-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GOev2X94OPHAHk7G6Fgn5VuuePK1KHwuqcgz6xWu6zi7KIgDbXI3ntNyCGNZgks5 xOUHp0wNxQcJsLEyw+yqQA== 0000083246-01-500028.txt : 20020410 0000083246-01-500028.hdr.sgml : 20020410 ACCESSION NUMBER: 0000083246-01-500028 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HSBC USA INC /MD/ CENTRAL INDEX KEY: 0000083246 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 132764867 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-07436 FILM NUMBER: 1788605 BUSINESS ADDRESS: STREET 1: 452 FIFTH AVE CITY: NEW YORK STATE: NY ZIP: 10018 BUSINESS PHONE: 2125256100 MAIL ADDRESS: STREET 1: 452 FIFTH AVENUE CITY: NEW YORK STATE: NY ZIP: 10018 10-Q 1 efin-10q.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 September 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 32 pages. 2. Part I - FINANCIAL INFORMATION Item 1 - Financial Statements Page Consolidated Balance Sheet September 30, 2001 and December 31, 2000 3 Consolidated Statement of Income For The Quarter and Nine Months Ended September 30, 2001 and 2000 4 Consolidated Statement of Changes in Shareholders' Equity For The Nine Months Ended September 30, 2001 and 2000 5 Consolidated Statement of Cash Flows For The Nine Months Ended September 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 29 Signatures 30 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
September 30, December 31, 2001 2000* - ----------------------------------------------------------------------------- in thousands Assets Cash and due from banks $ 2,078,353 $ 1,860,713 Interest bearing deposits with banks 4,148,466 5,129,490 Federal funds sold and securities purchased under resale agreements 3,360,544 1,895,492 Trading assets (incl.$59,080 pledged to creditors at Sept.30) 8,764,132 5,770,972 Securities available for sale (incl.$2,025,072 pledged to creditors at Sept.30) 15,190,148 17,336,832 Securities held to maturity (fair value $4,827,247 and $4,417,251) 4,596,627 4,260,492 Loans 42,930,129 40,417,847 Less - allowance for credit losses 540,252 524,984 - ----------------------------------------------------------------------------- Loans, net 42,389,877 39,892,863 Premises and equipment 791,674 777,610 Accrued interest receivable 488,912 785,286 Equity investments 268,377 55,596 Goodwill and other acquisition intangibles 2,972,439 3,229,479 Other assets 2,567,567 2,040,325 - ----------------------------------------------------------------------------- Total assets $ 87,617,116 $ 83,035,150 ============================================================================= Liabilities Deposits in domestic offices Noninterest bearing $ 4,726,970 $ 5,114,668 Interest bearing 32,267,138 30,631,511 Deposits in foreign offices Noninterest bearing 334,236 282,737 Interest bearing 19,482,903 20,013,588 - ----------------------------------------------------------------------------- Total deposits 56,811,247 56,042,504 - ----------------------------------------------------------------------------- Trading account liabilities 4,056,443 2,766,825 Short-term borrowings 9,602,959 8,562,363 Interest, taxes and other liabilities 5,093,271 3,232,918 Subordinated long-term debt and perpetual capital notes 2,979,120 3,027,014 Guaranteed mandatorily redeemable securities 735,605 711,737 Other long-term debt 1,188,194 1,357,904 - ----------------------------------------------------------------------------- Total liabilities 80,466,839 75,701,265 - ----------------------------------------------------------------------------- Shareholders' equity Preferred stock 500,000 500,000 Common shareholder's equity Common stock 4 4 Capital surplus 6,028,804 6,104,264 Retained earnings 570,248 612,798 Accumulated other comprehensive income 51,221 116,819 - ----------------------------------------------------------------------------- Total common shareholder's equity 6,650,277 6,833,885 - ----------------------------------------------------------------------------- Total shareholders' equity 7,150,277 7,333,885 - ----------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 87,617,116 $ 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 September 30, Nine months ended September 30, 2001 2000* 2001 2000* - ------------------------------------------------------------------------------------------- in thousands Interest income Loans $ 729,316 $ 783,359 $ 2,267,117 $ 2,272,272 Securities 296,260 402,246 1,012,144 1,188,379 Trading assets 52,670 37,656 175,797 89,794 Other short-term investments 73,080 131,183 288,113 402,789 - ------------------------------------------------------------------------------------------- Total interest income 1,151,326 1,354,444 3,743,171 3,953,234 - ------------------------------------------------------------------------------------------- Interest expense Deposits 440,769 604,368 1,532,997 1,711,258 Short-term borrowings 74,156 109,591 283,029 329,794 Long-term debt 81,750 101,083 256,925 317,352 - ------------------------------------------------------------------------------------------- Total interest expense 596,675 815,042 2,072,951 2,358,404 - ------------------------------------------------------------------------------------------- Net interest income 554,651 539,402 1,670,220 1,594,830 Provision for credit losses 47,500 50,608 143,050 106,607 - ------------------------------------------------------------------------------------------- Net interest income, after provision for credit losses 507,151 488,794 1,527,170 1,488,223 - ------------------------------------------------------------------------------------------- Other operating income Trust income 20,517 20,776 65,360 63,319 Service charges 47,738 42,834 139,177 129,515 Mortgage banking revenue 3,293 7,739 22,907 22,903 Other fees and commissions 86,753 71,770 245,762 225,444 Trading revenues 73,793 30,103 176,036 114,633 Security gains 20,891 9,081 146,671 10,443 Other income 22,817 29,262 40,520 53,785 - ------------------------------------------------------------------------------------------- Total other operating income 275,802 211,565 836,433 620,042 - ------------------------------------------------------------------------------------------- Total income from operations 782,953 700,359 2,363,603 2,108,265 - ------------------------------------------------------------------------------------------- Other operating expenses Salaries and employee benefits 243,464 241,090 728,053 738,269 