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CONFORMED 1.
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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 1-7436
HSBC USA Inc.
(Exact name of registrant as specified in its charter)
Maryland
(State of Incorporation)
13-2764867
(IRS Employer Identification No.)
452 Fifth Avenue, New York, New York 10018
(Address of principal executive offices)
(212) 525-3735
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
At July 31, 2004, all voting stock (704 shares of Common Stock, $5 par value) is
owned by an indirect wholly owned subsidiary of HSBC Holdings plc.
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HSBC USA Inc.
Form 10-Q
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
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Page
----
Item 1. Consolidated Financial Statements
Statement of Income 3
Balance Sheet 4
Statement of Changes in Shareholders' Equity 5
Statement of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (MD&A)
Average Balances and Interest Rates 17
Forward-Looking Statements 19
Executive Overview 19
Basis of Reporting 20
Results of Operations 24
Business Segments 35
Credit Quality 38
Derivative Instruments and Hedging Activities 40
Off-Balance Sheet Arrangements 41
Special Purpose and Variable Interest Entities 42
Capital 42
Risk Management 43
Item 3. Quantitative and Qualitative Disclosures About Market Risk 49
Item 4. Controls and Procedures 49
Part II OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings 50
Item 6. Exhibits and Reports on Form 8-K 50
Signature 51
2
Part I. Financial Information
Item 1. Consolidated Financial Statements
HSBC USA Inc.
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------------------------
in millions
Interest income:
Loans ................................................ $ 669 $ 585 $ 1,282 $ 1,196
Securities ........................................... 215 212 430 452
Trading assets ....................................... 38 34 71 74
Short-term investments ............................... 18 22 36 43
Other ................................................ 4 7 8 14
------- ------- ------- -------
Total interest income .................................... 944 860 1,827 1,779
------- ------- ------- -------
Interest expense:
Deposits ............................................. 158 173 318 361
Short-term borrowings ................................ 35 21 52 58
Long-term debt ....................................... 62 57 113 106
------- ------- ------- -------
Total interest expense ................................... 255 251 483 525
------- ------- ------- -------
Net interest income ...................................... 689 609 1,344 1,254
Provision for credit losses .............................. 6 31 (19) 87
------- ------- ------- -------
Net interest income after provision for credit losses .... 683 578 1,363 1,167
------- ------- ------- -------
Other revenues:
Trust income ......................................... 24 24 48 46
Service charges ...................................... 53 52 104 103
Other fees and commissions ........................... 122 116 231 224
Other income ......................................... 35 57 82 92
Mortgage banking revenue (expense) ................... (17) (14) (41) (6)
Trading revenues ..................................... 78 91 167 161
Security gains, net .................................. 3 33 41 49
------- ------- ------- -------
Total other revenues ..................................... 298 359 632 669
------- ------- ------- -------
Operating expenses:
Salaries and employee benefits ....................... 240 278 490 557
Occupancy expense, net ............................... 37 37 72 75
Other expenses ....................................... 243 177 447 346
------- ------- ------- -------
Total operating expenses ................................. 520 492 1,009 978
------- ------- ------- -------
Income before income tax expense ......................... 461 445 986 858
Income tax expense ....................................... 130 172 336 331
------- ------- ------- -------
Net income ............................................... $ 331 $ 273 $ 650 $ 527
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
3
HSBC USA Inc.
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CONSOLIDATED BALANCE SHEET
June 30, December 31,
2004 2003
- -----------------------------------------------------------------------------------------------------
in millions
Assets
Cash and due from banks ................................................ $ 3,095 $ 2,534
Interest bearing deposits with banks ................................... 1,667 843
Federal funds sold and securities purchased under resale agreements .... 3,728 2,446
Trading assets ......................................................... 15,779 14,646
Securities available for sale .......................................... 13,802 14,143
Securities held to maturity (fair value $4,213 and $4,648) ............. 4,142 4,512
Loans .................................................................. 62,066 48,474
Less - allowance for credit losses ..................................... 347 399
--------- ---------
Loans, net ....................................................... 61,719 48,075
Properties and equipment, net .......................................... 639 681
Intangible assets, net ................................................. 482 551
Goodwill ............................................................... 2,763 2,777
Other assets ........................................................... 4,975 4,354
--------- ---------
Total assets ........................................................... $ 112,791 $ 95,562
========= =========
Liabilities
Deposits in domestic offices:
Noninterest bearing .................................................. $ 7,084 $ 6,093
Interest bearing ..................................................... 45,719 38,995
Deposits in foreign offices:
Noninterest bearing .................................................. 532 453
Interest bearing ..................................................... 21,199 18,414
--------- ---------
Total deposits ................................................... 74,534 63,955
--------- ---------
Trading account liabilities ............................................ 10,954 10,460
Short-term borrowings .................................................. 9,499 6,782
Interest, taxes and other liabilities .................................. 3,854 3,089
Long-term debt ......................................................... 6,135 3,814
--------- ---------
Total liabilities ...................................................... 104,976 88,100
--------- ---------
Shareholders' equity
Preferred stock ........................................................ 500 500
Common shareholder's equity:
Common stock ($5 par; 150,000,000 shares authorized;
704 shares issued) ............................. --(1) --(1)
Capital surplus ...................................................... 6,026 6,027
Retained earnings .................................................... 1,445 807
Accumulated other comprehensive (loss) income ........................ (156) 128
--------- ---------
Total common shareholder's equity ................................ 7,315 6,962
--------- ---------
Total shareholders' equity ............................................. 7,815 7,462
--------- ---------
Total liabilities and shareholders' equity ............................. $ 112,791 $ 95,562
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
4
HSBC USA Inc.
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' EQUITY
Six months ended June 30,
2004 2003
- ----------------------------------------------------------------------------------------------------------------------
in millions
Preferred stock
Balance, January 1 and June 30, .......................................................... $ 500 $ 500
------- -------
Common stock
Balance, January 1 and June 30, .......................................................... --(1) --(1)
------- -------
Capital surplus
Balance, January 1, ...................................................................... 6,027 6,056
Capital contribution from parent ......................................................... 8 9
Return of capital ........................................................................ (9) (44)
------- -------
Balance, June 30, ........................................................................ 6,026 6,021
------- -------
Retained earnings
Balance, January 1, ...................................................................... 807 578
Net income ............................................................................... 650 527
Cash dividends declared:
Preferred stock ...................................................................... (12) (12)
Common stock ......................................................................... -- (255)
------- -------
Balance, June 30, ........................................................................ 1,445 838
------- -------
Accumulated other comprehensive (loss) income
Balance, January 1, ...................................................................... 128 262
Net change in unrealized (losses) gains on securities .................................... (222) (38)
Net change in unrealized (losses) gains on derivatives classified as cash flow hedges .... (58) 60
Foreign currency translation adjustments ................................................. (4) 23
------- -------
Other comprehensive (loss) income, net of tax ............................................ (284) 45
------- -------
Balance, June 30, ........................................................................ (156) 307
------- -------
Total shareholders' equity, June 30, ..................................................... $ 7,815 $ 7,666
======= =======
Comprehensive income
Net income ............................................................................... $ 650 $ 527
Other comprehensive (loss) income ........................................................ (284) 45
------- -------
Comprehensive income ..................................................................... $ 366 $ 572
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
(1) Less than $500 thousand
5
HSBC USA Inc.
