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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, 2001
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) 525-3735
IRS Employer Identification No.: State of Incorporation:
13-2764867 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
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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
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1. Business 4
2. Properties 6
3. Legal Proceedings 6
4. Submission of Matters to a Vote of Security Holders 7
Part II
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5. Market for the Registrant's Common Equity and
Related Stockholder Matters 7
6 Selected Financial Data 8
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
7A. Quantitative and Qualitative Disclosures About
Market Risk 36
8. Financial Statements and Supplementary Data 41
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 93
Part III
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10. Directors and Executive Officers of the Registrant 93
11. Executive Compensation 97
12. Security Ownership of Certain Beneficial Owners
and Management 100
13. Certain Relationships and Related Transactions 100
Part IV
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14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 101
3
PART I
Item 1. Business
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Overview
HSBC USA Inc. (the Company) is a New York State based bank holding company
registered under the Bank Holding Company Act of 1956, as amended. At December
31, 2001, the Company had assets of $87.1 billion and employed approximately
14,100 full and part time employees.
All of the Company's common stock is owned by HSBC North America Inc. (HNAI), an
indirect wholly owned subsidiary of HSBC Holdings plc (HSBC). HSBC, the ultimate
parent company of HSBC Bank plc, The Hongkong and Shanghai Banking Corporation
Limited (HongkongBank), and other financial services companies, 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 $696 billion at
December 31, 2001, is one of the world's largest banking and financial services
organizations.
The Company's principal subsidiary HSBC Bank USA (the Bank), had assets of $84.2
billion and deposits of $58.2 billion at December 31, 2001. The Company also is
a participant in a joint venture, Wells Fargo HSBC Trade Bank.
The Bank's domestic operations encompass the State of New York as well as two
branches in Pennsylvania, eight branches in Florida and three branches in
California. 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. In addition to its domestic offices, the Bank
maintains foreign branch offices, subsidiaries and/or representative offices in
the Caribbean, Europe, Panama, Asia, Latin America and Australia.
Acquisitions and Divestitures
On April 1, 2001, the Bank acquired approximately a 5 percent interest in the
voting shares of HSBC Republic Bank (Suisse) S.A. (Swiss Bank), an affiliate
wholly owned by the HSBC Group, in exchange for the contribution to the Swiss
Bank of private banking businesses conducted by the Bank's Singapore and Hong
Kong branches. The 5 percent interest represents the fair value estimate of the
businesses transferred to the Swiss Bank and is being accounted for using the
equity method of accounting. The Bank retained its banknotes activities in
Singapore and its banknotes and foreign currency businesses in Hong Kong, and
maintained its branch licenses in both locations.
The transaction was another step in an internal reorganization of the HSBC
Group's global private banking operations, which began late last year. The Swiss
Bank, a Switzerland based banking affiliate, will manage much of the HSBC
Group's worldwide private banking business. Swiss Bank is a foreign bank
chartered and regulated under the banking laws of Switzerland.
4
PART I
Item 1. Business Continued
================================================================================
On January 1, 2001, the Bank acquired the Panama branches of HSBC Bank plc for
approximately $22 million in cash. The purchase included two branches in Panama
City, one in the Colon Free Trade Zone, one in Colon and one in Aguadulce. The
Bank acquired approximately $500 million in assets and assumed $450 million in
customer and bank deposits. The acquisition was accounted for as a transfer of
assets between companies under common control at HSBC Bank plc's historical
cost.
On August 1, 2000, the Company purchased the banking operations of Chase
Manhattan Bank, Panama (Chase Panama). The transaction was accounted for as a
purchase. Accordingly, the results of Chase Panama are included with those of
the Company for the period subsequent to the date of acquisition. The branch
operations had over $750 million in assets and $720 million in deposit
liabilities.
On December 31, 1999, HSBC acquired Republic New York Corporation (Republic),
which it subsequently merged with the Company, and Safra Republic Holdings S.A.,
subsequently renamed HSBC Republic Holdings (Luxembourg) S.A. (HRH). Certain
operations of non-U.S. branches and subsidiaries of the Company have been
transferred to foreign operations of HSBC, such as the sale of a branch in Tokyo
to the Asia Pacific operations of HSBC.
The Bank had a 49% investment in HRH, a holding company, principally engaged in
international private banking and commercial banking with assets of $24.4
billion at December 31, 1999. HSBC held the remaining 51% ownership interest in
HRH. In connection with HSBC's internal international private banking operations
reorganization in December 2000, the Company distributed its interest in HRH to
HNAI, its parent. The distribution, in the form of a return of capital in the
amount of $2.8 billion, included its investment in a Bahamian subsidiary in
addition to the $2.5 billion investment in HRH.
Regulation, Supervision and Capital
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 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 GLB Act also required banks, securities firms and
insurance companies to adopt written privacy policies, designed to safeguard
5
PART I
Item 1. Business Continued
================================================================================
consumers' privacy, and to provide copies of those policies to their customers
on or before July 1, 2001. The Company devoted significant resources in 2001 to
this endeavor and successfully complied with the GLB Act in a timely manner.
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. For banks, five capital categories 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. For bank holding companies, regulators
also have guidelines regarding 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 assets of 3%. The Company's and the
Bank's ratios at December 31, 2001 exceeded all ratios required for the
well-capitalized banks and strong bank holding companies.
Competition
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.
Item 2. Properties
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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 400 other banking
offices in New York State located in 49 counties, two branches in Pennsylvania,
eight branches in Florida and three branches in California. Approximately 40% 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: Buenos Aires, Argentina;
Santiago, Chile; Panama City, Panama; Montevideo, Uruguay; Punta del Este,
Uruguay and Mexico City, Mexico.
Item 3. Legal Proceedings
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The information contained in Note 26 to the Financial Statements on page 81 of
this report is incorporated herein by reference.
6
PART I
Item 4. Submission of Matters to a Vote of Security Holders
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Reference is made to Item 5.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
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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.
7
Item 6. Selected Financial Data
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Year Ended December 31, 2001 2000 (1) 1999 (1) 1998 1997
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in millions
Net interest income $ 2,265.3 $ 2,118.5 $ 1,225.9 $ 1,165.3 $ 1,173.4
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Securities transactions 149.3 28.8 10.1 13.8 17.4
Interest on Brazilian tax settlement -- -- 13.1 32.7 --
Other operating income 946.4 803.6 440.8 413.6 342.0
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Total other operating income 1,095.7 832.4 464.0 460.1 359.4
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Princeton Note Matter 575.0 -- -- -- --
Other operating expenses 1,968.0 1,905.8 827.9 780.2 781.4
Provision for credit losses 238.4 137.6 90.0 80.0 87.4
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Income before taxes and cumulative effect
of accounting change 579.6 907.5 772.0 765.2 664.0
Applicable income tax expense 226.0 338.5 308.3 238.1 193.0
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Income before cumulative effect of
accounting change 353.6 569.0 463.7 527.1 471.0
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Cumulative effect of accounting change -
implementation of SFAS 133, net of tax (0.5) -- -- -- --
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Net income $ 353.1 $ 569.0 $ 463.7 $ 527.1 $ 471.0
=================================================================================================================================
Balances at year end
Total assets $ 87,114 $ 83,035 $ 87,246 $ 33,944 $ 31,518
Goodwill and other acquisition intangibles 2,896 3,229 3,307 335 370
Long-term debt 4,491 5,097 5,885 1,748 1,708
Common shareholder's equity 6,549 6,834 6,717 2,228 2,039
Total shareholders' equity 7,049 7,334 7,217 2,228 2,039
Ratio of shareholders' equity to total assets 8.09% 8.83% 8.27% 6.56% 6.47%
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Selected financial data (2)
Rate of return on
Total assets 0.41% 0.69% 1.35% 1.60% 1.62%
Total common shareholder's equity 4.80 8.22 20.31 24.93 22.93
Total shareholders' equity to total assets 8.50 8.56 6.67 6.44 7.14
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(1) Results of operations and balances for 2000 and 1999 were restated to
exclude an investment in an entity transferred to HSBC North America Inc.
during 2001.
