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HSBC Holdings PLC05 March 2007 Part 1 of 5 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from ______ to ______ Commission file number 1-7436 HSBC USA Inc. (Exact name of registrant as specified in its charter) Maryland 13-2764867 (State of Incorporation) (I.R.S. Employer Identification No.) 452 Fifth Avenue, New York, New York 10018(Address of principal executive offices) (Zip Code) (716) 841-2424 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered------------------------------------ -----------------------------------------Depositary Shares (each representing a one-fourth share of Adjustable Rate Cumulative Preferred Stock, Series D) New York Stock Exchange$2.8575 Cumulative Preferred Stock New York Stock ExchangeFloating Rate Non-Cumulative Preferred Stock, Series F New York Stock ExchangeDepositary Shares (each representing a one-fortieth share of Floating Rate Non-Cumulative Preferred Stock, Series G) New York Stock Exchange8.375% Debentures due 2007 New York Stock ExchangeDepositary Shares (each representing a one-fortieth share of Floating Rate Non-Cumulative Preferred Stock, Series H) New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, asdefined in Rule 405 of the Securities Act. Yes (X) No ( ) Indicate by check mark if the registrant is not required to file reportspursuant to Section 13 or Section 15(d) of the Act. Yes ( ) No (X) Indicate by check mark whether the registrant (1) had filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes (X) No ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of the Form 10-K or any amendment to thisForm 10-K. (X) Indicate by check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. See definition of "acceleratedfiler and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Checkone): Large accelerated filer ( ) Accelerated filer ( ) Non-accelerated filer (X) Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Act). Yes ( ) No (X) At February 28, 2007, all voting stock (706 shares of Common Stock $5 par value)is owned by an indirect wholly owned subsidiary of HSBC Holdings plc. DOCUMENTS INCORPORATED BY REFERENCE None ================================================================================ This page is intentionally left blank. 2 HSBC USA Inc. Form 10-K TABLE OF CONTENTS Part I-------------------------------------------------------------------------------- PageItem 1. Business History .............................................. 5 Description of Operations and Business Segments ...... 5 2006 Developments and Trends ......................... 7 Geographic Distribution of Assets and Earnings ....... 11 Regulation, Supervision and Capital .................. 11 Competition .......................................... 13 Cautionary Statement on Forward-Looking Statements ... 13 Statistical Disclosure by Bank Holding Companies: Average Balance Sheets and Interest Earned and Paid ............................................ 90 Changes in Interest Income and Expense Attributable to Changes in Rate and Volume ...... 34 Securities Portfolios ............................. 112 Loans Outstanding: Composition and Maturities ..................... 30 Risk Elements in the Loan Portfolio ............ 58-60, 120 Summary of Loan Loss Experience ................... 62 Deposits .......................................... 125 Short-Term Borrowings ............................. 126Item 1A. Risk Factors ............................................ 14Item 1B. Unresolved Staff Comments ............................... 18Item 2. Properties .............................................. 18Item 3. Legal Proceedings ....................................... 18Item 4. Submission of Matters to a Vote of Security Holders ..... 18 Part II-------------------------------------------------------------------------------- Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ............................................ 18Item 6. Selected Financial Data ................................. 19Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Executive Overview ................................... 20 Basis of Reporting ................................... 21 Critical Accounting Policies ......................... 25 Balance Sheet Review ................................. 29 Results of Operations ................................ 34 Business Segments .................................... 50 Credit Quality ....................................... 58 Off-Balance Sheet Arrangements and Contractual Obligations ........................................ 68 Risk Management ...................................... 70 Glossary of Terms .................................... 87Item 7A. Quantitative and Qualitative Disclosures about Market Risk .................................................. 88Item 8. Financial Statements and Supplementary Data ............. 92 3 Part III-------------------------------------------------------------------------------- Page Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ................... 157Item 9A. Controls and Procedures ................................. 157Item 9B. Other Information ....................................... 157Item 10. Directors, Executive Officers and Corporate Governance .. 158Item 11. Executive Compensation .................................. 164Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ............ 201Item 13. Certain Relationships and Related Transactions, and Director Independence ................................. 202Item 14. Principal Accounting Fees and Services .................. 204 Part IV-------------------------------------------------------------------------------- Item 15. Exhibits and Financial Statement Schedules and Reports on Form 8-K.................................. 205 4 PART I-------------------------------------------------------------------------------- Item 1. Business-------------------------------------------------------------------------------- History HSBC USA Inc., incorporated under the laws of Maryland, is a New York Statebased bank holding company registered under the Bank Holding Company Act of1956, as amended. HSBC USA Inc. and its subsidiaries are collectively referredto as "HUSI". HUSI's origin was in Buffalo, New York in 1850 as The Marine TrustCompany, which later became Marine Midland Banks, Inc. (Marine). In 1980, TheHongkong and Shanghai Banking Corporation Limited (now HSBC Holdings plc,hereinafter referred to as "HSBC") acquired 51% of the common stock of Marineand the remaining 49% of common stock in 1987. In December 1999, HSBC acquiredRepublic New York Corporation (Republic) and merged it with HUSI. At the mergerdate, Republic and HUSI had total assets of approximately $47 billion and $43billion, respectively. Through its affiliation with HSBC, HUSI offers its customers access to globalmarkets and services. In turn, HUSI plays a role in the delivery and processingof other HSBC products. HSBC is one of the largest banking and financialservices organizations in the world. Headquartered in London, England, HSBC'sinternational network comprises over 9,500 offices in 76 countries andterritories in Europe, the Asia-Pacific region, Latin America, North America,South America, the Middle East and Africa. Effective January 1, 2004, HSBC created a new North American organizationalstructure with HSBC North America Holdings Inc. (HNAH) as the top-tier UnitedStates (U.S.) bank holding company. At December 31, 2006, HNAH was among the 10largest U.S. bank holding companies ranked by assets. HUSI routinely conductstransactions with other principal subsidiaries of HNAH, which include: o HSBC Bank Canada (HBCA), a Canadian banking subsidiary; o HSBC Finance Corporation, a consumer finance company; o HSBC Markets (USA) Inc. (HMUS), a holding company for investment banking and markets subsidiaries; and o HSBC Technology & Services (USA) Inc. (HTSU), a provider of information technology services. Description of Operations and Business Segments At December 31, 2006, HUSI had total assets of $169 billion and approximately12,000 full and part time employees. HUSI is among the 15 largest bank holdingcompanies in the U.S. ranked by assets. Through its principal commercial bankingsubsidiary, HSBC Bank USA, National Association (HBUS), HUSI offers its threemillion customers a full range of commercial banking products and services. Itscustomers include individuals, including high net worth individuals, smallbusinesses, corporations, institutions and governments. HBUS also engages inmortgage banking, and is an international dealer in derivative instrumentsdenominated in U.S. dollars and other currencies, focusing on structuring oftransactions to meet clients' needs as well as for proprietary purposes. With total assets of $166 billion at December 31, 2006, HBUS is ranked among thetop ten banks in the U.S. HBUS's main office is in Delaware, and its domesticoperations are primarily located in New York State. It also has banking branchoffices and/or representative offices in Florida, California, New Jersey,Delaware, Pennsylvania, Washington, Oregon, Massachusetts, Virginia andWashington, D.C. In addition to its domestic offices, HBUS maintains foreignbranch offices, subsidiaries and/or representative offices in the Caribbean,Europe, Asia, Latin America, Australia and Canada. HUSI has five distinct business segments that it utilizes for managementreporting and analysis purposes. The segments are based upon customer groupings,as well as products and services offered. The segments are described in thefollowing paragraphs. Analysis of financial results for HUSI's business segmentsbegins on page 50 of this Form 10-K. 5 The Personal Financial Services (PFS) Segment This segment provides a broad range of financial products and services includinginstallment and revolving term loans, MasterCard(1)/Visa(2) credit cardreceivables, deposits, branch services, mutual funds, investments and insurance.These products are marketed to individuals primarily through HBUS's branchbanking network and increasingly through e-banking channels. Residentialmortgage lending provides loan financing through direct retail and wholesaleorigination channels. Mortgage loans are originated through a network ofbrokers, wholesale agents and retail origination offices. Servicing is performedon a contractual basis for residential mortgage loans owned by HBUS or by thirdparties. Effective January 1, 2006, activity related to certain commercial bankingrelationships, which was previously reported in the PFS segment, was transferredto the Commercial Banking (CMB) segment. For comparability purposes, 2005 and2004 results for the PFS segment have been revised to reflect these changes. The Consumer Finance (CF) Segment In 2005, HUSI formed the CF segment, which includes balances and activitypreviously reported as a component of the PFS segment. The CF segment includespoint of sale and other lending activities primarily to meet the financial needsof individuals. Specifically, operating activity within the CF segment relatesto higher quality nonconforming residential mortgage loans, other consumer loansand private label credit card receivables purchased from HSBC FinanceCorporation. The Commercial Banking (CMB) Segment This segment provides loan and deposit products to small businesses andmiddle-market corporations including specialized products such as real estatefinancing. Various credit and trade related products such as standby facilities,performance guarantees and acceptances are also offered. These products andservices are offered through multiple delivery systems, including the branchbanking network. Effective January 1, 2006, the CMB segment also includes activity related to anequity investment in Wells Fargo HSBC Trade Bank N.A., which was previouslyreported in the Other segment. This change was made to align financial reportingwith the segment that manages this relationship. In addition, also effectiveJanuary 1, 2006, activity related to certain commercial banking relationships,which was previously reported in the PFS segment, was transferred to the CMBsegment. For comparability purposes, 2005 and 2004 results for these segmentshave been revised to reflect these changes. The Corporate, Investment Banking and Markets (CIBM) Segment The CIBM segment provides tailored financial solutions to major government,corporate and institutional clients worldwide. With access to HSBC's worldwidepresence and capabilities, the CIBM segment serves subsidiaries and offices ofits clients on a global basis. Products and services offered are summarizedbelow. o Global Markets operations consisting of treasury and capital markets services and products, including: - foreign exchange; - currency, interest rate, bond, credit, equity and other specialized derivatives; - money market instruments; and - precious metals. ----------(1) MasterCard is a registered trademark of MasterCard International, Incorporated. (2) Visa is a registered trademark of Visa USA, Inc. 6 o Global Banking services, including corporate and institutional banking services, investment banking services, direct lending, lease financing and deposit-taking services. o Global Transaction Banking services, including: - payments and cash management services; - trade services; - securities services, including custody, clearing and funds administration; and - banknotes and currency services. o Investment services, including asset management and fund management services. The Private Banking (PB) Segment This segment offers a full range of services for high net worth individualsincluding deposit, lending, trading, trust, tax planning, branch services,mutual funds, insurance and investment management. Other Segment This segment includes an equity investment in HSBC Republic Bank (Suisse) S.A.Effective January 1, 2006, an equity investment in Wells Fargo HSBC Trade Bank,N.A., which was previously reported in the Other segment, was transferred to theCMB segment. For comparability purposes, 2005 and 2004 results have been revisedto reflect this change. 