10-Q 1 e2qfinal.txt CONFORMED 1. SECURITIES AND EXCHANGE COMMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended June 30, 2001 Commission file number 1-7436 HSBC USA INC. (Exact name of registrant as specified in its charter) Maryland Corporation (State or other jurisdiction of incorporation or organization) 13-2764867 (I.R.S. Employer Identification No.) 452 Fifth Avenue, New York, New York 10018 (Address of principal executive offices) (212) 525-6100 Registrant's telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ___ All voting stock (704 shares of Common Stock, $5 par value) is owned by HSBC North America Inc., an indirect wholly owned subsidiary of HSBC Holdings plc. This report includes a total of 31 pages. 2. Part I - FINANCIAL INFORMATION ----------------------------------------------------------------- Item 1 - Financial Statements Page Consolidated Balance Sheet June 30, 2001 and December 31, 2000 3 Consolidated Statement of Income For The Quarter and Six Months Ended June 30, 2001 and 2000 4 Consolidated Statement of Changes in Shareholders' Equity For The Six Months Ended June 30, 2001 and 2000 5 Consolidated Statement of Cash Flows For The Six Months Ended June 30, 2001 and 2000 6 Notes to Consolidated Financial Statements 7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Part II - OTHER INFORMATION ----------------------------------------------------------------- Item 6 - Exhibits and Reports on Form 8-K 28 Signatures 29
3. HSBC USA Inc. ----------------------------------------------------------------------------- C O N S O L I D A T E D B A L A N C E S H E E T June 30, December 31, 2001 2000* ----------------------------------------------------------------------------- in thousands Assets Cash and due from banks $ 1,799,801 $ 1,860,713 Interest bearing deposits with banks 4,464,175 5,129,490 Federal funds sold and securities purchased under resale agreements 3,338,625 1,895,492 Trading assets (incl.$167,398 pledged to creditors at June 30) 8,829,729 5,770,972 Securities available for sale (incl.$2,372,542 pledged to creditors at June 30) 13,943,034 17,336,832 Securities held to maturity (fair value $5,020,616 and $4,417,251) 4,867,068 4,260,492 Loans 41,988,236 40,417,847 Less - allowance for credit losses 537,877 524,984 ----------------------------------------------------------------------------- Loans, net 41,450,359 39,892,863 Premises and equipment 792,537 777,610 Accrued interest receivable 481,808 785,286 Equity investments 265,484 55,596 Goodwill and other acquisition intangibles 3,045,296 3,229,479 Other assets 2,145,374 2,040,325 ----------------------------------------------------------------------------- Total assets $ 85,423,290 $ 83,035,150 ============================================================================= Liabilities Deposits in domestic offices Noninterest bearing $ 5,188,876 $ 5,114,668 Interest bearing 32,584,323 30,631,511 Deposits in foreign offices Noninterest bearing 361,092 282,737 Interest bearing 19,903,807 20,013,588 ----------------------------------------------------------------------------- Total deposits 58,038,098 56,042,504 Trading account liabilities 3,568,295 2,766,825 Short-term borrowings 8,574,749 8,562,363 Interest, taxes and other liabilities 3,067,265 3,232,918 Subordinated long-term debt and perpetual capital notes 2,945,832 3,027,014 Guaranteed mandatorily redeemable securities 723,218 711,737 Other long-term debt 1,148,915 1,357,904 ----------------------------------------------------------------------------- Total liabilities 78,066,372 75,701,265 ----------------------------------------------------------------------------- Shareholders' equity Preferred stock 500,000 500,000 Common shareholder's equity Common stock 4 4 Capital surplus 6,025,013 6,104,264 Retained earnings 793,642 612,798 Accumulated other comprehensive income 38,259 116,819 ----------------------------------------------------------------------------- Total common shareholder's equity 6,856,918 6,833,885 ----------------------------------------------------------------------------- Total shareholders' equity 7,356,918 7,333,885 ----------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 85,423,290 $ 83,035,150 ============================================================================= The accompanying notes are an integral part of the consolidated financial statements. * Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001.
4. HSBC USA Inc. ------------------------------------------------------------------------------------- C O N S O L I D A T E D S T A T E M E N T O F I N C O M E Quarter ended June 30, Six months ended June 30, 2001 2000* 2001 2000* ------------------------------------------------------------------------------------- in thousands Interest income Loans $ 752,231 $ 750,239 $ 1,537,801 $ 1,488,913 Securities 340,222 401,591 715,884 786,133 Trading assets 62,207 23,796 123,126 52,138 Other short-term investments 99,610 165,131 215,033 271,606 ------------------------------------------------------------------------------------- Total interest income 1,254,270 1,340,757 2,591,844 2,598,790 ------------------------------------------------------------------------------------- Interest expense Deposits 509,388 577,779 1,092,228 1,106,890 Short-term borrowings 88,485 123,448 208,873 220,203 Long-term debt 84,607 112,085 175,175 216,268 ------------------------------------------------------------------------------------- Total interest expense 682,480 813,312 1,476,276 1,543,361 ------------------------------------------------------------------------------------- Net interest income 571,790 527,445 1,115,568 1,055,429 Provision for credit losses 48,000 28,007 95,550 56,000 ------------------------------------------------------------------------------------- Net interest income, after provision for credit losses 523,790 499,438 1,020,018 999,429 ------------------------------------------------------------------------------------- Other operating income Trust income 22,004 22,400 44,843 42,544 Service charges 47,536 43,173 91,440 86,681 Mortgage banking revenue 7,417 8,577 19,614 15,164 Other fees and commissions 82,511 74,240 159,010 153,674 Trading revenues 51,846 33,122 102,243 84,529 Security gains 56,601 3,763 125,780 1,362 Other income 269 12,251 17,702 24,523 ------------------------------------------------------------------------------------- Total other operating income 268,184 197,526 560,632 408,477 ------------------------------------------------------------------------------------- Total income from operations 791,974 696,964 1,580,650 1,407,906 ------------------------------------------------------------------------------------- Other operating expenses Salaries and employee benefits 241,429 248,625 484,589 497,179 Occupancy expense, net 38,136 43,870 76,200 85,593 Goodwill amortization 44,168 43,731 89,259 87,461 Other expenses 159,796 137,353 325,120 275,003 ------------------------------------------------------------------------------------- Total other operating expenses 483,529 473,579 975,168 945,236 ------------------------------------------------------------------------------------- Income before taxes and cumulative effect of accounting change 308,445 223,385 605,482 462,670 Applicable income tax expense 120,400 83,152 236,200 172,599 ------------------------------------------------------------------------------------- Income before cumulative effect of accounting change 188,045 140,233 369,282 290,071 ------------------------------------------------------------------------------------- Cumulative effect of accounting change - implementation of FAS 133 - - (451) - ------------------------------------------------------------------------------------- Net income $ 188,045 $ 140,233 $ 368,831 $ 290,071 ===================================================================================== The accompanying notes are an integral part of the consolidated financial statements. * Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
