FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a - 16 or 15d - 16 of
the Securities Exchange Act of 1934
For the month of March, 2007
HSBC Holdings plc
42nd Floor, 8 Canada
Square, London E14 5HQ, England
(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F).
Form 20-F X Form 40-F ......
(Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934).
Yes....... No X
(If "Yes" is marked, indicate below the file number assigned to the registrant
in connection with Rule 12g3-2(b): 82- ..............)
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HSBC Holdings plc
By:
Name: P A Stafford
Title: Assistant Group Secretary
Date: 05 March 2007
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
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
8.375% Debentures due 2007 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 ( )
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 ( ) 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 ( )
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 ( ) Accelerated filer ( ) 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 ( ) No (X)
At February 28, 2007, 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
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Page
Item 1. Business
History .............................................. 5
Description of Operations and Business Segments ...... 5
2006 Developments and Trends ......................... 7
Geographic Distribution of Assets and Earnings ....... 11
Regulation, Supervision and Capital .................. 11
Competition .......................................... 13
Cautionary Statement on Forward-Looking Statements ... 13
Statistical Disclosure by Bank Holding Companies:
Average Balance Sheets and Interest Earned and
Paid ............................................ 90
Changes in Interest Income and Expense
Attributable to Changes in Rate and Volume ...... 34
Securities Portfolios ............................. 112
Loans Outstanding:
Composition and Maturities ..................... 30
Risk Elements in the Loan Portfolio ............ 58-60, 120
Summary of Loan Loss Experience ................... 62
Deposits .......................................... 125
Short-Term Borrowings ............................. 126
Item 1A. Risk Factors ............................................ 14
Item 1B. Unresolved Staff Comments ............................... 18
Item 2. Properties .............................................. 18
Item 3. Legal Proceedings ....................................... 18
Item 4. Submission of Matters to a Vote of Security Holders ..... 18
Part II
--------------------------------------------------------------------------------
Item 5. Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities ............................................ 18
Item 6. Selected Financial Data ................................. 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Executive Overview ................................... 20
Basis of Reporting ................................... 21
Critical Accounting Policies ......................... 25
Balance Sheet Review ................................. 29
Results of Operations ................................ 34
Business Segments .................................... 50
Credit Quality ....................................... 58
Off-Balance Sheet Arrangements and Contractual
Obligations ........................................ 68
Risk Management ...................................... 70
Glossary of Terms .................................... 87
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk .................................................. 88
Item 8. Financial Statements and Supplementary Data ............. 92
3
Part III
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Page
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................... 157
Item 9A. Controls and Procedures ................................. 157
Item 9B. Other Information ....................................... 157
Item 10. Directors, Executive Officers and Corporate Governance .. 158
Item 11. Executive Compensation .................................. 164
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters ............ 201
Item 13. Certain Relationships and Related Transactions, and
Director Independence ................................. 202
Item 14. Principal Accounting Fees and Services .................. 204
Part IV
--------------------------------------------------------------------------------
Item 15. Exhibits and Financial Statement Schedules
and Reports on Form 8-K.................................. 205
4
PART I
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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 9,500 offices in 76 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 new 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, 2006, 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:
o HSBC Bank Canada (HBCA), a Canadian banking subsidiary;
o HSBC Finance Corporation, a consumer finance company;
o HSBC Markets (USA) Inc. (HMUS), a holding company for investment banking
and markets subsidiaries; and
o HSBC Technology & Services (USA) Inc. (HTSU), a provider of information
technology services.
Description of Operations and Business Segments
At December 31, 2006, HUSI had total assets of $169 billion and approximately
12,000 full and part time employees. HUSI is among the 15 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 three
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 $166 billion at December 31, 2006, HBUS is ranked among the
top ten 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 Florida, California, New Jersey,
Delaware, Pennsylvania, Washington, Oregon, Massachusetts, Virginia 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.
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.
5
The Personal Financial Services (PFS) Segment
This segment provides a broad range of financial products and services including
installment and revolving term loans, MasterCard(1)/Visa(2) 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 direct retail and wholesale
origination channels. Mortgage loans are originated through a network of
brokers, wholesale agents and retail origination offices. 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 and
2004 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.
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 and 2004 results for these segments
have been revised to reflect these changes.
The Corporate, Investment Banking and Markets (CIBM) Segment
The CIBM segment provides tailored financial solutions to major government,
corporate and institutional clients worldwide. With access to HSBC's worldwide
presence and capabilities, the CIBM segment serves subsidiaries and offices of
its clients on a global basis. Products and services offered are summarized
below.
o Global Markets operations consisting of treasury and capital markets
services and products, including:
- foreign exchange;
- currency, interest rate, bond, credit, equity and other specialized
derivatives;
- money market instruments; and
- precious metals.
----------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated.
(2) Visa is a registered trademark of Visa USA, Inc.
6
o Global Banking services, including corporate and institutional banking
services, investment banking services, direct lending, lease financing and
deposit-taking services.
o Global Transaction Banking services, including:
- payments and cash management services;
- trade services;
- securities services, including custody, clearing and funds
administration; and
- banknotes and currency services.
o Investment services, including asset management and fund management
services.
The Private Banking (PB) Segment
This segment offers a full range of services for high net worth individuals
including deposit, lending, trading, trust, tax planning, branch services,
mutual funds, insurance and investment management.
Other Segment
This segment includes an equity investment in HSBC Republic 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 and 2004 results have been revised
to reflect this change.
2006 Developments and Trends
Consolidated Balance Sheet Growth
HUSI's consolidated total assets increased $15 billion (10%) during 2006.
Balance sheet growth was primarily driven by HUSI's deposit strategy during
2006, which enhanced HUSI's liquidity position. The funds raised were primarily
invested in short-term, liquid assets. In addition, trading assets and
liabilities increased as a result of business expansion initiatives in the CIBM
segment. Analysis of balance sheet growth and funding begins on page 29 of this
Form 10-K.
Deposit Strategy and Growth
Beginning in 2004, HUSI implemented a growth strategy for its core banking
network, which includes building deposits over a three to five year period,
across multiple markets and segments, and utilizing multiple delivery systems.
During 2006 the strategy included various initiatives:
o full deployment of new personal and business checking and savings
products, including relationship based products;
o emphasis on more competitive pricing with the introduction of high
yielding products, including internet savings accounts, which have grown
significantly beginning in late 2005. Since their introduction in 2005,
internet savings balances have grown to $7 billion, of which $6 billion
was 2006 growth. $5 billion of the 2006 growth was from new customers;
o retail branch expansion in existing and new geographic markets;
o improving delivery systems, including use of internet capabilities;
o refined marketing and customer analytics for the affluent consumer
population; and
o strengthening current customer relationships, thereby driving increased
utilization of products and customer retention.
Total deposit growth was $13 billion and $12 billion during the calendar years
2006 and 2005, respectively. Deposit balances by major depositor categories are
summarized on page 31 of this Form 10-K.
7
Income Before Income Tax Expense - Significant Trends
Analysis of the components of HUSI's income before income tax expense begins on
page 34 of this Form 10-K. Income before income tax expense, and various trends
and activity affecting operations, are summarized in the following table.
------------------------------------------------------------------------------------------------------
Increase (Decrease) in 2006 from
--------------------------------------
2005 2004
------------------ -----------------
Year Ended December 31 2006 Amount % Amount %
------------------------------------------------------------------------------------------------------
($ in millions)
Income before income tax expense ................... $ 1,566 $ 24 2 $ (410) (21)
======= ======== ======= ======= =======
Impact on income before income tax expense:
Balance sheet management income (loss) (1) ...... $ (71) $ (325) (128) $ (473) (118)
Provision for credit losses (2) ................. (823) (149) (22) (840) *
Residential mortgage banking revenue (3) ........ 96 32 50 216 *
Trading revenues (4) ............................ 755 360 91 467 162
Private label receivable portfolio (5) .......... 85 266 * 85 *
Loans held for sale to an HSBC affiliate ........ 77 61 381 77 *
Sales of property and other financial assets
(6) .......................................... 74 (12) (14) (90) (55)
Equity investment activity (6) .................. 110 67 156 61 124
(1) Comprised primarily of net interest income and, to a lesser extent, gains
on sales of investments and trading revenues. Refer to commentary
regarding CIBM net interest income, trading revenues, and the CIBM
business segment on pages 55-56.
(2) Refer to commentary regarding the provision for credit losses on page 38
of this Form 10-K.
(3) Refer to commentary regarding residential mortgage banking revenue
beginning on page 43 of this Form 10-K.
(4) Refer to commentary regarding trading revenues beginning on page 46 of
this Form 10-K.
(5) Refer to commentary regarding the CF business segment, beginning on page
52 of this Form 10-K.
(6) Represents the net impact of various individual transactions. Refer to
commentary regarding other revenues beginning on page 40 of this Form
10-K.
* Not meaningful.
8
Residential Mortgage Loans Held for Sale to an HSBC Affiliate
In 2005, HUSI began acquiring residential mortgage loans from unaffiliated third
parties with the intent of selling these loans to HMUS. During 2006, HUSI also
began acquiring residential mortgage loans from HSBC Finance Corporation under
this program. HMUS in turn is selling these loans to securitization vehicles.
These loans are recorded by HUSI at the lower of their aggregate cost or market
value, with adjustments down to market value being recorded as a valuation
allowance. The loans are generally held on HUSI's balance sheet for 30-90 days,
resulting in activity that affects various balance sheet and income statement
line items, as summarized in the table below. HUSI maintains a portfolio of
derivatives and securities, which are used as economic hedges to offset changes
in market values of the loans held for sale to HMUS. Gains on sales associated
with these loans result from incremental value realized on pools of loans sold
to HMUS for securitization. During 2006, the following activity was recorded as
a result of acquiring, holding and selling these loans.
------------------------------------------------- --------------------------------------------------------
Year Ended December 31 2006 2005
------------------------------------------------- --------------------------------------------------------
(in millions)
Residential mortgage loans held for sale to HMUS:
Balance at beginning of year ................................................ $ 2,882 $ --
Loans acquired from originators ............................................. 16,466 5,116
Loans sold to HMUS .......................................................... (15,867) (2,188)
Other, primarily loans resold to originators and other third parties ........ (355) (46)
---------- ----------
Balance at end of year ...................................................... $ 3,126 $ 2,882
========== ==========
Valuation allowance for adjustments to market value:
Balance at beginning of year ................................................ $ (11) $ --
Increased valuation allowance for net reductions in market value ............ (133) (32)
Releases of valuation allowance for loans sold to HMUS ...................... 109 21
---------- ----------
Balance at end of year ...................................................... $ (35) $ (11)
========== ==========
Increases (decreases) to income before income taxes:
Increased net interest income associated with loans held for sale to HMUS ... $ 64 $ 11
Gains on sale of residential mortgage loans sold to HMUS, recorded in
other revenues ........................................................... 106 18
Increased valuation allowance for reductions in market value of loans held
for sale to HMUS, recorded in other revenues .............................. (133) (32)
Trading revenues recognized from economic hedges held to offset changes .....
in market values of loans held for sale to HMUS .......................... 68 25
Program costs included in other expenses .................................... (28) (6)
---------- ----------
Net impact on income before income taxes .................................... $ 77 $ 16
========== ==========
Transactions with HSBC Finance Corporation and Other HSBC Affiliates
2006 was highlighted by continued cooperation 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.
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 significantly due to increased
private label receivables and other loans acquired from HSBC Finance Corporation
and from their correspondents.
9
HNAH's technology services in North America were centralized by the creation of
a new subsidiary, HTSU, effective January 1, 2004. HUSI's technology services
employees, as well as technology services employees from other HSBC affiliates
in the United States, were transferred to HTSU. Technology related assets and
software purchased subsequent to January 1, 2004 are generally purchased and
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 2006, as HUSI continued to
upgrade its technology environment.
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 CIBM
segment have increased in 2006 due primarily to business expansion initiatives.
Details of these and other transactions with HSBC affiliates are presented in
Note 21 of the consolidated financial statements beginning on page 137 of this
Form 10-K.
Newly Chartered Banking Subsidiaries
During 2005, HUSI incorporated a nationally chartered limited purpose bank
subsidiary, HSBC Trust Company (Delaware), National Association (HTCD). During
2006, HTCD's charter was expanded to include the following primary activities:
o Custodian of investment securities for other HSBC affiliates;
o Personal trust services; and
o 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
sheet and results of operations for the years ended December 31, 2006 and 2005,
and are not expected to have a material impact for 2007.
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 will 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 sheet and results of operations
for the year ended December 31, 2006, and are not expected to have a material
impact for 2007.
10
Geographic Distribution of Assets and Earnings
HUSI's foreign operations represented less than 6% of HUSI's consolidated total
assets at December 31, 2006 and 2005, and less than 10% of consolidated income
before income tax expense for 2006, 2005 and 2004.
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 noninterest bearing cash reserves with the Federal
Reserve Bank, which averaged $311 million in 2006 and $709 million in 2005.
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 32 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 135 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 proposed 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 take effect
at the 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.
11
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, 2006 was 1.24 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 on 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 Bank Secrecy
Act and anti-money laundering compliance programs by the federal and state bank
regulators.
Basel Capital Standards (Basel II)
HUSI previously reported that it must have in place, by January 1, 2008, a Basel
II framework meeting the requirements of HSBC's principal regulator, the
Financial Services Authority in the United Kingdom (U.K.). However, U.S.
requirements for HUSI and other U.S. banks for which compliance is mandatory
(mandatory U.S. banks) have continued to evolve in 2006. A Notice of Proposed
Rulemaking was published by U.S. regulators on September 25, 2006 and is
expected to be finalized in the second half of 2007. Implementation by mandatory
U.S. banks will be expected within 3 years from the date of the final rule. The
different implementation timetables, as well as possible differences in
requirements of regulators in the U.S. and the U.K., may affect the cost and
difficulty of implementing Basel II.
HUSI's approach toward implementing the Basel framework is summarized on page 72
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 will be 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, 2008.
As a foreign registrant, HSBC is 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.
12
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, 2006, 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.
13
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:
o short-term and long-term interest rates;
o inflation;
o recession;
o monetary supply;
o fluctuations in both debt and equity capital markets in which HUSI funds
its operations;
o market value of consumer owned and commercial real estate throughout the
United States;
o consumer perception as to the availability of credit; and
o 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. In addition, the traditional segregation of the financial
services industry into prime and non-prime segments has eroded and in the future
is expected to continue to do so, further increasing competition in the
financial services industry. Such competition may impact the terms, rates, costs
and/or profits historically included in the loan 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.
14
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 future 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 financial, accounting, or
other data processing systems 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:
o computer viruses or electrical or telecommunications outages;
o natural disasters, such as hurricanes and earthquakes;
o events arising from local or regional politics, including terrorist acts;
o unforeseen problems encountered while implementing major new computer
systems; or
o 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.
15
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:
o threaten the assets of customers and of HUSI;
o negatively impact customer credit ratings;
o impact customers' ability to repay loan balances;
o increase costs for HUSI to respond to such threats and to enhance its
processes and systems to ensure maximum security of data; or
o 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:
o raising the minimum payment on credit card accounts;
o determinations to acquire or sell private label credit card receivables,
residential mortgage loans and other loans;
o changes to customer account management, risk management and collection
policies and practices;
o increasing investment in technology, business infrastructure and
specialized personnel; or
o 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 could therefore have a negative
effect on HUSI. Potential conditions that could negatively affect HUSI's
liquidity include:
o diminished access to capital markets;
o unforeseen cash or capital requirements;
o an inability to sell assets; and
o 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.
16
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:
o the total cost of integration;
o the time required to complete the integration;
o the amount of longer-term cost savings; or
o the overall performance of the combined entity.
Integration of an acquired business can be complex and costly, and may sometimes
include combining relevant accounting and data processing 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, 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:
o appropriately addressing potential conflicts of interest, legal and
regulatory requirements;
o ethical issues;
o adequacy of anti-money laundering processes;
o privacy issues;
o record-keeping;
o sales and trading practices;
o proper identification of the legal, reputational, credit, liquidity and
market risks inherent in products offered; and
o 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.
17
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, sixteen branches each in Florida and
California, fifteen branches in New Jersey, two branches in Pennsylvania and one
branch each in Oregon, Washington State, Delaware and Washington D.C.
Approximately 31% 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 on page 148 of this Form 10-K.
Item 4. Submission of Matters to a Vote of Security Holders
--------------------------------------------------------------------------------
Not applicable.
PART II
--------------------------------------------------------------------------------
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
--------------------------------------------------------------------------------
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.
18
Item 6. Selected Financial Data
--------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------------
($ in millions)
Income statement:
Net interest income ...................... $ 3,081 $ 3,063 $ 2,741 $ 2,510 $ 2,376
(Provision) credit for credit losses ..... (823) (674) 17 (113) (195)
Total other revenues ..................... 2,563 1,911 1,319 1,154 1,059
Total operating expenses ................. (3,255) (2,758) (2,101) (2,040) (1,875)
Income tax expense ....................... (530) (566) (718) (570) (510)
--------- --------- --------- ---------- ---------
Net income ............................... $ 1,036 $ 976 $ 1,258 $ 941 $ 855
========= ========= ========= ========== =========
Balances at year end:
Loans, net of allowance .................. 89,340 89,496 84,159 48,075 43,143
Total assets ............................. 168,957 153,859 141,050 95,562 89,426
Total tangible assets .................... 166,195 151,120 138,310 92,736 86,544
Total deposits ........................... 104,550 91,815 79,981 63,955 59,830
Common shareholder's equity .............. 10,571 10,278 10,366 6,962 6,897
Tangible common shareholder's equity ..... 8,034 7,562 7,611 4,022 3,737
Total shareholders' equity ............... 12,261 11,594 10,866 7,462 7,397
Selected financial ratios:
Total shareholders' equity to total
assets 7.26% 7.54% 7.70% 7.81% 8.27%
Tangible common shareholder's equity
to total tangible assets .............. 4.83 5.00 5.50 4.34 4.32
Rate of return on average (1):
Total assets ....................... .62 .66 1.12 1.02 .97
Total common shareholder's equity .. 9.03 8.78 16.35 13.06 12.42
Net interest margin to average (1):
Earning assets ..................... 2.25 2.49 3.00 3.39 3.29
Total assets ....................... 1.87 2.09 2.46 2.76 2.74
Average total shareholders' equity to
average total assets (1) .............. 7.24 7.85 7.18 8.20 8.20
Efficiency ratio (2) ..................... 57.66 55.44 51.73 55.65 54.59
(1) Selected financial ratios are defined in the Glossary of Terms beginning
on page 87 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 2006 and 2005
are summarized on pages 34-39 of this Form 10-K.
19
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
--------------------------------------------------------------------------------
Executive Overview
--------------------------------------------------------------------------------
Income before income tax expense for 2006 was $24 million (2%) higher than 2005,
but $410 million (21%) lower than 2004. Refer to page 35 of this Form 10-K for a
summary of significant trends affecting results for 2006 in comparison with the
two previous years.
Trading revenues within the CIBM segment increased significantly in 2006. Higher
revenues for the first half of 2006 attributable to expanded operations and
favorable market conditions were partially offset by reduced volumes of market
activity and less favorable market conditions in the second half of the year.
Refer to page 46 of this Form 10-K for additional commentary regarding trading
revenues.
Business expansion initiatives begun in 2005 within the PFS, CMB and PB business
segments, including rollout of the internet savings product, have led to strong
growth in commercial loans, consumer and commercial deposits and related
revenues for 2006. Higher revenues were offset by higher expenses associated
with expanding the core banking network and the CIBM business platform. Refer to
Business Segments commentary, beginning on page 50 of this Form 10-K, for
additional information regarding the impact of business expansion initiatives
for various segments.
Interest and fees earned from the private label receivable portfolio were
significantly higher in 2006, due to portfolio growth and to a significant
reduction in premium amortization. Refer to commentary regarding the CF business
segment, beginning on page 52 of this Form 10-K.
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). In 2006, HUSI also began acquiring loans from HSBC
Finance Corporation as part of this program. During 2006, the volume of loan
purchase and sale activity increased significantly. Impacts on HUSI's
consolidated balance sheet and income statement are summarized on page 9 of this
Form 10-K.
Increases in short-term interest rates during 2005 and the first half of 2006,
as well as a flatter yield curve during both calendar years, continued to have a
significant negative impact on net interest income during 2006, particularly
affecting balance sheet management income within the CIBM business segment. The
compression in the interest rate margin began to stabilize during the second
half of 2006. Refer to CIBM Net Interest Income commentary, beginning on page 34
of this Form 10-K, for additional information.
The provision for credit losses increased significantly in 2006, as compared
with the previous two years. Net charge off activity related to commercial loan
portfolios returned to more normalized levels for 2006 when compared with low
net charge offs for 2005 and net recoveries recorded for 2004. Specifically,
higher net charge offs were recorded in 2006 related to small business lending
within the CMB business segment, and to a specific commercial lending
relationship within the PB business segment. Expanding commercial loan and
credit card receivable portfolio balances also resulted in higher charge offs
and higher allowance requirements for credit losses expected within these
portfolios. Credit quality within the residential mortgage portfolio remained
strong in 2006, consistent with previous periods. Refer to Credit Quality
commentary, beginning on page 58 of this Form 10-K, for additional information
regarding the provision and allowance for credit losses.
HUSI's balance sheet growth in 2006 has been highlighted by:
o double-digit growth in domestic deposit balances, due in part to the
continued rollout of the internet savings product;
o significant growth in trading asset and liability balances, resulting from
expansion of various trading businesses within the CIBM business segment;
20
o increased investment in more liquid, short-term instruments, partially as
a result of surplus funds generated from HUSI's deposit growth strategy.
In addition, a rising interest rate environment and a flat yield curve
have limited opportunities for investment in longer-term assets; and
o increased commercial loans and credit card receivables during 2006 were
substantially offset by decreased residential mortgage loan balances, due
to lower residential mortgage loan originations and to strategic balance
sheet managementinitiatives to decrease investment in the residential
mortgage loan portfolio.
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 (IFRSs)
Because HSBC reports results in accordance with IFRSs and results under IFRSs
are used by HSBC in measuring and rewarding performance of employees, HUSI
management also separately monitors net income under IFRSs (a non-U.S. GAAP
financial measure). The following table reconciles HUSI's net income on a U.S.
GAAP basis to net income on an IFRSs basis.
--------------------------------------------------------------------------------
Year Ended December 31 2006 2005
--------------------------------------------------------------------------------
(in millions)
Net income - U.S. GAAP basis ........... $ 1,036 $ 976
Adjustments, net of tax:
Unquoted equity securities .......... 26 --
Property ............................ (1) (46)
Loan impairment ..................... (2) (11)
Stock-based compensation ............ (5) (17)
Purchase accounting/deferred taxes .. (21) --
Fair value option ................... (49) 18
Other ............................... (2) 12
----- ----
Total adjustments, net of tax .......... (54) (44)
------- ------
Net income - IFRSs basis ............... $ 982 $ 932
======= ======
Differences between U.S. GAAP and IFRSs 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.
IFRSs
o 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 OCI, or as trading securities, with
changes in fair value recognized in income.
U.S. GAAP
o 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".
21
Impact
o Changes in fair values of equity securities for which IFRSs require
recognition of the change and U.S. GAAP requires the securities to be held
at cost, impact net income and shareholders' equity when the security is
classified as trading under IFRSs and impact shareholders' equity when the
security is classified as available-for-sale under IFRSs.
Property
IFRSs
o 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 IFRSs. They will not be revalued in the
future. Assets held at historical or deemed cost are depreciated except
for freehold land.
o 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
o 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
o Under IFRSs, 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 IFRSs.
o There is a correspondingly lower depreciation charge and higher net income
under U.S. GAAP, partially offset by higher gains (or smaller losses) on
the disposal of fixed assets.
o For investment properties, net income under U.S. GAAP does not reflect the
unrealized gain or loss recorded under IFRSs for the period.
Loan impairment
IFRSs
o 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
o 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.
22
Impact
o Under both IFRSs 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 IFRSs.
o No asset for future recoveries arising from written-off assets was
recognized in the balance sheet under IFRSs prior to January 1, 2005.
o The establishment of the recovery asset under IFRSs associated with the
private label credit card portfolio purchased from HSBC Finance
Corporation results in higher earnings under IFRSs than under U.S. GAAP.
o Subsequent recoveries are credited to earnings under U.S. GAAP, but are
adjusted against the recovery asset under IFRSs, resulting in lower
earnings under IFRSs.
o Net interest income is higher under IFRSs than under U.S. GAAP due to the
imputed interest on the recovery asset.
Stock-based compensation
IFRSs
o 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
o 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.
o 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
o 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 IFRSs 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 IFRSs and U.S. GAAP. Net
income was, therefore, higher under U.S. GAAP in 2005.
o IFRSs and U.S. GAAP are now largely aligned and this transition difference
will be eliminated over the next few years.
Purchase accounting/deferred taxes
IFRSs
Deferred tax amounts are recorded in the consolidated balance sheet 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.
23
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 IFRSs, this
adjustment was charged to earnings.
Fair value option
IFRSs
o 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.
o 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.
o 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
o 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.
o 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
o 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.
24
o 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 IFRSs, where derivatives providing an
economic hedge for an asset or liability, and so designated under IFRSs,
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.
o Prior to January 1, 2006, debt issues which had embedded derivatives were
also reported at amortized cost with any embedded derivatives bifurcated
where required by SFAS 133.
Other
Other includes the net impact of differences relating to various adjustments,
none of which were individually material at and for the years ended December 31,
2006 and 2005.
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 99 of this Form
10-K.
Certain critical accounting policies, which affect the reported amounts of
assets, liabilities, revenues and expenses, are complex and involve significant
judgment by management, including the use of estimates and assumptions. As a
result, changes in estimates, assumptions or operational policies could
significantly affect HUSI's financial position or results of operations. The
accounting estimates are based upon historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities. Actual results may differ from these estimates under
different assumptions, customer account management policies and practices, risk
management/collection practices, or conditions as discussed below.
Of the significant accounting policies used in the preparation of HUSI's
consolidated financial statements, the items discussed below involve critical
accounting estimates and 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:
o changes in such estimates could significantly impact HUSI's credit loss
reserves and provision for credit losses;
o 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
o 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.
25
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:
o 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
o 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.
o 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.
o 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.
For consumer receivables, HUSI uses 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.
In 2004, HUSI implemented a new methodology to support the estimation of losses
inherent in pools of homogeneous commercial loans, leases and off-balance sheet
risk. These measures have been under development at HUSI for several years to
support more advanced credit risk management, estimation of credit economic
capital, enhanced portfolio management and the requirements of the Basel
framework. This new 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 was developed using quantitative and statistical
techniques, which are combined with expert judgment to support the assessment of
each transaction. They were developed using HUSI's internal data and
supplemented by data from external sources which was judged to be consistent
with HUSI's internal credit standards. As some of the requirements under Basel
differ from interpretations of U.S. GAAP requirements for the measurement of
inherent losses in homogeneous pools of loans, these measures are modified to
meet accounting 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 is 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.
26
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 58 of this Form 10-K.
HUSI's approach toward credit risk management begins on page 72 of this Form
10-K.
Goodwill
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. See Business Segments beginning on page 50 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, 2006, 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: (1) keeping all other variables constant and
assuming no future expense savings are achieved; and (2) keeping other variables
constant while cutting projected revenue growth rates in half. Results of these
tests were taken into consideration by management during the review of the
annual goodwill impairment test.
Mortgage Servicing Rights (MSRs)
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, during 2006 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. The cumulative effect adjustment to beginning
retained earnings was not material.
27
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.
Valuation of Derivative Instruments and Derivative Income
Derivative instruments are utilized as part of HUSI's risk management strategy
to protect the value of certain assets and liabilities and future cash flows
against adverse interest rate and foreign exchange rate movements. The valuation
of derivative instruments is a "critical accounting estimate" because certain
instruments are valued using discounted cash flow modeling techniques.
Discounted cash flow modeling techniques require the use of estimates regarding
the amount and timing of future cash flows, which are susceptible to significant
change in future periods based on changes in market rates. The assumptions used
in the cash flow projection models are based on forward yield curves which are
also susceptible to changes as market conditions change.
The fair value of a derivative instrument is defined as the amount at which an
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. The majority of HUSI's derivative
instruments are reported at fair value and are based upon quoted market prices
or on internally developed models that utilize independently sourced market
parameters, including interest rate yield curves, option volatilities and
currency rates.
The degree of management judgment involved in determining the fair value of a
derivative instrument is dependent upon the availability of quoted market prices
or observable market parameters. For financial instruments that are actively
traded and have quoted market prices or parameters readily available, there is
little to no subjectivity in determining fair value. When observable market
prices and parameters do not exist, management judgment is necessary to estimate
fair value. The valuation process takes into consideration factors such as
liquidity and concentration concerns and counterparty credit risk. For example,
there is often limited market data to rely on when estimating the fair value of
a large or aged position. Similarly, judgment must be applied in estimating
prices for less readily observable external parameters. 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.
Significant changes in the fair value can result in equity and earnings
volatility as follows:
o 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;
o 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
o changes in the fair value of derivatives held for trading purposes are
reported in current period earnings.
28
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.
o 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.
Balance Sheet Review
--------------------------------------------------------------------------------
Overview
HUSI utilizes deposits and borrowings from various sources to fund balance sheet
growth, to meet cash and capital needs, and to fund investments in subsidiaries.
During 2006, 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, 2005 December 31, 2004
December 31, ----------------- -----------------
2006 Amount % Amount %
--------------------------------------------------------------------------------------------
($ in millions)
Period end assets:
Short-term investments ......... $ 19,454 $ 7,444 62 $ 10,870 127
Loans, net ..................... 89,340 (156) -- 5,181 6
Trading assets ................. 26,038 4,818 23 6,223 31
Securities ..................... 22,755 1,820 9 4,219 23
Other assets ................... 11,370 1,172 11 1,414 14
------------ --------- ----- ---------- ----
$ 168,957 $ 15,098 10 $ 27,907 20
============ ========= ===== ========== ====
Funding sources:
Total deposits ................. $ 104,550 $ 12,735 14 $ 24,569 31
Trading liabilities ............ 14,046 3,336 31 1,926 16
Short-term borrowings .......... 5,073 (1,294) (20 (4,230) (45)
All other liabilities .......... 3,775 (3) -- (595) (14)
Long-term debt ................. 29,252 (343) (1 4,842 20
Shareholders' equity ........... 12,261 667 6 1,395 13
------------ --------- ----- ---------- ----
$ 168,957 $ 15,098 10 $ 27,907 20
============ ========= ===== ========== ====
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 2006
were primarily invested in short-term liquid assets (refer to page 7 of this
Form 10-K).
29
Loans Outstanding
Loan balances at December 31, 2006 and movements in comparison with prior
periods are summarized in the following table.
-----------------------------------------------------------------------------------------------
Increase (Decrease) from
-------------------------------------
December 31, 2005 December 31, 2004
December 31, ----------------- -----------------
2006 Amount % Amount %
-----------------------------------------------------------------------------------------------
($ in millions)
Total commercial loans ................. $ 29,482 $ 1,764 6 $ 6,512 28
------------ --------- ----- --------- -----
Consumer loans:
Residential mortgage ................ 39,808 (4,178) (9) (6,967) (15)
Credit card receivables:
Private label .................... 16,974 2,619 18 6,039 55
MasterCard/Visa .................. 1,286 127 11 143 13
Other consumer ...................... 2,687 (437) (14) (437) (14)
------------ --------- ----- --------- -----
Total consumer loans ................ 60,755 (1,869) (3) (1,222) (2)
------------ --------- ----- --------- -----
Total loans ............................ 90,237 (105) - 5,290 6
Allowance for credit losses ............ 897 51 6 109 14
------------ --------- ----- --------- -----
Loans, net ............................. $ 89,340 $ (156) - $ 5,181 6
============ ========= ===== ========= =====
Business expansion initiatives within the CMB and CIBM business segments
resulted in significant commercial loan growth in 2005 and, to a lesser extent,
in 2006.
2006 and 2005 growth in on-balance sheet private label credit card receivables
has been primarily due to the addition of new credit card relationships and, to
a lesser extent, to reduced funding requirements associated with off-balance
sheet credit card securitization trusts.
Beginning in 2005, as a result of balance sheet management initiatives to
enhance liquidity and to address interest rate risk, HUSI decided to decrease
the loan volume acquired through HSBC Finance Corporation's network of
residential mortgage loan correspondents. Purchases from correspondents were
discontinued effective September 1, 2005. In addition, HUSI continued to sell a
majority of its residential mortgage loan originations through the secondary
markets in 2006.
Commercial Loan Maturities and Sensitivity to Changes in Interest Rates
The contractual maturity and interest sensitivity of total commercial loans at
December 31, 2006 is summarized in the following table.
---------------------------------------------------------------------------------------------
One Over One Over
Year Through Five Total
December 31, 2006 or Less Five Years Years Loans
---------------------------------------------------------------------------------------------
(in millions)
Commercial:
Construction and other real estate ...... $ 3,257 $ 4,323 $ 1,338 $ 8,918
Other commercial ........................ 11,516 7,900 1,148 20,564
--------- ---------- --------- ---------
Total ...................................... $ 14,773 $ 12,223 $ 2,486 $ 29,482
========= ========== ========= =========
Loans with fixed interest rates ............ $ 5,331 $ 2,101 $ 1,024 $ 8,456
Loans having variable interest rates ....... 9,442 10,122 1,462 21,026
--------- ---------- --------- ---------
Total ...................................... $ 14,773 $ 12,223 $ 2,486 $ 29,482
========= ========== ========= =========
30
Trading Assets and Liabilities
Trading assets and liabilities balances at December 31, 2006, and movements in
comparison with prior periods, are summarized in the following table.
-----------------------------------------------------------------------------------------------
Increase (Decrease) from
-------------------------------------
December 31, 2005 December 31, 2004
December 31, ----------------- -----------------
2006 Amount % Amount %
-----------------------------------------------------------------------------------------------
($ in millions)
Trading assets:
Securities (1) ...................... $ 11,924 $ 1,145 11 $ 4,888 69
Precious metals ..................... 2,716 430 19 (456) (14)
Fair value of derivatives ........... 11,398 3,243 40 1,791 19
------------ --------- ----- --------- -----
$ 26,038 $ 4,818 23 $ 6,223 31
============ ========= ===== ========= =====
Trading liabilities:
Securities sold, not yet $ 1,914 $ 106 6 $ 963 101
purchased ...........................
Payables for precious metals ........ 1,336 175 15 202 18
Fair value of derivatives ........... 10,796 3,055 39 761 8
------------ --------- ----- --------- -----
$ 14,046 $ 3,336 31 $ 1,926 16
============ ========= ===== ========= =====
(1) Includes U.S. Treasury, U.S. Government agency, U.S. Government sponsored
enterprises, asset backed, corporate bonds and other securities.
Higher trading assets and liabilities within the CIBM business segment were due
to:
o higher volume of activity resulting from business growth initiatives begun
in 2005, which continued during 2006; and
o improved prices and market conditions, particularly related to higher
precious metals and securities asset balances.
Refer to page 46 of this Form 10-K for an analysis of trading revenues.
Deposits
The following table summarizes balances for major depositor categories.
-----------------------------------------------------------------------------------------------
December 31 2006 2005 2004 2003 2002
-----------------------------------------------------------------------------------------------
(in millions)
Individuals, partnerships and
corporations .......................... $ 83,371 $ 76,438 $ 65,312 $ 53,959 $ 51,470
Domestic and foreign banks ............ 18,080 12,871 12,759 7,580 7,114
U.S. Government and states and political
subdivisions ........................ 1,927 1,566 1,493 1,464 855
Foreign governments and official
institutions ........................ 1,172 940 417 952 391
--------- -------- -------- -------- --------
Total deposits ........................ $ 104,550 $ 91,815 $ 79,981 $ 63,955 $ 59,830
========= ======== ======== ======== ========
Deposits were the primary source of funding for balance sheet growth during 2006
and 2005. Total deposits increased 14% and 15% in 2006 and 2005, respectively.
For additional commentary regarding deposit growth and strategy, refer to page 7
of this Form 10-K.
Short-Term Borrowings
Lower short-term borrowings for 2006 and 2005 was due to a shift toward customer
deposits as the primary source of funding for balance sheet growth.
31
Long-Term Debt
Incremental borrowings from the $40 billion Global Bank Note Program were $1.6
billion and $1.4 billion for 2006 and 2005, respectively. Total borrowings
outstanding under this program were $12 billion at December 31, 2006. Additional
information regarding this program and other long-term debt is presented in Note
15 of the consolidated financial statements, beginning on page 127 of this
Form 10-K.
HUSI had borrowings from the Federal Home Loan Bank (FHLB) of $5 billion at both
December 31, 2006 and 2005, 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
and $1.0 billion were recorded in long-term debt at December 31, 2006 and 2005,
respectively. Refer to Note 27 of the consolidated financial statements,
beginning on page 151 of this Form 10-K, for additional information regarding
HUSI's VIE arrangements.
Preferred Stock
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.
In April 2005, HUSI issued Floating Rate Non-Cumulative Preferred Stock, Series
F with a stated value of $25 per share. In October 2005, HUSI issued Floating
Rate Non-Cumulative Preferred Stock, Series G with a stated value of $1,000 per
share. Total proceeds of these two issues, net of issuance costs, were $869
million.
In December 2005, HUSI redeemed all issued shares of $1.8125 Cumulative
Preferred Stock, Series E at their stated value of $25 per share, resulting in
total cash outlay of $75 million.
Refer to Note 18 of the consolidated financial statements, beginning on page 133
of this Form 10-K, for information regarding all outstanding preferred share
issues.
Capital Resources
A summary of changes in common shareholder's equity is presented in the
following table.
-------------------------------------------------------------------------------
2006 2005 2004
-------------------------------------------------------------------------------
(in millions)
Balance, January 1 ........................... $ 10,278 $ 10,366 $ 6,962
Increase (decrease) due to:
Net income ................................ 1,036 976 1,258
Dividends paid to common shareholder ...... (455) (675) (125)
Dividends paid to preferred shareholders .. (88) (46) (23)
Change in other comprehensive income ...... (202) (43) (97)
Capital contributions from parent (1) ..... 15 3 2,411
Reductions of capital surplus ............. (9) (303) (20)
Other ..................................... (4) - -
-------- -------- --------
Total net increase (decrease) ............. 293 (88) 3,404
-------- -------- --------
Balance, December 31 ......................... $ 10,571 $ 10,278 $ 10,366
======== ======== ========
(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 ($15 million, $3 million, and $11 million for 2006, 2005 and
2004, respectively).
32
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. Dividends paid to HNAI were significantly reduced
in 2004 in order to conserve funds for the December 2004 acquisition of private
label receivables and loans from HSBC Finance Corporation. In February 2007,
HUSI declared and paid a $305 million dividend to HNAI.
Capital contributions from parent in 2004 include $2.4 billion received to
provide additional funding for the private label portfolio acquisition.
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 135 of this
Form 10-K.
33
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 page 90 of this Form 10-K.
The following table presents changes in the components of net interest income
according to "volume" and "rate".
--------------------------------------------------------------------------------------------------------------------
2006 Compared to 2005 2005 Compared to 2004
Increase/(Decrease) Increase/(Decrease)
Year Ended December 31 2006 Volume Rate 2005 Volume Rate 2004
--------------------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Interest bearing deposits with
banks .............................. $ 225 $ 37 $ 68 $ 120 $ 24 $ 55 $ 41
Federal funds sold and securities
purchased under resale agreements .. 526 220 116 190 14 102 74
Trading assets ........................ 418 141 2 275 53 57 165
Securities ............................ 1,145 158 88 899 38 (24) 885
Loans:
Commercial ...................... 1,764 217 314 1,233 198 204 831
Consumer:
Residential mortgages ........ 2,200 (271) 150 2,321 491 (1) 1,831
Credit cards ................. 1,329 172 345 812 749 (44) 107
Other consumer ............... 279 (17) 32 264 87 34 143
-------- ------- ------ ------------- ------ ------- --------
Total consumer ............... 3,808 (116) 527 3,397 1,327 (11) 2,081
Other interest ........................ 91 50 9 32 4 10 18
-------- ------- ------ ------------- ------ ------- --------
Total interest income ................. 7,977 707 1,124 6,146 1,658 393 4,095
-------- ------- ------ ------------- ------ ------- --------
Interest expense:
Deposits in domestic offices:
Savings deposits ................ 981 150 513 318 12 127 179
Other time deposits ............. 1,152 14 316 822 255 202 365
Deposits in foreign offices:
Foreign banks deposits .......... 392 (13) 150 255 20 138 97
Other time and savings .......... 588 (1) 213 376 (7) 199 184
Short-term borrowings ................. 300 -- 30 270 33 110 127
Long-term debt ........................ 1,457 153 279 1,025 615 25 385
-------- ------- ------ ------------- ------ ------- --------
Total interest expense ................ 4,870 303 1,501 3,066 928 801 1,337
-------- ------- ------ ------------- ------ ------- --------
Net interest income -
taxable equivalent basis ........... 3,107 $ 404 $ (377) 3,080 $ 730 $ (408) 2,758
======= ====== ====== =======
Tax equivalent adjustment ............. 26 17 17
-------- ------------- --------
Net interest income -
non taxable equivalent basis ....... $ 3,081 $ 3,063 $ 2,741
======== ============= ========
34
Significant components of HUSI's net interest margin are summarized in the
following table.
-------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
-------------------------------------------------------------------------------
Yield on total earning assets ...................... 5.77% 4.96% 4.45%
Rate paid on interest bearing liabilities .......... 3.96 2.78 1.64
----- ------- -----
Interest rate spread ............................... 1.81 2.18 2.81
Benefit from net non-interest or paying funds ...... .44 .31 .19
----- ------- -----
Net interest margin on average earning assets (1) .. 2.25% 2.49% 3.00%
===== ======= =====
(1) Selected financial ratios are defined in the Glossary of Terms beginning
on page 87 of this Form 10-K.
Significant trends affecting the comparability of 2005 and 2006 net interest
income and interest rate spread are summarized in the following table. Net
interest income in the table is presented on a taxable equivalent basis (refer
to pages 90-91 of this Form 10-K).
-----------------------------------------------------------------------------------------------------
2006 2005 2004
------------------- ------------------ ------------------
Interest Interest Interest
Rate Rate Rate
Year Ended December 31 Amount Spread Amount Spread Amount Spread
-----------------------------------------------------------------------------------------------------
($ in millions)
Net interest income/interest
rate spread from prior year ...... $ 3,080 2.18% $ 2,758 2.81% $ 2,532 3.20%
======== ======== ========
Increase (decrease) in net
interest income associated with:
Trading related
activities (1) ............. (71) (61) (5)
Balance sheet
management activities (2) .. (269) (156) (35)
Private label
receivable portfolio (3) ... 210 435 --
Other activity ................ 157 104 266
-------- -------- ------- -------- ------- --------
Net interest income/interest
rate spread for current
year ............................. $ 3,107 1.81% $ 3,080 2.18% $ 2,758 2.81%
======== ======== ======= ======== ======= ========
(1) Refer to commentary regarding trading revenues, beginning on page 46 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 77 of this Form 10-K.
(3) Refer to commentary regarding the private label receivable portfolio,
beginning on page 52 of this Form 10-K.
Net interest income, presented by business segment on a non-taxable equivalent
basis, is summarized in the following table.
-----------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
---------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
-----------------------------------------------------------------------------------------------------------------------
($ in millions)
Business segment:
PFS:
Core banking activities ............. $ 985 $ 891 $ 799 $ 94 11 $ 92 12
Residential mortgage loans ......... 247 311 289 (64) (21) 22 8
-------- -------- ------ --------------- ---- -------- --------
Total PFS ........................... 1,232 1,202 1,088 30 2 114 10
-------- -------- ------ --------------- ---- -------- --------
CF ..................................... 738 583 182 155 27 401 220
CMB .................................... 745 662 586 83 13 76 13
CIBM ................................... 181 456 766 (275) (60) (310) (40)
PB ..................................... 199 172 130 27 16 42 32
Other .................................. (14) (12) (11) (2) * (1) *
-------- -------- ------ --------------- ---- -------- --------
Total .................................. $ 3,081 $ 3,063 $2,741 $ 18 1 $ 322 12
======== ======== ====== =============== ==== ======== ========
* Not meaningful.
35
PFS Business Segment
2006 Compared to 2005
Net interest income associated with core banking activities was higher for 2006
due primarily to the impact of a growing personal deposit base. Personal
deposits are the primary, and relatively low cost, funding source for the PFS
segment. Customers have migrated to higher yielding deposit products in 2006,
such as the internet savings product, leading to a change in product mix and
resulting in narrowing of deposit spreads, which partly offset the benefit of
higher deposit balances. Refer to page 7 of this Form 10-K for commentary
regarding deposit strategy and growth.
Lower residential mortgage banking net interest income was mainly due to:
o lower residential mortgage loan balances resulting from various balance
sheet management initiatives (refer to commentary regarding residential
mortgage banking revenue, beginning on page 43 of this Form 10-K); and
o interest rate spreads narrowing slightly in 2006 since residential
mortgage loans could not be repriced to offset higher funding costs.
2005 Compared to 2004
Higher net interest income for 2005 was due to:
o significant growth in consumer loan balances, particularly adjustable rate
residential mortgage loans; and
o more favorable interest rate spreads on a growing personal deposits base
during 2005; partially offset by
o $33 million of amortization of premium paid for MasterCard/Visa credit
card receivables acquired on a daily basis from HSBC Finance Corporation.
36
CF Business Segment
2006 Compared to 2005
The CF segment includes private label credit card receivables, residential
mortgage loans and other loans acquired from HSBC Finance Corporation. Higher
net interest income for 2006 primarily resulted from significantly reduced
amortization of the initial premiums paid for the private label credit card
portfolio and other loans acquired in December of 2004. The following table
summarizes the impact of premium amortization on net interest income for the CF
segment.
------------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
---------------------- --------------------
2006 2005 2004 Amount % Amount %
------------------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income, after
premium amortization ................ $ 738 $ 583 $ 182 $ 155 27 $ 401 220
-------- -------- ------ --------------- ---- -------- --------
Amortization associated with
premiums paid to HSBC Finance
Corporation for:
Initial purchase of private
label credit card
receivables (1) ............... 122 432 -- (310) (72) 432 *
Ongoing private label
credit card receivable
purchases (2) ................. 377 283 -- 94 33 283 *
Residential mortgage loans (3) ... 45 69 53 (24) (35) 16 30
Other loan purchases (3) ......... 6 41 -- (35) (85) 41 *
-------- -------- ------ --------------- ---- -------- --------
Total premium amortization ....... 550 825 53 (275) (33) 772 *
-------- -------- ------ --------------- ---- -------- --------
Net interest income, before
premium amortization ................ $ 1,288 $ 1,408 $ 235 $ (120) (9) $ 1,173 499
======== ======== ====== =============== ==== ======== ========
(1) In December 2004, HUSI acquired private label credit card receivables from
HSBC Finance Corporation. The premium paid for these credit card
receivables is being amortized against interest income over the estimated
life of the related receivables.
(2) By agreement, new receivables generated from private label credit card
relationships are being acquired from HSBC Finance Corporation on a daily
basis, at fair value, resulting in additional premiums, which are
amortized over the life of the related receivables.
(3) HUSI acquired residential mortgage and other consumer loans from December
2003 until these acquisitions were discontinued in September 2005, due to
balance sheet management initiatives to enhance liquidity and to address
interest rate risk.
* Not meaningful.
During 2006, private label credit card receivable balances grew 18% due to the
addition of new customer relationships during 2006 and 2005, and to decreased
funding requirements of off-balance sheet securitized receivable trusts. Despite
higher receivable balances however, net interest income, excluding the impact of
premium amortization as reflected in the table above, was lower for 2006. Higher
interest income resulting from growth in receivables was more than offset by
higher interest expense associated with funding the growth in receivables, the
latter being a consequence of higher market driven funding costs.
2005 Compared to 2004
2005 was the first full year of impact for the private label receivable
portfolio (the PLRP). During 2005, interest income for the PLRP was
significantly reduced by amortization of premiums paid for the portfolio, as
noted in the table above.
CMB Business Segment
Higher net interest income for 2006 and 2005 primarily resulted from strong
deposit growth across all businesses and loan growth within small business and
middle-market businesses. Resources have been invested in business expansion,
including the opening of new regional offices, which resulted in higher actual
and average loans and deposits balances for 2006 and 2005.
37
The average yield earned on commercial loans increased for 2006, due to
increases in general market rates and HBUS's prime lending rate.
Deposits are the primary funding source for the CMB business segment and a
significant component of CMB's revenue base. Growth in interest free demand
deposits was $541 million and $466 million in 2006 and 2005, respectively.
Although the CMB business segment generally earns favorable spreads on the
growing deposit base, net interest income growth during 2006 and 2005 was
partially offset by narrowing deposit spreads, as customers migrated to higher
yielding deposit products.
During the second quarter of 2004, HUSI transferred its Panamanian operations,
including commercial loans, deposits and related net interest income included
within the CMB segment, to an HSBC affiliate, which partially offset the benefit
from business expansion initiatives noted above.
CIBM Business Segment
Lower net interest income associated with balance sheet management and trading
activities for 2006 and 2005 primarily resulted from the cumulative effect of
higher short-term interest rates in the U.S. which, by flattening the interest
rate yield curve, reduced the available opportunities within CIBM to generate
additional net interest income. The compression in the interest rate margin
began to stabilize in the second half of 2006.
Beginning in 2005, the CIBM business segment expanded its operations and
products offered to clients, which resulted in increased trading activity,
higher trading assets and liabilities and improved trading results in 2006 and
2005. The resulting increases in trading assets and commercial loans partially
offset the negative impact of the rising rate environment and flat yield curve.
Refer to pages 31 and 46 of this Form 10-K for additional commentary regarding
trading assets and trading revenues, respectively.
PB Business Segment
During 2006 and 2005 additional resources have been allocated to expand products
and services provided to high net worth customers served by this business
segment, resulting in increased loan and deposit balances, and a corresponding
increase in net interest income.
Provision for Credit Losses
The provision for credit losses associated with various loan portfolios is
summarized in the following table.
------------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
---------------------- --------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
------------------------------------------------------------------------------------------------------------------------
($ in millions)
Commercial ............................. $ 136 $ (15) $ (107) $ 151 * $ 92 *
-------- -------- ------ --------------- ---- -------- --------
Consumer:
Residential mortgages ............... 32 37 21 (5) (14) 16 76
Credit card receivables ............. 592 560 51 32 6 509 *
Other consumer ...................... 63 92 18 (29) (32) 74 411
-------- -------- ------ --------------- ---- -------- --------
Total consumer ...................... 687 689 90 (2) * 599 666
-------- -------- ------ --------------- ---- -------- --------
Total provision for credit losses ...... $ 823 $ 674 $ (17) $ 149 22 $ 691 *
======== ======== ====== =============== ==== ======== ========
* Not meaningful.
38
Overview
HUSI's methodology and accounting policies related to its allowance for credit
losses are presented in Critical Accounting Policies beginning on page 25 and in
Note 2 of the consolidated financial statements beginning on page 99 of this
Form 10-K.
Additional commentary regarding credit quality begins on page 58 of this Form
10-K.
HUSI's approach toward credit risk management is summarized on pages 72-74 of
this Form 10-K.
2006 Compared to 2005
Higher commercial loan provision expense for 2006 resulted from:
o higher allowance requirements associated with higher small business and
real estate commercial loan portfolio balances in 2006 and 2005;
o higher charge offs associated with the growing small business portfolio;
o more normalized commercial loan charge off and recovery activity, in
comparison with 2005; and
o a combination of charge offs and increased allowance for credit losses
related to a specific commercial loan relationship within the PB business
segment, which resulted in a $29 million provision.
Increased provision expense associated with credit card receivables is
consistent with growth in private label credit card receivables during 2006.
Lower residential mortgage and other consumer loan balances were the primary
driver for lower allowance requirements and lower provisions associated with
these portfolios. Credit quality associated with HUSI's residential mortgage
loan portfolio remained strong in 2006.
2005 Compared to 2004
Higher provision expense for credit card receivables directly relates to the
private label receivable portfolio acquired from HSBC Finance Corporation. 2005
was the first full year of activity for this portfolio for HUSI.
Provisions for commercial, residential mortgage and other consumer loan
portfolios generally increased during 2005 due to allowance requirements
associated with overall growth within these portfolios. In addition, during
2004, exceptionally strong credit quality within the commercial loan portfolio
resulted in net recoveries of $6 million and a credit to provision for credit
losses of $107 million for the year.
39
Other Revenues
--------------------------------------------------------------------------------
The components of other revenues are summarized in the following table.
--------------------------------------------------------------------------------
2006 Compared to 2005 Compared to
2005 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
----------------------------------------------------------------------------------------------------------------------
($ in millions)
Trust income ........................... $ 88 $ 87 $ 95 $ 1 1 $ (8) (8)
-------- -------- -------- -------- ------- -------- -------
Service charges (also see HSBC
affiliate income below) ............. 204 195 196 9 5 (1) (1)
-------- -------- -------- -------- ------- -------- -------
Credit card fees:
Private label receivables ........... 479 241 3 238 99 238 *
MasterCard/Visa receivables ......... 101 82 79 19 23 3 4
-------- -------- -------- -------- ------- -------- -------
580 323 82 257 80 241 *
-------- -------- -------- -------- ------- -------- -------
Other fees and commissions
(also see HSBC affiliate
income below):
Letter of credit fees ............... 74 70 70 4 6 -- --
Wealth and tax advisory services .... 94 60 45 34 57 15 33
Other fee-based income, net of
referral fees .................... 233 174 201 59 34 (27) (13)
-------- -------- -------- -------- ------- -------- -------
401 304 316 97 32 (12) (4)
-------- -------- -------- -------- ------- -------- -------
Securitization revenue ................. 18 114 -- (96) (84) 114 *
-------- -------- -------- -------- ------- -------- -------
HSBC affiliate income:
Service charges ..................... 15 15 17 -- -- (2) (12)
Other fees and commissions .......... 51 71 27 (20) (28) 44 163
Gain on sale of residential
mortgage loans to HMUS ............ 106 18 -- 88 489 18 *
Gain on sale of refund
anticipation loans to HSBC
Finance Corporation ............... 22 19 -- 3 16 19 *
Gain on sale of credit card
relationships to HSBC Finance
Corporation ...................... -- -- 99 -- -- (99) *
Other affiliate income .............. 14 7 4 7 100 3 75
-------- -------- -------- -------- ------- -------- -------
208 130 147 78 60 (17) (12)
-------- -------- -------- -------- ------- -------- -------
Other income:
Insurance ........................... 47 48 63 (1) (2) (15) (24)
Valuation allowance increase for
changes in market value of
residential mortgage loans held
for sale to HMUS ................. (133) (32) -- (101) * (32) *
Interest on tax settlement .......... 4 -- 17 4 * (17) *
Gains on sale of property and
other financial assets .......... 52 67 65 (15) (22) 2 3
Earnings from equity investments .... 110 43 49 67 156 (6) (12)
Miscellaneous income ................ 104 67 36 37 55 31 86
-------- -------- -------- -------- ------- -------- -------
184 193 230 (9) (5) (37) (16)
-------- -------- -------- -------- ------- -------- -------
Residential mortgage banking revenue
(expense) ........................... 96 64 (120) 32 50 184 *
Trading revenues ....................... 755 395 288 360 91 107 37
Securities gains, net .................. 29 106 85 (77) (73) 21 25
-------- -------- -------- -------- ------- -------- -------
Total other revenues ................... $ 2,563 $ 1,911 $ 1,319 $ 652 34 $ 592 45
======== ======== ======== ======== ======= ======== =======
* Not meaningful
40
Credit Card Fees
Prior to December 2004, credit card fees were primarily associated with HUSI's
MasterCard/Visa credit card portfolio. In December 2004, HUSI acquired private
label credit card receivables from HSBC Finance Corporation, which resulted in
significant new credit card fee revenue for 2005 and 2006. Higher private label
credit card fees in 2006 resulted from the following portfolio activity:
o growth in the number of customer accounts and customer transaction
activity and receivable balances; and
o lower payments to merchant partners due to terminations and revisions to
certain merchant agreements.
Other Fees and Commissions
Increased wealth and tax advisory services revenue in 2006 and 2005 primarily
resulted from expansion of such services within the PB business segment (refer
to page 57 of this Form 10-K).
Higher other fee-based income is partially due to various growth initiatives
undertaken in 2005 and 2006, which resulted in general increases in fee income
recorded within the PFS, CMB and CIBM business segments. In addition, activity
for 2006 reflects one extra quarter of new service fees, recorded within the
CIBM business segment, generated by a subsidiary transferred to HUSI from HSBC
in March 2005, which provides accounting and valuation services for hedge fund
clients.
Securitization Revenue
Securitization revenue for 2006 and 2005 is comprised of servicing revenue and
excess servicing spread resulting directly from the purchase of residual
interests in securitized private label credit card receivables from HSBC Finance
Corporation in December 2004. During 2006, the balance requirements associated
with these off-balance sheet securitization trusts decreased significantly,
resulting in increased on-balance sheet receivables, increased interest and fee
income and decreased securitization revenue.
All collateralized funding transactions have been structured as secured
financings since the third quarter of 2004. Therefore, there were no new
securitization transactions during 2006 and 2005.
Additional commentary regarding securitization activities is provided in Note 9
of the consolidated financial statements beginning on page 121 of this Form
10-K.
HSBC Affiliate Income
In June 2005, HUSI began acquiring residential mortgage loans from unaffiliated
third parties and subsequently selling these loans to HMUS. During 2006, HUSI
also began acquiring residential mortgage loans from HSBC Finance Corporation
under this program. Higher gains on sales of loans to HMUS in 2006 resulted from
significantly increased activity under this program. Refer to other income for
commentary regarding the valuation allowance related to loans held for resale
under this program. Also, refer to page 9 of this Form 10-K for additional
commentary and analysis regarding the balance sheet and earnings impacts of this
program.
Effective October 2004, HBUS became the originating lender for HSBC Finance
Corporation's Taxpayer Financial Services business. During 2006 and 2005, mainly
in the first quarter of the respective years, HUSI recorded gains on the sale of
refund anticipation loans to HSBC Finance Corporation under this program.
In July of 2004, in order to centralize the servicing of credit card receivables
within a common HSBC affiliate in the United States, certain consumer
MasterCard/Visa credit card customer relationships of HUSI were sold to HSBC
Finance Corporation. A $99 million gain was recorded in other revenues as a
result of this transaction.
41
Other Income
Residential mortgage loans held for resale to HMUS are recorded at the lower of
cost or market value on HUSI's consolidated balance sheet. Changes in the
valuation allowance associated with these loans are recorded as a separate
component of other income. Cumulative net valuation losses related to loans held
for resale to HMUS for 2006 and 2005 are offset by gains on sales of these
loans, as reported in HSBC affiliate income, and by trading related revenues
associated with hedging the interest rate exposure on these loans. Refer to page
9 of this Form 10-K for additional commentary and analysis regarding the
balance sheet and earnings impacts of this program.
Gains on sale of property and other financial assets include the following
material transactions:
2006
o $30 million gain on the sale of property in the third quarter; and
o $13 million gain from the redemption of Venezuelan Brady Bonds in the
second quarter (refer to page 119 of this Form 10-K).
2005
o $17 million gain from the sale of property in the third quarter; and
o $26 million gain from the sale of property, as well as additional gains of
$7 million from sales of various branches, in the second quarter.
2004
o $45 million gain from the sale of an investment in NYCE Corporation in the
third quarter; and
o $9 million of combined gains from the sale of branches and other
properties.
Throughout 2006, HUSI recorded increased earnings from certain equity
investments, including a $40 million distribution from a foreign equity
investment in the third quarter of 2006. Refer to page 57 of this Form 10-K for
additional commentary regarding this equity investment, which is reported within
results for the PB business segment.
Business expansion initiatives and balance sheet growth have resulted in
generally higher revenues recorded as miscellaneous income during 2006 and 2005,
particularly within the CIBM business segment.
42
Residential Mortgage Banking Revenue
The following table presents the components of residential mortgage banking
revenue. Net interest income includes interest earned on assets and paid on
liabilities of the residential mortgage banking business as well as an
allocation of the funding cost or benefit associated with these balances. The
net interest income component of the table is included in net interest income in
the consolidated statement of income and reflects actual interest earned, net of
interest expense and corporate transfer pricing.
Effective January 2005, HUSI enhanced its funds transfer pricing methodology to
better approximate current external market pricing and valuation, resulting in
additional internal charges to the residential mortgage banking business. For
comparability purposes, 2004 amounts in the following table have also been
restated for this change in methodology, which decreased net interest income for
2004 by approximately $206 million.
--------------------------------------------------------------------------------
2006 Compared to 2005 Compared to
2005 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
----------------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income .................... $ 330 $ 447 $ 461 $ (117) (26) $ (14) (3)
-------- -------- -------- -------- ------- -------- -------
Servicing related income (expense):
Servicing fee income ............. 100 76 78 24 32 (2) (3)
Changes in fair value of MSRs
due to (1):
Changes in valuation inputs
or assumptions used in
valuation model ............... 44 -- -- 44 * -- --
Realization of cash flows ..... (87) -- -- (87) * -- --
MSRs amortization (2)
MSRs temporary impairment ........ -- (73) (101) 73 * 28 *
recovery (provision) (2) ....... -- 47 (102) (47) * 149 *
Trading - Derivative instruments
used to offset changes
in value of MSRs .............. (17) 2 8 (19) * (6) (75)
(Losses) gains on sales of
available for sale securities . -- (11) 8 11 * (19) (238)
-------- -------- -------- -------- ------- -------- -------
40 41 (109) (1) (2) 150 *
-------- -------- -------- -------- ------- -------- -------
Originations and sales related income:
Gains (losses) on sales of
residential mortgages .......... 33 17 (4) 16 94 21 *
Trading and hedging activity ..... 1 (13) (17) 14 * 4 *
-------- -------- -------- -------- ------- -------- -------
34 4 (21) 30 750 25 *
-------- -------- -------- -------- ------- -------- -------
Other mortgage income .................. 22 19 10 3 16 9 90
-------- -------- -------- -------- ------- -------- -------
Total residential mortgage banking
revenue (expense) included
in other revenues ................... 96 64 (120) 32 50 184 *
-------- -------- -------- -------- ------- -------- -------
Total residential mortgage banking
related revenue ...................... $ 426 $ 511 $ 341 $ (85) (17) $ 170 50
======== ======== ======== ======== ======= ======== =======
(1) Based upon adoption of SFAS 156 effective January 1, 2006. Refer to Note 2
of the consolidated financial statements, beginning on page 99 of this
Form 10-K for further discussion.
(2) Based upon methodology existing prior to adoption of SFAS 156.
* Not meaningful.
43
2006 Compared to 2005
As a result of balance sheet management initiatives to enhance liquidity and to
address interest rate risk, the following strategic decisions were undertaken in
2006 and 2005, which affected residential mortgage banking results:
o HUSI increased the proportion of loans originated through its retail
channels by leveraging the HSBC brand, branch network and customer base;
o HUSI opted to decrease the loan volumes generated through HSBC Finance
Corporation's network of residential mortgage loan correspondents.
Purchases from correspondents were discontinued in September 2005; and
o HUSI sold a higher proportion of its own adjustable rate mortgage loan
originations in 2006, which previously would have been held on the balance
sheet.
Net Interest Income
As a result of the strategies noted above, average residential mortgage loans
recorded on the consolidated balance sheet decreased 11% during 2006, which
resulted in a corresponding decrease in net interest income. Decreased net
interest income in 2006 was also partially attributable to a narrowing of
interest rate spreads on the core mortgage portfolio. Overall yields earned on
residential mortgage loans in 2006 were consistent with 2005 levels.
Servicing Related Income (Expense)
Higher servicing fee income in 2006 resulted primarily from the growth in the
portfolio of loans serviced for others, which increased approximately 24% in
2006 due to the following factors:
o HUSI sold substantially all adjustable rate loans in 2005 and 2006, which
previously would have been held on the balance sheet;
o in the fourth quarter of 2005, HUSI commenced servicing a portfolio of
loans previously serviced by a third party; and
o also in the fourth quarter of 2005, HUSI completed a sale of loans, which
were previously held in portfolio, to a government agency for which it
continues to provide servicing.
Overall, servicing related income in 2006 was flat in comparison with 2005
levels. Higher servicing fee income was offset by reductions in the value of
MSRs, primarily resulting from higher cash flow realization (classified as a
component of MSR amortization in prior years). The monthly fluctuation of rates
was generally less volatile in 2006 compared to 2005.
Under accounting rules in place prior to 2006, there was no direct relationship
between the lower of cost or market value (LOCOM) accounting model for valuing
MSRs and the fair value model for valuing related derivative instruments used to
offset changes in the economic value of MSRs. Under the guidance outlined in
SFAS 156, which became effective January 1, 2006, the accounting model for MSRs
now more closely matches the model for related hedging activity as both are fair
value models, which has reduced income statement volatility related to the
valuation of MSRs.
Additional analysis of MSRs activity is provided in Note 11 of the consolidated
financial statements beginning on page 122 of this Form 10-K.
Additional commentary regarding risk management associated with the MSRs hedging
program is provided on page 82 of this Form 10-K.
44
Origination and Sales Related Income (Expense)
HUSI routinely sells residential mortgage loans to government sponsored entities
and other private investors. The increase in originations and sales related
income for 2006 was attributable to a higher basis point gain on each individual
loan sale as compared with 2005, partially offset by lower volumes sold in 2006.
2005 Compared to 2004
The following strategic decisions and market factors affected residential
mortgage banking results for 2005:
o HUSI increased the proportion of loans originated through its retail
channels by leveraging the HSBC brand, branch network and customer base;
o as a result of balance sheet management initiatives to enhance liquidity
and to address interest rate risk, HUSI opted to decrease the loan volumes
generated through HSBC Finance Corporation's network of residential
mortgage loan correspondents. Purchases from correspondents were
discontinued in September 2005.
o HUSI sold a higher proportion of adjustable rate residential mortgage
loans in 2005, which previously would have been held on the balance sheet.
Residential mortgage loans originated with the intention to sell increased
41% in 2005, as compared with 2004; and
o as interest rates rose in 2005, loan originations slowed in comparison to
the prior year. Total loan originations declined 50% overall in 2005.
Adjustable rate loans originated, as a percentage of all loans originated,
fell from 67% in 2004 to 30% in 2005.
Net Interest Income
As a result of the strategies and market factors noted above, total residential
mortgage loans recorded on the consolidated balance sheet decreased 6% during
2005. Despite the decrease in actual balances however, average residential
mortgage loans increased 27% in 2005 due to full year impact of significant
portfolio growth in 2004, resulting in a significant increase in interest income
during the year.
Decreased net interest income in 2005 was attributable to a narrowing of
interest rate spreads on the core mortgage portfolio. Overall yields earned on
residential mortgage loans in 2005 were consistent with 2004.
Servicing Related Income (Expense)
Increased net servicing related income (expense) in 2005 was attributable to
decreased MSRs amortization expense and to recoveries of temporary impairment
valuation allowances during 2005, as compared with significant provisions for
impairment recorded in 2004.
During 2005, interest rates generally rose and prepayments of residential
mortgages, mostly in the form of loan refinancings, decreased in comparison with
2004 levels. Loan refinancing activity represented 44% of total originations in
2005, as compared with 50% in 2004. This led to lower amortization charges and
the subsequent release of temporary impairment provision on MSRs.
HUSI maintained an available for sale securities portfolio that was used to
offset changes in the economic value of MSRs. Net servicing related income
amounts in the table do not reflect unrealized losses, reported as a component
of other comprehensive income, or net interest income related to these
securities.
Origination and Sales Related Income (Expense)
HUSI routinely sells residential mortgage loans to government sponsored entities
and other private investors. The increase in originations and sales related
income for 2005 was attributable to a higher basis point gain on each individual
loan sale as compared with 2004, as well as a higher volume of originated loans
being sold during the year.
45
Trading Revenues
Trading revenues are generated by HUSI's participation in the foreign exchange,
credit derivative and precious metal markets; from trading derivative contracts,
including interest rate swaps and options; from trading securities; and as a
result of certain residential mortgage banking activities.
The following table presents trading related revenues by business. The data in
the table includes net interest income earned on trading instruments, as well as
an allocation of the funding benefit or cost associated with the trading
positions. The trading related net interest income component is included in net
interest income on the consolidated income statement. Trading revenues related
to the mortgage banking business are included in residential mortgage banking
revenue.
-----------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
----------------------- -----------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
-----------------------------------------------------------------------------------------------------------------------
($ in millions)
Trading revenues ..................... $ 755 $ 395 $ 288 $ 360 91 $ 107 37
Net interest income .................. (56) 15 76 (71) (473) (61) (80)
------ ------- ------- --------------- ----- ----------- ---------
Trading related revenues ............. $ 699 $ 410 $ 364 $ 289 70 $ 46 13
====== ======= ======= =============== ===== =========== =========
Business:
Derivatives ....................... $ 283 $ 166 $ 112 $ 117 70 $ 54 48
Economic hedges of loans held for sale
to HMUS ........................ 132 36 -- 96 267 36 *
Treasury (primarily securities) ... 8 24 37 (16) (67) (13) (35)
Foreign exchange and banknotes .... 182 133 143 49 37 (10) (7)
Precious metals ................... 87 42 49 45 107 (7) (14)
Other trading ..................... 7 9 23 (2) (22) (14) (61)
------ ------- ------- --------------- ----- ----------- ---------
Trading related revenues ............. $ 699 $ 410 $ 364 $ 289 70 $ 46 13
====== ======= ======= =============== ===== =========== =========
* Not meaningful
2006 Compared to 2005
During 2006, a wider range of product offerings and enhanced sales capabilities
drove significant trading gains across all major client-related activities,
primarily during the first half of the year. Derivatives trading revenue was
higher due to the success of new product launches, to increased sales of
structured products that are tailored to specific customer needs, and to the
recognition of income during 2006 that was deferred in the previous year, as
market inputs to valuation models became observable. Gains in the precious
metals business reflected volume growth driven by a surge in demand arising from
strong commodities markets. Income streams in the foreign exchange business
remained robust against the backdrop of a weakening U.S. dollar.
Effective since the third quarter of 2005, HUSI maintains a portfolio of
derivative instruments that are utilized as economic hedges to offset changes in
market values of loans held for sale to HMUS. During 2006, HUSI realized $68
million of net trading revenues and $64 million of net interest income related
to this program. Further analysis and commentary regarding these loans and the
associated hedges is provided on page 9 of this Form 10-K.
HUSI recognizes gain or loss at the inception of derivative transactions only
when the fair value of the transaction can be verified to market transactions or
if all significant pricing model assumptions can be verified to observable
market data. Gain or loss not recognized at inception is recorded in trading
assets and recognized over the term of the derivative contract, or when market
data becomes observable. During 2006, the availability of observable market data
resulted in recognition of $53 million in trading revenues.
46
Decreased net interest income was primarily due to steadily rising short-term
interest rates during 2005 and 2006, which had an adverse impact on interest
rate spreads related to funding of various trading activities.
2005 Compared to 2004
Improved trading markets during the second half of 2005 offset the difficult
markets encountered during the first half of the year. Overall, client and
proprietary trading revenues increased during 2005 as a result of the following
factors:
o improved trading results from an expanded credit derivatives trading desk;
o successful rollout of a new structured transactions business within the
CIBM segment, which has increased derivatives related revenues in 2005;
and
o revenues associated with the new business for acquiring residential
mortgage loans from unaffiliated third parties with the intent to sell
these loans to HMUS, which was initiated during 2005.
The yield curve continued to flatten during 2005, which resulted in significant
decreases in interest rate spreads associated with various trading assets.
Securities Gains, Net
HUSI maintains various securities portfolios as part of its balance sheet
diversification and risk management strategy. The following table summarizes the
net securities gains resulting from various strategies.
----------------------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
----------------------------------------------------------------------------------------------------------------------
(in millions)
Balance sheet diversity and reduction of risk ........................ $ 5 $ 33 $ 45
Reduction of Latin and South American exposure ....................... 22 22 30
Sale of an equity investment to an HSBC affiliate (1) ................ -- 48 --
Other ................................................................ 2 3 10
-------------- ------------- ------------
Total securities gains, net .......................................... $ 29 $ 106 $ 85
============== ============= ============
(1) In June 2005, HUSI sold shares in a foreign equity fund to an HSBC
affiliate for a gain of $48 million, which is recorded within the PB
segment.