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CONSOLIDATED STATEMENT OF CASH FLOWS
Six months ended June 30,
2004 2003
- ---------------------------------------------------------------------------------------------------
in millions
Cash flows from operating activities
Net income ........................................................ $ 650 $ 527
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation, amortization and deferred taxes ................ 52 323
Provision for credit losses .................................. (19) 87
Net change in other accrual accounts ......................... (41) 223
Net change in loans originated for sale ...................... (297) (246)
Net change in trading assets and liabilities ................. 204 (709)
Other, net ................................................... (262) (568)
-------- --------
Net cash provided (used) by operating activities ........ 287 (363)
-------- --------
Cash flows from investing activities
Net change in interest bearing deposits with banks ................ (1,174) (362)
Net change in short-term investments .............................. (1,510) (1,297)
Net change in securities available for sale:
Purchases of securities available for sale ................... (5,919) (6,878)
Proceeds from sales of securities available for sale ......... 2,916 2,826
Proceeds from maturities of securities available for sale .... 3,445 5,753
Net change in securities held to maturity:
Purchases of securities held to maturity ..................... (727) (1,087)
Proceeds from maturities of securities held to maturity ...... 1,099 1,455
Net change in loans:
Net change in credit card receivables ........................ (17) 7
Net change in other short-term loans ......................... (351) (62)
Net originations and maturities of long-term loans ........... (12,266) 278
Loans purchased .............................................. (870) --
Sales of loans/other ......................................... 92 238
Expenditures for properties and equipment ......................... (7) (19)
Net cash provided in acquisitions, net of cash acquired ........... 91 79
Other, net ........................................................ (485) (305)
-------- --------
Net cash (used) provided in investing activities ........ (15,683) 626
-------- --------
Cash flows from financing activities
Net change in deposits ............................................ 10,634 831
Net change in short-term borrowings ............................... 2,976 (710)
Net change in long-term debt:
Issuance of long-term debt ................................... 2,687 102
Repayment of long-term debt .................................. (329) (15)
Dividends paid .................................................... (11) (266)
-------- --------
Net cash provided (used) by financing activities ........ 15,957 (58)
-------- --------
Net change in cash and due from banks ................................. 561 205
Cash and due from banks at beginning of period ........................ 2,534 2,081
-------- --------
Cash and due from banks at end of period .............................. $ 3,095 $ 2,286
======== ========
Pending settlement receivables/payables related to securities and trading assets
and liabilities are treated as non cash items for cash flows reporting.
The accompanying notes are an integral part of the consolidated financial
statements.
6
Notes to Consolidated Financial Statements
1. Organization and Basis of Presentation
- --------------------------------------------------------------------------------
HSBC USA Inc. is an indirect wholly owned subsidiary of HSBC Holdings plc
(HSBC). The accompanying unaudited consolidated financial statements of HSBC USA
Inc. and its subsidiaries (collectively, the Company), including its principal
subsidiary, HSBC Bank USA, National Association (the Bank), have been prepared
in accordance with accounting principles generally accepted in the United States
of America (U.S. GAAP) for interim financial information, with the instructions
to Form 10-Q and with Article 10 of Regulation S-X, as well as in accordance
with predominant practice within the banking industry. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments, which are normal and recurring, considered
necessary for a fair presentation of financial position, results of operations
and cash flows for the interim periods, have been made. The unaudited interim
financial information should be read in conjunction with the Company's Annual
Report on Form 10-K (the 2003 Form 10-K) for the year ended December 31, 2003.
Certain reclassifications have been made to prior period amounts to conform to
the current period presentations. The accounting and reporting policies of the
Company are consistent, in all material respects, with those used to prepare the
2003 Form 10-K, except for the impact of new accounting pronouncements
summarized in Note 12.
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect reported amounts and
disclosures. Actual results could differ from those estimates. Interim results
should not be considered indicative of results in future periods.
Interim financial statement disclosures regarding segments and off-balance sheet
arrangements are included in the Management's Discussion and Analysis of
Financial Condition and Results of Operations (MD&A) section of this Form 10-Q.
In June 2004, the Company filed a Form 8-K with the SEC announcing approval by
the Office of the Comptroller of the Currency for the Company to consolidate its
banking operations under a single national charter, effective July 1, 2004. As a
result, on July 1, 2004, the Bank's legal name was changed from HSBC Bank USA to
HSBC Bank USA, National Association. The change to a national charter is not
expected to have a material effect on the existing operations of the Company.
7
2. Securities
- --------------------------------------------------------------------------------
At June 30, 2004 and December 31, 2003, the Company held no securities of any
single issuer (excluding the U.S. Treasury and federal agencies) with a book
value that exceeded 10% of shareholders' equity.
The following tables provide a summary of the amortized cost and fair value of
the securities available for sale and securities held to maturity portfolios.
- --------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ..................... $ 607 $ -- $ 13 $ 594
U.S. Government agency (1) ........ 10,760 79 378 10,461
Asset backed securities ........... 1,431 4 1 1,434
Other domestic debt securities .... 173 -- -- 173
Foreign debt securities ........... 1,000 4 9 995
Equity securities ................. 100 51 6 145
------- ------- ------- -------
$14,071 $ 138 $ 407 $13,802
======= ======= ======= =======
Securities held to maturity:
U.S. Treasury ..................... $ 65 $ -- $ -- $ 65
U.S. Government agency ............ 3,289 125 89 3,325
Obligations of U.S. states and
political subdivisions .......... 498 30 1 527
Other domestic debt securities .... 275 8 2 281
Foreign debt securities ........... 15 -- -- 15
------- ------- ------- -------
$ 4,142 $ 163 $ 92 $ 4,213
======= ======= ======= =======
- --------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2003 Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government agency (1) ........ $10,778 $ 155 $ 141 $10,792
Asset backed securities ........... 1,785 7 6 1,786
Other domestic debt securities .... 415 1 -- 416
Foreign debt securities ........... 904 12 -- 916
Equity securities ................. 187 50 4 233
------- ------- ------- -------
$14,069 $ 225 $ 151 $14,143
======= ======= ======= =======
Securities held to maturity:
U.S. Treasury ..................... $ 125 $ -- $ -- $ 125
U.S. Government agency ............ 3,513 123 40 3,596
Obligations of U.S. states and
political subdivisions .......... 572 47 -- 619
Other domestic debt securities .... 294 8 2 300
Foreign debt securities ........... 8 -- -- 8
------- ------- ------- -------
$ 4,512 $ 178 $ 42 $ 4,648
======= ======= ======= =======
(1) Includes mortgage backed securities issued or guaranteed by U.S.
Government agencies.
8
The following tables provide a summary of gross unrealized losses and related
fair values, classified as to the length of time the losses have existed.
- ------------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
----------------------------------------- -----------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
June 30, 2004 Securities Losses of Investment Securities Losses of Investment
- ------------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Treasury ................... 2 $ 13 $ 594 -- $ -- $ --
U.S. Government agency (1) ...... 333 190 4,970 182 188 2,155
All other securities ............ 102 13 626 40 3 226
------ ------ ------ ------ ------ ------
437 $ 216 $6,190 222 $ 191 $2,381
====== ====== ====== ====== ====== ======
Securities held to maturity:
U.S. Government agency .......... 46 $ 45 $1,001 17 $ 44 $ 300
All other securities ............ 39 2 37 8 1 11
------ ------ ------ ------ ------ ------
85 $ 47 $1,038 25 $ 45 $ 311
====== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------------
Less Than One Year Greater Than One Year
----------------------------------------- -----------------------------------------
Number Gross Aggregate Number Gross Aggregate
of Unrealized Fair Value of Unrealized Fair Value
December 31, 2003 Securities Losses of Investment Securities Losses of Investment
- ------------------------------------------------------------------------------------------------------------------------------
(in millions)
Securities available for sale:
U.S. Government agency (1) ...... 325 $ 141 $4,753 39 $ -- $ 66
All other securities ............ 101 5 388 47 5 257
------ ------ ------ ------ ------ ------
426 $ 146 $5,141 86 $ 5 $ 323
====== ====== ====== ====== ====== ======
Securities held to maturity:
U.S. Government agency .......... 40 $ 40 $ 905 -- $ -- $ --
All other securities ............ 8 1 11 8 1 6
------ ------ ------ ------ ------ ------
48 $ 41 $ 916 8 $ 1 $ 6
====== ====== ====== ====== ====== ======
(1) Includes mortgage backed securities issued or guaranteed by U.S.
Government agencies.