Occupancy expense, net 40,665 41,412 116,865 127,004 Goodwill amortization 43,803 44,417 133,062 131,878 Princeton Note Matter 575,000 - 575,000 - Other expenses 153,730 145,457 478,849 420,461 - ------------------------------------------------------------------------------------------- Total other operating expenses 1,056,662 472,376 2,031,829 1,417,612 - ------------------------------------------------------------------------------------------- Income (loss) before taxes and cumulative effect of accounting change (273,709) 227,983 331,774 690,653 Applicable income tax expense (credit) (106,500) 84,406 129,700 257,005 - ------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting change (167,209) 143,577 202,074 433,648 - ------------------------------------------------------------------------------------------- Cumulative effect of accounting change - implementation of FAS 133 - - (451) - - ------------------------------------------------------------------------------------------- Net income (loss) $ (167,209)$ 143,577 $ 201,623 $ 433,648 =========================================================================================== 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
Nine months ended September 30, 2001 2000* - -------------------------------------------------------------------- in thousands Preferred stock Balance, January 1, $ 500,000 $ 500,000 - -------------------------------------------------------------------- Balance, September 30, 500,000 500,000 - -------------------------------------------------------------------- Common stock Balance, January 1, 4 4 - -------------------------------------------------------------------- Balance, September 30, 4 4 - -------------------------------------------------------------------- Capital surplus Balance, January 1, 6,104,264 6,096,317 Return of capital (84,939) - Capital contribution from parent 9,479 4,813 - -------------------------------------------------------------------- Balance, September 30, 6,028,804 6,101,130 - -------------------------------------------------------------------- Retained earnings Balance, January 1, 612,798 671,578 Net income 201,623 433,648 Cash dividends declared: Preferred stock (19,173) (20,820) Common stock (225,000) (600,000) - -------------------------------------------------------------------- Balance, September 30, 570,248 484,406 - -------------------------------------------------------------------- Accumulated other comprehensive income (loss), net of tax Balance, January 1, 116,819 (50,534) Net change in unrealized gains (losses) on securities (16,970) 83,473 Net change in unrealized loss on derivatives classified as cash flow hedges (36,563) - Unrealized net transitional gain related to initial adoption of FAS 133 2,853 - Amortization of unrealized net transitional FAS 133 gains credited to current income (2,140) - Foreign currency translation adjustment (12,778) (6,251) - -------------------------------------------------------------------- Other comprehensive income (loss), net of tax (65,598) 77,222 - -------------------------------------------------------------------- Balance, September 30, 51,221 26,688 - -------------------------------------------------------------------- Total shareholders' equity, September 30, $ 7,150,277 $ 7,112,228 ==================================================================== Comprehensive income Net income $ 201,623 $ 433,648 Other comprehensive income (loss), net of tax (65,598) 77,222 - -------------------------------------------------------------------- Comprehensive income $ 136,025 $ 510,870 ==================================================================== 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
Nine months ended September 30, 2001 2000* ------------------------------------------------------------------------------------- in thousands Cash flows from operating activities Net income $ 201,623 $ 433,648 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, amortization and deferred taxes 166,353 328,312 Provision for credit losses 143,050 106,607 Net change in other accrual accounts 625,406 210,276 Net change in loans originated for sale (411,314) (1,471,028) Net change in trading assets and liabilities (1,307,093) (1,092,070) Other, net (317,226) (99,897) ------------------------------------------------------------------------------------- Net cash provided (used) by operating activities (899,201) (1,584,152) ------------------------------------------------------------------------------------- Cash flows from investing activities Net change in interest bearing deposits with banks 1,159,698 (2,365,845) Net change in short-term investments (1,465,052) (310,816) Purchases of securities held to maturity (113,587) (100,721) Proceeds from maturities of securities held to maturity 842,497 458,838 Purchases of securities available for sale (12,356,051) (11,478,657) Sales of securities available for sale 10,977,169 7,905,069 Proceeds from maturities of securities available for sale 3,318,574 11,393,188 Payment to shareholders of acquired company - (7,091,209) Net change in credit card receivables 38,554 28,915 Net change in other short term loans 341,188 448,677 Net originations and maturities of loans (2,401,691) (126,184) Sales of loans - 167,042 Expenditures for premises and equipment (87,254) (90,949) Net cash used in acquisitions, net of cash acquired (21,547) (87,492) Other, net 123,528 (96,628) ------------------------------------------------------------------------------------- Net cash provided (used) by investing activities 356,026 (1,346,772) ------------------------------------------------------------------------------------- Cash flows from financing activities Net change in deposits 320,950 (1,411,362) Net change in short-term borrowings 1,040,596 5,207,278 Issuance of long-term debt 374,391 594,219 Repayment of long-term debt (645,398) (774,426) Return of capital (84,939) - Dividends paid (244,785) (614,727) ------------------------------------------------------------------------------------- Net cash provided by financing activities 760,815 3,000,982 ------------------------------------------------------------------------------------- Net change in cash and due from banks 217,640 70,058 Cash and due from banks at beginning of period 1,860,713 1,959,213 ------------------------------------------------------------------------------------- Cash and due from banks at end of period $ 2,078,353 $ 2,029,271 ===================================================================================== Non-cash activities: Transfer of securities from held to maturity to available for sale $ 189,867 $ - 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 2000 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 wholly owned by the HSBC Group, in exchange for the contribution to the Swiss Bank of private banking businesses conducted by the Bank's Singapore and Hong Kong branches. The 5 percent interest represents the fair value estimate 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 was 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. 8. 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) 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 September 30, 2001.