(2) Based on average daily balances.
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 as of year end 1999. Accordingly, the results of operations
of Republic are included with those of the Company for the periods subsequent to
the acquisition.
8
Quarterly Results of Operations
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2001
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4th Q 3rd Q 2nd Q 1st Q
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in millions
Net interest income $ 595.0 $ 554.7 $ 571.8 $ 543.8
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Securities transactions 2.6 20.9 56.6 69.2
Other operating income 256.7 254.9 211.6 223.2
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Total other operating income 259.3 275.8 268.2 292.4
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Princeton Note Matter -- 575.0 -- --
Other operating expenses 511.1 481.7 483.6 491.6
Provision for credit losses 95.4 47.5 48.0 47.5
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Income (loss) before taxes and cumulative effect
of accounting change 247.8 (273.7) 308.4 297.1
Applicable income tax expense (credit) 96.3 (106.5) 120.4 115.8
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Income (loss) before cumulative effect of
accounting change 151.5 (167.2) 188.0 181.3
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Cumulative effect of accounting change -
implementation of SFAS 133, net of tax -- -- -- (0.5)
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Net income (loss) $ 151.5 $ (167.2) $ 188.0 $ 180.8
==============================================================================================================================
2000(1)
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4th Q 3rd Q 2nd Q 1st Q
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in millions
Net interest income $ 523.7 $ 539.4 $ 527.4 $ 528.0
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Securities transactions 18.4 9.1 3.7 (2.4)
Other operating income 194.0 202.5 193.8 213.3
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Total other operating income 212.4 211.6 197.5 210.9
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Other operating expenses 488.2 472.4 473.6 471.6
Provision for credit losses 31.0 50.6 28.0 28.0
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Income before taxes 216.9 228.0 223.3 239.3
Applicable income tax expense 81.6 84.4 83.1 89.4
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Net income $ 135.3 $ 143.6 $ 140.2 $ 149.9
==============================================================================================================================
(1) The 2000 quarterly results of operations as reported in the respective Form
10-Q's were restated to exclude an investment in an entity transferred to
HSBC North America Inc. during 2001.
9
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. Average
balances for 2000 were restated to exclude an investment in an entity
transferred to HSBC North America Inc. during 2001.
2001
---------------------------------------
Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------------------
Assets
Interest bearing deposits with banks $ 4,467 $ 207.2 4.64%
Federal funds sold and securities purchased under resale agreements 3,588 137.9 3.84
Trading assets 8,429 217.1 2.58
Securities 20,281 1,320.2 6.51
Loans
Domestic
Commercial 16,997 1,060.2 6.24
Consumer
Residential mortgages 17,123 1,247.5 7.29
Other consumer 3,186 344.8 10.83
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Total domestic 37,306 2,652.5 7.11
International 4,135 286.1 6.92
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Total loans 41,441 2,938.6 7.09
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Total earning assets 78,206 $4,821.0 6.16%
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Allowance for credit losses (541)
Cash and due from banks 1,891
Other assets 6,720
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Total assets $ 86,276
=============================================================================================================================
Liabilities and Shareholders' Equity
Interest bearing demand deposits $ 367 $ 2.3 0.61%
Consumer savings deposits 13,158 243.3 1.85
Other consumer time deposits 11,125 503.3 4.52
Commercial, public savings and other time deposits 6,921 222.9 3.22
Deposits in foreign offices 20,264 885.1 4.37
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Total interest bearing deposits 51,835 1,856.9 3.58
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Federal funds purchased and securities sold under repurchase agreements 2,553 78.2 3.06
Other short-term borrowings 7,341 259.0 3.53
Long-term debt 4,835 328.1 6.79
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Total interest bearing liabilities 66,564 $2,522.2 3.79%
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Interest rate spread 2.37%
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Noninterest bearing deposits 5,596
Other liabilities 6,782
Total shareholders' equity 7,334
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Total liabilities and shareholders' equity $ 86,276
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Net yield on average earning assets 2.94%
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Net yield on average total assets 2.66
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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 $55 million for 2001, $44 million for 2000 and $36 million for 1999.
10
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS (CONTINUED)
2000 1999
----------------------------------------------- ------------------------------------
Balance Interest Rate Balance Interest Rate
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in millions
Assets
Interest bearing deposits with banks $ 4,425 $ 308.7 6.98% $ 1,795 $ 97.0 5.40%
Federal funds sold and securities
purchased under resale agreements 3,260 215.0 6.59 2,238 116.5 5.21
Trading assets 5,504 140.5 2.55 919 50.8 5.52
Securities 22,158 1,605.2 7.24 3,654 214.7 5.88
Loans
Domestic
Commercial 16,444 1,265.8 7.70 9,927 784.4 7.90
Consumer
Residential mortgages 14,543 1,086.3 7.47 9,382 656.9 7.00
Other consumer 3,189 366.2 11.48 2,432 286.4 11.78
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Total domestic 34,176 2,718.3 7.95 21,741 1,727.7 7.95
International 4,790 355.5 7.42 1,644 115.5 7.02
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Total loans 38,966 3,073.8 7.89 23,385 1,843.2 7.88
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Total earning assets 74,313 $ 5,343.2 7.19% 31,991 $ 2,322.2 7.26%
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Allowance for credit losses (606) (379)
Cash and due from banks 1,794 1,046
Other assets 7,287 1,572
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Total assets $ 82,788 $ 34,230
================================================================================================================================
Liabilities and Shareholders' Equity
Interest bearing demand deposits $ 676 $ 8.0 1.18% $ 248 $ 2.3 0.91%
Consumer savings deposits 12,462 313.5 2.52 7,620 172.9 2.27
Other consumer time deposits 9,048 467.0 5.16 6,808 308.4 4.53
Commercial, public savings and other
time deposits 7,188 358.3 4.98 4,265 153.3 3.59
Deposits in foreign offices 19,595 1,187.3 6.06 4,584 216.0 4.71
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Total interest bearing deposits 48,969 2,334.1 4.77 23,525 852.9 3.63
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Federal funds purchased and securities
sold under repurchase agreements 2,082 123.8 5.95 951 45.2 4.75
Other short-term borrowings 6,574 320.9 4.88 1,618 84.4 5.21
Long-term debt 5,771 420.3 7.28 1,867 111.7 5.98
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Total interest bearing liabilities 63,396 $ 3,199.1 5.05% 27,961 $ 1,094.2 3.91%
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Interest rate spread 2.14% 3.35%
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Noninterest bearing deposits 6,063 3,111
Other liabilities 6,246 873
Total shareholders' equity 7,083 2,285
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Total liabilities and shareholders' equity $ 82,788 $34,230
================================================================================================================================
Net yield on average earning assets 2.89% 3.84%
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Net yield on average total assets 2.59 3.59
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11
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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The Company reported net income of $353.1 million for 2001 compared with $569.0
million in 2000. Return on average common shareholder's equity was 4.80% in 2001
and 8.22% in 2000. The decrease in net income for 2001 was driven by the $575.0
million charge taken by the Company related to the Princeton Note Matter. See
Note 26, Litigation, for additional information on the Princeton Note Matter.