Total gross unrealized losses for the available for sale and held to maturity
security portfolios have increased during the first six months of 2004. In
particular, market values of U.S. Government agency securities were negatively
impacted by rising interest rates associated with agency issued collateralized
mortgage obligations during the second quarter of 2004. The rise in interest
rates has also extended the average durations of the portfolios. The securities
are high credit grade (i.e. AAA or AA), and no permanent impairment is expected
to be realized.
9
3. Loans
- --------------------------------------------------------------------------------
The following table shows the composition of the loan portfolio.
- --------------------------------------------------------------------------------
June 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Domestic:
Commercial:
Construction and mortgage loans ............ $ 7,705 $ 7,075
Other business and financial ............... 8,961 8,658
Consumer:
Residential mortgages ...................... 38,934 26,294
Credit card receivables .................... 1,093 1,112
Other consumer loans ....................... 1,972 1,905
International .................................. 3,401 3,430
------- -------
$62,066 $48,474
======= =======
On March 31, 2004, the Company purchased approximately $900 million of domestic
residential mortgage loans at fair value from subsidiaries of Household
International, Inc. (Household), a related HSBC entity. The remaining net
increase in residential mortgages resulted from new originations during the
first six months of 2004.
4. Allowance for Credit Losses
- --------------------------------------------------------------------------------
The following table provides a summary of changes in the allowance for credit
losses.
- -------------------------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
---------------- -----------------
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------
(in millions)
Beginning balance ............................................. $ 357 $ 496 $ 399 $ 493
Allowance related to acquisitions and (dispositions), net ..... -- (3) (9) (8)
Provision charged (credited) to income ........................ 6 31 (19) 88
Charge offs:
Commercial .................................................. 11 35 14 75
Consumer .................................................... 23 19 44 38
International ............................................... 1 2 7 4
----- ----- ----- -----
Total charge offs ............................................. 35 56 65 117
----- ----- ----- -----
Recoveries on loans charged off:
Commercial .................................................. 14 4 32 12
Consumer .................................................... 4 3 7 6
International ............................................... 1 1 2 2
----- ----- ----- -----
Total recoveries .............................................. 19 8 41 20
----- ----- ----- -----
Total net charge offs ......................................... 16 48 24 97
----- ----- ----- -----
Ending balance ................................................ $ 347 $ 476 $ 347 $ 476
===== ===== ===== =====
10
5. Intangible Assets, Net
- --------------------------------------------------------------------------------
The following table summarizes the composition of intangible assets.
- -----------------------------------------------------------------------------------------------------------------------
June 30, December 31,
2004 2003
- -----------------------------------------------------------------------------------------------------------------------
(in millions)
Mortgage servicing rights, net of accumulated amortization and valuation allowance ...... $437 $503
Favorable lease arrangements, net of accumulated depreciation ........................... 45 48
---- ----
Intangible assets, net .................................................................. $482 $551
==== ====
Mortgage Servicing Rights (MSRs)
The Company recognizes the right to service mortgages as a separate and distinct
asset at the time the related loans are sold, or at the time the MSRs are
purchased. MSRs are 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. The carrying value of MSRs is periodically
evaluated for impairment. Permanent impairment results in direct write-down of
the gross MSRs balance. Temporary impairment is recorded through use of a
valuation allowance account.
The following table summarizes activity for MSRs and the related valuation
allowance.
- -------------------------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
---------------- ----------------
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------
(in millions)
MSRs, net of accumulated amortization:
Beginning balance ............................................ $ 459 $ 426 $ 526 $ 395
Additions related to loan sales .............................. 18 76 36 136
Net MSRs acquisitions (sales) ................................ 3 8 (53) 27
Permanent impairment charges ................................. (5) (4) (7) (14)
Amortization ................................................. (38) (47) (65) (85)
----- ----- ----- -----
Ending balance ............................................... 437 459 437 459
----- ----- ----- -----
Valuation allowance for MSRs:
Beginning balance ............................................ (81) (42) (23) (41)
Temporary impairment (provision) recovery .................... 75 (46) 13 (58)
Permanent impairment charges ................................. 6 3 7 14
Release of allowance related to MSRs sold .................... -- -- 3 --
----- ----- ----- -----
Ending balance ............................................... -- (85) -- (85)
----- ----- ----- -----
MSRs, net of accumulated amortization and valuation allowance .... $ 437 $ 374 $ 437 $ 374
===== ===== ===== =====
Normally scheduled amortization for the current MSRs portfolios is expected to
be approximately $115 million for the year ending December 31, 2004, declining
gradually to approximately $38 million for the year ending December 31, 2008.
Actual levels of amortization could increase or decrease depending upon changes
in interest rates, loan prepayment activity, saleable loan production levels and
associated levels of MSRs assets.
Favorable Lease Arrangements
Favorable lease arrangements resulted from various business acquisitions.
Scheduled amortization of favorable lease arrangements will approximate $5
million per year for 2004 through 2008.
11
6. Goodwill
- --------------------------------------------------------------------------------
During the second quarter of 2004, the Company completed its annual impairment
test of goodwill and determined that the fair value of each of the reporting
units exceeded its carrying value. As a result, no impairment loss was required
to be recognized.
7. Long-Term Debt
- --------------------------------------------------------------------------------
The following table presents a summary of long-term debt.
- --------------------------------------------------------------------------------
June 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Subordinated debt .............................. $4,113 $3,149
All other ...................................... 2,022 665
------ ------
Total long-term debt ........................... $6,135 $3,814
====== ======
In March 2004, the Bank issued $1 billion of Global Subordinated Notes, which
bear interest at 4.625% and mature in April 2014.
In June 2004, the Bank finalized a $10 billion Global Bank Note Program which
provides for the issuance of subordinated and senior global notes. In July 2004,
the Global Bank Note Program was expanded to $20 billion. The following debt
offerings were made under this program during 2004.
- In June 2004, the Bank issued $550 million of Floating Rate Senior
notes due 2009. The initial interest rate on these notes is 1.55%
per annum, payable on September 10, 2004. The rate then resets
quarterly based on the London Interbank Offered Rate rate plus .14%
per annum until the final interest payment date on June 10, 2009.
- In June 2004, the Bank issued $39 million of Fixed Rate Senior notes
due 2006. Interest is paid semi-annually at an initial rate of 2.75%
through the interest payment period ending on June 27, 2005 and at
4.10% per annum thereafter. The Bank may redeem these notes, in
whole but not in part, on June 27, 2005.
In June 2004, the Bank issued debt for the Euro equivalent of $500 million. The
non-subordinated loan, which matures in 2044, provides for quarterly payments of
principal and interest at a floating rate, initially 3.99%.
The Bank has a Global Medium-Term Note Program, which provides for the issuance
of up to $4 billion of equity linked notes having maturities of 7 days of more
from the date of issuance. During the six months ended June 30, 2004 the Bank
had net advances under this program of $274 million due 2004 to 2010. It is
expected that future issuances of this debt type will be made under the Global
Bank Note Program.
8. Income Taxes
The following table presents the effective tax rate for the three months and six
months ended June 30, 2004 and 2003.
- --------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
-------------- ---------------
2004 2003 2004 2003
- --------------------------------------------------------------------------------
Effective tax rate ..................... 28.2% 38.7% 34.1% 38.6%
In June 2004, approximately $51 million of income tax liability related to the
anticipated completion of an outstanding audit was released, reducing the
effective tax rate by 10.9% for the second quarter and 5.2% for the first six
months of 2004. Excluding the impact of this adjustment, the moderate increases
in the effective tax rate for the three months and six months ended June 30,
2004 were due to increased taxable income, which was taxed at the full corporate
rate.
12
9. Related Party Transactions
- --------------------------------------------------------------------------------
In the normal course of business, the Company conducts transactions with HSBC
and its subsidiaries (HSBC Group). These transactions occur at prevailing market
rates and terms. All extensions of credit by the Company to other HSBC
affiliates are legally required to be secured by eligible collateral. The
following table presents related party balances and the income and expense
generated by related party transactions.
