UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K


(Mark One)
x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______

Commission file number 1-7436

HSBC USA Inc.
(Exact name of registrant as specified in its charter)



Maryland		13-2764867
(State of Incorporation)		(I.R.S. Employer Identification No.)

452 Fifth Avenue, New York, New York		10018
(Address of principal executive offices)		(Zip Code)

(716) 841-2424
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

Depositary Shares (each representing a one-fourth share of Adjustable Rate Cumulative Preferred Stock, Series D)		New York Stock Exchange
$2.8575 Cumulative Preferred Stock		New York Stock Exchange
Floating Rate Non-Cumulative Preferred Stock, Series F		New York Stock Exchange
Depositary Shares (each representing a one-fortieth share of Floating Rate Non-Cumulative Preferred Stock, Series G)		New York Stock Exchange
Depositary Shares (each representing a one-fortieth share of Floating Rate Non-Cumulative Preferred Stock, Series H)		New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o No x

Indicate by check mark whether the registrant (1) had filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o	Accelerated filer o	Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No x

At February 29, 2008, all voting stock (706 shares of Common Stock $5 par value) is owned by an indirect wholly owned subsidiary of HSBC Holdings plc.

DOCUMENTS INCORPORATED BY REFERENCE

None

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HSBC USA Inc.
Form 10-K

TABLE OF CONTENTS


*Part I*


		Page
Item 1.	Business
	History	5
	Description of Operations and Business Segments	5
	2007 Developments and Trends	8
	Geographic Distribution of Assets and Earnings	10
	Regulation, Supervision and Capital	10
	Competition	12
	Cautionary Statement on Forward-Looking Statements	12
	Statistical Disclosure by Bank Holding Companies:
	Average Balance Sheets and Interest Earned and Paid	94
	Changes in Interest Income and Expense Attributable to Changes in Rate and Volume	35
	Securities Portfolios	116
	Loans, Net:
	Composition and Maturities	31
	Risk Elements in the Loan Portfolio	59-61 123
	Summary of Loan Loss Experience	62
	Deposits	127
	Short-Term Borrowings	127
Item 1A.	Risk Factors	13
Item 1B.	Unresolved Staff Comments	17
Item 2.	Properties	17
Item 3.	Legal Proceedings	17
Item 4.	Submission of Matters to a Vote of Security Holders	17

*Part II*


Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	17
Item 6.	Selected Financial Data	18
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Executive Overview	19
	Basis of Reporting	20
	Critical Accounting Policies	25
	Balance Sheet Review	30
	Results of Operations	35
	Business Segments	50
	Credit Quality	59
	Off-Balance Sheet Arrangements and Contractual Obligations	70
	Risk Management	75
	Glossary of Terms	91
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	92
Item 8.	Financial Statements and Supplementary Data	96


*Part III*


		Page

Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	164
Item 9A.	Controls and Procedures	164
Item 9B.	Other Information	167
Item 10.	Directors, Executive Officers and Corporate Governance	168
Item 11.	Executive Compensation	173
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	205
Item 13.	Certain Relationships and Related Transactions, and Director Independence	206
Item 14.	Principal Accounting Fees and Services	208

*Part IV*


Item 15.	Exhibits and Financial Statement Schedules and Reports on Form 8-K	209

P A R T I

Item 1. Business

History

HSBC USA Inc., incorporated under the laws of Maryland, is a New York State based bank holding company registered under the Bank Holding Company Act of 1956, as amended. HSBC USA Inc. and its subsidiaries are collectively referred to as “HUSI”. HUSI’s origin was in Buffalo, New York in 1850 as The Marine Trust Company, which later became Marine Midland Banks, Inc. (Marine). In 1980, The Hongkong and Shanghai Banking Corporation Limited (now HSBC Holdings plc, hereinafter referred to as “HSBC”) acquired 51% of the common stock of Marine and the remaining 49% of common stock in 1987. In December 1999, HSBC acquired Republic New York Corporation (Republic) and merged it with HUSI. At the merger date, Republic and HUSI had total assets of approximately $47 billion and $43 billion, respectively.

Through its affiliation with HSBC, HUSI offers its customers access to global markets and services. In turn, HUSI plays a role in the delivery and processing of other HSBC products. HSBC is one of the largest banking and financial services organizations in the world. Headquartered in London, England, HSBC’s international network comprises over 10,000 offices in 83 countries and territories in Europe, the Asia-Pacific region, Latin America, North America, South America, the Middle East and Africa.

Effective January 1, 2004, HSBC created a North American organizational structure with HSBC North America Holdings Inc. (HNAH) as the top-tier United States (U.S.) bank holding company. At December 31, 2007, HNAH was among the 10 largest U.S. bank holding companies ranked by assets. HUSI routinely conducts transactions with other principal subsidiaries of HNAH, which include:


•		HSBC Bank Canada (HBCA), a Canadian banking subsidiary;
•		HSBC Finance Corporation, a consumer finance company;
•		HSBC Markets (USA) Inc. (HMUS), a holding company for investment banking and markets subsidiaries; and
•		HSBC Technology & Services (USA) Inc. (HTSU), a provider of information technology services.

Description of Operations and Business Segments

At December 31, 2007, HUSI had total assets of $188 billion and approximately 12,000 full and part time employees. HUSI is among the 10 largest bank holding companies in the U.S. ranked by assets. Through its principal commercial banking subsidiary, HSBC Bank USA, National Association (HBUS), HUSI offers its four million customers a full range of commercial banking products and services. Its customers include individuals, including high net worth individuals, small businesses, corporations, institutions and governments. HBUS also engages in mortgage banking, and is an international dealer in derivative instruments denominated in U.S. dollars and other currencies, focusing on structuring of transactions to meet clients’ needs as well as for proprietary purposes.

With total assets of $184 billion at December 31, 2007, HBUS is ranked among the top 10 banks in the U.S. HBUS’s main office is in Delaware, and its domestic operations are primarily located in New York State. It also has banking branch offices and/or representative offices in California, Florida, New Jersey, Delaware, Pennsylvania, Massachusetts, Virginia, Washington, Oregon and Washington, D.C. In addition to its domestic offices, HBUS maintains foreign branch offices, subsidiaries and/or representative offices in the Caribbean, Europe, Asia, Latin America, Australia and Canada.

During 2005, HUSI incorporated a nationally chartered limited purpose bank subsidiary, HSBC Trust Company (Delaware), National Association (HTCD). HTCD’s charter includes the following primary activities:


•	Custodian of investment securities for other HSBC affiliates;
•	Personal trust services; and
•	Originator of refund anticipation loans and checks in support of taxpayer financial services business lines.

The operations of HTCD had an immaterial impact on HUSI’s consolidated balance sheets and results of operations for the years ended December 31, 2007 and 2006.

During 2006, HUSI also received regulatory approval for a new nationally chartered bank subsidiary, HSBC National Bank USA (HBMD). The charter for this new subsidiary directly supports HUSI’s retail branch expansion strategy by allowing for the opening of new branches in Connecticut, Maryland, Virginia and Illinois. These branches offer a full suite of deposit and loan products for its own retail and small business customers, as well as support certain customer service activities on behalf of HBUS. The operations of HBMD had an immaterial impact on HUSI’s consolidated balance sheets and results of operations for the years ended December 31, 2007 and 2006.

HUSI has five distinct business segments that it utilizes for management reporting and analysis purposes. The segments are based upon customer groupings, as well as products and services offered. The segments are described in the following paragraphs. Analysis of financial results for HUSI’s business segments begins on page 50 of this Form 10-K.

The Personal Financial Services (PFS) Segment

This segment provides a broad range of financial products and services including installment and revolving term loans, MasterCard¹/Visa² credit card receivables, deposits, branch services, mutual funds, investments and insurance. These products are marketed to individuals primarily through HBUS’s branch banking network and increasingly through e-banking channels. Residential mortgage lending provides loan financing through the branch network and wholesale origination channels. Servicing is performed on a contractual basis for residential mortgage loans owned by HBUS or by third parties.

Effective January 1, 2006, activity related to certain commercial banking relationships, which was previously reported in the PFS segment, was transferred to the Commercial Banking (CMB) segment. For comparability purposes, 2005 results for the PFS segment have been revised to reflect these changes.

The Consumer Finance (CF) Segment

In 2005, HUSI formed the CF segment, which includes balances and activity previously reported as a component of the PFS segment. The CF segment includes point of sale and other lending activities primarily to meet the financial needs of individuals. Specifically, operating activity within the CF segment relates to higher quality nonconforming residential mortgage loans, other consumer loans and private label credit card receivables purchased from HSBC Finance Corporation.

¹ MasterCard is a registered trademark of MasterCard, Incorporated.

² Visa is a registered trademark of Visa USA, Inc.

The Commercial Banking (CMB) Segment

This segment provides loan and deposit products to small businesses and middle-market corporations including specialized products such as real estate financing. Various credit and trade related products such as standby facilities, performance guarantees and acceptances are also offered. These products and services are offered through multiple delivery systems, including the branch banking network.

Effective January 1, 2006, the CMB segment also includes activity related to an equity investment in Wells Fargo HSBC Trade Bank N.A., which was previously reported in the Other segment. This change was made to align financial reporting with the segment that manages this relationship. In addition, also effective January 1, 2006, activity related to certain commercial banking relationships, which was previously reported in the PFS segment, was transferred to the CMB segment. For comparability purposes, 2005 results for these segments have been revised to reflect these changes.

The Global Banking and Markets Segment (formerly Corporate, Investment Banking and Markets “CIBM”)

The Global Banking and Markets segment is an emerging markets-led and financing-focused business that provides tailored financial solutions to major government, corporate and institutional clients worldwide.

Global Banking and Markets clients are served by teams that bring together relationship managers and product specialists to develop financial solutions that meet individual client needs. To ensure that a comprehensive understanding of each client's financial requirements is developed, the Global Banking and Markets teams take a long-term relationship management approach.

Client-focused business lines deliver the following full range of banking capabilities:


•	Investment banking and financing solutions for corporate and institutional clients, including corporate banking, investment banking, trade services, payments and cash management, and leveraged acquisition finance;

•	One of the largest markets businesses of its kind, with 24-hour coverage and knowledge of local markets and providing services in credit and rates, foreign exchange, money markets and securities services; and

•	Global asset management solutions for institutions, financial intermediaries and private investors worldwide.

	The Private Banking (PB) Segment

This segment offers a full range of wealth management services for high net worth individuals. Products and services include wealth structuring, investment management, credit and banking, legacy and philanthropy and family advisory services.

Other Segment

This segment includes an equity investment in HSBC Private Bank (Suisse) S.A. Effective January 1, 2006, an equity investment in Wells Fargo HSBC Trade Bank, N.A., which was previously reported in the Other segment, was transferred to the CMB segment. For comparability purposes, 2005 results have been revised to reflect this change.

2007 Developments and Trends

Income Before Income Tax Expense - Significant Trends

Adverse market conditions, particularly in the U.S. mortgage and credit markets, led to substantial declines in trading and other income (refer to the table below). Reduced liquidity, widening credit spreads and higher volatility in the credit and sub-prime lending markets impacted trading in mortgage backed securities and credit derivatives. These adverse market conditions resulted in a significant fall in revenues, due to substantial valuation adjustments in several asset classes, including trading securities, residential mortgage loans held for sale, commercial loans held for sale, and credit derivatives products. In addition, provisions for credit losses have increased significantly, primarily due to increased credit card receivable balances and increased delinquencies in the credit card portfolio.

Income before income tax expense, and various trends and activity affecting operations, are summarized in the following table.


		2007			2006			2005

(in millions)
Income before income tax expense from prior year	$	1,566		$	1,542		$	1,976

Increase (decrease) in income before income tax expense attributable to:
Balance sheet management activities (1)		(70	)		(325	)		(148	)
Trading related activities (2)		(606	)		289			46
Private label receivable portfolio (3)		(32	)		264			-
Loans held for sale (4)		(512	)		(120	)		(32	)
Residential mortgage banking revenue (5)		(92	)		(85	)		170
Earnings from equity investments (6)		(32	)		67			(6	)
All other activities (7)		(85	)		(66	)		(464	)

		(1,429	)		24			(434	)

Income before income tax expense for current year	$	137		$	1,566		$	1,542


(1)	Balance sheet management activities are comprised primarily of net interest income and, to a lesser extent, gains on sales of investments and trading revenues, resulting from management of interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. Refer to commentary regarding Global Banking and Markets net interest income, trading revenues, and the Global Banking and Markets business segment beginning on page 55 of this Form 10-K, respectively.



(2)	Refer to commentary regarding trading revenues beginning on page 40 of this Form 10-K.
(3)	Refer to commentary regarding the CF business segment beginning on page 52 of this Form 10-K.
(4)	Refer to commentary regarding loans held for sale beginning on page 121 of this Form 10-K.
(5)	Refer to commentary regarding residential mortgage banking revenue beginning on page 43 of this Form 10-K.
(6)	Refer to commentary regarding other income beginning on page 45 of this Form 10-K.
(7)	Represents core banking and other activities that have been affected by challenging market conditions. Refer to business segments commentary beginning on page 50 of this Form 10-K.

Consolidated Balance Sheet Growth

HUSI’s consolidated total assets increased $24 billion (14%) during 2007. Balance sheet growth was primarily driven by HUSI’s deposit strategy during 2007, which improved HUSI’s liquidity position. The funds raised were primarily invested in short-term, liquid assets such as trading assets which increased as a result of higher levels of trading activity in precious metals and derivatives businesses. Analysis of balance sheet growth and funding begins on page 30 of this Form 10-K.

Deposit Strategy and Growth

HUSI has a growth strategy for its core banking network, which includes building deposits across multiple markets and segments, and utilizing multiple delivery systems. This strategy includes various initiatives:


•	full deployment of new personal and business checking and savings products, including relationship-based products;
•	emphasis on more competitive pricing with the introduction of high yielding products, including on-line savings accounts. Since their introduction in 2005, internet savings balances have grown to $11 billion, of which $4 billion was 2007 growth. Substantially all of the 2007 growth was from new customers;
•	retail branch expansion in existing and new geographic markets;
•	improving delivery systems, including use of internet capabilities;
•	refined marketing and customer analytics for the affluent consumer population; and
•	strengthening current customer relationships, thereby driving increased utilization of products and customer retention.

Total deposit growth was $14 billion and $12 billion during the calendar years 2007 and 2006, respectively. Deposit balances by major depositor categories are summarized on page 32 of this Form 10-K.

Transactions with HSBC Finance Corporation and Other HSBC Affiliates

Cooperation continued during 2007 between HUSI and HSBC Finance Corporation to identify synergies in products and processes. Synergies have been achieved in loan origination and servicing, card processing, IT contingency rationalization, purchasing, call center cooperation, the shared use of HSBC’s service centers, and the consolidation of certain administrative functions. HUSI and HSBC Finance Corporation will continue to work cooperatively on product offerings and support functions.

HUSI has routinely purchased private label credit card receivables from HSBC Finance Corporation since December 2004. In addition, higher quality nonconforming residential mortgage loans were acquired from HSBC Finance Corporation’s correspondent network from December 2003 until September 2005. In most cases, HSBC Finance Corporation retained the right to service these portfolios. These purchases of residential mortgage and other loans were discontinued as a result of strategic balance sheet management initiatives intended to enhance HUSI’s liquidity position, particularly its loan to deposit ratio, and to address interest rate risk. Fees charged by HSBC Finance Corporation for loan origination and servicing expenses, which are primarily recorded in the CF segment, have increased mostly due to increased private label receivables.

HNAH’s technology services in North America are centralized in a separate subsidiary, HTSU. Technology related assets and software developed or purchased are generally owned by HTSU. Pursuant to a master service level agreement, HTSU charges HUSI for technology services and software development. Fees charged by HTSU to HUSI for technology services expenses have increased in 2007, as HUSI continued to upgrade its technology platform.

HUSI obtains certain underwriting, broker-dealer and administrative support services from HSBC and various other affiliates. Fees charged by these affiliates for treasury and traded markets services provided to HUSI’s Global Banking and Markets segment have increased in 2007 due primarily to increased trading activity.

Details of these and other transactions with HSBC affiliates are presented in Note 21 of the consolidated financial statements beginning on page 139 of this Form 10-K.

Geographic Distribution of Assets and Earnings

HUSI’s foreign operations represented less than 6% of HUSI’s consolidated total assets at December 31, 2007 and 2006, and less than 10% of consolidated income before income tax expense for 2007, 2006 and 2005.

Regulation, Supervision and Capital

Through June 30, 2004, HUSI and HBUS were supervised and routinely examined by the State of New York Banking Department and the Board of Governors of the Federal Reserve System (the Federal Reserve). Effective July 1, 2004, HBUS became a nationally chartered bank and is primarily supervised by the Office of the Comptroller of the Currency (OCC). HUSI, as a bank holding company, continues to be supervised by the Federal Reserve. HUSI, HBUS, HBMD and HTCD are subject to banking laws and regulations which place various restrictions on and requirements regarding their operations and administration, including the establishment and maintenance of branch offices, capital and reserve requirements, deposits and borrowings, investment and lending activities, payment of dividends and numerous other matters. The Federal Reserve Act restricts certain transactions between banks and their nonbank affiliates. Since the deposits of HBUS, HBMD and HTCD are insured by the Federal Deposit Insurance Corporation (FDIC), HBUS, HBMD and HTCD are subject to relevant FDIC regulations.

HBUS is required to maintain non-interest bearing cash reserves with the Federal Reserve Bank, which averaged $256 million in 2007 and $311 million in 2006.

HUSI and HBUS are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory actions and possibly additional discretionary actions by regulators. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

HUSI’s capital resources are summarized on page 34 of this Form 10-K.

Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios of total and Tier 1 capital (as defined in banking regulations). Capital amounts and ratios for HUSI and HBUS are summarized in Note 19 of the consolidated financial statements on page 137 of this Form 10-K. To be categorized as “well capitalized”, a banking institution must have the minimum ratios reflected in the table included in Note 19 and must not be subject to a directive, order or written agreement to meet and maintain specific capital levels.

From time to time, bank regulators propose amendments to or issue interpretations of risk-based capital guidelines. Such proposals or interpretations could, upon implementation, affect reported capital ratios and net risk weighted assets. U.S. regulators have adopted a new capital adequacy framework, which is further described under “Basel Capital Standards”.

HBUS, HBMD and HTCD are subject to risk-based assessments from the FDIC, the U.S. Government agency that insures deposits generally to a maximum of $100,000 per domestic depositor. During November 2006, the FDIC adopted final regulations that implement a new risk-based assessment system. Depository institutions subject to assessment are categorized based on supervisory ratings, financial ratios and long-term debt issuer ratings, with those in the highest rated categories paying lower assessments. The new assessment rates, which took effect at the

beginning of 2007, will vary between five and seven cents for every $100 of domestic deposits for nearly all banks. Banks that paid premiums in the past will have assessment credits to offset some or all of the premiums in 2007.

The Deposit Insurance Funds Act (DIFA) of 1996 authorized the Financing Corporation (FICO), a U.S. Government corporation, to collect funds from FDIC insured institutions to pay interest on FICO bonds. The FICO assessment rate in effect at December 31, 2007 was 1.14 percent of assessable deposits. The FICO assessment rate is adjusted quarterly. HBUS, HBMD and HTCD are subject to a quarterly FICO premium.

The USA Patriot Act (the Patriot Act), effective October 26, 2001, imposed significant record keeping and customer identity requirements, expanded the government’s powers to freeze or confiscate assets and increased the available penalties that may be assessed against financial institutions for violation of the requirements of the Patriot Act intended to detect and deter money laundering. The Patriot Act required the U.S. Treasury Secretary to develop and adopt final regulations with regard to the anti-money laundering compliance obligations of financial institutions (a term which includes insured U.S. depository institutions, U.S. branches and agencies of foreign banks, U.S. broker-dealers and numerous other entities). The U.S. Treasury Secretary delegated certain authority to a bureau of the U.S. Treasury Department known as the Financial Crimes Enforcement Network (FinCEN).

Many of the anti-money laundering compliance requirements of the Patriot Act, as implemented by FinCEN, are generally consistent with the anti-money laundering compliance obligations that applied to HBUS under the Bank Secrecy Act and applicable Federal Reserve Board regulations before the Patriot Act was adopted. These include requirements to adopt and implement an anti-money laundering program, report suspicious transactions and implement due diligence procedures for certain correspondent and private banking accounts. Certain other specific requirements under the Patriot Act involve compliance obligations. The Patriot Act and other recent events have resulted in heightened scrutiny of the Bank Secrecy Act and anti-money laundering compliance programs by the federal and state bank regulators.

Basel Capital Standards (Basel II)

HUSI is currently working toward compliance with final U.S. Basel II capital rule, published in December 2007. In addition, HUSI supports HSBC’s implementation of the Financial Services Authority’s (FSA) Basel II capital rule.

HUSI’s approach toward implementing the Basel framework is summarized beginning on page 76 of this Form 10-K.

Sarbanes-Oxley Act of 2002, Section 404 Compliance

As an SEC registrant of public debt and preferred shares, HUSI is required to comply with the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404) requires registrants and their auditors to assess and report on internal controls over financial reporting on an annual basis. Under the SEC’s current rules for non-accelerated filers, HUSI was required to complete a management assessment of internal controls over financial reporting for the fiscal year ending December 31, 2007. An audit of HUSI’s internal controls over financial reporting, along with management’s assessment of these controls, is required beginning in the fiscal year ending December 31, 2009.

As a foreign registrant, HSBC was required to comply with Section 404 beginning in the fiscal year ending December 31, 2006. As a subsidiary of a foreign registrant, HUSI has supported HSBC with its Section 404 compliance.

HUSI has adopted the internal control framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to complete its management assessment of the effectiveness of internal controls over financial reporting in compliance with Section 404. Certain other financial reporting risk assessment factors have also been included to ensure adequate coverage of safeguarding of assets and anti-fraud risks.

Competition

The Gramm-Leach-Bliley Act of 1999 (GLB Act), effective March 11, 2000, eliminated many of the regulatory restrictions on providing financial services. The GLB Act allows for financial institutions and other providers of financial products to enter into combinations that permit a single organization to offer a complete line of financial products and services. Therefore, HUSI and its subsidiaries face intense competition in all of the markets they serve, competing with both other financial institutions and non-banking institutions such as insurance companies, major retailers, brokerage firms and investment companies.

Following the enactment of the GLB Act, HUSI elected to be treated as a financial holding company (FHC). As an FHC, HUSI’s activities in the U.S. have been expanded enabling it to offer a more complete line of products and services. HUSI’s ability to engage in expanded financial activities as an FHC depends upon its meeting certain criteria, including requirements that its U.S. depository institution subsidiary, HBUS, its forty percent owned subsidiary, Wells Fargo HSBC Trade Bank N.A., HBMD and HTCD be well capitalized and well managed, and that they have achieved at least a satisfactory record of meeting community credit needs during their most recent examination pursuant to the Community Reinvestment Act. In general, an FHC would be required, upon notice by the Federal Reserve Board, to enter into an agreement to correct any deficiency in the requirements necessary to maintain its FHC election. Until such deficiencies are corrected, the Federal Reserve Board may impose limitations on the conduct or activities of an FHC or any of its affiliates as it deems appropriate. If such deficiencies are not corrected in a timely manner, the Federal Reserve Board may require an FHC to divest its control of any subsidiary depository institution or to cease to engage in certain financial activities. As of December 31, 2007, no known deficiencies exist, and HUSI is not subject to limitations or penalties relative to its status as an FHC.

Cautionary Statement on Forward-Looking Statements

Certain matters discussed throughout this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, HUSI may make or approve certain statements in future filings with the SEC, in press releases, or oral or written presentations by representatives of HUSI that are not statements of historical fact and may also constitute forward-looking statements. Words such as “may”, “should”, “would”, “could”, “believes”, “intends”, “expects”, “estimates”, “targeted”, “plans”, “anticipates”, “goal” and similar expressions are intended to identify forward-looking statements but should not be considered as the only means through which these statements may be made. These matters or statements will relate to future financial condition, results of operations, plans, objectives, performance or business developments and will involve known and unknown risks, uncertainties and other factors that may cause HUSI’s actual results, performance or achievements to be materially different from that which was expressed or implied by such forward-looking statements. Forward-looking statements are based on current views and assumptions and speak only as of the date they are made. HUSI undertakes no obligation to update any forward-looking statement to reflect subsequent circumstances or events.

Item 1A. Risk Factors

General Business, Economic, Political and Market Conditions

HUSI’s business and earnings are affected by general business, economic, market and political conditions in the United States and abroad. Given its concentration of business activities in the United States, HUSI is particularly exposed to downturns in the United States economy. For example, in a poor economic environment there is greater likelihood that more of HUSI’s customers or counterparties could become delinquent or default on their loans or other obligations. This could result in higher levels of charge offs and provisions for credit losses, which would adversely affect HUSI’s earnings. General business, economic and market conditions that could affect HUSI include, but are not limited to:


•	short-term and long-term interest rates;
•	inflation;
•	recession;
•	unemployment levels;
•	monetary supply and market liquidity;
•	fluctuations in both debt and equity capital markets in which HUSI funds its operations;
•	market value of consumer owned and commercial real estate throughout the United States;
•	consumer perception as to the availability of credit; and
•	the ease of filing for bankruptcy.

Certain changes to these conditions could diminish demand for HUSI’s products and services, or increase the cost to provide such products or services. Recent trends in world-wide financial markets related to, among other things, the growth of derivatives and hedge funds, could add instability and could change the way those markets work. Political conditions may also impact HUSI’s earnings. The economic health of geographic areas where HUSI has greater concentrations of business may decline relative to other geographic regions, with related impacts on HUSI’s earnings. Acts or threats of war or terrorism, as well as actions taken by the United States or other governments in response to such acts or threats, could affect business and economic conditions in the United States.

Competition

HUSI operates in a highly competitive environment. Competitive conditions are expected to continue to intensify as continued merger activity in the financial services industry produces larger, better-capitalized and more geographically diverse companies. New products, customers and channels of distribution are constantly emerging. Such competition may impact the terms, rates, costs and/or profits historically included in the financial products HUSI offers or purchases. The traditional segregation of commercial and investment banks has all but eroded. There is no assurance that the significant and increasing competition within the financial services industry will not materially and adversely affect HUSI’s future results of operations.

Federal and State Regulation

HUSI operates in a highly regulated environment. Changes in federal, state and local laws and regulations affecting banking, consumer credit, bankruptcy, privacy, consumer protection or other matters could materially impact HUSI’s performance. For example, anti-money laundering requirements under the Patriot Act are frequently revisited by the U.S. Congress and Executive Agencies. Broad or targeted legislative or regulatory initiatives may be aimed at lenders operating in consumer lending markets. These initiatives could affect HUSI in substantial and unpredictable ways, including limiting the types of consumer loan products it can offer. In addition, there may be amendments to, and new interpretations of, risk-based capital guidelines. HUSI cannot determine whether such legislative or regulatory amendments will be instituted or predict the impact that such amendments would have on results.

Changes in Accounting Standards

HUSI’s accounting policies and methods are fundamental to how HUSI records and reports its financial condition and the results of its operations. From time to time, the Financial Accounting Standards Board (FASB), the SEC and bank regulators, including the Office of Comptroller of the Currency and the Board of Governors of the Federal Reserve System, change the financial accounting and reporting standards that govern the preparation of external financial statements. These changes are beyond HUSI’s control, can be hard to predict and could materially impact how HUSI reports its financial condition and the results of its operations.

Management Financial Projections and Judgments

HUSI’s management is required to use certain estimates in preparing financial statements, including accounting estimates to determine loan loss reserves, reserves related to litigation, and the fair market value of certain assets and liabilities, among other items. In particular, loan loss reserve estimates are judgmental and are influenced by factors outside of HUSI’s control. Actual results could differ from those estimates.

Lawsuits and Regulatory Investigations and Proceedings

HUSI or one of its subsidiaries may be named as a defendant in various legal actions, including class actions and other litigation or disputes with third parties, as well as investigations or proceedings brought by regulatory agencies. These actions may result in judgments, settlements, fines, penalties or other results, including additional compliance requirements, adverse to HUSI which could have a material adverse effect on HUSI’s business, financial condition or results of operations, or cause serious reputational harm.

Operational Risks

HUSI’s businesses are dependent upon its ability to process a large number of increasingly complex transactions. If any of HUSI’s accounting, data processing and other record keeping systems and management controls fail or have other significant shortcomings, HUSI could be materially and adversely affected. HUSI is similarly dependent on its employees. HUSI could be materially and adversely affected if an employee causes a significant operational break-down or failure, either as a result of human error or where an individual intentionally sabotages or fraudulently manipulates HUSI’s operations or systems. Third parties with which HUSI does business could also be sources of operational risk, including risks associated with break-downs or failures of such parties’ own systems or employees. Any of these occurrences could result in diminished ability of HUSI to operate one or more of its businesses, potential liability to clients, reputational damage and regulatory intervention, all of which could have a material adverse effect on HUSI.

HUSI may also be subject to disruptions of its operating systems and businesses arising from events that are wholly or partially beyond its control. These may include:


•	computer viruses or electrical or telecommunications outages;
•	natural disasters, such as hurricanes and earthquakes;
•	events arising from local or regional politics, including terrorist acts;
•	unforeseen problems encountered while implementing major new computer systems; or
•	global pandemics, which could have a significant effect on HUSI’s business operations as well as on HSBC affiliates world-wide.

Such disruptions may give rise to losses in service to customers, an inability to collect receivables in affected areas and other loss or liability to HUSI.

In recent years, instances of identity theft and fraudulent attempts to obtain personal and financial information from individuals and from companies that maintain such information pertaining to their customers have become more prevalent. Use of the internet for these purposes has also increased. Such acts can have the following possible impacts:


•	threaten the assets of customers and of HUSI;
•	negatively impact customer credit ratings;
•	impact customers’ ability to repay loan balances;
•	increase costs for HUSI to respond to such threats and to enhance its processes and systems to ensure maximum security of data; or
•	damage HUSI’s reputation from public knowledge of intrusion into its systems and databases.

There is the risk that HUSI’s controls and procedures, business continuity planning, and data security systems could prove to be inadequate. Any such failure could affect HUSI’s operations and could have a material adverse effect on HUSI’s results of operations by requiring HUSI to expend significant resources to correct the defect, as well as by exposing HUSI to litigation or losses not covered by insurance.

Changes to operational practices from time to time could materially impact HUSI’s performance and results. Such changes may include:


•	raising the minimum payment on credit card accounts;
•	determinations to acquire or sell private label credit card receivables, residential mortgage loans and other loans;
•	changes to customer account management, risk management and collection policies and practices;
•	increasing investment in technology, business infrastructure and specialized personnel; or
•	outsourcing of various operations.

Liquidity

Adequate liquidity is critical to HUSI’s ability to operate its businesses, grow and be profitable. A compromise to liquidity caused by market disruptions and other events could therefore have a negative effect on HUSI. Potential conditions that could negatively affect HUSI’s liquidity include:


•	diminished access to capital markets;
•	unforeseen cash or capital requirements;
•	an inability to sell assets; and
•	an inability to obtain expected funding from HSBC affiliates and clients.

HUSI’s credit ratings are an important part of maintaining liquidity. Any downgrade in credit ratings could potentially increase borrowing costs, limit access to capital markets, require cash payments or collateral posting, and permit termination of certain contracts material to HUSI.

Acquisition Integration

HUSI has in the past, and may again in the future, seek to grow its business by acquiring other businesses or loan portfolios. There can be no assurance that acquisitions will have the anticipated positive results, including results relating to:


•	the total cost of integration;
•	the time required to complete the integration;
•	the amount of longer-term cost savings; or
•	the overall performance of the combined entity.

Integration of an acquired business can be complex and costly, and may sometimes include combining relevant accounting, data processing and other record keeping systems and management controls, as well as managing relevant relationships with clients, suppliers and other business partners, as well as with employees.

There is no assurance that any businesses or portfolios acquired in the future will be successfully integrated and will result in all of the positive benefits anticipated. If HUSI is not able to successfully integrate acquisitions, there is the risk that its results of operations could be materially and adversely affected.

Risk Management

HUSI seeks to monitor and manage its risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems, including models and programs that predict loan delinquency and loss. While HUSI employs a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every unfavorable event or the specifics and timing of every outcome. Accordingly, HUSI’s ability to successfully identify and balance risks and rewards, and to manage all significant risks, is an important factor that can significantly impact results of operations.

Employee Attraction and Retention

HUSI’s employees are its most important resource and, in many areas of the financial services industry, competition for qualified personnel is intense. If HUSI were unable to continue to attract and retain qualified employees to support the various functions of its business, HUSI’s performance, including its competitive position, could be materially and adversely affected.

Reputational Risk

HUSI’s ability to attract and retain customers and conduct business transactions with its counterparties could be adversely affected to the extent that its reputation, or the reputation of affiliates operating under the HSBC brand, are damaged. Failure to address, or appearing to fail to address, various issues that could give rise to reputational risk could cause harm to HUSI and its business prospects. Reputational issues include, but are not limited to:


•	appropriately addressing potential conflicts of interest, legal and regulatory requirements;
•	ethical issues;
•	adequacy of anti-money laundering processes;
•	privacy issues;
•	record-keeping;
•	sales and trading practices;
•	proper identification of the legal, reputational, credit, liquidity and market risks inherent in products offered; and
•	general company performance.

The failure to address these issues appropriately could make customers unwilling to do business with HUSI, which could adversely affect its results of operations.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The principal executive offices of HUSI are located at 452 Fifth Avenue, New York, New York 10018, which is owned by HBUS. The main office of HBUS is located at 1105 N. Market Street, Wilmington, Delaware 19801. The principal executive offices of HBUS are located at One HSBC Center, Buffalo, New York 14203, in a building under a long-term lease. HBUS has more than 385 other banking offices in New York State located in 44 counties, twenty-three branches in California, seventeen branches each in Florida and New Jersey, two branches in Pennsylvania and one branch each in Oregon, Washington State, Delaware and Washington D.C. Approximately 29% of these offices are located in buildings owned by HBUS and the remaining are located in leased quarters. In addition, there are branch offices and locations for other activities occupied under various types of ownership and leaseholds in states other than New York, none of which are materially important to the respective activities. HBUS also owns properties in Montevideo, Uruguay and Punta del Este, Uruguay.

Item 3. Legal Proceedings

HUSI’s legal proceedings are summarized in Note 25 of the consolidated financial statements beginning on page 152 of this Form 10-K.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

P A R T II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

All 706 shares of HUSI’s outstanding stock are owned by HSBC North America Inc. (HNAI), an indirect subsidiary of HSBC. Consequently, there is no public market in HUSI’s common stock.

Item 6. Selected Financial Data


Year Ended December 31	2007			2006			2005			2004				2003

($ in millions)
*Income statement:*
Net interest income	$	3,398		$	3,081		$	3,063			$	2,741			$	2,510
(Provision) credit for credit losses		(1,522	)		(823	)		(674	)			17				(113	)
Total other revenues		1,847			2,563			1,911				1,319				1,154
Total operating expenses		(3,586	)		(3,255	)		(2,758	)			(2,101	)			(2,040	)
Income tax benefit (expense)		1			(530	)		(566	)			(718	)			(570	)

Net income	$	138		$	1,036		$	976			$	1,258			$	941

*Balances at year end:*
Loans, net of allowance	$	93,535		$	89,340		$	89,496			$	84,159			$	48,075
Total assets		188,373			164,817			151,584				141,050				95,562
Total tangible assets		185,633			162,054			148,845				138,310				92,736
Total deposits		116,228			102,146			90,292				79,981				63,955
Common shareholder’s equity		9,672			10,571			10,278				10,366				6,962
Tangible common shareholder’s equity		7,297			8,034			7,562				7,611				4,022
Total shareholders’ equity		11,237			12,261			11,594				10,866				7,462

*Selected financial ratios:*
Total shareholders’ equity to total assets		5.97	%		7.44	%		7.65	%			7.70	%			7.81	%
Tangible common shareholder’s equity to total tangible assets		3.93			4.96			5.08				5.50				4.34
Rate of return on average (1):
Total assets		.08			.64			.66				1.12				1.02
Total common shareholder’s equity		.37			9.03			8.78				16.35				13.06
Net interest margin to average (1):
Earning assets		2.36			2.26			2.49				3.00				3.39
Total assets		1.99			1.91			2.09				2.46				2.76
Average total shareholders’ equity to average total assets (1)		7.02			7.39			7.85				7.18				8.20
Efficiency ratio (2)		68.34			57.66			55.44				51.73				55.65


(1)	Selected financial ratios are defined in the Glossary of Terms beginning on page 91 of this Form 10-K.

(2)	Represents the ratio of total operating expenses, reduced by minority interest, to the sum of net interest income and other revenues.

Significant trends and transactions that impacted net income for 2007 and 2006 are summarized on pages 35-49 of this Form 10-K.


*Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations*

Executive Overview

Adverse conditions, particularly in the U.S. mortgage and credit markets, led to substantial declines in trading and other income and to increases in provisions for consumer assets during the second half of 2007. This resulted in income before income tax expense of $137 million for the year ended December 31, 2007, a decrease of 91% from 2006. Net income decreased 87% to $138 million in 2007 from 2006.

Revenues decreased significantly led by declines in trading revenues and negative valuation adjustments on assets held for sale as market disruptions resulted in significantly wider credit spreads and severely diminished liquidity. These market conditions translated into substantial write-downs in the carrying value of several asset classes, including sub-prime residential mortgage and leveraged commercial loans held for sale, credit derivative products, including derivative contracts with monoline insurance companies, and other derivative trading activities. Trading revenues also reflect the decrease in value of derivative trading instruments used to hedge an investment in Class B shares issued by MasterCard, Incorporated, the fair value of which has increased significantly but which cannot be recognized until the investment is sold. The decrease was partially offset by gains on sale of a portion of HUSI’s investment in certain Class B shares, increased fees from credit card receivable portfolios, payments and cash management revenues and increased trading revenue from the foreign exchange desk.

The provision for credit losses increased significantly in 2007, primarily due to growing delinquencies within the credit card portfolio, a refinement to credit card loss reserve methodology and higher average credit card receivable balances. Provisions related to home equity lines of credit have also increased due to a higher rate of delinquencies in the portfolio during 2007 as conditions in the housing markets deteriorated. In addition, provisions for credit losses on consumer assets were unusually low in 2006, due to the impact of bankruptcy legislation enacted in 2005, which resulted in accelerated consumer charge offs and higher provision expense during 2005.

Net interest income was $3,398 million for 2007, an increase of 10% over 2006. This increase primarily resulted from growth in the private label credit card portfolio, reduced amortization of the initial premium paid for the portfolio and a more refined income recognition methodology on promotional balances. In addition, retail and commercial business expansion initiatives, including continued focus on the Online Savings product, new branches, expansion of services and products to small business customers and increased payments and cash management activities led to growth in deposits and commercial loans. Income from short term investments also increased as excess liquidity was invested. These increases were partially offset by narrowing of interest rate spreads on core banking products primarily due to competitive pressures as customers migrated to higher yielding deposit products and lower interest income from residential mortgage loans due to the impact of balance sheet initiatives to reduce the portfolio.

Operating expenses were negatively impacted for 2007 by a $70 million litigation charge related to Visa (Refer to Note 25 of the consolidated financial statements beginning on page 152 of this Form 10-K for commentary regarding Visa litigation) but also reflect higher salaries, marketing and other direct expenses related to business expansion initiatives in the retail and commercial businesses, as well as higher technology and other costs to support the build-out of enhanced product and service platforms.

During the first quarter of 2007, after a thorough review of its deferred income taxes, HUSI increased the carrying value of its deferred tax asset, with a corresponding decrease in income tax expense. The remaining decrease in income tax expense was mainly due to a concentration of normal tax credits, an adjustment of the tax provision to reflect the actual tax return liabilities and a lowering of the effective rate due to a change in the sourcing of income.

Basis of Reporting

HUSI’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP).

International Financial Reporting Standards (IFRS)

Effective January 1, 2007, corporate goals of HUSI are based upon results reported under IFRS (a non-U.S. GAAP measure). Operating results for HUSI are now monitored and reviewed, trends are being evaluated, and decisions are being made about allocating certain resources on an IFRS basis. In addition, HSBC reports its results in accordance with IFRS and IFRS results are used by HSBC in measuring and rewarding performance of employees. The following table reconciles HUSI’s net income on a U.S. GAAP basis to net income on an IFRS basis.



Year Ended December 31	2007				2006						2005

(in millions)
Net income – U.S. GAAP basis			$	138				$	1,036					$	976
Adjustments, net of tax:
Unquoted equity securities		58				26						—
Fair value option		124				(49	)					18
Loan origination		15				—						(7	)
Loan impairment		3				(2	)					(11	)
Purchase accounting/deferred taxes		—				(21	)					—
Stock based compensation		—				(5	)					(17	)
Property		13				(1	)					(46	)
Pension costs		16				6						5
Other		19				(8	)					15

Total adjustments, net of tax				248					(54	)					(43	)

Net income – IFRS basis			$	386				$	982					$	933

Differences between U.S. GAAP and IFRS are as follows:

Unquoted equity securities

HUSI holds certain equity securities whose market price is not quoted on a recognized exchange, but for which the fair value can be reliably measured either through an active market, comparison to similar equity securities which are quoted, or by using discounted cash flow calculations.


IFRS

•	Under IAS 39, equity securities which are not quoted on a recognized exchange, but for which fair value can be reliably measured, are required to be measured at fair value. Accordingly, such securities are measured at fair value and classified as either available-for-sale securities, with changes in fair value recognized in other comprehensive income, or as trading securities, with changes in fair value recognized in income.

U.S. GAAP

•	Under SFAS 115, equity securities that are not quoted on a recognized exchange are not considered to have a readily determinable fair value and are required to be measured at cost, less any provisions for impairment. Unquoted equity securities are reported within “Other assets”.

Impact

•	Changes in fair values of equity securities for which IFRS requires recognition of the change and U.S. GAAP requires the securities to be held at cost, impact net income when the security is classified as trading under IFRS and impact shareholders’ equity when the security is classified as available-for-sale under IFRS.

Fair value option


IFRS

•	Under IAS 39, a financial instrument, other than one held for trading, is classified in this category if it meets the criteria set out below, and is so designated by management. An entity may designate financial instruments at fair value where the designation:

	-	eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring financial assets or financial liabilities or recognizing the gains and losses on them on different bases; or

	-	applies to a group of financial assets, financial liabilities or both that is managed and its performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and where information about that group of financial instruments is provided internally on that basis to management; or

	-	relates to financial instruments containing one or more embedded derivatives that significantly modify the cash flows resulting from those financial instruments.

