Business Segments

We have four distinct business segments that we utilize for management reporting and analysis purposes, which are aligned with HSBC's global businesses and business strategy: Retail Banking and Wealth Management ("RBWM"), Commercial Banking ("CMB"), Global Banking and Markets ("GB&M") and Private Banking ("PB"). There have been no changes in the basis of our segmentation or measurement of segment profit as compared with the presentation in our 2013 Form 10-K with the exception that our segment reporting is described to be under the Group Reporting Basis. Prior to the fourth quarter of 2014, we had described segment reporting to be under IFRS. Our segment results in all periods are presented in accordance with the Group Reporting Basis.

Net interest income of each segment represents the difference between actual interest earned on assets and interest incurred on liabilities of the segment, adjusted for a funding charge or credit. Segments are charged a cost to fund assets (e.g. customer loans) and receive a funding credit for funds provided (e.g. customer deposits) based on equivalent market rates. The objective of these charges/credits is to transfer interest rate risk from the segments to one centralized unit in GB&M and more appropriately reflect the profitability of segments.

Certain other revenue and operating expense amounts are also apportioned among the business segments based upon the benefits derived from this activity or the relationship of this activity to other segment activity. These inter-segment transactions are accounted for as if they were with third parties.

Our segment results are presented in accordance with HSBC Group accounting and reporting policies, which apply International Financial Reporting Standards ("IFRS") and, as a result, our segment results are prepared and presented using financial information prepared on the basis of HSBC Group's accounting and reporting policies ("Group Reporting Basis") (a non-U.S. GAAP financial measure) as operating results are monitored and reviewed, trends are evaluated and decisions about allocating resources, such as employees are primarily made on this basis. However, we continue to monitor capital adequacy, establish dividend policy and report to regulatory agencies on a U.S. GAAP basis.

We are currently in the process of re-evaluating the financial information used to manage our businesses, including the scope and content of the U.S. GAAP financial data being reported to our Management and our Board. To the extent we make changes to this reporting in 2015, we will evaluate any impact such changes may have on our segment reporting.

A summary of differences between U.S. GAAP and Group Reporting Basis as they impact our results are presented below:

Net Interest Income

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

Deferred loan origination costs and fees - Certain loan fees and incremental direct loan costs, which would not have been incurred but for the origination of loans, are deferred and amortized to earnings over the life of the loan under the Group Reporting Basis. Certain loan fees and direct incremental loan origination costs, including internal costs directly attributable to the origination of loans in addition to direct salaries, are deferred and amortized to earnings under U.S. GAAP.

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

Derivative interest expense - Under the Group Reporting Basis, net interest income includes the interest element for derivatives which corresponds to debt designated at fair value. For U.S. GAAP, this is included in gain (loss) on instruments designated at fair value and related derivatives which is a component of other revenues.

Other Operating Income (Total Other Revenues)

Derivatives - Under the Group Reporting Basis, the up-front recognition of the difference between transaction price and fair value in the consolidated statement of income is permissible only if the inputs used in calculating fair value are based on observable inputs. If the inputs are not observable, profit and loss is deferred and is recognized (1) over the period of contract, (2) when the data becomes observable, or (3) when the contract is settled. There is no similar observability requirement under U.S. GAAP.

Loans held for sale - The Group Reporting Basis requires loans originated with the intent to sell to be classified as trading assets and recorded at their fair value, with income recorded in trading revenue. Under U.S. GAAP, such loans are classified as loans held for sale and, with the exception of certain loans accounted for under FVO accounting, are recorded at the lower of amortized cost or fair value, with income recorded in other revenue.

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

Reclassification of fair value measured financial assets during 2008 - Certain securities were reclassified from trading assets to loans and receivables under the Group Reporting Basis in 2008 pursuant to an amendment to IAS 39, and are no longer marked to market under the Group Reporting Basis. These securities continue to be classified as trading assets and are carried at fair value under U.S. GAAP.