During 2001, the Company achieved solid growth in income from banking
operations. Net interest income was $2,265.3 million in 2001 compared with
$2,118.5 million in 2000. The increase in net interest income for 2001 reflects
the impact of a larger balance sheet and a wider interest margin. Other
operating income was $1,095.7 million in 2001 compared with $832.4 million in
2000. This increase was driven by growth in wealth management, insurance and
bankcard fees. Also, trading related revenues increased significantly,
reflecting strategic decisions to strengthen trading capabilities, as well as
favorable market conditions for treasury related trading. The results for 2001
benefited from $149.3 million in securities gains. Other operating expenses
excluding the Princeton Note Matter were $1,968.0 million in 2001 compared with
$1,905.8 million in 2000. The increase in other operating expenses reflects
higher costs due to business expansion in trading and treasury, wealth
management and e-commerce, and increased marketing expenses. The provision for
credit losses for 2001 was $238.4 million compared with $137.6 million for 2000.
This increase reflects the general weakness in the U.S. economy coupled with
specific deterioration in markets and business sectors served by the Company.
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; 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 2001 operations with 2000 and 1999 follows. It
should be read in conjunction with the consolidated financial statements of the
Company which begin on page 44.
12
EARNINGS PERFORMANCE REVIEW
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.
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Increase(Decrease) Increase(Decrease)
2001 Amount % 2000 Amount % 1999
- ------------------------------------------------------------------------------------------------------------------------------------
in millions
Interest income $ 4,821.0 $ (522.2) (9.8) $ 5,343.2 $ 3,021.0 130.1 $ 2,322.2
Interest expense 2,522.2 (676.9) (21.2) 3,199.1 2,104.9 192.4 1,094.2
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis 2,298.8 154.7 7.2 2,144.1 916.1 74.6 1,228.0
Less: taxable equivalent
adjustment 33.5 7.9 30.8 25.6 23.5 1,102.6 2.1
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 2,265.3 $ 146.8 6.9 $ 2,118.5 $ 892.6 72.8 $ 1,225.9
- ------------------------------------------------------------------------------------------------------------------------------------
Average earning assets $ 78,206 $ 3,893 5.2 $ 74,313 $ 42,322 132.3 $ 31,991
Average nonearning assets 8,070 (405) (4.8) 8,475 6,236 278.5 2,239
- ------------------------------------------------------------------------------------------------------------------------------------
Average total assets $ 86,276 $ 3,488 4.2 $ 82,788 $ 48,558 141.9 $ 34,230
- ------------------------------------------------------------------------------------------------------------------------------------
Net yield on:
Average earning assets 2.94% .05% 1.7 2.89% (.95)% (24.7) 3.84%
Average total assets 2.66 .07 2.7 2.59 (1.00) (27.9) 3.59
====================================================================================================================================
2001 Compared to 2000
Net interest income was $2,265.3 million in 2001 compared with $2,118.5 million
in 2000. The 6.9% increase in net interest income for 2001 reflects the impact
of a larger balance sheet and a wider interest margin.
Average residential mortgages grew $2.6 billion for 2001 as the mortgage banking
division experienced record levels of production driven by a low rate
environment. Average investment securities decreased $1.9 billion for 2001 as
the Company sold securities, including mortgage backed securities, to adjust to
interest rate changes and to reconfigure exposure to residential mortgages.
Balance sheet growth for 2001 was funded largely by increased levels of consumer
savings and time deposits.
The Federal Reserve lowered short-term interest rates eleven times during 2001.
For the year 2001, the average annual prime rate decreased 2.3% and the average
three month LIBOR rate decreased by 2.8%. The declining interest rate
environment in 2001 led to lower gross yields earned and lower gross rates paid
on liabilities. In addition to the benefit of an increased level of lower cost
personal and commercial deposits, short-term rate cuts led to wider interest
margins in certain commercial businesses, the residential mortgage business and
treasury.
2000 Compared to 1999
The Republic acquisition was the principal factor contributing to the increase
in net interest income and average assets in 2000 as compared to 1999. The
decrease in net yield in 2000 from 1999 was primarily due to a higher
concentration of lower yielding treasury assets and higher costing foreign
deposits as a result of the Republic acquisition. The favorable volume variance
for residential mortgages also reflected loan growth achieved for
13
2000. The overall rate environment for 2000 was higher than 1999, with an
approximate 1.2% increase in average prime rate and a 1.1% increase in the
average three month LIBOR rate year to year. The unfavorable rate variances for
trading assets, domestic commercial loans and credit card receivables for 2000
compared to 1999 reflected the impact of lower yielding Republic assets. The
rate variance for short-term borrowings for 2000 compared to 1999 similarly
reflected the impact of lower rate Republic liabilities.
Forward Outlook
In 2002, the Company will pursue modest growth in high quality commercial loans,
residential mortgages and core personal and commercial deposits, despite a
continuing weak economy. The steeper yield curve which benefited the Company in
the later part of 2001 is expected to continue into the early part of 2002. As
the anticipated economic recovery emerges, the yield curve should be less steep
and interest margins will tighten.
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".
Net Interest Income Components Including Volume/Rate Analysis
================================================================================
2001 Compared to 2000 2000 Compared to 1999
Increase(Decrease) Increase(Decrease)
2001 Volume Rate 2000 Volume Rate 1999
- ----------------------------------------------------------------------------------------------------------------------------------
in millions
Interest income:
Interest bearing deposits
with banks $ 207.2 $ 2.9 $ (104.4) $ 308.7 $ 176.6 $ 35.1 $ 97.0
Federal funds sold and
securities purchased under
resale agreements 137.9 19.9 (97.0) 215.0 62.1 36.4 116.5
Trading assets 217.1 75.4 1.2 140.5 130.3 (40.6) 50.8
Securities 1,320.2 (129.7) (155.3) 1,605.2 1,329.4 61.1 214.7
Loans
Domestic
Commercial 1,060.2 41.4 (247.0) 1,265.8 502.2 (20.8) 784.4
Consumer
Residential mortgages 1,247.5 188.6 (27.4) 1,086.3 382.8 46.6 656.9
Credit card receivables 162.5 (11.8) (5.8) 180.1 (1.3) (5.5) 186.9
Other consumer 182.3 7.5 (11.3) 186.1 72.4 14.2 99.5
International 286.1 (46.4) (23.0) 355.5 233.1 6.9 115.5
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest income 4,821.0 147.8 (670.0) 5,343.2 2,887.6 133.4 2,322.2
- ----------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest bearing demand deposits 2.3 (2.8) (2.9) 8.0 4.9 .8 2.3
Consumer savings and
other time deposits 746.6 93.5 (127.4) 780.5 253.8 45.4 481.3
Commercial and public savings
and other time deposits 222.9 (12.9) (122.5) 358.3 131.1 73.9 153.3
Deposits in foreign offices 885.1 39.4 (341.6) 1,187.3 893.4 77.9 216.0
Short-term borrowings 337.2 57.2 (164.7) 444.7 312.6 2.5 129.6
Long-term debt 328.1 (64.9) (27.3) 420.3 279.5 29.1 111.7
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 2,522.2 109.5 (786.4) 3,199.1 1,875.3 229.6 1,094.2
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis $ 2,298.8 $ 38.3 $ 116.4 $ 2,144.1 $ 1,012.3 $ (96.2) $ 1,228.0
==================================================================================================================================
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.
