10-K 1 d73744_10-k.htm ANNUAL REPORT



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, 2007

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, New York

 

10018

(Address of principal executive offices)

 

(Zip Code)

(716) 841-2424
(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


 


Depositary Shares (each representing a one-fourth share of Adjustable Rate Cumulative Preferred Stock, Series D)

 

New York Stock Exchange

$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 Floating Rate Non-Cumulative Preferred Stock, Series G)

 

New York Stock Exchange

Depositary Shares (each representing a one-fortieth share of Floating Rate Non-Cumulative Preferred Stock, Series H)

 

New York Stock Exchange

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) had 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 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 the 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 or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
     Yes o    No x

At February 29, 2008, all voting stock (706 shares of Common Stock $5 par value) is owned by an indirect wholly owned subsidiary of HSBC Holdings plc.

DOCUMENTS INCORPORATED BY REFERENCE

None




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2



HSBC USA Inc.
Form 10-K

TABLE OF CONTENTS

 

 

 

 

Part I

 

 





 

 

 

 

 

 

 

Page

Item 1.

Business

 

 

History

 

5

Description of Operations and Business Segments

 

5

2007 Developments and Trends

 

8

Geographic Distribution of Assets and Earnings

 

10

Regulation, Supervision and Capital

 

10

Competition

 

12

Cautionary Statement on Forward-Looking Statements

 

12

 

Statistical Disclosure by Bank Holding Companies:

 

 

Average Balance Sheets and Interest Earned and Paid

 

94

Changes in Interest Income and Expense Attributable to Changes in Rate and Volume

 

35

Securities Portfolios

 

116

Loans, Net:

 

 

Composition and Maturities

 

31

Risk Elements in the Loan Portfolio

 

59-61 123

Summary of Loan Loss Experience

 

62

Deposits

 

127

Short-Term Borrowings

 

127

Item 1A.

Risk Factors

 

13

Item 1B.

Unresolved Staff Comments

 

17

Item 2.

Properties

 

17

Item 3.

Legal Proceedings

 

17

Item 4.

Submission of Matters to a Vote of Security Holders

 

17

 

 

 

 

Part II

 

 





 

 

 

 

Item 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

17

Item 6.

Selected Financial Data

 

18

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

Executive Overview

 

19

 

Basis of Reporting

 

20

 

Critical Accounting Policies

 

25

 

Balance Sheet Review

 

30

 

Results of Operations

 

35

 

Business Segments

 

50

 

Credit Quality

 

59

 

Off-Balance Sheet Arrangements and Contractual Obligations

 

70

 

Risk Management

 

75

 

Glossary of Terms

 

91

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

 

92

Item 8.

Financial Statements and Supplementary Data

 

96

3



 

 

 

 

Part III

 

 

 





 

 

 

 

 

 

 

Page

 

 

 

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

164

Item 9A.

Controls and Procedures

 

164

Item 9B.

Other Information

 

167

Item 10.

Directors, Executive Officers and Corporate Governance

 

168

Item 11.

Executive Compensation

 

173

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

205

Item 13.

Certain Relationships and Related Transactions, and Director Independence

 

206

Item 14.

Principal Accounting Fees and Services

 

208

 

 

 

 

Part IV

 

 

 





 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules and Reports on Form 8-K

 

209

4



P A R T  I


Item 1. Business

History

HSBC USA Inc., incorporated under the laws of Maryland, is a New York State based bank holding company registered under the Bank Holding Company Act of 1956, as amended. HSBC USA Inc. and its subsidiaries are collectively referred to as “HUSI”. HUSI’s origin was in Buffalo, New York in 1850 as The Marine Trust Company, which later became Marine Midland Banks, Inc. (Marine). In 1980, The Hongkong and Shanghai Banking Corporation Limited (now HSBC Holdings plc, hereinafter referred to as “HSBC”) acquired 51% of the common stock of Marine and the remaining 49% of common stock in 1987. In December 1999, HSBC acquired Republic New York Corporation (Republic) and merged it with HUSI. At the merger date, Republic and HUSI had total assets of approximately $47 billion and $43 billion, respectively.

Through its affiliation with HSBC, HUSI offers its customers access to global markets and services. In turn, HUSI plays a role in the delivery and processing of other HSBC products. HSBC is one of the largest banking and financial services organizations in the world. Headquartered in London, England, HSBC’s international network comprises over 10,000 offices in 83 countries and territories in Europe, the Asia-Pacific region, Latin America, North America, South America, the Middle East and Africa.

Effective January 1, 2004, HSBC created a North American organizational structure with HSBC North America Holdings Inc. (HNAH) as the top-tier United States (U.S.) bank holding company. At December 31, 2007, HNAH was among the 10 largest U.S. bank holding companies ranked by assets. HUSI routinely conducts transactions with other principal subsidiaries of HNAH, which include:

 
  HSBC Bank Canada (HBCA), a Canadian banking subsidiary;
  HSBC Finance Corporation, a consumer finance company;
  HSBC Markets (USA) Inc. (HMUS), a holding company for investment banking and markets subsidiaries; and
  HSBC Technology & Services (USA) Inc. (HTSU), a provider of information technology services.

Description of Operations and Business Segments

At December 31, 2007, HUSI had total assets of $188 billion and approximately 12,000 full and part time employees. HUSI is among the 10 largest bank holding companies in the U.S. ranked by assets. Through its principal commercial banking subsidiary, HSBC Bank USA, National Association (HBUS), HUSI offers its four million customers a full range of commercial banking products and services. Its customers include individuals, including high net worth individuals, small businesses, corporations, institutions and governments. HBUS also engages in mortgage banking, and is an international dealer in derivative instruments denominated in U.S. dollars and other currencies, focusing on structuring of transactions to meet clients’ needs as well as for proprietary purposes.

With total assets of $184 billion at December 31, 2007, HBUS is ranked among the top 10 banks in the U.S. HBUS’s main office is in Delaware, and its domestic operations are primarily located in New York State. It also has banking branch offices and/or representative offices in California, Florida, New Jersey, Delaware, Pennsylvania, Massachusetts, Virginia, Washington, Oregon and Washington, D.C. In addition to its domestic offices, HBUS maintains foreign branch offices, subsidiaries and/or representative offices in the Caribbean, Europe, Asia, Latin America, Australia and Canada.

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During 2005, HUSI incorporated a nationally chartered limited purpose bank subsidiary, HSBC Trust Company (Delaware), National Association (HTCD). HTCD’s charter includes the following primary activities:

Custodian of investment securities for other HSBC affiliates;
Personal trust services; and
Originator of refund anticipation loans and checks in support of taxpayer financial services business lines.

The operations of HTCD had an immaterial impact on HUSI’s consolidated balance sheets and results of operations for the years ended December 31, 2007 and 2006.

During 2006, HUSI also received regulatory approval for a new nationally chartered bank subsidiary, HSBC National Bank USA (HBMD). The charter for this new subsidiary directly supports HUSI’s retail branch expansion strategy by allowing for the opening of new branches in Connecticut, Maryland, Virginia and Illinois. These branches offer a full suite of deposit and loan products for its own retail and small business customers, as well as support certain customer service activities on behalf of HBUS. The operations of HBMD had an immaterial impact on HUSI’s consolidated balance sheets and results of operations for the years ended December 31, 2007 and 2006.

HUSI has five distinct business segments that it utilizes for management reporting and analysis purposes. The segments are based upon customer groupings, as well as products and services offered. The segments are described in the following paragraphs. Analysis of financial results for HUSI’s business segments begins on page 50 of this Form 10-K.

          The Personal Financial Services (PFS) Segment

This segment provides a broad range of financial products and services including installment and revolving term loans, MasterCard1/Visa2 credit card receivables, deposits, branch services, mutual funds, investments and insurance. These products are marketed to individuals primarily through HBUS’s branch banking network and increasingly through e-banking channels. Residential mortgage lending provides loan financing through the branch network and wholesale origination channels. Servicing is performed on a contractual basis for residential mortgage loans owned by HBUS or by third parties.

Effective January 1, 2006, activity related to certain commercial banking relationships, which was previously reported in the PFS segment, was transferred to the Commercial Banking (CMB) segment. For comparability purposes, 2005 results for the PFS segment have been revised to reflect these changes.

          The Consumer Finance (CF) Segment

In 2005, HUSI formed the CF segment, which includes balances and activity previously reported as a component of the PFS 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 to higher quality nonconforming residential mortgage loans, other consumer loans and private label credit card receivables purchased from HSBC Finance Corporation.


1 MasterCard is a registered trademark of MasterCard, Incorporated.
2 Visa is a registered trademark of Visa USA, Inc.

6



          The Commercial Banking (CMB) Segment

This segment provides loan and deposit products to small businesses and middle-market corporations including specialized products such as real estate financing. Various credit and trade related products such as standby facilities, performance guarantees and acceptances are also offered. These products and services are offered through multiple delivery systems, including the branch banking network.

Effective January 1, 2006, the CMB segment also includes activity related to an equity investment in Wells Fargo HSBC Trade Bank N.A., which was previously reported in the Other segment. This change was made to align financial reporting with the segment that manages this relationship. In addition, also effective January 1, 2006, activity related to certain commercial banking relationships, which was previously reported in the PFS segment, was transferred to the CMB segment. For comparability purposes, 2005 results for these segments have been revised to reflect these changes.

          The Global Banking and Markets Segment (formerly Corporate, Investment Banking and Markets “CIBM”)

The Global Banking and Markets segment is an emerging markets-led and financing-focused business that provides tailored financial solutions to major government, corporate and institutional clients worldwide.

Global Banking and Markets clients are served by teams that bring together relationship managers and product specialists to develop financial solutions that meet individual client needs. To ensure that a comprehensive understanding of each client's financial requirements is developed, the Global Banking and Markets teams take a long-term relationship management approach.

Client-focused business lines deliver the following full range of banking capabilities:

Investment banking and financing solutions for corporate and institutional clients, including corporate banking, investment banking, trade services, payments and cash management, and leveraged 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, money markets and securities services; and
         
Global asset management solutions for institutions, financial intermediaries and private investors worldwide.
 
The Private Banking (PB) Segment

This segment offers a full range of wealth management services for high net worth individuals. Products and services include wealth structuring, investment management, credit and banking, legacy and philanthropy and family advisory services.

          Other Segment

This segment includes an equity investment in HSBC Private Bank (Suisse) S.A. Effective January 1, 2006, an equity investment in Wells Fargo HSBC Trade Bank, N.A., which was previously reported in the Other segment, was transferred to the CMB segment. For comparability purposes, 2005 results have been revised to reflect this change.