Gross realized gains and losses from sales of securities are summarized in Note
6 of the consolidated financial statements, which begins on page 112 of this
Form 10-K.
47
Operating Expenses
--------------------------------------------------------------------------------
2006 Compared to 2005 Compared to
2005 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
-----------------------------------------------------------------------------------------------------------------------
($ in millions)
Salaries and employee benefits:
Salaries .............................. $ 916 $ 776 $ 720 $ 140 18 $ 56 8
Employee benefits ..................... 384 276 227 108 39 49 22
-------- -------- -------- --------- ----- --------- -------
1,300 1,052 947 248 24 105 11
Occupancy expense, net ................... 221 182 176 39 21 6 3
Support services from HSBC affiliates:
Fees paid to HSBC Finance
Corporation for loan servicing
and other administrative support ... 452 415 35 37 9 380 1,086
Fees paid to HMUS ..................... 227 162 114 65 40 48 42
Fees paid to HTSU for technology
services ........................... 235 216 172 19 9 44 26
Fees paid to other HSBC affiliates .... 162 126 99 36 29 27 27
-------- -------- -------- --------- ----- --------- -------
1,076 919 420 157 17 499 119
-------- -------- -------- --------- ----- --------- -------
Other expenses:
Equipment and software ................ 72 91 108 (19) (21) (17) (16)
Marketing ............................. 98 79 44 19 24 35 80
Outside services ...................... 125 116 103 9 8 13 13
Professional fees ..................... 78 67 55 11 16 12 22
Telecommunications .................... 21 19 17 2 11 2 12
Postage, printing and office supplies 34 26 25 8 31 1 4
Insurance business .................... 19 19 22 - - (3) (14)
Other ................................. 211 188 184 23 12 4 2
-------- -------- -------- --------- ----- --------- -------
Total other expenses .................. 658 605 558 53 9 47 8
-------- -------- -------- --------- ----- --------- -------
Total operating expenses ................. $ 3,255 $ 2,758 $ 2,101 $ 497 18 $ 657 31
======== ======== ======== ========= ===== ========= =======
Personnel - average number ............... 12,326 11,275 11,416 1,051 9 (141) (1)
Efficiency ratio ......................... 57.66% 55.44% 51.73%
Salaries and Employee Benefits
2006 Compared to 2005
Higher salary and benefits expenses for 2006 were primarily due to:
o higher staff counts and a changing mix of staffing to support various
business growth initiatives within the PFS, CMB, CIBM and PB business
segments (refer to commentary regarding Business Segments, beginning on
page 50 of this Form 10-K);
o higher incentive compensation expenses, largely due to growth in the CIBM
and PB segments;
o lower deferrals of salary costs within the residential mortgage banking
business, included within the PFS business segment, resulting from lower
loan originations during 2006;
o higher pension expense, resulting from changes in plan assumptions,
particularly a lower discount rate, for 2006; and
o higher employee welfare costs and payroll related taxes, which relate
directly to higher salary costs.
In addition, during 2006, HUSI recorded $12 million of increased compensation
expenses related to retirement and other transition of certain HUSI senior
executives.
48
2005 Compared to 2004
During the first half of 2004, HUSI transferred its brokerage subsidiary and
most of its branch operations in Panama to other HSBC affiliates, resulting in a
significant reduction in staffing levels and salaries. Excluding these
subsidiary transfers, the average number of personnel and associated salaries
from HUSI's remaining operations increased for 2005. Business expansion
initiatives in various business segments were the primary drivers of increased
staff counts and salaries expense. In addition, in March 2005, HSBC transferred
a subsidiary to HUSI that provides accounting and valuation services to hedge
fund clients, which also increased staff counts and salaries expense within the
CIBM business segment.
Higher employee benefits expenses in 2005 was primarily due to:
o increased employer share of payroll taxes and other benefit costs
associated with the overall staffing and salaries increases noted above;
and
o an increase in HUSI's employer matching of employee retirement savings
contributions due to changes in matching program provisions which took
effect during 2004.
Occupancy Expense, Net
Expansion of the core banking network has been a key component of HUSI's
business expansion initiatives during 2006 and 2005. New branches have been
opened and lending operations have been expanded, which have resulted in higher
rental, depreciation of leasehold improvements, utilities and other occupancy
expenses during both years, but particularly during 2006.
Support Services from HSBC Affiliates
Fees are charged by various HSBC affiliates for technology services, for
underwriting and broker-dealer services, for loan origination and servicing, and
for other operational and administrative support functions. Transactions with
HSBC affiliates are further described and summarized in Note 21 of the
consolidated financial statements beginning on page 137 of this Form 10-K.
Higher fees charged by HSBC Finance Corporation in 2006 and 2005 resulted from
the following:
o Loan origination and servicing fees - higher fees for 2006 and 2005
resulted from an increased number of accounts and increased balances
associated with various credit card receivable and consumer loan
portfolios serviced by HSBC Finance Corporation on behalf of HUSI.
o Various administrative services - higher administrative fees for 2006 and
2005 resulted from specific initiatives to centralize administrative
functions.
Higher fees charged by HMUS for treasury and traded markets services resulted
primarily from business expansion initiatives within the CIBM segment, which
have resulted in higher trading revenues (refer to page 46 of this Form 10-K)
and higher other revenues for 2006 and 2005. Additional commentary regarding
expansion initiatives for the CIBM segment is provided on pages 55 of this Form
10-K.
Fees charged by HTSU for technology services expenses increased in 2006 and
2005, due to continued initiatives by HUSI to upgrade its technology
environment. Equipment and software costs included in other expenses have
decreased in 2006 and 2005, as these costs are now included in the fees charged
by HTSU.
Higher fees charged by other HSBC affiliates in 2006 and 2005 primarily resulted
from treasury and traded markets services provided to support business expansion
initiatives within the CIBM segment, as well as higher data processing and other
charges related to expanded global outsourcing services.
49
Other Expenses
Business expansion initiatives within PFS, CMB, CIBM and PB business segments
have resulted in general increases in outside services and various other expense
categories, particularly during 2006.
Increased marketing and promotional expenses for 2006 and 2005 primarily
resulted from investment in HSBC brand activities, promotion of the internet
savings account and marketing support for branch expansion initiatives.
Efficiency Ratio
The higher efficiency ratios for 2006 and 2005 resulted primarily from higher
operating expenses related to various business expansion initiatives, which were
partially offset by higher revenues associated with these initiatives, as well
as improved results for the private label receivable portfolio. As expected
during the build out phase, expense growth associated with expansion initiatives
has outpaced related core banking revenue growth.
Income Taxes
--------------------------------------------------------------------------------
Income tax expense decreased $36 million (6%) in 2006, primarily resulting from
a lower effective tax rate compared with 2005. The lower effective tax rate for
2006 reflects higher revenues from operations in states with lower tax rates and
an increase in low income housing tax credits.
Income tax expense decreased $152 million (21%) in 2005 due principally to a
decrease in pretax income combined with an adjustment of prior years' state and
local tax provisions to reflect the actual tax liabilities per the returns filed
and a higher level of low income housing tax credits.
Refer to Note 17 of the consolidated financial statements on page 131 of
this Form 10-K for additional information regarding income taxes.
Business Segments
--------------------------------------------------------------------------------
HUSI's business segments are described on pages 50-58 of this Form 10-K. Results
for each segment are summarized in the following tables and commentary. Prior
period disclosures previously reported for 2005 and 2004 have been conformed
herein to the presentation of current segments.
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. In addition, also 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. For comparability
purposes, 2005 and 2004 results for these segments have been revised to reflect
these changes.
Personal Financial Services (PFS)
Lower overall results for the PFS segment in 2006 were primarily due to reduced
income before income tax expense for the residential mortgage banking business
and, to a lesser extent, to lower results for other core PFS businesses.
Lower residential mortgage related results were driven by strategic balance
sheet initiatives to decrease the residential mortgage loan portfolio, and by
tightening interest rate spreads. As a result, net interest income associated
with residential mortgage banking activities declined $117 million in 2006.
Operating expenses for the residential mortgage banking business increased in
2006, partly due to reduced cost deferrals related to a reduced volume of loan
originations.
50
Additional resources continue to be directed towards expansion of core retail
banking businesses outside of residential mortgage banking, including investment
in the HSBC brand, expansion of the core branch network in existing and new
geographic areas, and continued rollout of the internet savings product. Net
interest income associated with the core banking operations grew 19% for 2006 as
a result of favorable interest rate spreads on a growing deposit base. As
expected during the expansion build-out phase, expense growth associated with
expansion initiatives has outpaced related core banking revenue growth.
Average deposit balances grew $5 billion (18%) in 2006. Balance sheet growth
during 2006 was highlighted by successful rollout of the internet savings
product.
The following table summarizes results for the PFS segment.
------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
---------------------- --------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income .......... $ 1,232 $ 1,202 $ 1,088 $ 30 2 $ 114 10
Other revenues ............... 447 406 358 41 10 48 13
------- ------- ------- --------- ------- ------- ------
Total revenues ............... 1,679 1,608 1,446 71 4 162 11
Operating expenses ........... 1,192 1,002 922 190 19 80 9
------- ------- ------- --------- ------- ------- ------
487 606 524 (119) (20) 82 16
Provision for credit losses .. 58 103 81 (45) (44) 22 27
------- ------- ------- --------- ------- ------- ------
Income before income tax
expense ................... $ 429 $ 503 $ 443 $ (74) (15) $ 60 14
======= ======= ======= ========= ======= ======= ======
2006 Compared to 2005
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Higher operating expenses for 2006 were due to:
o higher staff costs from additional headcount recruited to support
investment in branch expansion and the internet savings program. Greater
emphasis was also placed on recruiting staff dedicated to sales and
customer relationship activities, which changed the staff mix, and
contributed to higher expenses;
o higher marketing and other direct costs associated with expansion of the
core banking network and growth of the internet savings business;
o higher expenses within the residential mortgage banking business
throughout 2006, partly due to reduced cost deferrals related to a reduced
volume of loan originations;
o increased fees paid to HTSU, as HUSI continued to upgrade its branch sales
platform; and
o allocations of various increased corporate expenses to the PFS business
segment, including various compensation costs.
The provision for credit losses decreased $45 million, mainly due to changes in
bankruptcy legislation in 2005, which accelerated charge offs and impairment
activity related to the legacy MasterCard/Visa credit card and automotive
finance portfolios in that year.
51
2005 Compared to 2004
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Higher other revenues for 2005 were primarily due to:
o higher residential mortgage servicing revenue, primarily resulting from
significant reversals of temporary MSRs impairment allowances recorded in
2004; and
o effective in October 2004, HBUS became the originating lender for HSBC
Finance Corporation's Taxpayer Financial Services program. Gains
recognized for tax refund anticipation loans sold to HSBC Finance
Corporation's Taxpayer Financial Services business were $19 million in
2005.
In addition, 2005 results reflect a reduction in gains on sale of properties and
other assets, as follows:
2005
o $26 million of gains on sales of certain properties to unaffiliated third
parties.
2004
o $99 million gain on sale of certain MasterCard/Visa credit card
relationships to HSBC Finance Corporation; and
o $45 million gain on sale of an equity investment.
Increased operating expenses for 2005 were due to:
o increased personnel, marketing and other direct expenses associated with
expanded consumer lending and retail banking operations; and
o increased fees paid to HTSU, as HUSI has continued to upgrade its
technology environment.
The provision for credit losses increased $22 million, as a direct result of
increased consumer loan balances.
Consumer Finance (CF)
In December 2004, HUSI acquired $12 billion of loans, primarily private label
credit card receivables, from HSBC Finance Corporation. The CF segment, which
was initiated in 2005, includes the PLRP and other consumer loans acquired from
HSBC Finance Corporation and its correspondents. Results of the CF segment have
been positively impacted by growth of private label credit card receivables
included within the PLRP and by decreased amortization of premiums paid to HSBC
Finance Corporation for those receivables. Private label credit card receivables
have grown to $17 billion at December 31, 2006, due to the addition of new
credit card relationships and to reduced funding requirements associated with
off-balance sheet securitization trusts.
52
The following table summarizes results for the CF segment.
----------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
----------------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income .................... $ 738 $ 583 $ 182 $ 155 27 $ 401 220
Other revenues ......................... 501 356 2 145 41 354 *
-------- -------- -------- -------- -------- -------- --------
Total revenues ......................... 1,239 939 184 300 32 755 410
Operating expenses ..................... 441 424 17 17 4 407 *
-------- -------- -------- -------- -------- -------- --------
798 515 167 283 55 348 208
Provision for credit losses ............ 659 599 22 60 10 577 *
-------- -------- -------- -------- -------- -------- --------
Income (loss) before
income tax expense .................. $ 139 $ (84) $ 145 $ 223 265 $ (229) *
======== ======== ======== ======== ======== ======== ========
* Not meaningful.
2006 Compared to 2005
The following tables summarize the impact of the PLRP on earnings for 2006 and
2005 in comparison with the other portfolios included within this segment,
mainly higher quality nonconforming residential mortgage loans.
----------------------------------------------------------------------------------------------------------------------
Total
Year Ended December 31 PLRP Other CF Segment
----------------------------------------------------------------------------------------------------------------------
(in millions)
2006
Net interest income ............................................................... $ 645 $ 93 $ 738
Other revenues .................................................................... 501 -- 501
-------- -------- ----------
Total revenues .................................................................... 1,146 93 1,239
Operating expenses ................................................................ 425 16 441
-------- -------- ----------
721 77 798
Provision for credit losses ....................................................... 636 23 659
-------- -------- ----------
Income before income tax expense .................................................. $ 85 $ 54 $ 139
======== ======== ==========
2005
Net interest income ............................................................... $ 435 $ 148 $ 583
Other revenues .................................................................... 356 -- 356
-------- -------- ----------
Total revenues .................................................................... 791 148 939
Operating expenses ................................................................ 408 16 424
-------- -------- ----------
383 132 515
Provision for credit losses ....................................................... 564 35 599
-------- -------- ----------
(Loss) income before income tax expense ........................................... $ (181) $ 97 $ (84)
======== ======== ==========
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Other revenues are primarily comprised of credit card fees and securitization
revenue. Fee income has grown significantly in 2006 due to significant growth in
the number of accounts included within the PLRP, higher on-balance sheet
receivable balances, increased late fees and lower fees paid to merchant
partners. Higher fees were partially offset by lower securitization revenue,
which decreased due to significantly reduced balance requirements associated
with off-balance sheet securitization trusts (refer to Note 9 of the
consolidated financial statements, beginning on page 121 of this Form 10-K, for
further information regarding HUSI's securitization activities).
Operating expenses are primarily fees paid to HSBC Finance Corporation for loan
servicing, fees paid to HTSU for technology services, and other administrative
expenses. Higher servicing fees paid for 2006 resulted directly from portfolio
growth.
Higher provision for credit losses for the PLRP portfolio is generally
consistent with higher credit card receivable balances.
53
In accordance with Federal Financial Institutions Examination Council (FFIEC)
guidance, HUSI completed its implementation of new minimum monthly payment
requirements for domestic private label credit card accounts during the first
quarter of 2006, resulting in an immaterial impact on 2006 CF segment results.
Commercial Banking (CMB)
Improved 2006 results, before the provision for credit losses, were primarily
due to continued rollout of business expansion initiatives, as HUSI continued to
expand its geographic presence in the U.S. Office locations and staffing levels
were expanded in 2006 and 2005, as were loan and deposit products offered to
small businesses, middle-market and commercial real estate customers, in
conjunction with increased marketing efforts. Average loans and deposits grew $1
billion (7%) and $3 billion (29%) respectively, in 2006.
The following table summarizes results for the CMB segment.
----------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
----------------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income .................... $ 745 $ 662 $ 586 $ 83 13 $ 76 13
Other revenues ......................... 274 228 200 46 20 28 14
-------- -------- -------- -------- -------- -------- --------
Total revenues ......................... 1,019 890 786 129 14 104 13
Operating expenses ..................... 508 410 374 98 24 36 10
-------- -------- -------- -------- -------- -------- --------
511 480 412 31 6 68 17
Provision (credit) for credit
losses .............................. 62 22 (26) 40 182 48 185
-------- -------- -------- -------- -------- -------- --------
Income before income tax
expense ............................. $ 449 $ 458 $ 438 $ (9) (2) $ 20 5
======== ======== ======== ======== ======== ======== ========
2006 Compared to 2005
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Higher other revenues primarily resulted from:
o sales of Venezuelan Brady Bonds and related instruments during 2006;
o increased syndication fees resulting from a strategic decision by the
Commercial Real Estate business to mitigate risk by reducing the balance
sheet; and
o higher other fees resulting from business expansion.
Higher operating expenses primarily resulted from:
o higher personnel costs from additional staff to support expansion
initiatives. Recruitment of additional relationship managers also changed
the mix of staff and drove costs higher;
o higher marketing and other direct costs associated with branch expansion
initiatives and new lending offices; and
o to a lesser extent, allocation to CMB of various increased corporate
expenses, including increased compensation costs.
Increased provision for credit losses for 2006 resulted from higher allowance
requirements associated with higher criticized commercial assets, and higher
charge offs associated with the growing small business loan portfolio. In
addition, net commercial loan charge offs for 2006 reflect a more normalized
credit environment in comparison to lower net charge offs recorded in the prior
year.
54
2005 Compared to 2004
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Higher other revenues for 2005 resulted from the successful rollout of planned
expansion of various small business, middle-market and real estate commercial
lending programs.
During 2005, HUSI sold certain properties to unaffiliated third parties,
resulting in $14 million of gains recorded in other revenues within the CMB
segment.
Increased operating expenses resulted from the business expansion initiatives
and from increased fees paid to HTSU for technology services as HUSI continued
to upgrade its technology environment.
The provision for credit losses increased $48 million in 2005 as a direct result
of higher commercial loan portfolio balances. In addition, unusually high
recoveries of loan balances previously charged off were recorded in 2004. Credit
quality continued to be strong and well-managed during 2005.
Corporate, Investment Banking and Markets (CIBM)
Various treasury and traded markets activities were expanded in 2006 and 2005,
resulting in new products offered to customers, increased marketing efforts for
those products, and an expanded infrastructure to support growth initiatives. As
a result of these initiatives, average loans increased $5 billion (69%) in 2006.
Strong trading results more than offset lower balance sheet management revenues,
which were adversely affected by rising short-term interest rates and a
flattening yield curve that reduced net interest income and limited
opportunities to profit from placing funds generated from operations.
The following table summarizes results for the CIBM segment.
----------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
----------------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income .................... $ 181 $ 456 $ 766 $ (275) (60) $ (310) (40)
Other revenues ......................... 1,011 641 534 370 58 107 20
-------- -------- -------- -------- -------- -------- --------
Total revenues ......................... 1,192 1,097 1,300 95 9 (203) (16)
Operating expenses ..................... 803 650 525 153 24 125 24
-------- -------- -------- -------- -------- -------- --------
389 447 775 (58) (13) (328) (42)
Provision (credit) for credit
losses .............................. 10 (47) (95) 57 121 48 51
-------- -------- -------- -------- -------- -------- --------
Income before income tax
expense ............................. $ 379 $ 494 $ 870 $ (115) (23) $ (376) (43)
======== ======== ======== ======== ======== ======== ========
2006 Compared to 2005
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Higher trading revenues, included in other revenues, were attributable to
expanded operations and favorable market conditions related to precious metals,
foreign exchange and structured products desks, especially during the first six
months of the year. Refer to page 46 of this Form 10-K for additional analysis
and commentary regarding trading revenues.
55
Excluding the trading revenues impact noted above, higher other revenues for
2006 mainly resulted from:
o higher fee-based income, primarily within the transaction banking
business, resulting from expanded product offerings; and
o one additional quarter in 2006 of service fees generated by a subsidiary
transferred to HUSI from HSBC in March 2005, which provides accounting and
valuation services for hedge fund clients.
Partially offsetting these increases were decreased realized gains on sales of
securities for 2006 (refer to page 112 of this Form 10-K).
Higher operating expenses were mainly due to the first full year impact of the
business expansion initiatives begun in 2005, as well as additional investments
in early 2006 to support the growing complexity of the CIBM business.
Specifically, cost growth in Global Markets was primarily driven by expansion
within the mortgage-backed securities, structured derivative and equity
businesses. Similarly, operating expenses grew in Transaction Banking, primarily
the payments and cash management and the securities services businesses, as
business volumes grew to historical highs, which drove higher transaction costs
and increased support for expanded capacity.
Staff costs increased due to higher performance incentives, which rose in line
with revenue growth, and due to the effect of additional people recruited
throughout 2005 and in early 2006. Business support areas, such as market risk,
credit and operations staff, also grew to support the expansion of various
business lines. Transition of senior executives also contributed to higher
compensation costs.
The net provision credit for 2005 resulted from continuation of relatively low
charge offs and higher than normal recoveries of amounts previously charged off.
Although recoveries have decreased during 2006, charge offs remain low and
credit quality remains well managed. Further commentary regarding credit quality
begins on page 58 of this Form 10-K.
2005 Compared to 2004
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Increased other revenues for 2005 were mainly due to increased trading revenues
and increased gains on sales of securities. Increased fee-based income,
resulting from business expansion initiatives, also contributed to the overall
increase in other revenues.
Increased operating expenses resulted from:
o increased direct expenses associated with expanded operations in risk
management and transaction banking businesses, and higher professional
fees related to the mortgage-backed securities business;
o increased expenses associated with development of an infrastructure to
support the growing complexity of the CIBM business; and
o increased fees paid to HTSU and other HSBC affiliates for technology
services, as CIBM required additional information technology resources to
support system conversions and business expansion.
Partially offsetting these increases were decreases in incentive compensation
expense resulting from a change in the amortization period utilized for
share-based compensation, and decreased incentive compensation expenses.
The provision for credit losses increased during 2005. The net provision credit
for 2004 reflected a period of unusually low loan charge offs and relatively
high recoveries of amounts previously charged off. The smaller net provision
credit for 2005 resulted from continuation of relatively low charge offs, but
lower recoveries of amounts previously charged off.
56
Private Banking (PB)
During 2006 and 2005, additional resources have been allocated to opening new
U.S. offices, and to expanding products offered and services provided to
customers served by the PB business segment. As a result of these initiatives,
average loans and deposits increased $1 billion (14%) and $2 billion (31%) in
2006, respectively.
The PB segment includes an equity investment in a non-consolidated foreign HSBC
affiliate (the foreign equity investment). Other revenues for 2006 included
higher earnings from that foreign equity investment, while other revenues for
2005 included a gain on sale of a separate investment in a foreign equity fund
to an HSBC affiliate. 2006 results also have been impacted by increased credit
loss provision expense associated with a specific commercial lending
relationship.
The following table summarizes results for the Private Banking (PB) segment.
----------------------------------------------------------------------------------------------------------------------
2006 Compared 2005 Compared
to 2005 to 2004
Increase/(Decrease) Increase/(Decrease)
------------------- -------------------
Year Ended December 31 2006 2005 2004 Amount % Amount %
----------------------------------------------------------------------------------------------------------------------
($ in millions)
Net interest income .................... $ 199 $ 172 $ 130 $ 27 16 $ 42 32
Other revenues ......................... 305 257 204 48 19 53 26
-------- -------- -------- -------- -------- -------- --------
Total revenues ......................... 504 429 334 75 17 95 28
Operating expenses ..................... 311 272 263 39 14 9 3
-------- -------- -------- -------- -------- -------- --------
193 157 71 36 23 86 121
Provision (credit) for credit
losses .............................. 34 (3) 1 37 * (4) (400)
-------- -------- -------- -------- -------- -------- --------
Income before income tax
expense ............................. $ 159 $ 160 $ 70 $ (1) (1) $ 90 129
======== ======== ======== ======== ======== ======== ========
* Not meaningful.
2006 Compared to 2005
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Fee income from wealth and tax advisory services is significantly higher for
2006, due to expanded services offered to customers. In addition, during 2006,
earnings from a foreign equity investment increased $44 million due to its sale
of shares in a foreign equity fund to an HSBC affiliate. Excluding this
transaction, equity earnings from this foreign equity investment are also
generally higher in 2006. In the second quarter of 2005, HUSI sold its shares in
the same foreign equity fund to an HSBC affiliate resulting in a gain of $48
million.
Increased operating expenses for 2006 mainly resulted from additional resources
being allocated to this segment to expand the services provided. Higher
personnel costs were driven by increased staff count and by increased
compensation expenses related to transition of senior executives. In addition,
fees charged by HSBC affiliates grew in 2006 due to higher technology related
costs and higher charges related to global outsourcing services.
Increased provision for credit losses during 2006 directly relates to a specific
commercial loan relationship for which a combination of charge offs and
increased allowances for credit losses resulted in a $29 million provision.
Further commentary regarding credit quality begins on page 58 of this Form 10-K.
57
2005 Compared to 2004
Commentary regarding net interest income begins on page 34 of this Form 10-K.
Other revenues included a $48 million gain from the sale of shares in a foreign
equity fund to an HSBC affiliate.
Increased operating expenses generally resulted from additional resources being
allocated to this segment to expand the services provided. Partially offsetting
increased operating expenses was the reversal of a portion of a provision for
U.S. withholding tax costs related to deficiencies in client tax documentation,
which was recorded in the fourth quarter of 2004.
Credit Quality
--------------------------------------------------------------------------------
Overview
HUSI enters into a variety of transactions in the normal course of business that
involve both on and off-balance sheet credit risk. Principal among these
activities is lending to various commercial, institutional, governmental and
individual customers. HUSI participates in lending activity throughout the U.S.
and, on a limited basis, internationally.
HUSI's approach toward credit risk management is summarized on pages 72-74 of
this Form 10-K.
HUSI's methodology and accounting policies related to its allowance for credit
losses are presented in Critical Accounting Policies beginning on page 25 and in
Note 2 of the consolidated financial statements beginning on page 99 of this
Form 10-K.
Problem Loan Management
Nonaccruing loans by portfolio, impaired loans and criticized assets are
summarized in Note 7 of the consolidated financial statements beginning on page
117 of this Form 10-K.
Nonaccruing Loans
HUSI's policies and practices for placing loans on nonaccruing status are
summarized in Note 2 of the consolidated financial statements, beginning on page
99 of this Form 10-K.
58
Nonaccruing loan statistics are summarized in the following table.
--------------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------------------
($ in millions)
Nonaccruing loans
Balance at end of period:
Commercial:
Construction and other real estate ............. $ 33 $ 15 $ 33 $ 30 $ 29
Other commercial ............................... 69 70 117 233 242
------- ------- ------- ------- -------
Total commercial ............................... 102 85 150 263 271
------- ------- ------- ------- -------
Consumer:
Residential mortgages .......................... 182 138 99 78 88
Credit card receivables ........................ 1 -- -- 22 27
Other consumer loans ........................... -- -- 1 3 1
------- ------- ------- ------- -------
Total consumer loans ........................... 183 138 100 103 116
------- ------- ------- ------- -------
Total nonaccruing loans .............................. $ 285 $ 223 $ 250 $ 366 $ 387
======= ======= ======= ======= =======
As a percent of loans:
Commercial:
Construction and other real estate ............. .37% .16% .40% .43% .46%
Other commercial ............................... .34 .38 .80 2.00 1.78
------- ------- ------- ------- -------
Total commercial ............................... .35 .31 .65 1.41 1.36
------- ------- ------- ------- -------
Consumer:
Residential mortgages .......................... .46 .31 .21 .29 .42
Credit card receivables ........................ .01 -- -- 1.89 2.37
Other consumer loans ........................... -- -- .03 .15 .05
------- ------- ------- ------- -------
Total consumer loans ........................... .30 .22 .16 .35 .49
------- ------- ------- ------- -------
Total ................................................ .32% .25% .29% .76% .89%
======= ======= ======= ======= =======
Interest income on nonaccruing loans
(Year Ended December 31):
Amount which would have been recorded
had the associated loans been current in
accordance with their original terms .............. $ 21 $ 25 $ 23 $ 28 $ 37
Amount actually recorded ............................. 8 12 17 12 9
Interest that has been accrued but unpaid on loans placed on nonaccruing status
generally is reversed and reduces current income at the time loans are so
categorized. Interest income on these loans may be recognized to the extent of
cash payments received. In those instances where there is doubt as to
collectibility of principal, any cash interest payments received are applied as
reductions of principal. Loans are not reclassified as accruing until interest
and principal payments are brought current and future payments are reasonably
assured.
Impaired Loans
A loan is considered to be impaired when it is deemed probable that all
principal and interest amounts due, according to the contractual terms of the
loan agreement, will not be collected. Probable losses from impaired loans are
quantified and recorded as a component of the overall allowance for credit
losses. Generally, impaired loans include loans in nonaccruing status, loans
which have been assigned a specific allowance for credit losses, loans which
have been partially or wholly charged off, and loans designated as troubled debt
restructurings. Impaired loan statistics are summarized in the following table.
--------------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------------------
(in millions)
Impaired loans:
Balance at end of period ................................ $ 100 $ 90 $ 236 $ 267 $ 288
Amount with impairment reserve .......................... 35 27 210 179 170
Impairment reserve ...................................... 13 10 18 86 89
59
Criticized Assets
Criticized asset classifications are based on the risk rating standards of
HUSI's primary regulator. Problem loans are assigned various criticized facility
grades under HUSI's allowance for credit losses methodology. The following
facility grades are deemed to be criticized.
Special Mention - generally includes loans that are protected by collateral
and/or the credit worthiness of the customer, but are potentially weak based
upon economic or market circumstances which, if not checked or corrected, could
weaken HUSI's credit position at some future date.
Substandard - includes loans that are inadequately protected by the underlying
collateral and/or general credit worthiness of the customer. These loans present
a distinct possibility that HUSI will sustain some loss if the deficiencies are
not corrected. This category also includes certain non-investment grade
securities, as required by HUSI's principal regulator.
Doubtful - includes loans that have all the weaknesses exhibited by substandard
loans, with the added characteristic that the weaknesses make collection or
liquidation in full of the recorded loan highly improbable. However, although
the possibility of loss is extremely high, certain factors exist which may
strengthen the credit at some future date, and therefore the decision to charge
off the loan is deferred. Loans graded as doubtful are required to be placed in
nonaccruing status.
Criticized assets are summarized in the following table.
---------------------------------------------------------------------------------------------------------
Increase/(Decrease) from
------------------------------------------
December 31, 2005 December 31, 2004
December 31, ------------------- -------------------
2006 Amount % Amount %
---------------------------------------------------------------------------------------------------------
($ in millions)
Special mention:
Commercial loans ......................... $ 1,364 $ 658 93 $ 580 74
------------ --------- ------ --------- ------
Substandard:
Commercial loans ......................... 765 612 400 551 257
Consumer loans ........................... 601 147 32 225 60
Non-investment grade securities .......... 30 (84) (74) 30 --
------------ --------- ------ --------- ------
1,396 675 94 806 137
------------ --------- ------ --------- ------
Doubtful:
Commercial loans ......................... 32 7 28 (14) (30)
------------ --------- ------ --------- ------
Total ....................................... $ 2,792 $ 1,340 92 $ 1,372 97
============ ========= ====== ========= ======
The increase in substandard commercial loans is addressed under Commercial Loan
Credit Quality on page 64. Higher substandard consumer loans primarily relate to
private label credit card receivables and, to a lesser extent, to residential
mortgage loans acquired from HSBC Finance Corporation. At December 31, 2006,
substandard credit card receivables and residential mortgage loans represented
1.8% and .6% of their respective total loan portfolios.
Concentrations of Credit Risk
A concentration of credit risk is defined as a significant credit exposure with
an individual or group engaged in similar activities or affected similarly by
economic conditions. HUSI's concentrations of credit risk include:
o residential mortgage loans with high loan-to-value (LTV) ratios and no
mortgage insurance, which could result in potential inability to recover
the entire investment in loans involving foreclosed or damaged properties;
o interest-only residential mortgage loans, which allow customers to pay
only the accruing interest for a period of time, resulting in lower
payments during the initial loan period;
o concentrations of second liens within the residential mortgage loan
portfolio; and
o adjustable rate residential mortgage loans that will experience their
first interest rate resets within the next two years.
60
Additional disclosures regarding credit risk concentrations are provided in Note
7 of the consolidated financial statements, beginning on page 117 of this Form
10-K.
Cross-Border Net Outstandings
Cross-border net outstandings, as calculated in accordance with Federal
Financial Institutions Examination Council (FFIEC) guidelines, are amounts
payable to HUSI by residents of foreign countries regardless of the currency of
claim and local country claims in excess of local country obligations.
Cross-border net outstandings include deposits placed with other banks, loans,
acceptances, securities available for sale, trading securities, revaluation
gains on foreign exchange and derivative contracts and accrued interest
receivable. Excluded from cross-border net outstandings are, among other things,
the following: local country claims funded by non-local country obligations
(U.S. dollar or other non-local currencies), principally certificates of deposit
issued by a foreign branch, where the providers of funds agree that, in the
event of the occurrence of a sovereign default or the imposition of currency
exchange restrictions in a given country, they will not be paid until such
default is cured or currency restrictions lifted or, in certain circumstances,
they may accept payment in local currency or assets denominated in local
currency (hereinafter referred to as constraint certificates of deposit); and
cross-border claims that are guaranteed by cash or other external liquid
collateral. Cross-border net outstandings that exceed .75% of total assets at
year-end are summarized in the following table.
--------------------------------------------------------------------------------
Banks and Commercial
Other Financial and
Institutions Industrial Total
--------------------------------------------------------------------------------
(in millions)
December 31, 2006:
France ......................... $ 1,782 $ 49 $ 1,831
Canada ......................... 1,305 793 2,098
United Kingdom ................. 1,738 1,127 2,865
--------------- ---------- -----------
$ 4,825 $ 1,969 $ 6,794
=============== ========== ===========
December 31, 2005:
United Kingdom ................. $ 1,497 $ 970 $ 2,467
=============== ========== ===========
December 31, 2004:
United Kingdom ................. $ 2,724 $ 1,086 $ 3,810
=============== ========== ===========
61
Provision and Allowance for Credit Losses
An analysis of the provision for credit losses is provided on page 38 of this
Form 10-K.
An analysis of overall changes in the allowance for credit losses and related
allowance ratios is presented in the following table.
-------------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004 2003 2002
-------------------------------------------------------------------------------------------------------------
($ in millions)
Total loans at year end ................... $ 90,237 $ 90,342 $ 84,947 $ 48,474 $ 43,636
Average total loans ....................... 88,853 87,898 60,328 44,187 42,054
Allowance for credit losses:
Balance at beginning of year ........... $ 846 $ 788 $ 399 $ 493 $ 506
Allowance related to acquisitions
and (dispositions), net ............. (8) -- 485 (15) (2)
Charge offs:
Commercial ............................. 136 75 54 160 151
Consumer:
Residential mortgages ............... 37 24 15 3 3
Credit card receivables ............. 728 659 65 59 63
Other consumer loans ................ 111 113 23 21 24
---------- ---------- ---------- ---------- ----------
Total consumer loans ................ 876 796 103 83 90
---------- ---------- ---------- ---------- ----------
Total charge offs ......................... 1,012 871 157 243 241
---------- ---------- ---------- ---------- ----------
Recoveries on loans charged off:
Commercial ............................. 38 71 60 35 21
Consumer:
Residential mortgages ............... 2 1 2 1 1
Credit card receivables ............. 170 146 8 8 8
Other consumer loans ................ 38 37 8 7 5
---------- ---------- ---------- ---------- ----------
Total consumer loans ................ 210 184 18 16 14
---------- ---------- ---------- ---------- ----------
Total recoveries .......................... 248 255 78 51 35
---------- ---------- ---------- ---------- ----------
Total net charge offs ..................... 764 616 79 192 206
---------- ---------- ---------- ---------- ----------
Provision charged (credited) to income .... 823 674 (17) 113 195
---------- ---------- ---------- ---------- ----------
Balance at end of year .................... $ 897 $ 846 $ 788 $ 399 $ 493
========== ========== ========== ========== ==========
Allowance ratios:
Total net charge offs to average loans:
Commercial ............................. .35% .02% (.03)% .63% .66%
Consumer:
Residential mortgages ............... .08 .05 .04 .01 .01
Credit card receivables ............. 3.49 3.81 4.69 4.57 5.00
Other consumer loans ................ 2.47 2.41 .71 .72 .96
---------- ---------- ---------- ---------- ----------
Total consumer loans ................ 1.10 .96 .21 .28 .34
---------- ---------- ---------- ---------- ----------
Total loans ............................ .86% .70% .13 % .43% .49%
========== ========== ========== ========== ==========
Year-end allowance to:
Year-end total loans ................ .99% .94% .93 % .82% 1.13%
Year-end total nonaccruing
loans (1) ........................ 314.74% 379.37% 315.20 % 109.02% 127.39%
(1) The increased allowance for credit losses at the end of 2006, 2005 and
2004 resulted from the acquisition of the private label credit card
receivables from HSBC Finance Corporation. As these receivable balances
are typically maintained as accruing until charged off, there were no loan
balances included in this portfolio which were classified as nonaccruing,
resulting in a significant increase in the ratio of allowance to
nonaccruing loans for 2006, 2005 and 2004 as compared with prior years.
62
Changes in the allowance for credit losses during 2006 and 2005, by general loan
categories, are summarized in the following tables.
-----------------------------------------------------------------------------------------------------------------------
Residential Credit Other
Year Ended December 31 Commercial Mortgage Card Consumer Unallocated Total
-----------------------------------------------------------------------------------------------------------------------
(in millions)
2006
Balance at beginning of year ........ $ 162 $ 34 $ 600 $ 36 $ 14 $ 846
---------- ----------- ----------- ----------- ----------- ----------
Allowance related to dispositions ... -- -- (8) -- -- (8)
Charge offs ......................... 136 37 728 111 -- 1,012
Recoveries .......................... 38 2 170 38 -- 248
---------- ----------- ----------- ----------- ----------- ----------
Net charge offs ..................... 98 35 558 73 -- 764
---------- ----------- ----------- ----------- ----------- ----------
Provision charged (credited)
to income ......................... 139 32 592 63 (3) 823
---------- ----------- ----------- ----------- ----------- ----------
Balance at end of year .............. $ 203 $ 31 $ 626 $ 26 $ 11 $ 897
========== =========== =========== =========== =========== ==========
2005
Balance at beginning of year ........ $ 182 $ 20 $ 553 $ 20 $ 13 $ 788
---------- ----------- ----------- ----------- ----------- ----------
Charge offs ......................... 75 24 659 113 -- 871
Recoveries .......................... 71 1 146 37 -- 255
---------- ----------- ----------- ----------- ----------- ----------
Net charge offs ..................... 4 23 513 76 -- 616
---------- ----------- ----------- ----------- ----------- ----------
Provision charged (credited)
to income ......................... (16) 37 560 92 1 674
---------- ----------- ----------- ----------- ----------- ----------
Balance at end of year .............. $ 162 $ 34 $ 600 $ 36 $ 14 $ 846
========== =========== =========== =========== =========== ==========
An allocation of the allowance for credit losses by major loan categories is
presented in the following table. The 2004 decrease in the unallocated portion
noted in the table is due to refinement in the allowance methodology during that
year.
------------------------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
----------------- ----------------- ---------------- ----------------- ----------------
% of % of % of % of % of
Loans Loans Loans Loans Loans
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------------------------------------------------------------------------------------------------------------------------
($ in millions)
Commercial ............. $ 203 33 $ 162 31 $ 182 27 $ 252 39 $ 346 46
Consumer:
Residential mortgages 31 44 34 49 20 55 13 55 11 47
Credit card receivables 626 20 600 17 553 14 54 2 51 3
Other consumer ....... 26 3 36 3 20 4 16 4 27 4
Unallocated reserve .... 11 -- 14 -- 13 -- 64 -- 58 --
------ -------- ------ -------- ------ -------- ------ -------- ------ --------
Total .................. $ 897 100 $ 846 100 $ 788 100 $ 399 100 $ 493 100
====== ======== ====== ======== ====== ======== ====== ======== ====== ========
63
Commercial Loan Credit Quality
Components of the commercial allowance for credit losses, as well as movements
in comparison with prior years, are summarized in the following table.
-------------------------------------------------------------------------------------------------------
Increase (Decrease) from
---------------------------------------------
December 31, 2005 December 31, 2004
December 31, --------------------- ---------------------
2006 Amount % Amount %
-------------------------------------------------------------------------------------------------------
($ in millions)
On-balance sheet allowance:
Specific ............................ $ 14 $ 5 56 $ (4) (22)
Collective .......................... 189 40 27 39 26
Transfer risk ....................... -- (4) (100) (14) (100)
------------ --------- --------- --------- ---------
203 41 25 21 12
Unallocated ......................... 11 (3) (21) (2) (15)
------------ --------- --------- --------- ---------
Total on-balance sheet allowance .... 214 38 22 19 10
------------ --------- --------- --------- ---------
Off-balance sheet allowance ............ 98 10 11 8 9
------------ --------- --------- --------- ---------
Total commercial allowances ............ $ 312 $ 48 18 $ 27 9
============ ========= ========= ========= =========
2006
HUSI's growth initiatives during 2005 and 2006 have resulted in a continuing
trend of growth in the size and complexity of HUSI's commercial loan portfolio.
In addition, certain segments of the economy continue to show signs of slowing,
resulting in higher probabilities of default, which is a key driver for credit
grading. The resulting net increase in criticized assets in 2006, in combination
with increased loan balances, resulted in higher specific and collective
allowances at December 31, 2006.
Criticized asset classifications are based on the risk rating standards of
HUSI's primary regulator. Higher substandard criticized assets (refer to page 60
of this Form 10-K) resulted mainly from downgrades in auto and insurance
industry exposures within the CIBM business segment, and middle market
commercial exposures within CMB. The downgrades resulted in part from changes in
the credit metrics for specific credits within these industries and portfolios.
Total nonaccruing commercial loans, as a percentage of total commercial loans,
remain low and are flat year over year. In addition, commercial loan net charge
offs remain below historical averages. Based upon evaluation of the repayment
capacity of the obligors, including support from adequately margined collateral,
performance on guarantees, and other mitigating factors, impairment is modestly
higher at December 31, 2006 as compared with prior reporting periods, and is
adequately reflected in the allowances for specific and collective impairment.
Continued increases in provisions and allowances for credit losses are expected
in the near future due to growing portfolio risk resulting from:
o HUSI's continued geographic expansion;
o increased borrower concentrations;
o increased number and complexity of products offered; and
o continuing signs of stress within certain segments of the economy.
HUSI management continues to monitor and reduce exposures to those industries
considered to be higher risk. During 2006, HUSI management began to make more
extensive use of available tools to more actively manage net exposure within its
corporate loan portfolios with an increased syndication capacity as well as
increased use of credit default swaps to economically hedge and reduce certain
exposures.
Any sudden and/or unexpected adverse economic events or trends could
significantly affect credit quality and increase provisions for credit losses.
For example, HUSI management is monitoring rising interest rates and high energy
prices, which could potentially lead to a deceleration of U.S. economic
activity. Recent events in the Middle East may also worsen the overall energy
picture.
64
2005
Calendar year 2004 was a period of unusually low charge offs and high recoveries
of commercial loans. During 2005, charge offs increased 39%, but the level of
charge offs was still well below 2003 and prior year levels. Recoveries
increased again in 2005 due to sales of certain problem credits at amounts
higher than recorded book values.
Commercial loan credit quality was generally stable throughout 2005. Nonaccruing
commercial loans decreased for the fifth consecutive year, reflecting HUSI's
generally strong credit underwriting standards and improving economic conditions
in recent years. Criticized assets classified as "substandard" increased $131
million during 2005, primarily due to the addition of non-investment grade
securities to the calculation of these assets. Excluding these securities,
criticized commercial loans declined among all categories during 2005.
Credit Card Receivable Credit Quality
Credit card receivables are primarily private label receivables, including
closed and open ended contracts, acquired from HSBC Finance Corporation.
Receivables included in the private label credit card portfolio are generally
maintained in accruing status until being charged off six months after
delinquency. The following table provides credit quality data for credit card
receivables.
----------------------------------------------------------------------------------------------------
December 31 2006 2005
----------------------------------------------------------------------------------------------------
($ in millions)
Accruing credit card receivables contractually past due 90 days or more:
Balance at end of period .................................................... $ 339 $ 248
As a percent of total credit card receivables ............................... 1.86% 1.60%
Allowance for credit losses associated with credit card receivables:
Balance at end of period .................................................... $ 626 $ 600
As a percent of total credit card receivables ............................... 3.43% 3.87%
Net charge offs of credit card receivables:
Total for the period ........................................................ $ 558 $ 513
Annualized net charge offs as a percent of average credit card receivables .. 3.49% 3.81%
2006
The allowance for credit losses associated with credit card receivables
increased $26 million (4%) during 2006. Net charge off and provision activity
during 2006, as well as the allowance balance at December 31, 2006, are
generally consistent with increased private label credit card receivable
balances (refer to page 52 of this Form 10-K for commentary regarding credit
card receivables).
2005
The allowance for credit losses associated with credit card receivables
increased $47 million during 2005. During the second half of the year, HUSI
recorded an incremental $15 million allowance for credit losses associated with
Hurricane Katrina and new bankruptcy legislation. Excluding these incremental
provisions, allowance activity reflects normal portfolio experience for the
increased balances associated with the private label receivables.
65
Residential Mortgage Loan Credit Quality
2006
The allowance for credit losses related to residential mortgage loans decreased
9% during 2006. Lower loan balances resulted in lower allowance requirements
during the year. HUSI's residential mortgage portfolio is primarily comprised of
prime mortgage loans, for which credit quality remained strong during 2006 and
2005.
2005
The allowance for credit losses associated with residential mortgage loans
increased 70% during 2005, primarily due to significant growth in this loan
portfolio during 2005 and 2004.
Reserve for Off-Balance Sheet Exposures
HUSI maintains a separate reserve for credit risk associated with certain
off-balance sheet exposures including letters of credit, unused commitments to
extend credit and financial guarantees. This reserve, included in other
liabilities, was $98 million and $88 million at December 31, 2006 and 2005,
respectively.
Credit and Market Risks Associated with Derivative Contracts
Credit (or repayment) risk in derivative instruments is minimized by entering
into transactions with high quality counterparties, including other HSBC
entities. Counterparties include financial institutions, government agencies,
both foreign and domestic, corporations, funds (mutual funds, hedge funds,
etc.), insurance companies and private clients. These counterparties are subject
to regular credit review by the credit risk management department. Most
derivative contracts are governed by an International Swaps and Derivatives
Association Master Agreement. Depending on the type of counterparty and the
level of expected activity, bilateral collateral arrangements may also be
required.
The total risk in a derivative contract is a function of a number of variables,
such as:
o whether counterparties exchange notional principal;
o volatility of interest rates, currencies, equity or corporate reference
entity used as the basis for determining contract payments;
o maturity and liquidity of contracts;
o credit worthiness of the counterparties in the transaction; and
o existence and value of collateral received from counterparties to secure
exposures.
The following table presents credit risk exposure and net fair value associated
with derivative contracts. In the table, current credit risk exposure is the
recorded fair value of derivative receivables, which represents revaluation
gains from the marking to market of derivative contracts held for trading
purposes, for all counterparties with an International Swaps and Derivatives
Association Master Agreement in place.
Future credit risk exposure in the following table is measured using rules
contained in the risk-based capital guidelines published by U.S. banking
regulatory agencies. The risk exposure calculated in accordance with the
risk-based capital guidelines potentially overstates actual credit exposure,
because:
o the risk-based capital guidelines ignore collateral that may have been
received from counterparties to secure exposures; and
o the risk-based capital guidelines compute exposures over the life of
derivative contracts. However, many contracts contain provisions that
allow a bank to close out the transaction if the counterparty fails to
post required collateral. As a result, these contracts have potential
future exposures that are often much smaller than the future exposures
derived from the risk-based capital guidelines.
66
The net credit risk exposure amount in the following table does not reflect the
impact of bilateral netting (i.e., netting with a single counterparty when a
bilateral netting agreement is in place). However, the risk-based capital
guidelines recognize that bilateral netting agreements reduce credit risk and
therefore allow for reductions of risk-weighted assets when netting requirements
have been met. In addition, risk-based capital rules require that netted
exposures of various counterparties be assigned risk-weightings, which result in
risk-weighted amounts for regulatory capital purposes that are a fraction of the
original netted exposures.
-------------------------------------------------------------------------------
December 31 2006 2005
-------------------------------------------------------------------------------
(in millions)
Risk associated with derivative contracts:
Current credit risk exposure ................. $ 11,398 $ 8,155
Future credit risk exposure .................. 72,447 61,548
---------- ----------
Total risk exposure .......................... 83,845 69,703
Less: collateral held against exposure ....... (3,989) (1,850)
---------- ----------
Net credit risk exposure ..................... $ 79,856 $ 67,853
========== ==========
The table below summarizes the risk profile of the counterparties of HUSI's on
balance sheet exposure to derivative contracts, net of cash and other highly
liquid collateral.
-------------------------------------------------------------------------------
Percent of Current Credit Risk
Exposure, Net of Collateral
------------------------------
Rating equivalent at December 31 2006 2005
-------------------------------------------------------------------------------
AAA to AA- ................................... 46% 28%
A+ to A- ..................................... 31 39
BBB+ to BBB- ................................. 15 22
BB+ to B- .................................... 4 4
CCC+ and below ............................... 4 7
----- ----
Total ........................................ 100% 100%
===== ====
Market risk is the adverse effect that a change in interest rates, currency, or
implied volatility rates has on the value of a financial instrument. HUSI
manages the market risk associated with interest rate and foreign exchange
contracts by establishing and monitoring limits as to the types and degree of
risk that may be undertaken. HUSI also manages the market risk associated with
the trading derivatives through hedging strategies that correlate the rates,
price and spread movements. HUSI measures this risk daily by using Value at Risk
(VAR) and other methodologies.
HUSI's Asset and Liability Policy Committee is responsible for monitoring and
defining the scope and nature of various strategies utilized to manage interest
rate risk that are developed through its analysis of data from financial
simulation models and other internal and industry sources. The resulting hedge
strategies are then incorporated into HUSI's overall interest rate risk
management and trading strategies.
67
Off-Balance Sheet Arrangements and Contractual Obligations
--------------------------------------------------------------------------------
Off-Balance Sheet Arrangements
The following table presents maturity information related to various off-balance
sheet arrangements. Descriptions of the various arrangements follow the table.
------------------------------------------------------------------------------------------------------------
Balance at December 31, 2006
---------------------------------------------------
One Over One Over Balance at
Year Through Five December 31,
or Less Five Years Years Total 2005
------------------------------------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of
participations (1) ................... $ 3,775 $ 3,371 $ 113 $ 7,259 $ 6,114
Commercial letters of credit ........... 748 47 -- 795 806
Loan sales with recourse (2) ........... -- 1 7 8 9
Credit derivative contracts (3) ........ 16,630 248,055 166,946 431,631 222,419
Commitments to extend credit:
Commercial .......................... 18,644 32,172 5,046 55,862 51,284
Consumer ............................ 9,627 -- -- 9,627 8,305
Securities lending indemnifications .... -- -- -- -- 4,135
---------- ---------- ------------ ----------- ------------
Total .................................. $ 49,424 $ 283,646 $ 172,112 $ 505,182 $ 293,072
========== ========== ============ =========== ============
(1) Includes $542 million and $523 million issued for the benefit of HSBC
affiliates at December 31, 2006 and 2005, respectively.
(2) $7 million of this amount is indemnified by HSBC affiliates at December
31, 2006 and 2005.
(3) Includes $71,908 million and $51,202 million issued for the benefit of
HSBC affiliates at December 31, 2006 and 2005, respectively.
Letters of Credit
HUSI may issue a letter of credit for the benefit of a customer, authorizing a
third party to draw on the letter for specified amounts under certain terms and
conditions. The issuance of a letter of credit is subject to HUSI's credit
approval process and collateral requirements. HUSI issues two types of letters
of credit, commercial and standby.
o A commercial letter of credit is drawn down on the occurrence of an
expected underlying transaction, such as the delivery of goods. Upon the
occurrence of the transaction, a commercial letter of credit is recorded
as a customer acceptance in other assets and other liabilities until
settled.
o A standby letter of credit is issued to third parties for the benefit of a
customer and is essentially a guarantee that the customer will perform, or
satisfy some obligation, under a contract. It irrevocably obligates HUSI
to pay a third party beneficiary when a customer either: (1) in the case
of a performance standby letter of credit, fails to perform some
contractual non-financial obligation, or (2) in the case of a financial
standby letter of credit, fails to repay an outstanding loan or debt
instrument.
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Included in other
liabilities are deferred fees on standby letters of credit, representing the
fair value of HUSI's "stand ready obligation to perform" under these guarantees,
amounting to $21 million and $19 million at December 31, 2006 and 2005,
respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit of $25 million and $20 million at
December 31, 2006 and 2005, respectively.
Loan Sales with Recourse
HUSI generally sells loans and other assets without recourse. In years prior to
2006, HUSI's mortgage banking subsidiary sold residential mortgage loans with
recourse upon borrower default, with partial indemnification from third parties.
68
Credit Derivatives
HUSI enters into credit derivative contracts both for its own benefit and to
satisfy the needs of its customers. Credit derivatives are arrangements that
provide for one party (the "beneficiary") to transfer the credit risk of a
"reference asset" to another party (the "guarantor"). Under this arrangement the
guarantor assumes the credit risk associated with the reference asset without
directly purchasing it. The beneficiary agrees to pay to the guarantor a
specified fee. In return, the guarantor agrees to pay the beneficiary an agreed
upon amount if there is a default during the term of the contract.
In accordance with its policy, HUSI offsets most of the market risk it assumes
in selling credit guarantees through a credit derivative contract with another
counterparty. Credit derivatives, although having characteristics of a
guarantee, are accounted for as derivative instruments and are carried at fair
value. The commitment amount included in the table on the preceding page is the
maximum amount that HUSI could be required to pay, without consideration of the
approximately equal amount receivable from third parties and any associated
collateral.
Commitments to Extend Credit
Commitments include arrangements whereby HUSI is contractually obligated to
extend credit in the form of loans, participations in loans, lease financing
receivables, or similar transactions. Consumer commitments are comprised of
unused credit card lines and commitments to extend credit secured by residential
properties. HUSI has the right to change or terminate any terms or conditions of
a customer's credit card or home equity line of credit account, upon
notification to the customer.
Securities Lending Indemnifications
Through December 31, 2005, HUSI occasionally lent securities of customers, on a
fully collateralized basis, as an agent to third party borrowers. Customers were
indemnified against the risk of loss, and collateral was obtained from the
borrower with a market value exceeding the value of the loaned securities.
Securities lending activities were terminated during the first quarter of 2006.
Commitments to Repurchase Mortgage Loans Previously Sold
In the normal course of business, HUSI's mortgage banking subsidiary routinely
sells loans to investors in the secondary market. As a result, HUSI is
contractually obligated to repurchase loans in the case of a breach of
representation or warranty, or in the case of an early payment default.
69
Contractual Obligations
Obligations to make future payments under contracts are presented in the
following table.
------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2006 or Less Five Years Years Total
------------------------------------------------------------------------------------------------------------
(in millions)
Subordinated long-term debt and perpetual capital notes (1) ..... $ -- $ 900 $ 4,561 $ 5,461
Other long-term debt, including capital lease obligations (1) ... 7,468 10,862 5,614 23,944
Pension and other postretirement benefit obligations (2) ........ 58 266 431 755
Minimum future rental commitments on operating leases (3) ....... 81 239 189 509
Purchase obligations (4) ........................................ 89 110 -- 199
-------- ---------- ------- -------
Total ........................................................... $ 7,696 $ 12,377 $10,795 $30,868
======== ========== ======= =======
(1) Represents future principal payments related to debt instruments included
in Note 15 of the consolidated financial statements beginning on page 127
of this Form 10-K.
(2) Represents estimated future employee service expected to be paid based on
assumptions used to measure HUSI's benefit obligation at December 31,
2006. See Note 23 of the consolidated financial statements beginning on
page 142 of this Form 10-K.
(3) Represents expected minimum lease payments under noncancellable operating
leases for premises and equipment included in Note 25 of the consolidated
financial statements beginning on page 148 of this Form 10-K.
(4) Represents binding agreements for facilities management and maintenance
contracts, custodial account processing services, internet banking
services, consulting services, real estate services and other services.
Risk Management
--------------------------------------------------------------------------------
Overview
Some degree of risk is inherent in virtually all of HUSI's activities. For the
principal activities undertaken by HUSI, the most important types of risks are
considered to be credit, interest rate, market, liquidity, operational,
fiduciary and reputational. Market risk broadly refers to price risk inherent in
mark to market positions taken on trading and non-trading instruments.
Operational risk technically includes legal and compliance risk. However, since
compliance risk, including anti-money laundering (AML) risk, has such broad
scope within HUSI's businesses, it is addressed below as a separate functional
discipline.
The objective of HUSI's risk management system is to identify, measure and
monitor risks so that:
o the potential costs can be weighed against the expected rewards from
taking the risks;
o unexpected losses can be minimized;
o appropriate disclosures can be made to all concerned parties;
o adequate protections, capital and other resources can be put in place to
weather all significant risks; and
o compliance with all relevant laws, regulations and regulatory requirements
is ensured through staff education, adequate processes and controls, and
ongoing monitoring efforts.
Historically, HUSI's approach toward risk management has emphasized a culture of
business line responsibility combined with central requirements for
diversification of customers and businesses. Extensive centrally determined
requirements for controls, limits, reporting and the escalation of issues have
been detailed in HUSI's and HSBC's policies and procedures. In addition, HUSI
has a formal independent compliance function, the staff of which has been
aligned with, and has advised, each business and support function.
70
As a result of an increasingly complex business environment, increased
regulatory scrutiny, and the evolution of improved risk management tools and
standards, HUSI has significantly upgraded, and continues to upgrade, its
methodologies and systems. New practices and techniques have been developed that
involve data development, modeling, simulation and analysis, management
information systems development, self-assessment, and staff education programs.
HUSI has a senior leadership structure under the direction of the Chief Risk
Officer, which includes dedicated independent risk specialists for operational,
AML and fiduciary risk, in addition to the existing specialists for managing
other risks. Staffing has been expanded, especially in the areas of
compliance/AML and market risk.
Risk management oversight begins with HUSI's Board of Directors and its various
committees, principally the Audit Committee. Specific oversight of various risk
management processes is provided by the Risk Management Committee, which was
assisted by five principal subcommittees through 2006:
o the Credit Risk Committee;
o the Asset and Liability Policy Committee;
o the Operational Risk Management Committee;
o the Fiduciary Risk Management Committee; and
o the Compliance Risk Management Committee.
The Risk Management Committee and each sub-committee were chartered by the Board
of Directors. While the charters were tailored to reflect the roles and
responsibilities of each committee, they all had the following common themes:
o defining risk appetites, policies and limits;
o monitoring and assessing exposures, trends and the effectiveness of risk
management;
o reporting to the Board of Directors; and
o promulgating a suitable risk taking, risk management, and compliance
culture.
In early 2007, in order to foster more enterprise-wide risk oversight, the Risk
Management Committee assumed responsibility for the functions of the Credit Risk
and Compliance Risk Management Committees.
Day-to-day management of credit risk is centralized under the Chief Credit
Officer. For retail consumer loan portfolios, such as credit cards, installment
loans, and residential mortgages, the Chief Credit Officer leverages off the
consumer credit management skills and tools of HSBC Finance Corporation.
Day-to-day management of interest rate and market risk is centralized
principally under the Treasurer. Operational, fiduciary, and compliance risk is
decentralized and is the responsibility of each business and support unit.
However, for all risk types, there are independent risk specialists that set
standards, develop new risk methodologies, maintain central risk databases, and
conduct reviews and analysis. The Chief Risk Officer and the Executive Vice
Presidents for Compliance and Anti-Money Laundering provide day-to-day oversight
of these activities and work closely with internal audit, and senior risk
officers and specialists at HNAH and HSBC.
Economic and Regulatory Capital
Economic Capital
Economic capital is defined as the amount of capital required to sustain a
business through a complete business cycle, enabling the business to absorb
unexpected losses and thus minimize the probability of insolvency. Economic
capital is measured at the business unit level based on four categories of risk:
o Credit risk
o Operational risk
o Market risk
o Interest rate risk
71
Whereas regulatory capital is calculated at the total bank level as a measure of
the minimum capital needed for regulatory compliance and is based on the amount
of capital maintained in relation to risk-weighted assets at a specific point in
time, economic capital is actually a measure of risk. As a result, economic
capital can be compared to total corporate capital resources and, since it can
be assigned to each business unit according to its risk characteristics, it can
be used to establish business performance measures, make pricing decisions or
set portfolio guidelines.
Economic capital is an internal measure developed by HUSI based on its unique
set of diverse businesses, risk appetites, and management practices. In 2004,
HUSI began to calculate economic capital from statistical analyses of possible
losses related to credit, market, interest rate and operational risk. HUSI
calculates economic capital sufficient to cover losses over a one year time
horizon at a 99.95% confidence level. This is consistent with HBUS's "AA"
rating, as "AA" rated credits have historically defaulted at a rate of about
..05% per year. The one year time horizon is also consistent with traditional
planning and budgeting time horizons. Quantification of possible losses related
to other risks, such as fiduciary and reputational risk, are broadly covered
under the credit, market and operational risk measurements.
Basel Capital Standards
The timing of HNAH's and HUSI's preparations relative to Basel II is summarized
on page 12 of this Form 10-K. Only the most advanced approaches toward
implementation of the Basel II framework are expected to be adopted by U.S.
regulators. For credit risk and operational risk, bank holding companies must
adopt the Advanced Internal Ratings Based approach and the Advanced Measurement
Approach, respectively, as described in the Basel framework. The final Basel
framework will include new rules and definitions for traded products, which will
result in revised market risk assessment.
HUSI will continue to leverage its internal economic capital development program
in its preparations for the new capital adequacy standards. Many of the
practices related to the calculation of economic capital will be used to satisfy
regulatory requirements. While HUSI expects to qualify to use the new approaches
in time to meet the final required implementation date in the U.S., the Basel II
framework must essentially be in place on January 1, 2008 to meet HSBC
requirements.
Credit Risk Management
Credit risk is the potential that a borrower or counterparty will default on a
credit obligation, as well as the impact on the value of credit instruments due
to changes in the probability of borrower default.
For HUSI, credit risk is inherent in various on and off-balance sheet
instruments and arrangements:
o in loan portfolios;
o in investment portfolios;
o in unfunded commitments such as letters of credit and lines of credit that
customers can draw upon; and o in treasury instruments, such as interest
rate swaps which, if more valuable today than when originally contracted,
may represent an exposure to the counterparty to the contract.
While credit risk exists widely within HUSI, diversification among various
commercial and consumer portfolios helps HUSI to lessen risk exposure.
HUSI assesses, monitors and controls credit risk with formal standards, policies
and procedures. An independent Credit Risk function is maintained under the
direction of Co-Chief Credit Officers, who report directly to the Chief
Executive Officer of HUSI, and indirectly to the Chief Risk Officer of HNAH and
to the Group General Manager, Head of Credit and Risk for HSBC.
72
The responsibilities of the credit risk function include:
o Formulating credit policies - HUSI's policies are designed to ensure that
various retail and commercial business units operate within clear
standards of acceptable credit risk. HUSI's policies ensure that the HSBC
standards are consistently implemented across all businesses and that all
regulatory requirements are also considered. Credit policies are reviewed
and approved annually by the Audit Committee.
o Approving new credit exposures and independently assessing large exposures
annually - The Co-Chief Credit Officers delegate credit authority to
various lending units throughout HUSI. However, most large credits are
reviewed and approved centrally through a dedicated Credit Approval Unit
that reports directly to the Co-Chief Credit Officers. In addition, the
Co-Chief Credit Officers coordinate the approval of material credits with
HSBC Group Credit and Risk which, subject to certain agreed-upon limits,
will review and concur on material new and renewal transactions.
o Maintaining and developing HUSI's risk rating system - HUSI utilizes a
two-dimensional credit risk rating system in order to categorize exposures
meaningfully and facilitate focused management of the attendant risks.
This ratings system is comprised of a 22 category Customer Risk Rating
which considers the probability of default of an obligor and a separate
assessment of a transaction's potential loss given default. This approach
increasingly allows for a more granular analysis of risk and trends.
Rating methodology is based upon a wide range of financial analytics
together with market data-based tools which are core inputs to the
assessment of counterparty risk. Although automated risk-rating processes
are increasingly in use, for the larger facilities ultimate responsibility
for setting risk grades rests in each case with the final approving
executive. Risk grades are reviewed frequently and amendments, where
necessary, are implemented promptly.
o Measuring portfolio credit risk - Over the past few years, the advanced
credit ratings system has been used to implement a credit economic capital
risk measurement system to measure the risk in HUSI's credit portfolios,
using the measure in certain internal and Board of Directors reporting.
Simulation models are used to determine the amount of unexpected losses,
beyond expected losses, that HUSI must be prepared to support with capital
given its targeted debt rating. Monthly credit economic capital reports
are generated and reviewed with management and the business units. Efforts
continue to refine both the inputs and assumptions used in the credit
economic capital model to increase its usefulness in pricing and the
evaluation of large and small commercial and retail customer portfolio
products and business unit return on risk.
o Monitoring portfolio performance - HUSI has implemented a credit data
warehouse to centralize the reporting of its credit risk, support the
analysis of risk using tools such as economic capital, and to calculate
its credit loss reserves. This data warehouse will also support HSBC's
wider effort to meet the requirements of Basel II and to generate credit
reports for management and the Board of Directors.
o Establishing counterparty and portfolio limits - HUSI monitors and limits
its exposure to individual counterparties and to the combined exposure of
related counterparties. In addition, selected industry portfolios, such as
real estate and structured products, are subject to caps that are
established by the Co-Chief Credit Officers and reviewed where appropriate
by management committees and the Board of Directors. Counterparty credit
exposure related to derivative activities is also managed under approved
limits. Since the exposure related to derivatives is variable and
uncertain, HUSI uses internal risk management methodologies to calculate
the 95% worst-case potential future exposure for each customer. These
methodologies take into consideration, among other factors, cross-product
close-out netting, collateral received from customers under Collateral
Support Annexes (CSAs), termination clauses, and off-setting positions
within the portfolio.
o Managing problem commercial loans - Special attention is paid to problem
loans. When appropriate, HUSI's Special Credits Unit provides customers
with intensive management and control support in order to help them avoid
default wherever possible and maximize recoveries.
73
o Establishing allowances for credit losses - The Co-Chief Credit Officers
share the responsibility with the Chief Financial Officer for establishing
appropriate levels of allowances for credit losses inherent in various
loan portfolios.
o Overseeing retail credit risk - Each retail business unit is supported by
dedicated advanced risk analytics units. The Co-Chief Credit Officers
provide independent oversight of credit risk associated with these retail
portfolios and is supported by expertise from HNAH's Retail Credit
Management unit, under the direction of HNAH's Chief Risk Officer.
o Chairing the Credit Risk Management Committee - Through 2006 the Chief
Credit Officer chaired the Credit Risk Management Committee and was
responsible for strategic and collective oversight of the scope of risk
taken, the adequacy of the tools used to measure it, and the adequacy of
reporting. Early in 2007, responsibility for credit risk management was
transferred to the Risk Management Committee.
Asset/Liability Management
Asset and liability management includes management of liquidity, interest rate
and market risk. Liquidity risk is the potential that an institution will be
unable to meet its obligations as they become due or fund its customers because
of inadequate cash flow or the inability to liquidate assets or obtain funding
itself. Market risk includes both interest rate and trading risk. Interest rate
risk is the potential impairment of net interest income due to mismatched
pricing between assets and liabilities and off-balance sheet instruments. Market
risk is the potential for losses in daily mark to market positions (mostly
trading) due to adverse movements in money, foreign exchange, equity or other
markets. In managing these risks, HUSI seeks to protect both its income stream
and the value of its assets.
HUSI has substantial, but historically well controlled, interest rate risk in
large part as a result of its large portfolio of residential mortgages and
mortgage backed securities, which consumers can prepay without penalty, and to a
lesser extent the result of its large base of demand and savings deposits. These
deposits can be withdrawn by consumers at will, but historically they have been
a stable source of relatively low cost funds. Market risk exists principally in
treasury businesses and to a lesser extent in the residential mortgage business
where mortgage servicing rights and the pipeline of forward mortgage sales are
hedged. HUSI has little foreign exchange exposure from investments in overseas
operations, which are limited in scope. Total equity investments, excluding
stock owned in the Federal Reserve and New York Federal Home Loan Bank,
represent less than 4% of total available for sale securities.
The management of liquidity, interest rate and most market risk is centralized
in treasury and mortgage banking operations. In all cases, the valuation of
positions and tracking of positions against limits is handled independently by
HUSI's finance units. Oversight of all liquidity, interest rate and market risks
is provided by the Asset and Liability Policy Committee (ALCO) which is chaired
by the Chief Financial Officer. Subject to the approval of the HUSI Board of
Directors and HSBC, ALCO sets the limits of acceptable risk, monitors the
adequacy of the tools used to measure risk, and assesses the adequacy of
reporting. ALCO also conducts contingency planning with regard to liquidity.
74
Liquidity Risk Management
Liquidity risk is the risk that an institution will be unable to meet its
obligations as they become due because of an inability to liquidate assets or
obtain adequate funding. Liquidity is managed to provide the ability to generate
cash to meet lending, deposit withdrawal and other commitments at a reasonable
cost in a reasonable amount of time, while maintaining routine operations and
market confidence. HUSI is planning its funding and liquidity management in
conjunction with HSBC Finance Corporation and HSBC, as the markets increasingly
view debt issuances from the separate companies within the context of their
common parent company. Liquidity management is performed at HUSI and at HBUS.
Each entity is required to have sufficient liquidity for a crisis situation.
ALCO is responsible for the development and implementation of related policies
and procedures to ensure that the minimum liquidity ratios and a strong overall
liquidity position are maintained.
In carrying out this responsibility, ALCO projects cash flow requirements and
determines the level of liquid assets and available funding sources to have at
HUSI's disposal, with consideration given to anticipated deposit and balance
sheet growth, contingent liabilities, and the ability to access wholesale
funding markets. HUSI's liquidity management approach has been supplemented by
increased deposits, potential sales (e.g. residential mortgage loans), and
securitizations (e.g. credit cards) in liquidity contingency plans. In addition,
ALCO monitors the overall mix of deposit and funding concentrations to avoid
undue reliance on individual funding sources and large deposit relationships. It
must also maintain a liquidity management contingency plan, which identifies
certain potential early indicators of liquidity problems, and actions that can
be taken both initially and in the event of a liquidity crisis, to minimize the
long-term impact on HUSI's business and customer relationships. In the event of
a cash flow crisis, HUSI's objective is to fund cash requirements without access
to the wholesale unsecured funding market for at least one year. Contingency
funding needs will be satisfied primarily through the sale of the investment
portfolio and liquidation of the residential mortgage portfolio. Securities may
be sold or used as collateral in a repurchase agreement depending on the
scenario. Portions of the mortgage and PLRP portfolios may be sold, securitized,
or used for collateral at the FHLB to increase borrowings.
Deposits from a diverse mix of "core" retail, commercial and public sources and
online savings accounts represent a significant, cost-effective and stable
source of liquidity under normal operating conditions. Total deposits increased
$13 billion and $12 billion during 2006 and 2005, respectively. Online savings
account growth was $6 billion and $1 billion for 2006 and 2005, respectively. In
conjunction with a minimal change in total loans in 2006, this deposit growth
led to improved liquidity ratios at HBUS and to reduced borrowing in the global
capital and wholesale markets. In particular, HUSI's loans to deposits ratio
improved significantly during 2006.
HUSI's ability to regularly attract wholesale funds at a competitive cost is
enhanced by strong ratings from the major credit ratings agencies. In June 2006,
Standard and Poor's upgraded the ratings of HBUS and HUSI. At December 31, 2006,
HUSI and HBUS maintained the following long and short-term debt ratings:
-----------------------------------------------------------------------------------------------
Moody's S&P Fitch
-----------------------------------------------------------------------------------------------
HUSI:
Short-term borrowings ........................................ P-1 A-1+ F1+
Long-term debt ............................................... Aa3 AA- AA
HBUS:
Short-term borrowings ........................................ P-1 A-1+ F1+
Long-term debt ............................................... Aa2 AA AA
HUSI's continued success and prospects for growth are dependent upon access to
the global capital markets. Numerous factors, internal and external, may impact
HUSI's access to and costs associated with issuing debt in these markets. These
factors include HUSI's debt ratings, overall economic conditions, overall
capital markets volatility and the effectiveness of HUSI's management of credit
risks inherent in its customer base.
