Business Segments

9 Months Ended

Sep. 30, 2011

Business Segments [Abstract]

Business Segments

12.   Business Segments

Through June 30, 2011, we reported the results of our operations in two reportable segments: Card and Retail Services and Consumer. These segments were managed separately and were characterized by different middle- market consumer lending products, originations processes, and locations. As previously discussed in Note 2, “Discontinued Operations,” in August 2011, we agreed to sell our Card and Retail Services business and these operations are now reported as discontinued operations. As our segment results are reported on a continuing operations basis, beginning in the third quarter of 2011, we have one remaining reportable segment: Consumer.

Our Consumer segment consists of our run-off Consumer Lending and Mortgage Services businesses. The Consumer segment provided real estate secured and personal non-credit card loans with both revolving and closed-end terms and with fixed or variable interest rates. Loans were originated through branch locations and direct mail. Products were also offered and customers serviced through the Internet. Prior to the first quarter of 2007, we acquired loans from correspondent lenders and prior to September 2007 we also originated loans sourced through mortgage brokers. While these businesses are all operating in run-off mode, they have not been reported as discontinued operations because we continue to generate cash flow from the ongoing collections of the receivables, including interest and fees.

The All Other caption includes our Insurance and Commercial businesses. Each of these businesses falls below the quantitative threshold tests under segment reporting accounting principles for determining reportable segments. The “All Other” caption also includes our corporate and treasury activities, which includes the impact of FVO debt as well as our run-off Union Privilege non-credit card portfolio operations which is not being sold. Certain fair value adjustments related to purchase accounting resulting from our acquisition by HSBC and related amortization have been allocated to corporate, which is included in the “All Other” caption within our segment disclosure.

We report results to our parent, HSBC, in accordance with its reporting basis, International Financial Reporting Standards (“IFRSs”). Our segment results are presented on an IFRSs legal entity basis (“IFRS Basis”) (a non-U.S. GAAP financial measure) as operating results are monitored and reviewed and trends are evaluated on an IFRS Basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis. Except as discussed above, there have been no other changes in measurement or composition of our segment reporting as compared with the presentation in our consolidated financial statements for the fiscal year ended December 31, 2010 included in our Current Report on Form 8-K filed with the SEC on May 27, 2011.

For segment reporting purposes, intersegment transactions have not been eliminated. We generally account for transactions between segments as if they were with third parties.

Reconciliation of our IFRS Basis segment results to the U.S. GAAP consolidated totals are as follows:

							Adjustments			IFRS Basis									U.S. GAAP
							Reconciling			Consolidated			IFRS			IFRS			Consolidated
	Consumer			All Other			Items			Totals			Adjustments(2)			Reclassifications(3)			Totals
	(in millions)
Three months ended September 30, 2011
Net interest income	$	714		$	140		$	-		$	854		$	(238	)	$	(164	)	$	452
Other operating income (Total other revenues)		(1	)		(337	)		(7	)(1)		(345	)		85			244			(16	)
Total operating income (loss)		713			(197	)		(7	)		509			(153	)		80			436
Loan impairment charges (Provision for credit losses)		1,821			2			-			1,823			359			-			2,182
		(1,108	)		(199	)		(7	)		(1,314	)		(512	)		80			(1,746	)
Operating expenses		172			22			(7	)		187			5			80			272
Profit (loss) before tax	$	(1,280	)	$	(221	)	$	-		$	(1,501	)	$	(517	)	$	-		$	(2,018	)
Intersegment revenues		22			(15	)		(7	)(1)		-			-			-			-
Balances at end of period:
Customer loans (Receivables)	$	49,992		$	209		$	-		$	50,201		$	(269	)	$	(110	)	$	49,822
Assets		48,629			11,758			-			60,387			(3,138	)		(81	)		57,168
Three months ended September 30, 2010
Net interest income	$	592		$	222		$	-		$	814		$	(64	)	$	(208	)	$	542
Other operating income (Total other revenues)		(2	)		(546	)		(6	)(1)		(554	)		1			305			(248	)
Total operating income (loss)		590			(324	)		(6	)		260			(63	)		97			294
Loan impairment charges (Provision for credit losses)		1,385			-			-			1,385			(80	)		-			1,305
		(795	)		(324	)		(6	)		(1,125	)		17			97			(1,011	)
Operating expenses		222			18			(6	)		234			9			97			340
Profit (loss) before tax	$	(1,017	)	$	(342	)	$	-		$	(1,359	)	$	8		$	-		$	(1,351	)
Intersegment revenues		16			(10	)		(6	)(1)		-			-			-			-
Balances at end of period:
Customer loans (Receivables)	$	59,665		$	1,998		$	-		$	61,663		$	(299	)	$	(1,875	)	$	59,489
Assets		59,880			13,083			-			72,963			(4,008	)		(135	)		68,820
Nine months ended September 30, 2011
Net interest income	$	2,037		$	429		$	-		$	2,466		$	(536	)	$	(522	)	$	1,408
Other operating income (Total other revenues)		(43	)		(508	)		(18	)(1)		(569	)		90			769			290
Total operating income (loss)		1,994			(79	)		(18	)		1,897			(446	)		247			1,698
Loan impairment charges (Provision for credit losses)		3,969			4			-			3,973			(500	)		-			3,473
		(1,975	)		(83	)		(18	)		(2,076	)		54			247			(1,775	)
Operating expenses		631			217			(18	)		830			13			247			1,090
Profit (loss) before tax	$	(2,606	)	$	(300	)	$	-		$	(2,906	)	$	41		$	-		$	(2,865	)
Intersegment revenues		58			(40	)		(18	)(1)		-			-			-			-
Nine months ended September 30, 2010
Net interest income	$	1,748		$	696		$	-		$	2,444		$	(199	)	$	(658	)	$	1,587
Other operating income (Total other revenues)		29			(889	)		(16	)(1)		(876	)		(19	)		895			-
Total operating income (loss)		1,777			(193	)		(16	)		1,568			(218	)		237			1,587
Loan impairment charges (Provision for credit losses)		4,465			2			-			4,467			(177	)		-			4,290
		(2,688	)		(195	)		(16	)		(2,899	)		(41	)		237			(2,703	)
Operating expenses		655			59			(16	)		698			46			237			981
Profit (loss) before tax	$	(3,343	)	$	(254	)	$	-		$	(3,597	)	$	(87	)	$	-		$	(3,684	)
Intersegment revenues		50			(34	)		(16	)(1)		-			-			-			-

