expected to be published in
the second half of 2006, and is expected to be finalized in early 2007.
Implementation by U.S. mandatory banks will be expected within 3 years. The
different implementation time tables, as well as possible differences in
requirements of regulators in the U.S. and the U.K., may affect the cost and
difficulty of implementing Basel II.
Liquidity Management
HUSI's approach to address liquidity risk is summarized on pages 67-68 of HUSI's
2005 Form 10-K. There have been no changes in HUSI's approach toward liquidity
risk management during 2006.
HUSI's ability to regularly attract wholesale funds at a competitive cost is
enhanced by strong ratings from the major credit rating agencies. Standard and
Poor's upgraded credit ratings for HUSI and HBUS in June 2006. At June 30, 2006,
HUSI and HBUS maintained the following debt and preferred stock ratings.
-------------------------------------------------------------------------------
At June 30, 2006 Moody's S&P Fitch
-------------------------------------------------------------------------------
HUSI:
Short-term borrowings P-1 A-1+ F1+
Long-term debt Aa3 AA- AA
Preferred stock A2 A AA-
HBUS:
Short-term borrowings P-1 A-1+ F1+
Long-term debt Aa2 AA AA
66
HUSI periodically issues capital instruments to fund balance sheet growth, to
meet cash and capital needs, or to fund investments in subsidiaries. In December
2005, the United States Securities and Exchange Commission (SEC) amended its
rules regarding registration, communications and offerings under the Securities
Act of 1933. The amended rules facilitate access to capital markets by
well-established public companies, provide more flexibility regarding
restrictions on corporate communications during a securities offering and
further integrate disclosures under the Securities Act of 1933 and the
Securities Exchange Act of 1934. The amended rules provide the most flexibility
to "well-known seasoned issuers", including the option of automatic
effectiveness upon filing of shelf registration statements and relief under the
liberalized communications rules. HUSI currently satisfies the eligibility
requirements for designation as a "well-known seasoned issuer", and has an
effective shelf registration statement with the SEC under which it may issue
debt securities, preferred stock, either separately or represented by depositary
shares, warrants, purchase contracts and units.
In May 2006, HUSI issued 14,950,000 depositary shares, each representing
one-fortieth of a share of 6.50% Non-Cumulative Preferred Stock, Series H. Total
proceeds of this issuance, net of transaction fees, were approximately $365
million.
Interest Rate Risk Management
Various techniques are utilized to quantify and monitor risks associated with
the repricing characteristics of HUSI's assets, liabilities, and derivative
contracts. The approach toward managing interest rate risk is summarized on
pages 69-71 of HUSI's 2005 Form 10-K. During the first six months of 2006, there
were no significant changes in policies or approach for managing interest rate
risk.
Present Value of a Basis Point (PVBP) Analysis
PVBP is the change in value of the balance sheet for a one basis point upward
movement in all interest rates. The following table reflects the PVBP position
at June 30, 2006.
--------------------------------------------------------------------------------
June 30, 2006 Values
--------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit $ 7.5
PVBP position at period end 2.1
Economic Value of Equity
Economic value of equity is the change in value of the assets and liabilities
(excluding capital and goodwill) for either a 200 basis point gradual rate
increase or decrease. The following table reflects the economic value of equity
position at June 30, 2006.
------------------------------------------------------------------------------------------------
June 30, 2006 Values (%)
------------------------------------------------------------------------------------------------
Institutional economic value of equity limit +/- 20
Projected change in value (reflects projected rate movements on July 1, 2006):
Change resulting from a gradual 200 basis point increase in interest rates (7)
Change resulting from a gradual 200 basis point decrease in interest rates 2
The projected decrease in value for a 200 basis point increase in rates is
primarily related to the anticipated slowing of prepayments for the held
mortgage and mortgage backed securities portfolios in this higher rate
environment. This assumes that no management actions are taken to manage
exposures to the changing interest rate environment.
67
Dynamic Simulation Modeling
Various modeling techniques are utilized to monitor a number of interest rate
scenarios for their impact on net interest income. These techniques include both
rate shock scenarios which assume immediate market rate movements by as much as
200 basis points, as well as scenarios in which rates rise or fall by as much as
200 basis points over a twelve month period. The following table reflects the
impact on net interest income of the scenarios utilized by these modeling
techniques.