•	Financial assets and financial liabilities so designated are recognized initially at fair value, with transaction costs taken directly to the income statement, and are subsequently remeasured at fair value. This designation, once made, is irrevocable in respect of the financial instruments to which it is made. Financial assets and financial liabilities are recognized using trade date accounting.

•	Gains and losses from changes in the fair value of such assets and liabilities are recognized in the income statement as they arise, together with related interest income and expense and dividends.

U.S. GAAP

•	Generally, for financial assets to be measured at fair value with gains and losses recognized immediately in the income statement, they must meet the definition of trading securities in SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. Financial liabilities are generally reported at amortized cost under U.S. GAAP.

•	Since January 1, 2006, HUSI has accounted for hybrid financial instruments under the provisions of SFAS 155, Accounting for Certain Hybrid Financial Instruments. Hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation are, where designated through an irrevocable election, initially and subsequently measured at fair value, with changes in fair value recognized through net income.

Impact

•	HUSI has principally used the fair value designation for certain fixed rate long-term debt issues whose interest rate characteristic has been changed to floating through interest rate swaps as part of a documented interest rate management strategy. Approximately $2 billion of HUSI’s debt issues have been accounted for using the option. The movement in fair value of these debt issues includes the effect of changes in the credit spread and any ineffectiveness in the economic relationship between the related swaps and this debt. Such ineffectiveness arises from the different credit characteristics of the swap and the debt coupled with the sensitivity of the floating leg of the swap to changes in short-term interest rates. In addition, the economic relationship between the swap and the debt can be affected by relative movements in market factors, such as bond and swap rates, and the relative bond and swap rates at inception. The size and direction of the accounting consequences of changes in credit spread and ineffectiveness can be volatile from period to period, but do not alter the cash flows anticipated as part of the documented interest rate management strategy.

•	Under U.S. GAAP, debt issues are generally reported at amortized cost. There are circumstances, by virtue of different technical requirements and the transition arrangements to IFRS, where derivatives providing an economic hedge for an asset or liability, and so designated under IFRS, are not so treated under U.S. GAAP, thereby creating a reconciliation difference and asymmetrical accounting between the asset and liability and the offsetting derivative.

Loan origination


IFRS

•	Certain loan fee income and incremental directly attributable loan origination costs are amortized to the income statement over the life of the loan as part of the effective interest calculation under IAS 39.

U.S. GAAP

•	Certain loan fee income and direct loan origination costs, including an apportionment of overheads, are amortized to the income statement over the life of the loan as an adjustment to interest income (SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”).

Impact

•	During the year ended 2007, the net costs amortized against earnings under U.S. GAAP exceeded net costs amortized under IFRS.

*Loan impairment*

IFRS

•	When statistical models, using historic loss rates adjusted for economic conditions, provide evidence of impairment in portfolios of loans, their values are written down to their net recoverable amount. The net recoverable amount is the present value of the estimated future recoveries discounted at the portfolio’s original effective interest rate. The calculations include a reasonable estimate of recoveries on loans individually identified for write-off pursuant to HUSI’s credit guidelines.

U.S. GAAP

•	When the delinquency status of loans in a portfolio is such that there is no realistic prospect of recovery, the loans are written off in full, or to recoverable value where collateral exists. Delinquency depends on the number of days payment is overdue. The delinquency status is applied consistently across similar loan products in accordance with HUSI’s credit guidelines. When local regulators mandate the delinquency status at which write-off must occur for different retail loan products and these regulations reasonably reflect estimated recoveries on individual loans, this basis of measuring loan impairment is reflected in U.S. GAAP accounting. Cash recoveries relating to pools of such written-off loans, if any, are reported as loan recoveries upon collection.

Impact

•	Under both IFRS and U.S. GAAP, HUSI’s policy and regulatory instructions mandate that individual loans evidencing adverse credit characteristics which indicate no reasonable likelihood of recovery are written off. When, on a portfolio basis, cash flows can reasonably be estimated in aggregate from these written-off loans, an asset equal to the present value of the future cash flows is recognized under IFRS.

•	No asset for future recoveries arising from written-off assets was recognized in the balance sheet under IFRS prior to January 1, 2005.

•	The establishment of the recovery asset under IFRS associated with the private label credit card portfolio purchased from HSBC Finance Corporation results in higher earnings under IFRS than under U.S. GAAP in the initial period and higher earnings under U.S. GAAP when subsequent recoveries are made.

•	Net interest income is higher under IFRS than under U.S. GAAP due to the imputed interest on the recovery asset.

Purchase accounting/deferred taxes


IFRS

•	Deferred tax amounts are recorded in the consolidated balance sheets to recognize differences between the tax bases and the cost of assets and liabilities recorded pursuant to an acquisition. Subsequent changes to the estimates of the tax bases are recorded as an adjustment of current period earnings.

U.S. GAAP

•	Changes in tax estimates of the basis in assets and liabilities or other tax estimates recorded at the date of acquisition are adjusted against goodwill.

Impact

•	In 2006, a deferred tax asset related to a previous acquisition was adjusted against the related goodwill account for U.S. GAAP reporting. Under IFRS, this adjustment was charged to earnings.

*Stock-based compensation*

IFRS

•	IFRS 2, Share-Based Payment, requires that when annual bonuses are paid in restricted shares and the employee must remain with HSBC for a fixed period in order to receive the shares, the award is expensed over that period.

U.S. GAAP

•	For awards made before July 1, 2005, SFAS 123, Accounting for Stock Based Compensation requires that compensation cost be recognized over the period(s) in which the related employee services are rendered. HUSI has interpreted this service period as the period to which the bonus relates.

•	For 2005 bonuses, awarded in early 2006, HSBC followed SFAS 123 (revised 2004), Share-Based Payment (SFAS 123R). SFAS 123R is consistent with IFRS 2 in requiring that restricted bonuses are expensed over the period the employee must remain with HSBC. However, SFAS 123R only applies to awards made after the date of adoption, which for HUSI is July 1, 2005.

Impact

•	Some of the bonuses awarded in respect of 2002, 2003 and 2004 were recognized over the relevant vesting period and were, therefore, expensed in net income under IFRS during 2005. Under U.S. GAAP, these awards were expensed in the years for which they were granted. 2005 bonuses will be expensed over the vesting period under both IFRS and U.S. GAAP. Net income was, therefore, higher under U.S. GAAP in 2005.

•	IFRS and U.S. GAAP are now largely aligned and this transition difference has now been eliminated.

Property


IFRS

•	Under the transition rules of IFRS 1, HSBC has elected to freeze the value of its properties at their January 1, 2004 valuations. These are the “deemed cost” of properties under IFRS. They will not be revalued in the future. Assets held at historical or deemed cost are depreciated except for freehold land.

•	Investment properties are recognized at current market values with gains or losses recognized in net income for the period. Investment properties are not depreciated.

U.S. GAAP

•	U.S. GAAP does not permit revaluations of property, including investment property, although it requires recognition of asset impairment. Any realized surplus or deficit is, therefore, reflected in net income on disposal of the property. Depreciation is charged on all properties based on cost.

Impact

•	Under IFRS, the value of property held for own use reflects revaluation surpluses recorded prior to January 1, 2004. Consequently, the values of tangible fixed assets and shareholders’ equity are lower under U.S. GAAP than under IFRS.

•	There is a correspondingly lower depreciation charge and higher net income as well as higher gains (or smaller losses) on the disposal of fixed assets under U.S. GAAP.

•	For investment properties, net income under U.S. GAAP does not reflect the unrealized gain or loss recorded under IFRS for the period.

*Pension costs*

IFRS

•	In accordance with IAS 19 (revised 2006), HSBC has elected to record all actuarial gains and losses on the pension surplus or deficit in the year in which they occur within the ‘Consolidated statement of recognized income and expense’.

U.S. GAAP

•	SFAS 87 does not permit recognition of all actuarial gains and losses in a statement other than the primary income statement. As permitted by U.S. GAAP, HSBC uses the ‘corridor method’, whereby actuarial gains and losses outside a certain range are recognized in the income statement in equal amounts over the remaining service lives of current employees. That range is 10 per cent of the greater of plan assets and plan liabilities. The remaining additional minimum pension liability and the transition to SFAS 158 are recognized directly in Other comprehensive income (OCI).

Impact

•	Net income under US GAAP is lower than under IFRS as a result of the amortization of the amount by which actuarial losses exceed gains beyond the 10 per cent ‘corridor’.

*Other*

In 2007, other includes the net impact of certain adjustments which represent a temporary difference between U.S. GAAP and IFRS. These adjustments were not individually material for the years ended 2007, 2006 and 2005.

Critical Accounting Policies

HUSI’s consolidated financial statements are prepared in accordance with U.S. GAAP. The significant accounting policies used in the preparation of HUSI’s consolidated financial statements are more fully described in Note 2 to the accompanying consolidated financial statements beginning on page 103 of this Form 10-K.

Many of HUSI’s significant accounting policies require complex judgments to estimate values of assets and liabilities. In making these judgments, management must make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Because changes in such estimates and assumptions could significantly affect HUSI’s reported financial position or results of operations, detailed policies and control procedures have been established to ensure that valuation methods, including judgments made as part of such methods, are well controlled, independently reviewed, and applied consistently from period to period.

Of the significant accounting policies used in the preparation of HUSI’s consolidated financial statements, the items discussed below require critical accounting estimates involving a high degree of judgment and complexity.

Allowance for Credit Losses

HUSI lends money to others, resulting in risk that borrowers may not repay amounts owed when they become contractually due. Consequently, an allowance for credit losses is maintained at a level that is considered appropriate to cover estimates of probable losses of principal, interest and fees in the existing portfolio. Allowance estimates are reviewed periodically, and adjustments are reflected through the provision for credit losses in the period when they become known. The accounting estimate relating to the allowance for credit losses is a “critical accounting estimate” for the following reasons:


•	changes in such estimates could significantly impact HUSI’s credit loss reserves and provision for credit losses;

•	estimates related to the reserve for credit losses require consideration of future delinquency and charge off trends, which are uncertain and require a high degree of judgment; and

•	the allowance for credit losses is influenced by factors outside of HUSI’s control. Customer payment patterns, economic conditions, bankruptcy trends and changes in laws and regulations all have an impact on the estimates.

HUSI’s allowance for credit losses is regularly assessed for adequacy through a detailed review of the loan portfolio. The allowance is comprised of two balance sheet components:

•	the allowance for credit losses, which is carried as a reduction to loans on the balance sheet, includes reserves for anticipated losses associated with all loans and leases outstanding; and

•	the reserve for off-balance sheet risk, which is recorded in other liabilities, includes probable and reasonably estimable losses arising from off-balance sheet arrangements such as letters of credit and undrawn commitments to lend.

Both types of reserves include amounts calculated for specific individual loan balances and for collective loan portfolios depending on the nature of the exposure and the manner in which risks inherent in that exposure are managed.


•	All commercial loans that exceed five hundred thousand dollars are evaluated individually for impairment. When a loan is found to be “impaired”, a specific reserve is calculated. Reserves against impaired loans are determined primarily by an analysis of discounted expected cash flows expected by HUSI with reference to independent valuations of underlying loan collateral and also considering secondary market prices for distressed debt where appropriate.

•	Loans which are not individually evaluated for impairment are pooled into homogeneous categories of loans and evaluated to determine if it is deemed probable, based on historical data, that a loss has been realized even though it has not yet been manifested in a specific loan.

For consumer receivables and certain small business revolving loans, HUSI uses a roll rate methodology (statistical analysis of historical trends used to estimate the probability of continued delinquency, ultimate charge off, and amount of consequential loss assessed at each time period for which payments are overdue) to support the estimation of inherent losses. The results of these models are reviewed by management in conjunction with changes in risk selection, changes in underwriting policies, national and local economic trends, trends in bankruptcy, loss severity and recoveries, and months of loss coverage. The resulting loss coverage ratio varies by portfolio based on inherent risk and, where applicable, regulatory guidance. Roll rates are regularly updated and benchmarked against actual outcomes to ensure that they remain appropriate.

An advanced credit risk methodology is utilized to support the estimation of losses inherent in pools of homogeneous commercial loans, leases and off-balance sheet risk. This methodology uses the probability of default from the customer rating assigned to each counterparty, the “Loss Given Default” rating assigned to each transaction or facility based on the collateral securing the transaction, and the measure of exposure based on the transaction. A suite of models, tools and templates is maintained using quantitative and statistical techniques, which are combined with expert judgment to support the assessment of each transaction. These were developed using internal data and supplemented with data from external sources which was judged to be consistent with HUSI’s internal credit standards. These advanced measures are applied to the homogeneous credit pools to estimate the reserves required.

The results from the advanced commercial analysis, consumer roll rate analysis and the specific/impairment reserving process are reviewed each quarter by a Credit Reserve Committee co-chaired by the Chief Financial Officer and Chief Credit Officer. This committee also considers other observable factors, both internal to HUSI and external in the general economy, to ensure that the estimates provided by the various models adequately include all known information at each reporting period. The Credit Reserve Committee may add to or reduce a general unallocated allowance to account for any observable factor not considered in the various models, for small portfolios or period ending manual entries not considered in a model and to recognize modeling imperfections. The credit reserves and the results of the Credit Reserve Committee are reviewed with HUSI’s Credit Risk Management Committee and the Board of Directors’ Audit Committee each quarter.

HUSI recognizes however, that there is a high degree of subjectivity and imprecision inherent in the process of estimating losses utilizing historical data. Accordingly, a discretionary component of the allowance for credit losses for unspecified potential losses inherent in the loan portfolios is provided based upon an evaluation of certain portfolio risk factors which, for consumer loans, may not be reflected in the statistical roll rate analysis. Critical factors include the impact of the national economic cycle, migration of loans within non-criticized loan portfolios, and loan portfolio concentration.

Additional credit quality related analysis begins on page 59 of this Form 10-K. HUSI’s approach toward credit risk management begins on page 77 of this Form 10-K.

Goodwill Impairment

Goodwill is not subject to amortization but is tested for possible impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of each reporting unit be compared to its carrying amount, including the goodwill. Significant and long-term changes in industry and economic conditions are considered to be primary indicators of potential impairment.

Impairment testing of goodwill is a “critical accounting estimate” due to the significant judgment required in the use of discounted cash flow models to determine fair value. Discounted cash flow models include such variables as revenue growth rates, expense trends, interest rates and terminal values. Based on an evaluation of key data and market factors, management’s judgment is required to select the specific variables to be incorporated into the models. Additionally, the estimated fair value can be significantly impacted by the cost of capital used to discount future cash flows. The cost of capital percentage is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of management’s judgment. When management’s judgment is that the anticipated cash flows have decreased and/or the cost of capital has increased, the effect will be a lower estimate of fair value. If the fair value is determined to be lower than the carrying value, an impairment charge will be recorded and net income will be negatively impacted.

Reporting units were identified based upon an analysis of each of HUSI’s individual operating segments. A reporting unit is defined as any distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews. Goodwill was allocated to the carrying value of each reporting unit based on its relative fair value. Refer to Note 24 beginning on page 147 of this Form 10-K for an allocation of recorded book value of goodwill by segment.

HUSI has established July 1 of each year as the date for conducting its annual goodwill impairment assessment. At July 1, 2007, there were no individual reporting units with a fair value less than carrying value, including goodwill. The fair value calculations were also tested for sensitivity to reflect reasonable variations, including stress testing of certain attributes such as cost saves, terminal values and the discount rate. Results of these tests were taken into consideration by management during the review of the annual goodwill impairment test.

As a result of a difficult business climate and the market volatility which occurred during the second half of 2007, HUSI performed an interim goodwill test in the Global Banking and Markets business segment, formerly Corporate, Investment Banking and Markets (CIBM), as of December 31, 2007. The results of this test showed the fair value of this business unit exceeded the carrying value including goodwill that was assigned. Based on these results, HUSI determined goodwill was not impaired in this business segment at December 31, 2007.

Fair Value of Financial Instruments and MSRs

A substantial portion of HUSI’s assets and liabilities are carried at fair value. These include trading assets and liabilities, including derivatives and commodities held for trading, derivatives used for hedging, securities available for sale, and mortgage servicing rights (MSRs). Loans held for sale, which are carried at the lower of amortized cost or fair value, are also reported at fair value when their amortized cost exceeds their current fair value.

Fair value is defined as the amount at which an asset or liability could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The fair value of a significant majority of HUSI’s assets and liabilities that are reported at fair value is based on quoted market prices or on internally developed valuation models that utilize observable market parameters, including interest rate yield curves, volatilities, option adjusted spreads, and currency rates.

For certain assets and liabilities, however, quoted market prices and observable market parameters are not available. For these items, fair value is estimated using internally-developed valuation models that require the use of significant management judgment to estimate certain required valuation parameters. The following is a description of the significant estimates used in the valuation of assets and liabilities for which quoted market prices and observable market parameters are not available.

Derivatives — Fair value estimates for the majority of HUSI’s derivative instruments are based on quoted market prices or on internally developed models that utilize independently sourced market parameters, including interest rate yield curves, option volatilities, and currency rates. Where such market data is not available, derivative instruments are valued using discounted cash flow modeling techniques that require the company to estimate the amount and timing of future cash flows. These estimates are susceptible to significant change in future periods as market conditions change.

The company may adjust certain values derived using the methods described above in order to ensure that those values represent appropriate estimates of fair value. These adjustments, which are applied consistently over time, are generally required to reflect factors, such as liquidity and concentration concerns and counterparty credit risk, that can affect prices in arms-length transactions with unrelated third parties. Finally, other factors such as model assumptions, market dislocations and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.

Derivatives designated as qualified hedges are tested for effectiveness. For these transactions, assessments are made at the inception of the hedge and on a recurring basis, whether the derivative used in the hedging transaction has been and is expected to continue to be highly effective in offsetting changes in fair values or cash flows of the hedged item. This assessment is conducted using statistical regression analysis.

If it is determined as a result of this assessment that a derivative is not expected to be a highly effective hedge or that it has ceased to be a highly effective hedge, hedge accounting is discontinued as of the quarter in which such determination was made. The assessment of the effectiveness of the derivatives used in hedging transactions is considered to be a “critical accounting estimate” due to the use of statistical regression analysis in making this determination. Similar to discounted cash flow modeling techniques, statistical regression analysis also requires the use of estimates regarding the amount and timing of future cash flows, which are susceptible to significant changes in future periods based on changes in market rates. Statistical regression analysis also involves the use of additional assumptions including the determination of the period over which the analysis should occur as well as selecting a convention for the treatment of credit spreads in the analysis.

The outcome of the statistical regression analysis serves as the foundation for determining whether or not the derivative is highly effective as a hedging instrument. This can result in earnings volatility as the mark to market on derivatives which do not qualify as effective hedges and the ineffectiveness associated with qualifying hedges are recorded in current period earnings.

Loans held for sale — Loans held for sale are carried at the lower of amortized cost or fair value. Accordingly, fair value for such loans must be estimated to determine any required write down to fair value when the amortized cost of the loans exceeds their current fair value. Loans held for sale include residential mortgage loans and commercial loans that have been originated by HUSI or purchased from third parties. Where quoted market prices and observable market parameters are not available, the fair value of loans held for sale is based on contractual cash flows adjusted for management’s estimates of prepayments, defaults, and recoveries, discounted at management’s estimate of the rate that would be required by investors in the current market given the specific loan characteristics and inherent credit risk.

Loans held for sale include certain mortgage loans, primarily subprime residential mortgage loans purchased from third parties, held for sale to an HSBC affiliate that subsequently securitizes them. Historically, the fair value of these loans has been estimated using parameters derived from the current pricing of securities backed by loans with similar characteristics. During 2007, however, the markets for securities backed by residential mortgages, and sub-prime residential mortgages in particular, became very illiquid. As a result, management judgment has been required to estimate a number of parameters that are no longer observable in the marketplace, including rates for prepayments, defaults, recoveries and discount rates that would be required by investors under current market conditions given the specific loan characteristics and perceived credit risk. The valuation of these loans reflects significant write downs from their amortized cost as a result of management’s views regarding these valuation parameters.

Loans held for sale also includes certain leveraged lending loans. Where available, quoted market prices are used to estimate the fair value of these loans. Where market quotes are not available, fair value is estimated using observable market prices of similar instruments, including bonds, credit derivatives, and loans with similar characteristics. During 2007, the commercial credit markets experienced a contraction that resulted in a significant decrease in the availability of observable market data for leveraged loans and similar instruments. As a result, the level of management judgment required to estimate fair value for these loans has increased. The lack of liquidity in the commercial credit markets has resulted in significant decreases in the valuation of these loans from their funded amounts, which reflects the impact of the view management takes with regard to various valuation assumptions in light of current market conditions.

Mortgage servicing rights — HUSI recognizes the right to service mortgage loans as a separate and distinct asset at the time the loans are sold. Upon adoption of Statement of Financial Accounting Standards No. 156, Accounting for Servicing of Financial Assets, (SFAS 156) on January 1, 2006, HUSI elected to measure its existing MSRs at fair value. As a result, MSRs are initially measured at fair value at the time that the related loans are sold and periodically re-measured using the fair value measurement method. This method requires that MSRs be measured at fair value at each reporting date with changes in fair value reflected in income in the period that the changes occur.

MSRs are subject to interest rate risk, in that their fair value will fluctuate as a result of changes in the interest rate environment. Fair value is determined based upon the application of valuation models and other inputs. The valuation models incorporate assumptions market participants would use in estimating future cash flows. These assumptions include expected prepayments, default rates and market based option adjusted spreads. The estimate of fair value is considered to be a “critical accounting estimate” because the assumptions used in the valuation models involve a high degree of subjectivity that is dependent upon future interest rate movements. The reasonableness of these pricing models is periodically validated by reference to external independent broker valuations and industry surveys.

Because the fair value of certain assets and liabilities are significantly impacted by the use of estimates, the use of different estimates can result in changes in the estimated fair value of those assets and liabilities, which can result in equity and earnings volatility as follows:


•	changes in the fair value of trading assets and liabilities are recorded in current period earnings;

•	changes in the fair value of securities available for sale are recorded in other comprehensive income;

•	changes in the fair value of loans held for sale below their amortized cost are recorded in current period earnings;

•	changes in the fair value of a derivative that has been designated and qualifies as a fair value hedge, along with the changes in the fair value of the hedged asset or liability (including losses or gains on firm commitments), are recorded in current period earnings;

•	changes in the fair value of a derivative that has been designated and qualifies as a cash flow hedge are recorded in other comprehensive income to the extent of its effectiveness, until earnings are impacted by the variability of cash flows from the hedged item; and

•	changes in the fair value of MSRs are reported in current period earnings.

Balance Sheet Review

Overview

HUSI utilizes deposits and borrowings from various sources to provide additional liquidity, to fund balance sheet growth, to meet cash and capital needs, and to fund investments in subsidiaries. During 2007, balance sheet growth was driven by HUSI’s deposit growth strategy. Funds generated from new deposits were generally invested in short-term liquid assets. Balance sheet growth and funding sources are summarized in the following table.



				Increase (Decrease) from

	December 31, 2007			December 31, 2006						December 31, 2005

				Amount			%			Amount			%

($ in millions)
Period end assets:
Short-term investments (1)		$	22,862	$	3,807			20		$	11,602			103
Loans, net			93,535		4,195			5			4,039			5
Trading assets			37,036		13,406			57			17,340			88
Securities			22,853		98			—			1,918			9
Other assets			12,087		2,050			20			1,890			19

		$	188,373	$	23,556			14		$	36,789			24

Funding sources:
Total deposits		$	116,228	$	14,082			14		$	25,936			29
Trading liabilities			16,253		3,939			32			6,294			63
Short-term borrowings			11,832		6,759			133			5,465			86
All other liabilities			4,555		784			21			778			21
Long-term debt			28,268		(984	)		(3	)		(1,327	)		(4	)
Shareholders’ equity			11,237		(1,024	)		(8	)		(357	)		(3	)

		$	188,373	$	23,556			14		$	36,789			24


(1)	Includes cash and due from banks, interest bearing deposits with banks and Federal funds sold and securities purchased under resale agreements.

Short-Term Investments

Short-term investments include cash and due from banks, interest bearing deposits with banks, Federal funds sold and securities purchased under resale agreements. The funds raised from HUSI’s deposit growth strategy during 2007 and 2006 were primarily invested in short-term liquid assets (refer to page 9 of this Form 10-K).

Loans, Net

Loan balances, which include loans held for sale, at December 31, 2007 and movements in comparison with prior years are summarized in the following table.



						Increase (Decrease) from

				December 31, 2006							December 31, 2005

	December 31, 2007			Amount				%			Amount			%

($ in millions)
Total commercial loans		$	37,923		$	8,441			29		$	10,205			37


Consumer loans:
Residential mortgages			35,380			(4,428	)		(11	)		(8,606	)		(20	)
Credit card receivables:
Private label			17,427			454			3			3,072			21
MasterCard/Visa			1,988			701			54			829			72
Other consumer			2,231			(456	)		(17	)		(893	)		(29	)

Total consumer loans			57,026			(3,729	)		(6	)		(5,598	)		(9	)

Total loans			94,949			4,712			5			4,607			5
Allowance for credit losses			1,414			517			58			568			67

Loans, net		$	93,535		$	4,195			5		$	4,039			5

Increased commercial loan balances in 2007 and 2006 were partly due to expansion of middle market activities and, in 2007, were also due to an increase in the draw-downs of previously unfunded commitments. Additionally, HUSI originates commercial loans in connection with its participation in a number of leveraged acquisition finance syndicates. A majority of these loans are originated with the intent of selling them to third parties.

Beginning in 2005, as a result of balance sheet initiatives to reduce prepayment risk and improve HBUS’s structural liquidity, HUSI decided to sell a majority of its residential loan originations through the secondary markets and allow the existing loan portfolio to run off, resulting in reductions in loan balances throughout 2007 and 2006.

The addition of new merchant and customer relationships to the private label and MasterCard/Visa credit card portfolios, higher average receivable balances, and decreased balance requirements of off-balance sheet securitized receivable trusts (refer to page 124 of this Form 10-K) have resulted in higher on-balance sheet credit card receivable balances for 2007 and 2006.

Commercial Loan Maturities and Sensitivity to Changes in Interest Rates

The contractual maturity and interest sensitivity of total commercial loans at December 31, 2007 is summarized in the following table.

December 31, 2007

One
Year
or Less

Over One
Through
Five Years

Over
Five
Years

Total
Loans

(in millions)

Commercial:

Construction and other real estate

4,002

3,533

919

8,454

Other commercial

17,412

8,474

3,583

29,469

Total

21,414

12,007

4,502

37,923

Loans with fixed interest rates

7,787

2,037

791

10,615

Loans having variable interest rates

13,627

9,970

3,711

27,308

Total

21,414

12,007

4,502

37,923

Trading Assets and Liabilities

Trading assets and liabilities balances at December 31, 2007, and movements in comparison with prior years, are summarized in the following table.



				Increase (Decrease) from

	December 31, 2007			December 31, 2006						December 31, 2005

				Amount			%			Amount			%

($ in millions)
Trading assets:
Securities (1)		$	13,537	$	1,613			14		$	2,758			26
Precious metals			8,788		6,072			224			6,502			284
Derivatives			14,711		5,721			64			8,080			122

		$	37,036	$	13,406			57		$	17,340			88

Trading liabilities:
Securities sold, not yet purchased		$	1,444	$	(470	)		(25	)	$	(364	)		(20	)
Payables for precious metals			1,523		187			14			362			31
Derivatives			13,286		4,222			47			6,296			90

		$	16,253	$	3,939			32		$	6,294			63


(1)	Includes U.S. Treasury, U.S. Government agency, U.S. Government sponsored enterprises, asset-backed, corporate bonds and other securities.

Increase in securities balances in 2007 and 2006 was attributable to higher volumes of activity in the Global Banking and Markets business segment. Also contributing to the increase in 2007 were purchases of emerging market securities as part of the continued development of our emerging-market franchise.

Higher precious metals balances were due to higher levels of trading activity, and to generally higher market prices for various metals, specifically gold and platinum.

Higher derivative balances resulted from increased fair values on various derivative products including credit default swaps, foreign currency forward contracts and equity swaps as a result of increasing credit spreads, increased trading volumes and volatility of foreign exchange rates and equity prices during 2007.

Deposits

The following table summarizes balances for major depositor categories.



December 31		2007		2006		2005		2004		2003

(in millions)
Individuals	$	47,751	$	43,266	$	33,394	$	30,882	$	30,691
Partnerships and corporations		43,718		39,538		42,503		34,430		23,268
Domestic and foreign banks		19,748		16,243		11,889		12,759		7,580

U.S. Government and states and political subdivisions		2,461		1,927		1,566		1,493		1,464
Foreign governments and official institutions		2,550		1,172		940		417		952

Total deposits	$	116,228	$	102,146	$	90,292	$	79,981	$	63,955


Total core deposits (1)	$	65,079	$	57,518	$	44,882	$	39,291	$	37,840


(1)	HUSI monitors “core deposits” as a key measure for assessing results of its core banking network. Core deposits generally include all domestic demand, money market and other savings accounts, as well as time deposits with balances not exceeding $100,000.

Deposits were the primary source of funding for balance sheet growth during 2007 and 2006. Total deposits increased 14% and 13% in 2007 and 2006, respectively. For additional commentary regarding deposit growth and strategy, refer to page 9 of this Form 10-K.

Short-Term Borrowings

Higher short-term borrowings for 2007 was a result of an increase in federal funds purchased and an increase in precious metals borrowings in response to favorable precious metals market conditions in comparison with the years ended 2006 and 2005.

Long-Term Debt

Incremental borrowings from the $40 billion Global Bank Note Program were $1.4 billion and $1.6 billion for 2007 and 2006, respectively. Total borrowings outstanding under this program were $10 billion at December 31, 2007. Additional information regarding this program and other long-term debt is presented in Note 15 of the consolidated financial statements, beginning on page 128 of this Form 10-K.

HUSI had borrowings from the Federal Home Loan Bank (FHLB) of $5.5 billion and $5.0 billion at December 31, 2007 and 2006, respectively, and had access to a potential secured borrowing facility as a member of the FHLB.

Beginning in 2005, HUSI entered into a series of transactions with Variable Interest Entities (VIEs) organized by HSBC affiliates and unrelated third parties. HUSI has determined that it is the primary beneficiary of these VIEs under the applicable accounting literature and, accordingly, consolidated the assets and debt of the VIEs. Debt obligations of the VIEs totaling $2.5 billion were recorded in long-term debt at December 31, 2007 and 2006. Refer to Note 27 of the consolidated financial statements, beginning on page 155 of this Form 10-K, for additional information regarding HUSI’s VIE arrangements.

Preferred Stock

In November 2007, HUSI redeemed all issued shares of Dutch Auction Rate Transferable Securities™ Preferred Stock (DARTS), Series A and B at their stated value of $100,000 per share, resulting in a total cash payment of $125 million.

In May 2006, HUSI issued 14,950,000 depositary shares, each representing one-fortieth of a share of 6.50% Non-Cumulative Preferred Stock, Series H ($1,000 stated value). Total issue proceeds, net of $9 million of underwriting fees and other expenses, were $365 million. When and if declared by HUSI’s Board of Directors, dividends of 6.50% per annum on the stated value per share will be payable quarterly on the first calendar day of January, April, July and October of each year.

Refer to Note 18 of the consolidated financial statements, beginning on page 135 of this Form 10-K, for information regarding all outstanding preferred share issues.

Capital Resources

A summary of changes in common shareholder’s equity is presented in the following table.



		2007			2006			2005

(in millions)
Balance, January 1	$	10,571		$	10,278		$	10,366
Increase (decrease) due to:
Net income		138			1,036			976
Dividends paid to common shareholder		(800	)		(455	)		(675	)
Dividends paid to preferred shareholders		(98	)		(88	)		(46	)
Change in other comprehensive income		(138	)		(202	)		(43	)
Capital contributions from parent (1)		4			15			3
Reductions of capital surplus		(5	)		(9	)		(303	)
Other		—			(4	)		—

Total net increase (decrease)		(899	)		293			(88	)

Balance, December 31	$	9,672		$	10,571		$	10,278


(1)	Capital contributions from parent include amounts related to an HSBC stock option plan in which almost all of HUSI’s employees are eligible to participate.

HUSI maintains rolling 12 month capital forecasts on a consolidated basis, and for its banking subsidiaries. Target capital ratios approved by the board of directors are set above levels established by regulators as “well capitalized”, and are partly based on a review of peer banks. Dividends are generally paid by HUSI to its parent company, HSBC North America, Inc. (HNAI), when available capital exceeds target levels.

Effective January 1, 2005, the separate U.S. defined benefit pension plans were merged into a single defined benefit pension plan which facilitates the development of a unified employee benefit policy and unified employee benefit plan administration for HSBC affiliates operating in the U.S. As a result, HUSI’s prepaid pension asset of $482 million and a related deferred tax liability of $203 million were transferred to HNAH. The net transfer amount of $279 million was recorded as a reduction of capital surplus.

HUSI and HBUS are required to meet minimum capital requirements by their principal regulators. Risk-based capital amounts and ratios are presented in Note 19 of the consolidated financial statements, beginning on page 137 of this Form 10-K.

Results of Operations

Net Interest Income

Net interest income is the total interest income on earning assets less the total interest expense on deposits and borrowed funds. In the discussion that follows, interest income and rates are presented and analyzed on a taxable equivalent basis to permit comparisons of yields on tax-exempt and taxable assets. An analysis of consolidated average balances and interest rates on a taxable equivalent basis is presented on pages 94-95 of this Form 10-K.

The following table presents changes in the components of net interest income according to “volume” and “rate”.



			2007 Compared to 2006									2006 Compared to 2005
			Increase (Decrease)									Increase (Decrease)
Year Ended December 31	2007			Volume			Rate			2006		Volume			Rate			2005

(in millions)
Interest income:
Interest bearing deposits with banks	$	309		$	91		$	(7	)	$	225	$	13		$	92		$	120
Federal funds sold and securities
purchased under resale agreements		610			70			14			526		220			116			190
Trading assets		633			20			195			418		140			3			275
Securities		1,221			51			25			1,145		158			88			899
Loans:
Commercial		2,017			213			40			1,764		217			314			1,233
Consumer:
Residential mortgages		2,042			(223	)		54			2,211		(271	)		161			2,321
Credit cards		1,764			170			265			1,329		172			345			812
Other consumer		249			(47	)		28			268		(17	)		21			264

Total consumer		4,055			(100	)		347			3,808		(116	)		527			3,397
Other interest		221			134			(4	)		91		53			6			32

Total interest income		9,066			479			610			7,977		685			1,146			6,146

Interest expense:
Deposits in domestic offices:
Savings deposits		1,376			253			142			981		150			513			318
Other time deposits		1,267			(74	)		189			1,152		(57	)		387			822
Deposits in foreign offices:
Foreign banks deposits		454			86			(24	)		392		(13	)		150			255
Other time and savings		743			60			95			588		(1	)		213			376
Short-term borrowings		357			(9	)		66			300		(19	)		49			270
Long-term debt		1,443			(43	)		29			1,457		187			245			1,025

Total interest expense		5,640			273			497			4,870		247			1,557			3,066

Net interest income - taxable equivalent basis		3,426		$	206		$	113			3,107	$	438		$	(411	)		3,080

Tax equivalent adjustment		28									26								17

Net interest income -
non taxable equivalent basis	$	3,398								$	3,081							$	3,063

Significant components of HUSI’s net interest margin are summarized in the following table.



Year Ended December 31	2007			2006			2005

Yield on total earning assets		6.24	%		5.79	%		4.96	%
Rate paid on interest bearing liabilities		4.35			4.03			2.78

Interest rate spread		1.89			1.76			2.18
Benefit from net non-interest or paying funds		.47			.50			.31

Net interest margin on average earning assets (1)		2.36	%		2.26	%		2.49	%


(1)	Selected financial ratios are defined in the Glossary of Terms beginning on page 91 of this Form 10-K.

Significant trends affecting net interest income and interest rate spreads are summarized in the following table. Net interest income in the table is presented on a taxable equivalent basis (refer to pages 94-95 of this Form 10-K).



	2007					2006					2005

Year Ended December 31		Amount		Interest Rate Spread			Amount		Interest Rate Spread				Amount		Interest Rate Spread

($ in millions)
Net interest income/interest rate spread from prior year	$	3,107		1.76	%	$	3,080		2.18	%		$	2,758		2.81	%

Increase (decrease) in net interest income associated with:
Trading related activities (1)		20					(71	)					(61	)
Balance sheet management activities (2)		(21	)				(269	)					(156	)
Private label receivable portfolio (3)		298					210						435
Other activity		22					157						104

Net interest income/interest rate spread for current year	$	3,426		1.89	%	$	3,107		1.76	%		$	3,080		2.18	%


(1)	Refer to commentary regarding trading revenues, beginning on page 40 of this Form 10-K.

(2)	Represents HUSI’s activities to manage interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. Interest rate risk, and HUSI’s approach to manage such risk, are described beginning on page 81 of this Form 10-K.

(3)	Refer to commentary regarding the private label receivable portfolio, beginning on page 52 of this Form 10-K.

Trading Related Activities

Net interest income for trading related activities increased primarily due to increased trading assets balances.

Balance Sheet Management Activities

Lower net interest income from balance sheet management activities continued to impact results for 2007. A relatively flat yield curve and elevated short term interest rates have continued to limit opportunities to generate additional net funds income.

Private Label Receivable Portfolio (PLRP)

Higher net interest income for the PLRP for 2007 resulted from:


•	increased credit card receivable balances, due to the addition of new PLRP merchant relationships during 2007 and 2006;

•	higher accrued income as a result of a more refined income recognition methodology on private label credit card promotional transactions; and

•	lower amortization of premiums paid for purchases of receivables included within the PLRP. Although premiums associated with daily purchases of receivables from HSBC Finance Corporation continue to be recorded and amortized, premium amortization associated with the initial portfolio acquisition in 2004 was $70 million lower for 2007, as compared to 2006.

Residential Mortgages

Lower net interest income from residential mortgage activities, included in other activity in the above table, primarily resulted from continued narrowing of interest rate spreads and from contraction of the residential mortgage loan portfolio. As a result of a continuing strategy to reduce prepayment risk and improve HBUS’s structural liquidity, HUSI continues to sell a majority of its residential mortgage loan originations and allow the residential mortgage loan portfolio to run off.

Other Core Banking Activity

Higher net interest income from other core banking activity mostly resulted from business expansion initiatives, which have led to increased deposits and loans.

Personal deposits continued to grow in 2007 as a result of continued success of the Online Savings product and expansion of the branch network. However, customers continued to migrate to higher yielding deposit products such as the Online Savings product, leading to a change in product mix and narrowing of deposit spreads, which partly offset the benefit of higher deposit balances. Refer to page 9 of this Form 10-K for commentary regarding HUSI’s deposit strategy and growth.

Significant resources have been dedicated to expansion of various commercial lending businesses and regional offices, which has resulted in increased loan and deposit balances. The average yield earned on commercial loans was also higher in 2007.

Provision for Credit Losses

The provision for credit losses associated with various loan portfolios is summarized in the following table.


								2007 Compared to 2006 Increase (Decrease)				2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007		2006		2005				Amount		%		Amount			%

($ in millions)
Commercial	$	205	$	136	$	(15	)		$	69	51		$	151		*

Consumer:
Residential mortgages		126		32		37				94	*			(5	)	(14	)
Credit card receivables		1,108		592		560				516	87			32		6
Other consumer		83		63		92				20	32			(29	)	(32	)

Total consumer		1,317		687		689				630	92			(2	)	*

Total provision for credit losses	$	1,522	$	823	$	674			$	699	85		$	149		22

* Not meaningful.

Overview

HUSI’s methodology and accounting policies related to its allowance for credit losses are presented in Critical Accounting Policies beginning on page 25 and in Note 2 of the consolidated financial statements beginning on page 103 of this Form 10-K.

Additional commentary regarding credit quality begins on page 59 of this Form 10-K.

HUSI’s approach toward credit risk management is summarized on pages 77-78 of this Form 10-K.

2007 Compared to 2006

Increased provision expense reflects a refinement in the methodology used to estimate inherent losses on private label loans less than 30 days delinquent, which increased credit loss reserves by $107 million in the fourth quarter. In addition, provision expense for 2006 was unusually low due to the impact of bankruptcy legislation enacted in 2005, which resulted in accelerated credit card receivable and other consumer loan charge offs during the fourth quarter of 2005. During the first quarter of 2007, HUSI refined its allowance methodology associated with MasterCard/Visa credit card receivables, resulting in a reduction in the allowance balance and provision expense, which partially offset overall increases in credit card allowances. Refer to additional commentary regarding credit card receivables credit quality on page 65 of this Form 10-K.

Provisions on residential mortgages have increased in 2007, as compared with 2006, due primarily to increased delinquencies and charge offs in the portfolio of higher quality nonconforming residential mortgage loans which HUSI purchased from HSBC Finance Corporation in order to hold in the residential mortgage loan portfolio. Also contributing to this increase are delinquencies within the Home Equity Line of Credit (HELOC) portfolio, which is primarily due to continued deterioration in the housing markets. Other prime mortgage loans are also experiencing minimal deterioration. Refer to additional commentary regarding residential mortgage credit quality beginning on page 65 of this Form 10-K.

Commercial loan provision expense increased $69 million for 2007, as compared with 2006, primarily due to higher criticized asset balances. Additionally, there was a refinement of the loan loss provision methodology related to the small business line of credit portfolio, which resulted in an increase to provision expense in 2007. During the second quarter of 2006, provision expense of $29 million was recorded due to a combination of charge offs and increased allowances related to a specific commercial real estate investment loan for which no specific allowance for credit losses was previously recorded. Refer to additional commentary regarding commercial loan credit quality beginning on page 64 of this Form 10-K.

2006 Compared to 2005

Higher commercial loan provision expense for 2006 resulted from:


•	higher allowance requirements associated with higher small business and real estate commercial loan portfolio balances in 2006 and 2005;

•	higher charge offs associated with the growing small business portfolio;

•	more normalized commercial loan charge off and recovery activity, in comparison with 2005; and

•	a combination of charge offs and increased allowance for credit losses related to a specific commercial loan relationship within the PB business segment, which resulted in a $29 million provision.