14
Other Operating Income
================================================================================
Other operating income was $1,095.7 million in 2001 compared with $832.4 million
in 2000 and $464.0 million in 1999.
- ------------------------------------------------------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
2001 Amount % 2000 Amount % 1999
- ------------------------------------------------------------------------------------------------------------------------------
in millions
Trust income $ 87.6 $ 2.7 3.2 $ 84.9 $ 32.7 62.6 $ 52.2
Service charges 189.0 16.7 9.7 172.3 43.7 33.9 128.6
Mortgage banking revenue 79.4 46.9 144.3 32.5 2.0 6.7 30.5
Letter of credit fees 61.0 7.5 13.9 53.5 21.0 64.6 32.5
Credit card fees 64.1 8.1 14.5 56.0 9.4 20.4 46.6
Other fee-based income 136.6 4.8 3.7 131.8 75.7 134.8 56.1
Investment product fees 67.8 8.8 14.8 59.0 26.6 82.1 32.4
Interest on Brazilian
tax settlement -- -- -- -- (13.1) -- 13.1
Other income 62.0 (11.4) (15.5) 73.4 21.5 41.5 51.9
- ------------------------------------------------------------------------------------------------------------------------------
Nontrading income 747.5 84.1 12.7 663.4 219.5 49.5 443.9
- ------------------------------------------------------------------------------------------------------------------------------
Trading revenues
Treasury business and other 266.0 125.8 89.7 140.2 130.2 1,300.0 10.0
Residential mortgage related (67.1) (67.1) -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Total trading revenues 198.9 58.7 41.9 140.2 130.2 1,300.0 10.0
- ------------------------------------------------------------------------------------------------------------------------------
Securities transactions 149.3 120.5 417.6 28.8 18.7 185.6 10.1
- ------------------------------------------------------------------------------------------------------------------------------
Total other operating income $ 1,095.7 $ 263.3 31.6 $ 832.4 $ 368.4 79.4 $ 464.0
==============================================================================================================================
Nontrading Income
================================================================================
2001 Compared to 2000
Nontrading income was $747.5 million in 2001 compared with $663.4 million in
2000. Wealth management, insurance and bankcard fees all grew during 2001 as
former Republic customers were introduced to new products. Despite a turbulent
equity and fixed income market, brokerage revenues were up $16.3 million or over
25% year to year due in part to higher levels of annuities sales. Insurance
revenues increased $10.1 million or 44% compared to 2000 as sales of life,
property and casualty, and disability insurance through the branch network were
strong. Within the commercial segment, harmonization of HSBC and the former
Republic product lines led to increases in deposit, cash management and loan
related fees. Mortgage banking revenue increased significantly due to higher
levels of gains on sales of mortgages resulting from a mortgage refinancing wave
and the adoption of SFAS 133 on January 1, 2001 which required interest rate
locks and forward sales commitments, previously part of mortgage banking
revenue, to be marked to market through trading revenue. The total dollar amount
of residential mortgages originated for sale was over three times greater than
last year. Offsetting the increase in mortgage banking revenue were losses in
residential mortgage related trading revenue. See trading revenue discussion in
the following section.
2000 Compared to 1999
The Republic acquisition was the principal factor contributing to the increase
in nontrading income in 2000 compared to 1999. In addition, increases in trust
income, investment product fees and insurance income reflect growth achieved in
our domestic wealth management business. Mortgage banking revenue for 2000
increased only slightly as a result of lower gains on sale of mortgages due to
the higher interest rate environment and competitive pricing pressures. The
Company received interest of $13.1 million in 1999 as a result
15
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.
Forward Outlook
In 2002, the Company will focus on growth in brokerage, insurance, trust, asset
management and trade service related fees. The Company will utilize its strong
retail distribution network, its improving brand visibility in the United States
as well as its HSBC Group linkage to pursue revenue growth despite a weak
economy. The Company continues to face strong competitive challenges from other
banks and financial service providers to maintain and grow market share in key
customer segments.
Trading Revenues
================================================================================
Trading revenues are generated by the Company's participation in the foreign
exchange and precious metal markets, from trading derivative contracts,
including interest rate swaps and options, from trading securities, and as a
result of certain residential mortgage banking activities classified as trading
revenue due to the adoption of SFAS 133 effective January 1, 2001. The following
table presents trading revenues by business. The data in the table includes net
interest income earned/(paid) on trading instruments, as well as an allocation
by management to reflect the funding benefit or cost associated with the trading
positions.
- ----------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
in millions
Trading revenues - treasury business and other $266.0 $140.2 $10.0
Net interest income 38.6 52.1 4.6
- ----------------------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $304.6 $192.3 $14.6
======================================================================================================================
Business:
Derivatives and treasury $120.2 $ 44.9 $10.0
Foreign exchange 93.1 74.4 4.6
Precious metals 52.6 49.1 --
Other trading 38.7 23.9 --
- ----------------------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $304.6 $192.3 $14.6
======================================================================================================================
Trading revenues - residential mortgage business related $(67.1) $ -- $ --
======================================================================================================================
Treasury Business and Other: 2001 Compared to 2000
Trading related revenues for 2001 increased 58% compared with the prior year.
Foreign exchange trading revenue increased $18.7 million or 25% as the Company
made a strategic decision to strengthen its capabilities in foreign exchange in
the U.S. market. The increase in foreign exchange trading income is a direct
result of that decision as trading volumes with clients and proprietary trading
revenue increased markedly over the prior year. Trading revenue in the Company's
banknote business, included in foreign exchange business results, also increased
in 2001. The Company also decided to expand its derivative capabilities in 2001.
The increased derivatives related trading revenues reflects increased client
activity and expanded product offerings. The Company was able to take advantage
of falling U.S. interest rates and price volatility to more than double its
domestic treasury business related trading revenue in 2001. Precious metals
trading revenue increased 7% in 2001 as the Company capitalized on interest rate
movements in those markets as well as profiting from precious metals option
trading.
16
Treasury Business and Other: 2000 Compared to 1999
The Republic acquisition was the principal factor contributing to the increase
for 2000 as compared to 1999. Overall market conditions for 2000 were stable.
During the second half of 2000, the flatter yield curve reduced opportunities in
some markets.
Treasury Business and Other: Forward Outlook
The Company expects to build on its expanded capabilities in foreign exchange
and interest rate derivatives to grow dealing related revenues during 2002.
However, these revenues will be under pressure from low economic growth on a
global basis. Downward pressure on U.S. interest rates is anticipated until
signs of economic recovery emerge, at which time the yield curve is expected to
be less steep. Net interest margins in treasury will decline reflecting
higher-margin securities sold in 2001 and the flatter yield curve as the economy
begins to improve.
