HSBC USA Inc 06 10-K Pt 1d/10

HSBC Holdings PLC 05 March 2007 Part 4 of 5 Note 22. Stock Option Plans and Restricted Share Plans -------------------------------------------------------------------------------- Options have been granted to employees of HUSI under the HSBC Holdings Group Share Option Plan (the Group Share Option Plan) and under the HSBC Holdings Savings-Related Share Option Plan (Sharesave). Since the shares and contribution commitment have been granted directly by HSBC, the offset to compensation expense was a credit to capital surplus, representing a contribution of capital from HSBC. The following table presents information for each plan. Descriptions of each plan follow the table. ----------------------------------------------------------------------------------------------------- December 31 2006 2005 2004 ----------------------------------------------------------------------------------------------------- Restricted Share Plan: Total compensation expense recognized (in millions) .................................... $ 59 $ 44 $ 50 Sharesave (5 year vesting period): Total options granted .............................. 83,000 262,000 207,000 Fair value per option granted ...................... $ 3.49 $ 3.78 $ 3.80 Total compensation expense recognized (in millions) .................................... $ * $ * $ * Significant assumptions used to calculate fair value: Risk free interest rate ...................... 5.0% 4.3% 5.0% Expected life (years) ........................ 5 5 5 Expected volatility .......................... 17% 20% 25% Sharesave (3 year vesting period): Total options granted .............................. 274,000 510,000 407,000 Fair value per option granted ...................... $ 3.42 $ 3.73 $ 3.44 Total compensation expense recognized (in millions) .................................... $ 1 $ 1 $ 1 Significant assumptions used to calculate fair value: Risk free interest rate ...................... 5.0% 4.3% 4.9% Expected life (years) ........................ 3 3 3 Expected volatility .......................... 17% 20% 25% Sharesave (1 year vesting period): Total options granted .............................. 81,000 Fair value per option granted ...................... $ 2.60 Total compensation expense recognized (in millions) .................................... $ * Significant assumptions used to calculate fair value: Risk free interest rate ...................... 5.0% Expected life (years) ........................ 1 Expected volatility .......................... 17% Group Share Option Plan: Total options granted .............................. -- -- 4,574,000 Fair value per option granted ...................... $ -- $ -- $ 2.83 Total compensation expense recognized (in millions) .................................... $ 14 $ 6 $ 10 Significant assumptions used to calculate fair value: Risk free interest rate ...................... --% --% 4.90% Expected life (years) ........................ -- -- 6.9 Expected volatility .......................... --% --% 25% * Less than $500 thousand 140 Restricted Share Plans Awards are granted to key individuals in the form of performance and non-performance restricted shares. The awards are based on an individual's demonstrated performance and future potential. Performance related restricted shares generally vest after three years from date of grant, based on HSBC's Total Shareholder Return (TSR) relative to a benchmark TSR during the performance period. TSR is defined as the growth in share value and declared dividend income during the period and the benchmark is composed of HSBC's peer group of financial institutions. If the performance conditions are met, the shares vest and are released to the recipients two years later. Non-performance restricted shares are released to the recipients based on continued service, typically at the end of a three year vesting period. Sharesave Plans Sharesave is an employee share option plan that enables eligible employees to enter into savings contracts of one, three or five year terms, with the ability to decide at the end of the contract term to either use their accumulated savings to purchase HSBC ordinary shares at a discounted option price or have the savings plus interest repaid in cash. The one year savings contracts were offered to employees for the first time in 2006. Employees can save up to $450 per month over all their Sharesave savings contracts. The option price is determined at the beginning of the offering period of each plan year and represents a 20% discount, for the three and five year savings contracts, and a 15% discount for the one year contract, from the average price in London on the HSBC ordinary shares over the five trading days preceding the offering. On contracts of three year or five year terms, the options are exercisable at the 20% discounted stock option price within six months following the third or fifth anniversary of the beginning of the relevant savings contracts. Upon the completion of a one year savings contract, if the share price is higher than the option price, the option will automatically be exercised and the shares will be purchased at the 15% discounted stock option price. The shares will then be transferred to a holding account where they will be held for one additional year, or until the employee decides to sell the shares. Regardless of the length of the savings contract, employees can decide to have their accumulated savings plus interest refunded to them at the end of the contract period, rather than choosing to exercise their purchase option. The fair value of options granted under Sharesave plans is estimated as of the date of grant using a third party option pricing model. Group Share Option Plan The Group Share Option Plan was a discretionary long-term incentive compensation plan available prior to 2005, to certain HUSI employees based on performance criteria. Options were granted at market value and are normally exercisable between the third and tenth anniversaries of the date of grant, subject to vesting conditions. Fair values of Group Share Option Plan awards made in 2004, measured at the date of grant, were calculated using a binomial lattice methodology that is based on the underlying assumptions of the Black-Scholes option pricing model. When modeling options with vesting dependent on attainment of certain performance conditions over a period of time, these performance targets are incorporated into the model using Monte-Carlo simulation. The expected life of options depends on the behavior of option holders, which is incorporated into the option model consistent with historic observable data. The fair values are inherently subjective and uncertain due to the assumptions made and the limitations of the model used. No options were granted under the Group Share Option Plan in 2005 or 2006, since the plan was terminated by HSBC in May 2005. In lieu of options, employees now receive grants of HSBC Holdings ordinary shares subject to certain vesting conditions (refer to Restricted Share Plans above). All existing stock option grants under the Group Share Option Plan remain in effect subject to the same conditions as before plan termination and compensation expense continues to be recognized over the various grant vesting periods. 141 Note 23. Pension and Other Postretirement Benefits -------------------------------------------------------------------------------- Defined Benefit Pension Plans In November 2004, sponsorship of the defined benefit pension plan of HUSI and the defined benefit pension plan of HSBC Finance Corporation was transferred to HNAH. Effective January 1, 2005, the two separate plans were combined into a single HNAH defined benefit pension plan which facilitates the development of a unified employee benefit policy and unified employee benefit plan administration for HSBC companies operating in the U.S. As a result, the pension asset relating to HUSI's defined benefit plan of $279 million, net of tax, was transferred to HNAH as a capital transaction in the first quarter of 2005. In 2006, HUSI adopted SFAS 158 (see New Accounting Pronouncements on page 109 of this Form 10-K), which requires balance sheet recognition of the funded status of pension and other postretirement benefit plans. Since HUSI's main pension plan was transferred to HNAH in 2005, adoption of SFAS 158 had no significant balance sheet impact related to pension obligations. The impact of SFAS 158 on other postretirement benefit plans is summarized on page 144 of this Form 10-K. The components of pension expense for the defined benefit plan reflected in HUSI's consolidated statement of income are shown in the table below. The pension expense for the years ended December 31, 2006 and 2005 reflect the portion of the pension expense of the combined HNAH pension plan which has been allocated to HUSI. ------------------------------------------------------------------------------------------------------- Year Ended December 31 2006 2005 2004 ------------------------------------------------------------------------------------------------------- (in millions) Service cost-benefits earned during the period ........... $ 30 $ 27 $ 31 Interest cost on projected benefit obligation ............ 65 62 69 Expected return on assets ................................ (84) (89) (96) Amortization of prior service cost ....................... 1 1 1 Recognized losses ........................................ 16 5 26 ------------ ------------ ------------ Pension expense .......................................... $ 28 $ 6 $ 31 ============ ============ ============ The information and activity presented in the following tables as of and for the years ended December 31, 2006 and 2005 relate to the post-merger HNAH defined benefit pension plan, unless noted otherwise. The information and activity presented as of and for the year ended December 31, 2004 reflect pre-merger HUSI defined benefit pension plan balances and activity. The assumptions used in determining pension expense of the defined benefit plan are as follows: ------------------------------------------------------------------------------------------------------- 2006 2005 2004 ------------------------------------------------------------------------------------------------------- Discount rate ............................................ 5.70% 6.00% 6.25% Salary increase assumption ............................... 3.75 3.75 3.75 Expected long-term rate of return on plan assets ......... 8.00 8.33 8.00 142 A reconciliation of beginning and ending balances of the fair value of plan assets associated with the HNAH defined benefit pension plan is shown below. --------------------------------------------------------------------------------------------------------- Year Ended December 31 2006 2005 --------------------------------------------------------------------------------------------------------- (in millions) Fair value of plan assets at beginning of year ..................................... $ 2,383 $ 1,304 Transfer of assets from the former HSBC Finance Corporation Plan ................... -- 1,000 Actual return on plan assets ....................................................... 246 168 Benefits paid ...................................................................... (62) (89) ------- ------- Fair value of plan assets at end of year ........................................... $ 2,567 $ 2,383 ======= ======= HUSI does not currently anticipate making employer contributions to the defined benefit plan in 2007. The allocation of the pension plan assets at December 31, 2006 and 2005 for the HNAH defined benefit pension plan is summarized in the following table: ------------------------------------------------------------------------------------------------------------- Percentage of Plan Assets at December 31, ------------------------- 2006 2005 ------------------------------------------------------------------------------------------------------------- Equity securities 69% 69% Debt securities 30 31 Other 1 -- ------- ---------- Total 100% 100% ======= ========== There were no investments in HSBC ordinary shares or American depositary shares at December 31, 2006 and 2005. The primary objective of the HNAH defined benefit pension plan is to provide eligible employees with regular pension benefits. Since the plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA), ERISA regulations serve as guidance for the management of plan assets. Consistent with prudent standards of preservation of capital and maintenance of liquidity, the goals of the plans are to earn the highest possible rate of return consistent with the tolerance for risk as determined by the investment committee in its role as a fiduciary. In carrying out these objectives, short-term fluctuations in the value of plan assets are considered secondary to long-term investment results. A third party and an HSBC affiliate are retained by HNAH to provide investment consulting services such as recommendations on the type of funds to be invested in and monitoring the performance of fund managers. In order to achieve the return objectives of the plans, the plans are diversified to ensure that adverse results from one security or security class will not have an unduly detrimental effect on the entire investment portfolio. Assets are diversified by type, characteristic and number of investments as well as by investment style of management organization. Equity securities are invested in large, mid and small capitalization domestic stocks as well as international stocks. 143 A reconciliation of beginning and ending balances of the projected benefit obligation of the HNAH defined benefit pension plan is shown in the following table. --------------------------------------------------------------------------- Year Ended December 31 2006 2005 --------------------------------------------------------------------------- (in millions) Projected benefit obligation at beginning of year ... $ 2,530 $ 1,174 Transfer in from the HSBC Finance Corporation Plan .. -- 1,019 Service cost ........................................ 102 94 Interest cost ....................................... 145 130 Actuarial (gains) losses ............................ (17) 203 Benefits paid ....................................... (62) (90) -------- ------- Projected benefit obligation at end of year ......... $ 2,698 $ 2,530 ======== ======= HUSI's share of the projected benefit obligation of the HNAH defined benefit pension plan at December 31, 2006 is approximately $1.2 billion. The accumulated benefit obligation for the HNAH defined benefit pension plan was approximately $2.4 billion and $2 billion at December 31, 2006 and 2005, respectively. HUSI's share of the accumulated benefit obligation at December 31, 2006 and 2005 was approximately $1.1 billion and $1 billion, respectively. The accumulated benefit obligation for HUSI's pre-merger defined benefit pension plans was approximately $1 billion at December 31, 2004. Estimated future benefit payments for the HNAH defined benefit pension plan and HUSI's share of those estimated payments are summarized in the following table --------------------------------------------------------------------------- HUSI's HNAH Share --------------------------------------------------------------------------- (in millions) 2007 ................................................ $ 122 $ 49 2008 ................................................ 130 53 2009 ................................................ 137 56 2010 ................................................ 144 59 2011 ................................................ 156 63 2012-2016 ........................................... 927 388 The assumptions used in determining the projected benefit obligation of the defined benefit pension plans at December 31 are summarized in the following table. -------------------------------------------------------------------------- 2006 2005 2004 -------------------------------------------------------------------------- Discount rate ................................ 5.90% 5.70% 6.00% Salary increase assumption ................... 3.75 3.75 3.75 Postretirement Plans Other Than Pensions HUSI's employees also participate in several plans which provide medical, dental and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. HUSI has instituted dollar limits on payments under the plans to control the cost of future medical benefits. As discussed in Note 2, the adoption of SFAS 158 resulted in additional pension liability of $31 million, a related deferred tax asset of $13 million, and an offset to other comprehensive income of $18 million at December 31, 2006. 144 The net postretirement benefit cost included the following components. ------------------------------------------------------------------------------------ Year Ended December 31 2006 2005 2004 ------------------------------------------------------------------------------------ (in millions) Service cost - benefits earned during the period ........ $ 1 $ 2 $ 2 Interest cost ........................................... 6 7 7 Amortization of transition obligation ................... 3 3 3 ------ ------ ----- Net periodic postretirement benefit cost ................ $ 10 $ 12 $ 12 ====== ====== ===== The assumptions used in determining the net periodic postretirement benefit cost for HUSI's postretirement benefit plans are shown in the following table. ------------------------------------------------------------------------------------ December 31 2006 2005 2004 ------------------------------------------------------------------------------------ Discount rate 5.70% 6.00% 5.75% Salary increase assumption 3.75 3.75 3.75 A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is shown in the following table. ---------------------------------------------------------------------------- Year Ended December 31 2006 2005 ---------------------------------------------------------------------------- (in millions) Accumulated benefit obligation at beginning of year ..... $ 119 $ 122 Service cost ............................................ 1 2 Interest cost ........................................... 6 7 Participant contributions ............................... 1 1 Actuarial gains ......................................... (13) (4) Benefits paid ........................................... (11) (9) ------ ------ Accumulated benefit obligation at end of year ........... $ 103 $ 119 ====== ====== HUSI's postretirement benefit plans are funded on a pay-as-you-go basis. Estimated future benefit payments for HUSI's postretirement plans are summarized in the following table. -------------------------------------------------------------------------------- (in millions) 2007 ...................................................... $ 9 2008 ...................................................... 