10-K 1 c62398e10vk.htm FORM 10-K e10vk
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
     
(Mark One)
 
x
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from           to          
 
Commission file number 1-7436
 
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
 
     
Maryland
  13-2764867
(State of incorporation)   (I.R.S. Employer Identification No.)
452 Fifth Avenue, New York
  10018
(Address of principal executive offices)
  (Zip Code)
(212) 525-5000
Registrant’s telephone number, including area code
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Floating Rate Notes due June 17, 2011
  New York Stock Exchange
3.125% Guaranteed Notes due December 16, 2011
  New York Stock Exchange
Floating Rate Guaranteed Notes due December 19, 2011
  New York Stock Exchange
Depositary Shares (each representing a one-fourth share of
  New York Stock Exchange
Adjustable Rate Cumulative Preferred Stock, Series D)
   
$2.8575 Cumulative Preferred Stock
  New York Stock Exchange
Floating Rate Non-Cumulative Preferred Stock, Series F
  New York Stock Exchange
Depositary Shares (each representing a one-fortieth share of
  New York Stock Exchange
Floating Rate Non-Cumulative Preferred Stock, Series G)
   
Depositary Shares (each representing a one-fortieth share of
  New York Stock Exchange
6.5% Non-Cumulative Preferred Stock, Series H)
   
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer o
  Accelerated filer o   Non-accelerated filer x
(Do not check if a smaller reporting company)
  Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x
 
As of February 25, 2011, there were 712 shares of the registrant’s common stock outstanding, all of which are owned by HSBC North America Inc.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
None.
 


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HSBC USA Inc.
 
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 EX-12
 EX-21
 EX-23
 EX-31
 EX-32


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PART I
 
Item 1. Business.
 
Organization History and Acquisition by HSBC
 
HSBC USA Inc. (“HSBC USA” and, together with its subsidiaries, “HUSI”), incorporated under the laws of the State of Maryland in 1973 as Republic New York Corporation, traces its origin to 1850 and The Marine Trust Company in Buffalo, New York, which later became Marine Midland Bank. In 1980, The Hongkong and Shanghai Banking Corporation Limited (now HSBC Holdings plc, hereinafter referred to as “HSBC”) acquired 51 percent of the common stock of Marine Midland Banks, Inc., the holding company for Marine Midland Bank, and the remaining 49 percent in 1987. In December 1999, HSBC acquired Republic New York Corporation through a merger with RNYC Merger Corporation, a wholly owned subsidiary of HSBC, with Republic New York Corporation surviving the merger and merged Marine Midland Banks, Inc., then known as HSBC USA Inc., with and into Republic New York Corporation. In January 2000, Republic New York Corporation changed its name to “HSBC USA Inc.”
 
HSBC North America Operations
 
HSBC North America Holdings Inc. (“HSBC North America”) is the holding company for HSBC’s operations in the United States. The principal subsidiaries of HSBC North America at December 31, 2010 were HSBC USA Inc., HSBC Markets (USA) Inc., a holding company for certain global banking and markets subsidiaries, HSBC Finance Corporation (“HSBC Finance”), a holding company for consumer finance businesses, and HSBC Technology & Services (USA) Inc. (“HTSU”), a provider of information technology and centralized operational and support services including human resources, tax, finance, compliance, legal, corporate affairs and other services shared among the subsidiaries of HSBC North America. In late January 2010, HSBC North America sold HSBC Bank Canada, a Federal bank chartered under the laws of Canada (“HBCA”), to an affiliate as part of an internal HSBC reorganization. As a result, HBCA is no longer a subsidiary of HSBC North America. Under the oversight of HSBC North America, HUSI works with its affiliates to maximize opportunities and efficiencies in HSBC’s operations in the United States. These affiliates do so by providing each other with, among other things, alternative sources of liquidity to fund operations and expertise in specialized corporate functions and services. This has been demonstrated by purchases and sales of receivables between HSBC Bank USA, National Association (“HSBC Bank USA”) and HSBC Finance and a pooling of resources within HTSU to provide shared, allocated support functions to all HSBC North America subsidiaries. In addition, clients of HSBC Bank USA, HSBC USA’s principal U.S. banking subsidiary, and other affiliates are investors in debt and preferred securities issued by HSBC USA and/or HSBC Bank USA, providing significant sources of liquidity and capital to both entities. HSBC Securities (USA) Inc., a Delaware corporation, a registered broker dealer and a subsidiary of HSBC Markets (USA) Inc., leads or participates as underwriter of all HUSI domestic issuances of term debt and HSBC Finance term debt and, historically, asset-backed securities. While neither HSBC USA nor HSBC Bank USA has received advantaged pricing, the underwriting fees and commissions payable to HSBC Securities (USA) Inc. benefit HSBC as a whole.
 
HSBC USA Inc. – General
 
HSBC Bank USA, HSBC USA’s principal U.S. banking subsidiary, is a national banking association with banking branch offices and/or representative offices in California, Connecticut, Delaware, Florida, Illinois, Maryland, Massachusetts, New Jersey, New York, Oregon, Pennsylvania, Texas, Virginia, Washington and the District of Columbia. In addition to its domestic offices, HSBC Bank USA maintains foreign branch offices, subsidiaries and/or representative offices in the Caribbean, Europe, Asia, Latin America and Canada. In this Form 10-K, HSBC USA and its subsidiaries are referred to as “we”, “us” or “our”. Through HSBC Bank USA, we offer our customers a full range of commercial and consumer banking products and related financial services. Our customers include individuals, including high net worth individuals, small businesses, corporations, institutions and governments. HSBC Bank USA also engages in mortgage banking, and is an international dealer in derivative instruments


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denominated in U.S. dollars and other currencies, focusing on structuring of transactions to meet clients’ needs. HSBC Bank USA’s main office is in McLean, Virginia, and its principal executive offices are located at 452 Fifth Avenue, New York, New York. Its domestic operations are located primarily in the state of New York.
 
In 2005, HSBC USA incorporated a nationally chartered limited purpose bank subsidiary, HSBC Trust Company (Delaware), National Association (“HTCD”), the primary activities of which are serving as custodian of investment securities for other HSBC affiliates and providing personal trust services. Prior to HSBC Finance exiting the Taxpayer Financial Services business in December 2010, HTCD also originated refund anticipation loans and checks in support of that program. The impact of HTCD’s operations on HSBC USA’s consolidated balance sheets and results of operations for the years ended December 31, 2010, 2009 and 2008 was not material.
 
In 2006, HSBC USA formed HSBC National Bank USA (“HBMD”), a national banking association established to support HSBC USA’s retail branch expansion strategy. HBMD was merged with and into HSBC Bank USA in December 2008, at which time HSBC Bank USA relocated our main office to McLean, Virginia. The impact of HBMD’s operations on HSBC USA’s consolidated balance sheet and results of operations for the year ended December 31, 2008 was not material.
 
Income Before Income Tax Expense – Significant Trends Income (loss) for continuing operations before income tax expense, and various trends and activity affecting operations, are summarized in the following table.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Income (loss) from continuing operations before income tax from prior year
  $ (299 )   $ (2,676 )   $ 86  
Increase (decrease) in income from continuing operations before income tax attributable to:
                       
Balance sheet management activities(1)
    (238 )     676       127  
Trading revenue(2)
    265       2,925       (2,689 )
Credit card fees(3)
    (446 )     477       62  
Loans held for sale(4)
    297       263       (9 )
Residential mortgage banking related revenue (loss)(5)
    (294 )     183       (85 )
Gain (loss) on own debt designated at fair value and related derivatives(6)
    733       (1,164 )     670  
Gain (loss) on instruments designated at fair value and related derivatives, excluding own debt(6)
    (186 )     625       (384 )
Provision for credit losses(7)
    3,011       (1,601 )     (1,021 )
Goodwill impairment loss(8)
    -       54       (54 )
All other activity(9)
    (543 )     (61 )     621  
                         
      2,599       2,377       (2,762 )
                         
Income (loss) from continuing operations before income tax for current year
  $ 2,300     $ (299 )   $ (2,676 )
                         
 
 
(1) Balance sheet management activities are comprised primarily of net interest income and, to a lesser extent, gains or losses on sales of investments, resulting from management of interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. For additional discussion regarding Global Banking and Markets net interest income, trading revenues, and the Global Banking and Markets business segment see the caption “Business Segments” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) section of this Form 10-K.
 
(2) For additional discussion regarding trading revenue, see the caption “Results of Operations” in the MD&A section of this Form 10-K.
 
(3) For additional discussion regarding credit card fees, see the caption “Results of Operations” in the MD&A section of this Form 10-K.
 
(4) For additional discussion regarding loans, see the caption “Balance Sheet Review” in the MD&A section of this Form 10-K.
 
(5) For additional discussion regarding residential mortgage banking revenue, see the caption “Results of Operations” in the MD&A section of this Form 10-K.
 
(6) For additional discussion regarding fair value option and fair value measurement, see Note 17 “Fair Value Option,” in the accompanying consolidated financial statements.
 
(7) For additional discussion regarding provision for credit losses, see the caption “Results of Operations” in the MD&A section of this Form 10-K.


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(8) For additional discussion regarding goodwill impairment, see Note 12, “Goodwill,” in the accompanying consolidated financial statements.
 
(9) Represents other banking activities.
 
Funding
 
We fund our operations using a diversified deposit base, supplemented by issuing short-term and long-term debt, borrowing under unsecured and secured financing facilities, issuing preferred equity, selling liquid assets and, as necessary, receiving capital contributions from our immediate parent, HSBC North America Inc. (“HNAI”). Our continued success is primarily dependent upon our ability to attract and retain deposits. Emphasis is placed on maintaining stability in core deposit balances. Numerous factors, both internal and external, may impact our access to, and the costs associated with, both retail and wholesale sources of funding. These factors may include our debt ratings, overall economic conditions, overall capital markets volatility, the counterparty credit limits of investors to the HSBC Group and the effectiveness of our management of the credit risks inherent in our business and customer base.
 
In 2010, our primary source of funds continued to be deposits, augmented by issuances of commercial paper and term debt. We have continued to reduce our reliance on debt capital markets by increasing stable deposits. We have increased our emphasis on relationship deposits where clients have purchased multiple products from us such as HSBC Premier for individuals, as those balances will tend to be significantly more stable than non-relationship deposits. We issued a total of $4.7 billion of long-term debt at various points during 2010, including $2.0 billion in subordinated term funding which provided additional capital and liquidity support. We also retired long-term debt of $5.4 billion in 2010. We did not receive any capital contributions from our parent, HNAI, in 2010, while maintaining capital at levels we believe are prudent in the current market conditions.
 
A detailed description of our sources and availability of funding are set forth in the “Liquidity and Capital Resources” and “Off Balance Sheet Arrangements” sections of the MD&A.
 
We use the cash generated by these funding sources to service our debt obligations, originate and purchase new loans, purchase investment securities and pay dividends to our preferred shareholders and, as available and appropriate, to our parent.
 
Employees and Customers
 
At December 31, 2010, we had approximately 12,000 employees, which reflects the centralization of certain staff function employees to HTSU effective as of January 1, 2010 and the transfer of certain real estate servicing employees from HSBC Finance to HUSI in July 2010.
 
At December 31, 2010, we had over 4 million customers, some of which are customers of more than one of our businesses. Customers residing in the state of New York accounted for 27 percent of our outstanding loans.
 
Operations
 
We have five reportable segments: Personal Financial Services (“PFS”), Consumer Finance (“CF”), Commercial Banking (“CMB”), Global Banking and Markets and Private Banking (“PB”). Our segments are managed separately and are based upon customer groupings as well as products and services offered. Adjustments made at the corporate level for fair value option accounting related to certain debt issued are included under the “Other” caption within our segment disclosure. We are currently in the process of re-evaluating the financial information used to manage our business, including the scope and content of the financial data being reported to our management and Board of Directors. To the extent we make changes to this reporting in 2011, we will evaluate any impact such changes may have to our segment reporting.
 
Corporate goals and individual goals of executives are currently calculated in accordance with International Financial Reporting Standards (“IFRSs”) under which HSBC prepares its consolidated financial statements. As a result, operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources,


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such as employees, are made almost exclusively on an IFRS basis (a non-U.S. GAAP financial measure). Accordingly, in accordance with applicable accounting standards, our segment reporting is on an IFRS basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis. For additional financial information relating to our businesses and operating segments and a summary of the significant differences between U.S. GAAP and IFRSs as they impact our results, see Note 24, “Business Segments,” in the accompanying consolidated financial statements.
 
Personal Financial Services Segment Through its 477 branches, 117 of which are in New York City, PFS provides banking and wealth products and services, including personal loans, MasterCard1 and Visa2 credit card loans, deposits, branch services and financial planning products and services such as mutual funds, investments and insurance. In recent years, we have expanded our branch network into the states of California, Pennsylvania, Connecticut, Washington, Florida, New Jersey, Maryland, Oregon, Washington, Virginia and the District of Columbia.
 
Our lead customer proposition, HSBC Premier, is a premium service wealth and relationship banking proposition designed for the internationally minded mass affluent consumer. HSBC Premier provides customers access to a broad selection of local and international banking and wealth products and services that have been tailored to the needs of our HSBC Premier customers. HSBC Premier enables customers to access all their accounts from a single on-line view and includes free international funds transfers between these accounts and access to a range of wealth management solutions. The Premier service is delivered by a personal Premier relationship manager, supported by a 24-hour priority telephone and internet service.
 
Consumer Finance Segment The CF segment includes point of sale and other lending activities primarily to meet the financial needs of individuals. Specifically, operating activity within the CF segment relates primarily to credit card receivables, including private label credit card receivables, purchased from HSBC Finance. In December 2004, we purchased the portfolio of credit card (“PLCC”) receivables originated under HSBC Finance’s private label credit card business. In January 2009, we purchased portfolios of credit card receivables originated under HSBC Finance’s General Motors MasterCard program and Union Plus MasterCard and Visa credit card program, as well as certain auto finance receivables, from HSBC Finance. We will also purchase additional receivable originations generated under existing and future PLCC, General Motors and Union Plus accounts. In 2010, the purchased auto finance loans were sold to Santander Consumer USA (“SC USA”). Prior to HSBC Finance exiting the Taxpayer Financial Services business in December 2010, the CF segment included lending activities as an originator of refund anticipation loans and checks in support of that program. These activities have historically not had a significant impact on our results of operations.
 
Commercial Banking Segment In support of HSBC’s strategy to be the leader in international banking in target markets, CMB serves the growing number of U.S. companies that are increasingly in need of international banking and financial products and services. CMB offers comprehensive domestic and international services and banking, insurance and investment products to companies, government entities and non-profit organizations, with a particular emphasis on geographical collaboration to meet the banking needs of its international business customers. CMB provides loan and deposit products, payments and cash management services, merchant services, trade and supply chain, corporate finance, global markets and risk advisory products and services to small businesses and middle-market corporations, including specialized products such as real estate financing. CMB also offers various credit and trade related products such as standby facilities, performance guarantees and acceptances. These products and services are offered through multiple delivery systems, including our branch banking network.
 
Global Banking and Markets Segment Our Global Banking and Markets business segment supports HSBC’s emerging markets-led and financing-focused global strategy by leveraging HSBC Group advantages and scale, strength in developed and emerging markets and Global Markets products expertise in order to focus on delivering international products to U.S. clients and local products to international clients, with New York as the hub for the Americas business. Global Banking and Markets provides tailored financial solutions to major government, corporate and institutional clients as well as private investors worldwide. Managed as a global business, Global Banking and Markets clients are served by sector-focused teams that bring together relationship managers and


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product specialists to develop financial solutions that meet individual client needs. With a focus on providing client connectivity between the emerging markets and developed markets, we ensure that a comprehensive understanding of each client’s financial requirements is developed with a long-term relationship management approach. In addition to Global Banking and Markets clients, we also work with other segments such as PFS, CMB and PB to meet their domestic and international banking needs.
 
Within client-focused business lines, Global Banking and Markets offers a full range of capabilities:
 
  •  Corporate and investment banking and financing solutions for corporate and institutional clients, including loans, working capital, investment banking, trade services, payments and cash management, and leveraged and acquisition finance;
 
  •  One of the largest markets businesses of its kind, with 24-hour coverage and knowledge of local markets and providing services in credit and rates, foreign exchange, derivatives, money markets, precious metals trading, cash equities, equity derivatives and securities services; and
 
  •  Global asset management solutions for institutions, financial intermediaries and private investors worldwide.
 
Private Banking Segment PB provides private banking and trustee services to high net worth individuals and families with local and international needs. Accessing the most suitable products from the marketplace, PB works with its clients to offer both traditional and innovative ways to manage and preserve wealth while optimizing returns. PB offers a wide range of wealth management and specialist advisory services, including banking, liquidity management, investment services, custody services, tailored lending, wealth planning, trust and fiduciary services, insurance, family wealth and philanthropy advisory services. PB also works to ensure that its clients have access to other products and services, capabilities, resources and expertise available throughout HSBC, such as credit cards, investment banking, commercial real estate lending and middle market lending, to deliver services and solutions for all aspects of their wealth management needs.
 
Regulation and Competition
 
Regulation We are subject to, among other things, the elements of an extensive statutory and regulatory framework applicable to bank holding companies, financial holding companies and banks. U.S. regulation of banks, bank holding companies and financial holding companies is intended primarily for the protection of depositors, the federal Deposit Insurance Fund and the banking system as a whole rather than the protection of security holders and creditors. Events since early 2008 affecting the financial services industry and, more generally, the financial markets and the economy have led to a significant number of initiatives regarding reform of the financial services industry. The following discussion describes the current regulatory framework in which HSBC USA operates and anticipated changes to that framework.
 
Financial Regulatory Reform On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (“Dodd-Frank”) was signed into law. This legislation is a sweeping overhaul of the financial regulatory system. The new law is comprehensive and includes many provisions specifically relevant to our businesses and the businesses of our affiliates.
 
For instance, over a transition period from 2013 to 2015, the Federal Reserve Board will apply more stringent capital and risk management requirements on bank holding companies such as HSBC North America, which will require a minimum leverage ratio of five percent and a minimum total risk-based capital ratio of ten percent. The legislation also phases out the use of trust preferred securities for Tier 1 capital treatment by bank holding companies, which may negatively impact our capital ratios.
 
In order to preserve financial stability in the industry, the legislation has created the Financial Stability Oversight Council which may take certain actions, including precluding mergers, restricting financial products offered, restricting or terminating activities or imposing conditions on activities or requiring the sale or transfer of assets, against any bank holding company with assets greater than $50.0 billion that is found to pose a grave threat to


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financial stability. Large bank holding companies, such as HSBC North America, will also be required to file resolution plans and identify how insured bank subsidiaries are adequately protected from risk of other affiliates. The Federal Reserve Board will also adopt a series of increased supervisory standards to be followed by large bank holding companies. Additionally, activities of bank holding companies, such as the ability to acquire U.S. banks or to engage in non-banking activities, will be more directly tied to examination ratings of “well-managed” and “well capitalized.” There are also provisions in Dodd-Frank that relate to governance of executive compensation, including disclosures evidencing the relationship between compensation and performance and a requirement that some executive incentive compensation is forfeitable in the event of an accounting restatement.
 
In relation to requirements for bank transactions with affiliates, the legislation, which will be in effect beginning in July 2012, extends current quantitative limits on credit transactions to now include credit exposure related to repurchase agreements, derivatives and securities lending transactions. This provision may limit the use of intercompany transactions between us and our affiliates, which may impact our current funding and hedging strategies.
 
The legislation has numerous provisions addressing derivatives. There is the imposition of comprehensive regulation of over-the-counter (“OTC”) derivatives markets, including credit default and interest rate swaps, as well as limits on FDIC-insured banks’ overall OTC derivatives activities. Most of the significant provisions are to be implemented within two to three years of the enactment of the legislation. There is also the requirement for the use of mandatory derivative clearing houses and exchanges, which will significantly change the derivatives industry.
 
The “Volcker Rule” provisions of the legislation impose certain restrictions and parameters on the ability of covered banking entities, such as HSBC Bank USA and our affiliates, to engage in proprietary trading activities and to sponsor or invest in hedge funds or private equity funds. Rulemaking to implement the provisions of the Volcker Rule has not been completed, and covered banking entities will be granted a certain period of time following the enactment of these rules to conform their activities to the new requirements. We believe the provisions of the Volcker Rule will require changes to the conduct of certain existing businesses.
 
The legislation also provides for an increase in FDIC insurance assessments on FDIC-insured banks, such as HSBC Bank USA. The FDIC reserve ratio has been increased from 1.15 to 1.35, with the target of 1.35 to be reached by 2020, with the incremental cost charged to banks with more than $10.0 billion in assets. The assessment methodology will be revised to a methodology based on assets, and the change take effect beginning with second quarter 2011 assessments. This shift will have financial implications for all FDIC-insured banks, including HSBC Bank USA.
 
The legislation has created the Bureau of Consumer Financial Protection (the “CFPB”). The CFPB will be a new independent bureau within the Federal Reserve Board and will act as a single primary Federal consumer protection supervisor to regulate credit, savings, payment and other consumer financial products and services and providers of those products and services. Establishment of the CFPB is underway and the agency expects to be operational as of July 21, 2011. The CFPB will have the authority to issue regulations to prevent unfair, deceptive or abusive practices in connection with consumer financial products or services and to ensure features of any consumer financial products or services are fully, accurately and effectively disclosed to consumers. The CFPB will also have authority to examine large banks, including HSBC Bank USA, and their affiliates for compliance with those regulations.
 
With respect to certain state laws governing the provision of consumer financial products by national banks such as HSBC Bank USA, the legislation codifies the current judicial standard of federal preemption with respect to national banks, but adds procedural steps which must be followed by the Office of the Comptroller of the Currency (“OCC”) when considering preemption determinations after July 21, 2011. Furthermore, the legislation removes the ability of subsidiaries or agents of a national bank to claim federal preemption of consumer financial laws after July 21, 2011, although the legislation does not purport to affect existing contracts. These limitations on federal preemption may elevate our costs of compliance, while increasing litigation expenses as a result of potential Attorney General or plaintiff challenges and the risk of courts not giving deference to the OCC, as well as increasing complexity due to the lack of uniformity in state law. At this time, we are unable to determine the extent to which the limitations on federal preemption will impact our businesses and those of our competitors.


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The legislation contains many other consumer-related provisions, including provisions addressing mortgage reform. In the area of mortgage origination, there is a requirement to apply a net tangible benefit test for all refinancing transactions. There are also numerous revised servicing requirements for mortgage loans.
 
The legislation authorizes the Federal Reserve to implement standards for assessing debit interchange fees that are reasonable and proportionate to the actual processing costs of the issuer. The Federal Reserve recently released proposed regulations that would limit interchange fees to no more than 12 cents per transaction and would, if adopted, result in a substantial reduction in interchange revenue to us.
 
The legislation will have a significant impact on the operations of many financial institutions in the U.S., including HSBC USA and HSBC Bank USA and our affiliates. As the legislation calls for extensive regulations to be promulgated to interpret and implement the legislation, we are unable to determine precisely the impact that Dodd-Frank and related regulations will have on financial results at this time.
 
Bank Holding Company Supervision As a bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and to inspection, examination and supervision by our primary regulator, the Federal Reserve Board. We are also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the Securities and Exchange Commission (the “SEC”).
 
We have registered as a financial holding company pursuant to the BHC Act and, accordingly, may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental or complementary to activities that are financial in nature. “Financial in nature” activities include securities underwriting, dealing and market making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board, in consultation with the Secretary of the U.S. Treasury, determines from time to time to be financial in nature or incidental to such financial activity. “Complementary activities” are activities that the Federal Reserve determines upon application to be complementary to a financial activity and do not pose a safety and soundness risk.
 
Because we are a financial holding company, if either of our subsidiary banks fails to maintain a satisfactory rating under the Community Reinvestment Act of 1977, as amended (“CRA”), we would be prohibited from engaging in any additional activities other than those permissible for bank holding companies that are not financial holding companies, which are limited to activities that are closely related to banking under the BHC Act. In addition, should the Federal Reserve Board determine that either of our subsidiary banks fails to meet applicable capital and management standards, we would be required to enter into an agreement with the Federal Reserve Board to comply with all applicable capital and management requirements (which may contain additional limitations or conditions). Until corrected, we would be prohibited from engaging in the broader range of financial activities permissible for financial holding companies and any new activity or acquisition of companies engaged in activities that are not closely related to banking under the BHC Act would require prior approval of the Federal Reserve Board. If we were to fail to correct any such condition within a prescribed period, the Federal Reserve Board could order us to divest our banking subsidiaries or, in the alternative, to cease engaging in activities other than those closely related to banking under the BHC Act. As of December 31, 2010, our subsidiary banks satisfied the capital, management and CRA requirements necessary to permit us to conduct the broader activities permissible for financial holding companies.
 
We are generally prohibited under the BHC Act from acquiring, directly or indirectly, ownership or control of more than five percent of any class of voting shares of, or substantially all the assets of, or exercising control over, any U.S. bank, bank holding company or many other types of depository institutions and/or their holding companies without the prior approval of the Federal Reserve Board and, potentially, other U.S. banking regulatory agencies.
 
The Gramm-Leach-Bliley Act of 1999 (“GLB Act”) and the regulations issued thereunder contain a number of other provisions that affect our operations and those of our subsidiary banks. One such provision contained detailed requirements relating to the financial privacy of consumers. In addition, the so-called ‘push-out’ provisions of the GLB Act removed the blanket exemption from registration for securities activities conducted in banks (including HSBC Bank USA) under the Exchange Act of 1934, as amended. New rules have been published to implement


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these changes and, when effective, will allow banks to continue to avoid registration as a broker or dealer only if they conduct securities activities that fall within a set of defined exceptions. A narrowed ‘dealer’ definition took effect in September 2003, and a narrowed ‘broker’ definition took effect for each bank on the first day of its fiscal year following September 30, 2008. Pursuant to the new regulations, certain securities activities currently conducted by HSBC Bank USA were restructured or transferred to one or more U.S.-registered broker-dealer affiliates effective January 1, 2009.
 
Our consumer lending businesses operate in a highly regulated environment. In addition to the establishment of the CFPB and the other consumer-related provisions of Dodd-Frank described above, these businesses are subject to laws relating to consumer protection including, without limitation, fair lending, fair debt collection practices, use of credit reports, privacy matters, and disclosure of credit terms and correction of billing errors. Local, state and national regulatory and enforcement agencies continue efforts to address perceived problems within the mortgage lending and credit card industries through broad or targeted legislative or regulatory initiatives aimed at lenders’ operations in consumer lending markets. There continues to be a significant amount of legislative activity, nationally, locally and at the state level, designed to limit certain lending practices while mandating servicing activities.
 
On May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”) was signed into law and we have implemented all applicable provisions. The CARD Act has required us to make changes to our business practices, and will require us and our competitors to manage risk differently than has historically been the case. Pricing, underwriting and product changes have either been implemented or are under continuing analysis. The implementation of the new rules did not have a material adverse impact on us as any impact is limited to only a portion of the existing credit card loan portfolio as the purchase price on future credit card sales volume paid to HSBC Finance has been adjusted to reflect the new requirements and the impact on future cash flows. See “Segment Results – IFRSs Basis” in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) within this Form 10-K for further discussion of the impact of the CARD Act on our business.
 
Due to the turmoil in the mortgage lending markets, there has also been a significant amount of federal and state legislative and regulatory focus on this industry. Increased regulatory oversight over residential mortgage lenders has occurred, including through state and federal examinations and periodic inquiries from state attorneys general for information. Several regulators, legislators and other governmental bodies have promoted particular views of appropriate or “model” loan modification programs, suitable loan products and foreclosure and loss mitigation practices. We have developed a modification program that employs procedures which we believe are most responsive to our customers needs and continue to enhance and refine these practices as other programs are announced, and we evaluate the results of our customer assistance efforts. We continue to be active in various home preservation initiatives through participation at local events sponsored by public officials, community leaders and consumer advocates.
 
State and federal officials are investigating the procedures followed by mortgage servicing companies and banks, including HSBC Bank USA and certain of our affiliates, relating to foreclosures. We and our affiliates have responded to all related inquiries and cooperated with all applicable investigations, including a joint examination by staffs of the Office of the Comptroller of the Currency (the “OCC”) and the Federal Reserve Board (the “Federal Reserve”) as part of their broad horizontal review of industry foreclosure practices. Following the examination, the OCC issued a supervisory letter to HSBC Bank USA noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures and in governance of and resources devoted to our foreclosure processes, including the evaluation and monitoring of third party law firms retained to effect our foreclosures. Certain other processes were deemed adequate. The Federal Reserve issued a similar supervisory letter to HSBC Finance and HSBC North America. We have suspended foreclosures until such time as we have substantially addressed the noted deficiencies in our processes. We are also reviewing foreclosures where judgment has not yet been entered and will correct deficient documentation and re-file affidavits where necessary. See “Executive Overview” in MD&A for further discussion.
 