2006 Developments and Trends Consolidated Balance Sheet Growth HUSI's consolidated total assets increased $15 billion (10%) during 2006.Balance sheet growth was primarily driven by HUSI's deposit strategy during2006, which enhanced HUSI's liquidity position. The funds raised were primarilyinvested in short-term, liquid assets. In addition, trading assets andliabilities increased as a result of business expansion initiatives in the CIBMsegment. Analysis of balance sheet growth and funding begins on page 29 of thisForm 10-K. Deposit Strategy and Growth Beginning in 2004, HUSI implemented a growth strategy for its core bankingnetwork, which includes building deposits over a three to five year period,across multiple markets and segments, and utilizing multiple delivery systems.During 2006 the strategy included various initiatives: o full deployment of new personal and business checking and savings products, including relationship based products; o emphasis on more competitive pricing with the introduction of high yielding products, including internet savings accounts, which have grown significantly beginning in late 2005. Since their introduction in 2005, internet savings balances have grown to $7 billion, of which $6 billion was 2006 growth. $5 billion of the 2006 growth was from new customers; o retail branch expansion in existing and new geographic markets; o improving delivery systems, including use of internet capabilities; o refined marketing and customer analytics for the affluent consumer population; and o strengthening current customer relationships, thereby driving increased utilization of products and customer retention. Total deposit growth was $13 billion and $12 billion during the calendar years2006 and 2005, respectively. Deposit balances by major depositor categories aresummarized on page 31 of this Form 10-K. 7 Income Before Income Tax Expense - Significant Trends Analysis of the components of HUSI's income before income tax expense begins onpage 34 of this Form 10-K. Income before income tax expense, and various trendsand activity affecting operations, are summarized in the following table. ------------------------------------------------------------------------------------------------------ Increase (Decrease) in 2006 from -------------------------------------- 2005 2004 ------------------ -----------------Year Ended December 31 2006 Amount % Amount %------------------------------------------------------------------------------------------------------ ($ in millions) Income before income tax expense ................... $ 1,566 $ 24 2 $ (410) (21) ======= ======== ======= ======= ======= Impact on income before income tax expense: Balance sheet management income (loss) (1) ...... $ (71) $ (325) (128) $ (473) (118) Provision for credit losses (2) ................. (823) (149) (22) (840) * Residential mortgage banking revenue (3) ........ 96 32 50 216 * Trading revenues (4) ............................ 755 360 91 467 162 Private label receivable portfolio (5) .......... 85 266 * 85 * Loans held for sale to an HSBC affiliate ........ 77 61 381 77 * Sales of property and other financial assets (6) .......................................... 74 (12) (14) (90) (55) Equity investment activity (6) .................. 110 67 156 61 124 (1) Comprised primarily of net interest income and, to a lesser extent, gains on sales of investments and trading revenues. Refer to commentary regarding CIBM net interest income, trading revenues, and the CIBM business segment on pages 55-56. (2) Refer to commentary regarding the provision for credit losses on page 38 of this Form 10-K. (3) Refer to commentary regarding residential mortgage banking revenue beginning on page 43 of this Form 10-K. (4) Refer to commentary regarding trading revenues beginning on page 46 of this Form 10-K. (5) Refer to commentary regarding the CF business segment, beginning on page 52 of this Form 10-K. (6) Represents the net impact of various individual transactions. Refer to commentary regarding other revenues beginning on page 40 of this Form 10-K. * Not meaningful. 8 Residential Mortgage Loans Held for Sale to an HSBC Affiliate In 2005, HUSI began acquiring residential mortgage loans from unaffiliated thirdparties with the intent of selling these loans to HMUS. During 2006, HUSI alsobegan acquiring residential mortgage loans from HSBC Finance Corporation underthis program. HMUS in turn is selling these loans to securitization vehicles.These loans are recorded by HUSI at the lower of their aggregate cost or marketvalue, with adjustments down to market value being recorded as a valuationallowance. The loans are generally held on HUSI's balance sheet for 30-90 days,resulting in activity that affects various balance sheet and income statementline items, as summarized in the table below. HUSI maintains a portfolio ofderivatives and securities, which are used as economic hedges to offset changesin market values of the loans held for sale to HMUS. Gains on sales associatedwith these loans result from incremental value realized on pools of loans soldto HMUS for securitization. During 2006, the following activity was recorded asa result of acquiring, holding and selling these loans. ------------------------------------------------- --------------------------------------------------------Year Ended December 31 2006 2005------------------------------------------------- -------------------------------------------------------- (in millions)Residential mortgage loans held for sale to HMUS: Balance at beginning of year ................................................ $ 2,882 $ -- Loans acquired from originators ............................................. 16,466 5,116 Loans sold to HMUS .......................................................... (15,867) (2,188) Other, primarily loans resold to originators and other third parties ........ (355) (46) ---------- ---------- Balance at end of year ...................................................... $ 3,126 $ 2,882 ========== ========== Valuation allowance for adjustments to market value: Balance at beginning of year ................................................ $ (11) $ -- Increased valuation allowance for net reductions in market value ............ (133) (32) Releases of valuation allowance for loans sold to HMUS ...................... 109 21 ---------- ---------- Balance at end of year ...................................................... $ (35) $ (11) ========== ========== Increases (decreases) to income before income taxes: Increased net interest income associated with loans held for sale to HMUS ... $ 64 $ 11 Gains on sale of residential mortgage loans sold to HMUS, recorded in other revenues ........................................................... 106 18 Increased valuation allowance for reductions in market value of loans held for sale to HMUS, recorded in other revenues .............................. (133) (32) Trading revenues recognized from economic hedges held to offset changes ..... in market values of loans held for sale to HMUS .......................... 68 25 Program costs included in other expenses .................................... (28) (6) ---------- ---------- Net impact on income before income taxes .................................... $ 77 $ 16 ========== ========== Transactions with HSBC Finance Corporation and Other HSBC Affiliates 2006 was highlighted by continued cooperation between HUSI and HSBC FinanceCorporation to identify synergies in products and processes. Synergies have beenachieved in loan origination and servicing, card processing, IT contingencyrationalization, purchasing, call center cooperation, the shared use of HSBC'sservice centers, and the consolidation of certain administrative functions. HUSIand HSBC Finance Corporation will continue to work cooperatively on productofferings and support functions. HUSI has routinely purchased private label credit card receivables from HSBCFinance Corporation since December 2004. In addition, higher qualitynonconforming residential mortgage loans were acquired from HSBC FinanceCorporation's correspondent network from December 2003 until September 2005. Inmost cases, HSBC Finance Corporation retained the right to service theseportfolios. These purchases of residential mortgage and other loans werediscontinued as a result of strategic balance sheet management initiativesintended to enhance HUSI's liquidity position, particularly its loan to depositratio, and to address interest rate risk. Fees charged by HSBC FinanceCorporation for loan origination and servicing expenses, which are primarilyrecorded in the CF segment, have increased significantly due to increasedprivate label receivables and other loans acquired from HSBC Finance Corporationand from their correspondents. 9 HNAH's technology services in North America were centralized by the creation ofa new subsidiary, HTSU, effective January 1, 2004. HUSI's technology servicesemployees, as well as technology services employees from other HSBC affiliatesin the United States, were transferred to HTSU. Technology related assets andsoftware purchased subsequent to January 1, 2004 are generally purchased andowned by HTSU. Pursuant to a master service level agreement, HTSU charges HUSIfor technology services and software development. Fees charged by HTSU to HUSIfor technology services expenses have increased in 2006, as HUSI continued toupgrade its technology environment. HUSI obtains certain underwriting, broker-dealer and administrative supportservices from HSBC and various other affiliates. Fees charged by theseaffiliates for treasury and traded markets services provided to HUSI's CIBMsegment have increased in 2006 due primarily to business expansion initiatives. Details of these and other transactions with HSBC affiliates are presented inNote 21 of the consolidated financial statements beginning on page 137 of thisForm 10-K. Newly Chartered Banking Subsidiaries During 2005, HUSI incorporated a nationally chartered limited purpose banksubsidiary, HSBC Trust Company (Delaware), National Association (HTCD). During2006, HTCD's charter was expanded to include the following primary activities: o Custodian of investment securities for other HSBC affiliates; o Personal trust services; and o Originator of refund anticipation loans and checks in support of taxpayer financial services business lines. The operations of HTCD had an immaterial impact on HUSI's consolidated balancesheet and results of operations for the years ended December 31, 2006 and 2005,and are not expected to have a material impact for 2007. During 2006, HUSI also received regulatory approval for a new nationallychartered bank subsidiary, HSBC National Bank USA (HBMD). The charter for thisnew subsidiary directly supports HUSI's retail branch expansion strategy byallowing for the opening of new branches in Connecticut, Maryland, Virginia andIllinois. These branches will offer a full suite of deposit and loan productsfor its own retail and small business customers, as well as support certaincustomer service activities on behalf of HBUS. The operations of HBMD had animmaterial impact on HUSI's consolidated balance sheet and results of operationsfor the year ended December 31, 2006, and are not expected to have a materialimpact for 2007. 