5. HSBC USA Inc. -------------------------------------------------------------------- C O N S O L I D A T E D S T A T E M E N T O F C H A N G E S I N S H A R E H O L D E R S' E Q U I T Y Six months ended June 30, 2001 2000* -------------------------------------------------------------------- in thousands Preferred stock Balance, January 1, $ 500,000 $ 500,000 -------------------------------------------------------------------- Balance, June 30, 500,000 500,000 -------------------------------------------------------------------- Common stock Balance, January 1, 4 4 -------------------------------------------------------------------- Balance, June 30, 4 4 -------------------------------------------------------------------- Capital surplus Balance, January 1, 6,104,264 6,096,317 Return of capital (84,939) - Capital contribution from parent 5,688 2,947 -------------------------------------------------------------------- Balance, June 30, 6,025,013 6,099,264 -------------------------------------------------------------------- Retained earnings Balance, January 1, 612,798 671,578 Net income 368,831 290,071 Cash dividends declared: Preferred stock (12,987) (13,868) Common stock (175,000) (450,000) -------------------------------------------------------------------- Balance, June 30, 793,642 497,781 -------------------------------------------------------------------- Accumulated other comprehensive income (loss), net of tax Balance, January 1, 116,819 (50,534) Net change in unrealized gains on securities (57,727) 3,677 Net change in unrealized loss on derivatives classified as cash flow hedges (19,024) - Unrealized net transitional gain related to initial adoption of FAS 133 2,853 - Amortization of unrealized transitional FAS 133 gains credited to current income (1,426) - Foreign currency translation adjustment (3,236) (4,631) -------------------------------------------------------------------- Other comprehensive income (loss), net of tax (78,560) (954) -------------------------------------------------------------------- Balance, June 30, 38,259 (51,488) -------------------------------------------------------------------- Total shareholders' equity, June 30, $ 7,356,918 $ 7,045,561 ==================================================================== Comprehensive income Net income $ 368,831 $ 290,071 Other comprehensive income (loss), net of tax (78,560) (954) -------------------------------------------------------------------- Comprehensive income $ 290,271 $ 289,117 ==================================================================== The accompanying notes are an integral part of the consolidated financial statements. *Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
6. HSBC USA Inc. ------------------------------------------------------------------------------------- C O N S O L I D A T E D S T A T E M E N T O F C A S H F L O W S Six months ended June 30, 2001 2000* ------------------------------------------------------------------------------------- in thousands Cash flows from operating activities Net income $ 368,831 $ 290,071 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, amortization and deferred taxes 125,129 124,370 Provision for credit losses 95,550 56,000 Net change in other accrual accounts (124,937) (379,194) Net change in loans originated for sale (454,045) (1,387,804) Net change in trading assets and liabilities (1,645,717) (35,504) Other, net (217,049) (51,650) ------------------------------------------------------------------------------------- Net cash provided (used) by operating activities (1,852,238) (1,383,711) ------------------------------------------------------------------------------------- Cash flows from investing activities Net change in interest bearing deposits with banks 486,641 (1,165,516) Net change in short-term investments (1,443,133) (120,155) Purchases of securities held to maturity (109,979) (70,186) Proceeds from maturities of securities held to maturity 506,413 304,389 Purchases of securities available for sale (8,766,313) (9,353,316) Sales of securities available for sale 8,464,567 6,222,983 Proceeds from maturities of securities available for sale 2,663,011 9,816,052 Payment to shareholders of acquired company - (7,091,209) Net change in credit card receivables 38,271 60,822 Net change in other short term loans 209,942 158,651 Net originations and maturities of loans (1,266,751) 688,351 Sales of loans - 167,149 Expenditures for premises and equipment (61,940) (66,541) Net cash used in acquisitions, net of cash acquired (21,547) - Other, net 115,355 (308,168) ------------------------------------------------------------------------------------- Net cash provided (used) by investing activities 814,537 (756,694) ------------------------------------------------------------------------------------- Cash flows from financing activities Net change in deposits 1,547,801 (1,377,579) Net change in short-term borrowings 12,386 4,079,050 Issuance of long-term debt 205,064 439,291 Repayment of long-term debt (514,908) (428,994) Return of capital (84,939) - Dividends paid (188,615) (457,987) ------------------------------------------------------------------------------------- Net cash provided by financing activities 976,789 2,253,781 ------------------------------------------------------------------------------------- Net change in cash and due from banks (60,912) 113,376 Cash and due from banks at beginning of period 1,860,713 1,959,213 ------------------------------------------------------------------------------------- Cash and due from banks at end of period $ 1,799,801 $ 2,072,589 ===================================================================================== Non-cash activities: Transfer of securities from held to maturity to available for sale $ 170,880 $ - Transfer of securities from available for sale to held to maturity 1,041,911 - ------------------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements. *Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
7. Notes to Consolidated Financial Statements 1. Basis of Presentation --------------------------------------------------------------- The accounting and reporting policies of HSBC USA Inc. (the Company) and its subsidiaries including its principal subsidiary, HSBC Bank USA (the Bank) conform to accounting principles generally accepted in the United States of America and to predominant practice within the banking industry. Such policies, except as described in Note 8 below, are consistent with those applied in the presentation of the Company's annual financial statements. The interim financial information in this report has not been audited. In the opinion of the Company's management, all adjustments necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods have been made. The interim financial information should be read in conjunction with the 2000 Annual Report on Form 10-K (the 2000 10-K). 2. Acquisitions --------------------------------------------------------------- On April 1, 2001, the Bank acquired approximately a 5 percent interest in the voting shares of HSBC Republic Bank (Suisse) S.A.("Swiss Bank"), an affiliate, in exchange for the contribution to the Swiss Bank of private banking businesses conducted by its Singapore and Hong Kong branches. The 5 percent interest represents the fair value of the businesses transferred to the Swiss Bank and is being accounted for using the equity method of accounting. The Bank retained its banknotes activities in Singapore and its banknotes and foreign currency businesses in Hong Kong, and maintained its branch licenses in both locations. The transaction is another step in an internal reorganization of the HSBC Group's global private banking operations, which began late last year. The Swiss Bank, a Switzerland based banking affiliate, will manage much of the HSBC Group's worldwide private banking business. Swiss Bank is a foreign bank chartered and regulated under the banking laws of Switzerland. On January 1, 2001, the Bank acquired the Panama branches of HSBC Bank plc for approximately $22 million in cash. The purchase included two branches in Panama City, one in the Colon Free Trade Zone, one in Colon and one in Aguadulce. The Bank acquired approximately $500 million in assets and assumed $450 million in customer and bank deposits. The acquisition was accounted for as a transfer of assets between companies under common control at HSBC Bank plc's historical cost. As well as aligning ownership along geographic lines, the purchase will allow the Bank to achieve better local synergies from its acquisition of Chase Manhattan's branches in Panama last year. As described in Note 2 to the consolidated financial statements contained in the Company's 2000 10-K, on December 31, 1999, HSBC Holdings plc (HSBC) 8. acquired Republic New York Corporation (Republic). Also on December 31, 1999, following the acquisition, HSBC merged Republic with the Company. The merger was accounted for as a purchase transaction. As a result of the Republic acquisition, the Company assumed certain liabilities associated with merging Republic's operations with those of the Company and recognized integration costs relating to the planned severance of employees and exiting of businesses of the Company. The following table represents the activity in these reserves through June 30, 2001.
