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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, 2002
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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2
T A B L E O F C O N T E N T S
Part 1
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Page
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Item 1. Description of Business
History and Development 4
Regulation, Supervision and Capital 4
Competition 7
Business Segments 27
International and Domestic Operations 89
Statistical Disclosure by Bank Holding Companies:
Average Balance Sheets and Interest Earned and Paid 10
Changes in Interest Income and Expense Attributable
to Changes in Rate and Volume 17
Securities Portfolios 38
Loans Outstanding:
Composition and Maturities 38, 40
Risk Elements in the Loan Portfolio 42
Summary of Loan Loss Experience 44
Deposits 71
Short-Term Borrowings 72
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
Part II
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Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 50
Item 8. Financial Statements and Supplementary Data 51
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 95
Part III
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Item 10. Directors and Executive Officers of the Registrant 95
Item 11. Executive Compensation 98
Item 12. Security Ownership of Certain Beneficial Owners
and Management 101
Item 13. Certain Relationships and Related Transactions 101
Item 14. Controls and Procedures 102
Part IV
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Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 103
3
P A R T I
Item 1. Business
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History and Development
HSBC USA Inc. (the Company), incorporated under the laws of Maryland, is a New
York State based bank holding company registered under the Bank Holding Company
Act of 1956, as amended. The Company's origin was in Buffalo, New York in 1850
as The Marine Trust Company, which later became Marine Midland Banks, Inc.
(Marine). In 1980, The Hongkong and Shanghai Banking Corporation (now HSBC
Holdings plc, hereinafter referred to as "HSBC") acquired 51% of the common
stock of Marine and the remaining 49% of common stock in 1987. HSBC is one of
the largest banking and financial services organizations in the world. In
December 1999, HSBC acquired Republic New York Corporation (Republic) and merged
it with the Company. At the merger date, Republic and the Company had total
assets of approximately $47 billion and $43 billion, respectively.
At December 31, 2002, the Company had assets of $89.4 billion and approximately
14,000 full and part time employees. The Company's principal subsidiary is HSBC
Bank USA (the Bank), which had assets of $86.4 billion and deposits of $60.2
billion at December 31, 2002. The Bank is the tenth largest U.S. commercial bank
ranked by assets.
The Company offers a full range of traditional commercial 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. The Bank also has
mortgage banking and retail brokerage operations. The Company is an
international dealer in derivative instruments denominated in U.S. dollars and
other currencies which include futures, forwards, swaps and options related to
interest rates, foreign exchange rates, equity indices, commodity prices and
credit, focusing on structuring of transactions to meet clients' needs.
The Bank's domestic operations are primarily in New York State. It also has
banking branch offices in Pennsylvania, Florida, Oregon, Washington and
California. 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, Australia and Canada.
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 Bank is required to maintain noninterest bearing cash reserves with the
Federal Reserve Bank. The Bank's reserves averaged $394.0 million in 2002 and
$211.0 million in 2001.
4
Item 1. Business Continued
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The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, specific capital
guidelines must be met that involve quantitative measures of assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classifications are also subject
to qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the maintenance of minimum amounts and ratios of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined) of
8% and 4%, respectively. Also required are ratios of Tier 1 capital (as defined)
to average assets (as defined) of 4% at the Bank level and 3% at the Company
level as long as the Company has a strong supervisory rating.
The most recent notification from the Federal Reserve Board (FRB) categorized
the Company and the Bank as well-capitalized under the regulatory framework for
prompt corrective action. Nothing has occurred since that notification that
would change that category. To be categorized as well capitalized, a banking
institution must have a minimum total risk-based ratio of at least 10%, a Tier 1
risk-based ratio of at least 6%, and a Tier 1 leverage ratio of at least 5%. The
actual amounts and ratios for the Company and the Bank were as follows.
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2002 2001
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December 31, Amount Ratio Amount Ratio
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in millions
Total capital
(to risk weighted assets)
Company $7,796 14.24% $7,404 13.31%
Bank 6,684 12.44 6,502 11.90
Tier 1 capital
(to risk weighted assets)
Company 5,127 9.36 4,639 8.34
Bank 4,719 8.78 4,493 8.22
Tier 1 capital
(to average assets)
Company 5,127 5.98 4,639 5.48
Bank 4,719 5.66 4,493 5.46
Risk weighted assets
Company 54,763 55,620
Bank 53,752 54,655
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5
Item 1. Business Continued
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The following shows the components of the Company's risk-based capital.
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December 31, 2002 2001
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in millions
Common shareholder's equity $ 6,634 $ 6,450
Preferred stock 375 375
Guaranteed mandatorily redeemable
preferred securities of subsidiaries 1,051 729
Less: Goodwill and identifiable intangibles (2,918) (2,896)
Foreign currency translation adjustment (15) (19)
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Tier 1 capital 5,127 4,639
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Long-term debt and other instruments
qualifying as Tier 2 capital 2,123 2,209
Qualifying aggregate allowance for
credit losses 539 556
Other Tier 2 components 7 -
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Tier 2 capital 2,669 2,765
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Total capital $7,796 $ 7,404
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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 weighted assets.
The Bank is subject to risk-based assessments from the Federal Deposit Insurance
Corporation (FDIC), the U. S. Government agency that insures deposits in the
Bank to a maximum of $100,000 per domestic depositor. Depository institutions
subject to assessment are categorized based on capital ratios and other factors,
with those in the highest rated categories paying no assessments. The Bank was
not assessed by the FDIC in the past three years.
The Deposit Insurance Funds Act (DIFA) of 1996 authorized the Financing
Corporation (FICO), a U.S. Government corporation, to collect funds from FDIC
insured institutions to pay interest on FICO bonds. The current FICO assessment
rate is 1.70 basis points annually for assessable deposits. The FICO assessment
rate is adjusted quarterly. The Bank is subject to a quarterly FICO premium.
The USA Patriot Act (Patriot Act), effective October 26, 2001, imposed
significant record keeping and customer identity requirements, expanded the
government's powers to freeze or confiscate assets and increased the available
penalties that may be assessed against financial institutions for violation of
the requirements of the Patriot Act intended to detect and deter money
laundering. The Patriot Act required the U.S. Treasury Secretary to develop and
adopt final regulations with regard to the anti-money laundering compliance
obligations on financial institutions (a term which includes insured U.S.
depository institutions, U.S. branches and agencies of foreign banks, U.S.
broker-dealers and numerous other entities). The U.S. Treasury Secretary
delegated this authority to a bureau of the U.S. Treasury Department known as
the Financial Crimes Enforcement Network (FinCEN).
Many of the new anti-money laundering compliance requirements of the Patriot
Act, as implemented by FinCEN, are generally consistent with the anti-money
laundering compliance obligations that applied to the Bank under the Bank
Secrecy Act and applicable Federal Reserve Board regulations before the Patriot
Act was adopted. These include requirements to adopt and implement an anti-money
laundering program, report suspicious transactions and implement due diligence
procedures for certain correspondent and private banking accounts. Certain other
specific requirements under the Patriot Act involve new compliance obligations.
The Patriot Act and other recent events have resulted in heightened scrutiny of
Bank Secrecy Act and anti-money laundering compliance programs by the federal
bank examiners. HSBC Bank USA is in the process of implementing a program to
ensure that it is in full compliance with all such requirements.
6
Competition
The Gramm-Leach-Bliley Act of 1999 (GLB Act), effective March 11, 2000,
eliminated many of the regulatory restrictions on providing financial services.
The Act allows for financial institutions and other providers of financial
products to enter into combinations that permit a single organization to offer a
complete line of financial products and services. Therefore, the Company and its
subsidiaries face intense competition in all of the markets they serve,
competing with both other financial institutions and non-banking institutions
such as insurance companies, major retailers, brokerage firms and investment
companies.
