Derivative Financial Instruments

12 Months Ended

Dec. 31, 2011

Derivative Financial Instruments [Abstract]

Derivative Financial Instruments

17.    Derivative Financial Instruments

In the normal course of business, we enter into derivative contracts for trading, market making and risk management purposes. For financial reporting purposes, a derivative instrument is designated in one of the following categories: (a) financial instruments held for trading, (b) hedging instruments designated as a qualifying hedge under derivative accounting principles or (c) a non-qualifying economic hedge. The derivative instruments held are predominantly swaps, futures, options and forward contracts. All freestanding derivatives, including bifurcated embedded derivatives, are stated at fair value. Where we enter into enforceable master netting arrangements with counterparties, the master netting arrangements permit us to net those derivative asset and liability positions and to offset cash collateral held and posted with the same counterparty.

Derivatives Held for Risk Management Purposes  Our risk management policy requires us to identify, analyze and manage risks arising from the activities conducted during the normal course of business. We use derivative instruments as an asset and liability management tool to manage our exposures in interest rate, foreign currency and credit risks in existing assets and liabilities, commitments and forecasted transactions. The accounting for changes in fair value of a derivative instrument will depend on whether the derivative has been designated and qualifies for hedge accounting under derivative accounting principles.

Accounting principles for qualifying hedges require detailed documentation that describes the relationship between the hedging instrument and the hedged item, including, but not limited to, the risk management objectives and hedging strategy and the methods to assess the effectiveness of the hedging relationship. We designate derivative instruments to offset the fair value risk and cash flow risk arising from fixed-rate and floating-rate assets and liabilities as well as forecasted transactions. We assess the hedging relationships, both at the inception of the hedge and on an ongoing basis, using a regression approach to determine whether the designated hedging instrument is highly effective in offsetting changes in the fair value or cash flows of the hedged item. We discontinue hedge accounting when we determine that a derivative is not expected to be effective going forward or has ceased to be highly effective as a hedge, the hedging instrument is terminated, or when the designation is removed by us.

In the tables that follow below, the fair value disclosed does not include swap collateral that we either receive or deposit with our interest rate swap counterparties. Such swap collateral is recorded on our balance sheet at an amount which approximates fair value and is netted on the balance sheet with the fair value amount recognized for derivative instruments.

Fair Value Hedges  In the normal course of business, we hold fixed-rate loans and securities and issue fixed-rate senior and subordinated debt obligations. The fair value of fixed-rate (USD and non-USD denominated) assets and liabilities fluctuates in response to changes in interest rates or foreign currency exchange rates. We utilize interest rate swaps, interest rate forward and futures contracts and foreign currency swaps to minimize the effect on earnings caused by interest rate and foreign currency volatility.

For reporting purposes, changes in fair value of a derivative designated in a qualifying fair value hedge, along with the changes in the fair value of the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. We recognized net losses of $74 million during 2011 compared to net gains of $33 million during 2010 which are reported in other income (loss) in the consolidated statement of income (loss) which represents the ineffective portion of all fair value hedges. The interest accrual related to the derivative contract is recognized in interest income.

The changes in fair value of the hedged item designated in a qualifying hedge are captured as an adjustment to the carrying amount of the hedged item (basis adjustment). If the hedging relationship is terminated and the hedged item continues to exist, the basis adjustment is amortized over the remaining life of the hedged item. We recorded basis adjustments for active fair value hedges which increased the carrying amount of our debt by $17 million and $32 million during 2011 and 2010, respectively. We amortized $11 million and $10 million of basis adjustments related to terminated and/or re-designated fair value hedge relationships during 2011 and 2010, respectively. The total accumulated unamortized basis adjustment amounted to an increase in the carrying amount of our debt of $53 million and $73 million as of December 31, 2011 and 2010, respectively. Basis adjustments for active fair value hedges of available-for-sale securities increased the carrying amount of the securities by $1.0 billion during 2011 compared to an increase in the carrying amount of the securities by $123 million during 2010. Total accumulated unamortized basis adjustments for active fair value hedges of available-for-sale securities amounted to an increase in carrying amount of $1.1 billion and $71 million as of December 31, 2011 and 2010, respectively.

The following table presents the fair value of derivative instruments designated and qualifying as fair value hedges and their location on the balance sheet.