75
Cash resources, short-term investments and a trading asset portfolio are
available to provide highly liquid funding for HUSI. Additional liquidity is
provided by debt securities. Approximately $3 billion of debt securities in this
portfolio at December 31, 2006 are expected to mature in 2007. The remaining $20
billion of debt securities not expected to mature in 2007 are available to
provide liquidity by serving as collateral for secured borrowings, or if needed,
by being sold. Further liquidity is available through HUSI's ability to sell or
securitize loans in secondary markets through whole-loan sales and
securitizations. In 2006, HUSI sold residential mortgage loans of approximately
$9.6 billion. The amount of residential mortgage loans and credit card
receivables available to be sold or securitized totaled approximately $54
billion at December 31, 2006.
The economics and long-term business impact of obtaining liquidity from assets
must be weighed against the economics of obtaining liquidity from liabilities,
along with consideration given to the associated capital ramifications of these
two alternatives. Currently, assets would be used to supplement liquidity
derived from liabilities only in a crisis scenario.
It is the policy of HBUS to maintain both primary and secondary collateral in
order to ensure precautionary borrowing availability from the Federal Reserve.
Primary collateral is that which is physically maintained at the Federal
Reserve, and serves as a safety net against any unexpected funding shortfalls
that may occur. Secondary collateral is collateral that is acceptable to the
Federal Reserve, but is not maintained there. If unutilized borrowing capacity
were to be low, secondary collateral would be identified and maintained as
necessary. Further liquidity is available from the Federal Home Loan Bank of New
York. As of December 31, 2006, HUSI had outstanding advances of $5 billion. HUSI
has access to further borrowings based on the amount of mortgages pledged as
collateral to the FHLB.
HUSI maintains sufficient liquidity to meet all unsecured debt obligations
scheduled to mature in 2007 at its parent company level without the need for
incremental access to the unsecured markets. As of December 31, 2006, HBUS can
declare dividends to HUSI, without regulatory approval, of approximately $1.6
billion, adjusted by the effect of net income (loss) for 2007 up to the date of
such dividend declaration. However, in determining the extent of dividends to
pay, HBUS must also consider the effect of dividend payments on applicable
risk-based capital and leverage ratio requirements, as well as policy statements
of federal regulatory agencies that indicate that banking organizations should
generally pay dividends out of current operating earnings.
HUSI filed a shelf registration statement with the Securities and Exchange
Commission in April 2006, under which it may issue debt securities, preferred
stock, either separately or represented by depositary shares, warrants, purchase
contracts and units. HUSI satisfies the eligibility requirements for designation
as a "well-known seasoned issuer", based on amended SEC rules regarding
registration, communications and offerings which took effect in December 2005.
During 2006, HUSI issued perpetual non-cumulative preferred stock totaling
approximately $.4 billion and $.1 billion senior debt from this shelf.
In December 2006, HBUS increased the size of its Global Bank Note Program from
$20 billion to $40 billion, which provides for issuance of subordinated and
senior notes. Borrowings from the Global Bank Note Program totaled $1.6 billion
in 2006. There is approximately $23 billion of availability remaining.
At December 31, 2006, HUSI also had a $2 billion back-up credit facility for
issuances of commercial paper.
76
Interest Rate Risk Management
HUSI is subject to interest rate risk associated with the repricing
characteristics of its balance sheet assets and liabilities. Specifically, as
interest rates change, amounts of interest earning assets and liabilities
fluctuate, and interest earning assets reprice at intervals that do not
correspond to the maturities or repricing patterns of interest bearing
liabilities. This mismatch between assets and liabilities in repricing
sensitivity results in shifts in net interest income as interest rates move. To
help manage the risks associated with changes in interest rates, and to manage
net interest income within ranges of interest rate risk that management
considers acceptable, HUSI uses derivative instruments such as interest rate
swaps, options, futures and forwards as hedges to modify the repricing
characteristics of specific assets, liabilities, forecasted transactions or firm
commitments.
The following table shows the repricing structure of assets and liabilities as
of December 31, 2006. For assets and liabilities whose cash flows are subject to
change due to movements in interest rates, such as the sensitivity of mortgage
loans to prepayments, data is reported based on the earlier of expected
repricing or maturity and reflects anticipated prepayments based on the current
rate environment. The resulting "gaps" are reviewed to assess the potential
sensitivity to earnings with respect to the direction, magnitude and timing of
changes in market interest rates. Data shown is as of year end, and one-day
figures can be distorted by temporary swings in assets or liabilities.
--------------------------------------------------------------------------------------------------------------
Within After One After Five After
One But Within But Within Ten
December 31, 2006 Year Five Years Ten Years Years Total
--------------------------------------------------------------------------------------------------------------
(in millions)
Commercial loans ........................... $ 26,316 $ 2,153 $ 855 $ 158 $ 29,482
Residential mortgages ...................... 19,417 16,692 2,483 1,216 39,808
Credit card receivables .................... 13,554 4,706 -- -- 18,260
Other consumer loans ....................... 1,424 1,252 11 -- 2,687
--------- ---------- ---------- --------- ---------
Total loans ........................... 60,711 24,803 3,349 1,374 90,237
--------- ---------- ---------- --------- ---------
Securities available for sale and securities
held to maturity ........................ 4,789 7,879 4,704 5,383 22,755
Other assets ............................... 51,255 3,860 850 -- 55,965
--------- ---------- ---------- --------- ---------
Total assets .......................... 116,755 36,542 8,903 6,757 168,957
--------- ---------- ---------- --------- ---------
Domestic deposits (1):
Savings and demand .................... 33,195 8,677 9,320 -- 51,192
Certificates of deposit ............... 15,173 815 90 184 16,262
Long-term debt ............................. 23,160 2,857 1,468 1,767 29,252
Other liabilities/equity ................... 62,419 8,976 332 524 72,251
--------- ---------- ---------- --------- ---------
Total liabilities and equity .......... 133,947 21,325 11,210 2,475 168,957
--------- ---------- ---------- --------- ---------
Total balance sheet gap ............... (17,192) 15,217 (2,307) 4,282 --
--------- ---------- ---------- --------- ---------
Effect of derivative contracts ............. 14,843 (12,484) (772) (1,587) --
--------- ---------- ---------- --------- ---------
Total gap position .................... $ (2,349) $ 2,733 $ (3,079) $ 2,695 $ --
========= ========== ========== ========= =========
(1) Does not include purchased or wholesale treasury deposits. The placement
of administered deposits such as savings and demand for interest rate risk
purposes reflects behavioral expectations associated with these balances.
Long-term core balances are differentiated from more fluid balances in an
effort to reflect anticipated shifts of non-core balances to other deposit
products or equities over time.
77
Various techniques are utilized to quantify and monitor risks associated with
the repricing characteristics of HUSI's assets, liabilities and derivative
contracts.
In the course of managing interest rate risk, Present Value of a Basis Point
(PVBP) analysis is utilized in conjunction with a combination of other risk
assessment techniques, including economic value of equity, dynamic simulation
modeling, capital risk and Value at Risk (VAR) analyses. The combination of
these tools enables management to identify and assess the potential impact of
interest rate movements and take appropriate action. This combination of
techniques, with some focusing on the impact of interest rate movements on the
value of the balance sheet (PVBP, economic value of equity, VAR) and others
focusing on the impact of interest rate movements on earnings (dynamic
simulation modeling) allows for comprehensive analyses from different
perspectives.
A key element of managing interest rate risk is the management of the convexity
of the balance sheet, largely resulting from the mortgage related products on
the balance sheet. Convexity risk arises as mortgage loan consumers change their
behavior significantly in response to large rate movements in market rates, but
do not change behavior appreciably for smaller changes in market rates. Certain
of the interest rate management tools described below, such as dynamic
simulation modeling and economic value of equity, better capture the embedded
convexity in the balance sheet, while measures such as PVBP are designed to
capture the risk of smaller changes in rates.
Refer to Market Risk Management, beginning on page 80 of this Form 10-K, for
commentary regarding the use of VAR analyses to monitor and manage interest rate
and other market risks.
The assessment techniques discussed below act as a guide for managing interest
rate risk associated with balance sheet composition and off-balance sheet
hedging strategy (the risk position). Calculated values within limit ranges
reflect an acceptable risk position, although possible future unfavorable trends
may prompt adjustments to on or off-balance sheet exposure. Calculated values
outside of limit ranges will result in consideration of adjustment of the risk
position, or consideration of temporary dispensation from making adjustments.
Present Value of a Basis Point (PVBP)
PVBP is the change in value of the balance sheet for a one basis point upward
movement in all interest rates. The following table reflects the PVBP position
at December 31, 2006.
--------------------------------------------------------------------------------
December 31, 2006 Values
--------------------------------------------------------------------------------
(in millions)
Institutional PVBP movement limit ............................... $ 7.5
PVBP position at period end ..................................... 2.1
Economic Value of Equity
Economic value of equity is the change in value of the assets and liabilities
(excluding capital and goodwill) for either a 200 basis point gradual rate
increase or decrease. The following table reflects the economic value of equity
position at December 31, 2006.
--------------------------------------------------------------------------------
December 31, 2006 Values (%)
--------------------------------------------------------------------------------
Institutional economic value of equity limit .................... +/- 20
Projected change in value (reflects projected rate movements on
January 1, 2007):
Change resulting from a gradual 200 basis point increase in
interest rates .......................................... (4)
Change resulting from a gradual 200 basis point decrease in
interest rates ................... ...................... (5)
The loss in value for a 200 basis point increase or decrease in rates is a
result of the negative convexity of the residential whole loan and mortgage
backed securities portfolios. If rates decrease, the projected prepayments
related to these portfolios will accelerate, causing less appreciation than a
comparable term, non-convex instrument. If rates increase, projected prepayments
will slow, which will cause the average lives of these positions to extend and
result in a greater loss in market value.
78
Dynamic Simulation Modeling
Various modeling techniques are utilized to monitor a number of interest rate
scenarios for their impact on net interest income. These techniques include both
rate shock scenarios which assume immediate market rate movements by as much as
200 basis points, as well as scenarios in which rates rise or fall by as much as
200 basis points over a twelve month period. The following table reflects the
impact on net interest income of the scenarios utilized by these modeling
techniques.
-----------------------------------------------------------------------------------------------------------
December 31, 2006 Amount %
-----------------------------------------------------------------------------------------------------------
($ in millions)
Projected change in net interest income (reflects projected rate movements on
January 1, 2007):
Institutional base earnings movement limit ........................................ (10)
Change resulting from a gradual 200 basis point increase in the yield curve ....... $ (146) (5)
Change resulting from a gradual 200 basis point decrease in the yield curve ....... 214 7
Change resulting from a gradual 100 basis point increase in the yield curve ....... (67) (2)
Change resulting from a gradual 100 basis point decrease in the yield curve ....... 99 3
Other significant scenarios monitored (reflects projected rate movements on
January 1, 2007):
Change resulting from an immediate 100 basis point increase in the yield curve .... (109) (4)
Change resulting from an immediate 100 basis point decrease in the yield curve .... 155 5
Change resulting from an immediate 200 basis point increase in the yield curve .... (236) (8)
Change resulting from an immediate 200 basis point decrease in the yield curve .... 196 6
The projections do not take into consideration possible complicating factors
such as the effect of changes in interest rates on the credit quality, size and
composition of the balance sheet. Therefore, although this provides a reasonable
estimate of interest rate sensitivity, actual results will vary from these
estimates, possibly by significant amounts.
Capital Risk/Sensitivity of Other Comprehensive Income
Large movements of interest rates could directly affect some reported capital
balances and ratios. The mark to market valuation of available for sale
securities is credited on a tax effective basis to accumulated other
comprehensive income. Although this valuation mark is excluded from Tier 1 and
Tier 2 capital ratios, it is included in two important accounting based capital
ratios: the tangible common equity to tangible assets and the tangible common
equity to risk weighted assets. As of December 31, 2006, HUSI had an available
for sale securities portfolio of approximately $20 billion with a net negative
mark to market of $298 million included in tangible common equity of $8 billion.
An increase of 25 basis points in interest rates of all maturities would lower
the mark to market by approximately $162 million to a net loss of $460 million
with the following results on the tangible capital ratios.
-----------------------------------------------------------------------------------------
Proforma - Reflecting
25 Basis Points
December 31, 2006 Actual Increase in Rates
-----------------------------------------------------------------------------------------
Tangible common equity to tangible assets .............. 4.83% 4.78%
Tangible common equity to risk weighted assets ......... 6.52 6.44
79
Market Risk Management
Value at Risk (VAR)
VAR analysis is used to estimate the potential losses that could occur on risk
positions as a result of movements in market rates and prices over a specified
time horizon and to a given level of confidence. VAR calculations are performed
for all material trading activities and as a tool for managing interest rate
risk inherent in non-trading activities. HUSI calculates VAR daily for a one-day
holding period to a 99% confidence level. At a 99% confidence level for a
two-year observation period, HUSI is setting as its limit the fifth worst loss
performance in the last 500 business days.
VAR - Overview
The VAR methodology used by HUSI is based on historical simulation. The
historical simulation model derives plausible future scenarios from historical
market rate data, taking account of inter-relationships between different
markets and rates, such as the relationship between interest rates and foreign
exchange rates. Potential movements in market prices are calculated with
reference to market data from the last two years. The model incorporates the
impact of option features in the underlying exposures.
For reporting purposes, in the second quarter of 2006, HUSI changed the assumed
holding period from a ten-day period to a one-day period as this reflects the
way HUSI manages its risk positions. Comparative VAR amounts have been restated
to reflect this change.
Although a valuable guide to risk, VAR should always be viewed in the context of
its limitations. For example:
o the use of historical data as a proxy for estimating future events may not
encompass all potential events, particularly those which are extreme in
nature;
o the use of a one-day holding period assumes that all positions can be
liquidated or hedged in one day. This may not fully reflect the market
risk arising at times of severe liquidity shortages, when a one-day
holding period may be insufficient to liquidate or hedge all positions
fully;
o the use of a 99% confidence level, by definition, does not take into
account losses that might occur beyond this level of confidence; and
o VAR is calculated on the basis of exposures outstanding at the close of
business and therefore does not necessarily reflect intra-day exposures.
VAR - Trading Activities
HUSI's management of market risk is based on restricting individual operations
to trading within a list of permissible instruments, and enforcing rigorous
approval procedures for new products. In particular, trading in the more complex
derivative products is restricted to offices with appropriate levels of product
expertise and robust control systems.
In addition, at both portfolio and position levels, market risk in trading
portfolios is monitored and controlled using a complementary set of techniques,
including VAR and various techniques for monitoring interest rate risk (refer to
pages 77-79 of this Form 10-K). These techniques quantify the impact on capital
of defined market movements.
Trading portfolios reside primarily within the Markets unit of the CIBM business
segment, which include warehoused residential mortgage loans purchased for
securitizations and within the mortgage banking subsidiary included within the
PFS business segment. Portfolios include foreign exchange, derivatives, precious
metals (gold, silver, platinum), equities and money market instruments including
"repos" and securities. Trading occurs as a result of customer facilitation,
proprietary position taking, and economic hedging. In this context, economic
hedging may include, for example, forward contracts to sell residential
mortgages and derivative contracts which, while economically viable, may not
satisfy the hedge requirements of Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS
133).
80
The trading portfolios have defined limits pertaining to items such as
permissible investments, risk exposures, loss review, balance sheet size and
product concentrations. "Loss review" refers to the maximum amount of loss that
may be incurred before senior management intervention is required.
The following table summarizes trading VAR for 2006.
-------------------------------------------------------------------------------------------------------
Full Year 2006
December 31, ------------------------------------------ December 31,
2006 Minimum Maximum Average 2005
-------------------------------------------------------------------------------------------------------
(in millions)
Total trading ....... $ 9 $ 8 $ 46 $ 18 $ 17
Precious metals ..... 2 -- (1) 5 1 2
Credit derivatives .. 4 3 13 6 6
Equities ............ -- (1) -- (1) 1 -- (1) -- (1)
Foreign exchange .... 2 1 7 2 1
Interest rate ....... 13 9 56 23 22
(1) Less than $500 thousand.
The following table summarizes the frequency distribution of daily market
risk-related revenues for Treasury trading activities during calendar year 2006.
Market risk-related Treasury trading revenues include realized and unrealized
gains (losses) related to Treasury trading activities, but exclude the related
net interest income. Analysis of the 2006 gain (loss) data shows that the
largest daily gain was $32 million and the largest daily loss was $14 million.
-----------------------------------------------------------------------------------------
Ranges of daily Treasury trading revenue
earned from market risk-related activities Below $(5) to $0 to $5 to Over
(in millions) $(5) $0 $5 $10 $10
-----------------------------------------------------------------------------------------
Number of trading days market risk-related
revenue was within the stated range ......... 30 48 73 56 43
VAR - Non-trading Activities
The principal objective of market risk management of non-trading portfolios is
to optimize net interest income. Market risk in non-trading portfolios arises
principally from mismatches between the future yield on assets and their funding
cost, as a result of interest rate changes. Analysis of this risk is complicated
by having to make assumptions on optionality in certain product areas, for
example, mortgage prepayments, and from behavioral assumptions regarding the
economic duration of liabilities which are contractually repayable on demand.
The prospective change in future net interest income from non-trading portfolios
will be reflected in the current realizable value of these positions, should
they be sold or closed prior to maturity. In order to manage this risk
optimally, market risk in non-trading portfolios is transferred to Global
Markets or to separate books managed under the supervision of ALCO. Once market
risk has been consolidated in Global Markets or ALCO-managed books, the net
exposure is typically managed through the use of interest rate swaps within
agreed-upon limits.
The following table summarizes non-trading VAR for 2006, assuming a 99%
confidence level for a two-year observation period and a one-day "holding
period".
--------------------------------------------------------------------------------------
Full Year 2006
December 31, ---------------------------------- December 31,
2006 Minimum Maximum Average 2005
--------------------------------------------------------------------------------------
(in millions)
Interest rate ........ $ 24 $ 19 $ 86 $ 47 $ 70
81
Trading Activities - HSBC Mortgage Corporation (USA)
HSBC Mortgage Corporation (USA) is HUSI's mortgage banking subsidiary. Trading
occurs in mortgage banking operations as a result of an economic hedging program
intended to offset changes in value of mortgage servicing rights and the salable
loan pipeline. Economic hedging may include, for example, forward contracts to
sell residential mortgages and derivative contracts used to protect the value of
MSRs.
MSRs are assets that represent the present value of net servicing income
(servicing fees, ancillary income, escrow and deposit float, net of servicing
costs). MSRs are separately recognized upon the sale of the underlying loans or
at the time that servicing rights are purchased. MSRs are subject to interest
rate risk, in that their value will decline as a result of actual and expected
acceleration of prepayment of the underlying loans in a falling interest rate
environment.
Interest rate risk is mitigated through an active hedging program that uses
trading securities and derivative instruments to offset changes in value of
MSRs. Since the hedging program involves trading activity, risk is quantified
and managed using a number of risk assessment techniques.
Rate Shock Analysis
Modeling techniques are used to monitor certain interest rate scenarios for
their impact on the economic value of net hedged MSRs, as reflected in the
following table.
---------------------------------------------------------------------------------------------------------
December 31, 2006 Value
---------------------------------------------------------------------------------------------------------
(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects projected rate
movements on January 1, 2007):
Value of hedged MSRs portfolio .................................................... $ 474
Change resulting from an immediate 50 basis point decrease in the yield curve:
Change limit (no worse than) ................................................... (16)
Calculated change in net market value .......................................... (4)
Change resulting from an immediate 50 basis point increase in the yield curve:
Change limit (no worse than) ................................................... (8)
Calculated change in net market value .......................................... 5
Change resulting from an immediate 100 basis point increase in the yield curve:
Change limit (no worse than) ................................................... (12)
Calculated change in net market value .......................................... 4
Economic Value of MSRs
The economic value of the net, hedged MSRs portfolio is monitored on a daily
basis for interest rate sensitivity. If the economic value declines by more than
established limits for one day or one month, various levels of management
review, intervention and/or corrective actions are required.
Hedge Volatility
The following table summarized the frequency distribution of the weekly economic
value of the MSR asset during calendar year 2006. This includes the change in
the market value of the MSR asset net of changes in the market value of the
underlying hedging positions used to hedge the asset. The changes in economic
value are adjusted for changes in MSR valuation assumptions that were made
during the course of the year.
------------------------------------------------------------------------------------------
Ranges of mortgage economic value from Below $(2) to $0 to $2 to Over
market risk-related activities (in millions) $(2) $0 $2 $4 $4
------------------------------------------------------------------------------------------
Number of trading weeks market risk-related
revenue was within the stated range .......... 8 17 17 7 3
82
Operational Risk
Operational risk is the risk of loss arising through fraud, unauthorized
activities, error, omission, inefficiency, system failure or from external
events. It is inherent in every business organization and covers a wide spectrum
of issues.
HUSI has established an independent Operational Risk Management discipline. The
Operational Risk Management Committee, chaired by the Executive Vice President -
Operations, is responsible for oversight of the operational risks being taken,
the analytic tools used to monitor those risks, and reporting. Results from this
Committee are communicated to the Risk Management Committee and subsequently to
the Audit Committee of the Board of Directors. Business unit line management is
responsible for managing and controlling all risks and for communicating and
implementing all control standards. A Corporate Operational Risk Coordinator
provides functional oversight by coordinating the following activities:
o maintaining a network of business line Operational Risk Coordinators;
o developing scoring and risk assessment tools and databases;
o providing training and developing awareness; and
o independently reviewing and reporting the assessments of operational
risks.
Management of operational risk includes identification, assessment, monitoring,
control and mitigation, rectification and reporting of the results of risk
events and compliance with local regulatory requirements. These key components
of the Operational Risk Management process have been communicated by issuance of
a high level standard. Key features within the standard that have been addressed
in HUSI's Operational Risk Management program include:
o each business and support department is responsible for the identification
and management of their operational risks;
o each risk is evaluated and scored by its likelihood to occur, its
potential impact on shareholder value and by exposure based on the
effectiveness of current controls to prevent or mitigate losses. An
operational risk automated database is used to record risk assessments and
track risk mitigation action plans. The risk assessments are reviewed at
least annually, or as business conditions change;
o key risk indicators are established where appropriate, and
monitored/tracked; and
o the database is also used to track operational losses for analysis of root
causes, comparison with risk assessments and lessons learned.
Management practices include standard monthly reporting to business line
managers, senior management and the Operational Risk Management Committee of
high risks, risk mitigation action plan exceptions, losses and key risk
indicators. Monthly certification of internal controls includes an operational
risk attestation. Operational Risk Management is an integral part of the new
product development process and the management performance measurement process.
An online certification process, attesting to the completeness and accuracy of
operational risk, is completed by senior business management on an annual basis.
Analysis of primary types of operational risks reflects a 60% concentration in
process risk. The remaining 40% is divided fairly equally between the other
three primary operational risk types - systems, people and external events. The
same percent distribution of primary operational risk types applies for the
higher or more critical operational risks. Within the process risk type, greater
than 75% of risk is concentrated within internal and external reporting and
payment/settlement/delivery risk.
Internal audits, including audits by specialist teams in information technology
and treasury, provide an important check on controls and test institutional
compliance with the Operational Risk Management policy.
An annual review of internal controls is conducted by internal audit as part of
HUSI's compliance with the Federal Deposit Insurance Corporation Improvement Act
(FDICIA) and its comprehensive examination and documentation of controls across
HUSI involving all business and support units.
83
Compliance Risk
Compliance risk is the risk arising from failure to comply with relevant laws,
regulations and regulatory requirements governing the conduct of specific
businesses. It is a composite risk that can result in regulatory sanctions,
financial penalties, litigation exposure and loss of reputation. Compliance risk
is inherent throughout the HUSI organization.
Consistent with HSBC's commitment to ensure adherence with applicable regulatory
requirements for all of its world-wide affiliates, HUSI has implemented a
multi-faceted Compliance Risk Management Program. This program addresses the
following priorities, among other issues:
o anti-money laundering (AML) regulations;
o fair lending laws;
o dealings with affiliates;
o the Community Reinvestment Act;
o permissible activities; and
o conflicts of interest.
Oversight of the Compliance Risk Management Program was provided by the Audit
Committee of the Board of Directors through the Risk Management Committee and,
through 2006, by its Compliance Risk Management Subcommittee. The effectiveness
of the overall compliance program was overseen and counsel was provided to line
and compliance management on major potential issues, strategic policy-making
decisions and reputational risk matters. Internal audit, through continuous
monitoring and periodic audits, tests the effectiveness of the overall
Compliance Risk Management Program.
The overall Corporate Compliance program elements include identification,
assessment, monitoring, control and mitigation of the risk and timely resolution
of the results of risk events. These functions are generally performed by line
management, with oversight provided by Corporate Compliance. Controls for
mitigating compliance risk are incorporated into business operating policies and
procedures. Processes are in place to ensure controls are appropriately updated
to reflect changes in regulatory requirements as well as changes in business
practices, including new or revised products, services and marketing programs. A
wide range of compliance training is provided to relevant staff, including
mandated programs for such areas as anti-money laundering, fair lending and
privacy.
The independent Corporate Compliance function is comprised of separate Corporate
Compliance units focusing on General Compliance and Anti-Money Laundering (AML)
compliance, as well as various compliance teams supporting specific business
units. The Corporate Compliance function is responsible for the following
activities:
o advising management on compliance matters;
o providing independent assessment, monitoring and review; and
o reporting compliance issues to HUSI senior management and Board of
Directors, as well as to HSBC Group Compliance.
The Corporate Compliance function has established a rigorous independent review
program which includes assessing the effectiveness of controls and testing for
adherence to compliance policies and procedures. The review program is executed
by centralized review teams and specialized business compliance officers who
work collaboratively to complement each others efforts.
84
Fiduciary Risk
Fiduciary risk is the risk associated with offering services honestly and
properly to clients in a fiduciary capacity in accordance with Regulation 12 CFR
9, Fiduciary Activity of National Banks. Fiduciary capacity is defined in the
regulation as:
o serving traditional fiduciary duties such as trustee, executor,
administrator, registrar of stocks and bonds, guardian, receiver or
assignee, or
o providing investment advice for a fee, or
o processing investment discretion on behalf of another.
Fiduciary risks, as defined above, reside in Private Banking businesses
(including Investment Management, Personal Trust, Custody, Middle Office
Operations) and other business lines outside of Private Banking (including
Retirement Financial Services and Corporate Trust). However, HUSI's Fiduciary
Risk Management infrastructure is also responsible for fiduciary risks
associated with certain SEC regulated Registered Investment Advisors (RIA),
which lie outside of the traditional regulatory fiduciary risk definition for
banks. The fiduciary risks present in both banking and RIA business lines almost
always occur where HUSI is entrusted to handle and execute client business
affairs and transactions in a fiduciary capacity. HUSI's policies and procedures
for addressing fiduciary risks generally address various risk categories
including suitability, conflicts, fairness, disclosure, fees, AML, operational,
safekeeping, efficiencies, etc.
Oversight for the Fiduciary Risk Management function falls to the Fiduciary Risk
Management Committee of the Risk Management Committee. This committee is chaired
by the Senior Executive Vice President - Private Banking and Wealth Management
and includes the Chief Risk Officer and the Senior Vice President - Fiduciary
Risk. The Senior Vice President - Fiduciary Risk is responsible for an
independent Fiduciary Risk Management Unit that is responsible for day to day
oversight of the Fiduciary Risk Management function. The main goals and
objectives of this unit include:
o development and implementation of control self assessments, which have
been completed for all fiduciary businesses;
o developing, tracking and collecting rudimentary key risk indicators (KRI),
and collecting data regarding errors associated with these risks. KRIs for
each fiduciary business are in the process of being expanded;
o designing, developing and implementing risk monitoring tools, approaches
and programs for the relevant business lines and senior management that
will facilitate the identification, evaluation, monitoring, measurement,
management and reporting of fiduciary risks. In this regard, a common
database is used for compliance, operational and fiduciary risks; and
o ongoing development and implementation of more robust and enhanced key
risk indicator/key performance indicator process with improved risk
focused reporting.
85
Business Continuity Planning
HUSI is committed to the protection of employees, customers and shareholders by
a quick response to all threats to the organization, whether they are of a
physical or financial nature. HUSI is governed by the HNAH Crisis Management
Framework, which provides an enterprise-wide response and communication approach
for managing major business continuity events or incidents. It is designed to be
flexible and is scaled to the scope and magnitude of the event or incident.
The Crisis Management Framework works in tandem with the HNAH Corporate
Contingency Planning Policy, business continuity plans and key business
continuity committees to manage events. The North American Crisis Management
Committee, a 24/7 standing committee, is activated to manage the Crisis
Management process in concert with senior HUSI management. This committee
provides critical strategic management of business continuity crisis issues,
risk management, communication, coordination and recovery management. Tactical
management of business continuity issues is handled by the Corporate and Local
Incident Response Teams in place at each major site. HUSI also has designated an
Institutional Manager for Business Continuity who plays a key role on the Crisis
Management Committee. All major business and support functions have a senior
representative assigned to HUSI's Business Continuity Planning Committee, which
is chaired by the Institutional Manager.
HUSI has dedicated certain work areas as hot and warm backup sites, which serve
as primary business recovery locations. HUSI has concentrations of major
operations in both upstate and downstate New York. This geographic split of
major operations is leveraged to provide secondary business recovery sites for
many critical business and support areas of HUSI. Remote working arrangements
are also a key component of HUSI's business continuity approach.
HUSI has built its own data center with the intention of developing the highest
level of resiliency for disaster recovery as defined by industry standards. Data
is mirrored synchronously to the disaster recovery site across duplicate dark
fiber loops. A high level of network backup resiliency has been established. In
a disaster situation, HUSI is positioned to bring main systems and server
applications online within predetermined timeframes.
HUSI tests business continuity and disaster recovery resiliency and capability
through routine contingency tests and actual events. Business continuity and
disaster recovery programs have been strengthened in numerous areas as a result
of these tests or actual events. There is a continuing effort to enhance the
program well beyond the traditional business resumption and disaster recovery
model.
In 2003, HUSI determined the applicability of the Interagency Paper on "Sound
Practices to Strengthen the Resiliency of the U.S. Financial System". HUSI has
met the requirements of the paper for the businesses impacted by the compliance
due date.
86
Glossary of Terms
--------------------------------------------------------------------------------
Balance Sheet Management - Represents HUSI's activities to manage interest rate
risk associated with the repricing characteristics of balance sheet assets and
liabilities.
Efficiency Ratio - Ratio of total operating expenses, reduced by minority
interests, to the sum of net interest income and other revenues.
Federal Reserve - the Federal Reserve Board; the principal regulator for HUSI.
Global Bank Note Program - $40 billion note program, under which HBUS issues
senior and subordinated debt.
Goodwill - Represents the excess of purchase price over the fair value of
identifiable net assets acquired, reduced by liabilities assumed, for business
combinations.
HBMD - HSBC National Bank (USA); a wholly-owned U.S. banking subsidiary of HUSI.
HBUS - HSBC Bank USA, National Association; HUSI's principal wholly-owned U.S.
banking subsidiary.
HMUS - HSBC Markets (USA) Inc.; an indirect wholly-owned subsidiary of HNAH, and
a holding company for investment banking and markets subsidiaries in the U.S.
HNAH - HSBC North America Holdings Inc.; a wholly-owned subsidiary of HSBC and
HSBC's top-tier bank holding company in North America.
HNAI - HSBC North America Inc.; an indirect wholly-owned subsidiary of HNAH.
HSBC - HSBC Holdings plc.; HNAH's U.K. parent company.
HSBC Affiliate - any direct or indirect subsidiary of HSBC outside of the HUSI
consolidated group of entities.
HSBC Finance Corporation - an indirect wholly-owned consumer finance company
subsidiary of HNAH.
HTCD - HSBC Trust Company (Delaware); a wholly-owned U.S. banking subsidiary of
HUSI.
HTSU - HSBC Technology & Services (USA) Inc.; an indirect wholly-owned
subsidiary of HNAH which provides information technology services to all
subsidiaries of HNAH and to other subsidiaries of HSBC.
HUSI - HSBC USA Inc.; the registrant, and a wholly-owned subsidiary of HNAI.
Intangible Assets - Assets (not including financial assets) that lack physical
substance. HUSI's acquired intangible assets include mortgage servicing rights
and favorable lease arrangements.
Mortgage Servicing Rights (MSRs) - Intangible assets representing the right to
service mortgage loans, which are recognized at the time the related loans are
sold or the rights are acquired.
Net Interest Margin to Earning Assets - Net interest income divided by average
interest earning assets for a given period.
Net Interest Margin to Total Assets - Net interest income divided by average
total assets for a given period.
Nonaccruing Loans - Loans for which interest is no longer accrued because
ultimate collection is unlikely.
OCC - the Office of the Comptroller of the Currency; the principal regulator for
HBUS.
87
Private Label Receivable Portfolio (PLRP) - Loan and credit card receivable
portfolio acquired from HSBC Finance Corporation on December 29, 2004.
Rate of Return on Common Shareholder's Equity - Net income, reduced by preferred
dividends, divided by average common shareholder's equity for a given period.
Rate of Return on Total Assets - Net income after taxes divided by average total
assets for a given period.
SEC - The Securities and Exchange Commission.
Total Average Shareholders' Equity to Total Assets - Average total shareholders'
equity divided by average total assets for a given period.
Total Period End Shareholders' Equity to Total Assets - Total shareholders'
equity divided by total assets as of a given date.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
--------------------------------------------------------------------------------
Refer to pages 77-82 in Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations, for commentary and analysis
regarding "Interest Rate Risk Management" and "Market Risk Management".
88
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89
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS
The following table shows the major consolidated assets, liabilities and
shareholders' equity, together with their respective interest amounts and rates
earned or paid on a taxable equivalent basis.
2006
-------------------------------------
Balance Interest Rate*
-------------------------------------
Assets
Interest bearing deposits with banks ....................................... $ 4,517 $ 225 4.98%
Federal funds sold and securities purchased under resale agreements ........ 10,326 526 5.10
Trading assets ............................................................. 10,893 418 3.84
Securities ................................................................. 22,177 1,145 5.16
Loans
Commercial .............................................................. 28,080 1,764 6.28
Consumer:
Residential mortgages ................................................ 41,826 2,200 5.26
Credit cards ......................................................... 15,987 1,329 8.31
Other consumer ....................................................... 2,960 279 9.42
----------- ----------- -------
Total consumer .......................................................... 60,773 3,808 6.27
----------- ----------- -------
Total loans ............................................................. 88,853 5,572 6.27
----------- ----------- -------
Other ...................................................................... 1,496 91 6.07
----------- ----------- -------
Total earning assets ....................................................... 138,262 $ 7,977 5.77%
----------- ----------- -------
Allowance for credit losses ................................................ (932)
Cash and due from banks .................................................... 3,977
Other assets ............................................................... 24,971
-----------
Total assets ............................................................... $ 166,278
===========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ........................................................ $ 34,910 $ 981 2.81%
Other time deposits ..................................................... 26,286 1,152 4.38
Deposits in foreign offices
Foreign banks deposits .................................................. 8,019 392 4.89
Other time and savings .................................................. 14,128 588 4.16
----------- ----------- -------
Total interest bearing deposits ............................................ 83,343 3,113 3.73
----------- ----------- -------
Short-term borrowings ...................................................... 10,880 300 2.76
Long-term debt ............................................................. 28,735 1,457 5.07
----------- ----------- -------
Total interest bearing liabilities ......................................... 122,958 4,870 3.96
----------- ----------- -------
Net interest income / Interest rate spread ................................. $ 3,107 1.81%
----------- -------
Noninterest bearing deposits ............................................... 12,869
Other liabilities .......................................................... 18,414
Total shareholders' equity ................................................. 12,037
-----------
Total liabilities and shareholders' equity ................................. $ 166,278
===========
Net interest margin on average earning assets .............................. 2.25%
-------
Net interest margin on average total assets ................................ 1.87%
=======
* Rates are calculated on unrounded numbers.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest for the
years ended December 31, 2006, 2005 and 2004 included fees of $53 million, $47
million and $78 million, respectively.
90
2005 2004
-------------------------------------- ----------------------------------
Balance Interest Rate* Balance Interest Rate*
---------------------------------------------------------------------------
(in millions)
Assets
Interest bearing deposits with banks ... $ 3,577 $ 120 3.35% $ 2,499 $ 41 1.66%
Federal funds sold and securities purchased
under resale agreements ............. 5,481 190 3.48 4,682 74 1.58
Trading assets ......................... 7,234 275 3.80 5,654 165 2.92
Securities ............................. 19,024 899 4.73 18,224 885 4.86
Loans
Commercial .......................... 24,192 1,233 5.10 19,919 831 4.17
Consumer:
Residential mortgages ............ 47,093 2,321 4.93 37,134 1,831 4.94
Credit cards ..................... 13,455 812 6.04 1,216 107 8.80
Other consumer ................... 3,158 264 8.36 2,059 143 6.93
------------ ----------- --------- ----------- ---------- --------
Total consumer ...................... 63,706 3,397 5.33 40,409 2,081 5.15
------------ ----------- --------- ----------- ---------- --------
Total loans ......................... 87,898 4,630 5.27 60,328 2,912 4.83
------------ ----------- --------- ----------- ---------- --------
Other .................................. 647 32 4.95 549 18 3.37
------------ ----------- --------- ----------- ---------- --------
Total earning assets ................... 123,861 $ 6,146 4.96% 91,936 $ 4,095 4.45%
------------ ----------- --------- ----------- ---------- --------
Allowance for credit losses ............ (910) (359)
Cash and due from banks ................ 3,717 3,275
Other assets ........................... 20,508 17,374
------------ -----------
Total assets ........................... $ 147,176 $ 112,226
============ ===========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits .................... $ 25,536 $ 318 1.25% $ 23,986 $ 179 0.75%
Other time deposits ................. 25,845 822 3.18 16,561 365 2.20
Deposits in foreign offices
Foreign banks deposits .............. 8,440 255 3.03 7,162 97 1.35
Other time and savings .............. 14,173 376 2.65 14,737 184 1.25
------------ ----------- --------- ----------- ---------- --------
Total interest bearing deposits ........ 73,994 1,771 2.39 62,446 825 1.32
------------ ----------- --------- ----------- ---------- --------
Short-term borrowings .................. 10,868 270 2.48 8,889 127 1.42
Long-term debt ......................... 25,274 1,025 4.06 10,086 385 3.82
------------ ----------- --------- ----------- ---------- --------
Total interest bearing liabilities ..... 110,136 3,066 2.78 81,421 1,337 1.64
------------ ----------- --------- ----------- ---------- --------
Net interest income / Interest rate spread $ 3,080 2.18% $ 2,758 2.81%
----------- --------- ---------- --------
Noninterest bearing deposits ........... 11,529 10,407
Other liabilities ...................... 13,957 12,341
Total shareholders' equity ............. 11,554 8,057
------------ -----------
Total liabilities and shareholders'
equity ................................. $ 147,176 $ 112,226
============ ===========
Net interest margin on average earning
assets ................................. 2.49% 3.00%
--------- --------
Net interest margin on average total
assets ................................. 2.09% 2.46%
========= ========
91
ITEM 8. Financial Statements and Supplementary Data
--------------------------------------------------------------------------------
Page
Report of Independent Registered Public Accounting Firm ................ 93
HSBC USA Inc.:
Consolidated Statement of Income .................................... 94
Consolidated Balance Sheet .......................................... 95
Consolidated Statement of Changes in Shareholders' Equity ........... 96
Consolidated Statement of Cash Flows ................................ 97
HSBC Bank USA, National Association:
Consolidated Balance Sheet .......................................... 98
Notes to Consolidated Financial Statements ............................. 99
92
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of HSBC USA Inc.:
We have audited the accompanying consolidated balance sheets of HSBC USA Inc.
and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2006,
and the accompanying consolidated balance sheets of HSBC Bank USA, N.A. and
subsidiaries (the Bank) as of December 31, 2006 and 2005. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2006 and 2005, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2006,
and the financial position of the Bank as of December 31, 2006 and 2005, in
conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
New York, New York
March 2, 2007
93
HSBC USA INC.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Year Ended December 31, 2006 2005 2004
------------------------------------------------------------------------------------------------------
(in millions)
Interest income:
Loans ........................................................ $ 5,572 $ 4,630 $ 2,912
Securities ................................................... 1,119 882 868
Trading assets ............................................... 418 275 165
Short-term investments ....................................... 751 310 115
Other ........................................................ 91 32 18
--------- --------- ----------
Total Interest Income ........................................... 7,951 6,129 4,078
--------- --------- ----------
Interest expense:
Deposits ..................................................... 3,113 1,771 825
Short-term borrowings ........................................ 300 270 127
Long-term debt ............................................... 1,457 1,025 385
--------- --------- ----------
Total interest expense .......................................... 4,870 3,066 1,337
--------- --------- ----------
Net interest income ............................................. 3,081 3,063 2,741
Provision (credit) for credit losses ............................ 823 674 (17)
--------- --------- ----------
Net interest income after provision for credit losses ........... 2,258 2,389 2,758
--------- --------- ----------
Other revenues:
Trust income ................................................. 88 87 95
Service charges .............................................. 204 195 196
Credit card fees ............................................. 580 323 82
Other fees and commissions ................................... 401 304 316
Securitization revenue ....................................... 18 114 --
HSBC affiliate income ........................................ 208 130 147
Other income ................................................. 184 193 230
Residential mortgage banking revenue (expense) ............... 96 64 (120)
Trading revenues ............................................. 755 395 288
Securities gains, net ........................................ 29 106 85
--------- --------- ----------
Total other revenues ............................................ 2,563 1,911 1,319
--------- --------- ----------
Operating expenses:
Salaries and employee benefits ............................... 1,300 1,052 947
Occupancy expense, net ....................................... 221 182 176
Support services from HSBC affiliates ........................ 1,076 919 420
Other expenses ............................................... 658 605 558
--------- --------- ----------
Total operating expenses ........................................ 3,255 2,758 2,101
--------- --------- ----------
Income before income tax expense ................................ 1,566 1,542 1,976
Income tax expense .............................................. 530 566 718
--------- --------- ----------
Net income ...................................................... $ 1,036 $ 976 $ 1,258
========= ========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
94
HSBC USA INC.
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31, 2006 2005
-------------------------------------------------------------------------------------------
(in millions)
Assets
Cash and due from banks ......................................... $ 3,359 $ 4,441
Interest bearing deposits with banks ............................ 2,320 3,001
Federal funds sold and securities purchased under resale
agreements ................................................... 13,775 4,568
Trading assets .................................................. 26,038 21,220
Securities available for sale ................................... 19,783 17,764
Securities held to maturity (fair value $3,040 and $3,262 at
December 31, 2006 and 2005, respectively ..................... 2,972 3,171
Loans ........................................................... 90,237 90,342
Less - allowance for credit losses .............................. 897 846
--------- ---------
Loans, net ................................................. 89,340 89,496
--------- ---------
Properties and equipment, net ................................... 540 538
Intangible assets ............................................... 521 463
Goodwill ........................................................ 2,716 2,694
Other assets .................................................... 7,593 6,503
--------- ---------
Total assets .................................................... $ 168,957 $ 153,859
========= =========
Liabilities
Deposits in domestic offices:
Noninterest bearing .......................................... $ 12,813 $ 12,040
Interest bearing ............................................. 63,942 55,566
Deposits in foreign offices:
Noninterest bearing .......................................... 727 320
Interest bearing ............................................. 27,068 23,889
--------- ---------
Total deposits ............................................ 104,550 91,815
--------- ---------
Trading liabilities ............................................. 14,046 10,710
Short-term borrowings ........................................... 5,073 6,367
Interest, taxes and other liabilities ........................... 3,775 3,778
Long-term debt .................................................. 29,252 29,595
--------- ---------
Total liabilities ............................................... 156,696 142,265
--------- ---------
Shareholders' equity
Preferred stock ................................................. 1,690 1,316
Common shareholder's equity:
Common stock ($5 par; 150,000,000 shares authorized;
706 shares issued and outstanding) ........................... -- (1) -- (1)
Capital surplus ................................................. 8,124 8,118
Retained earnings ............................................... 2,661 2,172
Accumulated other comprehensive loss ............................ (214) (12)
--------- ---------
Total common shareholder's equity ............................ 10,571 10,278
--------- ---------
Total shareholders' equity ...................................... 12,261 11,594
--------- ---------
Total liabilities and shareholders' equity ...................... $ 168,957 $ 153,859
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
95
HSBC USA INC.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' EQUITY
2006 2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Preferred stock
Balance, January 1 ................................................. $ 1,316 $ 500 $ 500
Preferred stock issuances, net of redemptions (see Note 18) ........ 374 816 --
--------- -------- --------
Balance, December 31, .............................................. 1,690 1,316 500
--------- -------- --------
Common stock
Balance, January 1 and December 31, ................................ -- (1) -- (1) -- (1)
--------- -------- --------
Capital surplus
Balance, January 1, ................................................ 8,118 8,418 6,027
Capital contribution from parent ................................... 15 3 2,411
Preferred stock issuance costs (see Note 18) ....................... (9) (22) --
Employee benefit plans and other ................................... -- (281) (20)
--------- -------- --------
Balance, December 31, .............................................. 8,124 8,118 8,418
--------- -------- --------
Retained earnings
Balance, January 1, ................................................ 2,172 1,917 807
Net income ......................................................... 1,036 976 1,258
Cash dividends declared on preferred stock ......................... (88) (46) (23)
Cash dividends declared on common stock ............................ (455) (675) (125)
Cumulative effect of change in accounting for mortgage servicing
assets (see Notes 6 and 11) ..................................... (4) -- --
--------- -------- --------
Balance, December 31, .............................................. 2,661 2,172 1,917
--------- -------- --------
Accumulated other comprehensive income
Balance, January 1, ................................................ (12) 31 128
Increase in net unrealized losses on securities, net of tax ........ (71) (149) (40)
(Decrease) increase in net unrealized gains on derivatives
classified as cash flow hedges, net of tax ....................... (106) 104 (58)
(Decrease) increase in net unrealized gains on interest only
strip receivables, net of tax .................................... (7) 7 --
Foreign currency translation adjustments, net of tax ............... -- (1) (5) 1
--------- -------- --------
Other comprehensive loss, net of tax ............................... (184) (43) (97)
Cumulative effect of change in accounting for pension and
postretirement benefits (see Note 23), net of tax ............... (18) -- --
--------- -------- --------
Balance, December 31, .............................................. (214) (12) 31
--------- -------- --------
Total shareholders' equity, december 31, ........................... $ 12,261 $ 11,594 $ 10,866
========= ======== ========
Comprehensive income
Net income ......................................................... $ 1,036 $ 976 $ 1,258
Other comprehensive loss, net of tax ............................... (184) (43) (97)
--------- -------- --------
Comprehensive income ............................................... $ 852 $ 933 $ 1,161
========= ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
96
HSBC USA INC.
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31, 2006 2005 2004
-------------------------------------------------------------------------------------------------------------
(in millions)
Cash flows from operating activities
Net income ......................................................... $ 1,036 $ 976 $ 1,258
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation, amortization and deferred taxes .................... 503 442 428
Provision (credit) for credit losses ............................. 823 674 (17)
Net change in other assets and liabilities ....................... 29 495 (1,444)
Net change in loans held for sale to HSBC Markets (USA) Inc.
(HMUS):
Loans acquired from originators ................................ (16,089) (5,061) --
Sales of loans to HMUS ......................................... 15,867 2,188 --
Net change in other loans held for sale .......................... 63 63 (427)
Net change in loans attributable to tax refund anticipation
loans program:
Originations of loans .......................................... (16,100) (15,100) --
Sales of loans to HSBC Finance Corporation, including
premium ...................................................... 15,888 15,100 --
Net change in trading assets and liabilities ..................... (2,255) (2,774) (3,267)
Net change in fair value of derivatives and hedged items ......... 689 (248) 166
--------- -------- --------
Net cash provided by (used in) operating activities ............ 454 (3,245) (3,303)
--------- -------- --------
Cash flows from investing activities
Net change in interest bearing deposits with banks ................. 681 (225) (1,933)
Net change in federal funds sold and securities purchased under
resale agreements ................................................ (9,207) (1,442) (680)
Net change in securities available for sale:
Purchases of securities available for sale ....................... (8,043) (12,301) (11,311)
Proceeds from sales of securities available for sale ............. 2,611 3,825 5,868
Proceeds from maturities of securities available for sale ........ 3,203 4,273 5,578
Net change in securities held to maturity:
Purchases of securities held to maturity ......................... (166) (694) (1,190)
Proceeds from maturities of securities held to maturity .......... 364 1,401 1,815
Net change in loans:
Originations, net of collections ................................. 23,083 19,405 (19,482)
Loans purchased from HSBC Finance Corporation .................... (23,908) (23,084) (16,227)
Net cash used for acquistions of properties and equipment .......... (81) (29) (11)
Net change in other investments and related accounts ............... (193) (240) (255)
--------- -------- --------
Net cash used in investing activities .......................... (11,656) (9,111) (37,828)
--------- -------- --------
Cash flows from financing activities
Net change in deposits ............................................. 12,735 11,834 16,546
Net change in short-term borrowings ................................ (1,293) (2,936) 2,811
Net change in long-term debt:
Issuance of long-term debt ....................................... 6,860 6,127 20,762
Repayment of long-term debt ...................................... (8,019) (706) (1,083)
Preferred stock issuance, net of issuance costs .................... 365 794 --
Other increases in capital surplus ................................. 15 (278) 2,391
Dividends paid ..................................................... (543) (720) (148)
--------- -------- --------
Net cash provided by financing activities ...................... 10,120 14,115 41,279
--------- -------- --------
Net change in cash and due from banks ................................. (1,082) 1,759 148
Cash and due from banks at beginning of year .......................... 4,441 2,682 2,534
--------- -------- --------
Cash and due from banks at end of year ................................ $ 3,359 $ 4,441 $ 2,682
========= ======== ========
Cash paid for: Interest ............................................... $ 4,811 $ 2,785 $ 1,195
Income taxes ........................................... 504 566 569
The accompanying notes are an integral part of the consolidated financial
statements.
Pending settlement receivables/payables related to securities and trading assets
and liabilities are treated as non-cash items for cash flow reporting.
97
HSBC BANK USA, NATIONAL ASSOCIATION
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
December 31, 2006 2005
-----------------------------------------------------------------------------------------------------
(in millions)
Assets
Cash and due from banks ................................................... $ 3,297 $ 4,440
Interest bearing deposits with banks ...................................... 2,193 2,917
Federal funds sold and securities purchased under resale agreements ....... 13,704 4,562
Trading assets ............................................................ 24,751 19,807
Securities available for sale ............................................. 19,500 17,548
Securities held to maturity (fair value $2,926 and $3,126)
December 31, 2006 and 2005, respectively .................................. 2,864 3,044
Loans ..................................................................... 90,125 90,214
Less - allowance for credit losses ........................................ 894 845
---------- ----------
Loans, net ............................................................. 89,231 89,369
---------- ----------
Properties and equipment, net ............................................. 538 536
Intangible assets ......................................................... 521 462
Goodwill .................................................................. 2,111 2,090
Other assets .............................................................. 6,963 5,904
---------- ----------
Total assets .............................................................. $ 165,673 $ 150,679
========== ==========
Liabilities
Deposits in domestic offices:
Noninterest bearing .................................................... $ 12,818 $ 12,002
Interest bearing ....................................................... 63,878 55,566
Deposits in foreign offices:
Noninterest bearing .................................................... 727 320
Interest bearing ....................................................... 29,842 27,160
---------- ----------
Total deposits ....................................................... 107,265 95,048
---------- ----------
Trading liabilities ....................................................... 14,033 10,644
Short-term borrowings ..................................................... 2,698 3,383
Interest, taxes and other liabilities ..................................... 3,253 3,167
Long-term debt ............................................................ 26,166 26,549
---------- ----------
Total liabilities ......................................................... 153,415 138,791
---------- ----------
Shareholder's equity
Common shareholder's equity:
Common stock ($100 par; 50,000 shares authorized; 20,005 and 20,004
shares issued and outstanding) ....................................... 2 2
Capital surplus ........................................................ 10,124 9,709
Retained earnings ...................................................... 2,348 2,192
Accumulated other comprehensive loss ................................... (216) (15)
---------- ----------
Total shareholder's equity ................................................ 12,258 11,888
---------- ----------
Total liabilities and shareholder's equity ................................ $ 165,673 $ 150,679
========== ==========
98
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization
--------------------------------------------------------------------------------
HSBC USA Inc., incorporated under the laws of Maryland, is a New York State
based bank holding company, and an indirect wholly owned subsidiary of HSBC
North America Holdings Inc. (HNAH). HSBC USA Inc. and its subsidiaries are
collectively referred to as "HUSI".
HNAH is an indirect wholly owned subsidiary of HSBC Holdings plc (HSBC).
Effective January 1, 2004, HSBC created a new North American organizational
structure, HNAH, as the top-tier bank holding company parent. HUSI routinely
conducts transactions in the normal course of business with HNAH's other
principal direct and indirect subsidiaries, which include:
o HSBC Finance Corporation, a consumer finance company;
o HSBC Bank USA, National Association (HBUS), HUSI's principal banking
subsidiary;
o HSBC Bank Canada (HBCA), a Canadian banking subsidiary;
o HSBC Markets (USA) Inc. (HMUS), a holding company for investment banking
and markets subsidiaries in the U.S.; and
o HSBC Technology & Services (USA) Inc. (HTSU), a provider of information
technology services for other HNAH subsidiaries and to other subsidiaries
of HSBC.
On July 1, 2004, HUSI consolidated its then existing banking operations under a
single national charter, following approval from the Office of the Comptroller
of the Currency (the OCC).
Note 2. Summary of Significant Accounting Policies and New Accounting
Pronouncements
--------------------------------------------------------------------------------
Significant Accounting Policies
Basis of Presentation
The accounting and reporting policies of HUSI conform to accounting principles
generally accepted in the United States of America (U.S. GAAP). The preparation
of financial statements in conformity with U.S. GAAP requires the use of
estimates and assumptions that affect reported amounts in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Certain reclassifications have been made to prior year amounts to
conform with the current year's presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of HUSI and its
subsidiaries. HUSI consolidates subsidiaries in which it holds, directly or
indirectly, more than 50% of the voting rights, or where it exercises control.
HUSI, in the ordinary course of business, makes use of Variable Interest Entity
(VIE) structures in a variety of business activities, primarily to facilitate
client needs. VIE structures are utilized after careful consideration of the
most appropriate structure needed to achieve HUSI's control and risk management
objectives and to help ensure an efficient and appropriate structure from a
regulatory and taxation perspective.
HUSI determines whether a VIE should be consolidated by evaluating if it is the
primary beneficiary of the VIE as defined by Financial Accounting Standards
Board Interpretation No. 46 (Revised) (FIN 46R). The primary beneficiary
generally maintains control over the VIE, and will generally receive the
majority of the risks and rewards of the assets of the VIE. Based upon this
assessment, HUSI has determined that it is the primary beneficiary of certain
VIEs, and has therefore consolidated these VIEs into its consolidated financial
statements.
99
Unaffiliated trusts to which HUSI has transferred securitized receivables which
are qualifying special purpose entities (QSPEs), as defined by Statement of
Financial Accounting Standards No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities (SFAS 140), are not
consolidated.
All material intercompany accounts and transactions have been eliminated.
Investments in companies in which the percentage of ownership is at least 20%,
but not more than 50%, are generally accounted for under the equity method and
reported as equity method investments in other assets.
Foreign Currency Translation
HUSI has foreign operations in several countries. The accounts of HUSI's foreign
operations are measured using local currency as the functional currency. Assets
and liabilities are translated into United States dollars at the rate of
exchange in effect on the balance sheet date. Income and expenses are translated
at average monthly exchange rates. Net exchange gains or losses resulting from
such translation are included in common shareholder's equity as a component of
accumulated other comprehensive income. Foreign currency denominated
transactions in other than the local functional currency are translated using
the period end exchange rate with any foreign currency transaction gain or loss
recognized currently in income.
Cash and Cash Equivalents
For the purpose of reporting cash flows, cash and cash equivalents include cash
on hand and amounts due from banks.
Resale and Repurchase Agreements
HUSI enters into purchases and borrowings of securities under agreements to
resell (resale agreements) and sales of securities under agreements to
repurchase (repurchase agreements) substantially identical securities. Resale
agreements and repurchase agreements are generally accounted for as secured
lending and secured borrowing transactions, respectively.
The amounts advanced under resale agreements and the amounts borrowed under
repurchase agreements are carried on the consolidated balance sheet at the
amount advanced or borrowed, plus accrued interest to date. Interest earned on
resale agreements is reported as interest income. Interest paid on repurchase
agreements is reported as interest expense. HUSI offsets resale and repurchase
agreements executed with the same counterparty under legally enforceable netting
agreements that meet the applicable netting criteria as permitted by U.S. GAAP.
Repurchase agreements may require HUSI to deposit cash or other collateral with
the lender. In connection with resale agreements, it is the policy of HUSI to
obtain possession of collateral, which may include the securities purchased,
with market value in excess of the principal amount loaned. The market value of
the collateral subject to the resale and repurchase agreements is regularly
monitored, and additional collateral is obtained or provided when appropriate,
to ensure appropriate collateral coverage of these secured financing
transactions.
Collateral
HUSI pledges assets as collateral as required for various transactions involving
security repurchase agreements, public deposits, Treasury tax and loan notes,
derivative agreements, short-term borrowings and long-term borrowings. Assets
that have been pledged as collateral, including those that can be sold or
repledged by the secured party, continue to be reported on HUSI's consolidated
balance sheet.
HUSI also accepts collateral, primarily as part of various transactions
involving security resale agreements. Collateral accepted by HUSI, including
collateral that can be sold or repledged by HUSI, is excluded from HUSI's
consolidated balance sheet.
100
The market value of collateral accepted or pledged by HUSI is regularly
monitored and additional collateral is obtained or provided as necessary to
ensure appropriate collateral coverage in these transactions.
Trading Assets and Liabilities
Financial instruments utilized in trading activities are stated at fair value.
Fair value is generally based on quoted market prices. If quoted market prices
are not available, fair values are estimated based on dealer quotes, pricing
models or quoted prices for instruments with similar characteristics. Realized
and unrealized gains and losses are recognized in trading revenues.
Securities
Debt securities that HUSI has the ability and intent to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of
discounts which are recognized as adjustments to yield over the expected lives
of the related securities. Securities acquired principally for the purpose of
selling them in the near term are classified as trading assets and reported at
fair value with unrealized gains and losses included in earnings.
Equity securities that are not quoted on a recognized exchange are not
considered to have a readily determinable fair value, and are recorded at cost,
less any provisions for impairment. Unquoted equity securities, which include
Federal Home Loan Bank (FHLB) stock, Federal Reserve Bank (FRB) stock and
MasterCard Class B securities, are recorded in other assets.
All other securities are classified as available for sale and carried at fair
value, with unrealized gains and losses, net of related income taxes, recorded
as adjustments to common shareholder's equity as a component of accumulated
other comprehensive income.
The fair value of securities is based on current market quotations where
available, or internal valuation models that approximate market pricing. The
validity of internal pricing models is regularly substantiated by reference to
actual market prices realized upon sale or liquidation of these instruments.
Realized gains and losses on sales of securities not classified as trading
assets are computed on a specific identified cost basis and are reported in
other revenues as security gains, net. HUSI regularly evaluates its securities
to identify declines in fair value that are considered other than temporary. Any
decline in the fair value of investments which is deemed to be other than
temporary is charged against current earnings in other revenues and a new cost
basis is established for the security. Fair value adjustments to trading
securities and gains and losses on the sale of such securities are reported in
other revenues as trading revenues.
Loans
Loans are stated at their amortized cost, which represents the principal amount
outstanding, net of unearned income, charge offs, unamortized purchase premium
or discount, unamortized nonrefundable fees and related direct loan origination
costs and purchase accounting fair value adjustments. Loans are further reduced
by the allowance for credit losses.
Loans held for sale are carried at the lower of aggregate cost or market value
and remain presented as loans in the consolidated balance sheet. Fair market
value is determined based on quoted fair market prices for similar loans,
outstanding investor commitments or discounted cash flow analysis using market
assumptions. Increases in the valuation allowance utilized to adjust loans held
for sale to market value, and subsequent recoveries of prior allowances
recorded, are recorded in other income in the consolidated income statement.
Premiums and discounts, including purchase accounting fair value adjustments on
receivables, are recognized as adjustments to yield over the expected lives of
the related loans. Interest income is recorded based on methods that result in
level rates of return over the terms of the loans.
101
Restructured loans are loans for which the original contractual terms have been
permanently modified to provide for terms that are less than HUSI would be
willing to accept for new loans with comparable risk because of deterioration in
the borrower's financial condition. Interest on these loans is accrued at the
renegotiated rates.
Loan Charge Off Policies and Practices
Commercial loan balances are charged off at the time all or a portion of the
balance is deemed uncollectible.
Consumer loan charge off policies, which vary by product, are summarized below.
Residential Mortgage Loans
Carrying values in excess of net realizable value are charged off at or before
the time foreclosure is completed or when settlement is reached with the
borrower. If foreclosure is not pursued, and there is no reasonable expectation
for recovery, the account is generally charged off no later than the end of the
month in which the account becomes six months contractually delinquent.
Auto Finance
Carrying values in excess of net realizable value are generally charged off no
later than the month in which the account becomes four months contractually
delinquent.
MasterCard/Visa and Private Label Credit Card Loans
Loan balances are generally charged off by the end of the month in which the
account becomes six months contractually delinquent.
Other Consumer Loans
Loan balances are generally charged off the month following the month in which
the account becomes four months contractually delinquent.
Nonaccruing Loan Policies and Practices
HUSI's nonaccruing policies vary by product and are summarized below.
Commercial
Commercial loans are categorized as nonaccruing when, in the opinion of
management, reasonable doubt exists with respect to the ultimate collectibility
of interest or principal based on certain factors including period of time past
due and adequacy of collateral. At the time a loan is classified as nonaccruing,
any accrued interest recorded on the loan is generally deemed uncollectible and
charged against income. Interest income on these loans is subsequently
recognized only to the extent of cash received or until the loan is placed on
accrual status. In those instances where there is doubt as to collectibility of
principal, any interest payments received are applied to principal. Loans are
not reclassified as accruing until interest and principal payments are brought
current and future payments are reasonably assured.
Consumer
Residential mortgage loans are generally designated as nonaccruing when
contractually delinquent for more than three months. Credit card receivables and
other consumer loans generally accrue interest until charge off.
102
Loan Fees and Costs
Nonrefundable fees and related direct costs associated with the origination of
loans are deferred and netted against outstanding loan balances. The
amortization of net deferred fees, which include points on real estate secured
loans and costs, is recognized in interest income, generally by the interest
method, based on the estimated or contractual lives of the related loans.
Amortization periods are periodically adjusted for loan prepayments and changes
in other market assumptions. MasterCard/Visa annual fees, net of direct lending
costs, are deferred and amortized on a straight-line basis over one year.
Nonrefundable fees related to lending activities other than direct loan
origination are recognized as other revenues over the period in which the
related service is provided. This includes fees associated with the issuance of
loan commitments where the likelihood of the commitment being exercised is
considered remote. In the event of the exercise of the commitment, the remaining
unamortized fee is recognized in interest income over the loan term using the
interest method. Other credit-related fees, such as standby letter of credit
fees, loan syndication and agency fees are recognized as other operating income
over the period the related service is performed. Net deferred costs totaled
$356 million at December 31, 2006 and $402 million at December 31, 2005.
Allowance for Credit Losses
HUSI maintains an allowance for credit losses that is, in the judgment of
management, adequate to absorb estimated probable losses of principal, interest
and fees inherent in its commercial and consumer loan portfolios. The adequacy
of the allowance for credit losses is assessed within the context of appropriate
U.S. GAAP guidance, and is based, in part, upon an evaluation of various factors
including:
o an analysis of individual exposures where applicable;
o current and historical loss experience;
o changes in the overall size and composition of the portfolio; and
o specific adverse situations and general economic conditions.
HUSI also assesses the overall adequacy of the allowance by considering key
ratios such as reserves to nonperforming loans and reserves as a percentage of
net charge offs in developing its loss reserve estimates. Loss estimates are
reviewed periodically and adjustments are reported in earnings when they become
known. These estimates are influenced by factors outside of the control of HUSI
management, such as consumer payment patterns and economic conditions, and there
is uncertainty inherent in these estimates, making it reasonably possible that
they could change.
For commercial and select consumer loan assets, HUSI conducts a periodic
assessment on a loan-by-loan basis of losses it believes to be inherent in the
loan portfolio. When it is deemed probable, based upon known facts and
circumstances, that full contractual interest and principal on an individual
loan will not be collected in accordance with its contractual terms, the loan is
considered impaired. An impairment reserve is established based upon the present
value of expected future cash flows, discounted at the loan's original effective
interest rate, or as a practical expedient, the loan's observable market price
or the fair value of the collateral if the loan is collateral dependent.
Generally, impaired loans include loans in nonaccruing status, loans which have
been assigned a specific allowance for credit losses, loans which have been
partially charged off, and loans designated as troubled debt restructures.
Problem commercial loans are assigned various criticized facility grades under
the allowance for credit losses methodology.
103
Formula-based reserves are also established against commercial loans when, based
upon an analysis of relevant data, it is probable that a loss has been incurred
and the amount of that loss can be reasonably estimated, even though an actual
loss has yet to be identified. A separate reserve for credit losses associated
with off-balance sheet exposures including letters of credit, guarantees to
extend credit and financial guarantees is also maintained and included in other
liabilities, which incorporates estimates of the probability that customers will
actually draw upon off-balance sheet obligations. This estimation 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. These reserves are determined by reference to
continuously monitored and updated historical loss rates or factors, derived
from a migration analysis which considers net charge off experience by loan and
industry type in relation to internal credit grading.
Probable losses for pools of homogeneous consumer loans are generally estimated
using a roll rate migration analysis that estimates the likelihood that a loan
will progress through the various stages of delinquency, or buckets, and
ultimately charge off. This analysis considers delinquency status, loss
experience and severity and takes into account whether loans are in bankruptcy,
have been restructured, rewritten, or are subject to forbearance, an external
debt management plan, hardship, modification, extension or deferment. The
allowance for credit losses on consumer receivables also takes into
consideration the loss severity expected based on the underlying collateral, if
any, for the loan in the event of default. In addition, loss estimates on
consumer receivables are maintained to reflect HUSI's judgment of portfolio risk
factors, which may not be fully reflected in the statistical roll rate
calculation. Risk factors considered in establishing loss reserves on consumer
loans include recent growth, product mix, bankruptcy trends, geographic
concentrations, economic conditions, portfolio seasoning, account management
policies and practices and current levels of charge offs and delinquencies.
Repossessed Collateral
Real estate owned with the intent to sell within a reasonable period is
classified as held for sale at the date of foreclosure and is valued at the
lower of cost or fair value less estimated costs to sell and recorded in other
assets. These values are periodically reviewed and reduced, if necessary. Costs
of holding real estate and related gains and losses on disposition are credited
or charged to operations as incurred as a component of operating expense.
Properties and Equipment, Net
Properties and equipment are recorded at cost, net of accumulated depreciation.
Depreciation is recorded on a straight-line basis over the estimated useful
lives of the related assets, which generally range from 3 to 40 years. Leasehold
improvements are depreciated over the lesser of the economic useful life of the
improvement or the term of the lease. Costs of maintenance and repairs are
expensed as incurred.
Mortgage Servicing Rights
Effective January 1, 2006, upon adoption of SFAS 156 (refer to New Accounting
Pronouncements on page 109), mortgage servicing rights (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. Prior to
January 1, 2006, MSRs were recorded at the lower of cost or fair value as
required by previous accounting requirements.
MSRs are subject primarily 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.
104
HUSI uses certain derivative financial instruments including options and
interest rate swaps to protect against the decline in economic value of MSRs.
These instruments have not been designated as qualifying hedges in accordance
with U.S. GAAP guidelines and are therefore recorded as trading instruments that
are marked to market through earnings.
Goodwill
Goodwill, representing the excess of purchase price over the fair value of
identifiable net assets acquired, results from purchase business combinations.
Goodwill is not amortized, but is reviewed for impairment annually using a
discounted cash flow methodology. Impairment may be reviewed earlier if
circumstances indicate that the carrying amount may not be recoverable. HUSI
considers significant and long-term changes in industry and economic conditions
to be primary indicators of potential impairment.
Receivables Sold and Serviced with Limited Recourse and Securitization
Revenue
Certain private label credit card receivables have been securitized and sold to
investors with limited recourse. Recourse is limited to HUSI's rights to future
cash flow and any subordinated interest that HUSI may retain. Upon sale, the
receivables are removed from the balance sheet and a gain on sale is recognized
for the difference between the carrying value of the receivables and the
adjusted sales proceeds. The adjusted sales proceeds include cash received and
the present value estimate of future cash flows to be received over the lives of
the sold receivables. Future cash flows are based on estimates of prepayments,
the impact of interest rate movements on yields of receivables and securities
issued, delinquency of receivables sold, servicing fees and other factors. The
resulting gain is also adjusted by a provision for estimated probable losses
under the recourse provision. This provision, and the related reserve for
receivables serviced with limited recourse, are established at the time of sale
to cover all probable credit losses over the life of the receivables sold based
on historical experience and estimates of expected future performance. The
methodologies vary depending upon the type of receivables sold, using either
historical net charge off rates applied to the expected balances to be received
over the remaining life of the receivable or a historical static pool analysis.
The reserves are reviewed periodically by evaluating the estimated future cash
flows of each securitized pool to ensure that there is sufficient remaining cash
flow to cover estimated future credit losses. Any changes to the estimates for
the reserve for receivables serviced with limited recourse are made in the
period they become known. Gains on sales net of recourse provisions, servicing
income and excess spread relating to securitized receivables are reported in the
accompanying consolidated statement of income as securitization revenue.
In connection with these transactions, HUSI records an interest-only strip
receivable, representing HUSI's contractual right to receive interest and other
cash flows from the securitization trusts. HUSI's interest-only strip
receivables are reported at fair value using discounted cash flow estimates as a
separate component of receivables net of HUSI's estimate of probable losses
under the recourse provisions. Cash flow estimates include estimates of
prepayments, the impact of interest rate movements on yields of receivables and
securities issued, delinquency of receivables sold, servicing fees and estimated
probable losses under the recourse provisions. Unrealized gains and losses are
recorded as adjustments to common shareholder's equity in accumulated other
comprehensive income, net of income taxes. The interest-only strip receivables
are reviewed for impairment quarterly or earlier if events indicate that the
carrying value may not be recovered. Any decline in the fair value of the
interest-only strip receivable which is deemed to be other than temporary is
charged against current earnings.
HUSI has also, in certain cases, retained other subordinated interests in these
securitizations. Neither the interest-only strip receivables nor the other
subordinated interests are in the form of securities.
Prior to the third quarter of 2004, private label credit card collateralized
funding transactions were structured as sales to revolving trusts that required
replenishments to support previously issued securities. Since the third quarter
of 2004, all new collateralized funding transactions have been structured as
secured financings.
HUSI has also continued to replenish, at reduced levels, certain non-public
private label securities issued to conduits in order to manage liquidity.
105
Income Taxes
HNAH files a consolidated federal income tax return, which includes HUSI.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as the estimated future tax consequences attributable to net
operating loss and tax credit carryforwards. These deferred tax assets and
liabilities are measured using the tax rates and laws that are expected to be in
effect. A valuation allowance is established if, based on available evidence, it
is more likely than not that some portion or all of the deferred tax asset will
not be realized. Foreign taxes paid are applied as credits to reduce federal
income taxes payable, to the extent that such credits can be utilized.
Derivative Financial Instruments
Derivative financial instruments are recognized on the balance sheet at their
fair value. On the date a derivative contract is entered into, HUSI designates
it as either:
o a qualifying hedge of the fair value of a recognized asset or liability or
of an unrecognized firm commitment (fair value hedge);
o a qualifying hedge of the variability of cash flows to be received or paid
related to a recognized asset, liability or forecasted transaction (cash
flow hedge); or
o as a trading or non-qualifying hedge.