---------------------------------------------------------------------- Severance Related Premises Other Total ---------------------------------------------------------------------- (in millions) Balance December 31, 2000 $151.8 $10.8 $5.3 $167.9 Less: Payments 73.6 5.5 1.4 80.5 ---------------------------------------------------------------------- Balance June 30, 2001 $ 78.2 $ 5.3 $3.9 $ 87.4 ----------------------------------------------------------------------
During 2000, $85.0 million of integration costs were expensed as systems and operations were combined, of which $19.1 million was incurred during the second quarter. During the second quarter of 2001, $6.6 million of integration costs were expensed. Integration costs for the first six months of 2001 were $12.5 million compared with $21.6 million for the same period of 2000. Although the consolidation of most systems and operations is nearing completion, it is anticipated that some further integration costs will be incurred during the remainder of 2001. 3. Litigation --------------------------------------------------------------- As described in Note 26 to the consolidated financial statements contained in the Company's 2000 10-K, the Company and certain of its subsidiaries are defendants in a number of legal actions arising out of the Princeton Note Matter (as defined in the 2000 10-K). These proceedings include investigations by regulatory and law enforcement agencies, including the U.S. Attorney for the Southern District of New York, the Securities and Exchange Commission and the Commodity Futures Trading Commission. As previously disclosed, Republic New York Securities Corporation ("RNYSC") is a target of the federal grand jury investigation being conducted by the U.S. Attorney. In light of a probable law enforcement proceeding against RNYSC in connection with the Princeton Note Matter, a matter that came to light before the acquisition of Republic, a provision of $79 million, the amount of shareholder's equity of RNYSC, was taken in the consolidated financial statements of the Company as of December 31, 2000, as an adjustment to the cost of the acquisition of Republic. During the course of the U.S. Attorney's investigation, with which the Company has been cooperating fully, discussions have been initiated to attempt to resolve the grand jury investigation and regulatory investigations, and such resolution if it occurs may also encompass resolution of some of the civil actions noted below. At the present time it is not possible to predict whether a resolution will be reached or to estimate the amount of its additional cost to the Company. 9. In addition to the regulatory and law enforcement investigations, nineteen separate civil actions have been brought to date in the United States District Court for the Southern District of New York against the Company and RNYSC by Japanese entities in connection with the Princeton Note Matter. The first eighteen of these actions are described in Note 26 to the Company's consolidated financial statements included in the Company's 2000 10-K. The nineteenth action, PG Star, Ltd. v. Republic New York Securities Corporation, et. al., was filed on March 28, 2001. It alleges an unpaid note in the amount of Yen 450 million (approximately $3.35 million). The complaint asserts common law claims and claims under the federal commodities laws. At the present time it is not possible to assess the outcome of the civil proceedings relating to the Princeton Note Matter. 4. Accounting for Derivatives and Hedging Activities --------------------------------------------------------------- Pursuant to FAS 133, all derivatives are recognized on the balance sheet at their fair value (see Note 8, New Accounting Standards). On the date the derivative contract is entered into (January 1, 2001 for all derivatives in place at that date) the Company designates it as (1) a qualifying FAS 133 hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment ("fair value" hedge); or (2) a qualifying FAS 133 hedge of a forecasted transaction of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge); or (3) as a trading position. 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 are recorded in other comprehensive income to the extent of their effectiveness, until earnings are impacted by the variability of cash flows from the hedged item. Changes in the fair value of derivatives held for trading purposes are reported in current period earnings. At the inception of each hedge (January 1, 2001 for all derivatives in place at that date), the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. 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. Increased earnings volatility will result from the on-going mark to market of certain economically viable derivative contracts that do not satisfy the hedging requirements of FAS 133, as well as from the hedge ineffectiveness associated with the qualifying contracts. The Company expects however that it will be able to continue to pursue its overall asset and liability risk management objectives using a combination of derivatives and cash instruments. 10. Embedded Derivatives The Company may acquire or originate a financial instrument that contains a derivative instrument "embedded" within it. Upon origination or acquisition of any such instrument, the Company assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining 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. 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 separated from the host contract, carried at fair value, and designated as a fair value hedge, cash flow hedge or as a trading instrument. Hedge Discontinuation The Company formally assesses, both at the hedge's inception and on an on-going 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. If it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below. The Company discontinues hedge accounting prospectively when (1) the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) it is unlikely that a forecasted transaction will occur; (4) the hedged firm commitment no longer meets the definition of a firm commitment; or (5) the designation of the derivative as a hedged 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 its fair value, and the hedged item will no longer be adjusted for changes in fair value or changes in the fair value of the derivative reclassified to other comprehensive income. 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 other comprehensive income, are reversed to current period earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period earnings unless redesignated as a qualifying FAS 133 hedge. 11. 5. Pledged Assets --------------------------------------------------------------- At June 30, 2001, assets amounting to $11.5 billion were pledged as collateral for borrowings, to secure public deposits and for other purposes. The significant components of the assets pledged at June 30, 2001 were as follows: $10.8 billion were securities and trading assets and $.6 billion were loans. In accordance with the Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140), debt securities pledged as collateral that can be sold or repledged by the secured party continue to be reported on the consolidated balance sheet. The following table provides the fair value of collateral that can be sold or repledged.
--------------------------------------------------------------- June 30, December 31, 2001 2000 --------------------------------------------------------------- (in billions) Trading assets $ .2 $.2 Securities available for sale 2.4 .4 ---------------------------------------------------------------
6. Collateral --------------------------------------------------------------- The fair value of collateral accepted by the Company not reported on the consolidated balance sheet that can be sold or repledged at June 30, 2001, totalled $2.1 billion compared with $.7 billion at December 31, 2000. This collateral was obtained under security resale agreements. Of this collateral, $1.8 billion at June 30, 2001 has been sold or repledged as collateral under repurchase agreements or to cover short sales compared with $.3 billion at December 31, 2000. 7. Business Segments --------------------------------------------------------------- The Company has four distinct segments that it utilizes for management reporting: commercial banking, corporate and institutional banking, personal banking, and investment banking and markets. The Commercial Banking Segment provides a diversified range of financial products and services. This segment provides loan and deposit products to small and middle-market corporations including specialized products such as equipment and real estate financing. These products and services are offered through multiple delivery systems, including the branch banking network. In addition, various credit and trade related products are offered such as standby facilities, performance guarantees, acceptances and accounts receivable factoring. The Corporate and Institutional Banking Segment provides deposit and lending functionality to large corporate and multi-national corporations. U.S. dollar clearing services are offered for domestic and international wire transfer transactions. Corporate trust provides various trustee, agency and custody products and services for both corporate and municipal customers. 12. Credit and trade related products such as standby facilities, performance guarantees and acceptances are also provided to large corporate entities. The Personal Banking Segment provides an extensive array of products and services including installment and revolving term loans, deposits, branch services, mutual funds, insurance, estate planning and other investment management services. These products are marketed to individuals through the branch banking network. Residential mortgage lending provides loan financing through direct retail and wholesale origination channels. Mortgage loans are originated through a network of brokers, wholesale agents and retail originations offices. Servicing is performed for the individual mortgage holder or on a contractual basis for mortgages owned by third parties. The Investment Banking and Markets Segment comprises treasury, traded markets, and international private banking businesses. The treasury function maintains overall responsibility for the investment and borrowing of funds to ensure liquidity, maximize return and manage interest rate risk. Traded markets encompasses the trading and sale of foreign exchange, banknotes, derivatives, precious metals, securities and emerging markets instruments, both domestically and internationally. International private banking offers a full range of services for high net worth individuals throughout the world including deposit, lending, trading, trust and investment management. Other consists of certain non-recurring expenses, including Republic related integration costs, goodwill amortization, preferred stock dividends and the provision for credit losses not assigned to business units. The segment results show the financial performance of the major business units. These results are determined based on the Company's management accounting process, which assigns balance sheet, revenue and expense items to each reportable business unit on a systematic basis. With respect to segment results, management does not analyze depreciation and amortization expense or expenditures for additions to long-lived assets which are not considered significant. As such, these amounts are included in other expenses and average assets, respectively, in the table.