- --------------------------------------------------------------------------------
June 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Assets:
Interest bearing deposits with banks ............... $ 165 $ 139
Loans .............................................. 660 330
Trading assets ..................................... 2,231 1,811
Other .............................................. 85 34
------- -------
Total assets ..................................... $ 3,141 $ 2,314
======= =======
Liabilities:
Deposits ........................................... $ 7,010 $ 7,512
Trading account liabilities ........................ 3,574 3,434
Short-term borrowings .............................. 434 735
Other .............................................. 191 79
------- -------
Total liabilities ................................ $11,209 $11,760
======= =======
- -----------------------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
---------------- ----------------
2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------------
(in millions)
Interest income ................................................. $ 1 $ 7 $ 4 $ 10
Interest expense ................................................ 18 26 39 48
Trading (losses) revenues ....................................... (137) 64 (70) 134
HSBC Group charges:
Fees paid to HTSU for technology services ..................... 44 -- 82 --
Fees paid to Household for loan origination, loan servicing
and other administrative support ............................. 7 -- 11 --
Other fees, primarily treasury and traded markets services .... 55 33 99 61
During 2004, HSBC has instituted certain changes to its organization structure
in an effort to integrate its North American operations. The following
organizational changes have resulted in changes in the classification of
revenues and/or expenses in 2004, as compared with 2003.
- - Efforts to centralize technology services resulted in creation of a new
HSBC subsidiary, HSBC Technology and Services (USA) Inc. (HTSU), effective
January 1, 2004. The Company's technology services employees, as well as
technology services employees from other HSBC entities in the United
States, were transferred to HTSU. All technology related assets and
software purchased subsequent to January 1, 2004 are generally purchased
and owned by HTSU. Technology related assets owned by the Company prior to
January 1, 2004 remain in place and were not transferred to HTSU. Pursuant
to a master service level agreement, HTSU charges the Company for its
share of technology services and software development costs. As a result,
HSBC charges for 2004 include amounts previously recorded as "salaries and
benefits" and "occupancy expense, net" and "other expenses" on the
consolidated statement of income for 2003.
- - As part of efforts to centralize certain securities underwriting and
broker-dealer functions in North America, several employees of the Company
were transferred to a related HSBC entity, HSBC Securities (USA) Inc.
(HSUI), effective January 1, 2004. Pursuant to various service level
agreements, HSUI provides underwriting, broker-dealer, and administrative
support to the Company. As a result, HSBC charges for 2004 include amounts
previously recorded as "salaries and benefits" on the consolidated
statement of income for 2003.
13
- - On June 1, 2004, The Company transferred its wholly owned subsidiary, HSBC
Brokerage (USA) Inc. (HBUI) to a related HSBC entity. As a result, HSBC
charges in 2004 include amounts previously recorded as "salaries and
benefits" on the consolidated statement of income for 2003.
HSBC charges also include charges by Household under various service level
agreements for certain loan origination and servicing as well as other
operational and administrative support. Amounts reported in the preceeding table
do not include fees associated with loan originations that have been deferred
and are being amortized over the life of the related loans.
At June 30, 2004 and December 31, 2003, the aggregate notional amounts of all
derivative contracts with other HSBC affiliates were approximately $208 billion
and $168 billion respectively. The net credit risk exposure related to these
contracts was approximately $2 billion at June 30, 2004 and December 31, 2003.
Employees of the Company participate in one or more stock compensation plans
sponsored by HSBC. The Company's share of the expense of the plans for the first
six months of 2004 and 2003 was $36 million and $28 million respectively. A
description of these plans is included on pages 91 and 92 of the Company's 2003
Form 10-K.
On March 31, 2004, the Company purchased approximately $900 million of domestic
residential mortgage loan assets at fair value from Household. In addition,
approximately $1.5 billion of loans were purchased from originating lenders
during the first six months of 2004 pursuant to a Household correspondent loan
program.
On July 1, 2004, certain consumer credit card customer relationships were sold
to Household at a premium of approximately $99 million. Receivable balances of
approximately $970 million associated with these relationships were not sold as
part of the transaction. Servicing for these relationships will also be
transferred to Household at a future date, subject to successful transition of
certain accounting systems and processes. Also effective July 1, 2004, new
receivable balances generated by these relationships will be purchased from
Household on a daily basis.
The Company is in the process of transferring its Panamanian operations to
another HSBC Group entity at an amount that approximates fair value. These
operations accounted for approximately $1.5 billion of consolidated total assets
and approximately $1.3 billion of consolidated foreign deposits at June 30,
2004. For the six months ended June 30, 2004, these operations contributed
approximately $17 million of the Company's income before taxes.
It was previously reported that subject to receipt of regulatory and other
approvals the Company expected to purchase approximately $18 billion of credit
card receivables and approximately $9 billion of residual interests in
securitized credit card receivables pools from Household during 2004. It was
also reported that subsequent to the initial transfer, additional credit card
receivables would be purchased from Household on a daily basis and that various
methods of funding these transfers were being explored. Given recent growth and
funding needs, the Company now expects to apply for regulatory approval to
purchase only Household's private label credit card portfolio in 2004. Potential
assignment will be considered for some of Household's MasterCard and Visa
receivables in the future based upon continuing evaluations of capital and
liquidity at each entity.
Subject to regulatory and other approvals, the private label receivables
expected to be purchased from Household by year-end will have a principal
balance of approximately $11 billion. Residual interests in securitized private
label credit card receivables pools of approximately $4 billion will also be
acquired. These increases in credit card receivables will have significant
impact on net interest income and the provision and allowance for credit losses
in future periods. However, the impact on future period results cannot currently
be estimated due to the uncertainty as to the timing of the purchases.
Additional information on the financial impact of the proposed transfer will be
reported as the regulatory and other approval processes progress and the amounts
become quantifiable.
14
10. Pledged Assets
- --------------------------------------------------------------------------------
The following table presents pledged assets included in the consolidated balance
sheet.
- --------------------------------------------------------------------------------
June 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
(in millions)
Interest bearing deposits with banks ............... $ 382 $ 140
Interest bearing deposits with nonbanks ............ 798 500
Trading assets ..................................... 432 647
Securities available for sale ...................... 5,679 4,171
Securities held to maturity ........................ 728 956
Loans .............................................. 1,553 360
------ ------
Total .............................................. $9,572 $6,774
====== ======
11. Pensions and Other Postretirement Benefits
- --------------------------------------------------------------------------------
The Company, the Bank and certain other subsidiaries maintain noncontributory
defined benefit pension plans covering substantially all of their employees
hired prior to January 1, 1997 and those employees who joined the Company
through acquisitions and were participating in a defined benefit plan at the
time of acquisition. Certain other HSBC subsidiaries participate in these plans.
The Company also maintains unfunded noncontributory health and life insurance
coverage for all employees who retired from the Company and were eligible for
immediate pension benefits from the Company's retirement plan. Employees
retiring after 1992 will absorb a portion of the cost of these benefits.
Employees hired after that same date are not eligible for these benefits. A
premium cap has been established for the Company's share of retiree medical
cost.
The following tables present the components of net periodic benefit cost.
- ----------------------------------------------------------------------------------------------------
Pension Benefits Other Postretirement Benefits
----------------- -----------------------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------
(in millions)
Three months ended June 30
Net periodic benefit cost
Service cost ....................... $ 9 $ 8 $ 1 $ 1
Interest cost ...................... 20 16 1 1
Expected return on plan assets ..... (28) (22) -- --
Prior service cost amortization .... --(1) --(1) -- --
Actuarial loss ..................... 6 8 -- --
Transition amount amortization ..... -- -- 1 1
---- ---- ---- ----
Net periodic benefit cost .......... $ 7 $ 10 $ 3 $ 3
==== ==== ==== ====
Six months ended June 30
Net periodic benefit cost
Service cost ....................... $ 16 $ 15 $ 1 $ 1
Interest cost ...................... 34 32 4 3
Expected return on plan assets ..... (48) (44) -- --
Prior service cost amortization .... 1 1 -- --
Actuarial loss ..................... 13 16 -- --
Transition amount amortization ..... -- -- 2 1
---- ---- ---- ----
Net periodic benefit cost .......... $ 16 $ 20 $ 7 $ 5
==== ==== ==== ====
(1) Less than $500 thousand.