We and our affiliates are engaged in discussions with the OCC and the Federal Reserve regarding the terms of consent cease and desist orders, which will prescribe actions to address the deficiencies noted in the joint examination. We expect the consent orders will be finalized shortly after the date this Form 10-K is filed. While the


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impact of the OCC consent order on HSBC Bank USA depends on the final terms, we believe it has the potential to increase our operational, reputational and legal risk profiles and expect implementation of its provisions will require significant financial and managerial resources. In addition, the consent orders will not preclude further actions against HSBC Bank USA or our affiliates by bank regulatory or other agencies, including the imposition of fines and civil money penalties. We are unable at this time, however, to determine the likelihood of any further action or the amount of penalties or fines, if any, that may be imposed by the regulators or agencies.
 
As a result of publicized foreclosure practices of certain servicers, certain courts have issued new rules relating to foreclosures and we anticipate that scrutiny of foreclosure documentation and practices, including practices of foreclosure law firms, will increase. In some areas, court officials are requiring additional verification of information filed prior to the foreclosure proceeding. If these trends continue after we have reinstituted foreclosures, there could be additional delays in the processing of foreclosures.
 
Supervision of Bank Subsidiaries Our subsidiary national banks, HSBC Bank USA and HTCD, are subject to regulation and examination primarily by the Office of the Comptroller of the Currency (“OCC”), secondarily by the FDIC, and by the Federal Reserve. HSBC Bank USA and HTCD are subject to banking laws and regulations that place various restrictions on and requirements regarding their operations and administration, including the establishment and maintenance of branch offices, capital and reserve requirements, deposits and borrowings, investment and lending activities, compliance activities, payment of dividends and numerous other matters.
 
Federal law imposes limitations on the payment of dividends by national banks. Dividends payable by HSBC Bank USA and HTCD are limited to the lesser of the amounts calculated under a “recent earnings” test and an “undivided profits” test. Under the recent earnings test, a dividend may not be paid if the total of all dividends declared by a bank in any calendar year is in excess of the current year’s net income combined with the retained net income of the two preceding years, unless the national bank obtains the approval of the OCC. Under the undivided profits test, a dividend may not be paid in excess of a bank’s undivided profits account. In addition, the OCC, the Federal Reserve Board, and the FDIC have authority to prohibit or to limit the payment of dividends by the banking organizations they supervise, including HSBC USA and HSBC Bank USA, if they would consider payment of such dividend to constitute an unsafe or unsound practice in light of the financial condition of the banking organization. HSBC Bank USA is also required to maintain reserves in the form of vault cash and deposits with the Federal Reserve Bank.
 
HSBC Bank USA and HTCD are subject to certain restrictions imposed by federal law on extensions of credit to, and certain other “covered transactions” with, HSBC USA or other affiliates. Covered transactions include loans and other extensions of credit, investments and asset purchases, and certain other transactions involving the transfer of value from a subsidiary bank to an affiliate or for the benefit of an affiliate. Unless an exemption applies, or a specific waiver is granted by the Federal Reserve Board, covered transactions by a bank with a single affiliate are limited to 10 percent of the bank’s capital and surplus, and all covered transactions with affiliates in the aggregate are limited to 20 percent of the bank’s capital and surplus. Where HSBC USA or another HSBC affiliate provides cash collateral for an extension or credit to an affiliate, that loan would be excluded from the 10 and 20 percent limitations. Loans and extensions of credit to affiliates by a bank generally are required to be secured in specified amounts with specific types of collateral. Starting July 2012, a bank’s credit exposure to an affiliate as a result of a derivative, securities lending or repurchase transaction, will be subject to these limits. A bank’s transactions with its non-bank affiliates are also generally required to be on arm’s length terms.
 
The types of activities in which the non-U.S. branches of HSBC Bank USA may engage are subject to various restrictions imposed by the Federal Reserve Board. These branches are also subject to the laws and regulatory authorities of the countries in which they operate.
 
Under current Federal Reserve Board policy, HSBC USA is expected to act as a source of financial and managerial strength to its subsidiary banks and, under appropriate circumstances, to commit resources to support each such subsidiary bank in circumstances where it might not do so absent such policy.
 
Regulatory Capital Requirements As a bank holding company, we are subject to regulatory capital requirements and guidelines imposed by the Federal Reserve Board, which are substantially similar to those imposed by the OCC and the FDIC on banks such as HSBC Bank USA and HTCD. A bank or bank holding company’s failure to meet


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minimum capital requirements can result in certain mandatory actions and possibly additional discretionary actions by its regulators. Under current capital guidelines, a bank or a bank holding company’s assets and certain specified off-balance sheet commitments and obligations are assigned to various risk categories. A bank or bank holding company’s capital, in turn, is classified into one of three tiers. Tier 1 capital includes common equity, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock at the holding company level, and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain other deductions. Tier 2 capital includes, among other things, perpetual preferred stock not qualified as Tier 1 capital, subordinated debt, and allowances for loan and lease losses, subject to certain limitations. Tier 3 capital includes qualifying unsecured subordinated debt. At least one-half of a bank’s total capital must qualify as Tier 1 capital. To be categorized as “well capitalized,” a banking institution must have the minimum ratios reflected in the table included in Note 25, “Retained Earnings and Regulatory Capital Requirements” of the consolidated financial statements and must not be subject to a directive, order or written agreement to meet and maintain specific capital levels. The federal bank regulatory agencies may, however, set higher capital requirements for an individual bank or when a bank’s particular circumstances warrant. The Federal Reserve Board may also set higher capital requirements for bank holding companies whose circumstances warrant it. As part of the regulatory approvals with respect to the credit card and auto receivable portfolio purchases completed in January 2009, HSBC USA and its ultimate parent, HSBC, committed, among other things, that HSBC Bank USA will hold sufficient capital with respect to the purchased receivables that are or become “low-quality assets,” as defined by the Federal Reserve Act. See Note 25, “Retained Earnings and Regulatory Capital Requirements,” in the consolidated financial statements for further discussion.
 
In December 2007, U.S. regulators published a final rule regarding Risk-Based Capital Standards: Advanced Capital Adequacy Framework – Basel II. This final rule represents the U.S. adoption of the Basel II International Capital Accord (“Basel II”). The final rule became effective April 1, 2008, and requires large bank holding companies, including HSBC North America, to adopt its provisions subject to regulatory approval no later than April 1, 2011, in accordance with current regulatory timelines. HSBC North America has established a comprehensive Basel II infrastructure. The formal adoption of Basel II will impact our capital requirements as well as those of HSBC North America. As a result, HSBC North America and its subsidiaries took a series of actions in 2010 to achieve targeted total capital levels under these new regulations, including the issuance by HSBC USA and HSBC Bank USA of collectively $2.0 billion in additional subordinated debt. Further increases in regulatory capital may be required prior to HSBC North America’s Basel II adoption date. The exact amount of additional capital required, however, will depend upon both our prevailing risk profile and that of our North America affiliates under various stress scenarios.
 
HSBC North America and HSBC USA also continue to support the HSBC implementation of the Basel II framework, as adopted by the U.K. Financial Services Authority (“FSA”). We supply data regarding credit risk, operational risk and market risk to support HSBC’s regulatory capital and risk weighted asset calculations. Revised FSA capital adequacy rules for HSBC became effective January 1, 2008.
 
In December 2010, the Basel Committee on Banking Supervision (the “Basel Committee”) issued final rules on “A global regulatory framework for more resilient banks and banking systems,” commonly referred to as Basel III, which presents details of a bank capital and liquidity reform program to address both firm-specific and broader, systemic risks to the banking sector. HSBC North America is in the process of evaluating the Basel III framework for liquidity risk management. Although the Basel Committee has issued guidance, we are still awaiting formal instructions as to how the ratios will be calculated by the U.S. regulators. The proposals include both a Liquidity Coverage Ratio (“LCR”) designed to ensure banks have sufficient high-quality liquid assets to survive a significant stress scenario lasting 30 days and a Net Stable Funding Ratio (“NSFR”) with a time horizon of one year to ensure a sustainable maturity structure of assets and liabilities. For both ratios, HSBC North America will be expected to achieve a ratio of 100 percent or better. The observation period for the ratios begins in 2012 with LCR introduced by 2015 and NSFR by 2018. Based on the results of the observation periods, the Basel Committee and the regulators may make further changes by 2013 and 2016 for LCR and NSFR, respectively. We anticipate meeting these requirements well in advance of their formal introduction. HSBC USA may need to increase its liquidity profile to


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support HSBC North America’s compliance with the new rules. We are unable at this time, however, to determine the extent of changes HSBC USA will need to make to its liquidity position, if any.
 
In addition, U.S. bank regulatory agencies have maintained the ‘leverage’ regulatory capital requirements that generally require United States banks and bank holding companies to maintain a minimum amount of capital in relation to their balance sheet assets (measured on a non-risk-weighted basis).
 
Our capital resources are summarized under “Liquidity and Capital Resources” in MD&A. Capital amounts and ratios for HSBC USA and HSBC Bank USA are summarized in Note 25, “Retained Earnings and Regulatory Capital Requirements” of the consolidated financial statements. From time to time, bank regulators propose amendments to or issue interpretations of risk-based capital guidelines. Such proposals or interpretations could, upon implementation, affect reported capital ratios and net risk weighted assets.
 
Deposit Insurance Deposits placed at HSBC Bank USA and HTCD are insured by the FDIC, subject to the limitations and conditions of applicable law and the FDIC’s regulations. In 2009, FDIC insurance coverage limits were increased temporarily from $100,000 to $250,000 per depositor and this increased limit was made permanent on July 21, 2010. Beginning on December 31, 2010 and continuing through December 31, 2012, Dodd-Frank requires FDIC insurance for deposits exceeding $250,000 in noninterest-bearing transaction accounts. HSBC Bank USA and HTCD are subject to risk-based assessments from the FDIC. Currently, depository institutions subject to assessment are categorized based on supervisory ratings, financial ratios and, in the case of larger institutions, long-term debt issuer ratings, with those in the highest rated categories paying lower assessments. While the assessments are generally payable quarterly, the FDIC also has the authority to impose special assessments to prevent the deposit insurance fund from declining to an unacceptable level. Pursuant to this authority, the FDIC imposed a 5 basis point special assessment on June 30, 2009. In November 2009, the FDIC amended its regulations to require depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 on or before December 30, 2009. Beginning with the second quarter 2011, FDIC assessments will be based on average consolidated total assets and risk profile, but we estimate that the change in assessment base will not increase our FDIC assessment materially.
 
Bank Secrecy Act/Anti-Money Laundering The USA Patriot Act (the “Patriot Act”), effective October 26, 2001, imposed significant record keeping and customer identity requirements, expanded the government’s powers to freeze or confiscate assets and increased the available penalties that may be assessed against financial institutions for violation of the requirements of the Patriot Act intended to detect and deter money laundering. The Patriot Act required the U.S. Treasury Secretary to develop and adopt final regulations with regard to the anti-money laundering (“AML”) compliance obligations of financial institutions (a term which includes insured U.S. depository institutions, U.S. branches and agencies of foreign banks, U.S. broker-dealers and numerous other entities). The U.S. Treasury Secretary delegated certain authority to a bureau of the U.S. Treasury Department known as the Financial Crimes Enforcement Network (“FinCEN”).
 
Many of the anti-money laundering compliance requirements of the Patriot Act, as implemented by FinCEN, are generally consistent with the anti-money laundering compliance obligations that applied to HSBC Bank USA under the Bank Secrecy Act (“BSA”) and applicable Federal Reserve Board regulations before the Patriot Act was adopted. These include requirements to adopt and implement an anti-money laundering program, report suspicious transactions and implement due diligence procedures for certain correspondent and private banking accounts. Certain other specific requirements under the Patriot Act involve compliance obligations. The Patriot Act has improved communication between law enforcement agencies and financial institutions. The Patriot Act and other recent events have also resulted in heightened scrutiny of the Bank Secrecy Act and anti-money laundering compliance programs by bank regulators.
 
As previously disclosed, HSBC Bank USA entered into a consent cease and desist order with the OCC and our indirect parent, HSBC North America, entered into a consent cease and desist order with the Federal Reserve Board in the first week of October 2010. These actions require improvements for an effective compliance risk management program across our U.S. businesses, including BSA and AML compliance. HSBC USA Inc. is committed to fully addressing the requirements of the consent orders, and to maintaining compliant and effective BSA and AML


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policies and procedures, and efforts to strengthen related functions will continue.
 
Competition Following the enactment of the GLB Act, HSBC USA elected to be treated as a financial holding company. The GLB Act also eliminated many of the regulatory restrictions on providing financial services. The GLB Act allows for financial institutions and other providers of financial products to enter into combinations that permit a single organization to offer a complete line of financial products and services. Therefore, we face intense competition in all of the markets we serve, competing with both other financial institutions and non-banking institutions such as insurance companies, major retailers, brokerage firms and investment companies. The financial services industry has experienced consolidation in recent years as financial institutions involved in a broad range of products and services have merged, been acquired or dispersed. This trend is expected to continue and has resulted in, among other things, greater concentrations of deposits and other resources. It is likely that competition will become more intense as our businesses compete with other financial institutions that have or may acquire access to greater liquidity or that may have a stronger presence in certain geographies.
 
Corporate Governance and Controls
 
We maintain a website at www.us.hsbc.com on which we make available, as soon as reasonably practicable after filing with or furnishing to the SEC, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports. Our website also contains our Corporate Governance Standards and committee charters for the Audit and Risk Committee, the Compliance Committee and the Fiduciary Committees of our Board of Directors. We have a Statement of Business Principles and Code of Ethics that expresses the principles upon which we operate our businesses. Integrity is the foundation of all our business endeavors and is the result of continued dedication and commitment to the highest ethical standards in our relationships with each other, with other organizations and individuals who are our customers. Our Statement of Business Principles and Code of Ethics can be found on our corporate website. We also have a Code of Ethics for Senior Financial Officers that applies to our finance and accounting professionals that supplements the Statement of Business Principles. That Code of Ethics is incorporated by reference in Exhibit 14 to this Form 10-K. Printed copies of this information can be requested at no charge. Requests should be made to HSBC USA Inc., 26525 North Riverwoods Boulevard, Mettawa, Illinois 60045, Attention: Corporate Secretary.
 
Certifications In addition to certifications from our Chief Executive Officer and Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (attached to this report on Form 10-K as Exhibits 31 and 32), we also file a written affirmation of an authorized officer with the New York Stock Exchange (the “NYSE”) certifying that such officer is not aware of any violation by HSBC USA of the applicable NYSE corporate governance listing standards in effect as of February 28, 2011.
 
Cautionary Statement on Forward-Looking Statements
 
Certain matters discussed throughout this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make or approve certain statements in future filings with the SEC, in press releases, or oral or written presentations by representatives of HSBC USA that are not statements of historical fact and may also constitute forward-looking statements. Words such as “may”, “will”, “should”, “would”, “could”, “appears”, “believe”, “intends”, “expects”, “estimates”, “targeted”, “plans”, “anticipates”, “goal” and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. These matters or statements will relate to our future financial condition, economic forecast, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from that which was expressed or implied by such forward-looking statements. Forward-looking statements are based on our current views and assumptions and speak only as of the date they are made. We undertake no obligation to update any forward-looking statement to reflect subsequent circumstances or events.


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Item 1A. Risk Factors
 
The following discussion provides a description of some of the important risk factors that could affect our actual results and could cause our results to vary materially from those expressed in public statements or documents. However, other factors besides those discussed below or elsewhere in other of our reports filed or furnished with the SEC could affect our business or results. The reader should not consider any description of such factors to be a complete set of all potential risks that we may face.
 
The current uncertain market and economic conditions may continue to affect our business, results of operations and financial condition. Our business and earnings are affected by general business, economic and market conditions in the United States and abroad. Given our concentration of business activities in the United States, we are particularly exposed to any additional turmoil in the economy, housing downturns, high unemployment, tighter credit conditions and reduced economic growth that have occurred over the past three years and appear likely to continue in 2011. General business, economic and market conditions that could continue to affect us include:
 
  •  low consumer confidence and reduced consumer spending;
 
  •  a “double dip” recession;
 
  •  unemployment levels;
 
  •  wage income levels and declines in wealth;
 
  •  market value of residential and commercial real estate throughout the United States;
 
  •  inflation;
 
  •  monetary supply;
 
  •  fluctuations in both debt and equity capital markets in which we fund our operations;
 
  •  unexpected geopolitical events;
 
  •  fluctuations in the value of the U.S. dollar;
 
  •  short-term and long-term interest rates;
 
  •  availability of liquidity;
 
  •  tight consumer credit conditions;
 
  •  higher bankruptcy filings; and
 
  •  new laws, regulations or regulatory initiatives.
 
In a challenging economic environment such as currently being experienced in the United States, more of our customers are likely to, and have in fact become, delinquent on their loans or other obligations as compared to historical periods as many of our customers are experiencing reductions in cash flow available to service their debt. These delinquencies, in turn, have adversely affected our earnings. The problems in the housing markets in the United States in the last four years have been exacerbated by continued high unemployment rates. If businesses remain cautious to hire, additional losses are likely to be significant in all types of our consumer loans, including credit cards, due to decreased consumer income.
 
Although during the first half of 2010, housing prices began to stabilize and even recover in certain markets, housing prices started to decline again in the later half of 2010. If housing prices continue to decline, there may be increased delinquency and losses in our real estate portfolio.
 
Mortgage lenders have substantially tightened lending standards. These actions have impacted borrowers’ abilities to refinance existing mortgage loans. This in turn, impacted both credit performance and run-off rates and has resulted in elevated delinquency rates for real estate secured loans in our portfolio. Additionally, the high levels of


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inventory of homes for sale combined with depressed property values in many markets has resulted in higher loss severities on homes that are foreclosed and remarketed. Despite our cessation in processing foreclosures in December, our inventory of foreclosed properties (“REO”) continued to increase.
 
In the event economic conditions continue to be depressed or become further depressed and lead to a “double dip” recession, there would be a significant negative impact on delinquencies, charge-offs and losses in all loan portfolios with a corresponding impact on our results of operations.
 
We may incur additional costs and expenses relating to mortgage loan repurchases and other mortgage loan securitization – related activities. In connection with our loan sale and securitization activities with Fannie Mae and Freddie Mac (the “Government Sponsored Entities” or “GSEs”) and loan sale and private-label securitization transactions, HUSI has made representations and warranties that the loans sold meet certain requirements. For transactions with the GSEs, these representations include type of collateral, underwriting standards, validity of certain borrower representations in connection with the loan, that primary mortgage insurance is in force for any mortgage loan with a loan-to-value ratio (“LTV”) greater than 80 percent, and the use of the GSEs’ standard legal documentation. We may be, and have been, required to repurchase loans and/or indemnify the GSEs and other private investors for losses due to breaches of these representations and warranties. Substantially all of the repurchase demands we have resolved to date, however, are related to loans sold to the GSEs.
 
In estimating our repurchase liability arising from breaches of representations and warranties, we consider several factors, including the level of outstanding repurchase demands in inventory and our historical defense rate, the level of outstanding demands for loan files and the related historical repurchase request conversion rate and defense rate, and the level of potential future demands based on historical conversion rates of loans which we have not received a repurchase demand. While we believe that our current repurchase liability reserves are adequate, the factors referred to above are subject to change in light of market developments, the economic environment and other circumstances, some of which are beyond our control and, accordingly, there can be no assurance that such reserves will not need to be increased in the future.
 
We have also been involved as a sponsor/seller of loans used to facilitate whole loan securitizations underwritten by our affiliate, HSBC Securities (USA) Inc. (“HSI”). Participants in the U.S. mortgage securitization market that purchased and repackaged whole loans have been the subject of lawsuits and governmental and regulatory investigations and inquires, which have been directed at groups within the U.S. mortgage market, such as servicers, originators, trustees or sponsors of securitizations, and at particular participants within these groups. We expect this level of focus will continue and, potentially, intensify, so long as the U.S. real estate markets continue to be distressed. As a result, we may be subject to additional litigation and governmental and regulatory scrutiny related to our participation in the U.S. mortgage securitization market, either individually or as a member of group. For additional discussion, see the caption “Mortgage Loan Repurchase Obligations” in Note 27, “Guarantee Arrangements,” in the accompanying consolidated financial statements.
 
We may incur additional costs and expenses in ensuring that we satisfy requirements relating to our mortgage foreclosure processes and the industry-wide delay in processing foreclosures may have a significant impact upon loss severity. State and federal officials are investigating the procedures followed by mortgage servicing companies and banks, including HSBC Bank USA and certain of our affiliates, relating to foreclosures. We and our affiliates have responded to all related inquiries and cooperated with all applicable investigations, including a joint examination by staffs of the OCC and the Federal Reserve as part of their broad horizontal review of industry foreclosure practices. Following the examination, the OCC issued a supervisory letter to HSBC Bank USA noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures and in governance of and resources devoted to our foreclosure processes, including the evaluation and monitoring of third party law firms retained to effect our foreclosures. Certain other processes were deemed adequate. The Federal Reserve issued a similar supervisory letter to HSBC Finance and HSBC North America. We have suspended foreclosures until such time as we have substantially addressed the noted deficiencies in our processes. We are also reviewing foreclosures where judgment has not yet been entered and will correct deficient documentation and re-file affidavits where necessary.


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We and our affiliates are engaged in discussions with the OCC and the Federal Reserve regarding the terms of consent cease and desist orders, which will prescribe actions to address the deficiencies noted in the joint examination. We expect the consent orders will be finalized shortly after the date this Form 10-K is filed. While the impact of the OCC consent order on HSBC Bank USA depends on the final terms, we believe it has the potential to increase our operational, reputational and legal risk profiles and expect implementation of its provisions will require significant financial and managerial resources. In addition, the consent orders will not preclude further actions against HSBC Bank USA or our affiliates by bank regulatory or other agencies, including the imposition of fines and civil money penalties. We are unable at this time, however, to determine the likelihood of any further action or the amount of penalties or fines, if any, that may be imposed by the regulators or agencies.
 
We expect to incur additional costs and expenses in connection with the correction or affirmation of previously-filed foreclosure paperwork and the resulting delays in foreclosures, including costs associated with the maintenance of properties while foreclosures are delayed, legal expenses associated with re-filing documents or, as necessary, re-filing foreclosure cases, and costs associated with fluctuations in home prices while foreclosures are delayed. These costs could increase depending on the length of the delay. In addition, we may incur additional costs and expenses as a result of legislative, administrative or regulatory investigations or actions relating to our foreclosure processes or with respect to the mortgage servicing industry in general. We may also see an increase in private litigation concerning our practices. However, it is not possible at this time to predict the ultimate outcome of these matters or the impact that they will have on our financial results.
 
Due to the significant slow-down in foreclosures, and in some instances, cessation of all foreclosure processing by numerous loan servicers, including us, for some period of time in 2011 there may be some reduction in the number of properties being marketed following foreclosure. The impact of that decrease may increase demand for properties currently on the market resulting in a stabilization of home prices but could also result in a larger number of vacant properties in communities creating downward pressure on general property values. As a result, the short term impact of the foreclosure processing delay is highly uncertain. However, the longer term impact is even more uncertain as eventually servicers will again begin to foreclose and market properties in large numbers which is likely to create a significant over-supply of housing inventory. This could lead to a significant increase in loss severity on REO properties.
 
Recently implemented Federal and state laws and regulations may significantly impact our operations. We operate in a highly regulated environment. Changes in federal, state and local laws and regulations, including changes in tax rates, affecting banking, consumer credit, bankruptcy, privacy, consumer protection or other matters could materially impact our performance. Ensuring compliance with increasing regulatory requirements and initiatives could affect operational costs and negatively impact our overall results. Specifically, attempts by local, state and national regulatory agencies to address perceived problems with the credit card industry and more recently, to additionally address perceived problems in the financial services industry generally through broad or targeted legislative or regulatory initiatives aimed at lenders’ operations in consumer lending markets, could affect us in substantial and unpredictable ways, including limiting the types of products we can offer, how these products may be originated, the fees and charges that may be applied to accounts and how accounts may be collected or security interests enforced, which ultimately could negatively impact our results. There is also significant focus on loss mitigation and foreclosure activity for real estate loans. We cannot fully anticipate the response by national regulatory agencies, state attorneys generals, or certain legislators, or if significant changes to our operations and practices will be required as a result.
 
On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” a sweeping overhaul of the financial services industry, was signed into law. For a description of the law, see the “Regulation – Financial Regulatory Reform” section under the “Regulation and Competition” section of Item 1. Business. The law will have significant impact on the operations of financial institutions in the U.S., including HSBC USA, HSBC Bank USA and our affiliates. We are unable at this time, however, to determine the full impact of the law due to the significant number of new rules and regulations that will be promulgated in order to implement the law. Also, specifically and of utmost relevance to our consumer business, we do not know what will be the far-reaching effect on our business


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of the newly created Consumer Financial Protection Bureau (“CFPB”), since the CFPB has been given broad based authority over consumer products and services such as those provided by our consumer businesses.
 
On May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 was signed into law and we have implemented all of its applicable provisions. The CARD Act required changes to our business practices, and will require us and our competitors to manage risk differently than has historically been the case. Pricing, underwriting and product changes have either been implemented or are under continuing analysis. The implementation of these new rules did not have a material adverse impact to us as any impact is limited to only a portion of the existing credit card loan portfolio as the purchase price on future credit card sales volume paid to HSBC Finance has been adjusted to fully reflect the new requirements and the impact on future cash flows.
 
The transition to Basel II in 2011 will continue to put significant pressure on regulatory capital. Subject to regulatory approval, HSBC North America will be required to adopt Basel II provisions no later than April 1, 2011, in accordance with current regulatory timelines. HSBC USA Inc. will not report separately under the new rules, but HSBC Bank USA will report under the new rules on a stand-alone basis. Further increases in regulatory capital may be required prior to the Basel II adoption date; however, the exact amount will depend upon our prevailing risk profile and that of our North America affiliates under various stress scenarios. Adoption of the Basel II provisions must be preceded by a parallel run period of at least four quarters, and requires the approval of U.S. regulators. This parallel run, which was initiated in January 2010, encompasses enhancements to a number of risk policies, processes and systems to align HSBC Bank USA with the Basel II final rule requirements. HSBC Bank USA will seek regulatory approval for adoption when the program enhancements have been completed which may extend beyond April 1, 2011.
 
Operational risks, such as systems disruptions or failures, breaches of security, human error, changes in operational practices or inadequate controls may adversely impact our business and reputation. Operational risk is inherent in virtually all of our activities. While we have established and maintain an overall risk framework that is designed to balance strong corporate oversight with well-defined independent risk management, we continue to be subject to some degree of operational risk. Our businesses are dependent on our ability to process a large number of complex transactions. If any of our financial, accounting, or other data processing and other recordkeeping systems and management controls fail or have other significant shortcomings, we could be materially adversely affected. HSBC North America will continue the implementation of several high priority systems improvements and enhancements in 2011, each of which may present increased or additional operational risk that may not be known until their implementation is complete. Also, in order to react quickly to newly-implemented regulatory requirements, implementation of changes to systems and enhancements may be required to be completed within very tight time frames, which would increase operational risk.
 
We may also be subject to disruptions of our operating systems infrastructure arising from events that are wholly or partially beyond our control, which may include:
 
  •  computer viruses or electrical or telecommunications outages;
 
  •  natural disasters, such as hurricanes and earthquakes;
 
  •  events arising from local, regional or international politics, including terrorist acts;
 
  •  unforeseen problems encountered while implementing major new computer systems; or
 
  •  global pandemics, which could have a significant effect on our business operations as well as on HSBC affiliates world-wide.
 
Such disruptions may give rise to losses in service to customers, an inability to collect our receivables in affected areas and other loss or liability to us.
 
We are similarly dependent on our employees. We could be materially adversely affected if an employee causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. Third parties with which we do business could also be sources of operational risk to us, including risks relating to break-downs or failures of such parties’ own


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systems or employees. Any of these occurrences could result in diminished ability by us to operate one or more of our businesses, potential liability to clients, reputational damage and regulatory intervention, all of which could materially adversely affect us. In a company as large and complex as ours, lapses or deficiencies in internal control over financial reporting are likely to occur from time to time.
 