Following the enactment of the Gramm-Leach-Bliley Act, the Company elected to be
treated as a financial holding company (FHC). As an FHC, the Company's
activities in the United States have been expanded enabling it to offer a more
complete line of products and services. The Company's ability to engage in
expanded financial activities as an FHC depends upon the Company's meeting
certain criteria, including requirements that its U.S. depository institution
subsidiary, the Bank, and its forty percent owned subsidiary, Wells Fargo HSBC
Trade Bank, N.A., be well capitalized and well managed, and that they have
achieved at least a satisfactory record of meeting community credit needs during
their most recent examination pursuant to the Community Reinvestment Act. In
general, an FHC would be required, upon notice by the Federal Reserve Board, to
enter into an agreement to correct any deficiency in the requirements necessary
to maintain its FHC election. Until such deficiencies are corrected, the Federal
Reserve Board may impose limitations on the conduct or activities of an FHC or
any of its affiliates as it deems appropriate. If such deficiencies are not
timely corrected, the Federal Reserve Board may require an FHC to divest its
control of any subsidiary bank or to cease to engage in certain financial
activities.
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, four branches in California and one branch in Oregon
and one in Washington. Approximately 39% 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 (See Note 22 Litigation)
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Item 4. Submission of Matters to a Vote of Security Holders (Not applicable)
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P A R T II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters (Not applicable)
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7
Item 6. Selected Financial Data (1)
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Year Ended December 31, 2002 2001 2000 1999 1998
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in millions
Net interest income $ 2,376.3 $ 2,265.3 $ 2,118.5 $ 1,225.9 $ 1,165.3
- --------------------------------------------------------------------------------------------------------------------
Total trading revenues 33.1 198.9 140.2 10.0 3.7
Securities transactions 118.2 149.3 28.8 10.1 13.8
Interest on Brazilian tax settlement -- -- -- 13.1 32.7
Other operating income 908.0 747.5 663.4 430.8 409.9
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Total other operating income 1,059.3 1,095.7 832.4 464.0 460.1
- --------------------------------------------------------------------------------------------------------------------
Goodwill amortization -- 176.5 176.1 33.3 37.7
Princeton Note Matter -- 575.0 -- -- --
Operating expenses 1,875.5 1,791.5 1,729.7 794.6 742.5
Provision for credit losses 195.0 238.4 137.6 90.0 80.0
- --------------------------------------------------------------------------------------------------------------------
Income before taxes and cumulative effect
of accounting change 1,365.1 579.6 907.5 772.0 765.2
Applicable income tax expense 509.7 226.0 338.5 308.3 238.1
- --------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of
accounting change 855.4 353.6 569.0 463.7 527.1
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Cumulative effect of accounting change -
implementation of SFAS 133, net of tax -- (0.5) -- -- --
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Net income $ 855.4 $ 353.1 $ 569.0 $ 463.7 $ 527.1
====================================================================================================================
Adjusted net income (2) $ 855.4 $ 529.6 $ 745.1 $ 497.0 $ 564.8
====================================================================================================================
Balances at year end
Total assets $ 89,426 $ 87,114 $ 83,035 $ 87,246 $ 33,944
Goodwill 2,829 2,842 3,172 3,245 333
Long-term debt 4,225 4,491 5,097 5,885 1,748
Common shareholder's equity 6,897 6,549 6,834 6,717 2,228
Total shareholders' equity 7,397 7,049 7,334 7,217 2,228
Ratio of shareholders'
equity to total assets 8.27% 8.09% 8.83% 8.27% 6.56%
- --------------------------------------------------------------------------------------------------------------------
Selected financial data (3)
Rate of return on
Total assets 0.97% 0.41% 0.69% 1.35% 1.60%
Total common shareholder's equity 12.42 4.80 8.22 20.31 24.93
Total shareholders' equity to total assets 8.20 8.50 8.56 6.67 6.44
- --------------------------------------------------------------------------------------------------------------------
(1) 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.
(2) With the adoption of Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (SFAS 142) on January 1, 2002, the
Company is no longer required to amortize goodwill but rather evaluate
goodwill for impairment annually. Accordingly, for prior periods
presented, goodwill amortization has been excluded from the adjusted
amounts for consistency purposes.
(3) Based on average daily balances.
8
Quarterly Results of Operations
2002
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4th Q 3rd Q (1) 2nd Q (1) 1st Q (1)
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in millions
Net interest income $ 625.2 (2) $ 595.1 $ 574.0 $ 582.0
- -------------------------------------------------------------------------------------------------------------------
Total trading revenues 10.1 21.5 (30.4) 31.9
Securities transactions (2.3) 16.2 66.3 38.0
Other operating income 259.3 (3) 211.2 230.3 207.2
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Total other operating income 267.1 248.9 266.2 277.1
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Operating expenses 496.9 457.4 471.2 450.0
Provision for credit losses 26.2 39.0 56.3 73.5
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Income before taxes 369.2 347.6 312.7 335.6
Applicable income tax expense 140.7 130.7 114.1 124.2
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Net income $ 228.5 $ 216.9 $ 198.6 $ 211.4
===================================================================================================================
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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Total trading revenues 22.9 73.8 51.8 50.4
Securities transactions 2.6 20.9 56.6 69.2
Other operating income 233.8 181.1 159.8 172.8
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Total other operating income 259.3 275.8 268.2 292.4
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Goodwill amortization 43.4 43.8 44.2 45.1
Princeton Note Matter -- 575.0 -- -
Operating expenses 467.7 437.9 439.4 446.5
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 (benefit) 96.3 (106.5) 120.4 115.8
- -------------------------------------------------------------------------------------------------------------------
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
===================================================================================================================
(1) Operating expenses for the first three quarters of 2002 were restated in
accordance with the adoption of SFAS 147 during the fourth quarter.
(2) Reflects the impact of growth in the balance sheet, primarily residential
mortgage loans, and wider interest margins on residential mortgage loans
and treasury investments.
(3) Reflects higher levels of fee-based income, including $12.8 million of
revenue earned by the newly formed wealth and tax advisory services
business. Also includes higher levels of mortgage banking revenue as a
result of increased gains on sale of mortgages from higher mortgage
origination volumes.
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.
2002
---------------------------------
Balance Interest Rate
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Assets
Interest bearing deposits with banks $ 1,996 $ 54.7 2.74%
Federal funds sold and securities purchased under resale agreements 5,289 94.7 1.79
Trading assets 10,943 161.3 1.47
Securities 18,541 975.3 5.26
Loans
Domestic
Commercial 16,464 841.5 5.11
Consumer
Residential mortgages 19,346 1,250.0 6.46
Other consumer 2,963 270.5 9.13
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Total domestic 38,773 2,362.0 6.09
International 3,281 160.1 4.88
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Total loans 42,054 2,522.1 6.00
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Other interest * 23.4 *
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Total earning assets 78,823 $ 3,831.5 4.86%
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Allowance for credit losses (533)
Cash and due from banks 2,017
Other assets 7,473
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Total assets $ 87,780
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Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits $ 21,070 $ 211.7 1.00%
Other time deposits 12,170 317.3 2.61
Deposits in foreign offices 18,705 406.7 2.17
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Total interest bearing deposits 51,945 935.7 1.80
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Federal funds purchased and securities sold under repurchase agreements 2,123 53.0 2.50
Other short-term borrowings 9,292 178.5 1.92
Long-term debt 4,610 263.3 5.71
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Total interest bearing liabilities 67,970 $ 1,430.5 2.10%
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Interest rate spread 2.76%
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Noninterest bearing deposits 5,631
Other liabilities 6,979
Total shareholders' equity 7,200
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Total liabilities and shareholders' equity $ 87,780
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Net yield on average earning assets 3.05%
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Net yield on average total assets 2.74
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* Other interest relates to Federal Reserve Bank and Federal Home Loan Bank
stock included in other assets.