Additionally, certain Leverage Acquisition Finance ("LAF") loans were classified as trading assets under the Group Reporting Basis and, to be consistent, an irrevocable fair value option was elected on these loans under U.S. GAAP on January 1, 2008. These loans were reclassified to loans and advances as of July 1, 2008 pursuant to the IAS 39 amendment discussed above. Under U.S. GAAP, these loans were classified as "held for sale" and carried at fair value due to the irrevocable nature of the fair value option. Substantially all of the remaining balance of these loans were sold in 2013.

Servicing assets – Under the Group Reporting Basis, servicing assets are initially recorded on the balance sheet at cost and amortized over the projected life of the assets. Servicing assets are periodically tested for impairment with impairment adjustments charged against current earnings. Under U.S. GAAP, servicing assets are initially recorded on the balance sheet at fair value. All subsequent adjustments to fair value are reflected in other revenue.

REO expense - Other revenues under the Group Reporting Basis include losses on sale and the lower of amortized cost or fair value of the collateral less cost to sell adjustments on REO properties which are classified as other expense under U.S. GAAP.

Gain on sale of London Branch precious metals business to affiliate - The Group Reporting Basis requires that operations be transferred to held for sale and carried at the lower of cost or fair value with gains recorded through earnings upon completion of the sale, regardless of whether the sale was to a third party or related party. Under U.S. GAAP, when the transfer of net assets is between affiliates under common control, gains are reflected as a capital transaction upon completion of the sale.

Low income housing tax credits - Under the Group Reporting Basis, given the inter-relationship between the tax benefits obtained from our investment in low income housing tax credit investments and the amortization of our investment balance, such amounts are presented net in other operating income. Under U.S. GAAP, such amounts are presented net in income tax expense.

Loan Impairment Charges (Provision for Credit Losses)

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

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

For consumer loans collectively evaluated for impairment under U.S. GAAP, bank industry practice which we adopted in 2012 generally results in a loss emergence period for these loans using a roll rate migration analysis which results in 12 months of losses in our allowance for credit losses. Under the Group Reporting Basis, we concluded that the estimated average period of time from last current status to write-off for real estate loans collectively evaluated for impairment using a roll rate migration analysis was 10 months (previously a period of 7 months was used) which was also adopted in 2012. In 2013, we updated our review under the Group Reporting Basis to reflect the period of time after a loss event a loan remains current before delinquency is observed which resulted in an estimated average period of time from a loss event occurring and its ultimate migration from current status through to delinquency, and ultimately write-off, for real estate loans collectively evaluated for impairment using a roll rate migration analysis of 12 months.

For commercial loans collectively evaluated for impairment we formerly utilized the same loss emergence period for both U.S. GAAP and the Group Reporting Basis, which resulted in a consistent calculation of loan impairment charges under the two bases of reporting. During 2014, we conducted a review of our loss emergence period estimate used for U.S. GAAP reporting purposes based upon regulatory guidance and bank industry practice in the U.S. As a result of this review, our emergence period was increased, resulting in an increase in loan impairment charges under U.S. GAAP. A separate review of our loss experience under the Group Reporting Basis was completed in December 2014. This review did not significantly change the loss emergence period compared with the prior year and resulted in a deviation between U.S. GAAP and the Group Reporting Basis in the fourth quarter of 2014 of approximately $174 million on a pre-tax basis. The difference was primarily attributable to different approaches for estimating loss emergence periods for U.S. GAAP and the Group Reporting Basis. We have determined that, based on the judgment involved and the practice which has evolved in different jurisdictions, both approaches for estimating loss emergence periods result in an appropriate allowance for credit losses under the reporting basis to which each is being applied.

Operating Expenses

Pension and other postretirement benefit costs - Pension expense under U.S. GAAP is generally higher than under the Group Reporting Basis as a result of the amortization of the amount by which actuarial losses exceeds the higher of 10 percent of the projected benefit obligation or fair value of plan assets (the "corridor."). As a result of amendments to IAS 19, "Employee Benefits" effective January 1, 2013, interest cost and expected return on plan assets is replaced by a finance cost component comprising the net interest on the net defined benefit liability. This has resulted in an increase in pension expense as the net interest does not reflect the benefit from the expectation of higher returns on plan assets. In 2012, amounts include a higher pension curtailment benefit under U.S. GAAP as a result of the decision in the third quarter to cease all future benefit accruals under the Cash Balance formula of the HSBC North America Pension Plan and freeze the plan effective January 1, 2013. In 2011, amounts reflect a pension curtailment gain relating to the branch sales as under the Group Reporting Basis recognition occurs when "demonstrably committed to the transaction" as compared with U.S. GAAP when recognition occurs when the transaction is completed.