7



2007 Developments and Trends

Income Before Income Tax Expense - Significant Trends

Adverse market conditions, particularly in the U.S. mortgage and credit markets, led to substantial declines in trading and other income (refer to the table below). Reduced liquidity, widening credit spreads and higher volatility in the credit and sub-prime lending markets impacted trading in mortgage backed securities and credit derivatives. These adverse market conditions resulted in a significant fall in revenues, due to substantial valuation adjustments in several asset classes, including trading securities, residential mortgage loans held for sale, commercial loans held for sale, and credit derivatives products. In addition, provisions for credit losses have increased significantly, primarily due to increased credit card receivable balances and increased delinquencies in the credit card portfolio.

Income before income tax expense, and various trends and activity affecting operations, are summarized in the following table.

    2007     2006     2005  










(in millions)                  
Income before income tax expense from prior year $ 1,566   $ 1,542   $ 1,976  
 
Increase (decrease) in income before income tax expense attributable to:                  
     Balance sheet management activities (1)   (70 )   (325 )   (148 )
     Trading related activities (2)   (606 )   289     46  
     Private label receivable portfolio (3)   (32 )   264     -  
     Loans held for sale (4)   (512 )   (120 )   (32 )
     Residential mortgage banking revenue (5)   (92 )   (85 )   170  
     Earnings from equity investments (6)   (32 )   67     (6 )
     All other activities (7)   (85 )   (66 )   (464 )
 





    (1,429 )   24     (434 )
 





Income before income tax expense for current year $ 137   $ 1,566   $ 1,542  
 






(1) Balance sheet management activities are comprised primarily of net interest income and, to a lesser extent, gains on sales of investments and trading revenues, resulting from management of interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. Refer to commentary regarding Global Banking and Markets net interest income, trading revenues, and the Global Banking and Markets business segment beginning on page 55 of this Form 10-K, respectively.
 
 
 
(2)
Refer to commentary regarding trading revenues beginning on page 40 of this Form 10-K.
(3)
Refer to commentary regarding the CF business segment beginning on page 52 of this Form 10-K.
(4)
Refer to commentary regarding loans held for sale beginning on page 121 of this Form 10-K.

(5)

Refer to commentary regarding residential mortgage banking revenue beginning on page 43 of this Form 10-K.
(6)
Refer to commentary regarding other income beginning on page 45 of this Form 10-K.

(7)

Represents core banking and other activities that have been affected by challenging market conditions. Refer to business segments commentary beginning on page 50 of this Form 10-K.

Consolidated Balance Sheet Growth

HUSI’s consolidated total assets increased $24 billion (14%) during 2007. Balance sheet growth was primarily driven by HUSI’s deposit strategy during 2007, which improved HUSI’s liquidity position. The funds raised were primarily invested in short-term, liquid assets such as trading assets which increased as a result of higher levels of trading activity in precious metals and derivatives businesses. Analysis of balance sheet growth and funding begins on page 30 of this Form 10-K.

8



Deposit Strategy and Growth

HUSI has a growth strategy for its core banking network, which includes building deposits across multiple markets and segments, and utilizing multiple delivery systems. This strategy includes various initiatives:

full deployment of new personal and business checking and savings products, including relationship-based products;
emphasis on more competitive pricing with the introduction of high yielding products, including on-line savings accounts. Since their introduction in 2005, internet savings balances have grown to $11 billion, of which $4 billion was 2007 growth. Substantially all of the 2007 growth was from new customers;
retail branch expansion in existing and new geographic markets;
improving delivery systems, including use of internet capabilities;
refined marketing and customer analytics for the affluent consumer population; and
strengthening current customer relationships, thereby driving increased utilization of products and customer retention.

Total deposit growth was $14 billion and $12 billion during the calendar years 2007 and 2006, respectively. Deposit balances by major depositor categories are summarized on page 32 of this Form 10-K.

Transactions with HSBC Finance Corporation and Other HSBC Affiliates

Cooperation continued during 2007 between HUSI and HSBC Finance Corporation to identify synergies in products and processes. Synergies have been achieved in loan origination and servicing, card processing, IT contingency rationalization, purchasing, call center cooperation, the shared use of HSBC’s service centers, and the consolidation of certain administrative functions. HUSI and HSBC Finance Corporation will continue to work cooperatively on product offerings and support functions.

In 2005, HUSI began acquiring residential mortgage loans from unaffiliated third parties with the intent of selling these loans to an HSBC affiliate, HSBC Markets (USA) Inc. (HMUS). During 2006, HUSI also began acquiring residential mortgage loans from HSBC Finance Corporation under this program. Loans acquired from unaffiliated third parties and HSBC Finance Corporation primarily include sub-prime residential mortgage loans. In addition, a number of prime adjustable rate mortgage loans originated by HUSI were identified for this program and were being held with the intent of selling these loans to HMUS. HUSI now holds its remaining portfolio for sale to a third party.

HUSI has routinely purchased private label credit card receivables from HSBC Finance Corporation since December 2004. In addition, higher quality nonconforming residential mortgage loans were acquired from HSBC Finance Corporation’s correspondent network from December 2003 until September 2005. In most cases, HSBC Finance Corporation retained the right to service these portfolios. These purchases of residential mortgage and other loans were discontinued as a result of strategic balance sheet management initiatives intended to enhance HUSI’s liquidity position, particularly its loan to deposit ratio, and to address interest rate risk. Fees charged by HSBC Finance Corporation for loan origination and servicing expenses, which are primarily recorded in the CF segment, have increased mostly due to increased private label receivables.

HNAH’s technology services in North America are centralized in a separate subsidiary, HTSU. Technology related assets and software developed or purchased are generally owned by HTSU. Pursuant to a master service level agreement, HTSU charges HUSI for technology services and software development. Fees charged by HTSU to HUSI for technology services expenses have increased in 2007, as HUSI continued to upgrade its technology platform.

HUSI obtains certain underwriting, broker-dealer and administrative support services from HSBC and various other affiliates. Fees charged by these affiliates for treasury and traded markets services provided to HUSI’s Global Banking and Markets segment have increased in 2007 due primarily to increased trading activity.

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Details of these and other transactions with HSBC affiliates are presented in Note 21 of the consolidated financial statements beginning on page 139 of this Form 10-K.

Geographic Distribution of Assets and Earnings

HUSI’s foreign operations represented less than 6% of HUSI’s consolidated total assets at December 31, 2007 and 2006, and less than 10% of consolidated income before income tax expense for 2007, 2006 and 2005.

Regulation, Supervision and Capital

Through June 30, 2004, HUSI and HBUS were supervised and routinely examined by the State of New York Banking Department and the Board of Governors of the Federal Reserve System (the Federal Reserve). Effective July 1, 2004, HBUS became a nationally chartered bank and is primarily supervised by the Office of the Comptroller of the Currency (OCC). HUSI, as a bank holding company, continues to be supervised by the Federal Reserve. HUSI, HBUS, HBMD and HTCD are subject to banking laws and regulations which 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, payment of dividends and numerous other matters. The Federal Reserve Act restricts certain transactions between banks and their nonbank affiliates. Since the deposits of HBUS, HBMD and HTCD are insured by the Federal Deposit Insurance Corporation (FDIC), HBUS, HBMD and HTCD are subject to relevant FDIC regulations.

HBUS is required to maintain non-interest bearing cash reserves with the Federal Reserve Bank, which averaged $256 million in 2007 and $311 million in 2006.

HUSI and HBUS are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory actions and possibly additional discretionary actions by regulators. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

HUSI’s capital resources are summarized on page 34 of this Form 10-K.

Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios of total and Tier 1 capital (as defined in banking regulations). Capital amounts and ratios for HUSI and HBUS are summarized in Note 19 of the consolidated financial statements on page 137 of this Form 10-K. To be categorized as “well capitalized”, a banking institution must have the minimum ratios reflected in the table included in Note 19 and must not be subject to a directive, order or written agreement to meet and maintain specific capital levels.

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. U.S. regulators have adopted a new capital adequacy framework, which is further described under “Basel Capital Standards”.

HBUS, HBMD and HTCD are subject to risk-based assessments from the FDIC, the U.S. Government agency that insures deposits generally to a maximum of $100,000 per domestic depositor. During November 2006, the FDIC adopted final regulations that implement a new risk-based assessment system. Depository institutions subject to assessment are categorized based on supervisory ratings, financial ratios and long-term debt issuer ratings, with those in the highest rated categories paying lower assessments. The new assessment rates, which took effect at the

10



beginning of 2007, will vary between five and seven cents for every $100 of domestic deposits for nearly all banks. Banks that paid premiums in the past will have assessment credits to offset some or all of the premiums in 2007.

The Deposit Insurance Funds Act (DIFA) of 1996 authorized the Financing Corporation (FICO), a U.S. Government corporation, to collect funds from FDIC insured institutions to pay interest on FICO bonds. The FICO assessment rate in effect at December 31, 2007 was 1.14 percent of assessable deposits. The FICO assessment rate is adjusted quarterly. HBUS, HBMD and HTCD are subject to a quarterly FICO premium.

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 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 HBUS under the Bank Secrecy Act 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 and other recent events have resulted in heightened scrutiny of the Bank Secrecy Act and anti-money laundering compliance programs by the federal and state bank regulators.

          Basel Capital Standards (Basel II)

HUSI is currently working toward compliance with final U.S. Basel II capital rule, published in December 2007. In addition, HUSI supports HSBC’s implementation of the Financial Services Authority’s (FSA) Basel II capital rule.

HUSI’s approach toward implementing the Basel framework is summarized beginning on page 76 of this Form 10-K.

          Sarbanes-Oxley Act of 2002, Section 404 Compliance

As an SEC registrant of public debt and preferred shares, HUSI is required to comply with the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404) requires registrants and their auditors to assess and report on internal controls over financial reporting on an annual basis. Under the SEC’s current rules for non-accelerated filers, HUSI was required to complete a management assessment of internal controls over financial reporting for the fiscal year ending December 31, 2007. An audit of HUSI’s internal controls over financial reporting, along with management’s assessment of these controls, is required beginning in the fiscal year ending December 31, 2009.

As a foreign registrant, HSBC was required to comply with Section 404 beginning in the fiscal year ending December 31, 2006. As a subsidiary of a foreign registrant, HUSI has supported HSBC with its Section 404 compliance.

HUSI has adopted the internal control framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to complete its management assessment of the effectiveness of internal controls over financial reporting in compliance with Section 404. Certain other financial reporting risk assessment factors have also been included to ensure adequate coverage of safeguarding of assets and anti-fraud risks.

11



Competition

The Gramm-Leach-Bliley Act of 1999 (GLB Act), effective March 11, 2000, 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, HUSI and its subsidiaries face intense competition in all of the markets they serve, competing with both other financial institutions and non-banking institutions such as insurance companies, major retailers, brokerage firms and investment companies.