10 Geographic Distribution of Assets and Earnings HUSI's foreign operations represented less than 6% of HUSI's consolidated totalassets at December 31, 2006 and 2005, and less than 10% of consolidated incomebefore income tax expense for 2006, 2005 and 2004. Regulation, Supervision and Capital Through June 30, 2004, HUSI and HBUS were supervised and routinely examined bythe State of New York Banking Department and the Board of Governors of theFederal Reserve System (the Federal Reserve). Effective July 1, 2004, HBUSbecame a nationally chartered bank and is primarily supervised by the Office ofthe Comptroller of the Currency (OCC). HUSI, as a bank holding company,continues to be supervised by the Federal Reserve. HUSI, HBUS, HBMD and HTCD aresubject to banking laws and regulations which place various restrictions on andrequirements regarding their operations and administration, including theestablishment and maintenance of branch offices, capital and reserverequirements, deposits and borrowings, investment and lending activities,payment of dividends and numerous other matters. The Federal Reserve Actrestricts certain transactions between banks and their nonbank affiliates. Sincethe deposits of HBUS, HBMD and HTCD are insured by the Federal Deposit InsuranceCorporation (FDIC), HBUS, HBMD and HTCD are subject to relevant FDICregulations. HBUS is required to maintain noninterest bearing cash reserves with the FederalReserve Bank, which averaged $311 million in 2006 and $709 million in 2005. HUSI and HBUS are subject to various regulatory capital requirementsadministered by federal banking agencies. Failure to meet minimum capitalrequirements can initiate certain mandatory actions and possibly additionaldiscretionary actions by regulators. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, specific capital guidelinesmust be met that involve quantitative measures of assets, liabilities, andcertain off-balance sheet items as calculated under regulatory accountingpractices. The capital amounts and classifications are also subject toqualitative judgments by the regulators about components, risk weightings andother factors. HUSI's capital resources are summarized on page 32 of this Form 10-K. Quantitative measures established by regulation to ensure capital adequacyrequire the maintenance of minimum amounts and ratios of total and Tier 1capital (as defined in banking regulations). Capital amounts and ratios for HUSIand HBUS are summarized in Note 19 of the consolidated financial statements onpage 135 of this Form 10-K. To be categorized as "well capitalized", a bankinginstitution must have the minimum ratios reflected in the table included in Note19 and must not be subject to a directive, order or written agreement to meetand maintain specific capital levels. From time to time, bank regulators propose amendments to or issueinterpretations of risk-based capital guidelines. Such proposals orinterpretations could, upon implementation, affect reported capital ratios andnet risk weighted assets. U.S. regulators have proposed a new capital adequacyframework, which is further described under "Basel Capital Standards". HBUS, HBMD and HTCD are subject to risk-based assessments from the FDIC, theU.S. Government agency that insures deposits generally to a maximum of $100,000per domestic depositor. During November 2006, the FDIC adopted final regulationsthat implement a new risk-based assessment system. Depository institutionssubject to assessment are categorized based on supervisory ratings, financialratios and long-term debt issuer ratings, with those in the highest ratedcategories paying lower assessments. The new assessment rates, which take effectat the beginning of 2007, will vary between five and seven cents for every $100of domestic deposits for nearly all banks. Banks that paid premiums in the pastwill have assessment credits to offset some or all of the premiums in 2007. 11 The Deposit Insurance Funds Act (DIFA) of 1996 authorized the FinancingCorporation (FICO), a U.S. Government corporation, to collect funds from FDICinsured institutions to pay interest on FICO bonds. The FICO assessment rate ineffect at December 31, 2006 was 1.24 percent of assessable deposits. The FICOassessment rate is adjusted quarterly. HBUS, HBMD and HTCD are subject to aquarterly FICO premium. The USA Patriot Act (the Patriot Act), effective October 26, 2001, imposedsignificant record keeping and customer identity requirements, expanded thegovernment's powers to freeze or confiscate assets and increased the availablepenalties that may be assessed against financial institutions for violation ofthe requirements of the Patriot Act intended to detect and deter moneylaundering. The Patriot Act required the U.S. Treasury Secretary to develop andadopt final regulations with regard to the anti-money laundering complianceobligations on financial institutions (a term which includes insured U.S.depository institutions, U.S. branches and agencies of foreign banks, U.S.broker-dealers and numerous other entities). The U.S. Treasury Secretarydelegated certain authority to a bureau of the U.S. Treasury Department known asthe Financial Crimes Enforcement Network (FinCEN). Many of the anti-money laundering compliance requirements of the Patriot Act, asimplemented by FinCEN, are generally consistent with the anti-money launderingcompliance obligations that applied to HBUS under the Bank Secrecy Act andapplicable Federal Reserve Board regulations before the Patriot Act was adopted.These include requirements to adopt and implement an anti-money launderingprogram, report suspicious transactions and implement due diligence proceduresfor certain correspondent and private banking accounts. Certain other specificrequirements under the Patriot Act involve compliance obligations. The PatriotAct and other recent events have resulted in heightened scrutiny of Bank SecrecyAct and anti-money laundering compliance programs by the federal and state bankregulators. Basel Capital Standards (Basel II) HUSI previously reported that it must have in place, by January 1, 2008, a BaselII framework meeting the requirements of HSBC's principal regulator, theFinancial Services Authority in the United Kingdom (U.K.). However, U.S.requirements for HUSI and other U.S. banks for which compliance is mandatory(mandatory U.S. banks) have continued to evolve in 2006. A Notice of ProposedRulemaking was published by U.S. regulators on September 25, 2006 and isexpected to be finalized in the second half of 2007. Implementation by mandatoryU.S. banks will be expected within 3 years from the date of the final rule. Thedifferent implementation timetables, as well as possible differences inrequirements of regulators in the U.S. and the U.K., may affect the cost anddifficulty of implementing Basel II. HUSI's approach toward implementing the Basel framework is summarized on page 72of this Form 10-K. Sarbanes-Oxley Act of 2002, Section 404 Compliance As an SEC registrant of public debt and preferred shares, HUSI is required tocomply with the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-OxleyAct of 2002 (Section 404) requires registrants and their auditors to assess andreport on internal controls over financial reporting on an annual basis. Underthe SEC's current rules for non-accelerated filers, HUSI will be required tocomplete a management assessment of internal controls over financial reportingfor the fiscal year ending December 31, 2007. An audit of HUSI's internalcontrols over financial reporting, along with management's assessment of thesecontrols, is required beginning in the fiscal year ending December 31, 2008. As a foreign registrant, HSBC is required to comply with Section 404 beginningin the fiscal year ending December 31, 2006. As a subsidiary of a foreignregistrant, HUSI has supported HSBC with its Section 404 compliance. HUSI has adopted the internal control framework established by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) to complete itsmanagement assessment of the effectiveness of internal controls over financialreporting in compliance with Section 404. Certain other financial reporting riskassessment factors have also been included to ensure adequate coverage ofsafeguarding of assets and anti-fraud risks. 12 Competition The Gramm-Leach-Bliley Act of 1999 (GLB Act), effective March 11, 2000,eliminated many of the regulatory restrictions on providing financial services.The GLB Act allows for financial institutions and other providers of financialproducts to enter into combinations that permit a single organization to offer acomplete line of financial products and services. Therefore, HUSI and itssubsidiaries face intense competition in all of the markets they serve,competing with both other financial institutions and non-banking institutionssuch as insurance companies, major retailers, brokerage firms and investmentcompanies. Following the enactment of the GLB Act, HUSI elected to be treated as afinancial holding company (FHC). As an FHC, HUSI's activities in the U.S. havebeen expanded enabling it to offer a more complete line of products andservices. HUSI's ability to engage in expanded financial activities as an FHCdepends upon its meeting certain criteria, including requirements that its U.S.depository institution subsidiary, HBUS, its forty percent owned subsidiary,Wells Fargo HSBC Trade Bank N.A., HBMD and HTCD be well capitalized and wellmanaged, and that they have achieved at least a satisfactory record of meetingcommunity credit needs during their most recent examination pursuant to theCommunity Reinvestment Act. In general, an FHC would be required, upon notice bythe Federal Reserve Board, to enter into an agreement to correct any deficiencyin the requirements necessary to maintain its FHC election. Until suchdeficiencies are corrected, the Federal Reserve Board may impose limitations onthe conduct or activities of an FHC or any of its affiliates as it deemsappropriate. If such deficiencies are not corrected in a timely manner, theFederal Reserve Board may require an FHC to divest its control of any subsidiarydepository institution or to cease to engage in certain financial activities. Asof December 31, 2006, no known deficiencies exist, and HUSI is not subject tolimitations or penalties relative to its status as an FHC. Cautionary Statement on Forward-Looking Statements Certain matters discussed throughout this Form 10-K constitute forward-lookingstatements within the meaning of the Private Securities Litigation Reform Act of1995. In addition, HUSI may make or approve certain statements in future filingswith the SEC, in press releases, or oral or written presentations byrepresentatives of HUSI that are not statements of historical fact and may alsoconstitute forward-looking statements. Words such as "may", "should", "would","could", "believes", "intends", "expects", "estimates", "targeted", "plans","anticipates", "goal" and similar expressions are intended to identifyforward-looking statements but should not be considered as the only meansthrough which these statements may be made. These matters or statements willrelate to future financial condition, results of operations, plans, objectives,performance or business developments and will involve known and unknown risks,uncertainties and other factors that may cause HUSI's actual results,performance or achievements to be materially different from that which wasexpressed or implied by such forward-looking statements. Forward-lookingstatements are based on current views and assumptions and speak only as of thedate they are made. HUSI undertakes no obligation to update any forward-lookingstatement to reflect subsequent circumstances or events. 