Residential Mortgage Business Related
In conjunction with the adoption of the Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133) on January 1, 2001, certain derivative financial instruments
including interest rate lock commitments granted to customers, forward sales
commitments associated with originated mortgage loans held for sale, and
instruments used to protect against the decline in economic value of mortgage
servicing rights, are recorded as trading positions. The mark to market of these
instruments recognized during 2001 was a loss of $39.7 million relating to
mortgage servicing rights and a loss of $27.4 million relating to mortgage loans
held for sale. In prior periods, the value of the interest rate lock commitments
and forward sale commitments were considered in the determination of the lower
of cost or market for loans held for sale and the ultimate gain or loss on sale
of mortgages. The economic hedges on mortgage servicing rights were considered
in assessing whether or not impairment needed to be recognized. Both were
reported as a component of mortgage banking revenue.
Securities Transactions
================================================================================
Gains for 2001 resulted from the sale of investments classified as available for
sale and from the redemption of certain held to maturity securities. Securities
transactions during 2001 resulted in net gains of $149.3 million compared with
net gains of $28.8 million in 2000. Gains for 2001 were primarily realized from
securities sales to adjust to interest rate changes and to reconfigure exposure
to residential mortgages. The gains for 2001 included a first quarter one-time
gain of $19.3 million on the sale of shares in Canary Wharf, a retail/office
development investment project in London, England. Gains for 2001 also included
$11.2 million on the sale of investment securities acquired to help protect
against the decline in economic value of mortgage servicing rights. During the
fourth quarter of 2001, the Company recognized losses of $38.2 million as it
significantly reduced its holdings of Brazilian securities.
17
Other Operating Expenses
===========================================================================================================================
Increase(Decrease) Increase(Decrease)
2001 Amount % 2000 Amount % 1999
- ---------------------------------------------------------------------------------------------------------------------------
in millions
Salaries and employee benefits $ 1,000.4 $ 25.0 2.6 $ 975.4 $ 554.1 131.5 $ 421.3
Net occupancy 155.5 (11.7) (7.0) 167.2 78.2 88.0 89.0
Equipment and software 129.4 14.4 12.5 115.0 61.3 114.3 53.7
Goodwill amortization 176.5 .3 .2 176.2 142.9 428.6 33.3
Marketing 39.9 5.6 16.3 34.3 9.9 40.9 24.4
Outside services 114.9 9.6 9.1 105.3 56.2 114.6 49.1
Professional fees 41.2 2.9 7.6 38.3 16.2 73.2 22.1
Telecommunications 41.7 6.5 18.5 35.2 18.0 104.8 17.2
Postage, printing and office
supplies 32.9 (.6) (1.9) 33.5 12.3 57.9 21.2
Princeton Note Matter 575.0 575.0 -- -- -- -- --
Other 235.6 10.2 4.5 225.4 128.8 133.3 96.6
- ---------------------------------------------------------------------------------------------------------------------------
Total other operating expenses $ 2,543.0 $ 637.2 33.4 $ 1,905.8 $ 1,077.9 130.2 $ 827.9
- ---------------------------------------------------------------------------------------------------------------------------
Personnel - average number 14,441 26 .2 14,415 5,509 61.9 8,906
===========================================================================================================================
2001 Compared to 2000
Other operating expenses were $2,543.0 million in 2001 compared with $1,905.8
million in 2000. The increase in other operating expenses reflects a $575.0
million third quarter charge taken by the Company to reflect the resolution of
the Princeton Note Matter as well as higher costs due to business expansion in
trading and treasury, wealth management and e-commerce, and increased marketing
expenses. See Note 26, Litigation, for additional information on the Princeton
Note Matter. Incentive compensation tied to performance also increased primarily
in the investment, banking and markets business. Average staffing levels (full
time equivalents) were 14,441 in 2001 compared with 14,415 in 2000. Republic
integration related costs for 2001 were $12.1 million. The integration costs do
not include the higher level of equipment and software depreciation incurred
during 2001 on infrastructure investments made during 2000 related to the
Republic acquisition. Caused by the weaker U.S. economy as well as the response
to the events of September 11, airlines have posted large losses, and the
Company made the decision to recognize a charge of $12.0 million for an
off-balance sheet airline exposure, included in other expenses above.
2000 Compared to 1999
The increase in other operating expenses for 2000 over 1999 was due primarily to
the Republic acquisition. Included in total other operating expenses for 2000
was $85.0 million of integration costs related to the Republic acquisition. See
Note 2, Acquisitions for further discussion. Additional expenses were also
incurred in 2000 to support growth in our domestic wealth management business,
as well as information technology related initiatives including a comprehensive
internet banking product for personal banking customers.
Forward Outlook
The Company is positioning itself to operate in a continuing weak economy.
Improving efficiencies and maintaining strict cost disciplines will be a
priority for 2002. Limited infrastructure and personnel related expansion are
anticipated to support continued growth in wealth management and selected
trading related businesses.
18
Provision for Credit Losses
================================================================================
The provision for credit losses is recorded to adjust the allowance for credit
losses to the level that management deems adequate to absorb losses inherent in
the loan and lease portfolio. Such provisions in 2001 were $238.4 million,
compared with $137.6 million in 2000, representing an increase of $100.8
million. This increase reflects the general weakness in the U.S. economy coupled
with specific deterioration in markets and business sectors served by the
Company including large corporate and middle market commercial business,
international sites, as well as the continued concerns over the consumer sector.
The Company experienced a decline in the overall quality of both its commercial
and consumer loan portfolios during the year although it is not directly evident
by analysis of the key credit statistics. In fact, total nonaccruing loans
decreased by $6.4 million to $416.8 million at December 31, 2001 from $423.2
million at December 31, 2000. This decrease however reflects the Company's
decision to liquidate certain problem credits which resulted in the sale of
$84.9 million of nonaccruing commercial loans during the year. Consumer loan
nonaccruals increased by $13.7 million to $118.1 million at December 31, 2001
from $104.4 million a year earlier, primarily attributable to weaknesses in the
residential mortgage sector. Overall key coverage statistics have remained
strong as the allowance for credit losses at December 31, 2001 represented 1.24%
of total loans as compared with 1.30% at December 31, 2000 and 121.5% of total
nonaccruing loans at December 31, 2001, compared with 124.1% at December 31,
2000.
Although total charge offs net of recoveries were $1.0 million less during 2001
compared to 2000, gross charge offs during the same period increased by $7.5
million. This reflects the decision to charge off certain large domestic problem
credits including specific exposure to the energy sector, as well as exposures
in certain international sites, primarily Panama and Argentina.
Criticized assets are loans that the Company has credit-graded either "special
mention", "substandard" or "doubtful". A key indicator of deterioration in
credit quality, criticized assets increased by $158.5 million during the year.
The Company anticipates that the impact of recent world events and the overall
weakness in the domestic and world economies will continue to have a significant
long-term effect on general economic conditions, governmental and corporate
spending priorities, consumer confidence and the general business climate.
Credit quality in all portfolios is a concern and the Company has and will
continue to take decisive action to quickly identify and address problem
situations.
Although the deterioration in the credit portfolios that manifested itself
during the year would be considered modest, a thorough review of the adequacy of
the allowance for credit losses, with consideration given to specific credits
and more general facts and circumstances, was performed during the year. The
provision for credit losses recognized during 2001 was the amount, based upon
the results of this review and in the judgment of management, deemed necessary
to provide for losses inherent in the portfolio.