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 that is attributable to the hedged risk (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, to the extent effective as a hedge, are recorded in accumulated
other comprehensive income, net of income taxes, and reclassified into earnings
in the period during which the hedged item affects earnings. Ineffectiveness is
reflected in current earnings. Changes in the fair value of derivatives held for
trading purposes or which do not qualify for hedge accounting are reported in
current period earnings.
At the inception of each hedge, HUSI formally documents all relationships
between hedging instruments and hedged items, as well as its risk management
objective and strategy for undertaking various hedge transactions, the nature of
the hedged risk, and how hedge effectiveness and ineffectiveness will be
measured. This process includes linking all derivatives that are designated as
fair value or cash flow hedges to specific assets and liabilities on the balance
sheet or to specific firm commitments or forecasted transactions. HUSI also
formally assesses, both at inception and on a recurring basis, whether the
derivatives that are used in hedging transactions are highly effective in
offsetting changes in fair values or cash flows of hedged items and whether they
are expected to continue to be highly effective in future periods. This
assessment is conducted using statistical regression analysis.
Earnings volatility may result from the on-going mark to market of certain
economically viable derivative contracts that do not satisfy the hedging
requirements under U.S. GAAP, as well as from the hedge ineffectiveness
associated with the qualifying contracts.
106
Embedded Derivatives
HUSI may acquire or originate a financial instrument that contains a derivative
instrument "embedded" within it. Upon origination or acquisition of any such
instrument, HUSI assesses whether the economic characteristics of the embedded
derivative are clearly and closely related to the economic characteristics of
the principal component of the financial instrument (i.e., the host contract)
and whether a separate instrument with the same terms as the embedded instrument
would meet the definition of a derivative instrument. With the adoption of
Statement of Financial Accounting Standards No. 155, Accounting for Certain
Hybrid Financial Instruments (SFAS 155), the election now exists to account for
an entire financial instrument at fair value through profit and loss if the
financial instrument contains an embedded derivative that would otherwise
require bifurcation. Hybrid financial instruments that HUSI has elected to carry
at fair value continue to be reported in their existing balance sheet
classification.
When it is determined that: (1) the embedded derivative possesses economic
characteristics that are not clearly and closely related to the economic
characteristics of the host contract; and (2) a separate instrument with the
same terms would qualify as a derivative instrument, the embedded derivative is
either separated from the host contract (bifurcated), carried at fair value, and
designated as a trading instrument or the entire financial instrument is carried
at fair value with all changes in fair value recorded to current period
earnings. If bifurcation is elected, any gain recognized at inception related to
the derivative is effectively embedded in the host contract and is recognized
over the life of the financial instrument.
Hedge Discontinuation
HUSI discontinues hedge accounting prospectively when:
o the derivative is no longer effective or expected to be effective in
offsetting changes in the fair value or cash flows of a hedged item
(including firm commitments or forecasted transactions);
o the derivative expires or is sold, terminated, or exercised;
o it is unlikely that a forecasted transaction will occur;
o the hedged firm commitment no longer meets the definition of a firm
commitment; or
o the designation of the derivative as a hedging instrument is no longer
appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value or cash flow hedge,
the derivative will continue to be carried on the balance sheet at fair value.
In the case of a fair value hedge of a recognized asset or liability, as long as
the hedged item continues to exist on the balance sheet, the hedged item will no
longer be adjusted for changes in fair value. The basis adjustment that had
previously been recorded to the hedged item during the period from the
designation date to the hedge discontinuation date is recognized as an
adjustment to the yield of the hedged item over the remaining life of the hedged
item.
In the case of a cash flow hedge of a recognized asset or liability, as long as
the hedged item continues to exist on the balance sheet, the effective portion
of the changes in fair value of the hedging derivative will no longer be
reclassified into other comprehensive income. The balance applicable to the
discontinued hedging relationship will be recognized in earnings over the
remaining life of the hedged item as an adjustment to yield. If the hedged item
was a firm commitment or forecasted transaction that is not expected to occur,
any amounts recorded on the balance sheet related to the hedged item, including
any amounts recorded in other comprehensive income, are reclassified to current
period earnings.
In the case of either a fair value hedge or a cash flow hedge, if the previously
hedged item is sold or extinguished, the basis adjustment to the underlying
asset or liability or any remaining unamortized other comprehensive income
balance will be reclassified to current period earnings.
In all other situations in which hedge accounting is discontinued, the
derivative will be carried at fair value on the balance sheet, with changes in
its fair value recognized in current period earnings unless redesignated as a
qualifying hedge.
107
Day One Revenue Recognition
HUSI recognizes gains and losses at the inception of derivative transactions
only when the fair value of the transaction can be verified to similar market
transactions or if all significant pricing model assumptions can be verified to
observable market data. If profit or loss is not recognized at inception due to
market observability, the net unrealized gain or loss associated with these
transactions is recorded in trading and is offset by a reserve until the
transaction can be verified to observable market data.
Interest Rate Lock and Purchase Agreements
HUSI enters into commitments to originate residential mortgage loans whereby the
interest rate on the loan is set prior to funding (rate lock commitments). HUSI
also enters into commitments to purchase residential mortgage loans through its
correspondent channel (purchase commitments). Both rate lock and purchase
commitments for residential mortgage loans that are classified as held for sale
are considered to be derivatives. Rate lock and purchase commitments that are
considered to be derivatives are recorded at fair value in other assets or other
liabilities in the consolidated balance sheet. Changes in fair value are
recorded in other income in the consolidated statement of income.
Pension and Other Post-Retirement Benefits
At December 31, 2006, as a result of the adoption of SFAS 158 (see New
Accounting Pronouncements on the following page), HUSI recognized the funded
status of pension and other post retirement benefits on the balance sheet with
the offset to accumulated other comprehensive income. Prior to 2006, the funded
status of these plans was not recognized on the balance sheet. Net pension and
post-retirement benefit cost charged to current earnings related to these plans
is based on various actuarial assumptions regarding expected future experience.
Certain HUSI employees are participants in various defined contribution and
other non-qualified supplemental retirement plans. HUSI's contributions to these
plans are charged to current earnings.
Through various subsidiaries, HUSI maintains various 401(k) plans covering
substantially all employees. Employer contributions to the plan, which are
charged to current earnings, are based on employee contributions.
Stock-Based Compensation
HUSI uses the fair value method of accounting for stock awards granted to
employees under various stock option and employee stock purchase plans. Stock
compensation costs are recognized prospectively for all new awards granted under
these plans. Compensation expense relating to share options is calculated using
a binomial lattice methodology that is based on the underlying assumptions of
the Black-Scholes option pricing model and is charged to expense over the
vesting period, generally three to five years. When modeling awards with vesting
dependent on performance targets, these performance targets are incorporated
into the model using Monte Carlo simulation. The expected life of these awards
depends on the behavior of the award holders, which is incorporated into the
model consistent with historic observable data.
Compensation expense relating to restricted stock rights (RSRs) is based upon
the market value of the RSRs on the date of grant and is charged to earnings
over the vesting period of the RSRs, generally three to five years.
Transactions With Related Parties
In the normal course of business, HUSI enters into transactions with HSBC and
its subsidiaries. These transactions occur at prevailing market rates and terms
and include funding arrangements, administrative and operational support, and
other miscellaneous services. All material related party balances and
transactions among various direct and indirect subsidiaries of HUSI are
eliminated in consolidation.
108
New Accounting Pronouncements
During 2006, the following additional accounting pronouncements were adopted.
Effective January 1, 2006, HUSI adopted Statement of Financial Accounting
Standards No. 123 (Revised), Share-Based Payment, (SFAS 123R). Because HUSI had
previously adopted the fair value method of accounting for all equity based
awards, the adoption of SFAS 123R did not have a material impact on HUSI's
financial position or results of operations.
Effective January 1, 2006, HUSI adopted Statement of Financial Accounting
Standards No. 154, Accounting Changes and Error Corrections: a replacement of
APB Opinion No. 20 and FASB Statement No. 3 (SFAS 154). The adoption of SFAS 154
did not have any impact on HUSI's financial position or results of operations.
In February 2006, the FASB issued Statement of Financial Accounting Standards
No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155). SFAS
155 permits companies to elect to measure at fair value entire financial
instruments containing embedded derivatives that would otherwise have to be
bifurcated and accounted for separately. SFAS 155 also requires companies to
identify interests in securitized financial assets that are free standing
derivatives or contain embedded derivatives that would have to be accounted for
separately, clarifies which interest-only and principal-only strip receivables
are subject to Statement of Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities (SFAS 133), and amends
Statement of Financial Accounting Standards No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140)
to revise the conditions of a qualifying special purpose entity. SFAS 155 is
effective for all financial instruments acquired or issued after the beginning
of a company's first fiscal year that begins after September 15, 2006. Early
adoption is permitted as of the beginning of a company's fiscal year, provided
the company has not yet issued financial statements for that fiscal year. HUSI
elected to early adopt SFAS 155 effective January 1, 2006. The adoption of SFAS
155 did not have a material impact on HUSI's financial position or results of
operations.
In March 2006, the FASB issued Statement of Financial Accounting Standards No.
156, Accounting for Servicing of Financial Assets (SFAS 156). SFAS 156 amends
previously issued guidance with respect to accounting for separately recognized
loan servicing rights. HUSI early adopted this standard as of January 1, 2006
and elected to account for residential mortgage servicing rights at fair value
prospectively. Refer to Notes 6 and 11 of the consolidated financial statements
for information relating to the adoption of SFAS 156.
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 158, Employer's Accounting for Defined Benefit Pension and Other
Postretirement Plans (SFAS 158). SFAS 158 requires balance sheet recognition of
the funded status of pension and other postretirement benefits with the offset
to accumulated other comprehensive income. Employers will recognize actuarial
gains and losses, prior service cost, and any remaining transition amounts when
recognizing a plan's funded status. SFAS 158 is effective for fiscal years
ending after December 15, 2006. The adoption of SFAS 158 did not have a material
impact on HUSI's financial position or results of operations.
In September 2006, the United States Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements (SAB 108). SAB 108 addresses how the effects of prior year
uncorrected misstatements should be considered when quantifying misstatements in
current year financial statements. SAB 108 requires companies to quantify
misstatements using both the balance sheet and income statement approaches and
to evaluate whether either approach results in quantifying an error that is
material in light of relevant quantitative and qualitative factors. SAB 108 is
effective for fiscal years ending after November 15, 2006. The adoption of SAB
108 did not have any impact on HUSI's financial position or results of
operations.
109
The following additional accounting pronouncements were issued in 2006 and 2007
and will be effective for HUSI in future periods.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48). FIN 48
establishes threshold and measurement attributes for financial statement
measurement and recognition of tax positions taken or expected to be taken in a
tax return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. FIN 48 is effective for fiscal years beginning after December 15,
2006. The adoption of FIN 48 on January 1, 2007 did not have a material impact
on HUSI's financial position or results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, Fair Value Measurements (SFAS 157). SFAS 157 establishes a single
authoritative definition of fair value, sets out a framework for measuring fair
value, and requires additional disclosures about fair value measurements. SFAS
157 is effective for fiscal years beginning after November 15, 2007 and interim
periods within those years. Early application is permissible only if no annual
or interim financial statements have been issued for the earlier periods. HUSI
is currently evaluating the impact that adoption of SFAS 157 will have on its
financial position and results of operations.
In December 2006, the FASB issued proposed FASB Staff Position No. FIN 39-a,
Amendment of FASB Interpretation No. 39 (Proposed FSP FIN39-a). Proposed FSP FIN
39-a would allow entities that are party to a master netting arrangement to
offset the receivable or payable recognized upon payment or receipt of cash
collateral against fair value amounts recognized for derivative instruments that
have been offset under the same master netting arrangement in accordance with
FASB Interpretation No. 39. The guidance in this proposed FSP will be effective
for fiscal years beginning after December 15, 2006. Entities will be required to
recognize the effects of applying this FSP as a change in accounting principle
through retrospective application for all financial statements presented unless
it is impracticable to do so. HUSI is currently evaluating the impact that
adoption will have on its financial position.
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, The Fair Value Option for Financial Assets and Financial Liabilities
(SFAS 159), which creates an alternative measurement method for certain
financial assets and liabilities. SFAS 159 permits fair value to be used for
both the initial and subsequent measurements on a contract-by-contract election,
with changes in fair value to be recognized in earnings as those changes occur.
This election is referred to as the "fair value option". SFAS 159 also requires
additional disclosures to compensate for the lack of comparability that will
arise from the use of the fair value option. SFAS 159 is effective for fiscal
years beginning after November 15, 2007, with early adoption permitted as of the
beginning of a company's fiscal year, provided the company has not yet issued
financial statements for that fiscal year. HUSI is currently evaluating the
impact the adoption of SFAS 159 will have on its financial position and results
of operations.
Note 3. Acquisitions and Divestitures
--------------------------------------------------------------------------------
2006 and 2005
There were no material business acquisitions or divestitures during 2006 or
2005.
2004
On December 29, 2004, HUSI purchased approximately $12 billion of private label
loans, primarily credit card receivables, from HSBC Finance Corporation at fair
value. HSBC Finance Corporation retained the customer relationships associated
with these balances. This portfolio acquisition resulted in creation of the
Consumer Finance business segment in 2005. See Note 24 beginning page 147 of
this Form 10-K for a summary of HUSI's results by business segment.
110
Note 4. Federal Funds Sold and Securities Purchased Under Resale Agreements
--------------------------------------------------------------------------------
Federal funds sold and securities borrowed or purchased under agreements to
resell are summarized in the following table.
--------------------------------------------------------------------------------
December 31 2006 2005
--------------------------------------------------------------------------------
(in millions)
Federal funds sold ...................................... $ 6,781 $ --
Securities purchased under agreements to resell ......... 6,994 4,568
------- -------
Total ................................................... $13,775 $ 4,568
======= =======
Funds generated from deposits growth during 2006 were primarily invested in
short-term investments such as Federal funds sold and securities purchased under
resale agreements.
Note 5. Trading Assets and Liabilities
--------------------------------------------------------------------------------
Trading assets and liabilities are summarized in the following table.
--------------------------------------------------------------------------------
December 31 2006 2005
--------------------------------------------------------------------------------
(in millions)
Trading assets:
U.S. Treasury ...................................... $ 646 $ 148
U.S. Government agency ............................. 1,902 1,238
Asset backed securities ............................ 3,053 1,981
Corporate bonds .................................... 1,420 2,786
Other securities ................................... 4,903 4,626
Precious metals .................................... 2,716 2,286
Fair value of derivatives .......................... 11,398 8,155
-------- --------
$ 26,038 $ 21,220
======== ========
Trading liabilities:
Securities sold, not yet purchased ................. $ 1,914 $ 1,808
Payables for precious metals ....................... 1,336 1,161
Fair value of derivatives .......................... 10,796 7,741
-------- --------
$ 14,046 $ 10,710
======== ========
111
Note 6. Securities
--------------------------------------------------------------------------------
At December 31, 2006 and 2005, HUSI held no securities of any single issuer
(excluding the U.S. Treasury, U.S. Government sponsored enterprises and U.S.
Government agencies) with a book value that exceeded 10% of shareholders'
equity. The amortized cost and fair value of the available for sale and held to
maturity securities portfolios are summarized in the following table.
----------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2006 Cost Gains Losses Value
----------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ........................................... $ 1,535 $ 3 $ (8) $ 1,530
U.S. Government sponsored enterprises (1) ............... 10,682 30 (257) 10,455
U.S. Government agency issued or guaranteed ............. 3,793 6 (72) 3,727
Obligations of U.S. states and political subdivisions ... 515 4 (1) 518
Asset backed securities ................................. 578 1 (3) 576
Other domestic debt securities .......................... 1,343 3 (19) 1,327
Foreign debt securities ................................. 860 7 (3) 864
Equity securities ....................................... 775 11 -- 786
---------- ---------- ---------- ----------
Securities available for sale ........................... $ 20,081 $ 65 $ (363) $ 19,783
========== ========== ========== ==========
Securities held to maturity:
U.S. Treasury ........................................... $ -- $ -- $ -- $ --
U.S. Government sponsored enterprises (1) ............... 1,845 43 (17) 1,871
U.S. Government agency issued or guaranteed ............. 584 25 (2) 607
Obligations of U.S. states and political subdivisions ... 325 19 -- 344
Other domestic debt securities .......................... 167 2 (2) 167
Foreign debt securities ................................. 51 -- -- 51
---------- ---------- ---------- ----------
Securities held to maturity ............................. $ 2,972 $ 89 $ (21) $ 3,040
========== ========== ========== ==========
(1) Includes primarily mortgage backed securities issued by the Federal
National Mortgage Association (FNMA) and the Federal Home Loan Mortgage
Corporation (FHLMC).
----------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2005 Cost Gains Losses Value
----------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ........................................... $ 711 $ -- $ (4) $ 707
U.S. Government sponsored enterprises (1) ............... 10,850 25 (251) 10,624
U.S. Government agency issued or guaranteed ............. 2,466 10 (48) 2,428
Obligations of U.S. states and political subdivisions ... 487 -- (5) 482
Asset backed securities ................................. 1,165 2 (4) 1,163
Other domestic debt securities .......................... 1,700 6 (15) 1,691
Foreign debt securities ................................. 611 8 (5) 614
Equity securities ....................................... 49 6 -- 55
---------- ---------- ---------- ----------
Securities available for sale ........................... $ 18,039 $ 57 $ (332) $ 17,764
========== ========== ========== ==========
Securities held to maturity:
U.S. Treasury ........................................... $ 83 $ -- $ -- $ 83
U.S. Government sponsored enterprises (1) ............... 1,860 57 (21) 1,896
U.S. Government agency issued or guaranteed ............. 644 31 (1) 674
Obligations of U.S. states and political subdivisions ... 369 25 -- 394
Other domestic debt securities .......................... 164 1 (1) 164
Foreign debt securities ................................. 51 -- -- 51
---------- ---------- ---------- ----------
Securities held to maturity ............................. $ 3,171 $ 114 $ (23) $ 3,262
========== ========== ========== ==========
(1) Includes primarily mortgage backed securities issued by the FNMA and
FHLMC.
112
HUSI adopted Statement of Financial Accounting Standards No. 156, Accounting for
Servicing of Financial Assets (SFAS 156) effective January 1, 2006 (refer to New
Accounting Pronouncements on page 109 of this Form 10-K). In accordance with
SFAS 156, HUSI elected to reclassify securities used to offset changes in
economic value of mortgage servicing rights from the available for sale
portfolio to trading assets at the effective date. At December 31, 2005, these
securities had an amortized cost of $115 million and a fair value of $111
million. The cumulative effect of $4 million was recorded as an adjustment to
retained earnings in 2006.
A summary of gross unrealized losses and related fair values, classified as to
the length of time the losses have existed, is presented in the following table.
------------------------------------------------------------------------------------------------------------------------
One Year or Less Greater Than One Year
--------------------------------------- ---------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
December 31, 2006 Securities Losses of Investment Securities Losses of Investment
------------------------------------------------------------------------------------------------------------------------
($ in millions)
Securities available for sale:
U.S. Treasury ................... 8 $ (1) $ 527 6 $ (7) $ 566
U.S. Government sponsored
enterprises (1) .............. 211 (114) 3,158 482 (143) 5,042
U.S. Government agency
issued or guaranteed ......... 691 (40) 2,334 268 (32) 1,076
Obligations of U.S. states and
political subdivisions ....... 12 (1) 85 3 * 27
Asset backed securities ......... 6 * 81 19 (3) 293
Other domestic debt securities .. 10 (1) 153 56 (18) 910
Foreign debt securities ......... 6 (1) 191 11 (2) 227
---------- ---------- ------------- ---------- ---------- -------------
Securities available for sale ... 944 $ (158) $ 6,529 845 $ (205) $ 8,141
========== ========== ============= ========== ========== =============
Securities held to maturity:
U.S. Treasury ................... -- $ -- $ -- -- $ -- $ --
U.S. Government sponsored
enterprises (1) .............. 23 * 15 22 (17) 389
U.S. Government agency
issued or guaranteed ......... 49 * 21 169 (2) 35
Obligations of U.S. states and
political subdivisions ....... 1 * * 9 * 4
Other domestic debt securities .. 2 * 22 4 (2) 33
Foreign debt securities ......... 2 * 51 -- -- --
---------- ---------- ------------- ---------- ---------- -------------
Securities held to maturity ..... 77 $ * $ 109 204 $ (21) $ 461
========== ========== ============= ========== ========== =============
(1) Includes primarily mortgaged-backed securities issued by FNMA and FHLMC.
* Less than $500 thousand.
113
------------------------------------------------------------------------------------------------------------------------
One Year or Less Greater Than One Year
--------------------------------------- ---------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
December 31, 2005 Securities Losses of Investment Securities Losses of Investment
------------------------------------------------------------------------------------------------------------------------
($ in millions)
Securities available for sale:
U.S. Treasury ................... 7 $ (4) $ 619 -- $ -- $ --
U.S. Government sponsored
enterprises (1) .............. 560 (176) 7,313 46 (75) 1,434
U.S. Government agency
issued or guaranteed ......... 288 (22) 1,346 82 (26) 434
Obligations of U.S. states and
political subdivisions ....... 61 (5) 436 -- -- --
Asset backed securities ......... 22 (4) 464 31 * 23
Other domestic debt securities .. 6 (14) 1,089 7 (1) 34
Foreign debt securities ......... 17 (5) 336 1 * 25
---------- ---------- ------------- ---------- ---------- -------------
Securities available for sale ... 961 $ (230) $ 11,603 167 $ (102) $ 1,950
========== ========== ============= ========== ========== =============
Securities held to maturity:
U.S. Treasury ................... 3 $ * $ 83 -- $ -- $ --
U.S. Government sponsored
enterprises (1) .............. 28 (14) 397 3 (7) 41
U.S. Government agency
issued or guaranteed ......... 181 (1) 34 -- -- --
Obligations of U.S. states and
political subdivisions ....... 2 * * 10 * 4
Other domestic debt securities 4 * 33 2 (1) 5
Foreign debt securities ......... 2 * 51 -- -- --
---------- ---------- ------------- ---------- ---------- -------------
Securities held to maturity ..... 220 $ (15) $ 598 15 $ (8) $ 50
========== ========== ============= ========== ========== =============
(1) Includes primarily mortgage-backed securities issued by FNMA and FHLMC.
* Less than $500 thousand.
Gross unrealized losses have increased within the available for sale securities
portfolio during 2006, due to changes in interest rates. Since substantially all
of these securities are high credit grade (i.e., AAA or AA), and HUSI has the
ability and intent to hold these securities until maturity or a market price
recovery, they are not considered to be other than temporarily impaired.
114
The following table summarizes realized gains and losses on investment
securities transactions attributable to available for sale and held to maturity
securities. Amounts in the table include net realized (losses) gains of $(11)
million and $8 million reported in residential mortgage banking revenue in the
consolidated statement of income for 2005 and 2004, respectively.
-----------------------------------------------------------------------------------
Net
Gross Gross Realized
Realized Realized Gains
Year Ended December 31 Gains (Losses) (Losses)
-----------------------------------------------------------------------------------
(in millions)
2006
Securities available for sale .................... $ 34 $ (6) $ 28
Securities held to maturity:
Maturities, calls and mandatory redemptions ... 1 -- 1
-------- -------- --------
$ 35 $ (6) $ 29
======== ======== ========
2005
Securities available for sale .................... $ 107 $ (13) $ 94
Securities held to maturity:
Maturities, calls and mandatory redemptions ... 1 -- 1
-------- -------- --------
$ 108 $ (13) $ 95
======== ======== ========
2004
Securities available for sale .................... $ 100 $ (8) $ 92
Securities held to maturity:
Maturities, calls and mandatory redemptions ... 1 -- 1
-------- -------- --------
$ 101 $ (8) $ 93
======== ======== ========
The amortized cost and fair values of securities available for sale and
securities held to maturity at December 31, 2006, by contractual maturity are
summarized in the following table. Expected maturities differ from contractual
maturities because borrowers have the right to prepay obligations without
prepayment penalties in certain cases. Available for sale amounts exclude equity
securities with a fair value of $786 million ($775 million cost) that do not
have stated maturities.
115
The following table also reflects the distribution of maturities of debt
securities held at December 31, 2006, together with the approximate taxable
equivalent yield of the portfolio. The yields shown are calculated by dividing
annual interest income, including the accretion of discounts and the
amortization of premiums, by the amortized cost of securities outstanding at
December 31, 2006. Yields on tax-exempt obligations have been computed on a
taxable equivalent basis using applicable statutory tax rates.
------------------------------------------------------------------------------------------------------------------------
Within After One After Five After
One But Within But Within Ten
Taxable Year Five Years Ten Years Years
Equivalent ---------------- ----------------- ------------------ ------------------
Basis Amount Yield Amount Yield Amount Yield Amount Yield
------------------------------------------------------------------------------------------------------------------------
($ in millions)
Available for sale:
U.S. Treasury ..................... $ 225 4.09% $ 1,187 4.41% $ 123 4.38% $ -- --%
U.S. Government sponsored
enterprises ..................... 50 2.63 582 3.56 852 4.76 9,198 4.89
U.S. Government agency issued or
guaranteed ...................... * 7.00 320 6.07 35 5.21 3,438 4.92
Obligations of U.S. states
and political subdivisions ...... -- -- -- -- 6 5.34 509 5.03
Asset backed securities ........... 1 5.96 329 3.95 159 4.92 89 5.33
Other domestic debt securities .... 21 5.96 63 4.23 44 5.02 1,215 5.14
Foreign debt securities ........... 152 6.57 200 5.79 242 6.08 266 7.62
------- ------- -------- --------
Total amortized cost ................ $ 449 4.86% $ 2,681 4.47% $ 1,461 4.98% $ 14,715 4.97%
======= ======= ======== ========
Total fair value .................... $ 448 $ 2,656 $ 1,429 $ 14,464
======= ======= ======== ========
Held to maturity:
U.S. Treasury ..................... $ -- --% $ -- --% $ -- --% $ -- --%
U.S. Government sponsored
enterprises ..................... 3 7.00 8 7.34 93 6.10 1,741 5.90
U.S. Government agency issued or
guaranteed ...................... 1 7.10 9 6.97 4 8.65 570 6.49
Obligations of U.S. states and
political subdivisions .......... 14 6.95 46 5.82 45 5.00 220 5.16
Other domestic debt securities .... -- -- -- -- -- -- 167 5.80
Foreign debt securities ........... 51 3.22 -- -- -- -- -- --
------- ------- -------- --------
Total amortized cost ................ $ 69 4.16% $ 63 6.19% $ 142 5.83% $ 2,698 5.96%
======= ======= ======== ========
Total fair value .................... $ 69 $ 66 $ 149 $ 2,756
======= ======= ======== ========
* Less than $500 thousand.
Investments in Federal Home Loan Bank (FHLB) stock, Federal Reserve Bank (FRB)
stock, and MasterCard Class B securities of $360 million, $306 million and $57
million, respectively, were included in other assets at December 31, 2006.
Investments in FHLB and FRB stock of $360 million and $292 million,
respectively, were included in other assets at December 31, 2005.
116
Note 7. Loans
--------------------------------------------------------------------------------
A distribution of the loan portfolio, including loans held for sale, is
summarized in the following table.
-----------------------------------------------------------------------------------------------------------------
2006 2005
------------------------------- --------------------------------
Total Held for Sale Total Held for Sale
Loans Included in Total Loans Included in Total
-----------------------------------------------------------------------------------------------------------------
(in millions)
Commercial:
Construction and other real estate ..... $ 8,918 $ 102 $ 9,122 $ 68
Other commercial ....................... 20,564 -- 18,596 --
---------- ----------------- ----------- -----------------
29,482 102 27,718 68
---------- ----------------- ----------- -----------------
Consumer:
Residential mortgage ................... 39,808 4,227 43,986 4,107
Credit card receivables ................ 18,260 -- 15,514 --
Other consumer loans ................... 2,687 394 3,124 390
---------- ----------------- ----------- -----------------
60,755 4,621 62,624 4,497
---------- ----------------- ----------- -----------------
Total loans ............................... $ 90,237 $ 4,723 $ 90,342 $ 4,565
========== ================= =========== =================
In December 2004, HUSI acquired a $12 billion private label loan portfolio from
HSBC Finance Corporation. The portfolio consisted of approximately $11 billion
of private label credit card receivables and $1 billion of other consumer and
commercial loans. The customer relationships were retained by HSBC Finance
Corporation. By agreement, HUSI is purchasing additional credit card receivables
generated from customer accounts at fair value on a daily basis. During 2006 and
2005, underlying customer balances included within the private label portfolio
have revolved, and new relationships have been added, bringing the total private
label credit card portfolio balance to approximately $17 billion at December 31,
2006.
Higher quality nonconforming residential mortgage loans were acquired from
originating lenders pursuant to HSBC Finance Corporation correspondent loan
programs from December 2003 until September 2005. Purchases of these loans were
discontinued as a result of strategic balance sheet initiatives to enhance
HUSI's liquidity position and to address interest rate risk.
Residential mortgage loan originations generally declined during 2006 and 2005
due to a rising interest rate environment. In addition, originations of various
adjustable rate residential mortgage loan products that would have been retained
on the balance sheet prior to 2005 were being sold in the secondary market
beginning in 2005 and throughout 2006, also as a result of strategic balance
sheet initiatives to enhance liquidity and to address interest rate risk. These
factors contributed to the overall decrease in residential mortgage loans during
2006.
HUSI has loans outstanding to certain executive officers and directors. The
loans were made on substantially the same terms, including interest rates and
collateral, as those prevailing at the same time for comparable transactions
with other persons and do not involve more than normal risk of collectibility.
The aggregate amount of such loans did not exceed 5% of shareholders' equity at
December 31, 2006 and 2005.
117
Loans Held for Sale
Beginning in June 2005, loans held for sale include residential mortgage loans
acquired from unaffiliated third parties and from HSBC Finance Corporation, with
the intent of selling the loans to HMUS. Loans held for sale to HMUS increased
$244 million in 2006 to $3.1 billion at December 31, 2006.
Loans held for sale are recorded at the lower of aggregate cost or market value.
Aggregate cost exceeded market value at December 31, 2006 and December 31, 2005.
Changes in the valuation allowance utilized to adjust loans held for sale to
market value are summarized in the following table.
-----------------------------------------------------------------------------------------------------------------------
2006 2005
------------------------------------ ------------------------------------
Valuation Allowance Related to Valuation Allowance Related to
------------------------------ ------------------------------
Loans Held Other Loans Held Other
for Sale Loans Held for Sale Loans Held
Year Ended December 31 to HMUS for Sale Total to HMUS for Sale Total
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of period ......... $ (11) $ (15) $ (26) $ -- $ (4) $ (4)
(Increased) decreased allowance
for net reductions in market value ... (133) 12 (121) (32) (11) (43)
Releases of valuation allowance
for loans sold ....................... 109 -- 109 21 -- 21
---------- ---------- -------- ---------- ---------- --------
Balance at end of period ............... $ (35) $ (3) $ (38) $ (11) $ (15) $ (26)
========== ========== ======== ========== ========== ========
Loans held for sale to HMUS are subject to interest rate risk, in that their
value will change as a result of changes in the interest rate environment.
Interest rate risk is mitigated through an active economic hedging program to
offset changes in value of the loans held for sale. Trading related revenues
related to this economic hedging program, which includes net interest income and
trading revenues were $132 million and $36 million for 2006 and 2005,
respectively.
Concentrations of Credit Risk
A concentration of credit risk is defined as a significant credit exposure with
an individual or group engaged in similar activities or affected similarly by
economic conditions. HUSI enters into a variety of transactions in the normal
course of business that involve both on- and off-balance sheet credit risk.
Principal among these activities is lending to various commercial,
institutional, governmental and individual customers. HUSI participates in
lending activity throughout the United States and internationally. In general,
HUSI controls the varying degrees of credit risk involved in on- and off-balance
sheet transactions through specific credit policies. These policies and
procedures provide for a strict approval, monitoring and reporting process. It
is HUSI's policy to require collateral when it is deemed appropriate. Varying
degrees and types of collateral are secured depending upon management's credit
evaluation.
As with any nonconforming and non-prime loan products, HUSI utilizes high
underwriting standards and prices these loans in a manner that is appropriate to
compensate for higher risk.
Certain residential mortgage loans have high loan-to-value (LTV) ratios and no
mortgage insurance, which could result in potential inability to recover the
entire investment in loans involving foreclosed or damaged properties.
HUSI also offers interest-only residential mortgage loans. These interest-only
loans allow customers to pay only the accruing interest for a period of time,
which results in lower payments during the initial loan period. Depending on a
customer's financial situation, the subsequent increase in the required payment
attributable to loan principal could affect a customer's ability to repay the
loan at some future date when the interest rate resets and/or principal payments
are required.
118
Outstanding balances of high LTV and interest-only loans are summarized in the
following table.
------------------------------------------------------------------------------------------------
December 31 2006 2005
------------------------------------------------------------------------------------------------
(in millions)
Residential mortgage loans with high LTV and no mortgage insurance ... $ 2,717 $ 3,510
Interest-only residential mortgage loans ............................. 7,537 8,713
---------- ---------
Total ................................................................ $ 10,254 $ 12,223
========== =========
Concentrations of first and second liens within the residential mortgage loan
portfolio are summarized in the following table. Amounts in the table exclude
loans held for sale.
------------------------------------------------------------------------------------------------
December 31 2006 2005
------------------------------------------------------------------------------------------------
(in millions)
Closed end:
First lien ........................................................ $ 31,876 $ 36,389
Second lien ....................................................... 474 193
Revolving:
Second lien ....................................................... 3,231 3,297
---------- ---------
Total ................................................................ $ 35,581 $ 39,879
========== =========
HUSI also offers adjustable rate residential mortgage loans which allow it to
adjust pricing on the loan in line with market movements. At December 31, 2006,
HUSI had approximately $21.2 billion in adjustable rate residential mortgage
loans. In 2007, approximately $2.5 billion of adjustable rate residential
mortgage loans will experience their first interest rate reset. In 2008,
approximately $3.6 billion of adjustable rate residential mortgage loans will
experience their first interest rate reset. As interest rates have risen over
the last three years, many adjustable rate loans are expected to require a
significantly higher monthly payment following their first adjustment. A
customer's financial situation at the time of the interest rate reset could
affect the customer's ability to repay the loan after the adjustment.
Regional exposure at December 31, 2006 for certain loan portfolios is summarized
in the following table.
--------------------------------------------------------------------------------------------------
Commercial Residential Credit
Construction and Other Mortgage Card
December 31, 2006 Real Estate Loans Loans Receivables
--------------------------------------------------------------------------------------------------
New York State ............................. 53% 24% 6%
North Central United States ................ 5 12 24
North Eastern United States ................ 7 12 14
Southern United States ..................... 17 24 31
Western United States ...................... 18 28 25
----- ----- ----
Total ...................................... 100% 100% 100%
===== ===== ====
Sale of Brady Bonds
At December 31, 2005, commercial loans included certain bonds issued by the
government of Venezuela as part of debt renegotiations (Brady Bonds) with a face
value of $178 million, and a recorded carrying value of $165 million. During the
second quarter of 2006, the Venezuelan government redeemed all Brady Bonds held
by HUSI at their face value resulting in a gain of $13 million, which was
recorded in other revenues.
119
Credit Quality Statistics
Nonaccruing loans information is summarized in the following table.
-------------------------------------------------------------------------------------------------------
2006 2005
-------------------------------------------------------------------------------------------------------
(in millions)
Nonaccruing loans
Balance at end of period:
Commercial:
Construction and other real estate ................................. $ 33 $ 15
Other commercial ................................................... 69 70
--------- ---------
Total commercial ................................................... 102 85
--------- ---------
Consumer:
Residential mortgages .............................................. 182 138
Credit card receivables ............................................ 1 --
Other consumer loans ............................................... -- --
--------- ---------
Total consumer loans ............................................... 183 138
--------- ---------
Total nonaccruing loans .................................................. $ 285 $ 223
========= =========
Interest income on nonaccruing loans is summarized in the following table.
------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
------------------------------------------------------------------------------------------------------
(in millions)
Interest income on nonaccruing loans:
Amount which would have been recorded had the associated loans
been current in accordance with their original terms ....... $ 21 $ 25 $ 23
Amount actually recorded ...................................... 8 12 17
Additional credit quality statistics are summarized in the following table.
------------------------------------------------------------------------------------------------------
December 31 2006 2005
------------------------------------------------------------------------------------------------------
(in millions)
Accruing loans contractually past due 90 days or more as to principal or
interest:
Total commercial ........................................................... $ 22 $ 19
--------- --------
Consumer:
Residential mortgages ................................................... 11 27
Credit card receivables ................................................. 339 248
Other consumer loans .................................................... 16 17
--------- --------
Total consumer loans .................................................... 366 292
--------- --------
Total accruing loans contractually past due 90 days or more ................ $ 388 $ 311
========= ========
Impaired loans:
Balance at end of period ................................................... $ 100 $ 90
Amount with impairment reserve ............................................. 35 27
Impairment reserve ......................................................... 13 10
Other real estate and owned assets:
Balance at end of period ................................................... $ 53 $ 35
120
Note 8. Allowance for Credit Losses
--------------------------------------------------------------------------------
An analysis of the allowance for credit losses is presented in the following
table.
-----------------------------------------------------------------------------------------------------
2006 2005 2004
-----------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of year ................................. $ 846 $ 788 $ 399
Provision charged (credited) to income ....................... 823 674 (17)
Charge offs .................................................. (1,012) (871) (157)
Recoveries ................................................... 248 255 78
Allowance related to acquisitions and (dispositions), net .... (8) -- 485
---------- --------- ---------
Balance at end of year ....................................... $ 897 $ 846 $ 788
========== ========= =========
Non--United States transfer risk reserves included in the
allowance for credit losses ................................ $ -- $ 4 $ 14
========== ========= =========
On December 29, 2004, HUSI acquired approximately $12 billion of private label
loans from HSBC Finance Corporation, including an allowance for credit losses
associated with the purchased loans.
Note 9. Securitizations and Secured Financings
--------------------------------------------------------------------------------
On December 29, 2004, HUSI acquired a domestic private label loan portfolio from
HSBC Finance Corporation, without recourse, which included a consumer private
label credit card portfolio, securitized receivables related to this portfolio,
and retained interest assets related to these securitizations. These credit card
securitization transactions were structured to receive sale treatment under U.S.
GAAP.
In a securitization, a designated pool of receivables is removed from the
balance sheet and transferred to an unaffiliated revolving trust. This
unaffiliated trust is a qualifying special purpose entity (QSPE) as defined by
SFAS 140 and, therefore, is not consolidated. The QSPE funds its purchase of
receivables through the issuance of securities to investors, entitling them to
receive specified cash flows during the life of the securities. The securities
are collateralized by the underlying receivables transferred to the QSPE. These
revolving securitization trusts require replenishment of receivables to support
previously issued securities. Replenishments for the revolving securitization
trusts were $3.6 billion and $8.7 billion in 2006 and 2005, respectively.
In the third quarter of 2006, the last remaining securitization trust agreement
related to the private label portfolio acquired from HSBC Finance Corporation in
2004 was amended. As a result, the securitization trust no longer qualifies for
sale treatment and the transaction is now recorded as a secured financing
transaction. At the transaction date, all outstanding investments, credit card
receivables and liabilities related to the trust were recorded on HUSI's
consolidated balance sheet.
All new collateralized funding transactions have been structured as secured
financings under U.S. GAAP since the third quarter of 2004. In a secured
financing, a designated pool of receivables are conveyed to a wholly owned
limited purpose subsidiary, which in turn transfers receivables to a trust that
sells interests to investors. Repayment of the debt issued by the trust is
secured by the receivables transferred. The receivables and the underlying debt
of the trust remain on HUSI's balance sheet. HUSI does not recognize a gain in a
secured financing transaction. Because the receivables and debt remain on the
balance sheet, revenues and expenses are reported consistently with the owned
balance sheet portfolio. There have been no new secured financings in 2006.
121
HUSI's securitized receivables and secured financings are summarized in the
following table.
-----------------------------------------------------------------------------------------------------------------------
Year ended December 31 2006 2005
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Securitized private label receivables at period end .............................. $ -- $ 1,343
============ ============
Secured financings in long-term debt:
Balance at period end ......................................................... $ 2,134 $ 1,500
============ ============
Private label credit card receivables and investment securities collateralizing
secured financings at period end ........................................... $ 2,439 $ 1,824
============ ============
Note 10. Properties and Equipment, Net
--------------------------------------------------------------------------------
The composition of properties and equipment, net of accumulated depreciation, is
summarized in the following table.
-----------------------------------------------------------------------------------------------------------------------
Depreciable
December 31 Life (Years) 2006 2005
-----------------------------------------------------------------------------------------------------------------------
($ in millions)
Land ......................................................... -- $ 79 $ 92
Buildings .................................................... 5-40 754 688
Furniture and equipment ...................................... 3-7 519 503
------------ ------------
Total ........................................................ 1,352 1,283
Less: accumulated depreciation ............................... (812) (745)
------------ ------------
Properties and equipment, net ................................ $ 540 $ 538
============ ============
Depreciation expense during the year ......................... $ 79 $ 85
============ ============
Note 11. Intangible Assets, Net
--------------------------------------------------------------------------------
The following table summarizes the composition of intangible assets.
-----------------------------------------------------------------------------------------------------------------------
December 31 2006 2005
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Mortgage servicing rights ........................................................ $ 474 $ 418
Other ............................................................................ 47 45
------------ ------------
Intangible assets, net ........................................................... $ 521 $ 463
============ ============
Mortgage Servicing Rights (MSRs)
HUSI has one class of MSRs arising from sales of residential mortgage loans.
HUSI recognizes the right to service mortgage loans as a separate and distinct
asset at the time the loans are sold. HUSI receives a fee for servicing the
related residential mortgage loans.
Effective January 1, 2006, HUSI adopted SFAS 156 electing to measure this one
class of MSRs at fair value. Upon adoption, HUSI recorded a cumulative effect
adjustment to beginning retained earnings of less than $1 million, representing
the difference between the fair value and the carrying amount of MSRs as of the
date of adoption.
MSRs are subject to prepayment and interest rate risk, in that their value will
fluctuate as a result of changes in the interest rate environment. Interest rate
risk is mitigated through an active economic hedging program that uses
securities and derivatives to offset changes in the fair value of MSRs. Since
the hedging program involves trading activity, risk is quantified and managed
using a number of risk assessment techniques, which are addressed in more detail
under Market Risk Management beginning on page 80 of this Form 10-K.
122
With the adoption of SFAS 156, HUSI also made an irrevocable election to
reclassify securities used to offset changes in economic value of MSRs from
available for sale to trading assets, effective January 1, 2006. At December 31,
2005, these securities had a book value of $115 million and a fair value of $111
million. The accumulated unrealized loss recorded in accumulated other
comprehensive income of $4 million was reversed effective January 1, 2006, with
the offsetting amount recorded as a cumulative effect adjustment to retained
earnings.
MSRs are initially measured at fair value at the time that the related loans are
sold, and periodically remeasured 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 of the asset reflected in residential mortgage banking
revenue in the period that the changes occur. 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 reasonableness of these valuation
models is periodically validated by reference to external independent broker
valuations and industry surveys.
Fair value of MSRs is calculated using the following critical assumptions.
-----------------------------------------------------------------------------------------------------------------------
December 31, December 31,
2006 2005
-----------------------------------------------------------------------------------------------------------------------
Annualized constant prepayment rate (CPR) ........................................ 20.80% 16.30%
Constant discount rate ........................................................... 10.34% 12.07%
Weighted average life ............................................................ 4.8 years 5.5 years
The following table summarizes MSRs activity for the year ended December 31,
2006, the reporting period since adoption of SFAS 156.
-----------------------------------------------------------------------------------------------------------------------
Year Ended December 31 2006
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Fair value of MSRs:
Beginning balance ................................................................................... $ 418
Additions related to loan sales ..................................................................... 100
Changes in fair value due to:
Change in valuation inputs or assumptions used in the valuation models ........................... 43
Realization of cash flows ........................................................................ (87)
------------
Ending balance ...................................................................................... $ 474
============
123
The following table summarizes activity for MSRs and the related valuation
allowance for the year ended December 31, 2005 and December 31, 2004, which was
prior to the adoption of SFAS 156.
-----------------------------------------------------------------------------------------------------------------------
2005 2004
-----------------------------------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Balance, January 1 ............................................................ $ 416 $ 526
Additions related to loan sales ............................................... 136 62
Net MSRs acquisitions (sales) ................................................. -- (54)
Permanent impairment charges .................................................. (21) (15)
Amortization .................................................................. (74) (103)
------------ ------------
Balance, December 31 .......................................................... 457 416
------------ ------------
Valuation allowance for MSRs:
Balance, January 1 ............................................................ (107) (23)
Temporary impairment (provision) recovery ..................................... 47 (102)
Permanent impairment charges .................................................. 21 15
Release of allowance related to MSRs sold ..................................... -- 3
------------ ------------
Balance, December 31 .......................................................... (39) (107)
------------ ------------
MSRs, net of accumulated amortization and valuation allowance at December 31 ..... $ 418 $ 309
============ ============
Information regarding residential mortgage loans serviced for others, which are
not included in the consolidated balance sheet, is summarized in the following
table.
-----------------------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Outstanding principal balances at period end ..................................... $ 34,736 $ 31,961
============ ============
Custodial balances maintained and included in noninterest bearing deposits at
period end .................................................................... $ 647 $ 628
============ ============
Servicing fee income recorded in residential mortgage banking revenue during the
period ........................................................................ $ 100 $ 76
============ ============
Other Intangible Assets
Other intangible assets include favorable lease arrangements and customer lists.
The weighted-average amortization period for these intangible assets is 87
months at December 31, 2006. Total amortization expense was approximately $6
million for 2006 and 2005. Scheduled amortization is approximately $6 million
per year for 2007 through 2011.
124
Note 12. Goodwill
--------------------------------------------------------------------------------
During the second quarter of 2006, HUSI completed its annual impairment test of
goodwill. In order to conform its testing date with that of HSBC and other HSBC
affiliates, HUSI changed its accounting policy for the impairment testing date
and completed an additional impairment test of goodwill in the third quarter. At
both testing dates, HUSI determined that the fair value of each of the reporting
units exceeded its carrying value. As a result, no impairment loss was required
to be recognized. In subsequent years, the annual impairment test of goodwill
will continue to be completed at July 1. During the year ended December 31,
2006, there were no material events or transactions which warranted
consideration for their impact on recorded book values assigned to goodwill.
The following table presents a summary of changes in goodwill.
-----------------------------------------------------------------------------------------------------------------------
Year ended December 31 2006 2005
-----------------------------------------------------------------------------------------------------------------------
(in millions)
Balance at beginning of year ..................................................... $ 2,694 $ 2,697
Purchase accounting adjustment ................................................... 22 --
Reductions related to branch disposals ........................................... -- (3)
------------ ------------
Balance at the end of the year ................................................... $ 2,716 $ 2,694
============ ============
During 2006, a deferred tax asset related to a previous acquisition was adjusted
against the related goodwill balance, resulting in the purchase accounting
adjustment noted in the table above.
Note 13. Deposits
--------------------------------------------------------------------------------
The aggregate amounts of time deposit accounts (primarily certificates of
deposits) each with a minimum of $100,000 included in domestic office deposits
were approximately $19 billion and $23 billion at December 31, 2006 and 2005,
respectively. Certain domestic deposits meet the definition of a hybrid
financial instrument as defined in SFAS 155. As a result, deposits totaling $1.3
billion at December 31, 2006 are being carried at fair value with all changes in
fair value recorded to profit and loss. The scheduled maturities of all time
deposits at December 31, 2006 is summarized in the following table.
-----------------------------------------------------------------------------------------------------------------------
Domestic Foreign
Offices Offices Total
-----------------------------------------------------------------------------------------------------------------------
(in millions)
2007:
0-90 days ................................................. $ 13,927 $ 9,262 $ 23,189
91-180 days ............................................... 5,039 328 5,367
181-365 days .............................................. 4,312 242 4,554
----------- ------------ ------------
23,278 9,832 33,110
2008 ......................................................... 1,528 20 1,548
2009 ......................................................... 144 8 152
2010 ......................................................... 125 -- 125
2011 ......................................................... 75 -- 75
Later years .................................................. 279 -- 279
----------- ------------ ------------
$ 25,429 $ 9,860 $ 35,289
=========== ============ ============
Overdraft deposits reclassified to loans were approximately $1,727 million and
$1,291 million at December 31, 2006 and 2005, respectively.
125
Note 14. Short-Term Borrowings
--------------------------------------------------------------------------------
The following table summarizes the components of short-term borrowings. At
December 31, 2006 and 2005, there were no categories of short-term borrowings
that exceeded 30% of total shareholders' equity.
--------------------------------------------------------------------------------
December 31 2006 2005
--------------------------------------------------------------------------------
(in millions)
Federal funds purchased (day to day) .................. $ 77 $ 57
Securities sold under repurchase agreements ........... 1,328 1,273
Commercial paper ...................................... 2,414 2,620
Precious metals ....................................... 1,146 1,812
Other ................................................. 108 605
--------- ---------
Total short-term borrowings ........................... $ 5,073 $ 6,367
========= =========
In July 2006, HUSI's unused $2 billion line of credit from HSBC Finance
Corporation expired and was not renewed.
At December 31, 2006, HUSI had an unused line of credit from HSBC of $2 billion.
This line of credit does not require compensating balance arrangements and
commitment fees are not significant. The interest rate is comparable to third
party rates for a line of credit with similar terms.
At December 31, 2006, HUSI had an unused line of credit from its parent, HSBC
North America Inc., of $150 million. The interest rate is comparable to third
party rates for a line of credit with similar terms.
As a member of the New York Federal Home Loan Bank (FHLB), HUSI has a secured
borrowing facility, which is collateralized by residential mortgage loans. At
December 31, 2006 and 2005, the facility included $5 billion of borrowings
included in long-term debt (see Note 15). The facility also allows access to
further short-term borrowings based upon the amount of residential mortgage
loans pledged as collateral with the FHLB, which were undrawn as of December 31,
2006 and 2005.
126
Note 15. Long-Term Debt
--------------------------------------------------------------------------------
The composition of long-term debt is presented in the following table. Interest
rates on floating rate notes are determined periodically by formulas based on
certain money market rates or, in certain instances, by minimum interest rates
as specified in the agreements governing the issues. Interest rates in effect at
December 31, 2006 are shown in parentheses.
--------------------------------------------------------------------------------------------------------------
December 31 2006 2005
--------------------------------------------------------------------------------------------------------------
(in millions)
Issued by HUSI or its subsidiaries other than HBUS:
Non-subordinated debt:
Medium-Term Floating Rate Notes due 2007-2011 (5.14% - 5.38%) .................... $ 53 $ --
8.375% Debentures due 2007 ....................................................... 100 101
Floating Rate Extendible Notes due 2008-2011 (5.35%) ............................. 1,499 1,497
--------- ---------
1,652 1,598
Subordinated debt:
7% Subordinated Notes due 2006 ................................................... -- 300
Fixed Rate Subordinated Notes due 2008-2097 (5.88% - 9.70%) ...................... 1,496 1,501
Perpetual Capital Notes (5.69%) .................................................. 127 126
Junior Subordinated Debentures due 2026-2032 (7.53% - 8.38%) ..................... 1,061 1,070
--------- ---------
2,684 2,997
--------- ---------
Total issued by HUSI or its subsidiaries other than HBUS ............................ 4,336 4,595
--------- ---------
Issued or acquired by HBUS or its subsidiaries:
Non-subordinated debt:
Global Bank Note Program:
Medium-Term Floating Rate Notes due 2007-2040 (5.14% - 5.63%) .................... 2,108 1,544
3.875% Fixed Rate Senior Global Bank Notes due 2009 .............................. 1,943 1,940
5.43% Fixed Rate Senior Global Bank Notes due 2009 ............................... 20 --
Floating Rate Senior Global Bank Notes due 2007-2009 (5.42% - 5.49%) ............. 4,646 8,890
Floating Rate Non-USD Global Bank Notes due 2008-2009 (3.54% - 3.56%) ............ 1,328 1,191
Floating Rate/Fixed Rate Senior Notes due 2012 (5.86%) ........................... 25 25
--------- ---------
10,070 13,590
Federal Home Loan Bank of New York (FHLB) advances:
Fixed Rate FHLB advances due 2007-2033 (2.01% - 7.24%) ........................... 10 8
Floating Rate FHLB advances due 2007-2036 (5.36% - 5.38%) ........................ 5,000 5,000
--------- ---------
5,010 5,008
Private Label Credit Card Secured Financing due 2007-2008 (5.49% - 6.52%), refer to
Note 9 ........................................................................... 2,134 1,500
Precious Metal Leases due 2007-2014 (0.10%-1.70%) ................................... 729 683
Obligations of consolidated Variable Interest Entities due 2010-2035 (5.26% - 5.96%),
refer to Note 27 ................................................................. 2,542 954
Other:
5.99% Fixed Rate Note due 2011 ................................................... 350 --
Floating Rate Note due 2011 (5.86%) .............................................. 4 --
6.60% Fixed Rate Note due 2021 ................................................... 858 --
3.99% Non-USD Senior Debt due 2044 ............................................... 530 481
Other ............................................................................ 34 40
--------- ---------
1,776 521
--------- ---------
Total non-subordinated debt ......................................................... 22,261 22,256
--------- ---------
Subordinated debt:
4.625% Global Subordinated Notes due 2014 ........................................ 995 994
Global Bank Note Program:
Fixed Rate Global Bank Notes due 2034-2035 (5.63% - 5.88%) ....................... 1,643 1,731
--------- ---------
Total subordinated debt ............................................................. 2,638 2,725
--------- ---------
Total issued or acquired by HBUS or its subsidiaries ................................ 24,899 24,981
--------- ---------
Obligations under capital leases .................................................... 17 19
--------- ---------
Total long-term debt ................................................................ $ 29,252 $ 29,595
========= =========
127
The table excludes $1,250 million of debt issued by HBUS or its subsidiaries
payable to HUSI. Of this amount, the earliest note is due to mature in October
2008 and the latest note is due to mature in 2097.
Debt Issued by HUSI or its Subsidiaries other than HBUS
In April 2006, HUSI filed an S-3 Shelf Registration Statement (the 2006 shelf)
with the Securities and Exchange Commission. Under the 2006 shelf, HUSI may
issue debt securities or preferred stock, either separately or represented by
depositary shares, warrants, purchase contracts and units comprised of any
combination of one or more of the aforementioned securities. The 2006 shelf,
which has no dollar limit, replaced a shelf filed in 2005 in the amount of $2.3
billion. The Medium-Term Floating Rate Notes due 2007-2011 were issued under the
2006 shelf.
The $1.5 billion Floating Rate Extendible Notes were issued by HUSI in November
2005. These senior debt securities require the noteholders to decide each month
whether or not to extend the maturity date of their notes by one month beyond
the initial maturity date of December 15, 2006. In no event will the maturity of
the notes be extended beyond December 15, 2011, the final maturity date. If on
any election date a noteholder decides not to extend the maturity of all or any
portion of the principal amount of his notes, the notes will mature on the
previously elected maturity date, which will be the maturity date that is twelve
months from the current election date. On the December 2006 election date, all
noteholders elected to extend the maturity date of their notes to January 15,
2008. The notes are not subject to redemption by HUSI prior to the final
maturity date. Interest is payable on the notes in arrears on the 15th day of
each month, commencing December 15, 2005 and ending on the final maturity date.
The interest rate will be determined by reference to the one-month LIBOR, plus
or minus the applicable spread for that particular interest period. The spread
for each interest period ranges from minus 2 basis points for the interest
period ending December 15, 2006 to plus 3 basis points for the interest period
ending December 15, 2011.
Debt Issued by HBUS or its Subsidiaries
In December 2006, HBUS increased the size of its Global Bank Note Program from
$20 billion to $40 billion. The Global Bank Note Program provides for the
issuance of fixed rate and floating rate, senior and subordinated notes. The
following debt issues were made under this program in 2006 and 2005.
o In November 2006, HBUS issued the $20 million 5.43% Senior Notes due 2009.
Interest is paid semiannually on May 20 and November 20 of each year,
commencing on May 20, 2007 and ending on the stated maturity date of
November 20, 2009. HBUS may redeem the notes, in whole but not in part, on
November 20, 2007.
o Certain Medium-Term Floating Rate Notes issued in 2006 meet the definition
of hybrid financial instruments under SFAS 155, which was adopted in 2006
(see Note 2). Medium-Term Floating Rate Notes totaling $900 million at
December 31, 2006 are being carried at fair value.
o In June 2005, HBUS issued the $25 million Floating Rate/Fixed Rate Senior
Notes due 2012. Interest on the notes is paid quarterly commencing
September 29, 2005. For each interest payment period in the period from
(and including) June 29, 2005 to (but excluding) the interest payment date
falling on June 29, 2007, the interest rate is determined by reference to
the three month LIBOR plus 0.50% per annum. For each interest payment
period in the period from (and including) June 29, 2007 to (but excluding)
the stated maturity date of June 29, 2012, the interest rate is 4.95% per
annum. HBUS may redeem the notes, in whole but not in part, on June 29,
2007.
o In August 2005, HBUS issued $750 million 5.625% Subordinated Notes due
2035. Interest is paid semiannually on February 15 and August 15 of each
year, commencing February 15, 2006 and ending on the stated maturity date
of August 15, 2035. These notes may not be redeemed by HBUS.
Other includes certain notes totaling $1.2 billion at December 31, 2006, which
resulted from a 2006 structured financing transaction.
128
As of December 31, 2006, the contractual scheduled maturities for total
long-term debt over the next five years are as follows.
--------------------------------------------------------------------------------
(in millions)
2007 ........................................................... $ 7,467
2008 ........................................................... 4,070
2009 ........................................................... 4,476
2010 ........................................................... 1,068
2011 ........................................................... 2,144
Note 16. Derivative Instruments and Hedging Activities
--------------------------------------------------------------------------------
HUSI is party to various derivative financial instruments as an end user (1) for
asset and liability management purposes; (2) in order to offset the risk
associated with changes in the value of various assets and liabilities accounted
for in the trading account; (3) to protect against changes in value of its
mortgage servicing rights portfolio; and (4) for trading in its own account.
HUSI is also an international dealer in derivative instruments denominated in
U.S. dollars and other currencies which include futures, forwards, swaps and
options related to interest rates, foreign exchange rates, equity indices,
commodity prices and credit, focusing on structuring of transactions to meet
clients' needs.
Fair Value Hedges
Specifically, interest rate swaps that call for the receipt of a variable market
rate and the payment of a fixed rate are utilized under fair value strategies to
hedge the risk associated with changes in the risk free rate component of the
value of certain fixed rate investment securities. Interest rate swaps that call
for the receipt of a fixed rate and payment of a variable market rate are
utilized to hedge the risk associated with changes in the risk free rate
component of certain fixed rate debt obligations. The regression method is
utilized in order to satisfy the retrospective and prospective assessment of
hedge effectiveness for SFAS 133.
HUSI recognized net gains (losses) of approximately $10 million, $2 million and
$(3) million for the years ended December 31, 2006, 2005 and 2004, respectively,
(reported as other income in the consolidated statement of income), which
represented the ineffective portion of all fair value hedges. Only the time
value component of these derivative contracts has been excluded from the
assessment of hedge effectiveness.
For the years ended December 31, 2006 and 2005, $5 million and $7 million of
gains related to the basis adjustment of terminated and/or redesignated fair
value hedge relationships were amortized to earnings. During 2007, HUSI expects
to amortize $6 million of remaining gains to earnings resulting from these
terminated and/or redesignated fair value hedges.
Cash Flow Hedges
Similarly, interest rate swaps and futures contracts that call for the payment
of a fixed rate are utilized under the cash flow strategy to hedge the
forecasted repricing of certain deposit liabilities. In order to satisfy the
retrospective and prospective assessment of hedge effectiveness for SFAS 133,
the regression method is utilized. Ineffectiveness is recorded to the statement
of income on a monthly basis.
The total ineffectiveness of all cash flow hedges was less than $1 million for
each of the years ended December 31, 2006, 2005 and 2004. Only the time value
component of these derivative contracts has been excluded from the assessment of
hedge effectiveness.
129
Gains or losses on derivative contracts that are reclassified from accumulated
other comprehensive income to current period earnings pursuant to this strategy,
are included in interest expense on deposit liabilities during the periods that
net income is impacted by the underlying liabilities. As of December 31, 2006,
approximately $7 million of deferred net gains on derivative instruments
accumulated in other comprehensive income are expected to be included in
earnings during 2007.
At December 31, 2006, the net unrealized loss on derivatives included in
accumulated other comprehensive income was $13 million, net of income taxes. Of
this amount, the $64 million gain represents the effective portion of the net
gains on derivatives that qualify as cash flow hedges, and the $77 million loss
relates to terminated and/or redesignated derivatives. For the years ended
December 31, 2006 and 2005, respectively, $35 million and $34 million of gains
related to terminated and/or redesignated cash flow hedge relationships were
amortized to earnings from other comprehensive income. During 2007, HUSI expects
to amortize $11 million of remaining gains to earnings resulting from these
terminated and/or redesignated cash flow hedges.
Trading and Other Activities
HUSI enters into certain derivative contracts for purely trading purposes in
order to realize profits from short-term movements in interest rates, commodity
prices, foreign exchange rates and credit spreads. In addition, certain
derivative contracts are accounted for on a full mark to market basis through
current earnings even though they were acquired for the purpose of protecting
the economic value of certain assets and liabilities.
130
Notional Values of Derivative Contracts
The following table summarizes the notional values of derivative contracts.
------------------------------------------------------------------------------------------
December 31 2006 2005
------------------------------------------------------------------------------------------
(in millions)
Interest rate:
Futures and forwards .................................... $ 94,204 $ 106,826
Swaps ................................................... 1,906,688 1,674,091
Options written ......................................... 510,023 199,676
Options purchased ....................................... 544,026 217,095
------------ ------------
3,054,941 2,197,688
------------ ------------
Foreign exchange:
Swaps, futures and forwards ............................. 394,621 308,264
Options written ......................................... 61,406 40,213
Options purchased ....................................... 63,795 40,959
Spot .................................................... 32,654 21,099
------------ ------------
552,476 410,535
------------ ------------
Commodities, equities and precious metals:
Swaps, futures and forwards ............................. 43,620 48,702
Options written ......................................... 12,263 14,378
Options purchased ....................................... 16,115 16,127
------------ ------------
71,998 79,207
------------ ------------
Credit derivatives ......................................... 816,422 391,814
------------ ------------
Total ...................................................... $ 4,495,837 $ 3,079,244
============ ============
The total notional amounts in the table above relate primarily to HUSI's trading
activities. Notional amounts included in the table related to non-trading fair
value, cash flow and economic hedging activities were $27 billion and $26
billion at December 31, 2006 and 2005, respectively.
Note 17. Income Taxes
--------------------------------------------------------------------------------
Total income taxes were allocated as follows.
------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
------------------------------------------------------------------------------------------------------
(in millions)
To income before income taxes ........................................ $ 530 $ 566 $ 718
To shareholders' equity as tax charge (benefit):
Net unrealized losses on securities available for sale ............ (22) (111) (20)
Unrealized (losses) gains on derivatives classified as cash flow
hedges ............................................................ (106) 78 (30)
Unrealized (losses) gains on interest-only strip receivables ...... (4) 4 --
Cumulative adjustment from adoption of new pension accounting
pronouncement .................................................. (13) -- --
Foreign currency translation, net ................................. -- (4) 4
------- ------- -------
$ 385 $ 533 $ 672
======= ======= =======
The components of income tax expense follow.
------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
------------------------------------------------------------------------------------------------------
(in millions)
Current:
Federal ........................................................... $ 466 $ 484 $ 455
State and local ................................................... 51 90 150
Foreign ........................................................... 18 7 17
------- ------- -------
Total current ........................................................ 535 581 622
Deferred, primarily federal .......................................... (5) (15) 96
------- ------- -------
Total income tax expense ............................................. $ 530 $ 566 $ 718
======= ======= =======
131
The following table is an analysis of the difference between effective rates
based on the total income tax provision attributable to pretax income and the
statutory U.S. Federal income tax rate.
------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
------------------------------------------------------------------------------------------------------
Statutory rate ....................................................... 35.0% 35.0% 35.0%
Increase (decrease) due to:
State and local income taxes ...................................... 2.1 4.2 5.6
Release of tax reserves ........................................... (.7) (.3) (2.9)
Tax exempt interest income ........................................ (.9) (.7) (.5)
Low income housing and miscellaneous other tax credits ............ (1.8) (1.4) (.5)
Other items ....................................................... .1 (.1) (.4)
------- -------- --------
Effective income tax rate ............................................ 33.8% 36.7% 36.3%
======= ======== ========
The components of the net deferred tax position are presented in the following
table.
------------------------------------------------------------------------------------------------------
December 31 2006 2005
------------------------------------------------------------------------------------------------------
(in millions)
Deferred tax assets:
Allowance for credit losses ................................................. $ 296 $ 322
Benefit accruals ............................................................ 100 96
Accrued expenses not currently deductible ................................... 80 55
Unrealized losses on securities available for sale .......................... 122 100
Net purchase discount on acquired companies ................................. (6) 39
Accrued pension cost ........................................................ 14 3
Premium on purchased receivables ............................................ 4 12
------- -------
Total deferred tax assets ................................................ 610 627
------- -------
Less deferred tax liabilities:
Lease financing income accrued .............................................. 7 13
Investment securities ....................................................... (20) 90
Accrued income on foreign bonds ............................................. -- 10
Deferred gain recognition ................................................... 34 31
Depreciation and amortization ............................................... 6 24
Interest and discount income ................................................ 168 227
Deferred fees/costs ......................................................... 97 87
Mortgage servicing rights ................................................... 177 137
Other ....................................................................... 40 6
------- -------
Total deferred tax liabilities ........................................... 509 625
------- -------
Net deferred tax asset ................................................... $ 101 $ 2
======= =======
Realization of deferred tax assets is contingent upon the generation of future
taxable income or the existence of sufficient taxable income within the
carryback period. Based upon the level of historical taxable income and the
scheduled reversal of the deferred tax liabilities over the periods in which the
deferred tax assets are deductible, management believes that it is more likely
than not HUSI would realize the benefits of these deductible differences.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN
48). FIN 48 establishes threshold and measurement attributes for financial
statement recognition of tax positions taken or expected to be taken on a tax
return. FIN 48 also provides guidance on derecognition, classification, interest
and penalties, accounting in interim periods, disclosure and transition. FIN 48
is effective for fiscal years beginning after December 15, 2006. The adoption of
FIN 48 will not have an impact on the financial results of HUSI. The adoption of
FIN 48 will result in the recognition of additional current tax liabilities and
offsetting deferred tax assets of $11 million.
132
Note 18. Preferred Stock
--------------------------------------------------------------------------------
The following table presents information related to the issues of preferred
stock outstanding.
--------------------------------------------------------------------------------------------------------------------
Amount
Shares Dividend Outstanding
Outstanding Rate ------------------------
December 31 2006 2006 2006 2005
--------------------------------------------------------------------------------------------------------------------
($ in millions)
Floating Rate Non-Cumulative Preferred Stock, Series F
($25 stated value) ........................................ 20,700,000 5.910% $ 517 $ 517
14,950,000 Depositary Shares each representing
a one-fortieth interest in a share of Floating Rate
Non-Cumulative Preferred Stock, Series G
($1,000 stated value) ..................................... 373,750 5.910 374 374
14,950,000 Depositary Shares each representing a
one-fortieth interest in a share of 6.50% Non-Cumulative
Preferred Stock, Series H ($1,000 stated value) ........... 373,750 6.500 374 --
6,000,000 Depositary shares each representing
a one-fourth interest in a share of Adjustable
Rate Cumulative Preferred Stock, Series D
($100 stated value) ....................................... 1,500,000 4.500 150 150
$2.8575 Cumulative Preferred Stock ($50 stated value) ........ 3,000,000 5.715 150 150
Dutch Auction Rate Transferable Securities(TM) Preferred
Stock (DARTS):
Series A ($100,000 stated value) ....................... 625 4.154 63 63
Series B ($100,000 stated value) ....................... 625 4.215 62 62
CTUS Inc. Preferred Stock .................................... 100 -- -- (1) -- (1)
--------- ---------
$ 1,690 $ 1,316
========= =========
(1) Less than $500 thousand
Preferred Stock
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. The Series H Preferred Stock may be redeemed at the option of
HUSI, in whole or in part, on or after July 1, 2011 at $1,000 per share, plus
accrued and unpaid dividends for the then-current dividend period.
Dividends on the Floating Rate Non-Cumulative Series F Preferred Stock are
non-cumulative and will be payable when and if declared by the Board of
Directors of HUSI quarterly on the first calendar day of January, April, July
and October of each year. Dividends on the stated value per share are payable
for each dividend period at a rate equal to a floating rate per annum of .75%
above three month LIBOR, but in no event will the rate be less than 3.5% per
annum. The Series F Preferred Stock may be redeemed at the option of HUSI, in
whole or in part, on or after April 7, 2010 at a redemption price equal to $25
per share, plus accrued and unpaid dividends for the then-current dividend
period.
Dividends on the Floating Rate Non-Cumulative Series G Preferred Stock are
non-cumulative and will be payable when and if declared by the Board of
Directors of HUSI quarterly on the first calendar day of January, April, July
and October of each year. Dividends on the stated value per share are payable
for each dividend period at a rate equal to a floating rate per annum of .75%
above three month LIBOR, but in no event will the rate be less than 4% per
annum. The Series G Preferred Stock may be redeemed at the option of HUSI, in
whole or in part, on or after January 1, 2011 at a redemption price equal to
$1,000 per share, plus accrued and unpaid dividends for the then-current
dividend period.
133
The Adjustable Rate Cumulative Preferred Stock, Series D is redeemable, as a
whole or in part, at the option of HUSI at $100 per share (or $25 per depositary
share), plus accrued and unpaid dividends. The dividend rate is determined
quarterly, by reference to a formula based on certain benchmark market interest
rates, but will not be less than 4 1/2% or more than 10 1/2% per annum for any
applicable dividend period.
The $2.8575 Cumulative Preferred Stock may be redeemed at the option of HUSI, in
whole or in part, on or after October 1, 2007 at $50 per share, plus accrued and
unpaid dividends. Dividends are paid quarterly.
DARTS of each series are redeemable at the option of HUSI, in whole or in part,
on any dividend payment date, at $100,000 per share, plus accrued and unpaid
dividends. Dividend rates for each dividend period are set pursuant to an
auction procedure. The maximum applicable dividend rates on the shares of DARTS
range from 110% to 150% of the 60 day "AA" composite commercial paper rate.
HUSI acquired CTUS Inc., a unitary thrift holding company in 1997 from CT
Financial Services Inc. (the Seller). CTUS owned First Federal Savings and Loan
Association of Rochester (First Federal). The acquisition agreement provided
that HUSI issue preferred shares to the Seller. The preferred shares provide
for, and only for, a contingent dividend or redemption equal to the amount of
recovery, net of taxes and costs, if any, by First Federal resulting from the
pending action against the United States government alleging breaches by the
government of contractual obligations to First Federal following passage of the
Financial Institutions Reform, Recovery and Enforcement Act of 1989. HUSI issued
100 preferred shares at a par value of $1.00 per share in connection with the
acquisition.
134
Note 19. Retained Earnings and Regulatory Capital Requirements
--------------------------------------------------------------------------------
Bank dividends are a major source of funds for payment by HUSI of shareholder
dividends and along with interest earned on investments, cover HUSI's operating
expenses which consist primarily of interest on outstanding debt. The approval
of the OCC is required if the total of all dividends declared by HBUS in any
year exceeds the net profits for that year, combined with the retained profits
for the two preceding years. Under a separate restriction, payment of dividends
is prohibited in amounts greater than undivided profits then on hand, after
deducting actual losses and bad debts. Bad debts are debts due and unpaid for a
period of six months unless well secured, as defined, and in the process of
collection.
Under the more restrictive of the above rules, as of December 31, 2006, HBUS can
pay dividends to HUSI of approximately $1.6 billion, adjusted by the effect of
its net income (loss) for 2007 up to the date of such dividend declaration.
