HSBC USA Inc. 10-Q-Pt.2

HSBC Holdings PLC 30 July 2007 PART 2 Residential Mortgage Loans Held for Sale to an HSBC Affiliate In 2005, HUSI began acquiring residential mortgage loans from unaffiliated third parties with the intent of selling these loans to an HSBC affiliate, HSBC Markets (USA) Inc. (HMUS). HMUS in turn is selling these loans to securitization vehicles. During 2006, HUSI also began acquiring residential mortgage loans from HSBC Finance Corporation under this program. These loans, which primarily include sub-prime residential mortgage loans, are recorded by HUSI at the lower of their aggregate cost or market value, with adjustments to market value being recorded as a valuation allowance. The loans are generally held on HUSI's balance sheet for 30-90 days, resulting in activity that affects various consolidated financial statement line items, as summarized in the table below. HUSI maintains a portfolio of derivatives and securities, which are used as economic hedges to offset changes in market values of the loans held for sale to HMUS. Gains on sales associated with these loans result from incremental value realized on pools of loans sold to HMUS for securitization. Activity recorded as a result of acquiring, holding and selling these loans is summarized in the following tables. Lower results and activity for this program for the second quarter and the first six months of 2007 primarily resulted from the overall weakness in the U.S. residential mortgage market. ----------------------------------------------------------------------------------------------------------- Three months ended June 30 2007 2006 ----------------------------------------------------------------------------------------------------------- (in millions) Residential mortgage loans held for sale to HMUS: Balance at beginning of period ..................................................... $ 3,745 $ 4,497 Loans acquired from originators .................................................... 1,564 4,784 Loans sold to HMUS ................................................................. (2,096) (4,413) Other, primarily loans resold to originators and other third parties ............... (154) (61) ------- ------- Balance at end of period ........................................................... $ 3,059 $ 4,807 ======= ======= Valuation allowance for changes in market value of loans held for sale to HMUS: Balance at beginning of period ..................................................... $ (24) $ (50) Valuation allowance increase for changes in market value ........................... (65) (73) Releases of valuation allowance for loans sold to HMUS ............................. 40 40 ------- ------- Balance at end of period ........................................................... $ (49) $ (83) ======= ======= Impact on income before income taxes: Net interest income associated with loans held for sale to HMUS (1) ................ $ 15 $ 18 Gains on sale of residential mortgage loans sold to HMUS, recorded in HSBC affiliate income ................................................................ 7 52 Valuation allowance increase for changes in market value of loans held for sale to HMUS, recorded in other income .................................................. (65) (73) Trading revenues recognized from economic hedges held to offset changes in market values of loans held for sale to HMUS (1) ....................................... 40 52 Net program costs included in other expenses ....................................... (4) (2) ------- ------- Net impact on income before income taxes ........................................... $ (7) $ 47 ======= ======= (1) Refer to trading revenues commentary beginning on page 43 of this Form 10-Q. 39 ----------------------------------------------------------------------------------------------------------- Six months ended June 30 2007 2006 ----------------------------------------------------------------------------------------------------------- (in millions) Residential mortgage loans held for sale to HMUS: Balance at beginning of period ..................................................... $ 3,116 $ 2,907 Loans acquired from originators .................................................... 5,029 10,130 Loans sold to HMUS ................................................................. (4,688) (8,156) Other, primarily loans resold to originators and other third parties ............... (398) (74) ------- ------- Balance at end of period ........................................................... $ 3,059 $ 4,807 ======= ======= Valuation allowance for changes in market value of loans held for sale to HMUS: Balance at beginning of period ..................................................... $ (26) $ (11) Valuation allowance increase for changes in market value ........................... (75) (152) Releases of valuation allowance for loans sold to HMUS ............................. 52 80 ------- ------- Balance at end of period ........................................................... $ (49) $ (83) ======= ======= Impact on income before income taxes: Net interest income associated with loans held for sale to HMUS (1) ................ $ 32 $ 38 Gains on sale of residential mortgage loans sold to HMUS, recorded in HSBC affiliate income ................................................................ 8 64 Valuation allowance increase for changes in market value of loans held for sale to HMUS, recorded in other income .................................................. (75) (152) Trading revenues recognized from economic hedges held to offset changes in market values of loans held for sale to HMUS (1) ....................................... 25 116 Net program costs included in other expenses ....................................... (12) (3) ------- ------- Net impact on income before income taxes ........................................... $ (22) $ 63 ======= ======= (1) Refer to trading revenues commentary beginning on page 43 of this Form 10-Q. Credit Card Fees Higher credit card fees in 2007 from private label and co-brand credit card portfolio activity included within the CF business segment were primarily due to the following factors. o Credit card receivables included in off-balance sheet securitization transactions for the first six months of 2006 were included in on-balance sheet credit card receivables for the first six months of 2007. Late fees associated with these receivables, which were recorded in securitization revenue in 2006 (refer to other income commentary below), are recorded in credit card fees for 2007. o The number of accounts, volume of customer transaction activity and average receivable balances included within the private label portfolio all were higher for 2007, due to the addition of merchant and customer relationships and to expansion of credit card products offered. Product repricing also resulted in higher fees. o Higher late fees due to increased delinquencies within the private label portfolio. HSBC Affiliate Income Higher fees and commissions from HSBC affiliates was primarily due to increased customer referral and other fees from HMUS and HSBC associated with current expansion of the payments and cash management business and previous expansion of various trading businesses. Fees from HSBC Finance Corporation for loan servicing have also increased in 2007. Other Income HUSI recorded no securitization revenue in the first six months of 2007. In the third quarter of 2006, the last remaining securitization trust agreement related to the private label credit card receivable portfolio was amended. As a result, the trust no longer qualified for sale treatment and all assets and liabilities of the trust were returned to HUSI's consolidated balance sheet. In addition, all new collateralized funding transactions have been structured as secured financings since the third quarter of 2004. The loss of securitization revenue for 2007 was offset by higher net interest income and higher fee revenue (refer to previous credit card fees commentary) from the receivables and liabilities that were returned to the consolidated balance sheet. 40 The PB business segment includes an equity investment in a non-consolidated foreign HSBC affiliate (the foreign equity investment). During the third quarter of 2006, the foreign equity investment sold a portion of its investment in a foreign equity fund to another HSBC affiliate. During the second quarter of 2007, the foreign equity investment sold its remaining investment in the foreign equity fund, resulting in a gain from which HUSI recorded additional equity earnings of $7 million. Excluding the impact of this transaction, the decrease in equity investment holdings resulted in lower equity earnings for the first six months of 2007. In the second quarter of 2006, MasterCard International, Inc. completed an initial public offering, which resulted in redemption of shares held by HUSI and by other financial institutions. Proceeds from this redemption were recorded as miscellaneous income for 2006. Residential Mortgage Banking Revenue The following tables present the components of residential mortgage banking revenue. Net interest income includes interest earned/paid on assets and liabilities of the residential mortgage banking business, as well as the funding cost or benefit associated with these balances. The net interest income component in the table is included in net interest income in the consolidated statement of income and reflects actual interest earned, net of cost of funds, and adjusted for corporate transfer pricing. ------------------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- Three months ended June 30 2007 2006 Amount % ------------------------------------------------------------------------------------------------------- ($ in millions) Net interest income ...................................... $ 67 $ 87 $(20) (23) ---- ---- ---- --- Servicing related income: Servicing fee income .................................. 29 24 5 21 Changes in fair value of MSRs due to (1): Changes in valuation inputs or assumptions used in valuation model ............... 57 30 27 90 Realization of cash flows ........................... (22) (18) (4) (22) Trading - Derivative instruments used to offset changes in value of MSRs ........................... (51) (23) (28) (122) ---- ---- ---- --- 13 13 -- -- ---- ---- ---- --- Originations and sales related income: Gains on sales of residential mortgages ............... 22 8 14 175 Trading and fair value hedge activity ................. -- -- -- -- ---- ---- ---- --- 22 8 14 175 ---- ---- ---- --- Other mortgage income .................................... 7 6 1 17 ---- ---- ---- --- Total residential mortgage banking revenue included in other revenues ....................................... 42 27 15 56 ---- ---- ---- --- Total residential mortgage banking related revenue ....... $109 $114 $ (5) (4) ==== ==== ==== === ------------------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- Six months ended June 30 2007 2006 Amount % ------------------------------------------------------------------------------------------------------- ($ in millions) Net interest income ...................................... $139 $182 $(43) (24) ---- ---- ---- --- Servicing related income: Servicing fee income .................................. 56 48 8 17 Changes in fair value of MSRs due to (1): Changes in valuation inputs or assumptions used in valuation model ............... 64 75 (11) (15) Realization of cash flows ........................... (46) (39) (7) (18) Trading - Derivative instruments used to offset changes in value of MSRs ........................... (54) (57) 3 5 ---- ---- ---- --- 20 27 (7) (26) ---- ---- ---- --- Originations and sales related income: Gains on sales of residential mortgages ............... 29 11 18 164 Trading and fair value hedge activity ................. -- 1 (1) * ---- ---- ---- --- 29 12 17 142 ---- ---- ---- --- Other mortgage income .................................... 14 11 3 27 ---- ---- ---- --- Total residential mortgage banking revenue included in other revenues ....................................... 63 50 13 26 ---- ---- ---- --- Total residential mortgage banking related revenue ....... $202 $232 $(30) (13) ==== ==== ==== === * Not meaningful. 41 Net Interest Income Decreased net interest income for the second quarter and first six months of 2007 resulted from lower average residential mortgage loans outstanding as well as a slight narrowing of interest rate spreads. During 2007, HUSI continued to sell the majority of new loan originations to government sponsored enterprises and private investors and to allow existing loans to runoff. The held loans portfolio is expected to continue to decline for the remainder of 2007 as a result of this initiative. Servicing Related Income Higher servicing fee income for the second quarter and first six months of 2007 resulted from a higher volume of loans included within the average serviced loans portfolio. The average serviced portfolio increased approximately 13% in the second quarter and first six months of 2007 due to the following factors: o HUSI sold a larger volume of loans in the second quarter and first six months of 2007 as compared to the same timeframes in 2006; and o in the first six months of 2007, HUSI commenced servicing a portfolio of loans previously serviced by a third party. The increased serviced loans portfolio, and its positive impact on service fee income, was partially offset by a decrease in value of the hedged MSRs portfolio including an increase in realization of cash flows on the growing portfolio of loans serviced for others for the second quarter and the first six months of 2007. Originations and Sales Related Income Higher originations and sales related income for the second quarter and first six months of 2007 resulted from: o higher basis point gains on individual sales of residential mortgages; and o increased volume of residential mortgages originated with the intention to sell, which increased 4% for the first six months of 2007. 