Total weighted average rate earned on earning assets is interest and fee
earnings divided by daily average amounts of total interest earning assets,
including the daily average amount on nonperforming loans. Loan interest
included fees of $42 million for 2002, $55 million for 2001 and $44 million for
2000.
10
SCHEDULE CONTINUED
2001 2000
- -------------------------------- ----------------------------------
Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------
in millions
$ 4,467 $ 207.2 4.64% $ 4,424 $ 308.7 6.98%
3,588 137.9 3.84 3,260 215.0 6.59
8,429 217.1 2.58 5,504 140.5 2.55
19,808 1,292.3 6.52 21,653 1,572.4 7.26
16,997 1,065.7 6.27 16,436 1,266.3 7.70
17,123 1,247.5 7.29 14,551 1,086.3 7.47
3,186 339.3 10.65 3,189 365.7 11.47
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37,306 2,652.5 7.11 34,176 2,718.3 7.95
4,135 286.1 6.92 4,790 355.5 7.42
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41,441 2,938.6 7.09 38,966 3,073.8 7.89
- --------------------------------------------------------------------------------------------
* 27.9 * * 32.8 *
- --------------------------------------------------------------------------------------------
77,733 $4,821.0 6.20% 73,807 $5,343.2 7.24%
- --------------------------------------------------------------------------------------------
(541) (606)
1,891 1,794
7,193 7,793
- --------------------------------------------------------------------------------------------
$ 86,276 $ 82,788
============================================================================================
$ 17,503 $ 275.7 1.58% $ 15,579 $ 333.2 2.14%
14,069 679.7 4.83 13,796 770.9 5.59
20,263 901.5 4.45 19,594 1,230.0 6.28
- --------------------------------------------------------------------------------------------
51,835 1,856.9 3.58 48,969 2,334.1 4.77
- --------------------------------------------------------------------------------------------
2,553 78.2 3.06 2,082 123.8 5.95
7,341 259.0 3.53 6,574 320.9 4.88
4,835 328.1 6.79 5,771 420.3 7.28
- --------------------------------------------------------------------------------------------
66,564 $2,522.2 3.79% 63,396 $3,199.1 5.05%
- --------------------------------------------------------------------------------------------
2.41% 2.19%
- --------------------------------------------------------------------------------------------
5,596 6,063
6,782 6,246
7,334 7,083
- --------------------------------------------------------------------------------------------
$ 86,276 $ 82,788
============================================================================================
2.96% 2.91%
- --------------------------------------------------------------------------------------------
2.66 2.59
============================================================================================
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 $855.4 million for 2002 compared with $353.1
million in 2001. Return on average common shareholder's equity was 12.42% in
2002 and 4.80% in 2001. Net income in 2001 included a $351.0 million after tax
charge for the Princeton Note Matter and $176.5 million of goodwill
amortization, not included in 2002 earnings under new U.S. GAAP accounting
rules. When 2001 is adjusted for these items, net income decreased by 3 percent
to $855.4 million for the year ended December 31, 2002 from $880.6 million for
the year ended December 31, 2001, although net income before taxes increased by
3 percent year over year.
During 2002, the Company achieved solid growth in income from banking
operations. Net interest income was $2,376.3 million in 2002 compared with
$2,265.3 million in 2001. The increase in net interest income reflects the
impact of growth in the balance sheet, primarily residential mortgage loans, and
wider interest margins in residential mortgage loans and treasury investments.
While total other operating income was down slightly compared to 2001, driven by
lower levels of market sensitive trading revenues, solid growth was achieved in
most categories of fee-based and other operating income. Total operating
expenses were $1,875.5 million for 2002 compared to $2,543.0 million for 2001.
The decrease in expense reflects the discontinuance of goodwill amortization in
2002 as well as the impact of the 2001 charge for the Princeton Note Matter. The
provision for credit losses was $195.0 million for 2002 compared to $238.4
million for 2001, as credit quality improved, as measured by criticized and
nonaccruing loans, during the later part of 2002.
This report includes forward-looking statements. Statements that are not
historical facts, including statements about management's beliefs and
expectations, are forward-looking statements and involve inherent risks and
uncertainties. 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 and challenges; significant changes in accounting, tax or
regulatory requirements; consumer behavior; marketplace perceptions of the
Company's reputation and competition in the geographic and business areas in
which the Company conducts its operations.
A detailed earnings performance review comparing 2002, 2001 and 2000 begins on
page 15. It should be read in conjunction with the consolidated financial
statements of the Company which begin on page 53.
Critical Accounting Estimates
- --------------------------------------------------------------------------------
Provision for Credit Losses
An assessment of the adequacy of the allowance for credit losses is regularly
conducted through a detailed review of the loan portfolio. The allocated portion
of the allowance is based on an evaluation of specific commercial and
residential mortgage problem loans considered "impaired". Reserves against
impaired loans are determined primarily by reference to independent valuations
of underlying loan collateral.
In addition, formula-based reserves are provided for homogeneous categories of
loans where it is deemed probable, based on historical data, that a loss has
been realized even though it has not yet been manifested in a specific loan.
12
In determining formula-based reserves, the Company utilizes historical data to
develop a range of loss factors. These factors are continually updated with
consideration given to specific industry forecasts and concentration risks,
along with trends in delinquency, nonaccruals and credit classifications. For
purposes of this analysis, commercial loan portfolios are segregated by specific
business unit while consumer loans are segregated by product type.
The Company then selects the individual loss factors from within the range based
upon an evaluation of critical data and trends. These loss factors are then
applied to outstanding balances to arrive at formula-based reserve amounts.
At December 31, 2002, there were $345.3 million of formula-based reserves
contained within the total allowance for credit losses. Had the loss factors
been utilized at the high end of the range, formula-based reserves would have
increased by $119.0 million to $464.3 million. In contrast, had the loss factors
been utilized at the low end of the range, formula-based reserves would have
decreased by $201.5 million to $143.8 million.
Changes in credit quality tend to occur over an extended period of time. As
such, movements in selected loss factors within the range tend to be gradual.
The Company does not believe the high or low end of the range would occur for
every segment of the loan portfolio at one point in time. Further the Company
would not expect the allowance for credit losses or associated provision expense
to materially change during any given reporting period strictly as a result of
movements in selected loss factors from within the range. Large movements
primarily result from the significant deterioration of large credits as a result
of factors not previously known.
The Company recognizes however that there is a high degree of subjectivity and
imprecision inherent in the process of estimating losses utilizing historical
data. Accordingly, additional unallocated reserves are provided based upon an
evaluation of certain other critical factors including the impact of the
national economic cycle, migration of loans within non-criticized loan
portfolios, as well as portfolio concentration.
Goodwill
Goodwill is not subject to amortization but must be tested for possible
impairment at least annually or more frequently if events or changes in
circumstances indicate that the asset might be impaired. Impairment testing
requires that the fair value of each reporting unit be compared to its carrying
amount, including the goodwill.
Reporting units were identified based upon an analysis of each of the Company's
individual operating segments. A reporting unit is defined as any distinct,
separately identifiable component of an operating segment for which complete,
discrete financial information is available that management regularly reviews.
Goodwill was allocated to the carrying value of each reporting unit based on its
relative fair value.
