Business Segments

We have four distinct business segments that we utilize for management reporting and analysis purposes, which are aligned with HSBC's global business strategy: Retail Banking and Wealth Management ("RBWM"), Commercial Banking ("CMB"), Global Banking and Markets ("GB&M") and Private Banking ("PB").

We previously announced that with effect from January 1, 2016, a portion of our Business Banking client group, generally representing those small business customers with $3 million or less in annual revenue (now referred to as Retail Business Banking), would be better managed as part of RBWM rather than CMB given the similarities in their banking activities with the RBWM customer base. Therefore, to coincide with the change in our management reporting effective beginning in the first quarter of 2016, we have included the results of Retail Business Banking in the RBWM segment for all periods presented. As a result, loss before tax for the RBWM segment was increased $33 million and $48 million during the years ended December 31, 2015 and 2014, respectively.

During 2016, we determined that a portion of our Large Corporate client group, generally representing those large business customers with more complex banking activities which require the levels of support routinely provided by relationship managers in GB&M, would be better managed as part of GB&M rather than CMB, effective October 1, 2016. Therefore, to coincide with the change in our management reporting effective beginning in the fourth quarter of 2016, we have included the results of the transferred client relationships in the GB&M segment for all periods presented. As a result, profit before tax for the GB&M segment was increased $83 million and $53 million during the years ended December 31, 2015 and 2014, respectively. In addition, loans and deposits for the GB&M segment were increased $4.8 billion and $2.8 billion, respectively, at December 31, 2015 and $3.8 billion and $1.1 billion, respectively, at December 31, 2014.

There have been no other changes in the basis of our segmentation or measurement of segment profit as compared with the presentation in our 2015 Form 10-K.

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 Balance Sheet Management and more appropriately reflect the profitability of the 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 IFRSs as issued by the IASB and as endorsed by the EU, and, as a result, our segment results are prepared and presented using financial information prepared on the Group Reporting Basis 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 and report to regulatory agencies on a U.S. GAAP basis. During the fourth quarter of 2016, HSBC Group made changes to its internal management reporting and, as a result, its segment reporting which we plan to implement during the first quarter of 2017, as discussed below.

In January 2017, we made the decision to implement changes to our internal management reporting for certain activities and functions and report them within a new Corporate Center segment. These activities and functions include Balance Sheet Management and our legacy structured credit products which are both currently reported in GB&M, as well as a portfolio of residential mortgage loans previously purchased from HSBC Finance, including certain loan servicing activities performed on behalf of HSBC Finance, which are currently reported in RBWM. In addition, we have reviewed central costs currently reported in the Other segment and will reallocate these costs to the global businesses where appropriate. Remaining residual costs will be reported in the Corporate Center along with all other remaining items currently reported in the Other segment. As a result, beginning in the first quarter of 2017, we will align our segment reporting with the changes made to our internal management reporting and begin to report these changes as part of the newly created Corporate Center segment for all periods presented.

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

Net Interest Income

Effective interest rate - The calculation of effective interest rates under the Group Reporting Basis 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 the 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 - For loans transferred to held for sale subsequent to origination, the Group Reporting Basis requires these loans 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, "Financial Instruments: Recognition and Measurement" ("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 upon transfer to held for sale related to credit risk is recorded in the statement of income as a provision for credit losses while the component related to interest rates and liquidity factors is reported in the statement of income in other revenues. Changes in the lower of amortized cost or fair value after the initial transfer to held for sale are reported in the statement of income in other revenues.

For loans originated with the intent to sell, the Group Reporting Basis requires these loans 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 changes in the lower of amortized cost or fair value adjustment recorded in other revenues.

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 revenues. During the fourth quarter of 2016, we sold our remaining MSRs portfolio.

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. The sale was completed in 2014.

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)

Loan impairment - 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.