42 Trading Revenues Trading revenues are generated by HUSI's participation in the foreign exchange, credit derivative and precious metal markets; from trading derivative contracts, including interest rate swaps and options; from trading securities; and as a result of certain residential mortgage banking activities. The following table summarizes trading related revenues by business. The data in the table includes net interest income earned on trading instruments, as well as an allocation of the funding benefit or cost associated with the trading positions. The trading related net interest income component is included in net interest income on the consolidated income statement. Trading revenues related to the mortgage banking business are included in residential mortgage banking revenue. ------------------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount % ------------------------------------------------------------------------------------------------------- ($ in millions) Three months ended June 30: Trading revenues ......................................... $312 $269 $ 43 16 Net interest expense ..................................... (5) (17) 12 71 ---- ---- ---- ---- Trading related revenues ................................. $307 $252 $ 55 22 ==== ==== ==== ==== Business: Derivatives instruments ............................... $181 $ 83 $ 98 118 Economic hedges of loans held for sale to HMUS ........ 55 70 (15) (21) Treasury (primarily securities) ....................... 6 4 2 50 Foreign exchange and banknotes ........................ 59 52 7 13 Precious metals ....................................... 8 36 (28) (78) Other trading ......................................... (2) 7 (9) (123) ---- ---- ---- ---- Trading related revenues ................................. $307 $252 $ 55 22 ==== ==== ==== ==== Six months ended June 30: Trading revenues ......................................... $449 $548 $(99) (18) Net interest expense ..................................... (29) (31) 2 6 ---- ---- ---- ---- Trading related revenues ................................. $420 $517 $(97) (19) ==== ==== ==== ==== Business: Derivatives instruments ............................... $233 $173 $ 60 35 Economic hedges of loans held for sale to HMUS ........ 57 154 (97) (63) Treasury (primarily securities) ....................... (6) 9 (15) 167 Foreign exchange and banknotes ........................ 114 95 19 20 Precious metals ....................................... 23 71 (48) (68) Other trading ......................................... (1) 15 (16) (107) ---- ---- ---- ---- Trading related revenues ................................. $420 $517 $(97) (19) ==== ==== ==== ==== During the first half of 2006, a wider range of product offerings and enhanced sales capabilities within the CIBM business segment, along with favorable market conditions in certain sectors, drove significant trading gains across all major client-related activities. Successful launches of new products and increased sales of structured products that are tailored to specific customer needs led to strong derivatives trading revenues. Gains in the precious metals business reflected volume growth driven by a surge in demand arising from strong commodities markets. Income streams in the foreign exchange business remained robust against the backdrop of a weakening U.S. dollar. The first half of 2007 was bolstered by strong derivatives revenues resulting from previous expansion of product capabilities in structured credit and emerging markets derivatives. This performance was partially offset by the credit weakness in the sub-prime lending market which impacted mortgage backed securities. In addition, the CIBM business segment experienced a decline in precious metals revenue related to lower price volatility. Effective during the second quarter of 2006, HUSI maintains a portfolio of MasterCard International, Inc. Class B shares (the MasterCard B shares) as part of a structured product transaction for a customer. In addition, HUSI uses derivative instruments to offset changes in the fair value of the MasterCard B shares. The decrease in value of the derivative instruments, which totaled $69 million and $77 million for the second quarter and first half of 2007, is reflected in trading revenue from derivative instruments. There were no fair value adjustments recorded for the first half of 2006 related to these derivative instruments. Under U.S. GAAP, the increased value of the MasterCard Class B shares is not recognized until they are sold. 43 HUSI also maintains a portfolio of derivative instruments that are utilized as economic hedges to offset changes in market values of loans held for sale to HMUS. Lower revenues from economic hedges of loans held for sale to HMUS resulted from the overall weakness of the U.S. housing market, which impacted residential mortgage related revenues. Lower trading results related to this program are generally offset by the changes in the valuation allowance related to loans held for sale to HMUS, which is recorded in other revenues. Further analysis and commentary regarding these loans and the associated hedges is provided beginning on page 39 of this Form 10-Q. HUSI recognizes gain or loss at the inception of derivative transactions only when the fair value of the transaction can be verified to market transactions or if all significant pricing model assumptions can be verified to observable market data. Gain or loss not recognized at inception is recorded in trading assets and recognized over the term of the derivative contract, or when market data becomes observable. The availability of observable market data resulted in recognition of $7 million and $35 million in trading revenues for the first six months of 2007 and 2006, respectively. Securities Gains, Net HUSI maintains various securities portfolios as part of its overall balance sheet diversification and risk management strategies. The following table summarizes net securities gains resulting from various strategies. -------------------------------------------------------------------------------- 2007 2006 -------------------------------------------------------------------------------- (in millions) Three months ended June 30: Balance sheet diversity and reduction of risk ................ $ 1 $-- Management of Latin American investment exposure ............. 15 -- Other ........................................................ -- 6 --- --- Securities gains, net ........................................ $16 $ 6 === === Six months ended June 30: Balance sheet diversity and reduction of risk ................ $ 9 $ 4 Management of Latin American investment exposure ............. 20 -- Sales of securities to an HSBC affiliate (1) ................. 8 -- Other ........................................................ -- 6 --- --- Securities gains, net ........................................ $37 $10 === === (1) Represents net gains realized from transfers of various available for sale securities, other non-marketable securities and equity investments as part of a strategy to consolidate certain investments into common HSBC entities. 44 Operating Expenses The components of operating expenses are summarized in the following tables. ---------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- Three months ended June 30 2007 2006 Amount % ---------------------------------------------------------------------------------------------- ($ in millions) Salaries and employee benefits: Salaries .......................................... $ 245 $ 218 $ 27 12 Employee benefits ................................. 96 103 (7) (7) ------- ------- ---- --- Total salaries and employee benefits .............. 341 321 20 6 ------- ------- ---- --- Occupancy expense, net ............................... 59 57 2 4 ------- ------- ---- --- Support services from HSBC affiliates: Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ..... 113 109 4 4 Fees paid to HMUS ................................. 66 52 14 27 Fees paid to HTSU for technology services ......... 62 49 13 27 Fees paid to other HSBC affiliates ................ 45 37 8 22 ------- ------- ---- --- Total support services from HSBC affiliates ....... 286 247 39 16 ------- ------- ---- --- Other expenses: Equipment and software ............................ 15 18 (3) (17) Marketing ......................................... 31 25 6 24 Outside services .................................. 42 31 11 35 Professional fees ................................. 16 14 2 14 Telecommunications ................................ 6 5 1 20 Postage, printing and office supplies ............. 9 9 -- -- Insurance business ................................ 4 6 (2) (33) Miscellaneous ..................................... 69 42 27 64 ------- ------- ---- --- Total other expenses .............................. 192 150 42 28 ------- ------- ---- --- Total operating expenses ............................. $ 878 $ 775 $103 13 ======= ======= ==== === Personnel - average number ........................... 12,325 12,110 215 2 ---------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- Six months ended June 30 2007 2006 Amount % ---------------------------------------------------------------------------------------------- ($ in millions) Salaries and employee benefits: Salaries .......................................... $ 490 $ 437 $ 53 12 Employee benefits ................................. 188 199 (11) (6) ------- ------- ---- --- Total salaries and employee benefits .............. 678 636 42 7 ------- ------- ---- --- Occupancy expense, net ............................... 118 108 10 9 ------- ------- ---- --- Support services from HSBC affiliates: Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ..... 232 225 7 3 Fees paid to HMUS ................................. 123 107 16 15 Fees paid to HTSU for technology services ......... 123 106 17 16 Fees paid to other HSBC affiliates ................ 87 73 14 19 ------- ------- ---- --- Total support services from HSBC affiliates ....... 565 511 54 11 ------- ------- ---- --- Other expenses: Equipment and software ............................ 29 38 (9) (24) Marketing ......................................... 63 46 17 37 Outside services .................................. 71 60 11 18 Professional fees ................................. 34 31 3 10 Telecommunications ................................ 10 10 - - Postage, printing and office supplies ............. 18 16 2 13 Insurance business ................................ 12 11 1 9 Miscellaneous ..................................... 123 93 30 32 ------- ------- ---- --- Total other expenses .............................. 360 305 55 18 ------- ------- ---- --- Total operating expenses ............................. $ 1,721 $ 1,560 $161 10 ======= ======= ==== === Personnel - average number ........................... 12,322 12,033 289 2 45 Overview Increased expenses for the second quarter and for the first six months of 2007 were largely driven by higher personnel, marketing, technology and other expense growth associated with continued rollout of various business growth initiatives affecting all business segments. Salaries and Employee Benefits Higher salaries expenses for the first six months of 2007 are mainly due to: o higher staff counts and a changing mix of staffing to support various business growth initiatives, primarily within the PFS, CIBM and PB business segments; o higher average salaries and pay rates, due to normal annual pay increases; and o higher personnel costs within the CIBM segment associated with the expansion of various businesses that are better positioned to leverage HSBC's global markets capabilities, and with repositioning certain other businesses in order to focus on building a financing and emerging markets led wholesale banking business. During the second quarter of 2006, the HSBC Remuneration Committee exercised its discretion to waive the Total Shareholder Return performance condition related to 2003 share option awards under the HSBC Group Share Option Plan (refer to page 141 of HUSI's 2006 Form 10-K for a description of this plan). This modification resulted in an additional charge to employee benefits expense of $9 million for the second quarter of 2006. No similar charge was recorded during 2007. Excluding this 2006 charge, higher employee benefits associated with increased salaries expenses were offset by lower pension costs. Occupancy Expense, Net Expansion of the core banking and commercial lending networks within the PFS and CMB business segments has been a key component of recent business expansion initiatives. New branches have been opened and lending operations have been expanded, which have resulted in higher rental expenses, depreciation of leasehold improvements, utilities and other occupancy expenses during the first six months of 2007. Support Services from HSBC Affiliates HUSI has routinely purchased private label credit card receivables from HSBC Finance Corporation since December 2004. In addition, higher quality nonconforming residential mortgage loans were acquired from HSBC Finance Corporation's correspondent network from December 2003 until September 2005. In most cases, HSBC Finance Corporation retained the right to service these portfolios. Fees charged by HSBC Finance Corporation for loan origination and servicing expenses, which are primarily recorded in the CF segment, have increased moderately for 2007 due to an increased number of private label credit card accounts serviced. Fees charged by HMUS pursuant to service level agreements for broker dealer, loan syndication, treasury and traded markets related services are included in support services from HSBC affiliates. Higher fees charged by HMUS for the first half of 2007 primarily relate to increased loan syndication services. HSBC's technology services in North America are centralized within HSBC Technology & Services (USA) Inc. (HTSU). Technology related assets and software acquired for HUSI are generally purchased and owned by HTSU. Pursuant to a master service level agreement, HTSU charges HUSI for equipment related costs and technology services. Fees charged by HTSU to HUSI for technology services are higher in 2007, as HUSI continues to upgrade its technology environment within all business segments. HUSI also utilizes other HSBC affiliates in support of global outsourcing initiatives and, to a lesser extent, for treasury and traded markets services. Higher expense for 2007 primarily resulted from expanded data processing and other global outsourcing services. 46 Miscellaneous Expenses Higher marketing and promotional expenses resulted from continuing investment in HSBC brand activities, promotion of the internet savings account and marketing support for branch expansion initiatives, primarily within the PFS business segment. As a result of a decision to discontinue operations of HBUS's real estate settlement services company, certain deferred start-up costs and other contractual costs totaling $6 million were included in outside services for the second quarter of 2007. Employment agency and staff recruitment fees, also included in outside services, have increased in 2007, primarily to support business expansion and ongoing technology enhancement projects. Miscellaneous expenses for the second quarter and the first half of 2006 were unusually low, mainly due to reversal of $13 million of accrued interest related to settlement of certain income tax liabilities during the second quarter of 2006. In addition, $5 million of accruals to errors and losses expense related to periods prior to 2006 were also reversed in the second quarter of 2006. Excluding these 2006 adjustments, higher miscellaneous expenses for 2007 were primarily due to increased insurance costs and other expenses associated with business expansion. Efficiency Ratio -------------------------------------------------------------------------------- Three months ended Six months ended June 30 June 30 ------------------ ----------------- 2007 2006 2007 2006 -------------------------------------------------------------------------------- Efficiency ratio (1)................ 