Determining the fair value of a reporting unit requires a high degree of
subjective management assumption. Discounted cash flow valuation models are
utilized that incorporate such variables as revenue growth rates, expense
trends, interest rates and terminal values. Based upon an evaluation of key data
and market factors, management selects from a range the specific variables to be
incorporated into the valuation model.
The Company has established April 30 of each year as the date for conducting its
annual goodwill impairment assessment. The variables are selected as of that
date and the valuation models are run to determine the fair value of each
reporting unit. At April 30, 2002, the Company did not identify any
13
individual reporting unit where fair value was less than carrying value,
including goodwill. In aggregate, fair value of all the reporting units exceeded
carrying value, including goodwill, by more than $4 billion. Only if the most
severely negative assumptions relative to these variables were incorporated into
the model, which in the opinion of management are not appropriate assumptions in
the current environment, would any individual reporting unit indicate
impairment.
Mortgage Servicing Rights
The Company recognizes the right to service mortgages as a separate and distinct
asset at the time the loans are sold. Servicing rights are then amortized in
proportion to net servicing income and carried on the balance sheet at the lower
of their initial carrying value, adjusted for amortization, or fair value.
As interest rates decline, prepayments generally accelerate, thereby reducing
future net servicing cash flows from the mortgage portfolio. The carrying value
of the mortgage servicing rights (MSRs) is periodically evaluated for impairment
based on the difference between the carrying value of such rights and their
current fair value. For purposes of measuring impairment, which is recorded
through the use of a valuation reserve, MSRs are stratified based upon interest
rates and whether such rates are fixed or variable and other loan
characteristics. Fair value is determined based upon the application of pricing
valuation models incorporating portfolio specific prepayment assumptions. These
assumptions involve a high degree of subjectivity that is dependent on future
interest rate movements. The reasonableness of these pricing models is
periodically substantiated by reference to independent broker price quotations
and actual market sales.
Note 6 to the consolidated financial statements contains information regarding
the factors (prepayment rate, discount rate, etc.) that were used in determining
the fair value of the MSRs at December 31, 2002. It also contains the isolated
impacts on fair value resulting from hypothetical changes in those factors, as
required by GAAP.
The Company manages its exposure to declines in the fair value of the MSRs by
reference to the interest rate environment. For instance, at December 31, 2002,
the Company estimates that the fair value of the MSRs would be approximately $63
million higher if intermediate term rates were to immediately increase by 100
basis points. Similarly, if there were an immediate decrease of 100 basis
points, the value would be approximately $114 million lower. However, in
evaluating the impact of rate changes, the effect of the various financial
instruments, including derivatives, that are used to protect the economic value
of the MSRs, is considered. After considering that effect, the adjusted positive
impact on operations of a 100 basis point increase in rates is $5 million. The
negative impact of a 100 basis point decrease is approximately $17 million.
14
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)
2002 Amount % 2001 Amount % 2000
- -----------------------------------------------------------------------------------------------------------------
in millions
Interest income $3,831.5 $ (989.5) (20.5) $4,821.0 $(522.2) (9.8) $5,343.2
Interest expense 1,430.5 (1,091.7) (43.3) 2,522.2 (676.9) (21.2) 3,199.1
- -----------------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent
basis 2,401.0 102.2 4.4 2,298.8 154.7 7.2 2,144.1
Less: taxable
equivalent adjustment 24.7 (8.8) (26.2) 33.5 7.9 30.8 25.6
- -----------------------------------------------------------------------------------------------------------------
Net interest income $2,376.3 $ 111.0 4.9 $2,265.3 $ 146.8 6.9 $2,118.5
- -----------------------------------------------------------------------------------------------------------------
Average earning assets $ 78,823 $ 1,090 1.4 $ 77,733 $ 3,926 5.3 $ 73,807
Average nonearning
assets 8,957 414 4.9 8,543 (438) (4.9) 8,981
- -----------------------------------------------------------------------------------------------------------------
Average total assets $ 87,780 $ 1,504 1.7 $ 86,276 $ 3,488 4.2 $ 82,788
- -----------------------------------------------------------------------------------------------------------------
Net yield on:
Average earning assets 3.05% .09% 3.0 2.96% .05% 1.7 2.91%
Average total assets 2.74 .08 3.0 2.66 .07 2.7 2.59
=================================================================================================================
2002 Compared to 2001
Net interest income was $2,376.3 million in 2002 compared with $2,265.3 million
in 2001. The 4.9% increase in net interest income for 2002 reflects the impact
of a larger balance sheet and a wider net interest margin in a declining rate
environment.
Average residential mortgages grew $2.2 billion for 2002 as the mortgage banking
division experienced record levels of production driven by the low rate
environment which began in 2001. Average investment securities decreased $1.3
billion compared to 2001 as the Company sold securities, including mortgage
backed, U.S. Treasury and Latin American securities to adjust to interest rate
changes and to reduce its credit risk. The Company invested additional amounts
in shorter term trading assets. A more profitable funding mix consisting of
higher levels of savings deposits and lower levels of certificate of deposit
products also contributed to the increase in net interest income for 2002 as
compared to 2001.
The Federal Reserve reductions in short-term rates in 2001 and the fourth
quarter of 2002 led to lower gross yields earned on assets and lower gross rates
paid on liabilities compared to 2001. The short-term rate cuts led to wider
interest margins in the residential mortgage business, treasury investment
operations and certain commercial lending businesses.
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 reflected the impact
of a larger balance sheet and a wider interest margin.
15
Average residential mortgages grew $2.6 billion for 2001 as the mortgage banking
division experienced increased levels of production driven by a low rate
environment. Average investment securities decreased $1.8 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 on assets 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.
Forward Outlook
The Company will continue to pursue modest growth in high quality commercial
loans and residential mortgages. Some less profitable commercial lending
relationships are expected to be exited. We expect continuing weakness in the
U.S. economy and the uncertain world wide political environment to encourage our
corporate customers to adopt a cautious approach towards revenue growth and
capital spending plans, and this will undoubtedly dampen future loan demand. The
ultimate level of activity in the residential mortgage portfolio will depend on
the rate environment and the Company's appetite for additional mortgage products
on the balance sheet. Lending activity should benefit from HSBC Group
initiatives, specifically our cross-border business is expected to benefit from
the HSBC Group's new North American alignment initiative. The goal of this
initiative is to increase HSBC brand awareness and to provide seamless North
American service propositions to customers of the Company and HSBC Bank Canada.
The acquisition of Household International, Inc. by HSBC, which is expected to
be completed during the first quarter of 2003, may also provide an opportunity
for future growth.
The Company expects to fund balance sheet growth with personal and commercial
deposits and some wholesale market funding. The Company is expected to continue
to benefit from the steep yield curve established in the later part of 2002 into
the early part of 2003. A continuing low level of interest rates means less
money will be earned by the Company on deposits. The lower rate environment may
also lead to further movements of customer funds from certificate of deposit
products and other investments into saving accounts, thus helping to sustain
current interest margins. However, if rates drop and the yield curve flattens in
2003, interest margins are likely to shrink. (See Quantitative and Qualitative
Disclosures About Market Risk). This margin shrinkage may be dampened by balance
sheet growth or other management actions.
16
The following table presents net interest income components on a taxable
equivalent basis, using tax rates approximating 35%, and quantifies the changes
in the components according to "volume and rate".