(1)	Eliminates intersegment revenues.
(2)	IFRS Adjustments consist of the accounting differences between U.S. GAAP and IFRSs which have been described more fully below.
(3)	Represents differences in balance sheet and income statement presentation between IFRSs and U.S. GAAP.

A summary of the significant differences between U.S. GAAP and IFRSs as they impact our results are presented below:

Net Interest Income

Effective interest rate – The calculation of effective interest rates under IAS 39, “Financial Instruments: Recognition and Measurement” (“IAS 39”), requires an estimate of changes in estimated contractual cash flows, including fees and points paid or recovered between parties to the contract that are an integral part of the effective interest rate be included. U.S. GAAP generally prohibits recognition of interest income to the extent the net investment in the loan would increase to an amount greater than the amount at which the borrower could settle the obligation. Under U.S. GAAP, prepayment penalties are generally recognized as received. U.S. GAAP also includes interest income on loans originated as held for sale which is included in other revenues for IFRSs.

Deferred loan origination costs and fees – Loan origination cost deferrals under IFRSs are more stringent and generally result in lower costs being deferred than permitted under U.S. GAAP. In addition, all deferred loan origination fees, costs and loan premiums must be recognized based on the expected life of the receivables under IFRSs as part of the effective interest calculation while under U.S. GAAP they may be recognized on either a contractual or expected life basis.

Net interest income – Under IFRSs, net interest income includes the interest element for derivatives which correspond to debt designated at fair value. For U.S. GAAP, this is included in Gain on debt designated at fair value and related derivatives which is a component of other revenues. Additionally, under IFRSs, insurance investment income is included in net interest income instead of as a component of other revenues under U.S. GAAP.

Other Operating Income (Total Other Revenues)

Present value of long-term insurance contracts – Under IFRSs, the present value of an in-force (“PVIF”) long-term insurance contract is determined by discounting future cash flows expected to emerge from business currently in force using appropriate assumptions plus a margin in assessing factors such as future mortality, lapse rates and levels of expenses, and a discount rate that reflects the risk free rate plus a margin for operational risk. Movements in the PVIF of long-term insurance contracts are included in other operating income. Under U.S. GAAP, revenue is recognized over the life insurance policy term.

Policyholder benefits – Other revenues under IFRSs include policyholder benefits expense which is classified as other expense under U.S. GAAP.

Loans held for sale – IFRSs requires loans designated as held for sale at the time of origination to be treated as trading assets and recorded at their fair value. Under U.S. GAAP, loans designated as held for sale are reflected as loans and recorded at the lower of amortized cost or fair value. Under IFRSs, the income and expenses related to receivables held for sale are reported in other operating income. Under U.S. GAAP, the income and expenses related to receivables held for sale are reported similarly to loans held for investment.

For receivables transferred to held for sale subsequent to origination, IFRSs requires these receivables to be reported separately on the balance sheet but does not change the recognition and measurement criteria. Accordingly, for IFRSs purposes such loans continue to be accounted for in accordance with IAS 39 with any gain or loss recorded at the time of sale. U.S. GAAP requires loans that meet the held for sale classification requirements be transferred to a held for sale category at the lower of amortized cost or fair value. Under U.S. GAAP, the component of the lower of amortized cost or fair value adjustment related to credit risk is recorded in the statement of income (loss) as provision for credit losses while the component related to interest rates and liquidity factors is reported in the statement of income (loss) in other revenues.