---------------------------------------------------------------------------------------------------------------------
June 30, 2006 Values
----------------------
Amount %
---------------------------------------------------------------------------------------------------------------------
($ in millions)
Projected change in net interest income (reflects projected rate movements on July 1, 2006):
Institutional base earnings movement limit (10)
Change resulting from a gradual 200 basis point increase in the yield curve $ (186) (6)
Change resulting from a gradual 200 basis point decrease in the yield curve 234 7
Change resulting from a gradual 100 basis point increase in the yield curve (92)
Change resulting from a gradual 100 basis point decrease in the yield curve 125
Other significant scenarios monitored (reflects projected rate movements on July 1, 2006):
Change resulting from an immediate 100 basis point increase in the yield curve (149)
Change resulting from an immediate 100 basis point decrease in the yield curve 152
Change resulting from an immediate 200 basis point increase in the yield curve (304)
Change resulting from an immediate 200 basis point decrease in the yield curve 348
Change resulting from an immediate 100 basis point increase in short-term rates (252)
The projections do not take into consideration possible complicating factors
such as the effect of changes in interest rates on the credit quality, size and
composition of the balance sheet. Therefore, although this provides a reasonable
estimate of interest rate sensitivity, actual results will vary from these
estimates, possibly by significant amounts.
Capital Risk/Sensitivity of Other Comprehensive Income
Large movements of interest rates could directly affect some reported capital
and capital ratios. The mark to market valuation of available for sale
securities is adjusted on a tax effective basis through other comprehensive
income in the consolidated statement of changes in shareholders' equity.
Although this valuation mark is excluded from Tier 1 and Tier 2 capital ratios,
it is included in two important accounting based capital ratios: the tangible
common equity to tangible assets and the tangible common equity to risk weighted
assets. As of June 30, 2006, HUSI had an available for sale securities portfolio
of approximately $20 billion with a net negative mark to market of $704 million
included in tangible common equity of $8 billion. An increase of 25 basis points
in interest rates of all maturities would lower the mark to market by
approximately $162 million to a net loss of $866 million with the following
results on the tangible capital ratios.
--------------------------------------------------------------------------------
Proforma - Reflecting
25 Basis Points
June 30, 2006 Actual Increase in Rates
--------------------------------------------------------------------------------
Tangible common equity to tangible assets 4.78% 4.73%
Tangible common equity to risk weighted assets 6.73 6.65
Trading Activities
Trading portfolios reside primarily in the CIBM and residential mortgage banking
areas and include foreign exchange, derivatives, precious metals (gold, silver,
platinum), commodities, equities and money market instruments. The trading
portfolios have defined limits pertaining to items such as permissible
investments, risk exposures, loss review, balance sheet size and product
concentrations. Loss review refers to the maximum amount of loss that may be
incurred before senior management intervention is required.
68
Trading Activities - Treasury
Value at Risk (VAR)
VAR analysis is used to measure market risk and to calculate capital required to
cover potential losses due to movements in market rates. VAR calculations are
performed for all material trading and non-trading portfolios. VAR estimates the
potential losses that could occur on risk positions as a result of movements in
market rates and prices over a specified time horizon and to a given level of
confidence. HUSI calculates VAR daily for a one-day holding period to a 99%
confidence level. At a 99% confidence level for a two-year observation period,
HUSI is setting as its limit the fifth worst loss performance in the last 500
business days.
The VAR methodology used by HUSI is based on historical simulation. The
historical simulation model derives plausible future scenarios from historical
market rate data, taking account of inter-relationships between different
markets and rates. Potential movements in market prices are calculated with
reference to market data from the last two years. The model incorporates the
impact of option features in the underlying exposures.
For reporting purposes, in the second quarter of 2006, HUSI changed the assumed
holding period from a ten-day period to a one-day period as this reflects the
way HUSI manages its risk positions. Comparative VAR amounts have been restated
to reflect this change.
Although a valuable guide to risk, VAR should always be viewed in the context of
its limitations. For example,
o the use of historical data as a proxy for estimating future events may not
encompass all potential events, particularly those which are extreme in
nature;
o the use of a one-day holding period assumes that all positions can be
liquidated or hedged in one day. This may not fully reflect the market
risk arising at times of severe liquidity shortages, when a one-day
holding period may be insufficient to liquidate or hedge all positions
fully;
o the use of a 99% confidence level, by definition, does not take into
account losses that might occur beyond this level of confidence; and
o VAR is calculated on the basis of exposures outstanding at the close of
business and therefore does not necessarily reflect intra-day exposures.
The following table summarizes trading VAR, assuming a 99% confidence level for
a two year observation period and a one-day "holding period".