Increased provision expense associated with credit card receivables was consistent with growth in private label credit card receivables during 2006.

Lower residential mortgage and other consumer loan balances were the primary driver for lower allowance requirements and lower provisions associated with these portfolios. Credit quality associated with HUSI’s residential mortgage loan portfolio remained strong in 2006.

Other Revenues

Decreased revenue for the year ended December 31, 2007, was mostly driven by reduced liquidity, higher volatility and widening spreads in the credit and sub-prime markets which led to substantial valuation losses being recorded. This was partially offset by increased credit card fees, other fees and commissions, and increased securities gains.

The components of other revenues are summarized in the following table.



										2007 Compared to 2006 Increase (Decrease)							2006 Compared to 2005 Increase (Decrease)

Year Ended December 31		2007			2006			2005			Amount				%		Amount				%

($ in millions)
Credit card fees	$	843		$	580		$	323				$	263		45			$	257		80

Trust income		101			88			87					13		15				1		1

Service charges		216			204			195					12		6				9		5

Other fees and commissions:
Letter of credit fees		75			74			70					1		1				4		6
Wealth and tax advisory services		104			94			60					10		11				34		57
Other fee-based income, net of referral fees		311			233			174					78		33				59		34

		490			401			304					89		22				97		32

Trading revenues		129			755			395					(626	)	(83	)			360		91

Securities gains, net		112			29			106					83		*				(77	)	(73	)


HSBC affiliate income:
Service charges		11			15			15					(4	)	(27	)			—		—
Other fees and commissions		105			51			71					54		106				(20	)	(28	)
Gain on sale of residential mortgage loans to HMUS		18			106			18					(88	)	(83	)			88		*
Gain on sale of refund anticipation loans to HSBC Finance Corporation		23			22			19					1		5				3		16
Other affiliate income		15			14			7					1		7				7		100

		172			208			130					(36	)	(17	)			78		60


Residential mortgage banking revenue		74			96			64					(22	)	(23	)			32		50


Other (loss) income:
Valuation of loans held for sale		(512	)		(120	)		(32	)				(392	)	*				(88	)	*
Insurance		47			47			48					—		—				(1	)	(2	)
Gains (loss) on sale of property and other financial assets		34			52			67					(18	)	(35	)			(15	)	(22	)
Earnings from equity investments		78			110			43					(32	)	(29	)			67		156
Securitization revenue		—			18			114					(18	)	(100	)			(96	)	(84	)
Miscellaneous income		63			95			67					(32	)	(34	)			28		42

		(290	)		202			307					(492	)	*				(105	)	(34	)


Total other revenues	$	1,847		$	2,563		$	1,911				$	(716	)	(28	)		$	652		34

* Not meaningful.

Credit Card Fees

Higher credit card fees in 2007 from private label and co-brand credit card portfolio activity were primarily due to the following factors:


•	the number of accounts, volume of customer transaction activity and average receivable balances included within the private label portfolio all were higher for 2007, due to the addition of merchant and customer relationships and to expansion of credit card products offered. Product repricing also resulted in higher fees; and

•	higher late fees due to increased delinquencies within the private label portfolio.

Other Fees and Commissions

Increased wealth and tax advisory services revenue in 2007 and 2006 primarily resulted from expansion of such services within the PB business segment (refer to page 57 of this Form 10-K).

Higher other fee-based income is partially due to various growth initiatives undertaken in 2007 and 2006, which resulted in general increases in fee income recorded within the PFS, CMB and Global Banking and Markets business segments.

Trading Revenues

Trading revenues are generated by HUSI’s participation in the foreign exchange, credit derivative and precious metal markets; from trading derivative contracts, including interest rate swaps and options; from trading securities; and as a result of certain residential mortgage banking activities.

The following table presents trading related revenues by business. The data in the table includes net interest income earned on trading instruments, as well as an allocation of the funding benefit or cost associated with the trading positions. The trading related net interest income component is included in net interest income on the consolidated income statement. Trading revenues related to the mortgage banking business are included in residential mortgage banking revenue.



									2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31		2007			2006			2005	Amount				%		Amount				%

($ in millions)
Trading revenues	$	129		$	755		$	395		$	(626	)	(83	)		$	360		91
Net interest (loss) income		(36	)		(56	)		15			20		(36	)			(71	)	*

Trading related revenues	$	93		$	699		$	410		$	(606	)	(87	)		$	289		70


Business:
Derivatives	$	(179	)	$	415		$	202		$	(594	)	(143	)		$	213		105
Treasury (primarily securities)		(82	)		8			24			(90	)	*				(16	)	(67	)
Foreign exchange and banknotes		245			182			133			63		35				49		37
Precious metals		77			87			42			(10	)	(11	)			45		107
Other trading		32			7			9			25		*				(2	)	(22	)

Trading related revenues	$	93		$	699		$	410		$	(606	)	(87	)		$	289		70

* Not meaningful.

2007 Compared to 2006

Trading revenue for 2007 was significantly affected by reduced liquidity, widening spreads and higher volatility in the credit and sub-prime lending markets. The market turmoil has caused a significant fall in revenues for 2007, as compared with 2006.

Trading revenues related to derivatives were substantially reduced primarily due to write downs and trading activity on credit derivatives. Most notably, recent downgrades in credit ratings of monoline insurance companies have resulted in fair value adjustments on derivative contracts with these entities due to counterparty credit risk exposures. As of December 31, 2007, this exposure totaled $1,083 million. HUSI recorded write-downs on contracts with monoline insurance companies of approximately $287 million in 2007, which reflects the decreased credit quality of these entities and concerns over their ability to perform at December 31, 2007. The exposure relating to monoline insurance companies rated CCC+ and lower was fully reserved for as of December 31, 2007.

Effective during the third quarter of 2006, HUSI maintains a portfolio of MasterCard Class B shares as part of structured product transactions for customers. In addition, HUSI uses derivative instruments to offset changes in the fair value of the MasterCard Class B shares. In 2007, the decrease in value of the derivative instruments totaling $91 million is reflected in trading revenue.

Trading related revenue also includes the increase or decrease in the value of derivatives used as an economic hedge on the interest rate risk of residential mortgages held for sale, as well as the net interest income associated with these loans. During 2007, HUSI realized total trading related revenues of $41 million, as compared to $132 million in 2006. Lower revenues from this program reflect the overall lack of liquidity in the market. Also refer to HSBC affiliate income beginning on page 42 of this Form 10-K for additional commentary on gains related to the sale of sub-prime residential mortgage loans.

HUSI recognizes gains or losses at the inception of derivative transactions only when the fair value of the transaction can be verified to market transactions or if all significant pricing model assumptions can be verified to observable market data. Gain or loss not recognized at inception is recorded in trading assets and recognized over the term of the derivative contract, or when market data becomes observable. The availability of observable market data resulted in recognition of $7 million and $53 million in trading revenues for 2007 and 2006, respectively.

Trading revenues related to securities were significantly reduced, primarily due to credit spread widening and write downs on asset backed securities held for trading purposes.

Precious metals revenue also experienced a decline in 2007, as compared to prior year, as a result of lower price volatility.

Partially offsetting the above noted declines in trading revenues, the foreign exchange business has continued to contribute solid revenues as a result of ongoing market volatility.

The increase in net interest income reflects higher trading assets and increased balances of loans held for sale resulting from loan syndication activity.

2006 Compared to 2005

During 2006, a wider range of product offerings and enhanced sales capabilities drove significant trading gains across all major client-related activities, primarily during the first half of the year. Derivatives trading revenue was higher due to the success of new product launches, to increased sales of structured products that are tailored to specific customer needs, and to the recognition of income during 2006 that was deferred in the previous year, as market inputs to valuation models became observable. Gains in the precious metals business reflected volume growth driven by a surge in demand arising from strong commodities markets. Income streams in the foreign exchange business remained robust against the backdrop of a weakening U.S. dollar.

Effective since the third quarter of 2005, HUSI maintains a portfolio of derivative instruments that are utilized as economic hedges to offset changes in market values of sub-prime residential mortgage loans held for sale. During 2006, HUSI realized $68 million of net trading revenues and $64 million of net interest income related to this program, as compared to $25 million and $11 million, respectively, in 2005.

Decreased net interest income was primarily due to steadily rising short-term interest rates during 2005 and 2006, which had an adverse impact on interest rate spreads related to funding of various trading activities.

Securities Gains, Net

HUSI maintains various securities portfolios as part of its balance sheet diversification and risk management strategy. The following table summarizes the net securities gains resulting from various strategies.



Year Ended December 31	2007		2006		2005

(in millions)
Sale of MasterCard Class B Shares	$	55	$	—	$	—
Balance sheet diversification and reduction of risk		22		5		33
Reduction of Latin and South American exposure		26		22		22
Sale of an equity investment to an HSBC affiliate (1)		9		—		48
Other		—		2		3

Total securities gains, net	$	112	$	29	$	106


(1)	In June 2005, HUSI sold shares in a foreign equity fund to an HSBC affiliate for a gain of $48 million, which is recorded within the PB segment.

Gross realized gains and losses from sales of securities are summarized in Note 6 of the consolidated financial statements, which begins on page 116 of this Form 10-K.

HSBC Affiliate Income

In 2007, higher fees and commissions from HSBC affiliates was primarily due to increased customer referral fees and other fees received related to the payments and cash management business. There was also an increase in fees received for various financial, operational and asset management functions performed by HUSI.

In June 2005, HUSI began acquiring residential mortgage loans from unaffiliated third parties and subsequently selling these loans to HMUS. During 2006, HUSI also began acquiring residential mortgage loans from HSBC Finance Corporation under this program. Lower gains on sales of loans to HMUS in 2007 resulted from decreased activity under the programs driven by illiquidity in the credit and sub-prime markets causing a decrease in loans sold. Refer to other income beginning on page 45 of this Form 10-K for commentary regarding the valuation allowance related to loans held for resale under this program.

Residential Mortgage Banking Revenue

The following table presents the components of residential mortgage banking revenue. The net interest income component of the table is included in net interest income in the consolidated statements of income and reflects actual interest earned, net of interest expense and corporate transfer pricing.



										2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007			2006			2005				Amount			%		Amount				%

($in millions)
Net interest income	$	260		$	330		$	447			$	(70	)	(21	)		$	(117	)		(26	)


Servicing related income:
Servicing fee income		116			100			76				16		16				24			32
Changes in fair value of MSRs due to (1):
Changes in valuation inputs or assumptions used in valuation model		(18	)		44			—				(62	)	(141	)			44			*
Realization of cash flows		(85	)		(87	)		—				2		2				(87	)		*
MSRs amortization (2)		—			—			(73	)			—		—				73			*
MSRs temporary impairment recovery (2)		—			—			47				—		—				(47	)		*
Trading – Derivative instruments used to offset changes in value of MSRs		10			(17	)		2				27		159				(19	)		*
Losses on sales of available for sale securities		—			—			(11	)			—		—				11			*

		23			40			41				(17	)	(43	)			(1	)		(2	)

Originations and sales related income
Gains on sales of residential mortgages:		26			33			17				(7	)	(21	)			16			94
Trading and hedging activity		—			1			(13	)			(1	)	(100	)			14			108

		26			34			4				(8	)	(24	)			30			*

Other mortgage income		25			22			19				3		14				3			16


Total residential mortgage banking revenue included in other revenues		74			96			64				(22	)	(23	)			32			50


Total residential mortgage banking related revenue	$	334		$	426		$	511			$	(92	)	(22	)		$	(85	)		(17	)


(1)	Based upon adoption of SFAS 156 effective January 1, 2006. Refer to Note 2 of the consolidated financial statements, beginning on page 103 of this Form 10-K for further discussion.

(2)	Based upon methodology existing prior to adoption of SFAS 156.

*	Not meaningful.

Overview

As a result of balance sheet management initiatives to enhance liquidity and to address interest rate risk, the following strategic decisions were undertaken affecting residential mortgage banking results:


•	HUSI opted to decrease the loan volumes generated through HSBC Finance Corporation’s network of residential mortgage loan correspondents for the purpose of holding loans in the portfolio. Purchases from correspondents were discontinued in September 2005; and

•	HUSI sold a higher proportion of its own adjustable rate mortgage loan originations in 2007 and 2006, which previously would have been held on the balance sheet.

2007 Compared to 2006

Net Interest Income

Decreased net interest income for 2007 resulted from lower average residential mortgage loans outstanding as well as a slight narrowing of interest rate spreads. During 2007, HUSI continued to sell the majority of new loan originations to government sponsored enterprises and private investors and to allow existing loans to runoff.

Servicing Related Income

Higher servicing fee income for 2007 resulted from a higher volume of loans included within the average serviced loans portfolio. The average serviced portfolio increased approximately 13% in 2007 as HUSI commenced servicing a portfolio of loans previously serviced by a third party. The increased serviced loans portfolio, and its positive impact on service fee income, was more than offset by changes in the value of the net hedged MSR position.

Origination and Sales Related Income

HUSI routinely sells residential mortgage loans to government sponsored entities and other private investors. The decrease in origination and sales related income for 2007 was attributable to a lower basis point gain on each individual loan sale as well as lower volumes as compared with 2006.

2006 Compared to 2005

Net Interest Income

As a result of the strategies previously noted, average residential mortgage loans recorded on the consolidated balance sheets decreased 11% during 2006, which resulted in a corresponding decrease in net interest income. Decreased net interest income in 2006 was also partially attributable to a narrowing of interest rate spreads on the core mortgage portfolio. Overall yields earned on residential mortgage loans in 2006 were consistent with 2005 levels.

Servicing Related Income

Higher servicing fee income in 2006 resulted primarily from the growth in the portfolio of loans serviced for others, which increased approximately 24% in 2006 due to the following factors:


•	HUSI sold substantially all adjustable rate loans in 2006 and 2005, which previously would have been held on the balance sheet;

•	in the fourth quarter of 2005, HUSI commenced servicing a portfolio of loans previously serviced by a third party; and

•	also in the fourth quarter of 2005, HUSI completed a sale of loans, which were previously held in portfolio, to a government agency for which it continues to provide servicing.

Overall, servicing related income in 2006 was flat in comparison with 2005 levels. Higher servicing fee income was offset by reductions in the value of MSRs, primarily resulting from higher cash flow realization (classified as a component of MSR amortization in prior years). The monthly fluctuation of rates was generally less volatile in 2006 compared to 2005.

Under accounting rules in place prior to 2006, there was no direct relationship between the lower of cost or market value (LOCOM) accounting model for valuing MSRs and the fair value model for valuing related derivative instruments used to offset changes in the economic value of MSRs. Under the guidance outlined in SFAS 156, which became effective January 1, 2006, the accounting model for MSRs now more closely matches the model for related hedging activity as both are fair value models, which has reduced income statement volatility related to the valuation of MSRs.

Additional analysis of MSRs activity is provided in Note 11 of the consolidated financial statements beginning on page 125 of this Form 10-K.

Additional commentary regarding risk management associated with the MSRs hedging program is provided beginning on page 86 of this Form 10-K.

Origination and Sales Related Income

HUSI routinely sells residential mortgage loans to government sponsored entities and other private investors. The increase in originations and sales related income for 2006 was attributable to a higher basis point gain on each individual loan sale as compared with 2005, partially offset by lower volumes sold in 2006.

Other (Loss) Income

The significant decrease in other (loss) income is primarily due to write downs on loans held for sale which totaled $512 million in 2007. Refer to Note 7 beginning on page 121 of this Form 10-K for additional commentary on loans held for sale and the related valuation allowance.

Valuation on Loans Held for Sale

In 2005, HUSI began acquiring residential mortgage loans from unaffiliated third parties with the intent of selling these loans to an HSBC affiliate, HSBC Markets (USA) Inc. (HMUS). During 2006, HUSI also began acquiring residential mortgage loans from HSBC Finance Corporation under this program. Loans acquired from unaffiliated third parties and HSBC Finance Corporation primarily include sub-prime residential mortgage loans. In addition, a number of prime adjustable rate mortgage loans originated by HUSI were identified for this program and were being held with the intent of selling these loans to HMUS. HUSI now holds its remaining portfolio for sale to a third party. Loans held for sale are recorded by HUSI at the lower of their aggregate cost or market value, with adjustments to market value being recorded as a valuation allowance. Lower results and activity for this program for 2007 generally resulted from the overall weakness and illiquidity in the U.S. residential mortgage market, and specifically from significantly reduced fair values of sub-prime loans, resulting in a significant increase in the valuation allowance for residential mortgage loans held for sale.

HUSI originates commercial loans in connection with its participation in a number of leveraged acquisition finance syndicates. A majority of these loans were originated with the intent of selling them to unaffiliated third parties, however, due to current market dislocations, a significant amount of these loans continue to be held for sale at December 31, 2007. Adverse conditions in the corporate credit markets have resulted in a substantial increase in the valuation allowance for commercial loans held for sale.

Gain (Loss) on Sale of Property and Other Financial Assets

In 2007, gains on sale of property and other financial assets included a gain of $27 million, of which $15 million was related to the sale of the Wealth and Tax Advisory Services (WTAS) business (refer to Note 3 beginning on page 114 of this Form 10-K). In 2006 and 2005, gains of $43 million were recorded in each of these years related primarily to the sale of property.

Earnings from Equity Investments

The PB business segment includes an equity investment in a non-consolidated foreign HSBC affiliate (the foreign equity investment). During the third quarter of 2006, the foreign equity investment sold a portion of its investment in a foreign equity fund to another HSBC affiliate. During the second quarter of 2007, the foreign equity investment sold its remaining investment in the foreign equity fund, resulting in a decrease in equity investment holdings and lower equity earnings in 2007.

Securitization Revenue

In the third quarter of 2006, the last remaining securitization trust agreement related to the private label credit card receivable portfolio was amended. As a result, the trust no longer qualified for sale treatment and all assets and liabilities of the trust were returned to HUSI’s consolidated balance sheet. The loss of securitization revenue for 2007 was offset by higher net interest income and higher fee revenue (refer to previous credit card fees commentary) from the receivables and liabilities that were returned to the consolidated balance sheet.

Miscellaneous Income

Lower miscellaneous income during 2007 is a result of loss on redemption of Junior Subordinated Debt Securities in the third quarter of 2007 (refer to Note 15, beginning on page 128 of this Form 10-K). This was partially offset by increased income from credit card enhancement products and services such as credit insurance.

Operating Expenses

The components of operating expenses are summarized in the following table.



													2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007				2006				2005				Amount				%		Amount				%

($ in millions)
Salaries and employee benefits:
Salaries		$	971			$	916			$	776			$	55		6			$	140		18
Employee benefits			381				384				276				(3	)	(1	)			108		39

Total salaries and employee benefits			1,352				1,300				1,052				52		4				248		24


Occupancy expense, net			243				221				182				22		10				39		21


Support services from HSBC affiliates:
Fees paid to HSBC Finance Corporation for loan servicing and other administrative support			468				452				415				16		4				37		9
Fees paid to HMUS			238				227				162				11		5				65		40
Fees paid to HTSU for technology services			260				235				216				25		11				19		9
Fees paid to other HSBC affiliates			196				162				126				34		21				36		29

Total support services from HSBC affiliates			1,162				1,076				919				86		8				157		17


Other expenses:
Equipment and software			54				72				91				(18	)	(25	)			(19	)	(21	)
Marketing			125				98				79				27		28				19		24
Outside services			137				125				116				12		10				9		8
Professional fees			79				78				67				1		1				11		16
Telecommunications			20				21				19				(1	)	(5	)			2		11
Postage, printing and office supplies			39				34				26				5		15				8		31
Insurance business			24				19				19				5		26				—		—
Miscellaneous			351				211				188				140		66				23		12

Total other expenses			829				658				605				171		26				53		9

Total operating expenses		$	3,586			$	3,255			$	2,758			$	331		10			$	497		18

Personnel - average number			12,336				12,326				11,275				10		—				1,051		9
Efficiency ratio			68.34	%			57.66	%			55.44	%

Overview

Increased operating expenses in 2007 was largely driven by higher personnel, marketing, technology and other expense growth associated with continued rollout of various retail and commercial business growth initiatives. Additionally, miscellaneous expenses increased as a result of a $70 million litigation expense related to our ownership interest in Visa.

Salaries and Employee Benefits

2007 Compared to 2006

Higher salaries expenses for 2007 are mainly due to:


•	changing mix of staffing to support various business growth initiatives, primarily within the PFS and CMB segments;

•	higher average salaries and pay rates, due to normal annual pay increases; and

•	higher personnel costs within the Global Banking and Markets segment associated with repositioning certain businesses in order to focus on building a financing and emerging markets led wholesale banking business.

During the second quarter of 2006, the HSBC Remuneration Committee exercised its discretion to waive the Total Shareholder Return performance condition related to 2003 share option awards under the HSBC Group Share Option Plan (refer to page 143 of HUSI’s 2007 Form 10-K for a description of this plan). This modification resulted in an additional charge to employee benefits expense of $9 million for the second quarter of 2006. No similar charge was recorded during 2007. Excluding this 2006 charge, higher employee benefit costs directly associated with increased salaries expenses were offset by lower pension costs.

2006 Compared to 2005

Higher salaries and benefits expenses for 2006 were primarily due to:


•	higher staff counts and a changing mix of staffing to support various business growth initiatives within the PFS, CMB, Global Banking and Markets and PB business segments (refer to commentary regarding Business Segments, beginning on page 50 of this Form 10-K);

•	higher incentive compensation expenses, largely due to growth in the Global Banking and Markets and PB segments;

•	lower deferrals of costs within the residential mortgage banking business, included within the PFS business segment, resulting from lower loan originations during 2006;

•	higher pension expense, resulting from changes in plan assumptions, particularly a lower discount rate, for 2006; and

•	higher employee welfare costs and payroll related taxes, which relate directly to higher salary costs.

In addition, during 2006, HUSI recorded $12 million of increased compensation expenses related to retirement and other transition of certain HUSI senior executives.

Occupancy Expense, Net

Expansion of the core banking and commercial lending networks within the PFS and CMB business segments has been a key component of recent business expansion initiatives. New branches have been opened and lending operations have been expanded, which have resulted in higher rental expenses, depreciation of leasehold improvements, utilities and other occupancy expenses during 2007.

Support Services from HSBC Affiliates

HUSI has routinely purchased private label credit card receivables from HSBC Finance Corporation since December 2004. In addition, higher quality nonconforming residential mortgage loans were acquired from HSBC Finance Corporation’s correspondent network from December 2003 until September 2005. In most cases, HSBC Finance Corporation retained the right to service these portfolios. Fees charged by HSBC Finance Corporation for loan origination and servicing expenses, which are primarily recorded in the CF segment, have increased moderately for 2007 due to an increased number of private label credit card receivables serviced.

Fees charged by HMUS pursuant to service level agreements for broker dealer, loan syndication, treasury and traded markets related services are included in support services from HSBC affiliates. Higher fees charged by HMUS in 2007 primarily relate to increased loan syndication services.

HSBC’s technology services in North America are centralized within HSBC Technology & Services (USA) Inc. (HTSU). Technology related assets and software acquired for HUSI are generally purchased and owned by HTSU. Pursuant to a master service level agreement, HTSU charges HUSI for equipment related costs and technology services. Fees charged by HTSU to HUSI for technology services are higher in 2007, as HUSI continues to upgrade its technology environment within all business segments.

HUSI also utilizes other HSBC affiliates in support of global outsourcing initiatives and, to a lesser extent, for treasury and traded markets services. Higher expense for 2007 primarily resulted from expanded data processing and other global outsourcing services.

Other Expenses

Higher marketing and promotional expenses resulted from continuing investment in HSBC brand activities, promotion of the internet savings account and marketing support for branch expansion initiatives, primarily within the PFS business segment.

As a result of a decision to discontinue operations of HBUS’s real estate settlement services company, certain deferred start-up costs and other contractual costs totaling $7 million were included in outside services in 2007. Market data services and collection agency fees, also included in outside services, increased $11 million in comparison to 2006. This was slightly offset by a decrease in employment agency and staff recruitment fees.

The increase in Insurance business expense in 2007 primarily relates to the costs incurred to terminate a portion of the annuity reinsurance business. Additionally, there was a nominal increase in claims during the third quarter of 2007.

Higher miscellaneous expenses for 2007 were primarily due to $70 million of litigation expense related to Visa (refer to Note 25 of the consolidated financial statements beginning on page 152 of this Form 10-K for commentary on the Visa litigation), increased insurance costs and higher expenses associated with business expansion in the PFS and CMB segments. In addition, miscellaneous expenses in 2006 were unusually low, mainly due to reversal of a charge for the accrued interest related to settlement of certain income tax liabilities during the second quarter of 2006.

Efficiency Ratio

Increase in efficiency ratio resulted primarily from a decrease in other revenues and increased operating expenses, partially offset by higher net interest income, for the year ended 2007, in comparison to 2006.

Income Taxes

Income tax expense decreased $531 million (100%) in 2007, as compared with 2006. The decrease in income tax expense and the related decrease in the effective tax rate is primarily due to the effect of a significantly reduced level of earnings and the effect of concentrating tax credits (primarily low income housing credits) over a significantly reduced level of pre-tax income.

Income tax expense decreased $36 million (6%) in 2006, primarily resulting from a lower effective rate compared with 2005. The lower effective tax rate for 2006 reflects higher revenues from operations in states with lower tax rates and an increase in low income housing tax credits.

Refer to Note 17 of the consolidated financial statements beginning on page 133 of this Form 10-K for additional information regarding income taxes.

Business Segment Results

HUSI has five distinct segments that are utilized for management reporting and analysis purposes. The segments, which are based upon customer groupings as well as products and services offered, are described on pages 6 and 7 of this Form 10-K.

Effective January 1, 2007, corporate goals of HUSI are based upon results reported under International Financial Reporting Standards (IFRS), which are utilized by HSBC to prepare its consolidated financial statements. Operating results for HUSI are now being monitored and reviewed, trends are being evaluated, and decisions are being made about allocating certain resources on an IFRS basis. As a result, business segment results are reported on an IFRS basis to align with the revised internal reporting mechanism for monitoring performance. Results for 2007, 2006 and 2005 in the tables that follow are reflected on an IFRS basis. Refer to Note 24 of this Form 10-K for additional information on business segments, including a reconciliation between IFRS and U.S. GAAP for reported results and certain other key balances.

Effective January 1, 2006, activity related to certain commercial banking relationships, which was previously reported in the PFS segment, was transferred to the CMB segment. In addition, also effective January 1, 2006, the CMB segment also includes activity related to an equity investment in Wells Fargo HSBC Trade Bank N.A., which was previously reported in the Other segment. For comparability purposes, prior period disclosures previously reported for 2006 and 2005 have been conformed herein to the presentation of current segments.

Results for each business segment on an IFRS basis are summarized in the following tables.

Personal Financial Services (PFS)

During 2007, resources continued to be directed towards expansion of the core retail banking business, including investment in the HSBC brand, expansion of the branch network in existing and new geographic areas, and continued rollout of HSBC Direct, the internet banking channel. As a result, balance sheet growth for core retail banking in 2007 was highlighted by a 22% increase in average deposits, as compared with 2006.

During 2007, HUSI continued to sell the majority of new residential mortgage loan originations to government sponsored enterprises and private investors and to allow the existing balance sheet to runoff. As a result, average residential mortgage loans decreased 11% in 2007, as compared with 2006.

The following table summarizes results for the PFS segment.



										2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007			2006			2005			Amount				%		Amount				%

($in millions)
Net interest income		$	1,102		$	1,155		$	948		$	(53	)	(5	)		$	207		22
Other revenues			559			496			704			63		13				(208	)	(30	)

Total revenues			1,661			1,651			1,652			10		1				(1	)	—
Provision for credit losses			139			52			100			87		167				(48	)	(48	)

			1,522			1,599			1,552			(77	)	(5	)			47		3
Operating expenses			1,302			1,173			1,023			129		11				150		15

Income before income tax expense			220			426			529			(206	)	(48	)			(103	)	(19	)


Income tax expense			52			154			218			(102	)	(66	)			(64	)	(29	)

Net income		$	168		$	272		$	311		$	(104	)	(38	)		$	(39	)	(13	)

2007 Compared to 2006

Lower overall results for the PFS segment in 2007 were primarily driven by higher operating expenses from expansion initiatives and higher provision for loan losses in the mortgage business, primarily related to increased delinquencies on home equity lines of credit.

Net interest income from continuing core banking activities has decreased in 2007 due to narrowing of interest rate spreads as customers migrated to higher yielding deposit products such as Online Savings and CDs. Net interest income for 2007 was also impacted by lower interest income and loan portfolio runoff on the residential mortgage portfolio.

Other revenues for 2007 were higher as compared to 2006 due to $45 million of gains realized on the sale of MasterCard Class B Shares and $21 million of gains realized on sales of branch premises to unaffiliated third parties.

Higher provision for credit losses was driven by an increase in delinquencies and charge offs within the Home Equity Line of Credit (HELOC) portfolio, which is primarily due to conditions in the housing markets deteriorating. Prime mortgage loans experienced minimal deterioration. In addition, provision expense for the first half of 2006 was unusually low due to the impact of bankruptcy legislation enacted in 2005, which resulted in accelerated consumer charge offs in the fourth quarter of 2005. This was partially offset by a reduction resulting from refinement of the allowance methodology associated with MasterCard/Visa receivables.

Higher expenses in 2007 are primarily due to $70 million of litigation expense related to Visa. Refer to Note 25 of this Form 10-K, beginning on page 152, for additional information regarding the Visa litigation. Also contributing to increased operating expenses was investment in branch expansion and HSBC Direct, which includes higher staff, occupancy, and marketing expenses.

2006 Compared to 2005

Net interest income associated with the core banking operations grew 22% for 2006 as a result of favorable interest rate spreads on a growing deposit base. As expected during the expansion build-out phase, expense growth associated with expansion initiatives has outpaced related core banking revenue growth.

Lower residential mortgage related results in 2006 were driven by strategic balance sheet initiatives to decrease the residential mortgage loan portfolio, and by tightening interest rate spreads.

The provision for credit losses decreased $48 million in 2006, as compared to 2005, mainly due to changes in bankruptcy legislation in 2005, which accelerated charge offs and impairment activity related to the legacy MasterCard/Visa credit card and automotive finance portfolios in that year.

Higher operating expenses for 2006, as compared to 2005, were primarily due to:


•	staff costs from additional headcount recruited to support branch expansion and the internet banking channel. Greater emphasis was also placed on recruiting staff dedicated to sales and customer relationship activities, which changed the staff mix, and contributed to higher expenses;

•	marketing and other direct costs associated with expansion of the core banking network and growth of the internet savings banking channel;

•	higher expenses within the residential mortgage banking business throughout 2006, partly due to reduced cost deferrals related to a reduced volume of loan originations; and

•	increased fees paid to HTSU, as HUSI continued to upgrade its branch sales platform.

Consumer Finance (CF)

The CF segment includes the private label receivable portfolio (the PLRP) and other loans acquired from HSBC Finance Corporation and its correspondents. Private label credit card receivable balances have continued to grow and are 5% higher at December 31, 2007 compared with 2006.

The following table summarizes results for the CF segment.



										2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)



Year Ended December 31	2007			2006		2005				Amount			%			Amount			%

($ in millions)
Net interest income		$	951	$	721	$	641		$		230			32		$	80			12
Other revenues (1)			294		105		(41	)			189			180			146			*

Total revenues			1,245		826		600				419			51			226			38
Provision for credit losses			1,187		654		662				533			81			(8	)		(1	)

			58		172		(62	)			(114	)		(66	)		234			*
Operating expenses			33		31		39				2			6			(8	)		(21	)

Income (loss) before income tax expense			25		141		(101	)			(116	)		(82	)		242			*

Income tax expense (benefit)			7		50		(38	)			(43	)		(86	)		88			*

Net income (loss)		$	18	$	91	$	(63	)	$		(73	)		(80	)	$	154			*


(1)	For IFRS reporting purposes, fees charged by HSBC Finance Corporation for servicing various loan and receivable portfolios are netted against other revenues. These fees totaled $420 million and $410 million for the year ended December 31, 2007 and 2006, respectively.

	*Not meaningful.


	*2007 Compared to 2006*

Higher net interest income in 2007 primarily resulted from increased credit card receivable balances, due to the addition of new private label merchant relationships during 2007 and 2006, and to lower amortization of premiums paid for purchases of receivables included within the PLRP. Although premiums associated with daily purchases of receivables from HSBC Finance Corporation continue to be recorded and amortized, the premium amortization associated with the initial portfolio acquisition in 2004 was lower in 2007 as compared to 2006. Additionally, in 2007, HUSI adopted a more refined income recognition methodology on private label credit card promotional transactions which resulted in an increase to net interest income during 2007.

Higher other revenues are directly related to increased credit card fees (refer to page 40 of this Form 10-K).

Higher provision expense for credit card receivables in 2007 primarily reflects higher levels of charge offs and delinquencies within the private label credit card portfolio as market conditions continue to deteriorate. Higher delinquencies and charge offs in the portfolio of higher quality non-conforming residential mortgage loans which HUSI purchased from HSBC Finance Corporation in order to hold in the residential mortgage loan portfolio also contributed to this increase. Additionally, increased provision expense reflects a refinement in the methodology used to estimate inherent losses on private label loans less than 30 days delinquent, which increased credit loss reserves by $107 million in the fourth quarter.

HUSI is considering the purchase of a portfolio of General Motors MasterCard and Visa receivables (the “GM Portfolio”) from HSBC Finance Corporation in the future in order to maximize the efficient use of capital and liquidity at each entity. Any such purchase will be subject to obtaining the necessary regulatory and other approvals, including the approval of HSBC Finance Corporation’s partner. HSBC Finance Corporation would, however, maintain the customer account relationships and, subsequent to the initial receivable purchase, HUSI would purchase additional volume on a daily basis. At December 31, 2007, the GM Portfolio had an outstanding principal balance of approximately $7 billion. If this bulk purchase occurs, it is expected to result in payment of a significant premium upon completion. In future periods, HUSI’s net interest income, fee income and provision for credit losses would be increased, while net interest income would decrease due to payment of premium from continuing purchases of credit card receivables, and servicing fees paid to HSBC Finance Corporation would increase. It is not anticipated that the net effect of these potential purchases would have a material impact on HUSI’s future results of operations.


	*2006 Compared to 2005*

Net interest income and other revenue grew in 2006, compared with 2005, due to significant growth in the number of accounts included within the PLRP, increased late fees and lower fees paid to merchant partners.

Lower provision for credit losses for the PLRP portfolio is primarily due to the impact of bankruptcy legislation enacted in 2005, which resulted in accelerated consumer charge offs and higher provision expense during 2005.

Commercial Banking (CMB)

Expansion of middle market lending activities in Chicago, Washington D.C. and the West Coast, contributed to growth in small business deposits and average commercial loans. However a slowdown in commercial real estate activity and deterioration in the credit environment coupled with business expansion, restructuring costs and lower gains on asset disposals have depressed results.

The following table summarizes results for the CMB segment.



											2007 Compared to 2006 Increase (Decrease)							2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007			2006			2005			Amount					%				Amount				%

($ in millions)
Net interest income		$	814		$	746		$	666			$	68			9				$	80			12
Other revenues			259			273			183				(14	)		(5	)				90			49

Total revenues			1,073			1,019			849				54			5					170			20
Provision for credit losses			126			70			27				56			80					43			159

			947			949			822				(2	)		—					127			15
Operating expenses			558			503			378				55			11					125			33

Income before income tax expense			389			446			444				(57	)		(13	)				2			—

Income tax expense			92			155			170				(63	)		(41	)				(15	)		(9	)

Net income		$	297		$	291		$	274			$	6			2				$	17			6


	*2007 Compared to 2006*

Net interest income grew by 9% to $814 million for 2007, as compared to 2006, mostly driven by average balance growth of 20% in middle market loans and 21% in small business deposits. Offsetting this, net interest income was constrained by lower commercial real estate activity and narrowing spreads, particularly on deposits, as customers migrated to higher yielding products.

Other revenues decreased in 2007, mainly due to lower gains on asset disposals.

Provisions for credit losses have increased by 80% in 2007, as compared to 2006. This is due to a change in loan loss reserve methodology for HUSI’s small business revolving line of credit product as well as higher commercial real estate provisions, mainly as a result of customer downgrades.

Higher operating expenses for 2007 over 2006, reflect organic growth in legacy markets and business expansion in Chicago, Washington D.C. and the West Coast. In addition, higher incentive compensation costs, business restructuring and increased community investment activities have also contributed to cost growth.

Deposit volumes continue to be a key driver of growth in 2007, driven by expansion initiatives and targeted marketing campaigns. For the CMB segment, average customer deposit balances are 20% higher in 2007 compared with 2006.

Loan growth resulted primarily from strong activity in middle market lending, with growth distributed between legacy and expansion markets. However, overall loan growth has been adversely impacted by a slowdown in commercial real estate activity. For the CMB segment, average loans are 4% higher for 2007, compared with 2006.


	*2006 Compared to 2005*

Higher other revenues primarily resulted from:


•	sales of Venezuelan Brady Bonds and related instruments during 2006;

•	increased syndication fees resulting from a strategic decision by the Commercial Real Estate business to mitigate risk by reducing the balance sheet; and

•	higher other fees resulting from business expansion.

Higher operating expenses primarily resulted from:


•	higher personnel costs from additional staff to support expansion initiatives. Recruitment of additional relationship managers also changed the mix of staff and drove costs higher;

•	higher marketing and other direct costs associated with branch expansion initiatives and new lending offices; and

•	to a lesser extent, allocation to CMB of various increased corporate expenses, including increased compensation costs.

Increased provision for credit losses for 2006 resulted from higher criticized commercial assets, and higher charge offs associated with the growing small business loan portfolio. In addition, net commercial loan charge offs for 2006 reflect a more normalized credit environment in comparison to lower net charge offs recorded in the prior year.

Global Banking and Markets

During the second half of 2007, the Global Banking and Markets segment was significantly affected by reduced market liquidity, widening spreads and higher volatility in the credit and sub-prime lending markets, which has led to a considerable fall in revenues for 2007, as compared with 2006. This impacted trading in mortgage backed securities and credit derivatives and led to substantial reserves in several asset classes. Partially offsetting this, the payments and cash management business and the foreign exchange business have contributed solid revenues.

The following table summarizes results for the Global Banking and Markets segment.



									2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007			2006		2005			Amount			%			Amount			%

($ in millions)
Net interest income	$	321		$	235	$	348		$	86			37		$	(113	)		(32	)
Other revenues		46			957		738			(911	)		(95	)		219			30

Total revenues		367			1,192		1,086			(825	)		(69	)		106			10
Provision (credit) for credit losses		35			3		(52	)		32			*			55			106

		332			1,189		1,138			(857	)		(72	)		51			4
Operating expenses		803			791		644			12			2			147			23

(Loss) income before income tax expense		(471	)		398		494			(869	)		*			(96	)		(19	)


Income tax (benefit) expense		(129	)		148		184			(277	)		(187	)		(36	)		(20	)

Net (loss) income	$	(342	)	$	250	$	310		$	(592	)		*		$	(60	)		(19	)


*	Not meaningful.

2007 Compared to 2006

Increased net interest income was primarily due to an increase in trading assets and also reflects higher lending balances and increased balances of loans held for sale resulting from loan syndication activity. Refer to page 32 of this Form 10-K for additional commentary on trading assets.

Other revenues were significantly affected by adverse market conditions. Specifically, substantial valuation losses were recorded on sub-prime residential mortgage and leveraged commercial loans held for sale. Additionally, reserves were recorded for trading securities, credit derivatives and structured derivative products.

Adverse market conditions have led to downgrades in internal credit ratings of monoline insurance companies. Fair value adjustments of approximately $287 million have been recorded due to counterparty credit risk exposures on derivative contracts with these entities, which reflects the decreased credit quality of these entities and concerns over their ability to perform at December 31, 2007. The exposure relating to monoline insurance companies, which are rated CCC+ and below has been fully reserved as of December 31, 2007.

Partially offsetting the above mentioned declines, revenues from the recently expanded payments and cash management business were significantly higher for 2007, as compared with 2006, reflecting higher deposit balances and higher associated transaction fee revenues. The foreign exchange business also contributed increased revenue as a result of ongoing market volatility and a weakening dollar. Additionally, revenue increased from emerging market and from interest rate trading activities.

Higher operating expenses for 2007, as compared with 2006, primarily resulted from incremental costs associated with repositioning certain non-strategic businesses in order to focus on building a financing and emerging markets led wholesale banking business.

2006 Compared to 2005

During 2006, successful launches of new products and increased sales of structured products that are tailored to specific customer needs led to strong derivatives trading revenues. Gains in the precious metals business reflected volume growth driven by a surge in demand arising from strong commodities markets. Income streams in the foreign exchange business were robust against the backdrop of a weak U.S. dollar.

Strong trading results more than offset lower balance sheet management revenues, which were adversely affected by rising short-term interest rates and a flattening yield curve that reduced net interest income and limited opportunities to profit from placing funds generated from operations.

Higher trading revenues, included in other revenues, were attributable to expanded operations and favorable market conditions related to precious metals, foreign exchange and structured products desks, especially during the first six months of 2006. Refer to page 40 of this Form 10-K for additional analysis and commentary regarding trading revenues.

Excluding the trading revenues impact noted above, higher other revenues for 2006, as compared to 2005, mainly resulted from higher fee-based income, primarily within the transaction banking business, resulting from expanded product offerings, and from one additional quarter in 2006 of service fees generated by a subsidiary transferred to HUSI from HSBC in March 2005, which provides accounting and valuation services for hedge fund clients.

Higher operating expenses were mainly due to the first full year impact of the business expansion initiatives begun in 2005, as well as additional investments in early 2006 to support the growing complexity of the Global Banking and Markets business. Specifically, cost growth in Global Markets was primarily driven by expansion within the mortgage backed securities, structured derivative and equity businesses. Similarly, operating expenses grew in Transaction Banking, primarily the payments and cash management and the securities services businesses, as business volumes grew to historical highs, which drove higher transaction costs and increased support for expanded capacity.

Staff costs increased due to higher performance incentives, which rose in line with revenue growth, and due to the effect of additional people recruited throughout 2005 and in early 2006. Business support areas, such as market risk, credit and operations staff, also grew to support the expansion of various business lines. Transition of senior executives also contributed to higher compensation costs.