13 Item 1A. Risk Factors-------------------------------------------------------------------------------- General Business, Economic, Political and Market Conditions HUSI's business and earnings are affected by general business, economic, marketand political conditions in the United States and abroad. Given itsconcentration of business activities in the United States, HUSI is particularlyexposed to downturns in the United States economy. For example, in a pooreconomic environment there is greater likelihood that more of HUSI's customersor counterparties could become delinquent or default on their loans or otherobligations. This could result in higher levels of charge offs and provisionsfor credit losses, which would adversely affect HUSI's earnings. Generalbusiness, economic and market conditions that could affect HUSI include, but arenot limited to: o short-term and long-term interest rates; o inflation; o recession; o monetary supply; o fluctuations in both debt and equity capital markets in which HUSI funds its operations; o market value of consumer owned and commercial real estate throughout the United States; o consumer perception as to the availability of credit; and o the ease of filing for bankruptcy. Certain changes to these conditions could diminish demand for HUSI's productsand services, or increase the cost to provide such products or services. Recenttrends in world-wide financial markets related to, among other things, thegrowth of derivatives and hedge funds, could add instability and could changethe way those markets work. Political conditions may also impact HUSI'searnings. The economic health of geographic areas where HUSI has greaterconcentrations of business may decline relative to other geographic regions,with related impacts on HUSI's earnings. Acts or threats of war or terrorism, aswell as actions taken by the United States or other governments in response tosuch acts or threats, could affect business and economic conditions in theUnited States. Competition HUSI operates in a highly competitive environment. Competitive conditions areexpected to continue to intensify as continued merger activity in the financialservices industry produces larger, better-capitalized and more geographicallydiverse companies. New products, customers and channels of distribution areconstantly emerging. In addition, the traditional segregation of the financialservices industry into prime and non-prime segments has eroded and in the futureis expected to continue to do so, further increasing competition in thefinancial services industry. Such competition may impact the terms, rates, costsand/or profits historically included in the loan products HUSI offers orpurchases. The traditional segregation of commercial and investment banks hasall but eroded. There is no assurance that the significant and increasingcompetition within the financial services industry will not materially andadversely affect HUSI's future results of operations. Federal and State Regulation HUSI operates in a highly regulated environment. Changes in federal, state andlocal laws and regulations affecting banking, consumer credit, bankruptcy,privacy, consumer protection or other matters could materially impact HUSI'sperformance. For example, anti-money laundering requirements under the PatriotAct are frequently revisited by the U.S. Congress and Executive Agencies. Broador targeted legislative or regulatory initiatives may be aimed at lendersoperating in consumer lending markets. These initiatives could affect HUSI insubstantial and unpredictable ways, including limiting the types of consumerloan products it can offer. In addition, there may be amendments to, and newinterpretations of, risk-based capital guidelines. HUSI cannot determine whethersuch legislative or regulatory amendments will be instituted or predict theimpact that such amendments would have on results. 14 Changes in Accounting Standards HUSI's accounting policies and methods are fundamental to how HUSI records andreports its financial condition and the results of its operations. From time totime, the Financial Accounting Standards Board (FASB), the SEC and bankregulators, including the Office of Comptroller of the Currency and the Board ofGovernors of the Federal Reserve System, change the financial accounting andreporting standards that govern the preparation of external financialstatements. These changes are beyond HUSI's control, can be hard to predict andcould materially impact how HUSI reports its financial condition and the resultsof its operations. Management Financial Projections and Judgments HUSI's management is required to use certain estimates in preparing financialstatements, including accounting estimates to determine loan loss reserves,reserves related to future litigation, and the fair market value of certainassets and liabilities, among other items. In particular, loan loss reserveestimates are judgmental and are influenced by factors outside of HUSI'scontrol. Actual results could differ from those estimates. Lawsuits and Regulatory Investigations and Proceedings HUSI or one of its subsidiaries may be named as a defendant in various legalactions, including class actions and other litigation or disputes with thirdparties, as well as investigations or proceedings brought by regulatoryagencies. These actions may result in judgments, settlements, fines, penaltiesor other results, including additional compliance requirements, adverse to HUSIwhich could have a material adverse effect on HUSI's business, financialcondition or results of operations, or cause serious reputational harm. Operational Risks HUSI's businesses are dependent upon its ability to process a large number ofincreasingly complex transactions. If any of HUSI's financial, accounting, orother data processing systems fail or have other significant shortcomings, HUSIcould be materially and adversely affected. HUSI is similarly dependent on itsemployees. HUSI could be materially and adversely affected if an employee causesa significant operational break-down or failure, either as a result of humanerror or where an individual intentionally sabotages or fraudulently manipulatesHUSI's operations or systems. Third parties with which HUSI does business couldalso be sources of operational risk, including risks associated with break-downsor failures of such parties' own systems or employees. Any of these occurrencescould result in diminished ability of HUSI to operate one or more of itsbusinesses, potential liability to clients, reputational damage and regulatoryintervention, all of which could have a material adverse effect on HUSI. HUSI may also be subject to disruptions of its operating systems and businessesarising from events that are wholly or partially beyond its control. These mayinclude: o computer viruses or electrical or telecommunications outages; o natural disasters, such as hurricanes and earthquakes; o events arising from local or regional politics, including terrorist acts; o unforeseen problems encountered while implementing major new computer systems; or o global pandemics, which could have a significant effect on HUSI's business operations as well as on HSBC affiliates world-wide. Such disruptions may give rise to losses in service to customers, an inabilityto collect receivables in affected areas and other loss or liability to HUSI. 15 In recent years, instances of identity theft and fraudulent attempts to obtainpersonal and financial information from individuals and from companies thatmaintain such information pertaining to their customers have become moreprevalent. Use of the internet for these purposes has also increased. Such actscan have the following possible impacts: o threaten the assets of customers and of HUSI; o negatively impact customer credit ratings; o impact customers' ability to repay loan balances; o increase costs for HUSI to respond to such threats and to enhance its processes and systems to ensure maximum security of data; or o damage HUSI's reputation from public knowledge of intrusion into its systems and databases. There is the risk that HUSI's controls and procedures, business continuityplanning, and data security systems could prove to be inadequate. Any suchfailure could affect HUSI's operations and could have a material adverse effecton HUSI's results of operations by requiring HUSI to expend significantresources to correct the defect, as well as by exposing HUSI to litigation orlosses not covered by insurance. Changes to operational practices from time to time could materially impactHUSI's performance and results. Such changes may include: o raising the minimum payment on credit card accounts; o determinations to acquire or sell private label credit card receivables, residential mortgage loans and other loans; o changes to customer account management, risk management and collection policies and practices; o increasing investment in technology, business infrastructure and specialized personnel; or o outsourcing of various operations. Liquidity Adequate liquidity is critical to HUSI's ability to operate its businesses, growand be profitable. A compromise to liquidity could therefore have a negativeeffect on HUSI. Potential conditions that could negatively affect HUSI'sliquidity include: o diminished access to capital markets; o unforeseen cash or capital requirements; o an inability to sell assets; and o an inability to obtain expected funding from HSBC affiliates and clients. HUSI's credit ratings are an important part of maintaining liquidity. Anydowngrade in credit ratings could potentially increase borrowing costs, limitaccess to capital markets, require cash payments or collateral posting, andpermit termination of certain contracts material to HUSI. 16 Acquisition Integration HUSI has in the past, and may again in the future, seek to grow its business byacquiring other businesses or loan portfolios. There can be no assurance thatacquisitions will have the anticipated positive results, including resultsrelating to: o the total cost of integration; o the time required to complete the integration; o the amount of longer-term cost savings; or o the overall performance of the combined entity. Integration of an acquired business can be complex and costly, and may sometimesinclude combining relevant accounting and data processing systems and managementcontrols, as well as managing relevant relationships with clients, suppliers andother business partners, as well as with employees. There is no assurance that any businesses or portfolios acquired in the futurewill be successfully integrated and will result in all of the positive benefitsanticipated. If HUSI is not able to successfully integrate acquisitions, thereis the risk that its results of operations could be materially and adverselyaffected. Risk Management HUSI seeks to monitor and manage its risk exposure through a variety of separatebut complementary financial, credit, operational, compliance and legal reportingsystems, including models and programs that predict loan delinquency and loss.While HUSI employs a broad and diversified set of risk monitoring and riskmitigation techniques, those techniques and the judgments that accompany theirapplication cannot anticipate every unfavorable event or the specifics andtiming of every outcome. Accordingly, HUSI's ability to successfully identifyand balance risks and rewards, and to manage all significant risks, is animportant factor that can significantly impact results of operations. Employee Attraction and Retention HUSI's employees are its most important resource and, in many areas of thefinancial services industry, competition for qualified personnel is intense. IfHUSI were unable to continue to attract and retain qualified employees tosupport the various functions of its business, HUSI's performance, including itscompetitive position, could be materially and adversely affected. Reputational Risk HUSI's ability to attract and retain customers and conduct business transactionswith its counterparties could be adversely affected to the extent that itsreputation, or the reputation of affiliates operating under the HSBC brand, aredamaged. Failure to address, or appearing to fail to address, various issuesthat could give rise to reputational risk could cause harm to HUSI and itsbusiness prospects. Reputational issues include, but are not limited to: o appropriately addressing potential conflicts of interest, legal and regulatory requirements; o ethical issues; o adequacy of anti-money laundering processes; o privacy issues; o record-keeping; o sales and trading practices; o proper identification of the legal, reputational, credit, liquidity and market risks inherent in products offered; and o general company performance. The failure to address these issues appropriately could make customers unwillingto do business with HUSI, which could adversely affect its results ofoperations. 