Additional information regarding regulation, supervision and capital for HUSI
and HBUS begins on page 11 of this Form 10-K.
Capital amounts and ratios of HUSI and HBUS, calculated in accordance with
banking regulations, are summarized in the following table.
-----------------------------------------------------------------------------------------------------------------------
2006 2005
------------------------------------ --------------------------------------
Capital Well-Capitalized Actual Capital Well-Capitalized Actual
December 31 Amount Minimum Ratio Ratio Amount Minimum Ratio Ratio
-----------------------------------------------------------------------------------------------------------------------
($ in millions)
Total capital (to risk weighted assets):
HUSI ............................ $ 15,501 10.00% 12.58% $ 14,808 10.00% 12.53%
HBUS ............................ 14,998 10.00 12.23 14,464 10.00 12.32
Tier 1 capital (to risk weighted assets):
HUSI ............................ 10,577 6.00 8.58 9,746 6.00 8.25
HBUS ............................ 10,278 6.00 8.38 9,737 6.00 8.29
Tier 1 capital (to average assets):
HUSI ............................ 10,577 3.00 6.36 9,746 3.00 6.51
HBUS ............................ 10,278 5.00 6.29 9,737 5.00 6.61
Risk weighted assets:
HUSI ............................ 123,262 118,145
HBUS ............................ 122,652 117,382
135
Note 20. Accumulated Other Comprehensive Income
--------------------------------------------------------------------------------
Accumulated other comprehensive income includes certain items that are reported
directly within a separate component of shareholders' equity. The following
table presents changes in accumulated other comprehensive income balances.
----------------------------------------------------------------------------------------------
2006 2005 2004
----------------------------------------------------------------------------------------------
(in millions)
Unrealized (losses) gains on available for sale securities:
Balance, January 1 ............................................. $ (128) $ 21 $ 61
Increase (decrease) in fair value, net of taxes of $10, $71
and $(19), in 2006, 2005 and 2004, respectively ........... (55) (94) 14
Net gains on sale of securities reclassified to net income,
net of taxes of $12, $40 and $39 in 2006, 2005 and 2004,
respectively .............................................. (16) (55) (54)
------- ------- ------
Net change .................................................. (71) (149) (40)
------- ------- ------
Balance, December 31 ........................................... (199) (128) 21
======= ======= ======
Unrealized (losses) gains on derivatives classified as cash flow
hedges:
Balance, January 1 ............................................. 98 (6) 52
Change in unrealized gain (loss) net of taxes of $106, $(78)
and $30 in 2006, 2005 and 2004, respectively .............. (106) 104 (58)
------- ------- ------
Net change .................................................. (106) 104 (58)
------- ------- ------
Balance, December 31 ........................................... (8) 98 (6)
======= ======= ======
Unrealized gains on interest-only strip receivables:
Balance, January 1 ............................................. 7 -- --
Change in unrealized gains on interest-only strip
receivables, net of taxes of $4 and $(4) in 2006 and 2005,
respectively .............................................. (7) 7 --
------- ------- ------
Net change .................................................. (7) 7 --
------- ------- ------
Balance, December 31 ........................................... -- 7 --
======= ======= ======
Foreign currency translation adjustments:
Balance, January 1 ............................................. 11 16 15
Translation gains, net of taxes of $4 and $(4) in 2005 and
2004, respectively ........................................ * (5) 1
------- ------- ------
Net change .................................................. -- (5) 1
------- ------- ------
Balance, December 31 ........................................... 11 11 16
======= ======= ======
Unfunded postretirement benefits liability:
Balance, January 1 ............................................. -- -- --
Cumulative effect of change in accounting for pension and
postretirement benefits, net of taxes of $13 in 2006 ...... (18) -- --
------- ------- ------
Net change .................................................. (18) -- --
------- ------- ------
Balance, December 31 ........................................... (18) -- --
======= ======= ======
Summary of accumulated other comprehensive (loss) income:
Accumulated other comprehensive (loss) income, January 1 ....... (12) 31 128
Other comprehensive loss, net of tax ........................... (184) (43) (97)
Cumulative effect of change in accounting for pension and
postretirement benefits, net of tax .......................... (18) -- --
------- ------- ------
Accumulated other comprehensive (loss) income, December 31 ..... $ (214) $ (12) $ 31
======= ======= ======
* Less than $500 thousand.
136
Note 21. Related Party Transactions
--------------------------------------------------------------------------------
In the normal course of business, HUSI conducts transactions with HSBC and its
affiliates (HSBC affiliates). These transactions occur at prevailing market
rates and terms. All extensions of credit by HUSI to other HSBC affiliates are
legally required to be secured by eligible collateral. The following table
presents related party balances and the income and expense generated by related
party transactions.
----------------------------------------------------------------------------------------------------
December 31 2006 2005 2004
----------------------------------------------------------------------------------------------------
(in millions)
Assets:
Cash and due from banks ..................................... $ 179 $ 121 $ 182
Interest bearing deposits with banks ........................ 59 67 283
Federal funds sold and securities purchased under resale
agreements ................................................ 141 111 47
Trading assets .............................................. 6,895 5,386 3,167
Loans ....................................................... 1,042 1,901 1,378
Other ....................................................... 1,192 78 126
--------- --------- ---------
Total assets ................................................ $ 9,508 $ 7,664 $ 5,183
========= ========= =========
Liabilities:
Deposits .................................................... $ 12,232 $ 10,131 $ 9,764
Trading liabilities ......................................... 6,473 4,545 5,748
Short-term borrowings ....................................... 464 698 1,089
Other ....................................................... 255 106 28
--------- --------- ---------
Total liabilities ........................................... $ 19,424 $ 15,480 $ 16,629
========= ========= =========
----------------------------------------------------------------------------------------------------
December 31 2006 2005 2004
----------------------------------------------------------------------------------------------------
(in millions)
Interest income ................................................ $ 51 $ 40 $ 20
Interest expense ............................................... 408 293 119
Other revenues:
Gains on sales of loans to HMUS ............................. 106 18 --
Other HSBC affiliates income ................................ 102 112 147
Support services from HSBC affiliates:
Fees paid to HSBC Finance Corporation ....................... 452 415 35
Fees paid to HMUS ........................................... 227 162 114
Fees paid to HSBC Technology & Services (USA) Inc. (HTSU)
for technology services ................................... 235 216 172
Fees paid to other HSBC affiliates .......................... 162 126 99
137
Transactions Conducted with HSBC Finance Corporation
Credit Card Receivables and Other Loan Transactions
o In December 2004, HUSI acquired a private label receivable portfolio from
HSBC Finance Corporation, which primarily included credit card receivables
and retained interests associated with securitized credit card
receivables. HSBC Finance Corporation retained and continues to service
the customer relationships, for which they charged HUSI servicing fees of
$367 million and $379 million for the year ended December 31, 2006 and
2005, respectively. In July 2004, HUSI sold certain MasterCard(1)/Visa(2)
credit card relationships to HSBC Finance Corporation, but retained the
receivable balances associated with these relationships. By agreement,
HUSI is purchasing receivables generated by these private label and
MasterCard/Visa customer relationships at fair value on a daily basis.
Premiums paid are being amortized to interest income over the estimated
life of the receivables purchased. Since the original private label
receivables acquisition and MasterCard/Visa relationship sale, the
underlying customer balances included within these portfolios have
revolved, and new private label relationships have been added. Activity
related to these portfolios is summarized in the following table.
-----------------------------------------------------------------------------------------------------
Private Label MasterCard/Visa
----------------------- ---------------------
For the year ended December 31 2006 2005 2006 2005
-----------------------------------------------------------------------------------------------------
(in millions)
Receivables acquired from HSBC Finance Corporation:
Balance at beginning of period .............. $ 14,355 $ 10,936 $ 1,159 $ 1,142
Receivables acquired ........................ 21,591 21,029 2,317 2,055
Customer payments, net charge offs and
other activity ............................ (18,973) (17,610) (2,189) (2,038)
--------- ---------- --------- ---------
Balance at end of period .................... $ 16,973 $ 14,355 $ 1,287 $ 1,159
========= ========== ========= =========
Premiums paid to HSBC Finance Corporation:
Unamortized balance at beginning of period .. $ 320 $ 624 $ 12 $ 11
Premiums paid ............................... 367 411 39 34
Amortization ................................ (499) (715) (36) (33)
--------- ---------- --------- ---------
Unamortized balance at end of period ........ $ 188 $ 320 $ 15 $ 12
========= ========== ========= =========
Other Transactions with HSBC Finance Corporation
o Support services from HSBC affiliates include charges by HSBC Finance
Corporation under various service level agreements for loan origination
and servicing as well as other operational and administrative support.
o HBUS is the originating lender for a federal income tax refund
anticipation loan program for clients of various third party tax
preparers, which is managed by HSBC Finance Corporation. By agreement,
HBUS processes applications, funds and subsequently sells these loans to
HSBC Finance Corporation. During 2006, primarily during the first quarter,
approximately $16.1 billion of loans were originated by HBUS and sold to
HSBC Finance Corporation, resulting in gains of approximately $22 million
and fees paid to HSBC Finance Corporation of $4 million. For 2005, $15.1
billion of loans were sold to HSBC Finance Corporation, resulting in gains
of $19 million and fees paid of $4 million.
o In July 2006, HUSI's unused $2 billion line of credit with HSBC Finance
Corporation expired and was not renewed.
----------
(1) MasterCard is a registered trademark of MasterCard International,
Incorporated.
(2) Visa is a registered trademark of Visa USA, Inc.
138
Transactions Conducted with HMUS
o HUSI utilizes HMUS for broker dealer, debt underwriting, customer
referrals and for other treasury and traded markets related services,
pursuant to service level agreements. Debt underwriting fees charged by
HMUS are deferred as a reduction of long-term debt and amortized to
interest expense over the life of the related debt. Preferred stock
issuance costs charged by HMUS are recorded as a reduction of capital
surplus. Customer referral fees paid to HMUS are netted against customer
fee income, which is included in other fees and commissions. All other
fees charged by HMUS are included in support services from HSBC
affiliates.
o In June 2005, HUSI began acquiring residential mortgage loans, excluding
servicing, from unaffiliated third parties and subsequently selling these
acquired loans to HMUS. HUSI maintains no ownership interest in the
residential mortgage loans after sale. During 2006, HUSI sold $16 billion
of loans to HMUS for total gains on sale of $106 million, which are
included in other revenues. For 2005, HUSI sold approximately $2 billion
of loans to HMUS for total gains on sale of $18 million. Refer to page 9
of this Form 10-K for further information regarding this program.
Other Transactions with HSBC Affiliates
At December 31, 2006, HUSI had an unused line of credit with HSBC of $2 billion.
HUSI has extended loans and lines of credit to various other HSBC affiliates
totaling $1.4 billion, of which $172 million was outstanding at December 31,
2006.
HUSI routinely enters into derivative transactions with HSBC Finance Corporation
and other HSBC affiliates as part of a global HSBC strategy to offset interest
rate or other market risks associated with debt issues, derivative contracts or
other financial transactions with unaffiliated third parties. At December 31,
2006 and December 31, 2005, the aggregate notional amounts of all derivative
contracts with other HSBC affiliates were approximately $772 billion and $570
billion, respectively. The net credit risk exposure (defined as the recorded
fair value of derivative receivables) related to these contracts was
approximately $7 billion and $5 billion at December 31, 2006 and 2005,
respectively. HUSI, within its Corporate, Investment Banking and Markets
business, accounts for these transactions on a mark to market basis, with the
change in value of contracts with HSBC affiliates substantially offset by the
change in value of related contracts entered into with unaffiliated third
parties.
Domestic employees of HUSI participate in a defined benefit pension plan
sponsored by HNAH. Additional information regarding pensions is provided in Note
23 of these consolidated financial statements, beginning on page 142 of this
Form 10-K.
Employees of HUSI participate in one or more stock compensation plans sponsored
by HSBC. HUSI's share of the expense of these plans on a pre-tax basis for the
year ended December 31, 2006 and 2005 was approximately $74 million and $51
million, respectively. As of December 31, 2006, HUSI's share of compensation
cost related to nonvested stock compensation plans was approximately $90
million, which is expected to be recognized over a weighted-average period of
1.6 years. A description of these stock compensation plans begins on page 140 of
this Form 10-K.
During 2005, HUSI sold shares in a foreign equity fund to an HSBC affiliate for
a gain of $48 million.
139
Note 22. Stock Option Plans and Restricted Share Plans
--------------------------------------------------------------------------------
Options have been granted to employees of HUSI under the HSBC Holdings Group
Share Option Plan (the Group Share Option Plan) and under the HSBC Holdings
Savings-Related Share Option Plan (Sharesave). Since the shares and contribution
commitment have been granted directly by HSBC, the offset to compensation
expense was a credit to capital surplus, representing a contribution of capital
from HSBC.
The following table presents information for each plan. Descriptions of each
plan follow the table.
-----------------------------------------------------------------------------------------------------
December 31 2006 2005 2004
-----------------------------------------------------------------------------------------------------
Restricted Share Plan:
Total compensation expense recognized
(in millions) .................................... $ 59 $ 44 $ 50
Sharesave (5 year vesting period):
Total options granted .............................. 83,000 262,000 207,000
Fair value per option granted ...................... $ 3.49 $ 3.78 $ 3.80
Total compensation expense recognized
(in millions) .................................... $ * $ * $ *
Significant assumptions used to calculate fair
value:
Risk free interest rate ...................... 5.0% 4.3% 5.0%
Expected life (years) ........................ 5 5 5
Expected volatility .......................... 17% 20% 25%
Sharesave (3 year vesting period):
Total options granted .............................. 274,000 510,000 407,000
Fair value per option granted ...................... $ 3.42 $ 3.73 $ 3.44
Total compensation expense recognized
(in millions) .................................... $ 1 $ 1 $ 1
Significant assumptions used to calculate fair
value:
Risk free interest rate ...................... 5.0% 4.3% 4.9%
Expected life (years) ........................ 3 3 3
Expected volatility .......................... 17% 20% 25%
Sharesave (1 year vesting period):
Total options granted .............................. 81,000
Fair value per option granted ...................... $ 2.60
Total compensation expense recognized
(in millions) .................................... $ *
Significant assumptions used to calculate fair
value:
Risk free interest rate ...................... 5.0%
Expected life (years) ........................ 1
Expected volatility .......................... 17%
Group Share Option Plan:
Total options granted .............................. -- -- 4,574,000
Fair value per option granted ...................... $ -- $ -- $ 2.83
Total compensation expense recognized
(in millions) .................................... $ 14 $ 6 $ 10
Significant assumptions used to calculate fair
value:
Risk free interest rate ...................... --% --% 4.90%
Expected life (years) ........................ -- -- 6.9
Expected volatility .......................... --% --% 25%
* Less than $500 thousand
140
Restricted Share Plans
Awards are granted to key individuals in the form of performance and
non-performance restricted shares. The awards are based on an individual's
demonstrated performance and future potential. Performance related restricted
shares generally vest after three years from date of grant, based on HSBC's
Total Shareholder Return (TSR) relative to a benchmark TSR during the
performance period. TSR is defined as the growth in share value and declared
dividend income during the period and the benchmark is composed of HSBC's peer
group of financial institutions. If the performance conditions are met, the
shares vest and are released to the recipients two years later. Non-performance
restricted shares are released to the recipients based on continued service,
typically at the end of a three year vesting period.
Sharesave Plans
Sharesave is an employee share option plan that enables eligible employees to
enter into savings contracts of one, three or five year terms, with the ability
to decide at the end of the contract term to either use their accumulated
savings to purchase HSBC ordinary shares at a discounted option price or have
the savings plus interest repaid in cash. The one year savings contracts were
offered to employees for the first time in 2006. Employees can save up to $450
per month over all their Sharesave savings contracts. The option price is
determined at the beginning of the offering period of each plan year and
represents a 20% discount, for the three and five year savings contracts, and a
15% discount for the one year contract, from the average price in London on the
HSBC ordinary shares over the five trading days preceding the offering. On
contracts of three year or five year terms, the options are exercisable at the
20% discounted stock option price within six months following the third or fifth
anniversary of the beginning of the relevant savings contracts. Upon the
completion of a one year savings contract, if the share price is higher than the
option price, the option will automatically be exercised and the shares will be
purchased at the 15% discounted stock option price. The shares will then be
transferred to a holding account where they will be held for one additional
year, or until the employee decides to sell the shares. Regardless of the length
of the savings contract, employees can decide to have their accumulated savings
plus interest refunded to them at the end of the contract period, rather than
choosing to exercise their purchase option.
The fair value of options granted under Sharesave plans is estimated as of the
date of grant using a third party option pricing model.
Group Share Option Plan
The Group Share Option Plan was a discretionary long-term incentive compensation
plan available prior to 2005, to certain HUSI employees based on performance
criteria. Options were granted at market value and are normally exercisable
between the third and tenth anniversaries of the date of grant, subject to
vesting conditions.
Fair values of Group Share Option Plan awards made in 2004, measured at the date
of grant, were calculated using a binomial lattice methodology that is based on
the underlying assumptions of the Black-Scholes option pricing model. When
modeling options with vesting dependent on attainment of certain performance
conditions over a period of time, these performance targets are incorporated
into the model using Monte-Carlo simulation. The expected life of options
depends on the behavior of option holders, which is incorporated into the option
model consistent with historic observable data. The fair values are inherently
subjective and uncertain due to the assumptions made and the limitations of the
model used.
No options were granted under the Group Share Option Plan in 2005 or 2006, since
the plan was terminated by HSBC in May 2005. In lieu of options, employees now
receive grants of HSBC Holdings ordinary shares subject to certain vesting
conditions (refer to Restricted Share Plans above). All existing stock option
grants under the Group Share Option Plan remain in effect subject to the same
conditions as before plan termination and compensation expense continues to be
recognized over the various grant vesting periods.
141
Note 23. Pension and Other Postretirement Benefits
--------------------------------------------------------------------------------
Defined Benefit Pension Plans
In November 2004, sponsorship of the defined benefit pension plan of HUSI and
the defined benefit pension plan of HSBC Finance Corporation was transferred to
HNAH. Effective January 1, 2005, the two separate plans were combined into a
single HNAH defined benefit pension plan which facilitates the development of a
unified employee benefit policy and unified employee benefit plan administration
for HSBC companies operating in the U.S. As a result, the pension asset relating
to HUSI's defined benefit plan of $279 million, net of tax, was transferred to
HNAH as a capital transaction in the first quarter of 2005.
In 2006, HUSI adopted SFAS 158 (see New Accounting Pronouncements on page 109 of
this Form 10-K), which requires balance sheet recognition of the funded status
of pension and other postretirement benefit plans. Since HUSI's main pension
plan was transferred to HNAH in 2005, adoption of SFAS 158 had no significant
balance sheet impact related to pension obligations. The impact of SFAS 158 on
other postretirement benefit plans is summarized on page 144 of this Form 10-K.
The components of pension expense for the defined benefit plan reflected in
HUSI's consolidated statement of income are shown in the table below. The
pension expense for the years ended December 31, 2006 and 2005 reflect the
portion of the pension expense of the combined HNAH pension plan which has been
allocated to HUSI.
-------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
-------------------------------------------------------------------------------------------------------
(in millions)
Service cost-benefits earned during the period ........... $ 30 $ 27 $ 31
Interest cost on projected benefit obligation ............ 65 62 69
Expected return on assets ................................ (84) (89) (96)
Amortization of prior service cost ....................... 1 1 1
Recognized losses ........................................ 16 5 26
------------ ------------ ------------
Pension expense .......................................... $ 28 $ 6 $ 31
============ ============ ============
The information and activity presented in the following tables as of and for the
years ended December 31, 2006 and 2005 relate to the post-merger HNAH defined
benefit pension plan, unless noted otherwise. The information and activity
presented as of and for the year ended December 31, 2004 reflect pre-merger HUSI
defined benefit pension plan balances and activity.
The assumptions used in determining pension expense of the defined benefit plan
are as follows:
-------------------------------------------------------------------------------------------------------
2006 2005 2004
-------------------------------------------------------------------------------------------------------
Discount rate ............................................ 5.70% 6.00% 6.25%
Salary increase assumption ............................... 3.75 3.75 3.75
Expected long-term rate of return on plan assets ......... 8.00 8.33 8.00
142
A reconciliation of beginning and ending balances of the fair value of plan
assets associated with the HNAH defined benefit pension plan is shown below.
---------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005
---------------------------------------------------------------------------------------------------------
(in millions)
Fair value of plan assets at beginning of year ..................................... $ 2,383 $ 1,304
Transfer of assets from the former HSBC Finance Corporation Plan ................... -- 1,000
Actual return on plan assets ....................................................... 246 168
Benefits paid ...................................................................... (62) (89)
------- -------
Fair value of plan assets at end of year ........................................... $ 2,567 $ 2,383
======= =======
HUSI does not currently anticipate making employer contributions to the defined
benefit plan in 2007.
The allocation of the pension plan assets at December 31, 2006 and 2005 for the
HNAH defined benefit pension plan is summarized in the following table:
-------------------------------------------------------------------------------------------------------------
Percentage of Plan Assets
at December 31,
-------------------------
2006 2005
-------------------------------------------------------------------------------------------------------------
Equity securities 69% 69%
Debt securities 30 31
Other 1 --
------- ----------
Total 100% 100%
======= ==========
There were no investments in HSBC ordinary shares or American depositary shares
at December 31, 2006 and 2005.
The primary objective of the HNAH defined benefit pension plan is to provide
eligible employees with regular pension benefits. Since the plans are governed
by the Employee Retirement Income Security Act of 1974 (ERISA), ERISA
regulations serve as guidance for the management of plan assets. Consistent with
prudent standards of preservation of capital and maintenance of liquidity, the
goals of the plans are to earn the highest possible rate of return consistent
with the tolerance for risk as determined by the investment committee in its
role as a fiduciary. In carrying out these objectives, short-term fluctuations
in the value of plan assets are considered secondary to long-term investment
results. A third party and an HSBC affiliate are retained by HNAH to provide
investment consulting services such as recommendations on the type of funds to
be invested in and monitoring the performance of fund managers. In order to
achieve the return objectives of the plans, the plans are diversified to ensure
that adverse results from one security or security class will not have an unduly
detrimental effect on the entire investment portfolio. Assets are diversified by
type, characteristic and number of investments as well as by investment style of
management organization. Equity securities are invested in large, mid and small
capitalization domestic stocks as well as international stocks.
143
A reconciliation of beginning and ending balances of the projected benefit
obligation of the HNAH defined benefit pension plan is shown in the following
table.
---------------------------------------------------------------------------
Year Ended December 31 2006 2005
---------------------------------------------------------------------------
(in millions)
Projected benefit obligation at beginning of year ... $ 2,530 $ 1,174
Transfer in from the HSBC Finance Corporation Plan .. -- 1,019
Service cost ........................................ 102 94
Interest cost ....................................... 145 130
Actuarial (gains) losses ............................ (17) 203
Benefits paid ....................................... (62) (90)
-------- -------
Projected benefit obligation at end of year ......... $ 2,698 $ 2,530
======== =======
HUSI's share of the projected benefit obligation of the HNAH defined benefit
pension plan at December 31, 2006 is approximately $1.2 billion. The accumulated
benefit obligation for the HNAH defined benefit pension plan was approximately
$2.4 billion and $2 billion at December 31, 2006 and 2005, respectively. HUSI's
share of the accumulated benefit obligation at December 31, 2006 and 2005 was
approximately $1.1 billion and $1 billion, respectively. The accumulated benefit
obligation for HUSI's pre-merger defined benefit pension plans was approximately
$1 billion at December 31, 2004.
Estimated future benefit payments for the HNAH defined benefit pension plan and
HUSI's share of those estimated payments are summarized in the following table
---------------------------------------------------------------------------
HUSI's
HNAH Share
---------------------------------------------------------------------------
(in millions)
2007 ................................................ $ 122 $ 49
2008 ................................................ 130 53
2009 ................................................ 137 56
2010 ................................................ 144 59
2011 ................................................ 156 63
2012-2016 ........................................... 927 388
The assumptions used in determining the projected benefit obligation of the
defined benefit pension plans at December 31 are summarized in the following
table.
--------------------------------------------------------------------------
2006 2005 2004
--------------------------------------------------------------------------
Discount rate ................................ 5.90% 5.70% 6.00%
Salary increase assumption ................... 3.75 3.75 3.75
Postretirement Plans Other Than Pensions
HUSI's employees also participate in several plans which provide medical, dental
and life insurance benefits to retirees and eligible dependents. These plans
cover substantially all employees who meet certain age and vested service
requirements. HUSI has instituted dollar limits on payments under the plans to
control the cost of future medical benefits.
As discussed in Note 2, the adoption of SFAS 158 resulted in additional pension
liability of $31 million, a related deferred tax asset of $13 million, and an
offset to other comprehensive income of $18 million at December 31, 2006.
144
The net postretirement benefit cost included the following components.
------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004
------------------------------------------------------------------------------------
(in millions)
Service cost - benefits earned during the period ........ $ 1 $ 2 $ 2
Interest cost ........................................... 6 7 7
Amortization of transition obligation ................... 3 3 3
------ ------ -----
Net periodic postretirement benefit cost ................ $ 10 $ 12 $ 12
====== ====== =====
The assumptions used in determining the net periodic postretirement benefit cost
for HUSI's postretirement benefit plans are shown in the following table.
------------------------------------------------------------------------------------
December 31 2006 2005 2004
------------------------------------------------------------------------------------
Discount rate 5.70% 6.00% 5.75%
Salary increase assumption 3.75 3.75 3.75
A reconciliation of the beginning and ending balances of the accumulated
postretirement benefit obligation is shown in the following table.
----------------------------------------------------------------------------
Year Ended December 31 2006 2005
----------------------------------------------------------------------------
(in millions)
Accumulated benefit obligation at beginning of year ..... $ 119 $ 122
Service cost ............................................ 1 2
Interest cost ........................................... 6 7
Participant contributions ............................... 1 1
Actuarial gains ......................................... (13) (4)
Benefits paid ........................................... (11) (9)
------ ------
Accumulated benefit obligation at end of year ........... $ 103 $ 119
====== ======
HUSI's postretirement benefit plans are funded on a pay-as-you-go basis.
Estimated future benefit payments for HUSI's postretirement plans are summarized
in the following table.
--------------------------------------------------------------------------------
(in millions)
2007 ...................................................... $ 9
2008 ...................................................... 8
2009 ...................................................... 9
2010 ...................................................... 9
2011 ...................................................... 9
2012-2016 ................................................. 43
145
The assumptions used in determining the benefit obligation of HUSI's
postretirement benefit plans at December 31 are as follows:
----------------------------------------------------------------------------
2006 2005 2004
----------------------------------------------------------------------------
Discount rate .................................. 5.90% 5.70% 6.00%
Salary increase assumption ..................... 3.75 3.75 3.75
A 10.5 percent annual rate of increase in the gross cost of covered health care
benefits was assumed for 2006. This rate of increase is assumed to decline
gradually to 5 percent in 2014.
Assumed health care cost trend rates have an effect on the amounts reported for
health care plans. A one-percentage point change in assumed health care cost
trend rates would increase (decrease) service and interest costs and the
postretirement benefit obligation as follows:
-----------------------------------------------------------------------------------------
One Percent One Percent
Increase Decrease
-----------------------------------------------------------------------------------------
(in millions)
Effect on total of service and interest cost components ..... $ * $ *
Effect on postretirement benefit obligation ................. 2 (2)
* Less than $500 thousand
Other Plans
HUSI maintains a 401(k) plan covering substantially all employees. Employer
contributions to the plan are based on employee contributions. Total expense
recognized for this plan was approximately $34 million, $33 million and $18
million in 2006, 2005 and 2004, respectively.
Certain employees are participants in various defined contribution and other
non-qualified supplemental retirement plans. Total expense recognized for these
plans was immaterial in 2006, 2005 and 2004.
146
Note 24. Business Segments
--------------------------------------------------------------------------------
HUSI has five distinct segments that it utilizes for management reporting and
analysis purposes. Descriptions of HUSI's business segments are presented on
pages 6-7 of this Form 10-K.
Results for each segment are summarized in the following tables. For
comparability purposes, 2005 and 2004 results have been revised to conform with
2006 presentation.
-----------------------------------------------------------------------------------------------------------------------
PFS CF CMB CIBM PB Other Total
-----------------------------------------------------------------------------------------------------------------------
(in millions)
2006
Net interest income (1) ........ $ 1,232 $ 738 $ 745 $ 181 $ 199 $ (14) $ 3,081
Other revenues ................. 447 501 274 1,011 305 25 2,563
--------- --------- --------- --------- --------- ------- ----------
Total revenues ................. 1,679 1,239 1,019 1,192 504 11 5,644
Operating expenses (2) ......... 1,192 441 508 803 311 -- 3,255
--------- --------- --------- --------- --------- ------- ----------
487 798 511 389 193 11 2,389
Provision for credit losses (3) 58 659 62 10 34 -- 823
--------- --------- --------- --------- --------- ------- ----------
Income before income tax expense $ 429 $ 139 $ 449 $ 379 $ 159 $ 11 $ 1,566
========= ========= ========= ========= ========= ======= ==========
Average loans .................. $ 37,242 $ 19,835 $ 14,921 $ 12,399 $ 4,456 $ -- $ 88,853
Average assets ................. 41,685 20,677 17,940 79,882 5,744 350 166,278
Average deposits ............... 33,586 17 15,202 37,617 9,790 -- 96,212
Average liabilities/ equity (4) 48,250 1,657 21,519 82,983 11,869 -- 166,278
Goodwill at December 31, 2006 (5) 1,177 -- 472 636 431 -- 2,716
2005
Net interest income (1) ........ $ 1,202 $ 583 $ 662 $ 456 $ 172 $ (12) $ 3,063
Other revenues ................. 406 356 228 641 257 23 1,911
--------- --------- --------- --------- --------- ------- ----------
Total revenues ................. 1,608 939 890 1,097 429 11 4,974
Operating expenses (2) ......... 1,002 424 410 650 272 -- 2,758
--------- --------- --------- --------- --------- ------- ----------
606 515 480 447 157 11 2,216
Provision for credit losses (3) 103 599 22 (47) (3) -- 674
--------- --------- --------- --------- --------- ------- ----------
Income before income tax expense $ 503 $ (84) $ 458 $ 494 $ 160 $ 11 $ 1,542
========= ========= ========= ========= ========= ======= ==========
Average loans .................. $ 44,143 $ 18,516 $ 14,001 $ 7,333 $ 3,905 $ -- $ 87,898
Average assets ................. 48,629 19,316 16,272 57,597 5,041 321 147,176
Average deposits ............... 28,436 286 11,745 37,592 7,464 -- 85,523
Average liabilities/ equity (4) 43,114 684 18,046 75,579 9,751 2 147,176
Goodwill at December 31, 2005 (5) 1,167 -- 468 631 428 -- 2,694
147
----------------------------------------------------------------------------------------------------------------------
PFS CF CMB CIBM PB Other Total
----------------------------------------------------------------------------------------------------------------------
(in millions)
2004
Net interest income (1) ........ $ 1,088 $ 182 $ 586 $ 766 $ 130 $ (11) $ 2,741
Other revenues ................. 358 2 200 534 204 21 1,319
--------- --------- --------- --------- --------- ------- ----------
Total revenues ................. 1,446 184 786 1,300 334 10 4,060
Operating expenses (2) ......... 922 17 374 525 263 -- 2,101
--------- --------- --------- --------- --------- ------- ----------
524 167 412 775 71 10 1,959
Provision for credit losses (3) 81 22 (26) (95) 1 -- (17)
--------- --------- --------- --------- --------- ------- ----------
Income before income tax expense $ 443 $ 145 $ 438 $ 870 $ 70 $ 10 $ 1,976
========= ========= ========= ========= ========= ======= ==========
Average loans .................. $ 36,847 $ 4,257 $ 12,287 $ 4,152 $ 2,785 $ -- $ 60,328
Average assets ................. 40,943 4,256 14,009 48,689 4,029 300 112,226
Average deposits ............... 24,145 3,998 9,535 27,508 7,667 -- 72,853
Average liabilities/ equity (4) 34,052 (2) 14,783 54,442 8,951 -- 112,226
Goodwill at December 31, 2004 (5) 1,167 -- 471 631 428 -- 2,697
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses.
(4) Common shareholder's equity and earnings on common shareholder's equity
are allocated back to the segments based on the percentage of capital
assigned to the business.
(5) During 2006, a deferred tax asset related to a previous acquisition was
adjusted against the related goodwill balance, resulting in a $22 million
increase in goodwill (refer to Note 12 on page 125 of this Form 10-K). The
reduction in goodwill from December 31, 2004 to December 31, 2005 resulted
from the sale of certain branches during 2005.
Note 25. Collateral, Commitments and Contingent Liabilities
--------------------------------------------------------------------------------
Pledged Assets
The following table presents pledged assets included in the consolidated balance
sheet.
--------------------------------------------------------------------------------
December 31 2006 2005
--------------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks ................. $ 764 $ 483
Trading assets (1) ................................... 2,961 1,452
Securities available for sale (2) .................... 6,775 6,369
Securities held to maturity .......................... 273 446
Loans (3) ............................................ 8,426 7,807
Other assets (4) ..................................... 849 687
---------- ----------
Total ................................................ $ 20,048 $ 17,244
========== ==========
(1) Trading assets are primarily pledged against liabilities associated with
consolidated variable interest entities (refer to Note 26).
(2) Securities available for sale are primarily pledged against various
short-term borrowings.
(3) Loans are primarily private label credit card receivables pledged against
long-term borrowings and residential mortgage loans pledged against
long-term borrowings from the Federal Home Loan Bank (refer to Note 14).
(4) Other assets represent cash on deposit with non-banks related to
derivative collateral support agreements.
Debt securities pledged as collateral that can be sold or repledged by the
secured party continue to be reported on the consolidated balance sheet. The
fair value of securities available for sale that can be sold or repledged was
$2,289 million and $2,152 million at December 31, 2006 and 2005, respectively.
148
The fair value of collateral accepted by HUSI not reported on the consolidated
balance sheet that can be sold or repledged was $8,161 million and $5,800
million at December 31, 2006 and 2005, respectively. This collateral was
obtained under security resale agreements. Of this collateral, $781 million and
$1,158 million has been sold or repledged as collateral under repurchase
agreements or to cover short sales at December 31, 2006 and 2005, respectively.
Lease Obligations
HUSI and its subsidiaries are obligated under a number of noncancellable leases
for premises and equipment. Certain leases contain renewal options and
escalation clauses. Expected minimum lease payments under noncancellable
operating leases as of December 31, 2006, net of sublease rentals, are
summarized in the following table.
--------------------------------------------------------------------------------
(in millions)
Expected minimum future payments:
2007 .............................................................. $ 81
2008 .............................................................. 71
2009 .............................................................. 64
2010 .............................................................. 56
2011 .............................................................. 48
Thereafter ........................................................ 189
----------
$ 509
==========
Litigation
HUSI is named in and is defending legal actions in various jurisdictions arising
from its normal business. None of these proceedings is regarded as material
litigation. In addition, there are certain proceedings related to the "Princeton
Note Matter" that are described below.
In relation to the Princeton Note Matter, as disclosed in HUSI's 2002 Annual
Report on Form 10-K, two of the noteholders were not included in the settlement
and their civil suits are continuing. The U.S. Government excluded one of them
from the restitution order (Yakult Honsha Co., Ltd.) because a senior officer of
the noteholder was being criminally prosecuted in Japan for his conduct relating
to its Princeton Notes. The senior officer in question was convicted during
September 2002 of various criminal charges related to the sale of the Princeton
Notes. The U.S. Government excluded the other noteholder (Maruzen Company,
Limited) because the sum it is likely to recover from the Princeton Receiver
exceeds its losses attributable to its funds transfers with Republic New York
Securities Corporation, as calculated by the U.S. Government. Both of these
civil suits seek compensatory, punitive, and treble damages pursuant to RICO and
assorted fraud and breach of duty claims arising from unpaid Princeton Notes
with face amounts totaling approximately $125 million. No amount of compensatory
damages is specified in either complaint. These two complaints name HUSI, HBUS,
and Republic New York Securities Corporation as defendants. HUSI and HBUS have
moved to dismiss both complaints. The motion is fully briefed and sub judice.
Mutual production of documents took place in 2001, but additional discovery
proceedings have been suspended pending the Court's resolution of the motions to
dismiss.
149
Note 26. Off-Balance Sheet Financial Guarantee Arrangements
--------------------------------------------------------------------------------
The following table provides information related to off-balance sheet financial
guarantee arrangements.
--------------------------------------------------------------------------------
December 31 2006 2005
--------------------------------------------------------------------------------
(in millions)
Standby letters of credit, net of participations (1) .. $ 7,259 $ 6,114
Loan sales with recourse (2) .......................... 8 9
Credit derivative contracts (3) ....................... 431,631 222,419
Securities lending indemnifications ................... - 4,135
---------- ----------
Total ................................................. $ 438,898 $ 232,677
========== ==========
(1) Includes $542 million and $523 million issued for the benefit of HSBC
affiliates at December 31, 2006 and 2005, respectively.
(2) $7 million of this amount is indemnified by HSBC affiliates at December
31, 2006 and 2005, respectively.
(3) Includes $71,908 million and $51,202 million issued for the benefit of
HSBC affiliates at December 31, 2006 and 2005, respectively.
Standby Letters of Credit
HUSI may issue a letter of credit for the benefit of a customer, authorizing a
third party to draw on the letter for specified amounts under certain terms and
conditions. The issuance of a letter of credit is subject to HUSI's credit
approval process and collateral requirements.
A standby letter of credit is issued to third parties for the benefit of a
customer and is essentially a guarantee that the customer will perform, or
satisfy some obligation, under a contract. It irrevocably obligates HUSI to pay
a third party beneficiary when a customer either: (1) in the case of a
performance standby letter of credit, fails to perform some contractual
non-financial obligation, or (2) in the case of a financial standby letter of
credit, fails to repay an outstanding loan or debt instrument.
Fees are charged for issuing letters of credit commensurate with the customer's
credit evaluation and the nature of any collateral. Included in other
liabilities are deferred fees on standby letters of credit, representing the
fair value of the "stand ready obligation to perform" under these guarantees,
amounting to $21 million and $19 million at December 31, 2006 and 2005,
respectively. Also included in other liabilities is an allowance for credit
losses on unfunded standby letters of credit of $25 million and $20 million at
December 31, 2006 and 2005, respectively.
Loan Sales with Recourse
HUSI securitizes and sells assets, generally without recourse. In prior years,
HUSI's mortgage banking subsidiary sold residential mortgage loans with recourse
upon borrower default, with partial indemnification from third parties.
Credit Derivatives
HUSI enters into credit derivative contracts primarily to satisfy the needs of
its customers and, in certain cases, for its own benefit. Credit derivatives are
arrangements that provide for one party (the "protection buyer") to transfer the
credit risk of a "reference asset" to another party (the "protection seller").
Under this arrangement the protection seller assumes the credit risk associated
with the reference asset without directly purchasing it. The protection buyer
agrees to pay a specified fee to the protection seller. In return, the
protection seller agrees to pay the protection buyer an agreed upon amount if
there is a default during the term of the contract.
In accordance with its policy, HUSI offsets most of the risk it assumes in
selling credit protection through a credit derivative contract with another
counterparty. Credit derivatives are recorded at fair value. The commitment
amount included in the table is the maximum amount that HUSI could be required
to pay, without consideration of the approximately equal amount receivable from
third parties and any associated collateral.
150
Securities Lending Indemnifications
Through December 31, 2005, HUSI occasionally lent securities of customers, on a
fully collateralized basis, as an agent to third party borrowers. Customers were
indemnified against the risk of loss, and collateral was obtained from the
borrower with a market value exceeding the value of the loaned securities.
Securities lending activities were terminated during the first quarter of 2006.
Note 27. Variable Interest Entities (VIEs)
--------------------------------------------------------------------------------
HUSI, in the ordinary course of business, makes use of VIE structures in a
variety of business activities, primarily to facilitate client needs. VIE
structures are utilized after careful consideration of the most appropriate
structure needed to achieve HUSI's control and risk management objectives and to
help ensure an efficient and appropriate structure from a regulatory and
taxation perspective.
Consolidated VIEs
HUSI entered into a series of transactions with VIEs organized by HSBC
affiliates and unrelated third parties. These VIEs were structured as trusts or
corporations that issue fixed or floating rate instruments backed by the assets
of the issuing entities. HUSI sold trading assets to the VIEs and subsequently
entered into total return swaps with the VIEs whereby HUSI receives the total
return on the transferred assets and, in return, pays a market rate of return to
its counterparties. HUSI has determined that it is the primary beneficiary of
these VIEs under the applicable accounting literature and, accordingly,
consolidated $2.6 billion in trading assets at December 31, 2006. These assets
are pledged as collateral for obligations of the VIEs, which are included in
long-term debt (refer to Note 15 on page 126 of this Form 10-K). The holders
of the instruments issued by the VIEs have no recourse to the general credit of
HUSI beyond the assets sold to the VIEs and pledged as collateral.
Unconsolidated VIEs
HUSI also holds variable interests in various other VIEs which are not
consolidated at December 31, 2006. HUSI is not the primary beneficiary of these
VIE structures. Information for unconsolidated VIEs is presented in the
following table and commentary.
-----------------------------------------------------------------------------------------------
December 31, 2006 December 31, 2005
---------------------- --------------------
Maximum Maximum
Total Exposure Total Exposure
Assets to Loss Assets to Loss
-----------------------------------------------------------------------------------------------
(in millions)
Asset backed commercial paper conduits ........ $ 14,104 $ 8,048 $ 10,183 $ 7,423
Securitization vehicles ....................... 2,242 612 1,774 565
Investment funds .............................. 200 2 2,513 --
Capital funding vehicles ...................... 1,093 32 1,093 32
Low income housing tax credits ................ 406 153 1,080 165
---------- --------- --------- --------
Total ......................................... $ 18,045 $ 8,847 $ 16,643 $ 8,185
========== ========= ========= ========
Asset Backed Commercial Paper Conduits
HSBC affiliates support the financing needs of customers by facilitating their
access to the commercial paper markets. Specifically, pools of customers'
assets, typically trade receivables, are sold to an independently rated,
commercial paper financing entity, which in turn issues short-term, asset backed
commercial paper that is collateralized by such assets. Neither the HSBC
affiliates nor HUSI service the assets or transfer their own receivables into
the financing entities.
HUSI and other banks provide one year liquidity facilities, in the form of
either loan or asset purchase commitments, in support of each transaction in the
financing entity. HUSI does not provide any program wide enhancements to the
financing entities. In the preceding table, HUSI's maximum exposure to loss is
the total notional amount of the liquidity facilities.
151
In the normal course of business, HUSI provides liquidity facilities to asset
backed commercial paper conduits sponsored by unrelated third parties. HUSI does
not transfer its own receivables into the financing entity, has no ownership
interest in, performs no administrative duties for, and does not service any
assets of these conduits. The only interest HUSI has in these entities are
liquidity facilities in the amount of approximately $1.5 billion and $1.4
billion at December 31, 2006 and 2005, respectively. These facilities are
excluded from the table summarizing HUSI's involvement in VIEs.
Credit risk is managed on these commitments by subjecting them to HUSI's normal
underwriting and risk management processes.
Securitization Vehicles
An HSBC affiliate and third parties organize trusts that are special purpose
entities (SPEs) that issue fixed or floating rate debt backed by the assets of
the trusts. Neither the HSBC affiliate nor HUSI transfer their own assets into
the trusts. HUSI's relationship with the SPEs is primarily as counterparty to
the SPEs' derivative transactions (interest rate, credit default and currency
swaps). HUSI's maximum exposure to loss from the unconsolidated trust entities
is comprised of investments in the trust and the market risk on the derivative
transactions.
Investment Funds
HUSI is a derivative counterparty (total return swap) with a hedge fund
established by an unrelated third party. The total return swap creates a
variable interest in the fund for HUSI. HUSI does not hold shares in or have any
other involvement with the fund. As such, HUSI is not the primary beneficiary.
HUSI is also an investor in a hedge fund established by an unrelated third
party. The shares owned by HUSI do not have voting rights but do participate in
profits and losses based on percentage of share ownership. HUSI does not hold
sufficient beneficial interests in the fund to be considered the primary
beneficiary.
HUSI is a sub-investment advisor to mutual funds structured as trusts and
managed by an HSBC affiliate. As sub-investment advisor, HUSI receives a
variable fee based on the value of funds. HUSI has no ownership interest in or
credit exposure resulting from its duties as investment advisor. During 2006,
the assets of certain of these trusts were liquidated, resulting in
significantly reduced assets to manage.
Capital Funding Vehicles
Prior to 2005, HUSI established five Capital Trust entities. These trusts issue
preferred securities and common stock. HUSI purchased all of the common equity
issued by the trusts, which equates to approximately 3% of the total assets of
the trusts. HUSI does not own any of the preferred securities issued by the
trusts. It has been determined that the majority of the benefit of profit and/or
risk of loss lies with the preferred security holders. Thus, HUSI is not the
primary beneficiary of the trusts and is not required to consolidate these
entities.
Low Income Housing Tax Credits
HUSI participates as a limited partner in Low Income Housing Tax Credit
Partnerships. These investments are recorded as other assets on the consolidated
balance sheet using the equity method of accounting. HUSI also receives tax
benefits over a period of time specified in the investment contracts. HUSI's
investment is reduced over time for its share of any operating losses incurred
by the partnership as well as for any amortization over the time period in which
tax credits are received. Tax credits may be subject to recapture if the
underlying properties do not remain in compliance with certain conditions. Some
of these partnerships have been determined to be VIEs. HUSI's maximum exposure
to loss shown in the table represents the net assets recorded on the balance
sheet, estimated expected reduction of future tax liabilities, and potential
recapture of tax credits allowed in prior years.
152
Note 28. Fair Value of Financial Instruments
--------------------------------------------------------------------------------
HUSI is required to disclose the estimated fair value of its financial
instruments in accordance with Statement of Financial Accounting Standards No.
107, Disclosures about Fair Value of Financial Instruments (SFAS 107). The
disclosures do not attempt to estimate or represent the fair value of HUSI as a
whole. The disclosures exclude assets and liabilities that are not financial
instruments, including intangible assets, such as goodwill. The estimation
methods and assumptions used by HUSI to value individual classifications of
financial instruments are described below. Different assumptions could
significantly affect the estimates. Accordingly, the net realizable values upon
liquidation of the financial instruments could be materially different from the
estimates presented.
Financial instruments with carrying value equal to fair value - The carrying
value of certain financial assets and liabilities is considered to be equal to
fair value as a result of their short-term nature and interest rates that
approximate market rates. These items include cash and due from banks, interest
bearing deposits with banks, federal funds sold and securities purchased under
resale agreements, accrued interest receivable, customers' acceptance liability
and certain financial liabilities including acceptances outstanding, short-term
borrowings and interest, taxes, and other liabilities.
Trading account assets and liabilities and derivative instruments included in
other assets and other liabilities - Trading account assets and liabilities,
including derivative trading accounts (see Note 5 of the consolidated financial
statements), and derivative accounts included in other assets and other
liabilities are recorded at fair value. Fair value is based on current market
quotations, where available. If quoted market prices are not available, fair
value is estimated based on the quoted price of similar instruments or internal
valuation models that approximate market pricing.
Securities - The fair value of securities contracts is based on current market
quotations, where available. If quoted market prices are not available, fair
value is estimated based on the quoted price of similar instruments or internal
valuation models that approximate market pricing. Available for sale securities
are recorded at fair value on the consolidated balance sheet, while held to
maturity securities are generally recorded at historical cost. The cost and fair
values of securities are reported in Note 6 of the consolidated financial
statements.
Loans - The fair value of the loan portfolio is determined primarily by
calculating the present value of expected cash flows using discount rates that
approximate current market rates for similar loans and adjusting for inherent
credit risk. The loans are grouped, to the extent possible, into homogeneous
pools, segregated by maturity, weighted average maturity and average coupon
rate. Depending upon the type of loan involved, maturity assumptions are based
on either the contractual or expected maturity date.
Deposits - The fair value of demand, savings and money market deposits
approximate their carrying value. For deposits with fixed maturities, fair value
is estimated using market interest rates currently offered on deposits with
similar characteristics and maturities.
Long-term debt - The fair values of various debt instruments are estimated using
market interest rates currently available for borrowings with similar
characteristics and maturities.
153
The following table includes certain financial instruments where the carrying
value does not equal or approximate fair value.
--------------------------------------------------------------------------------------------
2006 2005
----------------------- -----------------------
Carrying Fair Carrying Fair
December 31 Value Value Value Value
--------------------------------------------------------------------------------------------
(in millions)
Financial assets:
Securities held to maturity ......... $ 2,972 $ 3,040 $ 3,171 $ 3,262
Loans, net of allowance ............. 89,340 88,314 89,496 88,467
Financial liabilities:
Deposits:
Without fixed maturities ......... 88,474 88,474 77,924 77,924
Fixed maturities ................. 16,076 16,060 13,891 13,889
Long-term debt ...................... 29,252 29,525 29,595 30,084
The fair value of commitments to extend credit, standby letters of credit and
financial guarantees, is not included in the previous table. These instruments
generate fees, which approximate those currently charged to originate similar
commitments.
Note 29. Financial Statements of HSBC USA Inc. (Parent)
--------------------------------------------------------------------------------
Condensed parent company financial statements follow.
---------------------------------------------------------------------------------------------
Balance Sheet
December 31 2006 2005
---------------------------------------------------------------------------------------------
(in millions)
Assets:
Interest bearing deposits with banks ............................. $ 65 $ 65
Trading assets ................................................... 1,352 584
Securities purchased under resale agreements ..................... 71 6
Securities available for sale .................................... 238 157
Securities held to maturity (fair value $114 and $136) ........... 108 128
Loans (net of allowance for credit losses of $2 and $1) .......... 23 43
Receivables from subsidiaries .................................... 4,169 4,832
Receivables from other HSBC affiliates ........................... 82 88
Investment in subsidiaries at amount of their net assets:
Banking ....................................................... 12,258 11,888
Other ......................................................... 501 403
Goodwill ......................................................... 604 604
Other assets ..................................................... 196 158
----------- ----------
Total assets ..................................................... $ 19,667 $ 18,956
=========== ==========
Liabilities:
Interest, taxes and other liabilities ............................ $ 192 $ 66
Payables due to subsidiaries ..................................... 464 81
Short-term borrowings ............................................ 2,414 2,620
Long-term debt (1) ............................................... 4,336 4,595
----------- ----------
Total liabilities ................................................ 7,406 7,362
Shareholders' equity * ........................................... 12,261 11,594
----------- ----------
Total liabilities and shareholders' equity ....................... $ 19,667 $ 18,956
=========== ==========
* See Consolidated Statement of Changes in Shareholders' Equity, page 96.
(1) Contractual scheduled maturities for the debt over the next five years are
as follows: 2007, $148 million; 2008, $244 million; 2009, $555 million;
2010, $1 million; and 2011, $1,613 million.
154
----------------------------------------------------------------------------------------------------------
Statement of Income
Year Ended December 31 2006 2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Income:
Dividends from banking subsidiaries ................................... $ 855 $ 675 $ 125
Dividends from other subsidiaries ..................................... 2 2 2
Interest from subsidiaries ............................................ 240 168 105
Interest from other HSBC affiliates ................................... 5 16 5
Other interest income ................................................. 26 14 14
Securities transactions ............................................... (1) 13 4
Other income .......................................................... 189 35 91
------- ------- --------
Total income .............................................................. 1,316 923 346
------- ------- --------
Expenses:
Interest (including $86 paid to subsidiaries in 2004) ................. 437 350 240
Provision for credit losses ........................................... -- -- 3
Other expenses ........................................................ 17 17 20
------- ------- --------
Total expenses ............................................................ 454 367 263
------- ------- --------
Income before taxes and equity in undistributed income of subsidiaries .... 862 556 83
Income tax expense (benefit) .............................................. 10 (40) (21)
------- ------- --------
Income before equity in undistributed income of subsidiaries .............. 852 596 104
Equity in undistributed income of subsidiaries ............................ 184 380 1,154
------- ------- --------
Net income ................................................................ $ 1,036 $ 976 $ 1,258
======= ======= ========
----------------------------------------------------------------------------------------------------------
Statement of Cash Flows
Year Ended December 31 2006 2005 2004
----------------------------------------------------------------------------------------------------------
(in millions)
Cash flows from operating activities:
Net income .............................................................. $ 1,036 $ 976 $ 1,258
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, amortization and deferred taxes ......................... 2 (3) 13
Provision for credit losses ........................................... -- -- 3
Net change in other accrued accounts .................................. 74 (77) 137
Net change in fair value of non-trading derivatives ................... 39 5 (27)
Undistributed income of subsidiaries .................................. (184) (380) (1,154)
Other, net ............................................................ (465) (291) (53)
------- ------- --------
Net cash provided by operating activities ........................... 502 230 177
------- ------- --------
Cash flows from investing activities:
Net change in interest bearing deposits with banks ...................... 451 (1,930) (738)
Purchases of securities ................................................. (85) (174) (11)
Sales and maturities of securities ...................................... 19 58 41
Net originations and maturities of loans ................................ 342 414 (435)
Net change in investments in and advances to subsidiaries ............... (477) (490) (1,510)
Other, net .............................................................. (83) 181 (65)
------- ------- --------
Net cash provided by (used in) investing activities ................. 167 (1,941) (2,718)
------- ------- --------
Cash flows from financing activities:
Net change in short-term borrowings ..................................... (206) 140 733
Issuance of long-term debt, net of issuance costs ....................... -- 1,497 --
Repayment of long-term debt ............................................. (300) (3) (424)
Dividends paid .......................................................... (543) (720) (148)
Reductions of capital surplus ........................................... (9) (22) (20)
Preferred stock issuance, net of redemptions ............................ 374 816 --
Capital contribution from HNAI .......................................... 15 3 2,400
------- ------- --------
Net cash (used in) provided by financing activities ....................... (669) 1,711 2,541
------- ------- --------
Net change in cash and due from banks ..................................... -- -- --
Cash and due from banks at beginning of year .............................. -- -- --
------- ------- --------
Cash and due from banks at end of year .................................... $ -- $ -- $ --
======= ======= ========
Cash paid for:
Interest ................................................................ $ 428 $ 349 $ 237
======= ======= ========
HBUS is subject to legal restrictions on certain transactions with its nonbank
affiliates in addition to the restrictions on the payment of dividends to HUSI.
See Note 18 on page 133 for further discussion.
155
Quarterly Results of Operations (Unaudited)
--------------------------------------------------------------------------------
The following table presents a quarterly summary of selected financial
information.
---------------------------------------------------------------------------------------------------------
Quarter Ended December 31 September 30 June 30 March 31
---------------------------------------------------------------------------------------------------------
(in millions)
2006
Net interest income ................................. $ 794 $ 777 $ 775 $ 735
----------- ------------ --------- --------
Trading revenues .................................... 155 52 269 279
Residential mortgage banking revenue ................ 40 6 27 23
Securities gains, net ............................... 13 6 6 4
Other income ........................................ 410 550 371 352
----------- ------------ --------- --------
Total other revenues ................................ 618 614 673 658
----------- ------------ --------- --------
Operating expenses .................................. 876 819 775 785
Provision for credit losses ......................... 237 207 222 157
----------- ------------ --------- --------
Income before income tax expense .................... 299 365 451 451
Income tax expense .................................. 101 121 165 143
----------- ------------ --------- --------
Net income .......................................... $ 198 $ 244 $ 286 $ 308
=========== ============ ========= ========
2005
Net interest income ................................. $ 742 $ 761 $ 785 $ 775
----------- ------------ --------- --------
Trading revenues .................................... 127 137 35 96
Residential mortgage banking revenue (expense) ...... 23 31 (13) 23
Securities gains, net ............................... 2 17 64 23
Other income ........................................ 362 320 327 337
----------- ------------ --------- --------
Total other revenues ................................ 514 505 413 479
----------- ------------ --------- --------
Operating expenses .................................. 746 673 684 655
Provision for credit losses ......................... 198 199 170 107
----------- ------------ --------- --------
Income before income tax expense .................... 312 394 344 492
Income tax expense .................................. 116 142 131 177
----------- ------------ --------- --------
Net income .......................................... $ 196 $ 252 $ 213 $ 315
=========== ============ ========= ========
156
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
--------------------------------------------------------------------------------
There were no disagreements on accounting and financial disclosure matters
between HUSI and its independent accountants during 2006.
Item 9A. Controls and Procedures
--------------------------------------------------------------------------------
HUSI maintains a system of internal and disclosure controls and procedures
designed to ensure that information required to be disclosed in reports filed or
submitted under the Securities Exchange Act of 1934, as amended, (the Exchange
Act), is recorded, processed, summarized and reported on a timely basis. HUSI's
Board of Directors, operating through its Audit Committee, which is composed
entirely of independent outside directors, provides oversight to the financial
reporting process.
An evaluation was conducted, with the participation of the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of HUSI's disclosure
controls and procedures as of the end of the period covered by this report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that HUSI's disclosure controls and procedures were effective
as of the end of the period covered by this report, so as to alert them in a
timely fashion to material information required to be disclosed in reports filed
under the Exchange Act.
There have been no significant changes in HUSI's internal controls or in other
factors that could significantly affect internal and disclosure controls
subsequent to the date that the evaluation was carried out.
HUSI continues the process to complete a thorough review of its internal
controls as part of its preparation for compliance with the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404). Section 404
requires management to report on, and external auditors to attest to, the
effectiveness of HUSI's internal controls structure and procedures for financial
reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act,
HUSI's first report under Section 404 will be contained in its Form 10-K for the
period ended December 31, 2007.
Item 9B. Other Information
--------------------------------------------------------------------------------
None.
157
PART III
Item 10. Directors, Executive Officers and Corporate Governance
--------------------------------------------------------------------------------
Directors
Set forth below is certain biographical information relating to the members of
HUSI's Board of Directors as of February 21, 2007. Each director is elected
annually. There are no family relationships among the directors.
Salvatore H. Alfiero, age 69, joined the HUSI Board in 2000, the HBUS Board in
1996 and the HNAH Board in 2005. Mr. Alfiero has been the Chairman and Chief
Executive Officer of Protective Industries, LLC since 2001. He is also a
director of Phoenix Companies, Inc., Southwire Company and Fresh Del Monte
Produce Company.
Mr. Alfiero is Chair of the Audit Committee and a member of the Nominating &
Governance Committee.
Donald K. Boswell, age 55, joined the HUSI and HBUS Boards in 2002. Mr. Boswell
has been the President and Chief Executive Officer of Western New York Public
Broadcasting Association since 1998, and has been in public broadcasting since
1977.
Mr. Boswell is a member of the Fiduciary Committee and the Human Resources &
Compensation Committee.
James H. Cleave, age 64, joined the HUSI and HBUS Boards in 1991. Mr. Cleave was
the President and Chief Executive Officer of HUSI and HBUS from 1993 through
1997. Prior to that, he was President and Chief Executive Officer of HSBC Bank
Canada and is currently a director and Vice Chairman of HSBC Bank Canada.
Mr. Cleave is a member of the Audit Committee and the Executive Committee.
Dr. Frances D. Fergusson, age 62, joined the HBUS Board in 1990 and the HUSI
Board in 2000. She is President Emeritus of Vassar College and served as
President from 1986 to 2006. Prior to that, Dr. Fergusson was Provost and Vice
President for Academic Affairs, Bucknell University. Dr. Fergusson is also a
director of Wyeth Pharmaceuticals and Mattel, Inc., and a member of the Board of
Overseers of Harvard University.
Dr. Fergusson is the Chair of the Human Resources & Compensation Committee and a
member of the Nominating & Governance Committee and the Executive Committee.
Michael F. Geoghegan, age 53, joined the HUSI and HBUS Boards as Chairman in
September 2006. He joined HSBC in 1973 and has been an executive director of
HSBC since 2004 and the HSBC Group Chief Executive since May 2006. Mr. Geoghegan
served as Chief Executive of HSBC Bank plc from January 2004 to March 2006. He
is a director and Deputy Chairman of HSBC Bank plc and a director of The
Hongkong and Shanghai Banking Corporation Limited and HSBC France. Mr. Geoghegan
is also a non-executive director and Chairman of Young Enterprise UK.
Stuart T. Gulliver, age 47, joined the HUSI and HBUS Boards in September 2006.
He has been the Chief Executive, CIBM and Group Investment businesses for HSBC
since May 2006. Mr. Gulliver was appointed as a Group Managing Director and to
the Group Management Board in 2004. He served as a Group General Manager from
2000 to 2004. Mr. Gulliver joined HSBC in 1980 and has held a number of key
roles in various treasury and capital markets businesses, most recently as
Co-Head of Corporate, Investment Banking and Markets from 2003 to 2006 and Head
of Global Markets from 2002 to 2003. He is also a director of HSBC Bank plc and
The Hongkong and Shanghai Banking Corporation Limited.
158
Richard A. Jalkut, age 62, joined the HUSI Board in 2000 and the HBUS Board in
1992. Mr. Jalkut is the President and Chief Executive Officer of Telepacific
Communications. He was a director of Birch Telecom, Inc. until June 2006.
Formerly, he was the President and Chief Executive of Pathnet and, prior to
that, President and Group Executive, NYNEX Telecommunications. Mr. Jalkut is
also a director of IKON Office Solutions and Covad Communications.
Mr. Jalkut has been Lead Director of HUSI and HBUS since January 2005. He is the
chair of the Executive Committee, the Chair of the Nominating & Governance
Committee and a member of the Audit Committee.
Peter Kimmelman, age 62, joined the HUSI and HBUS Boards in 2000. Mr. Kimmelman
is a private investor and managing member of Peter Kimmelman Asset Management,
LLC, an investment advisory firm registered with the Securities and Exchange
Commission. He was formerly a director of Republic New York Corporation and
Republic National Bank of New York from 1976 until 1999.
Mr. Kimmelman is a member of the Audit Committee.
Paul J. Lawrence, age 45, joined the HUSI and HBUS Boards and was appointed
President and Chief Executive Officer of HUSI and HBUS as of February 21, 2007.
Mr. Lawrence joined HSBC in 1982 and has held numerous positions in Asia and the
United Kingdom. He was appointed Head of CIBM, North America for HUSI and HBUS
as of October 1, 2006. Mr. Lawrence held the position of Chief Executive
Officer, The Hongkong and Shanghai Banking Corporation Limited, Singapore from
2002 through September 2006 and, prior to that, served as Chief Executive
Officer of The Hongkong and Shanghai Banking Corporation Limited, Philippines.
Mr. Lawrence has been an HSBC Group General Manager since 2005.
Mr. Lawrence is a member of the Executive Committee.
Charles G. Meyer, Jr., age 69, joined the HUSI and HBUS Boards in 2000. Mr.
Meyer is an architect and former President of Cord Meyer Development Company.
Mr. Meyer was formerly a director of Republic National Bank of New York from
1987 until 1999.
Mr. Meyer is the Chair of the Fiduciary Committee and a member of the Nominating
& Governance Committee.
James L. Morice, age 69, joined the HUSI and HBUS Boards in 2000. Mr. Morice has
been the President and Chief Executive Officer of Morice Consulting, LLC,
successor to the JLM Group, LLC, a management consulting firm, since 2006. He
was previously Executive Vice President and Director of NationsBuilders
Insurance Services, Inc. Mr. Morice was a director of Republic New York
Corporation and Republic National Bank of New York from 1987 until 1999 and a
member of the Human Resources Committee of the University of New Haven from 2003
through 2005.
Mr. Morice is a member of the Fiduciary Committee and the Human Resources &
Compensation Committee.
159
Executive Officers
--------------------------------------------------------------------------------
Information regarding the executive officers of HUSI as of February 21, 2007 is
presented in the following table.
Year
Name Age Appointed Present Position with HUSI
-------------------------------------------------------------------------------------------------------------------
Paul J. Lawrence 45 2006 President and Chief Executive Officer
Kevin Newman 49 2007 Group General Manager, Personal Financial Services
Janet L. Burak 51 2004 Senior Executive Vice President, General Counsel and Secretary
Robert M. Butcher 63 1988 Senior Executive Vice President & Chief Risk Officer
Christopher Davies 45 2007 Senior Executive Vice President, Commercial Banking
David Dew 51 2006 Senior Executive Vice President & Chief Administrative Officer
Mark A. Hershey 54 2007 Senior Executive Vice President, Co-Head Chief Credit Officer
David C. Kotheimer 49 2007 Senior Executive Vice President, Business Performance
John J. McKenna 47 2005 Senior Executive Vice President & Chief Financial Officer
George T. Wendler 62 2000 Senior Executive Vice President, Co-Head Chief Credit Officer
Jeanne G. Ebersole 45 2004 Executive Vice President, Human Resources
Teresa A. Pesce 47 2005 Executive Vice President & Anti-Money Laundering (AML) Director
Carolyn M. Wind 53 2005 Executive Vice President, Compliance
Marlon Young 51 2006 Managing Director, Chief Executive Officer Private Bank Americas
Clive R. Bucknall 43 2006 Executive Vice President & Controller
-------------------------------------------------------------------------------------------------------------------
Kevin Newman, Group General Manager, Personal Financial Services since October
2006. Mr. Newman served as Senior Executive Vice President, Personal Financial
Services from September 2005 to October 2006 and as Executive Vice President,
Personal Financial Services from December 2003 to September 2005. Prior to that,
he served as Head of hsbc.com.
Janet L. Burak, Senior Executive Vice President, General Counsel and Secretary
for HUSI and HBUS since April 2004. Ms. Burak served as an attorney with HSBC
Finance Corporation for twelve years, most recently as Group General Counsel.
Prior to joining HSBC Finance Corporation, she was an associate with Shearman &
Sterling and an attorney with Citigroup.
Robert M. Butcher, Senior Executive Vice President & Chief Risk Officer for HUSI
and HBUS since May 2003. Mr. Butcher was Chief Financial Officer of HUSI and
HBUS from 1990 to 2003. Prior to joining HBUS's predecessor, Marine Midland
Bank, in 1988, Mr. Butcher was with Citicorp for 15 years where he held various
senior officer positions in the corporate finance department.
Christopher Davies, Senior Executive Vice President, Commercial Banking since
February 2007. Prior to this appointment, Mr. Davies was Head of Corporate and
Institutional Banking with HSBC Securities (USA) Inc. from 2004 to February
2007. From 2003 to 2004, he was Head of Client Service and Marketing, Global CIB
with HSBC Bank plc, and from 2000 to 2003 he was Credit & Banking Services
Director with First Direct, Leeds. Mr. Davies has held various senior officer
positions in credit, treasury and retail and commercial banking since joining
Midland Bank plc, now known as HSBC Bank plc, in 1985.
David Dew, Senior Executive Vice President & Chief Administrative Officer since
February 2007. He served as Senior Executive Vice President, Audit for HUSI and
HSBC North America Inc. (HNAI) from January 2006 to February 2007. Prior to this
appointment, Mr. Dew served as Chief Auditor, Group Audit, HSBC Finance
Corporation from November 2004 to December 2005. He was Executive Director &
Chief Operating Officer, The Saudi British Bank, Riyadh, Saudi Arabia from March
2001 to November 2004; Deputy Chief Executive Officer, The Hongkong and Shanghai
Banking Corporation Limited, Singapore from September 1997 to March 2001; and
Chief Executive Officer, HSBC Bank plc, Milan, Italy from November 1994 to
September 1997. Mr. Dew has been an HSBC employee since 1977.
160
Mark A. Hershey, Senior Executive Vice President, Co-Head Chief Credit Officer
since February 2007. Prior to this appointment Mr. Hershey was Senior Executive
Vice President, Commercial Banking since 2005 and Executive Vice President,
Commercial Banking from 2000 to 2005. Mr. Hershey was a senior officer of
Republic National Bank of New York when it was acquired by HSBC in December
1999.
David C. Kotheimer, Senior Executive Vice President, Business Performance since
December 2006. Mr. Kotheimer served as Senior Executive Vice President,
Tri-State, of HBUS from May 2006 to December 2006 and as an Executive Vice
President, Metro New York, of HBUS from November 2000 to May 2006. Since joining
HSBC in 1987, Mr. Kotheimer has held a variety of senior officer positions in
commercial banking, human resources and personal financial services.
John J. McKenna, Senior Executive Vice President and Chief Financial Officer of
HUSI since October 2005. Prior to this appointment, Mr. McKenna served as Chief
Financial Officer, HSBC Mexico, S.A. from November 2002 through September 2005.
From July 2000 to October 2002, he held the position of Senior Vice President
and Director of Financial Management for HUSI. Since joining HSBC in 1986, Mr.
McKenna has held a variety of financial management positions focusing on
strategic planning, business controllership and management information.
George T. Wendler, Senior Executive Vice President, Co-Head Chief Credit Officer
of HUSI since February 2007. Prior to this appointment, Mr. Wendler was Chief
Credit Officer of HUSI from January 2000 to February 2007, and he was Chief
Credit Officer and a member of the Senior Management Committee of Republic New
York Corporation when it was acquired by HSBC in December 1999. Mr. Wendler was
also a director and Vice Chairman of Republic New York Corporation from 1997 to
1999.
Jeanne G. Ebersole, Executive Vice President, Human Resources since May 2004.
Prior to this appointment, Ms. Ebersole had overall human resources
responsibility for HSBC Finance Corporation's retail services, insurance
services and refund lending businesses since August 2002. She held a variety of
human resources positions after joining HSBC Finance Corporation in 1980.
Teresa A. Pesce, Executive Vice President and Anti-Money Laundering (AML)
Director since September 2003. In 2004 she was appointed the AML Director for
all HSBC businesses in North America. Ms. Pesce joined HUSI from the United
States Attorney's Office, Southern District of New York where she was Senior
Trial Counsel, White Plains Division and previously Chief of the Major Crimes
Unit and Deputy Chief of the Criminal Division. From 1992 to 1999 she served as
a Line Assistant in the Major Crimes, Narcotics, and General Crimes Units.
Carolyn M. Wind, Executive Vice President, Compliance, was the Chief Compliance
Officer for Republic New York Corporation when it was acquired by HSBC in
December 1999. Prior to joining Republic New York Corporation, she was a senior
national bank examiner with the Office of the Comptroller of the Currency (OCC).
Marlon Young, Managing Director, CEO Private Bank Americas since October 2006.
Mr. Young joined HSBC as Managing Director and Head of Domestic Private Banking
for HBUS in March 2006. He served as Managing Director and Head of Private
Client Lending for Smith Barney from 2004 through 2006. Prior to that, Mr. Young
held various positions with Citigroup from 1979, most recently as Managing
Director and Head of Citigroup Private Bank (Northeast Region) from 2000 through
2004.
Clive R. Bucknall, Executive Vice President & Controller and Chief Accounting
Officer since March 7, 2006. Prior to this appointment Mr. Bucknall served as
Senior Financial Officer, HSBC Singapore from March 2002 through December 2005.
He was Senior Financial Officer, HSBC Thailand from September 1998 to March 2002
and Senior Area Accounting Manager, HSBC Hong Kong from September 1994 to
September 1998. In 1991, Mr. Bucknall joined Midland Bank in London, which was
acquired by HSBC in 1992, as Financial Accounting Manager.
161
Corporate Governance
--------------------------------------------------------------------------------
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act, as amended, requires our Directors, executive
officers and any persons who own more than 10 percent of a registered class of
our equity securities to report their initial ownership and any subsequent
change to the SEC and the New York Stock Exchange ("NYSE"). With respect to the
issues of HUSI preferred stock outstanding, we reviewed copies of all reports
furnished to us and obtained written representations from our Directors and
executive officers that no other reports were required. Based solely on a review
of copies of such forms furnished to us and written representations from the
Directors and executive officers, all Section 16(a) filing requirements were
complied with for the 2006 fiscal year.
Board of Directors - Committees and Charters
The Board of Directors of HSBC USA Inc. has five standing committees: the Audit
Committee, the Executive Committee, the Fiduciary Committee, the Human Resources
& Compensation Committee and the Nominating & Governance Committee. The charter
of each of these committees, as well as the HSBC USA Inc. Corporate Governance
Standards, are available upon written request to HSBC USA Inc., 452 Fifth
Avenue, New York, New York 10018, Attention: Corporate Secretary.
Audit Committee
The primary purpose of the Audit Committee is to assist the Board of Directors
in fulfilling its oversight responsibilities relating to HUSI's system of
internal controls over financial reporting and its accounting, auditing and
financial reporting practices. The Audit Committee is currently comprised of the
following independent directors (as defined by HSBC USA Inc.'s Corporate
Governance Standards, which are based upon the rules of the New York Stock
Exchange): Sal H. Alfiero (Chair), James H. Cleave, Richard A. Jalkut and Peter
Kimmelman. The Board of Directors has determined that each of these individuals
is financially literate. The Board of Directors has also determined that Messrs.
Alfiero and Cleave qualify as audit committee financial experts.
Executive Committee
The Executive Committee may exercise the powers and authority of the Board of
Directors in the management of HUSI's business and affairs during the intervals
between meetings of the Board of Directors. The executive committee is currently
comprised of the following directors: Richard A. Jalkut (Chair and Lead
Director), James H. Cleave, Dr. Frances D. Fergusson and Paul J. Lawrence.
Fiduciary Committee
The primary purpose of the Fiduciary Committee is to supervise the fiduciary
activities of HBUS to ensure the proper exercise of its fiduciary powers in
accordance with 12 U.S.C. Section 92a - Trust Powers of National Banks and
related regulations promulgated by the Office of the Comptroller of the
Currency. The Fiduciary Committee is currently comprised of the following
directors: Charles G. Meyer, Jr. (Chair), Donald K. Boswell and James L. Morice.
All members of the Fiduciary Committee are independent directors under HSBC USA
Inc.'s Corporate Governance Standards.
Human Resources & Compensation Committee
The primary purpose of the Human Resources & Compensation Committee is to assist
the Board of Directors in discharging its responsibilities related to the
compensation of the Chief Executive Officer, other officers of HUSI holding a
title of executive vice president and above and such other officers as may be
designated by the Board of Directors. The Human Resources & Compensation
Committee is currently comprised of the following directors: Dr. Frances D.
Fergusson (Chair), Donald K. Boswell and James L. Morice. All members of the
Human Resources & Compensation Committee are independent directors under HSBC
USA Inc.'s Corporate Governance Standards.
162
The Charter of the Human Resources & Compensation Committee lists the primary
responsibilities, powers and authorities of the committee. The listed items
include (i) review and approval of corporate goals and performance objectives
relevant to the compensation of the Chief Executive Officer and certain other
executive officers, evaluate the performance of the Chief Executive Officer and
other executive officers in light of those goals and objectives, and review its
findings with the Board of Directors in executive session, (ii) submit
recommendations concerning base salary, performance-based cash and long-term
equity-based incentive awards for the Chief Executive Officer and other
executive officers to the Remuneration Committee of HSBC ("REMCO") for approval,
(iii) recommend to REMCO equity incentives under HSBC plans to all employees,
except those awards that the Chief Executive Officer may determine based upon a
delegation of authority by REMCO, (iv) review and approve benefits and
perquisites of the Chief Executive Officer and other executive officers to the
extent such benefits are not available to all employees, (v) review and
recommend to REMCO any employment and severance arrangements for the Chief
Executive Officer and other executive officers, as well as any severance payouts
to such officers, (vi) review and consider "best practices" of peer companies
with respect to compensation philosophies, policies and practices, (vii) review
management's Compensation Discussion and Analysis ("CD&A") to be included in
HUSI's Annual Report on Form 10-K, discuss the CD&A's content with management,
and prepare the Compensation Committee Report concerning the CD&A and recommend
to the Board of Directors that the CD&A be included in the Annual Report on Form
10-K, and (viii) engage in an annual self assessment with the goal for
continuing improvement, and to review and assess the adequacy of this charter at
least annually and recommend any proposed changes to the Board of Directors for
approval.
The Human Resources & Compensation Committee may at its discretion retain and
discharge consultants to assist the committee in evaluating Chief Executive
Officer or other executive officer compensation and to determine the appropriate
terms of engagement and the fees to be paid to such consultants. The Chief
Executive Officer is given full authority, which may be delegated, to establish
the compensation and salary ranges for all other employees of HUSI and its
subsidiaries whose salaries are not subject to review by the Human Resources &
Compensation Committee and approval by REMCO. For more information about HUSI's
compensation policies and programs, please see Item 11. Executive Compensation -
Compensation Discussion and Analysis.
Nominating & Governance Committee
The primary purpose of the Nominating & Governance Committee is to assist the
Board of Directors of HUSI in discharging its responsibilities related to
identifying and nominating members of the Board of Directors to the Board,
recommending to the Board the composition of each committee of the Board and the
Chair of each committee, establishing and reviewing HUSI's corporate governance
and making recommendations to the Board regarding compensation for service of
the non-executive Board members. The Nominating & Governance Committee ensures
that HUSI maintains "best practices" with respect to corporate governance in
order to ensure effective representation of its stakeholders.
The Nominating & Governance Committee is currently comprised of the following
directors: Richard A. Jalkut (Chair), Sal H. Alfiero, Dr. Frances D. Fergusson
and Charles G. Meyer, Jr. All members of the Nominating & Governance Committee
are independent directors under HSBC USA Inc.'s Corporate Governance Standards.
Code of Ethics
HUSI has adopted a code of ethics that is applicable to its chief executive
officer, chief financial officer, chief accounting officer and controller, which
is incorporated by reference to Exhibit 14 of this Form 10-K. HUSI also has a
general code of ethics applicable to all employees that is referred to as its
Statement of Business Principles and Code of Ethics. Both documents are
available upon written request made to HSBC USA Inc., 452 Fifth Avenue, New
York, New York 10018, Attention: Corporate Secretary.
163
Item 11. Executive Compensation
--------------------------------------------------------------------------------
Compensation Discussion and Analysis
The following compensation discussion and analysis (the "2006 CD&A") summarizes
the principles, objectives and factors considered by HUSI in evaluating and
determining the compensation of executive officers in 2006. Specific
compensation information relating to Sandra L. Derickson, President and Chief
Executive Officer - Designate (and President and Chief Executive Officer from
January 1 until February 20, 2007); Martin J.G. Glynn, President and Chief
Executive Officer; John J. McKenna, Senior Executive Vice President and Chief
Financial Officer; Joseph A. Belfatto, Senior Executive Vice President & Head of
Global Markets Americas; Marlon Young, Managing Director, CEO, Private Bank
Americas; and Janet L. Burak, Senior Executive Vice President, General Counsel
and Secretary, is contained in this portion of the Form 10-K. The 2006 CD&A also
includes compensation information relating to Brendan McDonagh, Chief Operating
Officer; and Joseph M. Petri, Senior Executive Vice President, Treasurer and
Co-Head, CIBM Americas, both of whom served as an executive officer of HUSI
during part of 2006, but ceased providing services to HUSI prior to December 31,
2006.
Oversight of Compensation Decisions
HUSI is a wholly owned subsidiary of HSBC Holdings plc ("HSBC"). The Board of
Directors of HSBC has the authority to delegate any of its powers, authorities
and judgments to any committee consisting of one or more directors, and has
established a Remuneration Committee ("REMCO") for the purpose of setting the
remuneration policy for HSBC and its subsidiaries and the compensation of senior
executives. REMCO's responsibilities include reviewing and approving
performance-based remuneration by reference to corporate goals and objectives
established by the Board of Directors of HSBC from time to time and approving
overall market positioning of the compensation package, individual base salaries
and increases and annual and long-term incentive/bonus arrangements for certain
executives. In November 2006, REMCO delegated its authority for approval of
salaries and annual cash incentive awards relating to certain classes of
executives to Michael F. Geoghegan, the HSBC Group Chief Executive (the "HSBC
CEO"). However, REMCO retained exclusive authority over compensation of the more
senior executives within HSBC and its subsidiaries. As a result, REMCO had
authority over the compensation of Ms. Derickson and Messrs. Glynn, McDonagh and
Petri in 2006. Pursuant to a further delegation of authority from the HSBC CEO,
Siddharth N. Mehta, Chief Executive Officer of HNAH until February 15, 2007, had
approval authority over certain executives within HUSI, including Mr. McKenna
and Ms. Burak; Stuart T. Gulliver, HSBC Managing Director and Head of CIBM, has
approval authority over certain executives within the CIBM businesses; and Chris
M. Meares, Chief Executive Officer, Group Private Banking, has approval
authority over certain executives within the Private Banking businesses. REMCO
has exclusive authority with respect to all long-term incentive plan awards
involving interests in HSBC ordinary shares.
The members of REMCO in 2006 were Sir Mark Moody-Stuart (Chairman), W.K.L. Fung,
S. Hintze, Sir John Kemp-Welch (until retirement on May 26, 2006) and J.D.
Coombe (effective as of June 1, 2006), all of whom were or are non-executive
directors of HSBC. REMCO has retained the services of Towers Perrin, a human
resource consulting firm, to provide independent advice on executive
compensation issues. REMCO is provided with comparator information from Towers
Perrin, which obtains compensation data for executive positions with companies
of similar size and complexity that are subsidiaries of peer financial services
companies. In addition, market data has been obtained from American Express
Company, Bank of America Corporation, Bank One Corporation, BB&T Corporation,
Capital One Corporation, Citigroup, Inc., Countrywide Financial Corporation,
FifthThird Bancorp, KeyCorp, LaSalle Bank Corporation, Merrill Lynch & Co.,
Inc., National City Corporation, The PNC Financial Services Group Inc., Royal
Bank of Canada, State Street Corporation, Sun Trust Banks, Inc., Wachovia
Corporation, Washington Mutual Inc. and Wells Fargo & Company. Comparator and
market data is used by REMCO to evaluate the competitiveness of proposed
executive compensation.
164
The Human Resources and Compensation Committee of the Board of Directors of HUSI
(the "Compensation Committee") seeks to ensure that HUSI's compensation policies
and practices support the objectives of HUSI's compensation program, which is
based upon the compensation objectives established by REMCO. The Compensation
Committee makes advisory recommendations to REMCO for all compensation to be
paid to the HUSI Chief Executive Officer, the HSBC CEO or the Chief Executive
Officer of HNAH, as appropriate, for all executives holding a title of executive
vice president or above, other than executive officers in the CIBM and Private
Banking businesses. Mr. Gulliver makes advisory recommendations to REMCO for all
compensation to be paid to General Managers and certain other senior executives
within CIBM. Mr. Meares makes advisory recommendations to REMCO for all
compensation to be paid to Group General Managers and certain other senior
executives within Private Banking.
HUSI Human Resources executives work with HNAH Human Resources executives to
prepare a comprehensive annual compensation package for the Chief Executive
Officer. This package is reviewed by the Chief Executive Officer of HNAH, who
approves or requests revisions to the compensation package before it is
submitted to the Compensation Committee for review.
HUSI Human Resources executives consult with the Chief Executive Officer of HUSI
in preparing annual compensation packages for executives holding a title of
executive vice president and above (other than the Chief Executive Officer).
These compensation packages are also reviewed by the Chief Executive Officer of
HNAH. Any revisions to a compensation package recommended by the Chief Executive
Officer of HNAH are reviewed and considered by the Chief Executive Officer of
HUSI prior to the package being submitted to the Compensation Committee for
review.
The Compensation Committee reviews the compensation packages submitted to it,
and approves or requests revisions to one or more of the components of annual
compensation. The compensation packages, as approved or modified by the
Compensation Committee, are forwarded to HSBC Human Resources management for
submission to REMCO and the HSBC CEO, as appropriate, or to the Chief Executive
Officer of HNAH in late December or early January, and include advisory
recommendations for salaries for the ensuing calendar year, preliminary
performance-based cash awards and equity-based long-term incentive awards. As
the performance-based cash awards are dependent upon satisfaction of objectives
that cannot be evaluated until the end of the performance measurement year, the
final determination of this component of compensation is not made until the
Compensation Committee receives reports from management concerning satisfaction
of corporate, business unit and individual objectives in January. REMCO or the
HSBC CEO, as appropriate, will approve or revise the advisory recommendations
provided by the Compensation Committee.
Within the CIBM and Private Banking businesses, senior executives prepare annual
compensation package recommendations for executive officers within their
business units. Accordingly, the discretion and judgment of senior management
play a much more significant role in establishing appropriate compensation
packages to be included in advisory recommendations to REMCO or the Head of CIBM
or Chief Executive Officer, Group Private Banking, as appropriate. As is the
case for HUSI generally, performance-based cash awards are dependent upon
performance of the individual, the local business unit and the business globally
and, accordingly, cannot be determined until the end of the performance
measurement year.
Within CIBM, compensation recommendations for the Global Markets business are
prepared by Mike J. Powell, Group Head of Global Markets, recommendations for
the Global Banking business are prepared by Paul Hand, Co-Head of Global
Banking, and recommendations for the Group Investment Businesses are prepared by
Alain Dromer, Global Chief Executive Officer, Group Investment Businesses. These
recommendations are submitted to and reviewed by the Head of CIBM. Any revisions
to a compensation package recommended by the Head of CIBM are included in the
package before it is submitted to REMCO for review. REMCO will approve or revise
to the advisory recommendations provided by the Head of CIBM.
165
For Private Banking, compensation recommendations are prepared by Chris M.
Meares, Chief Executive Officer, Group Private Banking, and submitted to and
reviewed by the Director of Human Resources, CIBM/INV/GPB/Amanah and the HSBC
CEO. Any revisions to a compensation package recommended by the Director of
Human Resources or the HSBC CEO are included in the package before it is
submitted to REMCO for review. REMCO will approve or revise the advisory
recommendations provided by the Chief Executive Officer, Group Private Banking.
Objectives of HUSI's Compensation Program
HUSI's compensation program is designed to support the successful recruitment,
development and retention of high performing executive talent and to incent
those executives to achieve HUSI's short-term business objectives and to
optimize its long-term financial returns. We design our compensation program to
be competitive with a comparator group of benchmark financial institutions.
HUSI's comparator group is comprised of U.S.-based organizations that compete
with us for business, customers and executive talent. HUSI's comparator group
includes Bank of America Corporation, The Bank of New York Company, Inc., JP
Morgan Chase & Co., SunTrust Banks, Inc., Wachovia Corporation and Wells Fargo &
Company (collectively, the "Comparator Group"). While these organizations are
publicly-held companies, HUSI's operations are of comparable scale and
complexity. Accordingly, HUSI's compensation program is designed to provide the
flexibility to offer compensation that is competitive with the Comparator Group
so that we may attract and retain the highest performing executives.
The philosophy underlying HUSI's executive compensation program, which is
designed to promote the compensation objectives of our parent, HSBC, is
discussed below. Across businesses, individual compensation recommendations
reflect HSBC's strong stance with respect to diversity and equal opportunity for
all employees within the context of meritocracy and performance.
Link to Company Performance
We seek to offer competitive base salaries with a significant portion of
variable compensation components determined by measuring performance of the
executive, his or her respective business unit, HUSI and HSBC. The
performance-based cash compensation plans, which are more fully described under
Elements of Compensation - Annual Performance-Based Awards, emphasize revenue
and expense growth, net income, receivable growth, profits and other key
performance measures. Other considerations taken into account in setting
compensation policies and making compensation decisions include demonstrated
leadership, future potential, adherence to HSBC's ethical standards and the
ability to leverage capabilities across businesses. Corporate, business unit
and/or individual goals are established at the beginning of each year.
Compensation plans motivate our executives to improve the overall performance
and profitability of HSBC as well as the specific region, unit or function to
which they are assigned. Each executive's individual performance and
contribution is considered in making salary adjustments and determining the
amount of annual performance bonus paid and the value of HSBC equity-based
awards granted each year.
HUSI has historically used grants of stock options and restricted shares to
reward and provide longer term incentives for our executives. In 2005, however,
HSBC adopted a new philosophy to provide only restricted shares, called
"Achievement Shares," which vest on a specified date if the executive remains
employed through that date, and "Performance Shares," which require continued
employment and satisfaction of corporate performance conditions designed to
reinforce a long-term focus on HSBC's Managing for Growth strategy and
delivering value to its shareholders. Performance Shares are granted to the most
senior executives whose business units have the ability to have a direct impact
on HSBC's consolidated results. Achievement Share awards are granted to other
high performing executives. Within CIBM and Private Banking, restricted shares
are also used as a bonus deferral mechanism for executives within those
businesses who receive large bonus awards, as described below.
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Competitive Compensation Levels and Marketplace Research
HUSI endeavors to maintain compensation programs that are competitive with our
Comparator Group. We operate in a highly competitive business environment, in
which our Comparator Group and other financial services companies continuously
look to gain market share and competitive advantage by hiring top executive
talent. On an annual basis, and as needed when recruiting, we compare the
compensation for our executive officers to that of executives with similar
responsibilities for companies of similar industry, size and complexity. In
2006, the Compensation Committee considered comparative data from general
industry surveys of non-financial services companies and of financial services
companies, which included members of our Comparator Group, to help establish
compensation levels for our executives. The Compensation Committee also reviews
the Towers Perrin data provided to REMCO.
We research the types of compensation programs provided by other companies,
compensation levels for executives, details of certain compensation programs,
historical marketplace compensation trends, marketplace practices regarding
compensation mix, stock vesting terms, equity ownership levels, the amount of
compensation that is derived from equity incentives and the benefits provided to
executives. We also research different aspects of performance, including the
relationship between performance and compensation, a comparison of HUSI's
historical performance to our Comparator Group and types of performance measures
that are used by other companies for their annual and long-term incentive
programs. Research data is gathered from several different sources, including
general surveys of the marketplace.
HUSI's compensation program generally provides executives with the opportunity
to earn a base salary that is near the 50th percentile average of our Comparator
Group. We believe this represents a competitive base salary for meeting general
business objectives. However, total compensation, which includes incentive
awards, is targeted to be in the 75th percentile if HUSI, HSBC and the executive
meet established performance goals. This provides greater incentive to achieve
higher performance standards and the specific goals established by the
Compensation Committee each year. The level of compensation paid to an executive
from year to year will differ based on performance. This year-to-year difference
stems mainly from HUSI's and/or an individual business unit's performance
results and, for individuals eligible for performance-based equity awards,
awards may vary based upon HSBC's performance results. Compensation levels will
also increase or decrease based on the executive's individual performance and
level of responsibility.
CIBM and Private Banking
The philosophies underlying the compensation programs employed in the CIBM and
Private Banking businesses are consistent with the philosophy described above
for HUSI generally, but there are some specific variations in the compensation
methodologies that are employed
The overall approach for these businesses involves a carefully managed approach
to tracking of compensation expense throughout the year in relation to business
performance and planned overall expenditure on staff costs. This is combined
with a year-end pay review process that takes careful account of market pay
methods, levels and trends, as well as the actual levels of business and
individual performance that are achieved. The year-end pay review process is
itself subject to review and approval by HSBC senior management and by REMCO.
The approach to regular bonus accrual is agreed with REMCO and updated at
intervals to reflect changes in the competitive market. This agreement covers
factors such as the proportion of pre-tax profit that may be allocated to the
bonus pool for each business, taking into account aspects such as the maturity
and complexity of each business and also considering any appropriate
geographical variations. Annual operating plans for each business cover monthly
accrual of the planned bonus amounts. Development of these accruals against the
agreed parameters is reviewed at intervals during each year with the Group
Finance Director.
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At year end, the compensation levels within each business reflect individual
contribution, business unit performance and the competitive pay market. In
addition, compensation within CIBM and Private Banking also reflects the overall
(i.e., global) results of the respective business. Base salary and incentive
compensation (bonus) are sized within the context of a total compensation
package that is intended to be appropriately market competitive, but these
businesses apply a much less formulaic approach to the use of comparative market
data than is typical in some other parts of HUSI and HSBC. Compensation
proposals are based upon careful benchmarking of individual executives in the
correct competitive context, making use of independently compiled studies of
market pay levels, methods and trends. These studies are conducted by external
advisors with in-depth knowledge of the business areas concerned and they allow
careful verification against market of the compensation levels and methodologies
for executives in these businesses. With this information to hand, senior
management carefully considers and interprets the performance of each business,
and of CIBM or Private Banking globally, relative to the performance of key
competitors. Individual performance is assessed relative to performance in a
market context to ensure that each executive is correctly positioned against
market. Both CIBM and Private Banking target appropriate groups of competitors
for each business so that the total compensation for each executive can be
correctly positioned within the overall market range, ensuring a high degree of
differentiation towards the very best performers. Senior management also uses
market data in a similar way when designing appropriate recruitment and
retention initiatives.
The compensation programs within CIBM and Private Banking are designed to
support the successful recruitment, development and retention of high performing
executive talent and to incent those executives to maximize the performance of
their respective businesses. Within the context of the total compensation
package, performance-related adjustments emphasize variable pay (i.e.,
discretionary bonus awards) over fixed pay (i.e., base salary). As described
above, bonus awards are differentiated significantly towards the very best
performers and careful attention is also paid to those executives whose
retention is regarded as critical to the business. For those executives
receiving large bonus awards, a significant portion of the award is paid in the
form of restricted shares that vest over three years provided the individual
remains employed with HSBC, thus encouraging retention of the best performers.
The proportion of bonus that is deferred varies to some extent between specific
businesses but the typical approach is to apply a 'tax table' so that increasing
proportions of a bonus will be deferred above clearly defined hurdles. The
maximum proportion of bonus to be deferred within CIBM and Private Banking is
normally 50 percent. The proportion of bonus to be deferred and the related
vesting periods are positioned against competitive market practice using
information provided by the external advisors referenced above.
Elements of Compensation
HUSI strives for a compensation mix that reflects our pay for performance
philosophy and results-oriented culture. We attract and retain executives that
are highly motivated to achieve results, and our compensation program supports
that environment.
HUSI's philosophy is to place a significant amount of compensation at risk to
ensure that company performance objectives are met. In line with this pay for
performance philosophy, on average, approximately 20 percent of executive
compensation is base salary and 80 percent of compensation for top executives
relates to short-term and long-term incentives where the amount paid is based
upon defined performance goals. Of the 80 percent incentive compensation, on
average, approximately 45 percent of such compensation relates to long-term
incentives, while approximately 35 percent relates to short-term incentives. The
allocation between short-term and long-term incentives is based on HUSI's need
to recognize past performance (short-term incentives) in conjunction with the
need to motivate and retain our talent (long-term incentives). We believe these
allocations are competitive within the market and reinforce HUSI's
pay-for-performance philosophy, which requires that a greater part of
compensation is at risk and aligns executives' interests with those of HSBC's
shareholders.
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The primary elements of executive compensation are base salary, annual
non-equity performance-based awards, and long-term equity-based incentives. In
limited circumstances, discretionary bonuses may also be awarded. In addition,
executives are eligible to receive company funded retirement benefits that are
offered to all employees. Perquisites are not a significant component of
compensation. In establishing executive compensation packages, the Compensation
Committee provides advisory recommendations and, ultimately, REMCO and/or the
HSBC CEO establishes remuneration under each element based on what they believe
is an appropriate balance between performance-based compensation and other forms
of compensation, the level of responsibility and individual contribution of the
executive and competitive practice in the marketplace for executives from
companies of similar industry, size, and complexity as HUSI.
Within the CIBM and Private Banking businesses, the allocation of compensation
between base salary and incentive compensation, as well as between long-term and
short-term incentives, is recommended by senior management and reviewed and
approved by REMCO and/or the HSBC CEO. As further described below, short-term
incentive awards include cash awards under each business's discretionary bonus
program. Long-term incentives include the deferral of a portion of discretionary
bonus awards through HSBC equity-based awards. In establishing executive
compensation packages, remuneration under each element is based on what is
believed to be an appropriate balance between performance-based compensation and
other forms of compensation, the level of responsibility and individual
contribution of the executive, business unit performance and overall CIBM or
Private Banking results.
Base Salary
Base salary is reviewed annually and increases, if any, are based on corporate
and individual performance. When establishing base salaries for executives,
consideration is given to compensation paid for similar positions at companies
included in compensation surveys of HUSI's Comparator Group, targeting the 50th
percentile, which the Compensation Committee believes, when combined with
significant performance-based compensation opportunities, enables HUSI to
attract and retain high performing executives. In addition, other factors such
as individual and corporate performance, potential for future advancement,
specific job responsibilities, length of time in current position, individual
pay history, and comparison to comparable internal positions (internal equity)
influences the final base salary recommendations for individual executives.
Within the CIBM and Private Banking businesses, annual salary increases must be
accommodated within the annual operating plan for the business globally.
Accordingly, salary increases proposed by senior management are prioritized
towards high performing employees and those who have demonstrated rapid
development. Proposals for salary increases are justified against performance
and with reference to local market rates, where available. While individual
performance is assessed relative to performance in a market context to ensure
that the executive is correctly positioned within the market range, the CIBM and
Private Banking business generally do not apply formulaic rates in determining
compensation, but rely more on the discretion and judgment of senior management
in the context of performance relative to key competitors of that business.
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Annual Performance-Based Awards
Annual non-equity performance-based awards are paid in cash upon satisfaction of
individual, business unit, corporate financial and operational goals. Superior
performance is encouraged by placing a significant part of the executive's total
compensation at risk. In the event certain quantitative or qualitative
performance goals are not met, annual performance awards may be less than the
maximum permitted.
Performance goals are set based on prior year's performance, expectations for
the upcoming year, HUSI's annual business plan, the HSBC Managing for Growth
business strategy, and objectives related to building value for HSBC
shareholders. The general concept is if both HUSI and the executive perform well
for the year, the performance award earned should be at a high level. If either
HUSI or the executive does not perform well, the award earned should be at a low
level. The Management Incentive Program described below implements this approach
by defining "target" and "maximum" percentages for annual non-equity
performance-based awards. Target award percentages range form 20 percent to 100
percent of base salary and maximum award percentages range from 40 percent to
300 percent. The award percentage range assigned to an executive officer will be
determined on the basis of his or her position and level of responsibility
within HUSI. The actual amount of the award within the applicable range will be
determined on the basis of the performance goals established for HUSI and the
individual each year.
In support of our pay-for-performance philosophy, HUSI maintains the Management
Incentive Program, which is an annual cash incentive plan that uses quantitative
and qualitative goals to motivate HUSI employees who have a significant role in
the corporation and do not participate in another incentive compensation plan.
The quantitative objectives may include meeting designated financial performance
targets for the company and/or the executive's respective business unit.
Qualitative objectives may include key strategic business initiatives or
projects for the executive's respective business unit. Award opportunity and
payouts are determined as a percentage of base salary and are based on
comparison to other internal comparable positions (internal equity) and external
market practices. Cash incentive awards under the Management Incentive Program
are paid in February of the year following the measurement year.
Ms. Derickson, Messrs. Glynn, McKenna and McDonagh and Ms. Burak participated in
the Management Incentive Program in 2006. A discussion of the quantitative and
qualitative objectives for each of these executives and the performance against
those goals can be found below under the heading Compensation of Officers
Reported in the Summary Compensation Table.
Within the CIBM and Private Banking businesses, all regular employees are
eligible for consideration for a discretionary bonus award. Final bonus
recommendations are determined after full year results are available and are
evaluated within the context of the performance of each business unit,
including, where relevant, economic profit at the regional and global levels and
compensation proposals for all business units within CIBM or Private Banking, as
applicable. In conjunction with an assessment of the executive's individual
performance, senior management may consult market surveys to assist in
identifying both market pay levels and factors influencing pay (i.e., product,
market, length of service, etc.). However, as is the case with other components
of compensation, we rely more on the discretion and judgment of senior
management in the context of performance relative to our key competitors than a
mechanical application of market rates.
Long-term Incentives
Long-term incentive compensation is awarded through grants of HSBC equity
instruments. The purpose of equity-based incentives is to help HUSI attract and
retain outstanding employees and to promote the growth and success of our
business over a period of time by aligning the financial interests of these
employees with those of HSBC's shareholders. Historically, equity incentives
were awarded through stock options and restricted share grants.
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Prior to 2005, options on HSBC ordinary shares were granted to certain
executives and restricted shares to others. Awarded options have an exercise
price equal to the greater of the average market value of HSBC ordinary shares
on the five business days prior to the grant of the option and the market value
of HSBC ordinary shares on the grant date. The options typically vest in three,
four or five equal installments, subject to continued employment, and expire ten
years from the grant date. However, certain options awarded to key executives
had a "total shareholder return" performance vesting condition and only vest if
and when the condition is satisfied. No stock options were granted to executive
officers in 2005 or 2006 in conjunction with HSBC's philosophical shift on the
form of equity based compensation.
Awards of restricted shares is another form of long-term incentive compensation
utilized to compensate and incent our employees. When restricted shares are
granted to an executive officer, the underlying shares are held in a trust for
the benefit of the employee and are released only after the defined vesting
conditions are met at the end of the holding period. While in such trust,
dividend equivalents are paid on all underlying shares of restricted stock at
the same rate paid to ordinary shareholders. The dividend equivalents are paid
in the form of additional shares for awards made after 2004 and in cash paid to
the executive for all prior awards.
There are three types of restricted shares used by HSBC: those with a time
vesting condition awarded to recognize significant contribution to HUSI
("Achievement Shares"), those with time and performance-based vesting conditions
("Performance Shares") and those with a time vesting condition for retention
purposes ("Retention Awards"). Achievement Shares are awarded to key executives
as part of the annual pay review process in recognition of past performance and
to further motivate and retain executives. The amount granted is based on
general guidelines established by REMCO, which include a percentage of base pay,
position within HUSI and potential for growth. Performance Shares are awarded to
key executives whose performance can have a direct impact on HSBC's consolidated
results and, in 2006, within HUSI, only Mr. Glynn and Mr. McDonagh received such
awards. Retention Awards have typically not been granted on an annual basis but
rather have been granted on an as needed basis. No Retention Awards were granted
to executive officers in 2006.
As described above, Performance Shares are awarded to an executive and vesting
of those shares is based on achievement of defined levels of future performance
of HSBC. Performance Shares are divided into two equal parts subject to distinct
performance conditions measured over a three year period. A total shareholder
return award, which accounts for 50 percent of each Performance Share award,
will vest in whole or in part (based on a sliding scale of 0 percent to 100
percent) depending upon how the growth in HSBC's share value, plus declared
dividends, compares to the average shareholder return of a defined competitor
group which for 2006 grants was comprised of 28 major banking institutions
including: ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria, S.A., Banco
Santander Central Hispano S.A., Bank of America Corporation, The Bank of New
York Company, Inc., Barclays PLC, BNP Paribas S.A., Citigroup, Inc., Credit
Agricole SA, Credit Suisse Group, Deutsche Bank AG, HBOS plc, JP Morgan Chase,
Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group Inc., Mizuho Financial
Group Inc., Morgan Stanley, National Australia Bank Limited, Royal Bank of
Canada, The Royal Bank of Scotland Group plc, Societe Generale, Standard
Chartered PLC, UBS AG, Unicredito Italiano, US Bancorp, Wachovia Corporation,
Wells Fargo & Company and Westpac Banking Corporation.
The earnings per share award accounts for 50 percent of each Performance Share
award and is measured using a defined formula based on HSBC's earnings per share
growth over the three-year period as compared to the base-year earnings per
share, which is earnings per share for the year prior to the year the
Performance Shares are granted. None of the earnings per share Performance
Shares will vest unless a minimum earnings per share is reached at the end of
three years.
REMCO maintains discretion to determine that a Performance Share award will not
vest unless REMCO is satisfied that HSBC's financial performance has shown
sustained improvement since the date of the award. REMCO may also waive, amend
or relax performance conditions if it believes the performance conditions have
become unfair or impractical and believes it appropriate to do so. Due to the
probability of one or both of the performance conditions not being met in part
or in full, grants of Performance Shares are for a greater number of shares than
Achievement Share grants. The expected value of Performance Shares is equal to
44 percent of the face value. Additional information concerning the conditions
to vesting of Performance Share awards is contained in Footnote 2 to the Grants
of Plan Based Awards table on page 184.
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Within the CIBM and Private Banking businesses, a portion of each discretionary
bonus award is paid in restricted shares. The minimum deferral threshold, or the
portion of each bonus award paid in restricted shares, and vesting schedules may
vary by business unit within the parameters set by CIBM and Private Banking, as
applicable, for their businesses.
Repricing of Stock Options and Timing of Option Grants
For HSBC discretionary option plans, the exercise price of awards made in 2003
and 2004 was the higher of the average market value for HSBC ordinary shares on
the five business days preceding the grant date or the market value on the date
of the grant.
HSBC also offers all employees a plan in which options to acquire HSBC ordinary
shares are awarded when an employee commits to contribute up to 250 GBP (or the
equivalent) each month for one, three or five years. At the end of the term, the
accumulated amount, plus interest, may be used to purchase shares under the
option, if the employee chooses to do so. The exercise price for such options is
the average market value of HSBC ordinary shares on the five business days
preceding the date of the invitation to participate, less a 15 to 20 percent
discount (depending on the term).
HUSI does not, and our parent, HSBC, does not, reprice stock option grants. In
addition, neither HUSI nor HSBC has ever engaged in the practice known as
"back-dating" of stock option grants, nor have we attempted to time the granting
of historical stock options in order to gain a lower exercise price.
Dilution from Equity-Based Compensation
While dilution is not a primary factor in determining award amounts, there are
limits to the number of shares that can be issued under HSBC equity-based
compensation programs. These limits were established by vote of HSBC's
shareholders in 2005.
Perquisites
HUSI's philosophy is to provide perquisites that are intended to help executives
be more productive and efficient or to protect HUSI and its executives from
certain business risks and potential threats. Our review of competitive market
data indicates that the perquisites provided to executives are reasonable and
within market practice. See the "Summary Compensation Table" below for further
information on perquisites awarded to HUSI executives.
Retirement Benefits
HNAH offers a pension retirement plan in which HUSI executives may participate
that provides a benefit equal to that provided to all employees of HUSI.
However, both qualified and non-qualified defined benefit plans are maintained
so that this level of pension benefit can be continued without regard to certain
Internal Revenue Service limits. Executives and other highly compensated
employees can elect to participate in a nonqualified deferred compensation plan,
where such employees can elect to defer the receipt of earned compensation to a
future date. We also maintain a qualified 401(k) plan with company matching
contributions. Ms. Derickson and Ms Burak, as former executives of HSBC Finance
Corporation, also participate in a nonqualified deferred compensation plan that
provides executives and other highly compensated employees with a company
matching contribution based on the level of the deferral of the employee's
earned compensation to the qualified 401(k) plan to the extent that such company
contributions cannot be allocated to the 401(k) plan because of certain Internal
Revenue Service limits. HUSI does not pay any above-market or preferential
interest in connection with deferred amounts.
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Employment Contracts and Severance Protection
Ms. Derickson entered into an employment agreement with HSBC Finance
Corporation, an affiliate of HUSI, on November 14, 2002, which was amended and
restated on May 17, 2005. As of December 31, 2006, Ms. Derickson's employment
remained subject to the terms of that agreement, the main purpose of which was
to protect HSBC Finance Corporation and its affiliates (including HUSI) from
certain business risks (threats from competitors, loss of confidentiality or
trade secrets, solicitation of customers and employees) and to define HSBC
Finance Corporation's right to terminate the employment relationship. The
employment agreement also protected Ms. Derickson from certain risks, such as a
change in control, death or disability. The terms of Ms. Derickson's employment
agreement are summarized in the description of her compensation under the
heading Compensation of Officers Reported in the Summary Compensation Table.
In connection with his employment March 2006, HBUS extended an offer letter to
Mr. Young dated February 17, 2006. The primary purpose of the offer letter was
to define Mr. Young's terms of employment, compensation and the rights of the
parties in the event of Mr. Young's resignation or termination. The terms of Mr.
Young's offer letter are summarized in the description of his compensation under
the heading Compensation of Officers Reported in the Summary Compensation Table.
In connection with his retirement on December 31, 2006, Mr. Glynn entered into
an agreement with HNAH dated June 30, 2006. The primary purpose of the agreement
was to define the rights of the parties prior to and upon Mr. Glynn's
retirement. The terms of Mr. Glynn's agreement are summarized in the description
of his compensation under the heading Compensation of Officers Reported in the
Summary Compensation Table.
Prior to his retirement on August 5, 2006, Mr. Petri entered into a separation
agreement with HBUS dated August 1, 2006. The primary purpose of the agreement
was to define the rights of the parties prior to and upon Mr. Petri's
retirement. The terms of Mr. Petri's agreement are summarized in the
descriptions of his compensation under the heading Compensation of Officers
Reported in the Summary Compensation Table.
Accounting Considerations
We adopted the fair value method of accounting under Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share Based Payment" (SFAS 123(R))
effective January 1, 2006. SFAS 123(R) applies to all equity instruments granted
to employees beginning January 1, 2006 and does not apply to awards granted in
prior periods before the effective date, except to the extent that prior
periods' awards are modified, repurchased or cancelled after the required
effective date. Prior to 2006, we adopted the fair value method of accounting
prospectively in 2002 for all new equity instruments granted to employees as
provided under Statement of Financial Accounting Standards No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure (an amendment of FASB
Statement No. 123)." The Board of Directors believes that this treatment
reflects greater accuracy and transparency of the cost of these incentives and
promotes better corporate governance.
Tax Considerations
Limitations on the deductibility of compensation paid to executive officers
under Section 162(m) of the Internal Revenue Code is not applicable to HUSI, as
it is not a public corporation as defined by Section 162(m). As such, all
compensation to our executive officers is deductible for federal income tax
purposes, unless there are excess golden parachute payments under Section 4999
of the Internal Revenue Code following a change in control.
Compensation of Officers Reported in the Summary Compensation Table
Below is a summary of the factors that affected the compensation earned in 2006
by the executive officers listed in the Summary Compensation Table. In
recommending compensation for each of our executives, management and the
Compensation Committee evaluated competitive levels of compensation for
executives managing operations or functions of similar size and complexity and
the importance of retaining executives with the strategic, leadership and
financial skills to ensure HUSI's continued growth and success and their
potential for assumption of additional responsibilities.
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Chief Executive Officer Compensation - Ms. Derickson
Sandra L. Derickson was appointed President and Chief Executive Officer -
Designate of HUSI as of September 1, 2006 and succeeded Mr. Glynn as President
and Chief Executive Officer as of January 1, 2007. She resigned as President and
Chief Executive Officer on February 20, 2007. Until that time, Ms. Derickson
participated in the same programs and generally received compensation based on
the same factors as HUSI's other executive officers. However, Ms. Derickson's
overall compensation level reflected her greater degree of policy and
decision-making authority, her higher level of responsibility with respect to
the strategic direction of HUSI, and her ultimate responsibility for HUSI's
financial and operational results.
In connection with her appointment as of September 1, 2006, the Compensation
Committee set Ms. Derickson's base salary at an annualized level of $700,000 for
2006. In establishing Ms. Derickson's initial base salary, the Compensation
Committee sought to align Ms. Derickson's compensation level with that of her
predecessor, Mr. Glynn, which placed Ms. Derickson's compensation level at the
50th percentile among similarly-placed executives within the Comparator Group.
As Ms. Derickson's initial base salary with HUSI did not represent an increase
over her base salary for HSBC Finance Corporation, no further approvals were
sought or obtained.
Because she served as President & Chief Executive Officer - Designate for only a
portion of the year, Ms. Derickson did not receive an equity-based award with
respect to her service to HUSI in 2006. In January 2006, REMCO met and
considered the proposed equity-based awards for all HSBC executives and awarded
Ms. Derickson Performance Shares with a grant date value of $2,500,003 with
respect to Ms. Derickson's services as an executive officer of HSBC Finance
Corporation. In making the award, REMCO considered internal equity of
compensation paid to management peers within HSBC and its subsidiaries and
external benchmarking, as described above.
Under the Management Incentive Program, Ms. Derickson's 2006 target annual
incentive bonus opportunity was 100 percent of her base salary at December 31,
2006 and her maximum opportunity was 300 percent. In addition, pursuant to her
employment agreement, described below, Ms. Derickson was entitled to a bonus
guaranteed to be not less than $1,275,000. However, due to the disappointing
results in the HSBC Finance Corporation Mortgage Services business, Ms.
Derickson voluntarily waived her right to a guaranteed bonus under her
employment agreement.
Other compensation paid to Ms. Derickson in 2006, including perquisites, such as
life insurance premiums and social club membership fees, was consistent with
perquisites paid to similarly-placed executive officers within and outside of
HSBC.
Ms. Derickson had an employment agreement with HSBC Finance Corporation, which
was to expire on March 28, 2008. Pursuant to her agreement, Ms. Derickson served
as President and Chief Executive Officer of HUSI. The terms of that agreement
are summarized below. As stated above, Ms. Derickson resigned as of February 20,
2007. The terms of the severance arrangements agreed with Ms. Derickson will be
described in HUSI's Annual Report on Form 10-K for the year ending December 31,
2007.
During the term of the employment agreement, Ms. Derickson was entitled to
receive an annual base salary (which as of January 1, 2006 was increased to
$700,000), and an annual bonus of at least $1,275,000 (75 percent of the annual
average of her bonus earned in 2003, 2004 and 2005). During the term of the
agreement, Ms. Derickson was be eligible to participate in any equity-based
incentive compensation plan or program of HSBC as in effect from time to time
for similarly situated senior executives of HSBC Finance Corporation, as
approved by REMCO. In addition, during the term of the agreement, Ms. Derickson
was eligible to participate in the various retirement, medical, disability and
life insurance plans, programs and arrangements in accordance with the terms of
HSBC Finance Corporation's benefit plans.
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Under the terms of the employment agreement, if Ms. Derickson's employment was
terminated during the term of the agreement other than for "cause" or
disability, or she resigned for "good reason," subject to her execution of a
general release in favor of HSBC Finance Corporation and its affiliates, Ms.
Derickson was to continue to receive her base salary and annual bonus described
above as if she had remained employed until March 28, 2008. In addition, to the
extent permitted under the terms of the applicable plans, Ms. Derickson's
welfare benefits, umbrella liability insurance and automobile and financial
counseling allowances would continue until March 28, 2008, unless she became
eligible to participate in similar plans of another employer prior to that date.
In 2003 and 2005, Ms. Derickson was awarded Retention Awards of HSBC restricted
shares with values of $3.75 and $6 million, respectively, in each case based on
the closing price of HSBC ordinary shares as of the date of the grant. The 2003
award was to vest in five equal installments on March 28 of each year through
2008. The 2005 was to vest in five equal installments on March 26 of each year
through 2010. Each award was to vest in full upon termination of Ms. Derickson's
employment other than for cause or, with respect to the 2003 award, by Ms.
Derickson due to a material breach by HUSI of Ms. Derickson's employment
agreement, or with respect to the 2005 award, by Ms. Derickson for good reason.
Chief Executive Officer Compensation - Mr. Glynn
Martin J.G. Glynn retired as President and Chief Executive Officer as of
December 31, 2006. Prior to his retirement, Mr. Glynn participated in the same
programs and generally received compensation based on the same factors as the
other executive officers. However, Mr. Glynn's overall compensation level
reflected his greater degree of policy and decision-making authority, his higher
level of responsibility with respect to the strategic direction of HUSI, and his
ultimate responsibility for HUSI's financial and operational results. For 2006,
Mr. Glynn's compensation was comprised of base salary, non-equity incentive
compensation (bonus), an additional cash payment in lieu of stock awards, an
additional cash payment triggered by his retirement and perquisites.
In 2006, Mr. Glynn's base salary remained at $700,000, the same as for 2005. For
2006, the Compensation Committee reviewed competitive compensation levels and
found Mr. Glynn's then current cash compensation level was in line with the 50th
percentile among similarly-placed executives in our Comparator Group. In keeping
with the goal of maintaining executive base salaries in the 50th percentile, it
did not make an advisory recommendation to increase his salary.
In January 2006, REMCO approved the Compensation Committee's advisory
recommendation that Mr. Glynn receive a Performance Share award with a grant
date value of $1,400,000. The award is subject to three-year performance vesting
conditions. The vesting criteria of the Performance Shares are set out in
Footnote 2 to the Grants of Plan-Based Awards Table on page 184. The grant
reflected the view of the Compensation Committee and REMCO of the value of Mr.
Glynn's contribution to and leadership of HUSI and HSBC's desire to incent
outstanding performance.
Mr. Glynn's cash incentive under the Management Incentive Program is determined
based upon satisfaction of quantitative and qualitative objectives that provide
for a target cash award equal to 100 percent of his base salary, up to a maximum
of 300 percent of base salary. Mr. Glynn's cash incentive compensation required
satisfaction of objectives that included business goals related to HUSI's profit
before tax and initiates promoting diversity in employment, managing
reputational risk and improving HUSI's compliance environment. Management
assessed Mr. Glynn's and HUSI's performance against the objectives and found
that there was complete or substantial satisfaction of each objective. Mr. Glynn
was awarded cash incentive compensation of $1,600,000, or approximately 230
percent of his base salary, which was paid to him in February 2007. This amount
was consistent with the guaranteed cash incentive award provided for in Mr.
Glynn's agreement, as described below.
Other compensation paid to Mr. Glynn including perquisites, such as rent
allowance, car allowance and related tax gross-ups, is consistent with
perquisites paid to similarly-placed executive officers within and outside of
HSBC.
175
In connection with his retirement, Mr. Glynn entered into an agreement with HNAH
on June 30, 2006. Pursuant to the terms of this agreement, Mr. Glynn received
his regular base salary and benefits through his retirement on December 31,
2006. Mr. Glynn also received a full incentive bonus of $1,600,000 for 2006,
which was paid in February 2007. He is also entitled to an additional cash
payment of $616,000 in lieu of any equity-based award for 2006 and continued
vesting of his outstanding equity-based awards as reflected in the Outstanding
Equity Awards at Fiscal Year-End Table. Finally, Mr. Glynn received a lump sum
payment of $6,600,000 for general employment benefits that would otherwise have
accrued had he retired two years after December 31, 2006.
Chief Financial Officer Compensation
The Senior Executive Vice President & Chief Financial Officer of HUSI, John J.
McKenna, participates in general benefits available to executives of HUSI and
the Management Incentive Program. His cash compensation for 2006 was determined
by Mr. Mehta, the HNAH Chief Executive Officer, upon recommendation of the
Compensation Committee in consultation with HUSI Human Resources executives and
the Chief Financial Officer of HNAH. As with all HUSI executives, REMCO has
authority over Mr. McKenna's Achievement Share awards. For 2006, Mr. McKenna's
compensation was comprised of base salary, non-equity incentive compensation
(bonus), stock awards and perquisites.
Mr. McKenna's base salary increased by $25,050 in February 2006, bringing his
base salary to $325,050. In recommending Mr. McKenna's base salary, the
Compensation Committee and HUSI senior executives reviewed competitive
compensation levels and found Mr. McKenna's current compensation level was only
slightly below the 50th percentile among similarly-placed executives at HUSI's
Comparator Group. The recommendation also reflected the company's view of Mr.
McKenna's performance in 2005. The HNAH Chief Executive Officer agreed with the
recommendation and approved the increase in Mr. McKenna's base salary.
In March 2006, Mr. McKenna was granted Achievement Shares with a grant date
value of $400,000, which vest in three years and have no performance conditions.
This reflected management's recognition of the value of Mr. McKenna's
contribution to and leadership of HUSI and HSBC's desire to retain Mr. McKenna
and to incent outstanding performance.
Mr. McKenna's cash incentive under the Management Incentive Program is
determined based upon satisfaction of quantitative and qualitative objectives
that provide for a target cash award equal to 75 percent of his base salary, up
to a maximum of 150 percent of base salary. Mr. McKenna's cash incentive
compensation required satisfaction of the quantitative and qualitative
objectives described above for Mr. Glynn. Management assessed Mr. McKenna's and
HUSI's performance against the objectives and found that there was complete or
substantial satisfaction of each objective. Mr. McKenna was awarded cash
incentive compensation of $381,934, or approximately 119 percent of his base
salary, which was paid to him in February 2007.
Other compensation paid to Mr. McKenna, including perquisites such as life
insurance premiums, is consistent with perquisites paid to similarly-placed
executive officers within and outside of HSBC.
Joseph A. Belfatto Compensation
The Senior Executive Vice President and Head of Global Markets Americas, Joseph
A. Belfatto, participates in general benefits available to executives of HUSI
and the CIBM business. For 2006, Mr. Belfatto's compensation was comprised
primarily of base salary, non-equity incentive compensation (discretionary bonus
award) and stock awards.
Mr. Belfatto's total compensation increased by $20,000 in 2006, bringing his
total compensation to $3,750,000. In recommending Mr. Belfatto's compensation
package to the Group Head of CIBM, CIBM senior management considered the
performance of the CIBM business locally and globally and its judgment of
competitive compensation levels within the relevant markets. The recommendation
also reflected CIBM senior management's view of Mr. Belfatto's contribution to
the business's performance in 2005 and the desire to retain Mr. Belfatto within
the CIBM business. The Head of CIBM agreed with senior management's
recommendation and approved the increase in Mr. Belfatto's total compensation
package.
176
As described above, the allocation of compensation between base salary and
incentive compensation within CIBM, as well as between long-term and short-term
incentives, is recommended by senior management in its discretion and reviewed
and approved by REMCO and/or the HSBC CEO. For 2006, Mr. Belfatto's compensation
package consisted of $250,000, or approximately seven percent of his total
compensation, in base salary and $3,500,000, or approximately 93 percent, as a
discretionary bonus award. Of the discretionary bonus award, Mr. Belfatto
received $1,960,000 in cash and the balance will be deferred through a grant of
restricted shares in March 2007 with a grant date value of $1,540,000. One-third
of the shares vest on each of the first three anniversaries of the grant and
have no performance conditions.
Other compensation paid to Mr. Belfatto, including perquisites, is consistent
with perquisites paid to similarly-placed executive officers within and outside
of HSBC.
Marlon Young Compensation
The Managing Director, Chief Executive Officer, Private Bank Americas, Marlon
Young, participates in general benefits available to executives of HUSI and the
Private Banking business. For 2006, Mr. Young's compensation was comprised
primarily of base salary, non-equity incentive compensation (discretionary bonus
award) and stock awards.
Mr. Young was appointed Managing Director, Chief Executive Officer, Private Bank
Americas, in March 2006. His total compensation for 2006 was $1,875,000, which
included a $75,000 increase to his base salary in September 2006. In
recommending Mr. Young's compensation package, Group Private Banking senior
management considered the performance of the Private Banking business locally
and globally and the competitive compensation levels within the relevant
markets. The recommendation also reflected management's view of Mr. Young's
potential contribution to the business's performance and HSBC's desire to retain
Mr. Young within Private Banking. The Chief Executive Officer, Group Private
Banking agreed with senior management's assessment and approved Mr. Young's
compensation package.
As described above, the allocation of compensation between base salary and
incentive compensation within Private Banking, as well as between long-term and
short-term incentives, is recommended by senior management in its discretion and
reviewed and approved by REMCO. For 2006, Mr. Young's compensation package
consisted of $375,000, or 20 percent of his total compensation, in base salary
and $1,500,000, or 80 percent, as a discretionary bonus award. Of the
discretionary bonus award, Mr. Young received $750,000 in cash and the balance
will be deferred through a grant of restricted shares in March 2007 with a grant
date value of $750,000. One-third of the shares vest on each of the first three
anniversaries of the grant and have no performance conditions. These amounts
were consistent with the guaranteed cash incentive award provided for in Mr.
Young's offer letter, as described below.
Other compensation paid to Mr. Young, including perquisites, is consistent with
perquisites paid to similarly-placed executive officers within and outside of
HSBC.
In connection with his employment by HUSI in March 2006, HBUS extended an offer
letter to Mr. Young defining the terms of his employment. Pursuant to the offer
letter, Mr. Young is entitled to an annual salary of $300,000 and a guaranteed
bonus of $1,000,000 for each of the 2006 and 2007 performance years, 50 percent
of which is to be deferred through a grant of restricted shares. The offer
letter also provided for additional annual bonuses to be awarded in the sole
discretion of the company, subject to deferral pursuant to the Private Banking
discretionary bonus program. The offer letter also defined the rights of the
parties upon Mr. Young's resignation or termination, which are described under
below under Potential Payments upon Termination or Change-in-Control.
Janet L. Burak Compensation
The Senior Executive Vice President, General Counsel and Secretary of HUSI,
Janet L. Burak, participates in general benefits available to executives of HUSI
and the Management Incentive Program. Her cash compensation for 2006 was
determined by Mr. Mehta, the HNAH Chief Executive Officer, upon recommendation
of the Compensation Committee in consultation with HUSI Human Resources
executives. As with all HUSI executives, REMCO has authority over Ms. Burak's
Achievement Share awards. For 2006, Ms. Burak's compensation was comprised of
base salary, non-equity incentive compensation (bonus), stock awards and
perquisites.
177
Ms. Burak's base salary increased by $32,708 in February 2006, bringing her base
salary to $400,208. In recommending Ms. Burak's base salary, the Compensation
Committee and HUSI senior executives reviewed competitive compensation levels
and found Ms. Burak's current compensation level was in line with the 50th
percentile among similarly-placed executives at HUSI's Comparator Group. The
recommendation also reflected the company's view of Ms. Burak's performance in
2005. The HNAH Chief Executive Officer agreed with the recommendation and
approved the increase in Ms. Burak's base salary.
In March 2006, Ms. Burak was granted Achievement Shares with a grant date value
of $500,000, which vest in three years and have no performance conditions. This
reflected management's recognition of the value of Ms. Burak's expected
long-term contribution to and leadership of HUSI and HNAH, and HSBC's desire to
retain Ms. Burak and to incent outstanding performance.
Ms. Burak's cash incentive under the Management Incentive Program is determined
based upon satisfaction of quantitative and qualitative objectives that provide
for a target cash award equal to 100 percent of her base salary, up to a maximum
of 200 percent of base salary. Ms. Burak's cash incentive compensation required
satisfaction of the quantitative and qualitative objectives described above for
Mr. Glynn. Management assessed Ms. Burak's and HUSI's performance against the
objectives and found that there was complete or substantial satisfaction of each
objective. Ms. Burak was awarded cash incentive compensation of $735,383, or
approximately 186 percent of her base salary, which was paid to her in February
2007.
Other compensation paid to Ms. Burak including perquisites, such as life
insurance premiums, is consistent with perquisites paid to similarly-placed
executive officers within and outside of HSBC.
Brendan McDonagh Compensation
Mr. McDonagh served as Chief Operating Officer of HUSI until December 1, 2006.
For that portion of 2006, Mr. McDonagh participated in general benefits
available to executives of HUSI and the Management Incentive Program and certain
additional benefits available to HSBC's international staff executives. As an
HSBC Group General Manager, Mr. McDonagh's cash compensation for 2006 was
determined by REMCO upon advisory recommendation of the Compensation Committee
in consultation with HSBC Human Resources executives. As with all HUSI
executives, REMCO has authority over Mr. McDonagh's equity-based awards. For
2006, Mr. McDonagh's compensation was comprised of base salary, non-equity
incentive compensation (bonus), stock awards and perquisites.
Mr. McDonagh's base salary for 2006 was $676,553. In recommending Mr. McDonagh's
base salary to the Compensation Committee, HUSI and HNAH senior executives
reviewed competitive compensation levels and found Mr. McDonagh's current
compensation level was below the 50th percentile among similarly-placed
executives at HUSI's Comparator Group. The recommendation also reflected the
company's view of Mr. McDonagh's performance in 2005. The Compensation Committee
agreed with management's recommendation and made an advisory recommendation to
REMCO. REMCO concurred with the Compensation Committee's assessment and, as a
result, Mr. McDonagh's base salary was increased.
In January 2006, REMCO approved the Compensation Committee's advisory
recommendation that Mr. McDonagh receive a Performance Share award with a grant
date value of $635,000. The award is subject to three-year performance vesting
conditions. The vesting criteria of the Performance Shares are set out in
Footnote 2 to the Grants of Plan-Based Awards Table on page 184. The grant
reflects REMCO's view of the value of Mr. McDonagh's long-term contribution to
and leadership of HSBC, including HUSI and HNAH, and HSBC's desire to retain Mr.
McDonagh and to incent exceptional performance.
178
Under the Management Incentive Program, Mr. McDonagh's 2006 target annual
incentive bonus opportunity was 100 percent of his base salary at December 31,
2006 and his maximum opportunity was 200 percent. Mr. McDonagh's cash incentive
compensation was determined upon satisfaction of the quantitative and
qualitative objectives described above for Mr. Glynn. Management assessed Mr.
McDonagh's and HUSI's performance against the objectives and recommended a cash
incentive compensation award equal to $720,000, or approximately 106 percent of
his base salary, which was paid in February 2007. The Compensation Committee
agreed with management's assessment and made an advisory recommendation to REMCO
that Mr. McDonagh receive this amount. REMCO concurred with the assessment and
advisory recommendation of the Compensation Committee and approved the cash
incentive compensation.
Mr. McDonagh received other compensation in 2006, including perquisites relating
to housing, education, travel and tax equalization, that was significant when
compared to other compensation received by other executive officers within HUSI.
These amounts are consistent, however, with perquisites paid to similarly-placed
HSBC international staff executives, who are subject to appointment to HSBC
locations globally as deemed appropriate by HSBC senior management. The
additional perquisites and benefits available to HSBC international staff
executives, as described below in the Summary Compensation Table, are intended
to compensate executives for the significant cost and expense incurred in
connection with global postings.
Joseph M. Petri Compensation
Mr. Petri served as Senior Executive Vice President, Treasurer and Co-Head, CIBM
Americas until August 5, 2006. For that portion of 2006, Mr. Petri participated
in general benefits available to executives of HUSI and the CIBM business. For
2006, Mr. Petri's compensation was comprised primarily of base salary,
non-equity incentive compensation (discretionary bonus award) and a cash payment
triggered by his retirement.
In 2006, Mr. Petri's total compensation remained at $7,825,000, the same as for
2005. In recommending Mr. Petri's compensation package to the Group Head of
CIBM, CIBM senior management considered the performance of the CIBM business
locally and globally and its judgment of competitive compensation levels within
the relevant markets. The recommendation also reflected CIBM senior management's
view of Mr. Petri's contribution to the business's performance in 2005 and the
desire to retain Mr. Petri within the CIBM business. The Head of CIBM agreed
with senior management's recommendation and made an advisory recommendation to
REMCO to approve his compensation. REMCO concurred with the assessment and
recommendation of CIBM management and approved Mr. Petri's total compensation
package.
Mr. Petri entered into a separation agreement with HBUS on August 1, 2006.
Pursuant to the terms of his separation agreement, Mr. Petri received his
regular base salary and benefits through his retirement on August 4, 2006. Mr.
Petri received a lump sum payment of $146,339 as payment of the base salary that
would have accrued for continued employment through December 31, 2006. He also
received a lump sum payment of $3,960,000 in February 2007 in payment of the
portion Mr. Petri's minimum guaranteed bonus for 2006 not subject to deferral,
and is entitled to receive the balance of his guaranteed bonus amount for 2006
through a grant of restricted shares with a grant date value of $3,540,000. In
connection with Mr. Petri's retirement, REMCO also approved the continued
vesting of all outstanding restricted shares that have not yet vested, subject
to any existing performance conditions.
Other compensation paid to Mr. Petri, including perquisites, is consistent with
perquisites paid to similarly-placed executive officers within and outside of
HSBC.
179
Compensation Committee Interlocks and Insider Participation
The primary purpose of the Compensation Committee is to assist the Board of
Directors in discharging its responsibilities related to the compensation of the
Chief Executive Officer, other officers of HUSI holding a title of executive
vice president and above and such other officers as may be designated by the
Board of Directors. The Compensation Committee is comprised of the following
directors: Dr. Frances D. Fergusson (Chair), Donald K. Boswell and James L.
Morice. During 2006, with the exception of Mr. Glynn, the Compensation Committee
was comprised of independent directors, as defined under HUSI's Corporate
Governance Standards. HUSI's present intention is to maintain a Compensation
Committee that consists entirely of independent directors.
Additional information with regard to the Compensation Committee, including a
description of the committee's responsibilities under its charter, is contained
in the section of this Form 10-K entitled Item 10. Directors, Executive Officers
and Corporate Governance - Board of Directors - Committees and Charters.
Compensation Committee Report
We, the Human Resources & Compensation Committee of the Board of Directors of
HSBC USA Inc., have reviewed and discussed the Compensation Discussion and
Analysis ("2006 CD&A") set forth above with management and, based on such review
and discussion, have recommended to the Board of Directors that the 2006 CD&A be
included in this Annual Report on Form 10-K.
Human Resources & Compensation Committee
Dr. Frances D. Fergusson (Chair)
Donald K. Boswell
James L. Morice
180
Item 11. Executive Compensation
--------------------------------------------------------------------------------
The following tables and narrative text discuss the compensation awarded to,
earned by or paid to (i) Ms. Derickson, who served as our Chief Executive
Officer - Designate from September 1, 2006 to December 31, 2006, (ii) Mr. Glynn,
who served as our Chief Executive Officer during 2006, (iii) Mr. McKenna, who
served as our Chief Financial Officer during 2006, (iii) our three most highly
compensated executive officers (other than the chief executive officer and chief
financial officer) who were serving as executive officers as of December 31,
2006 and (iv) two additional individuals who served as executive officers during
2006, but were not serving as executive officers as of December 31, 2006.
Summary Compensation Table
--------------------------------------------------------------------------------
Change in
Pension Value
and
Nonqualified
Option Non-Equity Deferred All Other
Name and principal Stock Awards Incentive Plan Compensation Compensation
position Year Salary Bonus (4) Awards (5) (6) Compensation (7) Earnings (8) (9) Total
------------------------------------------------------------------------------------------------------------------------
Sandra L.
Derickson (1) 2006 $233,333 $ -- $ -- $ -- $ -- $ 63,386 $ 192,632 $ 489,351
President &
Chief Executive
Officer -
Designate
Martin J.G.
Glynn (1) 2006 700,000 -- 1,976,008 -- 1,600,000 1,899,593 7,651,080(10) 13,826,681
President &
Chief Executive
Officer
John J. McKenna 2006 321,196 -- 222,114 -- 381,934 92,238 16,685 1,034,167
Senior Executive
Vice President &
Chief Financial
Officer
Joseph A.
Belfatto 2006 250,000 1,960,000 952,379 -- -- 4,576 20,763 3,187,718
Senior Executive
Vice President &
Head, Global
Markets Americas
Marlon Young 2006 245,769 750,000 535,770 -- -- -- 1,463 1,533,002
Managing Director,
CEO Private Bank
Americas
Janet L. Burak 2006 395,176 -- 415,346 -- 736,383 368,753 92,597 2,008,255
Senior Executive
Vice President,
General Counsel
& Secretary
Brendan
McDonagh (2) 2006 676,553 -- 272,515 -- 720,000 488,925 635,401 2,793,394
Chief Operating
Officer
Joseph M.
Petri (3) 2006 206,250 3,960,000 5,420,744 -- -- 4,576 171,802(11) 9,763,372
Senior Executive
Vice President,
Treasurer and
Co-Head, CIBM
Americas
(1) Sandra L. Derickson was appointed President and Chief Executive Officer -
Designate of HUSI as of September 1, 2006 and succeeded Mr. Glynn as
President and Chief Executive Officer when he retired as of January 1,
2007. She resigned as President and Chief Executive Officer on February
20, 2007. The amount shown for Ms. Derickson is the pro rata portion of
her annual base salary of $700,000.
(2) Mr. McDonagh resigned his position as Chief Operating Officer of HUSI as
of December 1, 2006, and was appointed Group Executive of HSBC Finance
Corporation as of that date.
(3) Mr. Petri retired as Senior Executive Vice President, Treasurer and
Co-Head, CIBM Americas as of August 5, 2006.
(4) The amounts disclosed for Messrs. Belfatto, Young and Petri represent the
discretionary cash bonus relating to 2006 performance but paid in February
2007.
181
(5) Reflects the amounts of compensation expense amortized in 2006 for
accounting purposes under FAS 123R for outstanding restricted stock grants
made in the years 2003 through 2006. HUSI did not record a compensation
expense with respect to restricted stock grants made to Ms. Derickson by
HSBC Finance Corporation during this period and prior to her appointment
as President & Chief Executive Officer of HUSI. HSBC Finance Corporation
recorded an expense with respect to those grants in 2006 in the amount of
$2,720,809.
A portion of the expense reflected for Messrs. Glynn and McDonagh relates
to Performance Shares granted in 2005 and 2006 that will vest in whole or
in part three years from the date of grant if all or some of the
performance conditions are met, as follows: 50 percent of the award is
subject to a total shareholder return measure ("TSR") and will vest in
whole or in part (based on a sliding scale of 0 to 100 percent) depending
upon on how the growth in HSBC's share value, plus declared dividends,
compares to the average shareholder return of a defined competitor group,
which for 2006 grants was comprised of 28 major banking institutions,
including ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria, S.A.,
Banco Santander Central Hispano S.A., Bank of America Corporation, The
Bank of New York Company, Inc., Barclays PLC, BNP Paribas S.A., Citigroup,
Inc., Credit Agricole SA, Credit Suisse Group, Deutsche Bank AG, HBOS plc,
JP Morgan Chase, Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group
Inc., Mizuho Financial Group Inc., Morgan Stanley, National Australia Bank
Limited, Royal Bank of Canada, The Royal Bank of Scotland Group plc,
Societe Generale, Standard Chartered PLC, UBS AG, Unicredito Italiano, US
Bancorp, Wachovia Corporation, Wells Fargo & Company and Westpac Banking
Corporation. The remaining 50 percent of the award is subject to
satisfaction of an earnings per share measure ("EPS") and may vest based
on an incremental EPS percentage in accordance with a defined formula. If
the aggregate incremental EPS is less than 24 percent, the EPS portion
will be forfeited. If it is 52 percent or more, the EPS component will
vest in full. We have reduced the amount of expense related to the
Performance Shares that would have been recorded by 50 percent due to the
probability of a 0 percent vest on the TSR portion and a 100 percent vest
on the EPS portion for both years 2005 and 2006. HUSI records expense over
the three-year period based on the fair value, which is 100 percent of the
face value on the date of the award. The remaining grants are
non-performance-based awards and are subject to various time vesting
conditions as disclosed in the footnotes to the Outstanding Equity Awards
at Fiscal Year End Table and will be released as long as the named
executive officer is still in the employ of HUSI at the time of vesting.
HUSI records expense based on the fair value over the vesting period,
which is 100 percent of the face value on the date of the award. Dividend
equivalents, in the form of cash or additional shares, are paid on all
underlying shares of restricted stock at the same rate as paid to ordinary
share shareholders.
(6) The current philosophy of HSBC and HUSI, including within the CIBM and
Private Banking businesses, is to reward executive officers with awards of
restricted shares rather than stock options. Ms. Derickson received stock
option awards from HSBC Finance Corporation in 2002 and from HSBC in 2003
and 2004, all of which were awarded prior to her appointment as President
& Chief Executive Officer of HUSI. HUSI did not record a compensation
expense with respect to those stock options in 2006. The amount of
compensation expense amortized in 2006 by HSBC Finance Corporation for
accounting purposes under FAS 123R with respect to these stock options was
$787,646, which amount did not include any compensation expense
amortization with respect to the outstanding stock options awarded in
2004. The methodology of the valuation of the outstanding stock options
awarded in 2002 and 2003 was based on a Black-Scholes model for each of
the respective years. The stock options awarded to Ms. Derickson in 2004
are performance based with 100 percent of the condition tested against TSR
in 2007. The amount of compensation expense amortized in 2006 with respect
to the stock options awarded in 2004 has been excluded from the amounts
shown because of the probability of the performance condition not being
satisfied. The performance condition will be subject to a re-test in 2008,
and again in 2009, and must be satisfied in order for the shares to vest.
(7) The amounts disclosed for Messrs. Glynn, McKenna and McDonagh and Ms.
Burak represent the incentive bonus earned in 2006 but paid in February
2007 under the Management Incentive Program.
(8) The HSBC-North America (U.S.) Retirement Income Plan ("RIP"), the
Household Supplemental Retirement Income Plan ("SRIP"), the HSBC Bank
Supplemental Plans ("Excess Plans"), the HSBC Bank Canada Qualified and
Non-Qualified Retirement Plans and the HSBC International Staff Retirement
Benefit Scheme (Jersey) ("ISRBS") are described under Savings and Pension
Plans on page 190.
Increase in values by plan for each participant are: Ms. Derickson -
$5,453 (RIP), $57,933 (SRIP); Mr. Glynn - $150,274 (Canada Qualified),
$1,749,319 (Canada Non-Qualified); Mr. McKenna - $54,991 (RIP), $37,247
(Excess); Mr. Belfatto - $4,576 (RIP); Ms. Burak - $40,402 (RIP), $328,351
(SRIP); Mr. McDonagh - $488,925 (ISRBS, net of mandatory 2006
contribution); and Mr. Petri - $4,576 (RIP).
(9) Components of All Other Compensation are disclosed in the aggregate. All
Other Compensation includes perquisites and other personal benefits
received by each named executive officer, such as financial planning
services, physical exams, club initiation fees, expatriate benefits and
car allowances, to the extent such perquisites and other personal benefits
exceeded $10,000 in 2006. The following itemizes perquisites and other
benefits for each named executive officer who received perquisites and
other benefits in excess of $10,000: Car allowances for Mr. Glynn were
$13,800 and for Mr. McDonagh were $11,375 in 2006. The tax gross up on the
car allowances were $12,138 and $9,406 respectively. Club Dues and
Membership fees for Messrs. Glynn and McDonagh were $4,100 and $22,211,
respectively, and for Ms. Derickson were $11,000. Executive Tax Services
for Messrs. Glynn and McDonagh were each $500 excluding tax gross-ups of
$458 and $84, respectively. Mr. Glynn was reimbursed for approximately
$52,500 in Legal Fees and Expenses in 2006. Financial Counseling expenses
for Ms. Derickson were $4,000 in 2006. Ms. Derickson received Executive
Umbrella Liability Coverage in the amount of $1,850 for 2006. In 2006, Mr.
Glynn had $177,600 in Rent Allowance, excluding a tax gross up of
$150,522. In 2006, Mr. McDonagh had $90,233 in Children's Education
Allowance and a corresponding tax gross-up of $75,332, $17,663 in a
Relocation Allowance, $75,000 for Rent Allowance and a corresponding tax
gross-up of $62,615, $122,383 in Housing and Furniture Allowance and a
corresponding tax gross-up of $25,575, $72,454 in Executive Travel
Allowance, a $16,879 Loan Subsidy and $33,690 of Additional Income.
182
The total in the All Other Compensation column includes life insurance
premiums paid by HUSI in 2006 for the benefit of executives, as follows:
Ms. Derickson, $7,782; Mr. Glynn, $12,462; Mr. McKenna, $1,992; Mr.
Belfatto, $7,782; Mr. Young, $1,463; Mr. Petri, $5,088 and Ms. Burak,
$6,973. All Other Compensation also includes HUSI's contribution for the
named executive officer's participation in the HSBC-North America (U.S.)
Tax Reduction Investment Plan ("TRIP") in 2006, as follows: Mr. Glynn, Mr.
Petri, Ms. Derickson and Ms. Burak each had an $11,000 contribution; Mr.
McKenna had a $12,308 contribution and Mr. Belfatto had a $12,980
contribution. In addition, Ms. Derickson and Ms. Burak each had a company
contribution in the Supplemental Tax Reduction Investment Plan ("STRIP")
of $157,000 and $68,466 respectively, in 2006. TRIP and STRIP are
described under Savings and Pension Plans - Deferred Compensation Plans on
page 194.
(10) Pursuant to an agreement with HNAH entered into in connection with his
retirement, Mr. Glynn received $7,216,000 in additional cash compensation.
This included $6,600,000 for general employment benefits that would
otherwise have accrued had he retired two years after December 31, 2006,
and $616,000 as compensation for any equity-based award that would have
been awarded in 2007. See Chief Executive Officer Compensation - Mr. Glynn
in the 2006 CD&A for a description of Mr. Glynn's agreement.
(11) In 2006, Mr. Petri received $155,714 in additional compensation, which
included payment for general employment benefits that would otherwise have
accrued had his employment continued through 2006. Mr. Petri is also
entitled to receive restricted shares with a grant date value of
$3,540,000 as part of his 2006 bonus compensation. The shares vest 33 1/3
percent over the first three anniversaries from the date of grant and
forfeit only if Mr. Petri violates the terms of his separation agreement.
See Joseph M. Petri Compensation in the 2006 CD&A for a description of Mr.
Petri's separation agreement.
Grants Of Plan-Based Awards Table
--------------------------------------------------------------------------------
All Other All Other
Stock Option
Estimated Future Payouts Under Estimated Future Payouts Awards: Awards: Exercise Grant Date
Non-Equity Incentive Under Equity Incentive Number Number of or Base Fair Value
Plan Awards (1) Plan Awards (2) of Shares Securities Price of of Stock
----------------------------- ------------------------- of Stock Underlying Option and Option
Grant Threshold Target Maximum Threshold Target Maximum or Units Options Awards Awards
Name Date ($) ($) ($) (#) (4) (#) (#) (#) (#) ($/Sh) ($)(2)(3)
------------------------------------------------------------------------------------------------------------------------
Sandra L.
Derickson N/A N/A $700,000 $2,100,000 N/A N/A N/A N/A N/A N/A N/A
President &
Chief
Executive
Officer -
Designate
Martin J.G.
Glynn 3/6/2006 N/A 700,000 2,100,000 23,329 N/A 77,766 N/A N/A N/A $1,400,000
President &
Chief
Executive
Officer
John J.
McKenna 3/31/2006 N/A 243,788 487,575 N/A N/A N/A 23,612 (5) N/A N/A 414,785
Senior
Executive
Vice
President &
Chief
Financial
Officer
Joseph A.
Belfatto 3/6/2006 N/A N/A N/A N/A N/A N/A 83,178 (5) N/A N/A 1,440,000
Senior
Executive
Vice
President
and Head,
Global Markets
Americas
Marlon
Young 4/28/2006 N/A N/A N/A N/A N/A N/A 86,304 (5) N/A N/A 1,489,905
Managing
Director,
CEO Private
Bank
Americas
Janet L.
Burak 3/31/2006 N/A 400,208 800,416 N/A N/A N/A 29,513 (5) N/A N/A 518,447
Senior
Executive
Vice
President,
General
Counsel
& Secretary
Brendan
McDonagh 3/6/2006 N/A 676,453 1,353,106 10,596 N/A 35,319 N/A N/A N/A 635,839
Chief
Operating
Officer
Joseph M.
Petri 3/6/2006 N/A N/A N/A N/A N/A N/A 204,479 (5) N/A N/A 3,539,993
Senior
Executive
Vice
President,
Treasurer and
Co-Head, CIBM
Americas
183
(1) Pursuant to her employment agreement, Ms. Derickson was entitled to a
bonus guaranteed to be not less than $1,275,000. As discussed in the 2006
CD&A, Ms. Derickson's actual award was $0.
Messrs. Glynn, McKenna and McDonagh and Ms. Burak participate in the
Management Incentive Program. As discussed in the 2006 CD&A, the
Management Incentive Program is an annual cash incentive plan that is
comprised of both quantitative and qualitative individual, business unit
or company objectives that are determined at the beginning of the year
with each objective being assigned a target and maximum payout based upon
a percentage of base salary. The percentage of target and maximum payout
is determined by market data for the position the executive officer holds
and will not change unless the executive officer changes into a position
that has a different target and maximum payout. Typically, the maximum
payout is a 1x, 2x or 3x multiplier of target. Actual awards for the 2006
performance year for Messrs. Glynn, McKenna and Mr. McDonagh and Ms. Burak
were $1,600,000, $381,934, $720,000 and $736,383, respectively, and were
paid in February 2007. These amounts are included in the Summary
Compensation Table above under "Non-Equity Incentive Plan Compensation".
(2) Does not reflect the award of Performance Shares granted to Ms. Derickson
on March 6, 2006 while an executive with HSBC Finance Corporation and
prior to her appointment as President and Chief Executive Officer of HUSI,
the estimated future payouts under which are 41,660 (Threshold) and
138,868 (Maximum). The total grant date fair value for these Performance
Shares is $2,500,003, which amount is based on 100 percent of the fair
market value of the underlying HSBC ordinary shares on March 6, 2006 (the
date of grant) of GBP9.909706 and converted into U.S. dollars using the
GBP exchange rate at the time of funding of the grant (1.816677).
Reflects the award of Performance Shares granted to Messrs. Glynn and
McDonagh. As discussed in the 2006 CD&A and in Footnote 5 to the Summary
Compensation Table, Performance Shares are subject to two performance
conditions, each of which triggers a potential payout of 50 percent of the
aggregate award. The first objective is based upon total shareholder
return ("TSR") and the second objective is based upon earnings per share
("EPS"), both measured over a three-year performance period. TSR means the
growth in share value and declared dividend income on HSBC ordinary
shares, measured in Sterling, during the three-year performance period and
is based on HSBC's ranking against a comparator group of 28 major banks,
as listed on page 171. The calculation of the share price component within
HSBC's TSR will be the average market price over the 20 dealing days
commencing on the day when HSBC's annual results are announced with the
end point being the average market price over the 20 dealing days
commencing on the day on which the annual results of HSBC are announced
three years later. The TSR portion of the award will vest on a sliding
scale based on HSBC's relative ranking against the comparator group at the
end of the three year period. If HSBC is ranked 1st through 7th, the
vesting percentage will be 100 percent. If HSBC is ranked 8th through
14th, the vesting percentage will fall by 10 percent per rank. If HSBC is
ranked 15th through 28th, the vesting percentage will be zero. The
percentage of the TSR portion of the award that will vest is defined in
the following formula:
((X-Z) x (A-B)) + B
---------------
(Y-Z)
where:
X = the TSR performance of HSBC
Z = the TSR performance of the bank immediately below X
Y = the TSR performance of the bank immediately above X
A = the vesting percentage linked to the ranking of Y as detailed above
B = the vesting percentage linked to the ranking of Z as detailed above
The second performance condition is based upon EPS, which for purposes of
awarding Performance Shares is the profit attributable to shareholders,
divided by the weighted average number of shares in issue and held outside
of HSBC during the performance year. The base measure will be the EPS for
the financial year preceding that in which the award is made. EPS will
then be compared over the three consecutive financial years commencing
with the year in which the award is made. Incremental EPS will be
calculated by expressing, as a percentage of the EPS of the base year, the
difference each year of the measurement period between the EPS of that
year and the EPS of the base year. These percentages will be aggregated to
arrive at the total incremental EPS for the measurement period. The
percentage of the EPS objective that will vest will be determined in
accordance with the following formula: 30+2.5(X-24) where: 30 percent is
the minimum proportion of the objective that may vest and X is the
aggregate incremental EPS from the base year to the end of the measurement
period between and including 24 percent and 52 percent. If the aggregate
incremental EPS in accordance with the formula is less than 24 percent
then the EPS objective will be forfeited. If it is more than 52 percent,
then the EPS objective will vest in full.
For all plans, additional shares are awarded in amounts equivalent to the
same dividend rate on ordinary shares.
184
(3) The total grant date fair value reflected for Messrs. Glynn and McDonagh
is based on 100 percent of the fair market value of the underlying HSBC
ordinary shares on March 6, 2006 (the date of grant) of GBP9.909706 and
converted into U.S. dollars using the GBP exchange rate as of the time of
funding the grant (1.816677). The total grant date fair value reflected
for Mr. McKenna and Ms. Burak is based on 100 percent of the fair market
value of the underlying HSBC ordinary shares on March 31, 2006 (the date
of grant) of GBP9.6697 and converted into U.S. dollars using the GBP
exchange rate as of the time of funding the grant (1.816677). The total
grant date fair value reflected for Messrs. Belfatto and Petri is based on
100 percent of the fair market value of the underlying HSBC ordinary
shares on March 6, 2006 (the date of grant) of GBP 9.909706 and converted
into U.S. dollars using the GPB exchange rate at the time of purchase
(1.747). The total grant date fair value reflected for Mr. Young is based
on 100 percent of the fair market value of the underlying HSBC ordinary
shares on April 28, 2006 (the date of grant) of GBP 9.475 and converted
into U.S. dollars using the GPB exchange rate at the time of purchase
(1.822).
(4) As described in Footnote 2 above, the executives could receive no awards
under the equity incentive plan. However, the numbers presented under
"Threshold" represent the minimum awards the executives could receive if
the minimum (i.e., 30%) of either of the performance conditions is met.
(5) Reflects awards of Achievement Shares granted to Mr. McKenna and Ms.
Burak, which awards consist of shares of restricted stock that vest in
full at the end of a three-year period from the date of grant. The award
amount of Achievement Shares is based on the executive officer's position
within the organization, base salary, performance rating and scope for
growth. At the executive level, officers eligible to receive Achievement
Shares are eligible for awards ranging from 50 percent up to 300 percent
of base salary.
Reflects awards of restricted shares to Messrs. Belfatto and Petri on
March 6, 2006 and to Mr. Young on April 28, 2006, which awards consist of
shares of restricted stock that vest one-third on each of the first three
anniversaries of the date of grant. As described in the 2006 CD&A, a
portion of the executive's annual discretionary bonus award is deferred
through the award of restricted shares. The minimum deferral threshold, or
the portion of each bonus award paid in restricted shares, and vesting
schedules may vary by business unit within the parameters set by CIBM and
Private Banking, as applicable, for their businesses and approved by
REMCO.
Reflects awards of restricted shares to Mr. Young in connection with his
employment by HUSI, which were granted to compensate Mr. Young for
previous equity awards forfeited when he joined HUSI. These awards consist
of shares of restricted stock that vest one-third on each of the first
three anniversaries of the date of grant.
For all plans, additional shares are awarded in amounts equivalent to the
same dividend rate on ordinary shares.
185
Outstanding Equity Awards At Fiscal Year-End Table
--------------------------------------------------------------------------------
Option Awards
-----------------------------------------------------------------------
Equity
Incentive
Plan
Awards:
Number of Number of Number of
Securities Securities Securities
Underlying Underlying Underlying
Unexercised Unexercised Unexercised Option Option
Options (#) Options (#) Unearned Exercise Expiration
Name Exercisable Unexercisable Options (#) Price Date
--------------------------------------------------------------------------------------------
Sandra L. 107,000 (4) $ 18.40 11/13/2010
Derickson (3) 133,750 (4) $ 21.37 11/12/2011
President & 267,500 (4) $ 10.66 11/20/2012
Chief Executive 153,000 (5) 51,000 (5) GBP9.1350 11/03/2013
Officer - Designate 102,000 (6) GBP8.2830 04/30/2014
Martin J.G. Glynn
President &
Chief Executive
Officer
John J. McKenna
Senior Executive
Vice President &
Chief Financial
Officer
Joseph A. Belfatto
Senior Executive
Vice President and
Head, Global
Markets Americas
Marlon Young
Managing Director,
CEO Private Bank
Americas
Janet L. Burak 26,750 (4) $ 13.71 11/9/2008
Senior Executive 26,750 (4) $ 16.96 11/8/2009
Vice President, 26,750 (4) $ 18.40 11/13/2010
General Counsel &
Secretary
Brendan 18,900 (4) GBP6.3754 3/29/2009
McDonagh 9,000 (4) GBP6.2767 3/16/2008
Chief Operating
Officer
Joseph M. Petri
Senior Executive
Vice President,
Treasurer and
Co-Head, CIBM
Americas
Stock Awards
----------------------------------------------------
Equity Equity
Incentive Incentive
Plan Plan
Awards: Awards:
Number Market or
Number of Payout
of Unearned Value of
Shares Market Shares, Unearned
or Units Value of Units or Shares,
of Stock Shares or Other Units or
That Units of Rights Other
Have Stock that That Rights
Not Have Not Have Not That Have
Vested Vested Vested Not Vested
Name (#)(1) ($)(2) (#)(1) ($)(2)
-------------------------------------------------------------------------
Sandra L. 141,421 (7) $2,578,105 158,399 (9) $2,887,614
Derickson (3) 302,481 (8) $5,514,229 138,868 (10) $2,531,564
President &
Chief Executive
Officer - Designate
Martin J.G. Glynn 25,434 (11) $ 463,662
President & 34,339 (12) $ 626,000
Chief Executive 46,659 (9) $ 850,594
Officer 21,602 (10) $ 393,804
John J. McKenna 9,456 (13) $ 172,383 8,280 (15) $ 150,944
Senior Executive 23,612 (14) $ 430,429 8,697 (16) $ 158,546
Vice President &
Chief Financial
Officer
Joseph A. Belfatto 37,562 (17) $ 684,755
Senior Executive 22,567 (18) $ 411,396
Vice President and 2,594 (19) $ 47,289
Head, Global 83,178 (20) $1,516,335
Markets Americas
Marlon Young 31,778 (21) $ 579,313
Managing Director, 24,898 (22) $ 453,891
CEO Private Bank 29,628 (23) $ 540,118
Americas
Janet L. Burak 5,351 (24) $ 97,548 20,004 (26) $ 364,673
Senior Executive 13,334 (25) $ 243,079
Vice President, 31,678 (13) $ 577,490
General Counsel & 29,513 (14) $ 538,022
Secretary
Brendan 11,392 (27) $ 207,676 14,612 (15) $ 266,377
McDonagh 15,259 (16) $ 278,172
Chief Operating 23,734 (9) $ 432,671
Officer 35,319 (10) $ 643,865
Joseph M. Petri 77,818 (19) $1,418,622 9,176 (15) $ 167,278
Senior Executive 111,487 (17) $2,032,408 8,526 (16) $ 155,429
Vice President,
Treasurer and 204,479 (20) $3,727,652
Co-Head, CIBM
Americas
(1) Share amounts do not include additional awards accumulated over the
vesting periods.
(2) The market value of the shares on December 29, 2006 was GBP9.31 and the
exchange rate from GBP to U.S. dollars was 1.958, which equates to a U.S.
dollar share price of $18.23 per share.
(3) All amounts shown for Ms. Derickson reflect equity awards received while
an executive of HSBC Finance Corporation and prior to her appointment as
President & Chief Executive Officer of HUSI.
(4) Reflects fully vested options. Options shown for Ms. Burak reflect equity
awards received while employed by HSBC Finance Corporation and prior to
her appointment as Senior Executive Vice President, General Counsel and
Secretary of HUSI. Options shown for Mr. McDonagh reflect equity awards
received from HSBC prior to his appointment to HUSI.
186
(5) Seventy-five percent of this award vested on November 3, 2006. The
remaining 25 percent will vest on November 3, 2007.
(6) This award will vest in full, subject to satisfaction of performance
conditions, on the third anniversary of the date of grant, which was April
30, 2004. If the performance conditions are not satisfied on the third
anniversary, the performance conditions will be re-tested on the fourth
and fifth anniversaries of the date of grant. If the performance
conditions are not met on the fifth anniversary of the date of grant, the
options will be forfeited.
(7) Twenty percent this award vested on each of March 31, 2004, March 31, 2005
and March 31, 2006. Twenty percent of the award will vest on each of March
30, 2007 and May 31, 2008.
(8) Twenty percent of this award vested on May 26, 2006. Twenty percent of
this award will vest on each of May 25, 2007, May 26, 2008, May 26, 2009
and May 26, 2010.
(9) These awards will vest in part or in full on March 31, 2008 if performance
conditions are met. For Mr. Glynn, the amount of the award was pro-rated
based on the number of months between date of grant and date of retirement
divided by 36, pursuant to the terms of the agreement entered into in
connection with his retirement.
(10) These awards will vest in part or in full on March 31, 2009 if performance
conditions are met. For Mr. Glynn, the amount of the award was pro-rated
based on the number of months between date of grant and date of retirement
divided by 36, pursuant to the terms of the agreement entered into in
connection with his retirement.
(11) These awards vest in full on March 31, 2007 if performance conditions are
met. If the performance conditions are not met, the performance conditions
will be re-tested on March 31, 2008 and, if met, the shares will vest in
full. If the performance conditions are not met, the shares will be
forfeited.
(12) This award vests in full on March 31, 2007 if performance conditions are
met. If the performance conditions are not met, the shares will be
forfeited.
(13) These awards vest in full on March 31, 2008.
(14) These awards vest in full on March 31, 2009.
(15) These awards vest in full five years from date of grant (April 2, 2003) if
performance conditions are met as of the third, fourth or fifth
anniversary of the date of grant. If performance conditions are not met on
the fifth anniversary of the date of grant, the shares will be forfeited.
(16) These awards vest in full on the fifth anniversary of the date of grant
(April 1, 2004) if performance conditions are met as of the third
anniversary of the date of grant. If performance conditions are not met,
the shares will be forfeited with no re-test provision.
(17) Thirty-three percent of these awards vested on March 6, 2006. Thirty-three
percent will vest on announcement of 2006 annual results in 2007 and the
remaining 34 percent will vest on announcement of 2007 annual results in
2008.
(18) Fifty percent of this award vested on February 28, 2005 and the remaining
50 percent will vest on announcement of 2006 annual results in 2007.
(19) Thirty-three percent of this award vested on February 28, 2005 and 33
percent vested on March 6, 2006. The remaining 34 percent will vest on
announcement of 2006 annual results in 2007.
(20) Thirty-three percent of these awards will vest on March 5, 2007, 33
percent will vest on February 28, 2008 and 34 percent will vest on
February 28, 2009.
(21) Forty-three percent of this award will vest on January 31, 2007, 22
percent will vest on each of January 31, 2008 and 2009 and 13 percent will
vest on January 31, 2010.
(22) This award will vest in full on January 31, 2009.
(23) This award will vest in full on April 30, 2009.
(24) Thirty-three percent this award vested on November 21, 2005 and 33 percent
vested on November 20, 2006. The remaining 34 percent of this award will
vest on November 20, 2007.
(25) Thirty-three percent of this award vested on October 31, 2006.
Thirty-three percent of the award will vest on each of October 31, 2007
and 2008.
(26) Thirty-three percent of this award will vest on each of the third, fourth
and fifth anniversaries of the date of grant (April 30, 2004) if
performance conditions are satisfied as of the third anniversary of the
date of grant. If the performance conditions are not met as of the third
anniversary, the performance conditions will be re-tested on the fourth
and fifth anniversaries of the date of grant. If the performance
conditions are not met as of the fifth anniversary of the date of grant,
the shares will be forfeited.
(27) This award vests in full on April 16, 2007.
187
Option Exercises and Stock Vested Table
--------------------------------------------------------------------------------
Option Awards Stock Awards
------------------------------------- ---------------------------------------
Number of Value Realized Number of Shares Value Realized
Shares Acquired on Exercise Acquired on Vesting on Vesting
Name on Exercise(#) ($) (1) (#) (2) ($) (1)
--------------------------------------------------------------------------------------------------------
Sandra L. Derickson 161,201 (3) $2,769,142
President &
Chief Executive
Officer - Designate
Martin J.G. Glynn 34,936 (4) 580,052
President &
Chief Executive
Officer
John J. McKenna 26,600 (5) $129,162
Senior Executive Vice
President & Chief
Financial Officer
Joseph A. Belfatto 47,497 (6) 819,080
Senior Executive Vice
President and Head,
Global Markets
Americas
Marlon Young
Managing Director,
CEO Private Bank
Americas
Janet L. Burak 12,017 (7) 226,653
Senior Executive Vice
President, General
Counsel & Secretary
Brendan McDonagh 6,000 (8) 51,335 11,843 (9) 211,649
Chief Operating
Officer
Joseph M. Petri 254,908 (10) 4,408,267
Senior Executive Vice
President, Treasurer
and Co-Head, CIBM
Americas
(1) Value realized on exercise or vesting uses the GBP fair market value on
the date of exercise/release and the exchange rate from GBP to U.S.
dollars on the date of settlement.
(2) Includes the release of additional awards accumulated over vesting period.
(3) The amount shown for Ms. Derickson reflects equity awards received while
an executive of HSBC Finance Corporation and prior to her appointment as
President and Chief Executive Officer of HUSI and includes the release of
70,710 shares granted on April 15, 2003 and 75,620 shares granted on May
26, 2005. The remaining shares reflect the release of additional awards
accumulated over the vesting period.
(4) Includes the release of 9,829 shares granted on April 30, 2001 and 18,123
shares granted on March 8, 2002. Remaining shares are release of
additional awards accumulated over the vesting period.
(5) Includes the exercise of stock options granted on March 24, 1997 (3,000),
March 16, 1998 (4,500), March 29, 1999 (9,600), April 3, 2000 (3,000) and
April 23, 2001 (6,500).
(6) Includes the release of 18,781 shares granted on February 28, 2005, 2,594
shares granted on March 8, 2004 and 21,949 shares granted on March 13,
2003. Remaining shares are release of additional awards accumulated over
the vesting period.
(7) Includes the release of 5,350 shares granted on November 20, 2002 and
6,667 shares granted on November 3, 2003.
(8) Includes the exercise of stock options granted on March 24, 1997 from HSBC
prior to his appointment to HUSI.
188
(9) Includes the release of 7,645 shares granted on April 30, 2001 and 2,061
shares granted on May 12, 2003. Remaining shares are release of additional
awards accumulated over the vesting period.
(10) Includes release of 5,461 shares granted on April 30, 2001, 7,595 shares
granted on April 15, 2002, 83,173 shares granted on March 13, 2003, 77,817
shares granted on March 8, 2004 and 55,743 shares granted on February 28,
2005. Remaining shares are release of additional awards accumulated over
the vesting period.
Pension Benefits
--------------------------------------------------------------------------------
Number of Years Present Value Payments
Credited Service of Accumulated During Last
Name Plan Name (1) (#) Benefit Fiscal Year
--------------------------------------------------------------------------------------------------------
Sandra L. Derickson RIP-Account Based 6.3 $ 30,539 $ 0
President & SRIP-Account Based 6.3 $ 195,884 $ 0
Chief Executive Officer -
Designate
Martin J.G. Glynn (2) Canada Qualified 24.1 $ 528,375 $ 0
President & Canada Non-Qualified 24.1 $ 4,785,734 $ 0
Chief Executive Officer
John J. McKenna (3) RIP-HSBC Old 20.2 $ 261,473 $ 0
Senior Executive Vice Excess-HSBC Old 20.2 $ 37,247 $ 0
President & Chief Financial
Officer
Joseph A. Belfatto RIP-Account Based 4.6 $ 8,776 $ 0
Senior Executive Vice
President and Head,
Global Markets Americas
Marlon Young (4) RIP-Account Based 0.8 $ 0 $ 0
Managing Director, CEO SRIP-Account Based 0.8 $ 0
Private Bank Americas
Janet L. Burak RIP-Household New 14.8 $ 280,648 $ 0
Senior Executive Vice SRIP-Household New 14.8 $ 927,033 $ 0
President, General Counsel &
Secretary
Brendan McDonagh (5) ISRBS 26.0 $ 2,634,208 $ 0
Chief Operating Officer
Joseph M. Petri RIP-Account Based 6.7 $ 8,776 $ 0
Senior Executive Vice
President, Treasurer and Co-
Head, CIBM Americas
(1) Plan described under Savings and Pension Plans below.
(2) Value reflects January 1, 2007 retirement and actual benefit election.
(3) Value of age 65 benefit. At age 60, participant would be eligible for
unreduced early retirement, and accrued benefit has a present value of
$389,571 (RIP) and $55,432 (SRIP).
(4) Not yet a participant; will participate upon completion of one year of
service.
(5) Value of age 53 benefit. Participant is also eligible for an immediate
early retirement benefit with value of $3,130,166.
189
Savings and Pension Plans
Retirement Income Plan (RIP)
The HSBC-North America (U.S.) Retirement Income Plan ("RIP") is a
non-contributory, defined benefit pension plan for employees of HSBC North
America and its U.S. subsidiaries who are at least 21 years of age with one year
of service and not part of a collective bargaining unit. Benefits are determined
under a number of different formulas that vary based on year of hire and
employer.
Supplemental Retirement Income Plan (SRIP)
HSBC Bank (HBUS) Supplemental Plans (Excess Plans)
Supplemental Retirement Income Plan ("SRIP") is a non-qualified retirement plan
that is designed to provide benefits that are precluded from being paid to
legacy Household employees by the RIP due to legal constraints applicable to all
qualified plans. The HBUS Supplemental Benefit Plan and the Benefit Equalization
Plan (the "Excess Plans") are designed to provide benefits that are precluded
from being paid to legacy HBUS employees by the defined benefit formula under
the Retirement Income Plan (RIP) due to legal constraints applicable to all
qualified plans. For example, the maximum amount of compensation during 2006
that can be used to determine a qualified plan benefit is $220,000 and the
maximum annual benefit commencing at age 65 in 2006 is $175,000. SRIP and Excess
Plan benefits are calculated without regard to these limits. The resulting
benefit is then reduced by the value of qualified benefits payable by RIP so
that there is no duplication of payments. Benefits are paid in a lump sum for
retired executives covered by a Household Old, Household New, or Account Based
Formula, and in the same manner as elected for the qualified plan for executives
covered by a HBUS Old or New Plan Formula.
Formulas for Calculating Benefits
HBUS Old Plan Formula: Applies to executives who were participants in the HBUS
pension plan before January 1, 1989. The normal retirement benefit is the sum of
A and B below:
A. A benefit determined under the HBUS New Plan Formula, provided
service for this purpose is limited to 30 years reduced by years of
service used in B.
B. A benefit determined by multiplying (a) by (b) as described below:
(a) The gross benefit prior to offset by an integration amount is
equal to two percent of average salary multiplied by the first
30 years of service. This gross benefit is then reduced by an
integration amount equal to 2/3 of one percent of Social
Security multiplied by the first 30 years of service. However,
the integration amount cannot reduce the gross benefit by more
than 50 percent. Average salary, service, and Social Security
for the gross benefit and integration amount are determined as
of December 31, 1988.
(b) The benefit in (a) is multiplied by a fraction (but not less
than one), the numerator of which is average salary at date of
retirement and the denominator is average salary on December
31, 1988.
For this purpose, salary includes base wages but excludes bonuses. The formula
uses an average of salaries for the 60 highest consecutive months selected from
the 120 consecutive months preceding date of retirement. Executives who are at
least age 60 with 30 or more years of service are eligible to retire with
unreduced benefits. Executives who are at least age 55 with 10 or more years of
service may retire before age 65 in which case the benefit is reduced 3/12 of
one percent for the first 60 months and 5/12 of one percent for the next 60
months that payment precedes age 65.
190
HBUS New Plan Formula: Applies to executives who were hired prior to January 1,
1997 by HBUS and became participants in the pension plan after December 31,
1988. The normal retirement benefit at age 65 is the sum of (i) 1.55 percent of
average salary and (ii) 0.4 percent of average salary in excess of the
integration amount. The total of (i) and (ii) is then multiplied by the first 30
years of service. For this purpose, the integration amount is an average of the
Social Security taxable wage bases for the 35 year period ending with the year
in which full benefits are available; any such wage bases that have to be
estimated are based on the current wage base for the year of retirement. Salary
includes base wages but excludes bonuses. The formula uses an average of
salaries for the 60 highest consecutive months selected from the 120 consecutive
months preceding date of retirement. Executives who are at least age 60 with 30
or more years of service are eligible to retire with unreduced benefits.
Executives who are at least age 55 with 10 or more years of service may retire
before age 65 in which case the benefit is reduced 3/12 of one percent for the
first 60 months and 5/12 of one percent for the next 60 months that payment
precedes age 65.
Household Old Formula: Applies to executives who were hired prior to January 1,
1990 by Household International. The benefit at age 65 is determined under
whichever formula, A or B below, provides the higher amount.
A. The normal retirement benefit at age 65 is the sum of (i) 51 percent
of average salary that does not exceed the integration amount and
(ii) 57 percent of average salary in excess of the integration
amount. For this purpose, the integration amount is an average of
the Social Security taxable wage bases for the 35 year period ending
with the year of retirement. The benefit is reduced pro rata for
executives who retire with less than 15 years of service. If an
executive has more than 30 years of service, the benefit percentages
in the formula, (the 51 percent and 57 percent) are increased 1/24
of 1 percentage point for each month of service in excess of 30
years, but not more than 5 percentage points. The benefit
percentages are reduced for retirement prior to age 65.
B. The normal retirement benefit at age 65 is determined under (a)
below, limited to a maximum amount determined in (b):
(a) 55 percent of average salary, reduced pro rata for less than
15 years of service, and increased 1/24 of 1 percentage point
for each month in excess of 30 years, but not more than 5
percentage points; the benefit percentage of 55 percent is
reduced for retirement prior to age 65.
(b) The amount determined in (a) is reduced as needed so that when
added to 50 percent of the primary Social Security benefit,
the total does not exceed 65 percent of the average salary.
This maximum is applied for payments following the age at
which full Social Security benefits are available.
Both formulas use an average of salaries for the 48 highest consecutive months
selected from the 120 consecutive months preceding date of retirement; for this
purpose, salary includes total base wages and bonuses.
For executives who were participants on January 1, 1978, had attained age 35 and
had at least 10 years of employment, the minimum normal retirement benefit is 55
percent of final average salary. For this purpose, salary does not include
bonuses and the average is based on 60 consecutive months, rather than 48.
Executives who are at least age 50 with 15 years of service or at least age 55
with 10 years of service may retire before age 65, in which case the benefits
are reduced.
191
Household New Formula: Applies to executives who were hired after December 31,
1989, but prior to January 1, 2000, by Household International. The normal
retirement benefit at age 65 is the sum of (i) 51 percent of average salary that
does not exceed the integration amount and (ii) 57 percent of average salary in
excess of the integration amount. For this purpose, salaries include total base
wages and bonuses and are averaged over the 48 highest consecutive months
selected from the 120 consecutive months preceding date of retirement. The
integration amount is an average of the Social Security taxable wage bases for
the 35 year period ending with the year of retirement. The benefit is reduced
pro rata for executives who retire with less than 30 years of service. If an
executive has more than 30 years of service, the percentages in the formula,
(the 51 percent and 57 percent) are increased 1/24 of 1 percentage point for
each month of service in excess of 30 years, but not more than 5 percentage
points. Executives who are at least age 55 with 10 or more years of service may
retire before age 65 in which case the benefit percentages (51 percent and 57
percent) are reduced.
Account Based Formula: Applies to executives who were hired by Household
International after December 31, 1999. It also applies to executives who were
hired by HBUS after December 31, 1996 and became participants in the Retirement
Income Plan on January 1, 2005, or were hired by HSBC after March 28, 2003. The
formula provides for a notional account that accumulates two percent of annual
salary for each calendar year of employment. For this purpose, salary includes
total base wages and bonuses. At the end of each calendar year, interest is
credited on the notional account using the value of the account at the beginning
of the year. The interest rate is based on the lesser of average yields for
10-year and 30-year Treasury bonds during September of the preceding calendar
year. The notional account is payable at termination of employment for any
reason after three years of service although payment may be deferred to age 65.
Provisions Applicable to All U.S. Formulas: The amount of salary used to
determine benefits is subject to an annual maximum that varies by calendar year.
The limit for 2006 is $220,000. The limit for years after 2006 will increase
from time-to-time as specified by IRS regulations. Benefits are payable as a
life annuity, or for married participants, a reduced life annuity with 50
percent continued to a surviving spouse. Participants (with spousal consent, if
married) may choose from a variety of other optional forms of payment, which are
all designed to be equivalent in value if paid over an average lifetime. Retired
executives covered by a Household Old, Household New or Account Based Formula
may elect a lump sum form of payment (spousal consent is needed for married
executives).
Canadian Plans applicable to Martin Glynn
HSBC Bank Canada's qualified pension plan is a defined benefit plan under which
benefits are determined primarily by final average earnings, years of service
and a plan formula. Benefits payable under this plan are limited to the maximum
allowed by Canada Revenue Agency (CRA). For example, in year 2005 the limit was
$2,000 and in year 2006, the limit is $2,111.11 per year of pensionable service.
The following table, which is presented in Canadian currency, indicates the
maximum pension benefits allowed by law for plan participants in the specified
compensation and years of service classifications for year 2006. The table
assumes payments in the form of a life annuity, guaranteed for ten years.
--------------------------------------------------------------------------------
Compensation 15 20 25 30
--------------------------------------------------------------------------------
$ 500,000 $ 31,666 $ 42,222 $ 52,777 $ 63,333
600,000 31,666 42,222 52,777 63,333
700,000 31,666 42,222 52,777 63,333
800,000 31,666 42,222 52,777 63,333
900,000 31,666 42,222 52,777 63,333
1,000,000 31,666 42,222 52,777 63,333
The pension benefit for plan participants in the compensation levels presented
above is capped for all participants having the number of years of credited
service indicated. The compensation covered by the plan is limited to straight
salary. At the plan's normal retirement date of age 60, Mr. Glynn will have
28.75 years of credited service.
192
In addition to the pension benefit available from the HSBC Bank Canada qualified
plan, Mr. Glynn is entitled to receive an annual pension benefit during his
lifetime pursuant to a non-qualified supplemental retirement agreement with HSBC
Bank Canada. Under the terms of this agreement, the supplemental allowance is
forfeited if Mr. Glynn ceases employment with HSBC before age 55 and goes to
work for a competitor within two years. The supplemental allowance is calculated
based on Mr. Glynn's highest three years average base salary, excluding all
bonuses. The supplemental pension agreement formula is 2.5 percent of final
average earnings, times years of pensionable service. Mr. Glynn's earnings under
this formula are converted into Canadian currency by multiplying his current
earnings in U.S. currency by 1.3333.
Based on an annual salary of $933,310 in Canadian currency, the estimated annual
total pension benefit at the normal retirement age of 60 for Mr. Glynn is
$670,815. Of this amount, $60,694 is payable from the HSBC Bank Canada qualified
plan and $610,121 from the non-qualified supplemental retirement agreement. In
U.S. currency, these pension benefits amount to $45,522 from the qualified plan
and $457,602 from the non-qualified plan. Mr. Glynn attained age 55 on September
30, 2006 and retired effective as of January 1, 2007. Therefore, his pension
which began as of January 1 was reduced by 1/4 of one percent for each month
between the commencement date and his 60th birthday.
HSBC International Staff Retirement Benefits Scheme
The HSBC International Staff Retirement Benefits Scheme (Jersey) ("ISRBS") is a
defined benefit plan maintained for certain international managers. Each member
during his service must contribute five percent of his salary to the plan but
each member who has completed 20 years of service or who enters the senior
management or general management sections during his service shall contribute 6
2/3 percent of his salary. In addition, a member may make voluntary
contributions, but the total of voluntary and mandatory contributions cannot
exceed 15 percent of his total compensation. Upon leaving service, the value of
the member's voluntary contribution fund, if any, shall be commuted for a
retirement benefit.
The annual pension payable at normal retirement is 1/480 of the member's final
salary for each completed month in the executive section, 1.25/480 of his final
salary for each completed month in the senior management section, and 1.50/480
of his final salary for each completed month in the general management section.
A member's normal retirement date is the first day of the month coincident with
or next following his 53rd birthday. Payments may be deferred or suspended but
not beyond age 75.
If a member leaves before normal retirement with at least 15 years of service,
he will receive a pension which is reduced by .25 percent for each complete
month by which termination precedes normal retirement. If he terminates with at
least 5 years of service, he will receive an immediate lump sum equivalent of
his reduced pension.
Present Value of Accumulated Benefits
For the Account Based formula: The value of the notional account balances
currently available on December 31, 2006.
For other formulas: The present value of benefit payable at assumed retirement
using interest and mortality assumptions consistent with those used for
financial reporting purposes under SFAS 87 with respect to the company's audited
financial statements for the period ending December 31, 2006. However, no
discount has been assumed for separation prior to retirement due to death,
disability or termination of employment. Further, the amount of the benefit so
valued is the portion of the benefit at assumed retirement that has accrued in
proportion to service earned on December 31, 2006.
193
Deferred Compensation Plans
Tax Reduction Investment Plan HNAH maintains the HSBC-North America (U.S.) Tax
Reduction Investment Plan ("TRIP"), which is a deferred profit-sharing and
savings plan for its eligible employees. With certain exceptions, a U.S.
employee who has been employed for 30 days and who is not part of a collective
bargaining unit may contribute into TRIP, on a pre-tax and after-tax basis, up
to 40 percent (15 percent if highly compensated) of the participant's cash
compensation (subject to a maximum annual pre-tax contribution by a participant
of $15,000, as adjusted for cost of living increases, and certain other
limitations imposed by the Internal Revenue Code) and invest such contributions
in separate equity or income funds.
If the employee has been employed for at least one year, HUSI contributes three
percent of compensation on behalf of each participant who contributes one
percent and matches any additional participant contributions up to four percent
of compensation. However, matching contributions will not exceed six percent of
a participant's compensation if the participant contributes four percent or more
of compensation. The plan provides for immediate vesting of all contributions.
With certain exceptions, a participant's after-tax contributions which have not
been matched by us can be withdrawn at any time. Both our matching contributions
made prior to 1999 and the participant's after-tax contributions which have been
matched may be withdrawn after five years of participation in the plan. A
participant's pre-tax contributions and our matching contributions after 1998
may not be withdrawn except for an immediate financial hardship, upon
termination of employment, or after attaining age 59 1/2. Participants may
borrow from their TRIP accounts under certain circumstances.
Supplemental Tax Reduction Investment Plan HNAH also maintains the Supplemental
Tax Reduction Investment Plan ("STRIP"), which is an unfunded plan for eligible
employees of HUSI and its participating subsidiaries who are legacy Household
employees and whose participation in TRIP is limited by the Internal Revenue
Code. Only matching contributions required to be made by us pursuant to the
basic TRIP formula are invested in STRIP through a credit to a bookkeeping
account maintained by us which deems such contributions to be invested in equity
or income funds selected by the participant.
Non-Qualified Deferred Compensation Plan HNAH maintains a Non-Qualified Deferred
Compensation Plan for the highly compensated employees in the organization,
including executives of HUSI. The named executive officers are eligible to
contribute up to 80 percent of their salary and/or cash bonus compensation in
any plan year. Participants are required to make an irrevocable election with
regard to an amount or percentage of compensation to be deferred and the timing
and manner of future payout. Two types of distributions are permitted under the
plan, either a scheduled in-service withdrawal which must be scheduled at least
2 years after the end of the plan year in which the deferral is made, or payment
upon termination of employment. For either the scheduled in-service withdrawal
or payment upon termination, the participant may elect either a lump sum payment
or if the participant has made at least $25,000 of contributions and has over 10
years of service, he may request installment payments over 10 years. Due to the
unfunded nature of the plan, participant elections are deemed investments whose
gains or losses are calculated by reference to actual earnings of the investment
choices. The deemed investment choices are reviewed on a periodic basis by the
Investment Committee for the Plan which consists of members chosen by the Board
or Directors or Chief Executive Officer of HSBC North America Holdings Inc. and
are chosen based on a conservative mix of funds and currently include Van Kampen
Real Estate Securities - A Shares, Oppenheimer Global - A Shares, AIM Small Cap
Growth - Class A, HSBC Investor Small Cap Equity - Class Y, Fidelity Advisor Mid
Cap Stock - Class A, Dreyfus S&P 500 Index, HSBC Investor Growth & Income -
Class Y, HSBC Investor Fixed Income - Class Y and HSBC Investor Money Market -
Class Y. In order to provide the participants with the maximum amount of
protection under an unfunded plan, a Rabbi Trust has been established where the
participant contributions are segregated from the general assets of HUSI. The
Investment Committee for the plan endeavors to invest the contributions in a
manner consistent with the participant's deemed elections reducing the
likelihood of an underfunded plan.
194
Nonqualified Defined Contribution and Other Nonqualified Deferred Compensation
Plans
--------------------------------------------------------------------------------
NonQualified Supplemental
Deferred Tax Reduction
Compensation Investment
Plan (1) Plan (2)
Executive HUSI Aggregate Aggregate
Contributions in Contributions in Aggregate Withdrawals/ Balance at
Name 2006 2006 Earnings in 2006 Distributions 12/31/2006
---------------------------------------------------------------------------------------------------------------------
Sandra L. Derickson $ 0 $ 157,000 $ 161,379 $ 0 $ 2,286,511
President & Chief Executive
Officer - Designate
Martin J.G. Glynn 100,000 N/A 5,608 0 105,608
President &
Chief Executive Officer
John J. McKenna N/A N/A N/A N/A N/A
Senior Executive Vice
President & Chief Financial
Officer
Joseph A. Belfatto N/A N/A N/A N/A N/A
Senior Executive Vice
President and Head, Global
Markets Americas
Marlon Young N/A N/A N/A N/A N/A
Managing Director, CEO
Private Bank Americas
Janet L. Burak 19,822 68,466 54,776 0 638,286
Senior Executive Vice
President, General Counsel
& Secretary
Brendan McDonagh N/A N/A N/A N/A N/A
Chief Operating Officer
Joseph M. Petri N/A N/A N/A 73,423 (3) N/A
Senior Executive Vice
President, Treasurer and
Co-Head, CIBM Americas
(1) The Nonqualified Deferred Compensation Plan is described under Savings and
Pension Plans on page 194. Ms. Derickson has made prior contributions to
the plan, but elected not to make contributions in 2006.
(2) The Supplemental Tax Reduction Investment Plan (STRIP) is described under
Savings and Pension Plans on page 194. Company contributions are invested
in STRIP through a credit to a bookkeeping account, which deems such
contributions to be invested in equity or income mutual funds selected by
the participant. For this purpose, compensation includes amounts that
would be compensation but for the fact they were deferred under the terms
of the HSBC North America Non-Qualified Deferred Compensation Plan.
Distributions are made in a lump sum upon termination of employment. These
figures are also included in the "Other Compensation" column of the
Summary Compensation Table on page 181.
(3) The figure above represents a distribution from Mr. Petri's participation
in the HSBC Investment Banking and Markets 2001 Notional Co-Investment
Plan. This plan allowed the participant to waive some or all of a
discretionary cash bonus and have the notional amount contributed as a
deemed investment in European private equity and technology transactions
through the HSBC Private Equity Partnership Scheme and the HPE Technology
Fund.
195
Potential Payments Upon Termination Or Change-In-Control
--------------------------------------------------------------------------------
The following tables describe the payments that HUSI would be required to make
as of December 31, 2006 to Ms. Derickson, Mr. McKenna, Mr. Belfatto, Mr. Young
and Ms. Burak as a result of their termination, retirement, disability or death
or a change in control of the company as of that date. The specific
circumstances that would trigger such payments are identified in the tables. The
amounts and terms of such payments are defined by HSBC's employment and
severance policies, the particular terms of any equity-based awards and, in the
case of Ms. Derickson and Mr. Young, Ms. Derickson's employment agreement and
Mr. Young's offer letter.
Mr. Glynn retired as President and Chief Executive Officer as of December 31,
2006. The amounts paid to Mr. Glynn by HUSI were agreed to in an agreement
between Mr. Glynn and HNAH entered into in connection with his retirement.
Similarly, the amounts paid to Mr. Petri in connection with his retirement in
2006 were agreed to in a separation agreement between Mr. Petri and HBUS. These
agreements are summarized in the 2006 CD&A under Compensation of Officers
Reported in the Summary Compensation Table. Mr. McDonagh resigned his position
with HUSI and was appointed Group Executive of HSBC Finance Corporation, an
affiliate of HUSI, in 2006. His resignation and appointment did not trigger a
payment obligation on the part of HUSI. In addition, the termination of Mr.
McDonagh's employment with HSBC Finance Corporation for any reason would not
trigger a payment obligation on the part of HUSI. As a result, no additional
information for Messrs. Glynn, Petri or McDonagh is required or provided below.
Sandra L. Derickson
-----------------------------------------------------------------------------------
Involuntary
Executive Benefits Not for
and Payments Upon Voluntary Normal Cause
Termination Termination Disability Retirement Termination
-----------------------------------------------------------------------------------
Cash Compensation
Base Salary -- -- -- $ 875,000 (1)
Short Term Incentive -- -- -- 1,593,750 (1)
Long Term Incentive
Performance Shares (6) -- $2,317,332 (2) $2,317,332 (2) 2,317,332 (2)
Stock Options: -- -- -- 222,583 (4)
Unvested and
Accelerated
Restricted Stock (6): -- -- 8,092,333 (5)
Unvested and
Accelerated
Benefits and Perks
Healthcare -- -- -- 28,366
Life Insurance -- -- -- 1,800
Financial Planning -- -- -- 20,000
Umbrella Liability -- -- -- 3,700
-----------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Voluntary
Executive Benefits for Good Change in
and Payments Upon For Cause Reason Control
Termination Termination Termination Death Termination
-------------------------------------------------------------------------------
Cash Compensation
Base Salary -- $ 875,000 (1) -- --
Short Term Incentive -- 1,593,750 (1) -- --
Long Term Incentive
Performance Shares (6) -- 2,317,332 (2) $5,419,177 (3) $2,317,332 (2)
Stock Options: -- 222,583 (4) 222,583 (4) --
Unvested and
Accelerated
Restricted Stock (6): -- 8,092,333 (5) $8,092,333 (5) --
Unvested and
Accelerated
Benefits and Perks
Healthcare 28,366 -- --
Life Insurance 1,800 -- --
Financial Planning 20,000 -- --
Umbrella Liability 3,700 -- --
-------------------------------------------------------------------------------
(1) As of December 31, 2006, Ms. Derickson has an employment agreement, which
stipulates that she will receive her current salary and 75 percent of the
average of her bonus in the years 2003, 2004 and 2005 from the date of
termination through March 28, 2008. The figures above assume a termination
date of December 31, 2006.
(2) The figures above represent the pro-rata portion of the Performance
Shares, assuming "good leaver" status is granted by REMCO, that would vest
three years from the date of grant assuming a termination date of December
31, 2006, and are calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006. For an explanation of the
performance conditions, please refer to Footnote 2 of the Grants of
Plan-Based Awards Table.
(3) The figure above represents a full vest of the Performance Shares that
would vest three years from the date of grant assuming a termination date
of December 31, 2006, and is calculated using the closing price of HSBC
ordinary shares and exchange rate on December 29, 2006.
(4) In the event of death, the figure represents accelerated vesting of 100
percent of the outstanding, unvested stock options assuming the difference
between the strike price and the fair market value of HSBC ordinary shares
on December 29, 2006. The amounts represent outstanding unvested stock
options that would continue to vest according to schedule, if REMCO
approves such continued vesting, if a termination was involuntary not for
cause, or voluntary for good reason, and assumes the satisfaction of all
applicable performance conditions.
(5) The figures above represent a full vest of the outstanding restricted
shares assuming a termination date of December 31, 2006 and are calculated
using the closing price of HSBC ordinary shares and exchange rate on
December 29, 2006.
(6) Does not include additional awards accumulated through December 31, 2006,
the assumed date of termination.
196
John J. McKenna
------------------------------------------------------------------------------------------------------------------------
Executive
Benefits Involuntary Voluntary
and Payments Not for for Change in
Upon Voluntary Normal Cause For Cause Good Reason Control
Termination Termination Disability Retirement Termination Termination Termination Death Termination
------------------------------------------------------------------------------------------------------------------------
Cash
Compensation
Base Salary -- -- -- $ 250,038 (1) -- -- -- --
Short Term
Incentive -- -- -- 381,934 (1) -- -- -- --
Long Term
Incentive
Performance
Shares (6) -- $ 309,491 (2) -- 309,491 (3) -- -- $309,491 (5) $ 309,491 (3)
Restricted
Stock (6): -- 208,164 (4) -- 208,164 (4) -- $ 208,164 (4) 602,811 (5) 208,164 (4)
Unvested and
Accelerated
------------------------------------------------------------------------------------------------------------------------
(1) Under the terms of the HSBC Severance Policy, Mr. McKenna would receive 40
weeks of his current salary upon separation from the company and a
pro-rata amount of his earned bonus. The figures above represent the bonus
payment earned in 2006 assuming a termination date of December 31, 2006.
(2) The figures above represent accelerated vesting of 100 percent of the
outstanding Performance Shares assuming "good leaver" status is granted by
REMCO, a termination date of December 31, 2006 and that the performance
test has been passed using the month end prior to exit date as the
performance period. The amount has been calculated using the closing price
of HSBC ordinary shares and exchange rate on December 29, 2006. If the
performance test is not passed, 100 percent of the award remains
outstanding and the performance condition is re-tested on the third,
fourth and fifth anniversary of the award date. If the performance
condition is not passed by the fifth anniversary, the shares are
forfeited.
(3) The figures above represent accelerated vesting of 100 percent of the
outstanding Performance Shares assuming "good leaver" status is granted by
REMCO, a termination date of December 31, 2006 and that the performance
test has been passed using the month end prior to exit date as the
performance period. The amount has been calculated using the closing price
of HSBC ordinary shares and exchange rate on December 29, 2006. If the
performance test is not passed, the shares are forfeited.
(4) The figure represent a pro-rata portion of the March 31, 2005 and March
31, 2006 outstanding restricted share awards based on the number of months
elapsed between the date of grant and date of termination assuming a
termination date of December 31, 2006 and are calculated using the closing
price of HSBC ordinary shares and exchange rate on December 29, 2006.
(5) The figures above represent continued vesting of the outstanding shares
assuming a termination date of December 31, 2006, and are calculated using
the closing price of HSBC ordinary shares and exchange rate on December
29, 2006.
(6) Does not include additional awards accumulated through December 31, 2006,
the assumed termination date.
Joseph A. Belfatto
------------------------------------------------------------------------------------------------------------------------
Executive
Benefits Involuntary Voluntary
and Payments Not for for Change in
Upon Voluntary Normal Cause For Cause Good Reason Control
Termination Termination Disability Retirement Termination Termination Termination Death Termination
------------------------------------------------------------------------------------------------------------------------
Cash
Compensation
Base Salary -- -- -- $ 57,692 (1) -- -- -- --
Short Term
Incentive -- -- -- -- -- -- -- --
Long Term
Incentive
Restricted
Stock (4): -- $2,659,775 (2) -- $ 2,659,775 (2) -- -- $2,659,775 (2) $ 2,659,775 (3)
Unvested and
Accelerated
------------------------------------------------------------------------------------------------------------------------
(1) Under the terms of the HSBC Severance Policy, Mr. Belfatto will receive
12 weeks of his current salary upon separation from the company and a
pro-rata amount of his earned bonus. The figures above represent the bonus
payment earned in 2006 assuming a termination date of December 31, 2006.
(2) The figures above represent continued vesting of the outstanding
restricted shares assuming a termination date of December 31, 2006 and
assuming "good leaver" status is granted by REMCO, which shares will be
released according to the original vesting schedule. The figures are
calculated using the closing price of HSBC ordinary shares and exchange
rate on December 29, 2006.
(3) The figures above represent a full vest of the outstanding restricted
shares assuming a termination date of December 31, 2006 and are calculated
using the closing price of HSBC ordinary shares and exchange rate on
December 29, 2006.
(4) Does not include additional awards accumulated through December 31, 2006,
the assumed termination date.
197
Marlon Young
------------------------------------------------------------------------------------------------------------------------
Executive
Benefits Involuntary Voluntary
and Payments Not for for Change in
Upon Voluntary Normal Cause For Cause Good Reason Control
Termination Termination Disability Retirement Termination Termination Termination Death Termination
------------------------------------------------------------------------------------------------------------------------
Cash
Compensation
Base Salary -- -- -- $ 86,538 (1) -- -- -- --
Short Term
Incentive -- $1,000,000 (1) -- 1,000,000 (1) -- -- $1,000,000 (1) --
Long Term
Incentive
Restricted
Stock (4): -- 2,073,322 (2) -- 2,073,000 (2) -- $ 2,073,000 (2) 2,073,000 (2) $ 1,573,322 (3)
Unvested and
Accelerated
------------------------------------------------------------------------------------------------------------------------
(1) Under the terms of the HSBC Severance Policy, Mr. Young will receive 12
weeks of his current salary upon separation from the company. Pursuant to
his offer letter, Mr. Young would also receive his guaranteed cash bonus
for 2006 and 2007.
(2) The figures above represent a full vest of the outstanding restricted
shares assuming a termination date of December 31, 2006 and assuming "good
leaver" status is granted by REMCO. The figures are calculated using the
closing price of HSBC ordinary shares and exchange rate on December 29,
2006.
(3) The figure above represents a full vest of the outstanding restricted
shares assuming a termination date of December 31, 2006 and assuming "good
leaver" status is granted by REMCO. These figures are calculated using the
closing price of HSBC ordinary shares and exchange rate on December 29,
2006.
(4) Does not include additional awards accumulated through December 31, 2006,
the assumed termination date.
198
Janet L. Burak
------------------------------------------------------------------------------------------------------------------------
Executive
Benefits Involuntary Voluntary
and Payments Not for for Change in
Upon Voluntary Normal Cause For Cause Good Reason Control
Termination Termination Disability Retirement Termination Termination Termination Death Termination
------------------------------------------------------------------------------------------------------------------------
Cash
Compensation
Base Salary -- -- -- $ 215,497 (1) -- -- -- --
Short Term
Incentive -- -- -- 736,383 (1) -- -- -- --
Long Term
Incentive
Performance
Shares (9) -- $ 364,673 (2) -- 364,673 (2) -- -- $ 364,673 (3) $ 364,673 (3)
Restricted
Stock (9): -- $ 794,118 (4) -- 812,002 (5) -- $ 97,549 (6) $1,438,256 (7) $ 714,453 (8)
Unvested and
Accelerated
------------------------------------------------------------------------------------------------------------------------
(1) Under the terms of the HSBC Severance Policy, Ms. Burak will receive 28
weeks of her current salary upon separation from the company and a
pro-rata amount of her earned bonus. The figures above represent the bonus
payment earned in 2006 assuming a termination date of December 31, 2006.
(2) The figures above represent a full vest of the Performance Shares,
assuming "good leaver" status is granted by REMCO, a termination date of
December 31, 2006, and 100 percent of the performance condition being met
on the third anniversary of the date of grant. If the performance
condition is not passed on the third anniversary, the award is subject to
a re-test provision on the fourth and fifth anniversary of the date of
grant. If the performance condition is not passed on the fifth
anniversary, the award is forfeited. The amount is calculated using the
closing price of HSBC ordinary shares and exchange rate on December 29,
2006.
(3) The figures above represent a full vest of the Performance Shares that
would vest three years from the date of grant assuming a termination date
of December 31, 2006, and is calculated using the closing price of HSBC
ordinary shares and exchange rate on December 29, 2006.
(4) The figures above represent (a) a pro-rata portion of the November 20,
2002, March 31, 2005 and March 31, 2006 outstanding restricted share
awards based on the number of months elapsed between date of grant and
date of termination ($551,039) and (b) a full vest of the 11/3/03
outstanding restricted share award ($243,079) assuming a termination date
of December 31, 2006 and assuming "good leaver" status is granted by
REMCO. The figures are calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006.
(5) The figures above represent (a) a pro-rata portion of the March 31, 2005
and March 31, 2006 outstanding restricted share awards based on the number
of months elapsed between date of grant and date of termination ($471,374)
and (b) a full vest of the November 20, 2002 and November 3, 2003
outstanding restricted share awards ($340,628) assuming a termination date
of December 31, 2006 and assuming "good leaver" status is granted by
REMCO. The figures are calculated using the closing price of HSBC ordinary
shares and exchange rate on December 29, 2006.
(6) The figures above represent the full vest of the November 20, 2002
outstanding restricted share award assuming a termination date of December
31, 2006 and assuming "good leaver" status is granted by REMCO. The
figures are calculated using the closing price of HSBC ordinary shares and
exchange rate on December 29, 2006.
(7) The figures above represent (a) a pro-rata portion of the November 20,
2002 outstanding restricted share award based on the number of months
elapsed between date of grant and date of termination ($79,665) and (b) a
full vest of the November 3, 2002, March 31, 2005 and March 31, 2006
outstanding restricted share awards ($1,358,591) assuming a termination
date of December 31, 2006. The figures are calculated using the closing
price of HSBC ordinary shares and exchange rate on December 29, 2006.
(8) The figures above represent (a) a pro-rata portion of the March 31, 2005
and March 31, 2006 outstanding restricted share awards based on the number
of months elapsed between date of grant and date of termination ($471,374)
and (b) a full vest of the November 3, 2003 outstanding restricted share
award assuming a termination date of December 31, 2006 ($243,079). The
figures are calculated using the closing price of HSBC ordinary shares and
exchange rate on December 29, 2006.
(9) Does not include additional awards accumulated through December 31, 2006,
the assumed date of termination.
199
Director Compensation
The following table and narrative text discusses the compensation awarded to,
earned by or paid to our Directors in 2006.
Director Compensation
---------------------------------------------------------------------------------------------------------------------
Change in
Pension Value
Fees and
Earned or Non-Equity Nonqualified
Paid in Stock Option Incentive Plan Deferred All Other
Cash Awards Awards Compensation Compensation Compensation Total
Name ($)(1) ($)(2) ($)(3) ($)(4) Earnings ($)(5) ($)(6) ($)
---------------------------------------------------------------------------------------------------------------------
Salvatore H. Alfiero $60,000 -- -- -- $25,000 -- $ 85,000
Donald K. Boswell 50,000 -- -- -- -- -- 50,000
James H. Cleave 56,000 -- -- -- -- -- 56,000
Sandra L. Derickson -- -- -- -- -- -- --
Frances D. Fergusson 52,500 -- -- -- -- -- 52,500
Michael F. Geoghegan -- -- -- -- -- -- --
Martin J.G. Glynn -- -- -- -- -- -- --
Stuart T. Gulliver -- -- -- -- -- -- --
Richard A. Jalkut 83,500 -- -- -- 25,000 -- 108,500
Peter Kimmelman 56,000 -- 56,000
Siddharth N. Mehta -- -- -- -- -- -- --
Charles G. Meyer, Jr. 52,500 -- -- -- -- -- 52,500
James L. Morice 50,000 -- -- -- -- -- 50,000
(1) In 2006, the non-management Directors of HUSI received an annual cash
retainer of $50,000 for their services on the boards of HUSI and HBUS
(with the exception of Mr. Jalkut, who as Lead Director and Chair of the
Executive Committee, received a retainer of $75,000). In addition to the
Board retainer, Mr. Cleave, Mr. Jalkut and Mr. Kimmelman each received an
additional $6,000 for their membership in the Audit Committee, Mr. Alfiero
received an additional $10,000 as Chair of the Audit Committee, Mr. Meyer
received an additional $2,500 as Chair of the Fiduciary Committee, Dr.
Fergusson received an additional $2,500 as Chair of the Human Resources &
Compensation Committee, Mr. Jalkut received an additional $2,500 as Chair
of the Nominating & Governance Committee. Other than as stated above, HUSI
does not pay additional compensation for committee membership, or meeting
attendance fees to its Directors. Directors who are employees of HUSI or
any of its affiliates do not receive any additional compensation related
to their Board service. In September 2006, the Nominating & Governance
Committee reviewed its directors' compensation philosophy compared to
other same sized financial and professional service organizations and
determined that the current compensation structure should be reevaluated.
Non-management Directors elected prior to 1999 may elect to participate in
the HUSI/HBUS Plan for Deferral of Directors' Fees. Under this plan, they
may elect to defer receipt of all or a part of their retainer. The
deferred retainers accrue interest on a quarterly basis at the one to two
year Employee Extra CD rate in effect on the first business day of each
quarter. Upon retirement from the Board, the deferrals plus interest are
paid to the Director either in a lump sum or in quarterly or annual
installments over a one, five or ten year period. No Director elected to
defer receipt of their retainer for 2006.
(2) HUSI does not grant stock awards to its non-management directors nor do
any portion of employee directors' stock awards reflect services related
to their Board positions.
(3) HUSI does not grant stock option awards to its non-management directors.
(4) HUSI does not award directors' non-equity incentive plan compensation to
its non-management directors nor does any portion of the employee
directors' non-equity incentive plan compensation reflect compensation for
services related to their Board positions.
(5) The HUSI Directors' Retirement Plan covers non-management directors
elected prior to 1998 and excludes those serving as directors at the
request of HSBC. Eligible directors with at least five years of service
will receive quarterly retirement benefit payments commencing at the later
of age 65 or retirement from the Board, and continuing for ten years. The
annual amount of the retirement benefit is a percent of the annual
retainer in effect at the time of the last Board meeting the director
attended. The percentage is 50 percent after five years of service and
increases by five percent for each additional year of service to 100
percent upon completion of 15 years of service. If a director who has at
least five years of service dies before the retirement benefit has
commenced, the director's beneficiary will receive a death benefit
calculated as if the director had retired on the date of death. If a
retired director dies before receiving retirement benefit payments for the
ten year period, the balance of the payments will be continued to the
director's beneficiary. The plan is unfunded and payment will be made out
of the general funds of HUSI or HBUS.
200
(6) Non-management directors are offered, on terms that are not more favorable
than those available to the general public, a MasterCard/Visa credit card
issued by one of our subsidiaries with a credit limit of $15,000. HUSI
guarantees the repayment of amounts charged on each card. Under HUSI's
Matching Gift Program, HUSI matches charitable gifts to qualified
organizations (subject to a maximum of $10,000 per year), with a double
match for the first $500 donated to higher education institutions (both
public and private) and eligible non-profit organizations which promote
neighborhood revitalization or economic development for low and moderate
income populations. Each current independent Director may ask us to
contribute up to $10,000 annually to charities of the Director's choice
which qualify under our philanthropic program.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
--------------------------------------------------------------------------------
Security Ownership of Certain Beneficial Owners
HSBC USA Inc.'s common stock is 100 percent owned by HSBC North America Inc.
("HNAI"). HNAI is an indirect wholly owned subsidiary of HSBC.
Security Ownership by Management
The following table lists the beneficial ownership, as of January 31, 2007, of
HSBC ordinary shares or interests in HSBC ordinary shares and HSBC's American
Depositary Shares, Series A, by each director and the executive officers named
in the Summary Compensation Table on page 181, individually, and the directors
and executive officers as a group. Each of the individuals listed below and all
directors and executive officers as a group own less than one percent of the
HSBC ordinary shares. No director or executive officer of HUSI owned any of
HUSI's outstanding series of preferred stock at January 31, 2007.
------------------------------------------------------------------------------------------------------------------------
HSBC
Ordinary
Number of Shares That HSBC HSBC
HSBC May Be Restricted Holdings plc
Ordinary Acquired Shares Number of American
Shares Within 60 Days Released HSBC Ordinary Total HSBC Depositary
Beneficially By Exercise of Within 60 Share Ordinary Shares,
Owned (1)(2) Options (3) Days (4) Equivalents (5) Shares Series A (6)
------------------------------------------------------------------------------------------------------------------------
Directors
Salvatore H. Alfiero ....... 259,000 -- -- -- 259,000 325,000
Donald K. Boswell .......... 220 -- -- -- 220 --
James H. Cleave ............ 220,465 -- -- -- 220,465 --
Dr. Frances D. Fergusson ... 100 -- -- -- 100 --
Michael F. Geoghegan ....... 113,525 -- 45,449 -- 158,974 --
Stuart T. Gulliver ......... 1,192,823 -- -- -- 1,192,823 --
Paul J. Lawrence ........... -- -- -- -- -- --
Richard A. Jalkut .......... 250 -- -- -- 250 --
Peter Kimmelman ............ 5,335 -- -- -- 5,335 --
Charles G. Meyer, Jr. ...... -- -- -- -- -- --
James L. Morice ............ 631 -- -- -- 631 --
--
Named Executive Officers
Sandra L. Derickson ........ 93,003 661,250 70,710 27,079 852,042 --
Martin J.G. Glynn .......... 80,263 -- -- -- 80,263 --
John J. McKenna ............ 3,000 -- -- 1,550 4,550 --
Joseph A. Belfatto ......... 26,451 -- 71,668 -- 98,119 --
Marlon Young ............... -- -- 10,486 -- 10,486 --
Janet L. Burak ............. 17,982 80,250 -- -- 98,232 --
Brendan McDonagh ........... 40,960 27,900 -- -- 68,860 --
Joseph M. Petri ............ -- -- 199,702 -- 199,702 --
All directors and executive
officers as a group ..... 2,120,240 815,900 398,015 30,156 3,364,311 325,000
201
(1) Directors and executive officers have sole voting and investment power
over the shares listed above, except as follows.
The number of ordinary shares held by spouses, children and charitable or
family foundations for which a director or executive officer does not have
voting and investment power and beneficial ownership of which is denied is
as follows: Mr. Kimmelman, 1,756; Ms. Burak, 910; and Directors and
executive officers as a group, 3,612.
(2) Some of the shares included in the table above were held in American
Depository Shares, each of which represents five HSBC ordinary shares.
(3) Represents the number of ordinary shares that may be acquired by HUSI's
Directors and executive officers through April 1, 2007 pursuant to the
exercise of stock options.
(4) Represents the number of ordinary shares that may be acquired by HUSI's
Directors and executive officers through April 1, 2007 pursuant to the
satisfaction of certain conditions.
(5) Represents the number of ordinary share equivalents owned by executive
officers under HSBC-North America (U.S.) Tax Reduction Investment Plan and
HSBC-North America Employee Non-Qualified Deferred Compensation Plan. Some
of the shares included in the table above were held in American Depository
Shares, each of which represents five HSBC ordinary shares.
(6) Each depositary share represents one-fortieth of a share of HSBC's 6.20%
Non-Cumulative Dollar Preference Shares, Series A
Item 13. Certain Relationships and Related Transactions, and Director
Independence
--------------------------------------------------------------------------------
Transactions with Related Persons
During the fiscal year ended December 31, 2006, HUSI was not a participant in
any transaction, and there is currently no proposed transaction, in which the
amount involved exceeded or will exceed $120,000, and in which a director or an
executive officer, or a member of the immediate family of a director or an
executive officer, had or will have a direct or indirect material interest,
other than the agreements with Messrs. Glynn and Petri and Ms. Derickson
described in Item 11. Executive Compensation - Compensation Discussion and
Analysis - Compensation of Officers Reported in the Summary Compensation Table.
During 2006, HBUS provided loans to certain directors and executive officers of
HUSI and its subsidiaries in the ordinary course of business. Such loans were
provided on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable loans with persons
not related to HUSI and do not involve more than the normal risk of
collectibility or present other unfavorable features.
HUSI maintains a written Policy for the Review, Approval or Ratification of
Transactions with Related Persons, which provides that any "Transaction with a
Related Person" must be reviewed and approved or ratified in accordance with
specified procedures. The term "Transaction with a Related Person" includes any
transaction, arrangement or relationship, or series of similar transactions,
arrangements or relationships, in which (1) the aggregate dollar amount involved
will or may be expected to exceed $120,000 in any calendar year, (2) HUSI or any
of its subsidiaries is, or is proposed to be, a participant, and (3) a director
or an executive officer, or a member of the immediate family of a director or an
executive officer, has or will have a direct or indirect material interest
(other than solely as a result of being a director or a less than 10 percent
beneficial owner of another entity). The following are specifically excluded
from the definition of Transaction with a Related Person:
o compensation paid to directors and executive officers reportable under
rules and regulations promulgated by the Securities and Exchange
Commission;
o transactions with other companies if the only relationship of the
director, executive officer or family member to the other company is as an
employee (other than an executive officer), director or beneficial owner
of less than 10 percent of such other company's equity securities;
o charitable contributions, grants or endowments by HUSI or any of its
subsidiaries to charitable organizations, foundations or universities if
the only relationship of the director, executive officer or family member
to the organization, foundation or university is as an employee (other
than an executive officer) or a director;
202
o transactions where the interest of the director, executive officer or
family member arises solely from the ownership of HUSI's equity securities
and all holders of such securities received or will receive the same
benefit on a pro rata basis;
o transactions where the rates or charges involved are determined by
competitive bids;
o loans made in the ordinary course of business on substantially the same
terms (including interest rates and collateral requirements) as those
prevailing at the time for comparable loans with persons not related to
HUSI or any of its subsidiaries and that do not involve more than the
normal risk for collectibility or present other unfavorable features; and
o transactions involving services as a bank depositary of funds, transfer
agent, registrar, trustee under a trust indenture or similar services.
The policy requires each director and executive officer to notify the Office of
the General Counsel in writing of any Transaction with a Related Person in which
the director, executive officer or an immediate family member has or will have
an interest and to provide specified details of the transaction. The Office of
the General Counsel, through the Corporate Secretary, will deliver a copy of the
notice to the Chair of the Nominating & Governance Committee of the Board of
Directors. The Nominating & Governance Committee will review the facts of each
proposed Transaction with a Related Person at each regularly scheduled committee
meeting and approve, ratify or disapprove the transaction.
The vote of a majority of disinterested members of the Nominating & Governance
Committee is required for the approval or ratification of any Transaction with a
Related Person. The Nominating & Governance Committee may approve or ratify a
transaction if the committee determines, in its business judgment, based on the
review of all available information, that the transaction is fair and reasonable
to, and consistent with the best interests of, HUSI and its subsidiaries. In
making this determination, the Nominating & Governance Committee will consider,
among other things, (i) the business purpose of the transaction, (ii) whether
the transaction is entered into on an arms-length basis and on terms no less
favorable than terms generally available to an unaffiliated third-party under
the same or similar circumstances, (iii) whether the interest of the director,
executive officer or family member in the transaction is material and (iv)
whether the transaction would violate any provision of the HSBC North America
Holdings Inc. Statement of Business Principles and Code of Ethics, the HSBC USA
Inc. Code of Ethics for Senior Financial Officers or the HSBC USA Inc. Corporate
Governance Standards, as applicable.
In any case where the Nominating & Governance Committee determines not to
approve or ratify a transaction, the matter will be referred to the Office of
the General Counsel for review and consultation regarding the appropriate
disposition of such transaction including, but not limited to, termination of
the transaction, rescission of the transaction or modification of the
transaction in a manner that would permit it to be ratified and approved.
Director Independence
The HSBC USA Inc. Corporate Governance Standards, together with the charters of
the committees of the Board of Directors, provide the framework for HUSI's
corporate governance. Director independence is defined in the Corporate
Governance Standards, which are based upon the rules of the New York Stock
Exchange. The HSBC USA Inc. Corporate Governance Standards are incorporated by
reference to Exhibit 99.1 of this Form 10-K and are available upon written
request made to HSBC USA Inc., 452 Fifth Avenue, New York, New York 10018,
Attention: Corporate Secretary.
203
According to HUSI's Corporate Governance Standards, a majority of the members of
the Board of Directors must be independent. The composition requirement for each
committee of the Board of Directors is as follows:
Committee Independence/ Member Requirements
--------- ---------------------------------
Audit Committee Chair and all voting members
Fiduciary Committee Chair and all voting members
Human Resources & Compensation Committee Chair and a majority of members
Nominating & Governance Committee Chair and all voting members
Executive Committee Chair and all voting members,
other than the
Chief Executive Officer
Messrs. Alfiero, Boswell, Cleave, Jalkut, Kimmelman, Meyer and Morice and Dr.
Fergusson are considered to be independent directors. Mr. Geoghegan currently
serves as Group Chief Executive Officer; Mr. Lawrence currently serves as
President and Chief Executive Officer of HUSI and HBUS; and Mr. Gulliver
currently serves an HSBC Managing Director and Head of CIBM. Because of the
positions held by Messrs. Geoghegan, Lawrence and Gulliver, they are not
considered to be independent directors.
During 2006, Sandra L. Derickson, Martin J.G. Glynn and Siddharth N. (Bobby)
Mehta served as directors of HUSI and HBUS. Ms. Derickson also served as
President and Chief Executive Officer - Designate of HUSI and HBUS for part of
2006, Mr. Glynn served as President and Chief Executive Officer of HUSI and HBUS
in 2006 and Mr. Mehta served as Chief Executive Officer of HSBC Finance
Corporation, another principal subsidiary of HNAH, in 2006. Because of the
positions held by Ms. Derickson, Mr. Glynn and Mr. Mehta, they were not
considered to be independent directors.
See Item 10. Directors, Executive Officers and Corporate Governance - Corporate
Governance for more information about HUSI's Board of Directors and its
committees.
Item 14. Principal Accounting Fees and Services
--------------------------------------------------------------------------------
Fees billed to HUSI by its auditing firm, KPMG LLP, were as follows.
--------------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005
--------------------------------------------------------------------------------------------------------------
(in thousands)
Audit fees:
Auditing of financial statements, quarterly reviews, statutory audits,
preparation of comfort letters, consents and review of registration statements .... $ 5,522 $ 5,137
Audit related fees:
Employee benefit plan audits, due diligence assistance, internal control review
assistance, and certain attestation services ...................................... 467 870
Tax fees:
Tax related research, general tax services in connection with transactions and
legislation, and assistance with preparation of certain required filings .......... 34 51
------- --------
Total KPMG LLP fees ..................................................................... $ 6,023 $ 6,058
======= ========
Audit Committee Pre-approval Policies and Procedures
It is the practice of the Audit Committee of HUSI's Board of Directors to
approve the annual audit fees, including those covering audit services beyond
HUSI's financial statements, before any audit procedures are undertaken. Prior
to 2003, management had the implicit pre-approval of the Audit Committee to
engage KPMG LLP, or any other professional service firm, to perform tax and
other services. Any such services provided by KPMG LLP were reported to the
Audit Committee after the fact. Beginning in 2003, the Audit Committee assumed
responsibility for pre-approving all auditing services and permitted
non-auditing services, including the related fees and terms thereof.
204
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
--------------------------------------------------------------------------------
(a) (1) Financial Statements
HSBC USA Inc.:
Consolidated Balance Sheet
Consolidated Statement of Income
Consolidated Statement of Changes in Shareholders' Equity
Consolidated Statement of Cash Flows
HSBC Bank USA, National Association:
Consolidated Balance Sheet
Notes to Financial Statements
(2) Not applicable
(3) Exhibits
3 (i) Articles of Incorporation and amendments and
supplements thereto (incorporated by reference to Exhibit
3(a) to HUSI's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the Securities and
Exchange Commission on March 30, 2000, Exhibit 3 to HUSI's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2000, filed with the Securities and Exchange
Commission on November 9, 2000, Exhibits 3.2 and 3.3 to
HUSI's Current Report on Form 8-K dated March 30, 2005,
filed with the Securities and Exchange Commission on April
4, 2005, Exhibit 3.2 to HUSI's Current Report on Form 8-K
dated October 11, 2005 and filed with the Securities and
Exchange Commission on October 14, 2005 and Exhibit 3.1 to
HUSI's Current Report on Form 10-Q dated May 16, 2006,
filed with the Securities and Exchange Commission on May
22, 2006).
3 (ii) By-Laws dated February 5, 2007.
4 (i) Senior Indenture, dated as of October 24, 1996, by and
between HUSI and Bankers Trust Company, as trustee, as
amended and supplemented (incorporated by reference to
Exhibits 4.1 and 4.2 to Post-Effective Amendment No. 1 to
HUSI's registration statement on Form S-3, Registration No.
333-42421, filed with the Securities and Exchange
Commission on April 3, 2002, Exhibit 4.1 to HUSI's Current
Report on Form 8-K dated November 21, 2005 and filed with
the Securities and Exchange Commission on November 28,
2005).
4 (ii) Subordinated Indenture, dated as of October 24, 1996, by
and between HUSI and Bankers Trust Company, as trustee, as
amended and supplemented (incorporated by reference to
Exhibits 4.3, 4.4, 4.5 and 4.6 to Post-Effective Amendment
No. 1 to HUSI's registration statement on Form S-3,
Registration No. 333-42421, filed with the Securities and
Exchange Commission on April 3, 2002.
12 Computation of Ratio of Earnings to Fixed Charges and
Earnings to Combined Fixed Charges and Preferred Stock
Dividends
14 Code of Ethics for Senior Financial Officers
18 Letter from Independent Accountant Regarding Change in
Accounting Principles (incorporated by reference to Exhibit
18 to HUSI's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2006 filed with the Securities and
Exchange Commission on November 13, 2006).
21 Subsidiaries of HSBC USA Inc.
23 Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99 (i) HSBC USA Inc. Corporate Governance Standards
205
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HSBC USA Inc.
Registrant
--------------------------------------------------
/s/ Janet L. Burak
--------------------------------------------------
Janet L. Burak
Senior Executive Vice President, General Counsel
and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed on March 5, 2007 by the following persons on behalf of the
registrant and in the capacities indicated:
/s/ John J. McKenna Michael F. Geoghegan*
----------------------------------- Chairman of the Board
John J. McKenna Salvatore H. Alfiero* Director
Senior Executive Vice President and Donald K. Boswell* Director
Chief Financial Officer James H. Cleave* Director
(Principal Financial Officer) Frances D. Fergusson* Director
Paul J. Lawrence*
Director, President and Chief
Executive Officer
Stewart T. Gulliver * Director
/s/ Clive R. Bucknall Richard A. Jalkut* Director
----------------------------------- Peter Kimmelman* Director
Clive R. Bucknall Charles G. Meyer, Jr.* Director
Chief Accounting Officer James L. Morice* Director
(Principal Accounting Officer)
* /s/ Janet L. Burak
----------------------------------------
Janet L. Burak
Attorney-in-fact
206
Exhibit 3(ii)
HSBC USA INC.
BY-LAWS
(As Amended and Restated effective February 5, 2007)
207
BY-LAWS
OF
HSBC USA INC.
ARTICLE I
OFFICES
Section 1.1 The principal office of HSBC USA Inc. (the "Corporation") in the
State of Maryland shall be in the City of Baltimore, State of Maryland.
Section 1.2 The Corporation may also have offices at such other place or places,
both within and without the State of Maryland, as the Board of Directors, or the
President of the Corporation acting under delegated authority, may from time to
time determine.
ARTICLE II
STOCKHOLDERS
Section 2.1 Place of Stockholders' Meetings. Meetings of the Corporation's
stockholders shall be held at such place in the United States as is set from
time to time by the Corporation's Board of Directors.
Section 2.2 Annual Meetings of Stockholders. An annual meeting of the
Corporation's stockholders shall be held in April each year. At each annual
meeting, the Corporation's stockholders shall elect a Board of Directors and
transact such other business as may properly be brought before the meeting in
accordance with these By-Laws. Except as the Charter or statute provides
otherwise, any business may be considered at an annual meeting without the
purpose of the meeting having been specified in the notice. Failure to hold an
annual meeting does not invalidate the Corporation's corporate existence or
affect any otherwise valid corporate acts of the Corporation.
Section 2.3 Special Meetings of Stockholders. At any time in the interval
between annual meetings, a special meeting of the Corporation's stockholders may
be called by the Chairman of the Board or the President or by a majority of the
Corporation's Board of Directors by vote at a meeting or in writing (addressed
to the Corporate Secretary of the Corporation) with or without a meeting.
Special meetings of the Corporation's stockholders shall be called by the
Corporate Secretary on the written request of stockholders of the Corporation
entitled to cast at least 25 percent of all the votes entitled to be cast at the
meeting. A stockholders' request for a special meeting shall state the purpose
of the meeting and the matters proposed to be acted on at it. The Corporate
Secretary shall inform the stockholders who make the request of the reasonably
estimated costs of preparing and mailing a notice of meeting and, on payment of
these costs to the Corporation, notify each stockholder entitled to notice of
the meeting. Unless requested by stockholders entitled to cast a majority of all
the votes entitled to be cast at the meeting, a special meeting need not be
called to consider any matter which is substantially the same as a matter voted
on at any special meeting of stockholders of the Corporation held in the
preceding 12 months. Business transacted at any special meeting of stockholders
shall be limited to the purpose stated in the notice thereof.
Section 2.4 Notice of Stockholders' Meetings; Waiver of Notice. Not less than 10
days nor more than 90 days before the date of every stockholders' meeting, the
Corporate Secretary shall give to each stockholder entitled to vote at such
meeting written notice stating the time and place of the meeting and, in the
case of a special meeting or if notice of the purpose is required by statute,
the purpose or purposes for which the meeting is called, either by mail or by
presenting it to him personally or by leaving it at his residence or usual place
of business. If mailed, such notice shall be deemed to be given when deposited
in the United States mail addressed to the stockholder at his address as it
appears on the records of the Corporation, with postage thereon prepaid.
Notwithstanding the foregoing provisions, a waiver of notice in writing, signed
by the person or persons entitled to such notice and filed with the records of
the meeting, whether before or after the holding thereof, or actual attendance
at the meeting in person or by proxy, shall be deemed equivalent to the giving
of such notice to such persons.
208
Section 2.5 Quorum at Stockholders' Meetings; Voting; Adjournments. Unless any
statute or the Charter provides otherwise, at each meeting of the Corporation's
stockholders, the presence in person or by proxy of stockholders entitled to
cast a majority of all the votes entitled to be cast at the meeting constitutes
a quorum, and a majority of all the votes cast at a meeting at which a quorum is
present is sufficient to approve any matter which properly comes before the
meeting, except that a plurality of all votes cast at a meeting at which a
quorum is present is sufficient to elect a director. Whether or not a quorum is
present, a meeting of stockholders convened on the date for which it was called
may be adjourned from time to time without further notice by a majority vote of
the stockholders present in person or by proxy to a date not more than 120 days
after the original record date. Any business which might have been transacted at
the meeting as originally notified may be deferred and transacted at any such
adjourned meeting at which a quorum is present.
Section 2.6 General Right to Vote; Proxies. Unless the Charter provides for a
greater or lesser number of votes per share or limits or denies voting rights,
each outstanding share of stock, regardless of class, is entitled to one vote on
each matter submitted to a vote at a meeting of stockholders; however, a share
is not entitled to be voted if any installment payable on it is overdue and
unpaid. In all elections of directors, each share of stock may be voted for as
many persons as there are directors to be elected and for whose election the
share is entitled to be voted. A stockholder may vote the stock the stockholder
owns of record either in person or by proxy. A stockholder may sign a writing
authorizing another person to act as proxy. Signing may be accomplished by the
stockholder or the stockholder's authorized agent signing the writing or causing
the stockholder's signature to be affixed to the writing by any reasonable
means, including facsimile signature. A stockholder may authorize another person
to act as proxy by transmitting, or authorizing the transmission of, a telegram,
cablegram, datagram, or other means of electronic transmission to the person
authorized to act as proxy or to a proxy solicitation firm, proxy support
service organization, or other person authorized by the person who will act as
proxy to receive the transmission. Unless a proxy provides for a longer period,
it is not valid more than eleven months after its date. A proxy is revocable by
a stockholder at any time without condition or qualification unless the proxy
states that it is irrevocable and the proxy is coupled with an interest. The
interest with which a proxy may be coupled includes an interest in the stock to
be voted under the proxy or another general interest in the Corporation or its
assets or liabilities.
Section 2.7 List of Stockholders. At each meeting of stockholders, a full, true
and complete list of all stockholders entitled to vote at such meeting, showing
the number and class of shares held by each and certified by the transfer agent
for such class or by the Corporate Secretary, shall be furnished by the
Corporate Secretary.
Section 2.8 Conduct of Voting. At all meetings of stockholders, unless the
voting is conducted by inspectors, the proxies and ballots shall be received,
and all questions touching the qualification of voters and the validity of
proxies, the acceptance or rejection of votes and procedures for the conduct of
business not otherwise specified by these By-Laws, the Charter or law, shall be
decided or determined by the chairman of the meeting. If demanded by
stockholders, present in person or by proxy, entitled to cast 10% in number of
votes entitled to be cast, or if ordered by the chairman of the meeting, the
vote upon any election or question shall be taken by ballot. Before any meeting
of the stockholders, the Board of Directors may appoint persons to act as
inspectors of election at the meeting and any adjournment thereof. If no
inspectors of election are so appointed, the chairman of the meeting may, and on
the request of stockholders, present in person or by proxy, entitled to cast 10%
in number of votes entitled to be cast, shall, appoint inspectors of election at
the meeting. The number of inspectors shall be either one or more. If inspectors
are appointed at a meeting on the request of stockholders, the holders of a
majority of shares present in person or by proxy shall determine whether one or
more inspectors are to be appointed. No candidate for election as a director at
a meeting shall serve as an inspector thereat. If any person appointed as
inspector fails to appear or fails or refuses to act, the chairman of the
meeting may, and upon the request of a stockholder shall, appoint a person to
fill that vacancy. The inspectors shall determine the number of shares
outstanding and the voting power of each, the shares represented at the meeting,
the existence of a quorum, and the authenticity, validity and effect of proxies;
receive votes, ballots or consents; hear and determine all challenges and
questions in any way arising in connection with the right to vote; count and
tabulate all votes or consents; determine when polls shall close; determine the
result; and do any other acts that may be proper to conduct the election or vote
with fairness to all stockholders. Unless so demanded or ordered, no vote need
be by ballot and voting need not be conducted by inspectors.
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Section 2.9. Advance Notice Provisions for Election of Directors. Only persons
who are nominated in accordance with the following procedures shall be eligible
for election as directors of the Corporation. Nominations of persons for
election to the Board of Directors may be made at any annual meeting of
stockholders, or at any special meeting of stockholders called for the purpose
of electing directors, (a) by or at the direction of the Board of Directors (or
any duly authorized committee thereof) or (b) by any stockholder of the
Corporation (i) who is a stockholder of record on the date of the giving of the
notice provided for in this Section 2.9 and on the record date for the
determination of stockholders entitled to vote at such meeting and (ii) who
complies with the notice procedures set forth in this Section 2.9.
To be timely, a stockholder's notice must be delivered to or mailed and received
by the Corporate Secretary at the principal executive offices of the Corporation
(a) in the case of an annual meeting, not less than 120 days nor more than 150
days prior to the first anniversary of the preceding year's annual meeting;
provided, however, that in the event that the date of the annual meeting is
advanced by more than 30 days or delayed by more than 60 days from such
anniversary date, notice by the stockholder to be timely must be so delivered
not earlier than the 150th day prior to such annual meeting and not later than
the close of business on the later of the 120th day prior to such annual meeting
or the 10th day following the day on which public announcement of the date of
such meeting is first made; and (b) in the case of a special meeting of
stockholders called for the purpose of electing directors, not later than the
close of business on the 10th day following the day on which notice of the date
of the special meeting was mailed or public disclosure of the date of the
special meeting was made, whichever first occurs.
To be in proper written form, a stockholder's notice to the Corporate Secretary
must set forth (a) as to each person whom the stockholder proposes to nominate
for election as a director, all information relating to such person that is
required to be disclosed in connection with solicitations of proxies for
election of directors pursuant to Regulation 14A of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), and the rules and regulations
promulgated thereunder; and (b) as to the stockholder giving the notice, (i) the
name and address of such stockholder as they appear on the Corporation's books
and of the beneficial owner, if any, on whose behalf the nomination is made,
(ii) the class or series and number of shares of capital stock of the
Corporation which are owned beneficially or of record by such stockholder and
such beneficial owner, (iii) a description of all arrangements or understandings
between such stockholder and each proposed nominee and any other person or
persons (including their names) pursuant to which the nomination(s) are to be
made by such stockholder, (iv) a representation that such stockholder intends to
appear in person or by proxy at the meeting to nominate the persons named in its
notice and (v) any other information relating to such stockholder that would be
required to be disclosed in a proxy statement or other filings required to be
made in connection with solicitations of proxies for election of directors
pursuant to Regulation 14A of the Exchange Act and the rules and regulations
promulgated thereunder. Such notice must be accompanied by a written consent of
each proposed nominee to be named as a nominee and to serve as a director if
elected.
No person shall be eligible for election as a director of the Corporation unless
nominated in accordance with the procedures set forth in this Section 2.9. If
the chairman of the meeting determines that nomination was not made in
accordance with the foregoing procedures, the chairman shall declare to the
meeting that the nomination was defective and such defective nomination shall be
disregarded. No adjournment or postponement of a meeting of stockholders shall
commence a new period for the giving of notice of a stockholder proposal
hereunder.
Section 2.10. Advance Notice Provisions for Business to be Transacted at Annual
Meeting. No business may be transacted at an annual meeting of stockholders,
other than business that is either (a) specified in the notice of meeting (or
any supplement thereto) given by or at the direction of the Board of Directors
(or any duly authorized committee thereof), (b) otherwise properly brought
before the annual meeting by or at the direction of the Board of Directors (or
any duly authorized committee thereof) or (c) otherwise properly brought before
the annual meeting by any stockholder of the Corporation (i) who is a
stockholder of record on the date of the giving of the notice provided for in
this Section 2.10 and on the record date for the determination of stockholders
entitled to vote at such annual meeting and (ii) who complies with the notice
procedures set forth in this Section 2.10.
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To be timely, a stockholder's notice must be delivered to or mailed and received
by the Corporate Secretary at the principal executive offices of the Corporation
not less than 120 days nor more than 150 days prior to the first anniversary of
the preceding year's annual meeting; provided, however, that in the event that
the date of the annual meeting is advanced by more than 30 days or delayed by
more than 60 days from such anniversary date, notice by the stockholder to be
timely must be so delivered not earlier than the 150th day prior to such annual
meeting and not later than the close of business on the later of the 120th day
prior to such annual meeting or the 10th day following the day on which public
announcement of the date of such meeting is first made.
To be in proper written form, a stockholder's notice to the Corporate Secretary
must set forth as to each matter such stockholder proposes to bring before the
annual meeting (i) a brief description of the business desired to be brought
before the annual meeting and the reasons for conducting such business at the
annual meeting, (ii) the name and address of such stockholder as they appear on
the Corporation's books and of the beneficial owner, if any, on whose behalf the
proposal is made, (iii) the class or series and number of shares of capital
stock of the Corporation which are owned beneficially or of record by such
stockholder and such beneficial owner, (iv) a description of all arrangements or
understandings between such stockholder and any other person or persons
(including their names) in connection with the proposal of such business by such
stockholder and any material interest of such stockholder in such business, and
(v) a representation that such stockholder intends to appear in person or by
proxy at the annual meeting to bring such business before the meeting.
No business shall be conducted at the annual meeting of stockholders except
business brought before the annual meeting in accordance with the procedures set
forth in Section 2.09 or in this Section 2.10, provided, however, that once
business has been properly brought before the annual meeting in accordance with
such procedures, nothing in Section 2.09 nor in this Section 2.10 shall be
deemed to preclude discussion by any stockholder of any such business. If the
chairman of an annual meeting determines that business was not properly brought
before the annual meeting in accordance with the foregoing procedures, the
chairman shall declare to the meeting that the business was not properly brought
before the meeting and such business shall not be transacted. No adjournment or
postponement of a meeting of stockholders shall commence a new period for the
giving of notice of a stockholder proposal hereunder.
ARTICLE III
DIRECTORS
Section 3.1 The number of directors of the Corporation which shall constitute
the whole of the Corporation's Board of Directors (the "Board") shall not be
less than three nor more than thirty. Within the limits above specified, the
number of directors constituting the Board shall be determined by resolution of
the Board or by the Corporation's stockholders at the Annual Meeting, but the
tenure of office of a director shall not be affected by any decrease in the
number of directors so made by the Board. The directors shall be elected at the
Annual Meeting of stockholders, except as provided in Section 3.2 of this
Article, and each director elected shall hold office until the succeeding Annual
Meeting of stockholders or until his successor is elected and qualified.
Directors need not be stockholders.
Section 3.2 Vacancies and newly created directorships resulting from any
increase in the authorized number of directors may be filled by a majority of
the directors then in office, though less than a quorum, or by a sole remaining
director, and the directors so chosen shall hold office until the next Annual
Meeting and until their successors are duly elected and shall qualify, unless
sooner displaced.
Section 3.3 The business of the Corporation shall be managed by its Board, which
may exercise all such powers of the Corporation and do all such lawful acts and
things as are not by statute or by the Articles of Incorporation or by these
By-Laws directed or required to be exercised or done by the stockholders. The
directors shall choose from among their number a Chairman of the Board.
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Section 3.4 At any meeting of stockholders, duly called and at which a quorum is
present, the stockholders may, by the affirmative vote of the holders of a
majority of the votes entitled to be cast on the election or removal of such
director, remove any director or directors from office and may elect a successor
or successors to fill any resulting vacancies for the unexpired terms of removed
directors. In case such a removal occurs but the stockholders entitled to vote
thereon fail to fill any resulting vacancies, such vacancies may be filled by
the Board of Directors pursuant to Section 3.2.
MEETINGS OF THE BOARD OF DIRECTORS
Section 3.5 The Board may hold meetings, both regular and special, either within
or without the State of Maryland.
Section 3.6 After each meeting of stockholders at which a Board of Directors
shall have been elected, the Board of Directors so elected shall meet, as soon
as practicable, for the purpose of organization and the transaction of other
business; and, in the event that no other time is designated by the
stockholders, the Board of Directors shall meet one hour after the time for such
stockholders' meeting or immediately following the close of such meeting,
whichever is later, on the day of such meeting. No notice of such meeting shall
be necessary if held as hereinabove provided.
Section 3.7 Regular meetings of the Board shall be held at such time and place
as designated by the Board. No notice of a Regular Meeting shall be required if
the meeting is held according to a Schedule of Regular Meetings approved by the
Board.
Section 3.8 Special Meetings of the Board may be called by the Chairman or the
President upon notice to each director, either personally, by mail, by telex or
by telegram. Special Meetings shall be called by the President or Secretary in
like manner and on like notice upon the written request of three or more
directors. Notice of the place, day and hour of every Special Meeting shall be
given to each director at least twenty-four (24) hours before the time of the
meeting, by delivering the same to him personally, by telephone, by telex, by
telegraph, or by delivering the same at his residence or usual place of
business, or, in the alternative, by mailing such notice at least seventy-two
(72) hours before the time of the meeting, postage paid, and addressed to him at
his last known post office address, according to the records of the Corporation.
Unless required by the By-Laws or by resolution of the Board of Directors, no
notice of any meeting of the Board of Directors need state the business to be
transacted thereat. No notice of any meeting of the Board of Directors need be
given to any director who attends, or to any director who, in writing executed
and filed with the records of the meeting either before or after the holding
thereof, waives such notice. Any meeting of the Board of Directors, Annual or
Special, may adjourn from time to time to reconvene at the same or some other
place, and no notice need be given of any such adjourned meeting other than by
announcement.
Section 3.9 One third of the entire Board shall constitute a quorum at any
meeting except as may be otherwise specifically provided by statute or by the
Articles of Incorporation. If a quorum shall not be present at any meeting of
the Board, the directors present thereat may adjourn the meeting from time to
time, without notice other than announcement at the meeting, until a quorum
shall be present. Members of the Board or any committee designated thereby may
participate in a meeting of the Board or any such committee by means of a
conference telephone or similar communications equipment by means of which all
persons participating in the meeting can hear each other at the same time and
participation by such means shall constitute presence in person at such meeting.
Section 3.10 Unless otherwise restricted by the Articles of Incorporation or
these By-Laws, any action required or permitted to be taken at any meeting of
the Board or of any committee thereof may be taken without a meeting, if all
members of the Board or committee, as the case may be, consent thereto, in
writing or writings and the writing or writings are filed with the minutes of
the proceedings of the Board or committee.
Section 3.11 On any question on which the Board of Directors shall vote, the
names of those voting and their votes shall be entered in the minutes of the
meeting when any member of the Board so requests.
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COMMITTEES OF DIRECTORS
Section 3.12 Executive Committee. The Board of Directors may appoint from among
its members an Executive Committee of not less than three directors and one of
which shall be appointed Chairman of the Executive Committee. When the Board of
Directors is not in session, the Executive Committee shall have and may
exercise, in the absence of or subject to any restrictions which the Board of
Directors may from time to time impose, all of the powers of the Board of
Directors in the management of the business and affairs of the Corporation,
except the power to authorize dividends on stock, elect directors, issue stock
other than as provided in the next sentence, recommend to the stockholders any
action which requires stockholder approval, amend these By-Laws, or approve any
merger or share exchange which does not require stockholder approval. If the
Board of Directors has given general authorization for the issuance of stock
providing for or establishing a method or procedure for determining the number
of shares to be issued, a committee of the Board, in accordance with that
general authorization or any stock option or other plan or program adopted by
the Board of Directors, may authorize or fix the terms of stock subject to
classification or reclassification and the terms on which any stock may be
issued, including all terms and conditions required or permitted to be
established or authorized by the Board of Directors.
Section 3.13 Audit Committee. The Board shall designate an Audit Committee,
which shall hold office until the next annual meeting of the Board following the
annual meeting of stockholders, consisting of not less than three of its
members, other than officers of the Corporation, and whose duty it shall be to
make an examination at least once during each calendar year and within 15 months
of the last such examination into the affairs of the Corporation including the
administration of fiduciary powers, or cause suitable examinations to be made by
auditors responsible only to the Board and to report the result of such
examination in writing to the Board. Such report shall state whether the
Corporation is in a sound condition, whether adequate internal controls and
procedures are being maintained and shall recommend to the Board such changes in
the manner of conducting the affairs of the Corporation as shall be deemed
advisable.
Section 3.14 Other Committees. The Board of Directors may appoint any other
committees, each of which shall be composed of one or more directors, as
determined by the Board from time to time. Such other committees shall have such
powers, subject to the same limitations as are applicable to the Executive
Committee under Section 3.12, as shall be designated by the Board from time to
time.
Section 3.15 Committee Procedure. Each committee shall keep minutes of its
proceedings when exercising powers of the Board of Directors and may fix rules
of procedure for its business. A majority of the members of a committee shall
constitute a quorum for the transaction of business and the act of a majority of
those present at a meeting at which a quorum is present shall be the act of the
committee. The members of a committee present at any meeting, whether or not
they constitute a quorum, may appoint an eligible director to act in the place
of an absent member. Any action required or permitted to be taken at a meeting
of a committee may be taken without a meeting, if an unanimous written consent
which sets forth the action is signed by each member of the committee and filed
with the minutes of the committee. The members of a committee may conduct any
meeting thereof by conference telephone in accordance with the provisions of
Section 3.9.
COMPENSATION OF DIRECTORS
Section 3.16 The Board shall fix the amounts to be paid directors for their
services as directors and for their attendance at the meetings of the Board or
of committees or otherwise. No director who receives a salary from the
Corporation shall receive any fee for attending meetings of the Board or of any
of its committees.
RESIGNATION OF DIRECTORS
Section 3.17 Any director may resign at any time either by oral tender of such
resignation at any meeting of the Board or to the Chairman or President or by
giving written notice thereof to the Corporation. Any resignation shall be
effective immediately, unless a date certain is specified for it to take effect.
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ARTICLE IV
OFFICERS
Section 4.1 The Corporation shall have a President, a Corporate Secretary and a
Treasurer who shall be the Chief Financial Officer, and who need not be
directors. The Corporation shall also have a Chairman of the Board and a
Chairman of the Executive Committee, and may have one or more Vice Chairmen,
each of whom shall be directors. The Board shall designate who shall serve as
Chief Executive Officer, who shall have general supervision of the business and
affairs of the Corporation. The Corporation may also have one or more
Vice-Presidents, assistant and subordinate officers, other officers not
designated by these By-Laws, and agents as it shall deem necessary, none of whom
need be a director. A person may hold more than one office in the Corporation
except that no person may serve concurrently as both President and
Vice-President of the Corporation.
Section 4.2 Chairman of the Board. The Chairman of the Board shall be a director
and shall preside at all meetings of the Board and of the Stockholders at which
he shall be present.
Section 4.3 Chairman of the Executive Committee. The Chairman of the Executive
Committee shall be a director and shall chair meetings of the Executive
Committee, supervise and carry out policies adopted or approved by the Board and
exercise such further powers and duties as are, from time to time, conferred
upon or assigned to him by the Board. The Chairman of the Executive Committee
shall also serve as Lead Director for the Board. The duties and responsibilities
of the Chairman of the Executive Committee as Lead Director are as follows:
i) The Chairman of the Executive Committee shall be informed by, and
counsel, the Chairman and Chief Executive Officer on material strategy,
policy, and management matters.
ii) The Chairman of the Executive Committee shall be available to advise
and counsel the Chief Executive Officer on any matter relating to the
Corporation.
iii) The Chairman of the Executive Committee shall offer the Chief
Executive Officer counsel as to special interests and concerns of
Directors and will act as principal liaison between the Independent
Directors and the Chairman.
iv) In the absence or inability of the Chairman or Chief Executive Officer
to act, the Chairman of the Executive Committee shall perform those duties
of the Chairman pertaining to Board functions.
v) The Chairman of the Executive Committee shall recommend to the Chairman
the retention of consultants or other experts who would report directly to
the Board.
vi) The Chairman of the Executive Committee shall advise the Chairman as
to the quality, quantity and timeliness of the flow of information from
the Corporation that is necessary for the Directors to effectively and
responsibly perform their duties.
vii) The Chairman of the Executive Committee shall chair in camera
discussions requested by the Independent Directors.
viii) The Chairman of the Executive Committee shall serve as an ex-officio
member of each of the committees of the Board.
ix) The Chairman of the Executive Committee shall work with the Chairman
and other independent directors to give advice to the Chairman in the
development of Board membership.
Section 4.4 Vice Chairman. Each Vice Chairman, if one or more be elected, shall
be a director and shall perform such duties and may have such other powers as
are, from time to time, assigned to him by the Board.
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Section 4.5 President. The President shall be a director. The President may
execute, in the name of the Corporation, all authorized deeds, mortgages, bonds,
contracts or other instruments, except in cases in which the execution thereof
shall have been expressly delegated to some other officer or agent of the
Corporation. In general, he shall perform such duties usually performed by a
president of a corporation and shall perform such other duties and may have such
other powers as are from time to time assigned to him by the Board.
Section 4.6 Chief Executive Officer. The Chief Executive Officer shall exercise
general supervision over the policies and business affairs of the Corporation
and the carrying out of the policies adopted or approved by the Board. The
Chairman of the Board or the President may at the same time be appointed Chief
Executive Officer. Except as otherwise provided by these By-Laws, he shall have
power to determine the duties to be performed by the officers appointed as
provided in Section 4.9 of these By-Laws, and to employ and discharge officers
and employees. Except as otherwise provided by the By-Laws or the Board, he
shall be a member ex officio of all committees authorized by these By-Laws or
created by the Board. In the absence of the Chairman of the Board and the
President, he shall preside at all meetings of the Board and of shareholders.
Section 4.7 Chief Administrative Officer. The Board may appoint a Chief
Administrative Officer and said officer shall have such powers and duties as may
be assigned by the Board or the Chief Executive Officer.
Section 4.8 Corporate Secretary. The Corporate Secretary shall attend all
meetings of the stockholders and all meetings of the Board and record, or cause
to be recorded, all the procedures of the meetings of the stockholders and the
Board in books to be kept for that purpose. The Corporate Secretary may perform
like duties for the standing committees when required. He shall, as required,
give, or cause to be given, notice of all meetings of the stockholders and
meetings of the Board. He shall have custody of the corporate seal of the
Corporation and he, or a Deputy or Associate or Assistant Corporate Secretary,
shall affix the same to any instrument which is required or desired to be under
its seal and when so affixed, it may be attested by his signature or by the
signature of such Deputy or Associate or Assistant Corporate Secretary. The
Board may give general authority to any other officer to affix the seal of the
Corporation and to attest the affixing by his signature. In general, the
Corporate Secretary shall perform all duties incident to the office of a
secretary of a corporation, and shall perform such other duties and may have
such other powers as are from time to time assigned to him by the Board, the
Chief Executive Officer or the President.
Section 4.9 Deputy Corporate Secretary, Associate Corporate Secretary and
Assistant Corporate Secretary. The Deputy Corporate Secretary or the Associate
Corporate Secretary or the Assistant Corporate Secretary, or if there be more
than one, each of them, may, in the absence of the Corporate Secretary or during
his inability or refusal to act, perform the duties and exercise the powers of
the Corporate Secretary and shall perform such other duties and have such other
powers as are from time to time assigned to each of them by the Board, the Chief
Executive Officer, the President or the Corporate Secretary.
Section 4.10 Treasurer. The Treasurer shall be the Chief Financial Officer and
shall have charge of and be responsible for all corporate funds and securities
and shall keep, or cause to be kept, full and accurate accounts of receipts and
disbursements in books belonging to the Corporation and shall deposit, or cause
to be deposited, all moneys and other valuable effects, in the name and to the
credit of the Corporation, in such depositories as may from time to time be
designated. He shall render to the Board, the Chief Executive Officer or the
President, when so required, an account of the financial condition of the
Corporation. In general, the Treasurer shall perform all the duties incident to
the office of a treasurer of a corporation, and shall perform such other duties
and may have such other powers as are from time to time assigned to him by the
Board, the Chief Executive Officer or the President.
Section 4.11 Executive and Other Senior Officers. The Board shall by resolution
determine from time to time those officers whose appointment shall require
approval by the Board or a committee of the Board. Each such officer shall have
such powers and duties as may be assigned by the Board, a committee of the
Board, the President or the Chief Executive Officer.
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Section 4.12 Other Officers. The President or the Chief Executive Officer or his
designee may appoint all officers whose appointment does not require approval by
the Board or a committee of the Board, and assign to them such titles, as from
time to time may appear to be required or desirable to transact the business of
the Corporation. Each such officer shall have such powers and duties as may be
assigned by the Board, the President or the Chief Executive Officer.
Section 4.13 Tenure of Office. The Chairman of the Board, the President and the
Chief Executive Officer shall hold office for the current year for which the
Board was elected, unless they shall resign, become disqualified, or be removed.
All other officers shall hold office until their successors have been appointed
and qualify unless they shall resign, become disqualified or be removed. The
Board shall have the power to remove the Chairman of the Board, the President
and the Chief Executive Officer. The Board or the President or the Chief
Executive Officer or his designee shall have the power to remove all other
officers and employees. Any vacancy occurring in the offices of Chairman of the
Board, President or Chief Executive Officer shall be filled promptly by the
Board.
Section 4.14 Compensation. The Board shall by resolution determine from time to
time the officers whose compensation will require approval by the Board or a
committee of the Board. The Chief Executive Officer shall fix the compensation
of all officers and employees whose compensation does not require approval by
the Board.
ARTICLE V
CERTIFICATES OF STOCK
Section 5.1 Every holder of stock in the Corporation shall be entitled to have a
certificate, signed by, or in the name of the Corporation by the Chairman of the
Board or President or a Vice President and the Treasurer or an Assistant
Treasurer, or the Secretary or a Deputy or Associate or Assistant Secretary of
the Corporation, certifying the number of shares owned by him in the
Corporation.
Section 5.2 Where a certificate is manually countersigned (1) by a transfer
agent, other than the Corporation or its employee, or, (2) by a registrar, other
than the Corporation or its employee, any other signature on the certificate may
be facsimile. In case any officer, transfer agent or registrar who has signed or
whose facsimile signature has been placed upon a certificate shall have ceased
to be such officer, transfer agent or registrar before such certificate is
signed, it may be issued by the Corporation with the same effect as if he were
such officer, transfer agent or registrar at the date of issue.
LOST CERTIFICATES
Section 5.3 The Board may authorize a new certificate or certificates to be
issued in place of any certificate or certificates theretofore issued by the
Corporation alleged to have been lost, stolen or destroyed, upon the making of
an affidavit of that fact by the person claiming the certificate of stock to be
lost, stolen or destroyed. When authorizing such issue of a new certificate or
certificates, the Board may, in its discretion and as a condition precedent to
the issuance thereof, require the owner of such lost, stolen or destroyed
certificate or certificates, or his legal representative, to advertise the same
in such manner as it shall require and/or to give the Corporation a bond in such
sum as it may direct as indemnity against any claim that may be made against the
Corporation with respect to the certificate alleged to have been lost, stolen or
destroyed.
TRANSFER OF STOCK
Section 5.4 Upon surrender to the Corporation or the transfer agent of the
Corporation of a certificate for shares duly endorsed or accompanied by proper
evidence of succession, assignment or authority to transfer, it shall be the
duty of the Corporation to issue a new certificate to the person entitled
thereto, cancel the old certificate and record the transaction upon its books.
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Section 5.5 The Board may, at its discretion, appoint one or more banks or trust
companies in New York City, and in such other city or cities as the Board may
deem advisable, including any banking subsidiary of the Corporation, from time
to time, to act as transfer agent(s) and registrar(s) of the stock of the
Corporation.
FIXING RECORD DATE
Section 5.6 The Board is hereby empowered to fix, in advance, a date as the
record date for the purpose of determining stockholders, or stockholders
entitled to receive payment of any dividend or the allotment of any rights, or
in order to make determination of stockholders for any other proper purpose.
Such date in any case shall be not more than ninety (90) days, and in case of a
meeting of stockholders, not less than ten (10) days, prior to the date of which
the particular action, requiring such determination of stockholders is to be
taken. In lieu of fixing a record date, the Board may provide that the stock
transfer books shall be closed for a stated period but not to exceed, in any
case, twenty (20) days. If the stock transfer books are closed for the purpose
of determining stockholders entitled to notice of or to vote at a meeting of
stockholders, such books shall be closed for at least ten (10) days immediately
preceding such meeting.
STOCK LEDGER
Section 5.7 Original or duplicate stock ledgers, containing the name and
addresses of the stockholders of the Corporation and the number of shares of
each class held by them respectively, shall be kept at the offices of a transfer
agent for the particular class of stock, within or without the State of
Maryland, or, if none, at a principal office or the principal executive offices
of the Corporation.
REGISTERED STOCKHOLDERS
Section 5.8 The Corporation shall be entitled to recognize the exclusive right
of a person registered on its books as the owner of shares to receive dividends,
and to vote as such owner, and to hold liable for calls and assessments a person
registered on its books as the owner of shares, and shall not be bound to
recognize any equitable or other claim to or interest in such share or shares on
the part of any other person, whether or not it shall have express or other
notice thereof, except as otherwise provided by the laws of Maryland.
ARTICLE VI
GENERAL PROVISIONS
DIVIDENDS
Section 6.1 Subject to the provisions of the Articles of Incorporation,
dividends, if any, may be declared by the Board at any meeting, pursuant to the
law.
EXECUTION OF INSTRUMENTS
Section 6.2 All agreements, indentures, mortgages, deeds, conveyances,
transfers, certificates, declarations, receipts, discharges, releases,
satisfactions, settlements, petitions, schedules, accounts, affidavits, bonds,
undertakings, proxies and other instruments or documents may be signed,
executed, acknowledged, verified, delivered or accepted on behalf of the
Corporation by the Chairman of the Board, or the President, or the Chief
Executive Officer, or the Secretary, or any Vice President, or any other officer
or employee designated by the Board or the Chief Executive Officer or his
designee. Any such instruments may also be executed, acknowledged, verified,
delivered or accepted in behalf of the Corporation in such other manner and by
such other officers as the Board may from time to time direct. The provisions of
this Section 6.2 are supplementary to any other provisions of these By-Laws.
Each of the foregoing authorizations shall be at the pleasure of the Board, and
each such authorization by the Chief Executive Officer or his designee also
shall be at the pleasure of the Chief Executive Officer.
217
FISCAL YEAR
Section 6.3 The fiscal year of the Corporation shall be the calendar year.
SEAL
Section 6.4 The Corporation's seal shall have inscribed thereon the name of the
Corporation and the words "Corporate Seal, Maryland". The seal may be used by
causing it or a facsimile thereof to be impressed or affixed or reproduced or
otherwise.
SHARES OF OTHER CORPORATIONS
Section 6.5 The Chairman of the Board, the President, any Vice President, and
the Secretary is each authorized to vote, represent and exercise on behalf of
the Corporation all rights incident to any and all shares of any other
corporation or corporations standing in the name of the Corporation. The
authority herein granted to said officer to vote or represent on behalf of the
Corporation any and all shares held by the Corporation in any other corporation
or corporations may be exercised either by said officer in person or by any
other person authorized so to do by proxy or power of attorney duly executed by
said officers. Notwithstanding the above, however, the Board, in its discretion,
may designate by resolution the person to vote or represent said shares of other
corporations.
RECORDS
Section 6.6 The By-Laws and the proceedings of all meeting of the shareholders,
the Board, and standing committees of the Board, shall be recorded in
appropriate minute books provided for the purpose. The minutes of each meeting
shall be signed by the Secretary or other officer appointed to act as Secretary
of the meeting.
EMERGENCY OPERATIONS
Section 6.7 In the event of war or warlike damage or disaster of sufficient
severity to prevent the conduct and management of the affairs, business, and
property of the Corporation by its directors and officers as contemplated by
these By-Laws, any two or more available members of the then incumbent Board
shall constitute a quorum for the full conduct and management of the affairs,
business, and property of the Corporation. This By-Law shall be subject to
implementation by resolutions of the Board passed from time to time for that
purpose, and any provisions of these By-Laws (other than this Section) and any
resolutions which are contrary to the provisions of this Section or to the
provisions of any such implementary resolutions shall be suspended until it
shall be determined by any interim Board acting under this Section that it shall
be to the advantage of the Corporation to resume the conduct and management of
its affairs, business, and property under all of the other provisions of these
By-Laws.
218
RIGHT TO INDEMNIFICATION
Section 6.8 (a) . Each person who was or is made a party or is threatened to be
made a party to or is otherwise involved in any action, suit or proceeding,
whether civil, criminal, administrative or investigative, by reason of the fact
that he is or was a director or officer of the Corporation or, while a director
or officer of the Corporation is or was serving at the request of the
Corporation as a director, officer, employee or agent of another corporation or
of a partnership, joint venture, trust or other enterprise, including service
with respect to an employee benefit plan (an "Indemnitee"), whether the basis of
such proceeding is alleged action in an official capacity as a director,
officer, employee or agent or in any other capacity while serving as a director
or officer, shall be indemnified and held harmless by the Corporation to the
fullest extent authorized by the Annotated Code of Maryland, as the same exists
or may hereafter be amended, against all expense, liability and loss (including
attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts
paid in settlement) reasonably incurred or suffered by such Indemnitee in
connection therewith and such indemnification shall continue as to an Indemnitee
who has ceased to be a director or officer and shall inure to the benefit of the
Indemnitee's heirs, executors and administrators; provided, however, that,
except as provided in Section 6.8(b) hereof with respect to proceedings to
enforce rights to indemnification, the Corporation shall indemnify any such
Indemnitee in connection with a proceeding (or party thereof) initiated by such
Indemnitee only if such proceeding (or part thereof) was authorized by the
Board. The right to indemnification conferred in this Section 6.8 shall be a
contract right and shall include the right to be paid by the Corporation the
expenses incurred in defending any such proceeding in advance of its final
disposition; provided, however, that, if the Annotated Code of Maryland so
requires, an advancement of expenses incurred by an Indemnitee shall be made
only upon delivery to the Corporation of an undertaking, by or on behalf of such
Indemnitee, to repay all amounts so advanced if it shall ultimately be
determined by final judicial decision from which there is no further right to
appeal that such Indemnitee is not entitled to be indemnified for such expenses
under this Section or otherwise.
(b) Right of Indemnitee to Bring Suit. If a claim under paragraph
(a) of this Section 6.8 is not paid in full by the Corporation within sixty days
after a written claim has been received by the Corporation, except in the case
of a claim for an advancement of expenses, in which case the applicable period
shall be twenty days, the Indemnitee may at any time thereafter bring suit
against the Corporation to recover the unpaid amount of the claim. If successful
in whole or in part in any such suit, or in a suit brought by the Corporation to
recover an advancement of expenses pursuant to the terms of such Indemnitee's
undertaking the Indemnitee shall be entitled to be paid the expense of
prosecuting or defending such suit. In any suit brought by the Indemnitee to
enforce a right to indemnification hereunder it shall be a defense that, and in
any suit by the Corporation to recover an advancement of expenses pursuant to
the terms of an undertaking the Corporation shall be entitled to recover such
expenses upon a final adjudication that, the Indemnitee has not met the
applicable standard of conduct set forth in the Annotated Code of Maryland.
Neither the failure of the Corporation to have made a determination prior to the
commencement of such suit that indemnification of the Indemnitee is proper in
the circumstances because the Indemnitee has met the applicable standard of
conduct set forth in the Annotated Code of Maryland, nor an actual determination
by the Corporation that the Indemnitee has not met such applicable standard of
conduct, shall create a presumption that the Indemnitee has not met the
applicable standard of conduct or, in the case of such a suit brought by the
Indemnitee, be a defense to such suit. In any suit brought by the Indemnitee to
enforce a right to indemnification or to an advancement of expenses hereunder,
or by the Corporation to recover an advancement of expenses pursuant to the
terms of an undertaking by the Indemnitee, the Corporation shall have the burden
of proving that the Indemnitee is not entitled to be indemnified, or to such
advancement of expenses, under this Section 6.8 or otherwise.
(c) Non-Exclusivity of Rights. The rights to indemnification and to
the advancement of expenses conferred in this Section 6.8 shall not be exclusive
of any other right which any person may have or hereafter acquire under any
statute, the Corporation's Certificate of Incorporation, By-Law, agreement, vote
of shareholders or disinterested directors or otherwise.
(d) Indemnification of Employees and Agents of the Corporation. The
Corporation may, to the extent authorized from time to time by the Board, grant
rights to indemnification, and to the advancement of expenses to any employee or
agent of the Corporation to the fullest extent of the provisions of this Section
6.8 with respect to the indemnification and advancement of expenses of directors
and officers of the Corporation.
219
(e) Insurance. The Corporation may maintain insurance, at its
expense, to protect itself and any director, officer, employee or agent of the
Corporation or another corporation, partnership, joint venture, trust or other
enterprise against any expense, liability or loss, whether or not the
Corporation would have the power to indemnify such person against such expense
liability or loss under the Delaware General Corporation Law, as the same exists
or may hereafter be amended.
ARTICLE VII
AMENDMENTS
Section 7.1 The By-Laws may be added to, amended, altered or repealed at any
regular meeting of the Board, by a vote of a majority of the total number of the
directors, or at any meeting of shareholders, duly called and held, by a
majority of the stock represented at such meeting.
ARTICLE VIII
Section 8.1 Notwithstanding any other provision of the charter of the
Corporation or these By-Laws, Title 3, Subtitle 7 of the Corporations and
Associations Article of the Annotated Code of Maryland (or any successor
statute) shall not apply to the acquisition of all of the common stock, $5.00
par value per share, of the Corporation by HSBC Holdings plc, an English public
limited company, pursuant to that certain Transaction Agreement and Plan of
Merger, dated May 10, 1999, as amended by Amendment No. 1, dated November 8,
1999, and as may be further amended from time to time, by and among HSBC
Holdings Plc, the Corporation, Safra Republic Holdings S.A., a societe anonyme
organized and existing under the laws of Luxembourg, and RNYC Merger
Corporation, a Maryland corporation, and to the other transactions contemplated
thereby.
Section 8.2 Notwithstanding any other provision of the charter of the
Corporation or these By-Laws, Title 3, Subtitle 7 of the Corporations and
Associations Article of the Annotated Code of Maryland (or any successor
statute) shall not apply to the grant by the Corporation of the option to HSBC
Holdings Plc, an English public limited company, pursuant to that certain Stock
Option Agreement, dated May 10, 1999, between the Corporation and HSBC of shares
of the Corporation's common stock pursuant thereto.
Section 8.3 Notwithstanding any other provision of the charter of the
Corporation or these By-Laws, Title 3, Subtitle 7 of the Corporations and
Associations Article of the Annotated Code of Maryland (or any successor
statute) shall not apply to the Stockholders Agreement, dated May 10, 1999, as
amended by Amendment No. 1 to the Stockholders Agreement, dated November 8,
1999, and as may be further amended from time to time, among HSBC, an English
public limited company, RNYC Holdings Limited, a Gibraltar corporation,
Congregation Beit Yaakov, Saban S.A., a Panamanian corporation, Mr. Edmond J.
Safra, HSBC North America Inc., a Delaware corporation, and in part, the
Corporation, or the exercise by HSBC of its rights thereunder.
220
Exhibit 12
HSBC USA Inc.
Computation of Ratio of Earnings to Fixed Charges and
Earnings to Combined Fixed Charges and Preferred Stock Dividends
(in millions, except ratios)
----------------------------------------------------------------------------------------------------------------
Year Ended December 31 2006 2005 2004 2003 2002
----------------------------------------------------------------------------------------------------------------
Ratios excluding interest on deposits:
Net income ........................................... $ 1,036 $ 976 $ 1,258 $ 941 $ 855
Income tax expense ................................... 530 566 718 570 510
Less: Undistributed equity earnings .................. 34 73 21 6 7
Fixed charges:
Interest on:
Borrowed funds ................................. 300 276 132 91 232
Long-term debt ................................. 1,457 1,019 380 206 225
One third of rents, net of income from subleases .. 25 19 19 17 17
-------- -------- -------- -------- --------
Total fixed charges, excluding interest on deposits .. 1,782 1,314 531 314 474
Earnings before taxes and fixed charges,
net of undistributed equity earnings .............. $ 3,314 $ 2,783 $ 2,486 $ 1,819 $ 1,832
======== ======== ======== ======== ========
Ratio of earnings to fixed charges ................... 1.86 2.12 4.68 5.79 3.86
======== ======== ======== ======== ========
Total preferred stock dividend factor (1) ............ $ 133 $ 71 $ 36 $ 36 $ 37
-------- -------- -------- -------- --------
Fixed charges, including the preferred stock
dividend factor ................................... $ 1,915 $ 1,385 $ 567 $ 350 $ 511
======== ======== ======== ======== ========
Ratio of earnings to combined fixed charges and
preferred stock dividends ......................... 1.73 2.01 4.38 5.20 3.59
======== ======== ======== ======== ========
Ratios including interest on deposits:
Total fixed charges, excluding interest on deposits .. $ 1,782 $ 1,314 $ 531 $ 314 $ 474
Add: Interest on deposits ............................ 3,113 1,771 825 666 974
-------- -------- -------- -------- --------
Total fixed charges, including interest on deposits .. $ 4,895 $ 3,085 $ 1,356 $ 980 $ 1,448
======== ======== ======== ======== ========
Earnings before taxes and fixed charges,
net of undistributed equity earnings .............. $ 3,314 $ 2,783 $ 2,486 $ 1,819 $ 1,832
Add: Interest on deposits ............................ 3,113 1,771 825 666 974
-------- -------- -------- -------- --------
Total ................................................ $ 6,427 $ 4,554 $ 3,311 $ 2,485 $ 2,806
======== ======== ======== ======== ========
Ratio of earnings to fixed charges ................... 1.31 1.48 2.44 2.54 1.94
======== ======== ======== ======== ========
Fixed charges, including the preferred stock
dividend factor ................................... $ 1,915 $ 1,385 $ 567 $ 350 $ 511
Add: Interest on deposits ............................ 3,113 1,771 825 666 974
-------- -------- -------- -------- --------
Fixed charges, including the preferred stock
dividend factor and interest on deposits .......... $ 5,028 $ 3,156 $ 1,392 $ 1,016 $ 1,485
======== ======== ======== ======== ========
Ratio of earnings to combined fixed charges and
preferred stock dividends ......................... 1.28 1.44 2.38 2.45 1.89
======== ======== ======== ======== ========
(1) Preferred stock dividends grossed up to their pretax equivalents.
221
Exhibit 14
Code of Ethics for Senior Financial Officers
(As required by Section 406 of the Sarbanes-Oxley Act)
As (Chief Executive Officer) (Chief Financial Officer) (Controller) of HSBC USA
Inc. (the "Company"), I certify that I will adhere to the following principles
and responsibilities, as well as the Company's Statement of Policy and Code of
Ethics:
o Act with honesty and integrity, and comply with the Company's policies and
procedures relating to any actual or apparent conflict of interest
involving personal and professional relationships;
o Provide other officials and constituents of the Company information that
is full, fair, accurate, complete, objective, timely and understandable;
o Comply with rules and regulations of all U.S. and non-U.S. governmental
entities, as well as other private and public regulatory agencies to which
the Company is subject;
o Act at all times in good faith, responsibly, with due care, competence and
diligence, and without any misrepresentation of material facts;
o Act objectively, without allowing my independent judgment to be
subordinated;
o Respect the confidentiality of Company information, except when authorized
or otherwise required to make any disclosure, and avoid the use of any
Company information for personal advantage;
o Share my knowledge and skills with others to improve the Company's
communications to its constituents;
o Promote ethical behavior among employees under my supervision at the
Company;
o Promote responsible use of and control over all assets and resources of
the Company entrusted to me; and
o Promptly report any violations of the Code of Ethics to the Company's
General Counsel or Secretary.
Failure to comply with the Code of Ethics may lead to termination of employment.
Date: _________________ ________________________________________
Signature
222
Exhibit 21
Subsidiaries of HSBC USA Inc.
U.S. Affiliates:
USA or
US State
Names of Subsidiaries Organized
--------------------- ---------
CC&H Holdings LLC Delaware
Delaware Credit Corp. (USA) Delaware
Giller Ltd. New York
GWML Holdings, Inc. Delaware
Delaware Securities Processing Corp. Delaware
HSBC Bank USA, National Association USA
Capco/Cove, Inc. New York
Card-Flo #1, Inc. Delaware
Card-Flo #3, Inc. Delaware
CBS/Holdings, Inc. New York
Eagle Rock Holdings, Inc. New York
Ellenville Holdings, Inc. New York
F-Street Holdings, Inc. Delaware
Fairways Holdings, Inc. Delaware
H.W.D. Real Estate Co., Inc. New York
High Meadow Management, Inc. New York
HSBC AFS (USA) LLC New York
HSBC Business Credit (USA) Inc. Delaware
HSBC Financial Services Corporation (USA) Delaware
Identrus LLC Delaware
HSBC Insurance Agency (USA) Inc. New York
HSBC Investment Corporation (Delaware) Delaware
HSBC Funding (USA) Inc. V Delaware
HSBC Funding (USA) Inc. VI Delaware
HSBC Funding (USA) Inc. VII Delaware
HSBC Private Label Acquisition Corporation (USA) Delaware
HSBC Investments (USA) Inc. New York
HSBC Investor PBRS Corporation (Delaware) Delaware
HSBC Land Title Holdco (USA) Inc. Delaware
HSBC Land Title Agency (Florida), LLC Florida
HSBC Mortgage Corporation (USA) Delaware
HSBC Mortgage Investors Corporation (Delaware) Delaware
HSBC Motor Credit (USA) Inc. Delaware
HSBC Overseas Investments Corporation (New York) Maryland
HSBC Overseas Corporation (Delaware) Delaware
HSBC International Finance Corporation (Delaware) USA
HSBC Private Bank International USA
HSBC International Investments Corporation (Delaware) Delaware
HSBC Realty Credit Corporation (USA) Delaware
Alexandria Holdings, Inc. Delaware
Cabot Park Holdings, Inc. Delaware
HSBC Land Title Agency (USA) LLC New York
Midtown Land Services Agency LLC New York
MM Mooring #2 Corp. New York
Northridge Plaza, Inc. Delaware
HSBC Reinsurance (USA) Inc. Vermont
HSBC Retail Credit (USA) Inc. New York
HSBC Services Corporation (USA) New Jersey
Katonah Close Corp. New York
London Marine Midland Overseas Corporation Delaware
Marmid Aircraft Leasing Corporation New York
Oakwood Holdings, Inc. New York
Property Owner (USA) LLC Delaware
Tower Holding New York Corp. New York
Beachhouse Properties, Inc. New York
223
USA or
US State
Names of Subsidiaries Organized
--------------------- ---------
Cross Zou Holding Corp. New York
Cross-LA Realty, Inc. Louisiana
Crossturkey, Inc. New York
Sub 1-211, Inc. Pennsylvania
Sub 2-211, Inc. Pennsylvania
Tower Emmons Corp. New York
Tower Houma Corp. Louisiana
Tower L.I.C. Corp. New York
Tower Pierrepont Corp. New York
West 56th and 57th Street Corp. New York
TPBC Acquisition Corp. Florida
Trumball Management, Inc. New York
HSBC National Bank USA United States
HSBC Payment Services (USA) Inc. Delaware
HSBC Trust Company (Delaware), National Association United States
HSBC USA Capital Trust I Delaware
HSBC USA Capital Trust II Delaware
HSBC USA Capital Trust III Delaware
HSBC USA Capital Trust IV Delaware
HSBC USA Capital Trust V Delaware
HSBC USA Capital Trust VI Delaware
HSBC USA Capital Trust VII Delaware
Jefferies Partners Opportunity Fund, LLC USA
Marine Midland Mortgage (U.S.A.), Inc. New York
One Main Street, Inc. Florida
R/CLIP Corp. Delaware
Republic New York Securities Corporation Maryland
Republic Overseas Capital Corporation New York
Timberlink Settlement Services (USA) Inc. Delaware
Wealth and Tax Advisory Services, Inc. Delaware
Wells Fargo HSBC Trade Bank, N.A. USA
Non-U.S. Affiliates:
Country
Names of Subsidiaries Organized
--------------------- ---------
HSBC Private Bank (Suisse) SA Switzerland
HSBC Investment Holdings (Guernsey) Limited United Kingdom
HRMG Nominees Limited United Kingdom
HSBC Management (Guernsey) Limited United Kingdom
HSBC Republic Investments Limited United Kingdom
Republic New York Holdings (UK) United Kingdom
HSBC Financial Services (Uruguay) S.A. Montevideo
Republic Bullion (Far East) Limited Hong Kong
London Precious Metals Clearing Limited United Kingdom
HSBC Precious Metals (Australia) Limited New South Wales
HSBC Life Insurance (Cayman) Limited Cayman Islands
HSBC Alternative Investments (Guernsey) Limited United Kingdom
224
Exhibit 23
Consent of Independent Registered Public Accounting Firm
The Board of Directors
HSBC USA Inc.:
We consent to incorporation by reference in Registration Statements (No.
333-42421, 333-42421-01, 333-42421-02, 333-127603) on Form S-3 of HSBC USA Inc.
of our report dated March 2, 2007, relating to the consolidated balance sheets
of HSBC USA Inc. and subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
2006, and the consolidated balance sheets of HSBC Bank USA, National Association
and subsidiaries as of December 31, 2006 and 2005, which report appears in the
2006 HSBC USA Inc. Annual Report on Form 10-K.
/s/ KPMG LLP
New York, New York
March 2, 2007
225
Exhibit 31.1
Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Paul J. Lawrence, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC USA Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the
period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing
the equivalent functions):
a) All significant and material weaknesses in the design or operation
of internal controls over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls over financial reporting.
Date: March 5, 2007 /s/ Paul J. Lawrence
----------------------------------------
Paul J. Lawrence
President and Chief Executive Officer
226
Exhibit 31.2
Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, John J. McKenna, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC USA Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the
period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing
the equivalent functions):
a) All significant and material weaknesses in the design or operation
of internal controls over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls over financial reporting.
Date: March 5, 2007 /s/ John J. McKenna
----------------------------------------
John J. McKenna
Senior Executive Vice President and
Chief Financial Officer
227
Exhibit 32
Certification of Chief Executive Officer and Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and
(b) of section 1350, chapter 63 of title 18, United States Code), each of the
undersigned officers of HSBC USA Inc. (HUSI), a Maryland corporation, does
hereby certify, to such officer's knowledge, that:
The Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (the
Form 10-K) of HUSI fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 and the information contained in
the Form 10-K fairly presents, in all material respects, the financial condition
and results of operations of HUSI.
Date: March 5, 2007 /s/ Paul J. Lawrence
-------------------------------------
Paul J. Lawrence
President and Chief Executive Officer
Date: March 5, 2007 /s/ John J. McKenna
-------------------------------------
John J. McKenna
Senior Executive Vice President and
Chief Financial Officer
228
Exhibit 99(i)
Adopted by the Board of Directors 2/14/06
As amended as of 1/9/07
HSBC USA Inc.
HSBC Bank USA, N.A.
HSBC National Bank USA
CORPORATE GOVERNANCE STANDARDS
The following standards have been approved by the Boards of Directors and,
together with the charters of committees of the Boards of Directors, provide the
framework for the corporate governance of HSBC USA Inc., HSBC Bank USA, N.A. and
HSBC National Bank USA (each referred to herein as "HSBC" or the "Corporation").
These standards will be reviewed by the Boards periodically in order to ensure
HSBC maintains "best practices" in corporate governance.
Role of the Board and Management
HSBC's business is conducted by its employees, managers and officers, under the
direction of the Chief Executive Officer and the oversight of the Board, to
enhance long-term value of the Corporation for its shareholder. The Board has
ultimate responsibility for governing the affairs of the Corporation, including
the appointment of executive management, approval of business strategy and
assessment of major risks facing the Corporation, consistent with its
responsibilities to the Corporation's ultimate parent, HSBC Holdings plc (the
"Group") to ensure that the Corporation's activities are conducted within the
context of the Group's policies and business strategies. In all actions taken by
the Board, the Directors will exercise their business judgment in what they
reasonably believe to be in the best interests of the Corporation. In
discharging that obligation, Directors may rely on the honesty and integrity of
the Corporation's management and its outside advisors and independent auditors.
Management is expected to be loyal to the Corporation, implement approved
business strategy, appropriately resolve day-to-day operations issues, keep the
Board informed, and maintain and promote high ethical standards while seeking to
maximize returns to HSBC in all business dealings.
Composition and Qualification
The size of the Board shall consist of the number of Directors established by
the Board upon recommendation of the Chief Executive Officer from time to time.
The Chairman and the Chief Executive Officer of the Corporation shall be a
Director of the Corporation. A majority of the Independent Directors should be
active or retired senior executives (or the equivalent) of other large
companies, educational institutions, governmental agencies, service providers or
non-profit organizations.
Each Director will stand for election by the shareholder every year. HSBC
recognizes the benefits of reasonable term limits for Directors. However, HSBC
also believes that term limits should not cause the Corporation to lose the
increasing benefit of Directors who have been able to develop, over a period of
time, insight into the Corporation and its operations. The service of Directors
who join the Board after December 31, 2005 will be limited to a maximum of 15
years.
The Corporation also maintains a mandatory retirement policy for Directors
(excluding the Chairman and the Chief Executive Officer of the Corporation).
Retirement is required as of the annual meeting of the shareholder after the
date on which a Director attains the age of 72 or reaches the maximum length of
service.
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Non-Independent Directors who are senior executive officers of the Corporation
are expected to retire from the Board when they retire from the position that
entitles such individual to be a Director of the Corporation. With respect to
any Director, the Board may delay any retirement from the Board if business
conditions or other circumstances, in the opinion of the Board, so warrant such
action.
It is anticipated that Independent Directors will offer to resign from the Board
whenever there is (i) a major change in their career position or status (unless
such change in position or status results from normal retirement), or (ii) a
change in status as an "Independent Director". Similarly, it is anticipated that
Non-Independent Directors who are not senior executive officers of the
Corporation will offer to resign from the Board whenever there is a major change
in their career position or status (unless such change in position or status
results from normal retirement). The Chairman and the Chair of the Executive
Committee shall consult and determine whether to present the offer of
resignation to the Board for action. If presented, the Board has complete
discretion, after consultation with Group, to either accept or reject such
resignation.
Independent Directors shall not be a director, consultant or employee of or to
any competitor of the Corporation (i.e., a company that has a business segment
offering products or seeking customers that are similar to the products offered
or customers served by a business segment of the Corporation). To avoid
potential conflicts of interest, interlocking directorships will not be allowed.
Interlocking directorships shall be deemed to occur if a senior executive
officer of the Corporation (i.e., the Chairman, Chief Executive Officer,
President or any direct report to the Chief Executive Officer) serves on the
board or as a trustee of the company or institution that employs the Independent
Director (i.e., reciprocal directorship).
"Directors Emeriti" will not be elected to the Board. However, former Directors
may be invited to special events from time to time.
Director Responsibilities
The Board, representing the best interests of Group and the Corporation, shall:
o provide oversight of the Corporation's compliance with all legal and
regulatory obligations;
o approve the corporate mission statement, ethics plan, and affirmative
action plan;
o appoint and evaluate, and approve the compensation of, the CEO and other
executive management;
o approve a management succession plan;
o review and approve the business planning calendar to insure discussion,
input, analysis and decision making;
o review and approve the strategic plan and business plan on a timely basis;
receive and discuss periodic updates to these plans;
o oversee management's responsibility to develop systems to insure that the
business is conducted in a legal and ethical manner;
o oversee management's responsibility to implement adequate business control
systems;
o provide constructive dialogue to management during and between board
meetings;
o have the ability to spend the necessary time required to function
effectively as a Director;
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o develop and maintain a sound understanding of the strategies, business and
succession planning of the Corporation;
o carefully study all Board materials and provide active, objective and
constructive participation at meetings of the Board and its committees;
o provide assistance in representing HSBC to the world;
o be available to advise and consult on key organizational changes and to
counsel on corporate issues;
o develop and maintain a good understanding of global economic issues and
trends; and
o seek clarification from experts retained by the Corporation (including
employees of the Corporation) to better understand legal, financial or
business issues affecting the Corporation.
Director Independence
A majority of the Directors will be independent. Annually, the Board shall
determine whether each Director can exercise independent judgement from
management. The Board shall use the standards set forth in Appendix A hereto as
a foundation for its determinations concerning independence, which are based
upon the New York Stock Exchange (NYSE) listing standards.
Meetings
Annually, all Directors shall be provided with a schedule identifying all
regularly scheduled Board and committee meetings for the current and the next
succeeding year. There will be four regularly scheduled meetings of the Board
each year. At the first regularly scheduled meeting of each calendar year, a
detailed strategic focus of the Corporation's businesses will be discussed and
the Board will approve the annual operating plan and capital expenditure budget.
The Board will meet in "retreat" at least once a year to discuss the strategy of
the business. Independent Directors shall meet in executive session as required,
but no less than once a year. Personal attendance of the Directors at Board and
committee meetings is expected. The use of teleconference to facilitate such
attendance should be requested by Directors only in extraordinary situations.
The Chairman and the Chief Executive Officer will establish the agenda for each
Board meeting. The Chair of a committee in consultation with committee members
and senior management will develop the agenda for each committee meeting.
Directors are encouraged to suggest, to the Chairman, topics for inclusion on
any future agendas.
At every regularly scheduled Board meeting, the Chief Executive Officer or
his/her designee shall advise the Board of the operating performance of the
Corporation, focusing on important trends, achievements, plans and developments,
and how those matters may affect the annual operating plan approved by the
Board. Also, at every regularly scheduled Board meeting, the President, Chief
Financial Officer, Chief Accounting Officer or Controller shall present the
latest available financial detail with respect to the Corporation, focusing on
significant variances from the annual operating plan or capital expenditure plan
approved by the Board and from prior year/quarter results. Interim meetings will
be scheduled to discuss the business on an as required basis.
Information with respect to any Board or committee meeting should be sent to
Directors at least five (5) days in advance of the meeting, if possible.
Financial statements included in this information should be condensed with
commentary focused on important issues, trends or variances, noting the
perceived reasons therefore and the opportunities or risks, if any, that may
result.
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Minutes of all Board and committee meetings shall be sent to all Directors
unless it is legally required that such minutes be kept confidential.
Committees
The committee structure of the Board shall be reviewed annually. The Board will
have Audit, Human Resources, Executive, Fiduciary, and Nominating and Governance
Committees. No Director should serve on more than three of the standing
committees.
Each standing committee of the Board shall adopt and approve a charter. Each
such charter, and any amendments thereto, must be approved by the Board. At
least annually, each committee will review the appropriateness of its charter
and evaluate and report on its performance to the Board. Other than the
Executive Committee, which may act in place of the full Board, no committee
shall exercise any power and authority specifically delegated to any other
committee of the Board.
The Chairman, in consultation with the Chair of the Executive Committee, shall
make recommendations to the Nominating & Governance Committee regarding
membership on the committees. The Board will appoint all committee members and
the Chair of each committee.
Membership of the Executive Committee shall consist of Independent Directors and
the Chief Executive Officer of the Corporation. The Chair of the Executive
Committee shall be deemed the "lead director" for the Board and shall perform
the duties set forth on Appendix B to these Standards. The Chair of the
Executive Committee shall be an "ex officio" member of all other standing
committees.
Membership of the Nominating and Governance Committee shall consist of the Lead
Director and Chairs of the other committees, provided that such Directors are
each Independent Directors.
The Chair of each committee, in consultation with committee members and senior
management of the Corporation will determine the frequency and length of the
meetings of the committee.
A quorum and the vote required at any committee meeting shall be determined in
the same manner as a quorum for a meeting of the Board as set forth in the
by-laws of the Corporation.
Director Compensation
Director compensation will be in the form of cash compensation and, as may be
appropriate, restricted shares or other equity compensation. The amount of
compensation to be paid to Directors will be determined by the Chairman of the
Corporation, in consultation with the Nominating and Governance Committee.
Access to Senior Management and Independent Advisors
Directors shall have free and full access to senior management and other
employees of the Corporation. Any meetings or contacts that a Director wishes to
initiate may be arranged through the Chief Executive Officer or Corporate
Secretary or directly by the Director.
The Board and its committees shall have the right at any time to retain
independent outside financial, legal or other advisors.
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Director Orientation and Continuing Education
The Corporation shall provide a continuing education program for all members of
the Board including presentations by senior management on the Corporation's
strategic plans, its significant financial, accounting and risk management
issues, its compliance programs, its Statement of Business Principles, its
management structure and executive officers and its internal and independent
auditors. Directors shall be encouraged to participate in approved Director
training programs at the expense of the Corporation. New Directors will
participate in an organized Director orientation program.
Succession Planning
The Chief Executive Officer will report annually to the Human Resources
Committee and the Board on the plans or programs implemented by the Corporation
for management succession and development. Annually, all Independent Directors
will meet in a separate session, led by the Chair of the Executive Committee, to
review the performance of the Chairman, Chief Executive Officer and President,
if any, and senior officers including a discussion of the perceived
effectiveness of the processes implemented for management succession and
development.
Annual Evaluation
Annually, the Board shall perform and discuss a self-evaluation of the Board and
each committee. The Nominating and Governance Committee will lead a discussion
of the Board evaluation. Each Committee Chair will lead a discussion of the
respective committee evaluation.
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Appendix A
INDEPENDENT DIRECTOR STANDARDS
The Board shall consider all relevant facts and circumstances in assessing the
independence of Directors. As a foundation for such determinations, the Board
has established the following guidelines. An Independent Director is a Director
who:
o has no personal loans from the Corporation, other than credit cards and
charge cards or residential mortgage loans made in the ordinary course of
business on substantially the same terms as those prevailing at the time
for comparable transactions with non-affiliated persons;
o has not been retained by the Corporation or any of its affiliates in the
capacity of an employee or non-employee executive officer within the last
three years and is not currently receiving any compensation from the
Corporation or any of its affiliates (other than for Board service,
deferred compensation for prior service or benefits under a tax-qualified
retirement plan);
o has not received more than $100,000 in direct compensation from the
Corporation or any of its affiliates in any year, other than for Board
service with the Corporation, benefits under a tax-qualified retirement
plan or deferred compensation for prior service, within the last three
years;
o has not been affiliated with or employed by an organization (as a partner,
employee or 10% or more shareholder) that is an advisor or consultant,
including a current or former internal or external auditor, to the
Corporation, any of its subsidiaries, any of the senior executives of the
Corporation, or any pension, profit sharing or employee benefit plan
sponsored by the Corporation within the last three years;
o has not been an employee, partner or executive officer of any significant
vendor or customer of the Corporation or any of its subsidiaries, or a
pension, profit sharing or employee benefit plan sponsored by the
Corporation that makes payments to, or receives payments from the
Corporation in an amount that in any fiscal year exceeded the greater of
$1 million, or 2% of such entity's consolidated gross revenues within the
last three years;
o has not been an executive officer, director or trustee of a charitable
organization in which the Corporation or any of its subsidiaries made
contributions in any fiscal year that exceeded the greater of $1 million,
or 2% of the charitable organization's consolidated gross revenues;
o has no interest in any significant transactions or business relationships
with the Corporation or its subsidiaries that are required to be disclosed
by the rules and regulations of the Securities and Exchange Commission;
o is not a member of the immediate family of any person described above.
Immediate family members are the Director's spouse, parents, children,
siblings, mothers and fathers-in-law, sons and daughters-in-law, brothers
and sisters-in-law and anyone (other than domestic employees) who share
the Director's home.
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Appendix B
LEAD DIRECTOR DUTIES
The duties and responsibilities of the Chair of the Executive Committee (as the
Lead Director) shall be as follows:
1) The Chair of the Executive Committee shall be informed by, and
counsel, the Chairman and Chief Executive Officer on material
strategy, policy, and management matters.
2) The Chair of the Executive Committee shall be available to advise
and counsel the Chief Executive Officer on any matter relating to
the Corporation.
3) The Chair of the Executive Committee shall offer the Chief Executive
Officer counsel as to special interests and concerns of Directors
and will act as principal liaison between the Independent Directors
and the Chairman.
4) In the absence or inability of the Chairman or Chief Executive
Officer to act, the Chair of the Executive Committee shall perform
those duties of the Chairman pertaining to Board functions.
5) The Chair of the Executive Committee shall recommend to the Chairman
the retention of consultants or other experts who would report
directly to the Board.
6) The Chair of the Executive Committee shall advise the Chairman as to
the quality, quantity and timeliness of the flow of information from
the Corporation that is necessary for the Directors to effectively
and responsibly perform their duties.
7) The Chair of the Executive Committee shall chair in camera
discussions requested by the Independent Directors.
8) The Chair of the Executive Committee shall serve as an ex-officio
member of each of the committees of the Board.
9) The Chair of the Executive Committee shall work with the Chairman
and other independent directors to give advice to the Chairman in
the development of Board membership.
January 2005
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