Following the enactment of the GLB Act, HUSI elected to be treated as a financial holding company (FHC). As an FHC, HUSI’s activities in the U.S. have been expanded enabling it to offer a more complete line of products and services. HUSI’s ability to engage in expanded financial activities as an FHC depends upon its meeting certain criteria, including requirements that its U.S. depository institution subsidiary, HBUS, its forty percent owned subsidiary, Wells Fargo HSBC Trade Bank N.A., HBMD and HTCD be well capitalized and well managed, and that they have achieved at least a satisfactory record of meeting community credit needs during their most recent examination pursuant to the Community Reinvestment Act. In general, an FHC would be required, upon notice by the Federal Reserve Board, to enter into an agreement to correct any deficiency in the requirements necessary to maintain its FHC election. Until such deficiencies are corrected, the Federal Reserve Board may impose limitations on the conduct or activities of an FHC or any of its affiliates as it deems appropriate. If such deficiencies are not corrected in a timely manner, the Federal Reserve Board may require an FHC to divest its control of any subsidiary depository institution or to cease to engage in certain financial activities. As of December 31, 2007, no known deficiencies exist, and HUSI is not subject to limitations or penalties relative to its status as an FHC.

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, HUSI may make or approve certain statements in future filings with the SEC, in press releases, or oral or written presentations by representatives of HUSI that are not statements of historical fact and may also constitute forward-looking statements. Words such as “may”, “should”, “would”, “could”, “believes”, “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 future financial condition, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause HUSI’s 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 current views and assumptions and speak only as of the date they are made. HUSI undertakes no obligation to update any forward-looking statement to reflect subsequent circumstances or events.

12



Item 1A. Risk Factors

General Business, Economic, Political and Market Conditions

HUSI’s business and earnings are affected by general business, economic, market and political conditions in the United States and abroad. Given its concentration of business activities in the United States, HUSI is particularly exposed to downturns in the United States economy. For example, in a poor economic environment there is greater likelihood that more of HUSI’s customers or counterparties could become delinquent or default on their loans or other obligations. This could result in higher levels of charge offs and provisions for credit losses, which would adversely affect HUSI’s earnings. General business, economic and market conditions that could affect HUSI include, but are not limited to:

short-term and long-term interest rates;
inflation;
recession;
unemployment levels;
monetary supply and market liquidity;
fluctuations in both debt and equity capital markets in which HUSI funds its operations;
market value of consumer owned and commercial real estate throughout the United States;
consumer perception as to the availability of credit; and
the ease of filing for bankruptcy.

Certain changes to these conditions could diminish demand for HUSI’s products and services, or increase the cost to provide such products or services. Recent trends in world-wide financial markets related to, among other things, the growth of derivatives and hedge funds, could add instability and could change the way those markets work. Political conditions may also impact HUSI’s earnings. The economic health of geographic areas where HUSI has greater concentrations of business may decline relative to other geographic regions, with related impacts on HUSI’s earnings. Acts or threats of war or terrorism, as well as actions taken by the United States or other governments in response to such acts or threats, could affect business and economic conditions in the United States.

Competition

HUSI operates 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 HUSI offers or purchases. The traditional segregation of commercial and investment banks has all but eroded. There is no assurance that the significant and increasing competition within the financial services industry will not materially and adversely affect HUSI’s future results of operations.

Federal and State Regulation

HUSI operates in a highly regulated environment. Changes in federal, state and local laws and regulations affecting banking, consumer credit, bankruptcy, privacy, consumer protection or other matters could materially impact HUSI’s performance. For example, anti-money laundering requirements under the Patriot Act are frequently revisited by the U.S. Congress and Executive Agencies. Broad or targeted legislative or regulatory initiatives may be aimed at lenders operating in consumer lending markets. These initiatives could affect HUSI in substantial and unpredictable ways, including limiting the types of consumer loan products it can offer. In addition, there may be amendments to, and new interpretations of, risk-based capital guidelines. HUSI cannot determine whether such legislative or regulatory amendments will be instituted or predict the impact that such amendments would have on results.

13



Changes in Accounting Standards

HUSI’s accounting policies and methods are fundamental to how HUSI records and reports its financial condition and the results of its operations. From time to time, the Financial Accounting Standards Board (FASB), the SEC and bank regulators, including the Office of Comptroller of the Currency and the Board of Governors of the Federal Reserve System, change the financial accounting and reporting standards that govern the preparation of external financial statements. These changes are beyond HUSI’s control, can be hard to predict and could materially impact how HUSI reports its financial condition and the results of its operations.

Management Financial Projections and Judgments

HUSI’s management is required to use certain estimates in preparing financial statements, including accounting estimates to determine loan loss reserves, reserves related to litigation, and the fair market value of certain assets and liabilities, among other items. In particular, loan loss reserve estimates are judgmental and are influenced by factors outside of HUSI’s control. Actual results could differ from those estimates.

Lawsuits and Regulatory Investigations and Proceedings

HUSI or one of its subsidiaries may be named as a defendant 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. These actions may result in judgments, settlements, fines, penalties or other results, including additional compliance requirements, adverse to HUSI which could have a material adverse effect on HUSI’s business, financial condition or results of operations, or cause serious reputational harm.

Operational Risks

HUSI’s businesses are dependent upon its ability to process a large number of increasingly complex transactions. If any of HUSI’s accounting, data processing and other record keeping systems and management controls fail or have other significant shortcomings, HUSI could be materially and adversely affected. HUSI is similarly dependent on its employees. HUSI could be materially and adversely affected if an employee causes a significant operational break-down or failure, either as a result of human error or where an individual intentionally sabotages or fraudulently manipulates HUSI’s operations or systems. Third parties with which HUSI does business could also be sources of operational risk, including risks associated with break-downs or failures of such parties’ own systems or employees. Any of these occurrences could result in diminished ability of HUSI to operate one or more of its businesses, potential liability to clients, reputational damage and regulatory intervention, all of which could have a material adverse effect on HUSI.

HUSI may also be subject to disruptions of its operating systems and businesses arising from events that are wholly or partially beyond its control. These may include:

computer viruses or electrical or telecommunications outages;
natural disasters, such as hurricanes and earthquakes;
events arising from local or regional politics, including terrorist acts;
unforeseen problems encountered while implementing major new computer systems; or
global pandemics, which could have a significant effect on HUSI’s 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 receivables in affected areas and other loss or liability to HUSI.

14



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 customers and of HUSI;
negatively impact customer credit ratings;
impact customers’ ability to repay loan balances;
increase costs for HUSI to respond to such threats and to enhance its processes and systems to ensure maximum  security of data; or
damage HUSI’s reputation from public knowledge of intrusion into its systems and databases.

There is the risk that HUSI’s controls and procedures, business continuity planning, and data security systems could prove to be inadequate. Any such failure could affect HUSI’s operations and could have a material adverse effect on HUSI’s results of operations by requiring HUSI to expend significant resources to correct the defect, as well as by exposing HUSI to litigation or losses not covered by insurance.

Changes to operational practices from time to time could materially impact HUSI’s performance and results. Such changes may include:

raising the minimum payment on credit card accounts;
determinations to acquire or sell private label credit card receivables, residential mortgage loans and other loans;
changes to customer account management, risk management and collection policies and practices;
increasing investment in technology, business infrastructure and specialized personnel; or
outsourcing of various operations.

Liquidity

Adequate liquidity is critical to HUSI’s ability to operate its businesses, grow and be profitable. A compromise to liquidity caused by market disruptions and other events could therefore have a negative effect on HUSI. Potential conditions that could negatively affect HUSI’s liquidity include:

diminished access to capital markets;
unforeseen cash or capital requirements;
an inability to sell assets; and
an inability to obtain expected funding from HSBC affiliates and clients.

HUSI’s credit ratings are an important part of maintaining liquidity. Any downgrade in credit ratings could potentially increase borrowing costs, limit access to capital markets, require cash payments or collateral posting, and permit termination of certain contracts material to HUSI.

Acquisition Integration

HUSI has in the past, and may again in the future, seek to grow its 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.

15



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 HUSI is not able to successfully integrate acquisitions, there is the risk that its results of operations could be materially and adversely affected.

Risk Management

HUSI seeks to monitor and manage its 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 HUSI employs a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every unfavorable event or the specifics and timing of every outcome. Accordingly, HUSI’s ability to successfully identify and balance risks and rewards, and to manage all significant risks, is an important factor that can significantly impact results of operations.

Employee Attraction and Retention

HUSI’s employees are its most important resource and, in many areas of the financial services industry, competition for qualified personnel is intense. If HUSI were unable to continue to attract and retain qualified employees to support the various functions of its business, HUSI’s performance, including its competitive position, could be materially and adversely affected.

Reputational Risk

HUSI’s ability to attract and retain customers and conduct business transactions with its counterparties could be adversely affected to the extent that its reputation, or the reputation of affiliates operating under the HSBC brand, are damaged. Failure to address, or appearing to fail to address, various issues that could give rise to reputational risk could cause harm to HUSI and its business prospects. Reputational issues include, but are not limited to:

appropriately addressing potential conflicts of interest, legal and regulatory requirements;
ethical issues;
adequacy of anti-money laundering processes;
privacy issues;
record-keeping;
sales and trading practices;
proper identification of the legal, reputational, credit, liquidity and market risks inherent in products offered; and
general company performance.

The failure to address these issues appropriately could make customers unwilling to do business with HUSI, which could adversely affect its results of operations.

16



Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

 
The principal executive offices of HUSI are located at 452 Fifth Avenue, New York, New York 10018, which is owned by HBUS. The main office of HBUS is located at 1105 N. Market Street, Wilmington, Delaware 19801. The principal executive offices of HBUS are located at One HSBC Center, Buffalo, New York 14203, in a building under a long-term lease. HBUS has more than 385 other banking offices in New York State located in 44 counties, twenty-three branches in California, seventeen branches each in Florida and New Jersey, two branches in Pennsylvania and one branch each in Oregon, Washington State, Delaware and Washington D.C. Approximately 29% of these offices are located in buildings owned by HBUS and the remaining are located in leased quarters. In addition, there are branch offices and locations for other activities occupied under various types of ownership and leaseholds in states other than New York, none of which are materially important to the respective activities. HBUS also owns properties in Montevideo, Uruguay and Punta del Este, Uruguay.

Item 3. Legal Proceedings

 
HUSI’s legal proceedings are summarized in Note 25 of the consolidated financial statements beginning on page 152 of this Form 10-K.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

P A R T II

 
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 

 
All 706 shares of HUSI’s outstanding stock are owned by HSBC North America Inc. (HNAI), an indirect subsidiary of HSBC. Consequently, there is no public market in HUSI’s common stock.