In 2000, the provision for credit losses was $137.6 million compared with $90.0
million in 1999. Net charge offs in the credit card portfolio were $60.2 million
and $74.9 million in 2000 and 1999, respectively. Commercial loan net charge
offs were $166.3 million in 2000 compared with $8.7 million in 1999. Although
the overall credit quality of the portfolio remained sound, there was some
deterioration in the quality of highly leverage credits in 2000. These
constituted a small portion of total loans.
19
An analysis of the allowance for credit losses and the provision for credit
losses begins on page 33.
Income Taxes
================================================================================
The Company recognized income tax expense of $226.0 million and $338.5 million
in 2001 and 2000, respectively. The reduction in income tax expense for 2001 is
principally due to the decrease in pretax income.
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. At December 31, 2001, the Company had a
net deferred tax asset of $328.1 million, as compared with a net deferred tax
asset of $92.4 million at December 31, 2000. The increase in the net deferred
tax asset for 2001 is primarily due to the Princeton Note Matter.
Business Segments
================================================================================
The Company reports and manages its business segments consistently with the line
of business groupings used by HSBC. As a result of HSBC line of business
changes, the Company altered its business segments that it uses in 2001. Prior
year disclosures have been conformed to the presentation of current segments.
The Company has four distinct segments that it uses for management reporting:
commercial banking; corporate, investment banking and markets; personal
financial services; and private banking. A description of each segment and the
methodologies used to measure financial performance are included in Note 24,
Business Segments, to the financial statements. The following summarizes the
results for each segment.
20
Corporate,
Investment Personal
Commercial Banking and Financial Private
Banking Markets Services Banking Other Total
- -------------------------------------------------------------------------------------------------------------------------
in millions
2001
Net interest income (1) $ 646 $ 426 $ 1,099 $ 94 $ -- $ 2,265
Other operating income 191 455 393 57 -- 1,096
- -------------------------------------------------------------------------------------------------------------------------
Total income 837 881 1,492 151 -- 3,361
Operating expenses (2) 452 349 871 120 575 2,367
- -------------------------------------------------------------------------------------------------------------------------
Working contribution 385 532 621 31 (575) 994
Provision for credit losses (3) 90 80 62 6 -- 238
- -------------------------------------------------------------------------------------------------------------------------
CMBT* 295 452 559 25 (575) 756
- -------------------------------------------------------------------------------------------------------------------------
Average assets 17,562 41,485 23,944 3,285 -- 86,276
Average liabilities/equity (4) 13,124 30,010 31,703 11,295 144 86,276
- -------------------------------------------------------------------------------------------------------------------------
2000
Net interest income (1) $ 598 $ 447 $ 971 $ 103 $ -- $ 2,119
Other operating income 151 235 376 70 -- 832
- -------------------------------------------------------------------------------------------------------------------------
Total income 749 682 1,347 173 -- 2,951
Operating expenses (2) 415 311 882 121 -- 1,729
- -------------------------------------------------------------------------------------------------------------------------
Working contribution 334 371 465 52 -- 1,222
Provision for credit losses (3) 68 34 37 (1) -- 138
- -------------------------------------------------------------------------------------------------------------------------
CMBT* 266 337 428 53 -- 1,084
Average assets 16,147 41,911 21,325 3,405 -- 82,788
Average liabilities/equity (4) 12,249 28,441 31,234 10,864 -- 82,788
- -------------------------------------------------------------------------------------------------------------------------
1999
Net interest income (1) $ 369 $ 165 $ 692 $ -- $ -- $ 1,226
Other operating income 104 77 283 -- -- 464
- -------------------------------------------------------------------------------------------------------------------------
Total income 473 242 975 -- -- 1,690
Operating expenses (2) 183 73 539 -- -- 795
- -------------------------------------------------------------------------------------------------------------------------
Working contribution 290 169 436 -- -- 895
Provision for credit losses (3) 21 12 57 -- -- 90
- -------------------------------------------------------------------------------------------------------------------------
CMBT* 269 157 379 -- -- 805
- -------------------------------------------------------------------------------------------------------------------------
Average assets 9,141 9,692 15,397 -- -- 34,230
Average liabilities/equity (4) 6,983 8,846 18,401 -- -- 34,230
- -------------------------------------------------------------------------------------------------------------------------
*Contribution margin before tax represents pretax income (loss) excluding
goodwill amortization.
(1) Net interest income of each segment represents the difference between
actual interest earned on assets and interest paid on liabilities of the
segment adjusted for a funding charge or credit. Segments are charged a
cost to fund assets (e.g. customer loans) and receive a funding credit for
funds provided (e.g. customer deposits) based on equivalent market rates.
(2) Expenses for the segments include fully apportioned corporate overhead
expenses.
(3) The provision apportioned to the segments is based on the segments' net
charge offs and the change in allowance for credit losses. Credit loss
reserves are established at a level sufficient to absorb the losses
considered to be inherent in the portfolio.
(4) Common shareholder's equity and earnings on common shareholder's equity are
allocated back to the segments based on the percentage of capital assigned
to the business.
Commercial Banking
This segment contributed $295 million to CMBT in 2001. Growth in CMBT over 2000
was $29 million or 11%. The increase in net interest income for 2001 reflects
growth achieved in commercial deposits and real estate lending, an improved
margin in real estate lending and the impact of the Panama branch acquisitions.
Increased fees for commercial loans and deposit servicing/cash management were
the principal factors behind the growth in other operating
21
income. The expense increase for 2001 was principally due to the full year
impact of the Panama branch acquisitions. Higher provisions for credit losses
reflect the weaker economic conditions during 2001, with losses concentrated in
receivable and inventory lending portfolios.
Corporate, Investment Banking and Markets
This segment contributed $452 million to CMBT in 2001. Growth in CMBT over 2000
was $115 million or 34%. The increase in CMBT was driven by higher levels of
other operating income. Higher levels of trading revenues were earned as the
Company expanded its capabilities in foreign exchange, derivatives and other
trading. The Company was also able to take advantage of falling U.S. interest
rates as well as price volatility to significantly increase treasury related
trading revenue. Other operating income was up significantly year to year due to
gains realized from securities sales to adjust to interest rate changes and to
reconfigure exposure to residential mortgages. These security sales contributed
to the lower level of net interest income earned for 2001 in this business
segment. The increase in operating expenses reflects the higher costs associated
with the previously noted business expansions in traded markets as well as
increases in incentive compensation tied to performance. The higher provision
for credit losses reflects losses related to a single large corporate in the
energy sector.
Personal Financial Services
This segment contributed $559 million to CMBT in 2001. Growth in CMBT over 2000
was $131 million or 31%. The increase in net interest income for 2001 reflects
the impact of a larger balance sheet and a wider interest margin. Average
residential mortgages grew $2.6 billion for 2001, as the mortgage banking
division experienced record levels of production driven by a low rate
environment. Wider interest margins earned on residential mortgages and customer
deposits also contributed to increased net interest income. The growth in other
operating income reflects growth in wealth management fees, deposit service
charges and insurance. In conjunction with the adoption of SFAS 133 on January
1, 2001, mark to market losses were recognized in other operating income in the
residential mortgage business. Mark to market losses of $39.7 million related to
mortgage servicing rights and $27.4 million related to mortgage loans held for
sale were recorded in 2001. The increased provision for credit losses reflects a
weaker economy and higher delinquency rates on consumer loans.