- -------------------------------------------------------------------- Severance Related Premises Other Total - -------------------------------------------------------------------- (in millions) Balance December 31, 2000 $151.8 $10.8 $5.3 $167.9 Less: Payments 81.2 6.8 1.9 89.9 - -------------------------------------------------------------------- Balance September 30, 2001 $ 70.6 $ 4.0 $3.4 $ 78.0 - --------------------------------------------------------------------
During 2000, $85.0 million of integration costs were expensed as systems and operations were combined, of which $22.7 million was incurred during the third quarter. During the third quarter of 2001, $.6 million of integration costs were expensed. Integration costs for the first nine months of 2001 were $13.0 million compared with $44.3 million for the same period of 2000. The integration costs do not include the higher level of equipment and software depreciation incurred during 2001 on infrastructure investments made during 2000 related to the Republic acquisition. All restructuring related to the acquisition from a customer perspective is complete. 3. Litigation - --------------------------------------------------------------- As described in Note 26 to the consolidated financial statements contained in the Company's 2000 10-K and the Company's Form 10-Q for the second quarter of 2001, 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 9. resolution of many of the civil actions that have been previously described. Based on progress in such discussions the Company has taken a charge to earnings of $575 million before tax in the third quarter to reflect an anticipated resolution. There can be no assurance that such a resolution will be achieved, however. 4. Accounting for Derivatives and Hedging Activities - --------------------------------------------------------------- Pursuant to Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (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 its 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 may 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 principal component of the financial instrument (i.e., the "host contract") and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. 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 September 30, 2001, assets amounting to $10.3 billion were pledged as collateral for borrowings, to secure public deposits and for other purposes. The significant components of the assets pledged at September 30, 2001 were as follows: $9.7 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.
- --------------------------------------------------------------- September 30, December 31, 2001 2000 - --------------------------------------------------------------- (in billions) Trading assets $ .1 $.2 Securities available for sale 2.0 .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 September 30, 2001, totalled $1.5 billion compared with $.7 billion at December 31, 2000. This collateral was obtained under security resale agreements. Of this collateral, $1.0 billion at September 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 12. transfer transactions. Corporate trust provides various trustee, agency and custody products and services for both corporate and municipal customers. 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 includes 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 and expenses related to the Princeton Note Matter. 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 - ------------------------------------------------------------------------------------------------------------ Nine months ended September 30, 2001 - ------------------------------------------------------------------------------------------------------------ (in millions) Net interest income (1) $ 492 $ 103 $ 835 $ 312 $ (72) $ 1,670 Other operating income 127 80 256 355 19 837 - ------------------------------------------------------------------------------------------------------------ Total income 619 183 1,091 667 (53) 2,507 Operating expenses (2) 333 74 647 300 678 2,032 - ------------------------------------------------------------------------------------------------------------ Pretax income (loss) before provision for credit losses 286 109 444 367 (731) 475 Provision for credit losses (3) 20 65 57 1 - 143 - ------------------------------------------------------------------------------------------------------------ Pretax income (loss) 266 44 387 366 (731) 332 Taxes (4) 92 18 135 126 (241) 130 - ------------------------------------------------------------------------------------------------------------ Income (loss) before cumulative effect of accounting change 174 26 252 240 (490) 202 - ------------------------------------------------------------------------------------------------------------ Average assets 16,390 5,431 22,809 39,786 1,318 85,734 Average liabilities/equity (5) 11,923 3,779 28,226 36,445 5,361 85,734 - ------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------ Nine months ended September 30, 2000 - ------------------------------------------------------------------------------------------------------------ Net interest income (1) $ 437 $ 107 $ 771 $ 351 $ (71) $ 1,595 Other operating income 92 71 266 160 31 620 - ------------------------------------------------------------------------------------------------------------ Total income 529 178 1,037 511 (40) 2,215 Operating expenses (2) 290 70 647 257 153 1,417 - ------------------------------------------------------------------------------------------------------------ Pretax income (loss) before