Net Interest Income Components Including Volume/Rate Analysis
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
2002 Compared to 2001 2001 Compared to 2000
Increase(Decrease) Increase(Decrease)
2002 Volume Rate 2001 Volume Rate 2000
- -----------------------------------------------------------------------------------------------------------
in millions
Interest income:
Interest bearing
deposits with banks $ 54.7 $ (87.7) $ (64.8) $ 207.2 $ 2.9 $ (104.4) $ 308.7
Federal funds sold and
securities purchased
under resale agreements 94.7 49.0 (92.2) 137.9 19.9 (97.0) 215.0
Trading assets 161.3 53.4 (109.2) 217.1 75.4 1.2 140.5
Securities 975.3 (78.7) (238.3) 1,292.3 (127.7) (152.4) 1,572.4
Loans
Domestic
Commercial 841.5 (32.5) (191.7) 1,065.7 41.9 (242.5) 1,266.3
Consumer
Residential
mortgages 1,250.0 152.1 (149.6) 1,247.5 188.0 (26.8) 1,086.3
Other consumer 270.5 (22.6) (46.2) 339.3 (.5) (25.9) 365.7
International 160.1 (51.9) (74.1) 286.1 (46.4) (23.0) 355.5
Other interest * 23.4 (4.5) -- 27.9 (4.9) -- 32.8
- -----------------------------------------------------------------------------------------------------------
Total interest income 3,831.5 (23.4) (966.1) 4,821.0 148.6 (670.8) 5,343.2
- -----------------------------------------------------------------------------------------------------------
Interest expense:
Deposits in domestic
offices
Savings deposits 211.7 48.9 (112.9) 275.7 37.7 (95.2) 333.2
Other time deposits 317.3 (82.2) (280.2) 679.7 15.0 (106.2) 770.9
Deposits in foreign
offices 406.7 (64.7) (430.1) 901.5 40.7 (369.2) 1,230.0
Federal funds purchased
and securities sold
under repurchase
agreements 53.0 (12.0) (13.2) 78.2 23.7 (69.3) 123.8
Other short-term
borrowings 178.5 57.3 (137.8) 259.0 34.3 (96.2) 320.9
Long-term debt 263.3 (14.7) (50.1) 328.1 (64.9) (27.3) 420.3
- -----------------------------------------------------------------------------------------------------------
Total interest expense 1,430.5 (67.4) (1,024.3) 2,522.2 86.5 (763.4) 3,199.1
- -----------------------------------------------------------------------------------------------------------
Net interest income -
taxable equivalent basis $2,401.0 $ 44.0 $ 58.2 $2,298.8 $ 62.1 $ 92.6 $2,144.1
- -----------------------------------------------------------------------------------------------------------
* Other interest income relates to Federal Reserve Bank and Federal Home
Loan Bank stock included in other assets.
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.
17
Other Operating Income
- --------------------------------------------------------------------------------
Other operating income was $1,059.3 million in 2002 compared with $1,095.7
million in 2001 and $832.4 million in 2000.
- ----------------------------------------------------------------------------------------------------------------------
Increase/(Decrease) Increase/(Decrease)
2002 Amount % 2001 Amount % 2000
- ----------------------------------------------------------------------------------------------------------------------
in millions
Trust income $ 94.4 $ 6.8 7.8 $ 87.6 $ 2.7 3.2 $ 84.9
Service charges 206.5 17.5 9.2 189.0 16.7 9.7 172.3
Mortgage banking revenue 110.1 30.7 38.7 79.4 46.9 144.3 32.5
Letter of credit fees 66.4 5.4 8.8 61.0 7.5 13.9 53.5
Credit card fees 72.3 8.2 12.7 64.1 8.1 14.5 56.0
Other fee-based income 175.3 38.7 28.3 136.6 4.8 3.7 131.8
Investment product fees 89.1 21.3 31.5 67.8 8.8 14.8 59.0
Other income 93.9 31.9 51.5 62.0 (11.4) (15.5) 73.4
- -------------------------------------------------------------------------------------------------------------------
Nontrading income 908.0 160.5 21.5 747.5 84.1 12.7 663.4
- -------------------------------------------------------------------------------------------------------------------
Trading revenues
Treasury business and
other 130.1 (135.9) (51.1) 266.0 125.8 89.7 140.2
Residential mortgage
related (97.0) (29.9) (44.5) (67.1) (67.1) -- --
- -------------------------------------------------------------------------------------------------------------------
Total trading revenues 33.1 (165.8) (83.3) 198.9 58.7 41.9 140.2
- -------------------------------------------------------------------------------------------------------------------
Securities transactions 118.2 (31.1) (20.8) 149.3 120.5 417.6 28.8
- -------------------------------------------------------------------------------------------------------------------
Total other operating
income $1,059.3 $ (36.4) (3.3) $1,095.7 $ 263.3 31.6 $ 832.4
===================================================================================================================
Nontrading Income
- --------------------------------------------------------------------------------
2002 Compared to 2001
Nontrading income was $908.0 million in 2002 compared with $747.5 million in
2001. The increase in service charges for 2002 is due to growth in personal and
commercial deposit service charges, reflecting business growth in the New York
City region as well as fee increases instituted during 2002. The increase in
other fee-based income includes $15.1 million of revenue earned by the newly
formed wealth and tax advisory services business which commenced activity during
the third quarter of 2002. Also, increases in fee income were noted in the
International Private Banking, Treasury and Traded Markets businesses. The
growth in investment product fees was driven by increases in brokerage revenues
due primarily to the sale of annuity products. Revenues related to the sale of
annuity products increased $22.5 million compared with 2001. The increase in
other income reflects higher levels of insurance revenues. Insurance revenues
increased $13.8 million or 42.5% compared to 2001. Over 1,500 professionals are
now licensed to sell insurance and certain annuity products through our retail
network. The $24.3 million increase in earnings on investments, accounted for
under the equity method of accounting also contributed to the growth in other
income for 2002. These improved earnings related primarily to the equity
investment in HSBC Republic Bank (Suisse) S.A.
18
The following table presents the components of mortgage banking revenue for the
past three years.
- --------------------------------------------------------------------------------
2002 2001 2000(3)
- --------------------------------------------------------------------------------
in millions
Servicing fee income $72.4 $ 70.9 $ 71.1
MSRs amortization (133.6)(1) (58.1) (45.6)
Gain on sale of mortgages 163.7 66.6 7.0
Fair value hedge activity 7.6(2) -- --
- --------------------------------------------------------------------------------
Total mortgage banking revenue (4) $ 110.1 $ 79.4 $ 32.5
- --------------------------------------------------------------------------------
(1) Includes a $56.3 million provision for impairment. $40.6 million of the
provision is included in a valuation reserve at December 31, 2002.
(2) Includes SFAS 133 qualifying fair value adjustments related to residential
mortgage banking warehouse fair value hedging activity. Effective December
2002, the Company established a qualifying hedge strategy using forward
sales contracts to offset the fair value changes of conventional closed
mortgage loans originated for sale.
(3) Prior to the adoption of SFAS 133 on January 1, 2001, the value of
economic hedges against servicing rights were considered a component of
market value of servicing rights for purposes of assessing impairment.
Interest rate lock commitments and forward sales were not specifically
recognized until such time as related mortgages were sold at which time
they were considered in the determination of the gain or loss on sale.
After the adoption of SFAS 133, these instruments were marked to market as
a component of residential mortgage business related trading revenue.
(4) Does not include residential mortgage business related trading revenue or
net interest income impact of the mortgage business.
Mortgage banking revenue increased $30.7 million compared to 2001 as a result of
higher gains on the sale of mortgages from higher mortgage origination volumes.
This increase was partially offset by higher levels of mortgage servicing rights
(MSRs) amortization which included a provision for impairment of $56.3 million
associated with higher prepayment activity during 2002 due to the low rate
environment. The provision for impairment was partially offset by increased
market value of derivative instruments used to protect the value of MSRs. This
was recorded in residential mortgage business related trading revenue. The
residential mortgage business related trading revenue and the net interest
income impact of the mortgage business should also be considered when evaluating
overall profitability of the mortgage business.