Certain receivables that were previously classified as held for sale under U.S. GAAP have now been transferred to held for investment as we now intend to hold for the foreseeable future. Under U.S. GAAP, these receivables were subject to lower of amortized cost or fair value adjustments while held for sale and have been transferred to held for investment at the lower of amortized cost or fair value. Since these receivables were not classified as held for sale under IFRSs, these receivables were always reported within loans and the measurement criteria did not change. As a result, loan impairment charges are now being recorded under IFRSs which were essentially included as a component of the lower of amortized cost or fair value adjustments under U.S. GAAP.

Securities – Under IFRSs, securities include HSBC shares held for stock plans at fair value. These shares are recorded at fair value through other comprehensive income. If it is determined these shares have become impaired, the fair value loss is recognized in profit and loss and any fair value loss recorded in other comprehensive income is reversed. There is no similar requirement under U.S. GAAP.

During the second quarter of 2009, under IFRSs we recorded income for the value of additional shares attributed to HSBC shares held for stock plans as a result of HSBC’s rights offering earlier in 2009. During 2011 and 2010, under IFRSs we recorded additional gains as these shares vest. The additional shares are not recorded under U.S. GAAP.

Other-than-temporary impairments – Under U.S. GAAP, the credit loss component of an other-than-temporary impairment of a debt security is recognized in earnings while the remaining portion of the impairment loss is recognized in other comprehensive income provided a company concludes it neither intends to sell the security nor concludes that it is more-likely-than-not that it will have to sell the security prior to recovery. Under IFRSs, there is no bifurcation of other-than-temporary impairment and the entire decline in fair value is recognized in earnings.

REO expense – Other revenues under IFRSs includes losses on sale and the lower of amortized cost or fair value less cost to sell adjustments on REO properties which are classified as other expense under U.S. GAAP.

Loan Impairment Charges (Provision for Credit Losses)

IFRSs requires a discounted cash flow methodology for estimating impairment on pools of homogeneous customer loans which requires the discounting of cash flows including recovery estimates at the original effective interest rate of the pool of customer loans. The amount of impairment relating to the discounting of future cash flows unwinds with the passage of time, and is recognized in interest income. Also under IFRSs, if the recognition of a write-down to fair value on secured loans decreases because collateral values have improved and the improvement can be related objectively to an event occurring after recognition of the write-down, such write-down can be reversed, which is not permitted under U.S. GAAP. Additionally under IFRSs, future recoveries on charged-off loans or loans written down to fair value less cost to obtain title and sell the collateral are accrued for on a discounted basis and a recovery asset is recorded. Subsequent recoveries are recorded to earnings under U.S. GAAP, but are adjusted against the recovery asset under IFRSs. Under IFRSs, interest on impaired loans is recorded at the effective interest rate on the customer loan balance net of impairment allowances, and therefore reflects the collectibility of the loans.

As discussed above, under U.S. GAAP the credit risk component of the initial lower of amortized cost or fair value adjustment related to the transfer of receivables to held for sale is recorded in the statement of income (loss) as provision for credit losses. There is no similar requirement under IFRSs.

As previously discussed, in the third quarter of 2011 we adopted new guidance under U.S. GAAP for determining whether a restructuring of a receivable meets the criteria to be considered a TDR Loan. Credit loss reserves on TDR Loans are established based on the present value of expected future cash flows discounted at the loans’ original effective interest rate.

Under IFRSs, effective in the third quarter of 2011 the changes were made to the provisioning methodology for loans subject to forebearance to measure the effect of credit loss events which occurred prior to the reporting date. In certain circumstances, IFRSs may result in a lower overall credit loss reserve than under U.S. GAAP which is based on all expected future cash flows.

Operating Expenses

Policyholder benefits – Operating expenses under IFRSs are lower as policyholder benefits expenses are reported as an offset to other revenues as discussed above.

Pension costs – Net income under U.S. GAAP is lower than under IFRSs as a result of the amortization of the amount by which actuarial losses exceeded the higher of the projected benefit obligation or fair value of plan assets beyond the 10 percent “corridor”. Furthermore, in 2010 changes to future accruals for legacy participants under the HSBC North America Pension Plan were accounted for as a plan curtailment under IFRSs, which resulted in immediate income recognition. Under U.S. GAAP, these changes were considered to be a negative plan amendment which resulted in no immediate income recognition.

Share-based bonus arrangements – Under IFRSs, the recognition of compensation expense related to share-based bonuses begins on January 1 of the current year for awards expected to be granted in the first quarter of the following year. Under U.S. GAAP, the recognition of compensation expense related to share-based bonuses does not begin until the date the awards are granted.

Assets

Customer loans (Receivables) – On an IFRSs basis, loans designated as held for sale at the time of origination and accrued interest are classified as trading assets. However, the accounting requirements governing when receivables previously held for investment are transferred to a held for sale category are more stringent under IFRSs than under U.S. GAAP. Unearned insurance premiums are reported as a reduction to receivables on a U.S. GAAP basis but are reported as insurance reserves for IFRSs. IFRSs also allows for reversals of write-downs to fair value on secured loans when collateral values have improved which is not permitted under U.S. GAAP.

Other – In addition to the differences discussed above, derivative financial assets are higher under IFRSs than under U.S. GAAP as U.S. GAAP permits the netting of certain items. No similar requirement exists under IFRSs.