13. --------------------------------------------------------------------------------------------------- Segments ----------------------------------------------- Corporate/ Investment Commercial Institutional Personal Banking/ Banking Banking Banking Markets Other Total --------------------------------------------------------------------------------------------------- Six months ended June 30, 2001 --------------------------------------------------------------------------------------------------- (in millions) Net interest income (1) $ 319 $ 72 $ 548 $ 210 $ (34) $ 1,115 Other operating income 83 52 183 225 18 561 --------------------------------------------------------------------------------------------------- Total income 402 124 731 435 (16) 1,676 Operating expenses (2) 207 50 426 191 101 975 --------------------------------------------------------------------------------------------------- Pretax income (loss) before provision for credit losses 195 74 305 244 (117) 701 Provision for credit losses (3) 21 21 34 (5) 25 96 --------------------------------------------------------------------------------------------------- Pretax income (loss) 174 53 271 249 (142) 605 Taxes (4) 60 18 93 85 (20) 236 --------------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting change 114 35 178 164 (122) 369 --------------------------------------------------------------------------------------------------- Average assets 15,931 5,615 22,398 39,477 1,942 85,363 Average liabilities/equity (5) 11,972 3,927 28,124 35,935 5,405 85,363 --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Six months ended June 30, 2000 --------------------------------------------------------------------------------------------------- Net interest income (1) $ 279 $ 73 $ 502 $ 221 $ (20) $ 1,055 Other operating income 53 46 181 107 22 409 --------------------------------------------------------------------------------------------------- Total income 332 119 683 328 2 1,464 Operating expenses (2) 168 44 409 177 147 945 --------------------------------------------------------------------------------------------------- Pretax income (loss) before provision for credit losses 164 75 274 151 (145) 519 Provision for credit losses (3) 31 8 34 (5) (12) 56 --------------------------------------------------------------------------------------------------- Pretax income (loss) 133 67 240 156 (133) 463 Taxes (4) 43 21 77 50 (18) 173 --------------------------------------------------------------------------------------------------- Net income (loss) 90 46 163 106 (115) 290 --------------------------------------------------------------------------------------------------- Average assets 13,857 5,884 19,440 39,645 3,920 82,746 Average liabilities/equity (5) 9,751 5,239 28,701 32,211 6,844 82,746 --------------------------------------------------------------------------------------------------- (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 with the exception of non-recurring corporate expenses and goodwill amortization. (3) The provision apportioned to the segments is based on the segments' net charge offs and the change in allowance for credit losses. Credit loss reserves are established at a level sufficient to absorb the losses considered to be inherent in the portfolio. The difference between segment provisions and the Company provision is included in other. (4) Taxes are allocated to the segments based on pretax income excluding goodwill amortization. (5) Common shareholder's equity and earnings on common shareholder's equity are allocated back to the segments based on the percentage of capital assigned to the business.
14. 8. New Accounting Standards --------------------------------------------------------------- In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, Business Combinations (FAS 141). The Statement is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method that are completed after June 30, 2001. FAS 141 prohibits the pooling-of-interests method of accounting for business combinations and prescribes the initial recognition and measurement of goodwill and other intangible assets, accounting for negative goodwill and the required disclosures in respect of business combinations. In July 2001, the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (FAS 142). The Statement is effective for fiscal years beginning after December 15, 2001 and may not be retroactively applied to financial statements of prior periods. FAS 142 requires that goodwill, including previously existing goodwill, and intangible assets with indefinite useful lives should not be amortized but should be tested for impairment annually. Goodwill and intangible assets with indefinite useful lives will no longer be tested for impairment under Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (FAS 121). The Company is required to adopt the provisions of FAS 141 immediately and FAS 142 with effect from January 1, 2002. Any goodwill and any intangible asset determined to have an indefinite useful life acquired in a purchase business combination completed after June 30, 2001 will not be amortized and will continue to be evaluated for impairment under FAS 121 until the date that FAS 142 applies in its entirety. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until the adoption of FAS 142. As at the date of adoption, the Company expects to have unamortized goodwill of $2.9 billion, which will be subject to the transition provisions of FAS 141 and FAS 142. Amortization expense related to goodwill was $176.2 million and $89.3 million for the year ended December 31, 2000 and the six months ended June 30, 2001, respectively. Because of the extensive effort needed to comply with adopting FAS 141 and FAS 142, it is not practicable to estimate reasonably the impact of adopting these Statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will require to be recognized as the cumulative effect of a change in accounting principles. On January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133) as amended by FAS 137 and FAS 138. FAS 133 standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts. Under FAS 133, entities are 15. required to carry all derivatives in the consolidated balance sheet at fair value. The accounting for changes in fair value (i.e. gains or losses) of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, the type of hedge. In accordance with the transition provisions of FAS 133, the Company recorded a net of tax cumulative effect adjustment charge of $.5 million in earnings representing the difference between the fair value of derivatives that were designated as fair value hedging instruments at the date of adoption and the related mark to market of the previously hedged assets and liabilities. The Company also recorded a net of tax cumulative effect gain of $2.9 million in accumulated other comprehensive income representing the fair value of derivatives that were designated as cash flow hedging instruments at the date of adoption, all of which will be recognized in earnings during the current year. Gains and losses on derivatives that were previously deferred as adjustments to the carrying amount of hedged items were not affected and continue to be amortized over the life of the previously hedged items. In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140). FAS 140 replaced Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 125). It revised the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carried over most of FAS 125's provisions without change. FAS 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities of the Company occurring after March 31, 2001. Adoption of this standard has not had a material effect on the consolidated financial statements of the Company. 