	Derivative Assets(1)						Derivative Liabilities(1)
	Balance Sheet		Fair Value as of December 31,				Balance Sheet	Fair Value as of December 31,
	Location		2011		2010		Location	2011		2010
							(in millions)
Interest rate contracts		Other assets	$	4	$	140	Interest, taxes and other liabilities	$	1,134	$	164

⁽¹⁾  The derivative asset and derivative liabilities presented above may be eligible for netting and consequently may be shown net against a different line item on the consolidated balance sheet. Balance sheet categories in the above table represent the location of the assets and liabilities absent the netting of the balances.

The following table presents the gains and losses on derivative instruments designated and qualifying as hedging instruments in fair value hedges and their locations on the consolidated statement of income (loss).

	Location of Gain (Loss) Recognized in Income on Derivatives	Amount of Gain (Loss) Recognized in Income on Derivatives Year Ended December 31,
		2011			2010
		(in millions)
Interest rate contracts	Other income (loss)	$	(1,773	)	$	(378	)
Interest rate contracts	Interest income		(4	)		54
Total		$	(1,777	)	$	(324	)

The following table presents information on gains and losses on the hedged items in fair value hedges and their location on the consolidated statement of income (loss).

	Gain (Loss) on Derivative						Gain (Loss) on Hedged Items
	Interest Income (Expense)			Other Income (Expense)			Interest Income (Expense)			Other Income (Expense)
	(in millions)
Year Ended December 31, 2011:
Interest rate contracts/AFS Securities	$	(31	)	$	(1,762	)	$	712		$	1,694
Interest rate contracts/commercial loans		(22	)		2			-			(5	)
Interest rate contracts/subordinated debt		50			(13	)		(104	)		10
Total	$	(3	)	$	(1,773	)	$	608		$	1,699
Year Ended December 31, 2010:
Interest rate contracts/AFS Securities	$	(22	)	$	(405	)	$	272		$	413
Interest rate contracts/commercial loans		(2	)		2			2			(2	)
Interest rate contracts/subordinated debt		78			25			(100	)		-
Total	$	54		$	(378	)	$	174		$	411

Cash Flow Hedges  We own or issue floating rate financial instruments and enter into forecasted transactions that give rise to variability in future cash flows. As a part of our risk management strategy, we use interest rate swaps, currency swaps and futures contracts to mitigate risk associated with variability in the cash flows. We also hedge the variability in interest cash flows arising from on-line savings deposits.

Changes in fair value associated with the effective portion of a derivative instrument designated as a qualifying cash flow hedge are recognized initially in other comprehensive income (loss). When the cash flows for which the derivative is hedging materialize and are recorded in income or expense, the associated gain or loss from the hedging derivative previously recorded in accumulated other comprehensive income (loss) is recognized in earnings. If a cash flow hedge of a forecasted transaction is de-designated because it is no longer highly effective, or if the hedge relationship is terminated, the cumulative gain or loss on the hedging derivative to that date will continue to be reported in accumulated other comprehensive income (loss) unless the hedged forecasted transaction is no longer expected to occur, at which time the cumulative gain or loss is released into earnings. As of December 31, 2011 and 2010, active cash flow hedge relationships extend or mature through July 2036 and December 2012, respectively. During 2011 and 2010, $13 million and $10 million, respectively, of losses related to terminated and/or re-designated cash flow hedge relationships were amortized to earnings from accumulated other comprehensive income (loss). During the next twelve months, we expect to amortize $17 million of remaining losses to earnings resulting from these terminated and/or re-designated cash flow hedges. The interest accrual related to the derivative contract is recognized in interest income.

The following table presents the fair value of derivative instruments that are designated and qualifying as cash flow hedges and their location on the consolidated balance sheet.

	Derivative Assets(1)					Derivative Liabilities(1)
	Balance Sheet	Fair Value as of December 31,				Balance Sheet	Fair Value as of December 31,
	Location	2011		2010		Location	2011		2010
	(in millions)
Interest rate contracts	Other assets	$	29	$	-	Interest, taxes and other liabilities	$	248	$	18

⁽¹⁾  The derivative asset and derivative liabilities presented above may be eligible for netting and consequently may be shown net against a different line item on the consolidated balance sheet. Balance sheet categories in the above table represent the location of the assets and liabilities absent the netting of the balances.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in cash flow hedges (including amounts recognized in AOCI from all terminated cash flow hedges) and their locations on the consolidated statement of income (loss).

	Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)					Location of Gain (Loss) Reclassified from AOCI into Income (Effective	Gain (Loss) Reclassed From AOCI into Income (Effective Portion)						Location of Gain (Loss) Recognized in Income on the Derivative (Ineffective Portion and Amount Excluded from	Gain (Loss) Recognized in Income on the Derivative (Ineffective Portion)
	2011			2010		Portion)	2011			2010			Effectiveness Testing)	2011			2010
	(in millions)
Interest rate contracts	$	(265	)	$	11	Other income (loss)	$	(13	)	$	(10	)	Other income (loss)	$	(5	)	$	(1	)

Trading and Other Derivatives  In addition to risk management, we enter into derivative instruments for trading and market making purposes, to repackage risks and structure trades to facilitate clients’ needs for various risk taking and risk modification purposes. We manage our risk exposure by entering into offsetting derivatives with other financial institutions to mitigate the market risks, in part or in full, arising from our trading activities with our clients. In addition, we also enter into buy protection credit derivatives with other market participants to manage our counterparty credit risk exposure. Where we enter into derivatives for trading purposes, realized and unrealized gains and losses are recognized in trading revenue or residential mortgage banking revenue (loss). Credit losses arising from counterparty risk on over-the-counter derivative instruments and offsetting buy protection credit derivative positions are recognized as an adjustment to the fair value of the derivatives and are recorded in trading revenue.

Derivative instruments designated as economic hedges that do not qualify for hedge accounting are recorded at fair value through profit and loss. Realized and unrealized gains and losses are recognized in other income or residential mortgage banking revenue (loss) while the derivative asset or liability positions are reflected as other assets or other liabilities. As of December 31, 2011, we have entered into credit default swaps which are designated as economic hedges against the credit risks within our loan portfolio. In the event of an impairment loss occurring in a loan that is economically hedged, the impairment loss is recognized as provision for credit losses while the gain on the credit default swap is recorded as other income (loss). In addition, we also from time to time have designated certain forward purchase or sale of to-be-announced (“TBA”) securities to economically hedge mortgage servicing rights.

Changes in the fair value of TBA positions, which are considered derivatives, are recorded in residential mortgage banking revenue.

The following table presents the fair value of derivative instruments held for trading purposes and their location on the consolidated balance sheet.

	Derivative Assets (1)					Derivative Liabilities(1)
	Balance Sheet	Fair Value as of December 31,				Balance Sheet	Fair Value as of December 31,
	Location	2011		2010		Location	2011		2010
	(in millions)
Interest rate contracts	Trading assets	$	60,719	$	32,047	Trading liabilities	$	61,280	$	32,526
Foreign exchange contracts	Trading assets		15,654		16,367	Trading liabilities		15,413		16,742
Equity contracts	Trading assets		1,165		950	Trading liabilities		1,164		986
Precious metals contracts	Trading assets		1,842		1,004	Trading liabilities		1,248		2,073
Credit contracts	Trading assets		14,388		12,766	Trading liabilities		14,285		12,506
Other	Trading assets		-		4	Trading liabilities		-		23
Total		$	93,768	$	63,138		$	93,390	$	64,856

⁽¹⁾  The derivative asset and derivative liabilities presented above may be eligible for netting and consequently may be shown net against a different line item on the consolidated balance sheet. Balance sheet categories in the above table represent the location of the assets and liabilities absent the netting of the balances.

The following table presents the fair value of derivative instruments held for other purposes and their location on the consolidated balance sheet.

	Derivative Assets (1)					Derivative Liabilities(1)
	Balance Sheet	Fair Value as of December 31,				Balance Sheet	Fair Value as of December 31,
	Location	2011		2010		Location	2011		2010
	(in millions)
Interest rate contracts	Other assets	$	957	$	420	Interest, taxes and other liabilities	$	106	$	82
Foreign exchange contracts	Other assets		11		96	Interest, taxes and other liabilities		13		4
Equity contracts	Other assets		51		221	Interest, taxes and other liabilities		87		10
Credit contracts	Other assets		2		2	Interest, taxes and other liabilities		8		17
Total		$	1,021	$	739		$	214	$	113

⁽¹⁾  The derivative asset and derivative liabilities presented above may be eligible for netting and consequently may be shown net against a different line item on the consolidated balance sheet. Balance sheet categories in the above table represent the location of the assets and liabilities absent the netting of the balances.