For commercial loans collectively evaluated for impairment, we utilize different loss emergence periods for U.S. GAAP and the Group Reporting Basis. In 2016 and 2015, we updated the default populations utilized in determining the emergence period to include more recent defaults while dropping off the oldest defaults to maintain a consistent look-back period. These updates resulted in modest changes to our loss emergence period under U.S. GAAP which decreased our provision for credit losses by approximately $24 million in 2016 and increased our provision for credit losses by approximately $28 million in 2015 solely relating to these updates (in addition to differences otherwise attributable to applying the different approaches for calculating loan impairment charges discussed below), while the loss emergence period under the Group Reporting Basis did not significantly change. In 2016, loan impairment charges under the Group Reporting Basis were greater than under U.S. GAAP due to the default of certain credits where existing loan impairment allowances, prior to default, were lower under the Group Reporting Basis than under U.S. GAAP due to the shorter loss emergence period utilized for computing loan impairment allowances for commercial loans collectively evaluated for impairment under the Group Reporting Basis.

Prior to 2014, we 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. In 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 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 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.

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

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). In addition, under the Group Reporting Basis, pension expense is determined using a finance cost component comprising the net interest on the net defined benefit liability which does not reflect the benefit from the expectation of higher returns on plan assets. During 2015, the substantial majority of our postretirement benefit plans were amended relating to post-65 retirees which resulted in a reduction of our postretirement benefit liability as the amendments eliminated future health cost increases which were previously included in the liability. Under the Group Reporting Basis, the benefit from the amendments was recognized immediately while under U.S. GAAP the benefit is amortized to postretirement benefit expense over the remaining estimated covered period for those affected.

Share-based payments - 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 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 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 and leaseback 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 is being recognized over the lease term (which is ten years) 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. This creates differences in the timing of accrual recognition between the Group Reporting Basis and U.S. GAAP. Additionally, under the Group Reporting Basis, legal costs to defend litigation are accrued at the time that a liability is recorded for the related litigation while under U.S. GAAP these costs are recognized as services are performed.

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 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 loans 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, 2016
Net interest income⁽¹⁾	$	807		$	735	$	780	$	202		$	(51	)	$	(2	)	$	2,471	$	(76	)	$	89		$	2,484
Other operating income	370			227		766		89			69			2			1,523		(104		)	(87		)	1,332
Total operating income	1,177			962		1,546		291			18			—			3,994		(180		)	2			3,816
Loan impairment charges	60			50		384		—			—			—			494		(78		)	(44		)	372
	1,117			912		1,162		291			18			—			3,500		(102		)	46			3,444
Operating expenses⁽²⁾	1,144			588		987		232			255			—			3,206		(26		)	46			3,226
Profit (loss) before income tax expense	$	(27	)	$	324	$	175	$	59		$	(237	)	$	—		$	294	$	(76	)	$	—		$	218
Balances at end of period:
Total assets	$	20,203		$	25,082	$	192,995	$	7,714		$	512		$	—		$	246,506	$	(45,234	)	$	29		$	201,301
Total loans, net	17,473			24,125		24,842		6,024			—			—			72,464		(405		)	799			72,858
Goodwill	581			358		—		325			—			—			1,264		348			—			1,612
Total deposits	32,472			22,005		29,249		11,618			—			—			95,344		(4,379		)	38,283			129,248

Year Ended December 31, 2015
Net interest income⁽¹⁾	$	793		$	736	$	621	$	201		$	(22	)	$	(12	)	$	2,317	$	(78	)	$	231		$	2,470
Other operating income	336			244		1,017		99			239			12			1,947		(39		)	(236		)	1,672
Total operating income	1,129			980		1,638		300			217			—			4,264		(117		)	(5		)	4,142
Loan impairment charges	65			139		65		(5		)	—			—			264		130			(33		)	361
	1,064			841		1,573		305			217			—			4,000		(247		)	28			3,781
Operating expenses⁽²⁾	1,185			608		1,055		245			152			—			3,245		(52		)	28			3,221
Profit (loss) before income tax expense	$	(121	)	$	233	$	518	$	60		$	65		$	—		$	755	$	(195	)	$	—		$	560
Balances at end of period:
Total assets	$	20,396		$	26,763	$	178,143	$	8,428		$	800		$	—		$	234,530	$	(46,569	)	$	317		$	188,278
Total loans, net	17,396			23,538		30,565		6,715			—			—			78,214		317			3,474			82,005
Goodwill	581			358		—		325			—			—			1,264		348			—			1,612
Total deposits	31,814			20,599		27,921		13,811			—			—			94,145		(4,097		)	28,531			118,579