The Company expects to make no contribution for pension benefits and contribute
approximately $9 million for other postretirement benefits during fiscal year
2004.
15
12. New Accounting Pronouncements
- --------------------------------------------------------------------------------
In December 2003, the American Institute of Certified Public Accountants (AICPA)
released Statement of Position 03-3, Accounting for Certain Loans or Debt
Securities Acquired in a Transfer (SOP 03-3). SOP 03-3 addresses accounting for
differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities
acquired in a transfer if those differences are attributable to credit quality.
SOP 03-3 is effective for loans acquired in fiscal years beginning after
December 15, 2004. Adoption is not expected to have a material impact on the
Company's financial position or results of operations.
In December 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 132 (revised), Employers'
Disclosures about Pensions and Other Postretirement Benefits (SFAS 132
(revised)). SFAS 132 (revised) revises employers' disclosures about pension
plans and other postretirement benefit plans. It does not change the measurement
or recognition of those plans. SFAS 132 (revised) revises certain disclosure
requirements contained in the original SFAS 132. It also requires additional
disclosures about the assets, obligations, cash flows, and net periodic benefit
cost of defined benefit pension plans and other postretirement benefit plans.
The annual disclosure requirements for SFAS 132 (revised) were adopted in the
2003 Form 10-K and the interim period disclosure requirements were adopted in
the Form 10-Q beginning with the quarter ended March 31, 2004.
In January 2004, the FASB issued FASB Staff Position 106-1, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FSP 106-1). FSP 106-1 was issued in response to a
new Medicare bill that provides prescription drug coverage to Medicare-eligible
retirees and was signed into law in December 2003. FSP 106-1 allowed plan
sponsors the option of accounting for the effects of this new law in financial
statements for periods that cover the date of enactment or making a one-time
election to defer the accounting for the effects of the new law. The Company
elected to defer the accounting for the effects of the new law. In May 2004, the
FASB issued FASB Staff Position FAS 106-2, Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (FSP 106-2), which superceded FSP 106-1. FSP 106-2 is
effective for the first interim period beginning after June 15, 2004. For
companies that elected deferral under FSP 106-1, and for which enactment is
deemed to be a "significant event", FSP 106-2 provides two methods of transition
- - retroactive application or prospective application from the date of adoption.
If the effects of the new law are deemed not to be a "significant event", the
effect can be incorporated into the next measurement date following the
effective date. Adoption of FSP 106-2 is not expected to have a material impact
on the accumulated postretirement benefit obligation and the net periodic
benefit cost.
In March 2004, the FASB reached a consensus on EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides guidance for determining when an investment is
impaired and whether the impairment is other than temporary. EITF 03-1 also
incorporates into its consensus the required disclosures about unrealized losses
on investments announced by the EITF in late 2003 and adds new disclosure
requirements relating to cost-method investments. The impairment accounting
guidance is effective for reporting periods beginning after June 15, 2004 and
the new disclosure requirements for annual reporting periods ending after June
15, 2004. The adoption of the impairment guidance contained in EITF 03-1 is not
expected to have a material impact on the financial position or results of
operations of the Company.
In December 2003, the FASB issued Interpretation No. 46 Revised, Consolidation
of Variable Interest Entities (FIN 46R). The Company has adopted all of the
provisions of FIN 46R. All required disclosures are included in the MD&A section
of this Form 10-Q or in the Company's 2003 10-K under "Special Purpose and
Variable Interest Entities".
In March 2004, the SEC released Staff Accounting Bulletin No. 105, Application
of Accounting Principles to Loan Commitments (SAB 105) which provides guidance
regarding commitments related to loans to be held for sale, and accounted for as
derivative instruments. The guidance indicates that, for commitments issued
after March 31, 2004, expected future cash flows from servicing may not be
considered in valuing the derivatives and may only be recorded upon sale of the
related loans. The Company previously recorded those cash flows as assets and
income upon the issuance of the commitment. Implementation of the guidance for
commitments issued subsequent to March 31, 2004 is not expected to have material
impact on total mortgage banking revenue.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
HSBC USA Inc.
- --------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES (Taxable Equivalent Basis)
Three Months Ended June 30,
-------------------------------------------------------------------------
2004 2003
--------------------------------- ----------------------------------
Balance Interest Rate* Balance Interest Rate*
- ------------------------------------------------------------------------------------------------------------------------------
in millions
Assets
Interest bearing deposits with banks ........... $ 2,467 $ 7 1.22% $ 1,870 $ 7 1.50%
Federal funds sold and securities
purchased under resale agreements .......... 3,682 11 1.17 4,626 15 1.33
Trading assets ................................. 14,550 38 1.04 11,723 34 1.17
Securities ..................................... 17,584 220 5.02 18,618 217 4.67
Loans
Domestic
Commercial ................................. 15,493 159 4.12 16,733 201 4.80
Consumer
Residential mortgages ................. 34,425 413 4.80 20,662 293 5.67
Other consumer ........................ 3,367 69 8.30 2,980 61 8.29
--------- --------- ---- --------- --------- ----
Total domestic ........................... 53,285 641 4.84 40,375 555 5.51
International ................................ 3,608 27 3.06 3,167 31 3.86
--------- --------- ---- --------- --------- ----
Total loans .............................. 56,893 668 4.73 43,542 586 5.39
--------- --------- ---- --------- --------- ----
Other .......................................... 544 4 3.26 485 7 5.59
--------- --------- ---- --------- --------- ----
Total earning assets ........................... 95,720 $ 948 3.99% 80,864 $ 866 4.29%
--------- --------- ---- --------- --------- ----
Allowance for credit losses .................... (350) (502)
Cash and due from banks ........................ 3,204 2,402
Other assets ................................... 7,551 7,043
--------- ---------
Total assets ................................... $ 106,125 $ 89,807
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ........................... $ 27,762 $ 45 0.66% $ 24,462 $ 51 0.83%
Other time deposits ........................ 14,846 64 1.72 10,291 56 2.20
Deposits in foreign offices .................... 21,867 49 0.90 19,135 66 1.38
--------- --------- ---- --------- --------- ----
Total interest bearing deposits ................ 64,475 158 0.98 53,888 173 1.29
--------- --------- ---- --------- --------- ----
Short-term borrowings .......................... 9,782 35 1.44 8,850 21 0.93
Long-term debt ................................. 5,142 62 4.88 3,741 57 6.14
--------- --------- ---- --------- --------- ----
Total interest bearing liabilities ............. 79,399 255 1.29% 66,479 251 1.51%
--------- --------- ---- --------- --------- ----
Net interest income / Interest rate spread ..... $ 693 2.70% $ 615 2.78%
--------- ---- --------- ----
Noninterest bearing deposits ................... 7,636 6,197
Other liabilities .............................. 11,298 9,608
Total shareholders' equity ..................... 7,792 7,523
--------- ---------
Total liabilities and shareholders' equity ..... $ 106,125 $ 89,807
========= =========
* Rates are calculated on unrounded numbers
17
HSBC USA Inc.