In recent years, instances of identity theft and fraudulent attempts to obtain personal and financial information from individuals and from companies that maintain such information pertaining to their customers have become more prevalent. Use of the internet for these purposes has also increased. Such acts can have the following possible impacts:
 
  •  threaten the assets of our customers;
 
  •  negatively impact customer credit ratings;
 
  •  impact customers’ ability to repay loan balances;
 
  •  increase costs for us to respond to such threats and to enhance our processes and systems to ensure maximum security of data; or
 
  •  damage our reputation from public knowledge of intrusion into our systems and databases.
 
In addition, there is the risk that our controls and procedures as well as business continuity and data security systems could prove to be inadequate. Any such failure could affect our operations and could have a material adverse effect on our results of operations by requiring us to expend significant resources to correct the defect, as well as by exposing us to litigation or losses not covered by insurance.
 
Changes to operational practices from time to time could materially positively or negatively impact our performance and results. Such changes may include:
 
  •  raising the minimum payment or fees to be charged on credit card accounts;
 
  •  determining to acquire or sell credit card receivables, residential mortgage loans and other loans;
 
  •  changes to our customer account management and risk management/collection policies and practices;
 
  •  increasing investment in technology, business infrastructure and specialized personnel; or
 
  •  outsourcing of various operations.
 
Competition in the financial services industry may have a material adverse impact on our future results. We operate in a highly competitive environment. Competitive conditions are expected to continue to intensify as continued merger activity in the financial services industry produces larger, better-capitalized and more geographically diverse companies. New products, customers and channels of distribution are constantly emerging. Such competition may impact the terms, rates, costs and/or profits historically included in the financial products we offer and purchase. There is no assurance that the significant and increasing competition within the financial services industry will not materially adversely affect our future results.
 
Lawsuits and regulatory investigations and proceedings may continue and increase in the current economic and regulatory environment. HSBC USA and our subsidiaries are or may be named as defendants in various legal actions, including class actions and other litigation or disputes with third parties, as well as investigations or proceedings brought by regulatory agencies. We saw continued litigation in 2010 resulting from the deterioration of customers’ financial condition, the mortgage market downturn and general economic conditions. There is no certainty that the litigation will decrease in the near future, especially in the event of continued high unemployment rates, a resurgent recession or additional regulatory investigations by federal and state governmental agencies. With the increased regulatory environment, particularly in the financial services industry, there may be additional regulatory investigations and reviews conducted by banking regulators, state attorneys general or state regulators which may cause financial or reputational harm. With the increased regulatory environment, particularly in the financial services industry, there may be additional regulatory investigations and reviews conducted by regulators and other enforcement agencies that, if determined adversely, may result in judgments, settlements, fines, penalties


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or other results, including additional compliance requirements, which could materially adversely affect our business, financial condition or results of operations, or cause serious reputational harm.
 
Unanticipated risks may impact our results. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems, including models and programs that predict loan delinquency and loss. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques and prepare contingency plans in anticipation of developments, those techniques and plans and the judgments that accompany their application are complex and cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Accordingly, our ability to successfully identify and manage all significant risks we face is an important factor that can significantly impact our results.
 
Our inability to meet funding requirements due to deposit attrition or ratings could impact operations. Adequate liquidity is critical to our ability to operate our businesses. Despite the apparent improvements in market liquidity and our liquidity position, potential conditions remain that would negatively affect our liquidity, including:
 
  •  an inability to attract or retain deposits;
 
  •  diminished access to capital markets;
 
  •  unforeseen cash or capital requirements;
 
  •  an inability to sell assets; and
 
  •  an inability to obtain expected funding from HSBC subsidiaries and clients.
 
HSBC has provided capital support in the past and has indicated its commitment and capacity to fund the needs of the business in the future.
 
Our credit ratings are an important part of maintaining our liquidity. Any downgrade in credit ratings could potentially increase borrowing costs, impact the ability to issue commercial paper and, depending on the severity of the downgrade, substantially limit access to capital markets, require cash payments or collateral posting, and permit termination of certain significant contracts.
 
Management projections, estimates and judgments based on historical performance may not be indicative of our future performance. Our management is required to use certain estimates in preparing our financial statements, including accounting estimates to determine loan loss reserves, reserves related to litigation, deferred tax assets and the fair market value of certain assets and liabilities, including goodwill and intangibles, among other items. Loan loss reserve estimates and certain asset and liability valuations are judgmental and are influenced by factors outside our control. To the extent historical averages of the progression of loans into stages of delinquency and the amount of loss realized upon charge-off are not predictive of future losses and management is unable to accurately evaluate the portfolio risk factors not fully reflected in historical models, unexpected additional losses could result. Similarly, to the extent assumptions employed in measuring fair value of assets and liabilities not supported by market prices or other observable parameters do not sufficiently capture their inherent risk, unexpected additional losses could result.
 
Another example in which management judgment is significant is in the evaluation of the recognition of deferred tax assets and in the determination of whether there is a need for a related valuation allowance. We are required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders’ equity if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC as a necessary part of such plans and strategies. This process involves significant management judgment about assumptions that are subject to change from period to period. The recognition of deferred tax assets requires management to make significant judgments about future earnings, the periods in which items will impact taxable income, and the application of inherently complex tax laws. However, since market conditions have created losses in HSBC North America in recent periods


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and volatility on our pre-tax book income, the analysis of the realizability of the deferred tax asset significantly discounts any future taxable income expected from continuing operations and relies to a greater extent on continued capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. Included in our forecasts are assumptions regarding our estimate of future expected credit losses. The use of different estimates can result in changes in the amounts of deferred tax items recognized, which can result in equity and earnings volatility because such changes are reported in current period earnings. See Note 18, “Income Taxes,” in the accompanying consolidated financial statements for additional discussion of our deferred taxes/assets.
 
Changes in accounting standards are beyond our control and may have a material impact on how we report our financial results and condition. Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board (“FASB”), the International Accounting Standards Board (“IASB”), the SEC and our bank regulators, including the Office of Comptroller of the Currency and the Federal Reserve Board, change the financial accounting and reporting standards, or the interpretation thereof, and guidance that govern the preparation and disclosure of external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report and disclose our financial results and condition, including our segment results. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts. We may, in certain instances, change a business practice in order to comply with new or revised standards.
 
Key employees may be difficult to retain due to contraction of the business and limits on promotional activities. Our employees are our most important resource and, in many areas of the financial services industry, competition for qualified personnel is intense. If we were unable to continue to attract and retain qualified key employees to support the various functions of our businesses, our performance, including our competitive position, could be materially adversely affected. Our recent financial performance, reductions in variable compensation and other benefits and the expectation of continued weakness in the general economy could raise concerns about key employees’ future compensation and promotional opportunities. As economic conditions improve, there will be increased risk to retaining top performers and critical skill employees. If key personnel were to leave us and equally knowledgeable or skilled personnel are unavailable within HSBC or could not be sourced in the market to fill these roles, our ability to manage through the difficult economy may be hindered or impaired.
 
Our reputation has a direct impact on our financial results and ongoing operations. Our ability to attract and retain customers and conduct business transactions with our counterparties could be adversely affected to the extent our reputation, or the reputation of affiliates operating under the HSBC brand, is damaged. Our failure to address, or to appear to fail to address, various issues that could give rise to reputational risk could cause harm to us and our business prospects. Reputational issues include, but are not limited to:
 
  •  appropriately addressing potential conflicts of interest;
 
  •  legal and regulatory requirements;
 
  •  ethical issues;
 
  •  anti-money laundering and economic sanctions programs;
 
  •  privacy issues;
 
  •  fraud issues;
 
  •  data security issues related to our customers or employees;
 
  •  recordkeeping;
 
  •  sales and trading practices;
 
  •  the proper identification of the legal, reputational, credit, liquidity and market risks inherent in our businesses; and


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  •  general company performance.
 
The failure to address these issues appropriately could make our customers unwilling to do business with us or give rise to increased regulatory action, which could adversely affect our results of operations.
 
Significant reductions in pension assets may require additional financial contributions from us. Effective January 1, 2005, our previously separate qualified defined benefit pension plan was combined with that of HSBC Finance’s into a single HSBC North America qualified defined benefit plan. We are responsible for providing approximately 41 percent of the financial support required by the plan. In 2010 and 2009, the plan had allocated assets between three primary strategies: domestic equities, international equities and fixed income securities. At December 31, 2010, plan assets were lower than projected plan liabilities resulting in an under-funded status. During 2010, domestic and international equity indices increased between 11 percent and 17 percent while interest rates decreased. After expenses, the combination of positive equity returns and fixed income returns along with a $187 million contribution to the plan by HSBC North America in 2010 resulted in an overall increase in plan assets of 20 percent in 2010. This increase, when combined with an increase in the projected benefit obligation continued to result in an under-funded status. At December 31, 2010, the defined benefit plan was frozen, significantly reducing future benefit accruals. The accumulated benefit obligation exceeded the fair value of the plan assets by approximately $820 million. As these obligations relate to the HSBC North America pension plan, only a portion of this deficit should be considered our responsibility. We and other HSBC North American affiliates with employees participating in this plan will be required to make up this shortfall over a number of years as specified under the Pension Protection Act. This can be accomplished through direct contributions, appreciation in plan assets and/or increases in interest rates resulting in lower liability valuations. See Note 22, “Pension and Other Postretirement Benefits,” in the accompanying consolidated financial statements for further information concerning the HSBC North America defined benefit plan.
 
The inability to integrate business and portfolio acquisitions successfully could undermine the realization of the anticipated benefits of the acquisition and have a material adverse impact on our results of operation. We have in the past, and may again in the future, seek to grow our business by acquiring other businesses or loan portfolios. There can be no assurance that acquisitions will have the anticipated positive results, including results relating to:
 
  •  the total cost of integration;
 
  •  the time required to complete the integration;
 
  •  the amount of longer-term cost savings; or
 
  •  the overall performance of the combined entity.
 
Integration of an acquired business can be complex and costly, and may sometimes include combining relevant accounting, data processing and other record keeping systems and management controls, as well as managing relevant relationships with clients, suppliers and other business partners, as well as with employees.
 
There is no assurance that any businesses or portfolios acquired in the future will be successfully integrated and will result in all of the positive benefits anticipated. If we are not able to successfully integrate acquisitions, there is the risk that its results of operations could be materially and adversely affected.


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Item 1B. Unresolved Staff Comments.
 
We have no unresolved written comments from the Securities and Exchange Commission Staff that have been outstanding for more than 180 days at December 31, 2010.
 
Item 2. Properties.
 
The principal executive offices of HSBC USA and HSBC Bank USA are located at 452 Fifth Avenue, New York, New York 10018, which HSBC Bank USA owned until April 2010. In April 2010, HSBC Bank USA sold our headquarters building at 452 Fifth Avenue and entered into a lease for the entire building for one year and eleven floors of the building for a total of 10 years. The main office of HSBC Bank USA is located at 1800 Tysons Blvd., Suite 50, McLean, Virginia 22102. HSBC Bank USA has 370 branches in New York, 36 branches in California, 18 branches in Florida, 21 branches in New Jersey, 10 branches in Connecticut, six branches in Virginia, seven branches in Maryland and the District of Columbia, four branches in Washington, two branches in Pennsylvania and one branch in each of Delaware, Illinois, and Oregon. We also have one representative office each in Massachusetts and Texas. Approximately 26 percent of these offices are located in buildings owned by HSBC Bank USA and the remaining are located in leased premises. In addition, there are offices and locations for other activities occupied under various types of ownership and leaseholds in New York and other states, none of which are materially important to our operations. HSBC Bank USA also owns properties in Montevideo, Uruguay.
 
Item 3. Legal Proceedings
 
See “Litigation and Regulatory Matters” in Note 29, “Collateral, Commitments and Contingent Liabilities,” in the accompanying consolidated financial statements beginning on page 245 for our legal proceedings, disclosure which is incorporated herein by reference.
 
Item 4. Submission of Matters to a Vote of Security Holders
 
Not applicable.
 
PART II
 
Item 5.  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Not applicable.


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In June 2010, we decided to exit our wholesale banknotes business. During the fourth quarter of 2010, we completed the exit of substantially all of this business and as a result, this business is now reported as discontinued operations for all periods presented. The following selected financial data presented below excludes the results of our discontinued operations for all periods presented unless otherwise noted.
 
                                         
Year Ended December 31   2010     2009     2008     2007     2006  
   
    (dollars are in millions)  
 
Statement of Income (Loss) Data:
                                       
Net interest income
  $ 4,519     $ 5,136     $ 4,333     $ 3,405     $ 3,085  
Provision for credit losses
    1,133       4,144       2,543       1,522       823  
Total other revenues (losses)
    2,947       2,589       (921 )     1,735       2,476  
Total operating expenses
    4,033       3,880       3,545       3,532       3,205  
                                         
Income (loss) from continuing operations before income tax expense (benefit)
    2,300       (299 )     (2,676 )     86       1,533  
Income tax expense (benefit)
    742       (110 )     (943 )     (19 )     516  
                                         
Income (loss) from continuing operations
    1,558       (189 )     (1,733 )     105       1,017  
Income from discontinued operations, net of tax
    6       47       44       33       19  
                                         
Net income (loss)
  $ 1,564     $ (142 )   $ (1,689 )   $ 138     $ 1,036  
                                         
Balance Sheet Data as of December 31:
                                       
Loans:
                                       
Commercial loans
  $ 30,271     $ 30,304     $ 37,427     $ 36,835     $ 29,380  
Consumer loans
    42,798       49,185       43,686       53,721       56,134  
                                         
Total loans
    73,069       79,489       81,113       90,556       85,514  
Loans held for sale
    2,390       2,908       4,431       5,270       4,723  
Total assets
    183,813       171,079       185,569       187,965       164,817  
Total tangible assets
    181,168       168,406       182,889       185,225       162,054  
Total deposits
    120,651       118,234       118,979       116,074       102,048  
Long-term debt
    17,230       18,008       22,089       28,268       29,252  
Preferred stock
    1,565       1,565       1,565       1,565       1,690  
Common shareholder’s equity
    15,168       13,612       11,152       9,672       10,571  
Total shareholders’ equity
    16,733       15,177       12,717       11,237       12,261  
Tangible common shareholder’s equity
    12,522       11,110       9,258       7,297       8,034  
Selected Financial Ratios:
                                       
Total shareholders’ equity to total assets
    9.10 %     8.87 %     6.85 %     5.98 %     7.44 %
Tangible common shareholder’s equity to total tangible assets
    6.91       6.60       5.06       3.94       4.96  
Total capital to risk weighted assets
    18.14       14.19       12.04       11.29       12.58  
Tier 1 capital to risk weighted assets
    11.80       9.61       7.60       7.12       8.58  
Rate of return on average :
                                       
Total assets
    .84       (.11 )     (.94 )     .06       .62  
Total common shareholder’s equity
    10.06       (2.05 )     (18.02 )     .06       8.98  
Net interest margin
    2.80       3.36       2.92       2.36       2.26  
Loans to deposits ratio(1)
    80.56       94.36       120.89       147.25       155.33  
Efficiency ratio
    54.02       50.23       103.90       68.71       57.66  
Commercial allowance as a percent of loans(2)
    1.77       3.10       1.53       .81       .73  
Commercial net charge-off ratio(2)
    1.12       .88       .42       .39       .35  
Consumer allowance as a percent of loans(2)
    3.82       5.94       4.18       2.07       1.22  
Consumer two-months-and-over contractual delinquency
    5.04       6.02       4.62       2.56       1.33  
Consumer net charge-off ratio(2)
    5.54       5.35       2.83       1.65       1.19  
 
 
(1) Represents period end loans, net of allowance for loan losses, as a percentage of domestic deposits equal to or less than $100,000.
 
(2) Excludes loans held for sale.


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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Organization and Basis of Reporting HSBC USA Inc. (“HSBC USA” and, together with its subsidiaries, “HUSI”), is an indirect wholly owned subsidiary of HSBC North America Holdings Inc. (“HSBC North America”) which is an indirect wholly owned subsidiary of HSBC Holdings plc (“HSBC”). HUSI may also be referred to in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) as “we”, “us” or “our”.
 
Through our subsidiaries, we offer a comprehensive range of personal and commercial banking products and related financial services. HSBC Bank USA, National Association (“HSBC Bank USA”), our principal U.S. banking subsidiary, is a national banking association with banking branch offices and/or representative offices in 14 states and the District of Columbia. In addition to our domestic offices, we maintain foreign branch offices, subsidiaries and/or representative offices in the Caribbean, Europe, Asia, Latin America and Canada. Our customers include individuals, including high net worth individuals, small businesses, corporations, institutions and governments. We also engage in mortgage banking and serve as an international dealer in derivative instruments denominated in U.S. dollars and other currencies, focusing on structuring of transactions to meet clients’ needs.
 
The following discussion of our financial condition and results of operations excludes the results of our discontinued operations unless otherwise noted. See Note 3, “Discontinued Operations,” in the accompanying consolidated financial statements for further discussion.
 
Current Environment During 2010, economic conditions in the United States generally improved, although the pace of improvement continued to be slow. Liquidity returned to the financial markets for most sources of funding except for mortgage securitization. Companies in the financial sector are generally able to issue debt with credit spreads approaching levels historically seen prior to the financial crisis, despite the expiration of some of the U.S. government’s support programs. European sovereign debt fears first triggered by Greece in May and again by Ireland in November, continue to pressure borrowing costs in the U.S. and the prolonged period of low Federal funds rates continues to put pressure on spreads earned on our deposit base. During the first half of 2010, housing prices stabilized in many markets and began to recover in others as the first-time homebuyer tax credit and low interest rates attributable to government monetary policy actions served as stabilizing forces improving home sales. However, beginning in the third quarter of 2010 and continuing to the end of the year, we again began to see home price declines in many markets as the homebuyer tax credit ended and housing prices remain under pressure due to elevated foreclosure levels. Improved market conditions also resulted during 2010 in recovery of some of the valuation losses recorded during 2008 and into 2009 on several asset classes. How sustainable these improvements will be in the absence of government actions remains to be seen.
 
Despite positive job creation overall in 2010, the economy began to lose jobs again in the third quarter of 2010 as job creation in the private sector, while positive, slowed and was more than offset by reductions in government-related jobs. While job creation again turned positive in the fourth quarter, fear remains as to how pronounced any economic recovery may be. Such fear appeared to lessen, however, towards the end of 2010 as consumer spending began to increase and retail sales showed signs of improvement. U.S. unemployment rates, which have been a major factor in the deterioration of credit quality in the U.S. improved, but remained high at 9.4 percent in December 2010, decreasing from a rate of 10.2 percent in December 2009. However, a significant number of U.S. residents are no longer looking for work and, therefore, are not reflected in the U.S. unemployment rates. Unemployment rates in 18 states are at or above the U.S. national average and unemployment rates in five states are at or above 11 percent while in New York, where approximately 27 percent of our loan portfolio is concentrated, unemployment remained lower than the national average at 8.2 percent. High unemployment rates have generally been most pronounced in the markets which had previously experienced the highest appreciation in home values. Unemployment has continued to have an impact on the provision for credit losses in our loan portfolios and in loan portfolios across the industry.


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Concerns about the future of the U.S. economy, including the pace and magnitude of recovery from the recent economic recession, consumer confidence, volatility in energy prices, credit market volatility and trends in corporate earnings will continue to influence the U.S. economic recovery and the capital markets. In particular, continued improvement in unemployment rates and a sustained recovery of the housing markets remain critical components of a broader U.S. economic recovery. Further weakening in these components as well as in consumer confidence may result in additional deterioration in consumer payment patterns and credit quality. Weak consumer fundamentals including consumer spending, declines in wage income and wealth, as well as a difficult job market continue to depress consumer confidence. Additionally, there is uncertainty as to the future course of monetary policy and uncertainty as to the impact on the economy and consumer confidence when the remaining actions taken by the government to restore faith in the capital markets and stimulate consumer spending end, including the recent extension of unemployment insurance benefits and the prior presidential administration’s tax cuts. These conditions in combination with general economic weakness and the impact of recent regulatory changes will continue to impact our results in 2011, the degree of which is largely dependent upon the nature and extent of the economic recovery.
 
As discussed in prior filings, on May 22, 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (the “CARD Act”) was signed into law. For a discussion of the CARD Act as well as the impact to our operations, see “Segment Results – IFRSs Basis.”
 
State and federal officials are investigating the procedures followed by mortgage servicing companies and banks, including HSBC Bank USA and certain of our affiliates, relating to foreclosures. We and our affiliates have responded to all related inquiries and cooperated with all applicable investigations, including a joint examination by staffs of the Office of the Comptroller of the Currency (the “OCC”) and the Federal Reserve Board (the “Federal Reserve”) as part of their broad horizontal review of industry foreclosure practices. Following the examination, the OCC issued a supervisory letter to HSBC Bank USA noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures and in governance of and resources devoted to our foreclosure processes, including the evaluation and monitoring of third party law firms retained to effect our foreclosures. Certain other processes were deemed adequate. The Federal Reserve issued a similar supervisory letter to HSBC Finance and HSBC North America. We have suspended foreclosures until such time as we have substantially addressed the noted deficiencies in our processes. We are also reviewing foreclosures where judgment has not yet been entered and will correct deficient documentation and re-file affidavits where necessary.
 
We and our affiliates are engaged in discussions with the OCC and the Federal Reserve regarding the terms of consent cease and desist orders, which will prescribe actions to address the deficiencies noted in the joint examination. We expect the consent orders will be finalized shortly after the date this Form 10-K is filed. While the impact of the OCC consent order on HSBC Bank USA depends on the final terms, we believe it has the potential to increase our operational, reputational and legal risk profiles and expect implementation of its provisions will require significant financial and managerial resources. In addition, the consent orders will not preclude further actions against HSBC Bank USA or our affiliates by bank regulatory or other agencies, including the imposition of fines and civil money penalties. We are unable at this time, however, to determine the likelihood of any further action or the amount of penalties or fines, if any, that may be imposed by the regulators or agencies.
 
Due to the significant slow-down in foreclosures, and in some instances, cessation of all foreclosure processing by numerous loan servicers, including us, for some period of time in 2011 there may be some reduction in the number of properties being marketed following foreclosure. The impact of that decrease may increase demand for properties currently on the market resulting in a stabilization of home prices but could also result in a larger number of vacant properties in communities creating downward pressure on general property values. As a result, the short term impact of the foreclosure processing delay is highly uncertain. However, the longer term impact is even more uncertain as eventually servicers will again begin to foreclose and market properties in large numbers which is likely to create a significant over-supply of housing inventory. This could lead to an increase in loss severity on REO properties.
 
Financial Regulatory Reform On July 21, 2010, the “Dodd-Frank Wall Street Reform and Consumer Protection Act” was signed into law and is a sweeping overhaul of the financial regulatory system. For a full description of the law see “Regulation – Financial Regulatory Reform” section under the “Regulation and Competition” section in


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Item 1. Business. The legislation will have a significant impact on the operations of many financial institutions in the U.S., including our affiliates. As the legislation calls for extensive regulations to be promulgated to interpret and implement the legislation, it is not possible to precisely determine the impact to operations and financial results at this time.
 
2010 Events
 
  •  The improvements in market conditions described above and reduced outstanding exposure have resulted in a recovery of carrying value of several asset classes, including derivative products with monoline insurance companies and other structured credit products as well as subprime residential mortgage loans held for sale compared to valuation losses experienced in prior years due to the adverse market conditions which existed at that time.
 
A summary of the significant valuation adjustments associated with these market conditions that impacted revenue in 2010, 2009 and 2008 is presented in the following table:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Gains (Losses)
                       
Insurance monoline structured credit products(1)
  $ 93     $ (152 )   $ (1,020 )
Other structured credit products(1)
    126       (217 )     (1,439 )
Mortgage whole loans held for sale including whole loan purchase settlement (predominantly subprime)(2)
    50       (233 )     (505 )
Other-than-temporary impairment on securities available-for-sale(3)
    (79 )     (124 )     (231 )
Leverage acquisition finance loans held for sale(4)
    42       284       (431 )
                         
Total gains (losses)
  $ 232     $ (442 )   $ (3,626 )
                         
 
 
  (1)  Reflected in Trading revenue (loss) in the consolidated statement of income (loss).
 
  (2)  Reflected in Other income (expense) in the consolidated statement of income (loss).
 
  (3)  Reflected in Net other-than-temporary impairment losses in the consolidated statement of income (loss).
 
  (4)  Reflected in Gain (loss) on instruments designated at fair value and related derivatives in the consolidated statement of income (loss).
 
The market turmoil experienced over the past couple of years has created stress for certain counterparties with whom we conduct business as part of our lending and client intermediation activities. We assess, monitor and manage credit risk with formal standards, policies and procedures that are designed to ensure credit risks are assessed accurately, approved properly, monitored regularly and managed actively. Consequently, we believe any loss exposure related to counterparties with whom we conduct business has been adequately reflected in our financial statements for all periods presented.
 
  •  Improvements in the U.S. economy have positively impacted the credit quality of our consumer loan portfolio throughout 2010, which resulted in a significant decrease in our provision for credit losses. The improvements in economic and credit conditions have resulted in improved outlook on future loss estimates for our consumer loan portfolio. The provision for credit losses in our commercial loan portfolio also decreased as improvements in economic conditions has led to lower levels of criticized loans, including lower levels of nonperforming loans and improvements in the financial circumstance of several customer relationships which led to credit upgrades on certain loans.
 
  •  In the ordinary course of business, we originate and sell mortgage loans primarily to government sponsored entities (“GSEs”) and provide various representations and warranties related to these loans. In 2010, we saw a significant increase in repurchase demands on these loans and on loans sold across the industry. As a result, we increased our repurchase reserve to $262 million at December 31, 2010 as compared to $66 million at December 31, 2009, due to the increased repurchase demand volume.


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  •  In February 2010, we completed the sale of our interest in Wells Fargo HSBC Trade Bank (“WHTB”) to Wells Fargo and recorded a gain of $66 million. The sale allows our Commercial Banking business to fully and directly serve internationally connected trade related clients located in the eighteen western states previously served by WHTB.
 
  •  In April 2010, we completed the sale of our 452 Fifth Avenue property in New York City, including the 1 W. 39th Street building, for $330 million in cash. Under the terms of the sale, we will lease back the entire 452 Fifth Avenue property for one year and floors one to eleven for a total of 10 years. In addition, we subsequently agreed to temporarily lease back floors 12-15 for various terms the last of which expires on April 30, 2012. The sale resulted in a gain of approximately $155 million; however, it has been deferred and is being recognized over ten years due to our continuing involvement. The headquarters of HSBC Bank USA remains in New York.
 
  •  In June 2010, we decided that the wholesale banknotes business within our Global Banking and Markets segment did not fit with our core strategy in the U.S. and, therefore, made the decision to exit this business. This business, which has been managed out of the U.S. with operations in key locations worldwide, arranged for the physical distribution of banknotes globally to central banks, large commercial banks and currency exchanges. During the fourth quarter of 2010, we completed the exit of substantially all of this business and as a result, these operations are now included in discontinued operations. Discontinued operations include closure costs of $14 million relating to this business and a lower of cost or fair value adjustment of $12 million relating to the Asian Banknotes Operations which were classified as held for sale in September and sold to an unaffiliated third party during the fourth quarter. See Note 3, “Discontinued Operations,” in the accompanying consolidated financial statements for additional information regarding this business.
 
  •  In August 2010, we sold auto finance loans with a carrying value of $1.2 billion at the date of sale and other related assets to Santander Consumer USA (“SC USA”) for $1.2 billion in cash. As a result of this transaction, we recognized a gain of $9 million during the third quarter of 2010.
 
  •  In August 2010, we announced to employees that we are considering strategic options for our mortgage operations, with the objective of recommending the future course of our prime mortgage lending and mortgage servicing platforms. Strategic options may include, but are not limited to, the sale or outsourcing of all, or part, of these platforms. Under all options being explored, we plan to continue offering mortgages to our customers. Our review of strategic options is continuing.
 
  •  In December 2010, as a result of recent Internal Revenue Service decisions to stop providing information regarding certain unpaid taxpayer obligations which historically served as a significant part of the underwriting process, it was determined that tax refund anticipation loans could no longer be offered in a safe and sound manner and, therefore, we would no longer offer such loans and related products going forward. These products have historically had an insignificant impact to our results of operations. See Note 4, “Exit from Taxpayer Financial Services Loan Program,” for further discussion.
 