Private Banking (PB)

During 2007 and 2006, additional resources have been allocated to expand products and services provided to high net worth customers served by the PB business segment. As a result, total average loans and deposit balances were 7% and 13% higher, respectively, for 2007 compared with 2006. Assets under management also increased 4%. However, these increases were offset by higher operating expenses and lower one time gains from the sale of assets in 2007, as compared with 2006.

The following table summarizes results for the PB segment.



								2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007		2006		2005			Amount			%			Amount			%

($ in millions)
Net interest income	$	198	$	199	$	174		$	(1	)		(1	)	$	25			14
Other revenues		291		303		260			(12	)		(4	)		43			17

Total revenues		489		502		434			(13	)		(3	)		68			16
Provision (credit) for credit losses		10		36		(3	)		(26	)		(72	)		39			*

		479		466		437			13			3			29			7
Operating expenses		345		308		270			37			12			38			14

Income before income tax expense		134		158		167			(24	)		(15	)		(9	)		(5	)


Income tax expense		32		57		64			(25	)		(44	)		(7	)		(11	)

Net income	$	102	$	101	$	103		$	1			1		$	(2	)		(2	)


*	Not meaningful.

2007 Compared to 2006

Net interest income for 2007 was impacted by higher average balances for loans and deposits, offset by lower interest spreads.

The PB business segment includes an equity investment in a non-consolidated foreign HSBC affiliate (the foreign equity investment). During the third quarter of 2006, the foreign equity investment sold a portion of its investment in a foreign equity fund to another HSBC affiliate. During the second quarter of 2007, the foreign equity investment sold its remaining investment in the foreign equity fund. The decrease in equity investment holdings resulted in lower equity earnings of $47 million included in other revenues in 2007. This was largely offset by higher commission and fee revenues from managed products, derivatives and annuity products.

On December 31, 2007, HUSI completed the sale of its Wealth and Tax Advisory Services (WTAS) subsidiary to an independent firm formed by certain members of the WTAS management team. In exchange for the net assets of WTAS, HUSI received cash and secured promissory notes as well as an option to purchase a limited amount of common equity in future years. HUSI recognized a gain of $18 million as a result of this transaction.

Increased operating expenses in 2007, as compared to 2006 mainly resulted from higher staff costs related to business expansion initiatives.

The provision for credit losses includes the impact of an $8 million charge off in 2007 related to a specific client relationship, for which no allowance was previously recorded. For 2006, the provision includes a $29 million charge for a combination of charge offs and higher allowances related to a specific real estate investment loan relationship for which no specific allowance was previously recorded.

2006 Compared to 2005

During 2006 and 2005 additional resources have been allocated to expand products and services provided to high net worth customers served by this business segment, resulting in increased loan and deposit balances, and a corresponding increase in net interest income.

Fee income from wealth and tax advisory services was significantly higher for 2006, due to expanded services offered to customers. In addition, during 2006, earnings from a foreign equity investment increased $44 million due to its sale of shares in a foreign equity fund to an HSBC affiliate. Excluding this transaction, equity earnings from this foreign equity investment were also generally higher in 2006. In the second quarter of 2005, HUSI sold its shares in the same foreign equity fund to an HSBC affiliate resulting in a gain of $48 million.

Increased operating expenses for 2006 mainly resulted from additional resources being allocated to this segment to expand the services provided. Higher personnel costs were driven by increased staff count and by increased compensation expenses related to transition of senior executives. In addition, fees charged by HSBC affiliates grew in 2006 due to higher technology related costs and higher charges related to global outsourcing services.

Increased provision for credit losses during 2006 directly related to a specific commercial loan relationship for which a combination of charge offs and increased allowances for credit losses resulted in a $29 million provision. Further commentary regarding credit quality begins on page 59 of this Form 10-K.

Other

Overview

The Other segment primarily includes an equity investment in HSBC Republic Bank (Suisse) S.A., and adjustments made at the corporate level for fair value option accounting related to certain debt issued.

Operating Results

The following table summarizes results for the Other segment.



										2007 Compared to 2006 Increase (Decrease)						2006 Compared to 2005 Increase (Decrease)

Year Ended December 31	2007			2006			2005			Amount			%			Amount			%

($ in millions)
Net interest (loss)	$	(12	)	$	(10	)	$	(22	)	$	(2	)		(20	)	$	12			55
Other revenues (expense)		216			(46	)		28			262			*			(74	)		*

Total revenues (expense)		204			(56	)		6			260			*			(62	)		*
Provision for credit losses		—			—			—			—			—			—			—

		204			(56	)		6			260			*			(62	)		*
Operating expenses		4			2			—			2			100			2			—

Income (loss) before income tax expense		200			(58	)		6			258			*			(64	)		*


Income tax expense (benefit)		57			(35	)		8			92			*			(43	)		*

Net income (loss)	$	143		$	(23	)	$	(2	)	$	166			*		$	(21	)		*


*	Not meaningful.

The increase in other revenues for 2007 primarily resulted from decreases in the fair value of certain debt instruments to which fair value option accounting is applied, due to widening credit spreads, as compared to 2006.

The reduction in other revenues for 2006 primarily resulted from increases in the fair value of certain debt instruments to which fair value option accounting is applied, due to narrowing credit spreads, as compared to 2005.

Credit Quality

Overview

HUSI enters into a variety of transactions in the normal course of business that involve both on and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers. HUSI participates in lending activity throughout the U.S. and, on a limited basis, internationally.

HUSI’s approach toward credit risk management is summarized on pages 77-78 of this Form 10-K.

Nonaccruing Loans

HUSI’s policies and practices for placing loans on nonaccruing status are summarized in Note 2 of the consolidated financial statements, beginning on page 103 of this Form 10-K.

Nonaccruing loan statistics are summarized in the following table.



	2007			2006			2005			2004			2003

($ in millions)
Nonaccruing loans
Balance at end of period:
Commercial:
Construction and other real estate	$	34		$	33		$	15		$	33		$	30
Other commercial		89			69			70			117			233

Total commercial		123			102			85			150			263

Consumer:
Residential mortgages		640			265			138			99			78
Credit card receivables		1			1			—			—			22
Other consumer loans		—			—			—			1			3

Total consumer loans		641			266			138			100			103

Total nonaccruing loans	$	764		$	368		$	223		$	250		$	366


As a percent of loans:
Commercial:
Construction and other real estate		.40	%		.37	%		.16	%		.40	%		.43	%
Other commercial		.30			.34			.38			.80			2.00

Total commercial		.32			.35			.31			.65			1.41

Consumer:
Residential mortgages		1.81			.67			.31			.21			.29
Credit card receivables		.01			.01			—			—			1.89
Other consumer loans		—			—			—			.03			.15

Total consumer loans		1.12			.44			.22			.16			.35

Total		.80	%		.41	%		.25	%		.29	%		.76	%

Interest income on nonaccruing loans (Year ended December 31):
Amount which would have been recorded had the associated loans been current in accordance with their original terms	$	49		$	24		$	25		$	23		$	28
Amount actually recorded		7			8			12			17			12

Increase in consumer nonaccruing loans in 2007 was related primarily to sub-prime residential mortgage loans held for sale and occurred as a result of illiquidity in the U.S. mortgage market. This increase also relates to a portfolio of higher quality nonconforming residential mortgage loans which HUSI purchased from HSBC Finance Corporation in order to hold in the residential mortgage loan portfolio. Certain loans in the Home Equity Line of Credit (HELOC) portfolio and other prime mortgage loan portfolio have also contributed to this increase. Refer to Note 8 of this Form 10-K for additional credit quality statistics on nonaccruing loans.

Interest that has been accrued but unpaid on loans placed on nonaccruing status generally is reversed and reduces current income at the time loans are so categorized. Interest income on these loans may be recognized to the extent of cash payments received. In those instances where there is doubt as to collectibility of principal, any cash interest payments received are applied as reductions of principal. Loans are not reclassified as accruing until interest and principal payments are brought current and future payments are reasonably assured.

Impaired Loans

A loan is considered to be impaired when it is deemed probable that all principal and interest amounts due, according to the contractual terms of the loan agreement, will not be collected. Probable losses from impaired loans are quantified and recorded as a component of the overall allowance for credit losses. Generally, impaired loans include loans in nonaccruing status, loans which have been assigned a specific allowance for credit losses, loans which have been partially or wholly charged off, and loans designated as troubled debt restructurings. Impaired loan statistics are summarized in the following table. Refer to Note 8 on this Form 10-K for more information on impaired loans.



	2007		2006		2005		2004		2003

(in millions)
Impaired loans:
Balance at end of period	$	123	$	100	$	90	$	236	$	267
Amount with impairment reserve		41		35		27		210		179
Impairment reserve		15		13		10		18		86

Criticized Assets

Criticized asset classifications are based on the risk rating standards of HUSI’s primary regulator. Problem loans are assigned various criticized facility grades under HUSI’s allowance for credit losses methodology. The following facility grades are deemed to be criticized.

Special Mention – generally includes loans that are protected by collateral and/or the credit worthiness of the customer, but are potentially weak based upon economic or market circumstances which, if not checked or corrected, could weaken HUSI’s credit position at some future date.

Substandard – includes loans that are inadequately protected by the underlying collateral and/or general credit worthiness of the customer. These loans present a distinct possibility that HUSI will sustain some loss if the deficiencies are not corrected. This category also includes certain non-investment grade securities, as required by HUSI’s principal regulator.

Doubtful – includes loans that have all the weaknesses exhibited by substandard loans, with the added characteristic that the weaknesses make collection or liquidation in full of the recorded loan highly improbable. However, although the possibility of loss is extremely high, certain factors exist which may strengthen the credit at some future date, and therefore the decision to charge off the loan is deferred. Loans graded as doubtful are required to be placed in nonaccruing status.

Criticized assets are summarized in the following table.



	Increase (Decrease) from

	December 31, 2007		December 31, 2006						December 31, 2005

			Amount			%			Amount		%

($ in millions)
Special mention:
Commercial loans	$	2,402	$	1,151			92		$	1,742		264

Substandard:
Commercial loans		625		(56	)		(8	)		471		306
Consumer loans		1,168		567			94			714		157

		1,793		511			40			1,185		195

Doubtful:
Commercial loans		25		(7	)		(22	)		1		4

Total	$	4,220	$	1,655			65		$	2,928		227

The increase in criticized commercial loans is addressed under Commercial Loan Credit Quality on page 64. Higher substandard consumer loans primarily relate to private label credit card receivables and, to a lesser extent, to residential mortgage loans acquired from HSBC Finance Corporation.

Provision and Allowance for Credit Losses

An analysis of the provision for credit losses is provided on page 37 of this Form 10-K.

An analysis of overall changes in the allowance for credit losses and related allowance ratios is presented in the following table.



Year Ended December 31	2007			2006			2005			2004			2003

($ in millions)
Total loans at year end	$	94,949		$	90,237		$	90,342		$	84,947		$	48,474
Average total loans		89,462			88,853			87,898			60,328			44,187

Allowance for credit losses:
Balance at beginning of year	$	897		$	846		$	788		$	399		$	493
Allowance related to acquisitions and (dispositions), net		—			(8	)		—			485			(15	)

Charge offs:
Commercial		147			136			75			54			160
Consumer:
Residential mortgages		70			37			24			15			3
Credit card receivables		935			728			659			65			59
Other consumer loans		117			111			113			23			21

Total consumer loans		1,122			876			796			103			83

Total charge offs		1,269			1,012			871			157			243


Recoveries on loans charged off:
Commercial		28			38			71			60			35
Consumer:
Residential mortgages		1			2			1			2			1
Credit card receivables		198			170			146			8			8
Other consumer loans		37			38			37			8			7

Total consumer loans		236			210			184			18			16

Total recoveries		264			248			255			78			51


Total net charge offs		1,005			764			616			79			192


Provision charged (credited) to income		1,522			823			674			(17	)		113


Balance at end of year	$	1,414		$	897		$	846		$	788		$	399


Allowance ratios:
Total net charge offs to average loans:
Commercial		.38	%		.35	%		.02	%		(.03	)%		.63	%
Consumer:
Residential mortgages		.18			.08			.05			.04			.01
Credit card receivables		4.12			3.49			3.81			4.69			4.57
Other consumer loans		3.23			2.47			2.41			.73			.75

Total consumer loans		1.53			1.10			.96			.21			.28

Total loans		1.12	%		.86	%		.70	%		.13	%		.43	%


Year-end allowance to:
Year-end total loans		1.49	%		.99	%		.94	%		.93	%		.82	%
Year-end total nonaccruing loans (1)		185.08	%		243.75	%		379.37	%		315.20	%		109.02	%

(1)

The increased allowance for credit losses at the end of 2007, 2006, 2005 and 2004 resulted from the acquisition of the private label credit card receivables from HSBC Finance Corporation. As these receivable balances are typically maintained as accruing until charged off, there were no loan balances included in this portfolio which were classified as nonaccruing, resulting in a significant increase in the ratio of allowance to nonaccruing loans for 2007, 2006, 2005 and 2004 as compared with prior years.

Changes in the allowance for credit losses during 2007 and 2006 by general loan categories, are summarized in the following tables.



Year Ended December 31	Commercial			Residential Mortgage			Credit Card			Other Consumer			Unallocated				Total

(in millions)
2007
Balance at beginning of year		$	203		$	31	$	626			$	26		$	11		$	897

Allowance related to dispositions			—			—		—				—			—			—

Charge offs			147			70		935				117			—			1,269
Recoveries			28			1		198				37			—			264

Net charge offs			119			69		737				80			—			1,005

Provision charged to income			196			126		1,108				83			9			1,522

Balance at end of year		$	280		$	88	$	997			$	29		$	20		$	1,414

2006
Balance at beginning of year		$	162		$	34	$	600			$	36		$	14		$	846

Allowance related to dispositions			—			—		(8	)			—			—			(8	)

Charge offs			136			37		728				111			—			1,012
Recoveries			38			2		170				38			—			248

Net charge offs			98			35		558				73			—			764

Provision charged (credited) to income			139			32		592				63			(3	)		823

Balance at end of year		$	203		$	31	$	626			$	26		$	11		$	897

An allocation of the allowance for credit losses by major loan categories is presented in the following table. The 2004 decrease in the unallocated portion noted in the table is due to a refinement in the allowance methodology during that year.



	2007			2006			2005			2004			2003

	Amount		% of Loans to Total Loans	Amount		% of Loans to Total Loans	Amount		% of Loans to Total Loans	Amount		% of Loans to Total Loans	Amount		% of Loans to Total Loans

($ in millions)
Commercial	$	280	40	$	203	33	$	162	31	$	182	27	$	252	39
Consumer:

Residential mortgages		88	37		31	44		34	49		20	55		13	55

Credit card receivables		997	21		626	20		600	17		553	14		54	2
Other consumer		29	2		26	3		36	3		20	4		16	4

Unallocated reserve		20	—		11	—		14	—		13	—		64	—

Total	$	1,414	100	$	897	100	$	846	100	$	788	100	$	399	100

Commercial Loan Credit Quality

Components of the commercial allowance for credit losses, as well as movements in comparison with prior years, are summarized in the following table.



				Increase (Decrease) from

				December 31, 2006				December 31, 2005

	December 31, 2007			Amount			%	Amount			%

($ in millions)
On-balance sheet allowance:
Specific		$	15		$	1	7	$	6		67
Collective			265			76	40		116		78
Transfer risk			—			—	—		(4	)	(100	)

			280			77	38		118		73
Unallocated			20			9	82		6		43

Total on-balance sheet allowance			300			86	40		124		70

Off-balance sheet allowance			103			5	5		15		17

Total commercial allowances		$	403		$	91	29	$	139		53

2007

HUSI’s growth initiatives have resulted in a continuing trend of growth in the size and complexity of the commercial loan portfolio. In addition, certain segments of the economy continue to show signs of slowing, resulting in higher probabilities of default, which is a key driver for credit grading. The resulting net increase in criticized assets, in combination with increased loan balances, resulted in higher specific and collective allowances at December 31, 2007.

Overall, commercial loan credit quality remains stable and well-controlled. Higher total criticized loan balances for 2007 as compared with 2006 (refer to page 61 of this Form 10-K) resulted mainly from downgrades in real estate and middle market exposures. Total nonaccruing commercial loans, as a percentage of total commercial loans, remain low and are flat year over year. Based upon evaluation of the repayment capacity of the obligors, including support from adequately margined collateral, performance on guarantees, and other mitigating factors, impairment is moderately higher in 2007 as compared with 2006, and is adequately reflected in the allowances for specific and collective impairment.

Provisions on commercial loans have increased in 2007, as compared to 2006, primarily due to a change in loan loss reserve methodology for HUSI’s small business revolving line of credit product. Additionally, commercial real estate provisions have increased as a result of customer downgrades. Any sudden and/or unexpected adverse economic events or trends could significantly affect credit quality and increase provisions for credit losses.

2006

Criticized asset classifications are based on the risk rating standards of HUSI’s primary regulator. Higher substandard criticized assets (refer to page 61 of this Form 10-K) resulted mainly from downgrades in auto and insurance industry exposures within the Global Banking and Markets business segment, and middle market commercial exposures within CMB. The downgrades resulted in part from changes in the credit metrics for specific credits within these industries and portfolios. Total nonaccruing commercial loans remain low as a percentage of total commercial loans.

During 2006, HUSI’s management began to make more extensive use of available tools to more actively manage net exposure within its corporate loan portfolios with an increased syndication capacity as well as increased use of credit default swaps to economically hedge and reduce certain exposures.

Credit Card Receivable Credit Quality

Credit card receivables are primarily private label receivables, including closed and open ended contracts, acquired from HSBC Finance Corporation. Receivables included in the private label credit card portfolio are generally maintained in accruing status until being charged off six months after delinquency. The following table provides credit quality data for credit card receivables.



December 31	2007			2006

($ in millions)
Accruing credit card receivables contractually past due 90 days or more:
Balance at end of period	$	432		$	339
As a percent of total credit card receivables		2.23	%		1.86	%

Allowance for credit losses associated with credit card receivables:
Balance at end of period	$	997		$	626
As a percent of total credit card receivables		5.14	%		3.43	%

Net charge offs of credit card receivables:
Total for the year ended	$	737		$	558
Net charge offs as a percent of annual average credit card receivables		4.12	%		3.49	%

2007

The allowance for credit losses associated with credit card receivables increased 59% to $997 million in 2007. Net charge off and provision activity was higher during 2007 as compared to 2006 due to increased private label and MasterCard/Visa credit card receivable balances and to higher delinquencies within these portfolios, which have resulted in a higher collective allowance balance. Additionally, the increased allowance for credit losses associated with credit card receivables reflects a refinement in the methodology used to estimate inherent losses on private label loans less than 30 days delinquent, which increased credit loss reserves by $107 million in the fourth quarter. Underwriting criteria are continually being reviewed and will be modified as necessary based on the current economic environment.

2006

The allowance for credit losses associated with credit card receivables increased 4% to $626 million for 2006. Net charge off and provision activity during 2006, as well as the allowance balance at December 31, 2006, are generally consistent with increased private label credit card receivable balances (refer to page 52 of this Form 10-K for commentary regarding credit card receivables).

Residential Mortgage Loan Credit Quality

2007

The increase in the allowance for credit losses related to residential mortgage loans during 2007 was primarily related to increased delinquencies and charge offs in the portfolio of higher quality nonconforming residential mortgage loans which HUSI purchased from HSBC Finance Corporation in order to hold in the residential mortgage loan portfolio. Also contributing to this increase are delinquencies and charge offs within the Home Equity Line of Credit (HELOC) portfolio, primarily due to continued deterioration in the housing markets. Other prime mortgage loans are also experiencing minimal deterioration.

Additional disclosures regarding certain risk concentrations inherent within the residential mortgage loan portfolio are provided beginning on page 66 of this Form 10-K.

2006

The allowance for credit losses related to residential mortgage loans decreased 9% during 2006. Lower loan balances resulted in lower allowance requirements during the year. HUSI’s residential mortgage portfolio is primarily comprised of prime mortgage loans, for which credit quality remained strong during 2006 and 2005.

Reserve for Off-Balance Sheet Exposures

HUSI maintains a separate reserve for credit risk associated with certain off-balance sheet exposures including letters of credit, unused commitments to extend credit and financial guarantees. This reserve, included in other liabilities, was $105 million and $98 million at December 31, 2007 and 2006, respectively.

Concentrations of Credit Risk

A concentration of credit risk is defined as a significant credit exposure with an individual or group engaged in similar activities or affected similarly by economic conditions. HUSI enters into a variety of transactions in the normal course of business that involve both on and off-balance sheet credit risk. Principal among these activities is lending to various commercial, institutional, governmental and individual customers. HUSI participates in lending activity throughout the United States and internationally. In general, HUSI controls the varying degrees of credit risk involved in on and off-balance sheet transactions through specific credit policies. These policies and procedures provide for a strict approval, monitoring and reporting process. It is HUSI’s policy to require collateral when it is deemed appropriate. Varying degrees and types of collateral are secured depending upon management’s credit evaluation.

As with any nonconforming and non-prime loan products, HUSI utilizes high underwriting standards and prices these loans in a manner that is appropriate to compensate for higher risk.

Certain residential mortgage loans have high loan-to-value (LTV) ratios and no mortgage insurance, which could result in potential inability to recover the entire investment in loans involving foreclosed or damaged properties.

HUSI also offers interest-only residential mortgage loans. These interest-only loans allow customers to pay only the accruing interest for a period of time, which results in lower payments during the initial loan period. Depending on a customer’s financial situation, the subsequent increase in the required payment attributable to loan principal could affect a customer’s ability to repay the loan at some future date when the interest rate resets and/or principal payments are required.

Outstanding balances of high LTV and interest-only loans are summarized in the following table.



December 31	2007		2006

(in millions)
Residential mortgage loans with high LTV and no mortgage insurance	$	2,345	$	3,079
Interest-only residential mortgage loans		6,161		7,537

Total	$	8,506	$	10,616


Concentrations of first and second liens within the residential mortgage loan portfolio are summarized in the following table. Amounts in the table exclude loans held for sale.


December 31		2007		2006

(in millions)
Closed end:
First lien	$	28,315	$	31,876
Second lien		1,096		474
Revolving:
Second lien		3,082		3,231

Total	$	32,493	$	35,581

HUSI also offers adjustable rate residential mortgage loans which allow it to adjust pricing on the loan in line with market movements. At December 31, 2007, HUSI had approximately $17.9 billion in adjustable rate residential mortgage loans. In 2008, approximately $2.8 billion of adjustable rate residential mortgage loans will experience their first interest rate reset. In 2009, approximately $8.9 billion of adjustable rate residential mortgage loans will experience their first interest rate reset. As interest rates have risen over the last three years, many adjustable rate loans are expected to require a significantly higher monthly payment following their first adjustment. A customer’s financial situation at the time of the interest rate reset could affect the customer’s ability to repay the loan after the adjustment.

Regional exposure at December 31, 2007 for certain loan portfolios is summarized in the following table.



December 31, 2007	Commercial Construction and Other Real Estate Loans			Residential Mortgage Loans			Credit Card Receivables

New York State		51	%		26	%		10	%
North Central United States		3			11			24
North Eastern United States		9			12			14
Southern United States		18			23			28
Western United States		19			28			24

Total		100	%		100	%		100	%

Cross-Border Net Outstandings

Cross-border net outstandings, as calculated in accordance with Federal Financial Institutions Examination Council (FFIEC) guidelines, are amounts payable to HUSI by residents of foreign countries regardless of the currency of claim and local country claims in excess of local country obligations. Cross-border net outstandings include deposits placed with other banks, loans, acceptances, securities available for sale, trading securities, revaluation gains on foreign exchange and derivative contracts and accrued interest receivable. Excluded from cross-border net outstandings are, among other things, the following: local country claims funded by non-local country obligations (U.S. dollar or other non-local currencies), principally certificates of deposit issued by a foreign branch, where the providers of funds agree that, in the event of the occurrence of a sovereign default or the imposition of currency exchange restrictions in a given country, they will not be paid until such default is cured or currency restrictions lifted or, in certain circumstances, they may accept payment in local currency or assets denominated in local currency (hereinafter referred to as constraint certificates of deposit); and cross-border claims that are guaranteed by cash or other external liquid collateral. Cross-border net outstandings that exceed .75% of total assets at year-end are summarized in the following table.



	Banks and Other Financial Institutions			Commercial and Industrial			Total

(in millions)
December 31, 2007:
France		$	1,562		$	21	$	1,583
Canada			833			1,011		1,844
United Kingdom			2,697			1,204		3,901
Germany			2,017			60		2,077
Brazil			1,741			715		2,456

		$	8,850		$	3,011	$	11,861


December 31, 2006:
France		$	1,782		$	49	$	1,831
Canada			1,305			793		2,098
United Kingdom			1,738			1,127		2,865

		$	4,825		$	1,969	$	6,794


December 31, 2005:
United Kingdom		$	1,497		$	970	$	2,467

Credit and Market Risks Associated with Derivative Contracts

Credit (or repayment) risk in derivative instruments is minimized by entering into transactions with high quality counterparties, including other HSBC entities. Counterparties include financial institutions, government agencies, both foreign and domestic, corporations, funds (mutual funds, hedge funds, etc.), insurance companies, including monoline insurance companies, and private clients. These counterparties are subject to regular credit review by the credit risk management department. Most derivative contracts are governed by an International Swaps and Derivatives Association Master Agreement. Depending on the type of counterparty and the level of expected activity, bilateral collateral arrangements may also be required.

The total risk in a derivative contract is a function of a number of variables, such as:


•	whether counterparties exchange notional principal;

•	volatility of interest rates, currencies, equity or corporate reference entity used as the basis for determining contract payments;

•	maturity and liquidity of contracts;

•	credit worthiness of the counterparties in the transaction; and

•	existence and value of collateral received from counterparties to secure exposures.

The following table presents credit risk exposure and net fair value associated with derivative contracts. In the table, current credit risk exposure is the recorded fair value of derivative receivables, which represents revaluation gains from the marking to market of derivative contracts held for trading purposes, for all counterparties with an International Swaps and Derivatives Association Master Agreement in place.

Future credit risk exposure in the following table is measured using rules contained in the risk-based capital guidelines published by U.S. banking regulatory agencies. The risk exposure calculated in accordance with the risk-based capital guidelines potentially overstates actual credit exposure, because:


•	the risk-based capital guidelines ignore collateral that may have been received from counterparties to secure exposures; and

•	the risk-based capital guidelines compute exposures over the life of derivative contracts. However, many contracts contain provisions that allow a bank to close out the transaction if the counterparty fails to post required collateral, or is downgraded below a certain rating by external ratings agencies, or contracts may be subject to break clauses at specific dates. As a result, these contracts have potential future exposures that are often much smaller than the future exposures derived from the risk-based capital guidelines.

The net credit risk exposure amount in the following table does not reflect the impact of bilateral netting (i.e., netting with a single counterparty when a bilateral netting agreement is in place). However, the risk-based capital guidelines recognize that bilateral netting agreements reduce credit risk and therefore allow for reductions of risk-weighted assets when netting requirements have been met. In addition, risk-based capital rules require that netted exposures of various counterparties be assigned risk-weightings, which result in risk-weighted amounts for regulatory capital purposes that are a fraction of the original netted exposures.



December 31	2007			2006

(in millions)
Risk associated with derivative contracts:
Current credit risk exposure	$	14,711		$	11,398
Future credit risk exposure		74,236			72,447

Total risk exposure		88,947			83,845
Less: collateral held against exposure		(5,148	)		(3,989	)

Net credit risk exposure	$	83,799		$	79,856

The table below summarizes the risk profile of the counterparties of HUSI’s on balance sheet exposure to derivative contracts, net of cash and other highly liquid collateral. The exposure in the unrated category are exposures to counterparties that have not been rated by an external rating agency. These counterparties are, however, rated according to HUSI's Internal Credit Rating System and exposure is mostly equivalent to investment grade. Refer to pages 77-79 of this Form 10-K for additional commentary relating to the Internal Credit Rating System.



	Percent of Current Credit Risk Exposure, Net of Collateral

Rating equivalent at December 31	2007			2006

AAA to AA-		52	%		46	%
A+ to A-		29			31
BBB+ to BBB-		4			15
BB+ to B-		5			4
CCC+ and below		*			*
Unrated		10			4

Total		100	%		100	%

* Less than .5 percent

HUSI enters into basis trades to monetize the basis difference between a bond and a credit default swap (CDS). In a basis trade, HUSI subscribes newly-issued floating rate investment grade mortgage backed or asset backed securities and contemporaneously buys credit protection from monoline insurers for a premium. The sponsoring monoline provides financial guaranty to HUSI if there is a credit event. When the bond spread is higher than the CDS spread, the basis is “negative” and the trade is described as a negative basis trade. The monolines typically do not post collateral and HUSI trades with monolines based on their credit ratings. As of December 31, 2007, HUSI had approximately $5,911 million notional of CDS under the negative basis arrangements with monolines.

Due to recent downgrades in HUSI’s internal credit ratings of monoline insurance companies (refer to Credit Risk Management beginning on page 77 of this Form 10-K for additional commentary relating to HUSI’s credit rating system), fair value adjustments have been recorded due to counterparty credit exposures. As of December 31, 2007, this exposure totaled $1,083 million. HUSI recorded write-downs on these contracts of approximately $287 million, which reflects the decreased credit quality of these entities and concerns over their ability to perform at December 31, 2007. The exposure relating to monoline insurance companies which are rated CCC+ and below has been fully written down as of December 31, 2007.

Market risk is the adverse effect that a change in market liquidity, interest rates, currency, or implied volatility rates has on the value of a financial instrument. HUSI manages the market risk associated with interest rate and foreign exchange contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken. HUSI also manages the market risk associated with the trading derivatives through hedging strategies that correlate the rates, price and spread movements. HUSI measures this risk daily by using Value at Risk (VAR) and other methodologies. Refer to Market Risk Management, beginning on page 84 of this Form 10-K, for commentary regarding the use of VAR analyses to monitor and manage interest rate and other market risks.

HUSI’s Asset and Liability Policy Committee is responsible for monitoring and defining the scope and nature of various strategies utilized to manage interest rate risk that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedge strategies are then incorporated into HUSI’s overall interest rate risk management and trading strategies.

Off-Balance Sheet Arrangements and Contractual Obligations

Off-Balance Sheet Arrangements

As part of its normal operations, HUSI enters into various off-balance sheet arrangements with affiliates and third parties. These arrangements arise principally in connection with HUSI’s lending and client intermediation activities and involve primarily extensions of credit and guarantees.

As a financial services provider, HUSI routinely extends credit through loan commitments and lines and letters of credit and provides financial guarantees, including derivative transactions that meet the definition of a guarantee under FIN 45. The contractual amounts of these financial instruments represent HUSI’s maximum possible credit exposure in the event that a counterparty draws down the full commitment amount or HUSI is required to fulfill its maximum obligation under a guarantee.

The following table presents total contractual amounts and maturity information related to HUSI’s off-balance sheet arrangements. Many of these commitments and guarantees expire unused or without default; as a result, HUSI believes that the contractual amount is not representative of the actual future credit exposure or funding requirements. Descriptions of the various arrangements follow the table.

Balance at December 31, 2007

One

Over One

Over

Balance at

Year

Through

Five

December 31,

or Less

Five Years

Years

Total

2006

(in millions)

Standby letters of credit, net of participations (1)

6,527

2,371

123

9,021

7,259

Commercial letters of credit

818

116

—

934

795

Credit derivatives considered guarantees (2)

20,854

406,684

222,705

650,243

431,631

Other commitments to extend credit:

Commercial

30,640

25,204

3,197

59,041

55,862

Consumer

10,053

—

10,053

9,627

Total

68,892

434,375

226,025

729,292

505,174


(1)	Includes $598 million and $542 million issued for the benefit of HSBC affiliates at December 31, 2007 and 2006, respectively.

(2)	Includes $98,250 million and $71,908 million issued for the benefit of HSBC affiliates at December 31, 2007 and 2006, respectively.

Letters of Credit

HUSI may issue a letter of credit for the benefit of a customer, authorizing a third party to draw on the letter for specified amounts under certain terms and conditions. The issuance of a letter of credit is subject to HUSI’s credit approval process and collateral requirements. HUSI issues two types of letters of credit, commercial and standby.


•	A commercial letter of credit is drawn down on the occurrence of an expected underlying transaction, such as the delivery of goods. Upon the occurrence of the transaction, the amount drawn under the commercial letter of credit is recorded as a receivable from the customer in other assets and as a liability to the vendor in other liabilities until settled.

•	A standby letter of credit is issued to third parties for the benefit of a customer and is essentially a guarantee that the customer will perform, or satisfy some obligation, under a contract. It irrevocably obligates HUSI to pay a third party beneficiary when a customer either: (1) in the case of a performance standby letter of credit, fails to perform some contractual non-financial obligation, or (2) in the case of a financial standby letter of credit, fails to repay an outstanding loan or debt instrument.

Fees are charged for issuing letters of credit commensurate with the customer’s credit evaluation and the nature of any collateral. Included in other liabilities are deferred fees on standby letters of credit, representing the fair value of HUSI’s “stand ready obligation to perform” under these guarantees, amounting to $25 million and $21 million at December 31, 2007 and 2006, respectively. Fees are recognized ratably over the term of the standby letter of credit. Also included in other liabilities is an allowance for credit losses on unfunded standby letters of credit of $27 million and $25 million at December 31, 2007 and 2006, respectively.

Credit Derivatives Considered Guarantees

HUSI enters into credit derivative contracts both for its own benefit and to satisfy the needs of its customers. Credit derivatives are arrangements that provide for one party (the “beneficiary”) to transfer the credit risk of a “reference asset” to another party (the “guarantor”). Under this arrangement the guarantor assumes the credit risk associated with the reference asset without directly purchasing it. The beneficiary agrees to pay to the guarantor a specified fee. In return, the guarantor agrees to pay the beneficiary an agreed upon amount if there is a default during the term of the contract.

In accordance with its policy, HUSI offsets most of the market risk it assumes in selling credit guarantees through a credit derivative contract with another counterparty. Credit derivatives, although having characteristics of a guarantee, are accounted for as derivative instruments and are carried at fair value. The commitment amount included in the table on the preceding page is the maximum amount that HUSI could be required to pay, without consideration of the approximately equal amount receivable from third parties and any associated collateral.

Other Commitments to Extend Credit

Other commitments to extend credit include arrangements whereby HUSI is contractually obligated to extend credit in the form of loans, participations in loans, lease financing receivables, or similar transactions. Consumer commitments comprise unused credit card lines and commitments to extend credit secured by residential properties. HUSI has the right to change or terminate any terms or conditions of a customer’s credit card or home equity line of credit account, upon notification to the customer. Commercial commitments comprise primarily those related to secured and unsecured loans and lines of credit and certain asset purchase commitments. In connection with its commercial lending activities, HUSI provides liquidity support to a number of multi-seller and single-seller asset backed commercial paper conduits (ABCP conduits) sponsored by affiliates and third parties. These ABCP conduits and HUSI’s variable interests in them are more fully described in Note 27 Variable Interest Entities beginning on page 155 of this Form 10-K.

HUSI provides liquidity support to ABCP conduits in the form of liquidity loan agreements and liquidity asset purchase agreements. Liquidity facilities provided to multi-seller conduits support transactions associated with a specific seller of assets to the conduit and HUSI would only be required to provide support in the event of certain triggers associated with those transactions and the underlying assets. Liquidity facilities provided to single-seller conduits are not identified with specific transactions or assets and HUSI would be required to provide support upon occurrence of certain triggers that generally affect the conduit as a whole. HUSI’s obligations are generally pari passu with that of other institutions that also provide liquidity support to the same conduit or for the same transactions. HUSI does not provide any program-wide credit enhancements to ABCP conduits.

Under the terms of these liquidity agreements, the ABCP conduits may call upon HUSI to lend money or to purchase certain assets upon the occurrence of certain trigger events. These trigger events are generally limited to market disruptions and declines in the value of the underlying assets that result in an inability of the ABCP conduit to issue new commercial paper to replace maturing commercial paper. With regard to a multi-seller liquidity facility, the maximum amount that HUSI could be required to advance upon the occurrence of a trigger event is generally limited to the lesser of the amount of outstanding commercial paper related to the supported transaction and the balance of the assets underlying that transaction adjusted by a funding formula that excludes defaulted and impaired assets. Under a single-seller liquidity facility, the maximum amount that HUSI and other liquidity providers could be required to advance is also generally limited to each provider’s pro-rata share of the lesser of the amount of outstanding commercial paper and the balance of unimpaired performing assets held by the conduit. As a result, the maximum amount that HUSI would be required to fund may be significantly less than the maximum contractual amount specified by the liquidity agreement.

The tables below present information on HUSI’s liquidity facilities with ABCP conduits at December 31, 2007 excluding facilities with certain multi-seller ABCP conduits that are subject to agreements affecting HUSI’s obligations and which are separately discussed in the commentary following the tables. The maximum exposure to loss presented in the first table represents the maximum contractual amount of loans and asset purchases HUSI could be required to make under the liquidity agreements. This amount does not reflect the funding limits discussed above and also assumes that HUSI suffers a total loss on all amounts advanced and all assets purchased from the ABCP conduits. As such, HUSI believes that this measure significantly overstates its expected loss exposure.

Conduit Assets (1)

Conduit Funding (1)

Conduit Type

Maximum
Exposure
to Loss

Total
Assets

Weighted
Average Life
(Months)

Commercial
Paper

Weighted
Average Life
(Days)

($ in millions)

HSBC affiliate sponsored (multi-seller)

9,301

6,502

6,499

Third-party sponsored:

Multi-seller

296

Single-seller

1,149

26,227

24,837

Total

10,746

33,025

31,632


(1)	For multi-seller conduits, the amounts presented represent only the specific assets and related funding supported by HUSI’s liquidity facilities. For single-seller conduits, the amounts presented represent the total assets and funding of the conduit.



	Average Asset Mix			Average Credit Quality (1)

Asset Class				Aaa			Aa			A

Multi-seller conduits
Debt securities backed by:
Credit card receivables		29	%		59	%					41	%
Auto loans and leases		26									100	%
Trade receivables		20			22	%		18	%		60	%
Other securities		11			100	%
Capital calls		4									100	%
Collateralized debt obligations		3			100	%
Mortgages		3									100	%
Auto dealer floor plan loans		3									100	%
Consumer loans		1									100	%

Total		100	%

Single-seller conduits
Debt securities backed by:
Auto loans and leases		82	%		98	%		2	%
Commercial property leases		2									100	%
Loans and trade receivables:
Auto loans and leases		16						100	%

Total		100	%


(1)	Credit quality is based on Standard and Poor’s ratings at December 31, 2007 except for loans and trade receivables held by single-seller conduits, which are based on HUSI’s internal ratings.

HUSI receives fees for providing these liquidity facilities. Credit risk on these obligations is managed by subjecting them to HUSI’s normal underwriting and risk management processes.

During the second half of 2007, asset backed commercial paper markets experienced a decline in liquidity as concerns surrounding U.S. sub-prime residential mortgages spilled over into other credit markets. As a result, issuers of asset backed commercial paper found it increasingly difficult to refinance maturing commercial paper and many found it necessary to draw on liquidity facilities or obtain additional support in other forms. Despite market difficulties, none of the ABCP conduits included in the tables above drew on the liquidity facilities provided by HUSI during 2007. HUSI did, however, provide support to several HSBC-affiliate sponsored ABCP conduits by purchasing up to $1.16 billion of A-1/P-1 rated commercial paper issued by them. The majority of commercial paper purchased was repaid upon maturity, although HUSI continued to hold $306 million of such paper at December 31, 2007.

As noted, the tables above do not include information on liquidity facilities that HUSI provides to certain multi-seller ABCP conduits that are subject to agreements affecting HUSI’s contractual obligations under the facilities. As a result of difficulties in the asset backed commercial paper markets, HUSI entered into various agreements during the second half of 2007 that modified its obligations with respect to these facilities. Under one of these agreements, known as the Montreal Accord, the adhering parties agreed not to trade, trigger default provisions, pursue liquidity or collateral calls, or exercise security rights over assets held by the covered conduits while they work to restructure outstanding commercial paper into longer-term securities. Separately, HUSI agreed to purchase and hold a specified amount of commercial paper issued by certain conduits covered by HUSI liquidity facilities. While the parties to these arrangements also agreed not to trigger defaults, make liquidity calls, or exercise security rights, the sponsors of these conduits agreed to meet certain collateral calls made by HUSI. As of December 31, 2007, one of the conduits subject to the Montreal Accord had been restructured and, as a result, HUSI no longer had any obligation to, or amounts due from, the restructured conduit. At December 31, 2007, the total amount of liquidity facilities HUSI provided to multi-seller ABCP conduits subject to and awaiting restructure under the various agreements was $1.4 billion (net of participations of $414 million, which includes a $312 million participation that expired on December 31, 2007), of which $10 million had been funded. Additionally, HUSI is a party to various derivative transactions with these conduits. The current exposure to these contracts is fully collateralized. Commercial

paper purchased and held by HUSI in connection with these agreements was $408 million at December 31, 2007 and is reported in securities available for sale.

In addition to the facilities provided to ABCP conduits, HUSI also provides a $50 million liquidity facility to a third-party sponsored multi-seller structured investment vehicle (SIV). This SIV and HUSI’s involvement with it is more fully described in Note 27 Variable Interest Entities beginning on page 155 of this Form 10-K. At December 31, 2007, $19 million of this facility had been funded and is recorded in loans on HUSI’s balance sheet. The funded and unfunded amounts related to this liquidity facility were considered in the determination of HUSI’s allowance for loan losses and its reserve for off-balance sheet exposures, respectively, at December 31, 2007. In January 2008, HUSI funded the remainder of the facility and, as a result of a significant downgrade in the borrower’s credit rating, recorded a specific allowance against the fully drawn facility.

Money Market Funds

HUSI has established and manages a number of constant net asset value (CNAV) money market funds that invest in shorter-dated highly-rated money market securities to provide investors with a highly liquid and secure investment. These funds price the assets in their portfolio on an amortized cost basis, which enables them to create and liquidate shares at a constant price. The funds, however, are not permitted to price their portfolios at amortized cost if that amount varies by more than 50 basis points from the portfolio’s market value. In that case, the fund would be required to price its portfolio at market value and consequently would no longer be able to create or liquidate shares at a constant price.