Private Banking
This segment contributed $25 million to CMBT in 2001. CMBT decreased $28 million
or 53% compared to 2000. The lower level of other operating income was driven by
losses on sale of securities, as the Company significantly reduced its holdings
of Brazilian securities. The migration of international private banking business
in Asia to other HSBC Group members also contributed to lower revenues. Higher
operating expenses required to build the business were offset by lower costs
associated with above noted migration of Asian business.
Other
This segment for 2001 includes the expenses associated with the Princeton Note
settlement.
22
BALANCE SHEET REVIEW
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 Management Committee manages the
details of liquidity and interest rate risk. The management of credit risk is
further discussed on page 29.
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 Management 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 market rate risk assessment techniques,
principally dynamic simulation modeling, capital at risk analysis, gap analysis
and Value at Risk (VaR) to assess the sensitivity of its earnings and capital
positions to changes in interest rates. In addition, VaR, stress testing and
other analyses are used for trading activities. 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. VaR attempts to capture the potential
loss resulting from unfavorable market developments within a given time horizon
(typically 10 days) and given a certain confidence level (99%). Management of
market risk is further discussed on page 36.
Diversification is also a principle employed in asset/liability management. The
Company is 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
23
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.
On January 1, 2001 the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133) as amended by SFAS 137 and SFAS 138. As further described in the
Summary of Significant Accounting Policies beginning on page 49, SFAS 133
requires that all derivative financial instruments be recognized at fair value
on the balance sheet. To the extent these derivatives qualify for special hedge
accounting under SFAS 133, changes in their value may be offset by the
corresponding mark to market of hedged assets, liabilities, firm commitments or
for forecasted transactions, deferred as a component of shareholder's equity
until the transaction occurs. The ineffective portion of the change in value of
a derivative in a qualifying hedge relationship and derivative contracts that do
not qualify for hedge accounting under SFAS 133 are recognized currently in
earnings. Although the adoption of SFAS 133 resulted in the liquidation of
certain derivative contracts previously identified as qualifying hedges and the
mark to market as trading positions of many others, the Company pursues several
SFAS 133 qualifying hedge strategies.
Specifically, within the context of its overall balance sheet risk management
strategy, interest rate swap and futures contracts are utilized to protect
against changes in fair values and cash flows associated with certain balance
sheet assets, liabilities, forecasted transactions and firm commitments in order
to maintain net interest margin within a range that management considers
acceptable. Additionally, forward contracts are utilized to hedge the foreign
currency risk associated with available for sale debt securities. To achieve
this objective, the Company has identified and currently pursues several
qualifying SFAS 133 hedge strategies.
Interest rate swaps that call for the receipt of a variable market rate and the
payment of a fixed rate are utilized under fair value strategies to hedge the
risk associated with changes in the risk free rate component of the value of
certain fixed rate investment securities. Interest rate swaps that call for the
receipt of a fixed rate and payment of a variable market rate are utilized to
hedge the risk associated with changes in the risk free rate component of
certain fixed rate debt obligations.
Similarly, interest rate swaps that call for the receipt of a variable market
rate and the payment of a fixed rate are utilized under the cash flow strategy
to hedge the forecasted repricing of certain deposit liabilities.
Increased earnings volatility will result from the on-going mark to market of
certain economically viable derivative contracts that do not satisfy the
qualifying hedge requirements of SFAS 133, as well as from the hedge
ineffectiveness associated with the qualifying contracts. The Company expects
however that it will be able to continue to pursue its overall asset and
liability risk management objectives using a combination of derivatives and cash
instruments.
Liquidity Management
================================================================================
Liquidity is managed to provide the ability to generate cash to meet lending,
deposit withdrawal and other commitments at a reasonable cost in a reasonable
amount of time, while maintaining routine operations and market confidence. The
Asset Liability Management Committee is responsible for the development
24
and implementation of related policies and procedures to ensure that the minimum
liquidity ratios and a strong overall liquidity position are maintained.
In carrying out this responsibility, the Asset Liability Management Committee
projects cash flow requirements and determines the optimal level of liquid
assets and available funding sources to have at the Company's disposal, with
consideration given to anticipated deposit and balance sheet growth, contingent
liabilities, and the ability to access short-term wholesale funding markets. In
addition, the Committee must monitor deposit and funding concentrations in terms
of overall mix and to avoid undue reliance on individual funding sources and
large deposit relationships. They must also maintain a liquidity management
contingency plan, which identifies certain potential early indicators of
liquidity problems, and actions which can be taken both initially and in the
event of a liquidity crisis to minimize the long-term impact on the Company's
business and customer relationships.
Deposit accounts from a diverse mix of "core" retail, commercial and public
sources represent a significant, cost-effective source of liquidity under normal
operating conditions. The Company's ability to regularly attract wholesale funds
at a competitive cost is enhanced by strong ratings from the major credit
ratings agencies. As of December 31, 2001, the Company and its principal
operating subsidiary, HSBC Bank USA, maintained the following long and
short-term debt ratings:
Short-Term Debt Long-Term Debt
--------------- --------------
Moody's S&P Fitch Moody's S&P Fitch
------- --- ----- ------- --- -----
HSBC USA Inc. P-1 A-1 F1+ A1 A+ AA-
HSBC Bank USA P-1 A-1+ F1+ Aa3 AA- AA-
The Company has filed a shelf registration statement with the Securities and
Exchange Commission under which it may issue up to $1.1 billion in debt and
equity securities and has ready access to the capital markets for long-term
funding through the issuance of registered debt. In addition, the Company
maintains an unused $500 million bank line of credit with HSBC, and as member of
the New York Federal Home Loan Bank, a secured borrowing facility in excess of
$5 billion collateralized by residential mortgage loan assets. Off-balance sheet
special purpose vehicles or other off-balance sheet mechanisms are not utilized
as a material source of liquidity or funding.
Assets, principally consisting of a portfolio of highly rated investment
securities in excess of $20 billion, approximately $2 billion of which is
scheduled to mature during 2002, a liquid trading portfolio of approximately $9
billion, and residential mortgages are a primary source of liquidity to the
extent that they can be sold or used as collateral for borrowing. The economics
and long-term business impact of obtaining liquidity from assets must be weighed
against the economics of obtaining liquidity from liabilities, along with
consideration given to the associated capital ramifications of these two
alternatives. Currently, assets supplement liquidity derived from liabilities,
only in a crisis scenario.
It is the policy of the Bank to maintain both primary and secondary collateral
in order to ensure precautionary borrowing availability from the Federal
Reserve. Primary collateral is that which is physically maintained at the
Federal Reserve, and serves as a safety net against any unexpected funding
shortfalls that may occur. Secondary collateral is collateral that is acceptable
to the Federal Reserve, but is not maintained there. If unutilized borrowing
capacity were to be low, secondary collateral would be identified and maintained
as necessary.
25
With over $15 billion of available wholesale short-term funding at its disposal,
the Company has ample liquidity to handle almost any crisis scenario. For
example, in the event that the Company had no ability to access the wholesale
liability markets and additional funding of commercial credit lines and letters
of credit totaling up to $5 billion were to occur, there would still be more
than $5 billion of surplus cash to meet any additional withdrawals or funding
requirements.