8 2009 ...................................................... 9 2010 ...................................................... 9 2011 ...................................................... 9 2012-2016 ................................................. 43 145 The assumptions used in determining the benefit obligation of HUSI's postretirement benefit plans at December 31 are as follows: ---------------------------------------------------------------------------- 2006 2005 2004 ---------------------------------------------------------------------------- Discount rate .................................. 5.90% 5.70% 6.00% Salary increase assumption ..................... 3.75 3.75 3.75 A 10.5 percent annual rate of increase in the gross cost of covered health care benefits was assumed for 2006. This rate of increase is assumed to decline gradually to 5 percent in 2014. Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service and interest costs and the postretirement benefit obligation as follows: ----------------------------------------------------------------------------------------- One Percent One Percent Increase Decrease ----------------------------------------------------------------------------------------- (in millions) Effect on total of service and interest cost components ..... $ * $ * Effect on postretirement benefit obligation ................. 2 (2) * Less than $500 thousand Other Plans HUSI maintains a 401(k) plan covering substantially all employees. Employer contributions to the plan are based on employee contributions. Total expense recognized for this plan was approximately $34 million, $33 million and $18 million in 2006, 2005 and 2004, respectively. Certain employees are participants in various defined contribution and other non-qualified supplemental retirement plans. Total expense recognized for these plans was immaterial in 2006, 2005 and 2004. 146 Note 24. Business Segments -------------------------------------------------------------------------------- HUSI has five distinct segments that it utilizes for management reporting and analysis purposes. Descriptions of HUSI's business segments are presented on pages 6-7 of this Form 10-K. Results for each segment are summarized in the following tables. For comparability purposes, 2005 and 2004 results have been revised to conform with 2006 presentation. ----------------------------------------------------------------------------------------------------------------------- PFS CF CMB CIBM PB Other Total ----------------------------------------------------------------------------------------------------------------------- (in millions) 2006 Net interest income (1) ........ $ 1,232 $ 738 $ 745 $ 181 $ 199 $ (14) $ 3,081 Other revenues ................. 447 501 274 1,011 305 25 2,563 --------- --------- --------- --------- --------- ------- ---------- Total revenues ................. 1,679 1,239 1,019 1,192 504 11 5,644 Operating expenses (2) ......... 1,192 441 508 803 311 -- 3,255 --------- --------- --------- --------- --------- ------- ---------- 487 798 511 389 193 11 2,389 Provision for credit losses (3) 58 659 62 10 34 -- 823 --------- --------- --------- --------- --------- ------- ---------- Income before income tax expense $ 429 $ 139 $ 449 $ 379 $ 159 $ 11 $ 1,566 ========= ========= ========= ========= ========= ======= ========== Average loans .................. $ 37,242 $ 19,835 $ 14,921 $ 12,399 $ 4,456 $ -- $ 88,853 Average assets ................. 41,685 20,677 17,940 79,882 5,744 350 166,278 Average deposits ............... 33,586 17 15,202 37,617 9,790 -- 96,212 Average liabilities/ equity (4) 48,250 1,657 21,519 82,983 11,869 -- 166,278 Goodwill at December 31, 2006 (5) 1,177 -- 472 636 431 -- 2,716 2005 Net interest income (1) ........ $ 1,202 $ 583 $ 662 $ 456 $ 172 $ (12) $ 3,063 Other revenues ................. 406 356 228 641 257 23 1,911 --------- --------- --------- --------- --------- ------- ---------- Total revenues ................. 1,608 939 890 1,097 429 11 4,974 Operating expenses (2) ......... 1,002 424 410 650 272 -- 2,758 --------- --------- --------- --------- --------- ------- ---------- 606 515 480 447 157 11 2,216 Provision for credit losses (3) 103 599 22 (47) (3) -- 674 --------- --------- --------- --------- --------- ------- ---------- Income before income tax expense $ 503 $ (84) $ 458 $ 494 $ 160 $ 11 $ 1,542 ========= ========= ========= ========= ========= ======= ========== Average loans .................. $ 44,143 $ 18,516 $ 14,001 $ 7,333 $ 3,905 $ -- $ 87,898 Average assets ................. 48,629 19,316 16,272 57,597 5,041 321 147,176 Average deposits ............... 28,436 286 11,745 37,592 7,464 -- 85,523 Average liabilities/ equity (4) 43,114 684 18,046 75,579 9,751 2 147,176 Goodwill at December 31, 2005 (5) 1,167 -- 468 631 428 -- 2,694 147 ---------------------------------------------------------------------------------------------------------------------- PFS CF CMB CIBM PB Other Total ---------------------------------------------------------------------------------------------------------------------- (in millions) 2004 Net interest income (1) ........ $ 1,088 $ 182 $ 586 $ 766 $ 130 $ (11) $ 2,741 Other revenues ................. 358 2 200 534 204 21 1,319 --------- --------- --------- --------- --------- ------- ---------- Total revenues ................. 1,446 184 786 1,300 334 10 4,060 Operating expenses (2) ......... 922 17 374 525 263 -- 2,101 --------- --------- --------- --------- --------- ------- ---------- 524 167 412 775 71 10 1,959 Provision for credit losses (3) 81 22 (26) (95) 1 -- (17) --------- --------- --------- --------- --------- ------- ---------- Income before income tax expense $ 443 $ 145 $ 438 $ 870 $ 70 $ 10 $ 1,976 ========= ========= ========= ========= ========= ======= ========== Average loans .................. $ 36,847 $ 4,257 $ 12,287 $ 4,152 $ 2,785 $ -- $ 60,328 Average assets ................. 40,943 4,256 14,009 48,689 4,029 300 112,226 Average deposits ............... 24,145 3,998 9,535 27,508 7,667 -- 72,853 Average liabilities/ equity (4) 34,052 (2) 14,783 54,442 8,951 -- 112,226 Goodwill at December 31, 2004 (5) 1,167 -- 471 631 428 -- 2,697 (1) Net interest income of each segment represents the difference between actual interest earned on assets and interest paid on liabilities of the segment adjusted for a funding charge or credit. Segments are charged a cost to fund assets (e.g. customer loans) and receive a funding credit for funds provided (e.g. customer deposits) based on equivalent market rates. (2) Expenses for the segments include fully apportioned corporate overhead expenses. (3) The provision apportioned to the segments is based on the segments' net charge offs and the change in allowance for credit losses. (4) Common shareholder's equity and earnings on common shareholder's equity are allocated back to the segments based on the percentage of capital assigned to the business. (5) During 2006, a deferred tax asset related to a previous acquisition was adjusted against the related goodwill balance, resulting in a $22 million increase in goodwill (refer to Note 12 on page 125 of this Form 10-K). The reduction in goodwill from December 31, 2004 to December 31, 2005 resulted from the sale of certain branches during 2005. Note 25. Collateral, Commitments and Contingent Liabilities -------------------------------------------------------------------------------- Pledged Assets The following table presents pledged assets included in the consolidated balance sheet. -------------------------------------------------------------------------------- December 31 2006 2005 -------------------------------------------------------------------------------- (in millions) Interest bearing deposits with banks ................. $ 764 $ 483 Trading assets (1) ................................... 2,961 1,452 Securities available for sale (2) .................... 6,775 6,369 Securities held to maturity .......................... 273 446 Loans (3) ............................................ 8,426 7,807 Other assets (4) ..................................... 849 687 ---------- ---------- Total ................................................ $ 20,048 $ 17,244 ========== ========== (1) Trading assets are primarily pledged against liabilities associated with consolidated variable interest entities (refer to Note 26). (2) Securities available for sale are primarily pledged against various short-term borrowings. (3) Loans are primarily private label credit card receivables pledged against long-term borrowings and residential mortgage loans pledged against long-term borrowings from the Federal Home Loan Bank (refer to Note 14). (4) Other assets represent cash on deposit with non-banks related to derivative collateral support agreements. Debt securities pledged as collateral that can be sold or repledged by the secured party continue to be reported on the consolidated balance sheet. The fair value of securities available for sale that can be sold or repledged was $2,289 million and $2,152 million at December 31, 2006 and 2005, respectively. 148 The fair value of collateral accepted by HUSI not reported on the consolidated balance sheet that can be sold or repledged was $8,161 million and $5,800 million at December 31, 2006 and 2005, respectively. This collateral was obtained under security resale agreements. Of this collateral, $781 million and $1,158 million has been sold or repledged as collateral under repurchase agreements or to cover short sales at December 31, 2006 and 2005, respectively. Lease Obligations HUSI and its subsidiaries are obligated under a number of noncancellable leases for premises and equipment. Certain leases contain renewal options and escalation clauses. Expected minimum lease payments under noncancellable operating leases as of December 31, 2006, net of sublease rentals, are summarized in the following table. -------------------------------------------------------------------------------- (in millions) Expected minimum future payments: 2007 .............................................................. $ 81 2008 .............................................................. 71 2009 .............................................................. 64 2010 .............................................................. 56 2011 .............................................................. 48 Thereafter ........................................................ 189 ---------- $ 509 ========== Litigation HUSI is named in and is defending legal actions in various jurisdictions arising from its normal business. None of these proceedings is regarded as material litigation. In addition, there are certain proceedings related to the "Princeton Note Matter" that are described below. In relation to the Princeton Note Matter, as disclosed in HUSI's 2002 Annual Report on Form 10-K, two of the noteholders were not included in the settlement and their civil suits are continuing. The U.S. Government excluded one of them from the restitution order (Yakult Honsha Co., Ltd.) because a senior officer of the noteholder was being criminally prosecuted in Japan for his conduct relating to its Princeton Notes. The senior officer in question was convicted during September 2002 of various criminal charges related to the sale of the Princeton Notes. The U.S. Government excluded the other noteholder (Maruzen Company, Limited) because the sum it is likely to recover from the Princeton Receiver exceeds its losses attributable to its funds transfers with Republic New York Securities Corporation, as calculated by the U.S. Government. Both of these civil suits seek compensatory, punitive, and treble damages pursuant to RICO and assorted fraud and breach of duty claims arising from unpaid Princeton Notes with face amounts totaling approximately $125 million. No amount of compensatory damages is specified in either complaint. These two complaints name HUSI, HBUS, and Republic New York Securities Corporation as defendants. HUSI and HBUS have moved to dismiss both complaints. The motion is fully briefed and sub judice. Mutual production of documents took place in 2001, but additional discovery proceedings have been suspended pending the Court's resolution of the motions to dismiss. 149 Note 26. Off-Balance Sheet Financial Guarantee Arrangements -------------------------------------------------------------------------------- The following table provides information related to off-balance sheet financial guarantee arrangements. -------------------------------------------------------------------------------- December 31 2006 2005 -------------------------------------------------------------------------------- (in millions) Standby letters of credit, net of participations (1) .. $ 7,259 $ 6,114 Loan sales with recourse (2) .......................... 8 9 Credit derivative contracts (3) ....................... 431,631 222,419 Securities lending indemnifications ................... - 4,135 ---------- ---------- Total ................................................. $ 438,898 $ 232,677 ========== ========== (1) Includes $542 million and $523 million issued for the benefit of HSBC affiliates at December 31, 2006 and 2005, respectively. (2) $7 million of this amount is indemnified by HSBC affiliates at December 31, 2006 and 2005, respectively. (3) Includes $71,908 million and $51,202 million issued for the benefit of HSBC affiliates at December 31, 2006 and 2005, respectively. Standby Letters of Credit HUSI may issue a letter of credit for the benefit of a customer, authorizing a third party to draw on the letter for specified amounts under certain terms and conditions. The issuance of a letter of credit is subject to HUSI's credit approval process and collateral requirements. A standby letter of credit is issued to third parties for the benefit of a customer and is essentially a guarantee that the customer will perform, or satisfy some obligation, under a contract. It irrevocably obligates HUSI to pay a third party beneficiary when a customer either: (1) in the case of a performance standby letter of credit, fails to perform some contractual non-financial obligation, or (2) in the case of a financial standby letter of credit, fails to repay an outstanding loan or debt instrument. Fees are charged for issuing letters of credit commensurate with the customer's credit evaluation and the nature of any collateral. Included in other liabilities are deferred fees on standby letters of credit, representing the fair value of the "stand ready obligation to perform" under these guarantees, amounting to $21 million and $19 million at December 31, 2006 and 2005, respectively. Also included in other liabilities is an allowance for credit losses on unfunded standby letters of credit of $25 million and $20 million at December 31, 2006 and 2005, respectively. Loan Sales with Recourse HUSI securitizes and sells assets, generally without recourse. In prior years, HUSI's mortgage banking subsidiary sold residential mortgage loans with recourse upon borrower default, with partial indemnification from third parties. 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. 150 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. Note 27. Variable Interest Entities (VIEs) -------------------------------------------------------------------------------- HUSI, in the ordinary course of business, makes use of VIE structures in a variety of business activities, primarily to facilitate client needs. VIE structures are utilized after careful consideration of the most appropriate structure needed to achieve HUSI's control and risk management objectives and to help ensure an efficient and appropriate structure from a regulatory and taxation perspective. Consolidated VIEs HUSI entered into a series of transactions with VIEs organized by HSBC affiliates and unrelated third parties. These VIEs were structured as trusts or corporations that issue fixed or floating rate instruments backed by the assets of the issuing entities. HUSI sold trading assets to the VIEs and subsequently entered into total return swaps with the VIEs whereby HUSI receives the total return on the transferred assets and, in return, pays a market rate of return to its counterparties. HUSI has determined that it is the primary beneficiary of these VIEs under the applicable accounting literature and, accordingly, consolidated $2.6 billion in trading assets at December 31, 2006. These assets are pledged as collateral for obligations of the VIEs, which are included in long-term debt (refer to Note 15 on page 126 of this Form 10-K). The holders of the instruments issued by the VIEs have no recourse to the general credit of HUSI beyond the assets sold to the VIEs and pledged as collateral. Unconsolidated VIEs HUSI also holds variable interests in various other VIEs which are not consolidated at December 31, 2006. HUSI is not the primary beneficiary of these VIE structures. Information for unconsolidated VIEs is presented in the following table and commentary. ----------------------------------------------------------------------------------------------- December 31, 2006 December 31, 2005 ---------------------- -------------------- Maximum Maximum Total Exposure Total Exposure Assets to Loss Assets to Loss ----------------------------------------------------------------------------------------------- (in millions) Asset backed commercial paper conduits ........ $ 14,104 $ 8,048 $ 10,183 $ 7,423 Securitization vehicles ....................... 2,242 612 1,774 565 Investment funds .............................. 200 2 2,513 -- Capital funding vehicles ...................... 1,093 32 1,093 32 Low income housing tax credits ................ 406 153 1,080 165 ---------- --------- --------- -------- Total ......................................... $ 18,045 $ 8,847 $ 16,643 $ 8,185 ========== ========= ========= ======== Asset Backed Commercial Paper Conduits HSBC affiliates support the financing needs of customers by facilitating their access to the commercial paper markets. Specifically, pools of customers' assets, typically trade receivables, are sold to an independently rated, commercial paper financing entity, which in turn issues short-term, asset backed commercial paper that is collateralized by such assets. Neither the HSBC affiliates nor HUSI service the assets or transfer their own receivables into the financing entities. HUSI and other banks provide one year liquidity facilities, in the form of either loan or asset purchase commitments, in support of each transaction in the financing entity. HUSI does not provide any program wide enhancements to the financing entities. In the preceding table, HUSI's maximum exposure to loss is the total notional amount of the liquidity facilities. 