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 2000. Offsetting
the increase in mortgage banking revenue were losses in residential mortgage
related trading revenue.
19
Forward Outlook
During 2003, the Company will utilize its strong retail distribution network,
its HSBC Group linkage and its high quality sales and service culture to pursue
revenue growth despite an uncertain economy. The Company will continue to focus
on growth in brokerage, insurance, mortgage banking, trust, asset management,
private banking and trade service related fees. Maximization of the "cross-sell"
potential of the existing customer base will be a key business development theme
for the upcoming year. The Company is expecting to earn increased fee income
from the newly formed wealth and tax advisory service business, which commenced
activity during the third quarter of 2002. Expansion of the Company's
reinsurance business will be a strategic initiative for the upcoming year.
Mortgage banking will continue to leverage its strong New York and national
presence and multiple, well developed origination channels to position the
business to maximize production opportunities and maintain continuity in
different markets and rate environments. The Company will continue to utilize
its well developed secondary market strategy to sell loans to the "Agencies"
(FNMA, FHLMC and GNMA), private investors and conduits on a services retained
basis.
Trading Revenues
- --------------------------------------------------------------------------------
Trading revenues are generated by the Company's participation in the foreign
exchange, credit derivative and precious metal markets, from trading derivative
contracts, including interest rate swaps and options, from trading securities,
and as a result of certain residential mortgage banking activities 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 because trading activities are managed to maximize total
revenue. The trading related net interest income component is not included in
other operating income; it is included in net interest income.
- ----------------------------------------------------------------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
in millions
Trading revenues - treasury business and other $130.1 $266.0 $140.2
Net interest income * 74.3 38.6 52.1
- ----------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $204.4 $304.6 $192.3
==========================================================================================================
Business:
Derivatives and treasury $ 70.8 $120.2 $ 44.9
Foreign exchange 39.5 93.1 74.4
Precious metals 70.2 52.6 49.1
Other trading 23.9 38.7 23.9
- ----------------------------------------------------------------------------------------------------------
Trading related revenues - treasury business and other $204.4 $304.6 $192.3
==========================================================================================================
Trading revenues (loss) - residential mortgage business related $(97.0) $(67.1) $ --
==========================================================================================================
* Included in net interest income on the consolidated income statement.
20
Treasury Business and Other: 2002 Compared to 2001
Total treasury business and other trading related revenues were $204.4 million
in 2002 compared to $304.6 million for 2001. The decline in derivatives and
treasury trading revenue in 2002 results from mark to market losses on
derivative instruments used to protect against rising interest rates and also
from widening spread relationships that took place at various times during the
year. Offsetting these declines were increased trading revenues in credit and
interest rate derivatives resulting from increased customer activity and
proprietary trading positions, which profited from movements in credit and
interest rate spreads. The reduction in foreign exchange trading revenue for
2002 compared to 2001 reflects lower levels of proprietary trading revenue due
to reduced volatility in the foreign exchange markets and adverse rate exchange
movements. The increase in precious metals trading revenue for 2002 compared to
2001 is due to increased customer activity and proprietary trading positions,
which benefited from movement in precious metals spreads and prices.
Treasury Business and Other: 2001 Compared to 2000
Trading related revenues for 2001 increased 58% compared with 2000. 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 was a direct result
of that decision as trading volumes with clients and proprietary trading revenue
increased markedly over 2000. 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 reflected 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.
Treasury Business and Other: Forward Outlook
The Company expects to continue to build on its capabilities in foreign
exchange, credit and interest rate derivatives and precious and base metals to
expand its client franchise and grow related revenues. However, these revenues
are subject to market factors, among other things, and may vary significantly
from reporting period to reporting period.
Residential Mortgage Business Related
In conjunction with the adoption of Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133)
on January 1, 2001, certain derivatives including loan commitments granted to
customers, forward loan sales commitments (FLSC) 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 components of trading revenue (loss) related to these instruments
were as follows.
- ------------------------------------------------------------------------------
2002 2001
- ------------------------------------------------------------------------------
in millions
SFAS 133 FLSC/Rate locks $(141.6) $(27.4)
Derivative instruments used to
protect value of MSRs 44.6 (39.7)
- ------------------------------------------------------------------------------
Trading revenues (loss) - residential
mortgage business related $ (97.0) $(67.1)
==============================================================================
21
As a result of the adoption of SFAS 133, higher gains on sale of mortgages,
included in mortgage banking revenue (see other operating income), have been
recognized in 2002 and 2001 as compared to 2000. In periods prior to the
adoption of SFAS 133, 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 MSRs were considered in assessing whether or
not impairment needed to be recognized. Both were reported as a component of
mortgage banking revenue for 2000.
The increase in the market value of the servicing hedges of $44.6 million
through the trading account does not include mortgage backed securities (MBS's)
on the balance sheet that provide additional economic protection against a
decline in the value of MSRs. As the MBS's are classified as investment
securities available for sale, the increase in their market value is reflected
in the equity section of the balance sheet through other comprehensive income.
The change in market value of these securities is not recognized in income until
they are sold.
Mortgage banking revenue included in other operating income and the net interest
impact of the mortgage business should also be considered when evaluating
overall profitability of the mortgage business.
Forward Outlook
The Company will continue to employ a well developed risk management strategy to
reduce interest rate and prepayment risk by utilizing derivative instruments to
hedge both (a) the mortgage pipeline and (b) MSRs values through different
economic cycles and rate environments and within established guidelines.
The Company is pursuing hedge accounting treatment under SFAS 133 for additional
closed loans in the pipeline (primarily jumbo loans) that are currently on the
lower of cost or market basis and not subject to a mark to market treatment.
This would eliminate additional earnings volatility and timing differences
associated with this portion of the mortgage pipeline.
Securities Transactions
- --------------------------------------------------------------------------------
2002
Security gains for 2002 included gains on sales of mortgage backed, U.S.
Treasury and Latin American securities. The Company sold the securities to
adjust to interest rate changes and/or reduce its credit risk.
2001
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 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. The Company also recognized losses in 2001 of $38.2
million as it significantly reduced its holdings of Brazilian securities.
22
Operating Expenses
- --------------------------------------------------------------------------------
Increase(Decrease) Increase(Decrease)
2002 Amount % 2001 Amount % 2000
- ----------------------------------------------------------------------------------------------------------------------------
in millions
Salaries and employee
benefits $ 1,029.3 $ 28.9 2.9 $ 1,000.4 $ 25.0 2.6 $ 975.4
Net occupancy 155.7 .2 .1 155.5 (11.7) (7.0) 167.2
Equipment and software 141.6 12.2 9.4 129.4 14.4 12.5 115.0
Goodwill amortization -- (176.5) -- 176.5 .3 .2 176.2
Marketing 38.1 (1.8) (4.5) 39.9 5.6 16.3 34.3
Outside services 112.7 (2.2) (1.9) 114.9 9.6 9.1 105.3
Professional fees 42.7 1.5 3.5 41.2 2.9 7.6 38.3
Telecommunications 42.5 .8 2.0 41.7 6.5 18.5 35.2
Postage, printing and
office supplies 32.0 (.9) (2.8) 32.9 (.6) (1.9) 33.5
Princeton Note Matter -- (575.0) -- 575.0 575.0 -- --
Other 280.9 45.3 19.2 235.6 10.2 4.5 225.4
- ----------------------------------------------------------------------------------------------------------------------------
Total operating expenses $ 1,875.5 $ (667.5) (26.2) $ 2,543.0 $ 637.2 33.4 $ 1,905.8
- ----------------------------------------------------------------------------------------------------------------------------
Personnel - average number 13,856 (585) (4.1) 14,441 26 .2 14,415
============================================================================================================================
2002 Compared to 2001
Operating expenses were $1,875.5 million in 2002 compared with $2,543.0 million
for 2001. The decrease reflects the $575.0 million charge taken in 2001 by the
Company to reflect the resolution of the majority of the litigation in the
Princeton Note Matter. See Note 22 Litigation, for additional information on the
Princeton Note Matter. The decrease in operating expenses for 2002 also reflects
the adoption of SFAS 142. See Note 7 Goodwill and Intangible Assets for a
discussion of SFAS 142. Under SFAS 142, goodwill is no longer being amortized
through operating expenses. The increase in salaries and employee benefits
reflects cost of living increases, production driven increases in incentive
compensation for certain businesses and higher fringe benefit costs, primarily
related to health care and pension costs. Also contributing to this increase are
personnel costs related to the newly formed wealth and tax advisory services
business which commenced activity during the third quarter of 2002. The increase
in equipment and software expense reflects higher levels of depreciation on
infrastructure investments made during the past three years. The increase in
other expenses for 2002 as compared to 2001 is primarily due to the second
quarter 2002 charge related to reserves for letters of credit and for a
leveraged lease.