Securities - Under the Group Reporting Basis, HSBC shares held for stock plans are recorded in securities. Under the Group Reporting Basis, the recognition of compensation expense related to share-based bonuses begins on January 1 of the current year for awards expected to be granted in the first quarter of the following year. Under U.S. GAAP, the shares are recorded in other assets and the recognition of compensation expense related to share-based bonuses does not begin until the date the awards are granted.

Property - Under the Group Reporting Basis, the carrying amount of property held for own use reflects revaluation surpluses recorded prior to January 1, 2004. Consequently, the carrying amounts of tangible fixed assets and shareholders' equity are lower under U.S. GAAP than under the Group Reporting Basis. There is a correspondingly lower depreciation charge and higher net income as well as higher gains (or smaller losses) on the disposal of fixed assets under U.S. GAAP. For investment properties, net income under U.S. GAAP does not reflect the unrealized gain or loss recorded under the Group Reporting Basis for the period. In addition, the sale of our 452 Fifth Avenue property, including the 1 W. 39th Street building in April 2010, resulted in the recognition of a gain under the Group Reporting Basis while under U.S. GAAP, such gain is deferred and recognized over the lease term due to our continuing involvement.

Litigation expense - Under U.S. GAAP, litigation accruals are recorded when it is probable a liability has been incurred and the amount is reasonably estimable. Under the Group Reporting Basis, a present obligation and a probable outflow of economic benefits must exist for an accrual to be recorded. In certain cases, this creates differences in the timing of accrual recognition between the Group Reporting Basis and U.S. GAAP.

Goodwill impairment - Under the Group Reporting Basis, goodwill was amortized until 2005 however under U.S. GAAP, goodwill was amortized until 2002, which resulted in a lower carrying amount of goodwill and, therefore, a lower impairment charge under the Group Reporting Basis in 2013.

Assets

Unquoted equity securities – Under the Group Reporting Basis, equity securities which are not quoted on a recognized exchange, but for which fair value can be reliably measured, are required to be measured at fair value. Securities measured at fair value under the Group Reporting Basis are classified as either available-for-sale securities, with changes in fair value recognized in shareholders’ equity, or as trading securities, with changes in fair value recognized in income. Under U.S. GAAP, equity securities that are not quoted on a recognized exchange are not considered to have a readily determinable fair value and are required to be measured at cost, less any provisions for known impairment, and classified in other assets.

Customer loans (Loans) - As discussed more fully above under "Other Operating Income (Total Other Revenues) - Loans held for sale," on a Group Reporting Basis, loans designated as held for sale at the time of origination and accrued interest are classified as trading assets. However, the accounting requirements governing when receivables previously held for investment are transferred to a held for sale category are more stringent under the Group Reporting Basis than under U.S. GAAP which results in loans generally being reported as held for sale later then under U.S. GAAP.

Precious metals - Under U.S. GAAP, precious metals leased or loaned to customers are reclassified from trading precious metals into loans. Under the Group Reporting Basis, precious metals leased or loaned to customers continue to be part of the precious metal inventory recorded in other assets.

Derivatives - Under U.S. GAAP, derivative receivables and payables with the same counterparty may be reported on a net basis in the balance sheet when there is a legally enforceable netting agreement in place. In addition, under U.S. GAAP, fair value amounts recognized for the obligation to return cash collateral received or the right to reclaim cash collateral paid are offset against the fair value of derivative instruments. Under the Group Reporting Basis, these agreements do not necessarily meet the requirements for offset, and therefore such derivative receivables and payables are presented gross on the balance sheet.