151 In the normal course of business, HUSI provides liquidity facilities to asset backed commercial paper conduits sponsored by unrelated third parties. HUSI does not transfer its own receivables into the financing entity, has no ownership interest in, performs no administrative duties for, and does not service any assets of these conduits. The only interest HUSI has in these entities are liquidity facilities in the amount of approximately $1.5 billion and $1.4 billion at December 31, 2006 and 2005, respectively. These facilities are excluded from the table summarizing HUSI's involvement in VIEs. Credit risk is managed on these commitments by subjecting them to HUSI's normal underwriting and risk management processes. Securitization Vehicles An HSBC affiliate and third parties organize trusts that are special purpose entities (SPEs) that issue fixed or floating rate debt backed by the assets of the trusts. Neither the HSBC affiliate nor HUSI transfer their own assets into the trusts. HUSI's relationship with the SPEs is primarily as counterparty to the SPEs' derivative transactions (interest rate, credit default and currency swaps). HUSI's maximum exposure to loss from the unconsolidated trust entities is comprised of investments in the trust and the market risk on the derivative transactions. Investment Funds HUSI is a derivative counterparty (total return swap) with a hedge fund established by an unrelated third party. The total return swap creates a variable interest in the fund for HUSI. HUSI does not hold shares in or have any other involvement with the fund. As such, HUSI is not the primary beneficiary. HUSI is also an investor in a hedge fund established by an unrelated third party. The shares owned by HUSI do not have voting rights but do participate in profits and losses based on percentage of share ownership. HUSI does not hold sufficient beneficial interests in the fund to be considered the primary beneficiary. HUSI is a sub-investment advisor to mutual funds structured as trusts and managed by an HSBC affiliate. As sub-investment advisor, HUSI receives a variable fee based on the value of funds. HUSI has no ownership interest in or credit exposure resulting from its duties as investment advisor. During 2006, the assets of certain of these trusts were liquidated, resulting in significantly reduced assets to manage. Capital Funding Vehicles Prior to 2005, HUSI established five Capital Trust entities. These trusts issue preferred securities and common stock. HUSI purchased all of the common equity issued by the trusts, which equates to approximately 3% of the total assets of the trusts. HUSI does not own any of the preferred securities issued by the trusts. It has been determined that the majority of the benefit of profit and/or risk of loss lies with the preferred security holders. Thus, HUSI is not the primary beneficiary of the trusts and is not required to consolidate these entities. Low Income Housing Tax Credits HUSI participates as a limited partner in Low Income Housing Tax Credit Partnerships. These investments are recorded as other assets on the consolidated balance sheet using the equity method of accounting. HUSI also receives tax benefits over a period of time specified in the investment contracts. HUSI's investment is reduced over time for its share of any operating losses incurred by the partnership as well as for any amortization over the time period in which tax credits are received. Tax credits may be subject to recapture if the underlying properties do not remain in compliance with certain conditions. Some of these partnerships have been determined to be VIEs. HUSI's maximum exposure to loss shown in the table represents the net assets recorded on the balance sheet, estimated expected reduction of future tax liabilities, and potential recapture of tax credits allowed in prior years. 152 Note 28. Fair Value of Financial Instruments -------------------------------------------------------------------------------- HUSI is required to disclose the estimated fair value of its financial instruments in accordance with Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments (SFAS 107). The disclosures do not attempt to estimate or represent the fair value of HUSI as a whole. The disclosures exclude assets and liabilities that are not financial instruments, including intangible assets, such as goodwill. The estimation methods and assumptions used by HUSI to value individual classifications of financial instruments are described below. Different assumptions could significantly affect the estimates. Accordingly, the net realizable values upon liquidation of the financial instruments could be materially different from the estimates presented. Financial instruments with carrying value equal to fair value - The carrying value of certain financial assets and liabilities is considered to be equal to fair value as a result of their short-term nature and interest rates that approximate market rates. These items include cash and due from banks, interest bearing deposits with banks, federal funds sold and securities purchased under resale agreements, accrued interest receivable, customers' acceptance liability and certain financial liabilities including acceptances outstanding, short-term borrowings and interest, taxes, and other liabilities. Trading account assets and liabilities and derivative instruments included in other assets and other liabilities - Trading account assets and liabilities, including derivative trading accounts (see Note 5 of the consolidated financial statements), and derivative accounts included in other assets and other liabilities are recorded at fair value. Fair value is based on current market quotations, where available. If quoted market prices are not available, fair value is estimated based on the quoted price of similar instruments or internal valuation models that approximate market pricing. Securities - The fair value of securities contracts is based on current market quotations, where available. If quoted market prices are not available, fair value is estimated based on the quoted price of similar instruments or internal valuation models that approximate market pricing. Available for sale securities are recorded at fair value on the consolidated balance sheet, while held to maturity securities are generally recorded at historical cost. The cost and fair values of securities are reported in Note 6 of the consolidated financial statements. Loans - The fair value of the loan portfolio is determined primarily by calculating the present value of expected cash flows using discount rates that approximate current market rates for similar loans and adjusting for inherent credit risk. The loans are grouped, to the extent possible, into homogeneous pools, segregated by maturity, weighted average maturity and average coupon rate. Depending upon the type of loan involved, maturity assumptions are based on either the contractual or expected maturity date. Deposits - The fair value of demand, savings and money market deposits approximate their carrying value. For deposits with fixed maturities, fair value is estimated using market interest rates currently offered on deposits with similar characteristics and maturities. Long-term debt - The fair values of various debt instruments are estimated using market interest rates currently available for borrowings with similar characteristics and maturities. 153 The following table includes certain financial instruments where the carrying value does not equal or approximate fair value. -------------------------------------------------------------------------------------------- 2006 2005 ----------------------- ----------------------- Carrying Fair Carrying Fair December 31 Value Value Value Value -------------------------------------------------------------------------------------------- (in millions) Financial assets: Securities held to maturity ......... $ 2,972 $ 3,040 $ 3,171 $ 3,262 Loans, net of allowance ............. 89,340 88,314 89,496 88,467 Financial liabilities: Deposits: Without fixed maturities ......... 88,474 88,474 77,924 77,924 Fixed maturities ................. 16,076 16,060 13,891 13,889 Long-term debt ...................... 29,252 29,525 29,595 30,084 The fair value of commitments to extend credit, standby letters of credit and financial guarantees, is not included in the previous table. These instruments generate fees, which approximate those currently charged to originate similar commitments. Note 29. Financial Statements of HSBC USA Inc. (Parent) -------------------------------------------------------------------------------- Condensed parent company financial statements follow. --------------------------------------------------------------------------------------------- Balance Sheet December 31 2006 2005 --------------------------------------------------------------------------------------------- (in millions) Assets: Interest bearing deposits with banks ............................. $ 65 $ 65 Trading assets ................................................... 1,352 584 Securities purchased under resale agreements ..................... 71 6 Securities available for sale .................................... 238 157 Securities held to maturity (fair value $114 and $136) ........... 108 128 Loans (net of allowance for credit losses of $2 and $1) .......... 23 43 Receivables from subsidiaries .................................... 4,169 4,832 Receivables from other HSBC affiliates ........................... 82 88 Investment in subsidiaries at amount of their net assets: Banking ....................................................... 12,258 11,888 Other ......................................................... 501 403 Goodwill ......................................................... 604 604 Other assets ..................................................... 196 158 ----------- ---------- Total assets ..................................................... $ 19,667 $ 18,956 =========== ========== Liabilities: Interest, taxes and other liabilities ............................ $ 192 $ 66 Payables due to subsidiaries ..................................... 464 81 Short-term borrowings ............................................ 2,414 2,620 Long-term debt (1) ............................................... 4,336 4,595 ----------- ---------- Total liabilities ................................................ 7,406 7,362 Shareholders' equity * ........................................... 12,261 11,594 ----------- ---------- Total liabilities and shareholders' equity ....................... $ 19,667 $ 18,956 =========== ========== * See Consolidated Statement of Changes in Shareholders' Equity, page 96. (1) Contractual scheduled maturities for the debt over the next five years are as follows: 2007, $148 million; 2008, $244 million; 2009, $555 million; 2010, $1 million; and 2011, $1,613 million. 154 ---------------------------------------------------------------------------------------------------------- Statement of Income Year Ended December 31 2006 2005 2004 ---------------------------------------------------------------------------------------------------------- (in millions) Income: Dividends from banking subsidiaries ................................... $ 855 $ 675 $ 125 Dividends from other subsidiaries ..................................... 2 2 2 Interest from subsidiaries ............................................ 240 168 105 Interest from other HSBC affiliates ................................... 5 16 5 Other interest income ................................................. 26 14 14 Securities transactions ............................................... (1) 13 4 Other income .......................................................... 189 35 91 ------- ------- -------- Total income .............................................................. 1,316 923 346 ------- ------- -------- Expenses: Interest (including $86 paid to subsidiaries in 2004) ................. 437 350 240 Provision for credit losses ........................................... -- -- 3 Other expenses ........................................................ 17 17 20 ------- ------- -------- Total expenses ............................................................ 454 367 263 ------- ------- -------- Income before taxes and equity in undistributed income of subsidiaries .... 862 556 83 Income tax expense (benefit) .............................................. 10 (40) (21) ------- ------- -------- Income before equity in undistributed income of subsidiaries .............. 852 596 104 Equity in undistributed income of subsidiaries ............................ 184 380 1,154 ------- ------- -------- Net income ................................................................ $ 1,036 $ 976 $ 1,258 ======= ======= ======== ---------------------------------------------------------------------------------------------------------- Statement of Cash Flows Year Ended December 31 2006 2005 2004 ---------------------------------------------------------------------------------------------------------- (in millions) Cash flows from operating activities: Net income .............................................................. $ 1,036 $ 976 $ 1,258 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and deferred taxes ......................... 2 (3) 13 Provision for credit losses ........................................... -- -- 3 Net change in other accrued accounts .................................. 74 (77) 137 Net change in fair value of non-trading derivatives ................... 39 5 (27) Undistributed income of subsidiaries .................................. (184) (380) (1,154) Other, net ............................................................ (465) (291) (53) ------- ------- -------- Net cash provided by operating activities ........................... 502 230 177 ------- ------- -------- Cash flows from investing activities: Net change in interest bearing deposits with banks ...................... 451 (1,930) (738) Purchases of securities ................................................. (85) (174) (11) Sales and maturities of securities ...................................... 19 58 41 Net originations and maturities of loans ................................ 342 414 (435) Net change in investments in and advances to subsidiaries ............... (477) (490) (1,510) Other, net .............................................................. (83) 181 (65) ------- ------- -------- Net cash provided by (used in) investing activities ................. 167 (1,941) (2,718) ------- ------- -------- Cash flows from financing activities: Net change in short-term borrowings ..................................... (206) 140 733 Issuance of long-term debt, net of issuance costs ....................... -- 1,497 -- Repayment of long-term debt ............................................. (300) (3) (424) Dividends paid .......................................................... (543) (720) (148) Reductions of capital surplus ........................................... (9) (22) (20) Preferred stock issuance, net of redemptions ............................ 374 816 -- Capital contribution from HNAI .......................................... 15 3 2,400 ------- ------- -------- Net cash (used in) provided by financing activities ....................... (669) 1,711 2,541 ------- ------- -------- Net change in cash and due from banks ..................................... -- -- -- Cash and due from banks at beginning of year .............................. -- -- -- ------- ------- -------- Cash and due from banks at end of year .................................... $ -- $ -- $ -- ======= ======= ======== Cash paid for: Interest ................................................................ $ 428 $ 349 $ 237 ======= ======= ======== HBUS is subject to legal restrictions on certain transactions with its nonbank affiliates in addition to the restrictions on the payment of dividends to HUSI. See Note 18 on page 133 for further discussion. 155 Quarterly Results of Operations (Unaudited) -------------------------------------------------------------------------------- The following table presents a quarterly summary of selected financial information. --------------------------------------------------------------------------------------------------------- Quarter Ended December 31 September 30 June 30 March 31 --------------------------------------------------------------------------------------------------------- (in millions) 2006 Net interest income ................................. $ 794 $ 777 $ 775 $ 735 ----------- ------------ --------- -------- Trading revenues .................................... 155 52 269 279 Residential mortgage banking revenue ................ 40 6 27 23 Securities gains, net ............................... 13 6 6 4 Other income ........................................ 410 550 371 352 ----------- ------------ --------- -------- Total other revenues ................................ 618 614 673 658 ----------- ------------ --------- -------- Operating expenses .................................. 876 819 775 785 Provision for credit losses ......................... 237 207 222 157 ----------- ------------ --------- -------- Income before income tax expense .................... 299 365 451 451 Income tax expense .................................. 101 121 165 143 ----------- ------------ --------- -------- Net income .......................................... $ 198 $ 244 $ 286 $ 308 =========== ============ ========= ======== 2005 Net interest income ................................. $ 742 $ 761 $ 785 $ 775 ----------- ------------ --------- -------- Trading revenues .................................... 127 137 35 96 Residential mortgage banking revenue (expense) ...... 23 31 (13) 23 Securities gains, net ............................... 2 17 64 23 Other income ........................................ 362 320 327 337 ----------- ------------ --------- -------- Total other revenues ................................ 514 505 413 479 ----------- ------------ --------- -------- Operating expenses .................................. 746 673 684 655 Provision for credit losses ......................... 