  •  Effective January 1, 2010, we adopted new guidance issued by the Financial Accounting Standards Board which amended the accounting for the consolidation of variable interest entities. The adoption of the new guidance resulted in the consolidation of one commercial paper conduit (“Bryant Park”) managed by HSBC Bank USA. The impact of consolidating this entity beginning on January 1, 2010 resulted in an increase to our assets and liabilities of $3.2 billion and $3.5 billion, respectively, and a net reduction to common shareholder’s equity of $245 million. See Note 26, “Variable Interest Entities,” for further discussion on the adoption of this guidance.
 
In order to consolidate and streamline conduit administration across HSBC to reduce risk and achieve operational efficiencies, we have decided to assign substantially all of our Bryant Park liquidity facilities to HSBC Bank plc. Upon completion of this assignment, we will no longer have a controlling financial interest in Bryant Park and, therefore, we will no longer be required to consolidate Bryant Park Funding LLC. We expect the assignments will be completed by March 31, 2011.


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Performance, Developments and Trends Income from continuing operations was $1.6 billion in 2010 compared to a loss from continuing operations of $189 million in 2009 and $1.7 billion in 2008. Income from continuing operations before income tax was $2.3 billion in 2010 compared to a loss from continuing operations before income tax of $299 million in 2009 and $2.7 billion in 2008. Our results in all years were impacted by the change in the fair value of our own debt and the related derivatives for which we have elected fair value option and other non-recurring items which distort the ability of investors to compare the underlying performance trends of our business. The following table summarizes the collective impact of these items on our income (loss) from continuing operations before income tax for all periods presented:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Income (loss) from continuing operations before income tax, as reported
  $ 2,300     $ (299 )   $ (2,676 )
Change in value of own fair value option debt and related derivatives
    (239 )     494       (670 )
Gain on sale of MasterCard Class B or Visa Class B shares
    -       (48 )     (83 )
Gain relating to resolution of lawsuit(1)
    (5 )     (85 )     -  
Release of VISA litigation accrual
    (16 )     (9 )     (36 )
Gain on sale of equity interest in Wells Fargo HSBC Trade Bank
    (66 )     -       -  
Revenue associated with whole loan purchase settlement(2)
    (89 )     -       -  
Gain on sale of equity interest in HSBC Private Bank (Suisse) S.A. 
    -       (33 )     -  
                         
Income (loss) from continuing operations before income tax, excluding above items(3)
  $ 1,885     $ 20     $ (3,465 )
                         
 
 
(1) The proceeds of the resolution of this lawsuit were used to redeem 100 preferred shares held by CT Financial Services, Inc. as provided under the terms of the preferred shares.
 
(2) Represents loans previously purchased for resale from a third party.
 
(3) Represents a non-U.S. GAAP financial measure.
 
Our overall results for 2010 improved significantly as lower provisions for credit losses and higher other revenues were partially offset by lower net interest income and higher operating expenses. During 2010, we continued to reduce legacy and other risk positions as opportunities arose, including the sale of $276 million in subprime residential mortgage loans previously held for sale and continued reductions in monoline counterparty exposures.
 
Other revenues (losses) improved during 2010, driven by significantly higher gains on instruments designated at fair value and related derivatives due largely to changes in the value of our own debt and related derivatives as well as higher trading revenue. Improved market conditions in 2010 and reduced outstanding exposure have resulted in a reduction in valuation losses recorded in prior years. Other revenues during 2010 also reflect several non-recurring items as presented in the table above as well as the impact of changes in value of our own debt and related derivatives for which we elected fair value option. Excluding the impact of all these items, other revenue decreased $376 million during 2010 due primarily to lower credit card fees, lower mortgage banking revenue and lower securities gains, partially offset by higher trading revenue. Lower credit card fees were due to lower levels of credit card and private label receivables, changes in customer behavior, lower delinquency levels and the implementation of certain provisions of the CARD Act which resulted in lower over limit, late and payment processing fees. The lower mortgage banking revenue was driven by an increase in our estimated exposure on repurchase obligations associated with previously sold loans. Securities gains were lower in 2010 as the prior year period reflects gains of $236 million on the sale of securities in the second quarter of 2009 as part of a strategy to reduce risk.
 
Net interest income was $4.5 billion in 2010, a decrease of 12 percent over 2009. The decrease reflects the impact of lower average loan balances and rates earned on these balances. These reductions were partially offset by commercial loan repricings and repricing initiatives on private label cards and credit cards as well as a lower cost of funds, including lower overall average rates on deposits.


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Our provision for credit losses decreased $3.0 billion during 2010 primarily due to declines in loan balances and improvements in economic and credit conditions, including lower dollars of delinquency and reduced volatility in the housing markets which has resulted in a moderation of loss severities on real estate secured loans. These conditions have resulted in improved outlook on future loss estimates for our credit card and private label receivables as well as for our residential mortgage loan portfolio as compared with the prior year. Provision for credit losses also decreased for both loans and loan commitments in the commercial loan portfolio due to lower outstanding balances including managed reductions in certain exposures and improvements in the financial circumstances of several customer relationships which led to credit upgrades on certain problem credits and lower levels of nonperforming loans and criticized assets. Also contributing to the decrease were fewer customer downgrades across all business lines as compared to the prior year. The combination of all of these factors led to an overall net recovery in our provision for commercial loans during 2010.
 
Operating expenses increased $153 million in 2010, an increase of 4 percent over 2009. The increase largely resulted from higher fees paid to HTSU and other affiliates due to the centralization of additional shared services across North America including higher compliance costs and higher fees paid to HSBC Finance related to a change in how the refund anticipation loan program was managed in 2010. These increases were partially offset by lower salaries and employee benefit expense which reflects the centralization of additional shared services in North America within HTSU and continued cost management efforts, partially offset by increased salaries associated with the transfer of certain employees of HSBC Finance to the default mortgage loan servicing department (which cost is offset in other revenues). Compared with 2009 we also experienced lower occupancy expense, lower insurance costs, improved loss estimates on off-balance sheet credit exposure and significantly lower FDIC assessment fees as the prior year included an $82 million special assessment recorded in the second quarter of 2009.
 
Our efficiency ratio from continuing operations was 54.02 percent during 2010 as compared to 50.23 percent in 2009. The deterioration in the efficiency ratio in 2010 reflects higher operating expenses while the total of net interest income and other revenues declined.
 
Our effective tax rate for continuing operations was 32.3 percent in 2010 as compared to (36.8) percent in 2009. The effective tax rate for 2010 reflects a substantially higher level of pre-tax income, an increased level of low-income housing tax credits, an adjustment of uncertain tax positions, the release of valuation reserves on previously unrealizable deferred tax assets related to loss carry forwards and an adjustment of the tax rate used to record deferred taxes.
 
2009 vs. 2008 Although our overall results for 2009 improved compared to 2008, they continued to be impacted by reductions in other revenues (losses), largely trading revenue associated with credit derivative products due to the adverse financial market conditions which existed at the time, although the magnitude of such reductions declined significantly in 2009. Overall, our 2009 results improved compared to 2008, as higher net interest income and higher other revenues (losses) more than offset higher provisions for credit losses and higher operating expenses including higher FDIC insurance premiums. In 2008, our results declined markedly, largely relating to a significant decrease in trading revenue due to the adverse financial market conditions described above.
 
Net interest income was $5.1 billion in 2009, an increase of 19 percent over 2008. This increase primarily resulted from the impact of higher credit card receivable levels associated with the purchase of the GM and UP Portfolios in January 2009, lower promotional balances on private label credit cards, a reduction in the amortization of private label credit card premiums due largely to lower premiums being paid and a lower cost of funds, all of which contributed to higher net interest margin. These increases were partially offset by a narrowing of interest rate spreads on deposit products primarily due to lower market interest rates and competitive pressures as customers migrated to higher yielding deposit products, higher amortization of credit card premium due to the purchase of the GM and UP portfolios and the runoff of the residential mortgage and other consumer loan portfolios, including the sale of $4.5 billion of residential mortgage loans in 2009.
 
The increase in other revenues (losses) during 2009 reflects increased credit card fees resulting from the purchase of the GM and UP Portfolios, higher gains on sales of mortgage backed and asset backed securities due to our efforts to reduce exposure to these investments, higher trading revenue, higher transaction fees in Global Banking and


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Markets and higher gains on leveraged acquisition finance loans held for sale for which we elected to apply fair value option. Although other revenues (losses) were overall higher during 2009, we continue to be impacted by reductions in other revenues (losses), largely trading revenue associated with credit derivative products due to the adverse financial market conditions which existed at that time, although the magnitude of such reductions declined significantly from 2008. Partially offsetting the increase in other revenues (losses) was $537 million in losses on the fair value of financial instruments and the related derivative contracts (excluding leveraged acquisition finance loans held for sale) for which fair value option was elected as compared to gains of $717 million in 2008.
 
Our provision for credit losses increased $1.6 billion in 2009 primarily due to a higher provision for credit card receivables due to significantly higher credit card balances as a result of the purchase of the GM and UP Portfolios from HSBC Finance, higher delinquency and credit loss estimates relating to prime residential mortgage loans as conditions in the housing markets worsened and the U.S. economy deteriorated and higher credit loss provision in our commercial loan portfolio. Partially offsetting these increases was the impact from stabilization in the credit performance of private label credit card loans in the second half of the year and an improved outlook on future loss estimates as the impact of higher unemployment levels on losses was not as severe as previously anticipated. Provision for credit losses increased for both loans and loan commitments in the commercial loan portfolio due to higher delinquency and loss estimates and higher levels of criticized loans, including higher levels of substandard loans caused by customer credit downgrades and deteriorating economic conditions, particularly in real estate lending and corporate banking.
 
Operating expenses increased $335 million in 2009, an increase of 9 percent over 2008. Lower salaries and employee benefit expense due to continued cost management efforts, including the impact of global resourcing initiatives, which have resulted in lower headcount were more than offset by higher FDIC insurance premiums which were $208 million in 2009, as compared to $58 million in 2008, an increase of $150 million (including $82 million relating to a special assessment), higher pension costs, higher servicing fees paid to HSBC Finance as a result of the purchase of the GM, UP and Auto finance portfolios, higher fees paid to HTSU and increased costs related to the expansion of the retail banking network. Additionally in 2009, operating expenses includes an impairment write down of a data center building as part of our ongoing strategy to consolidate operations and improve efficiencies. Additionally, operating expenses in 2008 reflects a goodwill impairment charge of $54 million relating to the residential mortgage reporting unit in PFS and, in both 2009 and 2008, a release in the VISA litigation accrual that reduced operating expenses by $9 million in 2009 and $36 million in 2008.
 
Our efficiency ratio from continuing operations was 50.23 percent during 2009 as compared to 103.90 percent in 2008. The improvement in the efficiency ratio in 2009 resulted primarily from a significant increase in revenues as discussed more fully above.
 
Our effective tax rate for continuing operations was (36.8) percent in 2009 as compared to (35.2) percent in 2008. The effective tax rate for 2009 was impacted by the relative level of pre-tax income, the sale of a minority stock interest that was treated as a dividend for tax purposes, the effective settlement of an IRS audit with respect to agreed-upon items, an increase in the state and local income tax valuation allowance and an increased level of low income housing credits.
 
Loans Loans, excluding loans held for sale, were $73.1 billion at December 31, 2010 compared to $79.5 billion at December 31, 2009. The decrease in loans as compared to December 31, 2009 was driven by run-off in all of our consumer portfolios, including the sale in August 2010 of auto finance loans to SC USA as discussed above. We continue to sell the majority of new residential mortgage loan originations to government sponsored enterprises. The decline in credit card and private label receivables reflects fewer active customer accounts, the continued impact from actions previously taken to reduce risk in these portfolios and an increased focus by customers to reduce outstanding credit card debt. Commercial loans also decreased as compared to December 31, 2009 although increased paydowns and managed reductions in certain exposures were largely offset by the adoption of new accounting guidance on the consolidation of variable interest entities which resulted in the consolidation of an incremental $1.2 billion of commercial loans at December 31, 2010. See “Balance Sheet Review” for a more detailed discussion of the changes in loan balances.


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Credit Quality Our allowance for credit losses as a percentage of total loans decreased to 2.97 percent at December 31, 2010, as compared to 4.86 percent at December 31, 2009. The decrease in our allowance ratio reflects a lower allowance on all of our consumer loan portfolios due to improved credit quality, lower delinquency levels and improvement in economic conditions. Our commercial loan allowance for credit losses ratio also fell as economic conditions began to stabilize and related credit quality and future loss estimates improved.
 
Our consumer two-months-and-over contractual delinquency as a percentage of loans and loans held for sale (“delinquency ratio”) decreased to 5.04 percent at December 31, 2010 as compared to 6.02 percent at December 31, 2009. Dollars of delinquency fell across virtually all consumer portfolios while outstanding loan balances also declined. The decrease in the consumer delinquency ratio was driven largely by our residential mortgage, private label card and credit card portfolios, including the sale of $276 million of delinquent subprime mortgage whole loans during 2010. See “Credit Quality” for a more detailed discussion of the increase in our delinquency ratios.
 
Net charge-offs as a percentage of average loans (“net charge-off ratio”) increased to 3.76 percent in 2010, compared to 3.59 percent in 2009 driven by higher credit card charge-offs as charge-off levels in 2009 were positively impacted by the purchase of the GM and UP portfolios, a portion of which was recorded at fair value net of future anticipated losses at the time of acquisition, while average receivable levels declined. We experienced lower dollars of charge-off in all other consumer loan categories during 2010 driven by lower receivable levels and improved credit quality. These favorable trends were partially offset by the impact from continued weakness in the U.S. economy including continued high unemployment levels. See “Credit Quality” for a more detailed discussion of the increase in net charge-offs and the net charge-off ratio.
 
Funding and Capital Capital amounts and ratios are calculated in accordance with current banking regulations. Our Tier 1 capital ratio was 11.80 percent and 9.61 percent at December 31, 2010 and 2009, respectively. Our capital levels remain well above levels established by current banking regulations as “well capitalized.” We received no capital contributions from our immediate parent, HSBC North America Inc. (“HNAI”) during 2010 as compared to $2.2 billion during 2009.
 
As part of the regulatory approvals with respect to the affiliate receivable purchases completed in January 2009, HSBC Bank USA and HSBC made certain additional capital commitments to ensure that HSBC Bank USA holds sufficient capital with respect to the purchased receivables that are or may become “low-quality assets,” as defined by the Federal Reserve Act. These capital requirements, which require a risk-based capital charge of 100 percent for each “low-quality asset” transferred or arising in the purchased portfolios rather than a typical eight percent capital charge applied to similar assets that are not part of the transferred portfolios, are applied both for purposes of satisfying the terms of the commitments and for purposes of measuring and reporting HSBC Bank USA’s risk-based capital and related ratios. This treatment applies as long as the low-quality assets are owned by HSBC Bank USA. During 2010, HSBC Bank USA sold low quality auto finance loans with a net book value of approximately $178 million to a non-bank subsidiary of HSBC USA Inc. to reduce this capital requirement. These loans were subsequently sold to SC USA in August 2010. At December 31, 2010, the remaining purchased receivables subject to this requirement total $3.2 billion, of which $651 million were considered low-quality assets. We have exceeded the minimum capital ratios required at December 31, 2010.
 
During the third quarter of 2010, ten year subordinated debt of $1.3 billion and $750 million was issued by HSBC Bank USA and HSBC USA Inc., respectively, to support our capital position under Basel II and replace Tier 2 capital lost due to reduced capital treatment for future maturities of subordinated debt.
 
Subject to regulatory approval, HSBC North America will be required to implement Basel II provisions no later than April 1, 2011 in accordance with current regulatory timelines. HSBC USA Inc. will not report separately under the new rules, but HSBC Bank USA will report under the new rules on a stand-alone basis. Further increases in regulatory capital may be required prior to the Basel II adoption date; however, the exact amount will depend upon our prevailing risk profile and that of our North America affiliates under various stress scenarios. Adoption must be preceded by a parallel run period of at least four quarters, and requires the approval of U.S. regulators. This parallel run, which was initiated in January 2010, encompasses enhancements to a number of risk policies, processes and systems to align HSBC Bank USA with the Basel II final rule requirements. HSBC Bank USA will seek regulatory


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approval for adoption when the program enhancements have been completed which may extend beyond April 1, 2011.
 
Future Prospects Our operations are dependent upon our ability to attract and retain deposits and, to a lesser extent, access to the global capital markets. Numerous factors, both internal and external, may impact our access to, and the costs associated with, both sources of funding. These factors may include our debt ratings, overall economic conditions, overall market volatility, the counterparty credit limits of investors to the HSBC Group and the effectiveness of our management of credit risks inherent in our customer base.
 
Our results are also impacted by general economic conditions, including unemployment, housing market conditions, property valuations, interest rates and legislative and regulatory changes, all of which are beyond our control. Changes in interest rates generally affect both the rates we charge to our customers and the rates we must pay on our borrowings. The primary risks to achieving our business goals in 2011 are largely dependent upon macro-economic conditions which include a weak housing market, high unemployment rates, the nature and extent of the economic recovery, the level of consumer spending, volatility in the capital and debt markets and our ability to attract and retain customers, loans and deposits, all of which could impact trading and other revenue, net interest income, loan volume, charge-offs and ultimately our results of operations.
 
Basis of Reporting
 
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Unless noted, the discussion of our financial condition and results of operations included in MD&A are presented on a continuing operations basis of reporting. Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
 
In addition to the U.S. GAAP financial results reported in our consolidated financial statements, MD&A includes reference to the following information which is presented on a non-U.S. GAAP basis:


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International Financial Reporting Standards (“IFRSs”) Because HSBC reports results in accordance with IFRSs and IFRSs results are used in measuring and rewarding performance of employees, our management also separately monitors net income under IFRSs (a non-U.S. GAAP financial measure). The following table reconciles our net income on a U.S. GAAP basis to net income on an IFRSs basis.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Net income (loss) – U.S. GAAP basis
  $ 1,564     $ (142 )   $ (1,689 )
Adjustments, net of tax:
                       
Unquoted equity securities
    -       (19 )     (65 )
Reclassification of financial assets
    (102 )     (398 )     576  
Securities
    82       (79 )     (61 )
Derivatives
    11       17       10  
Loan impairment
    5       9       1  
Property
    28       -       -  
Pension costs
    77       38       1  
Purchased loan portfolios
    (53 )     66       -  
Servicing assets
    1       2       10  
Return of capital
    (3 )     (55 )     -  
Interest recognition
    3       (2 )     3  
Gain on sale of auto finance loans
    26       -       -  
Other
    5       (9 )     6  
                         
Net income (loss) – IFRSs basis
    1,644       (572 )     (1,208 )
Tax benefit (expense) – IFRSs basis
    (792 )     254       648  
                         
Profit (loss) before tax – IFRSs basis
  $ 2,436     $ (826 )   $ (1,856 )
                         
 
A summary of the significant differences between U.S. GAAP and IFRSs as they impact our results are presented below:
 
Unquoted equity securities – Under IFRSs, equity securities which are not quoted on a recognized exchange, but for which fair value can be reliably measured, are required to be measured at fair value. Securities measured at fair value under IFRSs are classified as either available-for-sale securities, with changes in fair value recognized in shareholders’ equity, or as trading securities, with changes in fair value recognized in income. Under U.S. GAAP, equity securities that are not quoted on a recognized exchange are not considered to have a readily determinable fair value and are required to be measured at cost, less any provisions for known impairment, in other assets.
 
Reclassification of financial assets – Certain securities were reclassified from “trading assets” to “loans and receivables” under IFRSs as of July 1, 2008 pursuant to an amendment to IAS 39, “Financial Instruments: Recognition and Measurement” (“IAS 39”), and are no longer marked to market under IFRSs. In November 2008, additional securities were similarly transferred to loans and receivables. These securities continue to be classified as “trading assets” under U.S. GAAP.
 
Additionally, certain Leverage Acquisition Finance (“LAF”) loans were classified as “Trading Assets” for IFRSs and to be consistent, an irrevocable fair value option was elected on these loans under U.S. GAAP on January 1, 2008. These loans were reclassified to “loans and advances” as of July 1, 2008 pursuant to the IAS 39 amendment discussed above. Under U.S. GAAP, these loans are classified as “held for sale” and carried at fair value due to the irrevocable nature of the fair value option.
 
Securities – Effective January 1, 2009 under U.S. GAAP, the credit loss component of an other-than-temporary impairment of a debt security is recognized in earnings while the remaining portion of the impairment loss is


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recognized in accumulated other comprehensive income provided we have concluded we do not intend to sell the security and it is more-likely-than-not that we will not have to sell the security prior to recovery. Under IFRSs, there is no bifurcation of other-than-temporary impairment and the entire amount is recognized in earnings. Also under IFRSs, recoveries in other-than-temporary impairment related to improvement in the underlying credit characteristics of the investment are recognized immediately in earnings while under U.S. GAAP, they are amortized to income over the remaining life of the security. There are also less significant differences in measuring other-than-temporary impairment under IFRSs versus U.S. GAAP.
 
Under IFRSs, securities include HSBC shares held for stock plans at fair value. These shares held for stock plans are recorded at fair value through other comprehensive income. If it is determined these shares have become impaired, the fair value loss is recognized in profit and loss and any fair value loss recorded in other comprehensive income is reversed. There is no similar requirement under U.S. GAAP. During the 2009 under IFRSs, we recorded income for the value of additional shares attributed to HSBC shares held for stock plans as a result of HSBC’s rights offering. The additional shares are not recorded under U.S. GAAP.
 
Derivatives – Effective January 1, 2008, U.S. GAAP removed the observability requirement of valuation inputs to allow up-front recognition of the difference between transaction price and fair value in the consolidated statement of loss. Under IFRSs, recognition is permissible only if the inputs used in calculating fair value are based on observable inputs. If the inputs are not observable, profit and loss is deferred and is recognized (1) over the period of contract, (2) when the data becomes observable, or (3) when the contract is settled.
 
Loan impairment – IFRSs requires a discounted cash flow methodology for estimating impairment on pools of homogeneous consumer loans which requires the incorporation of the time value of money relating to recovery estimates. Also under IFRSs, future recoveries on charged-off loans are accounted for on a discounted basis and a recovery asset is recorded. Subsequent recoveries are recorded to earnings under U.S. GAAP, but are adjusted against the recovery asset under IFRSs.
 
Property – The sale of our 452 Fifth Avenue property, including the 1 W. 39th Street building in April 2010, resulted in the recognition of a gain under IFRSs while under US GAAP, such gain is deferred and recognized over ten years due to our continuing involvement.
 
Pension costs – Net income under U.S. GAAP is lower than under IFRSs as a result of the amortization of the amount by which actuarial losses exceed gains beyond the 10 percent “corridor”. Furthermore, in 2010, changes to future accruals for legacy participants under the HSBC North America Pension Plan were accounted for as a plan curtailment under IFRSs, which resulted in immediate income recognition. Under US GAAP, these changes were considered to be a negative plan amendment which resulted in no immediate income recognition.
 
Purchased loan portfolios – Under US GAAP, purchased loans for which there has been evidence of credit deterioration at the time of acquisition are recorded at an amount based on the net cash flows expected to be collected. This generally results in only a portion of the loans in the acquired portfolio being recorded at fair value. Under IFRSs, the entire purchased portfolio is recorded at fair value. When recording purchased loans at fair value, the difference between all estimated future cash collections and the purchase price paid is recognized into income using the effective interest method. An allowance for loan loss is not established unless the original estimate of expected future cash collections declines.
 
Servicing assets – Under IAS 38, servicing assets are initially recorded on the balance sheet at cost and amortized over the projected life of the assets. Servicing assets are periodically tested for impairment with impairment adjustments charged against current earnings. Under U.S. GAAP, we generally record servicing assets on the balance sheet at fair value. Subsequent adjustments to fair value are generally reflected in current period earnings.
 
Return of capital – Reflects payments to CT Financial Services, Inc. in connection with the resolution of a lawsuit which for IFRSs was treated as the satisfaction of a liability and not as revenue and a subsequent capital transaction as was the case under U.S. GAAP.
 
Interest recognition – The calculation of effective interest rates under IAS 39 requires an estimate of “all fees and points paid or recovered between parties to the contract” that are an integral part of the effective interest rate be


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included. U.S. GAAP generally prohibits recognition of interest income to the extent the net interest in the loan would increase to an amount greater than the amount at which the borrower could settle the obligation. Also under U.S. GAAP, prepayment penalties are generally recognized as received.
 
Gain on sale of auto finance loans – The differences in the gain on sale of the auto finance loans primarily reflects differences in the basis of the purchased loans sold between IFRSs and U.S. GAAP as well as differences in loan impairment provisioning as discussed above. The combination of these differences resulted in a higher gain under IFRSs.
 
Other – Other includes the net impact of certain adjustments which represent differences between U.S. GAAP and IFRSs that were not individually material, including deferred loan origination costs and fees, restructuring costs, depreciation expense and loans held for sale. In 2008, other also includes the impact of a difference in the write off amount of goodwill related to our residential mortgage banking business unit and a timing difference with respect to the adoption of fair value measurement accounting principles for U.S. GAAP which resulted in the recognition of $10 million of net income relating to structured products.
 
Critical Accounting Policies and Estimates
 
Our consolidated financial statements are prepared in accordance with U.S. GAAP. We believe our policies are appropriate and fairly present the financial position of HSBC USA Inc.
 
The significant accounting policies used in the preparation of our consolidated financial statements are more fully described in Note 2, “Summary of Significant Accounting Policies and New Accounting Pronouncements,” to the accompanying consolidated financial statements. Certain critical accounting policies, which affect the reported amounts of assets, liabilities, revenues and expenses, are complex and involve significant judgment by our management, including the use of estimates and assumptions. We base and establish our accounting estimates on historical experience, observable market data, inputs derived from or corroborated by observable market data by correlation or other means and on various other assumptions including those based on unobservable inputs that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. In addition, to the extent we use certain modeling techniques to assist us in measuring the fair value of a particular asset or liability, we strive to use such techniques which are consistent with those used by other market participants. Actual results may differ from these estimates due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. The impact of estimates and assumptions on the financial condition or operating performance may be material.
 
We believe that of the significant accounting policies used in the preparation of our consolidated financial statements, the items discussed below require critical accounting estimates involving a high degree of judgment and complexity. Our management has discussed these critical accounting policies with the Audit Committee of our Board of Directors, including certain underlying estimates and assumptions, and the Audit Committee has reviewed our disclosure relating to these accounting policies and practices in this MD&A.
 
Allowance for Credit Losses Because we lend money to others, we are exposed to the risk that borrowers may not repay amounts owed when they become contractually due. Consequently, we maintain an allowance for credit losses at a level that we consider adequate, but not excessive, to cover our estimate of probable incurred losses in the existing loan portfolio. Allowance estimates are reviewed periodically and adjustments are reflected through the provision for credit losses in the period when they become known. The accounting estimate relating to the allowance for credit losses is a “critical accounting estimate” for the following reasons:
 
  •  Changes in the provision can materially affect our financial results;
 
  •  Estimates related to the allowance for credit losses require us to project future delinquency and charge off trends, which are uncertain and require a high degree of judgment; and


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  •  The allowance for credit losses is influenced by factors outside of our control such as customer payment patterns, economic conditions such as national and local trends in housing markets, interest rates, unemployment rates, bankruptcy trends and changes in laws and regulations all of which have an impact on our estimates.
 
Because our estimate of the allowance for credit losses involves judgment and is influenced by factors outside of our control, there is uncertainty inherent in these estimates, making it reasonably possible such estimates could change. Our estimate of probable incurred credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions which influence growth, portfolio seasoning, bankruptcy trends, trends in housing markets, delinquency rates and the flow of loans through various stages of delinquency, the realizability of any collateral and actual loss exposure. Changes in such estimates could significantly impact our allowance and provision for credit losses. For example, a 10 percent change in our projection of probable net credit losses on our loans would have resulted in a change of approximately $217 million in our allowance for credit losses at December 31, 2010. The allowance for credit losses is a critical accounting estimate for our Consumer Finance, Personal Financial Services, Commercial Banking, Global Banking and Markets and Private Banking segments.
 