17



 

Item 6. Selected Financial Data



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31

 

2007

 

2006

 

2005

 

2004

 

2003

 













($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income statement:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

3,398

 

$

3,081

 

$

3,063

 

 

$

2,741

 

 

 

$

2,510

 

 

(Provision) credit for credit losses

 

 

(1,522

)

 

(823

)

 

(674

)

 

 

17

 

 

 

 

(113

)

 

Total other revenues

 

 

1,847

 

 

2,563

 

 

1,911

 

 

 

1,319

 

 

 

 

1,154

 

 

Total operating expenses

 

 

(3,586

)

 

(3,255

)

 

(2,758

)

 

 

(2,101

)

 

 

 

(2,040

)

 

Income tax benefit (expense)

 

 

1

 

 

(530

)

 

(566

)

 

 

(718

)

 

 

 

(570

)

 

 

 



 



 



 

 



 

 

 



 

 

Net income

 

$

138

 

$

1,036

 

$

976

 

 

$

1,258

 

 

 

$

941

 

 

 

 



 



 



 

 



 

 

 



 

 

Balances at year end:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, net of allowance

 

$

93,535

 

$

89,340

 

$

89,496

 

 

$

84,159

 

 

 

$

48,075

 

 

Total assets

 

 

188,373

 

 

164,817

 

 

151,584

 

 

 

141,050

 

 

 

 

95,562

 

 

Total tangible assets

 

 

185,633

 

 

162,054

 

 

148,845

 

 

 

138,310

 

 

 

 

92,736

 

 

Total deposits

 

 

116,228

 

 

102,146

 

 

90,292

 

 

 

79,981

 

 

 

 

63,955

 

 

Common shareholder’s equity

 

 

9,672

 

 

10,571

 

 

10,278

 

 

 

10,366

 

 

 

 

6,962

 

 

Tangible common shareholder’s equity

 

 

7,297

 

 

8,034

 

 

7,562

 

 

 

7,611

 

 

 

 

4,022

 

 

Total shareholders’ equity

 

 

11,237

 

 

12,261

 

 

11,594

 

 

 

10,866

 

 

 

 

7,462

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected financial ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholders’ equity to total assets

 

 

5.97

%

 

7.44

%

 

7.65

%

 

 

7.70

%

 

 

 

7.81

%

 

Tangible common shareholder’s equity to total tangible assets

 

 

3.93

 

 

4.96

 

 

5.08

 

 

 

5.50

 

 

 

 

4.34

 

 

Rate of return on average (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

 

.08

 

 

.64

 

 

.66

 

 

 

1.12

 

 

 

 

1.02

 

 

Total common shareholder’s equity

 

 

.37

 

 

9.03

 

 

8.78

 

 

 

16.35

 

 

 

 

13.06

 

 

Net interest margin to average (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earning assets

 

 

2.36

 

 

2.26

 

 

2.49

 

 

 

3.00

 

 

 

 

3.39

 

 

Total assets

 

 

1.99

 

 

1.91

 

 

2.09

 

 

 

2.46

 

 

 

 

2.76

 

 

Average total shareholders’ equity to average total assets (1)

 

 

7.02

 

 

7.39

 

 

7.85

 

 

 

7.18

 

 

 

 

8.20

 

 

Efficiency ratio (2)

 

 

68.34

 

 

57.66

 

 

55.44

 

 

 

51.73

 

 

 

 

55.65

 

 


 

 

(1)

Selected financial ratios are defined in the Glossary of Terms beginning on page 91 of this Form 10-K.

 

 

(2)

Represents the ratio of total operating expenses, reduced by minority interest, to the sum of net interest income and other revenues.

Significant trends and transactions that impacted net income for 2007 and 2006 are summarized on pages 35-49 of this Form 10-K.

18



 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations




 

Executive Overview


Adverse conditions, particularly in the U.S. mortgage and credit markets, led to substantial declines in trading and other income and to increases in provisions for consumer assets during the second half of 2007. This resulted in income before income tax expense of $137 million for the year ended December 31, 2007, a decrease of 91% from 2006. Net income decreased 87% to $138 million in 2007 from 2006.

Revenues decreased significantly led by declines in trading revenues and negative valuation adjustments on assets held for sale as market disruptions resulted in significantly wider credit spreads and severely diminished liquidity. These market conditions translated into substantial write-downs in the carrying value of several asset classes, including sub-prime residential mortgage and leveraged commercial loans held for sale, credit derivative products, including derivative contracts with monoline insurance companies, and other derivative trading activities. Trading revenues also reflect the decrease in value of derivative trading instruments used to hedge an investment in Class B shares issued by MasterCard, Incorporated, the fair value of which has increased significantly but which cannot be recognized until the investment is sold. The decrease was partially offset by gains on sale of a portion of HUSI’s investment in certain Class B shares, increased fees from credit card receivable portfolios, payments and cash management revenues and increased trading revenue from the foreign exchange desk.

The provision for credit losses increased significantly in 2007, primarily due to growing delinquencies within the credit card portfolio, a refinement to credit card loss reserve methodology and higher average credit card receivable balances. Provisions related to home equity lines of credit have also increased due to a higher rate of delinquencies in the portfolio during 2007 as conditions in the housing markets deteriorated. In addition, provisions for credit losses on consumer assets were unusually low in 2006, due to the impact of bankruptcy legislation enacted in 2005, which resulted in accelerated consumer charge offs and higher provision expense during 2005.

Net interest income was $3,398 million for 2007, an increase of 10% over 2006. This increase primarily resulted from growth in the private label credit card portfolio, reduced amortization of the initial premium paid for the portfolio and a more refined income recognition methodology on promotional balances. In addition, retail and commercial business expansion initiatives, including continued focus on the Online Savings product, new branches, expansion of services and products to small business customers and increased payments and cash management activities led to growth in deposits and commercial loans. Income from short term investments also increased as excess liquidity was invested. These increases were partially offset by narrowing of interest rate spreads on core banking products primarily due to competitive pressures as customers migrated to higher yielding deposit products and lower interest income from residential mortgage loans due to the impact of balance sheet initiatives to reduce the portfolio.

Operating expenses were negatively impacted for 2007 by a $70 million litigation charge related to Visa (Refer to Note 25 of the consolidated financial statements beginning on page 152 of this Form 10-K for commentary regarding Visa litigation) but also reflect higher salaries, marketing and other direct expenses related to business expansion initiatives in the retail and commercial businesses, as well as higher technology and other costs to support the build-out of enhanced product and service platforms.

During the first quarter of 2007, after a thorough review of its deferred income taxes, HUSI increased the carrying value of its deferred tax asset, with a corresponding decrease in income tax expense. The remaining decrease in income tax expense was mainly due to a concentration of normal tax credits, an adjustment of the tax provision to reflect the actual tax return liabilities and a lowering of the effective rate due to a change in the sourcing of income.

19



 

Basis of Reporting


HUSI’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP).

International Financial Reporting Standards (IFRS)

Effective January 1, 2007, corporate goals of HUSI are based upon results reported under IFRS (a non-U.S. GAAP measure). Operating results for HUSI are now monitored and reviewed, trends are being evaluated, and decisions are being made about allocating certain resources on an IFRS basis. In addition, HSBC reports its results in accordance with IFRS and IFRS results are used by HSBC in measuring and rewarding performance of employees. The following table reconciles HUSI’s net income on a U.S. GAAP basis to net income on an IFRS basis.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 









Year Ended December 31

 

2007

 

2006

 

2005

 









(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income – U.S. GAAP basis

 

 

 

 

 

$

138

 

 

 

 

 

 

$

1,036

 

 

 

 

 

 

$

976

 

 

Adjustments, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unquoted equity securities

 

 

58

 

 

 

 

 

 

 

26

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value option

 

 

124

 

 

 

 

 

 

 

(49

)

 

 

 

 

 

 

18

 

 

 

 

 

 

Loan origination

 

 

15

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(7

)

 

 

 

 

 

Loan impairment

 

 

3

 

 

 

 

 

 

 

(2

)

 

 

 

 

 

 

(11

)

 

 

 

 

 

Purchase accounting/deferred taxes

 

 

 

 

 

 

 

 

 

(21

)

 

 

 

 

 

 

 

 

 

 

 

 

Stock based compensation

 

 

 

 

 

 

 

 

 

(5

)

 

 

 

 

 

 

(17

)

 

 

 

 

 

Property

 

 

13

 

 

 

 

 

 

 

(1

)

 

 

 

 

 

 

(46

)

 

 

 

 

 

Pension costs

 

 

16

 

 

 

 

 

 

 

6

 

 

 

 

 

 

 

5

 

 

 

 

 

 

Other

 

 

19

 

 

 

 

 

 

 

(8

)

 

 

 

 

 

 

15

 

 

 

 

 

 

 

 



 

 

 

 

 

 



 

 

 

 

 

 



 

 

 

 

 

 

Total adjustments, net of tax

 

 

 

 

 

 

248

 

 

 

 

 

 

 

(54

)

 

 

 

 

 

 

(43

)

 

 

 

 

 

 

 



 

 

 

 

 

 



 

 

 

 

 

 



 

 

Net income – IFRS basis

 

 

 

 

 

$

386

 

 

 

 

 

 

$

982

 

 

 

 

 

 

$

933 

 

 

 

 

 

 

 

 



 

 

 

 

 

 



 

 

 

 

 

 



 

 

Differences between U.S. GAAP and IFRS are as follows:

Unquoted equity securities

HUSI holds certain equity securities whose market price is not quoted on a recognized exchange, but for which the fair value can be reliably measured either through an active market, comparison to similar equity securities which are quoted, or by using discounted cash flow calculations.

 

 

IFRS

 

 

 

Under IAS 39, 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. Accordingly, such securities are measured at fair value and classified as either available-for-sale securities, with changes in fair value recognized in other comprehensive income, or as trading securities, with changes in fair value recognized in income.

 

 

U.S. GAAP

 

 

Under SFAS 115, 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 impairment. Unquoted equity securities are reported within “Other assets”.

 

 

Impact

 

 

Changes in fair values of equity securities for which IFRS requires recognition of the change and U.S. GAAP requires the securities to be held at cost, impact net income when the security is classified as trading under IFRS and impact shareholders’ equity when the security is classified as available-for-sale under IFRS.

20



Fair value option

 

 

 

IFRS

 

 

 

 

 

Under IAS 39, a financial instrument, other than one held for trading, is classified in this category if it meets the criteria set out below, and is so designated by management. An entity may designate financial instruments at fair value where the designation:

 

 

 

 

-

eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring financial assets or financial liabilities or recognizing the gains and losses on them on different bases; or

 

 

 

 

-

applies to a group of financial assets, financial liabilities or both that is managed and its performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and where information about that group of financial instruments is provided internally on that basis to management; or

 

 

 

 

-

relates to financial instruments containing one or more embedded derivatives that significantly modify the cash flows resulting from those financial instruments.