Contractual Obligations and Commercial Commitments
================================================================================
As disclosed in the notes to the consolidated financial statements, the Company
has certain obligations and commitments to make future payments under contracts.
The following table provides information related to contractual obligations.
- ------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2001 or Less Five Years Years Total
- ------------------------------------------------------------------------------------------------------------------
in millions
Subordinated long-term debt and
perpetual capital notes $ 646 $ 300 $1,753 $ 2,699
Guaranteed mandatorily redeemable
securities -- -- 750 750
Other long-term debt, including
capital lease obligations 191 240 602 1,033
Minimum future rental commitments
on operating leases 62 188 97 347
- ------------------------------------------------------------------------------------------------------------------
Total $ 899 $ 728 $3,202 $ 4,829
==================================================================================================================
The following table provides information related to commercial commitments.
- ------------------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2001 or Less Five Years Years Total
- ------------------------------------------------------------------------------------------------------------------
in millions
Standby letters of credit,
other letters of credit and
financial guarantees $ 4,452 $ 991 $ 140 $ 5,583
Commitments to extend credit 19,897 7,766 981 28,644
Commitments to deliver mortgage-
backed securities 2,122 -- -- 2,122
- ------------------------------------------------------------------------------------------------------------------
Total $26,471 $8,757 $1,121 $36,349
==================================================================================================================
Interest Rate Sensitivity
================================================================================
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 ranges of interest rate risk that management
considers acceptable, the Company uses derivative instruments such as interest
rate swaps, options, futures and forwards as hedges to modify the repricing
characteristics of specific assets, liabilities, forecasted transactions or firm
commitments.
The following table shows the repricing structure of assets and liabilities as
of December 31, 2001. For assets and liabilities whose cash flows are subject
26
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, 2001 Funds Days Days Days Year Total
- -----------------------------------------------------------------------------------------------------------------------
in millions
Assets $ 9,399 $ 39,366 $ 2,582 $ 5,197 $ 30,570 $87,114
Liabilities and shareholders'
equity 18,974 42,609 3,918 5,010 16,603 87,114
- -----------------------------------------------------------------------------------------------------------------------
(9,575) (3,243) (1,336) 187 13,967 --
Effect of derivative contracts -- 3,809 100 (3,060) (849) --
- -----------------------------------------------------------------------------------------------------------------------
Gap position $ (9,575) $ 566 $(1,236) $ (2,873) $ 13,118 $ --
=======================================================================================================================
Liabilities and shareholders' equity at year-end 2001 include time deposits of
$100,000 or more with maturity dates as follows: $2,987.8 million, 0-90 days;
$545.1 million, 91-180 days; $412.6 million, 181-365 days, and $210.4 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 36 through
38 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
================================================================================
The following table presents the contractual maturity and interest sensitivity
of domestic commercial and international loans at year end 2001.
- -------------------------------------------------------------------------------------------------------
One Over One Over
Year Through Five
December 31, 2001 or Less Five Years Years
- -------------------------------------------------------------------------------------------------------
in millions
Domestic:
Construction and mortgage loans $ 1,169 $2,832 $1,953
Other business and financial 7,025 3,452 87
International 2,448 821 267
- -------------------------------------------------------------------------------------------------------
Total $10,642 $7,105 $2,307
=======================================================================================================
Loans with fixed interest rates $ 4,028 $2,759 $2,013
Loans having variable interest rates 6,614 4,346 294
- -------------------------------------------------------------------------------------------------------
Total $10,642 $7,105 $2,307
=======================================================================================================
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 accumulated other
comprehensive income and reported as a separate component of shareholders'
equity.
27
The following table is an analysis of the carrying values of the securities
portfolios at the end of each of the last three years.
- ----------------------------------------------------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------ ----------------
December 31, 2001 2000 1999 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
in millions
U.S. Treasury $ 372 $ 323 $ 1,522 $ -- $ -- $ --
U.S. Government agency 8,068 9,119 16,383 3,882 3,530 4,092
Obligations of U.S. states and
political subdivisions -- -- -- 769 730 678
Asset backed securities 3,485 3,166 3,017 -- -- --
Other domestic debt securities 739 1,487 1,418 -- -- --
Foreign debt securities 2,435 2,555 1,805 -- -- --
Equity securities 646 687 472 -- -- --
- ----------------------------------------------------------------------------------------------------------------------
Total $15,745 $17,337 $24,617 $4,651 $4,260 $4,770
======================================================================================================================
Equity securities in the table above include Federal Reserve Bank and Federal
Home Loan Bank stock totaling $478 million at December 31, 2001, $463 million at
December 31, 2000 and $238 million at December 31, 1999.
The following table reflects the distribution of maturities of debt securities
held at year-end 2001 together with the approximate taxable equivalent yield of
the portfolio. The yields shown are calculated by dividing annual interest
income, including the accretion of discounts and the amortization of premiums,
by the amortized cost of securities outstanding at December 31, 2001. Yields on
tax-exempt obligations have been computed on a taxable equivalent basis using
applicable statutory tax rates.
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 $ 2 -% $ 196 2.76% $ 160 3.69% $ 8 .37%
U.S. Government agency 8 6.37 1,191 6.19 636 6.19 6,129 6.12
Asset backed securities 4 2.31 1,222 3.85 1,100 2.84 1,125 2.78
Other domestic debt
securities 333 1.67 109 5.20 44 4.75 192 4.08
Foreign debt securities 160 5.49 977 5.34 753 5.65 525 7.37
- -------------------------------------------------------------------------------------------------------------------------
Total amortized cost $ 507 2.95% $3,695 4.98% $2,693 4.00% $7,979 5.68%
- -------------------------------------------------------------------------------------------------------------------------
Total fair value $ 515 $3,788 $2,714 $8,082
=========================================================================================================================
Held to maturity:
U.S. Government agency $ 17 7.44% $ 143 7.25% $ 319 7.19% $3,403 7.13%
Obligations of U.S.
states and political
subdivisions 5 10.50 39 10.81 144 9.08 581 8.89
- -------------------------------------------------------------------------------------------------------------------------
Total amortized cost $ 22 8.10% $ 182 8.01% $ 463 7.78% $3,984 7.38%
- -------------------------------------------------------------------------------------------------------------------------
Total fair value $ 23 $ 191 $ 484 $4,142
=========================================================================================================================
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
28
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 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.
Loans Outstanding
================================================================================
The following table provides a breakdown of major loan categories as of year end
for the past five years.
- -------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
in millions
Domestic:
Commercial:
Construction and mortgage loans $ 5,954 $ 5,646 $ 5,648 $ 3,096 $ 2,235
Other business and financial 10,564 12,551 12,002 7,803 5,811
Consumer:
Residential mortgages 17,951 15,836 13,241 9,467 10,008
Credit card receivables 1,148 1,232 1,290 1,291 1,780
Other consumer loans 1,770 1,640 1,231 1,319 1,179
- -------------------------------------------------------------------------------------------------------------------
37,387 36,905 33,412 22,976 21,013
- -------------------------------------------------------------------------------------------------------------------
International:
Government and official institutions 169 302 444 331 345
Banks and other financial institutions 314 852 727 622 65
Commercial and industrial