- --------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES (Taxable Equivalent Basis)
Six Months Ended June 30,
-------------------------------------------------------------------------
2004 2003
--------------------------------- ----------------------------------
Balance Interest Rate* Balance Interest Rate*
- ------------------------------------------------------------------------------------------------------------------------------
in millions
Assets
Interest bearing deposits with banks ........... $ 2,022 $ 14 1.36% $ 1,545 $ 13 1.66%
Federal funds sold and securities
purchased under resale agreements .......... 3,842 22 1.16 4,496 30 1.36
Trading assets ................................. 15,129 71 0.94 12,727 74 1.17
Securities ..................................... 17,873 439 4.94 18,909 463 4.94
Loans
Domestic
Commercial ................................. 15,277 323 4.26 16,449 409 5.02
Consumer
Residential mortgages ................. 30,991 764 4.93 20,783 599 5.76
Other consumer ........................ 3,313 138 8.36 2,978 125 8.51
--------- --------- ---- --------- --------- ----
Total domestic ........................... 49,581 1,225 4.97 40,210 1,133 5.68
International ................................ 3,742 57 3.06 3,162 63 4.00
--------- --------- ---- --------- --------- ----
Total loans .............................. 53,323 1,282 4.84 43,372 1,196 5.56
--------- --------- ---- --------- --------- ----
Other .......................................... 517 8 3.28 480 14 5.72
--------- --------- ---- --------- --------- ----
Total earning assets ........................... 92,706 $ 1,836 4.01% 81,529 $ 1,790 4.45%
--------- --------- ---- --------- --------- ----
Allowance for credit losses .................... (371) (502)
Cash and due from banks ........................ 3,150 2,352
Other assets ................................... 7,396 6,998
--------- ---------
Total assets ................................... $ 102,881 $ 90,377
========= =========
Liabilities and Shareholders' Equity
Deposits in domestic offices
Savings deposits ........................... $ 27,199 $ 90 0.67% $ 23,810 $ 100 0.85%
Other time deposits ........................ 13,271 116 1.76 11,004 121 2.22
Deposits in foreign offices .................... 21,656 111 1.03 19,124 140 1.47
--------- --------- ---- --------- --------- ----
Total interest bearing deposits ................ 62,126 317 1.03 53,938 361 1.35
--------- --------- ---- --------- --------- ----
Short-term borrowings .......................... 9,161 53 1.16 9,745 58 1.21
Long-term debt ................................. 4,547 113 5.01 3,708 106 5.75
--------- --------- ---- --------- --------- ----
Total interest bearing liabilities ............. 75,834 483 1.28% 67,391 525 1.57%
--------- --------- ---- --------- --------- ----
Net interest income / Interest rate spread ..... $ 1,353 2.73% $ 1,265 2.88%
--------- ---- --------- ----
Noninterest bearing deposits ................... 7,413 6,074
Other liabilities .............................. 11,924 9,486
Total shareholders' equity ..................... 7,710 7,426
--------- ---------
Total liabilities and shareholders' equity ..... $ 102,881 $ 90,377
========= =========
* Rates are calculated on unrounded numbers
18
Forward-Looking Statements
- --------------------------------------------------------------------------------
This report includes forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company's results may
differ materially from those noted in the forward-looking statements. Words such
as "believe", "expects", "estimates", "targeted", "anticipates", "goal" and
similar expressions are intended to identify forward-looking statements but
should not be considered as the only means through which these statements are
made. Statements that are not historical facts, including statements about
management's beliefs and expectations, are forward-looking statements and
involve inherent risks and uncertainties and are based on current views and
assumptions. 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. For a list of important factors that may affect
the Company's actual results, see Forward-Looking Statements in Part I, Item 7
of the Company's 2003 Form 10-K.
Executive Overview
- --------------------------------------------------------------------------------
Net income increased $58 million in the second quarter of 2004, as compared with
the second quarter of 2003. Significantly improved net interest income, a
decreased provision for credit losses, and a reduction in income tax expense
were partially offset by decreased other revenues and increased operating
expenses.
For the six months ended June 30, 2004, net income increased $123 million from
the same 2003 period. Increased net interest income and a decreased provision
for credit losses were partially offset by decreased other revenues, increased
operating expenses, and increased income tax expense.
Balance sheet growth during the second quarter and first six months of 2004 was
highlighted by significant growth in residential mortgage loans. Asset growth
was primarily funded by low cost interest bearing deposits, short-term
borrowings, and long-term debt.
Net interest income increased $80 million in the second quarter of 2004, and
increased $90 million in the first half of 2004, as compared with the same 2003
periods. Increased residential mortgage loans and other loan balances were
primarily funded by lower cost funding sources. Net interest spreads were
negatively impacted, however, by a continued trend toward lower interest rates.
The provision for credit losses decreased $25 million during the second quarter
of 2004 and $106 million during the first half of 2004, as compared with the
same 2003 periods, reflecting the continuing trend of improved credit quality
within the commercial lending portfolios.
Other revenues decreased $61 million in the second quarter of 2004 and decreased
$37 million in the first half of 2004, as compared with the same 2003 periods.
Modest increases in fee-based income were more than offset by decreases in
mortgage banking revenue, trading related revenues, securities gains and other
income amounts.
Income tax expense decreased $42 million in the second quarter of 2004, and
increased $5 million during the first six months of 2004, as compared with the
same 2003 periods. In June 2004, approximately $51 million of income tax
liability related to the anticipated completion of an outstanding audit was
released. Excluding the impact of this adjustment, income tax expense for the
second quarter and the first six months of 2004 increased as a direct result of
increased taxable income, which is taxed at the full corporate rate.
19
The following table presents a five quarter summary of selected financial
information.
- -----------------------------------------------------------------------------------------------------------------------------------
June 30 March 31 December 31 September 30 June 30
Three months ended 2004 2004 2003 2003 2003
- -----------------------------------------------------------------------------------------------------------------------------------
(in millions)
Income statement data:
Net interest income ........................... $ 689 $ 655 $ 627 $ 629 $ 609
Provision for credit losses ................... 6 (25) 27 (1) 31
Other revenues ................................ 298 334 280 205 359
Operating expenses ............................ 520 489 539 523 492
Income tax expense ............................ 130 207 125 114 172
Net income .................................... 331 318 216 198 273
Balance sheet data (period end balances):
Loans, net .................................... $ 61,719 $ 52,075 $ 48,075 $ 44,473 $ 42,771
Total assets .................................. 112,791 102,502 95,562 92,718 92,990
Total deposits ................................ 74,534 67,994 63,955 62,098 60,381
Long-term debt ................................ 6,135 4,871 3,814 3,740 3,773
Total common shareholder's equity ............. 7,315 7,339 6,962 7,236 7,166
Total shareholders' equity .................... 7,815 7,839 7,462 7,736 7,666
Total tangible common shareholder's equity .... 4,673 4,341 4,022 4,196 4,000
Financial performance:
Net yield on average earning assets ........... 2.91% 2.96% 2.95% 3.09% 3.05%
Net yield on average total assets ............. 2.63 2.66 2.65 2.74 2.75
Basis of Reporting
- --------------------------------------------------------------------------------
HSBC reports results in accordance with accounting principles generally accepted
in the United Kingdom (U.K. GAAP). Therefore, management separately monitors net
income and earnings excluding goodwill amortization under U.K. GAAP (non-GAAP
financial measures). The following table reconciles net income of the Company on
a U.S. GAAP basis to net income on a U.K. GAAP basis.
- ----------------------------------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
---------------- ----------------
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------
(in millions)
Net income - U.S. GAAP basis .................................. $ 331 $ 273 $ 650 $ 527
Deferred loan origination fees and costs ...................... (13) -- (17) --
Derivative financial instruments .............................. (14) -- (6) --
Deferred taxation ............................................. (4) 3 14 18
Depreciation .................................................. 4 4 8 8
Software amortization ......................................... -- (1) 5 (1)
Other ......................................................... -- (1) -- (1)
----- ----- ----- -----
Earnings excluding goodwill amortization - U.K. GAAP basis .... 304 278 654 551
Goodwill amortization ......................................... (35) (40) (71) (81)
----- ----- ----- -----
Net income - U.K. GAAP basis .................................. $ 269 $ 238 $ 583 $ 470
===== ===== ===== =====
20
Differences between U.S. and U.K. GAAP are as follows:
Deferred loan origination fees and costs
U.K. GAAP
- - Fee and commission income is accounted for in the period when receivable,
except when it is charged to cover the costs of a continuing service to,
or risk borne for, the customer, or is interest in nature. In these cases,
it is recognized on an appropriate basis over the relevant period.