55.45% 53.49% 57.21% 54.91% (1) Ratio of total operating expenses, reduced by minority interests, to the sum of net interest income and other revenues. Higher net interest income and other revenues were more than offset by increased operating expenses for the second quarter and the first half of 2007, resulting in an increase in the efficiency ratio for both periods. 47 SEGMENT RESULTS -------------------------------------------------------------------------------- HUSI has five distinct segments that are utilized for management reporting and analysis purposes. The segments, which are based upon customer groupings as well as products and services offered, are described on pages 19-20 of HUSI's Form 10-Q for the quarterly period ended March 31, 2007. Effective January 1, 2007, corporate goals of HUSI are based upon results reported under International Financial Reporting Standards (IFRSs), which are utilized by HSBC to prepare its consolidated financial statements. Operating results for HUSI are now being monitored and reviewed, trends are being evaluated, and decisions are being made about allocating certain resources on an IFRSs basis. As a result, effective with this Form 10-Q, business segment results are reported on an IFRSs basis to align with the revised internal reporting mechanism for monitoring performance. Results for 2007 and 2006 in the tables that follow are reflected on an IFRSs basis. Results for each business segment on an IFRSs basis are summarized in the following tables. Personal Financial Services (PFS) Overview Additional resources continue to be directed towards expansion of the core retail banking business, including investment in the HSBC brand, expansion of the core branch network in existing and new geographic areas, and continued rollout of HSBC Direct, the internet banking business. Significant expense growth from these initiatives for the second quarter and the first half of 2007 has been partially offset by related growth in other revenues. Net interest income from core banking activities has also decreased in 2007 due to continued narrowing of interest rate spreads, which was partially offset by the positive impact of new customers and products. Balance sheet growth for core retail banking for the first six months of 2007 was highlighted by a 25% increase in average deposits, as compared with the same 2006 period, resulting from successful strategy to build deposits across multiple markets and business segments, utilizing multiple delivery systems. PFS business segment results for 2007 also have been impacted by lower residential mortgage banking revenue, primarily due to loan portfolio runoff. During 2007, as part of a continuing process to manage prepayment risk and liquidity, HUSI continues to sell a majority of its residential mortgage loan originations and allow the residential mortgage loan portfolio to run off. Operating Results The following table summarizes results for the PFS segment. -------------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount % -------------------------------------------------------------------------------- ($ in millions) Three months ended June 30: Net interest income ................... $274 $290 $(16) (6) Other revenues ........................ 113 106 7 7 ---- ---- ---- --- Total revenues ........................ 387 396 (9) (2) Provision for credit losses ........... 25 8 17 213 ---- ---- ---- --- 362 388 (26) (7) Operating expenses .................... 319 291 28 10 ---- ---- ---- --- Income before income tax expense ...... $ 43 $ 97 $(54) (56) ==== ==== ==== === Six months ended June 30: Net interest income ................... $560 $577 $(17) (3) Other revenues ........................ 263 242 21 9 ---- ---- ---- --- Total revenues ........................ 823 819 4 -- Provision for credit losses ........... 29 24 5 21 ---- ---- ---- --- 794 795 (1) -- Operating expenses .................... 611 580 31 5 ---- ---- ---- --- Income before income tax expense ...... $183 $215 $(32) (15) ==== ==== ==== === 48 Lower net interest income for the second quarter and the first half of 2007 was partially due to lower interest earned and lower interest rate spreads on the residential mortgage loan portfolio. Average residential mortgage loans decreased 10% for the first six months of 2007, as compared with the same 2006 period. Net interest income from core banking activities also decreased for the second quarter and first six months of 2007. Although deposits continued to grow in 2007, driven by the success of the Online Savings product and expansion of the retail branch network, the positive impact of the growing personal deposit base was offset by a narrowing of deposit spreads as customers continue to migrate to higher yielding deposit products, such as the Online Savings product. Refer to page 34 of this Form 10-Q for commentary regarding HUSI's deposit strategy and growth. Higher other revenues for the first six months of 2007 were due to $19 million of gains realized on sales of branch premises to unaffiliated third parties, which was partially offset by decreased servicing related income included within residential mortgage banking revenue. Higher provision for credit losses primarily resulted from increased delinquencies within various consumer portfolios, which was partially offset by a $13 million reduction in allowance resulting from refinement of the allowance methodology associated with MasterCard/Visa receivables. In addition, provision expense for the first half of 2006 was unusually low due to the impact of bankruptcy legislation enacted in 2005, which resulted in accelerated consumer charge offs in the fourth quarter of 2005. Increased operating expenses primarily resulted from higher staff, marketing, occupancy and technology costs associated with branch expansion and development of the HSBC Direct online platform. Consumer Finance (CF) Overview The CF segment includes the private label receivable portfolio (the PLRP) and other loans acquired from HSBC Finance Corporation and its correspondents. Results of the CF segment have been positively impacted by lower amortization of premiums paid to HSBC Finance Corporation for those receivables, and by growth of private label credit card receivables, which are 14% higher at June 30, 2007 compared with the prior year. Operating Results The following table summarizes results for the CF segment. ---------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount % ---------------------------------------------------------------------------- ($ in millions) Three months ended June 30: Net interest income ................ $210 $176 $ 34 19 Other revenues (1) ................. 59 29 30 103 ---- ---- ---- ---- Total revenues ..................... 269 205 64 31 Provision for credit losses ........ 214 154 60 39 ---- ---- ---- ---- 55 51 4 8 Operating expenses ................. 9 7 2 29 ---- ---- ---- ---- Income before income tax expense ... $ 46 $ 44 $ 2 5 ==== ==== ==== ==== Six months ended June 30: Net interest income ................ $409 $338 $ 71 21 Other revenues (1) ................. 107 40 67 168 ---- ---- ---- ---- Total revenues ..................... 516 378 138 37 Provision for credit losses ........ 388 299 89 30 ---- ---- ---- ---- 128 79 49 62 Operating expenses ................. 17 14 3 21 ---- ---- ---- ---- Income before income tax expense ... $111 $ 65 $ 46 71 ==== ==== ==== ==== (1) For IFRSs reporting purposes, fees charged by HSBC Finance Corporation for servicing various loan and receivable portfolios are netted against other revenues. These fees totaled $102 million and $99 million for the second quarter of 2007 and 2006, respectively, and $207 million and $203 million for the first six months of 2007 and 2006, respectively. 49 The following table summarizes the impact of the PLRP on earnings for the CF segment in comparison with the other portfolios. -------------------------------------------------------------------------------- Three months ended June 30 Plrp Other Total -------------------------------------------------------------------------------- (in millions) 2007 Net interest income ........................... $196 $14 $210 Other revenues ................................ 65 (6) 59 ---- --- ---- Total revenues ................................ 261 8 269 Provision for credit losses ................... 207 7 214 ---- --- ---- 54 1 55 Operating expenses ............................ 8 1 9 ---- --- ---- Income before income tax expense .............. $ 46 $ - $ 46 ==== === ==== 2006 Net interest income ........................... $157 $19 $176 Other revenues ................................ 27 2 29 ---- --- ---- Total revenues ................................ 184 21 205 Provision for credit losses ................... 148 6 154 ---- --- ---- 36 15 51 Operating expenses ............................ 6 1 7 ---- --- ---- Income before income tax expense .............. $ 30 $14 $ 44 ==== === ==== -------------------------------------------------------------------------------- Six months ended June 30 Plrp Other Total -------------------------------------------------------------------------------- (in millions) 2007 Net interest income ........................... $378 $31 $409 Other revenues ................................ 118 (11) 107 ---- --- ---- Total revenues ................................ 496 20 516 Provision for credit losses ................... 372 16 388 ---- --- ---- 124 4 128 Operating expenses ............................ 16 1 17 ---- --- ---- Income before income tax expense .............. $108 $ 3 $111 ==== === ==== 2006 Net interest income ........................... $289 $48 $337 Other revenues ................................ 42 (2) 40 ---- --- ---- Total revenues ............................... 331 46 377 Provision for credit losses ................... 287 12 299 ---- --- ---- 44 34 78 Operating expenses ............................ 12 2 14 ---- --- ---- Income before income tax expense .............. $ 32 $32 $ 64 ==== === ==== Higher net interest income for the second quarter and first six months of 2007 resulted from: o higher interest income from increased credit card receivable balances, due to the addition of new private label merchant relationships during 2006 and 2007; and o lower amortization of premiums paid for purchases of receivables included within the PLRP. Although premiums associated with daily purchases of receivables from HSBC Finance Corporation continue to be recorded and amortized, the premium amortization associated with the initial portfolio acquisition in 2004 was $51 million lower for the first half of 2007. Higher other revenues for the PLRP are directly related to increased credit card fees (refer to page 40 of this Form 10-Q). Higher provisions for credit losses for the PLRP resulted from higher allowance for credit losses required for private label credit card receivable growth and from higher delinquencies within the portfolio. Additional portfolio transfers from HSBC Finance Corporation that are consistent with HUSI's business and liquidity management strategies and objectives are currently being considered. 50 Commercial Banking (CMB) Overview Expansion of middle market activities in Chicago, Washington D.C. and the west coast of the U.S. has contributed to strong growth in loans, deposits, and overall performance within the CMB segment. Small business deposit growth also continues to be a key growth driver for higher results in 2007. Overall, average commercial loans and deposits are 2% and 20% higher, respectively, for the first six months of 2007, as compared with the same period in 2006. Commercial real estate lending has been impacted by a slowdown in this sector, which has partially offset overall growth. Operating Results The following table summarizes results for the CMB segment. -------------------------------------------------------------------------------- Increase (Decrease) -------------------- 2007 2006 Amount % -------------------------------------------------------------------------------- ($ in millions) Three months ended June 30: Net interest income .................... $202 $171 $ 31 18 Other revenues ......................... 66 62 4 6 ---- ---- ---- --- Total revenues ......................... 268 233 35 15 Provision for credit losses ............ 19 27 (8) (30) ---- ---- ---- --- 249 206 43 21 Operating expenses ..................... 142 114 28 25 ---- ---- ---- --- Income before income tax expense ....... $107 $ 92 $ 15 16 ==== ==== ==== === Six months ended June 30: Net interest income .................... $398 $350 $ 48 14 Other revenues ......................... 128 123 5 4 ---- ---- ---- --- Total revenues ......................... 526 473 53 11 Provision for credit losses ............ 37 31 6 19 ---- ---- ---- --- 489 442 47 11 Operating expenses ..................... 282 233 49 21 ---- ---- ---- --- Income before income tax expense ....... $207 $209 $ (2) (1) ==== ==== ==== === Higher net interest income for the second quarter and first six months of 2007 primarily resulted from growth in small business deposits and middle-market loans, which were partially offset by lower commercial real estate loans. Growth in net interest income continues to be partially offset by narrowing deposit spreads, as customers migrate to higher yielding deposit products. Despite lower provision for credit losses for the second quarter of 2007, provisions have increased overall for the first half of the year, primarily due to a specific charge off within the commercial real estate portfolio during the first quarter. In addition, growth in average commercial loan portfolio balances has resulted in moderately higher collective allowance requirements for the first six months of 2007. Additional commentary regarding credit quality begins on page 54 of this Form 10-Q. Higher operating expenses are primarily associated with business expansion, higher incentive compensation and increased community investment costs. Corporate, Investment Banking and Markets (CIBM) Overview Various treasury and traded markets activities were expanded in 2005 and 2006, resulting in new products offered to customers, increased marketing efforts for those products, and an expanded infrastructure to support growth initiatives. As a result of these initiatives, average commercial loans, trading assets and commercial deposits are 18%, 7% and 40% higher, respectively, for the first six months of 2007 in comparison with the same 2006 period. 