17 Item 1B. Unresolved Staff Comments-------------------------------------------------------------------------------- None. Item 2. Properties-------------------------------------------------------------------------------- The principal executive offices of HUSI are located at 452 Fifth Avenue, NewYork, New York 10018, which is owned by HBUS. The main office of HBUS is locatedat 1105 N. Market Street, Wilmington, Delaware 19801. The principal executiveoffices of HBUS are located at One HSBC Center, Buffalo, New York 14203, in abuilding under a long-term lease. HBUS has more than 385 other banking officesin New York State located in 44 counties, sixteen branches each in Florida andCalifornia, fifteen branches in New Jersey, two branches in Pennsylvania and onebranch each in Oregon, Washington State, Delaware and Washington D.C.Approximately 31% of these offices are located in buildings owned by HBUS andthe remaining are located in leased quarters. In addition, there are branchoffices and locations for other activities occupied under various types ofownership and leaseholds in states other than New York, none of which arematerially important to the respective activities. HBUS also owns properties inMontevideo, Uruguay and Punta del Este, Uruguay. Item 3. Legal Proceedings-------------------------------------------------------------------------------- HUSI's legal proceedings are summarized in Note 25 of the consolidated financialstatements on page 148 of this Form 10-K. Item 4. Submission of Matters to a Vote of Security Holders-------------------------------------------------------------------------------- Not applicable. PART II-------------------------------------------------------------------------------- Item 5. Market for the Registrant's Common Equity, Related Stockholder Mattersand Issuer Purchases of Equity Securities-------------------------------------------------------------------------------- All 706 shares of HUSI's outstanding stock are owned by HSBC North America Inc.(HNAI), an indirect subsidiary of HSBC. Consequently, there is no public marketin HUSI's common stock. 18 Item 6. Selected Financial Data --------------------------------------------------------------------------------------------------------Year Ended December 31 2006 2005 2004 2003 2002-------------------------------------------------------------------------------------------------------- ($ in millions) Income statement:Net interest income ...................... $ 3,081 $ 3,063 $ 2,741 $ 2,510 $ 2,376(Provision) credit for credit losses ..... (823) (674) 17 (113) (195)Total other revenues ..................... 2,563 1,911 1,319 1,154 1,059Total operating expenses ................. (3,255) (2,758) (2,101) (2,040) (1,875)Income tax expense ....................... (530) (566) (718) (570) (510) --------- --------- --------- ---------- ---------Net income ............................... $ 1,036 $ 976 $ 1,258 $ 941 $ 855 ========= ========= ========= ========== =========Balances at year end:Loans, net of allowance .................. 89,340 89,496 84,159 48,075 43,143Total assets ............................. 168,957 153,859 141,050 95,562 89,426Total tangible assets .................... 166,195 151,120 138,310 92,736 86,544Total deposits ........................... 104,550 91,815 79,981 63,955 59,830Common shareholder's equity .............. 10,571 10,278 10,366 6,962 6,897Tangible common shareholder's equity ..... 8,034 7,562 7,611 4,022 3,737Total shareholders' equity ............... 12,261 11,594 10,866 7,462 7,397 Selected financial ratios:Total shareholders' equity to total assets 7.26% 7.54% 7.70% 7.81% 8.27%Tangible common shareholder's equity to total tangible assets .............. 4.83 5.00 5.50 4.34 4.32Rate of return on average (1): Total assets ....................... .62 .66 1.12 1.02 .97 Total common shareholder's equity .. 9.03 8.78 16.35 13.06 12.42Net interest margin to average (1): Earning assets ..................... 2.25 2.49 3.00 3.39 3.29 Total assets ....................... 1.87 2.09 2.46 2.76 2.74Average total shareholders' equity to average total assets (1) .............. 7.24 7.85 7.18 8.20 8.20Efficiency ratio (2) ..................... 57.66 55.44 51.73 55.65 54.59 (1) Selected financial ratios are defined in the Glossary of Terms beginning on page 87 of this Form 10-K. (2) Represents the ratio of total operating expenses, reduced by minority interest, to the sum of net interest income and other revenues. Significant trends and transactions that impacted net income for 2006 and 2005are summarized on pages 34-39 of this Form 10-K. 19 Item 7. Management's Discussion and Analysis of Financial Condition and Resultsof Operations-------------------------------------------------------------------------------- Executive Overview-------------------------------------------------------------------------------- Income before income tax expense for 2006 was $24 million (2%) higher than 2005,but $410 million (21%) lower than 2004. Refer to page 35 of this Form 10-K for asummary of significant trends affecting results for 2006 in comparison with thetwo previous years. Trading revenues within the CIBM segment increased significantly in 2006. Higherrevenues for the first half of 2006 attributable to expanded operations andfavorable market conditions were partially offset by reduced volumes of marketactivity and less favorable market conditions in the second half of the year.Refer to page 46 of this Form 10-K for additional commentary regarding tradingrevenues. Business expansion initiatives begun in 2005 within the PFS, CMB and PB businesssegments, including rollout of the internet savings product, have led to stronggrowth in commercial loans, consumer and commercial deposits and relatedrevenues for 2006. Higher revenues were offset by higher expenses associatedwith expanding the core banking network and the CIBM business platform. Refer toBusiness Segments commentary, beginning on page 50 of this Form 10-K, foradditional information regarding the impact of business expansion initiativesfor various segments. Interest and fees earned from the private label receivable portfolio weresignificantly higher in 2006, due to portfolio growth and to a significantreduction in premium amortization. Refer to commentary regarding the CF businesssegment, beginning on page 52 of this Form 10-K. In 2005, HUSI began acquiring residential mortgage loans from unaffiliated thirdparties with the intent of selling these loans to an HSBC affiliate, HSBCMarkets (USA) Inc. (HMUS). In 2006, HUSI also began acquiring loans from HSBCFinance Corporation as part of this program. During 2006, the volume of loanpurchase and sale activity increased significantly. Impacts on HUSI'sconsolidated balance sheet and income statement are summarized on page 9 of thisForm 10-K. Increases in short-term interest rates during 2005 and the first half of 2006,as well as a flatter yield curve during both calendar years, continued to have asignificant negative impact on net interest income during 2006, particularlyaffecting balance sheet management income within the CIBM business segment. Thecompression in the interest rate margin began to stabilize during the secondhalf of 2006. Refer to CIBM Net Interest Income commentary, beginning on page 34of this Form 10-K, for additional information. The provision for credit losses increased significantly in 2006, as comparedwith the previous two years. Net charge off activity related to commercial loanportfolios returned to more normalized levels for 2006 when compared with lownet charge offs for 2005 and net recoveries recorded for 2004. Specifically,higher net charge offs were recorded in 2006 related to small business lendingwithin the CMB business segment, and to a specific commercial lendingrelationship within the PB business segment. Expanding commercial loan andcredit card receivable portfolio balances also resulted in higher charge offsand higher allowance requirements for credit losses expected within theseportfolios. Credit quality within the residential mortgage portfolio remainedstrong in 2006, consistent with previous periods. Refer to Credit Qualitycommentary, beginning on page 58 of this Form 10-K, for additional informationregarding the provision and allowance for credit losses. HUSI's balance sheet growth in 2006 has been highlighted by: o double-digit growth in domestic deposit balances, due in part to the continued rollout of the internet savings product; o significant growth in trading asset and liability balances, resulting from expansion of various trading businesses within the CIBM business segment; 20 o increased investment in more liquid, short-term instruments, partially as a result of surplus funds generated from HUSI's deposit growth strategy. In addition, a rising interest rate environment and a flat yield curve have limited opportunities for investment in longer-term assets; and o increased commercial loans and credit card receivables during 2006 were substantially offset by decreased residential mortgage loan balances, due to lower residential mortgage loan originations and to strategic balance sheet managementinitiatives to decrease investment in the residential mortgage loan portfolio. Basis of Reporting-------------------------------------------------------------------------------- HUSI's consolidated financial statements are prepared in accordance withaccounting principles generally accepted in the United States (U.S. GAAP). International Financial Reporting Standards (IFRSs) Because HSBC reports results in accordance with IFRSs and results under IFRSsare used by HSBC in measuring and rewarding performance of employees, HUSImanagement also separately monitors net income under IFRSs (a non-U.S. GAAPfinancial measure). The following table reconciles HUSI's net income on a U.S.GAAP basis to net income on an IFRSs basis. --------------------------------------------------------------------------------Year Ended December 31 2006 2005-------------------------------------------------------------------------------- (in millions)Net income - U.S. GAAP basis ........... $ 1,036 $ 976Adjustments, net of tax: Unquoted equity securities .......... 26 -- Property ............................ (1) (46) Loan impairment ..................... (2) (11) Stock-based compensation ............ (5) (17) Purchase accounting/deferred taxes .. (21) -- Fair value option ................... (49) 18 Other ............................... (2) 12 ----- ----Total adjustments, net of tax .......... (54) (44) ------- ------Net income - IFRSs basis ............... $ 982 $ 932 ======= ====== Differences between U.S. GAAP and IFRSs are as follows: Unquoted equity securities HUSI holds certain equity securities whose market price is not quoted on arecognized exchange, but for which the fair value can be reliably measuredeither through an active market, comparison to similar equity securities whichare quoted, or by using discounted cash flow calculations. IFRSs o Under IAS 39, 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. Accordingly, such securities are measured at fair value and classified as either available-for-sale securities, with changes in fair value recognized in OCI, or as trading securities, with changes in fair value recognized in income. U.S. GAAP o Under SFAS 115, 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 impairment. Unquoted equity securities are reported within "Other assets". 