 

 

 

Financial assets and financial liabilities so designated are recognized initially at fair value, with transaction costs taken directly to the income statement, and are subsequently remeasured at fair value. This designation, once made, is irrevocable in respect of the financial instruments to which it is made. Financial assets and financial liabilities are recognized using trade date accounting.

 

 

Gains and losses from changes in the fair value of such assets and liabilities are recognized in the income statement as they arise, together with related interest income and expense and dividends.

 

 

U.S. GAAP

 

 

Generally, for financial assets to be measured at fair value with gains and losses recognized immediately in the income statement, they must meet the definition of trading securities in SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. Financial liabilities are generally reported at amortized cost under U.S. GAAP.

 

 

Since January 1, 2006, HUSI has accounted for hybrid financial instruments under the provisions of SFAS 155, Accounting for Certain Hybrid Financial Instruments. Hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation are, where designated through an irrevocable election, initially and subsequently measured at fair value, with changes in fair value recognized through net income.

 

 

Impact

 

 

 

HUSI has principally used the fair value designation for certain fixed rate long-term debt issues whose interest rate characteristic has been changed to floating through interest rate swaps as part of a documented interest rate management strategy. Approximately $2 billion of HUSI’s debt issues have been accounted for using the option. The movement in fair value of these debt issues includes the effect of changes in the credit spread and any ineffectiveness in the economic relationship between the related swaps and this debt. Such ineffectiveness arises from the different credit characteristics of the swap and the debt coupled with the sensitivity of the floating leg of the swap to changes in short-term interest rates. In addition, the economic relationship between the swap and the debt can be affected by relative movements in market factors, such as bond and swap rates, and the relative bond and swap rates at inception. The size and direction of the accounting consequences of changes in credit spread and ineffectiveness can be volatile from period to period, but do not alter the cash flows anticipated as part of the documented interest rate management strategy.

 

 

Under U.S. GAAP, debt issues are generally reported at amortized cost. There are circumstances, by virtue of different technical requirements and the transition arrangements to IFRS, where derivatives providing an economic hedge for an asset or liability, and so designated under IFRS, are not so treated under U.S. GAAP, thereby creating a reconciliation difference and asymmetrical accounting between the asset and liability and the offsetting derivative.

21



Loan origination

 

 

 

IFRS

 

 

 

 

 

Certain loan fee income and incremental directly attributable loan origination costs are amortized to the income statement over the life of the loan as part of the effective interest calculation under IAS 39.

 

 

U.S. GAAP

 

 

Certain loan fee income and direct loan origination costs, including an apportionment of overheads, are amortized to the income statement over the life of the loan as an adjustment to interest income (SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”).

 

 

Impact

 

During the year ended 2007, the net costs amortized against earnings under U.S. GAAP exceeded net costs amortized under IFRS.

 

 

Loan impairment

 

IFRS

 

 

 

 

 

When statistical models, using historic loss rates adjusted for economic conditions, provide evidence of impairment in portfolios of loans, their values are written down to their net recoverable amount. The net recoverable amount is the present value of the estimated future recoveries discounted at the portfolio’s original effective interest rate. The calculations include a reasonable estimate of recoveries on loans individually identified for write-off pursuant to HUSI’s credit guidelines.

 

 

U.S. GAAP

 

 

When the delinquency status of loans in a portfolio is such that there is no realistic prospect of recovery, the loans are written off in full, or to recoverable value where collateral exists. Delinquency depends on the number of days payment is overdue. The delinquency status is applied consistently across similar loan products in accordance with HUSI’s credit guidelines. When local regulators mandate the delinquency status at which write-off must occur for different retail loan products and these regulations reasonably reflect estimated recoveries on individual loans, this basis of measuring loan impairment is reflected in U.S. GAAP accounting. Cash recoveries relating to pools of such written-off loans, if any, are reported as loan recoveries upon collection.

 

 

Impact

 

Under both IFRS and U.S. GAAP, HUSI’s policy and regulatory instructions mandate that individual loans evidencing adverse credit characteristics which indicate no reasonable likelihood of recovery are written off. When, on a portfolio basis, cash flows can reasonably be estimated in aggregate from these written-off loans, an asset equal to the present value of the future cash flows is recognized under IFRS.

 

 

No asset for future recoveries arising from written-off assets was recognized in the balance sheet under IFRS prior to January 1, 2005.

 

 

The establishment of the recovery asset under IFRS associated with the private label credit card portfolio purchased from HSBC Finance Corporation results in higher earnings under IFRS than under U.S. GAAP in the initial period and higher earnings under U.S. GAAP when subsequent recoveries are made.

 

 

Net interest income is higher under IFRS than under U.S. GAAP due to the imputed interest on the recovery asset.

22



Purchase accounting/deferred taxes

 

 

 

IFRS

 

 

 

Deferred tax amounts are recorded in the consolidated balance sheets to recognize differences between the tax bases and the cost of assets and liabilities recorded pursuant to an acquisition. Subsequent changes to the estimates of the tax bases are recorded as an adjustment of current period earnings.

 

 

U.S. GAAP

 

 

Changes in tax estimates of the basis in assets and liabilities or other tax estimates recorded at the date of acquisition are adjusted against goodwill.

 

 

Impact

 

In 2006, a deferred tax asset related to a previous acquisition was adjusted against the related goodwill account for U.S. GAAP reporting. Under IFRS, this adjustment was charged to earnings.

 

 

Stock-based compensation

 

IFRS

 

IFRS 2, Share-Based Payment, requires that when annual bonuses are paid in restricted shares and the employee must remain with HSBC for a fixed period in order to receive the shares, the award is expensed over that period.

 

 

U.S. GAAP

 

For awards made before July 1, 2005, SFAS 123, Accounting for Stock Based Compensation requires that compensation cost be recognized over the period(s) in which the related employee services are rendered. HUSI has interpreted this service period as the period to which the bonus relates.

 

 

For 2005 bonuses, awarded in early 2006, HSBC followed SFAS 123 (revised 2004), Share-Based Payment (SFAS 123R). SFAS 123R is consistent with IFRS 2 in requiring that restricted bonuses are expensed over the period the employee must remain with HSBC. However, SFAS 123R only applies to awards made after the date of adoption, which for HUSI is July 1, 2005.

 

 

Impact

 

Some of the bonuses awarded in respect of 2002, 2003 and 2004 were recognized over the relevant vesting period and were, therefore, expensed in net income under IFRS during 2005. Under U.S. GAAP, these awards were expensed in the years for which they were granted. 2005 bonuses will be expensed over the vesting period under both IFRS and U.S. GAAP. Net income was, therefore, higher under U.S. GAAP in 2005.

 

 

IFRS and U.S. GAAP are now largely aligned and this transition difference has now been eliminated.

23



Property

 

 

 

IFRS

 

 

 

Under the transition rules of IFRS 1, HSBC has elected to freeze the value of its properties at their January 1, 2004 valuations. These are the “deemed cost” of properties under IFRS. They will not be revalued in the future. Assets held at historical or deemed cost are depreciated except for freehold land.

 

 

 

Investment properties are recognized at current market values with gains or losses recognized in net income for the period. Investment properties are not depreciated.

 

 

 

U.S. GAAP

 

U.S. GAAP does not permit revaluations of property, including investment property, although it requires recognition of asset impairment. Any realized surplus or deficit is, therefore, reflected in net income on disposal of the property. Depreciation is charged on all properties based on cost.

 

 

Impact

 

Under IFRS, the value of property held for own use reflects revaluation surpluses recorded prior to January 1, 2004. Consequently, the values of tangible fixed assets and shareholders’ equity are lower under U.S. GAAP than under IFRS.

 

 

There is a correspondingly lower depreciation charge and higher net income as well as higher gains (or smaller losses) on the disposal of fixed assets under U.S. GAAP.

 

 

For investment properties, net income under U.S. GAAP does not reflect the unrealized gain or loss recorded under IFRS for the period.

 

 

Pension costs

 

IFRS

 

In accordance with IAS 19 (revised 2006), HSBC has elected to record all actuarial gains and losses on the pension surplus or deficit in the year in which they occur within the ‘Consolidated statement of recognized income and expense’.

 

 

U.S. GAAP

 

SFAS 87 does not permit recognition of all actuarial gains and losses in a statement other than the primary income statement. As permitted by U.S. GAAP, HSBC uses the ‘corridor method’, whereby actuarial gains and losses outside a certain range are recognized in the income statement in equal amounts over the remaining service lives of current employees. That range is 10 per cent of the greater of plan assets and plan liabilities. The remaining additional minimum pension liability and the transition to SFAS 158 are recognized directly in Other comprehensive income (OCI).

 

 

Impact

 

Net income under US GAAP is lower than under IFRS as a result of the amortization of the amount by which actuarial losses exceed gains beyond the 10 per cent ‘corridor’.

 

 

Other

 

In 2007, other includes the net impact of certain adjustments which represent a temporary difference between U.S. GAAP and IFRS. These adjustments were not individually material for the years ended 2007, 2006 and 2005.

24



 

Critical Accounting Policies


HUSI’s consolidated financial statements are prepared in accordance with U.S. GAAP. The significant accounting policies used in the preparation of HUSI’s consolidated financial statements are more fully described in Note 2 to the accompanying consolidated financial statements beginning on page 103 of this Form 10-K.

Many of HUSI’s significant accounting policies require complex judgments to estimate values of assets and liabilities. In making these judgments, management must make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Because changes in such estimates and assumptions could significantly affect HUSI’s reported financial position or results of operations, detailed policies and control procedures have been established to ensure that valuation methods, including judgments made as part of such methods, are well controlled, independently reviewed, and applied consistently from period to period.

Of the significant accounting policies used in the preparation of HUSI’s consolidated financial statements, the items discussed below require critical accounting estimates involving a high degree of judgment and complexity.

Allowance for Credit Losses

HUSI lends money to others, resulting in risk that borrowers may not repay amounts owed when they become contractually due. Consequently, an allowance for credit losses is maintained at a level that is considered appropriate to cover estimates of probable losses of principal, interest and fees in the existing 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 such estimates could significantly impact HUSI’s credit loss reserves and provision for credit losses;

 

 

estimates related to the reserve for credit losses require consideration of future delinquency and charge off trends, which are uncertain and require a high degree of judgment; and

 

 

the allowance for credit losses is influenced by factors outside of HUSI’s control. Customer payment patterns, economic conditions, bankruptcy trends and changes in laws and regulations all have an impact on the estimates.

 

 

HUSI’s 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 anticipated losses associated with all loans and leases outstanding; and

 

 

the reserve for off-balance sheet risk, which is recorded in other liabilities, includes probable and reasonably estimable losses arising from off-balance sheet arrangements such as letters of credit and undrawn commitments to lend.