- - Loan origination costs are generally expensed as incurred. As permitted by
U.K. GAAP, HSBC applies a restricted definition of the incremental,
directly attributable origination expenses that are deferred and
subsequently amortized over the life of the loans.
U.S. GAAP
- - In accordance with Statement of Financial Accounting Standards No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases (SFAS 91), certain loan
fee income and direct loan origination costs are amortized to the profit
and loss account over the life of the loan as an adjustment to interest
income.
Derivative financial instruments
U.K. GAAP
- - Non-trading derivatives are those which are held for hedging purposes as
part of our risk management strategy against cash flows, assets,
liabilities, or positions measured on an accruals basis. Non-trading
transactions include qualifying hedges and positions that synthetically
alter the characteristics of specified financial instruments.
- - Non-trading derivatives are accounted for on an equivalent basis to the
underlying assets, liabilities or net positions. Any profit or loss
arising is recognized on the same basis as that arising from the related
assets, liabilities or positions.
- - To qualify as a hedge, a derivative must effectively reduce the price,
foreign exchange or interest rate risk of the asset, liability or
anticipated transaction to which it is linked and be designated as a hedge
at inception of the derivative contract. Accordingly, changes in the
market value of the derivative must be highly correlated with changes in
the market value of the underlying hedged item at inception of the hedge
and over the life of the hedge contract. If these criteria are met, the
derivative is accounted for on the same basis as the underlying hedged
item. Derivatives used for hedging purposes include swaps, forwards and
futures.
- - Interest rate swaps are also used to alter synthetically the interest rate
characteristics of financial instruments. In order to qualify for
synthetic alteration, a derivative instrument must be linked to specific
individual, or pools of similar, assets or liabilities by the notional
principal and interest rate risk of the associated instruments, and must
achieve a result that is consistent with defined risk management
objectives. If these criteria are met, accrual based accounting is
applied, i.e. income or expense is recognized and accrued to the next
settlement date in accordance with the contractual terms of the agreement.
- - Any gain or loss arising on the termination of a qualifying derivative is
deferred and amortized to earnings over the original life of the
terminated contract. Where the underlying asset, liability or position is
sold or terminated, the qualifying derivative is immediately
marked-to-market through the profit and loss account.
- - Derivatives that do not qualify as hedges or synthetic alterations at
inception are marked-to-market through the profit and loss account, with
gains and losses included within "other income".
21
U.S. GAAP
- - All derivatives must be recognized as either assets or liabilities in the
balance sheet and be measured at fair value, in accordance with Statement
of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133).
- - The accounting for changes in the fair value of a derivative (that is,
gains and losses) depends on the intended use of the derivative and the
resulting designation as described below:
o For a derivative designated as hedging exposure to changes in the
fair value of a recognized asset or liability or a firm commitment,
the gain or loss is recognized in earnings in the period of change
together with the associated loss or gain on the hedged item
attributable to the risk being hedged. Any resulting net gain or
loss represents the ineffective portion of the hedge.
o For a derivative designated as hedging exposure to variable cash
flows of a recognized asset or liability, or of a forecast
transaction, the derivative's gain or loss associated with the
effective portion of the hedge is initially reported as a component
of other comprehensive income and subsequently reclassified into
earnings when the forecast transaction affects earnings. The
ineffective portion is reported in earnings immediately.
o For net investment hedges in which derivatives hedge the foreign
currency exposure of a net investment in a foreign operation, the
change in fair value of the derivative associated with the effective
portion of the hedge is included as a component of other
comprehensive income, together with the associated loss or gain on
the hedged item. The ineffective portion is reported in earnings
immediately.
o In order to apply hedge accounting it is necessary to comply with
documentation requirements and to demonstrate the effectiveness of
the hedge on an ongoing basis.
o For a derivative not designated as a hedging instrument, the gain or
loss is recognized in earnings in the period of change in fair
value.
Deferred taxation
U.K. GAAP
- - Deferred tax is generally recognized for all timing differences subject to
exceptions in FRS 19, Deferred Tax, and the assessment of the
recoverability of deferred tax assets.
- - Fair value adjustments on acquisition are treated as if they were timing
differences arising in the acquired entity's own accounts. Deferred tax is
recognized on fair value adjustments where they give rise to deferral or
acceleration of taxable cash flows.
U.S. GAAP
- - In accordance with Statement of Financial Accounting Standards No. 109,
Accounting For Income Taxes (SFAS 109), deferred tax liabilities and
assets are recognized for all temporary differences. A valuation allowance
is raised against any deferred tax asset where it is more likely than not
that the asset, or a part thereof, will not be realized (SFAS 109
`Accounting for Income Taxes').
- - The deferred taxation impact of all temporary differences arising from
fair value adjustments on acquisition is recognized as part of the
purchase accounting adjustment.
Depreciation
U.K. GAAP
- - HSBC revalues its properties on an annual basis. HSBC depreciates
non-investment properties based on their cost or revalued amounts. No
depreciation is charged on investment properties, other than leaseholds,
with useful lives of 20 years or less.
U.S. GAAP
- - U.S. GAAP does not permit revaluation of property, although it requires
recognition of asset impairment. Depreciation is recognized on all
properties, based on cost, over the useful lives of the assets.
22
Software amortization
U.K. GAAP
- - HSBC generally expenses costs of software developed for internal use. If
it can be shown that conditions for capitalization are met under FRS 10,
Goodwill and Intangible Assets, or FRS 15, Tangible Fixed Assets, the
software is capitalized and amortized over its useful life. Website design
and content development costs are capitalized only to the extent that they
lead to the creation of an enduring asset delivering benefits at least as
great as the amount capitalized.
U.S. GAAP
- - The American Institute of Certified Public Accountants' (AICPA) Statement
of Position 98-1, Accounting For the Costs of Computer Software Developed
or Obtained For Internal Use, requires that all costs incurred in the
preliminary project and post implementation stages of internal software
development be expensed. Costs incurred in the application development
stage must be capitalized and amortized over their estimated useful life.
Website design costs are capitalized and website content development costs
are expensed as they are incurred.
Goodwill amortization
U.K. GAAP
- - Goodwill arising on acquisitions of subsidiary undertakings, associates or
joint ventures prior to 1998 was charged against reserves in the year of
acquisition.
- - For acquisitions made on or after January 1, 1998, goodwill is included in
the balance sheet and amortized over its estimated useful life on a
straight-line basis. U.K. GAAP allows goodwill previously eliminated
against reserves to be reinstated, but does not require it.
- - Goodwill included in the balance sheet is tested for impairment when
necessary by comparing the recoverable amount of an entity with the
carrying value of its net assets, including attributable goodwill. The
recoverable amount of an entity is the higher of its value in use,
generally the present value of the expected future cash flows from the
entity, and its net realizable value.
- - At the date of disposal of subsidiaries, associates or joint ventures, any
unamortized goodwill or goodwill charged directly against reserves is
included in our share of the undertakings' total net assets in the
calculation of the gain or loss on disposal.
- - Where quoted securities are issued as part of the purchase consideration
in an acquisition, the fair value of those securities for the purpose of
determining the cost of acquisition is the market price at the date of
completion.
U.S. GAAP
- - Goodwill acquired up to June 30, 2001 was capitalized and amortized over
its useful life but not more than 25 years. The amortization of previously
acquired goodwill ceased from December 31, 2001.
- - Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142) requires that goodwill should not be
amortized but should be tested for impairment annually at the reporting
unit level by applying a fair-value-based test.
- - The goodwill of a reporting unit should be tested for impairment between
annual tests in response to events or changes in circumstance which could
result in an impairment.
- - Where quoted securities are issued as part of the purchase consideration
in an acquisition, the fair value of those securities for the purpose of
determining the cost of acquisition is the average market price of the
securities for a reasonable period before and after the date that the
terms of the acquisition are agreed and announced.