21 Impact o Changes in fair values of equity securities for which IFRSs require recognition of the change and U.S. GAAP requires the securities to be held at cost, impact net income and shareholders' equity when the security is classified as trading under IFRSs and impact shareholders' equity when the security is classified as available-for-sale under IFRSs. Property IFRSs o Under the transition rules of IFRS 1, HSBC has elected to freeze the value of its properties at their January 1, 2004 valuations. These are the "deemed cost" of properties under IFRSs. They will not be revalued in the future. Assets held at historical or deemed cost are depreciated except for freehold land. o Investment properties are recognized at current market values with gains or losses recognized in net income for the period. Investment properties are not depreciated. U.S. GAAP o U.S. GAAP does not permit revaluations of property, including investment property, although it requires recognition of asset impairment. Any realized surplus or deficit is, therefore, reflected in net income on disposal of the property. Depreciation is charged on all properties based on cost. Impact o Under IFRSs, the value of property held for own use reflects revaluation surpluses recorded prior to January 1, 2004. Consequently, the values of tangible fixed assets and shareholders' equity are lower under U.S. GAAP than under IFRSs. o There is a correspondingly lower depreciation charge and higher net income under U.S. GAAP, partially offset by higher gains (or smaller losses) on the disposal of fixed assets. o For investment properties, net income under U.S. GAAP does not reflect the unrealized gain or loss recorded under IFRSs for the period. Loan impairment IFRSs o When statistical models, using historic loss rates adjusted for economic conditions, provide evidence of impairment in portfolios of loans, their values are written down to their net recoverable amount. The net recoverable amount is the present value of the estimated future recoveries discounted at the portfolio's original effective interest rate. The calculations include a reasonable estimate of recoveries on loans individually identified for write-off pursuant to HUSI's credit guidelines. U.S. GAAP o When the delinquency status of loans in a portfolio is such that there is no realistic prospect of recovery, the loans are written off in full, or to recoverable value where collateral exists. Delinquency depends on the number of days payment is overdue. The delinquency status is applied consistently across similar loan products in accordance with HUSI's credit guidelines. When local regulators mandate the delinquency status at which write-off must occur for different retail loan products and these regulations reasonably reflect estimated recoveries on individual loans, this basis of measuring loan impairment is reflected in U.S. GAAP accounting. Cash recoveries relating to pools of such written-off loans, if any, are reported as loan recoveries upon collection. 22 Impact o Under both IFRSs and U.S. GAAP, HUSI's policy and regulatory instructions mandate that individual loans evidencing adverse credit characteristics which indicate no reasonable likelihood of recovery are written off. When, on a portfolio basis, cash flows can reasonably be estimated in aggregate from these written-off loans, an asset equal to the present value of the future cash flows is recognized under IFRSs. o No asset for future recoveries arising from written-off assets was recognized in the balance sheet under IFRSs prior to January 1, 2005. o The establishment of the recovery asset under IFRSs associated with the private label credit card portfolio purchased from HSBC Finance Corporation results in higher earnings under IFRSs than under U.S. GAAP. o Subsequent recoveries are credited to earnings under U.S. GAAP, but are adjusted against the recovery asset under IFRSs, resulting in lower earnings under IFRSs. o Net interest income is higher under IFRSs than under U.S. GAAP due to the imputed interest on the recovery asset. Stock-based compensation IFRSs o IFRS 2, Share-based Payment, requires that when annual bonuses are paid in restricted shares and the employee must remain with HSBC for a fixed period in order to receive the shares, the award is expensed over that period. U.S. GAAP o For awards made before July 1, 2005, SFAS 123, Accounting for Stock Based Compensation requires that compensation cost be recognized over the period(s) in which the related employee services are rendered. HUSI has interpreted this service period as the period to which the bonus relates. o For 2005 bonuses, awarded in early 2006, HSBC followed SFAS 123 (revised 2004), Share-Based Payment (SFAS 123R). SFAS 123R is consistent with IFRS 2 in requiring that restricted bonuses are expensed over the period the employee must remain with HSBC. However, SFAS 123R only applies to awards made after the date of adoption, which for HUSI is July 1, 2005. Impact o Some of the bonuses awarded in respect of 2002, 2003 and 2004 were recognized over the relevant vesting period and were, therefore, expensed in net income under IFRSs during 2005. Under U.S. GAAP, these awards were expensed in the years for which they were granted. 2005 bonuses will be expensed over the vesting period under both IFRSs and U.S. GAAP. Net income was, therefore, higher under U.S. GAAP in 2005. o IFRSs and U.S. GAAP are now largely aligned and this transition difference will be eliminated over the next few years. Purchase accounting/deferred taxes IFRSs Deferred tax amounts are recorded in the consolidated balance sheet to recognizedifferences between the tax bases and the cost of assets and liabilitiesrecorded pursuant to an acquisition. Subsequent changes to the estimates of thetax bases are recorded as an adjustment of current period earnings. U.S. GAAP Changes in tax estimates of the basis in assets and liabilities or other taxestimates recorded at the date of acquisition are adjusted against goodwill. 23 Impact In 2006, a deferred tax asset related to a previous acquisition was adjustedagainst the related goodwill account for U.S. GAAP reporting. Under IFRSs, thisadjustment was charged to earnings. Fair value option IFRSs o Under IAS 39, a financial instrument, other than one held for trading, is classified in this category if it meets the criteria set out below, and is so designated by management. An entity may designate financial instruments at fair value where the designation: - eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring financial assets or financial liabilities or recognizing the gains and losses on them on different bases; or - applies to a group of financial assets, financial liabilities or both that is managed and its performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and where information about that group of financial instruments is provided internally on that basis to management; or - relates to financial instruments containing one or more embedded derivatives that significantly modify the cash flows resulting from those financial instruments. o Financial assets and financial liabilities so designated are recognized initially at fair value, with transaction costs taken directly to the income statement, and are subsequently remeasured at fair value. This designation, once made, is irrevocable in respect of the financial instruments to which it is made. Financial assets and financial liabilities are recognized using trade date accounting. o Gains and losses from changes in the fair value of such assets and liabilities are recognized in the income statement as they arise, together with related interest income and expense and dividends. U.S. GAAP o Generally, for financial assets to be measured at fair value with gains and losses recognized immediately in the income statement, they must meet the definition of trading securities in SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. Financial liabilities are generally reported at amortized cost under U.S. GAAP. o Since January 1, 2006, HUSI has accounted for hybrid financial instruments under the provisions of SFAS 155, Accounting for Certain Hybrid Financial Instruments. Hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation are, where designated through an irrevocable election, initially and subsequently measured at fair value, with changes in fair value recognized through net income. Impact o HUSI has principally used the fair value designation for certain fixed rate long-term debt issues whose interest rate characteristic has been changed to floating through interest rate swaps as part of a documented interest rate management strategy. Approximately $2 billion of HUSI's debt issues have been accounted for using the option. The movement in fair value of these debt issues includes the effect of changes in the credit spread and any ineffectiveness in the economic relationship between the related swaps and this debt. Such ineffectiveness arises from the different credit characteristics of the swap and the debt coupled with the sensitivity of the floating leg of the swap to changes in short-term interest rates. In addition, the economic relationship between the swap and the debt can be affected by relative movements in market factors, such as bond and swap rates, and the relative bond and swap rates at inception. The size and direction of the accounting consequences of changes in credit spread and ineffectiveness can be volatile from period to period, but do not alter the cash flows anticipated as part of the documented interest rate management strategy. 24 o Under U.S. GAAP, debt issues are generally reported at amortized cost. There are circumstances, by virtue of different technical requirements and the transition arrangements to IFRSs, where derivatives providing an economic hedge for an asset or liability, and so designated under IFRSs, are not so treated under U.S. GAAP, thereby creating a reconciliation difference and asymmetrical accounting between the asset and liability and the offsetting derivative. o Prior to January 1, 2006, debt issues which had embedded derivatives were also reported at amortized cost with any embedded derivatives bifurcated where required by SFAS 133. Other Other includes the net impact of differences relating to various adjustments,none of which were individually material at and for the years ended December 31,2006 and 2005. Critical Accounting Policies-------------------------------------------------------------------------------- HUSI's consolidated financial statements are prepared in accordance with U.S.GAAP. The significant accounting policies used in the preparation of HUSI'sconsolidated financial statements are more fully described in Note 2 to theaccompanying consolidated financial statements beginning on page 99 of this Form10-K. Certain critical accounting policies, which affect the reported amounts ofassets, liabilities, revenues and expenses, are complex and involve significantjudgment by management, including the use of estimates and assumptions. As aresult, changes in estimates, assumptions or operational policies couldsignificantly affect HUSI's financial position or results of operations. Theaccounting estimates are based upon historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities. Actual results may differ from these estimates underdifferent assumptions, customer account management policies and practices, riskmanagement/collection practices, or conditions as discussed below. Of the significant accounting policies used in the preparation of HUSI'sconsolidated financial statements, the items discussed below involve criticalaccounting estimates and a high degree of judgment and complexity. Allowance for Credit Losses HUSI lends money to others, resulting in risk that borrowers may not repayamounts owed when they become contractually due. Consequently, an allowance forcredit losses is maintained at a level that is considered appropriate to coverestimates of probable losses of principal, interest and fees in the existingportfolio. Allowance estimates are reviewed periodically, and adjustments arereflected through the provision for credit losses in the period when they becomeknown. The accounting estimate relating to the allowance for credit losses is a"critical accounting estimate" for the following reasons: o changes in such estimates could significantly impact HUSI's credit loss reserves and provision for credit losses; o estimates related to the reserve for credit losses require consideration of future delinquency and charge off trends, which are uncertain and require a high degree of judgment; and o the allowance for credit losses is influenced by factors outside of HUSI's control. Customer payment patterns, economic conditions, bankruptcy trends and changes in laws and regulations all have an impact on the estimates. 