-----------------------------------------------------------------------------------------------
Six months ended June 30, 2006
June 30, --------------------------------- December 31,
2006 Minimum Maximum Average 2005
-----------------------------------------------------------------------------------------------
(in millions)
Total trading $ 16 $ 11 $ 46 $ 24 $ 17
Commodities 1 -- 3 1 2
Credit derivatives 8 4 11 7 6
Equities -- -- 1 -- --
Foreign exchange 1 1 3 2 1
Interest rate 18 15 56 30 22
69
Trading Volatility
The following tables summarize the frequency distribution of daily market
risk-related revenues for Treasury trading activities. Market risk-related
Treasury trading revenues include realized and unrealized gains (losses) related
to Treasury trading activities, but exclude the related net interest income.
Analysis of gain (loss) data for the second quarter of 2006 shows that the
largest daily gain was $28 million and the largest daily loss was $13 million.
-------------------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue earned Below $ (10) $0 to $10 to Over
from market risk-related activities (in millions) $ (10) to $0 $10 $20 $20
-------------------------------------------------------------------------------------------------
Three months ended June 30, 2006:
Number of trading days market risk-related revenue was
within the stated range 1 10 36 14 2
Six months ended June 30, 2006:
Number of trading days market risk-related revenue was
within the stated range 3 29 60 26 7
Trading Activities - HSBC Mortgage Corporation (USA)
HSBC Mortgage Corporation (USA) is HUSI's mortgage banking subsidiary. Trading
occurs in mortgage banking operations as a result of an economic hedging program
intended to offset changes in value of mortgage servicing rights and the salable
loan pipeline. Economic hedging may include, for example, forward contracts to
sell residential mortgages and derivative contracts used to protect the value of
MSRs.
MSRs are assets that represent the present value of net servicing income
(servicing fees, ancillary income, escrow and deposit float servicing costs).
MSRs are recognized upon the sale of the underlying loans or at the time that
servicing rights are purchased. MSRs are subject to interest rate risk, in that
their value will fluctuate as a result of a changing interest rate environment.
Interest rate risk is mitigated through an active hedging program that uses
trading securities and derivative instruments to offset changes in value of
MSRs. Since the hedging program involves trading activity, risk is quantified
and managed using a number of risk assessment techniques.
Rate Shock Analysis
Modeling techniques are used to monitor certain interest rate scenarios for
their impact on the economic value of net hedged MSRs, as reflected in the
following table.
-----------------------------------------------------------------------------------------------------------------
June 30, 2006 Values
-----------------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects projected rate
movements on July 1, 2006):
Value of hedged MSRs portfolio $ 499
Change resulting from an immediate 50 basis point decrease in the yield curve:
Change limit (no worse than) (16)
Calculated change in net market value (5)
Change resulting from an immediate 50 basis point increase in the yield curve:
Change limit (no worse than) (8)
Calculated change in net market value 7
Change resulting from an immediate 100 basis point increase in the yield curve:
Change limit (no worse than) (12)
Calculated change in net market value 17
70
Economic Value of MSRs
The economic value of the net, hedged MSRs portfolio is monitored on a daily
basis for interest rate sensitivity. If the economic value declines by more than
established limits for one day or one month, various levels of management
review, intervention and/or corrective actions are required.
Hedge Volatility
The following table summarizes the frequency distribution of the weekly economic
value of the MSR asset. This includes the change in the market value of the MSR
asset net of changes in the market value of the underlying hedging positions
used to hedge the asset. The changes in economic value are adjusted for changes
in MSR valuation assumptions that were made during the course of the quarter, if
applicable.
----------------------------------------------------------------------------------------
Ranges of mortgage economic value from Below $(2) to $0 to $2 to Over
market risk-related activities (in millions) $(2) $0 $2 $4 $4
----------------------------------------------------------------------------------------
Three months ended June 30, 2006:
Number of trading weeks market
risk-related revenue was within the
stated range -- 4 6 3 --
Six months ended June 30, 2006:
Number of trading weeks market
risk-related revenue was within the
stated range 3 8 10 4 1
71
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES
The following table shows the quarterly average balances of the principal
components of assets, liabilities and shareholders' equity, together with their
respective interest amounts and rates earned or paid, presented on a taxable
equivalent basis.