Other
- - Includes various immaterial items.
23
Results of Operations
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Net Interest Income
In the discussion that follows, interest income and rates are presented and
analyzed on a taxable equivalent basis to permit comparisons of yields on
tax-exempt and taxable assets. An analysis of consolidated average balances and
interest rates on a taxable equivalent basis is presented on pages 17-18 of this
Form 10-Q.
All increases and decreases referred to below for the second quarter and the
first six months of 2004 represent comparisons with the same 2003 periods.
Interest Income - Commercial Lending
Interest income earned from commercial loans decreased $42 million (21%) in the
second quarter of 2004, and decreased $86 million (21%) in the first six months
of 2004. Average commercial loan balances decreased approximately $1 billion
during both reporting periods, principally due to decisions made to exit or
restructure certain business lines, including equipment finance, commercial
finance and domestic receivables factoring businesses.
Operating and financial performance continue to stabilize and improve for large
corporate clients, leading to a generally improving credit profile within most
industry sectors. Demand for ongoing credit support for these customers during
the first half of 2004 was comparable to the same 2003 period. This stability is
expected to continue for the remainder of 2004.
The Company will continue efforts to improve its commercial loan mix as well as
grow certain commercial banking businesses. Additional resources are being
allocated to commercial middle market, real estate and small business lending,
particularly in the New York City, California and Florida markets. Overall
commercial loan growth will be limited, however, due to the 2003 sale of the
U.S. factoring business, and planned run-off of equipment financing and
commercial finance portfolios.
The supply of credit in the overall commercial lending market is increasing. The
increased credit supply is partially offset, however, by marginal credit supply
restrictions stemming from ongoing bank industry consolidation. The overall
increase in credit supply is placing downward competitive pressure on pricing
and fees. This trend may continue throughout the balance of the year, absent a
material change in economic conditions.
Interest Income - Residential Mortgage Loans
Interest income earned from residential mortgage loans increased $120 million
(41%) in the second quarter of 2004, and increased $165 million (28%) in the
first six months of 2004. Average residential mortgage loans increased $14
billion (67%) in the second quarter of 2004, and increased $10 billion (49%) in
the first six months of 2004.
On December 31, 2003, approximately $2.8 billion of domestic residential
mortgage loan assets were purchased from Household at fair value. On March 31,
2004, approximately $900 million of additional mortgages were purchased from
Household. During 2004, approximately $1.5 billion of residential mortgages have
been purchased from originating lenders pursuant to a Household correspondent
loan program. Originations of other residential mortgage loans during the first
half of 2004 continued to be strong, due to competitive pricing, expanded sales
force, development of a correspondent network, and increased marketing efforts.
The increased loan balances, and their positive effect on earnings, were
partially offset by continued decreases in the average yield on residential
mortgages during the second quarter and first half of 2004, as consumers
continued to take advantage of lower coupon adjustable rate products.
Competitive pricing in a contracting national mortgage originations market
contributed to a general trend toward declining mortgage rates in 2004, as
compared with 2003. The lower level of refinancings in 2004, and a reduction in
loans originated for sale, resulted in lower interest income on mortgages held
for sale.
24
Residential mortgage growth is expected to continue at a more moderate level
through the remainder of 2004 by expanding product offerings, including, jumbo
(mortgages greater than Government Sponsored Enterprise limits), other prime
(adjustable rate mortgages not sold to Government Sponsored Enterprises) and
limited documentation products. Loan originations from the relationship with
Household are also expected to provide some level of growth.
Interest Income - Other Consumer Lending
Interest earned from various other consumer lending programs increased $8
million (13%) in the second quarter of 2004, and $13 million (10%) in the first
six months of 2004. These increases resulted directly from increases in average
loan balances, especially in automobile and other installment lending programs.
Moderate expansion of these programs is expected to continue for the remainder
of 2004, driven mainly by increased consumer loan originations arising from the
relationship with Household.
On July 1, 2004, certain consumer credit card customer relationships were sold
to Household at a premium of approximately $99 million. Receivable balances of
approximately $970 million associated with these relationships were not sold as
part of the transaction. Servicing for these relationships will also be
transferred to Household at a future date, subject to successful transition of
certain accounting systems and processes. Also effective July 1, 2004, new
receivable balances generated by these relationships will be purchased at fair
value from Household on a daily basis.
It was previously reported that subject to receipt of regulatory and other
approvals the Company expected to purchase approximately $18 billion of credit
card receivables and approximately $9 billion of residual interests in
securitized credit card receivables pools from Household during 2004. It was
also reported that subsequent to the initial transfer, additional credit card
receivables would be purchased from Household on a daily basis and that various
methods of funding these transfers were being explored. Given recent growth and
funding needs, the Company now expects to apply for regulatory approval to
purchase only Household's private label credit card portfolio in 2004. Potential
assignment will be considered for some of Household's MasterCard and Visa
receivables in the future based upon continuing evaluations of capital and
liquidity at each entity.
Subject to regulatory and other approvals, the private label receivables
expected to be purchased from Household by year-end will have a principal
balance of approximately $11 billion. Residual interests in securitized private
label credit card receivables pools of approximately $4 billion will also be
acquired. These increases in credit card receivables will have significant
impact on net interest income and the provision and allowance for credit losses
in future periods. However, the impact on future period results cannot currently
be estimated due to the uncertainty as to the timing of the purchases.
Additional information on the financial impact of the proposed transfer will be
reported as the regulatory and other approval processes progress and the amounts
become quantifiable.
Interest Expense - Deposits in Domestic Offices
Interest expense on domestic interest bearing deposits for the second quarter of
2004 was relatively consistent with the prior year. For the first six months of
2004, interest expense decreased $15 million (7%). General increases in average
deposit balances were offset by decreases in average interest rates paid during
2004.
Total average domestic interest bearing deposits increased $8 billion (23%) in
the second quarter of 2004, and increased $6 billion (16%) in the first six
months of 2004. General increases were noted for commercial and personal
interest bearing deposit balances. Increased marketing efforts have also
resulted in increases in noninterest bearing demand deposit balances.
Interest rates paid on deposits have generally decreased in the second quarter
and the first half of 2004. The low interest rate environment, combined with
continued uncertainty of the equity markets, continues to cause many personal
and commercial customers to show preference for highly liquid but low yielding
demand and savings deposits as opposed to longer term time deposits and mutual
funds. This accounts for the significant increase in deposit balances, and also
effectively continues to reduce the overall rate paid on liabilities.
25
Balance sheet growth will continue to be partially funded by deposit growth for
the remainder of 2004, as marketing of deposit products will continue.
Interest Expense - Deposits in Foreign Offices
Interest expense on foreign deposits decreased $17 million (26%) in the second
quarter of 2004 and $29 million (21%) in the first half of 2004. Increases in
average balances were more than offset by significant decreases in rates paid on
these deposits.
Interest Expense - Long-Term Debt
Interest expense on long-term debt increased $5 million in the second quarter of
2004 and $7 million in the first six months of 2004, due mainly to new debt
issued in 2004. Long-term debt will be used as a primary funding source for
balance sheet growth for the remainder of 2004. For further details regarding
long-term debt, refer to Note 7 of the financial statements on page 12 of this
Form 10-Q.
Other Revenues
The following tables present the components of other revenues for the three
months and six months ended June 30, 2004 and 2003.
- --------------------------------------------------------------------------------------
Increase (Decrease)
Three months ended June 30 2004 2003 Amount %
- --------------------------------------------------------------------------------------
(in millions)
Trust income .......................... $ 24 $ 24 $ -- --
Service charges ....................... 53 52 1 1.9
Other fees and commissions:
Letter of credit fees ............... 18 17 1 5.9
Credit card fees .................... 23 20 3 15.0
Investment product fees ............. 16 21 (5) (23.8)
Wealth and tax advisory services .... 13 12 1 8.3
Other fee-based income .............. 52 46 6 13.0