Our allowance for credit losses is based on estimates and is intended to be adequate but not excessive. The allowance for credit losses is regularly assessed for adequacy through a detailed review of the loan portfolio. The allowance is comprised of two balance sheet components:
 
  •  The allowance for credit losses, which is carried as a reduction to loans on the balance sheet, includes reserves for inherent probable credit losses associated with all loans outstanding; and
 
  •  The reserve for off-balance sheet risk, which is recorded in other liabilities, includes probable and reasonably estimable credit losses arising from off-balance sheet arrangements such as letters of credit and undrawn commitments to lend.
 
Both components include amounts calculated for specific individual loan balances and for collective loan portfolios depending on the nature of the exposure and the manner in which risks inherent in that exposure are managed.
 
  •  All commercial loans that exceed $500,000 are evaluated individually for impairment. When a loan is found to be “impaired,” a specific reserve is calculated. Reserves against impaired loans are determined primarily by an analysis of discounted expected cash flows with reference to independent valuations of underlying loan collateral and considering secondary market prices for distressed debt where appropriate.
 
  •  Loans which are not individually evaluated for impairment and those evaluated and found not to be impaired are pooled into homogeneous categories of loans and evaluated to determine if it is deemed probable, based on historical data and other environmental factors, that a loss has been realized even though it has not yet been manifested in a specific loan.
 
For consumer receivables and certain small business loans, we utilize a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency and ultimately be charged-off based on recent historical experience. These estimates also take into consideration the loss severity expected based on the underlying collateral for the loan, if any, in the event of default. In addition, loss reserves are maintained on consumer receivables to reflect our judgment of portfolio risk factors which may not be fully reflected in the statistical roll rate calculation or when historical trends are not reflective of current inherent losses in the loan portfolio. Risk factors considered in establishing the allowance for credit losses on consumer receivables include growth, product mix and risk selection, unemployment rates, bankruptcy trends, geographic concentrations, loan product features such as adjustable rate loans, economic conditions such as national and local trends in unemployment, housing markets and interest rates, portfolio seasoning, changes in underwriting practices, current levels of charge-offs and delinquencies, changes in laws and regulations and other items which can affect consumer payment patterns on outstanding receivables such as natural disasters. We also consider key ratios such as number of months of loss coverage in developing our allowance estimates. The resulting loss coverage ratio varies by portfolio based on inherent risk and, where applicable, regulatory guidance. Roll rates are regularly updated and benchmarked against actual outcomes to ensure that they remain appropriate.


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An advanced credit risk methodology is utilized to support the estimation of incurred losses inherent in pools of homogeneous commercial loans, leases and off-balance sheet risk. This methodology uses the probability of default from the customer rating assigned to each counterparty, the “Loss Given Default” rating assigned to each transaction or facility based on the collateral securing the transaction, and the measure of exposure based on the transaction. A suite of models, tools and templates is maintained using quantitative and statistical techniques, which are combined with management’s judgment to support the assessment of each transaction. These were developed using internal data and supplemented with data from external sources which was judged to be consistent with our internal credit standards. These advanced measures are applied to the homogeneous credit pools to estimate the required allowance for credit losses.
 
The results from the commercial analysis, consumer roll rate analysis and the specific impairment reserving process are reviewed each quarter by the Credit Reserve Committee. This committee also considers other observable factors, both internal and external to us in the general economy, to ensure that the estimates provided by the various models adequately include all known information at each reporting period. Loss reserves are maintained to reflect the committee’s judgment of portfolio risk factors which may not be fully reflected in statistical models or when historical trends are not reflective of current inherent incurred losses in the loan portfolio. The allowance for credit losses are reviewed with our Risk Management Committee and the Audit Committee of the Board of Directors each quarter.
 
Goodwill Impairment Goodwill is not subject to amortization but is tested for possible impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of each reporting unit be compared to its carrying amount, including the goodwill. Significant and long-term changes in industry and economic conditions are considered to be primary indicators of potential impairment due to their impact on expected future cash flows. In addition, shorter-term changes may impact the discount rate applied to such cash flows based on changes in investor requirements or market uncertainties.
 
The impairment testing of our goodwill is a “critical accounting estimate” due to the significant judgment required in the use of discounted cash flow models to determine fair value. Discounted cash flow models include such variables as revenue growth rates, expense trends, interest rates and terminal values. Based on an evaluation of key data and market factors, management’s judgment is required to select the specific variables to be incorporated into the models. Additionally, the estimated fair value can be significantly impacted by the risk adjusted cost of capital used to discount future cash flows. The risk adjusted cost of capital percentage is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of that used by market participants which involves management’s judgment. Because our fair value estimate involves judgment and is influenced by factors outside our control, it is reasonably possible such estimate could change. When management’s judgment is that the anticipated cash flows have decreased and/or the cost of capital has increased, the effect will be a lower estimate of fair value. If the fair value is determined to be lower than the carrying value, an impairment charge may be recorded and net income will be negatively impacted.
 
Impairment testing of goodwill requires that the fair value of each reporting unit be compared to its carrying amount. Reporting units were identified based upon an analysis of each of our individual operating segments. A reporting unit is defined as any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. Goodwill was allocated to the carrying value of each reporting unit based on its relative fair value.
 
We have established July 1 of each year as the date for conducting our annual goodwill impairment assessment. The goodwill impairment analysis is a two step process. The first step, used to identify potential impairment, involves comparing each reporting unit’s fair value to its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, including allocated goodwill, there is no indication of impairment and no further procedures are required. If the carrying value including allocated goodwill exceeds fair value, the second step is performed to quantify the impairment amount, if any. If the implied fair value of goodwill as determined using the same methodology as used in a business combination is less than the carrying value of goodwill, an impairment


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charge is recorded for the excess. An impairment recognized cannot exceed the amount of goodwill assigned to a reporting unit. Subsequent reversals of goodwill impairment are not permitted. At July 1, 2010, the estimated fair value of each reporting unit exceeded its carrying value and, as such, none of our recorded goodwill was deemed to be impaired.
 
As a result of the continued focus on economic and credit conditions in the U.S., we performed interim impairment tests of the goodwill associated with our Global Banking and Markets and Private Banking reporting units as of December 31, 2010, September 30, 2010, June 30, 2010 and March 31, 2010. As a result of these tests, the fair value of our Global Banking and Markets and Private Banking reporting units continue to exceed their carrying value, including goodwill at each of these testing dates. At December 31, 2010, goodwill totaling $612 million and $415 million has been allocated to our Global Banking and Markets and Private Banking reporting units, respectively. As of the December 31, 2010 interim impairment testing date, the fair value of our Global Banking and Markets reporting unit did not significantly exceed its carrying value including goodwill, while the fair value of our Private Banking reporting unit significantly exceeded its carrying value, including goodwill. Our goodwill impairment testing is however, highly sensitive to certain assumptions and estimates used as discussed above. We continue to perform periodic analyses of the risks and strategies of our business and product offerings. If significant deterioration in the economic and credit conditions occur, or changes in the strategy or performance of our business or product offerings occur, an interim impairment test will again be required in 2011.
 
Valuation of Financial Instruments A substantial portion of our financial assets and liabilities are carried at fair value. These include trading assets and liabilities, including derivatives held for trading, derivatives used for hedging and securities available-for-sale. Certain loans held for sale, which are carried at the lower of amortized cost or fair value, are also reported at fair value when their amortized cost exceeds their current fair value.
 
Where available, we use quoted market prices to determine fair value. If quoted market prices are not available, fair value is determined using internally developed valuation models based on inputs that are either directly observable or derived from and corroborated by market data. These inputs include, but are not limited to, interest rate yield curves, option volatilities, option adjusted spreads and currency rates. Where neither quoted market prices nor observable market parameters are available, fair value is determined using valuation models that feature one or more significant unobservable inputs based on management’s expectation that market participants would use in determining the fair value of the asset or liability. However, these unobservable inputs must incorporate market participants’ assumptions about risks in the asset or liability and the risk premium required by market participants in order to bear the risks. The determination of appropriate unobservable inputs requires exercise of management judgment. A significant majority of our assets and liabilities that are reported at fair value are measured based on quoted market prices and observable market-based or independently-sourced inputs.
 
We review and update our fair value hierarchy classifications at the end of each quarter. Quarterly changes related to the observability of the inputs to a fair value measurement may result in a reclassification between hierarchy levels. Level 3 assets as a percentage of total assets measured at fair value were approximately four percent at December 31, 2010. Imprecision in estimating unobservable market inputs can impact the amount of revenue, loss or changes in other comprehensive income recorded for a particular financial instrument. Furthermore, while we believe our valuation methods are appropriate, the use of different methodologies or assumptions to determine the fair value of certain financial assets and liabilities could result in a different estimate of fair value at the reporting date. For a more detailed discussion of the determination of fair value for individual financial assets and liabilities carried at fair value see “Fair Value” under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
The following is a description of the significant estimates used in the valuation of financial assets and liabilities for which quoted market prices and observable market parameters are not available.
 
Complex derivatives held for trading – Fair value for the majority of our derivative instruments are based on internally developed models that utilize independently sourced market parameters. For complex or long-dated derivative products where market data is not available, fair value may be affected by the choice of valuation model and the underlying assumptions about the timing of cash flows and credit spreads. The fair values of certain


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structured credit and structured equity derivative products are sensitive to unobservable inputs such as default correlations and volatilities. These estimates are susceptible to significant changes in future periods as market conditions evolve.
 
We may adjust certain fair value estimates to ensure that those estimates appropriately represent fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors such as market liquidity and counterparty credit risk. Where relevant, a liquidity adjustment is applied to determine the measurement of an asset or a liability that is required to be reported at fair value. Assessing the appropriate level of liquidity adjustment requires management judgment and is often affected by the product type, transaction-specific terms and the level of liquidity for the product in the market. For financial liabilities, including derivatives measured at fair value, we consider the effect of our own non-performance risk on fair values. In assessing the credit risk relating to derivative assets and liabilities, we take into account the impact of risk mitigants including, but not limited to, master netting and collateral arrangements. Finally, other transaction specific factors such as the selection of valuation models available, the range of unobservable model inputs and other model assumptions can affect fair value estimates. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.
 
Loans held for sale – Certain residential mortgage whole loans are classified as held for sale and are accounted for at lower of cost or fair value. The fair value of certain of these loans have historically been determined based on valuations of mortgage-backed securities that would be observed in a hypothetical securitization adjusted for dissimilarity in the underlying collateral, market liquidity, and direct transaction costs to convert mortgage loans into securities. During the recent market turmoil, pricing information on mortgage related assets became less available. In an inactive market where securitizations of mortgage whole loans may not regularly occur, we utilize alternative market information by reference to different exit markets to determine or validate the fair value of our mortgage whole loans. The determination of fair value for mortgage whole loans takes into account factors such as the location of the collateral, the loan-to-value ratio, the estimated rate and timing of delinquency, the probability of foreclosure and loss severity if foreclosure does occur.
 
Loans elected for the fair value option – We elected to measure certain leveraged finance loans and commercial loans at fair value under the fair value option provided by U.S. GAAP. Where available, market-based consensus pricing obtained from independent sources is used to estimate the fair value of leveraged loans. Where consensus pricing information is not available, fair value is estimated using observable market prices of similar instruments, including bonds, credit derivatives, and loans with similar characteristics. Where observable market parameters are not available, fair value is determined based on contractual cash flows adjusted for estimates of prepayments, defaults, and recoveries, discounted at management’s estimate of the rate that would be required by market participants in the current market conditions. We attempt to corroborate estimates of prepayments, defaults, and recoveries using observable data by correlation or other means. We also consider the specific loan characteristics and inherent credit risk and risk mitigating factors such as the nature and characteristics of the collateral arrangements in determining fair value. Continued lack of liquidity in credit markets has resulted in a significant decrease in the availability of observable market data, which has resulted in an increased level of management judgment required to estimate fair value for loans held for sale.
 
Structured deposits and structured notes – Certain hybrid instruments, primarily structured notes and structured certificates of deposit, were elected to be measured at fair value in their entirety under the fair value option provided by U.S. GAAP. As a result, derivative features embedded in those instruments are included in the fair value measurement of the instrument. Depending on the complexity of the embedded derivative, the same elements of valuation uncertainty and adjustments described in the derivative sections above would apply to hybrid instruments. Additionally, cash flows for the funded notes and deposits are discounted at the appropriate rate for the applicable duration of the instrument adjusted for our own credit spreads. The credit spreads applied to these instruments are derived from the spreads at which institutions of similar credit standing would be charged for issuing similar structured instruments as of the measurement date.
 
Own debt issuances for which the fair value option has been elected are traded in the OTC market. The fair value of our own debt issuances is determined based on the observed prices for the specific debt instrument transacted in the


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secondary market. To the extent the inputs are observable, less judgment is required in determining the fair value. In many cases, management can obtain quoted prices for identical or similar liabilities. However, the markets may become inactive at various times where prices are not current or price quotations vary over time or among market makers. In these situations, valuation estimates involve using inputs other than quoted prices to value both the interest rate component and the credit component of the debt. Changes in such estimates, and in particular the credit component of the valuation, can be volatile from period to period and may markedly impact the total mark-to-market on debt designated at fair value recorded in our consolidated statement of income (loss).
 
Asset-backed securities – Mortgage-backed securities and other asset-backed securities including Collateralized Debt Obligations (“CDOs”) and Collateralized Loan Obligations (“CLOs”) are classified as either available-for-sale or held for trading and are measured at fair value. The fair value measurements of these asset classes are primarily determined or validated by inputs obtained from independent pricing sources adjusted for the differences in the characteristics and performance of the underlying collateral, such as prepayments and defaults. During the recent credit crisis, the valuations of certain mortgage-backed and asset-backed securities have become less transparent. For these securities, internal valuation estimates are used to validate the pricing information obtained from independent pricing sources which measure fair value based on information derived from both observable and unobservable inputs.
 
We have established a control framework designed to ensure that fair values are either determined or validated by a function independent of the risk-taker. Controls over the valuation process are summarized in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Fair Value.”
 
Because the fair value of certain financial assets and liabilities are significantly impacted by the use of estimates, the use of different assumptions can result in changes in the estimated fair value of those assets and liabilities, which can result in equity and earnings volatility as follows:
 
  •  Changes in the fair value of trading assets and liabilities are recorded in current period earnings;
 
  •  Changes in the fair value of securities available-for-sale are recorded in other comprehensive income;
 
  •  Changes in the fair value of loans held for sale when their amortized cost exceeds fair value are recorded in current period earnings;
 
  •  Changes in the fair value of a derivative that has been designated and qualifies as a fair value hedge, along with the changes in the fair value of the hedged asset or liability (including losses or gains on firm commitments), are recorded in current period earnings; and
 
  •  Changes in the fair value of a derivative that has been designated and qualifies as a cash flow hedge are recorded in other comprehensive income to the extent of its effectiveness, until earnings are impacted by the variability of cash flows from the hedged item.
 
Derivatives held for hedging Derivatives designated as qualified hedges are tested for effectiveness of the hedge. For these transactions, assessments are made at the inception of the hedge and on a recurring basis, whether the derivative used in the hedging transaction has been and is expected to continue to be highly effective in offsetting changes in fair values or cash flows of the hedged item. This assessment is conducted using statistical regression analysis.
 
If we determine as a result of this assessment that a derivative is not expected to be a highly effective hedge or that it has ceased to be a highly effective hedge, hedge accounting is discontinued as of the quarter in which such determination was made. The assessment of the effectiveness of the derivatives used in hedging transactions is considered to be a “critical accounting estimate” due to the use of statistical regression analysis in making this determination. Similar to discounted cash flow modeling techniques, statistical regression analysis requires the use of estimates regarding the amount and timing of future cash flows which are susceptible to significant changes in future periods based on changes in market rates. Statistical regression analysis also involves the use of additional


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assumptions including the determination of the period over which the analysis should occur as well as selecting a convention for the treatment of credit spreads in the analysis.
 
The outcome of the statistical regression analysis serves as the foundation for determining whether or not a derivative is highly effective as a hedging instrument. This can result in earnings volatility as the mark-to-market on derivatives which do not qualify as effective hedges and the ineffectiveness associated with qualifying hedges are recorded in current period earnings.
 
Impairment of securities available for sale Securities available-for-sale are measured at fair value and changes in fair value, net of related income taxes, are recognized in equity in other comprehensive income until the securities are either sold or an other-than-temporary impairment loss is recognized. Where the amount recognized in other comprehensive income related to a security available-for-sale represents a loss, the security is deemed to be impaired. To the extent that the impairment is deemed to be other-than-temporary, an other-than-temporary impairment loss is recognized. However for financial statement presentation purposes, only the credit loss component of such difference is recognized in earnings for a debt security that we do not intend to sell and for which it is not more-likely-than-not that we will be required to sell prior to recovery of its amortized cost basis. We do not consider impairment of held-to-maturity securities to be a critical accounting estimate as such security holdings are not significant.
 
Total securities available-for-sale amounted to $45.5 billion and $27.8 billion at December 31, 2010 and 2009, respectively, of which $45.4 billion or 99.8 percent at December 31, 2010 and $26.5 billion or 95.5 percent at December 31, 2009 were debt securities. The amount recorded in other comprehensive income relating to debt securities available-for-sale amounted to an increase of $211 million and $526 million during December 31, 2010 and 2009, respectively. A reduction in other comprehensive income relating to a debt security available-for-sale occurs when the fair value of the security is less than the security’s acquisition cost (net of any principal repayments and amortization) less any other-than-temporary impairment loss recognized in earnings.
 
Management is required to exercise judgment in determining whether an impairment is other-than-temporary or reflects a credit loss that must be recognized in earnings. For debt securities available-for-sale, the objective evidence required to determine whether an impairment is other-than-temporary or reflects a credit loss comprises evidence of the occurrence of a loss event that results in a decrease in estimated future cash flows. Where cash flows are readily determinable, a low level of judgment may be involved. Where determination of estimated future cash flows requires consideration of a number of variables, some of which may be unobservable in current market conditions, more significant judgment is required.
 
The most significant judgments concern more complex instruments, such as asset-backed securities (“ABSs”), where it is necessary to consider factors such as the estimated future cash flows on underlying pools of collateral, the extent and depth of market price declines and changes in credit ratings. The review of estimated future cash flows on underlying collateral is subject to estimation uncertainties where the assessment is based on historical information on pools of assets, and judgment is required to determine whether historical performance is likely to be representative of current economic and credit conditions.
 
There is no single factor to which our charge for other-than-temporary impairment of debt securities available-for-sale is particularly sensitive, because of the range of different types of securities held, the range of geographical areas in which those securities are held, and the wide range of factors which can affect the occurrence of loss events and cash flows of securities, including different types of collateral.
 
Management’s current assessment of the holdings of available-for-sale ABSs with the most sensitivity to possible future impairment is focused on subprime and Alt-A residential mortgage-backed securities (“MBSs”). Our principal exposure to these securities is in the Global Banking and Markets’ business. Excluding holdings in certain special purpose entities where significant first loss risks are borne by external investors, the available-for-sale holdings in these categories within Global Banking and Markets amounted to $4 million at December 31, 2010 ($136 million at December 31, 2009). The available-for-sale fair value adjustment as at December 31, 2010 in relation to these securities was an unrealized gain of $1 million and at December 31, 2009, an unrealized gain of $7 million.


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The main factors in the reduction in fair value of these securities over the period were the effects of reduced market liquidity and negative market sentiment. The level of actual credit losses experienced was relatively low in both 2010 and 2009, notwithstanding the deterioration in the performance of the underlying mortgages in the period as U.S. home prices remained under pressure and defaults increased. The absence of significant credit losses is judged to be attributable to the seniority of the tranches we held as well as the priority for cash flow held by these tranches. In 2010, we recognized other-than-temporary impairment on held-to-maturity and available-for-sale securities of $79 million in earnings. In 2009, we recognized other than temporary impairment on available-for-sale securities of $124 million in earnings.
 
It is reasonably possible that outcomes in the future could be different from the assumptions and estimates used in identifying impairment on available-for-sale debt securities and, as a result, impairment may be identified in available-for-sale debt securities which had previously been determined not to be impaired. It is possible that this could result in the recognition of material impairment losses in future periods.
 
Mortgage Servicing Rights We recognize retained rights to service mortgage loans as a separate and distinct asset at the time the loans are sold. We initially value Mortgage Servicing Rights (“MSRs”) at fair value at the time the related loans are sold and subsequently measure MSRs at fair value at each reporting date with changes in fair value reflected in income in the period that the changes occur.
 
MSRs are subject to interest rate risk in that their fair value will fluctuate as a result of changes in the interest rate environment. Fair value is determined based upon the application of valuation models and other inputs. The valuation models incorporate assumptions market participants would use in estimating future cash flows. These assumptions include expected prepayments, default rates and market-based option adjusted spreads. The estimate of fair value is considered to be a “critical accounting estimate” because the assumptions used in the valuation models involve a high degree of subjectivity that is dependent upon future interest rate movements. The reasonableness of these pricing models is validated on a quarterly basis by reference to external independent broker valuations and industry surveys.
 
Because the fair values of MSRs are significantly impacted by the use of estimates, the use of different estimates can result in changes in the estimated fair values of those MSRs, which can result in equity and earnings volatility because such changes are reported in current period earnings.
 
Deferred Tax Assets We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax credits and state net operating losses. Our deferred tax assets, net of valuation allowances, totaled $1.6 billion and $2.2 billion as of December 31, 2010 and 2009, respectively. We evaluate our deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including our historical financial performance, projections of future taxable income, future reversals of existing taxable temporary differences and any carryback availability. We are required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders’ equity if we determine, based on available evidence at the time the determination is made, that it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans, future capital requirements and ongoing tax planning strategies, including capital support from HSBC necessary as part of such plans and strategies. This process involves significant management judgment about assumptions that are subject to change from period to period. Because the recognition of deferred tax assets requires management to make significant judgments about future earnings, the periods in which items will impact taxable income, and the application of inherently complex tax laws, we have included the assessment of deferred tax assets and the need for any related valuation allowance as a critical accounting estimate.
 
Since recent market conditions have created significant downward pressure and volatility on HSBC North America’s near-term pretax book income, our analysis of the realizability of deferred tax assets significantly discounts any future taxable income expected from operations and relies to a greater extent on continued liquidity


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and capital support from our parent, HSBC, including tax planning strategies implemented in relation to such support. We are included in HSBC North America’s consolidated Federal income tax return and in certain combined state returns. As we have entered into tax allocation agreements with HSBC North America and its subsidiary entities included in the consolidated return which govern the current amount of taxes to be paid or received by the various entities, we look at HSBC North America and its affiliates, together with the tax planning strategies identified, in reaching our conclusion on recoverability. Absent capital support from HSBC and implementation of the related tax planning strategies, we would be required to record a valuation allowance against our deferred tax assets.
 
The use of different estimates can result in changes in the amounts of deferred tax items recognized, which can result in equity and earnings volatility because such changes are reported in current period earnings. Furthermore, if future events differ from our current forecasts, valuation allowances may need to be established or adjusted, which could have a material adverse effect on our results of operations, financial condition and capital position. We will continue to update our assumptions and forecasts of future taxable income and assess the need and adequacy of any valuation allowance.
 
Additional detail on our assumptions with respect to the judgments made in evaluating the realizability of our deferred tax assets and on the components of our deferred tax assets and deferred tax liabilities as of December 31, 2010 and 2009 can be found in Note 18, “Income Taxes,” in the accompanying consolidated financial statements.
 
 
We utilize deposits and borrowings from various sources to provide liquidity, fund balance sheet growth, meet cash and capital needs, and fund investments in subsidiaries. Balance sheet totals at December 31, 2010 and increases (decreases) over prior periods are summarized in the table below:
 
                                         
          Increase (Decrease) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     Amount     %     Amount     %  
   
    (dollars are in millions)  
 
Period end assets:
                                       
Short-term investments
  $ 18,014     $ (5,240 )     (22.5 )%   $ (10,521 )     (36.9 )%
Loans, net
    70,899       (4,729 )     (6.3 )     (7,817 )     (9.9 )
Loans held for sale
    2,390       (518 )     (17.8 )     (2,041 )     (46.1 )
Trading assets
    32,402       6,599       25.6       1,113       3.6  
Securities
    48,713       18,145       59.4       20,930       75.3  
Other assets
    11,395       (1,523 )     (11.8 )     (3,420 )     (23.1 )
                                         
    $ 183,813     $ 12,734       7.4 %   $ (1,756 )     (.9 )%
                                         
Funding sources:
                                       
Total deposits
  $ 120,651     $ 2,417       2.0 %   $ 1,672       1.4 %
Trading liabilities
    10,528       2,618       33.1       (5,791 )     (35.5 )
Short-term borrowings
    15,187       8,675       100+       4,692       44.7  
Interest, taxes and other liabilities
    3,484       (1,754 )     (33.5 )     (1,486 )     (29.9 )
Long-term debt
    17,230       (778 )     (4.3 )     (4,859 )     (22.0 )
Shareholders’ equity
    16,733       1,556       10.3       4,016       31.6  
                                         
    $ 183,813     $ 12,734       7.4 %   $ (1,756 )     (.9 )%
                                         
 
Short-Term Investments Short-term investments include cash and due from banks, interest bearing deposits with banks, Federal funds sold and securities purchased under resale agreements. Balances will fluctuate from year to


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year depending upon our liquidity position at the time. Overall balances decreased in 2010 as excess liquidity was redeployed into higher yielding securities.
 
Loans, Net Loan balances at December 31, 2010, and increases (decreases) over prior periods are summarized in the table below:
 
                                         
          Increase (Decrease) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     Amount     %     Amount     %  
   
    (dollars are in millions)  
 
Commercial loans:
                                       
Construction and other real estate
  $ 8,228     $ (630 )     (7.1 )%   $ (657 )     (7.4 )%
Business banking and middle market enterprises
    7,942       424       5.6       (2,352 )     (22.8 )
Large corporate
    10,745       1,020       10.5       (3,314 )     (23.6 )
Other commercial loans
    3,356       (847 )     (20.2 )     (833 )     (19.9 )
                                         
Total commercial loans
    30,271       (33 )     (0.1 )     (7,156 )     (19.1 )
                                         
Consumer loans:
                                       
Residential mortgages excluding home equity mortgages
    13,697       (25 )     (0.2 )     (4,251 )     (23.7 )
Home equity mortgages
    3,820       (344 )     (8.3 )     (729 )     (16.0 )
                                         
Total residential mortgages
    17,517       (369 )     (2.1 )     (4,980 )     (22.1 )
Auto finance
    -       (1,701 )     (100 )     (154 )     (100 )
Private label
    13,296       (1,795 )     (11.9 )     (3,778 )     (22.1 )
Credit Card
    10,814       (2,234 )     (17.1 )     8,677       100+  
Other consumer
    1,171       (288 )     (19.7 )     (653 )     (35.8 )
                                         
Total consumer loans
    42,798       (6,387 )     (13.0 )     (888 )     (2.0 )
                                         
Total loans
    73,069       (6,420 )     (8.1 )     (8,044 )     (9.9 )
Allowance for credit losses
    2,170       (1,691 )     (43.8 )     (227 )     (9.5 )
                                         
Loans, net
  $ 70,899     $ (4,729 )     (6.3 )%   $ (7,817 )     (9.9 ) %
                                         
 
Commercial loans at December 31, 2010 reflect the implementation of new accounting guidance relating to the consolidation of variable interest entities (“VIEs”) which resulted in an incremental $1.2 billion of large corporate commercial loans recognized on our balance sheet as of December 31, 2010. Excluding this impact, commercial loan balances decreased significantly as compared to 2009 and 2008 due to increased paydowns and managed reductions in certain exposures, including higher underwriting standards and lower overall demand from our core customer base.
 
Residential mortgage loans have decreased since December 31, 2009 and 2008. As a result of balance sheet initiatives to manage interest rate risk and improve the structural liquidity of HSBC Bank USA, we continue to sell a majority of our new residential loan originations through the secondary markets and have allowed the existing loan portfolio to run off, resulting in reductions in loan balances. In addition to normal sales activity, we also sold $4.5 billion of prime adjustable and fixed rate mortgage loans to third parties in 2009. The decreases were partially offset by increases to the portfolio associated with originations targeted at our Premier customer relationships.
 
As previously discussed, real estate markets in a large portion of the United States have been and continue to be affected by stagnation or declines in property values. As such, the loan-to-value (“LTV”) ratios for our mortgage loan portfolio have generally deteriorated since origination. Refreshed loan-to-value ratios for our mortgage loan portfolio,


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excluding subprime residential mortgage loans held for sale, are presented in the table below. The overall improvement in the average refreshed LTV ratio reflects the impact of new loan vintages which have lower LTV ratios.
 