The following table presents information on gains and losses on derivative instruments held for trading purposes and their locations on the consolidated statement of income (loss).

	Location of Gain (Loss)	Amount of  Gain (Loss) Recognized in Income on Derivatives Year Ended December 31,
	Recognized in Income on Derivatives	2011			2010
	(in millions)
Interest rate contracts	Trading revenue (loss)	$	(83	)	$	102
Interest rate contracts	Residential mortgage banking revenue (loss)		119			66
Foreign exchange contracts	Trading revenue (loss)		263			354
Equity contracts	Trading revenue (loss)		128			21
Precious metals contracts	Trading revenue (loss)		114			109
Credit contracts	Trading revenue (loss)		(174	)		(69	)
Other	Trading revenue (loss)		1			10
Total		$	368		$	593

The following table presents information on gains and losses on derivative instruments held for other purposes and their locations on the consolidated statement of income (loss).

	Location of Gain (Loss)	Amount of Gain (Loss) Recognized in Income on Derivatives Year Ended December 31,
	Recognized in Income on Derivatives	2011			2010
	(in millions)
Interest rate contracts	Other income (loss)	$	677		$	325
Interest rate contracts	Residential mortgage banking revenue (loss)		(11	)		4
Foreign exchange contracts	Other income (loss)		38			25
Equity contracts	Other income (loss)		22			451
Credit contracts	Other income (loss)		(2	)		(17	)
Other	Other income (loss)		-			1
Total		$	724		$	789

Credit-Risk Related Contingent Features  We enter into total return swap, interest rate swap, cross-currency swap and credit default swap contracts, amongst others which contain provisions that require us to maintain a specific credit rating from each of the major credit rating agencies. Sometimes the derivative instrument transactions are a part of broader structured product transactions. If HSBC Bank USA’s credit ratings were to fall below the current ratings, the counterparties to our derivative instruments could demand additional collateral to be posted with them. The amount of additional collateral required to be posted will depend on whether HSBC Bank USA is downgraded by one or more notches as well as whether the downgrade is in relation to long-term or short-term ratings. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position as of December 31, 2011, is $8.5 billion for which we have posted collateral of $10.3 billion. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position as of December 31, 2010, is $5.1 billion for which we have posted collateral of $7.3 billion. Substantially all of the collateral posted is in the form of cash which is reflected in either interest bearing deposits with banks or other assets. See Note 28, “Guarantee Arrangements,” and Note 30, “Collateral, Commitments and Contingent Liabilities,” for further details.

In the event of a credit downgrade, we do not expect HSBC Bank USA’s long-term ratings to go below A2 and A+ or the short-term ratings to go below P-2 and A-1 by Moody’s and S&P, respectively. The following tables summarize our obligation to post additional collateral (from the current collateral level) in certain hypothetical commercially reasonable downgrade scenarios. It is not appropriate to accumulate or extrapolate information presented in the tables below to determine our total obligation because the information presented to determine the obligation in hypothetical rating scenarios is not mutually exclusive.

Moody’s	Long-Term Ratings
Short-Term Ratings	Aa3		A1		A2
	(in millions)
P-1	$	-	$	263	$	356
P-2		50		361		502

S&P	Long-Term Ratings
Short-Term Ratings	AA-		A+		A
	(in millions)
A-1+	$	-	$	264	$	350
A-1		59		383		529

We would be required to post $64 million of additional collateral on total return swaps and certain other transactions if HSBC Bank USA is downgraded by S&P and Moody’s by two notches on our long term rating accompanied by one notch downgrade in our short term rating.

Notional Value of Derivative Contracts  The following table summarizes the notional values of derivative contracts.

At December 31,	2011		2010
	(in billions)
Interest rate:
Futures and forwards	$	320.3	$	356.9
Swaps		2,325.1		1,773.0
Options written		69.9		62.9
Options purchased		67.3		63.9
		2,782.6		2,256.7
Foreign Exchange:
Swaps, futures and forwards		725.0		603.3
Options written		39.7		22.0
Options purchased		40.4		22.3
Spot		60.1		56.5
		865.2		704.1
Commodities, equities and precious metals:
Swaps, futures and forwards		50.2		36.1
Options written		8.2		9.1
Options purchased		17.1		16.4
		75.5		61.6
Credit derivatives		657.3		701.0
Total	$	4,380.6	$	3,723.4