198 199 170 107 ----------- ------------ --------- -------- Income before income tax expense .................... 312 394 344 492 Income tax expense .................................. 116 142 131 177 ----------- ------------ --------- -------- Net income .......................................... $ 196 $ 252 $ 213 $ 315 =========== ============ ========= ======== 156 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure -------------------------------------------------------------------------------- There were no disagreements on accounting and financial disclosure matters between HUSI and its independent accountants during 2006. Item 9A. 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 have been no significant changes in HUSI's internal controls or in other factors that could significantly affect internal and disclosure controls subsequent to the date that the evaluation was carried out. 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 controls 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. Item 9B. Other Information -------------------------------------------------------------------------------- None. 157 PART III Item 10. Directors, Executive Officers and Corporate Governance -------------------------------------------------------------------------------- Directors Set forth below is certain biographical information relating to the members of HUSI's Board of Directors as of February 21, 2007. Each director is elected annually. There are no family relationships among the directors. Salvatore H. Alfiero, age 69, joined the HUSI Board in 2000, the HBUS Board in 1996 and the HNAH Board in 2005. Mr. Alfiero has been the Chairman and Chief Executive Officer of Protective Industries, LLC since 2001. He is also a director of Phoenix Companies, Inc., Southwire Company and Fresh Del Monte Produce Company. Mr. Alfiero is Chair of the Audit Committee and a member of the Nominating & Governance Committee. Donald K. Boswell, age 55, joined the HUSI and HBUS Boards in 2002. Mr. Boswell has been the President and Chief Executive Officer of Western New York Public Broadcasting Association since 1998, and has been in public broadcasting since 1977. Mr. Boswell is a member of the Fiduciary Committee and the Human Resources & Compensation Committee. James H. Cleave, age 64, joined the HUSI and HBUS Boards in 1991. Mr. Cleave was the President and Chief Executive Officer of HUSI and HBUS from 1993 through 1997. Prior to that, he was President and Chief Executive Officer of HSBC Bank Canada and is currently a director and Vice Chairman of HSBC Bank Canada. Mr. Cleave is a member of the Audit Committee and the Executive Committee. Dr. Frances D. Fergusson, age 62, joined the HBUS Board in 1990 and the HUSI Board in 2000. She is President Emeritus of Vassar College and served as President from 1986 to 2006. Prior to that, Dr. Fergusson was Provost and Vice President for Academic Affairs, Bucknell University. Dr. Fergusson is also a director of Wyeth Pharmaceuticals and Mattel, Inc., and a member of the Board of Overseers of Harvard University. Dr. Fergusson is the Chair of the Human Resources & Compensation Committee and a member of the Nominating & Governance Committee and the Executive Committee. Michael F. Geoghegan, age 53, joined the HUSI and HBUS Boards as Chairman in September 2006. He joined HSBC in 1973 and has been an executive director of HSBC since 2004 and the HSBC Group Chief Executive since May 2006. Mr. Geoghegan served as Chief Executive of HSBC Bank plc from January 2004 to March 2006. He is a director and Deputy Chairman of HSBC Bank plc and a director of The Hongkong and Shanghai Banking Corporation Limited and HSBC France. Mr. Geoghegan is also a non-executive director and Chairman of Young Enterprise UK. Stuart T. Gulliver, age 47, joined the HUSI and HBUS Boards in September 2006. He has been the Chief Executive, CIBM and Group Investment businesses for HSBC since May 2006. Mr. Gulliver was appointed as a Group Managing Director and to the Group Management Board in 2004. He served as a Group General Manager from 2000 to 2004. Mr. Gulliver joined HSBC in 1980 and has held a number of key roles in various treasury and capital markets businesses, most recently as Co-Head of Corporate, Investment Banking and Markets from 2003 to 2006 and Head of Global Markets from 2002 to 2003. He is also a director of HSBC Bank plc and The Hongkong and Shanghai Banking Corporation Limited. 158 Richard A. Jalkut, age 62, joined the HUSI Board in 2000 and the HBUS Board in 1992. Mr. Jalkut is the President and Chief Executive Officer of Telepacific Communications. He was a director of Birch Telecom, Inc. until June 2006. Formerly, he was the President and Chief Executive of Pathnet and, prior to that, President and Group Executive, NYNEX Telecommunications. Mr. Jalkut is also a director of IKON Office Solutions and Covad Communications. Mr. Jalkut has been Lead Director of HUSI and HBUS since January 2005. He is the chair of the Executive Committee, the Chair of the Nominating & Governance Committee and a member of the Audit Committee. Peter Kimmelman, age 62, joined the HUSI and HBUS Boards in 2000. Mr. Kimmelman is a private investor and managing member of Peter Kimmelman Asset Management, LLC, an investment advisory firm registered with the Securities and Exchange Commission. He was formerly a director of Republic New York Corporation and Republic National Bank of New York from 1976 until 1999. Mr. Kimmelman is a member of the Audit Committee. Paul J. Lawrence, age 45, joined the HUSI and HBUS Boards and was appointed President and Chief Executive Officer of HUSI and HBUS as of February 21, 2007. Mr. Lawrence joined HSBC in 1982 and has held numerous positions in Asia and the United Kingdom. He was appointed Head of CIBM, North America for HUSI and HBUS as of October 1, 2006. Mr. Lawrence held the position of Chief Executive Officer, The Hongkong and Shanghai Banking Corporation Limited, Singapore from 2002 through September 2006 and, prior to that, served as Chief Executive Officer of The Hongkong and Shanghai Banking Corporation Limited, Philippines. Mr. Lawrence has been an HSBC Group General Manager since 2005. Mr. Lawrence is a member of the Executive Committee. Charles G. Meyer, Jr., age 69, joined the HUSI and HBUS Boards in 2000. Mr. Meyer is an architect and former President of Cord Meyer Development Company. Mr. Meyer was formerly a director of Republic National Bank of New York from 1987 until 1999. Mr. Meyer is the Chair of the Fiduciary Committee and a member of the Nominating & Governance Committee. James L. Morice, age 69, joined the HUSI and HBUS Boards in 2000. Mr. Morice has been the President and Chief Executive Officer of Morice Consulting, LLC, successor to the JLM Group, LLC, a management consulting firm, since 2006. He was previously Executive Vice President and Director of NationsBuilders Insurance Services, Inc. Mr. Morice was a director of Republic New York Corporation and Republic National Bank of New York from 1987 until 1999 and a member of the Human Resources Committee of the University of New Haven from 2003 through 2005. Mr. Morice is a member of the Fiduciary Committee and the Human Resources & Compensation Committee. 159 Executive Officers -------------------------------------------------------------------------------- Information regarding the executive officers of HUSI as of February 21, 2007 is presented in the following table. Year Name Age Appointed Present Position with HUSI ------------------------------------------------------------------------------------------------------------------- Paul J. Lawrence 45 2006 President and Chief Executive Officer Kevin Newman 49 2007 Group General Manager, Personal Financial Services Janet L. Burak 51 2004 Senior Executive Vice President, General Counsel and Secretary Robert M. Butcher 63 1988 Senior Executive Vice President & Chief Risk Officer Christopher Davies 45 2007 Senior Executive Vice President, Commercial Banking David Dew 51 2006 Senior Executive Vice President & Chief Administrative Officer Mark A. Hershey 54 2007 Senior Executive Vice President, Co-Head Chief Credit Officer David C. Kotheimer 49 2007 Senior Executive Vice President, Business Performance John J. McKenna 47 2005 Senior Executive Vice President & Chief Financial Officer George T. Wendler 62 2000 Senior Executive Vice President, Co-Head Chief Credit Officer Jeanne G. Ebersole 45 2004 Executive Vice President, Human Resources Teresa A. Pesce 47 2005 Executive Vice President & Anti-Money Laundering (AML) Director Carolyn M. Wind 53 2005 Executive Vice President, Compliance Marlon Young 51 2006 Managing Director, Chief Executive Officer Private Bank Americas Clive R. Bucknall 43 2006 Executive Vice President & Controller ------------------------------------------------------------------------------------------------------------------- Kevin Newman, Group General Manager, Personal Financial Services since October 2006. Mr. Newman served as Senior Executive Vice President, Personal Financial Services from September 2005 to October 2006 and as Executive Vice President, Personal Financial Services from December 2003 to September 2005. Prior to that, he served as Head of hsbc.com. Janet L. Burak, Senior Executive Vice President, General Counsel and Secretary for HUSI and HBUS since April 2004. Ms. Burak served as an attorney with HSBC Finance Corporation for twelve years, most recently as Group General Counsel. Prior to joining HSBC Finance Corporation, she was an associate with Shearman & Sterling and an attorney with Citigroup. Robert M. Butcher, Senior Executive Vice President & Chief Risk Officer for HUSI and HBUS since May 2003. Mr. Butcher was Chief Financial Officer of HUSI and HBUS from 1990 to 2003. Prior to joining HBUS's predecessor, Marine Midland Bank, in 1988, Mr. Butcher was with Citicorp for 15 years where he held various senior officer positions in the corporate finance department. Christopher Davies, Senior Executive Vice President, Commercial Banking since February 2007. Prior to this appointment, Mr. Davies was Head of Corporate and Institutional Banking with HSBC Securities (USA) Inc. from 2004 to February 2007. From 2003 to 2004, he was Head of Client Service and Marketing, Global CIB with HSBC Bank plc, and from 2000 to 2003 he was Credit & Banking Services Director with First Direct, Leeds. Mr. Davies has held various senior officer positions in credit, treasury and retail and commercial banking since joining Midland Bank plc, now known as HSBC Bank plc, in 1985. David Dew, Senior Executive Vice President & Chief Administrative Officer since February 2007. He served as Senior Executive Vice President, Audit for HUSI and HSBC North America Inc. (HNAI) from January 2006 to February 2007. Prior to this appointment, Mr. Dew served as Chief Auditor, Group Audit, HSBC Finance Corporation from November 2004 to December 2005. He was Executive Director & Chief Operating Officer, The Saudi British Bank, Riyadh, Saudi Arabia from March 2001 to November 2004; Deputy Chief Executive Officer, The Hongkong and Shanghai Banking Corporation Limited, Singapore from September 1997 to March 2001; and Chief Executive Officer, HSBC Bank plc, Milan, Italy from November 1994 to September 1997. Mr. Dew has been an HSBC employee since 1977. 160 Mark A. Hershey, Senior Executive Vice President, Co-Head Chief Credit Officer since February 2007. Prior to this appointment Mr. Hershey was Senior Executive Vice President, Commercial Banking since 2005 and Executive Vice President, Commercial Banking from 2000 to 2005. Mr. Hershey was a senior officer of Republic National Bank of New York when it was acquired by HSBC in December 1999. David C. Kotheimer, Senior Executive Vice President, Business Performance since December 2006. Mr. Kotheimer served as Senior Executive Vice President, Tri-State, of HBUS from May 2006 to December 2006 and as an Executive Vice President, Metro New York, of HBUS from November 2000 to May 2006. Since joining HSBC in 1987, Mr. Kotheimer has held a variety of senior officer positions in commercial banking, human resources and personal financial services. John J. McKenna, Senior Executive Vice President and Chief Financial Officer of HUSI since October 2005. Prior to this appointment, Mr. McKenna served as Chief Financial Officer, HSBC Mexico, S.A. from November 2002 through September 2005. From July 2000 to October 2002, he held the position of Senior Vice President and Director of Financial Management for HUSI. Since joining HSBC in 1986, Mr. McKenna has held a variety of financial management positions focusing on strategic planning, business controllership and management information. George T. Wendler, Senior Executive Vice President, Co-Head Chief Credit Officer of HUSI since February 2007. Prior to this appointment, Mr. Wendler was Chief Credit Officer of HUSI from January 2000 to February 2007, and he was Chief Credit Officer and a member of the Senior Management Committee of Republic New York Corporation when it was acquired by HSBC in December 1999. Mr. Wendler was also a director and Vice Chairman of Republic New York Corporation from 1997 to 1999. Jeanne G. Ebersole, Executive Vice President, Human Resources since May 2004. Prior to this appointment, Ms. Ebersole had overall human resources responsibility for HSBC Finance Corporation's retail services, insurance services and refund lending businesses since August 2002. She held a variety of human resources positions after joining HSBC Finance Corporation in 1980. Teresa A. Pesce, Executive Vice President and Anti-Money Laundering (AML) Director since September 2003. In 2004 she was appointed the AML Director for all HSBC businesses in North America. Ms. Pesce joined HUSI from the United States Attorney's Office, Southern District of New York where she was Senior Trial Counsel, White Plains Division and previously Chief of the Major Crimes Unit and Deputy Chief of the Criminal Division. From 1992 to 1999 she served as a Line Assistant in the Major Crimes, Narcotics, and General Crimes Units. Carolyn M. Wind, Executive Vice President, Compliance, was the Chief Compliance Officer for Republic New York Corporation when it was acquired by HSBC in December 1999. Prior to joining Republic New York Corporation, she was a senior national bank examiner with the Office of the Comptroller of the Currency (OCC). Marlon Young, Managing Director, CEO Private Bank Americas since October 2006. Mr. Young joined HSBC as Managing Director and Head of Domestic Private Banking for HBUS in March 2006. He served as Managing Director and Head of Private Client Lending for Smith Barney from 2004 through 2006. Prior to that, Mr. Young held various positions with Citigroup from 1979, most recently as Managing Director and Head of Citigroup Private Bank (Northeast Region) from 2000 through 2004. Clive R. Bucknall, Executive Vice President & Controller and Chief Accounting Officer since March 7, 2006. Prior to this appointment Mr. Bucknall served as Senior Financial Officer, HSBC Singapore from March 2002 through December 2005. He was Senior Financial Officer, HSBC Thailand from September 1998 to March 2002 and Senior Area Accounting Manager, HSBC Hong Kong from September 1994 to September 1998. In 1991, Mr. Bucknall joined Midland Bank in London, which was acquired by HSBC in 1992, as Financial Accounting Manager. 161 Corporate Governance -------------------------------------------------------------------------------- Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act, as amended, requires our Directors, executive officers and any persons who own more than 10 percent of a registered class of our equity securities to report their initial ownership and any subsequent change to the SEC and the New York Stock Exchange ("NYSE"). With respect to the issues of HUSI preferred stock outstanding, we reviewed copies of all reports furnished to us and obtained written representations from our Directors and executive officers that no other reports were required. Based solely on a review of copies of such forms furnished to us and written representations from the Directors and executive officers, all Section 16(a) filing requirements were complied with for the 2006 fiscal year. Board of Directors - Committees and Charters The Board of Directors of HSBC USA Inc. has five standing committees: the Audit Committee, the Executive Committee, the Fiduciary Committee, the Human Resources & Compensation Committee and the Nominating & Governance Committee. The charter of each of these committees, as well as the HSBC USA Inc. Corporate Governance Standards, are available upon written request to HSBC USA Inc., 452 Fifth Avenue, New York, New York 10018, Attention: Corporate Secretary. Audit Committee The primary purpose of the Audit Committee is to assist the Board of Directors in fulfilling its oversight responsibilities relating to HUSI's system of internal controls over financial reporting and its accounting, auditing and financial reporting practices. The Audit Committee is currently comprised of the following independent directors (as defined by HSBC USA Inc.'s Corporate Governance Standards, which are based upon the rules of the New York Stock Exchange): Sal H. Alfiero (Chair), James H. Cleave, Richard A. Jalkut and Peter Kimmelman. The Board of Directors has determined that each of these individuals is financially literate. The Board of Directors has also determined that Messrs. Alfiero and Cleave qualify as audit committee financial experts. Executive Committee The Executive Committee may exercise the powers and authority of the Board of Directors in the management of HUSI's business and affairs during the intervals between meetings of the Board of Directors. The executive committee is currently comprised of the following directors: Richard A. Jalkut (Chair and Lead Director), James H. Cleave, Dr. Frances D. Fergusson and Paul J. Lawrence. Fiduciary Committee The primary purpose of the Fiduciary Committee is to supervise the fiduciary activities of HBUS to ensure the proper exercise of its fiduciary powers in accordance with 12 U.S.C. Section 92a - Trust Powers of National Banks and related regulations promulgated by the Office of the Comptroller of the Currency. The Fiduciary Committee is currently comprised of the following directors: Charles G. Meyer, Jr. (Chair), Donald K. Boswell and James L. Morice. All members of the Fiduciary Committee are independent directors under HSBC USA Inc.'s Corporate Governance Standards. Human Resources & Compensation Committee The primary purpose of the Human Resources & Compensation Committee is to assist the Board of Directors in discharging its responsibilities related to the compensation of the Chief Executive Officer, other officers of HUSI holding a title of executive vice president and above and such other officers as may be designated by the Board of Directors. The Human Resources & Compensation Committee is currently comprised of the following directors: Dr. Frances D. Fergusson (Chair), Donald K. Boswell and James L. Morice. All members of the Human Resources & Compensation Committee are independent directors under HSBC USA Inc.'s Corporate Governance Standards. 