At December 31, 2007, one of HUSI’s sponsored CNAV funds, which had total net assets of $7.6 billion, held $558 million of investments issued by SIVs. As a result of recent market conditions and rating agency actions, these investments have experienced declines in market value. HUSI has no legal obligation, and currently has no plan, to offer financial support to this fund in the event that it is unable to maintain a constant net asset value as a result of becoming unable to value its assets at amortized cost. This fund has, however, received support from an affiliate of HUSI, which in January 2008 provided a letter of limited indemnity in relation to certain of the fund’s SIV investments.

HUSI does not consolidate the CNAV funds it sponsors as they are not VIEs and HUSI does not hold a majority voting interest.

Contractual Obligations

Obligations to make future payments under contracts are presented in the following table.

December 31, 2007

One
Year
or Less

Over One
Through
Five Years

Over
Five
Years

Total

(in millions)

Subordinated long-term debt and perpetual capital notes (1)

250

779

4,726

5,755

Other long-term debt, including capital lease obligations (1)

8,628

8,851

5,102

22,581

Pension and other postretirement benefit obligations (2)

287

471

820

Minimum future rental commitments on operating leases (3)

106

362

288

756

Purchase obligations (4)

—

114

Total

9,129

10,310

10,587

30,026


(1)	Represents future principal payments related to debt instruments included in Note 15 of the consolidated financial statements beginning on page 128 of this Form 10-K.

(2)	Represents estimated future employee service expected to be paid based on assumptions used to measure HUSI’s benefit obligation at December 31, 2007. See Note 23 of the consolidated financial statements beginning on page 144 of this Form 10-K.

(3)	Represents expected minimum lease payments under noncancellable operating leases for premises and equipment included in Note 25 of the consolidated financial statements beginning on page 152 of this Form 10-K.

(4)	Represents binding agreements for facilities management and maintenance contracts, custodial account processing services, internet banking services, consulting services, real estate services and other services.

Risk Management

Overview

Some degree of risk is inherent in virtually all of HUSI’s activities. For the principal activities undertaken by HUSI, the most important types of risks are considered to be credit, interest rate, market, liquidity, operational, fiduciary and reputational. Market risk broadly refers to price risk inherent in mark to market positions taken on trading and non-trading instruments. Operational risk technically includes legal and compliance risk. However, since compliance risk, including anti-money laundering (AML) risk, has such broad scope within HUSI’s businesses, it is addressed below as a separate functional discipline. During 2007, there were no significant changes to the policies or approach for managing various types of risk, although HUSI continues to monitor current market conditions and will adjust risk management policies and procedures if deemed necessary.

The objective of HUSI’s risk management system is to identify, measure and monitor risks so that:


•	the potential costs can be weighed against the expected rewards from taking the risks;

•	appropriate disclosures can be made to all concerned parties;

•	adequate protections, capital and other resources can be put in place to weather all significant risks; and

•	compliance with all relevant laws, regulations and regulatory requirements is ensured through staff education, adequate processes and controls, and ongoing monitoring efforts.

Historically, HUSI’s approach toward risk management has emphasized a culture of business line responsibility combined with central requirements for diversification of customers and businesses. Extensive centrally determined requirements for controls, limits, reporting and the escalation of issues have been detailed in HUSI’s and HSBC’s policies and procedures. In addition, HUSI has a formal independent compliance function, the staff of which has been aligned with, and has advised, each business and support function.

As a result of an increasingly complex business environment, increased regulatory scrutiny, and the evolution of improved risk management tools and standards, HUSI has significantly upgraded, and continues to upgrade, its methodologies and systems. New practices and techniques have been developed that involve data development, modeling, simulation and analysis, management information systems development, self-assessment, and staff education programs.

Risk management oversight begins with HUSI’s Board of Directors and its various committees, principally the Audit Committee. Specific oversight of various risk management processes is provided by the Risk Management Committee, which was assisted by three principal subcommittees through 2007:


•	the Asset and Liability Policy Committee;

•	the Operational Risk Management Committee; and

•	the Credit Risk Committee.

The Risk Management Committee and each sub-committee were chartered by the Board of Directors. While the charters were tailored to reflect the roles and responsibilities of each committee, they all had the following common themes:


•	defining risk appetites, policies and limits;

•	monitoring and assessing exposures, trends and the effectiveness of risk management;

•	reporting to the Board of Directors; and

•	promulgating a suitable risk taking, risk management, and compliance culture.

Day-to-day management of credit risk is performed by the Co-Chief Credit Officers. For retail consumer loan portfolios, such as credit cards, installment loans, and residential mortgages, the consumer credit management skills and tools of HSBC Finance Corporation are leveraged. Day-to-day management of interest rate and market risk is centralized principally under the Treasurer. Operational, fiduciary, and compliance risk is decentralized and is the responsibility of each business and support unit. However, for all risk types, there are independent risk specialists that set standards, develop new risk methodologies, maintain central risk databases, and conduct reviews and analysis. The Chief Operating Officer, the Co-Chief Credit Officers and the Executive Vice President for Compliance and Anti-Money Laundering provide day-to-day oversight of these activities and work closely with internal audit and senior risk specialists at HNAH and HSBC.

Economic and Regulatory Capital

Economic Capital

Economic capital is defined as the amount of capital required to sustain a business through a complete business cycle, enabling the business to absorb unexpected losses and thus limit the probability of insolvency. Economic capital is measured at the business unit level based on four categories of risk:


•	Credit risk

•	Operational risk

•	Market risk

•	Interest rate risk

HUSI has begun a process to quantify additional risks, beyond the few risks quantified under economic capital. The quantification process is undertaken in conjunction with the HBUS Internal Capital Adequacy Assessment Process (ICAAP), and will include an evaluation of risks such as pension risk, liquidity risk, business risk, strategic risk and other risks. ICAAP is being developed in conjunction with the HBUS adoption of the Basel II framework as adopted by the U.S. Regulators.

Whereas regulatory capital is traditionally only calculated at the total bank level as a measure of the minimum capital needed for regulatory compliance and is based on the amount of capital maintained in relation to risk-weighted assets at a specific point in time, economic capital is actually a measure of risk. As a result, economic capital can be compared to total corporate capital resources and, since it can be assigned to each business unit according to its risk characteristics, it can be used to establish business performance measures, make pricing decisions or set portfolio guidelines.

Economic capital is an internal measure developed by HUSI based on its unique set of diverse businesses, risk appetites, and management practices. In 2004, HUSI began to calculate economic capital from statistical analyses of possible losses related to credit, market, interest rate and operational risk. HUSI calculates economic capital sufficient to cover losses over a one year time horizon at a 99.95% confidence level. This is consistent with HBUS’s “AA” rating, as “AA” rated credits have historically defaulted at a rate of about .05% per year. The one year time horizon is also consistent with traditional planning and budgeting time horizons. Quantification of possible losses related to fiduciary and reputational risk, are broadly covered under the credit, market and operational risk measurements.

Basel Capital Standards

In December 2007, U.S. regulators published a final rule regarding Risk-Based Capital Standards. This final rule represents the U.S. adoption of the Basel II Capital Accord. The final rule will become effective April 1, 2008, and requires HUSI to adopt its provisions no later than April 1, 2011. Final adoption must be preceded by a parallel run period of at least four quarters.

An implementation plan for the new rule must be presented to the HUSI Board of Directors prior to October 1, 2008, in compliance with the final rule. The implementation plan will detail HUSI’s readiness for adopting the new standard, as well as the expected timing for adoption.

In addition, HUSI continues to support the HSBC Group implementation of the Basel II framework, as adopted by the Financial Services Authority (FSA). HUSI supplies data regarding credit risk, operational risk, and market risk to support the Group’s regulatory capital and risk weighted asset calculations. Revised FSA capital adequacy rules for the HSBC Group became effective January 1, 2008.

Credit Risk Management

Credit risk is the potential that a borrower or counterparty will default on a credit obligation, as well as the impact on the value of credit instruments due to changes in the probability of borrower default.

For HUSI, credit risk is inherent in various on and off-balance sheet instruments and arrangements:


•	in loan portfolios;

•	in investment portfolios;

•	in unfunded commitments such as letters of credit and lines of credit that customers can draw upon; and

•	in treasury instruments, such as interest rate swaps which, if more valuable today than when originally contracted, may represent an exposure to the counterparty to the contract.

While credit risk exists widely within HUSI, diversification among various commercial and consumer portfolios helps HUSI to lessen risk exposure. Analysis of HUSI’s credit quality begins on page 59 of this Form 10-K.

HUSI assesses, monitors and controls credit risk with formal standards, policies and procedures. An independent Credit Risk function is maintained under the direction of Co-Chief Credit Officers, who report directly to the Chief Executive Officer of HUSI.

The responsibilities of the credit risk function include:


•	Formulating credit risk policies - HUSI’s policies are designed to ensure that various retail and commercial business units operate within clear standards of acceptable credit risk. HUSI’s policies ensure that the HSBC standards are consistently implemented across all businesses and that all regulatory requirements are also considered. Credit policies are reviewed and approved annually by the Audit Committee.

•	Approving new credit exposures and independently assessing large exposures annually - The Co-Chief Credit Officers delegate credit authority to various lending units throughout HUSI. However, most large credits are reviewed and approved centrally through a dedicated Credit Approval Unit that reports directly to the Co-Chief Credit Officers. In addition, the Co-Chief Credit Officers coordinate the approval of material credits with HSBC Group Credit Risk which, subject to certain agreed-upon limits, will review and concur on material new and renewal transactions.

•	Maintaining and developing the governance and operation of HUSI’s risk rating system - HUSI utilizes a two-dimensional credit risk rating system in order to categorize exposures meaningfully and enable focussed management of the risks involved. This ratings system is comprised of a 22 category Customer Risk Rating which considers the probability of default of an obligor and a separate assessment of a transaction’s potential loss given default. Rating methodologies are based upon a wide range of analytics and market data-based tools, which are core inputs to the assessment of counterparty risk. Although automated risk rating processes are increasingly used, for larger facilities the ultimate responsibility for setting risk grades rests in each case with the final approving executive. Risk grades are reviewed frequently and amendments, where necessary, are implemented promptly.


•	Measuring portfolio credit risk - Over the past few years, the advanced credit ratings system has been used to implement a credit economic capital risk measurement system to measure the risk in HUSI’s credit portfolios, using the measure in certain internal and Board of Directors reporting. Simulation models are used to determine the amount of unexpected losses, beyond expected losses, that HUSI must be prepared to support with capital given its targeted debt rating. Monthly credit economic capital reports are generated and reviewed with management and the business units. Efforts continue to refine both the inputs and assumptions used in the credit economic capital model to increase its usefulness in pricing and the evaluation of large and small commercial and retail customer portfolio products and business unit return on risk.

•	Monitoring portfolio performance - HUSI has implemented a credit data warehouse to centralize the reporting of its credit risk, support the analysis of risk using tools such as economic capital, and to calculate its credit loss reserves. This data warehouse also supports HSBC’s wider effort to meet the requirements of Basel II and to generate credit reports for management and the Board of Directors.

•	Establishing counterparty and portfolio limits - HUSI monitors and limits its exposure to individual counterparties and to the combined exposure of related counterparties. In addition, selected industry portfolios, such as real estate and structured products, are subject to caps that are established by the Co-Chief Credit Officers and reviewed where appropriate by management committees and the Board of Directors. Counterparty credit exposure related to derivative activities is also managed under approved limits. Since the exposure related to derivatives is variable and uncertain, HUSI uses internal risk management methodologies to calculate the 95% worst-case potential future exposure for each customer. These methodologies take into consideration, among other factors, cross-product close-out netting, collateral received from customers under Collateral Support Annexes (CSAs), termination clauses, and off-setting positions within the portfolio.

•	Managing problem commercial loans - Special attention is paid to problem loans. When appropriate, HUSI’s Special Credits Unit provides customers with intensive management and control support in order to help them avoid default wherever possible and maximize recoveries.

•	Establishing allowances for credit losses - The Co-Chief Credit Officers share the responsibility with the Chief Financial Officer for establishing appropriate levels of allowances for credit losses inherent in various loan portfolios.

•	Overseeing retail credit risk - Each retail business unit is supported by dedicated advanced risk analytics units. The Co-Chief Credit Officers provide independent oversight of credit risk associated with these retail portfolios and is supported by expertise from HNAH’s Retail Credit Management unit.

•	Chairing the Credit Risk Management Committee - The Co-Chief Credit Officers chair the Credit Risk Management Committee, which is responsible for strategic and collective oversight of the scope of risk taken, the adequacy of the tools used to measure it, and the adequacy of reporting.

Asset/Liability Management

Asset and liability management includes management of liquidity, interest rate and market risk. Liquidity risk is the potential that an institution will be unable to meet its obligations as they become due or fund its customers because of inadequate cash flow or the inability to liquidate assets or obtain funding itself. Market risk includes both interest rate and trading risk. Interest rate risk is the potential impairment of net interest income due to mismatched pricing between accrual accounted assets and liabilities. Market risk is the potential for losses in daily mark to market positions (mostly trading) due to adverse movements in money, foreign exchange, equity or other markets. In managing these risks, HUSI seeks to protect both its income stream and the value of its assets.

HUSI has substantial, but historically well controlled, interest rate risk in large part as a result of its portfolio of residential mortgages and mortgage backed securities, which consumers can prepay without penalty, and its large base of demand and savings deposits. These deposits can be withdrawn by consumers at will, but historically they have been a stable source of relatively low cost funds. Market risk exists principally in treasury businesses and to a lesser extent in the residential mortgage business where mortgage servicing rights and the pipeline of forward mortgage sales are hedged. HUSI has little foreign currency exposure from investments in overseas operations, which are limited in scope. Total equity investments, excluding stock owned in the Federal Reserve and New York Federal Home Loan Bank, represent less than 4% of total available for sale securities.

The management of liquidity, interest rate and most market risk is centralized in treasury and mortgage banking operations. In all cases, the valuation of positions and tracking of positions against limits is handled independently by HUSI’s finance units. Oversight of all liquidity, interest rate and market risks is provided by the Asset and Liability Policy Committee (ALCO) which is chaired by the Chief Financial Officer. Subject to the approval of the HUSI Board of Directors and HSBC, ALCO sets the limits of acceptable risk, monitors the adequacy of the tools used to measure risk, and assesses the adequacy of reporting. ALCO also conducts contingency planning with regard to liquidity.

Liquidity Risk Management

Liquidity risk is the risk that an institution will be unable to meet its obligations as they become due because of an inability to liquidate assets or obtain adequate funding. Liquidity is managed to provide the ability to generate cash to meet lending, deposit withdrawal and other commitments at a reasonable cost in a reasonable amount of time, while maintaining routine operations and market confidence. HUSI plans its market funding in conjunction with HSBC Finance Corporation and HSBC, as the markets increasingly view debt issuances from the separate companies within the context of their common parent company. Liquidity management is performed at HUSI and at HBUS. Each entity is required to have sufficient liquidity for a crisis situation. ALCO is responsible for the development and implementation of related policies and procedures to ensure that the minimum liquidity ratios and a strong overall liquidity position are maintained.

In carrying out this responsibility, ALCO projects cash flow requirements and determines the level of liquid assets and available funding sources to have at HUSI’s disposal, with consideration given to anticipated deposit and balance sheet growth, contingent liabilities, and the ability to access wholesale funding markets. HUSI’s liquidity management approach includes increased deposits, potential sales (e.g. residential mortgage loans), and securitizations/conduits (e.g. credit cards) in liquidity contingency plans. In addition, ALCO monitors the overall mix of deposit and funding concentrations to avoid undue reliance on individual funding sources and large deposit relationships. It must also maintain a liquidity management contingency plan, which identifies certain potential early indicators of liquidity problems, and actions that can be taken both initially and in the event of a liquidity crisis, to minimize the long-term impact on HUSI’s business and customer relationships. In the event of a cash flow crisis, HUSI’s objective is to fund cash requirements without access to the wholesale unsecured funding market for at least one year. Contingency funding needs will be satisfied primarily through the sale of the investment portfolio and liquidation of the residential mortgage portfolio. Securities may be sold or used as collateral in a repurchase agreement depending on the scenario. Portions of the mortgage portfolio may be sold, securitized, or used for collateral at the FHLB to increase borrowings.

Deposits from a diverse mix of “core” retail, commercial and public sources and online savings accounts represent a significant, cost-effective and stable source of liquidity under normal operating conditions. Total deposits increased $14 billion and $13 billion during 2007 and 2006, respectively. Online savings account growth was $4 billion and $6 billion for 2007 and 2006, respectively.

HUSI’s ability to regularly attract wholesale funds at a competitive cost is enhanced by strong ratings from the major credit ratings agencies. At December 31, 2007, HUSI and HBUS maintained the following long and short-term debt ratings:



	Moody’s	S&P	Fitch	DBRS *

HUSI:
Short-term borrowings	P-1	A-1+	F1+	R-1
Long-term debt	Aa3	AA-	AA	AA

HBUS:
Short-term borrowings	P-1	A-1+	F1+	R-1
Long-term debt	Aa2	AA	AA	AA

* Dominion Bond Rating Service.

Numerous factors, internal and external, may impact HUSI’s access to and costs associated with issuing debt in the global capital markets. These factors include HUSI’s debt ratings, overall economic conditions, overall capital markets volatility and the effectiveness of HUSI’s management of credit risks inherent in its customer base.

Cash resources, short-term investments and a trading asset portfolio are available to provide highly liquid funding for HUSI. Additional liquidity is provided by debt securities. Approximately $5 billion of debt securities in this portfolio at December 31, 2007 are expected to mature in 2008. The remaining $18 billion of debt securities not expected to mature in 2008 are available to provide liquidity by serving as collateral for secured borrowings, or if needed, by being sold. Further liquidity is available through HUSI’s ability to sell or securitize loans in secondary markets through whole-loan sales and securitizations. In 2007, HUSI sold residential mortgage loans of approximately $15 billion. The amount of residential mortgage loans and credit card receivables available to be sold or securitized totaled approximately $51 billion at December 31, 2007.

The economics and long-term business impact of obtaining liquidity from assets must be weighed against the economics of obtaining liquidity from liabilities, along with consideration given to the associated capital ramifications of these two alternatives. Currently, assets would be used to supplement liquidity derived from liabilities only in a crisis scenario.

It is the policy of HBUS to maintain both primary and secondary collateral in order to ensure precautionary borrowing availability from the Federal Reserve. Primary collateral is that which is physically maintained at the Federal Reserve, and serves as a safety net against any unexpected funding shortfalls that may occur. Secondary collateral is collateral that is acceptable to the Federal Reserve, but is not maintained there. If unutilized borrowing capacity were to be low, secondary collateral would be identified and maintained as necessary. Further liquidity is available from the Federal Home Loan Bank of New York. As of December 31, 2007, HUSI had outstanding advances of $5.5 billion. HUSI has access to further borrowings based on the amount of mortgages pledged as collateral to the FHLB.

As of December 31, 2007, dividends from HBUS to HUSI would require the approval of the OCC, in accordance with 12 USC 60. Refer to Note 19 for further details. In determining the extent of dividends to pay, HBUS must also consider the effect of dividend payments on applicable risk-based capital and leverage ratio requirements, as well as policy statements of federal regulatory agencies that indicate that banking organizations should generally pay dividends out of current operating earnings.

HUSI filed a shelf registration statement with the Securities and Exchange Commission in April 2006, under which it may issue debt securities, preferred stock, either separately or represented by depositary shares, warrants, purchase contracts and units. HUSI satisfies the eligibility requirements for designation as a “well-known seasoned issuer” which allows it to file a registration statement that does not have a limit on issuance capacity. HUSI’s ability to issue debt under the registration statement is limited by the debt issuance authority granted by the Board. HUSI is currently authorized to issue up to $7 billion, of which $6.2 billion is available. During 2007, HUSI issued $.4 billion of senior debt from this shelf.

In December 2006, HBUS increased the size of its Global Bank Note Program from $20 billion to $40 billion, which provides for issuance of subordinated and senior notes. Borrowings from the Global Bank Note Program totaled $1.5 billion in 2007, of which $.5 billion was subordinated. There is approximately $21 billion of availability remaining.

At December 31, 2007, HUSI also had a $2.5 billion back-up credit facility for issuances of commercial paper.

Interest Rate Risk Management

HUSI is subject to interest rate risk associated with the repricing characteristics of its balance sheet assets and liabilities. Specifically, as interest rates change, amounts of interest earning assets and liabilities fluctuate, and interest earning assets reprice at intervals that do not correspond to the maturities or repricing patterns of interest bearing liabilities. This mismatch between assets and liabilities in repricing sensitivity results in shifts in net interest income as interest rates move. To help manage the risks associated with changes in interest rates, and to manage net interest income within ranges of interest rate risk that management considers acceptable, HUSI uses derivative instruments such as interest rate swaps, options, futures and forwards as hedges to modify the repricing characteristics of specific assets, liabilities, forecasted transactions or firm commitments.

The following table shows the repricing structure of assets and liabilities as of December 31, 2007. For assets and liabilities whose cash flows are subject to change due to movements in interest rates, such as the sensitivity of mortgage loans to prepayments, data is reported based on the earlier of expected repricing or maturity and reflects anticipated prepayments based on the current rate environment. The resulting “gaps” are reviewed to assess the potential sensitivity to earnings with respect to the direction, magnitude and timing of changes in market interest rates. Data shown is as of year end, and one-day figures can be distorted by temporary swings in assets or liabilities.

December 31, 2007

Within
One
Year

After One
But Within
Five Years

After Five
But Within
Ten Years

After
Ten
Years

Total

(in millions)

Commercial loans

35,100

2,034

700

37,923

Residential mortgages

17,179

13,851

2,713

1,637

35,380

Credit card receivables

13,140

6,275

—

19,415

Other consumer loans

1,285

945

—

2,231

Total loans

66,704

23,105

3,414

1,726

94,949

Securities available for sale and securities held to maturity

5,633

6,689

4,851

5,680

22,853

Other assets

66,837

2,884

850

—

70,571

Total assets

139,174

32,678

9,115

7,406

188,373

Domestic deposits (1):

Savings and demand

42,027

9,387

10,043

—

61,457

Certificates of deposit

15,007

573

129

15,777

Long-term debt

23,222

2,939

1,657

450

28,268

Other liabilities/equity

73,604

8,743

—

524

82,871

Total liabilities and equity

153,860

21,642

11,829

1,042

188,373

Total balance sheet gap

(14,686

)

11,036

(2,714

)

6,364

—

Effect of derivative contracts

2,757

(1,043

)

(189

)

(1,525

)

—

Total gap position

(11,929

)

9,993

(2,903

)

4,839

—

(1)

Does not include purchased or wholesale treasury deposits. The placement of administered deposits such as savings and demand for interest rate risk purposes reflects behavioral expectations associated with these balances. Long-term core balances are differentiated from more fluid balances in an effort to reflect anticipated shifts of non-core balances to other deposit products or equities over time.

Various techniques are utilized to quantify and monitor risks associated with the repricing characteristics of HUSI’s assets, liabilities and derivative contracts.

In the course of managing interest rate risk, Present Value of a Basis Point (PVBP) analysis is utilized in conjunction with a combination of other risk assessment techniques, including economic value of equity, dynamic simulation modeling, capital risk and Value at Risk (VAR) analyses. The combination of these tools enables management to identify and assess the potential impact of interest rate movements and take appropriate action. This combination of techniques, with some focusing on the impact of interest rate movements on the value of the balance sheet (PVBP, economic value of equity, VAR) and others focusing on the impact of interest rate movements on earnings (dynamic simulation modeling) allows for comprehensive analyses from different perspectives.

A key element of managing interest rate risk is the management of the convexity of the balance sheet, largely resulting from the mortgage related products on the balance sheet. Convexity risk arises as mortgage loan consumers change their behavior significantly in response to large rate movements in market rates, but do not change behavior appreciably for smaller changes in market rates. Certain of the interest rate management tools described below, such as dynamic simulation modeling and economic value of equity, better capture the embedded convexity in the balance sheet, while measures such as PVBP are designed to capture the risk of smaller changes in rates.

Refer to Market Risk Management, beginning on page 84 of this Form 10-K, for commentary regarding the use of VAR analyses to monitor and manage interest rate and other market risks.

The assessment techniques discussed below act as a guide for managing interest rate risk associated with balance sheet composition and off-balance sheet hedging strategy (the risk position). Calculated values within limit ranges reflect an acceptable risk position, although possible future unfavorable trends may prompt adjustments to on or off-balance sheet exposure. Calculated values outside of limit ranges will result in consideration of adjustment of the risk position, or consideration of temporary dispensation from making adjustments.

Present Value of a Basis Point (PVBP)

PVBP is the change in value of the balance sheet for a one basis point upward movement in all interest rates. The following table reflects the PVBP position at December 31, 2007.



December 31, 2007	Values

(in millions)
Institutional PVBP movement limit		$	6.5
PVBP position at period end			.9

Economic Value of Equity

Economic value of equity is the change in value of the assets and liabilities (excluding capital and goodwill) for either a 200 basis point gradual rate increase or decrease. The following table reflects the economic value of equity position at December 31, 2007.



December 31, 2007	Values (%)

Institutional economic value of equity limit	+/-	20
Projected change in value (reflects projected rate movements on January 1, 2008):
Change resulting from a gradual 200 basis point increase in interest rates		(5	)
Change resulting from a gradual 200 basis point decrease in interest rates		(6	)

The loss in value for a 200 basis point increase or decrease in rates is a result of the negative convexity of the residential whole loan and mortgage backed securities portfolios. If rates decrease, the projected prepayments related to these portfolios will accelerate, causing less appreciation than a comparable term, non-convex instrument.

If rates increase, projected prepayments will slow, which will cause the average lives of these positions to extend and result in a greater loss in market value.

Dynamic Simulation Modeling

Various modeling techniques are utilized to monitor a number of interest rate scenarios for their impact on net interest income. These techniques include both rate shock scenarios which assume immediate market rate movements by as much as 200 basis points, as well as scenarios in which rates rise or fall by as much as 200 basis points over a twelve month period. The following table reflects the impact on net interest income of the scenarios utilized by these modeling techniques.



December 31, 2007	Amount				%

($ in millions)
Projected change in net interest income (reflects projected rate movements on January 1, 2008):
Institutional base earnings movement limit					(10	)
Change resulting from a gradual 200 basis point increase in the yield curve		$	(251	)	(7	)
Change resulting from a gradual 200 basis point decrease in the yield curve			153		4
Change resulting from a gradual 100 basis point increase in the yield curve			(122	)	(3	)
Change resulting from a gradual 100 basis point decrease in the yield curve			93		2

Other significant scenarios monitored (reflects projected rate movements on January 1, 2008):
Change resulting from an immediate 100 basis point increase in the yield curve			(179	)	(5	)
Change resulting from an immediate 100 basis point decrease in the yield curve			117		3
Change resulting from an immediate 200 basis point increase in the yield curve			(366	)	(10	)
Change resulting from an immediate 200 basis point decrease in the yield curve			129		3

The projections do not take into consideration possible complicating factors such as the effect of changes in interest rates on the credit quality, size and composition of the balance sheet. Therefore, although this provides a reasonable estimate of interest rate sensitivity, actual results will vary from these estimates, possibly by significant amounts.

Capital Risk/Sensitivity of Other Comprehensive Income

Large movements of interest rates could directly affect some reported capital balances and ratios. The mark to market valuation of available for sale securities is credited on a tax effective basis to accumulated other comprehensive income. Although this valuation mark is excluded from Tier 1 and Tier 2 capital ratios, it is included in two important accounting based capital ratios: the tangible common equity to tangible assets and the tangible common equity to risk weighted assets. As of December 31, 2007, HUSI had an available for sale securities portfolio of approximately $20 billion with a net negative mark to market of $314 million included in tangible common equity of $7 billion. An increase of 25 basis points in interest rates of all maturities would lower the mark to market by approximately $138 million to a net loss of $452 million with the following results on the tangible capital ratios.



December 31, 2007	Actual			Proforma – Reflecting 25 Basis Points Increase in Rates

Tangible common equity to tangible assets		3.93	%	3.89	%
Tangible common equity to risk weighted assets		5.39		5.33

Market Risk Management

Value at Risk (VAR)

VAR analysis is used to estimate the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. VAR calculations are performed for all material trading activities and as a tool for managing interest rate risk inherent in non-trading activities. HUSI calculates VAR daily for a one-day holding period to a 99% confidence level. At a 99% confidence level for a two-year observation period, HUSI is setting as its limit the fifth worst loss performance in the last 500 business days.

VAR - Overview

The VAR methodology used by HUSI is based on historical simulation. The historical simulation model derives plausible future scenarios from historical market rate data, taking account of inter-relationships between different markets and rates, such as the relationship between interest rates and foreign exchange rates. Potential movements in market prices are calculated with reference to market data from the last two years. The model incorporates the impact of option features in the underlying exposures.

For reporting purposes, in the second quarter of 2006, HUSI changed the assumed holding period from a ten-day period to a one-day period as this reflects the way HUSI manages its risk positions. Comparative VAR amounts have been restated to reflect this change.

Although a valuable guide to risk, VAR should always be viewed in the context of its limitations. For example:


•	the use of historical data as a proxy for estimating future events may not encompass all potential events, particularly those which are extreme in nature;

•	the use of a one-day holding period assumes that all positions can be liquidated or hedged in one day. This may not fully reflect the market risk arising at times of severe liquidity shortages, when a one-day holding period may be insufficient to liquidate or hedge all positions fully;

•	the use of a 99% confidence level, by definition, does not take into account losses that might occur beyond this level of confidence; and

•	VAR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect intra-day exposures.

VAR - Trading Activities

HUSI’s management of market risk is based on restricting individual operations to trading within a list of permissible instruments, and enforcing rigorous approval procedures for new products. In particular, trading in the more complex derivative products is restricted to offices with appropriate levels of product expertise and robust control systems.

In addition, at both portfolio and position levels, market risk in trading portfolios is monitored and controlled using a complementary set of techniques, including VAR and various techniques for monitoring interest rate risk (refer to pages 81-83 of this Form 10-K). These techniques quantify the impact on capital of defined market movements.

Trading portfolios reside primarily within the Markets unit of the Global Banking and Markets business segment, which include warehoused residential mortgage loans purchased for securitizations and within the mortgage banking subsidiary included within the PFS business segment. Portfolios include foreign exchange, derivatives, precious metals (gold, silver, platinum), equities and money market instruments including “repos” and securities. Trading occurs as a result of customer facilitation, proprietary position taking, and economic hedging. In this context, economic hedging may include, for example, forward contracts to sell residential mortgages and derivative contracts which, while economically viable, may not satisfy the hedge requirements of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133).

The trading portfolios have defined limits pertaining to items such as permissible investments, risk exposures, loss review, balance sheet size and product concentrations. “Loss review” refers to the maximum amount of loss that may be incurred before senior management intervention is required.

The following table summarizes trading VAR for 2007.



				Full Year 2007
	December 31, 2007												December 31, 2006
	December 31, 2007			Minimum			Maximum			Average			December 31, 2006

Total trading		$	25		$	9		$	32		$	18		$	9
Precious metals			2			*			4			1			2
Equities			*			*			4			*			*
Foreign exchange			3			—			3			1			2
Interest rate			17			7			38			16			13


*	Less than $500 thousand.

The following table summarizes the frequency distribution of daily market risk-related revenues for Treasury trading activities during calendar year 2007. Market risk-related Treasury trading revenues include realized and unrealized gains (losses) related to Treasury trading activities, but exclude the related net interest income. Analysis of the 2007 gain (loss) data shows that the largest daily gain was $114 million and the largest daily loss was $33 million.

Ranges of daily Treasury trading revenue earned from market risk-related activities

Below
$(5)

$ (5) to
$0

$ 0 to
$5

$ 5 to
$10

Over
$10

($ in millions)

Number of trading days market risk-related revenue was within the stated range

VAR - Non-trading Activities

The principal objective of market risk management of non-trading portfolios is to optimize net interest income. Market risk in non-trading portfolios arises principally from mismatches between the future yield on assets and their funding cost, as a result of interest rate changes. Analysis of this risk is complicated by having to make assumptions on optionality in certain product areas, for example, mortgage prepayments, and from behavioral assumptions regarding the economic duration of liabilities which are contractually repayable on demand. The prospective change in future net interest income from non-trading portfolios will be reflected in the current realizable value of these positions, should they be sold or closed prior to maturity. In order to manage this risk optimally, market risk in non-trading portfolios is transferred to Global Markets or to separate books managed under the supervision of ALCO. Once market risk has been consolidated in Global Markets or ALCO-managed books, the net exposure is typically managed through the use of interest rate swaps within agreed-upon limits.

The following table summarizes non-trading VAR for 2007, assuming a 99% confidence level for a two-year observation period and a one-day “holding period”.



				Full Year 2007
	December 31, 2007												December 31, 2006
	December 31, 2007			Minimum			Maximum			Average			December 31, 2006

(in millions)
Interest rate		$	46		$	18		$	56		$	33		$	24

Trading Activities – HSBC Mortgage Corporation (USA)

HSBC Mortgage Corporation (USA) is HUSI’s mortgage banking subsidiary. Trading occurs in mortgage banking operations as a result of an economic hedging program intended to offset changes in value of mortgage servicing rights and the salable loan pipeline. Economic hedging may include, for example, forward contracts to sell residential mortgages and derivative instruments used to protect the value of MSRs.

MSRs are assets that represent the present value of net servicing income (servicing fees, ancillary income, escrow and deposit float, net of servicing costs). MSRs are separately recognized upon the sale of the underlying loans or at the time that servicing rights are purchased. MSRs are subject to interest rate risk, in that their value will decline as a result of actual and expected acceleration of prepayment of the underlying loans in a falling interest rate environment.

Interest rate risk is mitigated through an active hedging program that uses trading securities and derivative instruments to offset changes in value of MSRs. Since the hedging program involves trading activity, risk is quantified and managed using a number of risk assessment techniques.

Rate Shock Analysis

Modeling techniques are used to monitor certain interest rate scenarios for their impact on the economic value of net hedged MSRs, as reflected in the following table.



December 31, 2007	Value

(in millions)
Projected change in net market value of hedged MSRs portfolio (reflects projected rate movements on January 1, 2008):
Value of hedged MSRs portfolio		$	494
Change resulting from an immediate 50 basis point decrease in the yield curve:
Change limit (no worse than)			(16	)
Calculated change in net market value			3
Change resulting from an immediate 50 basis point increase in the yield curve:
Change limit (no worse than)			(8	)
Calculated change in net market value			1
Change resulting from an immediate 100 basis point increase in the yield curve:
Change limit (no worse than)			(12	)
Calculated change in net market value			5

Economic Value of MSRs

The economic value of the net, hedged MSRs portfolio is monitored on a daily basis for interest rate sensitivity. If the economic value declines by more than established limits for one day or one month, various levels of management review, intervention and/or corrective actions are required.

Hedge Volatility

The following table summarized the frequency distribution of the weekly economic value of the MSR asset during calendar year 2007. This includes the change in the market value of the MSR asset net of changes in the market value of the underlying hedging positions used to hedge the asset. The changes in economic value are adjusted for changes in MSR valuation assumptions that were made during the course of the year.



Ranges of mortgage economic value from market risk-related activities	Below $(2)	$(2) to $0	$0 to $2	$2 to $4	Over $4

($ in millions)
Number of trading weeks market risk-related revenue was within the stated range	12	12	20	4	4

Operational Risk

Operational risk is the risk of loss arising through fraud, unauthorized activities, error, omission, inefficiency, system failure or from external events. It is inherent in every business organization and covers a wide spectrum of issues.

HUSI has established an independent Operational Risk Management discipline. The Operational Risk Management Committee, chaired by the Chief Operating Officer, is responsible for oversight of the operational risks being taken, the analytic tools used to monitor those risks, and reporting. Results from this Committee are communicated to the Risk Management Committee and subsequently to the Audit Committee of the Board of Directors. Business unit line management is responsible for managing and controlling all risks and for communicating and implementing all control standards. A Corporate Operational Risk Coordinator provides functional oversight by coordinating the following activities:


•	maintaining a network of business line Operational Risk Coordinators;

•	developing scoring and risk assessment tools and databases;

•	providing training and developing awareness; and

•	independently reviewing and reporting the assessments of operational risks.

Management of operational risk includes identification, assessment, monitoring, control and mitigation, rectification and reporting of the results of risk events, including losses and compliance with local regulatory requirements. These key components of the Operational Risk Management process have been communicated by issuance of a high level standard. Key features within the standard that have been addressed in HUSI’s Operational Risk Management program include:


•	each business and support department is responsible for the identification and management of their operational risks;

•	each risk is evaluated and scored by its likelihood to occur, its potential impact on shareholder value and by exposure based on the effectiveness of current controls to prevent or mitigate losses. An operational risk automated database is used to record risk assessments and track risk mitigation action plans. The risk assessments are reviewed at least annually, or as business conditions change;

•	key risk indicators are established where appropriate, and monitored/tracked; and

•	the database is also used to track operational losses for analysis of root causes, comparison with risk assessments and lessons learned.

Management practices include standard monthly reporting to business line managers, senior management and the Operational Risk Management Committee of high risks, risk mitigation action plan exceptions, losses and key risk indicators. Monthly certification of internal controls includes an operational risk attestation. Operational Risk Management is an integral part of the new product development process and the management performance measurement process. An online certification process, attesting to the completeness and accuracy of operational risk, is completed by senior business management on an annual basis.

Analysis of primary types of operational risks reflects a 60% concentration in process risk. The remaining 40% is divided fairly equally between the other three primary operational risk types - systems, people and external events. The same percent distribution of primary operational risk types applies for the higher or more critical operational risks. Within the process risk type, approximately 85% of this risk is concentrated within internal and external reporting and payment/settlement/delivery risk.

Internal audits, including audits by specialist teams in information technology and treasury, provide an important check on controls and test institutional compliance with the Operational Risk Management policy.

Compliance Risk

Compliance risk is the risk arising from failure to comply with relevant laws, regulations and regulatory requirements governing the conduct of specific businesses. It is a composite risk that can result in regulatory sanctions, financial penalties, litigation exposure and loss of reputation. Compliance risk is inherent throughout the HUSI organization.

Consistent with HSBC’s commitment to ensure adherence with applicable regulatory requirements for all of its world-wide affiliates, HUSI has implemented a multi-faceted Compliance Risk Management Program. This program addresses the following priorities, among other issues:


•	anti-money laundering (AML) regulations;

•	fair lending laws;

•	dealings with affiliates;

•	the Community Reinvestment Act;

•	permissible activities; and

•	conflicts of interest.

Oversight of the Compliance Risk Management Program is provided by the Audit Committee of the Board of Directors through the Risk Management Committee. The effectiveness of the overall compliance program was overseen and counsel was provided to line and compliance management on major potential issues, strategic policy-making decisions and reputational risk matters. Internal audit, through continuous monitoring and periodic audits, tests the effectiveness of the overall Compliance Risk Management Program.

The Compliance Risk Management program elements include identification, assessment, monitoring, control and mitigation of the risk and timely resolution of the results of risk events. The execution of the Program is generally performed by line management, with oversight provided by Corporate Compliance. Controls for mitigating compliance risk are incorporated into business operating policies and procedures. Processes are in place to ensure controls are appropriately updated to reflect changes in regulatory requirements as well as changes in business practices, including new or revised products, services and marketing programs. A wide range of compliance training is provided to relevant staff, including mandated programs for such areas as anti-money laundering, fair lending and privacy.

The independent Corporate Compliance function is comprised of units focusing on General Compliance and Anti-Money Laundering (AML) compliance, as well as various compliance teams supporting specific business units. The Corporate Compliance function is responsible for the following activities:


•	advising management on compliance matters;

•	providing independent assessment, monitoring and review; and

•	reporting compliance issues to HUSI senior management and Board of Directors, as well as to HSBC Group Compliance.

The Corporate Compliance function has established a rigorous independent review program which includes assessing the effectiveness of controls and testing for adherence to compliance policies and procedures. The review program is executed by centralized review teams and specialized business compliance officers who work collaboratively to complement each others efforts.

Fiduciary Risk

Fiduciary risk is the risk associated with offering services honestly and properly to clients in a fiduciary capacity in accordance with Regulation 12 CFR 9, Fiduciary Activity of National Banks. Fiduciary capacity is defined in the regulation as:


•	serving traditional fiduciary duties such as trustee, executor, administrator, registrar of stocks and bonds, guardian, receiver or assignee;

•	providing investment advice for a fee; or

•	processing investment discretion on behalf of another.

Fiduciary risks, as defined above, reside in Private Banking businesses (including Investment Management, Personal Trust, Custody, Middle Office Operations) and other business lines outside of Private Banking (including Corporate Trust). However, HUSI’s Fiduciary Risk Management infrastructure is also responsible for fiduciary risks associated with certain SEC regulated Registered Investment Advisors (RIA), which lie outside of the traditional regulatory fiduciary risk definition for banks. The fiduciary risks present in both banking and RIA business lines almost always occur where HUSI is entrusted to handle and execute client business affairs and transactions in a fiduciary capacity. HUSI’s policies and procedures for addressing fiduciary risks generally address various risk categories including suitability, conflicts, fairness, disclosure, fees, AML, operational, safekeeping, efficiencies, etc.

Oversight for the Fiduciary Risk Management function falls to the Fiduciary Risk Management Committee of the Risk Management Committee. This committee is chaired by the Managing Director - Private Banking. The Senior Vice President - Fiduciary Risk is responsible for an independent Fiduciary Risk Management Unit that is responsible for day to day oversight of the Fiduciary Risk Management function. The main goals and objectives of this unit include:


•	development and implementation of control self assessments, which have been completed for all fiduciary businesses;

•	developing, tracking and collecting rudimentary key risk indicators (KRIs), and collecting data regarding errors associated with these risks. KRIs for each fiduciary business are in the process of being expanded;

•	designing, developing and implementing risk monitoring tools, approaches and programs for the relevant business lines and senior management that will facilitate the identification, evaluation, monitoring, measurement, management and reporting of fiduciary risks. In this regard, a common database is used for compliance, operational and fiduciary risks; and

•	ongoing development and implementation of more robust and enhanced key risk indicator/key performance indicator process with improved risk focused reporting.

Business Continuity Planning

HUSI is committed to the protection of employees, customers and shareholders by a quick response to all threats to the organization, whether they are of a physical or financial nature. HUSI is governed by the HNAH Crisis Management Framework, which provides an enterprise-wide response and communication approach for managing major business continuity events or incidents. It is designed to be flexible and is scaled to the scope and magnitude of the event or incident.