provision for credit losses 239 108 390 254 (193) 798 Provision for credit losses (3) 52 5 35 15 - 107 - ------------------------------------------------------------------------------------------------------------ Pretax income (loss) 187 103 355 239 (193) 691 Taxes (4) 53 32 108 74 (10) 257 - ------------------------------------------------------------------------------------------------------------ Net income (loss) 134 71 247 165 (183) 434 - ------------------------------------------------------------------------------------------------------------ Average assets 14,861 5,715 19,842 39,685 2,624 82,727 Average liabilities/equity (5) 10,072 5,088 28,654 32,387 6,526 82,727 - ------------------------------------------------------------------------------------------------------------ (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, goodwill amortization and expenses related to the Princeton Note Matter. (3)The provision apportioned to the segments is based on the segments' net charge offs and the change in allowance for credit losses. Credit loss reserves are established at a level sufficient to absorb the losses considered to be inherent in the portfolio. (4)Taxes are allocated to the segments based on pretax income (loss) 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.
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 14. 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. FAS 142 does not carry forward the concept of corporate or enterprise-wide goodwill found in current accounting literature. Under FAS 142, all goodwill must be assigned to one or more reporting units of the entity and evaluated for impairment at that level. This represents a significant departure from current accounting guidance which generally applies an acquisition-specific or an enterprise-wide basis for evaluating goodwill for impairment. 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 current accounting literature 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 full adoption of FAS 142 on January 1, 2002. At the date of adoption, the Company expects to have unamortized goodwill of approximately $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 $133.1 million for the year ended December 31, 2000 and the nine months ended September 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 be required to be recognized as the cumulative effect of a change in accounting principles. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (FAS 143), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal use of the asset. FAS 143 requires the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the 15. liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The Company is required and plans to adopt the provisions of FAS 143 for the quarter ending March 31, 2003. Adoption of this standard is not expected to have a material effect on the consolidated financial statements of the Company. 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 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 for the nine months ended September 30, 2001 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 as the hedged items impact operating results. 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 a third quarter 2001 net loss of $(167.2) million, compared with net income of $143.6 million in the third quarter of 2000. For the first nine months of 2001, net income was $201.6 million compared with $433.6 million for the first nine months of last year. The third quarter 2001 net loss and the lower year-to-date net income reflect the impact of the third quarter 2001 expenses related to the Princeton Note Matter (See Note 3). Excluding the Princeton related expenses, net income for the third quarter and nine months of 2001 was $183.8 million and $552.6 million, respectively. Net Interest Income - --------------------------------------------------------------- Net interest income for the third quarter of 2001 was $554.7 million compared with $539.4 million for the third quarter of 2000. The 2.8% increase in net interest income for the third quarter of 2001 compared to the third quarter of 2000 was due to a larger balance sheet. Growth in commercial loans and residential mortgages fueled overall loan growth of 8% which was largely funded by higher consumer deposits. Interest rate reductions in 2001 have led to declining levels of both interest income and interest expense throughout the year. Securities sales in 2001 led to sizable gains in other operating income, but was a factor causing spreads to contract slightly in the third quarter of 2001. For the first nine months of 2001, net interest income was $1,670.2 million compared with $1,594.8 million for the first nine months of 2000. The 4.7% increase in net interest income for the first nine months of 2001 compared to 2000 was due principally to a larger balance sheet, coupled with slightly wider spreads. Growth in commercial loans and residential mortgages were the most significant factors driving asset growth which was largely funded by a higher level of consumer deposits. The declining interest rate environment in 2001 has led to lower gross yields earned on assets and lower gross rates paid on liabilities. The improved balance sheet mix, specifically higher levels of loans and deposits, led to slightly wider margins. Interest income was $1,151.4 million in the third quarter of 2001 compared with $1,354.4 million in the third quarter of 2000. Average earning assets were $78.5 billion for the third quarter of 2001 compared with $74.3 billion a year ago. The average rate earned on earning assets was 5.87% for the third quarter of 2001 compared with 7.29% a year ago. Interest income was $3,743.2 million for the first nine months of 2001 compared with $3,953.2 million in the first nine months of 2000. Average earning assets were $77.8 billion for the first nine months of 2001 compared with $74.2 billion for the first nine months of 2000. The average rate earned on earning assets was 6.48% for the first nine months of 2001 compared with 7.15% a year ago. Interest expense for the third quarter of 2001 was $596.7 million compared with $815.0 million in the third quarter of 2000. Average interest bearing liabilities for the third quarter of 2001 were $67.2 billion, compared with 17. $63.4 billion a year ago. The average rate paid on interest bearing liabilities was 3.52% compared with 5.12% a