                                 
    Refreshed LTVs(1)(2)
    Refreshed LTVs(1)(2)
 
    at December 31, 2010     at December 31, 2009  
    First Lien     Second Lien     First Lien     Second Lien  
   
 
LTV < 80%
    75.1 %     64.1 %     71.5 %     62.8 %
80% £ LTV < 90%
    11.9       13.5       14.3       14.9  
90% £ LTV < 100%
    6.8       9.8       7.7       9.5  
LTV ³ 100%
    6.2       12.6       6.5       12.8  
Average LTV for portfolio
    67.1 %     73.6 %     68.1 %     74.2 %
 
 
(1) Refreshed LTVs for first liens are calculated using the loan balance as of the reporting date. Refreshed LTVs for second liens are calculated using the loan balance as of the reporting date plus the senior lien amount at origination. Current estimated property values are derived from the property’s appraised value at the time of loan origination updated by the change in the Office of Federal Housing Enterprise Oversight’s house pricing index (“HPI”) at either a Core Based Statistical Area (“CBSA”) or state level. The estimated value of the homes could vary from actual fair values due to changes in condition of the underlying property, variations in housing price changes within metropolitan statistical areas and other factors. As a result, actual property values associated with loans which end in foreclosure may be significantly lower than the estimates used for purposes of this disclosure.
 
(2) Current property values are calculated using the most current HPI’s available and applied on an individual loan basis, which results in an approximately three month delay in the production of reportable statistics. Therefore, the information in the table above reflects current estimated property values using HPIs as of September 30, 2010 and 2009, respectively.
 
Credit card and private label receivable balances decreased from 2009 due to fewer active customer accounts, the continued impact from actions previously taken to mitigate risk including tighter underwriting criteria to lower the risk profile of the portfolio, an increased focus by customers to reduce outstanding credit card debt and, as it relates to the private label portfolio, the exit of certain merchant relationships. At December 31, 2010, private label receivables include $911 million associated with merchants for which we no longer finance new purchases. Credit card receivables increased as compared to 2008 largely due to the purchase of the GM and UP Portfolios, with an outstanding principal balance of $12.4 billion at the time of purchase in January 2009 from HSBC Finance while private label receivables decreased from 2008 for the reasons discussed above.
 
Auto finance loans decreased from both 2009 and 2008 as a result of the sale of the remainder of our auto finance loans to SC USA in August 2010.
 
Other consumer loans have decreased primarily due to the discontinuation of originations of student loans and run-off of our installment loan portfolio.
 
Loans Held for Sale Loans held for sale at December 31, 2010 and increases (decreases) over prior periods are summarized in the following table.
 
                                         
          Increase (Decrease) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     Amount     %     Amount     %  
   
    (dollars are in millions)  
 
Total commercial loans
  $ 1,356     $ 230       20.4 %   $ 482       55.1 %
                                         
Consumer loans:
                                       
Residential mortgages
    954       (432 )     (31.2 )     (2,558 )     (72.8 )
Auto finance
    -       (353 )     (100 )     -       -  
Other consumer
    80       37       86.0       35       77.8  
                                         
Total consumer loans
    1,034       (748 )     (42.0 )     (2,523 )     (70.9 )
                                         
Total loans held for sale
  $ 2,390     $ (518 )     (17.8 )%   $ (2,041 )     (46.1 ) %
                                         
 
We originate commercial loans in connection with our participation in a number of leveraged acquisition finance syndicates. A substantial majority of these loans were originated with the intent of selling them to unaffiliated third parties and are classified as commercial loans held for sale. Commercial loans held for sale under this program were


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$1.0 billion, $1.1 billion and $874 million at December 31, 2010, 2009 and 2008, respectively, all of which are recorded at fair value as we have elected to designate these loans under fair value option. Commercial loan balances under this program decreased compared to 2009 primarily due to loan sales, partially offset by improved valuations and increased compared to 2008 due primarily to improved valuations, partially offset by loan sales. In addition during 2010, we provided foreign currency denominated loans to third parties which are classified as commercial loans held for sale and for which we also elected to apply fair value option. The fair value of commercial loans held for sale under this program was $273 million at December 31, 2010. See Note 17, “Fair Value Option,” in the accompanying consolidated financial statements for further information.
 
Residential mortgage loans held for sale include subprime residential mortgage loans of $391 million, $757 million and $1.2 billion at December 31, 2010, 2009 and 2008, respectively, which were acquired from unaffiliated third parties and from HSBC Finance with the intent of securitizing or selling the loans to third parties. Also included in residential mortgage loans held for sale are first mortgage loans originated and held for sale primarily to various government sponsored enterprises. In addition to normal sale activity, during 2009, we sold approximately $4.5 billion of prime adjustable and fixed rate residential mortgage loans. No such sales occurred in 2010. We retained the servicing rights in relation to the mortgages upon sale. Overall balances have declined in 2010 largely due to subprime residential mortgage loan sales.
 
Auto finance loans held for sale at December 31, 2009 were sold to HSBC Finance during the first quarter of 2010 to facilitate the completion of a loan sale to a third party.
 
Other consumer loans held for sale consist of student loans which we no longer originate. Higher balances at December 31, 2010 reflect the reclassification of approximately $50 million of student loans from held for investment to held for sale in 2010, partially offset by the sale of a portion of these loans in the first quarter of 2010.
 
Consumer loans held for sale are recorded at the lower of cost or market value. While the book value of loans held for sale continued to exceed fair value at December 31, 2010, we experienced a decrease in the valuation allowance during 2010 primarily due to lower balances driven by loan sales. The book value of loans held for sale exceeded fair value at December 31, 2009, although the adverse conditions in the U.S. residential mortgage markets in 2009 resulted in increases to the related valuation allowance during 2009.
 
Trading Assets and Liabilities Trading assets and liabilities balances at December 31, 2010, and increases (decreases) over prior periods, are summarized in the following table.
 
                                         
          Increase (Decrease) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     Amount     %     Amount     %  
   
    (dollars are in millions)  
 
Trading assets:
                                       
Securities(1)
  $ 9,665     $ 4,325       81.0 %   $ 4,552       89.0 %
Precious metals
    16,725       4,471       36.5       11,820       100+  
Derivatives
    6,012       (2,197 )     (26.8 )     (15,259 )     (71.7 )
                                         
    $ 32,402     $ 6,599       25.6 %   $ 1,113       3.6 %
                                         
Trading liabilities:
                                       
Securities sold, not yet purchased
    212       81       61.8       (194 )     (47.8 )
Payables for precious metals
    5,326       2,868       100+       3,727       100+  
Derivatives
    4,990       (331 )     (6.2 )     (9,324 )     (65.1 )
                                         
    $ 10,528     $ 2,618       33.1 %   $ (5,791 )     (35.5 )%
                                         
 
 
(1) Includes U.S. Treasury securities, securities issued by U.S. government agencies and U.S. government sponsored enterprises, other asset backed securities, corporate bonds and debt securities.


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Securities balances as well as balances of securities sold, not yet purchased at December 31, 2010 increased from 2009 due to an increase in Treasury positions related to hedges for derivative positions in both the interest rate and emerging market trading portfolio. Securities balance increases from 2008 also reflect increased market values for asset backed securities from levels experienced in 2008 partially offset by the impact of sales of mortgage backed and asset backed securities held for trading purposes in 2009.
 
Precious metals trading assets at December 31, 2010 increased compared to 2009 and 2008 primarily due to higher prices on most metals and, compared to 2008, higher gold inventory. The higher payable for precious metals compared to both periods was primarily due to higher gold balances.
 
Derivative assets and liabilities balances as compared to 2009 were impacted by market volatility as valuations of credit derivatives decreased from small spread tightening and transaction unwinds, partially offset by increased value in foreign exchange and interest rate derivatives. Derivative assets and liabilities from December 31, 2008 were impacted by market volatilities as valuations of foreign exchange, interest rate and credit derivatives all reduced from significant spreads tightening in all sectors since 2008. In addition, credit derivatives had a large decrease as a number of transaction unwinds and commutations reduced the outstanding market value as management sought to actively reduce exposure.
 
Deposits Deposit balances by major depositor categories at December 31, 2010, and increases (decreases) over prior periods, are summarized in the following table.
 
                                         
          Increase (Decrease) From  
          December 31,
    December 31,
 
    December 31,
    2009     2008  
    2010     Amount     %     Amount     %  
   
    (dollars are in millions)  
 
Individuals, partnerships and corporations
  $ 103,988     $ 5,581       5.7 %   $ 5,355       5.4 %
Domestic and foreign banks
    11,912       (1,534 )     (11.4 )     (4,505 )     (27.4 )
U.S. government and states and political subdivisions
    4,293       (121 )     (2.7 )     1,343       45.5  
Foreign governments and official institutions
    458       (1,509 )     (76.7 )     (521 )     (53.2 )
                                         
Total deposits
  $ 120,651     $ 2,417       2.0 %   $ 1,672       1.4 %
                                         
Total core deposits(1)
  $ 90,971     $ 7,744       9.3 %   $ 22,191       32.3 %
                                         
 
 
(1) We monitor “core deposits” as a key measure for assessing results of our core banking network. Core deposits generally include all domestic demand, money market and other savings accounts, as well as time deposits with balances not exceeding $100,000.
 
Deposits were a significant source of funding during 2010, 2009 and 2008. Deposits at December 31, 2010 have increased since December 31, 2009 and 2008 as higher deposits from affiliates, growth in branch-based deposit products driven primarily by our Premier and branch expansion strategies and continued stability in the online savings product was partially offset by our efforts to manage down low margin wholesale deposits in order to maximize profitability. Our relative liquidity strength has also allowed us to lower rates to be in line with our competition on several low margin deposit products. Core domestic deposits, which are a substantial source of our core liquidity, increased during 2010 from both 2009 and 2008 driven by continuing growth in our Premier balances and increases in institutional transaction account balances.
 
We maintain a growth strategy for our core retail banking business, which includes building deposits and wealth management across multiple markets, channels and segments. This strategy includes various initiatives, such as:
 
  •  HSBC Premier, HSBC’s global banking service that offers internationally minded mass affluent customers unique international services seamlessly delivered through HSBC’s global network coupled with a premium local service with a dedicated premier relationship manager. Total Premier deposits have grown to $29.5 billion at December 31, 2010 as compared to $23.6 billion at December 31, 2009;


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  •  Retail branch expansion in existing and new geographic markets to largely support the needs of our internationally minded customers. During 2010, we opened five new branches in the states of California, Maryland and Virginia; and
 
  •  Deepening our existing customer relationships by needs-based sales of wealth, banking and mortgage products.
 
Short-Term Borrowings Balances at December 31, 2010 compared to 2009 and 2008 reflect significantly increased levels of securities sold under agreements to repurchase, as well as higher commercial paper balances due to the consolidation of the Bryant Park commercial paper conduit as a result of adopting new VIE accounting guidance effective January 1, 2010, which increased short-term borrowings by $3.0 billion at December 31, 2010.
 
Long-Term Debt Long-term debt at December 31, 2010 decreased as compared to 2009 due to an increased mix of lower rate short-term funding, the impact of long-term debt retirements and continued focus on deposit gathering activities. These increases were partially offset by the issuance of $4.7 billion of term-debt funding in 2010, including the collective issuance of $2.0 billion in subordinated debt by HSBC Bank USA and HSBC USA Inc. Long-term debt at December 31, 2009 declined as compared to 2008 as our overall asset levels decreased and we continued to focus on deposit gathering activities.
 
Incremental issuances from the $40.0 billion HSBC Bank USA Global Bank Note Program totaled $1.9 billion during 2010 and $698 million during 2009. Total debt outstanding under this program was $4.9 billion and $3.5 billion at December 31, 2010 and 2009, respectively.
 
Incremental long-term debt issuances from our shelf registration statement with the Securities and Exchange Commission totaled $2.5 billion during 2010 compared to incremental issuances of $2.6 billion during 2009. Total long-term debt outstanding under this shelf was $6.5 billion and $5.5 billion at December 31, 2010 and 2009, respectively.
 
Borrowings from the Federal Home Loan Bank of New York (“FHLB”) totaled $1.0 billion at December 31, 2010 and 2009. At December 31, 2010, we had the ability to access further borrowings of up to $2.7 billion based on the amount pledged as collateral with the FHLB.
 
In January 2009, as part of the purchase of the GM and UP Portfolio from HSBC Finance, we assumed $6.1 billion of securities backed by credit card receivables that were accounted for as secured financings. Borrowings under these facilities totaled $150 million and $2.4 billion at December 31, 2010 and 2009, respectively.
 
We have entered into a series of transactions with VIEs organized by HSBC affiliates and unrelated third parties. We are the primary beneficiary of certain of these VIEs under the applicable accounting literature and, accordingly, we have consolidated the assets and the debt of these VIEs. On January 1, 2010, we adopted new guidance issued by the Financial Accounting Standards Board which amends accounting rules relating to the consolidation of VIEs. Application of this new guidance has resulted in the consolidation of one additional VIE and, therefore, the consolidated debt of VIE’s we now report is greater than that reported in previous periods. Debt obligations of VIEs totaling $3.0 billion and $205 million were included in short-term borrowings and long-term debt, respectively, at December 31, 2010. Debt obligations of VIEs totaling $3.0 billion were included in long-term debt at December 31, 2009. See Note 26, “Variable Interest Entities,” in the accompanying consolidated financial statements for additional information regarding VIE arrangements.
 
Results of Operations
 
Unless noted otherwise, the following discusses amounts from continuing operations as reported in our consolidated statement of income (loss).
 
Net Interest Income Net interest income is the total interest income on earning assets less the total interest expense on deposits and borrowed funds. In the discussion that follows, interest income and rates are presented and analyzed on a taxable equivalent basis to permit comparisons of yields on tax-exempt and taxable assets. An analysis of


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consolidated average balances and interest rates on a taxable equivalent basis is presented in this MD&A under the caption “Consolidated Average Balances and Interest Rates.”
 
The following table presents changes in the components of net interest income according to “volume” and “rate.”
 
                                                         
          2010 Compared to 2009
          2009 Compared to 2008
       
          Increase (Decrease)           Increase (Decrease)        
Year Ended December 31   2010     Volume     Rate     2009     Volume     Rate     2008  
   
    (in millions)  
 
Interest income:
                                                       
Interest bearing deposits with banks
  $ 73     $ 30     $ (1 )   $ 44     $ 132     $ (270 )   $ 182  
Federal funds sold and securities purchased under resale agreements
    38       (13 )     6       45       (52 )     (132 )     229  
Trading assets
    147       62       (134 )     219       (226 )     (90 )     535  
Securities
    1,181       387       (203 )     997       152       (422 )     1,267  
Loans:
                                                       
Commercial
    955       (110 )     (95 )     1,160       (189 )     (566 )     1,915  
Consumer:
                                                       
Residential mortgages
    678       (142 )     (64 )     884       (470 )     (56 )     1,410  
Home equity mortgages
    129       (16 )     (2 )     147       (3 )     (72 )     222  
Private label cards
    1,313       (219 )     (103 )     1,635       (119 )     41       1,713  
Credit cards
    974       (179 )     (97 )     1,250       1,070       23       157  
Auto finance
    169       (249 )     (24 )     442       348       81       13  
Other consumer
    98       (23 )     (13 )     134       (30 )     (24 )     188  
                                                         
Total consumer
    3,361       (828 )     (303 )     4,492       796       (7 )     3,703  
Other interest
    48       (12 )     14       46       (16 )     (157 )     219  
                                                         
Total interest income
    5,803       (484 )     (716 )     7,003       597       (1,644 )     8,050  
                                                         
Interest expense:
                                                       
Deposits in domestic offices:
                                                       
Savings deposits
    376       65       (272 )     583       63       (484 )     1,004  
Other time deposits
    163       (39 )     (148 )     350       (175 )     (344 )     869  
Deposits in foreign offices:
                                                       
Foreign banks deposits
    20       (5 )     12       13       (41 )     (164 )     218  
Other time and savings
    21       10       (32 )     43       9       (294 )     328  
Short-term borrowings
    81       49       (42 )     74       (34 )     (175 )     283  
Long-term debt
    605       (199 )     22       782       (31 )     (172 )     985  
                                                         
Total interest expense
    1,266       (119 )     (460 )     1,845       (209 )     (1,633 )     3,687  
                                                         
Net interest income - taxable equivalent basis
    4,537     $ (365 )   $ (256 )     5,158     $ 806     $ (11 )     4,363  
                                                         
Tax equivalent adjustment
    18                       22                       30  
                                                         
Net interest income – non taxable equivalent basis
  $ 4,519                     $ 5,136                     $ 4,333  
                                                         


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The significant components of net interest margin are summarized in the following table.
 
                         
Year Ended December 31   2010     2009     2008  
   
 
Yield on total earning assets
    3.58 %     4.57 %     5.39 %
Rate paid on interest bearing liabilities
    .94       1.46       2.71  
                         
Interest rate spread
    2.64       3.11       2.68  
Benefit from net non-interest or paying funds
    .16       .25       .24  
                         
Net interest margin
    2.80 %     3.36 %     2.92 %
                         
 
Significant trends affecting the comparability of 2010 and 2009 net interest income and interest rate spread are summarized in the following table. Net interest income in the table is presented on a taxable equivalent basis.
 
                                                 
    2010     2009     2008  
          Interest Rate
          Interest Rate
          Interest Rate
 
Year Ended December 31   Amount     Spread     Amount     Spread     Amount     Spread  
   
    (dollars are in millions)  
 
Net interest income/interest rate spread from prior year
  $ 5,158       3.11 %   $ 4,363       2.68 %   $ 3,432       1.90 %
                                                 
Increase (decrease) in net interest income associated with:
                                               
Trading related activities
    (107 )             (78 )             300          
Balance sheet management activities(1)
    (26 )             (219 )             634          
Private label receivable portfolio
    (158 )             237               260          
Credit card portfolio
    (234 )             1,068               77          
Commercial loans
    (155 )             143               317          
Deposits
    117               (216 )             (627 )        
Residential mortgage banking
    (28 )             (6 )             (5 )        
Other activity
    (30 )             (134 )             (25 )        
                                                 
Net interest income/interest rate spread for current year
  $ 4,537       2.64 %   $ 5,158       3.11 %   $ 4,363       2.68 %
                                                 
 
 
(1) Represents our activities to manage interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. Interest rate risk, and our approach to managing such risk, are described under the caption “Risk Management” in this Form 10-K.
 
Trading related activities Net interest income for trading related activities decreased during 2010 and 2009 primarily due to lower balances on interest earning trading assets, such as trading bonds, which was partially offset by lower cost of funds. Net interest income for trading related activities increased during 2008 due primarily to decreased funding costs.
 
Balance sheet management activities Lower net interest income from balance sheet management activities during 2010 and 2009 was primarily due to the sale of securities and the re-investment into lower margin securities, partially offset by positions taken in expectation of decreasing short-term rates including in 2010, additional purchases of U.S. Treasuries and Government National Mortgage Association mortgage-backed securities. During 2008, higher net interest income from balance sheet management activities was due primarily to positions taken in expectation of decreasing short-term rates.
 
Private label credit card portfolio Net interest income on private label credit card receivables was lower during 2010 as a result of higher premiums, lower average balances outstanding and lower receivable levels at penalty pricing, partially offset by lower funding costs and repricing initiatives. Net interest income was higher during both


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2009 and 2008 as a result of lower funding costs and lower amortization of premiums on the initial purchase as well as lower daily premiums.
 
Credit card portfolio Net interest income on credit card receivables decreased during 2010 primarily reflecting lower average balances outstanding, lower receivables levels at penalty pricing and higher premiums, partially offset by lower funding costs and repricing initiatives. Higher net interest income on credit card receivables during 2009 primarily reflects the impact of the purchase of the GM and UP Portfolios from HSBC Finance. Net interest income was higher in 2008 primarily due to the growing co-brand portfolio and lower funding costs.
 
Commercial loans Net interest income on commercial loans decreased during 2010 primarily due to lower average loan balances, partially offset by loan repricing, lower levels of nonperforming loans and lower funding costs. Net interest income on commercial loans was higher during 2009 due primarily to loan repricing and lower funding costs, partially offset by lower average balances. Net interest income was higher in 2008 due to higher levels of commercial loans, particularly to middle market customers.
 
Deposits Higher net interest income during 2010 reflects improved spreads in the Personal Financial Services (“PFS”) and Commercial Banking business (“CMB”) segments as deposit pricing has been optimized to reflect the on-going low interest rate environment. Both segments continue to be impacted, relative to historical trends, by the current rate environment and the growth in higher yielding deposit products such as on-line savings and Premier investor accounts.
 
Lower net interest income during 2009 and 2008 related to deposits is primarily due to spread compression on core banking activities in the PFS and CMB business segments. These segments were affected by falling interest rates, growth in higher yielding deposit products and an overall competitive retail market.
 
Residential mortgage banking Lower net interest income during 2010, 2009 and 2008 resulted from lower average residential loans outstanding partially offset by lower funding costs. Lower average residential loans outstanding resulted in part from the sale, in addition to normal sale activity, of approximately $4.5 billion and $7.0 billion of prime adjustable and fixed rate residential mortgages during 2009 and 2008, respectively.
 
Other activity Net interest income on other activity was lower in 2010, largely driven by lower net interest income on auto finance receivables, partially offset by lower interest expense related to long-term debt and higher net interest income related to interest bearing deposits with banks. Net interest income was lower in 2009 due to lower break funding charges charged back to specific loan portfolios, which was partially offset by higher net interest income related to a portfolio of auto finance loans purchased in January 2009 and lower funding costs on non-earning assets. Lower net interest income in 2008 was the result of lower interest income on consumer closed-end loans such as student loans and other consumer loans as balances declined from 2007, which was partially offset by lower funding costs on non-earning assets.


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Provision for Credit Losses The provision for credit losses associated with our various loan portfolios is summarized in the following table:
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Commercial:
                       
Construction and other real estate
  $ 102     $ 179     $ 105  
Business banking and middle market enterprises
    18       135       187  
Large corporate
    (163 )     214       86  
Other commercial
    (23 )     137       50  
                         
Total commercial
  $ (66 )   $ 665     $ 428  
                         
Consumer:
                       
Residential mortgages, excluding home equity mortgages
    (14 )     364       286  
Home equity mortgages
    13       195       219  
Private label card receivables
    523       1,280       1,282  
Credit card receivables
    623       1,450       223  
Auto finance
    35       104       4  
Other consumer
    19       86       101  
                         
Total consumer
    1,199       3,479       2,115  
                         
Total provision for credit losses
  $ 1,133     $ 4,144     $ 2,543  
                         
 
During 2010, we decreased our credit loss reserves as the provision for credit losses was $1.7 billion lower than net charge-offs. During 2009, we increased our credit loss reserves as the provision for credit losses was $1.0 billion greater than net charge-offs. The decrease in 2010 reflects lower loss estimates in our commercial and consumer loan portfolios while loss estimates in these portfolios in 2009 were higher as discussed in more detail below. The provision as a percentage of average receivables was 1.52 percent in 2010, 4.79 percent in 2009 and 2.92 percent in 2008.
 
Commercial loan provision for credit losses decreased during 2010 as a result of lower loss estimates in all commercial portfolios due to lower outstanding balances including managed reductions in certain exposures and improvements in the financial circumstances of several customer relationships which led to credit upgrades on certain problem credits. Lower loss estimates in 2010 also reflect lower levels of nonperforming loans and criticized assets. The combination of all these factors has led to an overall net recovery in provision for commercial loans during 2010. These decreases were partially offset by a continuing high level of provision relating to certain commercial real estate lending relationships. Given the nature of the factors driving the reduction in commercial loan provision during the year, provision levels recognized in 2010 should not be considered indicative of provision levels in the future.
 
The increase in the commercial loan provision in 2009 was a result of higher loss estimates on our real estate, business banking and large corporate banking portfolios due to higher criticized loan levels reflecting customer downgrades in certain counterparties largely due to deteriorating economic conditions. Increased provision in our commercial real estate portfolio was largely due to condominium loans and land loans in the condominium construction market in South Florida and California, as well as in hotel and office construction in all markets, especially in the large metropolitan markets where construction projects were delayed. Our business banking portfolio experienced weakness particularly in small balance relationships. Although our large corporate banking portfolio deteriorated in most industry segments and geographies, consistent with the overall deterioration in the U.S. economy in 2009, customers in those areas of the economy that experienced above average weakness such as apparel, auto related suppliers and construction related businesses were particularly affected. Commercial loan provision also increased in 2009 as a result of a specific provision relating to a single private banking client


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relationship. These increases were partially offset by lower overall provisions in our middle market portfolio due to fewer downgrades in 2009.
 
The provision for credit losses on residential mortgages including home equity mortgages decreased $560 million during 2010 compared to an increase of $54 million during 2009. The decrease in 2010 was attributable to lower receivable levels and improvements in residential mortgage loan credit quality as dollars of delinquency and charge-off declined as compared to the prior year as outstanding balances continued to fall and housing market volatility declined. During 2009, the increase in provision for credit losses on residential mortgages was attributable to increased delinquencies within the prime residential first mortgage loan portfolio.
 
Provision expense associated with our private label card portfolio decreased $757 million in 2010 due to lower receivable levels, improved economic and credit conditions including lower delinquency levels and an improved outlook on future loss estimates as the impact of the economic environment including high unemployment levels on losses has not been as severe as previously anticipated. Provision expense associated with our private label card portfolio was relatively flat in 2009 as the impact of higher charge-off levels was largely offset by lower receivable levels, stable delinquency trends and an improved outlook on future loss estimates.
 
The provision for credit losses associated with credit card receivables decreased $827 million during 2010 compared to an increase of $1,227 million during 2009. The decrease in 2010 reflects lower receivable levels, improved economic and credit conditions, including lower dollars of delinquency, as well as an improved outlook on future loss estimates as the impact of the economic environment, including high unemployment rates, on losses has not been as severe as previously anticipated due in part to improved customer payment behavior, home price stability through much of 2010 and the impact of tighter underwriting initiated in prior periods. Lower receivable levels reflect fewer active customer accounts, the impact of actions previously taken to reduce risk as well as an increased focus by consumers to pay down credit card debt. The increase in the provision for credit losses associated with credit card receivables in 2009 reflects the impact of the purchase of the GM and UP Portfolios as previously discussed. Excluding these portfolios in 2009, provision remained higher primarily from higher delinquencies and charge offs within the co-brand credit card portfolios due to higher levels of personal bankruptcy filings, the impact from a weakened U.S. economy and lower recovery rates.
 
Provision expense associated with our auto finance portfolio decreased during 2010 as a result of the sale of the remaining auto loans purchased from HSBC Finance in August 2010 as previously discussed while prior to the sale, the portfolio continued to liquidate and used car prices continued to improve. Provision expense associated with our auto finance portfolio during 2009 increased due to the purchase of $3.0 billion in auto finance loans from HSBC Finance in January 2009.
 
Our methodology and accounting policies related to the allowance for credit losses are presented in “Critical Accounting Policies and Estimates” in this MD&A and in Note 2, “Summary of Significant Accounting Policies and New Accounting Pronouncements” in the accompanying consolidated financial statements. See “Credit Quality” in this MD&A for additional discussion on the allowance for credit losses associated with our various loan portfolios.


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Other Revenues (Losses) The components of other revenues are summarized in the following tables.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Credit card fees
  $ 910     $ 1,356     $ 879  
Other fees and commissions
    888       803       709  
Trust income
    102       125       150  
Trading revenue
    538       263       (2,662 )
Net other-than-temporary impairment losses
    (79 )     (124 )     (231 )
Other securities gains, net
    74       304       82  
HSBC affiliate income:
                       
Fees and commissions
    97       129       108  
Other affiliate income
    59       11       20  
                         
Total HSBC affiliate income
    156       140       128  
Residential mortgage banking revenue(1)
    (122 )     172       (11 )
Gain (loss) on instruments designated at fair value and related derivatives
    294       (253 )     286  
Other income (loss):
                       
Valuation of loans held for sale
    47       (250 )     (513 )
Insurance
    17       24       37  
Earnings from equity investments
    30       30       61  
Miscellaneous income
    92       (1 )     164  
                         
Total other income (loss)
    186       (197 )     (251 )
                         
Total other revenues (losses)
  $ 2,947     $ 2,589     $ (921 )
                         
 
 
(1) Includes servicing fees received from HSBC Finance of $8 million, $12 million and $14 million during 2010, 2009 and 2008, respectively.
 