25 HUSI's allowance for credit losses is regularly assessed for adequacy through adetailed review of the loan portfolio. The allowance is comprised of two balancesheet components: o the allowance for credit losses, which is carried as a reduction to loans on the balance sheet, includes reserves for anticipated losses associated with all loans and leases outstanding; and o the reserve for off-balance sheet risk, which is recorded in other liabilities, includes probable and reasonably estimable losses arising from off-balance sheet arrangements such as letters of credit and undrawn commitments to lend. Both types of reserves include amounts calculated for specific individual loanbalances and for collective loan portfolios depending on the nature of theexposure and the manner in which risks inherent in that exposure are managed. o All commercial loans that exceed five hundred thousand dollars are evaluated individually for impairment. When a loan is found to be "impaired", a specific reserve is calculated. Reserves against impaired loans are determined primarily by an analysis of discounted expected cash flows expected by HUSI with reference to independent valuations of underlying loan collateral and also considering secondary market prices for distressed debt where appropriate. o Loans which are not individually evaluated for impairment are pooled into homogeneous categories of loans and evaluated to determine if it is deemed probable, based on historical data, that a loss has been realized even though it has not yet been manifested in a specific loan. For consumer receivables, HUSI uses roll rate methodology (statistical analysisof historical trends used to estimate the probability of continued delinquency,ultimate charge off, and amount of consequential loss assessed at each timeperiod for which payments are overdue) to support the estimation of inherentlosses. The results of these models are reviewed by management in conjunctionwith changes in risk selection, changes in underwriting policies, national andlocal economic trends, trends in bankruptcy, loss severity and recoveries, andmonths of loss coverage. The resulting loss coverage ratio varies by portfoliobased on inherent risk and, where applicable, regulatory guidance. Roll ratesare regularly updated and benchmarked against actual outcomes to ensure thatthey remain appropriate. In 2004, HUSI implemented a new methodology to support the estimation of lossesinherent in pools of homogeneous commercial loans, leases and off-balance sheetrisk. These measures have been under development at HUSI for several years tosupport more advanced credit risk management, estimation of credit economiccapital, enhanced portfolio management and the requirements of the Baselframework. This new methodology uses the probability of default from thecustomer rating assigned to each counterparty, the "Loss Given Default" ratingassigned to each transaction or facility based on the collateral securing thetransaction, and the measure of exposure based on the transaction. A suite ofmodels, tools and templates was developed using quantitative and statisticaltechniques, which are combined with expert judgment to support the assessment ofeach transaction. They were developed using HUSI's internal data andsupplemented by data from external sources which was judged to be consistentwith HUSI's internal credit standards. As some of the requirements under Baseldiffer from interpretations of U.S. GAAP requirements for the measurement ofinherent losses in homogeneous pools of loans, these measures are modified tomeet accounting standards. These advanced measures are applied to thehomogeneous credit pools to estimate the reserves required. The results from the advanced commercial analysis, consumer roll rate analysisand the specific/impairment reserving process is reviewed each quarter by aCredit Reserve Committee co-chaired by the Chief Financial Officer and ChiefCredit Officer. This committee also considers other observable factors, bothinternal to HUSI and external in the general economy, to ensure that theestimates provided by the various models adequately include all knowninformation at each reporting period. The Credit Reserve Committee may add to orreduce a general unallocated allowance to account for any observable factor notconsidered in the various models, for small portfolios or period ending manualentries not considered in a model and to recognize modeling imperfections. Thecredit reserves and the results of the Credit Reserve Committee are reviewedwith HUSI's Credit Risk Management Committee and the Board of Directors' AuditCommittee each quarter. 26 HUSI recognizes however, that there is a high degree of subjectivity andimprecision inherent in the process of estimating losses utilizing historicaldata. Accordingly, a discretionary component of the allowance for credit lossesfor unspecified potential losses inherent in the loan portfolios is providedbased upon an evaluation of certain portfolio risk factors which, for consumerloans, may not be reflected in the statistical roll rate analysis. Criticalfactors include the impact of the national economic cycle, migration of loanswithin non-criticized loan portfolios, and loan portfolio concentration. Additional credit quality related analysis begins on page 58 of this Form 10-K.HUSI's approach toward credit risk management begins on page 72 of this Form10-K. Goodwill Goodwill is not subject to amortization but is tested for possible impairment atleast annually or more frequently if events or changes in circumstances indicatethat the asset might be impaired. Impairment testing requires that the fairvalue of each reporting unit be compared to its carrying amount, including thegoodwill. Significant and long-term changes in industry and economic conditionsare considered to be primary indicators of potential impairment. Impairment testing of goodwill is a "critical accounting estimate" due to thesignificant judgment required in the use of discounted cash flow models todetermine fair value. Discounted cash flow models include such variables asrevenue growth rates, expense trends, interest rates and terminal values. Basedon an evaluation of key data and market factors, management's judgment isrequired to select the specific variables to be incorporated into the models.Additionally, the estimated fair value can be significantly impacted by the costof capital used to discount future cash flows. The cost of capital percentage isgenerally derived from an appropriate capital asset pricing model, which itselfdepends on a number of financial and economic variables which are established onthe basis of management's judgment. When management's judgment is that theanticipated cash flows have decreased and/or the cost of capital has increased,the effect will be a lower estimate of fair value. If the fair value isdetermined to be lower than the carrying value, an impairment charge will berecorded and net income will be negatively impacted. Reporting units were identified based upon an analysis of each of HUSI'sindividual operating segments. A reporting unit is defined as any distinct,separately identifiable component of an operating segment for which complete,discrete financial information is available that management regularly reviews.Goodwill was allocated to the carrying value of each reporting unit based on itsrelative fair value. See Business Segments beginning on page 50 of this Form10-K for an allocation of recorded book value of goodwill by segment. HUSI has established July 1 of each year as the date for conducting its annualgoodwill impairment assessment. At July 1, 2006, there were no individualreporting units with a fair value less than carrying value, including goodwill.The fair value calculations were also tested for sensitivity to reflectreasonable variations, including: (1) keeping all other variables constant andassuming no future expense savings are achieved; and (2) keeping other variablesconstant while cutting projected revenue growth rates in half. Results of thesetests were taken into consideration by management during the review of theannual goodwill impairment test. Mortgage Servicing Rights (MSRs) HUSI recognizes the right to service mortgage loans as a separate and distinctasset at the time the loans are sold. Upon adoption of Statement of FinancialAccounting Standards No. 156, Accounting for Servicing of Financial Assets,(SFAS 156) on January 1, 2006, HUSI elected to measure its existing MSRs at fairvalue. As a result, during 2006 MSRs are initially measured at fair value at thetime that the related loans are sold and periodically re-measured using the fairvalue measurement method. This method requires that MSRs be measured at fairvalue at each reporting date with changes in fair value reflected in income inthe period that the changes occur. The cumulative effect adjustment to beginningretained earnings was not material. 27 MSRs are subject to interest rate risk, in that their fair value will fluctuateas a result of changes in the interest rate environment. Fair value isdetermined based upon the application of valuation models and other inputs. Thevaluation models incorporate assumptions market participants would use inestimating future cash flows. These assumptions include expected prepayments,default rates and market based option adjusted spreads. The estimate of fairvalue is considered to be a "critical accounting estimate" because theassumptions used in the valuation models involve a high degree of subjectivitythat is dependent upon future interest rate movements. The reasonableness ofthese pricing models is periodically validated by reference to externalindependent broker valuations and industry surveys. Valuation of Derivative Instruments and Derivative Income Derivative instruments are utilized as part of HUSI's risk management strategyto protect the value of certain assets and liabilities and future cash flowsagainst adverse interest rate and foreign exchange rate movements. The valuationof derivative instruments is a "critical accounting estimate" because certaininstruments are valued using discounted cash flow modeling techniques.Discounted cash flow modeling techniques require the use of estimates regardingthe amount and timing of future cash flows, which are susceptible to significantchange in future periods based on changes in market rates. The assumptions usedin the cash flow projection models are based on forward yield curves which arealso susceptible to changes as market conditions change. The fair value of a derivative instrument is defined as the amount at which aninstrument could be exchanged in a current transaction between willing parties,other than in a forced or liquidation sale. The majority of HUSI's derivativeinstruments are reported at fair value and are based upon quoted market pricesor on internally developed models that utilize independently sourced marketparameters, including interest rate yield curves, option volatilities andcurrency rates. The degree of management judgment involved in determining the fair value of aderivative instrument is dependent upon the availability of quoted market pricesor observable market parameters. For financial instruments that are activelytraded and have quoted market prices or parameters readily available, there islittle to no subjectivity in determining fair value. When observable marketprices and parameters do not exist, management judgment is necessary to estimatefair value. The valuation process takes into consideration factors such asliquidity and concentration concerns and counterparty credit risk. For example,there is often limited market data to rely on when estimating the fair value ofa large or aged position. Similarly, judgment must be applied in estimatingprices for less readily observable external parameters. Finally, other factorssuch as model assumptions, market dislocations and unexpected correlations canaffect estimates of fair value. Imprecision in estimating these factors canimpact the amount of revenue or loss recorded for a particular position. Significant changes in the fair value can result in equity and earningsvolatility as follows: o 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 (including losses or gains on firm commitments), are recorded in current period earnings; o 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; and o changes in the fair value of derivatives held for trading purposes are reported in current period earnings. 