23
2001 Compared to 2000
Operating expenses were $2,543.0 million in 2001 compared with $1,905.8 million
in 2000. The increase in operating expenses reflected a $575.0 million third
quarter charge taken by the Company to reflect the resolution of the majority of
the litigation in 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. 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 compared to $85.0 million for 2000. The integration costs did 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, 2001, airlines 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.
Forward Outlook
The Company is anticipating higher fringe benefit costs related to pension and
health care and corporate insurance. The Company continues to actively take
steps necessary to reduce the impact of higher health care costs which are
rapidly rising for both the Company and its employees. The Company continues to
position itself to operate in an uncertain economy. Improving efficiencies,
lowering the cost of traditional delivery channels and maintaining strict cost
disciplines will be a priority. Limited incremental costs will be incurred for
new business initiatives during 2003. Increased costs are expected relative to
the wealth and tax advisory service business, which commenced activity during
the third quarter of 2002. To a lesser extent, additional costs are anticipated
to support growth in the Company's reinsurance business. Other business
initiatives are expected to be funded by cost savings elsewhere in the
organization.
As a member of a global organization, the Company has the opportunity to gain
cost advantages through the utilization of human, technological and operational
resources in low cost environments. The HSBC Group currently operates global
processing centers in India and China and plans to open additional sites in Asia
this year. The Company has commenced the migration of certain operational and
customer service activities to India and intends to continue to do so over the
next few years. A qualified team is in place to manage the transition of the
work ensuring no negative customer impact and the sensitive handling of affected
employees.
The Company is also expected to realize cost savings as a result of the HSBC
Group's new North American alignment initiative. The Company and HSBC Bank
Canada, the HSBC Group's Canadian based bank, are actively seeking opportunities
to better leverage their collective infrastructures and best business practices.
These efforts are expected to improve cost efficiencies of both organizations.
24
Provision for Credit Losses
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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 2002 were $195.0 million,
compared with $238.4 million in 2001, representing a decrease of $43.4 million.
This decrease reflects improvement in the overall quality of the Company's loan
portfolios as evidenced by a declining level of nonaccruals, reduced charge offs
and a stabilization of criticized asset totals. The Company's outlook remains
cautious given continued weakness in the U.S. economy and uncertainty as to the
outcome of certain significant world events.
Criticized assets, which include loans credit graded "special mention",
"substandard" or "doubtful", are a key indicator of credit quality. Criticized
asset totals remained relatively stable increasing by just $10.2 million to
$2,210.2 million at December 31, 2002 from $2,200.0 million at December 31,
2001. In 2001, criticized assets totals increased by $158.5 million.
Consumer and commercial nonaccruing loans decreased by a total $29.4 million to
$387.4 million at December 31, 2002 from $416.8 million at December 31, 2001.
This decrease reflects the migration of $312.4 million of loans into nonaccrual
status offset by $341.7 million of payoffs and pay downs, charge offs, returns
to accrual and other movements. In 2001, $507.5 million of loans migrated to
nonaccrual status.
Total net charge offs were $205.7 million for the year ended December 31, 2002,
a $32.0 million decrease from $237.7 million for the year ended December 31,
2001. The significantly slower pace of migration to criticized and nonaccrual
status, coupled with a lower level of net charge offs reflect the improvement in
the Company's overall credit quality profile.
Overall key coverage statistics have remained strong as the allowance for credit
losses at December 31, 2002 represented 1.13% of total loans as compared with
1.24% at December 31, 2001 and 127.3% of total nonaccruing loans at December 31,
2002, compared with 121.5% at December 31, 2001.
The Company also maintains a separate reserve for credit losses associated with
certain off-balance sheet exposures including letters of credit, unused
commitments to extend credit and financial guarantees. This reserve increased by
$2.0 million to $51.4 million at December 31, 2002 from $49.4 million at
December 31, 2001. The net result was an increase in the reserves held against
certain criticized letters of credit, offset by the settlement of the exposure
on a specific financial performance guarantee in 2002, and $22.0 million of new
provisions which are recorded as a charge to other expense. This represents an
increase of $12.4 million from the previous year.
Although criticized letters of credit increased by $55.0 million to $369.2
million at December 31, 2002 from $314.2 million at December 31, 2001, this was
primarily the result of the credit downgrade of two large corporate exposures.
The Company does not believe these specific downgrades to be indicative of a
trend toward deterioration in the overall quality of the off balance sheet
portfolio.
25
Forward Outlook
Although the credit quality of both the consumer and commercial portfolios has
been relatively stable, there have been signs of improvement. As credit quality
in all portfolios remains a concern, the Company will continue to monitor
closely key economic indicators and trends including governmental and corporate
spending priorities, consumer confidence and the general business climate, and
will take decisive action to quickly identify and address problem situations.
An analysis of the allowance for credit losses and the provision for credit
losses begins on page 44.
Income Taxes
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The Company recognized income tax expense of $509.7 million and $226.0 million
in 2002 and 2001, respectively. The increase in income tax expense for 2002 is
principally due to an increase 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, 2002, the Company had a
net deferred tax liability of $209.2 million, as compared with a net deferred
tax asset of $328.1 million at December 31, 2001. The change from a net deferred
tax asset position to a net deferred tax liability position is primarily
attributable to settlement payments made during the first quarter of 2002
related to the Princeton Note litigation, tax deductible pension contributions
and the tax effect of items accounted for on a mark to market basis.
26
Business Segments
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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 the business segments that it used in 2002 to
reflect the movement of certain domestic private banking activities from the
Personal Financial Services Segment to the Private Banking Segment. Also
activity related to selected commercial customers was moved from the Commercial
Banking Segment to the Corporate, Investment Banking and Markets Segment. Prior
year disclosures have been conformed herein to the presentation of current
segments.
The Company has four distinct segments that it utilizes for management reporting
and analysis purposes. These segments are based upon products and services
offered and are identified in a manner consistent with the requirements outlined
in Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information (SFAS 131). The segment
results show the financial performance of the major business units.
These results are determined based on the Company's management accounting
process, which assigns balance sheet, revenue and expense items to each
reportable business unit on a systematic basis. Management does not analyze
depreciation and amortization expense or expenditures for additions to
long-lived assets since they are not considered significant. As such, these
amounts are included in other expenses and average assets, respectively, in the
table. The following describes the four reportable segments.