Both types of reserves 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 five hundred thousand dollars 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 expected by HUSI with reference to independent valuations of underlying loan collateral and also considering secondary market prices for distressed debt where appropriate.

 

 

Loans which are not individually evaluated for impairment are pooled into homogeneous categories of loans and evaluated to determine if it is deemed probable, based on historical data, that a loss has been realized even though it has not yet been manifested in a specific loan.

25



For consumer receivables and certain small business revolving loans, HUSI uses a roll rate methodology (statistical analysis of historical trends used to estimate the probability of continued delinquency, ultimate charge off, and amount of consequential loss assessed at each time period for which payments are overdue) to support the estimation of inherent losses. The results of these models are reviewed by management in conjunction with changes in risk selection, changes in underwriting policies, national and local economic trends, trends in bankruptcy, loss severity and recoveries, and months of loss coverage. 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.

An advanced credit risk methodology is utilized to support the estimation of 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 expert 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 HUSI’s internal credit standards. These advanced measures are applied to the homogeneous credit pools to estimate the reserves required.

The results from the advanced commercial analysis, consumer roll rate analysis and the specific/impairment reserving process are reviewed each quarter by a Credit Reserve Committee co-chaired by the Chief Financial Officer and Chief Credit Officer. This committee also considers other observable factors, both internal to HUSI and external in the general economy, to ensure that the estimates provided by the various models adequately include all known information at each reporting period. The Credit Reserve Committee may add to or reduce a general unallocated allowance to account for any observable factor not considered in the various models, for small portfolios or period ending manual entries not considered in a model and to recognize modeling imperfections. The credit reserves and the results of the Credit Reserve Committee are reviewed with HUSI’s Credit Risk Management Committee and the Board of Directors’ Audit Committee each quarter.

HUSI recognizes however, that there is a high degree of subjectivity and imprecision inherent in the process of estimating losses utilizing historical data. Accordingly, a discretionary component of the allowance for credit losses for unspecified potential losses inherent in the loan portfolios is provided based upon an evaluation of certain portfolio risk factors which, for consumer loans, may not be reflected in the statistical roll rate analysis. Critical factors include the impact of the national economic cycle, migration of loans within non-criticized loan portfolios, and loan portfolio concentration.

Additional credit quality related analysis begins on page 59 of this Form 10-K. HUSI’s approach toward credit risk management begins on page 77 of this Form 10-K.

26



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.

Impairment testing of 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 cost of capital used to discount future cash flows. The 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 management’s judgment. 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 will be recorded and net income will be negatively impacted.

Reporting units were identified based upon an analysis of each of HUSI’s 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. Refer to Note 24 beginning on page 147 of this Form 10-K for an allocation of recorded book value of goodwill by segment.

HUSI has established July 1 of each year as the date for conducting its annual goodwill impairment assessment. At July 1, 2007, there were no individual reporting units with a fair value less than carrying value, including goodwill. The fair value calculations were also tested for sensitivity to reflect reasonable variations, including stress testing of certain attributes such as cost saves, terminal values and the discount rate. Results of these tests were taken into consideration by management during the review of the annual goodwill impairment test.

As a result of a difficult business climate and the market volatility which occurred during the second half of 2007, HUSI performed an interim goodwill test in the Global Banking and Markets business segment, formerly Corporate, Investment Banking and Markets (CIBM), as of December 31, 2007. The results of this test showed the fair value of this business unit exceeded the carrying value including goodwill that was assigned. Based on these results, HUSI determined goodwill was not impaired in this business segment at December 31, 2007.

Fair Value of Financial Instruments and MSRs

A substantial portion of HUSI’s assets and liabilities are carried at fair value. These include trading assets and liabilities, including derivatives and commodities held for trading, derivatives used for hedging, securities available for sale, and mortgage servicing rights (MSRs). 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.

Fair value is defined as the amount at which an asset or liability could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The fair value of a significant majority of HUSI’s assets and liabilities that are reported at fair value is based on quoted market prices or on internally developed valuation models that utilize observable market parameters, including interest rate yield curves, volatilities, option adjusted spreads, and currency rates.

27



For certain assets and liabilities, however, quoted market prices and observable market parameters are not available. For these items, fair value is estimated using internally-developed valuation models that require the use of significant management judgment to estimate certain required valuation parameters. The following is a description of the significant estimates used in the valuation of assets and liabilities for which quoted market prices and observable market parameters are not available.

Derivatives — Fair value estimates for the majority of HUSI’s derivative instruments are based on quoted market prices or on internally developed models that utilize independently sourced market parameters, including interest rate yield curves, option volatilities, and currency rates. Where such market data is not available, derivative instruments are valued using discounted cash flow modeling techniques that require the company to estimate the amount and timing of future cash flows. These estimates are susceptible to significant change in future periods as market conditions change.

The company may adjust certain values derived using the methods described above in order to ensure that those values represent appropriate estimates of fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors, such as liquidity and concentration concerns and counterparty credit risk, that can affect prices in arms-length transactions with unrelated third parties. Finally, other factors such as model assumptions, market dislocations and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.

Derivatives designated as qualified hedges are tested for effectiveness. 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 it is determined 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 also 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 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 the 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.

Loans held for sale — Loans held for sale are carried at the lower of amortized cost or fair value. Accordingly, fair value for such loans must be estimated to determine any required write down to fair value when the amortized cost of the loans exceeds their current fair value. Loans held for sale include residential mortgage loans and commercial loans that have been originated by HUSI or purchased from third parties. Where quoted market prices and observable market parameters are not available, the fair value of loans held for sale is based on contractual cash flows adjusted for management’s estimates of prepayments, defaults, and recoveries, discounted at management’s estimate of the rate that would be required by investors in the current market given the specific loan characteristics and inherent credit risk.

28



Loans held for sale include certain mortgage loans, primarily subprime residential mortgage loans purchased from third parties, held for sale to an HSBC affiliate that subsequently securitizes them. Historically, the fair value of these loans has been estimated using parameters derived from the current pricing of securities backed by loans with similar characteristics. During 2007, however, the markets for securities backed by residential mortgages, and sub-prime residential mortgages in particular, became very illiquid. As a result, management judgment has been required to estimate a number of parameters that are no longer observable in the marketplace, including rates for prepayments, defaults, recoveries and discount rates that would be required by investors under current market conditions given the specific loan characteristics and perceived credit risk. The valuation of these loans reflects significant write downs from their amortized cost as a result of management’s views regarding these valuation parameters.

Loans held for sale also includes certain leveraged lending loans. Where available, quoted market prices are used to estimate the fair value of these loans. Where market quotes are not available, fair value is estimated using observable market prices of similar instruments, including bonds, credit derivatives, and loans with similar characteristics. During 2007, the commercial credit markets experienced a contraction that resulted in a significant decrease in the availability of observable market data for leveraged loans and similar instruments. As a result, the level of management judgment required to estimate fair value for these loans has increased. The lack of liquidity in the commercial credit markets has resulted in significant decreases in the valuation of these loans from their funded amounts, which reflects the impact of the view management takes with regard to various valuation assumptions in light of current market conditions.

Mortgage servicing rights — HUSI recognizes the right to service mortgage loans as a separate and distinct asset at the time the loans are sold. Upon adoption of Statement of Financial Accounting Standards No. 156, Accounting for Servicing of Financial Assets, (SFAS 156) on January 1, 2006, HUSI elected to measure its existing MSRs at fair value. As a result, MSRs are initially measured at fair value at the time that the related loans are sold and periodically re-measured using the fair value measurement method. This method requires that MSRs be measured 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 periodically validated by reference to external independent broker valuations and industry surveys.

Because the fair value of certain assets and liabilities are significantly impacted by the use of estimates, the use of different estimates 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 below their amortized cost 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;

 

 

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; and

 

 

changes in the fair value of MSRs are reported in current period earnings.

29



 

Balance Sheet Review


Overview

HUSI utilizes deposits and borrowings from various sources to provide additional liquidity, to fund balance sheet growth, to meet cash and capital needs, and to fund investments in subsidiaries. During 2007, balance sheet growth was driven by HUSI’s deposit growth strategy. Funds generated from new deposits were generally invested in short-term liquid assets. Balance sheet growth and funding sources are summarized in the following table.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

Increase (Decrease) from

 

 

 

 

 


 

 

 

December 31,
2007

 

December 31, 2006

 

December 31, 2005

 

 

 

 


 


 

 

 

 

Amount

 

%

 

Amount

 

%

 













($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Period end assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term investments (1)

 

 

$

22,862

 

 

$

3,807

 

 

20

 

$

11,602

 

 

103

 

Loans, net

 

 

 

93,535

 

 

 

4,195

 

 

5

 

 

4,039

 

 

5

 

Trading assets

 

 

 

37,036

 

 

 

13,406

 

 

57

 

 

17,340

 

 

88

 

Securities

 

 

 

22,853

 

 

 

98

 

 

 

 

1,918

 

 

9

 

Other assets

 

 

 

12,087

 

 

 

2,050

 

 

20

 

 

1,890

 

 

19

 

 

 

 



 

 



 

 


 



 

 


 

 

 

 

$

188,373

 

 

$

23,556

 

 

14

 

$

36,789

 

 

24

 

 

 

 



 

 



 

 


 



 

 


 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

 

$

116,228

 

 

$

14,082

 

 

14

 

$

25,936

 

 

29

 

Trading liabilities

 

 

 

16,253

 

 

 

3,939

 

 

32

 

 

6,294

 

 

63

 

Short-term borrowings

 

 

 

11,832

 

 

 

6,759

 

 

133

 

 

5,465

 

 

86

 

All other liabilities

 

 

 

4,555

 

 

 

784

 

 

21

 

 

778

 

 

21

 

Long-term debt

 

 

 

28,268

 

 

 

(984

)

 

(3

)

 

(1,327

)

 

(4

)

Shareholders’ equity

 

 

 

11,237

 

 

 

(1,024

)

 

(8

)

 

(357

)

 

(3

)

 

 

 



 

 

 


 

 


 

 



 


 

 

 

 

$

188,373

 

 

$

23,556

 

 

14

 

$

36,789

 

 

24

 

 

 

 



 

 

 


 

 


 



 

 


 

 

 

 

(1)

Includes cash and due from banks, interest bearing deposits with banks and Federal funds sold and securities purchased under resale agreements.

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. The funds raised from HUSI’s deposit growth strategy during 2007 and 2006 were primarily invested in short-term liquid assets (refer to page 9 of this Form 10-K).