year ago. Interest expense for the first nine months of 2001 was $2,073.0 million compared with $2,358.4 million in the first nine months of 2000. Average interest bearing liabilities for the first nine months of 2001 were $66.8 billion, compared with $63.2 billion a year ago. The average rate paid on interest bearing liabilities was 4.15% for the first nine months of 2001 compared with 4.99% a year ago. The taxable equivalent net yield on average total assets for the third quarter of 2001 was 2.59%, compared with 2.63% a year ago. The taxable equivalent net yield on average total assets for the first nine months of 2001 was 2.64%, compared with 2.61% a year ago. Other Operating Income - --------------------------------------------------------------- Total other operating income was $275.8 million in the third quarter of 2001, compared with $211.6 million in the 2000 third quarter. For the first nine months of 2001, total operating income was $836.4 million compared with $620.0 million for the first nine months of 2000. Security gains for the first nine months 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. Wealth management and insurance, loan and bankcard fees and service charges were all strong during the first nine months of 2001. Fee income from domestic wealth management was $157.7 million during the first nine months of 2001, an increase of 14.4 percent compared to the same period in 2000. The third quarter 2001 mortgage banking revenue was adversely impacted by the impairment of mortgage servicing rights due to lower interest rates. In addition, the gains on sale of mortgage loan assets, included in mortgage banking revenue, was impacted by timing issues associated with interest rate locks and forward loan sale commitments, which were marked to market as required under FAS 133. The World Trade Center disaster has had minor effect so far on revenues and is estimated to be between $2.0 million and $3.0 million, including lower personal banking charges, bankcard fees and brokerage fees. 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. 18.
- --------------------------------------------------------------- Nine months ended September 30, 2001 2000 - --------------------------------------------------------------- (in millions) Foreign exchange $128.9 $ 79.5 Precious metals (28.0) 2.5 Trading account profits and commissions 75.1 32.6 - --------------------------------------------------------------- Trading revenues $176.0 $114.6 - ---------------------------------------------------------------
The above table presents trading revenue by category of financial instruments and is not necessarily indicative of trading business line results. See the following comments on precious metals trading. 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 nine months of 2000 trading revenues was approximately $12.7 million of revenue earned by certain non-U.S. entities that were transferred or sold to other HSBC entities during the first nine months of 2000. The first nine months 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 $1,056.7 million in the third quarter of 2001 compared with $472.4 million for the third quarter of 2000. Other operating expenses were $2,031.8 million for the first nine months of 2001 compared with $1,417.6 million a year ago. The increase in other operating expenses reflect the $575.0 million third quarter 2001 expenses related to the Princeton Note Matter (See Note 3). Excluding the Princeton related expenses, other operating expenses for the third quarter and nine months of 2001 were $481.7 million and $1,456.8 million, respectively. Excluding the Princeton related expenses and treasury and general incentive compensation tied to performance, operating expenses were flat year to year. During the third quarter, $3.0 million in specific charges for World Trade Center related expenses were recognized, including insurance policy deductibility and contributions made to the American Red Cross. There may be additional costs in the fourth and later quarters, however they are not expected to be material. Operating expenses for the third quarter of 2001 included $.6 million of Republic acquisition related integration costs versus $22.7 million for the same period of 2000. Republic integration costs for the first nine months of 2001 were $13.0 million compared with $44.3 million for the same period of 2000. The integration costs do not include the higher level of equipment and software depreciation incurred during 2001 on infrastructure investments made during 2000 related to the Republic acquisition. 19. Income Taxes - --------------------------------------------------------------- The effective tax rate was 39% in the third quarter and first nine months of 2001 compared with 37% in the same periods of 2000. The net deferred tax asset at September 30, 2001 was $227 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.
- ----------------------------------------------------------------------------------- 3rd 3rd 9 Months Year 9 Months Quarter Quarter Ended Ended Ended 2001 2000 9/30/01 12/31/00 9/30/00 - ----------------------------------------------------------------------------------- (in millions) Allowance for Credit Losses Balance at beginning of period $537.9 $614.6 $ 525.0 $ 638.0 $ 638.0 Allowance related to acquisitions/transfers - (8.5) (19.0) (11.3) (12.0) Provision charged to income 47.5 50.6 143.1 137.6 106.6 Net charge offs (44.8) (98.3) (108.3) (238.7) (173.8) Translation adjustment (.3) (.1) (.5) (.6) (.5) - ------------------------------------------------------------------------------------ Balance at end of period $540.3 $558.3 $ 540.3 $ 525.0 $ 558.3 - ------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------ September 30, December 31, September 30, 2001 2000 2000 - ------------------------------------------------------------------------------------ (in millions) Nonaccruing Loans Balance at end of period $394.3 $423.2 $299.1 As a percent of loans outstanding .92% 1.05% .75% Nonperforming Loans and Assets * Balance at end of period $410.6 $443.7 $317.6 As a percent of total assets .47% .53% .38% Allowance Ratios Allowance for credit losses as a percent of: Loans 1.26% 1.30% 1.40% Nonaccruing loans 137.01 124.06 186.7 - ------------------------------------------------------------------------------------ * Includes nonaccruing loans, other real estate and other owned assets.