The Crisis Management Framework works in tandem with the HNAH Corporate Contingency Planning Policy, business continuity plans and key business continuity committees to manage events. The North American Crisis Management Committee, a 24/7 standing committee, is activated to manage the Crisis Management process in concert with senior HUSI management. This committee provides critical strategic management of business continuity crisis issues, risk management, communication, coordination and recovery management. In particular, the HNAH Crisis Management Committee has implemented an enterprise-wide plan, response and communication approach for pandemic preparedness. This was tested in 2007 as part of the U.S. Pandemic Simulations exercise. Tactical management of business continuity issues is handled by the Corporate and Local Incident Response Teams in place at each major site. HUSI also has designated an Institutional Manager for Business Continuity who plays a key role on the Crisis Management Committee. All major business and support functions have a senior representative assigned to HUSI’s Business Continuity Planning Committee, which is chaired by the Institutional Manager.

HUSI has dedicated certain work areas as hot and warm backup sites, which serve as primary business recovery locations. HUSI has concentrations of major operations in both upstate and downstate New York. This geographic split of major operations is leveraged to provide secondary business recovery sites for many critical business and support areas of HUSI. Remote working arrangements are also a key component of HUSI’s business continuity approach.

HUSI has built its own data center with the intention of developing the highest level of resiliency for disaster recovery as defined by industry standards. Data is mirrored synchronously to the disaster recovery site across duplicate dark fiber loops. A high level of network backup resiliency has been established. In a disaster situation, HUSI is positioned to bring main systems and server applications online within predetermined timeframes.

HUSI tests business continuity and disaster recovery resiliency and capability through routine contingency tests and actual events. Business continuity and disaster recovery programs have been strengthened in numerous areas as a result of these tests or actual events. There is a continuing effort to enhance the program well beyond the traditional business resumption and disaster recovery model.

In 2003, HUSI determined the applicability of the Interagency Paper on “Sound Practices to Strengthen the Resiliency of the U.S. Financial System”. HUSI has met the requirements of the paper for the businesses impacted by the compliance due date.

Glossary of Terms

Balance Sheet Management – Represents HUSI’s activities to manage interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities.

Efficiency Ratio – Ratio of total operating expenses, reduced by minority interests, to the sum of net interest income and other revenues.

Federal Reserve – the Federal Reserve Board; the principal regulator for HUSI.

Global Bank Note Program – $40 billion note program, under which HBUS issues senior and subordinated debt.

Goodwill – Represents the excess of purchase price over the fair value of identifiable net assets acquired, reduced by liabilities assumed, for business combinations.

HBMD – HSBC National Bank (USA); a wholly-owned U.S. banking subsidiary of HUSI.

HBUS – HSBC Bank USA, National Association; HUSI’s principal wholly-owned U.S. banking subsidiary.

HMUS – HSBC Markets (USA) Inc.; an indirect wholly-owned subsidiary of HNAH, and a holding company for investment banking and markets subsidiaries in the U.S.

HNAH – HSBC North America Holdings Inc.; a wholly-owned subsidiary of HSBC and HSBC’s top-tier bank holding company in North America.

HNAI – HSBC North America Inc.; an indirect wholly-owned subsidiary of HNAH.

HSBC – HSBC Holdings plc.; HNAH’s U.K. parent company.

HSBC Affiliate – any direct or indirect subsidiary of HSBC outside of the HUSI consolidated group of entities.

HSBC Finance Corporation – an indirect wholly-owned consumer finance company subsidiary of HNAH.

HTCD – HSBC Trust Company (Delaware); a wholly-owned U.S. banking subsidiary of HUSI.

HTSU – HSBC Technology & Services (USA) Inc.; an indirect wholly-owned subsidiary of HNAH which provides information technology services to all subsidiaries of HNAH and to other subsidiaries of HSBC.

HUSI – HSBC USA Inc.; the registrant, and a wholly-owned subsidiary of HNAI.

Intangible Assets – Assets (not including financial assets) that lack physical substance. HUSI’s acquired intangible assets include mortgage servicing rights and favorable lease arrangements.

Mortgage Servicing Rights (MSRs) – Intangible assets representing the right to service mortgage loans, which are recognized at the time the related loans are sold or the rights are acquired.

Net Interest Margin to Earning Assets – Net interest income divided by average interest earning assets for a given period.

Net Interest Margin to Total Assets – Net interest income divided by average total assets for a given period.

Nonaccruing Loans – Loans for which interest is no longer accrued because ultimate collection is unlikely.

OCC – the Office of the Comptroller of the Currency; the principal regulator for HBUS.

Private Label Receivable Portfolio (PLRP) – Loan and credit card receivable portfolio acquired from HSBC Finance Corporation on December 29, 2004.

Rate of Return on Common Shareholder’s Equity – Net income, reduced by preferred dividends, divided by average common shareholder’s equity for a given period.

Rate of Return on Total Assets – Net income after taxes divided by average total assets for a given period.

SEC – The Securities and Exchange Commission.

Total Average Shareholders’ Equity to Total Assets – Average total shareholders’ equity divided by average total assets for a given period.

Total Period End Shareholders’ Equity to Total Assets – Total shareholders’ equity divided by total assets as of a given date.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Refer to pages 81-87 in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for commentary and analysis regarding “Interest Rate Risk Management” and “Market Risk Management”.

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CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES - THREE YEARS

The following table shows the year to date 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.


	2007

(in millions)	Balance			Interest		Rate*

*Assets*
Interest bearing deposits with banks	$	5,557		$	309		5.56	%
Federal funds sold and securities purchased under resale agreements		11,671			610		5.23
Trading assets		11,380			633		5.56
Securities		23,156			1,221		5.27
Loans
Commercial		31,396			2,017		6.42
Consumer:
Residential mortgages		37,694			2,042		5.42
Credit cards		17,897			1,764		9.86
Other consumer		2,475			249		10.07

Total consumer		58,066			4,055		6.99

Total loans		89,462			6,072		6.79

Other		3,977			221		5.57

Total earning assets		145,203		$	9,066		6.24	%

Allowance for credit losses		(1,006	)
Cash and due from banks		3,019
Other assets		24,713

*Total assets*	$	171,929


*Liabilities and Shareholders’ Equity*
Deposits in domestic offices
Savings deposits	$	43,228		$	1,376		3.18	%
Other time deposits		22,651			1,267		5.60
Deposits in foreign offices
Foreign banks deposits		9,863			454		4.61
Other time and savings.		15,490			743		4.80

Total interest bearing deposits		91,232			3,840		4.21

Short-term borrowings		9,838			357		3.63
Long-term debt		28,629			1,443		5.04

Total interest bearing liabilities		129,699			5,640		4.35

Net interest income / Interest rate spread				$	3,426		1.89	%

Noninterest bearing deposits		13,737
Other liabilities		16,430
Total shareholders’ equity		12,063

*Total liabilities and shareholders’ equity*	$	171,929

Net interest margin on average earning assets							2.36	%

Net interest margin on average total assets							1.99	%

* Rates are calculated on unrounded numbers.

Total weighted average rate earned on earning assets is interest and fee earnings divided by daily average amounts of total interest earning assets, including the daily average amount on nonperforming loans. Loan interest for the years ended December 31, 2007, 2006 and 2005 included fees of $40 million, $53 million and $47 million, respectively.


	2006

(in millions)	Balance			Interest		Rate*

*Assets*
Interest bearing deposits with banks	$	3,927		$	225		5.73	%
Federal funds sold and securities purchased under resale agreements		10,326			526		5.10
Trading assets		10,893			418		3.84
Securities		22,177			1,145		5.16
Loans
Commercial		28,080			1,764		6.28
Consumer:
Residential mortgages		41,826			2,211		5.29
Credit cards		15,987			1,329		8.31
Other consumer		2,960			268		9.07

Total consumer		60,773			3,808		6.27

Total loans		88,853			5,572		6.27

Other		1,569			91		5.78

Total earning assets		137,745		$	7,977		5.79	%

Allowance for credit losses		(932	)
Cash and due from banks		3,977
Other assets		22,033

*Total assets*	$	162,823


*Liabilities and Shareholders’ Equity*
Deposits in domestic offices
Savings deposits	$	34,910		$	981		2.81	%
Other time deposits		24,134			1,152		4.77
Deposits in foreign offices
Foreign banks deposits		8,020			392		4.89
Other time and savings.		14,127			588		4.16

Total interest bearing deposits		81,191			3,113		3.83

Short-term borrowings		10,131			300		2.96
Long-term debt		29,484			1,457		4.94

Total interest bearing liabilities		120,806			4,870		4.03

Net interest income / Interest rate spread				$	3,107		1.76	%

Noninterest bearing deposits		12,869
Other liabilities		17,111
Total shareholders’ equity		12,037

*Total liabilities and shareholders’ equity.*	$	162,823

Net interest margin on average earning assets							2.26	%

Net interest margin on average total assets							1.91	%


	2005

(in millions)	Balance			Interest		Rate*

*Assets*
Interest bearing deposits with banks	$	3,577		$	120		3.35	%
Federal funds sold and securities purchased under resale agreements		5,481			190		3.48
Trading assets		7,234			275		3.80
Securities		19,024			899		4.73
Loans
Commercial		24,192			1,233		5.10
Consumer:
Residential mortgages		47,093			2,321		4.93
Credit cards		13,455			812		6.04
Other consumer		3,158			264		8.36

Total consumer		63,706			3,397		5.33

Total loans		87,898			4,630		5.27

Other		647			32		4.95

Total earning assets		123,861		$	6,146		4.96	%

Allowance for credit losses		(910	)
Cash and due from banks		3,717
Other assets		20,508

*Total assets*	$	147,176


*Liabilities and Shareholders’ Equity*
Deposits in domestic offices
Savings deposits	$	25,536		$	318		1.25	%
Other time deposits		25,845			822		3.18
Deposits in foreign offices
Foreign banks deposits		8,440			255		3.03
Other time and savings.		14,173			376		2.65

Total interest bearing deposits		73,994			1,771		2.39

Short-term borrowings		10,868			270		2.48
Long-term debt		25,274			1,025		4.06

Total interest bearing liabilities		110,136			3,066		2.78

Net interest income / Interest rate spread				$	3,080		2.18	%

Noninterest bearing deposits		11,529
Other liabilities		13,957
Total shareholders’ equity		11,554

*Total liabilities and shareholders’ equity.*	$	147,176

Net interest margin on average earning assets							2.49	%

Net interest margin on average total assets							2.09	%

Item 8. Financial Statements and Supplementary Data


	Page

Report of Independent Registered Public Accounting Firm	97
HSBC USA Inc.:
Consolidated Statements of Income	98
Consolidated Balance Sheets	99
Consolidated Statements of Changes in Shareholders’ Equity	100
Consolidated Statements of Cash Flows	101

HSBC Bank USA, National Association:
Consolidated Balance Sheets	102

Notes to Consolidated Financial Statements	103

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of
HSBC USA Inc.:

We have audited the accompanying consolidated balance sheets of HSBC USA Inc. and subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007, and the accompanying consolidated balance sheets of HSBC Bank USA, National Association and subsidiaries (the Bank) as of December 31, 2007 and 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007, and the financial position of the Bank as of December 31, 2007 and 2006, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 3, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

New York, New York
March 3, 2008

HSBC USA Inc.

CONSOLIDATED STATEMENTS OF INCOME


Year Ended December 31,	2007			2006		2005

(in millions)
Interest income:
Loans	$	6,072		$	5,572	$	4,630
Securities		1,193			1,119		882
Trading assets		633			418		275
Short-term investments		919			751		310
Other		221			91		32

*Total interest income*		9,038			7,951		6,129

Interest expense:
Deposits		3,840			3,113		1,771
Short-term borrowings		357			300		270
Long-term debt		1,443			1,457		1,025

*Total interest expense*		5,640			4,870		3,066

Net interest income		3,398			3,081		3,063
Provision for credit losses		1,522			823		674

*Net interest income after provision for credit losses*		1,876			2,258		2,389

Other revenues:
Credit card fees		843			580		323
Trust income		101			88		87
Service charges		216			204		195
Other fees and commissions		490			401		304
Trading revenues		129			755		395
Securities gains, net		112			29		106
HSBC affiliate income		172			208		130
Residential mortgage banking revenue		74			96		64
Other (loss) income		(290	)		202		307

*Total other revenues*		1,847			2,563		1,911

Operating expenses:
Salaries and employee benefits		1,352			1,300		1,052
Support services from HSBC affiliates		1,162			1,076		919
Occupancy expense, net		243			221		182
Other expenses		829			658		605

*Total operating expenses*		3,586			3,255		2,758

Income before income tax expense		137			1,566		1,542
Income tax (benefit) expense		(1	)		530		566

*Net income*	$	138		$	1,036	$	976

The accompanying notes are an integral part of the consolidated financial statements.

HSBC USA Inc.

CONSOLIDATED BALANCE SHEETS


December 31,	2007			2006

(in millions)
*Assets*
Cash and due from banks	$	3,567		$	3,359
Interest bearing deposits with banks		5,618			1,921
Federal funds sold and securities purchased under agreements to resell		13,677			13,775
Trading assets		37,036			23,630
Securities available for sale		19,962			19,783
Securities held to maturity (fair value of $2,945 million and $3,040 million at December 31, 2007 and 2006, respectively)		2,891			2,972
Loans		94,949			90,237
Less - allowance for credit losses		1,414			897

Loans, net		93,535			89,340

Properties and equipment, net		568			540
Intangible assets		534			521
Goodwill		2,701			2,716
Other assets		8,284			6,260

*Total assets*	$	188,373		$	164,817

*Liabilities*
Deposits in domestic offices:
Noninterest bearing	$	13,889		$	12,813
Interest bearing (includes $1,479 million and $1,322 million of deposits recorded at fair value at December 31, 2007 and 2006, respectively)		68,237			61,538
Deposits in foreign offices:
Noninterest bearing		1,030			727
Interest bearing		33,072			27,068

Total deposits		116,228			102,146

Trading liabilities		16,253			12,314
Short-term borrowings		11,832			5,073
Interest, taxes and other liabilities		4,555			3,771
Long-term debt		28,268			29,252

*Total liabilities*		177,136			152,556

*Shareholders’ equity*
Preferred stock		1,565			1,690
Common shareholder’s equity:
Common stock ($5 par; 150,000,000 shares authorized; 706 shares issued and outstanding)		—	(1)		—	(1)
Capital surplus		8,123			8,124
Retained earnings		1,901			2,661
Accumulated other comprehensive loss		(352	)		(214	)

Total common shareholder’s equity		9,672			10,571

*Total shareholders’ equity*		11,237			12,261

*Total liabilities and shareholders’ equity*	$	188,373		$	164,817

The accompanying notes are an integral part of the consolidated financial statements.

(1) Less than $500 thousand

HSBC USA Inc.

CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY


	2007			2006			2005

(in millions)
*Preferred stock*
Balance, January 1,	$	1,690		$	1,316		$	500
Preferred stock issuances		—			374			891
Preferred stock redemptions		(125	)		—			(75	)

Balance, December 31,		1,565			1,690			1,316


*Common stock*
Balance, January 1 and December 31,		—	(1)		—	(1)		—	(1)


*Capital surplus*
Balance, January 1,		8,124			8,118			8,418
Capital contribution from parent		4			15			3
Preferred stock issuance costs		(1	)		(9	)		(22	)
Employee benefit plans and other		(4	)		—			(281	)

Balance, December 31,		8,123			8,124			8,118


*Retained earnings*
Balance, January 1,		2,661			2,172			1,917
Net income		138			1,036			976
Cash dividends declared on preferred stock		(98	)		(88	)		(46	)
Cash dividends declared on common stock		(800	)		(455	)		(675	)
Cumulative effect of change in accounting principle relating to mortgage servicing rights		—			(4	)		—

Balance, December 31,		1,901			2,661			2,172


*Accumulated other comprehensive loss*
Balance, January 1,		(214	)		(12	)		31


Net change in net unrealized losses on securities available for sale, net of tax		11			(71	)		(149	)
Net change in net unrealized (losses) gains on derivatives classified as cash flow hedges, net of tax		(165	)		(106	)		104
Net change in net unrealized gains on interest only strip receivables, net of tax		—			(7	)		7
Unrecognized actuarial gains, transition obligation and prior service costs relating to pension and postretirement benefits, net of tax		12			—			—
Foreign currency translation adjustments, net of tax		4			—	(1)		(5	)

Other comprehensive loss, net of tax		(138	)		(184	)		(43	)
Cumulative effect of change in accounting principle relating to pension and post retirement benefits, net of tax		—			(18	)		—

Balance, December 31,		(352	)		(214	)		(12	)

*Total shareholders’ equity, December 31,*	$	11,237		$	12,261		$	11,594


*Comprehensive income*
Net income	$	138		$	1,036		$	976
Other comprehensive loss, net of tax		(138	)		(184	)		(43	)

*Comprehensive income*	$	—		$	852		$	933

The accompanying notes are an integral part of the consolidated financial statements.

(1) Less than $500 thousand

100

HSBC USA Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS


Year ended December 31,	2007			2006			2005

(in millions)
*Cash flows from operating activities*
Net income	$	138		$	1,036		$	976
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation, amortization and deferred taxes		3			503			442
Provision for credit losses		1,522			823			674
Net change in other assets and liabilities		(1,109	)		1,359			495
Net change in loans held for sale to HSBC Markets (USA) Inc. (HMUS):
Loans acquired from originators		(5,026	)		(16,089	)		(5,061	)
Sales of loans to HMUS		6,198			15,867			2,188
Net change in other loans held for sale		(1,718	)		63			63
Net change in loans attributable to tax refund anticipation loans program:
Originations of loans		(17,433	)		(16,100	)		(15,100	)
Sales of loans to HSBC Finance Corporation, including premium		17,645			15,888			15,100
Net change in trading assets and liabilities		(9,152	)		(2,352	)		(2,001	)
Net change in fair value of derivatives and hedged items		770			689			(248	)

Net cash (used in) provided by operating activities		(8,162	)		1,687			(2,472	)

*Cash flows from investing activities*
Net change in interest bearing deposits with banks		(3,697	)		329			526
Net change in federal funds sold and securities purchased under agreements to resell		98			(9,207	)		(1,442	)
Net change in securities available for sale:
Purchases of securities available for sale		(14,175	)		(8,043	)		(12,301	)
Proceeds from sales of securities available for sale		5,157			2,611			3,825
Proceeds from maturities of securities available for sale		8,928			3,203			4,273
Net change in securities held to maturity:
Purchases of securities held to maturity		(260	)		(166	)		(694	)
Proceeds from maturities of securities held to maturity		341			364			1,401
Net change in loans:
Originations, net of collections		18,714			23,083			19,405
Loans purchased from HSBC Finance Corporation		(24,169	)		(23,908	)		(23,084	)
Net cash used for acquisitions of properties and equipment		(99	)		(81	)		(29	)
Other, net		(182	)		(193	)		(240	)

Net cash used in investing activities		(9,344	)		(12,008	)		(8,360	)

*Cash flows from financing activities*
Net change in deposits		14,082			11,854			10,310
Net change in short-term borrowings		6,759			(1,293	)		(2,936	)
Net change in long-term debt:
Issuance of long-term debt		5,607			6,860			6,127
Repayment of long-term debt		(7,710	)		(8,019	)		(706	)
Preferred stock (redemption) issuance, net of issuance costs		(126	)		365			794
Other increases (decreases) in capital surplus		—			15			(278	)
Dividends paid		(898	)		(543	)		(720	)

Net cash provided by financing activities		17,714			9,239			12,591

Net change in cash and due from banks		208			(1,082	)		1,759
Cash and due from banks at beginning of period		3,359			4,441			2,682

*Cash and due from banks at end of period*	$	3,567		$	3,359		$	4,441

Cash paid for: Interest	$	5,733		$	4,815		$	2,785
Income taxes		462			504			566

The accompanying notes are an integral part of the consolidated financial statements.

101

HSBC Bank USA, National Association

CONSOLIDATED BALANCE SHEETS


December 31,	2007			2006

(in millions)
*Assets*
Cash and due from banks	$	3,545		$	3,297
Interest bearing deposits with banks		5,402			1,794
Federal funds sold and securities purchased under agreements to resell		13,676			13,704
Trading assets		35,718			22,343
Securities available for sale		19,676			19,500
Securities held to maturity (fair value of $2,867 million and $2,926 million at December 31, 2007 and 2006, respectively)		2,816			2,864
Loans		94,141			90,125
Less - allowance for credit losses		1,414			894

Loans, net		92,727			89,231

Properties and equipment, net		555			538
Intangible assets		534			521
Goodwill		2,111			2,111
Other assets		7,732			5,629

*Total assets*	$	184,492		$	161,532

*Liabilities*
Deposits in domestic offices:
Noninterest bearing	$	13,873		$	12,818
Interest bearing (includes $1,479 million and $1,322 million of deposits recorded at fair value at December 31, 2007 and 2006, respectively)		68,124			61,474
Deposits in foreign offices:
Noninterest bearing		1,030			727
Interest bearing		36,731			29,842

Total deposits		119,758			104,861

Trading liabilities		16,223			12,300
Short-term borrowings		7,938			2,698
Interest, taxes and other liabilities		4,202			3,249
Long-term debt		24,829			26,166

*Total liabilities*		172,950			149,274

*Shareholder’s equity*
Common shareholder’s equity:
Common stock ($100 par; 50,000 shares authorized; 20,005 shares issued and outstanding)		2			2
Capital surplus		10,123			10,124
Retained earnings		1,769			2,348
Accumulated other comprehensive loss		(352	)		(216	)

*Total shareholder’s equity*		11,542			12,258

*Total liabilities and shareholder’s equity*	$	184,492		$	161,532

102

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


*Note 1.*	*Organization*

HSBC USA Inc., incorporated under the laws of Maryland, is a New York State based bank holding company, and an indirect wholly owned subsidiary of HSBC North America Holdings Inc. (HNAH). HSBC USA Inc. and its subsidiaries are collectively referred to as “HUSI”.

HNAH is an indirect wholly owned subsidiary of HSBC Holdings plc (HSBC). Effective January 1, 2004, HSBC created a new North American organizational structure, HNAH, as the top-tier bank holding company parent. HUSI routinely conducts transactions in the normal course of business with HNAH’s other principal direct and indirect subsidiaries, which include:


•	HSBC Finance Corporation, a consumer finance company;

•	HSBC Bank USA, National Association (HBUS), HUSI’s principal banking subsidiary;

•	HSBC Bank Canada (HBCA), a Canadian banking subsidiary;

•	HSBC Markets (USA) Inc. (HMUS), a holding company for investment banking and markets subsidiaries in the U.S.; and

•	HSBC Technology & Services (USA) Inc. (HTSU), a provider of information technology services for other HNAH subsidiaries and to other subsidiaries of HSBC.

On July 1, 2004, HUSI consolidated its then existing banking operations under a single national charter, following approval from the Office of the Comptroller of the Currency (OCC).


*Note 2.*	*Summary of Significant Accounting Policies and New Accounting Pronouncements*

Significant Accounting Policies

Basis of Presentation

The accounting and reporting policies of HUSI conform to accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions that affect reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Certain reclassifications have been made to prior year amounts to conform with the current year’s presentation.

Principles of Consolidation

The consolidated financial statements include the accounts of HUSI and its subsidiaries. HUSI consolidates subsidiaries in which it holds, directly or indirectly, more than 50% of the voting rights, or where it exercises control. In addition, HUSI consolidates variable interest entities (VIEs) where it is deemed to be the primary beneficiary.

HUSI assesses whether an entity is a VIE and, if so, whether HUSI is its primary beneficiary at the time of initial involvement with the entity. HUSI’s involvement is subsequently reassessed only upon the occurrence of certain changes in the entity’s governing documents or planned operations that result in changes to the entity’s equity structure or its expected losses. HUSI’s assessment is made in accordance with FASB Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities, (FIN 46(R)). FIN 46(R) defines a VIE as an entity in which the equity investment at risk is not sufficient to finance the entity’s activities, where the equity investors lack certain characteristics of a controlling financial interest, or where voting rights are not proportionate to the economic interests of a particular equity investor and the entity’s activities are conducted primarily on behalf of that investor. FIN 46(R) requires a VIE to be consolidated by its primary beneficiary, which is the entity that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both.

103

Entities that are deemed to be qualifying special purpose entities (QSPEs), as defined by Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities (SFAS 140), such as certain trusts to which HUSI has transferred receivables, are not consolidated.

All material intercompany accounts and transactions have been eliminated. Investments in companies in which the percentage of ownership is at least 20%, but not more than 50%, are generally accounted for under the equity method and reported as equity method investments in other assets.

Use of Estimates and Assumptions

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and related footnote disclosures. Estimates used in connection with fair value measurements, consolidation assessments related to variable interest entities, impairments of assets, provisions for losses from credit-related exposures and contingencies, and tax-related reserves are often complex and may significantly impact the amounts reported for those items. Current market conditions increase the risk and uncertainty associated with these estimates and assumptions and, although management uses its best judgment, actual results could differ from estimated amounts.

Transfers of Financial Assets and Securitizations

Transfers of financial assets in which HUSI surrenders control over the transferred assets are accounted for as sales. Control is generally considered to have been surrendered when (i) the transferred assets are legally isolated from HUSI and its creditors, even in bankruptcy or other receivership, (ii) the transferee (or, if the transferee is a QSPE, the holders of its beneficial interests) has the right to pledge or exchange the assets (or beneficial interests held, for a holder of a QSPE’s beneficial interests) without any constraints that would provide a benefit to HUSI, and (iii) HUSI has no obligation, right, or option to reclaim or repurchase the assets. If the sale criteria are met, the transferred assets are removed from HUSI’s balance sheet. If the sale criteria are not met, the transfer is recorded as a secured borrowing in which the assets remain on HUSI’s balance sheet and the proceeds from the transaction are recognized as a liability. For a majority of financial asset transfers, it is clear whether or not HUSI has surrendered control. For other transfers, such as in connection with complex transactions or where HUSI has continuing involvement such as servicing responsibilities, HUSI generally obtains a legal opinion as to whether the transfer results in a true sale by law.

HUSI securitizes certain private label credit card receivables where securitization provides an attractive source of funding. Prior to the third quarter of 2004, private label credit card securitizations utilized revolving trusts that met the definition of a QSPE under SFAS 140. All new private label credit card securitization transactions since the third quarter of 2004 have been structured as secured financings using trusts that are not QSPEs. Transfers of receivables to QSPE trusts established prior to the third quarter of 2004, including transfers of receivables to support previously issued securities, were structured and recorded as sales until the third quarter of 2006. HUSI provided limited recourse to investors in connection with these sales and recorded a provision for estimated probable losses under the recourse provisions. In the third quarter of 2006, the QSPE trusts established prior to the third quarter of 2004 were restructured and no longer meet the definition of a QSPE. As a result, subsequent transfers of receivables to these trusts to support previously issued securities no longer qualify for sale treatment and are recorded as secured financings. Refer to Note 9, Securitizations and Secured Financings, on page 124 of these consolidated financial statements for additional information on these transactions.

Foreign Currency Translation

HUSI has foreign operations in several countries. The accounts of HUSI’s foreign operations are measured using local currency as the functional currency. Assets and liabilities are translated into U.S. dollars at the rate of exchange in effect on the balance sheet date. Income and expenses are translated at average monthly exchange rates. Net exchange gains or losses resulting from such translation are included in common shareholder’s equity as a component of accumulated other comprehensive income. Foreign currency denominated transactions in other than the local functional currency are translated using the period end exchange rate with any foreign currency transaction gain or loss recognized currently in income.

Cash and Cash Equivalents

For the purpose of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks.

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Resale and Repurchase Agreements

HUSI enters into purchases and borrowings of securities under agreements to resell (resale agreements) and sales of securities under agreements to repurchase (repurchase agreements) substantially identical securities. Resale and repurchase agreements are generally accounted for as secured lending and secured borrowing transactions, respectively.

The amounts advanced under resale agreements and the amounts borrowed under repurchase agreements are carried on the consolidated balance sheets at the amount advanced or borrowed, plus accrued interest to date. Interest earned on resale agreements is reported as interest income. Interest paid on repurchase agreements is reported as interest expense. HUSI offsets resale and repurchase agreements executed with the same counterparty under legally enforceable netting agreements that meet the applicable netting criteria as permitted by U.S. GAAP.

Repurchase agreements may require HUSI to deposit cash or other collateral with the lender. In connection with resale agreements, it is the policy of HUSI to obtain possession of collateral, which may include the securities purchased, with market value in excess of the principal amount loaned. The market value of the collateral subject to the resale and repurchase agreements is regularly monitored, and additional collateral is obtained or provided when appropriate, to ensure appropriate collateral coverage of these secured financing transactions.

Collateral

HUSI pledges assets as collateral as required for various transactions involving security repurchase agreements, public deposits, Treasury tax and loan notes, derivative agreements, short-term borrowings and long-term borrowings. Assets that have been pledged as collateral, including those that can be sold or repledged by the secured party, continue to be reported on HUSI’s consolidated balance sheets.

HUSI also accepts collateral, primarily as part of various transactions involving security resale agreements. Collateral accepted by HUSI, including collateral that can be sold or repledged by HUSI, is excluded from HUSI’s consolidated balance sheets.

The market value of collateral accepted or pledged by HUSI is regularly monitored and additional collateral is obtained or provided as necessary to ensure appropriate collateral coverage in these transactions.

Trading Assets and Liabilities

Financial instruments utilized in trading activities are stated at fair value. Fair value is generally based on quoted market prices at trade date. If quoted market prices are not available, fair values are estimated based on dealer quotes, pricing models or quoted prices for instruments with similar characteristics. The validity of internal pricing models is regularly substantiated by reference to actual market prices realized upon sale or liquidation of these instruments. Realized and unrealized gains and losses are recognized in trading revenues.

Securities

Debt securities that HUSI has the ability and intent to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to yield over the expected lives of the related securities. Securities acquired principally for the purpose of selling them in the near term are classified as trading assets and reported at fair value with unrealized gains and losses included in earnings.

Equity securities that are not quoted on a recognized exchange are not considered to have a readily determinable fair value, and are recorded at cost, less any provisions for impairment. Unquoted equity securities, which include Federal Home Loan Bank (FHLB) stock, Federal Reserve Bank (FRB) stock and MasterCard Class B securities, are recorded in other assets.

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All other securities are classified as available for sale and carried at fair value, with unrealized gains and losses, net of related income taxes, recorded as adjustments to common shareholder’s equity as a component of accumulated other comprehensive income.

Securities that are classified as trading are stated at fair value. Fair value is generally based on quoted market prices at trade date. If quoted market prices are not available, fair values are estimated based on dealer quotes, pricing models or quoted prices for instruments with similar characteristics. The validity of internal pricing models is regularly substantiated by reference to actual market prices realized upon sale or liquidation of these instruments.

Realized gains and losses on sales of securities not classified as trading assets are computed on a specific identified cost basis and are reported in other revenues as security gains, net. HUSI regularly evaluates its securities to identify declines in fair value that are considered other-than-temporary. Any decline in the fair value of investments, which is deemed to be other-than-temporary is charged against current earnings in other revenues and a new cost basis is established for the security. Fair value adjustments to trading securities and gains and losses on the sale of such securities are reported in other revenues as trading revenues.

Loans

Loans are stated at their amortized cost, which represents the principal amount outstanding, net of unearned income, charge offs, unamortized purchase premium or discount, unamortized nonrefundable fees and related direct loan origination costs and purchase accounting fair value adjustments. Loans are further reduced by the allowance for credit losses.

Loans that are classified as held for sale are carried at the lower of aggregate cost or market value and remain presented as loans in the consolidated balance sheets. Fair value is determined based on quoted fair market prices for similar loans, outstanding investor commitments or discounted cash flow analysis using market assumptions. Increases in the valuation allowance utilized to adjust loans that are classified as held for sale to market value, and subsequent recoveries of prior allowances recorded, are recorded in other income in the consolidated income statement.

Premiums and discounts and purchase accounting fair value adjustments are recognized as adjustments to yield over the expected lives of the related loans. Interest income is recorded based on methods that result in level rates of return over the terms of the loans.

Restructured loans are loans for which the original contractual terms have been permanently modified to provide for terms that are less than HUSI would be willing to accept for new loans with comparable risk because of deterioration in the borrower’s financial condition. Interest on these loans is accrued at the effective rates.

Loan Charge Off Policies and Practices

Commercial loan balances are charged off at the time all or a portion of the balance is deemed uncollectible.

Consumer loan charge off policies, which vary by product, are summarized below.

Residential Mortgage Loans

Carrying values in excess of net realizable value are charged off at or before the time foreclosure is completed or when settlement is reached with the borrower. If foreclosure is not pursued, and there is no reasonable expectation for recovery, the account is generally charged off no later than the end of the month in which the account becomes six months contractually delinquent.

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Auto Finance

Carrying values in excess of net realizable value are generally charged off no later than the month in which the account becomes four months contractually delinquent.

MasterCard ¹/Visa² and Private Label Credit Card Loans

Loan balances are generally charged off by the end of the month in which the account becomes six months contractually delinquent.

Other Consumer Loans

Loan balances are generally charged off the month following the month in which the account becomes four months contractually delinquent.

Nonaccruing Loan Policies and Practices

HUSI’s nonaccruing policies vary by product and are summarized below.

Commercial

Commercial loans are categorized as nonaccruing when, in the opinion of management, reasonable doubt exists with respect to the ultimate collectibility of interest or principal based on certain factors including period of time past due and adequacy of collateral. At the time a loan is classified as nonaccruing, any accrued interest recorded on the loan is generally deemed uncollectible and charged against income. Interest income on these loans is subsequently recognized only to the extent of cash received or until the loan is placed on accrual status. In those instances where there is doubt as to collectibility of principal, any interest payments received are applied to principal. Loans are not reclassified as accruing until interest and principal payments are brought current and future payments are reasonably assured.

Consumer

Residential mortgage loans are generally designated as nonaccruing when contractually delinquent for more than three months. Credit card receivables and other consumer loans generally accrue interest until charge off.

Loan Fees and Costs

Nonrefundable fees and related direct costs associated with the origination of loans are deferred and netted against outstanding loan balances. The amortization of net deferred fees, which include points on real estate secured loans and costs, is recognized in interest income, generally by the interest method, based on the estimated or contractual lives of the related loans. Amortization periods are periodically adjusted for loan prepayments and changes in other market assumptions. Annual fees on MasterCard/Visa and Home Equity Line of Credit (HELOC), net of direct lending costs, are deferred and amortized on a straight-line basis over one year. Nonrefundable fees related to lending activities other than direct loan origination are recognized as other revenues over the period in which the related service is provided. This includes fees associated with the issuance of loan commitments where the likelihood of the commitment being exercised is considered remote. In the event of the exercise of the commitment, the remaining unamortized fee is recognized in interest income over the loan term using the interest method. Other credit-related fees, such as standby letter of credit fees, loan syndication and agency fees are recognized as other operating income over the period the related service is performed.


¹	MasterCard is a registered trademark of MasterCard, Incorporated.

²	Visa is a registered trademark of Visa USA, Inc.

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Allowance for Credit Losses

HUSI maintains an allowance for credit losses that is, in the judgment of management, adequate to absorb estimated probable losses of principal, interest and fees inherent in its commercial and consumer loan portfolios. The adequacy of the allowance for credit losses is assessed within the context of appropriate U.S. GAAP guidance, and is based, in part, upon an evaluation of various factors including:


•	an analysis of individual exposures where applicable;

•	current and historical loss experience;

•	changes in the overall size and composition of the portfolio; and

•	specific adverse situations and general economic conditions.

HUSI also assesses the overall adequacy of the allowance for credit losses by considering key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge offs in developing its loss reserve estimates. Loss estimates are reviewed periodically and adjustments are reported in earnings when they become known. These estimates are influenced by factors outside of the control of HUSI management, such as consumer payment patterns and economic conditions, and there is uncertainty inherent in these estimates, making it reasonably possible that they could change.

For commercial and select consumer loan assets, HUSI conducts a periodic assessment on a loan-by-loan basis of losses it believes to be inherent in the loan portfolio. When it is deemed probable, based upon known facts and circumstances, that full contractual interest and principal on an individual loan will not be collected in accordance with its contractual terms, the loan is considered impaired. An impairment reserve is established based upon the present value of expected future cash flows, discounted at the loan’s original effective interest rate, or as a practical expedient, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. Generally, impaired loans include loans in nonaccruing status, loans which have been assigned a specific allowance for credit losses, loans which have been partially charged off, and loans designated as troubled debt restructures. Problem commercial loans are assigned various criticized facility grades under the allowance for credit losses methodology.

Formula-based reserves are also established against commercial loans when, based upon an analysis of relevant data, it is probable that a loss has been incurred and the amount of that loss can be reasonably estimated, even though an actual loss has yet to be identified. A separate reserve for credit losses associated with off-balance sheet exposures including letters of credit, guarantees to extend credit and financial guarantees is also maintained and included in other liabilities, which incorporates estimates of the probability that customers will actually draw upon off-balance sheet obligations. This estimation methodology uses the probability of default from the customer rating assigned to each counterparty, the “Loss Given Default” rating assigned to each transaction or facility based on the collateral securing the transaction, and the measure of exposure based on the transaction. These reserves are determined by reference to continuously monitored and updated historical loss rates or factors, derived from a migration analysis which considers net charge off experience by loan and industry type in relation to internal credit grading.

Probable losses for pools of homogeneous consumer loans are generally estimated using a roll rate migration analysis that estimates the likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimately charge off. This analysis considers delinquency status, loss experience and severity and takes into account whether loans are in bankruptcy, have been restructured, rewritten, or are subject to forbearance, an external debt management plan, hardship, modification, extension or deferment. The allowance for credit losses on consumer receivables also takes into consideration the loss severity expected based on the underlying collateral, if any, for the loan in the event of default. In addition, loss estimates on consumer receivables are maintained to reflect HUSI’s judgment of portfolio risk factors, which may not be fully reflected in the statistical roll rate calculation. Risk factors considered in establishing loss reserves on consumer loans include recent growth, product mix, bankruptcy trends, geographic concentrations, economic conditions, portfolio seasoning, account management policies and practices and current levels of charge offs and delinquencies.

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Repossessed Collateral

Real estate owned with the intent to sell within a reasonable period is classified as held for sale at the date of foreclosure and is valued at the lower of cost or fair value less estimated costs to sell and is recorded in other assets. The valuation reserve is created to recognize write down to fair value less costs to sell. These values are periodically reviewed and adjusted against valuation allowance but not in excess of cumulative loss previously recognized. Costs of holding real estate and related gains and losses on disposition are credited or charged to operations as incurred as a component of operating expense.

Properties and Equipment, Net

Properties and equipment are recorded at cost, net of accumulated depreciation. Depreciation is recorded on a straight-line basis over the estimated useful lives of the related assets, which generally range from 3 to 40 years. Leasehold improvements are depreciated over the lesser of the economic useful life of the improvement or the term of the lease. Costs of maintenance and repairs are expensed as incurred. Impairment testing is performed whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

Mortgage Servicing Rights

Effective January 1, 2006, upon adoption of SFAS 156, mortgage servicing rights (MSRs) are initially measured at fair value at the time that the related loans are sold and periodically re-measured using the fair value measurement method. MSRs are measured at fair value at each reporting date with changes in fair value reflected in earnings in the period that the changes occur. Prior to January 1, 2006, MSRs were recorded at the lower of cost or fair value as required by previous accounting requirements.

MSRs are subject primarily to interest rate risk, in that their fair value will fluctuate as a result of changes in the interest rate environment. Fair value is determined based upon the application of valuation models and other inputs. The valuation models incorporate assumptions market participants would use in estimating future cash flows. These assumptions include expected prepayments, default rates and market based option adjusted spreads.

HUSI uses certain derivative financial instruments including options and interest rate swaps to protect against the decline in economic value of MSRs. These instruments have not been designated as qualifying hedges in accordance with U.S. GAAP guidelines and are therefore recorded as trading assets that are marked to market through earnings.

Goodwill

Goodwill, representing the excess of purchase price over the fair value of identifiable net assets acquired, results from purchase business combinations. Goodwill is not amortized, but is reviewed for impairment annually using a discounted cash flow methodology. Impairment is reviewed earlier if circumstances indicate that the carrying amount may not be recoverable. HUSI considers significant and long-term changes in industry and economic conditions to be primary indicators of potential impairment.

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Income Taxes

HNAH files a consolidated federal income tax return, which includes HUSI. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as the estimated future tax consequences attributable to net operating loss and tax credit carryforwards. These deferred tax assets and liabilities are measured using the tax rates and laws that are expected to be in effect. A valuation allowance is established if, based on available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. Foreign taxes paid are applied as credits to reduce federal income taxes payable, to the extent that such credits can be utilized.

HUSI has entered into tax allocation agreements with HNAH and its subsidiary entities included in the consolidated return which governs the timing and amount of income tax payments required by the various entities. Generally, such agreements allocate taxes to members of the affiliated group based on the calculation of tax on a separate return basis, adjusted for the utilization or limitation of credits of the consolidated group.

Derivative Financial Instruments

Derivative financial instruments are recognized on the consolidated balance sheets at their fair value. On the date a derivative contract is entered into, HUSI designates it as either:


•	a qualifying hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge);

•	a qualifying hedge of the variability of cash flows to be received or paid related to a recognized asset, liability or forecasted transaction (cash flow hedge); or

•	as a trading or non-qualifying hedge.

Changes in the fair value of a derivative that has been designated and qualifies as a fair value hedge, along with the changes in the fair value of the hedged asset or liability that is attributable to the hedged risk (including losses or gains on firm commitments), are recorded in current period earnings. Changes in the fair value of a derivative that has been designated and qualifies as a cash flow hedge, to the extent effective as a hedge, are recorded in accumulated other comprehensive income, net of income taxes, and reclassified into earnings in the period during which the hedged item affects earnings. Ineffectiveness is reflected in current earnings. Changes in the fair value of derivatives held for trading purposes or which do not qualify for hedge accounting are reported in current period earnings.

At the inception of each hedge, HUSI formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions, the nature of the hedged risk, and how hedge effectiveness and ineffectiveness will be measured. This process includes linking all derivatives that are designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. HUSI also formally assesses, both at inception and on a recurring basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items and whether they are expected to continue to be highly effective in future periods. This assessment is conducted using statistical regression analysis.