Goodwill - The Group Reporting Basis and U.S. GAAP require goodwill to be tested for impairment at least annually, or more frequently if circumstances indicate that goodwill may be impaired. Under the Group Reporting Basis, goodwill was amortized until 2005, however goodwill was amortized under U.S. GAAP until 2002, which resulted in a lower carrying amount of goodwill under the Group Reporting Basis.

The following table summarizes the results for each segment on a Group Reporting Basis, as well as provides a reconciliation of total results under the Group Reporting Basis to U.S. GAAP consolidated totals:



	Group Reporting Basis Consolidated Amounts
	RBWM			CMB		GB&M			PB			Other			Adjustments/ Reconciling Items			Total			Group Reporting Basis Adjustments⁽³⁾			Group Reporting Basis Reclassi- fications⁽⁴⁾			U.S. GAAP Consolidated Totals
	(in millions)
Year Ended December 31, 2014
Net interest income⁽¹⁾	$	802		$	800	$	378		$	199		$	60		$	(3	)	$	2,236		$	(74	)	$	142		$	2,304
Other operating income	414			308		1,034			104			36			3			1,899			(132		)	(161		)	1,606
Total operating income	1,216			1,108		1,412			303			96			—			4,135			(206		)	(19		)	3,910
Loan impairment charges	27			42		66			(8		)	—			—			127			80			(19		)	188
	1,189			1,066		1,346			311			96			—			4,008			(286		)	—			3,722
Operating expenses⁽²⁾	1,227			683		1,308			238			126			—			3,582			(158		)	—			3,424
Profit (loss) before income tax expense	$	(38	)	$	383	$	38		$	73		$	(30	)	$	—		$	426		$	(128	)	$	—		$	298
Balances at end of period:
Total assets	$	19,648		$	29,009	$	181,946		$	8,184		$	849		$	—		$	239,636		$	(54,138	)	$	41		$	185,539
Total loans, net	16,704			27,777		22,693			6,528			—			—			73,702			1,032			2,327			77,061
Goodwill	581			358		—			325			—			—			1,264			348			—			1,612
Total deposits	28,323			22,086		35,143			10,818			—			—			96,370			(4,811		)	24,559			116,118
Year Ended December 31, 2013
Net interest income⁽¹⁾	$	842		$	706	$	423		$	189		$	(46	)	$	(13	)	$	2,101		$	(76	)	$	16		$	2,041
Other operating income	347			293		1,165			109			(78		)	13			1,849			22			(14		)	1,857
Total operating income	1,189			999		1,588			298			(124		)	—			3,950			(54		)	2			3,898
Loan impairment charges	129			45		(4		)	5			—			—			175			—			18			193
	1,060			954		1,592			293			(124		)	—			3,775			(54		)	(16		)	3,705
Operating expenses⁽²⁾	1,206			680		1,464			254			98			—			3,702			201			(16		)	3,887
Profit (loss) before income tax expense	$	(146	)	$	274	$	128		$	39		$	(222	)	$	—		$	73		$	(255	)	$	—		$	(182	)
Balances at end of period:
Total assets	$	19,267		$	23,427	$	180,559		$	8,340		$	766		$	—		$	232,359		$	(49,879	)	$	3,007		$	185,487
Total loans, net	16,233			22,254		18,336			6,206			—			—			63,029			1,503			2,557			67,089
Goodwill	581			358		—			325			—			—			1,264			348			—			1,612
Total deposits	30,220			21,601		33,231			12,036			—			—			97,088			(3,869		)	19,389			112,608
Year Ended December 31, 2012
Net interest income⁽¹⁾	$	854		$	673	$	606		$	184		$	(43	)	$	(15	)	$	2,259		$	(123	)	$	22		$	2,158
Other operating income	555			539		916			106			(269		)	15			1,862			43			68			1,973
Total operating income	1,409			1,212		1,522			290			(312		)	—			4,121			(80		)	90			4,131
Loan impairment charges	204			4		(1		)	(3		)	—			—			204			73			16			293
	1,205			1,208		1,523			293			(312		)	—			3,917			(153		)	74			3,838
Operating expenses⁽²⁾	1,301			631		997			232			1,465			—			4,626			(36		)	74			4,664
Profit before income tax expense	$	(96	)	$	577	$	526		$	61		$	(1,777	)	$	—		$	(709	)	$	(117	)	$	—		$	(826	)
Balances at end of period:
Total assets	$	22,789		$	23,585	$	203,680		$	8,208		$	633		$	—		$	258,895		$	(67,543	)	$	94		$	191,446
Total loans, net	16,422			19,754		17,530			5,707			—			—			59,413			3,495			(297		)	62,611
Goodwill	581			358		480			325			—			—			1,744			484			—			2,228
Total deposits	35,406			21,759		37,134			12,141			—			—			106,440			(5,122		)	16,353			117,671