Credit card fees Lower credit card fees during 2010 was due primarily to lower receivable levels as a result of fewer active customer accounts, changes in customer behavior, the continuing impact of efforts to manage risk initiated in prior periods, improved delinquency levels and the implementation of certain provisions of the CARD Act. The CARD Act has resulted in significant decreases in overlimit fees as customers must now opt-in for such fees, restrictions on fees charged to process on-line and telephone payments and lower late fees due to limits on fees that can be assessed all of which are considered in determining the purchase price of the receivables purchased daily from HSBC Finance. Also contributing to the decrease were higher revenue share payments due to improved cash flows and renegotiation of certain merchant agreements as well as higher reversals of fee income stemming from reduced charge-off activity related to the acquisition of the GM and UP Portfolios in January 2009 due to purchase accounting. During 2009, higher credit card fees were due primarily to substantially higher outstanding credit card balances due to the purchase of the GM and UP Portfolios as previously discussed. Also contributing to the increase were higher late fees on private label cards due to increased average delinquency levels throughout 2009 partially offset by higher fee charge-offs due to increased loan defaults.
 
Other fees and commissions Other fee-based income increased during 2010 driven by higher commercial loan fee accruals and higher refund anticipation loan fees. Beginning in 2010, we began to keep a portion of originated refund anticipation loans on our balance sheet. As a result, we earn fee income on these loans. The loans we kept were transferred to HSBC Finance at par only if they reached a certain defined delinquency status. During 2009, other fee-based income increased due to higher customer referral fees, commercial loan commitment fees, loan syndication fees and fees generated by the Payments and Cash Management business.


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Trust income Trust income declined in 2010 and 2009 primarily due to lower domestic custody fees from lower assets under management and margin pressures as money market assets have shifted from higher fee asset classes to lower fee institutional class funds.
 
Trading revenue (loss) is generated by participation in the foreign exchange, rates, credit and precious metals markets. The following table presents trading related revenue (loss) 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 statement of income (loss). Trading revenues related to the mortgage banking business are included in residential mortgage banking revenue.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Trading revenue (loss)
  $ 538     $ 263     $ (2,662 )
Net interest income
    32       165       193  
                         
Trading related revenue (loss)
  $ 570     $ 428     $ (2,469 )
                         
Business:
                       
Derivatives
  $ 243     $ (362 )   $ (2,445 )
Balance sheet management
    87       103       (433 )
Foreign exchange
    174       245       392  
Precious metals
    60       67       96  
Global banking
    11       386       (99 )
Other trading
    (5 )     (11 )     20  
                         
Trading related revenue (loss)
  $ 570     $ 428     $ (2,469 )
                         
 
2010 Compared to 2009 Trading revenue increased during 2010 as the prior year reflects reductions to revenue associated with credit derivative products due to the adverse market conditions which existed at that time. Improved market conditions in 2010 and continued reductions in counterparty exposure have resulted in increases to trading revenues in 2010.
 
Trading revenue related to derivatives improved during 2010 largely due to the performance of structured credit products which reported total gains of $219 million during 2010 as compared to losses of $369 million during 2009. The performance of credit derivatives also improved during 2010 as credit spread volatility and the outlook for corporate defaults improved and exposures to several counterparties, including monoline insurers, were reduced as a result of the early termination of transactions. As a result, we recorded gains for monolines of $93 million during 2010 compared to losses of $152 million in 2009. Partly offsetting the improvement in credit derivatives revenue were reductions in other derivative products substantially due to lower deal activity as the demand in the marketplace for highly structured products declined.
 
Trading income related to balance sheet management activities declined in 2010 primarily due to lower net interest income as holdings of certain collateralized mortgage obligations were sold for risk management purposes.
 
Foreign exchange trading revenue declined in 2010 primarily due to narrower trading spreads as increased competition reduced trading margins.
 
Precious metals volumes increased in 2010 as a result of continued demand for metals as a perceived safe haven investment. Trading revenue declined compared to the prior year due to narrower trading spreads and higher funding costs associated with higher inventory levels required to support trading volumes.
 
Global banking trading revenue decreased significantly during 2010 due to the sale of high yield corporate debt securities sold in the early part of 2010 that appreciated during 2009.


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2009 Compared to 2008 Trading revenue (loss) during 2009 continued to be affected by reduced liquidity and volatility in the credit markets although the magnitude of such impacts was not as severe when compared to the prior year. While liquidity improved in 2009, it continued to be lower than experienced before the financial crisis. Trading revenue (loss) for 2008 was significantly affected by reduced liquidity, widening spreads and higher volatility in the credit markets.
 
Trading revenue related to derivatives improved significantly during 2009 due to the performance of structured credit products which reported total losses of $369 million during 2009 as compared to total losses of $2.5 billion during 2008. The performance of credit derivatives improved in 2009 as credit spread volatility and the outlook for corporate defaults stabilized, and exposures to several counterparties, including monoline insurers, were reduced as a result of the early termination of transactions. As a result we recorded losses for monolines of $152 million during 2009 compared to losses of $1.0 billion in 2008.
 
Trading revenue related to balance sheet management activities improved in 2009 primarily due to more favorable trends in credit spreads on asset backed securities held for trading purposes and increased sales of mortgage backed and other asset backed securities held for trading purposes.
 
Foreign exchange revenue declined in 2009 primarily due to lower volumes and narrower trading spreads.
 
Precious metals continued to deliver strong results in 2009, however revenue declined from 2008 levels which benefitted from a higher demand for metals due to economic instability, which eased somewhat in 2009.
 
Global banking revenue increased during 2009 primarily due to increased values on corporate bonds as credit spreads narrowed on these securities compared to 2008.
 
Net other-than-temporary impairment (losses) recoveries During 2010 and 2009, 39 and 28 debt securities, respectively, were determined to have either initial other-than-temporary impairment or changes to previous other-than-temporary impairment estimates with only the credit component of such other-than-temporary impairment recognized in earnings. Prior to 2009, all other-than-temporary impairment losses were recorded in earnings. The following table presents other-than-temporary impairment recognized in earnings.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Other-than-temporary impairment losses recognized in consolidated statement of income (loss)
  $ (79 )   $ (124 )   $ (231 )
                         
 
Other securities gains, net We maintain various securities portfolios as part of our balance sheet diversification and risk management strategies. The following table summarizes the net other securities gains (losses) resulting from various strategies.
 
                         
Year Ended December 31,   2010     2009     2008  
   
    (in millions)  
 
Sale of MasterCard or Visa Class B Shares
  $ -     $ 48     $ 83  
Securities available-for-sale
    74       256       -  
Other
    -       -       (1 )
                         
Total securities gains (losses), net
  $ 74     $ 304     $ 82  
                         
 
Gross realized gains and losses from sales of securities are summarized in Note 6, “Securities,” in the accompanying consolidated financial statements.


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During 2010, we sold $14.1 billion of U.S. Treasury, municipal, mortgage-backed and other asset-backed securities as part of a strategy to adjust portfolio risk duration as well as to reduce risk-weighted asset levels and recognized gains of $177 million and losses of $103 million, which is included as a component of other security gains, net above. During 2009, we sold $17.4 billion of U.S. Treasury, municipal, mortgage-backed and other asset-backed securities for the reasons discussed above and recognized gains of $312 million and losses of $56 million during the year which is included as a component of other security gains, net above.
 
HSBC affiliate income Affiliate income was higher during 2010 due to higher fees and commissions earned from HSBC Finance affiliates as compared to the prior year driven by the transfer of certain real estate default servicing employees from HSBC Finance in July 2010, partially offset by lower fees and commissions earned from HSBC Markets USA (“HMUS”) and other HSBC affiliates and lower fees on tax refund anticipation loans as in 2010, we transferred only a portion of these loans to HSBC Finance upon origination as discussed above. During 2009, affiliate income was higher due largely to higher fees and commissions earned from HMUS and HSBC Securities, USA. These increases in 2009 were partially offset by lower net sales credits received from affiliates for customer referrals and lower gains on tax refund anticipation loans due to lower origination volumes as there was an on-going relationship with only one third party provider during the 2009 tax season, as well as a shift in mix to lower revenue, lower risk products.
 
During the third quarter of 2010, the Internal Revenue Service (“IRS”) announced it would stop providing information regarding certain unpaid obligations of a taxpayer (the “Debt Indicator”), which historically served as a significant part of our underwriting process for Taxpayer Financial Services (“TFS”) tax refund products. It was determined that, without use of the Debt Indicator, we could no longer offer the product that has historically accounted for the substantial majority of our TFS loan production in a safe and sound manner and, therefore, we would no longer offer tax refund anticipation loans and other related products going forward in 2011.
 
Residential mortgage banking revenue The following table presents the components of residential mortgage banking revenue. The net interest income component reflected in the table is included in net interest income in the consolidated statement of income (loss) and reflects actual interest earned, net of interest expense and corporate transfer pricing.
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ 221     $ 249     $ 255  
                         
Servicing related income:
                       
Servicing fee income
    121       129       130  
Changes in fair value of MSRs due to:
                       
Changes in valuation, including inputs or assumptions
    (12 )     60       (213 )
Realization of cash flows
    (92 )     (56 )     (96 )
Trading – Derivative instruments used to offset changes in value of MSRs
    115       (31 )     160  
                         
Total servicing related income
    132       102       (19 )
                         
Originations and sales related income:
                       
Gains (losses) on sales of residential mortgages
    53       95       (17 )
Provision for repurchase obligations
    (341 )     (65 )     -  
Trading and hedging activity
    4       18       3  
                         
Total originations and sales related income
    (284 )     48       (14 )
                         
Other mortgage income
    30       22       22  
                         
Total residential mortgage banking revenue included in other revenues (losses)
    (122 )     172       (11 )
                         
Total residential mortgage banking related revenue
  $ 99     $ 421     $ 244  
                         


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Lower net interest income during 2010 and 2009 reflects lower loan balances, partially offset by lower funding costs as well as reduced deferred cost amortization on lower average outstandings. Lower loan balances reflect, in addition to normal sale activity, the sale of approximately $4.5 billion and $7.0 billion in 2009 and 2008, respectively, of prime adjustable and fixed rate residential mortgages for which we retained the servicing rights. We continue to sell the majority of new loan originations to government sponsored enterprises and allow existing loans to runoff. Consistent with our Premier strategy, additions to the portfolio are comprised largely of Premier relationship products.
 
Total servicing related income increased in 2010 and 2009 due to improved net hedged MSR performance, partially offset during 2010 by increased realization of cash flows and lower servicing fee income as the average serviced loan portfolio declined as new originations sold were more than offset by prepayments. In 2009, servicing fee income was flat as payments owed to the GSEs increased significantly as prepayments increased which offset the impact of a higher average serviced portfolio.
 
Originations and sales related income decreased significantly in 2010 as higher gains from normal loan sales (excluding held mortgage asset sales) were more than offset by higher estimates of exposure on repurchase obligations associated with previously sold loans. In addition, we recorded gains of $70 million during 2009 related to held mortgage asset sales on sales of approximately $4.5 billion. There were no held mortgage asset sales during 2010. During 2010, we recorded expense of $341 million due to an increase in our estimated exposure associated with repurchase obligations on loans previously sold compared to expense of $65 million recorded in 2009 for such exposure. During 2009, originations and sales related income increased primarily due to gains from loan sales as discussed above, partially offset by an increase in our reserve for potential repurchase liability exposure. In 2008, we recorded gains of $17 million on sales of approximately $7.0 billion in 2008. In addition, 2008 reflects a write down on a pool of Alt A loans classified as held for sale due to the volatile market conditions which existed at that time.
 
Gain (loss) on instruments designated at fair value and related derivatives We have elected to apply fair value option accounting to commercial leveraged acquisition finance loans, unfunded commitments, certain own fixed-rate debt issuances and all structured notes and structured deposits issued after January 1, 2006 that contain embedded derivatives. We also use derivatives to economically hedge the interest rate risk associated with certain financial instruments for which fair value has been elected. See Note 17, “Fair Value Option,” in the accompanying consolidated financial statements for additional information including a breakout of these amounts by individual component.
 
Valuation of loans held for sale Valuation adjustments on loans held for sale improved during 2010 due to reduced volatility in the U.S. residential mortgage markets throughout much of 2010. Valuations on loans held for sale relate primarily to residential mortgage loans purchased from third parties and HSBC affiliates with the intent of securitization or sale. Included in this portfolio are sub-prime residential mortgage loans with a fair value of $391 million and $757 million as of December 31, 2010 and 2009, respectively. Loans held for sale are recorded at the lower of their aggregate cost or market value, with adjustments to market value being recorded as a valuation allowance. Valuations on residential mortgage loans we originate are recorded as a component of residential mortgage banking revenue in the consolidated statement of income (loss). Valuations on loans held for sale in 2010 also reflects an $89 million settlement gain relating to certain whole loans previously purchased for re-sale from a third party. In 2009, valuation adjustments on loans held for sale were not as severe as experienced in 2008 as market conditions began to improve in the second half of 2009. During 2009, overall weakness and illiquidity in the U.S. residential mortgage market and continued delinquencies, particularly in the sub-prime market, resulted in valuation adjustments totaling $233 million being recorded on these loans. In addition, we recorded valuation adjustments on education loans held for sale of $17 million during 2009.
 
Other income (loss) Excluding the valuation of loans held for sale discussed above, other income (loss) increased during 2010 due largely to higher miscellaneous income due to improved performance related to credit derivatives used to economically hedge certain commercial loans, a $9 million gain on the sale of auto finance loans to SC USA and a $66 million gain relating to the sale of our equity investment in Wells Fargo HSBC Trade Bank partially offset by lower gains on a judgment as discussed below. Excluding the valuation of loans held for sale discussed above,


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during 2009 other income (loss) decreased due to lower valuations on credit default swaps used to economically hedge credit exposures, combined with lower equity investment income driven by the sale of our equity interest in HSBC Private Bank (Suisse) S.A. in the first quarter of 2009. These decreases were partially offset by an $85 million gain related to a judgment whose proceeds were used to redeem 100 preferred shares issued to CT Financial Services Inc. The obligation to redeem the preferred shares upon our receipt of the proceeds from the judgment represented a contractual arrangement established in connection with our purchase of a community bank from CT Financial Services Inc. in 1997 at which time this litigation remained outstanding. We received a final payment of $5 million in March 2010, relating to this judgment.
 
Operating Expenses The components of operating expenses are summarized in the following table.
 
                         
Year Ended December 31   2010     2009     2008  
   
    (dollars are in millions)  
 
Salaries and employee benefits:
                       
Salaries
  $ 595     $ 617     $ 713  
Employee benefits
    466       496       503  
                         
Total salary and employee benefits
    1,061       1,113       1,216  
                         
Occupancy expense, net
    267       280       277  
                         
Support services from HSBC affiliates:
                       
Fees paid to HSBC Finance for loan servicing and other administrative support
    715       725       473  
Fees paid to HMUS
    288       247       210  
Fees paid to HTSU
    780       471       255  
Fees paid to other HSBC affiliates
    117       144       210  
                         
Total support services from HSBC affiliates
    1,900       1,587       1,148  
                         
Other expenses:
                       
Equipment and software
    48       40       42  
Marketing
    110       116       137  
Outside services
    132       98       118  
Professional fees
    74       89       81  
Telecommunications
    14       14       20  
Postage, printing and office supplies
    15       16       36  
Off-balance sheet credit reserves
    (29 )     20       81  
FDIC assessment fee
    134       208       58  
Goodwill impairment(1)
    -       -       54  
Insurance business
    (2 )     51       43  
Miscellaneous
    309       248       234  
                         
Total other expenses
    805       900       904  
                         
Total operating expenses
  $ 4,033     $ 3,880     $ 3,545  
                         
Personnel – average number
    9,507       9,587       11,731  
Efficiency ratio
    54.02 %     50.23 %     103.90 %
 
 
(1) Represents the entire amount of goodwill allocated to the residential mortgage banking reporting unit.
 
Salaries and employee benefits Salaries and employee benefits expense decreased in 2010 due to the transfer of additional support services employees to HTSU in 2010 as described below and continued cost management efforts partially offset by increased costs associated with the transfer of certain employees from HSBC Finance to the


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default mortgage loan servicing department of a subsidiary of HSBC Bank USA in July 2010. During 2009, salaries and employee benefits expense were lower due to the transfer of support services employees to an affiliate, as described below, as well as continued cost management efforts, including the impact of global resourcing initiatives undertaken by management, which resulted in lower headcount, partially offset by higher pension expense stemming from reduced plan asset values due to the volatile capital markets.
 
Occupancy expense, net Occupancy expense during 2010 included lease abandonment costs of $8 million associated with the closure of several non-strategic branches and in 2009, included a $20 million impairment of a data center building held for use. Excluding the impact of these items from both years, occupancy expense was flat in 2010 as higher costs associated with the expansion of the core banking network within the PFS segment were offset by the transfer of additional shared services employees and their related workspace expenses to an affiliate, as discussed below. During 2010, we opened five new branches resulting in higher rental expenses, depreciation of leasehold improvements, utilities and other occupancy expenses. Excluding the impact of the impairment described above, during 2009 occupancy expense declined due to the transfer of shared services employees and their related workspace expenses to an affiliate as discussed below, partially offset by higher occupancy expense due to the continued expansion of the core banking and commercial lending networks within the PFS and CMB business segments as we opened 18 branches in 2009.
 
Support services from HSBC affiliates includes technology and certain centralized support services, including human resources, corporate affairs and other shared services and beginning in January 2010, legal, compliance, tax and finance charged to us by HTSU. Support services from HSBC affiliates also includes services charged to us by an HSBC affiliate located outside of the United States which provides operational support to our businesses, including among other areas, customer service, systems, collection and accounting functions as well as servicing fees paid to HSBC Finance for servicing nonconforming residential mortgage loans, private label card receivables, credit card receivables and auto finance receivables until the auto finance portfolio was sold in August 2010.
 
Higher support services from HSBC affiliates during 2010 reflects the increased level of services provided, including higher compliance costs and higher fees paid to HSBC Finance for servicing and assuming the credit risk associated with refund anticipation loans originated and held on our balance sheet as a result of the change in the management of the refund anticipation loan program between HSBC Bank USA and HSBC Finance in 2010. These increases in 2010 were partially offset by lower levels of receivables being serviced. During 2009, support services from HSBC affiliates increased as a result of a significant increase in fees paid to HSBC Finance for servicing largely as a result of the purchase of the GM and UP Portfolios and certain auto finance loans from HSBC Finance in early January 2009 as well as higher fees paid to HTSU due to increased services being provided as human resources, corporate affairs and other shared services were centralized beginning in January 2009. Support services from HSBC affiliates also increased in both periods as a result from higher utilization of other HSBC affiliates in support of global resourcing initiatives, which has resulted in a corresponding reduction in salary and employee benefit expense.
 
Marketing expenses Lower marketing and promotional expenses in 2010 and 2009 resulted from continued optimization of marketing spend as a result of general cost saving initiatives, partially offset by a continuing investment in HSBC brand activities and marketing support for branch expansion initiatives, primarily within the PFS business segment and during 2010 in the CMB business segment.
 
Other expenses Other expenses (excluding marketing expenses) decreased during 2010 due to lower FDIC assessment fees as the prior year included an $82 million special assessment recorded in the second quarter of 2009 as well as improved estimates of off-balance sheet exposure and lower insurance costs during 2010. The decreases were partially offset by higher miscellaneous expenses, including higher legal costs, higher collection agency costs and higher outside services costs. During 2009 other expenses increased due to the higher FDIC assessment fees discussed above and higher corporate insurance costs, partially offset by lower outside services fees, improved estimates of off balance sheet credit reserves and the impact of goodwill impairment charges recorded during 2008 with no similar charge being recorded in 2009.


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Efficiency ratio Our efficiency ratio, which is the ratio of total operating expenses, reduced by minority interests, to the sum of net interest income and other revenues, was 54.02 percent in 2010 compared to 50.23 percent in 2009 and 103.90 percent in 2008. The deterioration in 2010 reflects higher operating expenses while the total of net interest income and other revenues declined. The improvement in the efficiency ratio in 2009 resulted primarily from an increase in other revenues (losses) and net interest income, partially offset by higher operating expenses.
 
Segment Results – IFRS Basis
 
We have 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 under Item 1, “Business” in this Form 10-K. There have been no changes in the basis of segmentation or measurement of segment profit (loss) as compared with the presentation in our 2009 Form 10-K. Our segment results are reported on a continuing operations basis.
 
We report to our parent, HSBC, in accordance with its reporting basis, IFRSs. As a result, our segment results are presented on an IFRSs Basis (a non-U.S. GAAP financial measure) as operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources such as employees are made almost exclusively on an IFRSs basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis. The significant differences between U.S. GAAP and IFRSs as they impact our results are summarized in Note 24, “Business Segments,” in the accompanying consolidated financial statements and under the caption “Basis of Reporting” in the MD&A section of this Form 10-K.
 
We are currently in the process of re-evaluating the financial information used to manage our business including the scope and content of the financial data being reported to our management and Board of Directors. To the extent we make changes to this reporting in 2011, we will evaluate any impact such changes may have to our segment reporting.
 
As discussed in Note 3, “Discontinued Operations,” our wholesale banknotes business (“Banknotes Business”), which was previously reported in our Global Banking and Markets segment, is now reported as discontinued operations and is no longer included in our segment presentation.
 
Personal Financial Services (“PFS”)  During 2010, we continue to direct resources towards the expansion of the core retail banking business and in particular the growth of wealth services and HSBC Premier, HSBC’s global banking service that offers customers a seamless international service. In addition, expansion of the branch network continued during 2010 with the opening of five new branches in geographic markets with international connectivity as well as continued investment in the HSBC brand. We intend to open additional new branches in strategic geographies as the opportunity arises. Premier customers increased to approximately 490,000 at December 31, 2010, a 38 percent increase from December 31, 2009. We remain focused on providing differentiated premium services to the internationally minded mass affluent and upwardly mobile customers.
 
We continue to sell the majority of new residential mortgage loan originations to government sponsored enterprises. Consistent with our strategy, additions to our portfolio are primarily comprised of Premier relationship products. In addition to normal sales activity, we sold prime adjustable and fixed rate mortgage loan portfolios to third parties in prior years. In addition to normal sales volume, during 2009 and 2008, we sold approximately $4.5 billion and $7.0 billion, respectively, of prime adjustable and fixed rate residential mortgage loans to third parties. No such sales occurred during 2010. We retained the servicing rights in relation to the mortgages upon sale. As a result, average residential mortgage loans outstanding have continued to decline during 2010, decreasing approximately 18 percent in 2010 and 35 percent in 2009 as compared to average residential mortgage loans outstanding during 2009 and 2008, respectively.


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The following table summarizes the IFRSs Basis results for our PFS segment:
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ 976     $ 916     $ 849  
Other operating income
    164       262       327  
                         
Total operating income
    1,140       1,178       1,176  
Loan impairment charges
    50       616       520  
                         
      1,090       562       656  
Operating expenses
    1,277       1,255       1,353  
                         
Loss before tax
  $ (187 )   $ (693 )   $ (697 )
                         
 
2010 loss before tax compared to 2009 Our PFS segment reported a loss before tax during 2010 which was lower than the loss before tax during the prior year. The improvement was driven by lower loan impairment charges as well as higher net interest income, which was partially offset by lower other operating income and higher operating expenses.
 
Net interest income increased in 2010, driven by a combination of customer deposit interest rate reductions and additional funding credits on deposits. The higher net interest income was partially offset by lower levels of mortgage loans outstanding in part due to mortgage loan sales as the portfolio continues to decline.
 
Other operating income decreased in 2010 reflecting the impact of increases in our estimate of exposure on repurchase obligations associated with previously sold loans which reduced other operating income in 2010 by $341 million as compared to $65 million in 2009. In addition, changes to the ability to charge overdraft fees implemented on July 1, 2010 reduced deposit fee income by $18 million. Other operating income in 2009 also reflects the impact of intersegment charges from the Global Banking and Markets segment of $170 million relating to costs associated with early termination of the funding associated with residential mortgage loan sales, partially offset by net gains on the sales of these residential mortgage loans of $73 million. There were no similar transactions during 2010.
 
Loan impairment charges declined in 2010, driven largely by improvements in residential mortgage loan credit quality as dollars of delinquency and loss severities in 2010 have moderated which, along with lower loan balances, has led to an improvement in our future loss estimates.
 
Operating expenses increased in 2010 driven by higher costs from shared services, including higher compliance and technology costs and from the expansion of our branch network. This was partially offset by lower FDIC assessment fees largely driven by the special assessment in the second quarter of 2009 as discussed above and the impact of a $48 million pension curtailment gain recorded in the first quarter of 2010 as a result of the decision in February 2010 to cease all future benefit accruals for legacy participants under the final average pay formula components of the HSBC North America defined benefit pension plan effective January 1, 2011. In addition, we recorded a recovery of $16 million in 2010 related to the Visa legal accrual previously established in 2007 as compared to a recovery of $9 million in 2009.
 
2009 loss before tax compared to 2008 Our PFS segment reported a decreased loss before tax in 2009 due to higher net interest income and lower operating expenses partially offset by lower other operating income and higher loan impairment charges.
 
Net interest income increased compared to prior year driven by a combination of customer rate cuts and additional funding credits on deposits as well as widening interest rate spreads on credit card balances due to reduced funding costs in the lower short term rate environment. This was partially offset by lower levels of mortgage loans outstanding driven by mortgage loan sales of approximately $4.5 billion during 2009.


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Other operating income decreased during 2009 primarily due to lower personal service charges, ATM and other fees, and, beginning in 2009, a reclassification of loyalty program expenses for cards as a reduction to revenue. Additionally, 2008 benefited from an $83 million gain on the sale of Visa Class B shares. Also contributing to lower other operating income in 2009 was higher mortgage reinsurance costs and break funding charges from the Global Banking and Markets segment of $170 million relating to costs associated with early termination of the funding associated with residential mortgage loan sales compared with a similar charge of $142 million during 2008. These charges were partially offset by net gains on the sales of these same residential mortgage loans of $73 million and $22 million during 2009 and 2008, respectively, as well as better net hedged MSR performance following a very volatile mortgage market in 2008.
 
Deterioration in credit quality, particularly on prime residential mortgage loans and credit cards negatively impacted results in 2009. Higher loan impairment charges in 2009 were driven by an increase in delinquencies, which resulted in significantly increased charge offs within the home equity mortgage loan and residential first mortgage loan portfolios due to increased loss severities as real estate values continued to deteriorate in certain markets. Loan impairment charges on credit card receivables and other consumer loans also increased. The increase in charge offs within the prime residential mortgage loan portfolio was partially offset by a lower increase in overall reserve levels in 2009 compared to that experienced in 2008. Increased levels of personal bankruptcy filings and deterioration in the U.S. economy, including rising unemployment rates, resulted in the deterioration in credit quality across all products as compared to the prior year.
 
Operating expenses decreased in 2009 as a result of efficiency programs in the branch network and a reclassification of customer loyalty expenses for credit cards to revenue, which more than offset growth in costs from branch expansion initiatives and higher FDIC assessment fees, including the special assessment in the second quarter of 2009. Operating expenses in 2009 also benefited from a $9 million release related to the VISA litigation accrual set up in 2007. The prior year period was also impacted by a $54 million goodwill impairment charge taken relating to the residential mortgage reporting unit, partially offset by a benefit from a release of $36 million related to the Visa legal accrual set up in 2007. In addition, customer loyalty program expenses for credit cards of $19 million were included in operating expense in the year-ago periods but were reclassified as reduction to revenue beginning in the first quarter of 2009 as discussed above.
 
Consumer Finance (“CF”) The CF segment includes the private label and co-brand credit cards, and other loans acquired from HSBC Finance or its correspondents, including the GM and UP Portfolios and certain auto finance loans which were sold to SC USA in August 2010 as well as portfolios of nonconforming residential mortgage loans (the “HMS Portfolio”) purchased in 2003 and 2004. HSBC Finance services the receivables purchased for a fee.
 
The following table summarizes the IFRSs Basis results for our CF segment:
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ 1,865     $ 2,101     $ 1,250  
Other operating income
    171       353       325  
                         
Total operating income
    2,036       2,454       1,575  
Loan impairment charges
    972       2,073       1,650  
                         
      1,064       381       (75 )
Operating expenses
    162       88       46  
                         
Profit (loss) before tax
  $ 902     $ 293     $ (121 )
                         
 
2010 profit (loss) before tax compared to 2009 Our CF segment reported a higher profit before tax during 2010 largely due to lower loan impairment charges which was partially offset by lower net interest income, lower other operating income and higher operating expenses.