16. Management's Discussion and Analysis of Financial Condition and Results of Operations --------------------------------------------------------------- HSBC USA Inc. (the Company) reported second quarter 2001 net income of $188.0 million, compared with $140.2 million in the second quarter of 2000. For the first six months of 2001, net income was $368.8 million compared with $290.1 million for the first six months of last year. The key factors contributing to the increased net income for the first six months of 2001 compared with 2000 were increased net interest income and gains on securities sales. Net Interest Income --------------------------------------------------------------- Net interest income for the second quarter of 2001 was $571.8 million compared with $527.4 million for the second quarter of 2000. For the first six months of 2001, net interest income was $1,115.6 million compared with $1,055.4 million for the first six months of 2000. The increased net interest income for the first six months of 2001 reflects loan and core deposit growth, the recent short term rate cuts and a steeper yield curve which have led to wider interest margins in certain commercial businesses, the residential mortgage business and treasury investment operations. Interest income was $1,254.3 million in the second quarter of 2001 compared with $1,340.8 million in the second quarter of 2000. Average earning assets were $77.3 billion for the second quarter of 2001 compared with $75.3 billion a year ago. The average rate earned on earning assets was 6.56% for the second quarter of 2001 compared with 7.19% a year ago. Interest income was $2,591.8 million for the first six months of 2001 compared with $2,598.8 million in the first six months of 2000. Average earning assets were $77.4 billion for the first six months of 2001 compared with $74.2 billion the first six months of 2000. The average rate earned on earning assets was 6.79% for the first six months of 2001 compared with 7.08% a year ago. Interest expense for the second quarter of 2001 was $682.5 million compared with $813.3 million in the second quarter of 2000. Average interest bearing liabilities for the second quarter of 2001 were $67.1 billion, compared with $64.6 billion a year ago. The average rate paid on interest bearing liabilities was 4.08% compared with 5.07% a year ago. Interest expense for the first six months of 2001 was $1,476.3 million compared with $1,543.4 million in the first six months of 2000. Average interest bearing liabilities for the first six months of 2001 were $66.6 billion, compared with $63.1 billion a year ago. The average rate paid on interest bearing liabilities was 4.47% for the first six months of 2001 compared with 4.92% a year ago. The taxable equivalent net yield on average total assets for the second quarter of 2001 was 2.72%, compared with 2.56% a year ago. The taxable equivalent net yield on average total assets for the first six months of 2001 was 2.67%, compared with 2.60% a year ago. 17. Other Operating Income --------------------------------------------------------------- Total other operating income was $268.2 million in the second quarter of 2001, compared with $197.5 million in the 2000 second quarter. For the first six months of 2001, total operating income was $560.6 million compared with $408.5 million for the first six months of 2000. Security gains for the first half of 2001 were primarily realized from securities sales to adjust to interest rate changes and to reconfigure exposure to residential mortgages. The security gains for 2001 also included a first quarter one- time gain of $19.3 million on the sale of shares in Canary Wharf, a retail/office development investment project in London, England. Fee income from domestic wealth management was $102.7 million during the first half of 2001, an increase of 13 percent compared to the same period in 2000. Trading revenues are generated by the Company's participation in the foreign exchange and precious metals markets, trading activities in derivative contracts and from trading securities. The Company reports the net revenues from these activities, which include mark to market adjustments and any related direct trading expenses, as trading revenues in the consolidated statement of income. Trading revenues are summarized by categories of financial instruments in the following table.
----------------------------------------------------------------- Six months ended June 30 2001 2000 ----------------------------------------------------------------- (in millions) Foreign exchange $ 68.4 $55.5 Precious metals (3.2) 2.5 Trading account profits and commissions 37.0 26.5 ----------------------------------------------------------------- Trading revenues $102.2 $84.5 -----------------------------------------------------------------
The increase in trading revenues reflects improved foreign exchange profits due to an expansion of business activities and favorable market conditions as well as the impact of adopting FAS 133. Included in the first half 2000 trading revenues was $12.7 million of revenue earned by certain non-U.S. entities that were transferred or sold to other HSBC entities during the first half of 2000. The first half 2001 precious metals results reflect unrealized losses on positions impacted by lower short term interest rates. These precious metals losses are offset by unrealized gains recorded in trading account profits on swaps which appreciated in value, as well as additional net interest income. Other Operating Expenses --------------------------------------------------------------- Other operating expenses were $483.5 million in the second quarter of 2001 compared with $473.6 million for the second quarter of 2000. Other operating expenses were $975.2 million for the first six months of 2001 compared with $945.2 million a year ago. The increase in other operating expenses versus the first half of 2000 was a result of infrastructure investment initiatives and business expansion, particularly in treasury/capital markets. Other new business initiatives against which expenditure had been incurred in the period are focused on developing e-commerce delivery capabilities and on growth in the private banking and wealth management businesses. Operating 18. expenses for the second quarter of 2001 included $6.6 million of Republic acquisition related integration costs versus $19.1 million for the same period of 2000. Republic integration costs for the first six months of 2001 were $12.5 million compared with $21.6 million for the same period of 2000. Equipment and software depreciation was higher than the first half of last year, because of infrastructure investments made during 2000 related to the Republic acquisition. Income Taxes --------------------------------------------------------------- The effective tax rate was 39% in the second quarter of 2001 compared with 37% in the same period of 2000. The effective tax rate was 39% in the first half of 2001 compared with 37% in the same period of 2000. The net deferred tax asset at June 30, 2001 was $144 million compared with $94 million at December 31, 2000.
Asset Quality --------------------------------------------------------------- The following table provides a summary of the allowance for credit losses and nonaccruing loans. --------------------------------------------------------------------------------- 2nd 2nd 6 Months Year 6 Months Quarter Quarter Ended Ended Ended 2001 2000 6/30/01 12/31/00 6/30/00 --------------------------------------------------------------------------------- (in millions) Allowance for Credit Losses --------------------------- Balance at beginning of period $552.7 $638.0 $525.0 $ 638.0 $638.0 Allowance related to acquisitions/transfers (19.0) (3.5) (19.0) (11.3) (3.5) Provision charged to income 48.0 28.0 95.6 137.6 56.0 Net charge offs (42.9) (47.7) (63.5) (238.7) (75.5) Translation adjustment (.9) (.2) (.2) (.6) (.4) --------------------------------------------------------------------------------- Balance at end of period $537.9 $614.6 $537.9 $ 525.0 $614.6 ---------------------------------------------------------------------------------
June 30, December 31, June 30, 2001 2000 2000 --------------------------------------------------------------------------------- (in millions) Nonaccruing Loans ----------------- Balance at end of period $389.8 $423.2 $352.2 As a percent of loans outstanding .93% 1.05% .91% Nonperforming Loans and Assets * ------------------------------ Balance at end of period $408.3 $443.7 $365.9 As a percent of total assets .48% .53% .44% Allowance Ratios ---------------- Allowance for credit losses as a percent of: Loans 1.28% 1.30% 1.59% Nonaccruing loans 137.98 124.06 174.49 --------------------------------------------------------------------------------- * Includes nonaccruing loans, other real estate and other owned assets.