⁽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. The objective of these charges/credits is to transfer interest rate risk from the segments to one centralized unit in Balance Sheet Management and more appropriately reflect the profitability of segments.


⁽²⁾	Expenses for the segments include fully apportioned corporate overhead expenses.


⁽³⁾	Represents adjustments associated with differences between the Group Reporting Basis and the U.S. GAAP basis of accounting. These adjustments, which are more fully described above, consist of the following:



	Net Interest Income			Other Revenues			Provision for Credit Losses			Operating Expenses			Profit (Loss) before Income Tax Expense			Total Assets
	(in millions)
December 31, 2014
Unquoted equity securities	$	—		$	—		$	—		$	—		$	—		$	(195	)
Reclassification of financial assets	(10		)	8			—			—			(2		)	11
Securities	—			—			—			(3		)	3			(13		)
Derivatives	—			(4		)	—			—			(4		)	(53,973		)
Loan impairment	(56		)	1			120			1			(176		)	(204		)
Property	—			—			—			(16		)	16			28
Pension costs	—			—			—			11			(11		)	(166		)
Goodwill	—			—			—			—			—			348
Litigation	—			—			—			(135		)	135			1
Gain on sale of London Branch precious metals business to affiliate	—			(98		)	—			—			(98		)	—
Low Income Housing Tax Credits	—			(16		)	—			—			(16		)	—
Other	(8		)	(23		)	(40		)	(16		)	25			25
Total	$	(74	)	$	(132	)	$	80		$	(158	)	$	(128	)	$	(54,138	)
December 31, 2013
Unquoted equity securities	$	—		$	—		$	—		$	—		$	—		$	(163	)
Reclassification of financial assets	(14		)	40			—			—			26			11
Securities	—			(1		)	—			(2		)	1			(24		)
Derivatives	—			(3		)	—			—			(3		)	(49,876		)
Loan impairment	(57		)	1			(11		)	1			(46		)	(94		)
Property	—			—			—			(17		)	17			37
Pension costs	—			—			—			24			(24		)	(154		)
Goodwill impairment	—			—			—			135			(135		)	348
Low Income Housing Tax Credits	—			(30		)	—			—			(30		)	—
Other	(5		)	15			11			60			(61		)	36
Total	$	(76	)	$	22		$	—		$	201		$	(255	)	$	(49,879	)
December 31, 2012
Unquoted equity securities	$	—		$	—		$	—		$	—		$	—		$	(108	)
Reclassification of financial assets	(64		)	181			—			—			117			(4		)
Securities	—			—			—			(12		)	12			(27		)
Derivatives	(4		)	(5		)	—			—			(9		)	(67,762		)
Loan impairment	(34		)	3			73			—			(104		)	(66		)
Property	(9		)	16			—			(21		)	28			42
Pension costs	—			—			—			11			(11		)	(137		)
Sale of Cards and Retail Services business	—			(92		)	—			—			(92		)	—
Low Income Housing Tax Credits	—			(29		)	—			—			(29		)	—
Other	(12		)	(31		)	—			(14		)	(29		)	519
Total	$	(123	)	$	43		$	73		$	(36	)	$	(117	)	$	(67,543	)


⁽⁴⁾	Represents differences in financial statement presentation between Group Reporting Basis and U.S. GAAP.