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Net interest income was lower in 2010 driven by lower outstanding receivable levels including lower auto loan receivables as a result of the sale of the auto loan portfolio to SC USA, lower credit card and private label card yields due to lower receivable levels at penalty pricing primarily due to the impact of the CARD Act, higher premiums and higher charge-offs of credit card interest as the GM and UP portfolios recorded at fair value upon purchase in January 2009 continue to decline and be replaced by new volume. This was partially offset by repricing initiatives, a lower cost of funds due to a lower short term interest rate environment and a refinement to the assumptions used in allocating interest to the portion of the GM and UP portfolio previously recorded at fair value.
 
Other operating income decreased during 2010 due to lower fee income resulting from lower levels of credit card and private label card receivables outstanding including lower late fees on these portfolios driven by changes in customer behavior and the impact of the CARD Act, lower delinquency levels, higher charge-off of credit card fees on the GM and UP portfolios due to the runoff of purchase accounting as discussed above and higher revenue share payments. These decreases were partially offset by lower servicing fees on portfolios serviced by our affiliate, HSBC Finance (which is recorded as a reduction to other operating income) due to lower outstanding receivable levels including the transfer of the servicing of the auto finance loans in March 2010 to SC USA, which servicing costs were reflected in operating expense and a $49 million gain in August 2010 on the sale of the remaining auto finance loans to SC USA.
 
Loan impairment charges associated with credit card receivables, including private label credit card receivables, decreased during 2010 due to lower receivable levels driven by fewer active customer accounts, higher customer payment rates and previous risk mitigation efforts. Also contributing to the decrease were improved economic and credit conditions including lower dollars of delinquency as well as an improved outlook on future loss estimates as the impact of the current economic environment including high unemployment levels, has not been as severe as originally expected due in part to improved customer payment behavior. In addition, the GM and UP Portfolios experienced increased loan impairment charges in 2009 as these portfolios were recorded at fair value when they were purchased in January 2009 which resulted in no allowance for loan losses being established upon acquisition, creating the need to establish loan loss reserves as new volume was originated.
 
Operating expenses increased in 2010 due to higher collection costs on bad debt accounts which were previously reported in loan impairment charges, higher fraud expenses and prior to disposition, increased servicing costs associated with the transfer of the servicing associated with our auto finance portfolio from HSBC Finance to SC USA, partially offset by the impact of higher FDIC assessment fees in the prior year due to a special FDIC assessment during the second quarter of 2009.
 
As discussed in previous filings, on May 22, 2009, the CARD Act was signed into law. We have implemented all provisions of the CARD Act. The CARD Act has required us to make changes to our business practices, and will require us and our competitors to manage risk differently than has historically been the case. Pricing, underwriting and product changes in response to the new legislation have either been implemented or are under continuing analysis. The implementation of these new rules did not have a material adverse impact to us as the lower revenue associated with certain provisions of the CARD Act was considered in the purchase price to HSBC Finance on new sales volume.
 
2009 profit (loss) before tax compared to 2008 Our CF segment reported a higher profit before tax during 2009 due to higher net interest income and higher other operating income, partially offset by higher loan impairment charges and higher operating expenses. The higher profit was driven by the impact of the GM and UP credit card portfolios as well as auto finance receivables purchased from HSBC Finance in early 2009 which collectively contributed profit before tax of $284 million in 2009.
 
Net interest income increased during 2009 due to higher levels of receivables primarily due to the purchase of the GM and UP Portfolios and the auto finance receivables in January 2009, as well as lower amortization of premiums paid on the initial bulk and subsequent purchases of receivables associated with the private label portfolio, partially offset by higher charge offs of interest as a result of higher levels of credit card receivables outstanding and deterioration in credit quality. The original bulk purchase premium on the private label portfolio was fully amortized during 2008. Net interest income was also higher during 2009 due to higher yields as a result of repricing


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initiatives on the private label credit card portfolio and a lower cost of funds due to a declining interest rate environment.
 
Other operating income increased during 2009 primarily due to higher credit card fees associated with the purchase of the GM and UP credit card portfolios. This was partially offset by increased servicing fees on portfolios serviced by our affiliate, HSBC Finance (which are recorded as a reduction to other operating income), higher charge off of fees relating to private label cards due to deterioration in credit quality and credit cards due to higher levels of credit card receivables outstanding as well as lower late fees on co-brand credit card portfolios due to change in customer behavior.
 
Loan impairment charges associated with credit card receivables, including private label credit card receivables, increased substantially during 2009 due to higher receivable balances driven by our purchase of the GM and UP Portfolios from HSBC Finance as previously discussed, increased delinquencies and higher net charge-offs due to the impact of deterioration in the U.S. economy, including higher levels of personal bankruptcy filings and lower recovery rates on previously charged-off balances. Higher loan impairment charges were partially offset by an improved outlook on future loss estimates on private label credit card receivables as the impact of higher unemployment levels on losses has not been as severe as previously anticipated due to signs of home price stability in the second half of the year, tighter underwriting and as it relates to private label credit cards, the impact of lower receivable balances.
 
Operating expenses increased due to higher FDIC insurance premiums, including the special assessment recorded in the second quarter of 2009 and higher expenses related to the higher receivable levels and increased collection costs on late stage delinquent accounts.
 
Commercial Banking (“CMB”) Our Commercial Banking segment serves three client groups, notably Middle Market Enterprises, Business Banking and Commercial Real Estate. CMB’s business strategy is to be the leader in international banking in target markets. In the U.S., CMB strives to execute on that vision and strategy by proactively targeting the growing number of U.S. companies that are increasingly in need of international banking, financial products and services. The products and services provided to these client groups are offered through multiple delivery systems including the branch banking network. We continue to focus on building our core proposition to mid size international companies based on the west coast and in Texas and Florida.
 
During 2010, interest rate spreads, while improved from the prior year, continued to be pressured from a low interest rate environment while loan impairment charges improved. An increase in demand for loans towards the end of 2010 coupled with customer deleveraging in the fourth quarter of 2009 has resulted in a 6 percent increase in loans outstanding to middle-market customers at December 31 2010 as compared to December 31, 2009. The business banking loan portfolio has seen a 5 percent decrease in loans outstanding since December 31, 2009 resulting from an increase in paydowns and a decline in the demand for new credit facilities. The commercial real estate business continues to focus on deal quality and portfolio management rather than volume, which resulted in a 9 percent decline in outstanding receivables for this portfolio since December 31, 2009. Average customer deposit balances across all CMB business lines during 2010 increased 5 percent as compared to December 31, 2009 and average loans decreased 11 percent as compared to December 31, 2009. In February 2010, we completed the sale of our interest in Wells Fargo HSBC Trade Bank (“WHTB”) to Wells Fargo and recorded a gain of $66 million which is included in other operating income.


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The following table summarizes the IFRSs Basis results for our CMB segment:
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ 704     $ 725     $ 753  
Other operating income
    455       353       322  
                         
Total operating income
    1,159       1,078       1,075  
Loan impairment charges
    115       309       288  
                         
      1,044       769       787  
Operating expenses
    681       634       594  
                         
Profit before tax
  $ 363     $ 135     $ 193  
                         
 
2010 profit before tax compared to 2009 Our CMB segment reported a higher profit before tax during 2010 as higher other operating income and lower loan impairment charges were partially offset by lower net interest income and higher operating expenses.
 
Net interest income decreased in 2010 as lower loan balances offset growth in deposit balances and improved loan spreads from re-pricing activities in late 2009.
 
Other operating income increased during 2010 reflecting higher income from Agency sales, syndications, higher commercial loan fee accruals and gains on the sale of certain commercial real estate loans. The increase in 2010 also reflects a $66 million gain on the sale of our equity investment in WHTB.
 
Loan impairment charges decreased in 2010 as economic conditions improved and credit quality began to stabilize resulting in improvements in the financial circumstances of several customer relationships which led to credit upgrades on certain problem credits and fewer customer downgrades across all business lines. These improvements were partially offset by a specific provision on a single commercial real estate lending relationship.
 
Operating expenses increased during 2010 due to higher expenses relating to infrastructure costs such as compliance, higher retail network expenses and higher performance related compensation costs, which were partially offset by a $16 million pension curtailment gain recorded in the first quarter of 2010 as well as lower FDIC assessment fees due to a special FDIC assessment recorded during the second quarter of 2009.
 
2009 profit before tax compared to 2008 Our CMB segment reported a lower profit before tax during 2009 due to lower net interest income, higher loan impairment charges and higher operating expenses, partially offset by higher other operating income.
 
Net interest income decreased in 2009 due primarily to narrower spreads on deposits and lower loan balances, partially offset by growth in deposit balances and improved loan spreads from repricing. Loan impairment charges increased in 2009 as worsening economic conditions resulted in higher levels of criticized assets due to downward credit migration and specific credit reserves on impaired loans. Net charge-offs, although relatively low, were higher across all commercial business lines. Operating expenses increased due to higher FDIC insurance premiums, including the special assessment recorded in the second quarter of 2009, partially offset by reduced staff costs and efficiency savings, including lower marketing spend. Other operating income increased in 2009 largely due to higher fee income, partially offset by fewer syndications which resulted in lower fees and lower gains on sale of real estate loans.
 
Global Banking and Markets Our Global Banking and Markets business segment supports HSBC’s emerging markets-led and financing-focused global strategy by leveraging HSBC Group advantages and scale, strength in developed and emerging markets and Global Markets products expertise in order to focus on delivering international products to U.S. clients and local products to international clients, with New York as the hub for the Americas business.


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There are four major lines of business within Global Banking and Markets: Global Banking, Global Markets, Transaction Banking and Asset Management. The Global Banking business line includes corporate lending and investment banking activities, and this unit also coordinates client relationships across all Global Markets and Banking products. The Global Markets business services the requirements of the world’s central banks, corporations, institutional investors and financial institutions through our global trading platforms and distribution capabilities. Transaction Banking provides payments and cash management, trade finance, supply chain and security services primarily to corporations and financial institutions. Asset Management provides investment solutions to institutions, financial intermediaries and individual investors. In 2010, we decided to exit our wholesale banknotes business.
 
The Global Banking and Markets segment results in 2010 benefited from improved credit market conditions, which when combined with our risk management efforts, led to an increase in the credit quality of our corporate lending relationships, lower securities impairment charges, and reduced losses and gains in certain legacy positions as compared to the year ago periods. The improved credit quality of the portfolio and improved market conditions resulted in a tightening of the net interest margin in the Global Banking and Markets portfolio. As credit markets improved during the first half of the year and then stabilized, results from legacy positions including credit derivatives and subprime mortgage loans contributed to higher other operating income. Substantial counterparty credit reserves for monoline exposure and significant valuation losses were taken in both the trading and available-for-sale securities portfolios throughout 2008 and into 2009 due to market volatility.
 
Under the provisions of the IAS 39 amendment issued in October 2008, we elected to re-classify $1.8 billion in leveraged loans and high yield notes and $892 million in securities held for balance sheet management purposes from trading assets to loans and available-for-sale investment securities, effective July 1, 2008. In November 2008, $967 million in additional securities were also transferred from trading assets to available-for-sale investment securities. If these IFRS reclassifications had not been made, our profit before tax for 2010 and 2009 would have been higher by $153 million and $617 million, respectively, and our loss before tax for 2008 would have been greater by $893 million.
 
The following table summarizes IFRSs Basis results for the Global Banking and Markets segment.
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ 638     $ 812     $ 1,005  
Other operating income
    1,048       543       (2,011 )
                         
Total operating income
    1,686       1,355       (1,006 )
Loan impairment charges
    (180 )     591       165  
                         
      1,866       764       (1,171 )
Operating expenses
    760       761       733  
                         
Profit (loss) before tax
  $ 1,106     $ 3     $ (1,904 )
                         
 
2010 profit (loss) before tax compared to 2009 Our Global Banking and Markets segment performance improved significantly during 2010 due primarily to higher other operating income and lower loan impairment charges, partially offset by lower net interest income.
 
Net interest income decreased during 2010 as a result of sales of higher yielding assets in our available-for-sale securities portfolio since March 2009 which were made for risk management purposes and lower margins on deposit balances.
 
Other operating income increased in 2010 due to improved performance of credit derivatives, sub-prime mortgage loans held for sale and precious metals. Partially offsetting these improvements were reductions in foreign exchange trading and lower intersegment income.


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Other operating income increased in 2010 reflecting gains on structured credit products of $130 million during 2010 as compared to losses of $395 million during the prior year as the credit markets stabilized beginning in the second half of 2009 resulting in fewer losses from hedging activity and counterparty exposures. Also contributing to the increase in other operating income were lower valuation losses on sub-prime residential mortgage loans held for sale as compared to the prior year and improved precious metals revenue as higher vault storage fees more than offset lower trading revenue, partially offset by a decline in foreign exchange trading revenue due to narrower spreads as increased competition reduced trading margins. Other operating income in 2010 also includes a gain of $89 million associated with a settlement relating to certain loans previously purchased for resale from a third party. During 2009, other operating income includes intersegment income of $170 million from PFS relating to the fee charged for the early termination of funding associated with the sale of residential mortgage loans. There was no similar transaction during 2010.
 
Exposure to insurance monolines continued to impact revenues but deterioration abated in 2010, resulting in gains of $93 million during 2010 compared to losses of $152 million during the prior year. Valuation losses of $59 million were recorded during 2010 against the fair values of sub-prime residential mortgage loans held for sale as compared to valuation losses of $233 million during the prior year.
 
Loan impairment charges decreased in 2010 due to an improved credit environment combined with active risk mitigation efforts. This resulted in a decrease in higher risk rated loan balances and stabilization of credit downgrades which led to an overall release in loss reserves. In addition, 2009 impairments included a charge of $208 million on securities determined to be other-than-temporarily impaired compared to no similar impairments in the current year.
 
Operating expenses remained flat in 2010 compared to 2009 as an increase in compensation costs and higher compliance costs was offset by a decrease in legal and professional costs due to the curtailment of the sub-prime residential mortgage securitization and structured credit product activities and lower FDIC assessment fees as the year-ago year-to-date period included a special FDIC assessment recorded in the second quarter of 2009.
 
2009 profit (loss) before tax compared to 2008 Our Global Banking and Markets segment performance improved considerably in 2009 due primarily to significantly higher other operating income, partially offset by lower net interest income, higher loan impairment charges and a slightly higher increase in operating expenses as a result of the business environment discussed above.
 
Net interest income declined during 2009 as a result of sales of higher yielding assets in our available-for-sale securities portfolio which were made for risk management purposes, and lower margins on deposit balances. Partially offsetting these declines was higher margin due to loan repricing in our commercial loan portfolio driven by wider credit spreads.
 
Other operating income improved $2.5 billion during 2009 due to lower valuation losses on credit derivatives and sub-prime mortgage loans held for sale, lower other-than-temporary impairments and valuation losses in the securities portfolio, gains on sales of available-for-sale securities, higher break funding fees from PFS as discussed more fully below and higher transaction fees in Corporate Banking and Transaction Banking. Other operating income overall continued to be affected by adverse market conditions but to a lesser extent than in the prior year period. Other operating income in 2009 would have been higher in 2009 had we not reclassified assets from trading to available-for-sale assets and to loans and receivables under the IAS 39 amendment as previously discussed.
 
Other operating income reflects losses on structured credit products of $395 million during 2009 compared to total net losses of $2.5 billion during 2008, as the credit markets began to stabilize resulting in lower losses from hedging activity and counterparty exposures. Exposure to insurance monoline continued to adversely impact revenues as deterioration in creditworthiness persisted, although the pace of such deterioration slowed significantly, resulting in losses of $152 million during 2009 compared to losses of $1 billion during 2008.
 
Valuation losses of $233 million during 2009 were recorded against the fair values of sub-prime residential mortgage loans held for sale as compared to valuation losses of $505 million during 2008. Fair value adjustments on our leveraged loan portfolio of $2 million in 2009 reflects the classification of substantially all leveraged loans and notes as loans and receivables compared to losses of $102 million during 2008 when these assets were subject to fair


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value accounting. Other operating income also benefited from gains of $254 million on sales of securities, primarily during the second quarter of 2009 and from intersegment income of $170 million from PFS in 2009 relating to the break funding fee charged for the early termination of funding associated with the sale of the residential mortgage loans compared to a similar benefit of $142 million during 2008.
 
Other operating losses in 2008 included a reduction of $203 million related to the other-than-temporary impairment of FNMA equity securities. There were no similar charges in 2009.
 
Loan impairment charges increased during 2009 due to a number of credit downgrades in Global Banking on our exposure to the financial services industry and other downgrades on specific accruing loans. In addition, impairments included a charge of $208 million on securities determined to be other-than-temporarily impaired compared to $28 million in the prior year.
 
Operating expenses increased modestly during 2009 as higher FDIC assessment charges, including the special assessment recorded during the second quarter of 2009 and higher performance related compensation costs due to improved results were offset by lower salary and other staff costs resulting from a decreased overall number of employees.
 
Private Banking (“PB”) As part of HSBC’s global network, the PB segment offers integrated domestic and international services to high net worth individuals, their families and their businesses. These services address both resident and non-resident financial needs. During 2010, we continued to dedicate resources to strengthen product and service leadership in the wealth management market. Areas of focus are banking and cash management, investment advice including discretionary portfolio management, banking and cash management, residential mortgages, as well as wealth planning for trusts and estates.
 
Average client deposit levels increased 2 percent as compared to December 31, 2009 as growth in deposits from core clients was partially offset by withdrawals from domestic institutional clients during early 2010. Total average loans decreased 3 percent compared to December 31, 2009 from runoff and reductions of commercial loan borrowings partially offset by growth in the tailored mortgage product. Overall client assets decreased to $33.0 billion at December 31, 2010, or 11 percent since December 31, 2009, driven primarily by withdrawals by institutional clients who had added assets temporarily during the financial crisis.
 
The following table summarizes IFRSs Basis results for the PB segment.
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ 184     $ 172     $ 192  
Other operating income
    132       106       156  
                         
Total operating income
    316       278       348  
Loan impairment charges
    (38 )     98       17  
                         
      354       180       331  
Operating expenses
    242       232       268  
                         
Profit (loss) before tax
  $ 112     $ (52 )   $ 63  
                         
 
2010 profit (loss) before tax compared to 2009 Our PB segment reported a higher profit before tax during 2010 due to lower loan impairment charges, higher net interest income and higher other operating income, partially offset by higher operating expenses.
 
Net interest income increased in 2010 primarily due to improved interest spreads on loans and deposits.
 
Other operating income increased in 2010 primarily due to higher fees on managed products, structured products and recurring fund fees.


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Loan impairment charges were lower in 2010 due to lower reserves required relating to certain exposures due to improved credit conditions and improvements in client credit ratings as well as a partial recovery related to a single client relationship which led to an overall release in loss reserves. During 2009 we recorded a large specific provision relating to this client relationship.
 
Operating expenses increased in 2010 as higher technology costs and higher performance related pay was partially offset by lower FDIC assessment fees due to a special FDIC assessment recorded during the second quarter of 2009 and a $5 million pension curtailment gain recorded in 2010 as discussed above.
 
2009 Profit (loss) before tax compared to 2008 Our PB segment reported a loss before tax during 2009 due largely to lower net interest income, higher loan impairment charges and lower other operating income, partially offset by lower operating expenses.
 
Net interest income was lower during 2009 primarily as a result of narrowing interest rate spreads due to declining market rates and lower outstanding loan and deposit balances.
 
Other operating income was lower primarily due to lower performance fees from equity investments, and lower fee income from credit derivatives, managed products, structured products and recurring fund fees and insurance commissions.
 
Loan impairment charges increased during 2009 largely to a specific provision relating to a single client relationship recorded in the third quarter of 2009 and higher reserve levels associated with the downgrade of a separate specific domestic client relationship.
 
Operating expenses decreased as a result of lower staff costs due to lower headcount resulting from efficiency initiatives. Travel and entertainment, marketing and communications costs were also lower, partially offset by higher FDIC assessment fees, including the special assessment recorded during the second quarter of 2009.
 
Other The other segment primarily includes adjustments made at the corporate level for fair value option accounting related to certain debt issued, the offset to funding credits provided to CMB for holding certain investments, income and expense associated with certain affiliate transactions, adjustments to the fair value on HSBC shares held for stock plans, gains on the sale of various owned properties, the impact of the resolution of a lawsuit as discussed below and for 2009 include the earnings on an equity investment in HSBC Private Bank (Suisse) S.A which was sold in March 2009 for a gain.
 
The following table summarizes IFRSs Basis results for the Other segment.
 
                         
Year Ended December 31   2010     2009     2008  
   
    (in millions)  
 
Net interest income
  $ (11 )   $ 17     $ (5 )
Gain (loss) on own debt designated at fair value and related derivatives
    162       (565 )     636  
Other operating income
    31       50       (89 )
                         
Total operating income
    182       (498 )     542  
Loan impairment charges
    -       -       -  
                         
      182       (498 )     542  
Operating expenses
    70       87       -  
                         
Profit (loss) before tax
  $ 112     $ (585 )   $ 542  
                         
 
2010 profit (loss) before tax compared to 2009 Profit (loss) before tax in 2010 was impacted by credit and interest rate related changes in the fair value of certain own debt instruments to which fair value option was elected. Along with the related fair value option derivatives, we recorded total gains relating to these instruments of $162 million during 2010 compared to losses of $565 million in the prior year.


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Other operating income declined in 2010, as lower income from support services from affiliates due to the transfer of additional support functions to HTSU, lower net gains related to the resolution of a lawsuit whose proceeds in 2009 were used to redeem preferred stock issued to CT Financial Services Inc. and lower equity income due to the sale of our investment in Private Bank (Suisse S.A. in March 2009 (which also resulted in a $43 million gain), was partially offset by a $56 million gain on sale of our 452 Fifth Avenue property in New York City (including the 1 W. 39th Street building) and a $4 million gain on the sale of a branch located in Brooklyn, New York in 2010.
 
Operating expenses declined in 2010 largely reflecting lower closure costs as 2009 includes higher expenses relating to the closure of a data center.
 
2009 profit (loss) before tax compared to 2008 We reported lower profit before tax during 2009 largely due to a loss on own debt designated at fair value and related derivatives in 2009 and higher operating expenses, partially offset by higher other operating income. Results were negatively impacted in 2009 by an increase in the fair value of certain of our own debt instruments outstanding to which fair value option accounting is applied for which we recorded a loss in 2009 of $565 million due to narrowing credit spreads.
 
Other operating income improved in 2009 due to higher income from support services provided to affiliates, a net gain of $30 million relating to the resolution of a lawsuit and a gain associated with the sale of an equity investment in HSBC Private Bank (Suisse) S.A. referred to above, partially offset by lower equity earnings on this investment, higher losses associated with funding credits provided to CMB and an impairment charge relating to a building held for use. Additionally, other operating income in 2008 reflects adjustments to the fair value on HSBC shares held for stock plans which reduced other operating income by $97 million.
 
Operating expenses in 2009 largely reflect higher costs relating to affiliate transactions as well as $16 million of expense associated with the closure of a data center.
 
Reconciliation of Segment Results As previously discussed, segment results are reported on an IFRS Basis. See Note 24, “Business Segments,” in the accompanying consolidated financial statements for a discussion of the differences between IFRSs and U.S. GAAP. For segment reporting purposes, intersegment transactions have not been eliminated. We generally account for transactions between segments as if they were with third parties. Also see Note 24, “Business Segments,” in the accompanying consolidated financial statements for a reconciliation of our IFRS Basis segment results to U.S. GAAP consolidated totals.
 
Credit Quality
 
In the normal course of business, we enter into a variety of transactions that involve both on and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers. We participate in lending activity throughout the U.S. and, on a limited basis, internationally.
 
Allowance for Credit Losses For commercial loans, we conduct a periodic assessment on a loan-by-loan basis of losses we believe to be inherent in the loan portfolio. When it is deemed probable based upon known facts and circumstances that full contractual interest and principal on an individual loan will not be collected in accordance with its contractual terms, the loan is considered impaired. An impairment reserve is established based on the present value of expected future cash flows, discounted at the loan’s original effective interest rate, or as a practical expedient, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Updated appraisals for collateral dependent loans are generally obtained only when such loans are considered troubled and the frequency of such updates are generally based on management judgment under the specific circumstances on a case-by-case basis. Problem commercial loans are assigned various obligor grades under the allowance for credit losses methodology. Each credit grade has a probability of default estimate.
 
Our credit grades align with U.S. regulatory risk ratings and are mapped to our probability of default master scale. These probability of default estimates are validated on an annual basis using back-testing of actual default rates and benchmarking of the internal ratings with external rating agency data like S&P ratings and default rates. Substantially all appraisals in connection with commercial real estate loans are ordered by the independent real estate appraisal unit at HSBC. The appraisal must be reviewed and accepted by this unit. For loans greater than


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$250,000, an appraisal is generally ordered when the loan is classified as Substandard as defined by the Office of the Comptroller of the Currency. On average, it is approximately four weeks from the time the appraisal is ordered until it is completed and the values accepted by HSBC’s independent appraisal review unit. Subsequent provisions or charge-offs are completed shortly thereafter, generally within the quarter in which the appraisal is received.
 
In situations where an external appraisal is not used to determine the fair value the underlying collateral of impaired loans, current information such as rent rolls and operating statements of the subject property are reviewed and presented in a standardized format. Operating results such as net operating income and cash flows before and after debt service are established and reported with relevant ratios. Third-party market data is gathered and reviewed for relevance to the subject collateral. Data is also collected from similar properties within the portfolio. Actual sales levels of condominiums, operating income and expense figures and rental data on a square foot basis are derived from existing loans and, when appropriate, used as comparables for the subject property. Property specific data, augmented by market data research, is used to project a stabilized year of income and expense to create a 10-year cash flow model to be discounted at appropriate rates into present value. These valuations are then used to determine if any impairment on the underlying loans exists and an appropriate allowance is recorded when warranted.
 
Probable losses for pools of homogeneous consumer loans are generally estimated using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge off. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been re-aged or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. The allowance for credit losses on consumer receivables also takes into consideration the loss severity expected based on the underlying collateral, if any, for the loan in the event of default based on historical and recent trends.
 
The roll rate methodology is a migration analysis based on contractual delinquency and rolling average historical loss experience which captures the increased likelihood of an account migrating to charge-off as the past due status of such account increases. The roll rate models used were developed by tracking the movement of delinquencies by age of delinquency by month (bucket) over a specified time period. Each “bucket” represents a period of delinquency in 30-day increments. The roll from the last delinquency bucket results in charge-off. Contractual delinquency is a method for determining aging of past due accounts based on the status of payments under the loan. The roll percentages are converted to reserve requirements for each delinquency period (i.e., 30 days, 60 days, etc.). Average roll rates are developed to avoid temporary aberrations caused by seasonal trends in delinquency experienced by some product types. We have determined that a 12-month average roll rate balances the desire to avoid temporary aberrations, while at the same time analyzing recent historical data. The calculations are performed monthly and are done consistently from period to period. In addition, loss reserves on consumer receivables including credit card receivables are maintained to reflect our judgment of portfolio risk factors which may not be fully reflected in the statistical roll rate calculation.
 
Our allowance for credit losses methodology and our accounting policies related to the allowance for credit losses are presented in further detail under the caption “Critical Accounting Policies and Estimates” in this MD&A and in Note 2, “Summary of Significant Accounting Policies and New Accounting Pronouncements,” in the accompanying consolidated financial statements. Our approach toward credit risk management is summarized under the caption “Risk Management” in this MD&A.


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The following table sets forth the allowance for credit losses for the periods indicated:
 
                                         
At December 31,   2010     2009     2008     2007     2006  
   
    (dollars are in millions)  
 
Allowance for credit losses
  $ 2,170     $ 3,861     $ 2,397     $ 1,414     $ 897  
                                         
Ratio of Allowance for credit losses to:
                                       
Loans:(1)
                                       
Commercial
    1.77 %     3.10 %     1.53 %     .81 %     .73 %
Consumer:
                                       
Residential mortgages, excluding home equity mortgages
    1.22       2.53       1.15       .19       .08  
Home equity mortgages
    2.02       4.44       3.67       .80       .16  
Private label card receivables
    5.66       7.85       6.86       4.84       3.21  
Credit card receivables
    5.60       8.48       9.73       6.55       4.12  
Auto finance
          2.12       3.25       2.47       1.72  
Other consumer loans
    2.73       4.46       3.68 &