During the first nine months of 2001, credit quality remained relatively stable, notwithstanding a more volatile business and credit environment. However, it is still too early to determine what effect, if any, the events of September 11 and the general economic slowdown will have on the credit portfolio. Provisions for credit losses were $47.5 million in the third quarter of 2001 compared with $50.6 million in the third quarter of 2000. Provisions for credit losses for the first nine months of 2001 were $143.1 million compared 20. with $106.6 million during the first nine months of 2000. Net charge offs in the credit card portfolio were $44.0 million and $45.8 million in the first nine months of 2001 and 2000, respectively. The delinquency rate for the credit card portfolio was 3.92% at September 30, 2001 compared with 3.75% at December 31, 2000 and 3.64% at September 30, 2000. Net charge offs on commercial loans were $54.8 million and $121.2 million in the first nine months of 2001 and 2000, respectively. The Company identified impaired loans totaling $194 million at September 30, 2001, of which $116 million had a specific credit loss allowance of $59 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. 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 21. 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 nine months ended September 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 nine months ended September 30, 2001, the Company recognized a net gain of $2.9 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 September 30, 2001, $7.1 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, 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. 22. 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. The Company's Asset and Liability Policy Committee is responsible for implementing various hedging strategies that are developed through its 23. 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 September 30, 2001. Wholesale liabilities were $19.9 billion at September 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 $6.7 billion at September 30, 2001, compared with $6.8 billion as December 31, 2000. Under risk-based capital guidelines, the Company's capital ratios were 7.92% at the Tier 1 level and 12.60% at the total capital level at September 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 5.66% at September 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, Value at Risk (VaR) 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 September 30, 2001 was plus or minus $4.7 million, which includes distinct limits associated with trading portfolio activities and financial 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 24. than $4.7 million. As of September 30, 2001, the Company had a position of $(3.3) 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 various financial instruments including interest rate floors and mortgage backed securities. 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 September 30, 2001, for a gradual 200 basis point increase in rates, the value was projected to drop by 4.6% and for a 200 basis point gradual decrease in rates, value was projected to drop by 7.5% 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 particularly monitors, on a monthly basis, the simulated 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 derivative instruments 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. Utilizing these modeling techniques, a gradual 200 basis point parallel rise or fall in the yield curve on October 1, 2001 would cause projected net interest income for the next twelve months to decrease by $31 million and 25. increase by $20 million, respectively. This +/- 1% change is well within the Company's +/- 10% limit. An immediate 100 basis point parallel rise or fall in the yield curve on October 1, 2001, would cause projected net interest income for the next twelve months to decrease by $40 million and $19 million, respectively. An immediate 200 basis point parallel rise or fall would decrease projected net interest income for the next twelve months by $90 million and $43 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 defined limits pertaining to items such as permissible investments, risk exposures, loss review, balance sheet size and product concentrations. "Loss review" refers to the maximum amount of loss that may be incurred before senior management intervention is required. The Company relies upon Value at Risk (VaR) analysis as a basis for quantifying and managing risks associated with the trading portfolios. 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 and given a certain confidence level. VaR calculations are performed for all material trading and investment portfolios and for market risk-related treasury activities. The VaR is calculated using the historical simulation or the variance/covariance (parametric) method. 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. 26. The trading VaR at September 30, 2001 was $25.0 million compared with $20.3 million at December 31, 2000. The maximum trading VaR during the third quarter of 2001 was $39.3 million, the minimum $11.1 million and the average $22.9 million. The following summary illustrates the Company's daily revenue earned from market risk-related activities during the third quarter of 2001. Market risk-related revenues include realized and unrealized gains (losses) related to treasury and trading activities but excludes the related net interest income. The analysis of the frequency distribution of daily market risk-related revenues shows that there were 13 days with negative revenue during the third quarter of 2001. The most frequent result was a daily revenue of between zero and $2 million with 35 occurrences. The highest daily revenue was $7.9 million.
- ---------------------------------------------------------------------------------------------- Ranges of daily revenue earned from market risk- related activities (in millions) $(4) to $(2) $(2) to $0 $0 to $2 $2 to $4 $4 to $6 Over $6 - ---------------------------------------------------------------------------------------------- Number of trading days market risk-related revenue was within the stated range 2 11 35 8 4 3 - ----------------------------------------------------------------------------------------------
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. 27. HSBC USA Inc. - --------------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES*
Third Quarter 2001 Third Quarter 2000** Balance Interest Rate Balance Interest Rate - --------------------------------------------------------------------------------------- in millions Assets Interest bearing deposits with banks $ 4,762 $ 40.7 3.39 % $ 4,006 $ 71.1 7.06 % Federal funds sold and securities purchased under resale agreements 3,594 32.4 3.57 3,638 60.1 6.57 Trading assets 8,773 52.7 2.40 5,698 37.7 2.65 Securities 19,191 305.8 6.32 21,883 408.4 7.43 Loans Domestic Commercial 17,140 260.2 6.02 16,031 314.0 7.79 Consumer Residential mortgages 17,593 317.0 7.21 15,028 285.3 7.59 Other consumer 3,221 84.5 10.41 3,215 93.8 11.61 - --------------------------------------------------------------------------------------- Total domestic 37,954 661.7 6.92 34,274 693.1 8.05 International 4,255 67.8 6.32 4,803 90.5 7.49 - --------------------------------------------------------------------------------------- Total loans 42,209 729.5 6.86 39,077 783.6 7.98 - --------------------------------------------------------------------------------------- Total earning assets 78,529 $ 1,161.1 5.87 % 74,302 $ 1,360.9 7.29 % - --------------------------------------------------------------------------------------- Allowance for credit losses (539) (610) Cash and due from banks 1,914 1,969 Other assets 6,560 7,029 - --------------------------------------------------------------------------------------- Total assets $ 86,464 $ 82,690 ======================================================================================= Liabilities and Shareholders' Equity Interest bearing demand deposits $ 361 $ 0.5 0.53 % $ 741 $ 2.3 1.27 % Consumer savings deposits 13,293 58.7 1.75 12,374 80.4 2.58 Other consumer time deposits 11,097 118.7 4.24 8,808 117.7 5.31 Commercial, public savings and other time deposits 7,656 62.0 3.21 7,228 88.2 4.85 Deposits in foreign offices 19,542 200.9 4.08 19,973 315.8 6.29 - --------------------------------------------------------------------------------------- Total interest bearing deposits 51,949 440.8 3.37 49,124 604.4 4.89 - --------------------------------------------------------------------------------------- Federal funds purchased and securities sold under repurchase agreements 2,968 23.8 3.20 1,828 28.5 6.21 Other short-term borrowings 7,410 50.4 2.70 6,684 81.0 4.82 Long-term debt 4,840 81.7 6.70 5,742 101.1 7.00 - --------------------------------------------------------------------------------------- Total interest bearing liabilities 67,167 $ 596.7 3.52 % 63,378 $ 815.0 5.12 % - --------------------------------------------------------------------------------------- Interest rate spread 2.35 % 2.17 % - --------------------------------------------------------------------------------------- Noninterest bearing deposits 5,398 6,119 Other liabilities 6,501 6,181 Shareholders' equity 7,398 7,012 - --------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 86,464 $ 82,690 ======================================================================================= Net yield on average earning assets 2.85 % 2.92 % Net yield on average total assets 2.59 2.63 ======================================================================================= * 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. HSBC USA Inc. - -------------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND INTEREST RATES*
Nine Months 2001 Nine Months 2000** Balance Interest Rate Balance Interest Rate - -------------------------------------------------------------------------------------- in millions Assets Interest bearing deposits with banks $ 4,721 $ 174.9 4.95 % $ 4,512 $ 232.9 6.90 % Federal funds sold and securities purchased under resale agreements 3,282 113.1 4.61 3,484 169.9 6.51 Trading assets 8,284 175.9 2.83 5,217 89.9 2.30 Securities 20,193 1,036.9 6.87 22,395 1,207.0 7.20 Loans Domestic Commercial 16,909 833.6 6.59 16,496 951.8 7.71 Consumer Residential mortgages 16,898 937.5 7.40 14,180 786.3 7.39 Other consumer 3,223 269.5 11.18 3,185 270.5 11.35 - -------------------------------------------------------------------------------------- Total domestic 37,030 2,040.6 7.37 33,861 2,008.6 7.92 International 4,244 227.2 7.16 4,777 264.4 7.39 - -------------------------------------------------------------------------------------- Total loans 41,274 2,267.8 7.35 38,638 2,273.0 7.86 - -------------------------------------------------------------------------------------- Total earning assets 77,754 $ 3,768.6 6.48 % 74,246 $ 3,972.7 7.15 % - -------------------------------------------------------------------------------------- Allowance for credit losses (543) (627) Cash and due from banks 1,858 1,828 Other assets 6,665 7,280 - -------------------------------------------------------------------------------------- Total assets $ 85,734 $ 82,727 ====================================================================================== Liabilities and Shareholders' Equity Interest bearing demand deposits $ 369 $ 1.8 0.65 % $ 771 $ 6.7 1.16 % Consumer savings deposits 12,863 193.5 2.01 12,513 232.5 2.48 Other consumer time deposits 11,381 404.6 4.75 8,327 315.1 5.05 Commercial, public savings and other time deposits 7,066 186.3 3.53 7,486 290.2 5.18 Deposits in foreign offices, primarily banks 20,529 746.8 4.86 19,411 866.8 5.97 - -------------------------------------------------------------------------------------- Total interest bearing deposits 52,208 1,533.0 3.93 48,508 1,711.3 4.71 - -------------------------------------------------------------------------------------- Federal funds purchased and securities sold under repurchase agreements 2,500 74.3 3.96 1,947 84.3 5.78 Other short-term borrowings 7,139 208.8 3.91 6,879 245.5 4.77 Long-term debt 4,913 256.9 6.99 5,853 317.3 7.24 - -------------------------------------------------------------------------------------- Total interest bearing liabilities 66,760 $ 2,073.0 4.15 % 63,187 $ 2,358.4 4.99 % - -------------------------------------------------------------------------------------- Interest rate spread 2.33 % 2.16 % - -------------------------------------------------------------------------------------- Noninterest bearing deposits 5,552 6,225 Other liabilities 6,064 6,264 Shareholders' equity 7,358 7,051 - -------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 85,734 $ 82,727 ====================================================================================== Net yield on average earning assets 2.92 % 2.90 % Net yield on average total assets 2.64 2.61 ====================================================================================== * 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.