162 The Charter of the Human Resources & Compensation Committee lists the primary responsibilities, powers and authorities of the committee. The listed items include (i) review and approval of corporate goals and performance objectives relevant to the compensation of the Chief Executive Officer and certain other executive officers, evaluate the performance of the Chief Executive Officer and other executive officers in light of those goals and objectives, and review its findings with the Board of Directors in executive session, (ii) submit recommendations concerning base salary, performance-based cash and long-term equity-based incentive awards for the Chief Executive Officer and other executive officers to the Remuneration Committee of HSBC ("REMCO") for approval, (iii) recommend to REMCO equity incentives under HSBC plans to all employees, except those awards that the Chief Executive Officer may determine based upon a delegation of authority by REMCO, (iv) review and approve benefits and perquisites of the Chief Executive Officer and other executive officers to the extent such benefits are not available to all employees, (v) review and recommend to REMCO any employment and severance arrangements for the Chief Executive Officer and other executive officers, as well as any severance payouts to such officers, (vi) review and consider "best practices" of peer companies with respect to compensation philosophies, policies and practices, (vii) review management's Compensation Discussion and Analysis ("CD&A") to be included in HUSI's Annual Report on Form 10-K, discuss the CD&A's content with management, and prepare the Compensation Committee Report concerning the CD&A and recommend to the Board of Directors that the CD&A be included in the Annual Report on Form 10-K, and (viii) engage in an annual self assessment with the goal for continuing improvement, and to review and assess the adequacy of this charter at least annually and recommend any proposed changes to the Board of Directors for approval. The Human Resources & Compensation Committee may at its discretion retain and discharge consultants to assist the committee in evaluating Chief Executive Officer or other executive officer compensation and to determine the appropriate terms of engagement and the fees to be paid to such consultants. The Chief Executive Officer is given full authority, which may be delegated, to establish the compensation and salary ranges for all other employees of HUSI and its subsidiaries whose salaries are not subject to review by the Human Resources & Compensation Committee and approval by REMCO. For more information about HUSI's compensation policies and programs, please see Item 11. Executive Compensation - Compensation Discussion and Analysis. Nominating & Governance Committee The primary purpose of the Nominating & Governance Committee is to assist the Board of Directors of HUSI in discharging its responsibilities related to identifying and nominating members of the Board of Directors to the Board, recommending to the Board the composition of each committee of the Board and the Chair of each committee, establishing and reviewing HUSI's corporate governance and making recommendations to the Board regarding compensation for service of the non-executive Board members. The Nominating & Governance Committee ensures that HUSI maintains "best practices" with respect to corporate governance in order to ensure effective representation of its stakeholders. The Nominating & Governance Committee is currently comprised of the following directors: Richard A. Jalkut (Chair), Sal H. Alfiero, Dr. Frances D. Fergusson and Charles G. Meyer, Jr. All members of the Nominating & Governance Committee are independent directors under HSBC USA Inc.'s Corporate Governance Standards. Code of Ethics HUSI has adopted a code of ethics that is applicable to its chief executive officer, chief financial officer, chief accounting officer and controller, which is incorporated by reference to Exhibit 14 of this Form 10-K. HUSI also has a general code of ethics applicable to all employees that is referred to as its Statement of Business Principles and Code of Ethics. Both documents are available upon written request made to HSBC USA Inc., 452 Fifth Avenue, New York, New York 10018, Attention: Corporate Secretary. 163 Item 11. Executive Compensation -------------------------------------------------------------------------------- Compensation Discussion and Analysis The following compensation discussion and analysis (the "2006 CD&A") summarizes the principles, objectives and factors considered by HUSI in evaluating and determining the compensation of executive officers in 2006. Specific compensation information relating to Sandra L. Derickson, President and Chief Executive Officer - Designate (and President and Chief Executive Officer from January 1 until February 20, 2007); Martin J.G. Glynn, President and Chief Executive Officer; John J. McKenna, Senior Executive Vice President and Chief Financial Officer; Joseph A. Belfatto, Senior Executive Vice President & Head of Global Markets Americas; Marlon Young, Managing Director, CEO, Private Bank Americas; and Janet L. Burak, Senior Executive Vice President, General Counsel and Secretary, is contained in this portion of the Form 10-K. The 2006 CD&A also includes compensation information relating to Brendan McDonagh, Chief Operating Officer; and Joseph M. Petri, Senior Executive Vice President, Treasurer and Co-Head, CIBM Americas, both of whom served as an executive officer of HUSI during part of 2006, but ceased providing services to HUSI prior to December 31, 2006. Oversight of Compensation Decisions HUSI is a wholly owned subsidiary of HSBC Holdings plc ("HSBC"). The Board of Directors of HSBC has the authority to delegate any of its powers, authorities and judgments to any committee consisting of one or more directors, and has established a Remuneration Committee ("REMCO") for the purpose of setting the remuneration policy for HSBC and its subsidiaries and the compensation of senior executives. REMCO's responsibilities include reviewing and approving performance-based remuneration by reference to corporate goals and objectives established by the Board of Directors of HSBC from time to time and approving overall market positioning of the compensation package, individual base salaries and increases and annual and long-term incentive/bonus arrangements for certain executives. In November 2006, REMCO delegated its authority for approval of salaries and annual cash incentive awards relating to certain classes of executives to Michael F. Geoghegan, the HSBC Group Chief Executive (the "HSBC CEO"). However, REMCO retained exclusive authority over compensation of the more senior executives within HSBC and its subsidiaries. As a result, REMCO had authority over the compensation of Ms. Derickson and Messrs. Glynn, McDonagh and Petri in 2006. Pursuant to a further delegation of authority from the HSBC CEO, Siddharth N. Mehta, Chief Executive Officer of HNAH until February 15, 2007, had approval authority over certain executives within HUSI, including Mr. McKenna and Ms. Burak; Stuart T. Gulliver, HSBC Managing Director and Head of CIBM, has approval authority over certain executives within the CIBM businesses; and Chris M. Meares, Chief Executive Officer, Group Private Banking, has approval authority over certain executives within the Private Banking businesses. REMCO has exclusive authority with respect to all long-term incentive plan awards involving interests in HSBC ordinary shares. The members of REMCO in 2006 were Sir Mark Moody-Stuart (Chairman), W.K.L. Fung, S. Hintze, Sir John Kemp-Welch (until retirement on May 26, 2006) and J.D. Coombe (effective as of June 1, 2006), all of whom were or are non-executive directors of HSBC. REMCO has retained the services of Towers Perrin, a human resource consulting firm, to provide independent advice on executive compensation issues. REMCO is provided with comparator information from Towers Perrin, which obtains compensation data for executive positions with companies of similar size and complexity that are subsidiaries of peer financial services companies. In addition, market data has been obtained from American Express Company, Bank of America Corporation, Bank One Corporation, BB&T Corporation, Capital One Corporation, Citigroup, Inc., Countrywide Financial Corporation, FifthThird Bancorp, KeyCorp, LaSalle Bank Corporation, Merrill Lynch & Co., Inc., National City Corporation, The PNC Financial Services Group Inc., Royal Bank of Canada, State Street Corporation, Sun Trust Banks, Inc., Wachovia Corporation, Washington Mutual Inc. and Wells Fargo & Company. Comparator and market data is used by REMCO to evaluate the competitiveness of proposed executive compensation. 164 The Human Resources and Compensation Committee of the Board of Directors of HUSI (the "Compensation Committee") seeks to ensure that HUSI's compensation policies and practices support the objectives of HUSI's compensation program, which is based upon the compensation objectives established by REMCO. The Compensation Committee makes advisory recommendations to REMCO for all compensation to be paid to the HUSI Chief Executive Officer, the HSBC CEO or the Chief Executive Officer of HNAH, as appropriate, for all executives holding a title of executive vice president or above, other than executive officers in the CIBM and Private Banking businesses. Mr. Gulliver makes advisory recommendations to REMCO for all compensation to be paid to General Managers and certain other senior executives within CIBM. Mr. Meares makes advisory recommendations to REMCO for all compensation to be paid to Group General Managers and certain other senior executives within Private Banking. HUSI Human Resources executives work with HNAH Human Resources executives to prepare a comprehensive annual compensation package for the Chief Executive Officer. This package is reviewed by the Chief Executive Officer of HNAH, who approves or requests revisions to the compensation package before it is submitted to the Compensation Committee for review. HUSI Human Resources executives consult with the Chief Executive Officer of HUSI in preparing annual compensation packages for executives holding a title of executive vice president and above (other than the Chief Executive Officer). These compensation packages are also reviewed by the Chief Executive Officer of HNAH. Any revisions to a compensation package recommended by the Chief Executive Officer of HNAH are reviewed and considered by the Chief Executive Officer of HUSI prior to the package being submitted to the Compensation Committee for review. The Compensation Committee reviews the compensation packages submitted to it, and approves or requests revisions to one or more of the components of annual compensation. The compensation packages, as approved or modified by the Compensation Committee, are forwarded to HSBC Human Resources management for submission to REMCO and the HSBC CEO, as appropriate, or to the Chief Executive Officer of HNAH in late December or early January, and include advisory recommendations for salaries for the ensuing calendar year, preliminary performance-based cash awards and equity-based long-term incentive awards. As the performance-based cash awards are dependent upon satisfaction of objectives that cannot be evaluated until the end of the performance measurement year, the final determination of this component of compensation is not made until the Compensation Committee receives reports from management concerning satisfaction of corporate, business unit and individual objectives in January. REMCO or the HSBC CEO, as appropriate, will approve or revise the advisory recommendations provided by the Compensation Committee. Within the CIBM and Private Banking businesses, senior executives prepare annual compensation package recommendations for executive officers within their business units. Accordingly, the discretion and judgment of senior management play a much more significant role in establishing appropriate compensation packages to be included in advisory recommendations to REMCO or the Head of CIBM or Chief Executive Officer, Group Private Banking, as appropriate. As is the case for HUSI generally, performance-based cash awards are dependent upon performance of the individual, the local business unit and the business globally and, accordingly, cannot be determined until the end of the performance measurement year. Within CIBM, compensation recommendations for the Global Markets business are prepared by Mike J. Powell, Group Head of Global Markets, recommendations for the Global Banking business are prepared by Paul Hand, Co-Head of Global Banking, and recommendations for the Group Investment Businesses are prepared by Alain Dromer, Global Chief Executive Officer, Group Investment Businesses. These recommendations are submitted to and reviewed by the Head of CIBM. Any revisions to a compensation package recommended by the Head of CIBM are included in the package before it is submitted to REMCO for review. REMCO will approve or revise to the advisory recommendations provided by the Head of CIBM. 165 For Private Banking, compensation recommendations are prepared by Chris M. Meares, Chief Executive Officer, Group Private Banking, and submitted to and reviewed by the Director of Human Resources, CIBM/INV/GPB/Amanah and the HSBC CEO. Any revisions to a compensation package recommended by the Director of Human Resources or the HSBC CEO are included in the package before it is submitted to REMCO for review. REMCO will approve or revise the advisory recommendations provided by the Chief Executive Officer, Group Private Banking. Objectives of HUSI's Compensation Program HUSI's compensation program is designed to support the successful recruitment, development and retention of high performing executive talent and to incent those executives to achieve HUSI's short-term business objectives and to optimize its long-term financial returns. We design our compensation program to be competitive with a comparator group of benchmark financial institutions. HUSI's comparator group is comprised of U.S.-based organizations that compete with us for business, customers and executive talent. HUSI's comparator group includes Bank of America Corporation, The Bank of New York Company, Inc., JP Morgan Chase & Co., SunTrust Banks, Inc., Wachovia Corporation and Wells Fargo & Company (collectively, the "Comparator Group"). While these organizations are publicly-held companies, HUSI's operations are of comparable scale and complexity. Accordingly, HUSI's compensation program is designed to provide the flexibility to offer compensation that is competitive with the Comparator Group so that we may attract and retain the highest performing executives. The philosophy underlying HUSI's executive compensation program, which is designed to promote the compensation objectives of our parent, HSBC, is discussed below. Across businesses, individual compensation recommendations reflect HSBC's strong stance with respect to diversity and equal opportunity for all employees within the context of meritocracy and performance. Link to Company Performance We seek to offer competitive base salaries with a significant portion of variable compensation components determined by measuring performance of the executive, his or her respective business unit, HUSI and HSBC. The performance-based cash compensation plans, which are more fully described under Elements of Compensation - Annual Performance-Based Awards, emphasize revenue and expense growth, net income, receivable growth, profits and other key performance measures. Other considerations taken into account in setting compensation policies and making compensation decisions include demonstrated leadership, future potential, adherence to HSBC's ethical standards and the ability to leverage capabilities across businesses. Corporate, business unit and/or individual goals are established at the beginning of each year. Compensation plans motivate our executives to improve the overall performance and profitability of HSBC as well as the specific region, unit or function to which they are assigned. Each executive's individual performance and contribution is considered in making salary adjustments and determining the amount of annual performance bonus paid and the value of HSBC equity-based awards granted each year. HUSI has historically used grants of stock options and restricted shares to reward and provide longer term incentives for our executives. In 2005, however, HSBC adopted a new philosophy to provide only restricted shares, called "Achievement Shares," which vest on a specified date if the executive remains employed through that date, and "Performance Shares," which require continued employment and satisfaction of corporate performance conditions designed to reinforce a long-term focus on HSBC's Managing for Growth strategy and delivering value to its shareholders. Performance Shares are granted to the most senior executives whose business units have the ability to have a direct impact on HSBC's consolidated results. Achievement Share awards are granted to other high performing executives. Within CIBM and Private Banking, restricted shares are also used as a bonus deferral mechanism for executives within those businesses who receive large bonus awards, as described below. 166 Competitive Compensation Levels and Marketplace Research HUSI endeavors to maintain compensation programs that are competitive with our Comparator Group. We operate in a highly competitive business environment, in which our Comparator Group and other financial services companies continuously look to gain market share and competitive advantage by hiring top executive talent. On an annual basis, and as needed when recruiting, we compare the compensation for our executive officers to that of executives with similar responsibilities for companies of similar industry, size and complexity. In 2006, the Compensation Committee considered comparative data from general industry surveys of non-financial services companies and of financial services companies, which included members of our Comparator Group, to help establish compensation levels for our executives. The Compensation Committee also reviews the Towers Perrin data provided to REMCO. We research the types of compensation programs provided by other companies, compensation levels for executives, details of certain compensation programs, historical marketplace compensation trends, marketplace practices regarding compensation mix, stock vesting terms, equity ownership levels, the amount of compensation that is derived from equity incentives and the benefits provided to executives. We also research different aspects of performance, including the relationship between performance and compensation, a comparison of HUSI's historical performance to our Comparator Group and types of performance measures that are used by other companies for their annual and long-term incentive programs. Research data is gathered from several different sources, including general surveys of the marketplace. HUSI's compensation program generally provides executives with the opportunity to earn a base salary that is near the 50th percentile average of our Comparator Group. We believe this represents a competitive base salary for meeting general business objectives. However, total compensation, which includes incentive awards, is targeted to be in the 75th percentile if HUSI, HSBC and the executive meet established performance goals. This provides greater incentive to achieve higher performance standards and the specific goals established by the Compensation Committee each year. The level of compensation paid to an executive from year to year will differ based on performance. This year-to-year difference stems mainly from HUSI's and/or an individual business unit's performance results and, for individuals eligible for performance-based equity awards, awards may vary based upon HSBC's performance results. Compensation levels will also increase or decrease based on the executive's individual performance and level of responsibility. CIBM and Private Banking The philosophies underlying the compensation programs employed in the CIBM and Private Banking businesses are consistent with the philosophy described above for HUSI generally, but there are some specific variations in the compensation methodologies that are employed The overall approach for these businesses involves a carefully managed approach to tracking of compensation expense throughout the year in relation to business performance and planned overall expenditure on staff costs. This is combined with a year-end pay review process that takes careful account of market pay methods, levels and trends, as well as the actual levels of business and individual performance that are achieved. The year-end pay review process is itself subject to review and approval by HSBC senior management and by REMCO. The approach to regular bonus accrual is agreed with REMCO and updated at intervals to reflect changes in the competitive market. This agreement covers factors such as the proportion of pre-tax profit that may be allocated to the bonus pool for each business, taking into account aspects such as the maturity and complexity of each business and also considering any appropriate geographical variations. Annual operating plans for each business cover monthly accrual of the planned bonus amounts. Development of these accruals against the agreed parameters is reviewed at intervals during each year with the Group Finance Director. 167 At year end, the compensation levels within each business reflect individual contribution, business unit performance and the competitive pay market. In addition, compensation within CIBM and Private Banking also reflects the overall (i.e., global) results of the respective business. Base salary and incentive compensation (bonus) are sized within the context of a total compensation package that is intended to be appropriately market competitive, but these businesses apply a much less formulaic approach to the use of comparative market data than is typical in some other parts of HUSI and HSBC. Compensation proposals are based upon careful benchmarking of individual executives in the correct competitive context, making use of independently compiled studies of market pay levels, methods and trends. These studies are conducted by external advisors with in-depth knowledge of the business areas concerned and they allow careful verification against market of the compensation levels and methodologies for executives in these businesses. With this information to hand, senior management carefully considers and interprets the performance of each business, and of CIBM or Private Banking globally, relative to the performance of key competitors. Individual performance is assessed relative to performance in a market context to ensure that each executive is correctly positioned against market. Both CIBM and Private Banking target appropriate groups of competitors for each business so that the total compensation for each executive can be correctly positioned within the overall market range, ensuring a high degree of differentiation towards the very best performers. Senior management also uses market data in a similar way when designing appropriate recruitment and retention initiatives. The compensation programs within CIBM and Private Banking are designed to support the successful recruitment, development and retention of high performing executive talent and to incent those executives to maximize the performance of their respective businesses. Within the context of the total compensation package, performance-related adjustments emphasize variable pay (i.e., discretionary bonus awards) over fixed pay (i.e., base salary). As described above, bonus awards are differentiated significantly towards the very best performers and careful attention is also paid to those executives whose retention is regarded as critical to the business. For those executives receiving large bonus awards, a significant portion of the award is paid in the form of restricted shares that vest over three years provided the individual remains employed with HSBC, thus encouraging retention of the best performers. The proportion of bonus that is deferred varies to some extent between specific businesses but the typical approach is to apply a 'tax table' so that increasing proportions of a bonus will be deferred above clearly defined hurdles. The maximum proportion of bonus to be deferred within CIBM and Private Banking is normally 50 percent. The proportion of bonus to be deferred and the related vesting periods are positioned against competitive market practice using information provided by the external advisors referenced above. Elements of Compensation HUSI strives for a compensation mix that reflects our pay for performance philosophy and results-oriented culture. We attract and retain executives that are highly motivated to achieve results, and our compensation program supports that environment. HUSI's philosophy is to place a significant amount of compensation at risk to ensure that company performance objectives are met. In line with this pay for performance philosophy, on average, approximately 20 percent of executive compensation is base salary and 80 percent of compensation for top executives relates to short-term and long-term incentives where the amount paid is based upon defined performance goals. Of the 80 percent incentive compensation, on average, approximately 45 percent of such compensation relates to long-term incentives, while approximately 35 percent relates to short-term incentives. The allocation between short-term and long-term incentives is based on HUSI's need to recognize past performance (short-term incentives) in conjunction with the need to motivate and retain our talent (long-term incentives). We believe these allocations are competitive within the market and reinforce HUSI's pay-for-performance philosophy, which requires that a greater part of compensation is at risk and aligns executives' interests with those of HSBC's shareholders. 168 The primary elements of executive compensation are base salary, annual non-equity performance-based awards, and long-term equity-based incentives. In limited circumstances, discretionary bonuses may also be awarded. In addition, executives are eligible to receive company funded retirement benefits that are offered to all employees. Perquisites are not a significant component of compensation. In establishing executive compensation packages, the Compensation Committee provides advisory recommendations and, ultimately, REMCO and/or the HSBC CEO establishes remuneration under each element based on what they believe is an appropriate balance between performance-based compensation and other forms of compensation, the level of responsibility and individual contribution of the executive and competitive practice in the marketplace for executives from companies of similar industry, size, and complexity as HUSI. Within the CIBM and Private Banking businesses, the allocation of compensation between base salary and incentive compensation, as well as between long-term and short-term incentives, is recommended by senior management and reviewed and approved by REMCO and/or the HSBC CEO. As further described below, short-term incentive awards include cash awards under each business's discretionary bonus program. Long-term incentives include the deferral of a portion of discretionary bonus awards through HSBC equity-based awards. In establishing executive compensation packages, remuneration under each element is based on what is believed to be an appropriate balance between performance-based compensation and other forms of compensation, the level of responsibility and individual contribution of the executive, business unit performance and overall CIBM or Private Banking results. Base Salary Base salary is reviewed annually and increases, if any, are based on corporate and individual performance. When establishing base salaries for executives, consideration is given to compensation paid for similar positions at companies included in compensation surveys of HUSI's Comparator Group, targeting the 50th percentile, which the Compensation Committee believes, when combined with significant performance-based compensation opportunities, enables HUSI to attract and retain high performing executives. In addition, other factors such as individual and corporate performance, potential for future advancement, specific job responsibilities, length of time in current position, individual pay history, and comparison to comparable internal positions (internal equity) influences the final base salary recommendations for individual executives. Within the CIBM and Private Banking businesses, annual salary increases must be accommodated within the annual operating plan for the business globally. Accordingly, salary increases proposed by senior management are prioritized towards high performing employees and those who have demonstrated rapid development. Proposals for salary increases are justified against performance and with reference to local market rates, where available. While individual performance is assessed relative to performance in a market context to ensure that the executive is correctly positioned within the market range, the CIBM and Private Banking business generally do not apply formulaic rates in determining compensation, but rely more on the discretion and judgment of senior management in the context of performance relative to key competitors of that business. 169 Annual Performance-Based Awards Annual non-equity performance-based awards are paid in cash upon satisfaction of individual, business unit, corporate financial and operational goals. Superior performance is encouraged by placing a significant part of the executive's total compensation at risk. In the event certain quantitative or qualitative performance goals are not met, annual performance awards may be less than the maximum permitted. Performance goals are set based on prior year's performance, expectations for the upcoming year, HUSI's annual business plan, the HSBC Managing for Growth business strategy, and objectives related to building value for HSBC shareholders. The general concept is if both HUSI and the executive perform well for the year, the performance award earned should be at a high level. If either HUSI or the executive does not perform well, the award earned should be at a low level. The Management Incentive Program described below implements this approach by defining "target" and "maximum" percentages for annual non-equity performance-based awards. Target award percentages range form 20 percent to 100 percent of base salary and maximum award percentages range from 40 percent to 300 percent. The award percentage range assigned to an executive officer will be determined on the basis of his or her position and level of responsibility within HUSI. The actual amount of the award within the applicable range will be determined on the basis of the performance goals established for HUSI and the individual each year. In support of our pay-for-performance philosophy, HUSI maintains the Management Incentive Program, which is an annual cash incentive plan that uses quantitative and qualitative goals to motivate HUSI employees who have a significant role in the corporation and do not participate in another incentive compensation plan. The quantitative objectives may include meeting designated financial performance targets for the company and/or the executive's respective business unit. Qualitative objectives may include key strategic business initiatives or projects for the executive's respective business unit. Award opportunity and payouts are determined as a percentage of base salary and are based on comparison to other internal comparable positions (internal equity) and external market practices. Cash incentive awards under the Management Incentive Program are paid in February of the year following the measurement year. Ms. Derickson, Messrs. Glynn, McKenna and McDonagh and Ms. Burak participated in the Management Incentive Program in 2006. A discussion of the quantitative and qualitative objectives for each of these executives and the performance against those goals can be found below under the heading Compensation of Officers Reported in the Summary Compensation Table. Within the CIBM and Private Banking businesses, all regular employees are eligible for consideration for a discretionary bonus award. Final bonus recommendations are determined after full year results are available and are evaluated within the context of the performance of each business unit, including, where relevant, economic profit at the regional and global levels and compensation proposals for all business units within CIBM or Private Banking, as applicable. In conjunction with an assessment of the executive's individual performance, senior management may consult market surveys to assist in identifying both market pay levels and factors influencing pay (i.e., product, market, length of service, etc.). However, as is the case with other components of compensation, we rely more on the discretion and judgment of senior management in the context of performance relative to our key competitors than a mechanical application of market rates. Long-term Incentives Long-term incentive compensation is awarded through grants of HSBC equity instruments. The purpose of equity-based incentives is to help HUSI attract and retain outstanding employees and to promote the growth and success of our business over a period of time by aligning the financial interests of these employees with those of HSBC's shareholders. Historically, equity incentives were awarded through stock options and restricted share grants. 170 Prior to 2005, options on HSBC ordinary shares were granted to certain executives and restricted shares to others. Awarded options have an exercise price equal to the greater of the average market value of HSBC ordinary shares on the five business days prior to the grant of the option and the market value of HSBC ordinary shares on the grant date. The options typically vest in three, four or five equal installments, subject to continued employment, and expire ten years from the grant date. However, certain options awarded to key executives had a "total shareholder return" performance vesting condition and only vest if and when the condition is satisfied. No stock options were granted to executive officers in 2005 or 2006 in conjunction with HSBC's philosophical shift on the form of equity based compensation. Awards of restricted shares is another form of long-term incentive compensation utilized to compensate and incent our employees. When restricted shares are granted to an executive officer, the underlying shares are held in a trust for the benefit of the employee and are released only after the defined vesting conditions are met at the end of the holding period. While in such trust, dividend equivalents are paid on all underlying shares of restricted stock at the same rate paid to ordinary shareholders. The dividend equivalents are paid in the form of additional shares for awards made after 2004 and in cash paid to the executive for all prior awards. There are three types of restricted shares used by HSBC: those with a time vesting condition awarded to recognize significant contribution to HUSI ("Achievement Shares"), those with time and performance-based vesting conditions ("Performance Shares") and those with a time vesting condition for retention purposes ("Retention Awards"). Achievement Shares are awarded to key executives as part of the annual pay review process in recognition of past performance and to further motivate and retain executives. The amount granted is based on general guidelines established by REMCO, which include a percentage of base pay, position within HUSI and potential for growth. Performance Shares are awarded to key executives whose performance can have a direct impact on HSBC's consolidated results and, in 2006, within HUSI, only Mr. Glynn and Mr. McDonagh received such awards. Retention Awards have typically not been granted on an annual basis but rather have been granted on an as needed basis. No Retention Awards were granted to executive officers in 2006. As described above, Performance Shares are awarded to an executive and vesting of those shares is based on achievement of defined levels of future performance of HSBC. Performance Shares are divided into two equal parts subject to distinct performance conditions measured over a three year period. A total shareholder return award, which accounts for 50 percent of each Performance Share award, will vest in whole or in part (based on a sliding scale of 0 percent to 100 percent) depending upon how the growth in HSBC's share value, plus declared dividends, compares to the average shareholder return of a defined competitor group which for 2006 grants was comprised of 28 major banking institutions including: ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria, S.A., Banco Santander Central Hispano S.A., Bank of America Corporation, The Bank of New York Company, Inc., Barclays PLC, BNP Paribas S.A., Citigroup, Inc., Credit Agricole SA, Credit Suisse Group, Deutsche Bank AG, HBOS plc, JP Morgan Chase, Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group Inc., Mizuho Financial Group Inc., Morgan Stanley, National Australia Bank Limited, Royal Bank of Canada, The Royal Bank of Scotland Group plc, Societe Generale, Standard Chartered PLC, UBS AG, Unicredito Italiano, US Bancorp, Wachovia Corporation, Wells Fargo & Company and Westpac Banking Corporation. The earnings per share award accounts for 50 percent of each Performance Share award and is measured using a defined formula based on HSBC's earnings per share growth over the three-year period as compared to the base-year earnings per share, which is earnings per share for the year prior to the year the Performance Shares are granted. None of the earnings per share Performance Shares will vest unless a minimum earnings per share is reached at the end of three years. REMCO maintains discretion to determine that a Performance Share award will not vest unless REMCO is satisfied that HSBC's financial performance has shown sustained improvement since the date of the award. REMCO may also waive, amend or relax performance conditions if it believes the performance conditions have become unfair or impractical and believes it appropriate to do so. Due to the probability of one or both of the performance conditions not being met in part or in full, grants of Performance Shares are for a greater number of shares than Achievement Share grants. The expected value of Performance Shares is equal to 44 percent of the face value. Additional information concerning the conditions to vesting of Performance Share awards is contained in Footnote 2 to the Grants of Plan Based Awards table on page 184. 