30



Loans, Net

Loan balances, which include loans held for sale, at December 31, 2007 and movements in comparison with prior years are summarized in the following table.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

Increase (Decrease) from

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

December 31, 2006

 

December 31, 2005

 

 

 

 

 

 

 

 


 



 

 

 

December 31,
2007

 

Amount

 

%

 

Amount

 

%

 














($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total commercial loans

 

 

 

$

37,923

 

 

 

$

8,441

 

 

29

 

$

10,205

 

 

37

 

 

 

 

 



 

 

 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

 

 

 

35,380

 

 

 

 

(4,428

)

 

(11

)

 

(8,606

)

 

(20

)

Credit card receivables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Private label

 

 

 

 

17,427

 

 

 

 

454

 

 

3

 

 

3,072

 

 

21

 

MasterCard/Visa

 

 

 

 

1,988

 

 

 

 

701

 

 

54

 

 

829

 

 

72

 

Other consumer

 

 

 

 

2,231

 

 

 

 

(456

)

 

(17

)

 

(893

)

 

(29

)

 

 

 

 



 

 

 



 



 



 



 

Total consumer loans

 

 

 

 

57,026

 

 

 

 

(3,729

)

 

(6

)

 

(5,598

)

 

(9

)

 

 

 

 



 

 

 



 



 



 



 

Total loans

 

 

 

 

94,949

 

 

 

 

4,712

 

 

5

 

 

4,607

 

 

5

 

Allowance for credit losses

 

 

 

 

1,414

 

 

 

 

517

 

 

58

 

 

568

 

 

67

 

 

 

 

 



 

 

 



 



 



 



 

Loans, net

 

 

 

$

93,535

 

 

 

$

4,195

 

 

5

 

$

4,039

 

 

5

 

 

 

 

 



 

 

 



 



 



 



 

Increased commercial loan balances in 2007 and 2006 were partly due to expansion of middle market activities and, in 2007, were also due to an increase in the draw-downs of previously unfunded commitments. Additionally, HUSI originates commercial loans in connection with its participation in a number of leveraged acquisition finance syndicates. A majority of these loans are originated with the intent of selling them to third parties.

Beginning in 2005, as a result of balance sheet initiatives to reduce prepayment risk and improve HBUS’s structural liquidity, HUSI decided to sell a majority of its residential loan originations through the secondary markets and allow the existing loan portfolio to run off, resulting in reductions in loan balances throughout 2007 and 2006.

The addition of new merchant and customer relationships to the private label and MasterCard/Visa credit card portfolios, higher average receivable balances, and decreased balance requirements of off-balance sheet securitized receivable trusts (refer to page 124 of this Form 10-K) have resulted in higher on-balance sheet credit card receivable balances for 2007 and 2006.

          Commercial Loan Maturities and Sensitivity to Changes in Interest Rates

The contractual maturity and interest sensitivity of total commercial loans at December 31, 2007 is summarized in the following table.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

December 31, 2007

 

One
Year
or Less

 

Over One
Through
Five Years

 

Over
Five
Years

 

Total
Loans

 










 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction and other real estate

 

$

4,002

 

 

$

3,533

 

$

919

 

$

8,454

 

Other commercial

 

 

17,412

 

 

 

8,474

 

 

3,583

 

 

29,469

 

 

 



 

 



 



 



 

Total

 

$

21,414

 

 

$

12,007

 

$

4,502

 

$

37,923

 

 

 



 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans with fixed interest rates

 

$

7,787

 

 

$

2,037

 

$

791

 

$

10,615

 

Loans having variable interest rates

 

 

13,627

 

 

 

9,970

 

 

3,711

 

 

27,308

 

 

 



 

 



 



 



 

Total

 

$

21,414

 

 

$

12,007

 

$

4,502

 

$

37,923

 

 

 



 

 



 



 



 

31



Trading Assets and Liabilities

Trading assets and liabilities balances at December 31, 2007, and movements in comparison with prior years, are summarized in the following table.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


















 

 

 

 

 

Increase (Decrease) from

 

 

 

 

 

 


 

 

 

December 31,
2007

 

December 31, 2006

 

December 31, 2005

 

 

 

 






 






 

 

 

 

Amount

 

%

 

Amount

 

%

 













($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities (1)

 

 

$

13,537

 

$

1,613

 

 

14

 

$

2,758

 

 

26

 

Precious metals

 

 

 

8,788

 

 

6,072

 

 

224

 

 

6,502

 

 

284

 

Derivatives

 

 

 

14,711

 

 

5,721

 

 

64

 

 

8,080

 

 

122

 

 

 

 

 


 



 



 



 



 

 

 

$

37,036

 

$

13,406

 

 

57

 

$

17,340

 

 

88

 

 

 

 

 


 



 



 



 



 

Trading liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold, not yet purchased

 

 

$

1,444

 

$

(470

)

 

(25

)

$

(364

)

 

(20

)

Payables for precious metals

 

 

 

1,523

 

 

187

 

 

14

 

 

362

 

 

31

 

Derivatives

 

 

 

13,286

 

 

4,222

 

 

47

 

 

6,296

 

 

90

 

 

 

 

 


 



 



 



 



 

 

 

 

$

16,253

 

$

3,939

 

 

32

 

$

6,294

 

 

63

 

 

 

 

 


 



 



 



 



 


 

 

(1)

Includes U.S. Treasury, U.S. Government agency, U.S. Government sponsored enterprises, asset-backed, corporate bonds and other securities.

Increase in securities balances in 2007 and 2006 was attributable to higher volumes of activity in the Global Banking and Markets business segment. Also contributing to the increase in 2007 were purchases of emerging market securities as part of the continued development of our emerging-market franchise.

Higher precious metals balances were due to higher levels of trading activity, and to generally higher market prices for various metals, specifically gold and platinum.

Higher derivative balances resulted from increased fair values on various derivative products including credit default swaps, foreign currency forward contracts and equity swaps as a result of increasing credit spreads, increased trading volumes and volatility of foreign exchange rates and equity prices during 2007.

Deposits

The following table summarizes balances for major depositor categories.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


















December 31

 

 

2007

 

 

2006

 

 

2005

 

 

2004

 

 

2003

 


















(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individuals

 

 

$

47,751

 

$

43,266

 

$

33,394

 

$

30,882

 

$

30,691

 

Partnerships and corporations

 

 

 

43,718

 

 

39,538

 

 

42,503

 

 

34,430

 

 

23,268

 

Domestic and foreign banks

 

 

 

19,748

 

 

16,243

 

 

11,889

 

 

12,759

 

 

7,580

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and states and political subdivisions

 

 

 

2,461

 

 

1,927

 

 

1,566

 

 

1,493

 

 

1,464

 

Foreign governments and official institutions

 

 

 

2,550

 

 

1,172

 

 

940

 

 

417

 

 

952

 

 

 

 



 



 



 



 



 

Total deposits

 

 

$

116,228

 

$

102,146

 

$

90,292

 

$

79,981

 

$

63,955

 

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total core deposits (1)

 

 

$

65,079

 

$

57,518

 

$

44,882

 

$

39,291

 

$

37,840

 

 

 

 



 



 



 



 



 


 

 

(1)

HUSI monitors “core deposits” as a key measure for assessing results of its 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 the primary source of funding for balance sheet growth during 2007 and 2006. Total deposits increased 14% and 13% in 2007 and 2006, respectively. For additional commentary regarding deposit growth and strategy, refer to page 9 of this Form 10-K.

32



Short-Term Borrowings

Higher short-term borrowings for 2007 was a result of an increase in federal funds purchased and an increase in precious metals borrowings in response to favorable precious metals market conditions in comparison with the years ended 2006 and 2005.

Long-Term Debt

Incremental borrowings from the $40 billion Global Bank Note Program were $1.4 billion and $1.6 billion for 2007 and 2006, respectively. Total borrowings outstanding under this program were $10 billion at December 31, 2007. Additional information regarding this program and other long-term debt is presented in Note 15 of the consolidated financial statements, beginning on page 128 of this Form 10-K.

HUSI had borrowings from the Federal Home Loan Bank (FHLB) of $5.5 billion and $5.0 billion at December 31, 2007 and 2006, respectively, and had access to a potential secured borrowing facility as a member of the FHLB.

Beginning in 2005, HUSI entered into a series of transactions with Variable Interest Entities (VIEs) organized by HSBC affiliates and unrelated third parties. HUSI has determined that it is the primary beneficiary of these VIEs under the applicable accounting literature and, accordingly, consolidated the assets and debt of the VIEs. Debt obligations of the VIEs totaling $2.5 billion were recorded in long-term debt at December 31, 2007 and 2006. Refer to Note 27 of the consolidated financial statements, beginning on page 155 of this Form 10-K, for additional information regarding HUSI’s VIE arrangements.

Preferred Stock

In November 2007, HUSI redeemed all issued shares of Dutch Auction Rate Transferable Securities™ Preferred Stock (DARTS), Series A and B at their stated value of $100,000 per share, resulting in a total cash payment of $125 million.

In May 2006, HUSI issued 14,950,000 depositary shares, each representing one-fortieth of a share of 6.50% Non-Cumulative Preferred Stock, Series H ($1,000 stated value). Total issue proceeds, net of $9 million of underwriting fees and other expenses, were $365 million. When and if declared by HUSI’s Board of Directors, dividends of 6.50% per annum on the stated value per share will be payable quarterly on the first calendar day of January, April, July and October of each year.

Refer to Note 18 of the consolidated financial statements, beginning on page 135 of this Form 10-K, for information regarding all outstanding preferred share issues.

33



Capital Resources

A summary of changes in common shareholder’s equity is presented in the following table.

 

 

 

 

 

 

 

 

 

 

 












 

 

 

2007

 

 

2006

 

 

2005

 












(in millions)

 

 

 

 

 

 

 

 

 

 

Balance, January 1

 

$

10,571

 

$

10,278

 

$

10,366

 

Increase (decrease) due to:

 

 

 

 

 

 

 

 

 

 

Net income

 

 

138

 

 

1,036

 

 

976

 

Dividends paid to common shareholder

 

 

(800

)

 

(455

)

 

(675

)

Dividends paid to preferred shareholders

 

 

(98

)

 

(88

)

 

(46

)

Change in other comprehensive income

 

 

(138

)

 

(202

)

 

(43

)

Capital contributions from parent (1)

 

 

4

 

 

15

 

 

3

 

Reductions of capital surplus

 

 

(5

)

 

(9

)

 

(303

)

Other

 

 

 

 

(4

)

 

 

 

 



 



 



 

Total net increase (decrease)

 

 

(899

)

 

293

 

 

(88

)

 

 



 



 



 

Balance, December 31

 

$

9,672

 

$

10,571

 

$

10,278

 

 

 



 



 



 


 

(1)

Capital contributions from parent include amounts related to an HSBC stock option plan in which almost all of HUSI’s employees are eligible to participate.