Three Months Ended June 30,
---------------------------------------------------------------
2006 2005
------------------------------ ------------------------------
Balance Interest Rate* Balance Interest Rate*
---------------------------------------------------------------
(in millions)
Assets
Interest bearing deposits with banks $ 5,490 $ 74 5.42% $ 3,913 $ 29 2.95%
Federal funds sold and securities purchased
under resale agreements 9,721 119 4.88 5,285 41 3.14
Trading assets 10,982 102 3.74 6,609 60 3.66
Securities 21,925 281 5.13 19,158 218 4.58
Loans:
Commercial 27,932 431 6.20 23,049 289 5.02
Consumer:
Residential mortgages 42,461 560 5.27 47,542 581 4.89
Credit cards 15,215 324 8.55 12,688 200 6.32
Other consumer 3,092 67 8.68 3,717 66 7.10
-------- --------- ------- --------- --------- ------
Total consumer 60,768 951 6.28 63,947 847 5.31
-------- --------- ------- --------- --------- ------
Total loans 88,700 1,382 6.25 86,996 1,136 5.24
-------- --------- ------- --------- --------- ------
Other 1,829 24 5.21 638 9 5.12
-------- --------- ------- --------- --------- ------
Total earning assets 138,647 $ 1,982 5.73% 122,599 $ 1,493 4.89%
-------- --------- ------- --------- --------- ------
Allowance for credit losses (921) (885)
Cash and due from banks 3,808 3,447
Other assets 27,223 20,134
-------- ---------
Total assets $168,757 $ 145,295
======== =========
Liabilities and Shareholders' Equity
Deposits in domestic offices:
Savings deposits $ 38,134 $ 239 2.51% $ 27,792 $ 69 1.00%
Other time deposits 26,574 281 4.25 24,173 177 2.94
Deposits in foreign offices:
Foreign banks deposits 7,385 95 5.17 8,297 74 3.58
Other time and savings 15,244 154 4.04 14,381 76 2.12
-------- --------- ------- --------- --------- ------
Total interest bearing deposits 87,337 769 3.53 74,643 396 2.13
-------- --------- ------- --------- --------- ------
Short-term borrowings 11,634 75 2.60 13,176 67 2.01
Long-term debt 28,113 356 5.07 23,889 242 4.07
-------- --------- ------- --------- --------- ------
Total interest bearing liabilities 127,084 1,200 3.79 111,708 705 2.53
-------- --------- ------- --------- --------- ------
Net interest income / Interest rate spread $ 782 1.94% $ 788 2.36%
--------- ------- --------- ------
Noninterest bearing deposits 8,784 8,643
Other liabilities 20,858 13,463
Total shareholders' equity 12,031 11,481
-------- ---------
Total liabilities and shareholders' equity $168,757 $ 145,295
======== =========
Net interest margin on average earning assets 2.26% 2.58%
------- ------
Net interest margin on average total assets 1.86% 2.18%
======= ======
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest for the
three months ended June 30, 2006 and 2005 included fees of $16 million and $11
million respectively.
72
HSBC USA Inc.
--------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES
The following table shows the year to date average balances of the principal
components of assets, liabilities and shareholders' equity, together with their
respective interest amounts and rates earned or paid, presented on a taxable
equivalent basis.
Six Months Ended June 30,
----------------------------------------------------------
2006 2005
---------------------------- ---------------------------
Balance Interest Rate* Balance Interest Rate*
----------------------------------------------------------
(in millions)
Assets
Interest bearing deposits with banks $ 5,102 $ 127 5.00% $ 3,882 $ 54 2.78%
Federal funds sold and securities purchased
under resale agreements 8,210 192 4.72 4,467 65 2.94
Trading assets 10,542 210 4.02 6,616 119 3.64
Securities 21,621 550 5.13 18,741 432 4.65
Loans:
Commercial 27,146 816 6.07 22,777 539 4.77
Consumer:
Residential mortgages 43,161 1,129 5.23 47,503 1,160 4.88
Credit cards 15,188 592 7.86 12,430 358 5.81
Other consumer 3,166 132 8.42 3,681 128 7.02
--------- -------- ----- -------- -------- -----
Total consumer 61,515 1,853 6.07 63,614 1,646 5.22
--------- -------- ----- -------- -------- -----
Total loans 88,661 2,669 6.07 86,391 2,185 5.10
--------- -------- ----- -------- -------- -----
Other 1,256 37 5.98 626 15 4.66
--------- -------- ----- -------- -------- -----
Total earning assets 135,392 $ 3,785 5.64% 120,723 $ 2,870 4.79%
--------- -------- ----- -------- -------- -----
Allowance for credit losses (928) (890)
Cash and due from banks 3,977 3,729
Other assets 25,205 20,137
--------- --------
Total assets $ 163,646 $143,699
========= ========
Liabilities and Shareholders' Equity
Deposits in domestic offices:
Savings deposits $ 35,076 $ 392 2.25% $ 27,283 $ 120 0.89%
Other time deposits 27,576 563 4.11 23,987 325 2.73
Deposits in foreign offices:
Foreign banks deposits 7,303 172 4.75 9,273 118 2.58
Other time and savings 15,013 292 3.92 13,787 160 2.33
--------- -------- ----- -------- -------- -----
Total interest bearing deposits 84,968 1,419 3.37 74,330 723 1.96
--------- -------- ----- -------- -------- -----
Short-term borrowings 11,198 149 2.68 11,048 119 2.17
Long-term debt 28,154 694 4.97 23,880 461 3.90
--------- -------- ----- -------- -------- -----
Total interest bearing liabilities 124,320 2,262 3.67 109,258 1,303 2.41
--------- -------- ----- -------- -------- -----
Net interest income / Interest rate spread $ 1,523 1.97% $ 1,567 2.38%
-------- ----- -------- -----
Noninterest bearing deposits 9,470 9,201
Other liabilities 17,983 14,027
Total shareholders' equity 11,873 11,213
--------- --------
Total liabilities and shareholders' equity $ 163,646 $143,699
========= ========
Net interest margin on average earning assets 2.27% 2.62%
----- -----
Net interest margin on average total assets 1.88% 2.20%
===== =====
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest for the
six months ended June 30, 2006 and 2005 included fees of $28 million and $19
million respectively.