171 Within the CIBM and Private Banking businesses, a portion of each discretionary bonus award is paid in restricted shares. The minimum deferral threshold, or the portion of each bonus award paid in restricted shares, and vesting schedules may vary by business unit within the parameters set by CIBM and Private Banking, as applicable, for their businesses. Repricing of Stock Options and Timing of Option Grants For HSBC discretionary option plans, the exercise price of awards made in 2003 and 2004 was the higher of the average market value for HSBC ordinary shares on the five business days preceding the grant date or the market value on the date of the grant. HSBC also offers all employees a plan in which options to acquire HSBC ordinary shares are awarded when an employee commits to contribute up to 250 GBP (or the equivalent) each month for one, three or five years. At the end of the term, the accumulated amount, plus interest, may be used to purchase shares under the option, if the employee chooses to do so. The exercise price for such options is the average market value of HSBC ordinary shares on the five business days preceding the date of the invitation to participate, less a 15 to 20 percent discount (depending on the term). HUSI does not, and our parent, HSBC, does not, reprice stock option grants. In addition, neither HUSI nor HSBC has ever engaged in the practice known as "back-dating" of stock option grants, nor have we attempted to time the granting of historical stock options in order to gain a lower exercise price. Dilution from Equity-Based Compensation While dilution is not a primary factor in determining award amounts, there are limits to the number of shares that can be issued under HSBC equity-based compensation programs. These limits were established by vote of HSBC's shareholders in 2005. Perquisites HUSI's philosophy is to provide perquisites that are intended to help executives be more productive and efficient or to protect HUSI and its executives from certain business risks and potential threats. Our review of competitive market data indicates that the perquisites provided to executives are reasonable and within market practice. See the "Summary Compensation Table" below for further information on perquisites awarded to HUSI executives. Retirement Benefits HNAH offers a pension retirement plan in which HUSI executives may participate that provides a benefit equal to that provided to all employees of HUSI. However, both qualified and non-qualified defined benefit plans are maintained so that this level of pension benefit can be continued without regard to certain Internal Revenue Service limits. Executives and other highly compensated employees can elect to participate in a nonqualified deferred compensation plan, where such employees can elect to defer the receipt of earned compensation to a future date. We also maintain a qualified 401(k) plan with company matching contributions. Ms. Derickson and Ms Burak, as former executives of HSBC Finance Corporation, also participate in a nonqualified deferred compensation plan that provides executives and other highly compensated employees with a company matching contribution based on the level of the deferral of the employee's earned compensation to the qualified 401(k) plan to the extent that such company contributions cannot be allocated to the 401(k) plan because of certain Internal Revenue Service limits. HUSI does not pay any above-market or preferential interest in connection with deferred amounts. 172 Employment Contracts and Severance Protection Ms. Derickson entered into an employment agreement with HSBC Finance Corporation, an affiliate of HUSI, on November 14, 2002, which was amended and restated on May 17, 2005. As of December 31, 2006, Ms. Derickson's employment remained subject to the terms of that agreement, the main purpose of which was to protect HSBC Finance Corporation and its affiliates (including HUSI) from certain business risks (threats from competitors, loss of confidentiality or trade secrets, solicitation of customers and employees) and to define HSBC Finance Corporation's right to terminate the employment relationship. The employment agreement also protected Ms. Derickson from certain risks, such as a change in control, death or disability. The terms of Ms. Derickson's employment agreement are summarized in the description of her compensation under the heading Compensation of Officers Reported in the Summary Compensation Table. In connection with his employment March 2006, HBUS extended an offer letter to Mr. Young dated February 17, 2006. The primary purpose of the offer letter was to define Mr. Young's terms of employment, compensation and the rights of the parties in the event of Mr. Young's resignation or termination. The terms of Mr. Young's offer letter are summarized in the description of his compensation under the heading Compensation of Officers Reported in the Summary Compensation Table. In connection with his retirement on December 31, 2006, Mr. Glynn entered into an agreement with HNAH dated June 30, 2006. The primary purpose of the agreement was to define the rights of the parties prior to and upon Mr. Glynn's retirement. The terms of Mr. Glynn's agreement are summarized in the description of his compensation under the heading Compensation of Officers Reported in the Summary Compensation Table. Prior to his retirement on August 5, 2006, Mr. Petri entered into a separation agreement with HBUS dated August 1, 2006. The primary purpose of the agreement was to define the rights of the parties prior to and upon Mr. Petri's retirement. The terms of Mr. Petri's agreement are summarized in the descriptions of his compensation under the heading Compensation of Officers Reported in the Summary Compensation Table. Accounting Considerations We adopted the fair value method of accounting under Statement of Financial Accounting Standards No. 123 (revised 2004), "Share Based Payment" (SFAS 123(R)) effective January 1, 2006. SFAS 123(R) applies to all equity instruments granted to employees beginning January 1, 2006 and does not apply to awards granted in prior periods before the effective date, except to the extent that prior periods' awards are modified, repurchased or cancelled after the required effective date. Prior to 2006, we adopted the fair value method of accounting prospectively in 2002 for all new equity instruments granted to employees as provided under Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure (an amendment of FASB Statement No. 123)." The Board of Directors believes that this treatment reflects greater accuracy and transparency of the cost of these incentives and promotes better corporate governance. Tax Considerations Limitations on the deductibility of compensation paid to executive officers under Section 162(m) of the Internal Revenue Code is not applicable to HUSI, as it is not a public corporation as defined by Section 162(m). As such, all compensation to our executive officers is deductible for federal income tax purposes, unless there are excess golden parachute payments under Section 4999 of the Internal Revenue Code following a change in control. Compensation of Officers Reported in the Summary Compensation Table Below is a summary of the factors that affected the compensation earned in 2006 by the executive officers listed in the Summary Compensation Table. In recommending compensation for each of our executives, management and the Compensation Committee evaluated competitive levels of compensation for executives managing operations or functions of similar size and complexity and the importance of retaining executives with the strategic, leadership and financial skills to ensure HUSI's continued growth and success and their potential for assumption of additional responsibilities. 173 Chief Executive Officer Compensation - Ms. Derickson Sandra L. Derickson was appointed President and Chief Executive Officer - Designate of HUSI as of September 1, 2006 and succeeded Mr. Glynn as President and Chief Executive Officer as of January 1, 2007. She resigned as President and Chief Executive Officer on February 20, 2007. Until that time, Ms. Derickson participated in the same programs and generally received compensation based on the same factors as HUSI's other executive officers. However, Ms. Derickson's overall compensation level reflected her greater degree of policy and decision-making authority, her higher level of responsibility with respect to the strategic direction of HUSI, and her ultimate responsibility for HUSI's financial and operational results. In connection with her appointment as of September 1, 2006, the Compensation Committee set Ms. Derickson's base salary at an annualized level of $700,000 for 2006. In establishing Ms. Derickson's initial base salary, the Compensation Committee sought to align Ms. Derickson's compensation level with that of her predecessor, Mr. Glynn, which placed Ms. Derickson's compensation level at the 50th percentile among similarly-placed executives within the Comparator Group. As Ms. Derickson's initial base salary with HUSI did not represent an increase over her base salary for HSBC Finance Corporation, no further approvals were sought or obtained. Because she served as President & Chief Executive Officer - Designate for only a portion of the year, Ms. Derickson did not receive an equity-based award with respect to her service to HUSI in 2006. In January 2006, REMCO met and considered the proposed equity-based awards for all HSBC executives and awarded Ms. Derickson Performance Shares with a grant date value of $2,500,003 with respect to Ms. Derickson's services as an executive officer of HSBC Finance Corporation. In making the award, REMCO considered internal equity of compensation paid to management peers within HSBC and its subsidiaries and external benchmarking, as described above. Under the Management Incentive Program, Ms. Derickson's 2006 target annual incentive bonus opportunity was 100 percent of her base salary at December 31, 2006 and her maximum opportunity was 300 percent. In addition, pursuant to her employment agreement, described below, Ms. Derickson was entitled to a bonus guaranteed to be not less than $1,275,000. However, due to the disappointing results in the HSBC Finance Corporation Mortgage Services business, Ms. Derickson voluntarily waived her right to a guaranteed bonus under her employment agreement. Other compensation paid to Ms. Derickson in 2006, including perquisites, such as life insurance premiums and social club membership fees, was consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. Ms. Derickson had an employment agreement with HSBC Finance Corporation, which was to expire on March 28, 2008. Pursuant to her agreement, Ms. Derickson served as President and Chief Executive Officer of HUSI. The terms of that agreement are summarized below. As stated above, Ms. Derickson resigned as of February 20, 2007. The terms of the severance arrangements agreed with Ms. Derickson will be described in HUSI's Annual Report on Form 10-K for the year ending December 31, 2007. During the term of the employment agreement, Ms. Derickson was entitled to receive an annual base salary (which as of January 1, 2006 was increased to $700,000), and an annual bonus of at least $1,275,000 (75 percent of the annual average of her bonus earned in 2003, 2004 and 2005). During the term of the agreement, Ms. Derickson was be eligible to participate in any equity-based incentive compensation plan or program of HSBC as in effect from time to time for similarly situated senior executives of HSBC Finance Corporation, as approved by REMCO. In addition, during the term of the agreement, Ms. Derickson was eligible to participate in the various retirement, medical, disability and life insurance plans, programs and arrangements in accordance with the terms of HSBC Finance Corporation's benefit plans. 174 Under the terms of the employment agreement, if Ms. Derickson's employment was terminated during the term of the agreement other than for "cause" or disability, or she resigned for "good reason," subject to her execution of a general release in favor of HSBC Finance Corporation and its affiliates, Ms. Derickson was to continue to receive her base salary and annual bonus described above as if she had remained employed until March 28, 2008. In addition, to the extent permitted under the terms of the applicable plans, Ms. Derickson's welfare benefits, umbrella liability insurance and automobile and financial counseling allowances would continue until March 28, 2008, unless she became eligible to participate in similar plans of another employer prior to that date. In 2003 and 2005, Ms. Derickson was awarded Retention Awards of HSBC restricted shares with values of $3.75 and $6 million, respectively, in each case based on the closing price of HSBC ordinary shares as of the date of the grant. The 2003 award was to vest in five equal installments on March 28 of each year through 2008. The 2005 was to vest in five equal installments on March 26 of each year through 2010. Each award was to vest in full upon termination of Ms. Derickson's employment other than for cause or, with respect to the 2003 award, by Ms. Derickson due to a material breach by HUSI of Ms. Derickson's employment agreement, or with respect to the 2005 award, by Ms. Derickson for good reason. Chief Executive Officer Compensation - Mr. Glynn Martin J.G. Glynn retired as President and Chief Executive Officer as of December 31, 2006. Prior to his retirement, Mr. Glynn participated in the same programs and generally received compensation based on the same factors as the other executive officers. However, Mr. Glynn's overall compensation level reflected his greater degree of policy and decision-making authority, his higher level of responsibility with respect to the strategic direction of HUSI, and his ultimate responsibility for HUSI's financial and operational results. For 2006, Mr. Glynn's compensation was comprised of base salary, non-equity incentive compensation (bonus), an additional cash payment in lieu of stock awards, an additional cash payment triggered by his retirement and perquisites. In 2006, Mr. Glynn's base salary remained at $700,000, the same as for 2005. For 2006, the Compensation Committee reviewed competitive compensation levels and found Mr. Glynn's then current cash compensation level was in line with the 50th percentile among similarly-placed executives in our Comparator Group. In keeping with the goal of maintaining executive base salaries in the 50th percentile, it did not make an advisory recommendation to increase his salary. In January 2006, REMCO approved the Compensation Committee's advisory recommendation that Mr. Glynn receive a Performance Share award with a grant date value of $1,400,000. The award is subject to three-year performance vesting conditions. The vesting criteria of the Performance Shares are set out in Footnote 2 to the Grants of Plan-Based Awards Table on page 184. The grant reflected the view of the Compensation Committee and REMCO of the value of Mr. Glynn's contribution to and leadership of HUSI and HSBC's desire to incent outstanding performance. Mr. Glynn's cash incentive under the Management Incentive Program is determined based upon satisfaction of quantitative and qualitative objectives that provide for a target cash award equal to 100 percent of his base salary, up to a maximum of 300 percent of base salary. Mr. Glynn's cash incentive compensation required satisfaction of objectives that included business goals related to HUSI's profit before tax and initiates promoting diversity in employment, managing reputational risk and improving HUSI's compliance environment. Management assessed Mr. Glynn's and HUSI's performance against the objectives and found that there was complete or substantial satisfaction of each objective. Mr. Glynn was awarded cash incentive compensation of $1,600,000, or approximately 230 percent of his base salary, which was paid to him in February 2007. This amount was consistent with the guaranteed cash incentive award provided for in Mr. Glynn's agreement, as described below. Other compensation paid to Mr. Glynn including perquisites, such as rent allowance, car allowance and related tax gross-ups, is consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. 