HUSI maintains rolling 12 month capital forecasts on a consolidated basis, and for its banking subsidiaries. Target capital ratios approved by the board of directors are set above levels established by regulators as “well capitalized”, and are partly based on a review of peer banks. Dividends are generally paid by HUSI to its parent company, HSBC North America, Inc. (HNAI), when available capital exceeds target levels.

Effective January 1, 2005, the separate U.S. defined benefit pension plans were merged into a single defined benefit pension plan which facilitates the development of a unified employee benefit policy and unified employee benefit plan administration for HSBC affiliates operating in the U.S. As a result, HUSI’s prepaid pension asset of $482 million and a related deferred tax liability of $203 million were transferred to HNAH. The net transfer amount of $279 million was recorded as a reduction of capital surplus.

HUSI and HBUS are required to meet minimum capital requirements by their principal regulators. Risk-based capital amounts and ratios are presented in Note 19 of the consolidated financial statements, beginning on page 137 of this Form 10-K.

34



 

Results of Operations



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 consolidated average balances and interest rates on a taxable equivalent basis is presented on pages 94-95 of this Form 10-K.

The following table presents changes in the components of net interest income according to “volume” and “rate”.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 












 

 

 

 

2007 Compared to 2006

 

 

 

2006 Compared to 2005

 

 

 

 

 

 

Increase (Decrease)

 

 

 

Increase (Decrease)

 

 

Year Ended December 31

 

2007

 

Volume

 

Rate

 

2006

 

Volume

 

Rate

 

2005

 

















(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits with banks

 

$

309

 

$

91

 

$

(7

)

$

225

 

$

13

 

$

92

 

$

120

 

Federal funds sold and securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

purchased under resale agreements

 

 

610

 

 

70

 

 

14

 

 

526

 

 

220

 

 

116

 

 

190

 

Trading assets

 

 

633

 

 

20

 

 

195

 

 

418

 

 

140

 

 

3

 

 

275

 

Securities

 

 

1,221

 

 

51

 

 

25

 

 

1,145

 

 

158

 

 

88

 

 

899

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

2,017

 

 

213

 

 

40

 

 

1,764

 

 

217

 

 

314

 

 

1,233

 

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

 

2,042

 

 

(223

)

 

54

 

 

2,211

 

 

(271

)

 

161

 

 

2,321

 

Credit cards

 

 

1,764

 

 

170

 

 

265

 

 

1,329

 

 

172

 

 

345

 

 

812

 

Other consumer

 

 

249

 

 

(47

)

 

28

 

 

268

 

 

(17

)

 

21

 

 

264

 

 

 



 



 



 



 



 



 



 

Total consumer

 

 

4,055

 

 

(100

)

 

347

 

 

3,808

 

 

(116

)

 

527

 

 

3,397

 

Other interest

 

 

221

 

 

134

 

 

(4

)

 

91

 

 

53

 

 

6

 

 

32

 

 

 



 



 



 



 



 



 



 

Total interest income

 

 

9,066

 

 

479

 

 

610

 

 

7,977

 

 

685

 

 

1,146

 

 

6,146

 

 

 



 



 



 



 



 



 



 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits in domestic offices:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings deposits

 

 

1,376

 

 

253

 

 

142

 

 

981

 

 

150

 

 

513

 

 

318

 

Other time deposits

 

 

1,267

 

 

(74

)

 

189

 

 

1,152

 

 

(57

)

 

387

 

 

822

 

Deposits in foreign offices:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign banks deposits

 

 

454

 

 

86

 

 

(24

)

 

392

 

 

(13

)

 

150

 

 

255

 

Other time and savings

 

 

743

 

 

60

 

 

95

 

 

588

 

 

(1

)

 

213

 

 

376

 

Short-term borrowings

 

 

357

 

 

(9

)

 

66

 

 

300

 

 

(19

)

 

49

 

 

270

 

Long-term debt

 

 

1,443

 

 

(43

)

 

29

 

 

1,457

 

 

187

 

 

245

 

 

1,025

 

 

 



 



 



 



 



 



 



 

Total interest expense

 

 

5,640

 

 

273

 

 

497

 

 

4,870

 

 

247

 

 

1,557

 

 

3,066

 

 

 



 



 



 



 



 



 



 

Net interest income - taxable equivalent basis

 

 

3,426

 

$

206

 

$

113

 

 

3,107

 

$

438

 

$

(411

)

 

3,080

 

 

 

 

 

 



 



 

 

 

 



 



 

 

 

 

Tax equivalent adjustment

 

 

28

 

 

 

 

 

 

 

 

26

 

 

 

 

 

 

 

 

17

 

 

 



 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

Net interest income -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

non taxable equivalent basis

 

$

3,398

 

 

 

 

 

 

 

$

3,081

 

 

 

 

 

 

 

$

3,063

 

 

 



 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

Significant components of HUSI’s net interest margin are summarized in the following table.

 

 

 

 

 

 

 

 

 

 

 












Year Ended December 31

 

2007

 

2006

 

2005

 









Yield on total earning assets

 

 

6.24

%

 

5.79

%

 

4.96

%

Rate paid on interest bearing liabilities

 

 

4.35

 

 

4.03

 

 

2.78

 

 

 



 



 



 

Interest rate spread

 

 

1.89

 

 

1.76

 

 

2.18

 

Benefit from net non-interest or paying funds

 

 

.47

 

 

.50

 

 

.31

 

 

 



 



 



 

Net interest margin on average earning assets (1)

 

 

2.36

%

 

2.26

%

 

2.49

%

 

 



 



 



 


 

 

(1)

Selected financial ratios are defined in the Glossary of Terms beginning on page 91 of this Form 10-K.

35



Significant trends affecting net interest income and interest rate spreads are summarized in the following table. Net interest income in the table is presented on a taxable equivalent basis (refer to pages 94-95 of this Form 10-K).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

































 

 

 

2007

 

 

 

 

2006

 

 

 

2005

 

 

 

 

 


 

 

 

 


 

 

 


 

 

Year Ended December 31

 

 

 

Amount

 

 

 

 

Interest
Rate
Spread

 

 

 

 

Amount

 

 

 

 

Interest
Rate
Spread

 

 

 

 

Amount

 

 

 

 

Interest
Rate
Spread

 

 

































($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income/interest rate spread from prior year

 

 

$

3,107

 

 

 

 

1.76

%

 

 

 

$

3,080

 

 

 

 

 

2.18

%

 

 

 

$

2,758

 

 

 

 

 

2.81

%

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

 

 


 

 

Increase (decrease) in net interest income associated with:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading related activities (1)

 

 

 

20

 

 

 

 

 

 

 

 

(71

)

 

 

 

 

 

 

 

 

 

 

(61

)

 

 

 

 

 

 

 

Balance sheet management activities (2)

 

 

 

(21

)

 

 

 

 

 

 

 

 

 

(269

)

 

 

 

 

 

 

 

 

 

 

(156

)

 

 

 

 

 

 

 

Private label receivable portfolio (3)

 

 

 

298

 

 

 

 

 

 

 

 

 

 

210

 

 

 

 

 

 

 

 

 

 

 

435

 

 

 

 

 

 

 

 

Other activity

 

 

 

22

 

 

 

 

 

 

 

 

 

 

157

 

 

 

 

 

 

 

 

 

 

 

104

 

 

 

 

 

 

 

 

 

 

 

 


 

 

 

 


 

 

 

 

 


 

 

 

 

 


 

 

 

 

 


 

 

 

 

 


 

 

Net interest income/interest rate spread for current year

 

 

$

3,426

 

 

 

 

1.89

%

 

 

 

$

3,107

 

 

 

 

 

1.76

%

 

 

 

$

3,080

 

 

 

 

 

2.18

%

 

 

 

 



 

 

 

 


 

 

 

 



 

 

 

 

 


 

 

 

 



 

 

 

 

 


 

 


 

 

(1)

Refer to commentary regarding trading revenues, beginning on page 40 of this Form 10-K.

 

 

(2)

Represents HUSI’s activities to manage interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. Interest rate risk, and HUSI’s approach to manage such risk, are described beginning on page 81 of this Form 10-K.

 

 

(3)

Refer to commentary regarding the private label receivable portfolio, beginning on page 52 of this Form 10-K.

          Trading Related Activities

Net interest income for trading related activities increased primarily due to increased trading assets balances.

          Balance Sheet Management Activities

Lower net interest income from balance sheet management activities continued to impact results for 2007. A relatively flat yield curve and elevated short term interest rates have continued to limit opportunities to generate additional net funds income.

          Private Label Receivable Portfolio (PLRP)

Higher net interest income for the PLRP for 2007 resulted from:

 

 

increased credit card receivable balances, due to the addition of new PLRP merchant relationships during 2007 and 2006;

 

 

higher accrued income as a result of a more refined income recognition methodology on private label credit card promotional transactions; and

 

 

lower amortization of premiums paid for purchases of receivables included within the PLRP. Although premiums associated with daily purchases of receivables from HSBC Finance Corporation continue to be recorded and amortized, premium amortization associated with the initial portfolio acquisition in 2004 was $70 million lower for 2007, as compared to 2006.

          Residential Mortgages

Lower net interest income from residential mortgage activities, included in other activity in the above table, primarily resulted from continued narrowing of interest rate spreads and from contraction of the residential mortgage loan portfolio. As a result of a continuing strategy to reduce prepayment risk and improve HBUS’s structural liquidity, HUSI continues to sell a majority of its residential mortgage loan originations and allow the residential mortgage loan portfolio to run off.

36



          Other Core Banking Activity

Higher net interest income from other core banking activity mostly resulted from business expansion initiatives, which have led to increased deposits and loans.

Personal deposits continued to grow in 2007 as a result of continued success of the Online Savings product and expansion of the branch network. However, customers continued to migrate to higher yielding deposit products such as the Online Savings product, leading to a change in product mix and narrowing of deposit spreads, which partly offset the benefit of higher deposit balances. Refer to page 9 of this Form 10-K for commentary regarding HUSI’s deposit strategy and growth.

Significant resources have been dedicated to expansion of various commercial lending businesses and regional offices, which has resulted in increased loan and deposit balances. The average yield earned on commercial loans was also higher in 2007.

 

Provision for Credit Losses


The provision for credit losses associated with various loan portfolios is summarized in the following table.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007 Compared
to 2006
Increase (Decrease)

 

2006 Compared
to 2005
Increase (Decrease)

 

 

 

 

 

 

 

 

 

 

 

 


 


 

Year Ended December 31

 

 

2007

 

 

 

2006

 

 

 

2005

 

 

 

Amount

 

 

 

%

 

 

Amount

 

 

 

%

 





























($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

$

205

 

 

 

$

136

 

 

 

$

(15

)

 

 

$

69

 

 

 

51

 

 

$

151

 

 

 

*

 

 

 

 



 

 

 



 

 

 




 

 



 

 

 


 

 



 

 

 


 

Consumer: