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Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1999 Commission file number 1-7436
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
452 Fifth Avenue
New York, New York 10018
(Address of principal executive offices)
Telephone (212) 525-6100
IRS Employer Identification No. 13-2764867. State of Incorporation: Maryland
Securities registered on the New York Stock Exchange pursuant to Section 12(b)
of the Act:
Depositary Shares, each representing a one-fourth interest in a share of
Adjustable Rate Cumulative Preferred Stock, Series D
$1.8125 Cumulative Preferred Stock
$2.8575 Cumulative Preferred Stock
7% Subordinated Notes due 2006
8.375% Debentures due 2007
Securities registered pursuant to Section 12(g) of the Act: None
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]
All voting stock (704 shares of Common Stock $5 par value) is owned by HSBC
North America Inc., an indirect wholly owned subsidiary of HSBC Holdings plc.
Documents incorporated by reference: None
1
This page is intentionally left blank.
2
T A B L E O F C O N T E N T S
Page
Part I
1. Business 4
2. Properties 6
3. Legal Proceedings 6
4. Submission of Matters to a Vote of
Security Holders 6
Part II
5. Market for the Registrant's Common Equity
and Related Stockholder Matters 6
6. Selected Financial Data 7
7. Management's Discussion and Analysis
of Financial Condition and
Results of Operations 10
7A. Quantitative and Qualitative Disclosures
About Market Risk 32
8. Financial Statements and
Supplementary Data 35
9. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 77
Part III
10. Directors and Executive Officers
of the Registrant 77
11. Executive Compensation 81
12. Security Ownership of Certain Beneficial
Owners and Management 82
13. Certain Relationships and Related
Transactions 83
Part IV
14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K 83
3
P A R T I
Item 1. Business
HSBC USA Inc. (the Company), formerly HSBC Americas, Inc., is a New York State
based bank holding company registered under the Bank Holding Company Act of
1956, as amended. All of the Company's common stock is owned by HSBC North
America Inc., an indirect wholly owned subsidiary of HSBC Holdings plc (HSBC).
HSBC, the ultimate parent company of HSBC Bank plc, formerly Midland Bank plc,
and The Hongkong and Shanghai Banking Corporation Limited (HongkongBank), is
an international banking and financial services organization with major
commercial and investment banking franchises operating in the Asia-Pacific
region, Europe, the Americas, the Middle East and Africa. The principal
executive offices of HSBC are located in London, England. HSBC, with assets
of $569 billion at December 31, 1999, is one of the world's largest banking
and financial services organizations.
HSBC completed the purchase of Republic New York Corporation (Republic), a
bank holding company with consolidated total assets of $46.9 billion, on
December 31, 1999. Also on December 31, 1999, following the purchase,
Republic merged with the Company. At December 31, 1999, the combined Company
had assets of $90.2 billion and employed approximately 15,100 full and part
time employees.
The Company's principal subsidiary HSBC Bank USA (the Bank), formerly Marine
Midland Bank, merged with Republic National Bank of New York (Republic Bank)
on December 31, 1999. After the merger, on a combined basis, the Bank had
assets of $79.6 billion and deposits of $58.5 billion at December 31, 1999.
The Company also is a participant in a joint venture, Wells Fargo HSBC Trade
Bank. The Company has a factoring and asset-based lending subsidiary and a
commercial bank in California acquired with the Republic merger.
The Bank's domestic operations encompass the entire State of New York as well
as two branches in Pennsylvania and seven branches in Florida. Selected
commercial and consumer banking products are offered on a national basis. The
Bank is engaged in a general commercial banking business, offering a full
range of banking products and services to individuals including high-net-worth
individuals, corporations, institutions and governments. Through its
affiliation with HSBC, the Bank offers its customers access to global markets
and services. In turn, the Bank plays a role in the delivery and processing
of other HSBC products. As a result of the merger with Republic, in addition
to its domestic offices, the Bank now maintains foreign branch offices,
subsidiaries and/or representative offices in the Caribbean, Canada, Europe,
Asia and Latin America.
As a result of the merger with Republic, the Bank has a 49% investment in HSBC
Republic Holdings (Luxembourg) S.A. (HSBC Republic), formerly Safra Republic
Holdings S.A., a holding company, principally engaged in international private
banking and commercial banking with assets of $24.4 billion at December 31,
1999. HSBC, in a transaction separate from the acquisition of Republic, also
acquired the remaining 51% ownership interest in HSBC Republic on December 31,
1999.
4
P A R T I Continued
Item 1. Business Continued
The Bank is 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), and it is subject to banking laws and regulations which
place various restrictions on and requirements regarding its 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. The deposits of the Bank are insured by the Federal
Deposit Insurance Corporation (FDIC) and subject to relevant FDIC regulations.
The Company has been prohibited, with certain exceptions, from engaging,
directly or indirectly, in activities which are not closely related to
banking. The enactment of the Gramm-Leach-Bliley Act of 1999 (GLB Act),
effective March 11, 2000, provides expanded opportunities for banks, other
depository institutions, insurance companies and securities firms to enter
into combinations that permit a single financial services organization to
offer a more complete line of financial products and services. Further
competitive pressures are anticipated from industry consolidations in the wake
of the passage of the GLB Act.
The Company and the Bank are subject to risk-based capital and leverage
guidelines issued by the Federal Reserve. The Federal Reserve is required by
law to take specific prompt actions with respect to financial institutions
that do not meet minimum capital standards. Five capital standards have been
identified, the highest of which is well-capitalized. A well-capitalized bank
must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based
capital ratio of at least 10% and a leverage ratio of at least 5% and not be
subject to a capital directive order. The leverage ratio measures Tier 1
capital against total non-risk weighted assets. The Bank's ratios at
December 31, 1999 exceeded all ratios required for the well-capitalized
category.
The Company and its subsidiaries face competition in all the markets they
serve, competing with other financial institutions, including commercial
banks, investment banks, savings and loan associations, credit unions,
consumer finance companies, money market funds and other non-banking
institutions such as insurance companies, major retailers, brokerage firms and
investment companies. Many of these institutions are not subject to the same
laws and regulations imposed on the Company and its subsidiaries.
5
Item 2. Properties
The principal executive offices of the Company are located at 452 Fifth
Avenue, New York, New York 10018, which is owned by the Bank. The principal
executive offices of the Bank are located at One HSBC Center, Buffalo, New
York 14203, in a building under a long-term lease. The Bank has more than 450
other banking offices in New York State located in 49 counties, two branches
in Pennsylvania and seven branches in Florida. Approximately 38% of these
offices are located in buildings owned by the Bank 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 is materially
important to the respective activities. The Bank owns properties in: Miami,
Florida; Buenos Aires, Argentina; Santiago, Chile; Montevideo, Uruguay; Mexico
City, Mexico; Milan, Italy and London, England.
Item 3. Legal Proceedings
The information contained in Note 27 to the Financial Statements on page 67 of
this report is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders
Reference is made to Item 5.
P A R T II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Since all common stock of the Company is owned by HSBC North America Inc.,
shares of the Company's common stock are not listed or traded on a securities
exchange.
6
Item 6. Selected Financial Data
- -----------------------------------------------------------------------------------------------------
HSBC acquired Republic New York Corporation (Republic) and merged it with the Company on December 31,
1999. The acquisition was accounted for as a purchase by the Company so that the fair value of the
assets and liabilities of Republic are included in balances at year end 1999, whereas results of
operations for all periods presented exclude those of Republic.
Year Ended December 31, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------
in millions
Net interest income $1,225.9 $1,165.3 $1,173.4 $ 961.8 $ 892.2
- ----------------------------------------------------------------------------------------------------
Securities transactions 10.1 13.8 17.4 7.9 12.3
Interest on Brazilian tax settlement 13.1 32.7 - - -
Other operating income 440.8 413.6 342.0 303.0 302.5
- ----------------------------------------------------------------------------------------------------
Total other operating income 464.0 460.1 359.4 310.9 314.8
- ----------------------------------------------------------------------------------------------------
Other operating expenses 827.9 780.2 781.4 656.8 695.8
Provision for credit losses 90.0 80.0 87.4 64.7 175.3
- ----------------------------------------------------------------------------------------------------
Income before taxes 772.0 765.2 664.0 551.2 335.9
Applicable income tax expense 308.3 238.1 193.0 171.0 52.3
- ----------------------------------------------------------------------------------------------------
Net income $ 463.7 $ 527.1 $ 471.0 $ 380.2 $ 283.6
- ----------------------------------------------------------------------------------------------------
Balances at year end
Total assets $ 90,240 $ 33,944 $31,518 $23,630 $20,553
Goodwill and other acquisition intangibles 3,307 335 370 158 35
Long-term debt 5,885 1,748 1,708 1,080 710
Common shareholder's equity 9,541 2,228 2,039 1,875 1,599
Total shareholders' equity 10,041 2,228 2,039 1,973 1,697
Ratio of shareholders' equity to total assets 11.13% 6.56% 6.47% 8.35% 8.26%
- ----------------------------------------------------------------------------------------------------
Selected financial data (1)
Rate of return on
Total assets 1.35% 1.60% 1.62% 1.83% 1.50%
Total common shareholder's equity 20.24 24.93 22.93 21.33 16.53
Total shareholders' equity to total assets 6.70 6.44 7.14 8.90 9.37
- ----------------------------------------------------------------------------------------------------
Quarterly Results of Operations
1999 1998
- ----------------------------------------------------------------------------------------------------
4th Q 3rd Q 2nd Q 1st Q 4th Q 3rd Q 2nd Q 1stQ
- ----------------------------------------------------------------------------------------------------
in millions
Net interest income $302.2 $305.5 $306.9 $311.3 $295.3 $287.8 $293.8 $288.4
- ----------------------------------------------------------------------------------------------------
Securities transactions 2.9 (0.1) 4.9 2.4 3.3 4.4 1.5 4.6
Interest on Brazilian
tax settlement 13.1 - - - 32.7 - - -
Other operating income 109.4 108.2 104.0 119.2 94.0 97.7 113.2 108.7
- ----------------------------------------------------------------------------------------------------
Total other operating
income 125.4 108.1 108.9 121.6 130.0 102.1 114.7 113.3
- ----------------------------------------------------------------------------------------------------
Other operating expenses 217.2 200.3 203.8 206.6 200.2 192.7 194.6 192.7
Provision for credit
losses 22.5 22.5 22.5 22.5 21.0 20.0 19.5 19.5
- ----------------------------------------------------------------------------------------------------
Income before taxes 187.9 190.8 189.5 203.8 204.1 177.2 194.4 189.5
Applicable income tax
expense 74.0 75.9 76.0 82.4 45.5 58.1 68.2 66.3
- ----------------------------------------------------------------------------------------------------
Net income $113.9 $114.9 $113.5 $121.4 $158.6 $119.1 $126.2 $123.2
====================================================================================================
(1) Based on average daily balances.
7
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS
The following table shows the average balances of the principal components
of assets, liabilities and shareholders' equity, together with their
respective interest amounts and rates earned or paid on a taxable
equivalent basis.
1999
---------------------------
Balance Interest Rate
- ------------------------------------------------------------------------------
Assets
Interest bearing deposits with banks $ 1,795 $ 97.0 5.40%
Federal funds sold and securities purchased
under resale agreements 2,238 116.5 5.21
Trading assets 919 50.8 5.52
Securities 3,658 214.7 5.87
Loans
Domestic
Commercial 10,500 825.3 7.86
Consumer
Residential mortgages 9,388 656.9 7.00
Other consumer 2,430 285.6 11.75
- ------------------------------------------------------------------------------
Total domestic 22,318 1,767.8 7.92
International 1,066 75.4 7.07
- ------------------------------------------------------------------------------
Total loans 23,384 1,843.2 7.88
- ------------------------------------------------------------------------------
Total earning assets 31,994 $2,322.2 7.26%
- ------------------------------------------------------------------------------
Allowance for credit losses (379)
Cash and due from banks 1,046
Other assets 1,577
- ------------------------------------------------------------------------------
Total assets $34,238
==============================================================================
Liabilities and Shareholders' Equity
Interest bearing demand deposits $ 2,236 $ 20.3 0.91%
Consumer savings deposits 5,672 142.9 2.52
Other consumer time deposits 6,884 321.4 4.67
Commercial, public savings and other time deposits 4,149 152.3 3.67
Deposits in foreign offices, primarily banks 4,584 216.0 4.71
- ------------------------------------------------------------------------------
Total interest bearing deposits 23,525 852.9 3.63
- ------------------------------------------------------------------------------
Federal funds purchased and securities sold
under repurchase agreements 951 45.2 4.75
Other short-term borrowings and trading liabilities 1,627 84.4 5.19
Long-term debt 1,867 111.7 5.98
- ------------------------------------------------------------------------------
Total interest bearing liabilities 27,970 $1,094.2 3.91%
- ------------------------------------------------------------------------------
Interest rate spread 3.35%
- ------------------------------------------------------------------------------
Noninterest bearing deposits 3,112
Other liabilities 864
Total shareholders' equity 2,292
- ------------------------------------------------------------------------------
Total liabilities and shareholders' equity $34,238
==============================================================================
Net yield on average earning assets 3.84%
Net yield on average total assets 3.59
==============================================================================
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 fees
included were $36 million for 1999, $28 million for 1998, $20 million for 1997.
8
1998 1997
------------------------------ ------------------------------
Balance Interest Rate Balance Interest Rate
----------------------------------------------------------------------
in millions
$ 2,377 $ 136.6 5.75% $ 1,698 $ 98.7 5.82%
2,299 128.0 5.57 977 51.8 5.30
851 51.0 5.99 980 58.9 6.01
3,930 232.6 5.92 3,567 219.2 6.14
8,569 738.3 8.62 7,457 666.9 8.94
9,531 684.7 7.18 8,829 652.8 7.39
2,652 319.8 12.06 3,083 369.8 12.00
----------------------------------------------------------------------
20,752 1,742.8 8.40 19,369 1,689.5 8.72
640 44.6 6.96 680 45.9 6.76
----------------------------------------------------------------------
21,392 1,787.4 8.36 20,049 1,735.4 8.66
----------------------------------------------------------------------
30,849 $2,335.6 7.57% 27,271 $2,164.0 7.94%
----------------------------------------------------------------------
(404) (426)
1,128 1,010
1,274 1,171
----------------------------------------------------------------------
$32,847 $29,026
======================================================================
$ 2,097 $ 22.9 1.09% $ 1,974 $ 22.7 1.15%
5,527 148.3 2.68 5,369 156.9 2.92
6,452 352.2 5.46 5,971 317.4 5.32
3,132 133.0 4.25 2,105 86.9 4.13
4,074 211.0 5.18 1,846 95.2 5.15
----------------------------------------------------------------------
21,282 867.4 4.08 17,265 679.1 3.93
----------------------------------------------------------------------
917 48.1 5.24 1,977 108.3 5.48
2,717 156.1 5.74 1,588 88.4 5.57
1,469 96.1 6.54 1,755 111.8 6.37
----------------------------------------------------------------------
26,385 $1,167.7 4.45% 22,585 $ 987.6 4.42%
----------------------------------------------------------------------
3.11% 3.53%
----------------------------------------------------------------------
3,665 3,891
683 478
2,114 2,072
----------------------------------------------------------------------
$32,847 $29,026
======================================================================
3.79% 4.31%
3.56 4.05
======================================================================
9
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Company reported pretax income of $772.0 million for 1999 compared with
$765.2 million in 1998. For the year 1999 net income was $463.7 million
compared with $527.1 million in 1998. Return on average common shareholder's
equity was 20.24% in 1999 and 24.93% in 1998. Business growth and expense
discipline helped spur growth in income in 1999 as well as did certain one-
time items. Results for 1999 and 1998 included the settlement with the U.S.
Internal Revenue Service on Brazilian tax credits disallowed in the 1980's.
The settlement contributed $13.1 million of interest to pretax income in 1999
and $32.7 million of interest to pretax income in 1998 and also reduced taxes
by a net amount of $10.2 million in 1998.
HSBC acquired Republic New York Corporation (Republic) and merged it with the
Company on December 31, 1999. The acquisition was accounted for as a purchase
by the Company. The fair value of the assets and liabilities of Republic are
included in the financial statements of the Company as of December 31, 1999.
The Company's 1999 results of operations were not affected by the Republic
merger transaction.
Republic engaged in five principal lines of business: private banking;
consumer financial services; lending; treasury; and markets. Republic
National Bank of New York (Republic Bank) had 83 branches in the greater New
York metropolitan area, where it was the third-largest deposit taking
institution, and 7 branches in Florida, as well as 36 branches, representative
offices or wholly-owned subsidiaries in Latin America, the Caribbean, Europe
and Asia. Republic was a world leader in banknotes and bullion trading and
provided the fifth-largest factoring service in the United States. In
addition, it had significant international private banking operations in New
York, Miami, Los Angeles and in Asia. At December 31, 1999 Republic had total
assets of $46.9 billion, deposits of $29.9 billion and common shareholders'
equity of $2.9 billion. Republic's net income for 1999 was $418 million. See
page 30 for additional analysis of Republic.
This report includes forward-looking statements that involve inherent risks
and uncertainties. Statements that are not historical facts, including
statements about management's beliefs and expectations, are forward-looking
statements. A number of important factors could cause actual results to
differ materially from those contained in any forward-looking statements.
Such factors include, but are not limited to: sharp and/or rapid changes in
interest rates; significant changes in the economic conditions which could
materially change anticipated credit quality trends and the ability to
generate loans; cost savings and revenue enhancements as well as the nature,
costs and timing of integration of businesses relating to the acquisition;
technology changes; significant changes in accounting, tax or regulatory
requirements; and competition in the geographic and business areas in which
the Company conducts its operations.
A detailed review comparing 1999 operations with 1998 and 1997 follows. It
should be read in conjunction with the consolidated financial statements of
the Company which begin on page 38.
10
E A R N I N G S P E R F O R M A N C E R E V I E W
Net Interest Income
Net interest income is the total interest income on earning assets less the
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, in order to permit comparisons of yields on tax-exempt and
taxable assets.
- ------------------------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
1999 Amount % 1998 Amount % 1997
- ------------------------------------------------------------------------------------------------
in millions
Interest income $2,322.2 $(13.4) (.6) $2,335.6 $171.6 7.9 $2,164.0
Interest expense 1,094.2 (73.5) (6.3) 1,167.7 180.1 18.2 987.6
- ------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis 1,228.0 60.1 5.1 1,167.9 (8.5) (.7) 1,176.4
Taxable equivalent
adjustment 2.1 (.5) (17.5) 2.6 (.4) (15.1) 3.0
- ------------------------------------------------------------------------------------------------
Net interest income $1,225.9 $ 60.6 5.2 $1,165.3 $ (8.1) (.7) $1,173.4
- ------------------------------------------------------------------------------------------------
Average earning assets $ 31,994 $1,145 3.7 $ 30,849 $3,578 13.1 $ 27,271
Average nonearning assets 2,244 246 12.3 1,998 243 13.8 1,755
- ------------------------------------------------------------------------------------------------
Average total assets $ 34,238 $1,391 4.2 $ 32,847 $3,821 13.2 $ 29,026
- ------------------------------------------------------------------------------------------------
Net yield on:
Average earning assets 3.84% .05% 1.3 3.79% (.52)% (12.1) 4.31%
Average total assets 3.59 .03 .8 3.56 (.49) (12.1) 4.05
================================================================================================
Net interest income was $1,228.0 million in 1999 compared with $1,167.9
million in 1998. The increase in net yield in 1999 from 1998 was primarily
due to commercial loan growth and deposit repricing, partially offset by lower
loan rates.
The following table presents net interest income components on a taxable
equivalent basis, using marginal tax rates of 35%, and quantifies the changes
in the components according to "volume and rate".
11
Net Interest Income Components Including Volume/Rate Analysis
- -------------------------------------------------------------------------------------------------------------
1999 Compared to 1998 1998 Compared to 1997
Increase(Decrease) Increase(Decrease)
1999 Volume Rate 1998 Volume Rate 1997
- -------------------------------------------------------------------------------------------------------------
in millions
Interest income:
Interest bearing deposits with banks $ 97.0 $(31.8) $ (7.8) $ 136.6 $ 39.1 $ (1.2) $ 98.7
Federal funds sold and securities
purchased under resale agreements 116.5 (3.3) (8.2) 128.0 73.4 2.8 51.8
Trading assets 50.8 3.9 (4.1) 51.0 (7.7) (.2) 58.9
Securities 214.7 (16.0) (1.9) 232.6 21.6 (8.2) 219.2
Loans:
Domestic:
Commercial 825.3 155.9 (68.9) 738.3 96.5 (25.1) 666.9
Consumer
Residential mortgages 656.9 (10.2) (17.6) 684.7 50.8 (18.9) 652.8
Credit card receivables 186.9 (21.0) (4.2) 212.1 (52.9) 10.8 254.2
Other consumer 98.7 (6.8) (2.2) 107.7 (6.8) (1.1) 115.6
International 75.4 30.1 .7 44.6 (2.7) 1.4 45.9
- -------------------------------------------------------------------------------------------------------------
Total interest income 2,322.2 100.8 (114.2) 2,335.6 211.3 (39.7) 2,164.0
- -------------------------------------------------------------------------------------------------------------
Interest expense:
Interest bearing demand deposits 20.3 1.4 (4.0) 22.9 1.4 (1.2) 22.7
Consumer savings and
other time deposits 464.3 23.3 (59.5) 500.5 26.7 (.5) 474.3
Commercial and public savings
and other time deposits 152.3 39.1 (19.8) 133.0 43.5 2.6 86.9
Deposits in foreign offices 216.0 25.0 (20.0) 211.0 115.4 .4 95.2
Short-term borrowings 129.6 (54.8) (19.8) 204.2 3.9 3.6 196.7
Long-term debt 111.7 24.3 (8.7) 96.1 (18.6) 2.9 111.8
- -------------------------------------------------------------------------------------------------------------
Total interest expense 1,094.2 58.3 (131.8) 1,167.7 172.3 7.8 987.6
- -------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis $1,228.0 $ 42.5 $ 17.6 $1,167.9 $ 39.0 $(47.5) $1,176.4
=============================================================================================================
The changes in interest income and interest expense due to both rate and
volume have been allocated in proportion to the absolute amounts of the change
in each.
Average Balances and Interest Rates
Average balances and interest rates earned or paid for the past three years
are reported on pages 8 and 9. Average earning assets increased to $31,994
million in 1999 from $30,849 million in 1998 resulting in increased interest
income even though rates earned declined to 7.26% in 1999 from 7.57% in 1998.
The increase in net interest income is primarily attributable to commercial
loan growth described in the following paragraph and deposit repricing
partially offset by lower loan rates.
Average commercial loans were $10,500 million in 1999, compared with $8,569
million in 1998. The growth in average commercial loans included the
acquisition of commercial loans from the U.S. branches of The Hongkong and
Shanghai Banking Corporation Limited (HongkongBank) in late 1998. Yields on
commercial loans were 7.86% in 1999 compared with 8.62% in 1998. Average
residential mortgages were $9,388 million in 1999 compared with $9,531 million
in 1998. The yield on residential mortgages was 7.00% in 1999 compared with
7.18% in 1998.
12
Interest bearing deposits averaged $23,525 million during 1999 compared with
$21,282 million in 1998. A significant part of this increase was attributable
to higher levels of deposits placed by institutional and public customers and
other members of the HSBC Group.
Other Operating Income
Other operating income was $464.0 million in 1999 compared with $460.1 million
in 1998 and $359.4 million in 1997.
- -----------------------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
1999 Amount % 1998 Amount % 1997
- -----------------------------------------------------------------------------------------------
in millions
Trust income $ 52.2 $ 4.9 10.4 $ 47.3 $ 4.3 10.0 $ 43.0
Service charges 128.6 13.2 11.5 115.4 11.4 11.0 104.0
Mortgage servicing revenue 30.5 (12.6) (29.4) 43.1 13.4 45.4 29.7
Letter of credit fees 32.5 6.6 25.5 25.9 4.4 20.4 21.5
Credit card fees 44.5 3.0 7.4 41.5 (9.4) (18.6) 50.9
Other fee-based income 90.5 12.4 15.9 78.1 15.8 25.3 62.3
Investment and insurance
product fees 32.4 5.7 21.3 26.7 6.5 32.6 20.2
Interest on Brazilian
tax settlement 13.1 (19.6) (59.8) 32.7 32.7 - -
Other income 19.7 (12.2) (38.4) 31.9 27.6 649.1 4.3
- -----------------------------------------------------------------------------------------------
Nontrading income 444.0 1.4 .3 442.6 106.7 31.8 335.9
- -----------------------------------------------------------------------------------------------
Trading asset revenue (loss) 3.9 5.6 320.8 (1.7) (3.4) (200.9) 1.7
Foreign exchange revenue 6.0 .6 11.3 5.4 1.0 21.2 4.4
- -----------------------------------------------------------------------------------------------
Trading revenues 9.9 6.2 170.6 3.7 (2.4) (39.2) 6.1
- -----------------------------------------------------------------------------------------------
Securities transactions 10.1 (3.7) (27.1) 13.8 (3.6) (20.6) 17.4
- -----------------------------------------------------------------------------------------------
Total other operating income $464.0 $ 3.9 .8 $460.1 $100.7 28.0 $359.4
===============================================================================================
Nontrading Income
Nontrading income was $444.0 million in 1999 compared with $442.6 million in
1998. The Company received interest of $13.1 million and $32.7 million in
1999 and 1998, respectively, as a result of the settlement of previously
disallowed income tax credits on Brazilian debt. Other income in 1999
included a gain on the sale of a student loan business of $15.0 million and in
1998 included gains of $28.1 million on the sales of selected credit card
portfolios. Excluding these items, nontrading income was up from 1998 as a
result of increases in deposit service charges, fees from the sale of
investment and insurance products and commercial loan fees. Partially
offsetting these was a decrease in mortgage servicing revenue including lower
gains on sales of residential mortgages compared with 1998.
13
Trading Asset Revenues
Trading revenues include securities trading gains and losses, commissions
earned from distributing municipal obligations, and foreign exchange revenue
from transactions with corporate clients and correspondent banks. It does not
include interest income from these activities (included as a component of net
interest income), which is usually substantial. The following is an analysis
of the average balance outstanding, interest income (on a taxable equivalent
basis) and trading revenue related to trading assets. This analysis excludes
foreign exchange revenue which is separately disclosed in the table of other
operating income.
- --------------------------------------------------------------------------------------------------------
Mortgage
and Other
U.S. Asset-Backed Other Precious
Government Securities Securities Metals Derivatives Total
- --------------------------------------------------------------------------------------------------------
in millions
1999
Average balance $172 $ 729 $ 8 $2 $ 8 $ 919
Interest income 8.7 41.7 .4 - - 50.8
Trading asset revenue (loss) 2.9 (1.4) 1.6 - .8 3.9
1998
Average balance 9 834 6 - 2 851
Interest income .5 50.0 .5 - - 51.0
Trading asset revenue (loss) .7 (2.6) 1.5 - (1.3) (1.7)
1997
Average balance 2 972 5 - 1 980
Interest income .2 58.3 .4 - - 58.9
Trading asset revenue (loss) .3 .4 1.3 - (.3) 1.7
========================================================================================================
The balance in precious metals relates to the Republic acquisition at year end
which included a precious metal inventory of $567 million.
Securities Transactions
Securities transactions during 1999 resulted in net gains of $10.1 million
compared with net gains of $13.8 million in 1998. These gains resulted from
the sale of investments classified as available for sale, primarily highly
leveraged partnership interests.
Other Operating Expenses
- -----------------------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
1999 Amount % 1998 Amount % 1997
- -----------------------------------------------------------------------------------------------
in millions
Salaries and employee benefits $421.3 $11.0 2.7 $410.3 $ 12.3 3.1 $398.0
Net occupancy 89.0 (.4) (.5) 89.4 (1.6) (1.7) 91.0
Equipment 53.7 2.3 4.4 51.4 6.3 13.9 45.1
Amortization of intangibles 33.3 (4.4) (11.7) 37.7 3.3 9.7 34.4
FDIC assessment 4.6 .1 2.5 4.5 .3 6.6 4.2
Marketing 24.4 3.0 13.7 21.4 (5.6) (20.6) 27.0
Outside services 39.5 (.8) (2.0) 40.3 1.4 3.7 38.9
Professional fees 22.1 2.4 12.5 19.7 (3.1) (13.9) 22.8
Other real estate and
owned asset expense (13.9) 3.2 19.1 (17.1) (19.6) (775.3) 2.5
Other 153.9 31.3 25.5 122.6 5.1 4.3 117.5
- -----------------------------------------------------------------------------------------------
Total other operating expenses $827.9 $47.7 6.1 $780.2 $ (1.2) (.2) $781.4
- -----------------------------------------------------------------------------------------------
Personnel - average number 8,906 (32) (.4) 8,938 (72) (.8) 9,010
===============================================================================================
14
Other operating expenses were $827.9 million in 1999 compared with $780.2
million in 1998. The increase over 1998 was due in part to restructuring
charges included in other operating expenses of $26.7 million recognized in
1999 for the estimated cost of severing employees and vacating space of the
Company stemming from the Republic acquisition. See Note 1, Acquisitions, to
the financial statements for further discussion. Without this expense, the
cost:income ratio for 1999 was 47.4% compared with 48.0% in 1998. Personnel
expense increased to $421.3 million in 1999 from $410.3 million in 1998
principally due to normal merit increases. Average staffing levels (full time
equivalents) were 8,906 in 1999 compared with 8,938 in 1998. Other real
estate and owned asset expense in 1999 and 1998 benefited from gains on
disposals of properties.
Year 2000 Readiness Disclosure
The Company recognized that with the approach of the new millennium the
inability of systems around the world to recognize the date change from
December 31, 1999 to January 1, 2000 could pose significant issues. The
Company assessed the impact of Year 2000. The relevant systems were
remediated and tested and as a result the Company did not experience
significant disruptions from its systems not being Year 2000 compliant.
The Company estimated the total cost of the project to be $59.3 million
including $10 million relating to other than information technology (IT)
projects. Approximately $57 million had been incurred as of December 31, 1999
for the total project, including $13.4 million in 1999. These costs include
capitalizable costs of $15.2 million for upgrading personal computers and
replacing software, of which $5.7 million was incurred in 1999. No material
incremental costs were incurred in any single period as generally the costs
represented the redeployment of existing IT resources. Although the
redeployment has resulted in deferral of some IT projects and the acceleration
of others, the Company does not expect the deferrals to have a material effect
on its financial position or results of operations.
Provision for Credit Losses
Provision for credit losses was $90.0 million in 1999 compared with $80.0
million in 1998. Net charge offs in the credit card portfolio were $74.9
million and $90.1 million in 1999 and 1998, respectively. The delinquency
rate for the credit card portfolio was 3.41% at December 31, 1999 compared
with 3.91% at December 31, 1998. Commercial loan credit quality resulted in
net charge offs of $8.7 million in 1999 compared with $5.0 million in 1998.
An analysis of the allowance for credit losses and the provision for credit
losses begins on page 26.
15
Income Taxes
The Company recognized income tax expense of $308.3 million and $238.1 million
in 1999 and 1998, respectively. The 1998 amount includes a credit of $10.2
million relating to the income tax refund received from the U.S. Internal
Revenue Service on the Brazilian tax credits, net of additional taxes due on
the interest income received on the tax settlement.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss carryforwards. The Company has a valuation
allowance for the portion of the Company's net deductible temporary
differences which are not expected to be realized. Income tax expense was
reduced in 1998 through reductions in the valuation allowance of $45.0
million. At December 31, 1999, the Company had a net deferred tax asset of
$120.7 million, as compared with a net deferred tax asset of $59.3 million at
December 31, 1998.
Business Segments
The Company has four distinct business segments for purposes of management
reporting: commercial banking, mortgage banking, personal banking and
treasury. A description of each segment and the methodologies used to measure
financial performance are included in Note 25, Business Segments, to the
financial statements. The following summarizes the results for each segment.
- --------------------------------------------------------------------------------------------------------
Average Liabilities/
Average Assets Equity Pretax Income
--------------------------- -------------------------- ------------------
1999 1998 1997 1999 1998 1997 1999 1998 1997
- --------------------------------------------------------------------------------------------------------
in millions
Segments:
Commercial Banking $11,797 $ 9,202 $ 7,683 $ 7,033 $ 5,873 $5,272 $273 $235 $259
Mortgage Banking 8,438 8,489 7,792 326 327 296 69 87 55
Personal Banking 4,014 4,346 4,691 15,038 14,731 14,037 256 254 178
Treasury 4,921 5,279 3,677 6,312 6,720 3,683 17 13 8
Other 5,068 5,531 5,183 5,529 5,196 5,738 157 176 164
- --------------------------------------------------------------------------------------------------------
Total $34,238 $32,847 $29,026 $34,238 $32,847 $29,026 $772 $765 $664
- --------------------------------------------------------------------------------------------------------
The following summarizes the results for the commercial banking segment.
- --------------------------------------------------------------------------------------------------------
Average Assets Average Liabilities Pretax Income
-------------------------- ------------------------- -------------------
1999 1998 1997 1999 1998 1997 1999 1998 1997
- --------------------------------------------------------------------------------------------------------
in millions
Loans $10,162 $7,662 $6,258 $ 7 $ 4 $ 4 $ 99 $ 92 $116
Deposits 559 649 567 5,464 4,817 3,960 105 88 83
Payment processing 441 471 499 1,208 928 1,193 38 33 40
Other 635 420 359 354 124 115 31 22 20
- --------------------------------------------------------------------------------------------------------
Total $11,797 $9,202 $7,683 $7,033 $5,873 $5,272 $273 $235 $259
- --------------------------------------------------------------------------------------------------------
Commercial banking segment's pretax income increased in 1999 from 1998. A
major factor contributing to the increased financial results in commercial
banking over 1998 was the acquisition of commercial loans from HongkongBank
late in 1998, partially offset by expenses to service the portfolio and higher
credit quality expenses. Deposits' pretax income increased in 1999 from 1998
16
due to growth in outstanding balances partially offset by the general
tightening of spreads resulting from declining interest rates. Payment
processing pretax income increased in 1999 from 1998. Other pretax income,
which includes trade services, standby credit facilities and corporate trust
activities, increased as a result of the Company's efforts to grow fee-based
businesses.
The following summarizes the results for the mortgage banking segment.
- ----------------------------------------------------------------------------------------------
Average Assets Average Liabilities Pretax Income
------------------------ -------------------- ------------------
1999 1998 1997 1999 1998 1997 1999 1998 1997
- ----------------------------------------------------------------------------------------------
in millions
Mortgages held $7,885 $7,994 $7,535 $ - $ - $ - $48 $55 $36
Mortgages serviced * 553 495 257 326 327 296 21 32 19
- ----------------------------------------------------------------------------------------------
Total $8,438 $8,489 $7,792 $326 $327 $296 $69 $87 $55
- ----------------------------------------------------------------------------------------------
* Represents on-balance sheet assets. The principal amount of off-balance sheet mortgage
loans held by others and serviced on their behalf was $13.1 billion (before Republic
acquisition at year end), $12.1 billion and $11.8 billion at year ends 1999, 1998 and 1997,
respectively.
The mortgage banking segment's pretax income decreased in 1999 because of
lower gains on the sales of residential mortgages compared with 1998. Smaller
portfolio sales occurred as a result of competitive pricing pressures. Lower
provisions for credit losses in 1998 also contributed to the reduced pretax
income.
The following summarizes the results for the personal banking segment.
- ------------------------------------------------------------------------------------------------------
Average Assets Average Liabilities Pretax Income
------------------------ ------------------------ -------------------
1999 1998 1997 1999 1998 1997 1999 1998 1997
- ------------------------------------------------------------------------------------------------------
in millions
Revolving credit $1,287 $1,410 $1,738 $ 4 $ 3 $ 4 $ 18 $ 40 $(18)
Installment loans 2,329 2,500 2,543 4 4 4 55 44 36
Deposits 115 152 151 14,777 14,507 13,826 178 168 164
Other 283 284 259 253 217 203 5 2 (4)
- ------------------------------------------------------------------------------------------------------
Total $4,014 $4,346 $4,691 $15,038 $14,731 $14,037 $256 $254 $178
- ------------------------------------------------------------------------------------------------------
During 1999, pretax income for the personal banking segment remained at the
same level as 1998. Pretax income on revolving credit products included gains
of $28.1 million from the sale of certain credit card portfolios in 1998.
Pretax income on installment loans included a gain of $15.0 million on the
sale of a student loan business in 1999. Pretax income on personal deposits
increased as a result of an increase in deposit balances, partially offset by
higher operating costs.
During 1999, pretax income in the treasury segment increased primarily as a
result of more favorable trading conditions compared with 1998. The treasury
segment results do not significantly impact the financial results of the
Company. See Note 25 for further discussion.
Pretax income in the other segment declined as 1998 reflected significantly
higher one time gains, primarily in a $32.7 million Brazilian tax settlement.
Changes are currently being considered to management reporting due to the
Republic acquisition that could alter the business segments the Company uses
to manage operations in the year 2000.
17
B A L A N C E S H E E T R E V I E W
Risk Management
The Company's organizational structure includes a Risk Management Committee
comprised of senior officers to oversee the risk management process. This
committee is charged with the review of the internal control framework which
identifies, measures, monitors and controls the risks undertaken by the
various business and support units and the Company as a whole. It is
responsible for the review of all risks associated with significant new
products and activities and their primary internal controls prior to
implementation. The spectrum of risks includes, but is not limited to,
liquidity, market, credit, operational, legal and reputational risk. The
Asset and Liability Policy Committee manages the details of liquidity and
interest rate risk. The management of credit risk is further discussed on
page 22.
Asset/Liability Management
The principal objectives of asset/liability management are to ensure adequate
liquidity and to manage exposure to interest rate, currency and other market
risks. In managing these risks, the Company seeks to protect both its income
stream and the value of its assets.
Liquidity management requires maintaining funds to meet customers' borrowing
and deposit withdrawal requirements as well as funding anticipated growth.
Interest rate exposure management seeks to control both the near term and
longer term effects of interest rate movements on net interest income and
other correlated income.
The Company has a variety of available techniques for implementing asset/
liability management decisions. Overall balance sheet strategy is centralized
under the Asset and Liability Policy Committee, comprised of senior officers.
Authority and responsibility for implementation of the Committee's broad
strategy is controlled under a framework of defined balance sheet position
limits.
The Company employs a combination of interest rate risk assessment techniques,
principally dynamic simulation modeling, capital at risk analysis and gap
analysis to assess the sensitivity of its earnings and capital positions to
changes in interest rates. In addition, increasing reliance will be placed on
Value at Risk (VaR) analysis prospectively as a result of the significant
increase in the volume and scope of trading activities resulting from the
Republic acquisition. These techniques take into consideration all on-balance
sheet and off-balance sheet items. In dynamic simulation modeling, the
primary technique currently used, reactions to a range of possible future
positive and negative interest rate movements are projected with consideration
given to known activities and to the behavioral patterns of specific pools of
assets and liabilities in the corresponding rate environments. The
optionality of some instruments such as mortgage backed securities and the
mortgage loan portfolio is taken into consideration. In VaR, the potential
dollar loss is calculated if historical movements repeat themselves. VaR is
18
calculated for movements during a given time period (for example, ten days)
that have occurred over a given historical period (usually two years). A
confidence level (99% of the time) is statistically established.
The Company maintains a strong liquidity position which was further enhanced
by the Republic acquisition. The size and stability of the deposit base are
complemented by the maintenance of a surplus borrowing capacity in the money
markets, including the ability to issue additional commercial paper and access
unused lines of credit of $600 million at December 31, 1999. Wholesale
liabilities increased to $26,857 million at December 31, 1999 from $7,960
million a year ago. The Company also has strong liquidity as a result of a
high level of assets available for immediate sale or pledge including
securities available for sale, trading assets, mortgages and other assets.
Diversification is also a principle employed in asset/liability management.
As a result of the Republic acquisition, the Company is now an active
participant in international banking markets. Managing this activity requires
diversification of the risks among many countries and counterparties
throughout the world. Liabilities, which are primarily interest bearing
deposits and other purchased funds, are obtained from both domestic and
international sources. These sources of funds represent a wide range of
depositors, mostly individuals, and product types. The stability of the
funding base is enhanced by the diversification of the funding sources.
The Company is subject to interest rate risk associated with the repricing
characteristics of its balance sheet assets and liabilities. Specifically,
as interest rates change, 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
optimize net interest income within the ranges of interest rate risk that
management considers acceptable, the Company uses off-balance sheet derivative
instruments such as interest rate swaps, caps, options and forwards as hedges
to modify the repricing characteristics of specific on-balance sheet assets or
liabilities. Certain changes in authoritative accounting literature required
to be adopted in 2001 may alter the Company's use of these instruments in the
management of balance sheet risk. For additional information, see discussion
in Note 20 to the financial statements.
19
Interest Rate Sensitivity
The following table shows the repricing structure of assets and liabilities as
of December 31, 1999. 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. 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 one day,
and one day figures can be distorted by temporary swings in assets or
liabilities.
- --------------------------------------------------------------------------------------------------
Interest Bearing Funds
Noninterest ---------------------------------------
Bearing 0-90 91-180 181-365 Over 1
December 31, 1999 Funds Days Days Days Year Total
- --------------------------------------------------------------------------------------------------
in millions
Assets $ 10,465 $39,394 $4,671 $ 4,324 $31,386 $90,240
Liabilities and shareholders'
equity 29,079 35,306 4,399 5,500 15,956 90,240
- --------------------------------------------------------------------------------------------------
(18,614) 4,088 272 (1,176) 15,430
Effect of derivative contracts - 3,311 1,783 (2,544) (2,550)
- --------------------------------------------------------------------------------------------------
Gap position $(18,614) $ 7,399 $2,055 $(3,720) $12,880
==================================================================================================
Liabilities and shareholders' equity at year-end 1999 include time deposits of
$100,000 or more with maturity dates as follows: $3,703 million, 0-90 days;
$519 million, 91-180 days; $418 million, 181-365 days, and $192 million over 1
year.
The Company does not use the static "gap" measurement of interest rate risk
reflected in the table above as a primary management tool. See pages 32
through 34 for further description of earnings at risk measurements and
dynamic simulation modeling employed by the Company to manage interest rate
risk.
Commercial Loan Maturities and Sensitivity to Changes in Interest Rates
- --------------------------------------------------------------------------- One
One Over One Over
Year Through Five
December 31, 1999 or Less Five Years Years
- ---------------------------------------------------------------------------
in millions
Domestic:
Construction and mortgage loans $ 904 $2,626 $2,118
Other business and financial 7,082 4,201 253
International 3,963 623 312
- ---------------------------------------------------------------------------
Total $11,949 $7,450 $2,683
===========================================================================
Loans with fixed interest rates $ 2,859 $2,691 $2,146
Loans having variable interest rates 9,090 4,759 537
- ---------------------------------------------------------------------------
Total $11,949 $7,450 $2,683
===========================================================================
The table presents the contractual maturity and interest sensitivity of
domestic commercial and international loans at year-end 1999.
20
Securities Portfolios
Debt securities that the Company has the ability and intent to hold to
maturity are reported at amortized cost. Securities acquired principally for
the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings. All other securities are classified as available for
sale and carried at fair value, with unrealized gains and losses included in
other comprehensive income and reported as a separate component of
shareholders' equity.
The following table is an analysis of the carrying values of the securities
portfolios at the end of each of the last three years. The Company did not
hold any securities in the held to maturity category prior to December 31,
1999.
- ----------------------------------------------------------------------------------------
Held to
Available for Sale Maturity
--------------------------- --------
December 31, 1999 1998 1997 1999
- ----------------------------------------------------------------------------------------
in millions
U.S. Treasury $ 1,522 $1,580 $2,433 $ -
U.S. Government agency obligations 16,396 1,913 1,099 4,122
Obligations of U.S. states and
political subdivisions 8 - - 678
Other domestic debt securities 4,484 569 295 12
Foreign debt securities 3,092 - - -
Equity securities 472 176 172 -
- ----------------------------------------------------------------------------------------
Total $25,974 $4,238 $3,999 $4,812
========================================================================================
Equity securities in the table above include Federal Reserve Bank and Federal
Home Loan Bank stock totaling $238 million at December 31, 1999, $156 million
at December 31, 1998 and $147 million at December 31, 1997.
The following table reflects the distribution of maturities of debt securities
held at year-end 1999 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 fair value of securities outstanding at December 31, 1999. Yields on
tax-exempt obligations have been computed on a taxable equivalent basis using
applicable statutory tax rates.
21
Securities - Contractual Final Maturities and Yield
- -------------------------------------------------------------------------------------------------------
Within After One After Five After
Taxable One but Within but Within Ten
equivalent Year Five Years Ten Years Years
basis Amount Yield Amount Yield Amount Yield Amount Yield
- -------------------------------------------------------------------------------------------------------
in millions
Available for sale:
U.S. Treasury $ 50 4.96% $1,311 5.57% $ 160 3.83% $ 1 6.73%
U.S. Gov't agency 6,727 5.53 543 7.02 475 7.01 8,651 6.73
Other debt securities 1,033 10.13 1,668 6.79 1,551 7.47 3,332 6.83
- -------------------------------------------------------------------------------------------------------
Total fair value $7,810 6.13% $3,522 6.37% $2,186 7.11% $11,984 6.76%
- -------------------------------------------------------------------------------------------------------
Total amortized cost $7,812 $3,564 $2,193 $12,016
=======================================================================================================
Held to maturity:
U.S. Gov't agency $ - * 9.69% $ 51 7.62% $ 455 6.90% $ 3,616 7.44%
Other debt securities 2 13.28 48 10.24 98 8.75 542 7.27
- -------------------------------------------------------------------------------------------------------
Total amortized cost $ 2 13.09% $ 99 8.91% $ 553 7.21% $ 4,158 7.42%
=======================================================================================================
* Less than $500,000
The maturity distribution of U.S. Government agency obligations and other
securities which include asset-backed securities, primarily mortgages, are
based on the contractual due date of the final payment. These securities have
an anticipated cash flow that includes contractual principal payments and
estimated prepayments generally resulting in shorter average lives than those
based on contractual maturities.
Credit Risk Management
The credit approval and policy function is centralized under the control of
the Chief Credit Officer. The structure is designed to emphasize credit
decision accountability, optimize credit quality, facilitate control of credit
policies and procedures and encourage consistency in the approach to, and
management of, the credit process throughout the Company.
The Risk Management Committee is responsible for oversight of credit policy
and the credit risk profile of the loan portfolio. The Chief Credit Officer
is responsible for the design and management of the credit function including
monitoring and making changes, where appropriate, to written credit policies.
In addition to active supervision and evaluation by lending officers, periodic
reviews of the loan portfolio are made by internal auditors, independent
auditors, the Board of Directors and regulatory agency examiners. These
reviews cover selected borrowers' current financial position, past and
prospective earnings and cash flow, and realizable value of collateral and
guarantees. These reviews also serve as an early identification of problem
credits.
22
Loans Outstanding
As a result of the Republic acquisition, loans increased approximately $14
billion at December 31, 1999 comprised of $6 billion commercial loans, $4
billion residential mortgages and $4 billion international loans. In 1998 the
Company acquired $1.7 billion of commercial loans from the U.S. corporate
banking unit of the HongkongBank completing the consolidation of HSBC's
commercial banking activities in the U.S. Credit card portfolios of
approximately $370 million were sold in 1998. Acquisitions in 1997 included a
commercial mortgage portfolio of approximately $400 million and a residential
mortgage portfolio of $5.1 billion.
International loans to banks and other financial institutions included $107
million and $609 million at year ends 1999 and 1998, respectively, to the HSBC
Group. With respect to other business and financial commercial loans, no
single industry group's aggregate borrowings from the Company exceeded 10% of
the total loan portfolio at December 31, 1999. The following table provides a
breakdown of major loan categories as of year end for the past five years.
- ----------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------
in millions
Domestic:
Commercial:
Construction and mortgage loans $ 5,648 $ 3,096 $ 2,235 $ 2,085 $ 1,427
Other business and financial 11,536 7,803 5,811 5,094 5,208
Consumer:
Residential mortgages 13,241 9,467 10,008 3,632 3,080
Credit card receivables 1,290 1,291 1,780 1,939 1,844
Other consumer loans 1,231 1,319 1,179 1,433 1,472
- ----------------------------------------------------------------------------------------------
32,946 22,976 21,013 14,183 13,031
- ----------------------------------------------------------------------------------------------
International:
Government and official institutions 444 331 345 359 373
Banks and other financial institutions 727 622 65 95 284
Commercial and industrial 3,792 120 199 55 84
- ----------------------------------------------------------------------------------------------
4,963 1,073 609 509 741
- ----------------------------------------------------------------------------------------------
Total loans $37,909 $24,049 $21,622 $14,692 $13,772
==============================================================================================
Problem Loan Management
Borrowers who experience difficulties in meeting the contractual payment terms
of their loans receive special attention. Depending on circumstances,
decisions may be made to cease accruing interest on such loans.
The Company complies with regulatory requirements which mandate that interest
not be accrued on commercial loans with principal or interest past due for a
period of ninety days unless the loan is both adequately secured and in
process of collection. In addition, commercial loans are designated as
nonaccruing when, in the opinion of management, reasonable doubt exists with
respect to collectibility of all interest and principal based on certain
factors, including adequacy of collateral.
Interest that has been recorded 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
23
to collectibility of principal, any cash interest payments received are
applied as principal reductions. Loans are not reclassified as accruing until
interest and principal payments are brought current and future payments are
reasonably assured.
Risk Elements in the Loan Portfolio at Year End
- -----------------------------------------------------------------------------------
1999 1998 1997 1996 1995
- -----------------------------------------------------------------------------------
in millions
Nonaccruing loans:
Domestic:
Construction and other commercial
real estate $ 83 $ 104 $ 129 $ 176 $ 170
Other domestic loans 255 233 181 181 298
- -----------------------------------------------------------------------------------
Subtotal 338 337 310 357 468
International 6 - 1 - -
- -----------------------------------------------------------------------------------
Total nonaccruing loans 344 337 311 357 468
Other real estate and owned assets 14 9 12 14 110
- -----------------------------------------------------------------------------------
Total nonaccruing loans, other real estate
and owned assets $358 $ 346 $ 323 $ 371 $ 578
===================================================================================
Ratios:
Nonaccruing loans to total loans .91% 1.40% 1.44% 2.43% 3.40%
Nonaccruing loans, other real estate
and owned assets to total assets .40 1.02 1.02 1.57 2.81
- -----------------------------------------------------------------------------------
Accruing loans contractually past due
90 days or more as to principal or
interest (all domestic):
Residential real estate mortgages $ 13 $ 2 $ 1 $ 12 $ 15
Credit card receivables 1 5 33 35 22
Other consumer loans 3 10 10 12 14
All other 23 13 13 16 9
- -----------------------------------------------------------------------------------
Total accruing loans contractually past
due 90 days or more $ 40 $ 30 $ 57 $ 75 $ 60
===================================================================================
In certain situations where the borrower is experiencing temporary cash flow
problems, and after careful examination by management, the interest rate and
payment terms may be adjusted from the original contractual agreement. When
this occurs and the revised terms at the time of renegotiation are less than
the Company would be willing to accept for a new loan with comparable risk,
the loan is separately identified as restructured.
Nonaccruing loans at December 31, 1999 totaled $344 million compared with $337
million a year ago. Nonaccruing loans that have been restructured but remain
in nonaccruing status amounted to $32 million, $21 million and $34 million at
December 31, 1999, 1998 and 1997, respectively. Cash payments received on
loans on nonaccruing status during 1999, or since loans were placed on
nonaccruing status, whichever was later, totaled $53 million, $29 million of
which was recorded as interest income and $24 million as reduction of loan
principal.
Residential mortgages are generally designated as nonaccruing when delinquent
for more than ninety days. Loans to credit card customers that are past due
more than ninety days are designated as nonaccruing if the customer has agreed
to credit counseling. Other consumer loans are generally not designated as
nonaccruing and are charged off against the allowance for credit losses
according to an established delinquency schedule.
24
The Company identified impaired loans totaling $216 million at December 31,
1999 of which $110 million had an allocation from the allowance of $64
million. At December 31, 1998, identified impaired loans were $183 million,
of which $81 million had an allocation from the allowance of $32 million.
Cross-Border Net Outstandings
The following table presents total cross-border net outstandings in accordance
with Federal Financial Institutions Examination Council (FFIEC) guidelines.
Cross-border net outstandings are amounts payable to the Company by residents
of foreign countries regardless of the currency of claim and local country
claims in excess of local country obligations. Excluded from cross-border
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 deposits 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 deposits); and cross-border claims that are
guaranteed by cash or other external liquid collateral. At December 31, 1999,
the Company's cross-border net outstandings excluded $545 million of Brazilian
assets funded by constraint certificates of deposits.
Cross-border net outstandings include deposits in other banks, loans,
acceptances, securities available for sale, trading securities, revaluation
gains on foreign exchange and derivative contracts and accrued interest
receivable.
Cross-Border Net Outstandings Which Exceed .75% of Total Assets at Year End
- -----------------------------------------------------------------------------
Banks and Other Government and Commercial
Financial Official and
Institutions Institutions Industrial(1) Total
- -----------------------------------------------------------------------------
in millions
December 31, 1999:
Germany $888 $15 $ 114 $1,017
Luxembourg (2) 18 2 2,595 2,615
United Kingdom 523 1 265 789
December 31, 1998:
France 345 - - 345
United Kingdom 52 - 641 693
December 31, 1997:
Canada 198 - 55 253
France 267 - - 267
Japan 268 - - 268
Netherlands 232 - 27 259
United Kingdom 57 - 183 240
=============================================================================
(1) Includes excess of local country claims over local country obligations.
(2) Included in commercial and industrial in 1999 is $2,493 million which
represents the Company's investment in HSBC Republic, formerly Safra
Republic Holdings S.A.
25
Allowance for Credit Losses and Charge Offs
At year-end 1999, the allowance was $660 million, or 1.74% of total loans,
compared with $380 million, or 1.58% of total loans, a year ago. The Republic
acquisition added $289 million to the allowance at December 31, 1999. The
ratio of the allowance to nonaccruing loans was 192.01% at December 31, 1999
compared with 112.74% a year earlier.
- --------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------------------
in millions
Total loans at year end $37,909 $24,049 $21,622 $14,692 $13,772
Average total loans 23,384 21,392 20,049 13,905 13,200
Allowance for credit losses:
Balance at beginning of year $ 379.7 $ 409.4 $ 418.2 $ 477.5 $ 531.5
Allowance related to acquired
businesses 290.2 - 40.3 3.4 .4
Charge offs:
Commercial:
Construction and mortgage loans - - - - 44.9
Other business and financial 27.0 27.9 28.3 69.8 174.8
Consumer:
Residential mortgages 12.1 10.2 7.7 2.6 2.0
Credit card receivables 86.5 105.0 137.2 97.9 57.8
Other consumer loans 9.5 9.5 13.5 11.2 6.3
- --------------------------------------------------------------------------------------------
Total charge offs 135.1 152.6 186.7 181.5 285.8
- --------------------------------------------------------------------------------------------
Recoveries on loans charged off:
Commercial:
Construction and mortgage loans - - - 1.1 11.9
Other business and financial 18.3 22.9 31.3 38.3 29.8
Consumer:
Residential mortgages 1.0 .8 1.0 .5 -
Credit card receivables 11.6 14.9 14.1 10.2 9.2
Other consumer loans 3.9 4.3 3.8 4.0 5.2
- --------------------------------------------------------------------------------------------
Total recoveries 34.8 42.9 50.2 54.1 56.1
- --------------------------------------------------------------------------------------------
Total net charge offs 100.3 109.7 136.5 127.4 229.7
- --------------------------------------------------------------------------------------------
Provision charged to income 90.0 80.0 87.4 64.7 175.3
- --------------------------------------------------------------------------------------------
Balance at end of year $ 659.6 $ 379.7 $ 409.4 $ 418.2 $ 477.5
- --------------------------------------------------------------------------------------------
Allowance ratios:
Total net charge offs to
average loans .43% .51% .68% .92% 1.74%
Year-end allowance to:
Year-end total loans 1.74 1.58 1.89 2.85 3.47
Year-end total nonaccruing loans 192.01 112.74 131.62 116.98 101.95
============================================================================================
Charge offs of individual commercial loans and residential mortgages reflect
management's judgment with respect to the ultimate collectibility of all or
part of the specific loan. Charge offs of consumer loans, excluding
residential mortgages, occur according to an established delinquency schedule.
The allowance for credit losses is evaluated based on an assessment of the
losses inherent in the loan portfolio. This assessment results in an
allowance consisting of allocated and unallocated components.
The allocated component of the allowance includes specific reserves resulting
from the analysis of individual loans and formula-based reserves assigned to
pools of similar loans based on historical loss experience for each loan
category. The specific reserves are based on a regular analysis of all
26
significant commercial credits where the internal credit rating is at or below
a predetermined classification. All other commercial loans are grouped into
pools by credit facility grade. Formula reserves are established based on
historical one year default rates for each pool using data from the last eight
quarters, adjusted for known changes in the economic environment and
management judgment. The allocated portion of the allowance also includes
management's determination of the amounts necessary for loan concentrations.
Residential mortgage loans which are more than 90 days past due are
individually analyzed and appropriate specific reserves are assigned. Other
residential mortgages are grouped into pools based on delinquency status and
formula reserves are established to cover, at a minimum, twelve months of
historical net charge offs using data from the past twelve months' pool loss
rates.
Other consumer loans, including credit card receivables, are grouped into
pools based on product and delinquency status. Formula reserves are
established to cover, at a minimum, six months of historical charge offs using
data from the past twelve months' pool loss rates.
The unallocated portion of the allowance is determined based on management's
assessment of general economic conditions as well as specific economic factors
in the individual markets in which the Company operates. This determination
inherently involves a higher degree of uncertainty and considers current risk
factors that may not have yet manifested themselves in the Company's
historical loss factors used to determine the allocated component of the
allowance, and it recognizes that knowledge of the portfolio may be
incomplete.
An allocation of the allowance by major loan categories follows.
Allocation of Allowance for Credit Losses
- -------------------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------------
% of % of % of % of % of
Loans Loans Loans Loans Loans
to to to to to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ------------------------------------------------------------------------------------------------------------------------
in millions
Domestic:
Commercial:
Construction and
mortgage loans $ 45 14.9 $ 23 12.8 $ 31 10.4 $ 21 14.2 $ 13 10.4
Other business 173 30.4 62 32.4 53 26.9 75 34.7 149 37.8
Consumer:
Residential mortgages 43 34.9 12 39.4 30 46.3 7 24.7 6 22.3
Credit card receivables 40 3.4 45 5.4 60 8.2 55 13.2 40 13.4
Other consumer 17 3.3 12 5.5 17 5.4 9 9.8 8 10.7
International 128 13.1 31 4.5 26 2.8 26 3.4 28 5.4
Unallocated 214 - 195 - 192 - 225 - 234 -
- ------------------------------------------------------------------------------------------------------------------------
Total $660 100.0 $380 100.0 $409 100.0 $418 100.0 $478 100.0
========================================================================================================================
Changes in the allocated reserves from 1998 are due principally to the
Republic acquisition.
27
The allocations in the table are based on management's current allocation
methodologies. The use of other methods to allocate the allowance would
change the assigned allocation. For instance, increasing the loss coverage of
consumer loans from six months of historical charge offs to twelve months,
would increase the allocated allowance by $38 million at year-end 1999.
Management concludes that the allowance for credit losses, including the
unallocated component, is appropriately stated at December 31, 1999. The U.S.
banking industry continues to carefully assess credit risk considering, among
other things, (1) credit issues still remaining in U.S. consumer banking
businesses, (2) the effect that increasing energy prices will have on bank
customers, and (3) the likelihood of continued economic expansion and the
effect on loan portfolios.
Capital Resources
Total common shareholders' equity at year-end 1999 was $9,541 million,
compared with $2,228 million at year-end 1998. The equity base increased by
$7,088 million in capital contributed by HSBC in connection with the Republic
acquisition and $8 million relating to the merger of an affiliated company.
See Note 1 to the financial statements for a description of these
transactions. The equity base was further increased by $464 million from net
income and reduced by $155 million for common shareholder dividends paid to
HSBC and $95 million from the change in net unrealized losses on securities
available for sale. The other capital contribution from the parent of $3
million relates to an HSBC stock option plan in which almost all of the
Company's employees are eligible to participate.
The ratio of common shareholders' equity to total year-end assets was 10.58%
at December 31, 1999 compared with 6.56% at December 31, 1998. Although
the acquisition of Republic was effective December 31, 1999, payment to
Republic shareholders of $7,091 million was delayed, as agreed by the parties
to the transaction in advance, until January 7, 2000 in order to avoid
settlement crossing Year 2000. Had the payment been made at December 31,
1999, the ratio of common shareholders' equity to total year-end assets would
have been 11.48%.
Capital Adequacy
The Federal Reserve Board (FRB) has Risk-Based Capital Guidelines for
assessing the capital adequacy of U.S. banking organizations. The guidelines
place balance sheet assets into four categories of risk weights, primarily
based on the relative credit risk of the counterparty. Some off-balance sheet
items such as letters of credit and loan commitments are taken into account by
applying different categories of "credit conversion factors" to arrive at
credit-equivalent amounts, which are then weighted in the same manner as
balance sheet assets involving similar counterparties. For off-balance sheet
items relating to interest rate and foreign exchange rate contracts, the
credit-equivalent amounts are arrived at by estimating both the current
exposure, mark to market value, and the potential exposure over the remaining
life of each contract. The credit-equivalent amount is similarly assigned to
the risk weight category appropriate to the counterparty.
28
The guidelines include a measure for market risk inherent in the trading
portfolio. Under the market risk requirements, capital is allocated to
support the amount of market risk that relates to the Company's trading
activities including off-balance sheet derivative contracts associated with
trading activities.
The guidelines include the concept of Tier 1 capital and total capital. The
guidelines establish a minimum standard risk-based target ratio of 8%, of
which at least 4% must be in the form of Tier 1 capital. Effective with the
acquisition of Republic at year-end 1999, the Company includes an adjustment
for its investment in HSBC Republic in the calculation of its total capital
ratio in accordance with requirements of the FRB specifically applied to the
Company. The following table shows the components of the Company's risk-based
capital.
- ------------------------------------------------------------------------------
December 31, 1999 1998
- ------------------------------------------------------------------------------
in millions
Common shareholder's equity $ 9,541 $2,228
Preferred stock 375 -
Guaranteed mandatorily redeemable
preferred securities of subsidiaries 710 400
Less: Goodwill (3,307) (335)
Other additions (deductions)* 51 (45)
- ------------------------------------------------------------------------------
Tier 1 capital 7,370 2,248
- ------------------------------------------------------------------------------
Long-term debt qualifying as risk-
based capital 2,605 562
Qualifying aggregate allowance for
credit losses 660 327
45% of unrealized gain on available
for sale equity securities 1 3
- ------------------------------------------------------------------------------
Tier 2 capital 3,266 892
Less: Investment in HSBC Republic (2,493) -
- ------------------------------------------------------------------------------
Total capital $ 8,143 $3,140
- ------------------------------------------------------------------------------
* Other additions (deductions) include the unrealized net (gain) loss on
available for sale securities carried at fair value.
The capital adequacy guidelines establish a limit on the amount of certain
deferred tax assets that may be included in (that is, not deducted from) Tier
1 capital for risk-based and leverage capital purposes. The deferred tax
asset recognized by the Company meets the criteria for capital recognition and
has been included in the calculation of the Company's capital ratios.
The Company's total risk adjusted assets and off-balance sheet items were
approximately $54.9 billion and $26.1 billion at year ends 1999 and 1998,
respectively. Risk adjusted capital ratios were 13.42% at the Tier 1 level
and 15.53% at the total capital level. These ratios compared with 8.62% at
the Tier 1 level and 12.04% at the total capital level at December 31, 1998.
Banking industry regulators also have guidelines that set forth the leverage
ratios to be applied to banking organizations in conjunction with the
risk-based capital framework. Under these guidelines, strong bank holding
companies must maintain a minimum leverage ratio of Tier 1 capital to
quarterly average total assets of 3%. At December 31, 1999, the Company had a
23.41% leverage ratio compared with 6.76% at December 31, 1998 based on
quarterly averages. Based on period end assets, the ratio was 8.48% at
December 31, 1999.
29
From time to time, the 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 adjusted assets.
Republic Acquisition
As mentioned, the Company acquired Republic on December 31, 1999. Republic's
businesses are briefly described on page 10. The following schedule reports
the historical separate condensed balance sheets of the Company and Republic
and the resulting combined condensed balance sheet at December 31, 1999, after
purchase accounting entries including fair value adjustments.
- -------------------------------------------------------------------------------------------------
Historical
---------------------
HSBC USA Republic
December 31, 1999 Inc. NY Corp. Adjustments Combined
- -------------------------------------------------------------------------------------------------
in millions
Assets
Cash and due from banks $ 1,140 $ 845 $ (7) (2) $ 1,978
Interest bearing deposits with banks 1,744 2,488 3 (1)(2) 4,235
Federal funds sold and securities
purchased under resale agreements 2,658 1,660 (2,000) (3) 2,318
Trading assets 1,014 3,516 (3) (2) 4,527
Securities 3,336 21,111 6,339 (1) 30,786
Loans 23,472 14,471 (34) (2) 37,909
Less - allowance for credit losses 371 289 - 660
- -------------------------------------------------------------------------------------------------
Loans, net 23,101 14,182 (34) 37,249
Goodwill and other acquisition
intangibles 325 236 2,746 (2) 3,307
Equity investments 29 884 1,628 (2) 2,541
Other assets 1,239 2,027 33 (2) 3,299
- -------------------------------------------------------------------------------------------------
Total assets $34,586 $46,949 $ 8,705 $90,240
=================================================================================================
Liabilities
Deposits in domestic offices $22,092 $13,331 $ (25) (2) $35,398
Deposits in foreign offices 5,218 16,576 (742) (2) 21,052
Trading account liabilities 57 2,390 (6) (2) 2,441
Short-term borrowings 2,207 5,065 (2,000) (3) 5,272
Payable to shareholders of Republic - - 7,091 (2) 7,091
Interest, taxes and other liabilities 822 1,955 283 (2) 3,060
Long-term debt 1,737 4,240 (92) (2) 5,885
- -------------------------------------------------------------------------------------------------
Total liabilities 32,133 43,557 4,509 80,199
- -------------------------------------------------------------------------------------------------
Shareholders' equity
Preferred stock - 500 - 500
Common shareholders' equity
Common stock - 524 (524) (2) -
Capital surplus 1,832 56 7,032 (1)(2) 8,920
Retained earnings 672 2,657 (2,657) (2) 672
Accumulated other comprehensive loss (51) (345) 345 (2) (51)
- -------------------------------------------------------------------------------------------------
Total common shareholders' equity 2,453 2,892 4,196 9,541
- -------------------------------------------------------------------------------------------------
Total shareholders' equity 2,453 3,392 4,196 10,041
- -------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $34,586 $46,949 $ 8,705 $90,240
===================================================================================================
(1) Contribution from HSBC.
(2) Purchase of Republic less fair value adjustments including elimination of Republic's common
shareholders' equity.
(3) Elimination of intercompany receivable/payable.
30
The pro forma combined income statement for the year ended December 31, 1999
reflects the combination of historical operating results of the Company and
Republic and includes the amortization of necessary acquisition adjustments as
if the combination had taken place at the beginning of 1999.
- -----------------------------------------------------------------------------------
Historical Amortization
------------------- of
HSBC Republic Acquisition Pro Forma
Year Ended December 31, 1999 USA Inc. NY Corp. Adjustments Combined
- -----------------------------------------------------------------------------------
in millions
Interest income $2,320 $2,793 $ 30 $5,143
Interest expense 1,094 1,749 46 2,889
- -----------------------------------------------------------------------------------
Net interest income 1,226 1,044 (16) 2,254
Provision for credit losses 90 12 - 102
- -----------------------------------------------------------------------------------
Net interest income after
provision for credit losses 1,136 1,032 (16) 2,152
Other operating income 464 628 (84) 1,008
- -----------------------------------------------------------------------------------
1,600 1,660 (100) 3,160
Operating expenses 828 1,086 131 2,045
- -----------------------------------------------------------------------------------
Income before taxes 772 574 (231) 1,115
Income tax expense (benefit) 308 156 (11) 453
- -----------------------------------------------------------------------------------
Net income $ 464 $ 418 $(220) $ 662
===================================================================================
This pro forma information may not be indicative of the results that actually
would have occurred if the purchase had been consummated on January 1, 1999 or
which may be obtained in the future. While the Company expects to achieve
certain operating cost savings as a result of the combination, no adjustment
has been included in the pro forma amounts for anticipated operating cost
savings or revenue enhancements. Operating results may also be impacted by
the nature, costs and timing of the integration of businesses. Certain
foreign operations may be integrated into the respective foreign operations of
other HSBC group entities.
The following table sets forth the projected effect of purchase accounting
adjustments relating to the acquisition on the operating results of future
periods. The annual amortization of goodwill of $149 million (incremental
$120 million) as well as the amortization of the premium associated with the
equity investment in affiliate of $80 million, is not subject to deduction for
Federal and state taxes. The projected amortization and accretion is subject
to change if such assets and liabilities are subsequently sold and variations
between future prepayments assumed in the preparation of the table and those
which may actually occur.
- -----------------------------------------------------------------------------------
2000 2001 2002 2003 2004
- -----------------------------------------------------------------------------------
in millions
Amortization of premium/discount on:
Equity investment in affiliate $ (80) $ (80) $ (80) $ (80) $ (80)
Other fair value adjustments (31) 16 42 42 42
Goodwill (120) (120) (120) (120) (120)
- -----------------------------------------------------------------------------------
Charge to operations $(231) $(184) $(158) $(158) $(158)
===================================================================================
Further, both the Company and Republic recognized certain one-time items in
their 1999 operating results. Pre-tax results for the Company included
settlement with the U.S. Internal Revenue Service on Brazilian tax credits of
$13.1 million and a gain on the sale of a student loan business of $15.0
million partially offset by an acquisition related restructuring charge of
31
$26.7 million. Republic's 1999 pre-tax operating results included
restructuring charges of $97.0 million (unrelated to the acquisition by the
Company) partially offset by a gain of $69.8 million relating to a real estate
investment.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
In consideration of the degree of interest rate risk inherent in the banking
industry, the Company has interest rate risk management policies designed to
meet performance objectives within defined risk/safety parameters. In the
course of managing interest rate risk, a combination of risk assessment
techniques, including dynamic simulation modeling, gap analysis, and capital
at risk analysis are employed. The combination of these tools enables
management to identify and assess the potential impact of interest rate
movements and take appropriate action.
Certain limits and benchmarks that serve as guidelines in determining the
appropriate levels of interest rate risk for the institution have been
established. One such limit is expressed in terms of the Present Value of a
Basis Point (PVBP), which reflects the change in value of the balance sheet
for a one basis point movement in all interest rates. The institutional PVBP
limit is plus or minus $3.6 million, which includes distinct limits associated
with trading portfolio activities and off-balance sheet instruments. Thus,
for a one basis point change in interest rates, the policy dictates that the
value of the balance sheet shall not change by more than $3.6 million. As of
December 31, 1999, the Company had a position of $(3.5) million PVBP.
Mortgage servicing rights are excluded from the PVBP determination as their
interest rate risk is significantly different from other balance sheet items.
The mortgage servicing rights risk is to lower interest rates, which is
managed through the purchase of interest rate floors.
The Company also monitors changes in value of the balance sheet for large
movements in interest rates with an overall limit of +/- 10%, after tax,
change from the base case for a 200 basis point gradual rate movement. As of
December 31, 1999, for a gradual 200 basis point increase in rates, the value
was projected to drop by 7% and for a 200 basis point gradual decrease in
rates, value was projected to drop by 1% were no management actions ever taken
to manage exposures to the changing environment.
In addition to the above mentioned limits, the Company's Asset and Liability
Policy Committee monitors, on a monthly basis, the impact of a number of
interest rate scenarios on net interest income. These scenarios include both
rate shock scenarios which assume immediate market rate movements of +/- 10%
and 200 basis points, as well as rate change scenarios in which rates rise or
fall by 200 basis points over a twelve month period. The individual limit for
such gradual 200 basis point movement is currently +/- 10%, pretax, of base
case earnings over a twelve month period. Simulations are also performed for
other relevant interest rate scenarios including immediate rate movements and
changes in the shape of the yield curve or in competitive pricing policies.
Net interest income under the various scenarios is reviewed over a twelve
month period, as well as over a three year period. The simulations capture
the effects of the timing of the repricing of all on-balance sheet assets and
liabilities, as well as all off-balance sheet positions such as interest rate
32
swaps, futures and option contracts. Additionally, the simulations
incorporate any behavioral aspects such as prepayment sensitivity under
various scenarios.
For purposes of simulation modeling, base case earnings reflect the existing
balance sheet composition, with balances generally maintained at current
levels by the anticipated reinvestment of expected runoff. These balance
sheet levels will however, factor in specific known or likely changes
including material increases, decreases or anticipated shifts in balances due
to management actions. Current rates and spreads are then applied to produce
base case earnings estimates on both a twelve month and three year time
horizon. Rate shocks are then modeled and compared to base earnings (earnings
at risk), and include behavioral assumptions as dictated by specific scenarios
relating to such factors as prepayment sensitivity and the tendency of
balances to shift among various products in different rate environments. It
is assumed that no management actions are taken to manage exposures to the
changing environment being simulated.
Utilizing these modeling techniques, a gradual 200 basis point parallel rise
and fall in the yield curve on January 1, 2000 would cause projected 2000 net
interest income to decrease by $37 million and increase by $42 million,
respectively. This +/- 2% change is well within the Company's +/- 10% limit.
An immediate 100 basis point parallel rise and fall in the yield curve on
January 1, 2000, would cause projected 2000 net interest income to decrease by
$43 million and increase by $43 million, respectively. A 200 basis point
parallel rise and fall would decrease projected net interest income by $80
million and $52 million, respectively.
The projections noted above 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 estima