175 In connection with his retirement, Mr. Glynn entered into an agreement with HNAH on June 30, 2006. Pursuant to the terms of this agreement, Mr. Glynn received his regular base salary and benefits through his retirement on December 31, 2006. Mr. Glynn also received a full incentive bonus of $1,600,000 for 2006, which was paid in February 2007. He is also entitled to an additional cash payment of $616,000 in lieu of any equity-based award for 2006 and continued vesting of his outstanding equity-based awards as reflected in the Outstanding Equity Awards at Fiscal Year-End Table. Finally, Mr. Glynn received a lump sum payment of $6,600,000 for general employment benefits that would otherwise have accrued had he retired two years after December 31, 2006. Chief Financial Officer Compensation The Senior Executive Vice President & Chief Financial Officer of HUSI, John J. McKenna, participates in general benefits available to executives of HUSI and the Management Incentive Program. His cash compensation for 2006 was determined by Mr. Mehta, the HNAH Chief Executive Officer, upon recommendation of the Compensation Committee in consultation with HUSI Human Resources executives and the Chief Financial Officer of HNAH. As with all HUSI executives, REMCO has authority over Mr. McKenna's Achievement Share awards. For 2006, Mr. McKenna's compensation was comprised of base salary, non-equity incentive compensation (bonus), stock awards and perquisites. Mr. McKenna's base salary increased by $25,050 in February 2006, bringing his base salary to $325,050. In recommending Mr. McKenna's base salary, the Compensation Committee and HUSI senior executives reviewed competitive compensation levels and found Mr. McKenna's current compensation level was only slightly below the 50th percentile among similarly-placed executives at HUSI's Comparator Group. The recommendation also reflected the company's view of Mr. McKenna's performance in 2005. The HNAH Chief Executive Officer agreed with the recommendation and approved the increase in Mr. McKenna's base salary. In March 2006, Mr. McKenna was granted Achievement Shares with a grant date value of $400,000, which vest in three years and have no performance conditions. This reflected management's recognition of the value of Mr. McKenna's contribution to and leadership of HUSI and HSBC's desire to retain Mr. McKenna and to incent outstanding performance. Mr. McKenna's cash incentive under the Management Incentive Program is determined based upon satisfaction of quantitative and qualitative objectives that provide for a target cash award equal to 75 percent of his base salary, up to a maximum of 150 percent of base salary. Mr. McKenna's cash incentive compensation required satisfaction of the quantitative and qualitative objectives described above for Mr. Glynn. Management assessed Mr. McKenna's and HUSI's performance against the objectives and found that there was complete or substantial satisfaction of each objective. Mr. McKenna was awarded cash incentive compensation of $381,934, or approximately 119 percent of his base salary, which was paid to him in February 2007. Other compensation paid to Mr. McKenna, including perquisites such as life insurance premiums, is consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. Joseph A. Belfatto Compensation The Senior Executive Vice President and Head of Global Markets Americas, Joseph A. Belfatto, participates in general benefits available to executives of HUSI and the CIBM business. For 2006, Mr. Belfatto's compensation was comprised primarily of base salary, non-equity incentive compensation (discretionary bonus award) and stock awards. Mr. Belfatto's total compensation increased by $20,000 in 2006, bringing his total compensation to $3,750,000. In recommending Mr. Belfatto's compensation package to the Group Head of CIBM, CIBM senior management considered the performance of the CIBM business locally and globally and its judgment of competitive compensation levels within the relevant markets. The recommendation also reflected CIBM senior management's view of Mr. Belfatto's contribution to the business's performance in 2005 and the desire to retain Mr. Belfatto within the CIBM business. The Head of CIBM agreed with senior management's recommendation and approved the increase in Mr. Belfatto's total compensation package. 176 As described above, the allocation of compensation between base salary and incentive compensation within CIBM, as well as between long-term and short-term incentives, is recommended by senior management in its discretion and reviewed and approved by REMCO and/or the HSBC CEO. For 2006, Mr. Belfatto's compensation package consisted of $250,000, or approximately seven percent of his total compensation, in base salary and $3,500,000, or approximately 93 percent, as a discretionary bonus award. Of the discretionary bonus award, Mr. Belfatto received $1,960,000 in cash and the balance will be deferred through a grant of restricted shares in March 2007 with a grant date value of $1,540,000. One-third of the shares vest on each of the first three anniversaries of the grant and have no performance conditions. Other compensation paid to Mr. Belfatto, including perquisites, is consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. Marlon Young Compensation The Managing Director, Chief Executive Officer, Private Bank Americas, Marlon Young, participates in general benefits available to executives of HUSI and the Private Banking business. For 2006, Mr. Young's compensation was comprised primarily of base salary, non-equity incentive compensation (discretionary bonus award) and stock awards. Mr. Young was appointed Managing Director, Chief Executive Officer, Private Bank Americas, in March 2006. His total compensation for 2006 was $1,875,000, which included a $75,000 increase to his base salary in September 2006. In recommending Mr. Young's compensation package, Group Private Banking senior management considered the performance of the Private Banking business locally and globally and the competitive compensation levels within the relevant markets. The recommendation also reflected management's view of Mr. Young's potential contribution to the business's performance and HSBC's desire to retain Mr. Young within Private Banking. The Chief Executive Officer, Group Private Banking agreed with senior management's assessment and approved Mr. Young's compensation package. As described above, the allocation of compensation between base salary and incentive compensation within Private Banking, as well as between long-term and short-term incentives, is recommended by senior management in its discretion and reviewed and approved by REMCO. For 2006, Mr. Young's compensation package consisted of $375,000, or 20 percent of his total compensation, in base salary and $1,500,000, or 80 percent, as a discretionary bonus award. Of the discretionary bonus award, Mr. Young received $750,000 in cash and the balance will be deferred through a grant of restricted shares in March 2007 with a grant date value of $750,000. One-third of the shares vest on each of the first three anniversaries of the grant and have no performance conditions. These amounts were consistent with the guaranteed cash incentive award provided for in Mr. Young's offer letter, as described below. Other compensation paid to Mr. Young, including perquisites, is consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. In connection with his employment by HUSI in March 2006, HBUS extended an offer letter to Mr. Young defining the terms of his employment. Pursuant to the offer letter, Mr. Young is entitled to an annual salary of $300,000 and a guaranteed bonus of $1,000,000 for each of the 2006 and 2007 performance years, 50 percent of which is to be deferred through a grant of restricted shares. The offer letter also provided for additional annual bonuses to be awarded in the sole discretion of the company, subject to deferral pursuant to the Private Banking discretionary bonus program. The offer letter also defined the rights of the parties upon Mr. Young's resignation or termination, which are described under below under Potential Payments upon Termination or Change-in-Control. Janet L. Burak Compensation The Senior Executive Vice President, General Counsel and Secretary of HUSI, Janet L. Burak, participates in general benefits available to executives of HUSI and the Management Incentive Program. Her cash compensation for 2006 was determined by Mr. Mehta, the HNAH Chief Executive Officer, upon recommendation of the Compensation Committee in consultation with HUSI Human Resources executives. As with all HUSI executives, REMCO has authority over Ms. Burak's Achievement Share awards. For 2006, Ms. Burak's compensation was comprised of base salary, non-equity incentive compensation (bonus), stock awards and perquisites. 177 Ms. Burak's base salary increased by $32,708 in February 2006, bringing her base salary to $400,208. In recommending Ms. Burak's base salary, the Compensation Committee and HUSI senior executives reviewed competitive compensation levels and found Ms. Burak's current compensation level was in line with the 50th percentile among similarly-placed executives at HUSI's Comparator Group. The recommendation also reflected the company's view of Ms. Burak's performance in 2005. The HNAH Chief Executive Officer agreed with the recommendation and approved the increase in Ms. Burak's base salary. In March 2006, Ms. Burak was granted Achievement Shares with a grant date value of $500,000, which vest in three years and have no performance conditions. This reflected management's recognition of the value of Ms. Burak's expected long-term contribution to and leadership of HUSI and HNAH, and HSBC's desire to retain Ms. Burak and to incent outstanding performance. Ms. Burak's cash incentive under the Management Incentive Program is determined based upon satisfaction of quantitative and qualitative objectives that provide for a target cash award equal to 100 percent of her base salary, up to a maximum of 200 percent of base salary. Ms. Burak's cash incentive compensation required satisfaction of the quantitative and qualitative objectives described above for Mr. Glynn. Management assessed Ms. Burak's and HUSI's performance against the objectives and found that there was complete or substantial satisfaction of each objective. Ms. Burak was awarded cash incentive compensation of $735,383, or approximately 186 percent of her base salary, which was paid to her in February 2007. Other compensation paid to Ms. Burak including perquisites, such as life insurance premiums, is consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. Brendan McDonagh Compensation Mr. McDonagh served as Chief Operating Officer of HUSI until December 1, 2006. For that portion of 2006, Mr. McDonagh participated in general benefits available to executives of HUSI and the Management Incentive Program and certain additional benefits available to HSBC's international staff executives. As an HSBC Group General Manager, Mr. McDonagh's cash compensation for 2006 was determined by REMCO upon advisory recommendation of the Compensation Committee in consultation with HSBC Human Resources executives. As with all HUSI executives, REMCO has authority over Mr. McDonagh's equity-based awards. For 2006, Mr. McDonagh's compensation was comprised of base salary, non-equity incentive compensation (bonus), stock awards and perquisites. Mr. McDonagh's base salary for 2006 was $676,553. In recommending Mr. McDonagh's base salary to the Compensation Committee, HUSI and HNAH senior executives reviewed competitive compensation levels and found Mr. McDonagh's current compensation level was below the 50th percentile among similarly-placed executives at HUSI's Comparator Group. The recommendation also reflected the company's view of Mr. McDonagh's performance in 2005. The Compensation Committee agreed with management's recommendation and made an advisory recommendation to REMCO. REMCO concurred with the Compensation Committee's assessment and, as a result, Mr. McDonagh's base salary was increased. In January 2006, REMCO approved the Compensation Committee's advisory recommendation that Mr. McDonagh receive a Performance Share award with a grant date value of $635,000. The award is subject to three-year performance vesting conditions. The vesting criteria of the Performance Shares are set out in Footnote 2 to the Grants of Plan-Based Awards Table on page 184. The grant reflects REMCO's view of the value of Mr. McDonagh's long-term contribution to and leadership of HSBC, including HUSI and HNAH, and HSBC's desire to retain Mr. McDonagh and to incent exceptional performance. 178 Under the Management Incentive Program, Mr. McDonagh's 2006 target annual incentive bonus opportunity was 100 percent of his base salary at December 31, 2006 and his maximum opportunity was 200 percent. Mr. McDonagh's cash incentive compensation was determined upon satisfaction of the quantitative and qualitative objectives described above for Mr. Glynn. Management assessed Mr. McDonagh's and HUSI's performance against the objectives and recommended a cash incentive compensation award equal to $720,000, or approximately 106 percent of his base salary, which was paid in February 2007. The Compensation Committee agreed with management's assessment and made an advisory recommendation to REMCO that Mr. McDonagh receive this amount. REMCO concurred with the assessment and advisory recommendation of the Compensation Committee and approved the cash incentive compensation. Mr. McDonagh received other compensation in 2006, including perquisites relating to housing, education, travel and tax equalization, that was significant when compared to other compensation received by other executive officers within HUSI. These amounts are consistent, however, with perquisites paid to similarly-placed HSBC international staff executives, who are subject to appointment to HSBC locations globally as deemed appropriate by HSBC senior management. The additional perquisites and benefits available to HSBC international staff executives, as described below in the Summary Compensation Table, are intended to compensate executives for the significant cost and expense incurred in connection with global postings. Joseph M. Petri Compensation Mr. Petri served as Senior Executive Vice President, Treasurer and Co-Head, CIBM Americas until August 5, 2006. For that portion of 2006, Mr. Petri participated in general benefits available to executives of HUSI and the CIBM business. For 2006, Mr. Petri's compensation was comprised primarily of base salary, non-equity incentive compensation (discretionary bonus award) and a cash payment triggered by his retirement. In 2006, Mr. Petri's total compensation remained at $7,825,000, the same as for 2005. In recommending Mr. Petri's compensation package to the Group Head of CIBM, CIBM senior management considered the performance of the CIBM business locally and globally and its judgment of competitive compensation levels within the relevant markets. The recommendation also reflected CIBM senior management's view of Mr. Petri's contribution to the business's performance in 2005 and the desire to retain Mr. Petri within the CIBM business. The Head of CIBM agreed with senior management's recommendation and made an advisory recommendation to REMCO to approve his compensation. REMCO concurred with the assessment and recommendation of CIBM management and approved Mr. Petri's total compensation package. Mr. Petri entered into a separation agreement with HBUS on August 1, 2006. Pursuant to the terms of his separation agreement, Mr. Petri received his regular base salary and benefits through his retirement on August 4, 2006. Mr. Petri received a lump sum payment of $146,339 as payment of the base salary that would have accrued for continued employment through December 31, 2006. He also received a lump sum payment of $3,960,000 in February 2007 in payment of the portion Mr. Petri's minimum guaranteed bonus for 2006 not subject to deferral, and is entitled to receive the balance of his guaranteed bonus amount for 2006 through a grant of restricted shares with a grant date value of $3,540,000. In connection with Mr. Petri's retirement, REMCO also approved the continued vesting of all outstanding restricted shares that have not yet vested, subject to any existing performance conditions. Other compensation paid to Mr. Petri, including perquisites, is consistent with perquisites paid to similarly-placed executive officers within and outside of HSBC. 179 Compensation Committee Interlocks and Insider Participation The primary purpose of the Compensation Committee is to assist the Board of Directors in discharging its responsibilities related to the compensation of the Chief Executive Officer, other officers of HUSI holding a title of executive vice president and above and such other officers as may be designated by the Board of Directors. The Compensation Committee is comprised of the following directors: Dr. Frances D. Fergusson (Chair), Donald K. Boswell and James L. Morice. During 2006, with the exception of Mr. Glynn, the Compensation Committee was comprised of independent directors, as defined under HUSI's Corporate Governance Standards. HUSI's present intention is to maintain a Compensation Committee that consists entirely of independent directors. Additional information with regard to the Compensation Committee, including a description of the committee's responsibilities under its charter, is contained in the section of this Form 10-K entitled Item 10. Directors, Executive Officers and Corporate Governance - Board of Directors - Committees and Charters. Compensation Committee Report We, the Human Resources & Compensation Committee of the Board of Directors of HSBC USA Inc., have reviewed and discussed the Compensation Discussion and Analysis ("2006 CD&A") set forth above with management and, based on such review and discussion, have recommended to the Board of Directors that the 2006 CD&A be included in this Annual Report on Form 10-K. Human Resources & Compensation Committee Dr. Frances D. Fergusson (Chair) Donald K. Boswell James L. Morice 180 This information is provided by RNS The company news service from the London Stock Exchange More to Follow FR BGGDXDUGGGRU

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