19. During the first half of 2001, credit quality remained relatively stable, notwithstanding a more volatile business and credit environment. Provisions for credit losses were $48.0 million in the second quarter of 2001 compared with $28.0 million in the second quarter of 2000. Provisions for credit losses for the first half of 2001 were $95.6 million compared with $56.0 million during the first half of 2000. Net charge offs in the credit card portfolio were $30.0 million and $30.8 million in the first half of 2001 and 2000, respectively. The delinquency rate for the credit card portfolio was 3.60% at June 30, 2001 compared with 3.75% at December 31, 2000 and 3.36% at June 30, 2000. Net charge offs on commercial loans were $29.8 million and $41.5 million in the first half of 2001 and 2000, respectively. The Company identified impaired loans totaling $194 million at June 30, 2001, of which $139 million had a specific credit loss allowance of $65 million. At December 31, 2000, impaired loans were $224 million of which $109 million had a specific credit loss allowance of $46 million. Derivative Instruments and Hedging Activities --------------------------------------------------------------- The Company 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 speculative trading in its own account. The Company 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 and commodity prices, focusing on structuring of transactions to meet clients' needs. Types of Derivatives Derivative instruments are contracts whose value is derived from that of an underlying instrument, physical commodity or market index and generally do not involve the exchange of principal but may involve the payment of a fee or receipt of a premium at inception of a contract. Certain instruments such as futures and forward contracts commit the Company to buy or sell a specified financial instrument, currency, precious metal or other commodity at a future date. Futures contracts are exchange-trading instruments that settle through an independent clearinghouse and require daily cash settlement. Forward contracts are customized transactions that require no cash settlement until the end of the contract. Other contracts, such as interest rate swaps, involve commitments to make periodic cash settlements based upon the differential between specified rates or indices applied to a stated notional amount. Purchased option contracts give the right, but do not obligate the holder, to acquire or sell for a limited time a financial instrument, precious metal or commodity at a designated price upon payment for assuming the risk of unfavorable changes in the price of the underlying instrument or index. 20. Within the context of its overall balance sheet risk management strategy, derivatives are utilized to protect against changes in fair values and cash flows associated with certain balance sheet assets, liabilities, forecasted transactions and firm commitments in order to maintain net interest margin within a range that management considers acceptable. To achieve this objective, the Company has identified and currently pursues two qualifying FAS 133 fair value hedge strategies and one qualifying cash flow hedge strategy. Fair Value Hedges Specifically, interest rate swaps that call for the receipt of a variable market rate and the payment of a fixed rate are utilized under fair value strategies to hedge the risk associated with changes in the risk free rate component of the value of certain fixed rate investment securities. Interest rate swaps that call for the receipt of a fixed rate and payment of a variable market rate are utilized to hedge the risk associated with changes in the risk free rate component of certain fixed rate debt obligations. For the six months ended June 30, 2001, the Company recognized a net gain of $.1 million (reported as other income in the consolidated statement of income), which represented the ineffective portion of all fair value hedges. Only the time value component of these derivative contracts has been excluded from the assessment of hedge effectiveness. Cash Flow Hedges Similarly, interest rate swaps that call for the receipt of a variable market rate and the payment of a fixed rate are utilized under the cash flow strategy to hedge the forecasted repricing of certain deposit liabilities. For the six months ended June 30, 2001, the Company recognized a net gain of $1.1 million (reported as other income in the consolidated statement of income), which represented the total ineffectiveness of all cash flow hedges. Only the time value component of the change in the fair value of these derivative contracts has been excluded from the assessment of hedge effectiveness. 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 repricing. As of June 30, 2001, $4.8 million of deferred net losses on derivative instruments accumulated in other comprehensive income are expected to be charged to earnings during the remainder of 2001. Trading and Other Activities The Company enters into certain derivative contracts for purely speculative trading purposes in order to realize profits from short-term movements in interest rates, commodity prices and foreign exchange rates. In addition, 21. certain contracts do not qualify as FAS 133 hedges and are accounted for on a full mark to market basis through current earnings even though they were not acquired for trading purposes. For example, in conjunction with managing the risks associated with its mortgage banking business, the Company purchases interest rate floors. Although these derivative contracts do not qualify as hedges under FAS 133, they have the economic impact of largely offsetting the erosion in value of the mortgage servicing rights portfolio in declining rate environments. The changes in value of these and all such "economic hedges" are recognized in current period earnings as if they were trading positions. Credit and Market Risks By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the fair value gain in a derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes the Company, and, therefore, creates a repayment risk for the Company. When the fair value of a derivative contract is negative, the Company owes the counterparty and, therefore, it has no repayment risk. The Company minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high quality counterparties including other members of the HSBC Group. Exposures are reviewed periodically by the Company's credit committee. Counterparties generally include financial institutions including banks, other government agencies, both foreign and domestic, and insurance companies. The Company also maintains a policy of requiring that all derivative contracts be governed by an International Swaps and Derivatives Association Master Agreement; depending on the nature of the derivative transaction, bilateral collateral arrangements may be required as well. When the Company has more than one outstanding derivative transaction with a counterparty, and there exists a legally enforceable master netting agreement, the "net" mark to market exposure represents the netting of the positive and negative exposure with the same counterparty. When there is a net negative exposure, the Company considers its exposure to be zero. The net mark to market position with a particular counterparty represents a reasonable measure of credit risk when there is a legally enforceable master netting agreement (i.e., a legal right of set off of receivable and payable derivative contracts) between the Company and a counterparty. The Company's policy is to use master netting agreements with all counterparties. Market risk is the adverse effect that a change in interest rates, currency, or implied volatility rates has on the value of a financial instrument. The Company 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. The Company periodically measures this risk by using a value at risk methodology. 22. The Company's Asset and Liability Policy Committee is responsible for implementing various hedging strategies 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 the Company's overall interest rate risk management and trading strategies. Liquidity --------------------------------------------------------------- The Company maintains a strong liquidity position. The size and stability of its deposit base are complemented by its maintenance of a surplus borrowing capacity in the money markets, including the ability to issue additional commercial paper and access unused lines of credit of $500 million at June 30, 2001. Wholesale liabilities were $20.1 billion at June 30, 2001 compared with $18.5 billion at December 31, 2000. The Company also has strong liquidity as a result of a high level of immediately saleable or pledgeable assets including its available for sale securities portfolio, trading assets, mortgages and other assets. Capital --------------------------------------------------------------- Total common shareholder's equity was $6.9 billion at June 30, 2001, approximately the same level as December 31, 2000. Under risk-based capital guidelines, the Company's capital ratios were 8.46% at the Tier 1 level and 13.42% at the total capital level at June 30, 2001. These ratios compared with 8.39% at the Tier 1 level and 13.56% at the total capital level at December 31, 2000. Under guidelines for leverage ratios, the Company's ratio of Tier 1 capital to quarterly average total assets was 5.90% at June 30, 2001 compared with 5.73% at December 31, 2000. Quantitative and Qualitative Disclosures About Market Risk --------------------------------------------------------------- In consideration of the degree of interest rate risk inherent in the banking industry, the Company has interest