51 The first half of 2007 was bolstered by strong derivatives revenues resulting from previous expansion of product capabilities in structured credit and emerging markets derivatives. Foreign exchange revenues remained strong during 2007 against the backdrop of a weakening U.S. dollar. This performance was partially offset by the credit weakness in the sub-prime lending market which impacted trading in mortgage backed securities. In addition, the CIBM business segment experienced a decline in precious metals revenue related to lower price volatility. Revenues from the recently expanded payments and cash management business were significantly higher for the second quarter and first six months of 2007, as compared with the same 2006 periods, reflecting higher deposit balances and higher associated transaction fee revenues. A relatively flat yield curve has reduced net interest income from balance sheet management activities for the first half of 2007 and has continued to limit opportunities to generate additional net funds income within the CIBM business segment. During the first half of 2006, a wider range of product offerings and enhanced sales capabilities within the CIBM business segment drove significant trading gains across all major client-related activities. Favorable market conditions in certain sectors also enhanced trading profits. Successful launches of new products and increased sales of structured products that are tailored to specific customer needs led to strong derivatives trading revenues. Gains in the precious metals business reflected volume growth driven by a surge in demand arising from strong commodities markets. Income streams in the foreign exchange business remained robust against the backdrop of a weak U.S. dollar. Operating Results The following table summarizes results for the CIBM segment. ----------------------------------------------------------------------------- Increase (Decrease) ------------------- 2007 2006 Amount % ----------------------------------------------------------------------------- ($ in millions) Three months ended June 30: Net interest income ................... $141 $112 $ 29 26 Other revenues ........................ 321 270 51 19 ---- ---- ---- --- Total revenues ........................ 462 382 80 21 (Credit) provision for credit losses .. (5) (14) 9 64 ---- ---- ---- --- 467 396 71 18 Operating expenses .................... 198 184 14 8 ---- ---- ---- --- Income before income tax expense ...... $269 $212 $ 57 27 ==== ==== ==== === Six months ended June 30: Net interest income ................... $138 $137 $ 1 1 Other revenues ........................ 575 559 16 3 ---- ---- ---- --- Total revenues ........................ 713 696 17 2 (Credit) provision for credit losses .. (10) (12) 2 17 ---- ---- ---- --- 723 708 15 2 Operating expenses .................... 387 355 32 9 ---- ---- ---- --- Income before income tax expense ...... $336 $353 $(17) (5) ==== ==== ==== === Lower revenues primarily resulted from lower balance sheet management income and lower trading related revenues (refer to pages 27 and 43 of this Form 10-Q), which were partially offset by higher gains realized from sales of securities (refer to page 44 of this Form 10-Q). Higher operating expenses for the first six months of 2007, as compared with the same 2006 period, resulted from higher personnel costs associated with expansion of various businesses that are better positioned to leverage HSBC's global markets capabilities. Expenses for 2007 also included incremental costs associated with repositioning certain other non-strategic businesses in order to focus on building a financing and emerging markets led wholesale banking business. 52 Private Banking (Pb) Overview During 2005 and 2006, additional resources have been allocated to expand products and services provided to high net worth customers served by the PB business segment. As a result, total average loans and deposit balances were 13% and 20% higher, respectively, for the first half of 2007, compared with the same 2006 period. Operating Results The following table summarizes results for the PB segment. ----------------------------------------------------------------------------- 2007 Compared to 2006 Increase (Decrease) ---------------------- 2007 2006 Amount % ----------------------------------------------------------------------------- ($ in millions) Three months ended June 30: Net interest income ................... $ 50 $ 48 $ 2 4 Other revenues ........................ 71 60 11 18 ---- ---- ---- --- Total revenues ........................ 121 108 13 12 Provision for credit losses ........... 5 30 (25) (83) ---- ---- ---- --- 116 78 38 49 Operating expenses .................... 86 72 14 19 ---- ---- ---- --- Income before income tax expense ...... $ 30 $ 6 $ 24 400 ==== ==== ==== === Six months ended June 30: Net interest income ................... $100 $ 96 $ 4 4 Other revenues ........................ 144 137 7 5 ---- ---- ---- --- Total revenues ........................ 244 233 11 5 Provision for credit losses ........... 12 30 (18) (60) ---- ---- ---- --- 232 203 29 14 Operating expenses .................... 168 149 19 13 ---- ---- ---- --- Income before income tax expense ...... $ 64 $ 54 $ 10 19 ==== ==== ==== === Higher net interest income for the second quarter and first six months of 2007 resulted from the mix of higher average loans and deposit balances. The PB business segment includes an equity investment in a non-consolidated foreign HSBC affiliate (the foreign equity investment). During the third quarter of 2006, the foreign equity investment sold a portion of its investment in a foreign equity fund to another HSBC affiliate. During the second quarter of 2007, the foreign equity investment sold its remaining investment in the foreign equity fund, resulting in a gain from which HUSI recorded additional equity earnings of $7 million. Excluding the impact of this transaction, the decrease in equity investment holdings resulted in lower equity earnings included in other revenues for the first six months of 2007, which was offset by higher commission and fee revenues from managed products, derivatives and annuity products. Increased operating expenses for the second quarter and first six months of 2007 mainly resulted from higher staff costs related to business expansion initiatives. The provision for credit losses for the first six months of 2007 includes the impact of an $8 million charge off related to a specific commercial customer relationship, for which no allowance was previously recorded. For 2006, the provision includes a $29 million charge for a combination of charge offs and higher allowances related to a specific commercial real estate investment loan relationship for which no allowance was previously recorded. 53 Other Overview The Other segment primarily includes an equity investment in HSBC Republic Bank (Suisse) S.A., and adjustments made at the corporate level for fair value option accounting related to certain debt issued. Operating Results The following table summarizes results for the Other segment. -------------------------------------------------------------------------------------- 2007 Compared to 2006 Increase (Decrease) --------------------- 2007 2006 Amount % -------------------------------------------------------------------------------------- ($in millions) Three months ended June 30: Net interest income (expense) ............ $ (3) $ (7) $ 4 * Other revenues ........................... (66) 22 (88) * ---- ---- ---- ----- Total revenues ........................... (69) 15 (84) * Provision for credit losses .............. -- -- -- -- ---- ---- ---- ----- (69) 15 (84) * Operating expenses ....................... 1 4 (3) * ---- ---- ---- ----- (Loss) income before income tax expense .. $(70) $ 11 $(81) * ==== ==== ==== ===== Six months ended June 30: Net interest income (expense) ............ $ (4) $(10) $ 6 * Other revenues ........................... (61) (3) (58) * ---- ---- ---- ----- Total revenues ........................... (65) (13) (52) * Provision for credit losses .............. -- -- -- -- ---- ---- ---- ----- (65) (13) (52) * Operating expenses ....................... 2 4 (2) * ---- ---- ---- ----- (Loss) income before income tax expense .. $(67) $(17) $(50) * ==== ==== ==== ===== * Not meaningful. The decrease in other revenues for the second quarter and the first half of 2007 primarily resulted from decreases in the fair value of certain debt instruments, as compared with the same 2006 periods. CREDIT QUALITY -------------------------------------------------------------------------------- HUSI enters into a variety of transactions in the normal course of business that involve both on and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers. HUSI participates in lending activity throughout the U.S. and, on a limited basis, internationally. HUSI's allowance for credit losses methodology and its accounting policies related to the allowance for credit losses are presented in Critical Accounting Policies beginning on page 25 of its 2006 Form 10-K and in Note 2 of the consolidated financial statements beginning on page 99 of its 2006 Form 10-K. HUSI's approach toward credit risk management is summarized on pages 72-74 of its 2006 Form 10-K. There have been no material revisions to policies or methodologies during the first half of 2007. 54 Overview The allowance for credit losses increased $40 million (5%) and increased $5 million (less than 1%) during the three month and six month periods ended June 30, 2007, respectively. Higher allowances associated with the growing private label and MasterCard/Visa credit card receivable portfolios were the primary drivers for the overall increase. Allowance for credit losses balances and activity, by loan portfolio, are summarized on page 57 of this Form 10-Q. The provision for credit losses increased $42 million (19%) for the second quarter of 2007, and increased $90 million (24%) for the first six months of 2007 as compared with the same 2006 periods, primarily due to higher provisions associated with credit card receivable portfolios, which were partially offset by lower commercial loan provisions. The provision for credit losses associated with various loan portfolios is summarized on page 36 of this Form 10-Q. Problem Loan Management Nonaccruing loans by portfolio and impaired loans are summarized in Note 4 of the consolidated financial statements beginning on page 10 of this Form 10-Q. HUSI's policies and practices for placing loans on nonaccruing status are summarized in Note 2 of the consolidated financial statements, beginning on page 99 of its 2006 Form 10-K. Criticized Assets Criticized asset classifications are based on the risk rating standards of HUSI's primary regulator. Problem credit facilities, which include loans and other credit arrangements such as letters of credit, are assigned various criticized facility grades under HUSI's allowance for credit losses methodology. Criticized credit facilities are summarized in the following table. -------------------------------------------------------------------------------- Increase (Decrease) from --------------------------------- December 31, 2006 June 30, 2006 June 30, ----------------- ------------- Balance at 2007 Amount % Amount % -------------------------------------------- ($ in millions) Special mention (1): Commercial loans ............ $1,437 $ 186 15 $ 659 85 ------ ----- --- ------ --- Substandard (2): Commercial loans ............ 503 (178) (26) 252 100 Consumer loans .............. 628 27 4 120 24 ------ ----- --- ------ --- 1,131 (151) (12) 372 49 ------ ----- --- ------ --- Doubtful (3): Commercial loans ............ 26 (6) (19) (14) (35) ------ ----- --- ------ --- Total .......................... $2,594 $ 29 1 $1,017 64 ====== ===== === ====== === (1) Generally includes credit facilities that are protected by collateral and/or the credit worthiness of the customer, but are potentially weak based upon economic or market circumstances which, if not checked or corrected, could weaken HUSI's credit position at some future date. (2) Includes credit facilities that are inadequately protected by the underlying collateral and/or general credit worthiness of the customer. These credit facilities present a distinct possibility that HUSI will sustain some loss if the deficiencies are not corrected. (3) Includes credit facilities that have all the weaknesses exhibited by substandard credit facilities, with the added characteristic that the weaknesses make collection or liquidation in full of the recorded loan highly improbable. However, although the possibility of loss is extremely high, certain factors exist which may strengthen the credit at some future date, and therefore the decision to charge off the loan is deferred. Loans graded as doubtful are required to be placed in nonaccruing status. 55 Allowance for Credit Losses Changes in the allowance for credit losses by general loan categories are summarized in the following table. ---------------------------------------------------------------------------------------------------------- June 30, March 31, December 31, September 30, June 30, Quarter ended 2007 2007 2006 2006 2006 ---------------------------------------------------------------------------------------------------------- ($ in millions) Total loans at quarter end .............. $87,409 $88,893 $90,237 $90,020 $91,205 Average total loans ..................... 88,477 88,092 89,343 88,739 88,699 Allowance balance at beginning of quarter .............................. $ 862 $ 897 $ 886 $ 869 $ 837 Allowance related to disposal of certain credit card receivables ...... -- -- (2) -- -- Charge offs: Commercial ......................... 34 36 43 29 44 Consumer: Residential mortgages ............ 12 14 10 9 7 Credit card receivables .......... 221 224 205 188 165 Other consumer loans ............. 26 31 32 27 23 ------- ------- ------- ------- ------- Total consumer loans ............. 259 269 247 224 195 ------- ------- ------- ------- ------- Total charge offs .................. 293 305 290 253 239 ------- ------- ------- ------- ------- Recoveries on loans charged off: Commercial ......................... 8 6 9 8 6 Consumer: Residential mortgages ............ 1 -- 1 1 -- Credit card receivables .......... 50 49 47 49 28 Other consumer loans ............. 10 10 9 5 15 ------- ------- ------- ------- ------- Total consumer loans ............. 