Earnings volatility may result from the on-going mark to market of certain economically viable derivative contracts that do not satisfy the hedging requirements under U.S. GAAP, as well as from the hedge ineffectiveness associated with the qualifying contracts.

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Embedded Derivatives

HUSI may acquire or originate a financial instrument that contains a derivative instrument “embedded” within it. Upon origination or acquisition of any such instrument, HUSI assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the principal component of the financial instrument (i.e., the host contract) and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. With the adoption of Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155), the election now exists to account for an entire financial instrument at fair value through profit and loss if the financial instrument contains an embedded derivative that would otherwise require bifurcation. Hybrid financial instruments that HUSI has elected to carry at fair value continue to be reported in their existing balance sheet classification.

When it is determined that: (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract; and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is either separated from the host contract (bifurcated), carried at fair value, and designated as a trading instrument or the entire financial instrument is carried at fair value with all changes in fair value recorded to current period earnings. If bifurcation is elected, any gain recognized at inception related to the derivative is effectively embedded in the host contract and is recognized over the life of the financial instrument.

Hedge Discontinuation

HUSI discontinues hedge accounting prospectively when:


•	the derivative is no longer effective or expected to be effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions);

•	the derivative expires or is sold, terminated, or exercised;

•	it is unlikely that a forecasted transaction will occur;

•	the hedged firm commitment no longer meets the definition of a firm commitment; or

•	the designation of the derivative as a hedging instrument is no longer appropriate.

When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value or cash flow hedge, the derivative will continue to be carried on the balance sheet at fair value.

In the case of a fair value hedge of a recognized asset or liability, as long as the hedged item continues to exist on the balance sheet, the hedged item will no longer be adjusted for changes in fair value. The basis adjustment that had previously been recorded to the hedged item during the period from the designation date to the hedge discontinuation date is recognized as an adjustment to the yield of the hedged item over the remaining life of the hedged item.

In the case of a cash flow hedge of a recognized asset or liability, as long as the hedged item continues to exist on the balance sheet, the effective portion of the changes in fair value of the hedging derivative will no longer be reclassified into other comprehensive income. The balance applicable to the discontinued hedging relationship will be recognized in earnings over the remaining life of the hedged item as an adjustment to yield. If the hedged item was a firm commitment or forecasted transaction that is not expected to occur, any amounts recorded on the balance sheet related to the hedged item, including any amounts recorded in accumulated other comprehensive income, are reclassified to current period earnings.

In the case of either a fair value hedge or a cash flow hedge, if the previously hedged item is sold or extinguished, the basis adjustment to the underlying asset or liability or any remaining unamortized other comprehensive income balance will be reclassified to current period earnings.

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In all other situations in which hedge accounting is discontinued, the derivative will be carried at fair value on the consolidated balance sheets, with changes in its fair value recognized in current period earnings unless redesignated as a qualifying hedge.

Day One Revenue Recognition

HUSI recognizes gains and losses at the inception of derivative transactions only when the fair value of the transaction can be verified to similar market transactions or if all significant pricing model assumptions can be verified to observable market data. If profit or loss is not recognized at inception due to market observability, the net unrealized gain or loss associated with these transactions is recorded in trading and is offset by a reserve until the transaction can be verified to observable market data.

Interest Rate Lock and Purchase Agreements

HUSI enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is set prior to funding (rate lock commitments). HUSI also enters into commitments to purchase residential mortgage loans through its correspondent channel (purchase commitments). Both rate lock and purchase commitments for residential mortgage loans that are classified as held for sale are derivatives. Rate lock and purchase commitments that are considered to be derivatives are recorded at fair value in other assets or other liabilities in the consolidated balance sheets. Changes in fair value are recorded in other income in the consolidated statements of income.

Pension and Other Postretirement Benefits

At December 31, 2006, as a result of the adoption of SFAS 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, HUSI recognized the funded status of the postretirement benefit plans on the consolidated balance sheets with the offset to accumulated other comprehensive income. Prior to 2006, the funded status of these plans was not recognized on the consolidated balance sheets. Net postretirement benefit cost charged to current earnings related to these plans is based on various actuarial assumptions regarding expected future experience.

Certain HUSI employees are participants in various defined contribution and other non-qualified supplemental retirement plans. HUSI’s contributions to these plans are charged to current earnings.

Through various subsidiaries, HUSI maintains various 401(k) plans covering substantially all employees. Employer contributions to the plan, which are charged to current earnings, are based on employee contributions.

Stock-Based Compensation

HUSI uses the fair value method of accounting for stock awards granted to employees under various stock option and employee stock purchase plans. Stock compensation costs are recognized prospectively for all new awards granted under these plans. Compensation expense relating to share options is calculated using a binomial lattice methodology that is based on the underlying assumptions of the Black-Scholes option pricing model and is charged to expense over the vesting period, generally three to five years. When modeling awards with vesting dependent on performance targets, these performance targets are incorporated into the model using Monte Carlo simulation. The expected life of these awards depends on the behavior of the award holders, which is incorporated into the model consistent with historic observable data.

Compensation expense relating to restricted stock rights (RSRs) is based upon the market value of the RSRs on the date of grant and is charged to earnings over the vesting period of the RSRs, generally three to five years.

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Transactions With Related Parties

In the normal course of business, HUSI enters into transactions with HSBC and its subsidiaries. These transactions occur at prevailing market rates and terms and include funding arrangements, administrative and operational support, and other miscellaneous services. All material related party balances and transactions among various direct and indirect subsidiaries of HUSI are eliminated in consolidation.

New Accounting Pronouncements

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 establishes threshold and measurement attributes for financial statement measurement and recognition of tax positions taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN 48 on January 1, 2007 did not have a material impact on HUSI’s financial position or results of operations. Refer to Note 17 beginning on page 133 of this Form 10-K.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands the disclosure requirements for fair value measurements. In addition, SFAS 157 nullifies footnote 3 to EITF Issue No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, which prohibited the recognition of gains or losses at the inception of a derivative contract unless the fair value of the derivative contract is determined based on observable market price or other valuation technique that incorporate observable market data. SFAS 157 also requires HUSI to consider its own credit risk when measuring the fair value of liabilities including but not limited to debt issuances and derivative contracts. HUSI adopted SFAS 157 effective January 1, 2008. In accordance with the transition provisions of SFAS 157, HUSI recorded an after-tax cumulative-effect adjustment of approximately $36 million as an increase to the opening balance of retained earnings at the date of adoption.

In April 2007, the FASB issued FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (FSP FIN 39-1). FSP FIN 39-1 allows entities that are party to a master netting arrangement to offset the receivable or payable recognized upon payment or receipt of cash collateral against fair value amounts recognized for derivative instruments that have been offset under the same master netting arrangement in accordance with FASB Interpretation No. 39. The guidance in FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. Entities are required to recognize the effects of applying FSP FIN 39-1 as a change in accounting principle through retrospective application for all financial statements presented unless it is impracticable to do so. HUSI adopted FSP FIN 39-1 during the second quarter of 2007, the impact of which is described in Note 5 of these consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159), which creates an alternative measurement method for certain financial assets and liabilities. SFAS 159 permits fair value to be used for both the initial and subsequent measurements on a contract-by-contract election, with changes in fair value to be recognized in earnings as those changes occur. This election is referred to as the “fair value option”. SFAS 159 also requires additional disclosures to compensate for the lack of comparability that will arise from the use of the fair value option. HUSI adopted SFAS 159 on January 1, 2008 and elected the fair value option for certain fixed rate debt obligations, certain portfolios of loans held for sale, structured notes as well as other financial instruments. The adoption resulted in a cumulative-effect after-tax increase to the January 1, 2008 opening balance of retained earnings of approximately $77 million.

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In November 2007, the SEC issued Staff Accounting Bulletin 109, Written Loan Commitments Recorded at Fair Value Through Earnings (SAB 109), which supersedes SAB 105, Application of Accounting Principles to Loan Commitments. SAB 109 revises the views expressed by the staff in SAB 105 to specify that the expected net future cash flows related to the associated servicing of a loan should be included in the measurement of written loan commitments that are accounted for at fair value through earnings. SAB 109 is effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The adoption of SAB 109 is not expected to have a material impact on the HUSI consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (Revised), Business Combinations (SFAS 141(R)). This statement requires an acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at fair value as of the date of acquisition. This replaces the guidance in Statement 141 which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. SFAS 141(R) also changes the recognition and measurement criteria for certain assets and liabilities including those arising from contingencies, contingent consideration, and bargain purchases. SFAS 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements (SFAS 160). This statement amends ARB 51 and provides guidance on the accounting and reporting of noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires disclosure of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statements of income. This statement also requires expanded disclosures that identify and distinguish between parent and noncontrolling interests. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008.


*Note 3. Acquisitions and Divestitures*


	*2007*

On December 31, 2007, HUSI completed the sale of its Wealth and Tax Advisory Services (WTAS) subsidiary to an independent firm formed by certain members of the WTAS management team. In exchange for the net assets of WTAS, HUSI received cash and secured promissory notes, as well as an option to purchase a limited amount of common equity in future years. HUSI recognized a gain of $15 million as a result of this transaction.

There were no other material business acquisitions or divestitures in 2007.

2006 and 2005

There were no material business acquisitions or divestitures during 2006 or 2005.

Note 4. Federal Funds Sold and Securities Purchased Under Agreements to Resell

Federal funds sold and securities borrowed or purchased under agreements to resell are summarized in the following table.



December 31	2007		2006

(in millions)
Federal funds sold	$	975	$	6,781
Securities purchased under agreements to resell		12,702		6,994

Total	$	13,677	$	13,775

Funds generated from deposits growth during 2007 were primarily invested in short-term investments such as Federal funds sold and securities purchased under agreements to resell.

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Note 5. Trading Assets and Liabilities

Trading assets and liabilities are summarized in the following table.



December 31	2007		2006

(in millions)
Trading assets:
U.S. Treasury	$	460	$	646
U.S. Government agency		3,009		1,902
Asset backed securities		2,942		3,053
Corporate bonds		1,296		1,420
Other securities		5,830		4,903
Precious metals		8,788		2,716
Fair value of derivatives		14,711		8,990

	$	37,036	$	23,630

Trading liabilities:
Securities sold, not yet purchased	$	1,444	$	1,914
Payables for precious metals		1,523		1,336
Fair value of derivatives		13,286		9,064

	$	16,253	$	12,314

During the second quarter of 2007, HUSI adopted the reporting requirements of FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39 (refer to Note 2 of these consolidated financial statements). In accordance with this standard, HUSI offsets fair value amounts recognized for the obligation to return cash collateral or the right to reclaim cash collateral against the fair value of derivative instruments executed with the same counterparty under a master netting agreement. As a result of application of this standard, certain reclassifications have been made to the December 31, 2006 consolidated balance sheet, as noted below.

At December 31, 2007 and December 31, 2006, the fair value of derivatives included in trading assets have been reduced by $3.6 billion and $2.4 billion, respectively, of amounts recognized for the obligation to return cash collateral received under master netting agreements with derivative counterparties. At December 31, 2006, these amounts were originally reported as interest bearing deposits.

At December 31, 2007 and December 31, 2006, the fair value of derivatives included in trading liabilities have been reduced by $5.6 billion and $1.7 billion, respectively, of amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties. At December 31, 2006, $.4 billion of these amounts were originally reported as interest bearing deposits with banks and $1.3 billion were reported as other assets.

115

Note 6. Securities

At December 31, 2007 and 2006, HUSI held no securities of any single issuer (excluding the U.S. Treasury, U.S. Government sponsored enterprises and U.S. Government agencies) with a book value that exceeded 10% of shareholders’ equity. The amortized cost and fair value of the available for sale and held to maturity securities portfolios are summarized in the following table.



December 31, 2007	Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses				Fair Value

(in millions)
Securities available for sale:
U.S. Treasury		$	1		$	—		$	—			$	1
U.S. Government sponsored enterprises (1)			11,141			60			(271	)			10,930
U.S. Government agency issued or guaranteed			3,193			13			(34	)			3,172
Obligations of U.S. states and political subdivisions			668			3			(3	)			668
Asset backed securities			1,563			2			(72	)			1,493
Other domestic debt securities			2,649			15			(25	)			2,639
Foreign debt securities			1,036			1			(3	)			1,034
Equity securities			25			—			—				25

Securities available for sale		$	20,276		$	94		$	(408	)		$	19,962


Securities held to maturity:
U.S. Government sponsored enterprises (1)		$	1,862		$	42		$	(22	)		$	1,882
U.S. Government agency issued or guaranteed			528			24			(1	)			551
Obligations of U.S. states and political subdivisions			255			14			—				269
Other domestic debt securities			176			1			(4	)			173
Foreign debt securities			70			—			—				70

Securities held to maturity		$	2,891		$	81		$	(27	)		$	2,945


(1)	Includes primarily mortgage backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).



December 31, 2006	Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses				Fair Value

(in millions)
Securities available for sale:
U.S. Treasury		$	1,535		$	3		$	(8	)		$	1,530
U.S. Government sponsored enterprises (1)			10,682			30			(257	)			10,455
U.S. Government agency issued or guaranteed			3,793			6			(72	)			3,727
Obligations of U.S. states and political subdivisions			515			4			(1	)			518
Asset backed securities			578			1			(3	)			576
Other domestic debt securities			1,343			3			(19	)			1,327
Foreign debt securities			860			7			(3	)			864
Equity securities			775			11			—				786

Securities available for sale		$	20,081		$	65		$	(363	)		$	19,783


Securities held to maturity:
U.S. Government sponsored enterprises (1)		$	1,845		$	43		$	(17	)		$	1,871
U.S. Government agency issued or guaranteed			584			25			(2	)			607
Obligations of U.S. states and political subdivisions			325			19			—				344
Other domestic debt securities			167			2			(2	)			167
Foreign debt securities			51			—			*				51

Securities held to maturity		$	2,972		$	89		$	(21	)		$	3,040


(1)	Includes primarily mortgage backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).

*	Less than $500 thousand.

116

A summary of gross unrealized losses and related fair values, classified as to the length of time the losses have existed, is presented in the following table.



	One Year or Less							Greater Than One Year

December 31, 2007	Number of Securities		Gross Unrealized Losses			Aggregate Fair Value of Investment		Number of Securities		Gross Unrealized Losses			Aggregate Fair Value of Investment

($ in millions)
Securities available for sale:
U.S. Government sponsored enterprises (1)		48	$	(57	)	$	1,581		565	$	(214	)	$	5,818
U.S. Government agency issued or guaranteed		9		*			13		440		(34	)		1,607
Obligations of U.S. states and political subdivisions		43		(2	)		256		13		(1	)		106
Asset backed securities		33		(70	)		969		15		(2	)		127
Other domestic debt securities		31		(13	)		642		50		(12	)		735
Foreign debt securities		5		(1	)		71		6		(2	)		158

Securities available for sale		169	$	(143	)	$	3,532		1,089	$	(265	)	$	8,551

Securities held to maturity:
U.S. Government sponsored enterprises (1)		11	$	(3	)	$	87		20	$	(19	)	$	377
U.S. Government agency issued or guaranteed		1		*			15		82		(1	)		42
Obligations of U.S. states and political subdivisions		7		*			4		—		—			—
Other domestic debt securities		3		(1	)		41		7		(3	)		66
Foreign debt securities		—		—			—		—		—			—

Securities held to maturity		22	$	(4	)	$	147		109	$	(23	)	$	485


(1)	Includes primarily mortgage backed securities issued by FNMA and FHLMC.
*	Less than $500 thousand.

117



	One Year or Less							Greater Than One Year

December 31, 2006	Number of Securities		Gross Unrealized Losses			Aggregate Fair Value of Investment		Number of Securities		Gross Unrealized Losses			Aggregate Fair Value of Investment

($ in millions)
Securities available for sale:
U.S. Treasury		8	$	(1	)	$	527		6	$	(7	)	$	566
U.S. Government sponsored enterprises (1)		211		(114	)		3,158		482		(143	)		5,042
U.S. Government agency issued or guaranteed		691		(40	)		2,334		268		(32	)		1,076
Obligations of U.S. states and political subdivisions		12		(1	)		85		3		*			27
Asset backed securities		6		*			81		19		(3	)		293
Other domestic debt securities		10		(1	)		153		56		(18	)		910
Foreign debt securities		6		(1	)		191		11		(2	)		227

Securities available for sale		944	$	(158	)	$	6,529		845	$	(205	)	$	8,141

Securities held to maturity:
U.S. Government sponsored enterprises (1)		23	$	*		$	15		22	$	(17	)	$	389
U.S. Government agency issued or guaranteed		49		*			21		169		(2	)		35
Obligations of U.S. states and political subdivisions		1		*			*		9		*			4
Other domestic debt securities		2		*			22		4		(2	)		33
Foreign debt securities		2		*			51		—		—			—

Securities held to maturity		77	$	*		$	109		204	$	(21	)	$	461


(1)	Includes primarily mortgage backed securities issued by FNMA and FHLMC.
*	Less than $500 thousand.

Gross unrealized losses have increased within the available for sale securities portfolio during 2007, due to the impact of general increases in market interest rates on HUSI’s portfolios, which are primarily fixed rate securities. Since substantially all of these securities are high credit grade (i.e., AAA or AA), and HUSI has the ability and intent to hold these securities until maturity or a market price recovery, they are not considered to be other than temporarily impaired.

118

The following table summarizes realized gains and losses on investment securities transactions attributable to available for sale and held to maturity securities. Amounts in the table include net realized losses of $11 million reported in residential mortgage banking revenue in the consolidated statement of income for 2005.



Year Ended December 31	Gross Realized Gains			Gross Realized (Losses			)	Net Realized Gains

(in millions)
2007
Securities available for sale		$	67		$	(17	)		$	50
Securities held to maturity:
Maturities, calls and mandatory redemptions			1			—				1

		$	68		$	(17	)		$	51

2006
Securities available for sale		$	34		$	(6	)		$	28
Securities held to maturity:
Maturities, calls and mandatory redemptions			1			—				1

		$	35		$	(6	)		$	29

2005
Securities available for sale		$	107		$	(13	)		$	94
Securities held to maturity:
Maturities, calls and mandatory redemptions			1			—				1

		$	108		$	(13	)		$	95

The amortized cost and fair values of securities available for sale and securities held to maturity at December 31, 2007, by contractual maturity are summarized in the following table. Expected maturities differ from contractual maturities because borrowers have the right to prepay obligations without prepayment penalties in certain cases. Securities available for sale amounts exclude equity securities with a fair value and cost of $25 million as they do not have stated maturities.

119

The following table also reflects the distribution of maturities of debt securities held at December 31, 2007, together with the approximate taxable equivalent yield of the portfolio. The yields shown are calculated by dividing annual interest income, including the accretion of discounts and the amortization of premiums, by the amortized cost of securities outstanding at December 31, 2007. Yields on tax-exempt obligations have been computed on a taxable equivalent basis using applicable statutory tax rates.



Taxable Equivalent	Within One Year						After One But Within Five Years						After Five But Within Ten Years						After Ten Years
Basis
	Amount			Yield			Amount			Yield			Amount			Yield			Amount			Yield

($ in millions)
Available for sale:
U.S. Treasury		$	*		—	%		$	1		4.62	%		$	—		—	%		$	—		—	%
U.S. Government sponsored enterprises			230		2.94				348		6.00				579		5.06				9,984		5.08
U.S. Government agency issued or guaranteed			*		6.65				72		3.51				66		4.99				3,055		4.92
Obligations of U.S. states and political subdivisions			—		—				—		—				64		5.04				604		5.02
Asset backed securities			1		4.84				193		4.27				49		5.22				1,320		5.17
Other domestic debt securities			10		4.00				95		5.36				54		4.88				2,490		5.40
Foreign debt securities			799		5.21				86		6.03				46		6.02				105		6.85

Total amortized cost		$	1,040		4.69	%		$	795		5.28	%		$	858		5.10	%		$	17,558		5.11	%

Total fair value		$	1,039					$	774					$	858					$	17,266

Held to maturity:
U.S. Government sponsored enterprises		$	*		7.09	%		$	8		7.08	%		$	69		6.05	%		$	1,785		5.89	%
U.S. Government agency issued or guaranteed			1		6.82				2		7.26				7		8.69				518		6.41
Obligations of U.S. states and political subdivisions			10		5.93				44		5.44				38		4.99				163		5.10
Other domestic debt securities			—		—				—		—				—		—				176		5.80
Foreign debt securities			70		3.92				—		—				—		—				—		—

Total amortized cost		$	81		4.22	%		$	54		5.77	%		$	114		5.85	%		$	2,642		5.94	%

Total fair value		$	82					$	57					$	121					$	2,685

* Less than $500 thousand.

Investments in Federal Home Loan Bank (FHLB) stock, Federal Reserve Bank (FRB) stock, and MasterCard Class B shares of $373 million, $304 million and $56 million, respectively, were included in other assets at December 31, 2007. Investments in FHLB stock, FRB stock and MasterCard Class B shares of $360 million, $306 million and $57 million, respectively, were included in other assets at December 31, 2006.

120

Note 7. Loans

A distribution of the loan portfolio, including loans held for sale, is summarized in the following table.



	December 31, 2007						December 31, 2006

	Loans Held for Sale		All Other Loans		Total Loans		Loans Held for Sale		All Other Loans		Total Loans

(in millions)
Commercial loans:
Construction and other real estate	$	26	$	8,428	$	8,454	$	102	$	8,816	$	8,918
Other commercial		1,939		27,530		29,469		—		20,564		20,564

		1,965		35,958		37,923		102		29,380		29,482

Consumer loans:
Sub-prime residential mortgages		1,869		—		1,869		2,582		—		2,582
Other residential mortgages		1,018		32,493		33,511		1,645		35,581		37,226
Credit card receivables		—		19,415		19,415		—		18,260		18,260
Other consumer		418		1,813		2,231		394		2,293		2,687

		3,305		53,721		57,026		4,621		56,134		60,755

Total loans	$	5,270	$	89,679	$	94,949	$	4,723	$	85,514	$	90,237

In December 2004, HUSI acquired a $12 billion private label loan portfolio from HSBC Finance Corporation. The portfolio consisted of approximately $11 billion of private label credit card receivables and $1 billion of other consumer and commercial loans. The customer relationships were retained by HSBC Finance Corporation. By agreement, HUSI is purchasing additional credit card receivables generated from customer accounts at fair value on a daily basis. During 2007 and 2006, underlying customer balances included within the private label portfolio have revolved, and new relationships have been added, bringing the total private label credit card portfolio balance to approximately $17 billion at December 31, 2007 and 2006.

Residential mortgage loan originations generally declined during 2007 and 2006 due to a rising interest rate environment. In addition, originations of various adjustable rate residential mortgage loan products that would have been retained on the consolidated balance sheets prior to 2005 were being sold in the secondary market beginning in 2005 and throughout 2007 and 2006, also as a result of strategic balance sheet initiatives to enhance liquidity and to address interest rate risk. These factors contributed to the overall decrease in residential mortgage loans during 2007 and 2006.

HUSI has loans outstanding to certain executive officers and directors. The loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons and do not involve more than normal risk of collectibility. The aggregate amount of such loans did not exceed 5% of shareholders’ equity at December 31, 2007 and 2006.

Loans Held for Sale

HUSI originates commercial loans in connection with its participation in a number of leveraged acquisition finance syndicates. A substantial majority of these loans were originated with the intent of selling them to unaffiliated third parties and are classified as other commercial loans held for sale at December 31, 2007. Commercial loans held for sale under this program are classified as other commercial loans in the above table and were $1.9 billion at December 31, 2007.

Residential mortgage loans held for sale include sub-prime residential mortgage loans acquired from unaffiliated third parties and from HSBC Finance Corporation, with the intent of selling the loans to HMUS. Also included in other residential mortgage loans held for sale are prime mortgage loans originated and held for sale primarily to various governmental agencies.

Other consumer loans held for sale consists primarily of student loans.

121

Loans held for sale are recorded at the lower of cost or market value. The cost of loans held for sale exceeded market value at December 31, 2007 and December 31, 2006, resulting in the recording of a valuation allowance. Changes in the valuation allowance utilized to adjust loans held for sale to market value, that is included in the determination of net income, are summarized in the following table and reflect the recording of substantial valuation adjustments as a result of adverse conditions in the corporate credit and U.S. residential mortgage markets. Also, see commentary regarding changes in the valuation allowance included in the Management’s Discussion and Analysis of Financial Condition and Results of Operation (MD&A) on page 45 of this
Form 10-K.

The valuation allowance related to loans held for sale is presented in the following table.



	2007			2006

(in millions)
Balance at beginning of year	$	(29	)	$	(26	)
Increase in allowance for net reductions in market value		(512	)		(120	)
Releases of valuation allowance for loans sold		66			117

Balance at end of year	$	(475	)	$	(29	)

Loans held for sale are subject to credit risk and interest rate risk, in that their value will fluctuate as a result of changes in market conditions, as well as the interest rate and credit environment. Interest rate risk for residential mortgage loans held for sale is partially mitigated through an economic hedging program to offset changes in the fair value of the mortgage loans held for sale. There was a loss of $8 million recognized from the economic hedges of loans held for sale for 2007, compared to a $68 million gain for 2006.

Note 8. Allowance for Credit Losses and Credit Quality Statistics

An analysis of the allowance for credit losses is presented in the following table.



	2007			2006			2005

(in millions)
Balance at beginning of year	$	897		$	846		$	788
Provision charged to income		1,522			823			674
Charge offs		(1,269	)		(1,012	)		(871	)
Recoveries		264			248			255
Allowance related to dispositions, net		—			(8	)		—

Balance at end of year	$	1,414		$	897		$	846

Non-United States transfer risk reserves included in the allowance
for credit losses	$	—		$	—		$	4

122

Credit Quality Statistics

Nonaccruing loans information is summarized in the following table.



December 31		2007		2006

(in millions)
Nonaccruing loans
Commercial:
Construction and other real estate	$	34	$	33
Other commercial		89		69

Total commercial		123		102

Consumer:
Residential mortgages		640		265
Credit card receivables		1		1

Total consumer loans		641		266

Total nonaccruing loans	$	764	$	368

Interest income on nonaccruing loans is summarized in the following table.



Year Ended December 31	2007		2006		2005

(in millions)
Interest income on non accruing loans:
Amount which would have been recorded had the associated loans been current in accordance with their original terms	$	49	$	24	$	25
Amount actually recorded		7		8		12

Additional credit quality statistics are summarized in the following table.



December 31		2007		2006

(in millions)
Accruing loans contractually past due 90 days or more as to principal or interest:
Total commercial	$	8	$	22

Consumer:
Residential mortgages		—		11
Credit card receivables		432		339
Other consumer loans		16		16

Total consumer loans		448		366

Total accruing loans contractually past due 90 days or more	$	456	$	388


Impaired loans:
Balance at end of period	$	123	$	100
Amount with impairment reserve		41		35
Impairment reserve		15		13

Other real estate and owned assets:
Balance at end of period	$	71	$	53

123

Note 9. Securitizations and Secured Financings

On December 29, 2004, HUSI acquired a domestic private label loan portfolio from HSBC Finance Corporation, without recourse, which included securitized private label credit card receivables and retained interest assets related to these securitizations. The securitization transactions utilized revolving trusts structured as QSPEs and transfers of receivables to these QSPE trusts were structured to receive sale treatment under SFAS 140.

Under IFRS, HUSI’s private label credit card securitizations do not qualify for sale treatment and are treated as secured financings. In order to align its accounting treatment with that of HSBC, all new securitizations of private label credit cards since the third quarter of 2004 have been structured as secured financings under U.S. GAAP. In addition, the last remaining securitization trust agreement related to the securitized private label credit card receivables acquired from HSBC Finance Corporation in 2004 was amended in the third quarter of 2006. As a result, the related securitization trust no longer qualifies as a QSPE. Subsequent transfers of receivables to this trust, which are required to support previously issued securities, no longer qualify for sale treatment under U.S. GAAP and are recorded as secured financings. As of the amendment date, HUSI also began consolidating the trust as its primary beneficiary and all outstanding investments, credit card receivables and liabilities related to the trust are recorded on HUSI’s consolidated balance sheets.

Refer to Note 27, Variable Interest Entities (VIEs), on page 155 of this Form 10-K for additional information about the assets of private label credit card securitization trusts consolidated by HUSI.

Note 10. Properties and Equipment, Net

The composition of properties and equipment, net of accumulated depreciation, is summarized in the following table.



December 31	Depreciable Life (Years)		2007				2006

($ in millions)
Land		—		$	76			$	79
Buildings		5-40			832				754
Furniture and equipment		3-7			360				519

Total					1,268				1,352
Less: accumulated depreciation					(700	)			(812	)

Properties and equipment, net				$	568			$	540


Depreciation expense during the year				$	71			$	79

124

Note 11. Intangible Assets

The following table summarizes the composition of intangible assets.



December 31	2007		2006

(in millions)
Mortgage servicing rights	$	494		$	474
Other		40			47

Intangible assets	$	534		$	521

Mortgage Servicing Rights (MSRs)

HUSI recognizes the right to service mortgage loans as a separate and distinct asset at the time the loans are sold. Servicing fees collected by HUSI are included in residential mortgage banking revenue, and were $116 million, $100 million and $76 million for the years ended December 31, 2007, 2006 and 2005, respectively.

Effective January 1, 2006, HUSI adopted SFAS 156 electing to measure this one class of MSRs at fair value. Upon adoption, HUSI recorded a cumulative effect adjustment to beginning retained earnings of less than $1 million, representing the difference between the fair value and the carrying amount of MSRs as of the date of adoption.

MSRs are subject to credit and interest rate risk, in that their value will fluctuate as a result of changes in the interest rate environment. Interest rate risk is mitigated through an active economic hedging program that uses securities and derivatives to offset changes in the fair value of MSRs. Since the hedging program involves trading activity, risk is quantified and managed using a number of risk assessment techniques, which are addressed in more detail under Market Risk Management beginning on page 84 of this Form 10-K.

MSRs are initially measured at fair value at the time that the related loans are sold, and periodically remeasured using the fair value measurement method. MSRs are measured at fair value at each reporting date with changes in fair value of the asset reflected in residential mortgage banking revenue in the period that the changes occur. Fair value is determined based upon the application of valuation models and other inputs. The valuation models incorporate assumptions market participants would use in estimating future cash flows. These assumptions include expected prepayments, default rates and market-based option adjusted spreads. The reasonableness of these valuation models is periodically validated by reference to external independent broker valuations and industry surveys.

Fair value of MSRs is calculated using the following critical assumptions.



	December 31, 2007			December 31, 2006

Annualized constant prepayment rate (CPR)		21.40	%		20.80	%
Constant discount rate		10.44	%		10.34	%
Weighted average life		4.9 years			4.8 years

125

The following table summarizes MSRs activity for the years ended December 31, 2007 and 2006, the reporting periods since adoption of SFAS 156.



Year Ended December 31	2007				2006

(in millions)
Fair value of MSRs:
Beginning balance		$	474			$	418
Additions related to loan sales			124				100
Changes in fair value due to:
Change in valuation inputs or assumptions used in the valuation models			(19	)			43
Realization of cash flows			(85	)			(87	)

Ending balance		$	494			$	474

Information regarding residential mortgage loans serviced for others, which are not included in the consolidated balance sheet, is summarized in the following table.



Year Ended December 31		2007		2006

(in millions)
Outstanding principal balances at period end	$	37,401	$	34,736


Custodial balances maintained and included in noninterest bearing deposits at period end	$	596	$	647

Other Intangible Assets

Other intangible assets include favorable lease arrangements and customer lists. The weighted-average amortization period for these intangible assets is 75 months at December 31, 2007. Total amortization expense was approximately $6 million for 2007 and 2006. Scheduled amortization is approximately $6 million per year for 2008 through 2012.

Note 12. Goodwill

During the third quarter of 2007, HUSI completed its annual impairment test of goodwill. At the testing date, HUSI determined that the fair value of each of its reporting units exceeded its carrying value. As a result, no impairment loss was required to be recognized.

The following table presents a summary of changes in goodwill.



Year Ended December 31	2007			2006

(in millions)
Balance at beginning of year	$	2,716		$	2,694
Purchase accounting adjustment		—			22
Reductions related to business disposals		(15	)		—

Balance at the end of the year	$	2,701		$	2,716

During December 2007, HUSI sold the Wealth and Tax Advisory business, which resulted in a reduction to goodwill of approximately $15 million.

126

Note 13. Deposits

The aggregate amounts of time deposit accounts (primarily certificates of deposits), each with a minimum of $100,000 included in domestic office deposits, were approximately $17 billion and $19 billion at December 31, 2007 and 2006, respectively. Certain domestic deposits meet the definition of a hybrid financial instrument as defined in SFAS 155. As a result, deposits totaling $1,479 million and $1,322 million at December 31, 2007 and 2006, respectively, are being carried at fair value with all changes in fair value recorded to profit and loss. The scheduled maturities of all time deposits at December 31, 2007 is summarized in the following table.

Domestic
Offices

Foreign
Offices

Total

(in millions)

2008:

0-90 days

14,812

11,317

26,129

91-180 days

4,577

461

5,038

181-365 days

3,199

229

3,428

22,588

12,007

34,595

2009

380

—

380

2010

141

—

141

2011

—

2012

—

Later years

199

—

199

23,422

12,007

35,429

Overdraft deposits, which are classified as loans, were approximately $2,281 million and $1,727 million at December 31, 2007 and 2006, respectively.

Note 14. Short-Term Borrowings

The following table summarizes the components of short-term borrowings. At December 31, 2007 and 2006, there were no categories of short-term borrowings that exceeded 30% of total shareholders’ equity.



December 31	2007		2006

(in millions)
Federal funds purchased (day to day)	$	2,055	$	77
Securities sold under repurchase agreements		2,247		1,328
Commercial paper		3,925		2,414
Precious metals		3,078		1,146
Other		527		108

Total short-term borrowings	$	11,832	$	5,073

At December 31, 2007 and 2006, HUSI had an unused line of credit from HSBC of $2.5 billion and $2 billion, respectively. This line of credit does not require compensating balance arrangements and commitment fees are not significant. The interest rate is comparable to third party rates for a line of credit with similar terms.

At December 31, 2007 and 2006, HUSI had an unused line of credit from its parent, HSBC North America Inc. (HNAI), of $150 million. The interest rate is comparable to third party rates for a line of credit with similar terms.

As a member of the New York Federal Home Loan Bank (FHLB), HUSI has a secured borrowing facility, which is collateralized by residential mortgage loans. At December 31, 2007 and 2006, the facility included $5.5 billion and $5.0 billion, respectively, of borrowings included in long-term debt (see Note 15). The facility also allows access to further short-term borrowings based upon the amount of residential mortgage loans pledged as collateral with the FHLB, which were undrawn as of December 31, 2007 and 2006.

127

Note 15. Long-Term Debt

The composition of long-term debt is presented in the following table. Interest rates on floating rate notes are determined periodically by formulas based on certain money market rates or, in certain instances, by minimum interest rates as specified in the agreements governing the issues. Interest rates in effect at December 31, 2007 are shown in parentheses.



December 31	2007		2006

(in millions)
Issued by HUSI or its subsidiaries other than HBUS:
Non-subordinated debt:
Medium-Term Floating Rate Notes due 2008-2012 (4.42% - 5.10%)	$	357	$	53
8.375% Debentures due 2007		—		100
Floating Rate Extendible Notes due 2008 (5.04%)		1,500		1,499

		1,857		1,652
Subordinated debt:
Fixed Rate Subordinated Notes due 2008-2097 (5.88% - 9.70%)		1,489		1,496
Perpetual Capital Notes (5.63%)		127		127
Junior Subordinated Debentures due 2026-2032 (7.75% - 8.38%)		866		1,061

		2,482		2,684


Total issued by HUSI or its subsidiaries other than HBUS		4,339		4,336


Issued or acquired by HBUS or its subsidiaries:
Non-subordinated debt:
Global Bank Note Program:
Medium-Term Notes due 2008-2040 (.78% - 5.94%)		2,927		2,108
3.875% Fixed Rate Senior Global Bank Notes due 2009		1,945		1,943
5.43% Fixed Rate Senior Global Bank Notes due 2009		—		20
Floating Rate Senior Global Bank Notes due 2009 (5.19% - 5.29%)		1,798		4,646
Floating Rate Non-USD Senior Global Bank Notes due 2008-2009 (2.59% - 4.88%)		1,459		1,328
4.95% Fixed Rate Senior Notes due 2012		25		25

		8,154		10,070
Federal Home Loan Bank of New York (FHLB) advances:
Fixed Rate FHLB advances due 2008-2037 (2.01% - 7.24%)		9		10
Floating Rate FHLB advances due 2008-2036 (4.88% - 5.25%)		5,500		5,000

		5,509		5,010

Precious metal leases due 2008-2014 (.10% - 1.70%)		1,044		729

Private label credit card secured financing due 2008-2012 (4.67% - 5.35%), refer to Note 9		1,549		2,134

Secured financings with Structured Note Vehicles, refer to Note 27		2,486		2,542

Other:
5.99% Fixed Rate Note due 2011		350		350
Floating Rate Note due 2011 (5.49%)		1		4
6.60% Fixed Rate Note due 2021		1,009		858
3.99% Non-USD Senior Debt due 2044		579		530
Other		22		34

		1,961		1,776

Total non-subordinated debt		20,703		22,261


Subordinated debt:
4.625% Global Subordinated Notes due 2014		996		995
Global Bank Note Program:
Fixed Rate Global Bank Notes due 2017-2035 (5.63% - 6.00%)		2,215		1,643

Total subordinated debt		3,211		2,638


Total issued or acquired by HBUS or its subsidiaries		23,914		24,899


Obligations under capital leases		15		17


Total long-term debt	$	28,268	$	29,252

128

The table excludes $900 million of long-term debt issued by HBUS or its subsidiaries payable to HUSI. Of this amount, the earliest note is due to mature in 2012 and the latest note is due to mature in 2097.

Debt Issued by HUSI or its Subsidiaries other than HBUS

In April 2006, HUSI filed an S-3 Shelf Registration Statement (the 2006 shelf) with the Securities and Exchange Commission. Under the 2006 shelf, HUSI may issue debt securities or preferred stock, either separately or represented by depositary shares, warrants, purchase contracts and units comprised of any combination of one or more of the aforementioned securities. The 2006 shelf, which has no dollar limit, replaced a shelf filed in 2005 in the amount of $2.3 billion. The Medium-Term Floating Rate Notes due 2008–2012 were issued under the 2006 shelf.

All of the Medium-Term Floating Rate Notes at December 31, 2007 and December 31, 2006 meet the definition of hybrid financial instruments under SFAS 155, which was adopted in 2006, (see Note 2) and are being carried at fair value.

The $1.5 billion Floating Rate Extendible Notes were issued by HUSI in November 2005. These senior debt securities require the noteholders to decide each month whether or not to extend the maturity date of their notes by one month beyond the initial maturity date of December 15, 2006. In no event will the maturity of the notes be extended beyond December 15, 2011, the final maturity date. If on any election date a noteholder decides not to extend the maturity of all or any portion of the principal amount of his notes, the notes will mature on the previously elected maturity date, which will be the maturity date that is twelve months from the current election date. On the August 2007 election date, noteholders of $749,500,000 of this debt exercised their option not to extend the maturity date of their notes. These notes will mature on August 15, 2008. On the September 2007 election date, noteholders of $690,000,000 of this debt exercised their option not to extend the maturity date of their notes. These notes will mature on September 15, 2008. On the October 2007 election date, noteholders of the remaining $60,500,000 of this debt elected not to extend the maturity of their notes. Therefore, these notes will mature on October 15, 2008. Interest is payable on the notes in arrears on the 15^th day of each month, commencing December 15, 2005. The interest rate will be determined by reference to the one-month LIBOR, plus or minus the applicable spread for that particular interest period. The spread for each interest period ranges from minus 2 basis points for the interest period ending December 15, 2006 to plus 1 basis point for the interest period ending October 15, 2008.

The Junior Subordinated Debentures due 2026-2032 are held by four capital funding trusts established by HUSI to issue guaranteed capital debt securities in the form of preferred stock backed by the debentures and guaranteed by HUSI. The trusts also issued common stock, all of which is held by HUSI and recorded in other assets. The debentures issued to the capital funding trusts, less the amount of their common stock held by HUSI, qualify as Tier 1 capital. Although the capital funding trusts are VIEs, HUSI’s investment in their common stock is not deemed to be a variable interest because that stock is not deemed to be equity at risk. HUSI holds no other interests in the capital funding trusts and therefore is not their primary beneficiary and does not consolidate them. During September 2007, HUSI exercised its right to redeem $206 million of the 7.53% Junior Subordinated Debentures that had an original maturity date of December 4, 2026.

129

Debt Issued by HBUS or its Subsidiaries

In December 2006, HBUS increased the size of its Global Bank Note Program from $20 billion to $40 billion. The Global Bank Note Program provides for the issuance of fixed rate and floating rate, senior and subordinated notes. The following debt issues were made under this program in 2007 and 2006.


•	In August 2007, HBUS issued $500 million of 6.00% Subordinated Bank Notes due 2017. Interest is paid semiannually on February 9 and August 9 of each year, commencing on February 9, 2008 and ending on the stated maturity date of August 9, 2017. These notes may not be redeemed by HBUS.

•	In November 2006, HBUS issued the $20 million 5.43% Senior Notes due 2009. Interest is paid semiannually on May 20 and November 20 of each year, commencing on May 20, 2007 and ending on the stated maturity date of November 20, 2009. HBUS exercised its right to redeem these notes in whole on November 20, 2007.

•	Certain Medium-Term Notes issued in 2006 meet the definition of hybrid financial instruments under SFAS 155, which was adopted in 2006 (see Note 2). Medium-Term Notes totaling $1,403 million and $849 million at December 31, 2007 and 2006, respectively, are being carried at fair value.

Other includes certain notes totaling $1.4 billion and $1.2 billion at December 31, 2007 and 2006, respectively, which resulted from 2006 structured financing transactions.

As of December 31, 2007, the contractual scheduled maturities for total long-term debt over the next five years are as follows.



(in millions)
2008	$	8,875
2009		5,970
2010		1,868
2011		962
2012		824

Note 16. Derivative Instruments and Hedging Activities

HUSI is party to various derivative financial instruments as an end user (1) for asset and liability management purposes; (2) in order to offset the risk associated with changes in the value of various assets and liabilities accounted for in the trading account; (3) to protect against changes in value of its mortgage servicing rights portfolio; and (4) for trading in its own account.