rate risk management policies designed to meet performance objectives within defined risk/safety parameters. In the course of managing interest rate risk, a combination of risk assessment techniques, including dynamic simulation modeling, gap analysis, and capital at risk analysis are employed. The combination of these tools enables management to identify and assess the potential impact of interest rate movements and take appropriate action. Certain limits and benchmarks that serve as guidelines in determining the appropriate levels of interest rate risk for the institution have been established. One such limit is expressed in terms of the Present Value of a Basis Point (PVBP), which reflects the change in value of the balance sheet for a one basis point movement in all interest rates. The institutional PVBP limit as of June 30, 2001 was plus or minus $4.7 million, which includes distinct limits associated with trading portfolio activities and off-balance 23. sheet instruments. Thus, for a one basis point change in interest rates, the policy dictates that the value of the balance sheet shall not change by more than $4.7 million. As of June 30, 2001, the Company had a position of $(3.1) million PVBP reflecting the impact of a one basis point increase in interest rates. Mortgage servicing rights are excluded from the PVBP determination as their interest rate risk is significantly different from other balance sheet items. The mortgage servicing rights risk is to lower interest rates, which is managed through the purchase of appropriate interest rate floors. The Company also monitors changes in value of the balance sheet for large movements in interest rates with an overall limit of +/- 10%, after tax, change from the base case valuation for a 200 basis point gradual rate movement. As of June 30, 2001, for a gradual 200 basis point increase in rates, the value was projected to drop by 5.6% and for a 200 basis point gradual decrease in rates, value was projected to drop by 6.8% if there were no management actions taken to manage exposures to the changing environment. In addition to the above mentioned limits, the Company's Asset and Liability Policy Committee monitors, on a monthly basis, the impact of a number of interest rate scenarios on net interest income. These scenarios include both rate shock scenarios which assume immediate market rate movements of 200 basis points, as well as rate change scenarios in which rates rise or fall by 200 basis points over a twelve month period. The individual limit for such gradual 200 basis point movements is currently +/- 10%, pretax, of base case earnings over a twelve month period. Simulations are also performed for other relevant interest rate scenarios including immediate rate movements and changes in the shape of the yield curve or in competitive pricing policies. Net interest income under the various scenarios is reviewed over a twelve month period, as well as over a three year period. The simulations capture the effects of the timing of the repricing of all on-balance sheet assets and liabilities, as well as all off-balance sheet positions such as interest rate swaps, futures and option contracts. Additionally, the simulations incorporate any behavioral aspects such as prepayment sensitivity under various scenarios. For purposes of simulation modeling, base case earnings reflect the existing balance sheet composition, with balances generally maintained at current levels by the anticipated reinvestment of expected runoff. These balance sheet levels will however, factor in specific known or likely changes including material increases, decreases or anticipated shifts in balances due to management actions. Current rates and spreads are then applied to produce base case earnings estimates on both a twelve month and three year time horizon. Rate shocks are then modeled and compared to base earnings (earnings at risk), and include behavioral assumptions as dictated by specific scenarios relating to such factors as prepayment sensitivity and the tendency of balances to shift among various products in different rate environments. It is assumed that no management actions are taken to manage exposures to the changing environment being simulated. 24. Utilizing these modeling techniques, a gradual 200 basis point parallel rise and fall in the yield curve on July 1, 2001 would cause projected net interest income for the next twelve months to decrease by $9 million and increase by $13 million, respectively. This +/- 1% change is well within the Company's +/- 10% limit. An immediate 100 basis point parallel rise and fall in the yield curve on July 1, 2001, would cause projected net interest income for the next twelve months to decrease by $33 million and decrease by $4 million, respectively. A 200 basis point parallel rise and fall would decrease projected net interest income for the next twelve months by $76 million and decrease by $22 million, respectively. The projections noted above 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. Trading Activities --------------------------------------------------------------- The trading portfolios of the Company have distinct 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 Company relies upon Value at Risk (VaR) analysis as a basis for quantifying and managing risks associated with the trading portfolio. Such analysis is based upon the following two general principles: (i) VaR applies to all trading positions across all risk classes including interest rate, equity, optionality and global/foreign exchange risks and (ii) VaR is based on the concept of independent valuations, with all transactions being repriced by an independent risk management function using separate models prior to being stressed against VaR parameters. VaR attempts to capture the potential loss resulting from unfavorable market developments within a given time horizon (typically ten days) and given a certain confidence level (99%). It involves historical simulation of the changes in value of the portfolios based upon scenarios that reflect movements in various market variables covering each risk asset class dating back two years. The correlation between different markets and risk factors is implicitly captured in historical scenarios. A VaR report broken down by trading business and on a consolidated basis is distributed daily to management. To measure the accuracy of the VaR model output, the daily VaR is compared to the actual result from trading activities. 25. The VaR model incorporates estimates of the specific risk associated with certain securities traded by the Company. This includes elements such as spread risk on sovereign or corporate debt which is modeled through historical simulation of the relevant portfolio to past changes on spreads of U.S. treasury securities. Specific risk models are continually tested to alert risk management immediately to any shift in their relevance. On a historical simulation approach, trading VaR at June 30, 2001 was $39.5 million compared with $20.3 million at December 31, 2000. The maximum trading VaR during the second quarter of 2001 was $43.1 million, the minimum $15.9 million and the average $29.1 million. Forward-Looking Statements --------------------------------------------------------------- This report includes forward-looking statements. Statements that are not historical facts, including statements about management's beliefs and expectations, are forward-looking statements and involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward- looking statements. Such factors include, but are not limited to: sharp and/or rapid changes in interest rates; significant changes in the economic conditions which could materially change anticipated credit quality trends and the ability to generate loans; technology changes and challenges; significant changes in accounting, tax or regulatory requirements; and competition in the geographic and business areas in which the Company conducts its operations.
26. HSBC USA Inc. -------------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES* Second Quarter 2001 Second Quarter 2000** Balance Interest Rate Balance Interest Rate -------------------------------------------------------------------------------------- in millions Assets Interest bearing deposits with banks $ 4,698 $ 61.9 5.28 % $ 5,919 $ 103.1 7.00 % Federal funds sold and securities purchased under resale agreements 3,322 37.8 4.56 3,838 62.0 6.50 Trading assets 8,149 62.2 3.06 4,669 23.9 2.04 Securities 19,962 349.9 7.03 22,722 408.0 7.22 Loans Domestic Commercial 16,851 276.8 6.59 16,306 314.0 7.74 Consumer Residential mortgages 16,900 312.1 7.39 14,061 258.7 7.36 Other consumer 3,143 89.0 11.36 3,238 92.4 11.47 -------------------------------------------------------------------------------------- Total domestic 36,894 677.9 7.37 33,605 665.1 7.96 International 4,297 74.6 6.97 4,588 85.4 7.48 -------------------------------------------------------------------------------------- Total loans 41,191 752.5 7.33 38,193 750.5 7.90 -------------------------------------------------------------------------------------- Total earning assets 77,322 $ 1,264.3 6.56 % 75,341 $ 1,347.5 7.19 % -------------------------------------------------------------------------------------- Allowance for credit losses (553) (631) Cash and due from banks 1,916 1,757 Other assets 6,992 7,316 -------------------------------------------------------------------------------------- Total assets $ 85,677 $ 83,783 ====================================================================================== Liabilities and Shareholders' Equity Interest bearing demand deposits $ 378 $ 0.4 0.37 % $ 787 $ 2.2 1.11 % Consumer savings deposits 12,809 62.6 1.96 