61 59 57 55 43 ------- ------- ------- ------- ------- Total recoveries ................... 69 65 66 63 49 ------- ------- ------- ------- ------- Total net charge offs ................ 224 240 224 190 190 ------- ------- ------- ------- ------- Provision charged to income .......... 264 205 237 207 222 ------- ------- ------- ------- ------- Allowance balance at end of quarter ............................ $ 902 $ 862 $ 897 $ 886 $ 869 ======= ======= ======= ======= ======= Allowance ratios: Annualized net charge offs to average loans: Commercial ......................... .35% .43% .47% .29% .54% Consumer: Residential mortgages ............ .11 .15 .09 .08 .07 Credit card receivables .......... 3.91 4.01 3.62 3.39 3.61 Other consumer loans ............. 2.58 3.20 3.27 2.95 1.06 ------- ------- ------- ------- ------- Total consumer ................... 1.35 1.43 1.25 1.12 1.00 ------- ------- ------- ------- ------- Total loans ........................ 1.01% 1.11% 1.00% .85% .86% ======= ======= ======= ======= ======= Quarter-end allowance to: Quarter-end total loans .......... 1.03% .97% .99% .98% .95% Quarter-end total nonaccruing loans ......................... 277.54% 280.78% 314.74% 331.84% 354.69% 56 Changes in the allowance for credit losses by general loan categories are summarized in the following tables. --------------------------------------------------------------------------------------------------------- Residential Credit Other Three months ended June 30 Commercial Mortgage Card Consumer Unallocated Total --------------------------------------------------------------------------------------------------------- (in millions) 2007 Balance at beginning of period ..... $206 $31 $591 $23 $11 $862 ---- --- ---- --- --- ---- Charge offs ........................ 34 12 221 26 -- 293 Recoveries ......................... 8 1 50 10 -- 69 ---- --- ---- --- --- ---- Net charge offs ................. 26 11 171 16 -- 224 ---- --- ---- --- --- ---- Provision charged to income ........ 32 10 204 18 -- 264 ---- --- ---- --- --- ---- Balance at end of period ........... $212 $30 $624 $25 $11 $902 ==== === ==== === === ==== 2006 Balance at beginning of period ..... $171 $30 $589 $32 $15 $837 ---- --- ---- --- --- ---- Allowance related to disposals ..... -- -- -- -- -- -- Charge offs ........................ 44 7 165 23 -- 239 Recoveries ......................... 6 -- 28 15 -- 49 ---- --- ---- --- --- ---- Net charge offs ................. 38 7 137 8 -- 190 ---- --- ---- --- --- ---- Provision charged to income ........ 59 8 148 5 2 222 ---- --- ---- --- --- ---- Balance at end of period ........... $192 $31 $600 $29 $17 $869 ==== === ==== === === ==== --------------------------------------------------------------------------------------------------------- Residential Credit Other Six months ended June 30 Commercial Mortgage Card Consumer Unallocated Total --------------------------------------------------------------------------------------------------------- (in millions) 2007 Balance at beginning of period .......................... $203 $31 $626 $26 $11 $897 ---- --- ---- --- --- ---- Charge offs ........................ 70 26 445 57 -- 598 Recoveries ......................... 14 1 99 20 -- 134 ---- --- ---- --- --- ---- Net charge offs ................. 56 25 346 37 -- 464 ---- --- ---- --- --- ---- Provision charged to income ........ 65 24 344 36 -- 469 ---- --- ---- --- --- ---- Balance at end of period ........... $212 $30 $624 $25 $11 $902 ==== === ==== === === ==== 2006 Balance at beginning of period ..... $162 $34 $600 $36 $14 $846 ---- --- ---- --- --- ---- Allowance related to disposals ..... -- -- (6) -- -- (6) Charge offs ........................ 64 18 335 52 -- 469 Recoveries ......................... 21 -- 74 24 -- 119 ---- --- ---- --- --- ---- Net charge offs ................. 43 18 261 28 -- 350 ---- --- ---- --- --- ---- Provision charged to income ........ 73 15 267 21 3 379 ---- --- ---- --- --- ---- Balance at end of period ........... $192 $31 $600 $29 $17 $869 ==== === ==== === === ==== Commercial Loan Credit Quality Components of the commercial allowance for credit losses, as well as movements in comparison with prior periods, are summarized in the following table. --------------------------------------------------------------------------------------- Increase (Decrease) from --------------------------------- December 31, 2006 June 30, 2006 June 30, ----------------- ------------- 2007 Amount % Amount % --------------------------------------------------------------------------------------- ($ in millions) On-balance sheet allowance: Specific ............................ $ 21 $ 7 50 $ 5 31 Collective .......................... 191 2 1 15 9 ---- --- ---- --- --- 212 9 4 20 10 Unallocated ......................... 11 -- -- (6) (35) ---- --- ---- --- --- Total on-balance sheet allowance .... 223 9 4 14 7 ---- --- ---- --- --- Off-balance sheet allowance ............ 90 (8) (8) 5 6 ---- --- ---- --- --- Total commercial allowances ............ $313 $ 1 -- $19 6 ==== === ==== === === 57 Despite an increase in average commercial loans for the first half of 2007, as compared with the same 2006 period, total criticized commercial loans were relatively unchanged from December 31, 2006 to June 30, 2007 (refer to page 55 of this Form 10-Q). Overall, commercial loan credit quality remains stable and well-controlled. Higher criticized loan balances from June 30, 2006 to June 30, 2007 (refer to page 55 of this Form 10-Q) resulted mainly from downgrades in real estate and middle market exposures. The downgrades resulted in part from changes in the credit metrics for specific credits within these portfolios. Total nonaccruing commercial loans remain low as a percentage of total commercial loans. Based upon evaluation of the repayment capacity of the obligors, including support from adequately margined collateral, performance on guarantees, and other mitigating factors, impairment is modestly higher in 2007 as compared with prior reporting periods, and is adequately reflected in the allowances for specific and collective impairment. HUSI management continues to monitor the following factors that could affect portfolio risk: o recent growth initiatives which have resulted in growth in the size and complexity of the commercial loan portfolio; o HUSI's continued geographic expansion; o borrower concentrations; o increased number and complexity of products offered; and o continuing signs of stress within certain segments of the economy. HUSI management continues to monitor and reduce exposures to those industries considered to be higher risk. During 2006, HUSI management began to make more extensive use of available tools to more actively manage net exposure within its corporate loan portfolios with an increased syndication capacity as well as increased use of credit default swaps to economically hedge and reduce certain exposures. Any sudden and/or unexpected adverse economic events or trends could significantly affect credit quality and increase provisions for credit losses. For example, HUSI management is monitoring the U.S. housing market, rising interest rates and high energy prices, which could potentially lead to a deceleration of U.S. economic activity. Credit Card Receivable Credit Quality Credit card receivables are primarily private label receivables, including closed and open ended contracts, acquired from HSBC Finance Corporation. Receivables included in the private label credit card portfolio are generally maintained in accruing status until being charged off six months after delinquency. Selected credit quality data for credit card receivables is summarized in the following table. -------------------------------------------------------------------------------------------------------- June 30, December 31, June 30, 2007 2006 2006 -------------------------------------------------------------------------------------------------------- ($ in millions) Accruing balances contractually past due 90 days or more: Balance at end of quarter ....................................... $ 315 $ 339 $ 283 As a percent of total credit card receivables ................... 1.79% 1.86% 1.85% Allowance for credit losses associated with credit card receivables: Balance at end of quarter ....................................... $ 624 $ 626 $ 600 As a percent of total credit card receivables ................... 3.54% 3.43% 3.92% Net charge offs of credit card receivables: Total for the quarter ended ..................................... $ 171 $ 158 $ 137 Annualized net charge offs as a percent of average credit card receivables ........................................ 3.91% 3.62% 3.61% The allowance for credit losses associated with credit card receivables increased $33 million (6%) during the second quarter and was relatively unchanged for the first half of 2007. Net charge off and provision activity was higher during the second quarter and the first half of 2007 due to increased private label and MasterCard/Visa credit card receivable balances and to higher delinquencies within these portfolios, which have resulted in a higher collective allowance balance. 58 Residential Mortgage Loan Credit Quality The allowance for credit losses related to residential mortgage loans was relatively unchanged during the second quarter and the first six months of 2007. HUSI's residential mortgage portfolio is primarily comprised of prime mortgage loans, for which credit quality has remained strong during 2007. Additional disclosures regarding certain risk concentrations inherent within the residential mortgage loan portfolio are provided beginning on page 63 of this Form 10-Q. Reserve for Off-Balance Sheet Exposures HUSI maintains a separate reserve for credit risk associated with certain off-balance sheet exposures including letters of credit, unused commitments to extend credit and financial guarantees. This reserve, included in other liabilities, was $90 million, $98 million and $85 million at June 30, 2007, December 31, 2006 and June 30, 2006, respectively. Off-balance sheet exposures are summarized on page 61 of this Form 10-Q. Credit and Market Risks Associated with Derivative Contracts Credit (or repayment) risk in derivative instruments is minimized by entering into transactions with high quality counterparties, including other HSBC entities. Counterparties include financial institutions, government agencies, both foreign and domestic, corporations, funds (mutual funds, hedge funds, etc.), insurance companies and private clients. These counterparties are subject to regular credit review by the credit risk management department. Most derivative contracts are governed by an International Swaps and Derivatives Association Master Agreement. Depending on the type of counterparty and the level of expected activity, bilateral collateral arrangements may also be required. The total risk in a derivative contract is a function of a number of variables, such as: o the existence of a master netting agreement among the counterparties; o volatility of interest rates, currencies, equity or corporate reference entity used as the basis for determining contract payments; o maturity and liquidity of contracts; o credit worthiness of the counterparties in the transaction; and o existence and value of collateral received from counterparties to secure exposures. The following table presents credit risk exposure and net fair value associated with derivative contracts. In the table, current credit risk exposure is the recorded fair value of derivative receivables, which represents revaluation gains from the marking to market of derivative contracts held for trading purposes, for all counterparties with an International Swaps and Derivatives Association Master Agreement in place. Future credit risk exposure in the following table is measured using rules contained in the risk-based capital guidelines published by U.S. banking regulatory agencies. The risk exposure calculated in accordance with the risk-based capital guidelines potentially overstates actual credit exposure, because: o the risk-based capital guidelines ignore collateral that may have been received from counterparties to secure exposures; and o the risk-based capital guidelines compute exposures over the life of derivative contracts. However, many contracts contain provisions that allow a bank to close out the transaction if the counterparty fails to post required collateral. As a result, these contracts have potential future exposures that are often much smaller than the future exposures derived from the risk-based capital guidelines. 59 The net credit risk exposure amount in the following table does not reflect the impact of bilateral netting (i.e., netting with a single counterparty when a bilateral netting agreement is in place). However, the risk-based capital guidelines recognize that bilateral netting agreements reduce credit risk and therefore allow for reductions of risk-weighted assets when netting requirements have been met. Therefore, risk-weighted amounts for regulatory capital purposes are a fraction of the original gross exposures. ----------------------------------------------------------------------- June 30, December 31, 2007 2006 ----------------------------------------------------------------------- (in millions) Risk associated with derivative contracts: Current credit risk exposure ................ $ 9,279 $11,398 Future credit risk exposure ................. 76,377 72,447 ------- ------- Total risk exposure ......................... 85,656 83,845 Less: collateral held against exposure ...... (4,674) (3,989) ------- ------- Net credit risk exposure .................... $80,982 $79,856 ======= ======= Market risk is the adverse effect that a change in interest rates, currency, or implied volatility rates has on the value of a financial instrument. HUSI manages the market risk associated with interest rate and foreign exchange contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken. HUSI also manages the market risk associated with the trading derivatives through hedging strategies that correlate the rates, price and spread movements. HUSI measures this risk daily by using Value at Risk (VAR) and other methodologies (refer to pages 66-67 of this Form 10-Q). HUSI's Asset and Liability Policy Committee is responsible for monitoring and defining the scope and nature of various strategies utilized to manage interest rate risk that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedge strategies are then incorporated into HUSI's overall interest rate risk management and trading strategies. Notional values of derivative contracts are summarized in the following table. ------------------------------------------------------------------------------ June 30, December 31, 2007 2006 ------------------------------------------------------------------------------ (in millions) Interest rate: Futures and forwards .......................... $ 145,042 $ 94,204 Swaps ......................................... 