Year Ended December 31, 2014
Net interest income⁽¹⁾	$	820		$	703	$	457	$	199		$	60		$	(3	)	$	2,236	$	(74	)	$	142		$	2,304
Other operating income	417			272		1,067		104			36			3			1,899		(132		)	(161		)	1,606
Total operating income	1,237			975		1,524		303			96			—			4,135		(206		)	(19		)	3,910
Loan impairment charges	29			36		70		(8		)	—			—			127		80			(19		)	188
	1,208			939		1,454		311			96			—			4,008		(286		)	—			3,722
Operating expenses⁽²⁾	1,294			561		1,363		238			126			—			3,582		(158		)	—			3,424
Profit (loss) before income tax expense	$	(86	)	$	378	$	91	$	73		$	(30	)	$	—		$	426	$	(128	)	$	—		$	298
Balances at end of period:
Total assets	$	19,731		$	25,122	$	185,750	$	8,184		$	849		$	—		$	239,636	$	(54,138	)	$	41		$	185,539
Total loans, net	16,787			23,890		26,497		6,528			—			—			73,702		1,032			2,327			77,061
Goodwill	581			358		—		325			—			—			1,264		348			—			1,612
Total deposits	29,005			20,275		32,613		10,818			—			—			92,711		(4,811		)	28,218			116,118

⁽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 the segments.


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


⁽³⁾	Represents adjustments associated with differences between U.S. GAAP and the Group Reporting Basis. 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, 2016
Unquoted equity securities	$	—		$	—		$	—		$	—		$	—		$	(163	)
Derivatives	—			—			—			—			—			(44,911		)
Loan impairment	(57		)	7			(58		)	1			7			(326		)
Property	—			—			—			(19		)	19			16
Pension and other postretirement benefit costs	—			—			—			19			(19		)	(191		)
Goodwill	—			—			—			—			—			348
Litigation	—			—			—			(8		)	8			(3		)
Loan origination	(21		)	—			—			(19		)	(2		)	35
Loans held for sale	—			(80		)	(20		)	—			(60		)	(31		)
Low Income Housing Tax Credits	—			(9		)	—			—			(9		)	—
Other	2			(22		)	—			—			(20		)	(8		)
Total adjustments	$	(76	)	$	(104	)	$	(78	)	$	(26	)	$	(76	)	$	(45,234	)

December 31, 2015
Unquoted equity securities	$	—		$	—		$	—		$	—		$	—		$	(228	)
Derivatives	—			(3		)	—			—			(3		)	(46,245		)
Loan impairment	(61		)	3			132			1			(191		)	(329		)
Property	—			—			—			(19		)	19			21
Pension and other postretirement benefit costs	—			—			—			15			(15		)	(177		)
Goodwill	—			—			—			—			—			348
Litigation	—			—			—			(2		)	2			—
Loan origination	(22		)	(3		)	—			(47		)	22			49
Loans held for sale	—			(16		)	(2		)	—			(14		)	(4		)
Low Income Housing Tax Credits	—			(12		)	—			—			(12		)	—
Other	5			(8		)	—			—			(3		)	(4		)
Total adjustments	$	(78	)	$	(39	)	$	130		$	(52	)	$	(195	)	$	(46,569	)

December 31, 2014
Unquoted equity securities	$	—		$	—		$	—		$	—		$	—		$	(195	)
Derivatives	—			(4		)	—			—			(4		)	(53,973		)
Loan impairment	(56		)	1			120			1			(176		)	(204		)
Property	—			—			—			(16		)	16			28
Pension and other postretirement benefit 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	(18		)	(15		)	(40		)	(19		)	26			23
Total adjustments	$	(74	)	$	(132	)	$	80		$	(158	)	$	(128	)	$	(54,138	)


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