HUSI is also an international dealer in derivative instruments denominated in U.S. dollars and other currencies which include futures, forwards, swaps and options related to interest rates, foreign exchange rates, equity indices, commodity prices and credit, focusing on structuring of transactions to meet clients’ needs.

Fair Value Hedges

Specifically, interest rate swaps that call for the receipt of a variable market rate and the payment of a fixed rate and short forward contracts are utilized under fair value strategies to hedge the risk associated with changes in the risk free rate component of the value of certain fixed rate investment securities. Interest rate swaps that call for the receipt of a fixed rate and payment of a variable market rate are utilized to hedge the risk associated with changes in the risk free rate component of certain fixed rate debt obligations. The regression method is utilized in order to satisfy the retrospective and prospective assessment of hedge effectiveness for SFAS 133.

HUSI recognized net (losses) gains of approximately $(8) million, $10 million and $2 million for the years ended December 31, 2007, 2006 and 2005, respectively, (reported as other income in the consolidated statements of income), which represented the ineffective portion of all fair value hedges.

130

For the years ended December 31, 2007, 2006 and 2005, $5 million, $5 million and $7 million of gains related to the basis adjustment of terminated and/or redesignated fair value hedge relationships were amortized to earnings. During 2008, HUSI expects to amortize $7 million of remaining gains to earnings resulting from these terminated and/or redesignated fair value hedges.

Cash Flow Hedges

Similarly, interest rate swaps and futures contracts that call for the payment of a fixed rate are utilized under the cash flow strategy to hedge the forecasted repricing of certain deposit liabilities. In order to satisfy the retrospective and prospective assessment of hedge effectiveness for SFAS 133, the regression method is utilized. Ineffectiveness is recorded to the statement of income on a monthly basis. The total ineffectiveness of all cash flow hedges was $1.4 million for the year ended December 31, 2007 and was less than $1 million for the years ended December 31, 2006 and 2005.

Gains or losses on derivative contracts that are reclassified from accumulated other comprehensive income to current period earnings pursuant to this strategy, are included in interest expense on deposit liabilities during the periods that net income is impacted by the underlying liabilities. As of December 31, 2007, approximately $66 million of deferred net losses on derivative instruments accumulated in other comprehensive income are expected to be included in earnings during 2008.

At December 31, 2007, the net unrealized loss on derivatives included in accumulated other comprehensive income was $157 million, net of income taxes. Of this amount, the $68 million gain represents the effective portion of the net gains on derivatives that qualify as cash flow hedges, and the $89 million loss relates to terminated and/or redesignated derivatives. For the years ended December 31, 2007 and 2006, respectively, $12 million of losses and $35 million of gains related to terminated and/or redesignated cash flow hedge relationships were amortized to earnings from other comprehensive income. During 2008, HUSI expects to amortize $66 million of remaining gains to earnings resulting from these terminated and/or redesignated cash flow hedges.

Trading and Other Activities

HUSI enters into certain derivative contracts for purely trading purposes in order to realize profits from short-term movements in interest rates, commodity prices, foreign exchange rates and credit spreads. In addition, certain derivative contracts are accounted for on a full mark to market basis through current earnings even though they were acquired for the purpose of protecting the economic value of certain assets and liabilities.

131

Notional Values of Derivative Contracts

The following table summarizes the notional values of derivative contracts.



December 31	2007		2006

(in millions)
Interest rate:
Futures and forwards	$	96,077	$	94,204
Swaps		1,874,340		1,906,688
Options written		97,198		510,023
Options purchased		102,015		544,026

		2,169,630		3,054,941

Foreign exchange:
Swaps, futures and forwards		534,988		394,621
Options written		87,730		61,406
Options purchased		86,350		63,795
Spot		39,963		32,654

		749,031		552,476

Commodities, equities and precious metals:
Swaps, futures and forwards		49,080		43,620
Options written		19,394		12,263
Options purchased		18,730		16,115

		87,204		71,998


Credit derivatives		1,252,337		816,422


Total	$	4,258,202	$	4,495,837

The total notional amounts in the table above relate primarily to HUSI’s trading activities. Notional amounts included in the table related to non-trading fair value, cash flow and economic hedging activities were $15 billion and $27 billion at December 31, 2007 and 2006, respectively.

132

Note 17. Income Taxes

Total income taxes were allocated as follows.



Year Ended December 31	2007				2006				2005

(in millions)
Income tax (benefit) expense		$	(1	)		$	530			$	566
To shareholders’ equity as tax charge (benefit):
Net unrealized losses on securities available for sale			(13	)			(22	)			(111	)
Unrealized (losses) gains on derivatives classified as cash flow hedges			(74	)			(106	)			78
Unrealized (losses) gains on interest-only strip receivables			—				(4	)			4
Employer accounting for post-retirement plans			5				(13	)			—
Foreign currency translation, net			2				—				(4	)

		$	(81	)		$	385			$	533

The components of income tax expense follow.



Year Ended December 31	2007				2006				2005

(in millions)
Current:
Federal		$	301			$	466			$	484
State and local			40				51				90
Foreign			28				18				7

Total current			369				535				581
Deferred, primarily federal			(370	)			(5	)			(15	)

Total income tax (benefit) expense		$	(1	)		$	530			$	566

The following table is an analysis of the difference between effective rates based on the total income tax provision attributable to pretax income and the statutory U.S. Federal income tax rate.



Year Ended December 31	2007		2006		2005

Statutory rate	35.0	%	35.0	%	35.0	%
Increase (decrease) due to:
State and local income taxes	14.3		2.1		4.2
Adjustment of tax rate used to value deferred taxes	17.4		—		—
Goodwill related to disposition of WTAS business	3.8		—		—
Valuation allowance	4.4		—		—
Validation of deferred tax balances	(20.5	)	1.1		—
Release of tax reserves	(6.3	)	(.7	)	(.3	)
Tax exempt interest income	(11.1	)	(.9	)	(.7	)
Low income housing and miscellaneous other tax credits	(34.1	)	(1.8	)	(1.4	)
Non-taxable income	(5.5	)	—		—
Other items	1.9		(1.0	)	(.1	)

Effective income tax rate	(.7%	)	33.8	%	36.7	%

133

The components of the net deferred tax position are presented in the following table.



December 31	2007			2006

(in millions)
Deferred tax assets:
Allowance for credit losses	$	524		$	296
Benefit accruals		120			100
Accrued expenses not currently deductible		102			80
LOCOM adjustments		136			—
Unrealized losses on securities available for sale		112			122
Investment securities		88			20
Accrued pension cost		5			14
Premium on purchased receivables		—			4

Total deferred tax assets before valuation allowance		1,087			636
Valuation allowance		(7	)		—

Total deferred tax assets		1,080			636


Less deferred tax liabilities:
Lease financing income accrued		(6	)		7
Deferred gain recognition		(48	)		34
Depreciation and amortization		22			6
Interest and discount income		201			168
Deferred fees/costs		86			97
Mortgage servicing rights		150			177
Net purchase discount on acquired companies		7			6
Other		93			40

Total deferred tax liabilities		505			535

Net deferred tax asset	$	575		$	101

Realization of deferred tax assets is contingent upon the generation of future taxable income or the existence of sufficient taxable income within the carryback period. Based upon the level of historical taxable income and the scheduled reversal of the deferred tax liabilities over the periods in which the deferred tax assets are deductible, management believes that it is more likely than not HUSI would realize the benefits of these deductible differences, net of the valuation allowance noted above. The valuation allowance relates primarily to potential limitations on the utilization of excess foreign tax credits.

At December 31, 2007, HUSI had foreign tax credit carryforwards of $6 million for U.S. federal income tax purposes which expire as follows: $2 million in 2016 and $4 million in 2017.

As discussed in Note 2, HUSI adopted FIN 48 effective January 1, 2007. The adoption resulted in the recognition of additional current tax liabilities and offsetting deferred tax assets of $11 million. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows.



(in millions)
Balance at January 1, 2007	$	86
Additions based on tax positions related to the current year		23
Additions for tax positions of prior years		27
Reductions for tax positions of prior years		(21	)

Balance at December 31, 2007	$	115

The state tax portion of this amount is reflected gross and not reduced by federal tax effect. The total amount of unrecognized tax benefits at December 31, 2007 that, if recognized, would affect the effective income tax rate is $56 million.

134

Major taxing jurisdictions for HUSI and tax years for each that remain subject to examination are as follows.


U.S. Federal	2004 and later
New York State	1992 and later
New York City	1995 and later

The U.S. federal audit of the 2004 and 2005 tax years, as well as certain state audits, have a reasonable possibility of being effectively settled within the next 12 months. No estimate as to the potential outcome of these audits is possible at this time.

HUSI recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in other operating expenses. As of January 1, 2007, we had accrued $16 million for the payment of interest associated with uncertain tax positions. During the twelve months ended December 31, 2007, we increased our accrual for the payment of interest associated with uncertain positions by $11 million.

Note 18. Preferred Stock

The following table presents information related to the issues of preferred stock outstanding.

Shares
Outstanding
2007

Dividend
Rate
2007

Amount
Outstanding

December 31

2007

2006

($ in millions)

Floating Rate Non-Cumulative Preferred Stock, Series F ($25 stated value)

20,700,000

6.159

517

517

14,950,000 Depositary Shares each representing a one-fortieth interest in a share of Floating Rate Non-Cumulative Preferred Stock, Series G ($1,000 stated value)

373,750

6.159

374

374

14,950,000 Depositary Shares each representing a one-fortieth interest in a share of 6.50% Non-Cumulative Preferred Stock, Series H ($1,000 stated value)

373,750

6.500

374

374

6,000,000 Depositary shares each representing a one-fourth interest in a share of Adjustable Rate Cumulative Preferred Stock, Series D ($100 stated value)

1,500,000

4.500

150

150

$2.8575 Cumulative Preferred Stock ($50 stated value)

3,000,000

5.715

150

150

CTUS Inc. Preferred Stock

100

—

Dutch Auction Rate Transferable Securities™ Preferred Stock (DARTS):

Series A ($100,000 stated value)

—

4.527

—

Series B ($100,000 stated value)

—

4.565

—

1,565

1,690

* Less than $500 thousand.

Preferred Stock

135

Dividends on the Floating Rate Non-Cumulative Series F Preferred Stock are non-cumulative and will be payable when and if declared by the Board of Directors of HUSI quarterly on the first calendar day of January, April, July and October of each year. Dividends on the stated value per share are payable for each dividend period at a rate equal to a floating rate per annum of .75% above three month LIBOR, but in no event will the rate be less than 3.5% per annum. The Series F Preferred Stock may be redeemed at the option of HUSI, in whole or in part, on or after April 7, 2010 at a redemption price equal to $25 per share, plus accrued and unpaid dividends for the then-current dividend period.

Dividends on the Floating Rate Non-Cumulative Series G Preferred Stock are non-cumulative and will be payable when and if declared by the Board of Directors of HUSI quarterly on the first calendar day of January, April, July and October of each year. Dividends on the stated value per share are payable for each dividend period at a rate equal to a floating rate per annum of .75% above three month LIBOR, but in no event will the rate be less than 4% per annum. The Series G Preferred Stock may be redeemed at the option of HUSI, in whole or in part, on or after January 1, 2011 at a redemption price equal to $1,000 per share, plus accrued and unpaid dividends for the then-current dividend period.

The Adjustable Rate Cumulative Preferred Stock, Series D is redeemable, as a whole or in part, at the option of HUSI at $100 per share (or $25 per depositary share), plus accrued and unpaid dividends. The dividend rate is determined quarterly, by reference to a formula based on certain benchmark market interest rates, but will not be less than 4½% or more than 10½% per annum for any applicable dividend period.

The $2.8575 Cumulative Preferred Stock may be redeemed at the option of HUSI, in whole or in part, on or after October 1, 2007 at $50 per share, plus accrued and unpaid dividends. Dividends are paid quarterly.

HUSI acquired CTUS Inc., a unitary thrift holding company, in 1997 from CT Financial Services Inc. (the Seller). CTUS owned First Federal Savings and Loan Association of Rochester (First Federal). The acquisition agreement provided that HUSI issue preferred shares to the Seller. The preferred shares provide for, and only for, a contingent dividend or redemption equal to the amount of recovery, net of taxes and costs, if any, by First Federal resulting from the pending action against the United States government alleging breaches by the government of contractual obligations to First Federal following passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. HUSI issued 100 preferred shares at a par value of $1.00 per share in connection with the acquisition.

In November 2007, HUSI redeemed all issued shares of DARTS Preferred Stock, Series A and B at their stated value of $100,000 per share, resulting in total cash payment of $125 million.

136

Note 19. Retained Earnings and Regulatory Capital Requirements

Bank dividends are a major source of funds for payment by HUSI of shareholder dividends and along with interest earned on investments, cover HUSI’s operating expenses which consist primarily of interest on outstanding debt. Under 12 USC 60, the approval of the OCC is required if the total of all dividends declared by HBUS in any year exceeds the cumulative net profits for that year, combined with the profits for the two preceding years reduced by dividends attributable to those years. Under a separate restriction, payment of dividends is prohibited in amounts greater than undivided profits then on hand, after deducting actual losses and bad debts. Bad debts are debts due and unpaid for a period of six months unless well secured, as defined, and in the process of collection. These rules restrict HBUS from paying dividends to HUSI as of December 31, 2007, as cumulative net profits for 2007, 2006 and 2005 are less than dividends attributable to those years.

Additional information regarding regulation, supervision and capital for HUSI and HBUS begins on page 10 of this Form 10-K.

Capital amounts and ratios of HUSI and HBUS, calculated in accordance with current banking regulations, are summarized in the following table. In December 2007, U.S. regulators published a revision to the regulatory capital rules which will go into effect on April 1, 2008. This revision will significantly affect the ratios shown in the table below. HUSI’s approach toward implementing the Basel II framework is summarized on page 76 of this Form 10-K.

2007

2006

December 31

Capital
Amount

Well-Capitalized
Minimum Ratio ⁽¹⁾

Actual
Ratio

Capital
Amount

Well-Capitalized
Minimum Ratio ⁽¹⁾

Actual
Ratio

($ in millions)

Total capital (to risk weighted assets):

HUSI

15,276

10.00

11.29

15,501

10.00

12.58

HBUS

15,330

10.00

11.40

14,998

10.00

12.23

Tier 1 capital (to risk weighted assets):

HUSI

9,639

6.00

7.12

10,577

6.00

8.58

HBUS

9,696

6.00

7.21

10,278

6.00

8.38

Tier 1 capital (to average assets):

HUSI

9,639

3.00

⁽²⁾

5.34

10,577

3.00

6.36

HBUS

9,696

5.00

5.46

10,278

5.00

6.29

Risk weighted assets:

HUSI

135,339

122,652

HBUS

134,501

122,652


(1)	HUSI and HBUS are categorized as “well-capitalized”, as defined by their principal regulators. To be categorized as well-capitalized under regulatory guidelines, a banking institution must have the minimum ratios reflected in the above table, and must not be subject to a directive, order, or written agreement to meet and maintain specific capital levels.

(2)	There is no Tier 1 leverage ratio component in the definition of a well-capitalized bank holding company. The ratio shown is the minimum required ratio.

137

Note 20. Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss includes certain items that are reported directly within a separate component of shareholders’ equity. The following table presents changes in accumulated other comprehensive loss balances.



	2007			2006			2005

(in millions)
Unrealized (losses) gains on available for sale securities:
Balance, January 1	$	(199	)	$	(128	)	$	21
Increase (decrease) in fair value, net of taxes of $(15), $10, and $71, in 2007, 2006 and 2005, respectively		42			(55	)		(94	)
Net gains on sale of securities reclassified to net income, net of taxes of $19, $12, and $40 in 2007, 2006 and 2005, respectively		(31	)		(16	)		(55	)

Net change		11			(71	)		(149	)

Balance, December 31		(188	)		(199	)		(128	)


Unrealized (losses) gains on derivatives classified as cash flow hedges:
Balance, January 1		(8	)		98			(6	)
Change in unrealized (loss) gain net of taxes of $72, $106, and $(78) in 2007, 2006 and 2005, respectively		(165	)		(106	)		104

Net change		(165	)		(106	)		104

Balance, December 31		(173	)		(8	)		98


Unrealized gains on interest-only strip receivables:
Balance, January 1		—			7			—
Change in unrealized gains on interest-only strip receivables, net of taxes of $4 and $(4) in 2006 and 2005, respectively		—			(7	)		7

Net change		—			(7	)		7

Balance, December 31		—			—			7


Foreign currency translation adjustments:
Balance, January 1		11			11			16
Translation gains, net of taxes of $2 and $4 in 2007 and 2005,respectively		4			*			(5	)

Net change		4			*			(5	)

Balance, December 31		15			11			11


Unfunded postretirement benefits liability:
Balance, January 1		(18	)		—			—
Cumulative effect of change in accounting for pension and postretirement benefits, net of taxes of $13 in 2006		—			(18	)		—
Change in unfunded postretirement liability, net of taxes of $(6) in 2007		12			—			—

Net change		12			(18	)		—

Balance, December 31		(6	)		(18	)		—


Summary of accumulated other comprehensive loss:
Accumulated other comprehensive (loss) income, January 1		(214	)		(12	)		31
Other comprehensive loss, net of tax		(150	)		(184	)		(43	)
Cumulative effect of change in accounting for pension and postretirement benefits and change in unfunded postretirement liability, net of tax		12			(18	)		—

Accumulated other comprehensive loss, December 31	$	(352	)	$	(214	)	$	(12	)

* Less than $500 thousand.

138

Note 21. Related Party Transactions

In the normal course of business, HUSI conducts transactions with HSBC and its subsidiaries (HSBC affiliates). These transactions occur at prevailing market rates and terms. All extensions of credit by HBUS to other HSBC affiliates are legally required to be secured by eligible collateral. The following table presents related party balances and the income and expense generated by related party transactions.



December 31	2007		2006		2005

(in millions)
Assets:
Cash and due from banks	$	97	$	179	$	121
Interest bearing deposits with banks		134		59		67
Federal funds sold and securities purchased under agreements to resell		356		141		111
Trading assets		11,640		6,895		5,386
Loans		2,007		813		1,562
Other		390		226		79

Total assets	$	14,624	$	8,313	$	7,326


Liabilities:
Deposits	$	13,088	$	12,233	$	10,133
Trading liabilities		14,552		6,473		4,545
Short-term borrowings		982		464		698
Other		840		254		104

Total liabilities	$	29,462	$	19,424	$	15,480



December 31	2007		2006		2005

(in millions)
Interest income	$	178	$	51	$	40
Interest expense		424		408		293
HSBC affiliate income:
Other fees and commissions:
HSBC		67		28		34
HSBC Finance Corporation		18		12		13
HMUS		13		5		18
Other HSBC affiliates		7		6		6
Service charges		11		15		15
Gains on sales of loans to HMUS		18		106		18
Gains on sales of refund anticipation loans to HSBC Finance Corporation		23		22		19
Other HSBC affiliates income		15		14		7
Support services from HSBC affiliates:
Fees paid to HSBC Finance Corporation		468		452		415
Fees paid to HMUS		238		227		162
Fees paid to HTSU for technology services		260		235		216
Fees paid to other HSBC affiliates		196		162		126

139

Transactions Conducted with HSBC Finance Corporation


•	Support services from HSBC affiliates includes charges by HSBC Finance Corporation under various service level agreements for loan origination and servicing as well as other operational and administrative support.

•	By agreement, HUSI purchases receivables generated by private label and MasterCard¹/Visa² credit card relationships on a daily basis at a value that approximates fair value, as determined by an independent third party. Premiums paid are amortized to interest income over the estimated life of the receivables purchased. HSBC Finance Corporation continues to service the customer relationships, for which they charged HUSI servicing fees of $374 million and $367 million, respectively, for the year ended December 31, 2007 and 2006 for the private label credit relationships. HUSI was charged service fees of $61 million and $38 million, respectively, for the year ended December 31, 2007 and 2006 for the MasterCard/Visa credit card relationship. Activity related to these portfolios is summarized in the following table.



	Private Label						MasterCard/Visa

For the year ended December 31	2007			2006			2007			2006

(in millions)
Receivables acquired from HSBC Finance Corporation:
Balance at beginning of period	$	16,973		$	14,355		$	1,287		$	1,159
Receivables acquired		21,341			21,591			2,828			2,317
Customer payments, net charge offs and other activity		(20,887	)		(18,973	)		(2,127	)		(2,189	)

Balance at end of period	$	17,427		$	16,973		$	1,988		$	1,287


Premiums paid to HSBC Finance Corporation:
Unamortized balance at beginning of period	$	188		$	320		$	15		$	12
Premiums paid		329			367			105			39
Amortization		(405	)		(499	)		(77	)		(36	)

Unamortized balance at end of period	$	112		$	188		$	43		$	15


•	HUSI services a portfolio of residential mortgage loans owned by HSBC Finance Corporation. The related service fee income was $10.5 million and $4.3 million for the year ended December 31, 2007 and 2006, respectively.

•	HUSI’s wholly-owned subsidiaries HBUS and HSBC Trust Company (Delaware), N.A. (HTCD) are the originating lenders for a federal income tax refund anticipation loan program for clients of various third party tax preparers, which are managed by HSBC Finance Corporation. By agreement, HBUS and HTCD process applications, fund and subsequently sell these loans to HSBC Finance Corporation. For the year ended December 31, 2007 and 2006, HBUS and HTCD originated approximately $17 billion and $16 billion, respectively, that were sold to HSBC Finance Corporation. This resulted in gains of $23 million and $22 million, respectively, for the year ended December 31, 2007 and 2006.

•	Certain of HUSI’s consolidated subsidiaries have secured lines of credit totaling $1.0 billion with HSBC Finance Corporation. There were no balances outstanding under any of these lines of credit at December 31, 2007 or 2006.

•	In 2006, HUSI began acquiring residential mortgage loans at fair value from HSBC Finance Corporation with the original intent of selling these loans to HMUS (see “Transactions Conducted with HMUS” on the next page). For the year ended December 31, 2007, HUSI acquired $615 million of loans from HSBC Finance Corporation for a net discount of $12 million.



¹	MasterCard is a registered trademark of MasterCard, Incorporated.

²	Visa is a registered trademark of Visa USA, Inc.

140

Transactions Conducted with HMUS


•	HUSI utilizes HMUS for broker dealer, debt and preferred stock underwriting, customer referrals, loan syndication and other treasury and traded markets related services, pursuant to service level agreements. Fees charged by HMUS for broker dealer, loan syndication services, treasury and traded markets related services are included in support services from HSBC affiliates. Debt underwriting fees charged by HMUS are deferred as a reduction of long-term debt and amortized to interest expense over the life of the related debt. Preferred stock issuance costs charged by HMUS are recorded as a reduction of capital surplus. Customer referral fees paid to HMUS are netted against customer fee income, which is included in other fees and commissions.

•	In 2005, HUSI began acquiring residential mortgage loans from unaffiliated third parties with the original intent of selling these loans for HMUS. During 2006, HUSI also began acquiring residential mortgage loans from HSBC Finance Corporation under this program. HUSI maintains no ownership interest in the residential mortgage loans after sale. Under this program, HUSI sold $6.2 billion and $15.9 billion of loans to HMUS during the year ended December 31, 2007 and 2006, respectively. Total gains on sale were $18 million and $106 million for the year ended December 31, 2007 and 2006, respectively. Refer to page 9 of this Form 10-K for further information regarding this program.

•	During the first quarter of 2007, as part of a strategy to consolidate certain investments into a common HSBC entity in North America, HUSI sold certain non-marketable investments to HMUS resulting in total net gains of $6 million. The carrying value of these investments totaled $10 million at the time of the sale.

Other Transactions with HSBC Affiliates

At December 31, 2007 and 2006, HUSI had an unused line of credit with HSBC of $2.5 billion and $2 billion, respectively.

HUSI has extended loans and lines of credit to various other HSBC affiliates totaling $1.6 billion, of which $225 million was outstanding at December 31, 2007. HUSI has also extended a subordinated loan to HSBC Securities (USA) Inc. in the amount of $500 million, of which $350 million was outstanding at December 31, 2007.

HUSI routinely enters into derivative transactions with HSBC Finance Corporation and other HSBC affiliates as part of a global HSBC strategy to offset interest rate or other market risks associated with debt issues, derivative contracts or other financial transactions with unaffiliated third parties. At December 31, 2007 and December 31, 2006, the aggregate notional amounts of all derivative contracts with other HSBC affiliates were approximately $996 billion and $772 billion, respectively. The net credit risk exposure (defined as the recorded fair value of derivative receivables) related to these contracts was approximately $12 billion and $7 billion at December 31, 2007 and 2006, respectively. HUSI, within its Global Banking and Markets business, accounts for these transactions on a mark to market basis, with the change in value of contracts with HSBC affiliates substantially offset by the change in value of related contracts entered into with unaffiliated third parties.

Domestic employees of HUSI participate in a defined benefit pension plan sponsored by HNAH. Additional information regarding pensions is provided in Note 23 of these consolidated financial statements, beginning on page 144 of this Form 10-K.

Employees of HUSI participate in one or more stock compensation plans sponsored by HSBC. HUSI’s share of the expense of these plans on a pre-tax basis for the year ended December 31, 2007 and 2006 was approximately $68 million and $74 million, respectively. As of December 31, 2007, HUSI’s share of compensation cost related to nonvested stock compensation plans was approximately $84 million, which is expected to be recognized over a weighted-average period of 1.5 years. A description of these stock compensation plans begins on page 142 of this Form 10-K.

141

HUSI declared and paid dividends of $800 million and $455 million for the year ended December 31, 2007 and 2006, respectively, to its parent company, HNAI.

Note 22. Stock Option Plans and Restricted Share Plans

Options have been granted to employees of HUSI under the HSBC Holdings Group Share Option Plan (the Group Share Option Plan) and under the HSBC Holdings Savings-Related Share Option Plan (Sharesave). Since the shares and contribution commitment have been granted directly by HSBC, the offset to compensation expense was a credit to capital surplus, representing a contribution of capital from HSBC.

The following table presents information for each plan. Descriptions of each plan follow the table.



December 31	2007			2006			2005

Restricted Share Plan:
Total compensation expense recognized (in millions)	$	68		$	59		$	44

Sharesave (5 year vesting period):
Total options granted		132,000			83,000			262,000
Fair value per option granted	$	4.09		$	3.49		$	3.78
Total compensation expense recognized (in millions)	$	1		$	*		$	*
Significant assumptions used to calculate fair value:
Risk free interest rate		4.6	%		5.0	%		4.3	%
Expected life (years)		5			5			5
Expected volatility		17	%		17	%		20	%

Sharesave (3 year vesting period):
Total options granted		445,000			274,000			510,000
Fair value per option granted	$	4.25		$	3.42		$	3.73
Total compensation expense recognized (in millions)	$	1		$	1		$	1
Significant assumptions used to calculate fair value:
Risk free interest rate		4.6	%		5.0	%		4.3	%
Expected life (years)		3			3			3
Expected volatility		17	%		17	%		20	%

Sharesave (1 year vesting period):
Total options granted		145,000			81,000
Fair value per option granted	$	3.71		$	2.60
Total compensation expense recognized (in millions)	$	*		$	*
Significant assumptions used to calculate fair value:
Risk free interest rate		4.9	%		5.0	%
Expected life (years)		1			1
Expected volatility		17	%		17	%

Group Share Option Plan:
Total options granted		—			—			—
Fair value per option granted	$	—		$	—		$	—
Total compensation expense recognized (in millions)	$	(2	)	$	14		$	6
Significant assumptions used to calculate fair value:
Risk free interest rate		—	%		—	%		—	%
Expected life (years)		—			—			—
Expected volatility		—	%		—	%		—	%

* Less than $500 thousand

142

Restricted Share Plans

Awards are granted to key individuals in the form of performance and non-performance restricted shares. The awards are based on an individual’s demonstrated performance and future potential. Performance related restricted shares generally vest after three years from date of grant, based on HSBC’s Total Shareholder Return (TSR) relative to a benchmark TSR during the performance period. TSR is defined as the growth in share value and declared dividend income during the period and the benchmark is composed of HSBC’s peer group of financial institutions. If the performance conditions are met, the shares vest and are released to the recipients two years later. Non-performance restricted shares are released to the recipients based on continued service, typically at the end of a three year vesting period.

Sharesave Plans

Sharesave is an employee share option plan that enables eligible employees to enter into savings contracts of one, three or five year terms, with the ability to decide at the end of the contract term to either use their accumulated savings to purchase HSBC ordinary shares at a discounted option price or have the savings plus interest repaid in cash. The one year savings contracts were offered to employees for the first time in 2006. Employees can save up to $450 per month over all their Sharesave savings contracts. The option price is determined at the beginning of the offering period of each plan year and represents a 20% discount, for the three and five year savings contracts, and a 15% discount for the one year contract, from the average price in London on the HSBC ordinary shares over the five trading days preceding the offering. On contracts of three year or five year terms, the options are exercisable at the 20% discounted stock option price within six months following the third or fifth anniversary of the beginning of the relevant savings contracts. Upon the completion of a one year savings contract, if the share price is higher than the option price, the option will automatically be exercised and the shares will be purchased at the 15% discounted stock option price. The shares will then be transferred to a holding account where they will be held for one additional year, or until the employee decides to sell the shares. Regardless of the length of the savings contract, employees can decide to have their accumulated savings plus interest refunded to them at the end of the contract period, rather than choosing to exercise their purchase option.

The fair value of options granted under Sharesave plans is estimated as of the date of grant using a third party option pricing model.

Group Share Option Plan

The Group Share Option Plan was a discretionary long-term incentive compensation plan available prior to 2005, to certain HUSI employees based on performance criteria. Options were granted at market value and are normally exercisable between the third and tenth anniversaries of the date of grant, subject to vesting conditions.

No options were granted under the Group Share Option Plan in 2005, 2006 or 2007, since the plan was terminated by HSBC in May 2005. In lieu of options, employees now receive grants of HSBC Holdings ordinary shares subject to certain vesting conditions (refer to Restricted Share Plans above). All stock option grants under the Group Share Option Plan have fully vested and the associated expense fully recognized. In addition, a credit of $2 million was recognized in 2007 which reflects an adjustment to the expense accrued on the stock options granted in 2004, which was the last year of stock option grants under the Group Share Option Plan.

143

Note 23. Pension and Other Postretirement Benefits

Defined Benefit Pension Plans

In November 2004, sponsorship of the defined benefit pension plan of HUSI and the defined benefit pension plan of HSBC Finance Corporation was transferred to HNAH. Effective January 1, 2005, the two separate plans were combined into a single HNAH defined benefit pension plan which facilitates the development of a unified employee benefit policy and unified employee benefit plan administration for HSBC companies operating in the U.S. As a result, the pension asset relating to HUSI’s defined benefit plan of $279 million, net of tax, was transferred to HNAH as a capital transaction in the first quarter of 2005.

In 2006, HUSI adopted SFAS 158, which requires balance sheet recognition of the funded status of pension and other postretirement benefit plans. Since HUSI’s main pension plan was transferred to HNAH in 2005, adoption of SFAS 158 had no significant balance sheet impact related to pension obligations. The impact of SFAS 158 on other postretirement benefit plans is summarized on page 146 of this Form 10-K.

The components of pension expense for the defined benefit plan reflected in HUSI’s consolidated statements of income are shown in the table below. The pension expense for the years ended December 31, 2007, 2006 and 2005 reflect the portion of the pension expense of the combined HNAH pension plan which has been allocated to HUSI.



Year Ended December 31	2007			2006			2005

(in millions)
Service cost–benefits earned during the period	$	31		$	30		$	27
Interest cost on projected benefit obligation		72			65			62
Expected return on assets		(91	)		(84	)		(89	)
Amortization of prior service cost		1			1			1
Recognized losses		9			16			5

Pension expense	$	22		$	28		$	6

The assumptions used in determining pension expense of the defined benefit plan are as follows:



	2007			2006			2005

Discount rate		5.90	%		5.70	%		6.00	%
Salary increase assumption		3.75			3.75			3.75
Expected long-term rate of return on plan assets		8.00			8.00			8.33

A reconciliation of beginning and ending balances of the fair value of plan assets associated with the HNAH defined benefit pension plan is shown below.



Year Ended December 31	2007			2006

(in millions)
Fair value of plan assets at beginning of year	$	2,568		$	2,384
Actual return on plan assets		185			246
Benefits paid		(136	)		(62	)

Fair value of plan assets at end of year	$	2,617		$	2,568

HUSI does not currently anticipate making employer contributions to the defined benefit plan in 2008.

144

The allocation of the pension plan assets for the HNAH defined benefit pension plan is summarized in the following table:



	Percentage of Plan Assets

December 31	2007			2006

Equity securities		69	%		69	%
Debt securities		31			30
Other		—			1

Total		100	%		100	%

There were no investments in HSBC ordinary shares or American depositary shares at December 31, 2007 and 2006.

The primary objective of the HNAH defined benefit pension plan is to provide eligible employees with regular pension benefits. Since the plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA), ERISA regulations serve as guidance for the management of plan assets. Consistent with prudent standards of preservation of capital and maintenance of liquidity, the goals of the plans are to earn the highest possible rate of return consistent with the tolerance for risk as determined by the investment committee in its role as a fiduciary. In carrying out these objectives, short-term fluctuations in the value of plan assets are considered secondary to long-term investment results. A third party and an HSBC affiliate are retained by HNAH to provide investment consulting services such as recommendations on the type of funds to be invested in and monitoring the performance of fund managers. In order to achieve the return objectives of the plans, the plans are diversified to ensure that adverse results from one security or security class will not have an unduly detrimental effect on the entire investment portfolio. Assets are diversified by type, characteristic and number of investments as well as by investment style of management organization. Equity securities are invested in large, mid and small capitalization domestic stocks as well as international stocks.

A reconciliation of beginning and ending balances of the projected benefit obligation of the HNAH defined benefit pension plan is shown in the following table.



Year Ended December 31	2007			2006

(in millions)
Projected benefit obligation at beginning of year	$	2,698		$	2,530
Service cost		111			102
Interest cost		160			145
Actuarial (gains) losses		(86	)		(17	)
Benefits paid		(136	)		(62	)

Projected benefit obligation at end of year	$	2,747		$	2,698

HUSI’s share of the projected benefit obligation of the HNAH defined benefit pension plan was approximately $1.2 billion at December 31, 2007 and 2006. The accumulated benefit obligation for the HNAH defined benefit pension plan was approximately $2.4 billion at December 31, 2007 and 2006. HUSI’s share of the accumulated benefit obligation at December 31, 2007 and 2006 was approximately $1.1 billion. These amounts are included in HNAH’s consolidated balance sheets.

Estimated future benefit payments for the HNAH defined benefit pension plan and HUSI’s share of those estimated payments are summarized in the following table.



	HNAH		HUSI’s Share

(in millions)
2008	$	133	$	54
2009		142		58
2010		151		61
2011		163		66
2012		181		70
2013-2017		1,027		436

145

The assumptions used in determining the projected benefit obligation of the defined benefit pension plan are summarized in the following table.



December 31	2007			2006

Discount rate		6.55	%		5.90	%
Salary increase assumption		3.75			3.75

Postretirement Plans Other Than Pensions

HUSI’s employees also participate in several plans which provide medical, dental and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. HUSI has instituted dollar limits on payments under the plans to control the cost of future medical benefits.

As discussed in Note 2, the adoption of SFAS 158 resulted in additional pension liability of $31 million, a related deferred tax asset of $13 million, and an offset to other comprehensive income of $18 million at December 31, 2006.

The net postretirement benefit cost included the following components.



Year Ended December 31	2007			2006		2005

(in millions)
Service cost – benefits earned during the period	$	1		$	1	$	2
Interest cost		6			6		7
Amortization of transition obligation		3			3		3
Amortization of recognized actuarial gain		(1	)		—		—

Net periodic postretirement benefit cost	$	9		$	10	$	12

The assumptions used in determining the net periodic postretirement benefit cost for HUSI’s postretirement benefit plans are shown in the following table.



December 31	2007			2006			2005

Discount rate		5.90	%		5.70	%		6.00	%
Salary increase assumption		3.75			3.75			3.75

A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is shown in the following table.



Year Ended December 31		2007			2006

(in millions)
Accumulated benefit obligation at beginning of year	$	103		$	119
Service cost		1			1
Interest cost		6			6
Participant contributions		1			1
Actuarial gains		(8	)		(13	)
Benefits paid		(10	)		(11	)

Accumulated benefit obligation at end of year	$	93		$	103

146

HUSI’s postretirement benefit plans are funded on a pay-as-you-go basis. Estimated future benefit payments for HUSI’s postretirement plans are summarized in the following table.



(in millions)
2008	$	8
2009		8
2010		8
2011		8
2012		8
2013-2017		35

The assumptions used in determining the benefit obligation of HUSI’s postretirement benefit plans at December 31 are as follows:



	2007		2006

Discount rate	6.55	%	5.90	%
Salary increase assumption	3.75		3.75

A 9.6 percent annual rate of increase in the gross cost of covered health care benefits was assumed for 2007. This rate of increase is assumed to decline gradually to 5 percent in 2014.

Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service and interest costs and the postretirement benefit obligation as follows:



	One Percent Increase		One Percent Decrease

(in millions)
Effect on total of service and interest cost components	$	*	$	*
Effect on postretirement benefit obligation		1		(1	)

* Less than $500 thousand

Other Plans

HUSI maintains a 401(k) plan covering substantially all employees. Employer contributions to the plan are based on employee contributions. Total expense recognized for this plan was approximately $36 million, $34 million and $33 million in 2007, 2006 and 2005, respectively.

Certain employees are participants in various defined contribution and other non-qualified supplemental retirement plans. Total expense recognized for these plans was immaterial in 2007, 2006 and 2005.

Note 24. Business Segments

HUSI has five distinct segments that it utilizes for management reporting and analysis purposes, which are generally based upon customer groupings, as well as products and services offered. Descriptions of HUSI’s business segments are presented on pages 6 and 7 of this Form 10-K.

Effective January 1, 2007, corporate goals of HUSI are based upon results reported under International Financial Reporting Standards (IFRS), which are utilized by HSBC to prepare its consolidated financial statements. Operating results for HUSI are now being monitored and reviewed, trends are being evaluated, and decisions are being made about allocating certain resources on an IFRS basis. As a result, business segment results are reported on an IFRS basis to align with the revised internal reporting mechanism for monitoring performance. Results for 2006 and 2005 have been restated on an IFRS basis to conform with 2007 presentation.

147

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. The objective of these charges/credits is to transfer interest rate risk from the segments to one centralized unit in Treasury and more appropriately reflect the profitability of segments.

Certain other revenue and operating expense amounts are also apportioned among the business segments based upon the benefits derived from this activity or the relationship of this activity to other segment activity. For segment reporting purposes, these inter-segment transactions are accounted for as if they were with third parties and have not been eliminated.

Results for each segment on an IFRS basis, as well as a reconciliation of total results under IFRS to U.S. GAAP consolidated totals, are provided in the following tables. Descriptions of the significant differences between IFRS and U.S. GAAP that impact HUSI’s results follow the tables.



	IFRS Consolidated Amounts																			(4) IFRS Adjustments			(5) IFRS Reclassifications			U.S. GAAP Consolidated Totals

December 31, 2007	PFS		CF		CMB		Global Banking and Markets			PB		Other			Intersegmental Revenue			Total

(in millions)
Net interest income (1)	$	1,102	$	951	$	814	$	321		$	198	$	(12	)	$	(652	)	$	2,722	$	17		$	659		$	3,398
Other revenues		559		294		259		46			291		216			652			2,317		(313	)		(157	)		1,847

Total revenues		1,661		1,245		1,073		367			489		204			—			5,039		(296	)		502			5,245
Provision for credit losses (3)		139		1,187		126		35			10		—			—			1,497		33			(8	)		1,522

		1,522		58		947		332			479		204			—			3,542		(329	)		510			3,723
Operating expenses (2)		1,302		33		558		803			345		4			—			3,045		30			511			3,586

Income before income tax expense		220		25		389		(471	)		134		200			—			497		(359	)		(1	)		137


Income tax expense		52		7		92		(129	)		32		57			—			111		(111	)		(1	)		(1	)


Net income	$	168	$	18	$	297	$	(342	)	$	102	$	143		$	—		$	386	$	(248	)	$	—		$	138


Balances at end of period:
Total assets	$	36,322	$	22,145	$	18,851	$	162,757		$	6,191	$	193		$	—		$	246,459	$	(58,120	)	$	34		$	188,373
Total loans		31,015		21,639		16,831		28,389			5,416		—			—			103,290		—			(8,341	)		94,949
Goodwill		925		—		368		497			325		—			—			2,115		586			—			2,701
Total deposits		42,642		35		18,164		41,983			12,247		2			—			115,073		—			1,155			116,228


(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 assigned to the segments is based on the segments’ net charge offs and the change in allowance for credit losses.

(4)	Represents adjustments associated with differences between IFRS and U.S. GAAP bases of accounting. These adjustments, which are more fully described beginning on page 150 of this Form 10-K, consist of the following:



	Net Interest Income			Other Revenues			Provision for Credit Losses		Operating Expenses			Income before Income Tax Expense			Total Assets

(in millions)
Unquoted equity securities	$	—		$	(90	)	$	—	$	—		$	(90	)	$	—
Fair value option		(2	)		(190	)		—		—			(192	)		—
Loan origination		(15	)		(9	)		—		(2	)		(22	)		—
Loan impairment		22			—			26		—			(4	)		—
Purchase accounting/deferred taxes		—			—			—		(4	)		4			—
Stock based compensation		—			—			—		(2	)		2			—
Property		—			(7	)		—		14			(21	)		—
Pension cost		—			—			—		24			(24	)		—
Recording derivative assets and liabilities gross		—			—			—		—			—			(58,120	)
Other		12			(17	)		7		—			(12	)		—

Total	$	17		$	(313	)	$	33	$	30		$	(359	)	$	(58,120	)


(5)	Represents differences in financial statement presentation between IFRS and U.S. GAAP.

148

IFRS Consolidated Amounts

(4)
IFRS
Adjustments

(5)
IFRS
Reclassifications

U.S. GAAP
Consolidated
Totals

December 31,
2006

Global Banking
and Markets

Intersegmental
Revenue

PFS

CMB

Other

Total