1,977,492 1,906,688 Options written ............................... 235,099 510,023 Options purchased ............................. 244,758 544,026 ---------- ---------- 2,602,391 3,054,941 ---------- ---------- Foreign exchange: Swaps, futures and forwards ................... 486,198 394,621 Options written ............................... 104,366 61,406 Options purchased ............................. 105,163 63,795 Spot .......................................... 49,161 32,654 ---------- ---------- 744,888 552,476 ---------- ---------- Commodities, equities and precious metals: Swaps, futures and forwards ................... 43,326 43,620 Options written ............................... 21,699 12,263 Options purchased ............................. 21,669 16,115 ---------- ---------- 86,694 71,998 ---------- ---------- Credit derivatives ............................... 1,022,232 816,422 ---------- ---------- Total ............................................ $4,456,205 $4,495,837 ========== ========== The total notional amounts in the table above relate primarily to HUSI's trading activities. Notional amounts included in the table related to non-trading fair value, cash flow and economic hedging activities were $23 billion and $27 billion at June 30, 2007 and December 31, 2006, respectively. 60 OFF-BALANCE SHEET ARRANGEMENTS -------------------------------------------------------------------------------- The following table provides maturity information related to off-balance sheet arrangements. Descriptions of these arrangements are found on pages 68-69 of HUSI's 2006 Form 10-K. ---------------------------------------------------------------------------------------------------- Balance at June 30, 2007 ------------------------------------------ One Over One Over Balance at Year Through Five December 31, or Less Five Years Years Total 2006 ---------------------------------------------------------------------------------------------------- (in millions) Standby letters of credit, net of participations (1) .................. $ 5,314 $ 2,445 $ 145 $ 7,904 $ 7,259 Commercial letters of credit ........... 992 187 -- 1,179 795 Loan sales with recourse ............... -- 1 6 7 8 Credit derivative contracts (2) ........ 19,796 284,778 228,900 533,474 431,631 Commitments to extend credit: Commercial .......................... 17,107 33,445 5,855 56,407 55,862 Consumer ............................ 9,668 -- -- 9,668 9,627 ------- -------- -------- -------- -------- Total .................................. $52,877 $320,856 $234,906 $608,639 $505,182 ======= ======== ======== ======== ======== (1) Includes $570 million and $542 million issued for the benefit of HSBC affiliates at June 30, 2007 and December 31, 2006, respectively. (2) Includes $84,952 million and $71,908 million issued for the benefit of HSBC affiliates at June 30, 2007 and December 31, 2006, respectively. Letters of Credit Fees are charged for issuing letters of credit commensurate with the customer's credit evaluation and the nature of any collateral. Included in other liabilities are deferred fees on standby letters of credit, representing the fair value of the "stand ready obligation to perform" under these guarantees, amounting to $24 million and $21 million at June 30, 2007 and December 31, 2006, respectively. Also included in other liabilities is an allowance for credit losses on unfunded standby letters of credit of $25 million at June 30, 2007 and December 31, 2006. 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. Securitizations and Secured Financings On December 29, 2004, HUSI acquired a domestic private label loan portfolio from HSBC Finance Corporation, without recourse, which included securitized private label credit card receivables, and retained interest assets related to these securitizations. These credit card securitization transactions were structured to receive sale treatment under Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125 (SFAS 140). 61 In the third quarter of 2006, the last remaining securitization trust agreement related to the private label portfolio acquired from HSBC Finance Corporation in 2004 was amended. As a result, the securitization trust no longer qualifies for sale treatment in accordance with U.S. GAAP, and the transaction is now recorded as a secured financing transaction. At the agreement amendment date, all outstanding investments, credit card receivables and liabilities related to the trust were recorded on HUSI's consolidated balance sheet. Under IFRSs, HUSI's securitizations are treated as secured financings. In order to align its accounting treatment with that of HSBC, all of HUSI's collateralized funding transactions have been structured as secured financings under U.S. GAAP since the third quarter of 2004. In a secured financing, a designated pool of receivables is conveyed to a wholly owned limited purpose subsidiary, which in turn transfers the receivables to a trust that sells interests to investors. Repayment of the debt issued by the trust is secured by the receivables transferred. The transactions are structured as secured financings under SFAS 140. Therefore, the receivables and the underlying debt of the trust remain on HUSI's balance sheet. HUSI does not recognize a gain in a secured financing transaction. Because the receivables and debt remain on the balance sheet, revenues and expenses are reported consistent with the owned balance sheet portfolio. There have been no new secured financing transactions in the first six months of 2007. HUSI's secured financings and securitized receivables are summarized in the following table. ----------------------------------------------------------------------------------------------------- June 30, December 31, 2007 2006 ----------------------------------------------------------------------------------------------------- (in millions) Secured financings included in long-term debt ............................. $1,350 $2,134 ====== ====== Private label credit card receivables collateralizing secured financings at period end ............................................................. $1,646 $2,439 ====== ====== 62 RISK MANAGEMENT -------------------------------------------------------------------------------- Overview Some degree of risk is inherent in virtually all of HUSI's activities. For the principal activities undertaken by HUSI, the most important types of risks are considered to be credit, interest rate, market, liquidity, operational, fiduciary and reputational. Market risk broadly refers to price risk inherent in mark to market positions taken on trading and non-trading instruments. Operational risk technically includes legal and compliance risk. However, since compliance risk, including anti-money laundering (AML) risk, has such broad scope within HUSI's businesses, it is addressed as a separate functional discipline. During the first six months of 2007, there have been no significant changes in policies or approach for managing various types of risk. Liquidity Management HUSI's approach to address liquidity risk is summarized on pages 75-76 of HUSI's 2006 Form 10-K. There have been no changes in HUSI's approach toward liquidity risk management during 2007. HUSI's ability to regularly attract wholesale funds at a competitive cost is enhanced by strong ratings from the major credit rating agencies. At June 30, 2007, HUSI and HBUS maintained the following debt ratings. -------------------------------------------------------------------------------- At June 30, 2007 Moody's S&P Fitch -------------------------------------------------------------------------------- HUSI: Short-term borrowings .............................. P-1 A-1+ F1+ Long-term debt ..................................... Aa3 AA- AA HBUS: Short-term borrowings .............................. P-1 A-1+ F1+ Long-term debt ..................................... Aa2 AA AA HUSI periodically issues capital instruments to fund balance sheet growth, to meet cash and capital needs, or to fund investments in subsidiaries. In December 2005, the United States Securities and Exchange Commission (SEC) amended its rules regarding registration, communications and offerings under the Securities Act of 1933. The amended rules facilitate access to capital markets by well-established public companies, provide more flexibility regarding restrictions on corporate communications during a securities offering and further integrate disclosures under the Securities Act of 1933 and the Securities Exchange Act of 1934. The amended rules provide the most flexibility to "well-known seasoned issuers", including the option of automatic effectiveness upon filing of shelf registration statements and relief under the liberalized communications rules. HUSI currently satisfies the eligibility requirements for designation as a "well-known seasoned issuer", and has an effective shelf registration statement with the SEC under which it may issue debt securities, preferred stock, either separately or represented by depositary shares, warrants, purchase contracts and units. Concentrations of Risk Inherent in Loan Portfolios Certain risk concentrations are inherent within the residential mortgage loan portfolio, including concentrations that result in credit risk. A concentration of risk is defined as a significant exposure with an individual or group engaged in similar activities or affected similarly by economic conditions. As is true for all loan portfolios, HUSI utilizes high underwriting standards and prices loans in a manner that is appropriate to compensate for the higher risk associated with these concentrations. HUSI originates certain residential mortgage loans that have high loan-to-value (LTV) ratios and no mortgage insurance, which could result in potential inability to recover the entire investment in loans involving foreclosed or damaged properties. At June 30, 2007 and December 31, 2006, high LTV loans were mainly loans on primary residences with LTV ratios equal to or exceeding 90%. 63 HUSI also originates interest-only residential mortgage loans that allow borrowers to pay only the accruing interest for a period of time, which results in lower payments during the initial loan period. Depending on a customer's financial situation, the subsequent increase in the required payment attributable to loan principal could affect a customer's ability to repay the loan at some future date when the interest rate resets and/or principal payments are required. Outstanding balances of high LTV and interest-only residential mortgage loans are summarized in the following table. -------------------------------------------------------------------------------- June 30, December 31, 2007 2006 -------------------------------------------------------------------------------- (in millions) Residential mortgage loans with high LTV and no mortgage insurance ............................... $2,361 $ 2,717 Interest-only residential mortgage loans ............ 6,788 7,537 ------ ------- Total ............................................... $9,149 $10,254 ====== ======= Concentrations of first and second liens within the residential mortgage loan portfolio are summarized in the following table. Amounts in the table exclude loans held for sale. -------------------------------------------------------------------------------- June 30, December 31, 2007 2006 -------------------------------------------------------------------------------- (in millions) Closed end: First lien ........................................ $29,989 $31,876 Second lien ....................................... 661 474 Revolving: Second lien ....................................... 3,058 3,231 ------- ------- Total ................................................ $33,708 $35,581 ======= ======= HUSI also offers adjustable rate residential mortgage loans which allow it to adjust pricing on the loan in line with market movements. As interest rates have risen over the last three years, many adjustable rate loans are expected to require a significantly higher monthly payment following their first adjustment. A customer's financial situation at the time of the interest rate reset could affect their ability to repay the loan after the adjustment, or may cause the customer to prepay or refinance the loan. At June 30, 2007, HUSI had approximately $19.3 billion in adjustable rate residential mortgage loans. For the remainder of 2007, approximately $.9 billion of adjustable rate residential mortgage loans will experience their first interest rate reset. In 2008, approximately $3.3 billion of adjustable rate residential mortgage loans will experience their first interest rate reset. Interest Rate Risk Management Various techniques are utilized to quantify and monitor risks associated with the repricing characteristics of HUSI's assets, liabilities, and derivative contracts. The approach toward managing interest rate risk is summarized on pages 77-79 of HUSI's 2006 Form 10-K. During the first six months of 2007, there were no significant changes in policies or approach for managing interest rate risk. Present Value of a Basis Point (PVBP) Analysis PVBP is the change in value of the balance sheet for a one basis point upward movement in all interest rates. HUSI's PVBP position is summarized in the following table. -------------------------------------------------------------------------------- June 30, 2007 Values -------------------------------------------------------------------------------- (in millions) Institutional PVBP movement limit .............................. $6.5 PVBP position at period end .................................... 2.6 64 Economic Value of Equity Economic value of equity is the change in value of the assets and liabilities (excluding capital and goodwill) for either a 200 basis point gradual rate increase or decrease. HUSI's economic value of equity position is summarized in the following table. --------------------------------------------------------------------------------------------------------- June 30, 2007 Values (%) --------------------------------------------------------------------------------------------------------- Institutional economic value of equity limit ............................................ +/- 20 Projected change in value (reflects projected rate movements on July 1, 2007): Change resulting from a gradual 200 basis point increase in interest rates ........... (7) Change resulting from a gradual 200 basis point decrease in interest rates ........... -- (1) (1) Less than .5% loss in value The loss in value for a 200 basis point increase or decrease in rates is a result of the negative convexity of the residential whole loan and mortgage backed securities portfolios. If rates decrease, the projected prepayments related to these portfolios will accelerate, causing less appreciation than a comparable term, non-convex instrument. If rates increase, projected prepayments will slow, which will cause the average lives of these positions to extend and result in a greater loss in market value. Dynamic Simulation Modeling Various modeling techniques are utilized to monitor a number of interest rate scenarios for their impact on net interest income. These techniques include both rate shock scenarios which assume immediate market rate movements by as much as 200 basis points, as well as scenarios in which rates rise or fall by as much as 200 basis points over a twelve month period. The following table reflects the impact on net interest income of the scenarios utilized by these modeling techniques. ----------------------------------------------------------------------------------------------------------------- June 30, 2007 Values ----------------------- Amount % ----------------------------------------------------------------------------------------------------------------- ($ in millions) Projected change in net interest income for scenarios subject to a formal institutional movement limit (reflects projected rate movements on July 1, 2007): Institutional base earnings movement limit .......................................... (10) Change resulting from a gradual 200 basis point increase in the yield curve ......... $(211) (7) Change resulting from a gradual 200 basis point decrease in the yield curve ......... 245 8 Change resulting from a gradual 100 basis point increase in the yield curve ......... (101) (3) Change resulting from a gradual 100 basis point decrease in the yield curve ......... 125 4 Other significant scenarios monitored for internal purposes, not subject to a formal institutional movement limit (reflects projected rate movements on July 1, 2007): Change resulting from an immediate 100 basis point increase in the yield curve ...... (178) (6) Change resulting from an immediate 100 basis point decrease in the yield curve ...... 200 6 Change resulting from an immediate 200 basis point increase in the yield curve ...... (368) (11) Change resulting from an immediate 200 basis point decrease in the yield curve ...... 341 11 The projections do not take into consideration possible complicating factors such as the effect of changes in interest rates on the credit quality, size and composition of the balance sheet. Therefore, although this provides a reasonable estimate of interest rate sensitivity, actual results will vary from these estimates, possibly by significant amounts. 65 Capital Risk/Sensitivity of Other Comprehensive Income Large movements of interest rates could directly affect some reported capital and capital ratios. The mark to market valuation of available for sale securities is adjusted on a tax effective basis through other comprehensive income in the consolidated statement of changes in shareholders' equity. Although this valuation mark is excluded from Tier 1 and Tier 2 capital ratios, it is included in two important accounting based capital ratios: the tangible common equity to tangible assets and the tangible common equity to risk weighted assets. As of June 30, 2007, HUSI had an available for sale securities portfolio of approximately $20 billion with a net negative mark to market of $644 million included in tangible common equity of $8 billion. An increase of 25 basis points in interest rates of all maturities would lower the mark to market by approximately $180 million to a net loss of $824 million with the following results on the tangible capital ratios. ---------------------------------------------------------------------------------------- Proforma - Reflecting 25 Basis Points June 30, 2007 Actual Increase in Rates ---------------------------------------------------------------------------------------- Tangible common equity to tangible assets ............. 4.77% 4.71% Tangible common equity to risk weighted assets ........ 6.52 6.43 Market Risk Management Value at Risk (VAR) VAR analysis is used to estimate the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. VAR calculations are performed for all material trading activities and as a tool for managing interest rate risk inherent in non-trading activities. HUSI calculates VAR daily for a one-day holding period to a 99% confidence level. At a 99% confidence level for a two-year observation period, HUSI is setting as its limit the fifth worst loss performance in the last 500 business days. VAR - Trading Activities HUSI's management of market risk is based on restricting individual operations to trading within a list of permissible instruments, and enforcing rigorous approval procedures for new products. In particular, trading in the more complex derivative products is restricted to offices with appropriate levels of product expertise and robust control systems. In addition, at both portfolio and position levels, market risk in trading portfolios is monitored and controlled using a complementary set of techniques, including VAR and various techniques for monitoring interest rate risk (beginning on page 64 of this Form 10-Q). These techniques quantify the impact on capital of defined market movements. Trading portfolios reside primarily within the Markets unit of the CIBM business segment, which include warehoused residential mortgage loans purchased for securitizations and within the mortgage banking subsidiary included within the PFS business segment. Portfolios include foreign exchange, derivatives, precious metals (gold, silver, platinum), equities, money market instruments and securities. Trading occurs as a result of customer facilitation, proprietary position taking, and economic hedging. In this context, economic hedging may include, for example, forward contracts to sell residential mortgages and derivative contracts which, while economically viable, may not satisfy the hedge requirements of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The trading portfolios have defined limits pertaining to items such as permissible investments, risk exposures, loss review, balance sheet size and product concentrations. "Loss review" refers to the maximum amount of loss that may be incurred before senior management intervention is required. 66 Trading VAR for 2007 is summarized in the following table. -------------------------------------------------------------------------------------------- Six months ended June 30, 2007 June 30, ------------------------------ December 31, 2007 Minimum Maximum Average 2006 -------------------------------------------------------------------------------------------- (in millions) Total trading .............. $19 $ 8 $19 $13 $ 9 Precious metals ............ -- (1) -- (1) 4 1 2 Credit derivatives ......... 6 2 7 4 4 Equities ................... 1 -- (1) 4 -- (1) -- (1) Foreign exchange ........... 1 1 3 1 2 Interest rate .............. 5 8 20 14 13 (1) Less than $500 thousand. The frequency distribution of daily market risk-related revenues for trading activities during 2007 is summarized in the following table. Market risk-related trading revenues include realized and unrealized gains (losses) related to trading activities, but exclude the related net interest income. Analysis of the gain (loss) data for the three months ended June 30, 2007 shows that the largest daily gain was $25 million and the largest daily loss was $9 million. Analysis of the gain (loss) data for the six months ended June 30, 2007 shows that the largest daily gain was $25 million and the largest daily loss was $12 million. -------------------------------------------------------------------------------------------------- Ranges of daily Treasury trading revenue earned from market risk-related activities Below $(5) to $0 to $5 to Over (in millions) $(5) $0 $5 $10 $10 -------------------------------------------------------------------------------------------------- Three months ended June 30, 2007: Number of trading days market risk-related revenue was within the stated range ....................... 3 8 30 16 6 Six months ended June 30, 2007: Number of trading days market risk-related revenue was within the stated range ....................... 14 38 50 17 6 VAR - Non-trading Activities The principal objective of market risk management of non-trading portfolios is to optimize net interest income. Market risk in non-trading portfolios arises principally from mismatches between the future yield on assets and their funding cost, as a result of interest rate changes. Analysis of this risk is complicated by having to make assumptions on optionality in certain product areas, for example, mortgage prepayments, and from behavioral assumptions regarding the economic duration of liabilities which are contractually repayable on demand. The prospective change in future net interest income from non-trading portfolios will be reflected in the current realizable value of these positions, should they be sold or closed prior to maturity. In order to manage this risk optimally, market risk in non-trading portfolios is transferred to Global Markets or to separate books managed under the supervision of ALCO. Once market risk has been consolidated in Global Markets or ALCO-managed books, the net exposure is typically managed through the use of interest rate swaps within agreed-upon limits. Non-trading VAR for 2007, assuming a 99% confidence level for a two-year observation period and a one-day "holding period", is summarized in the following table. ----------------------------------------------------------------------------------------- Six months ended June 30, 2007 June 30, ------------------------------- December 31, 2007 Minimum Maximum Average 2006 ----------------------------------------------------------------------------------------- (in millions) Interest rate ............. $41 $18 $55 $29 $24 67 Trading Activities - HSBC Mortgage Corporation (USA) HSBC Mortgage Corporation (USA) is HUSI's mortgage banking subsidiary. Trading occurs in mortgage banking operations as a result of an economic hedging program intended to offset changes in value of mortgage servicing rights and the salable loan pipeline. Economic hedging may include, for example, forward contracts to sell residential mortgages and derivative contracts used to protect the value of MSRs. MSRs are assets that represent the present value of net servicing income (servicing fees, ancillary income, escrow and deposit float, net of servicing costs). MSRs are recognized upon the sale of the underlying loans or at the time that servicing rights are purchased. MSRs are subject to interest rate risk, in that their value will fluctuate as a result of a changing interest rate environment. Interest rate risk is mitigated through an active hedging program that uses trading securities and derivative instruments to offset changes in value of MSRs. Since the hedging program involves trading activity, risk is quantified and managed using a number of risk assessment techniques. Rate Shock Analysis Modeling techniques are used to monitor certain interest rate scenarios for their impact on the economic value of net hedged MSRs, as reflected in the following table. ------------------------------------------------------------------------------------------------------- June 30, 2007 Values ------------------------------------------------------------------------------------------------------- (in millions) Projected change in net market value of hedged MSRs portfolio (reflects projected rate movements on July 1, 2007): Value of hedged MSRs portfolio ..................................................... $552 Change resulting from an immediate 50 basis point decrease in the yield curve: Change limit (no worse than) .................................................... (16) Calculated change in net market value ........................................... (3) Change resulting from an immediate 50 basis point increase in the yield curve: Change limit (no worse than) .................................................... (8) Calculated change in net market value ........................................... 5 Change resulting from an immediate 100 basis point increase in the yield curve: Change limit (no worse than) .................................................... (12) Calculated change in net market value ........................................... 11 Economic Value of MSRs The economic value of the net, hedged MSRs portfolio is monitored on a daily basis for interest rate sensitivity. If the economic value declines by more than established limits for one day or one month, various levels of management review, intervention and/or corrective actions are required. Hedge Volatility The frequency distribution of the weekly economic value of MSR assets during 2007 is summarized in the following table. This includes the change in the market value of the MSR asset net of changes in the market value of the underlying hedging positions used to hedge the asset. The changes in economic value are adjusted for changes in MSR valuation assumptions that were made during the course of the quarter, if applicable. ------------------------------------------------------------------------------------------------- Ranges of mortgage economic value from market risk- Below $(2) to $0 to $2 to Over related activities (in millions) $(2) $0 $2 $4 $4 ------------------------------------------------------------------------------------------------- Three months ended June 30, 2007: Number of trading weeks market risk-related revenue was within the stated range ........................ 2 3 5 2 1 Six months ended June 30, 2007: Number of trading weeks market risk-related revenue was within the stated range ........................ 4 6 10 4 2 68 HSBC USA Inc. Consolidated Average Balances and Interest Rates -------------------------------------------------------------------------------- The following table shows the quarter to date average balances of the principal components of assets, liabilities and shareholders' equity together with their respective interest amounts and rates earned or paid, presented on a taxable equivalent basis. Three months ended June 30, --------------------------------------------------------------- 2007 2006 ---------------------------- ----------------------------- Balance Interest Rate* Balance Interest Rate* --------------------------------------------------------------- (in millions) Assets Interest bearing deposits with banks ............ $ 5,745 $ 81 5.64% $ 4,893 $ 74 6.08% Federal funds sold and securities purchased under resale agreements ............ 