73
Item 3. Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------------------
Refer to Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations, under the captions "Interest Rate Risk Management" and
"Trading Activities", beginning on page 67 of this Form 10-Q.
Item 4. Controls and Procedures
--------------------------------------------------------------------------------
HUSI maintains a system of internal and disclosure controls and procedures
designed to ensure that information required to be disclosed in reports filed or
submitted under the Securities Exchange Act of 1934, as amended, (the Exchange
Act), is recorded, processed, summarized and reported on a timely basis. HUSI's
Board of Directors, operating through its Audit Committee, which is composed
entirely of independent outside directors, provides oversight to the financial
reporting process.
An evaluation was conducted, with the participation of the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of HUSI's disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that HUSI's disclosure controls and procedures were effective
as of the end of the period covered by this report so as to alert them in a
timely fashion to material information required to be disclosed in reports filed
under the Exchange Act.
There were no changes in HUSI's internal controls over financial reporting
during the period covered by this report that have materially affected, or are
reasonably likely to materially affect, HUSI's internal control over financial
reporting.
HUSI continues the process to complete a thorough review of its internal
controls as part of its preparation for compliance with the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404). Section 404
requires management to report on, and external auditors to attest to, the
effectiveness of HUSI's internal control structure and procedures for financial
reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act,
HUSI's first report under Section 404 will be contained in its Form 10-K for the
period ended December 31, 2007.
74
Part II - OTHER INFORMATION
--------------------------------------------------------------------------------
Item 1A. Risk Factors
--------------------------------------------------------------------------------
Risk factors were set forth in HUSI's Form 10-Q for the period ended March 31,
2006. There have been no material changes from the risk factors disclosed in
that Form 10-Q.
Item 6. Exhibits
--------------------------------------------------------------------------------
3(i) Articles of Incorporation and amendments and supplements thereto
(incorporated by reference to Exhibit 3(a) to HSBC USA Inc.'s Annual
Report on Form 10-K for the year ended December 31, 1999, filed with the
Securities and Exchange Commission on March 30, 2000, Exhibit 3 to HSBC
USA Inc.'s Quarterly Report on Form 10-Q for the quarter ended September
30, 2000, filed with the Securities and Exchange Commission on November 9,
2000, Exhibits 3.2 and 3.3 to HSBC USA Inc.'s Current Report on Form 8-K
dated March 30, 2005 and filed with the Securities and Exchange Commission
on April 4, 2005, Exhibit 3.2 to HSBC USA Inc.'s Current Report on Form
8-K dated October 11, 2005 and filed with the Securities and Exchange
Commission on October 14, 2005, and Exhibit 3.2 to HSBC USA Inc.'s Current
Report on Form 8-K dated May 18, 2006 and filed with the Securities and
Exchange Commission on May 22, 2006).
12 Computation of Ratio of Earnings to Fixed Charges and Earnings to Combined
Fixed Charges and Preferred Stock Dividends.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.0 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
75
SIGNATURE
--------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC USA Inc.
-------------
(Registrant)
Date: July 31, 2006 /s/ Clive R. Bucknall
----------------------------
Clive R. Bucknall
Chief Accounting Officer
(On behalf of Registrant)
76
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