12,596 76.6 2.45 Other consumer time deposits 11,453 137.4 4.81 8,106 101.3 5.03 Commercial, public savings and other time deposits 7,249 62.2 3.44 7,701 104.9 5.48 Deposits in foreign offices 20,698 246.8 4.78 19,528 292.8 6.03 -------------------------------------------------------------------------------------- Total interest bearing deposits 52,587 509.4 3.89 48,718 577.8 4.77 -------------------------------------------------------------------------------------- Federal funds purchased and securities sold under repurchase agreements 2,567 24.9 3.89 2,180 31.1 5.73 Other short-term borrowings 7,037 63.6 3.62 7,735 92.3 4.80 Long-term debt 4,874 84.6 6.96 5,941 112.1 7.59 -------------------------------------------------------------------------------------- Total interest bearing liabilities 67,065 $ 682.5 4.08 % 64,574 $ 813.3 5.07 % -------------------------------------------------------------------------------------- Interest rate spread 2.48 % 2.12 % -------------------------------------------------------------------------------------- Noninterest bearing deposits 5,640 6,258 Other liabilities 5,665 5,945 Shareholders' equity 7,307 7,006 -------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 85,677 $ 83,783 ====================================================================================== Net yield on average earning assets 3.02 % 2.85 % Net yield on average total assets 2.72 2.56 ====================================================================================== * Interest and rates are presented on a taxable equivalent basis. ** Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
27. HSBC USA Inc. ------------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES* Six Months 2001 Six Months 2000 Balance Interest Rate Balance Interest Rate ------------------------------------------------------------------------------------- in millions Assets Interest bearing deposits with banks $ 4,726 $ 134.2 5.73 % $ 4,766 $ 161.9 6.83 % Federal funds sold and securities purchased under resale agreements 3,123 80.8 5.22 3,406 109.8 6.48 Trading assets 8,036 123.2 3.07 4,973 52.2 2.10 Securities 20,702 731.1 7.12 22,655 798.6 7.09 Loans Domestic Commercial 16,584 573.6 6.98 16,735 637.9 7.67 Consumer Residential mortgages 16,545 620.6 7.50 13,751 501.0 7.29 Other consumer 3,224 184.8 11.56 3,170 176.6 11.20 ------------------------------------------------------------------------------------- Total domestic 36,353 1,379.0 7.65 33,656 1,315.5 7.86 International 4,446 159.3 7.23 4,760 173.9 7.35 ------------------------------------------------------------------------------------- Total loans 40,799 1,538.3 7.60 38,416 1,489.4 7.80 ------------------------------------------------------------------------------------- Total earning assets 77,386 $ 2,607.6 6.79 % 74,216 $ 2,611.9 7.08 % ------------------------------------------------------------------------------------- Allowance for credit losses (545) (636) Cash and due from banks 1,804 1,759 Other assets 6,718 7,407 ------------------------------------------------------------------------------------- Total assets $ 85,363 $ 82,746 ===================================================================================== Liabilities and Shareholders' Equity Interest bearing demand deposits $ 373 $ 1.3 0.71 % $ 786 $ 4.3 1.11 % Consumer savings deposits 12,645 134.8 2.15 12,583 152.1 2.43 Other consumer time deposits 11,525 285.8 5.00 8,085 197.5 4.91 Commercial, public savings and other time deposits 6,766 124.4 3.71 7,616 202.0 5.33 Deposits in foreign offices, primarily banks 21,031 545.9 5.23 19,127 551.0 5.79 ------------------------------------------------------------------------------------- Total interest bearing deposits 52,340 1,092.2 4.21 48,197 1,106.9 4.62 ------------------------------------------------------------------------------------- Federal funds purchased and securities sold under repurchase agreements 2,262 50.5 4.46 2,007 55.8 5.59 Other short-term borrowings 7,001 158.4 4.56 6,978 164.4 4.74 Long-term debt 4,950 175.2 7.14 5,909 216.3 7.36 ------------------------------------------------------------------------------------- Total interest bearing liabilities 66,553 $ 1,476.3 4.47 % 63,091 $ 1,543.4 4.92 % ------------------------------------------------------------------------------------- Interest rate spread 2.32 % 2.16 % ------------------------------------------------------------------------------------- Noninterest bearing deposits 5,631 6,278 Other liabilities 5,842 6,306 Shareholders' equity 7,337 7,071 ------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 85,363 $ 82,746 ===================================================================================== Net yield on average earning assets 2.95 % 2.90 % Net yield on average total assets 2.67 2.60 ===================================================================================== * Interest and rates are presented on a taxable equivalent basis. ** Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
28. Part II - OTHER INFORMATION --------------------------------------------------------------- Item 6 - Exhibits and Reports on Form 8-K (a) Exhibit 12.01 Computation of Ratio of Earnings to Fixed Charges 12.02 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends. (b) Reports on Form 8-K None 29. SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HSBC USA Inc. (Registrant) Date: August 6, 2001 /s/ Gerald A. Ronning ------------------------------------- Gerald A.Ronning Executive Vice President & Controller (On behalf of Registrant and as Chief Accounting Officer)
30. Exhibit 12.01 HSBC USA Inc. Computation of Ratio of Earnings to Fixed Charges (in millions, except ratios) ------------------------------------------------------------------------ Six months ended June 30, 2001 2000* ------------------------------------------------------------------------ Excluding interest on deposits Income before cumulative effect of accounting change $ 369 $ 290 Applicable income tax expense 236 173 Less undistributed equity earnings 3 3 Fixed charges: Interest on: Borrowed funds 209 220 Long-term debt 175 216 One third of rents, net of income from subleases 9 11 ------------------------------------------------------------------------ Total fixed charges 393 447 Earnings before taxes and cumulative effect of accounting change based on income and fixed charges $ 995 $ 907 ------------------------------------------------------------------------ Ratio of earnings to fixed charges 2.53 2.03 ------------------------------------------------------------------------ Including interest on deposits Total fixed charges (as above) $ 393 $ 447 Add: Interest on deposits 1,092 1,107 ------------------------------------------------------------------------ Total fixed charges and interest on deposits $1,485 $1,554 ------------------------------------------------------------------------ Earnings before taxes and cumulative effect of accounting change based on income and fixed charges (as above) $ 995 $ 907 Add: Interest on deposits 1,092 1,107 ------------------------------------------------------------------------ Total $2,087 $2,014 ------------------------------------------------------------------------ Ratio of earnings to fixed charges 1.41 1.30 ------------------------------------------------------------------------ *Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
31. Exhibit 12.02 HSBC USA Inc. Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends (in millions, except ratios) ------------------------------------------------------------------------ Six months ended June 30, 2001 2000* ------------------------------------------------------------------------ Excluding interest on deposits Income before cumulative effect of accounting change $ 369 $ 290 Applicable income tax expense 236 173 Less undistributed equity earnings 3 3 Fixed charges: Interest on: Borrowed funds 209 220 Long-term debt 175 216 One third of rents, net of income from subleases 9 11 ------------------------------------------------------------------------ Total fixed charges 393 447 Earnings before taxes and cumulative effect of accounting change based on income and fixed charges $ 995 $ 907 ------------------------------------------------------------------------ Total fixed charges $ 393 $ 447 Preferred dividends 13 14 Ratio of pretax income to income before cumulative effect of accounting change 1.64 1.60 ------------------------------------------------------------------------ Total preferred stock dividend factor 21 22 Fixed charges, including preferred stock dividend factor $ 414 $ 469 ------------------------------------------------------------------------ Ratio of earnings to combined fixed charges and preferred dividends 2.40 1.93 ------------------------------------------------------------------------ Including interest on deposits Total fixed charges, including preferred stock dividend factor (as above) $ 414 $ 469 Add: Interest on deposits 1,092 1,107 ------------------------------------------------------------------------ Fixed charges, including preferred stock dividend factor and interest on deposits $1,506 $1,576 ------------------------------------------------------------------------ Earnings before taxes and cumulative effect of accounting change based on income and fixed charges (as above) $ 995 $ 907 Add: Interest on deposits 1,092 1,107 ------------------------------------------------------------------------ Total $2,087 $2,014 ------------------------------------------------------------------------ Ratio of earnings to combined fixed charges and preferred dividends 1.39 1.28 ------------------------------------------------------------------------ *Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.