12,855 177 5.53 9,722 119 4.88 Trading assets .................................. 12,582 168 5.37 10,982 102 3.74 Securities ...................................... 21,907 282 5.16 21,925 281 5.13 Loans Commercial ................................... 29,538 480 6.52 27,994 431 6.18 Consumer: Residential mortgages .................... 38,904 530 5.46 42,483 560 5.29 Credit cards ............................. 17,555 405 9.26 15,215 324 8.55 Other consumer ........................... 2,480 62 10.08 3,007 67 8.91 -------- ------ ------ -------- ------ ------ Total consumer ............................. 58,939 997 6.79 60,705 951 6.28 -------- ------ ------ -------- ------ ------ Total loans ................................ 88,477 1,477 6.70 88,699 1,382 6.25 -------- ------ ------ -------- ------ ------ Other ........................................... 3,035 44 5.74 1,829 24 5.21 -------- ------ ------ -------- ------ ------ Total earning assets ............................ 144,601 $2,229 6.18% 138,050 $1,982 5.76% -------- ====== ------ -------- ====== ------ Allowance for credit losses ..................... (918) (921) Cash and due from banks ......................... 2,804 3,808 Other assets .................................... 21,515 23,944 -------- -------- Total assets .................................... $168,002 $164,881 ======== ======== Liabilities and Shareholders' Equity Deposits in domestic offices Savings deposits ............................. $ 43,434 $ 356 3.29% $ 35,195 $ 239 2.72% Other time deposits .......................... 22,236 303 5.47 24,177 281 4.67 Deposits in foreign offices Foreign banks deposits ....................... 8,860 112 5.05 7,385 95 5.17 Other time and savings ....................... 15,685 188 4.81 15,245 154 4.04 -------- ------ ------ -------- ------ ------ Total interest bearing deposits ................. 90,215 959 4.26 82,002 769 3.76 -------- ------ ------ -------- ------ ------ Short-term borrowings ........................... 8,948 105 4.70 10,825 74 2.73 Long-term debt .................................. 28,806 350 4.88 28,922 357 4.95 -------- ------ ------ -------- ------ ------ Total interest bearing liabilities .............. 127,969 1,414 4.43 121,749 1,200 3.95 -------- ------ ------ -------- ------ ------ Net interest income / Interest rate spread ...... $ 815 1.75% $ 782 1.81% ====== ------ ====== ------ Noninterest bearing deposits .................... 13,188 11,722 Other liabilities ............................... 14,652 19,378 Total shareholders' equity ...................... 12,193 12,032 -------- -------- Total liabilities and shareholders' equity ...... $168,002 $164,881 ======== ======== Net interest margin on average earning assets ... 2.26% 2.27% ------ ------ Net interest margin on average total assets ..... 1.94% 1.90% ====== ====== * Rates are calculated on unrounded numbers. Total weighted average rate earned on earning assets is interest and fee earnings divided by daily average amounts of total interest earning assets, including the daily average amount on nonperforming loans. Loan interest for the three months ended June 30, 2007 and 2006 included fees of $13 million and $17 million, respectively. 69 HSBC USA Inc. Consolidated Average Balances and Interest Rates -------------------------------------------------------------------------------- The following table shows the year to date average balances of the principal components of assets, liabilities and shareholders' equity together with their respective interest amounts and rates earned or paid, presented on a taxable equivalent basis. Six months ended June 30, --------------------------------------------------------------- 2007 2006 ---------------------------- ----------------------------- Balance Interest Rate* Balance Interest Rate* --------------------------------------------------------------- (in millions) Assets Interest bearing deposits with banks ............ $ 4,855 $ 137 5.72% $ 4,421 $ 127 5.77% Federal funds sold and securities purchased under resale agreements ............ 12,467 340 5.50 8,210 192 4.72 Trading assets .................................. 11,677 309 5.34 10,542 210 4.02 Securities ...................................... 22,214 576 5.23 21,621 551 5.13 Loans Commercial ................................... 29,104 939 6.51 27,237 816 6.05 Consumer: Residential mortgages .................... 38,994 1,057 5.47 43,180 1,129 5.27 Credit cards ............................. 17,619 797 9.12 15,188 592 7.86 Other consumer ........................... 2,568 126 9.89 3,056 132 8.71 -------- ------ ------ -------- ------ ------ Total consumer ............................. 59,181 1,980 6.75 61,424 1,853 6.08 -------- ------ ------ -------- ------ ------ Total loans ................................ 88,285 2,919 6.67 88,661 2,669 6.07 -------- ------ ------ -------- ------ ------ Other ........................................... 2,656 76 5.74 1,256 37 5.98 -------- ------ ------ -------- ------ ------ Total earning assets ............................ 142,154 $4,357 6.18% 134,711 $3,786 5.67% -------- ====== ------ -------- ====== ------ Allowance for credit losses ..................... (928) (928) Cash and due from banks ......................... 2,989 3,977 Other assets .................................... 21,548 22,573 -------- -------- Total assets .................................... $165,763 $160,333 ======== ======== Liabilities and Shareholders' Equity Deposits in domestic offices Savings deposits ............................. $ 41,939 $ 677 3.26% $ 32,189 $ 392 2.46% Other time deposits .......................... 22,798 612 5.41 25,449 563 4.46 Deposits in foreign offices Foreign banks deposits ....................... 8,958 221 4.97 7,303 172 4.75 Other time and savings ....................... 14,467 338 4.71 15,013 292 3.92 -------- ------ ------ -------- ------ ------ Total interest bearing deposits ................. 88,162 1,848 4.23 79,954 1,419 3.58 -------- ------ ------ -------- ------ ------ Short-term borrowings ........................... 8,797 176 4.04 10,435 146 2.82 Long-term debt .................................. 29,029 723 5.02 28,917 697 4.86 -------- ------ ------ -------- ------ ------ Total interest bearing liabilities .............. 125,988 2,747 4.40 119,306 2,262 3.82 -------- ------ ------ -------- ------ ------ Net interest income / Interest rate spread ...... $1,610 1.78% $1,524 1.85% ====== ------ ====== ------ Noninterest bearing deposits .................... 13,558 12,358 Other liabilities ............................... 14,002 16,796 Total shareholders' equity ...................... 12,215 11,873 -------- -------- Total liabilities and shareholders' equity ...... $165,763 $160,333 ======== ======== Net interest margin on average earning assets ... 2.28% 2.28% ------ ------ Net interest margin on average total assets ..... 1.96% 1.92% ====== ====== * Rates are calculated on unrounded numbers. Total weighted average rate earned on earning assets is interest and fee earnings divided by daily average amounts of total interest earning assets, including the daily average amount on nonperforming loans. Loan interest for the six months ended June 30, 2007 and 2006 included fees of $23 million and $29 million, respectively. 70 Item 3. Quantitative and Qualitative Disclosures About Market Risk -------------------------------------------------------------------------------- Refer to Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, under the captions "Interest Rate Risk Management" and "Trading Activities", beginning on page 63 of this Form 10-Q. Item 4. Controls and Procedures -------------------------------------------------------------------------------- HUSI maintains a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, as amended, (the Exchange Act), is recorded, processed, summarized and reported on a timely basis. HUSI's Board of Directors, operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight to the financial reporting process. An evaluation was conducted, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of HUSI's disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that HUSI's disclosure controls and procedures were effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports filed under the Exchange Act. There have been no 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 control structure and procedures for financial reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, HUSI's first report under Section 404 will be contained in its Form 10-K for the period ended December 31, 2007. 71 Part II - OTHER INFORMATION -------------------------------------------------------------------------------- Item 1A. Risk Factors -------------------------------------------------------------------------------- Risk factors were set forth in HUSI's Form 10-K for the period ended December 31, 2006. There have been no material changes from the risk factors disclosed in that Form 10-K. Item 6. Exhibits -------------------------------------------------------------------------------- 12 Computation of Ratio of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.0 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 72 SIGNATURE -------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HSBC USA Inc. ------------- (Registrant) Date: July 30, 2007 /s/ Joseph R. Simpson ------------------------------------------ Joseph R. Simpson Executive Vice President and Controller (On behalf of Registrant) 73 Exhibit 12 HSBC USA Inc. Computation of Ratio of Earnings to Fixed Charges and Earnings to Combined Fixed Charges and Preferred Stock Dividends (in millions, except ratios) -------------------------------------------------------------------------------------------------- Six months ended June 30 2007 2006 -------------------------------------------------------------------------------------------------- Ratios excluding interest on deposits: Net income ................................................................... $ 564 $ 594 Income tax expense ........................................................... 253 308 Less: Undistributed equity earnings .......................................... -- 25 Fixed charges: Interest on: Borrowed funds ......................................................... 176 146 Long-term debt ......................................................... 723 697 One third of rents, net of income from subleases .......................... 14 12 ------ ------ Total fixed charges, excluding interest on deposits .......................... 913 855 Earnings before taxes and fixed charges, net of undistributed equity earnings .................................................................. $1,730 $1,732 ====== ====== Ratio of earnings to fixed charges ........................................... 1.89 2.03 ====== ====== Total preferred stock dividend factor (1) .................................... $ 72 $ 57 ------ ------ Fixed charges, including the preferred stock dividend factor ................. $ 985 $ 912 ====== ====== Ratio of earnings to combined fixed charges and preferred stock dividends .... 1.76 1.90 ====== ====== Ratios including interest on deposits: Total fixed charges, excluding interest on deposits .......................... $ 913 $ 855 Add: Interest on deposits .................................................... 1,848 1,419 ------ ------ Total fixed charges, including interest on deposits .......................... $2,761 $2,274 ====== ====== Earnings before taxes and fixed charges, net of undistributed equity earnings .................................................................. $1,730 $1,732 Add: Interest on deposits .................................................... 1,848 1,419 ------ ------ Total ........................................................................ $3,578 $3,151 ====== ====== Ratio of earnings to fixed charges ........................................... 1.30 1.39 ====== ====== Fixed charges, including the preferred stock dividend factor ................. $ 985 $ 912 Add: Interest on deposits .................................................... 1,848 1,419 ------ ------ Fixed charges, including the preferred stock dividend factor and interest on deposits ............................................................... $2,833 $2,331 ====== ====== Ratio of earnings to combined fixed charges and preferred stock dividends .... 1.26 1.35 ====== ====== (1) Preferred stock dividends grossed up to their pretax equivalents. 74 Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. -------------------------------------------------------------------------------- I, Paul J. Lawrence, certify that: 1. I have reviewed this report on Form 10-Q for the quarterly period ended June 30, 2007 of HSBC USA Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal controls over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: July 30, 2007 /s/ Paul J. Lawrence --------------------------------------- Paul J. Lawrence President and Chief Executive Officer 75 Exhibit 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. -------------------------------------------------------------------------------- I, Gerard Mattia, certify that: 1. I have reviewed this report on Form 10-Q for the quarterly period ended June 30, 2007 of HSBC USA Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal controls over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: July 30, 2007 /s/ Gerard Mattia --------------------------------------- Gerard Mattia Senior Executive Vice President and Chief Financial Officer 76 Exhibit 32.0 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -------------------------------------------------------------------------------- Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of HSBC USA Inc., a Maryland corporation (HUSI), does hereby certify, to such officer's knowledge, that: The Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 (the Form 10-Q) of HUSI fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of HUSI. Date: July 30, 2007 /s/ Paul J. Lawrence ---------------------------------------- Paul J. Lawrence President and Chief Executive Officer Date: July 30, 2007 /s/ Gerard Mattia ---------------------------------------- Gerard Mattia Senior Executive Vice President and Chief Financial Officer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code) and is not being filed as part of the Form 10-Q or as a separate disclosure document. A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to HSBC USA Inc. and will be retained by HSBC USA Inc. and furnished to the United States Securities and Exchange Commission or its staff upon request. 77 This information is provided by RNS The company news service from the London Stock Exchange

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