The Personal Financial Services Segment provides an extensive array of products
and services including installment and revolving term loans, deposits, branch
services, mutual funds and insurance. These products are marketed to individuals
primarily through the branch banking network. Residential mortgage lending
provides loan financing through direct retail and wholesale origination
channels. Mortgage loans are originated through a network of brokers, wholesale
agents and retail originations offices. Servicing is performed for the
individual mortgage holder or on a contractual basis for mortgages owned by
third parties.
The Commercial Banking Segment provides a diversified range of financial
products and services. This segment provides loan and deposit products to small
and middle-market corporations including specialized products such as equipment
and real estate financing. These products and services are offered through
multiple delivery systems, including the branch banking network. In addition,
various credit and trade related products are offered such as standby
facilities, performance guarantees, acceptances and accounts receivable
factoring.
The Corporate, Investment Banking and Markets Segment is comprised of
Corporate/Institutional Banking (CIB) and Investment Banking and Markets (IB&M).
CIB provides deposit and lending functionality to large corporate and
multi-national corporations and banks. U.S. dollar clearing services are offered
for domestic and international wire transfer transactions. Credit and trade
related products such as standby facilities, performance guarantees and
acceptances are also provided to large corporate entities. The IB&M component
includes treasury and traded markets. The treasury function maintains overall
responsibility for the investment and borrowing of funds to ensure liquidity,
manages interest rate risk and capital at risk. Traded markets encompasses the
trading and sale of foreign exchange, banknotes, derivatives, precious metals,
securities and emerging markets instruments, both domestically and
internationally.
27
The Private Banking Segment offers a full range of services for high net worth
individuals including deposit, lending, trading, trust and investment
management.
Other Segment for 2001 included the expense associated with the Princeton Note
settlement and related liabilities recorded in September of 2001 and paid in
January of 2002.
The following summarizes the results for each segment.
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Corporate,
Personal Investment
Financial Commercial Banking and Private
Services Banking Markets Banking Other Total
- ------------------------------------------------------------------------------------------------------------------------------------
in millions
2002
Net interest income (1) $ 1,192 $ 643 $ 412 $ 129 $ -- $ 2,376
Other operating income 371 161 401 127 -- 1,060
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Total income 1,563 804 813 256 -- 3,436
Operating expenses (2) 893 407 375 201 -- 1,876
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Working contribution 670 397 438 55 -- 1,560
Provision for credit losses (3) 72 92 22 9 -- 195
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CMBT 598 305 416 46 -- 1,365
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Average assets 27,133 15,229 42,631 2,787 -- 87,780
Average liabilities/equity (4) 32,818 13,093 33,115 8,736 18 87,780
- ------------------------------------------------------------------------------------------------------------------------------------
2001
Net interest income (1) $ 1,066 $ 588 $ 469 $ 142 $ -- $ 2,265
Other operating income 325 170 489 112 -- 1,096
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Total income 1,391 758 958 254 -- 3,361
Operating expenses (2) * 817 435 365 175 575 2,367
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Working contribution 574 323 593 79 (575) 994
Provision for credit losses (3) 71 76 80 11 -- 238
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CMBT * 503 247 513 68 (575) 756
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Average assets 23,763 15,663 42,418 4,432 -- 86,276
Average liabilities/equity (4) 29,856 11,884 32,170 12,222 144 86,276
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2000
Net interest income (1) $ 955 $ 592 $ 447 $ 125 $ -- $ 2,119
Other operating income 306 150 247 129 -- 832
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Total income 1,261 742 694 254 -- 2,951
Operating expenses (2) * 822 406 327 174 -- 1,729
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Working contribution 439 336 367 80 -- 1,222
Provision for credit losses (3) 38 66 35 (1) -- 138
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CMBT * 401 270 332 81 -- 1,084
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Average assets 21,099 16,045 41,562 4,082 -- 82,788
Average liabilities/equity (4) 31,821 12,197 27,311 11,459 -- 82,788
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* Contribution margin before tax (CMBT) represents pretax income (loss)
excluding goodwill amortization in 2001 and 2000.
(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.
28
Personal Financial Services: 2002 Compared to 2001
This segment contributed $598 million to CMBT in 2002. Growth in CMBT over 2001
was $95 million or 19%. The increase in net interest income for 2002 reflects
the impact of a larger balance sheet, a wider interest margin earned on
residential mortgages and a more profitable funding mix consisting of higher
levels of savings deposits and lower levels of certificate of deposit products.
Average residential mortgages grew $2.2 billion for 2002, as the mortgage
banking division experienced record levels of production driven by a low rate
environment. Other operating income has increased over the previous year
reflecting growth in brokerage, primarily due to higher annuity sales, and
insurance related income. Expense increases are attributable to performance
related incentive compensation programs in brokerage, mortgage and branch
banking.
Commercial Banking: 2002 Compared to 2001
This segment contributed $305 million to CMBT in 2002 compared to $247 million
in 2001. The increase in net interest income reflects improved margins in
middle-market commercial banking as well as a larger overall balance sheet. The
Company continues to exit less profitable commercial lending relationships. The
lower level of operating expenses are due to decreases in support/infrastructure
costs for regional middle-market commercial banking. The higher provision for
credit losses for 2002 is due to a small number of problem loans. The credit
quality deterioration that began late in 2001 and continued in early 2002, began
to improve in the later part of the year.
Corporate, Investment Banking and Markets: 2002 Compared to 2001
This segment contributed $416 million to CMBT in 2002 compared to $513 million
in 2001. The reduction in other operating income reflects a decline in trading
related revenues. Derivatives and treasury trading revenue declined due to mark
to market losses on derivative instruments used to protect against rising
interest rates and also from widening spread relationships that took place at
various times during the year. A reduction in foreign exchange trading revenue
for 2002 compared to 2001 reflects lower levels of proprietary trading revenue
due to reduced volatility in the foreign exchange markets and adverse rate
exchange movements. The higher provision for credit losses in 2001 reflects
losses related to a single large corporate customer in the energy sector.
Private Banking: 2002 Compared to 2001
This segment contributed $46 million to CMBT in 2002 compared to $68 million in
2001. The reduction in net interest income and average liabilities compared to
2001 reflects the migration of customers from deposit products to mutual funds
and annuities due to the lower rate environment. Reduced net interest income and
average assets and liabilities also reflect the continuing migration of
customers in Asia to other HSBC Group members. The increase in other operating
income is due to increased levels of fee income earned on wealth management
products and revenue earned by the newly formed wealth and tax advisory service
business. The increase in operating expenses relates to costs associated with
the newly formed wealth and tax advisory service business.
Other: 2002 Compared to 2001
This segment for 2001 included the expenses associated with the Princeton Note
settlement and related liabilities recorded in September 2001 and paid in
January of 2002.
29
Personal Financial Services: 2001 Compared to 2000
The increase in net interest income for 2001 reflected 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 higher
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 reflected
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. The increased provision for credit losses reflected a weaker economy
and higher delinquency rates on consumer loans.
Commercial Banking: 2001 Compared to 2000
Increased fees for commercial loans and deposit servicing/cash management were
the principal factors behind the growth in other operating income. The operating
expense increase for 2001 was principally due to the full year impact of the
Panama branch acquisitions. Higher provisions for credit losses reflected the
weaker economic conditions during 2001, with losses concentrated in receivable
and inventory lending portfolios.
Corporate, Investment Banking and Markets: 2001 Compared to 2000
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 reflected 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
reflected losses related to a single large corporate in the energy sector.
Private Banking: 2001 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 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 the
noted migration of Asian business.
Other: 2001 Compared to 2000
This segment for 2001 included the expenses associated with the Princeton Note
settlement and related liabilities recorded in September 2001 and paid in
January of 2002.
30
BALANCE SHEET REVIEW
Risk Management
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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 39.
Asset/Liability Management
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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 implementati