29. 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 30. 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: November 14, 2001 /s/ Gerald A. Ronning Gerald A.Ronning Executive Vice President & Controller (On behalf of Registrant and as Chief Accounting Officer) 31. Exhibit 12.01 HSBC USA Inc. Computation of Ratio of Earnings to Fixed Charges (in millions, except ratios) - -----------------------------------------------------------------
Nine months ended September 30, 2001 2000* - ----------------------------------------------------------------- Excluding interest on deposits Income before cumulative effect of accounting change $ 202 $ 434 Applicable income tax expense 130 257 Less undistributed equity earnings 6 5 Fixed charges: Interest on: Borrowed funds 283 330 Long-term debt 257 317 One third of rents, net of income from subleases 14 16 - ----------------------------------------------------------------- Total fixed charges 554 663 Earnings before taxes and cumulative effect of accounting change based on income and fixed charges $ 880 $1,349 - ----------------------------------------------------------------- Ratio of earnings to fixed charges 1.59 2.03 - ----------------------------------------------------------------- Including interest on deposits Total fixed charges (as above) $ 554 $ 663 Add: Interest on deposits 1,533 1,711 - ----------------------------------------------------------------- Total fixed charges and interest on deposits $2,087 $2,374 - ----------------------------------------------------------------- Earnings before taxes and cumulative effect of accounting change based on income and fixed charges (as above) $ 880 $1,349 Add: Interest on deposits 1,533 1,711 - ----------------------------------------------------------------- Total $2,413 $3,060 - ----------------------------------------------------------------- Ratio of earnings to fixed charges 1.16 1.29 - ----------------------------------------------------------------- *Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
32. Exhibit 12.02 HSBC USA Inc. Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends (in millions, except ratios) - -----------------------------------------------------------------
Nine months ended September 30, 2001 2000* - ----------------------------------------------------------------- Excluding interest on deposits Income before cumulative effect of accounting change $ 202 $ 434 Applicable income tax expense 130 257 Less undistributed equity earnings 6 5 Fixed charges: Interest on: Borrowed funds 283 330 Long-term debt 257 317 One third of rents, net of income from subleases 14 16 - ----------------------------------------------------------------- Total fixed charges 554 663 Earnings before taxes and cumulative effect of accounting change based on income and fixed charges $ 880 $1,349 - ----------------------------------------------------------------- Total fixed charges $ 554 $ 663 Preferred dividends 19 21 Ratio of pretax income to income before cumulative effect of accounting change 1.64 1.59 - ----------------------------------------------------------------- Total preferred stock dividend factor 31 33 Fixed charges, including preferred stock dividend factor $ 585 $ 696 - ----------------------------------------------------------------- Ratio of earnings to combined fixed charges and preferred dividends 1.50 1.94 - ----------------------------------------------------------------- Including interest on deposits Total fixed charges, including preferred stock dividend factor (as above) $ 585 $ 696 Add: Interest on deposits 1,533 1,711 - ----------------------------------------------------------------- Fixed charges, including preferred stock dividend factor and interest on deposits $2,118 $2,407 - ----------------------------------------------------------------- Earnings before taxes and cumulative effect of accounting change based on income and fixed charges (as above) $ 880 $1,349 Add: Interest on deposits 1,533 1,711 - ----------------------------------------------------------------- Total $2,413 $3,060 - ----------------------------------------------------------------- Ratio of earnings to combined fixed charges and preferred dividends 1.14 1.27 - ----------------------------------------------------------------- *Restated to exclude investments in entities transferred to HSBC North America Inc. during 2001 and 2000.
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