28 Derivatives designated as qualified hedges are tested for effectiveness. Forthese transactions, assessments are made at the inception of the hedge and on arecurring basis, whether the derivative used in the hedging transaction has beenand is expected to continue to be highly effective in offsetting changes in fairvalues or cash flows of the hedged item. This assessment is conducted usingstatistical regression analysis. o If it is determined as a result of this assessment that a derivative is not expected to be a highly effective hedge or that it has ceased to be a highly effective hedge, hedge accounting is discontinued as of the quarter in which such determination was made. The assessment of the effectiveness of the derivatives used in hedging transactions is considered to be a "critical accounting estimate" due to the use of statistical regression analysis in making this determination. Similar to discounted cash flow modeling techniques, statistical regression analysis also requires the use of estimates regarding the amount and timing of future cash flows, which are susceptible to significant changes in future periods based on changes in market rates. Statistical regression analysis also involves the use of additional assumptions including the determination of the period over which the analysis should occur as well as selecting a convention for the treatment of credit spreads in the analysis. The outcome of the statistical regression analysis serves as the foundation fordetermining whether or not the derivative is highly effective as a hedginginstrument. This can result in earnings volatility as the mark to market onderivatives which do not qualify as effective hedges and the ineffectivenessassociated with qualifying hedges are recorded in current period earnings. Balance Sheet Review-------------------------------------------------------------------------------- Overview HUSI utilizes deposits and borrowings from various sources to fund balance sheetgrowth, to meet cash and capital needs, and to fund investments in subsidiaries.During 2006, balance sheet growth was driven by HUSI's deposit growth strategy.Funds generated from new deposits were generally invested in short-term liquidassets. Balance sheet growth and funding sources are summarized in the followingtable. -------------------------------------------------------------------------------------------- Increase (Decrease) from ------------------------------------- December 31, 2005 December 31, 2004 December 31, ----------------- ----------------- 2006 Amount % Amount %-------------------------------------------------------------------------------------------- ($ in millions) Period end assets: Short-term investments ......... $ 19,454 $ 7,444 62 $ 10,870 127 Loans, net ..................... 89,340 (156) -- 5,181 6 Trading assets ................. 26,038 4,818 23 6,223 31 Securities ..................... 22,755 1,820 9 4,219 23 Other assets ................... 11,370 1,172 11 1,414 14 ------------ --------- ----- ---------- ---- $ 168,957 $ 15,098 10 $ 27,907 20 ============ ========= ===== ========== ====Funding sources: Total deposits ................. $ 104,550 $ 12,735 14 $ 24,569 31 Trading liabilities ............ 14,046 3,336 31 1,926 16 Short-term borrowings .......... 5,073 (1,294) (20 (4,230) (45) All other liabilities .......... 3,775 (3) -- (595) (14) Long-term debt ................. 29,252 (343) (1 4,842 20 Shareholders' equity ........... 12,261 667 6 1,395 13 ------------ --------- ----- ---------- ---- $ 168,957 $ 15,098 10 $ 27,907 20 ============ ========= ===== ========== ==== Short-Term Investments Short-term investments include cash and due from banks, interest bearingdeposits with banks, Federal funds sold and securities purchased under resaleagreements. The funds raised from HUSI's deposit growth strategy during 2006were primarily invested in short-term liquid assets (refer to page 7 of thisForm 10-K). 29 Loans Outstanding Loan balances at December 31, 2006 and movements in comparison with priorperiods are summarized in the following table. ----------------------------------------------------------------------------------------------- Increase (Decrease) from ------------------------------------- December 31, 2005 December 31, 2004 December 31, ----------------- ----------------- 2006 Amount % Amount %----------------------------------------------------------------------------------------------- ($ in millions) Total commercial loans ................. $ 29,482 $ 1,764 6 $ 6,512 28 ------------ --------- ----- --------- ----- Consumer loans: Residential mortgage ................ 39,808 (4,178) (9) (6,967) (15) Credit card receivables: Private label .................... 16,974 2,619 18 6,039 55 MasterCard/Visa .................. 1,286 127 11 143 13 Other consumer ...................... 2,687 (437) (14) (437) (14) ------------ --------- ----- --------- ----- Total consumer loans ................ 60,755 (1,869) (3) (1,222) (2) ------------ --------- ----- --------- -----Total loans ............................ 90,237 (105) - 5,290 6Allowance for credit losses ............ 897 51 6 109 14 ------------ --------- ----- --------- -----Loans, net ............................. $ 89,340 $ (156) - $ 5,181 6 ============ ========= ===== ========= ===== Business expansion initiatives within the CMB and CIBM business segmentsresulted in significant commercial loan growth in 2005 and, to a lesser extent,in 2006. 2006 and 2005 growth in on-balance sheet private label credit card receivableshas been primarily due to the addition of new credit card relationships and, toa lesser extent, to reduced funding requirements associated with off-balancesheet credit card securitization trusts. Beginning in 2005, as a result of balance sheet management initiatives toenhance liquidity and to address interest rate risk, HUSI decided to decreasethe loan volume acquired through HSBC Finance Corporation's network ofresidential mortgage loan correspondents. Purchases from correspondents werediscontinued effective September 1, 2005. In addition, HUSI continued to sell amajority of its residential mortgage loan originations through the secondarymarkets in 2006. Commercial Loan Maturities and Sensitivity to Changes in Interest Rates The contractual maturity and interest sensitivity of total commercial loans atDecember 31, 2006 is summarized in the following table. --------------------------------------------------------------------------------------------- One Over One Over Year Through Five TotalDecember 31, 2006 or Less Five Years Years Loans--------------------------------------------------------------------------------------------- (in millions)Commercial: Construction and other real estate ...... $ 3,257 $ 4,323 $ 1,338 $ 8,918 Other commercial ........................ 11,516 7,900 1,148 20,564 --------- ---------- --------- ---------Total ...................................... $ 14,773 $ 12,223 $ 2,486 $ 29,482 ========= ========== ========= ========= Loans with fixed interest rates ............ $ 5,331 $ 2,101 $ 1,024 $ 8,456Loans having variable interest rates ....... 9,442 10,122 1,462 21,026 --------- ---------- --------- ---------Total ...................................... $ 14,773 $ 12,223 $ 2,486 $ 29,482 ========= ========== ========= ========= 30 Trading Assets and Liabilities Trading assets and liabilities balances at December 31, 2006, and movements incomparison with prior periods, are summarized in the following table. ----------------------------------------------------------------------------------------------- Increase (Decrease) from ------------------------------------- December 31, 2005 December 31, 2004 December 31, ----------------- ----------------- 2006 Amount % Amount %----------------------------------------------------------------------------------------------- ($ in millions)Trading assets: Securities (1) ...................... $ 11,924 $ 1,145 11 $ 4,888 69 Precious metals ..................... 2,716 430 19 (456) (14) Fair value of derivatives ........... 11,398 3,243 40 1,791 19 ------------ --------- ----- --------- ----- $ 26,038 $ 4,818 23 $ 6,223 31 ============ ========= ===== ========= =====Trading liabilities: Securities sold, not yet $ 1,914 $ 106 6 $ 963 101 purchased ........................... Payables for precious metals ........ 1,336 175 15 202 18 Fair value of derivatives ........... 10,796 3,055 39 761 8 ------------ --------- ----- --------- ----- $ 14,046 $ 3,336 31 $ 1,926 16 ============ ========= ===== ========= ===== (1) Includes U.S. Treasury, U.S. Government agency, U.S. Government sponsored enterprises, asset backed, corporate bonds and other securities. Higher trading assets and liabilities within the CIBM business segment were dueto: o higher volume of activity resulting from business growth initiatives begun in 2005, which continued during 2006; and o improved prices and market conditions, particularly related to higher precious metals and securities asset balances. Refer to page 46 of this Form 10-K for an analysis of trading revenues. Deposits The following table summarizes balances for major depositor categories. -----------------------------------------------------------------------------------------------December 31 2006 2005 2004 2003 2002----------------------------------------------------------------------------------------------- (in millions)Individuals, partnerships andcorporations .......................... $ 83,371 $ 76,438 $ 65,312 $ 53,959 $ 51,470Domestic and foreign banks ............ 18,080 12,871 12,759 7,580 7,114U.S. Government and states and political subdivisions ........................ 1,927 1,566 1,493 1,464 855Foreign governments and official institutions ........................ 1,172 940 417 952 391 --------- -------- -------- -------- --------Total deposits ........................ $ 104,550 $ 91,815 $ 79,981 $ 63,955 $ 59,830 ========= ======== ======== ======== ======== Deposits were the primary source of funding for balance sheet growth during 2006and 2005. Total deposits increased 14% and 15% in 2006 and 2005, respectively.For additional commentary regarding deposit growth and strategy, refer to page 7of this Form 10-K. Short-Term Borrowings Lower short-term borrowings for 2006 and 2005 was due to a shift toward customerdeposits as the primary source of funding for balance sheet growth. 31 Long-Term Debt Incremental borrowings from the $40 billion Global Bank Note Program were $1.6billion and $1.4 billion for 2006 and 2005, respectively. Total borrowingsoutstanding under this program were $12 billion at December 31, 2006. Additionalinformation regarding this program and other long-term debt is presented in Note15 of the consolidated financial statements, beginning on page 127 of thisForm 10-K. HUSI had borrowings from the Federal Home Loan Bank (FHLB) of $5 billion at bothDecember 31, 2006 and 2005, and had access to a potential secured borrowingfacility as a member of the FHLB. Beginning in 2005, HUSI entered into a series of transactions with VariableInterest Entities (VIEs) organized by HSBC affiliates and unrelated thirdparties. HUSI has determined that it is the primary beneficiary of these VIEsunder the applicable accounting literature and, accordingly, consolidated theassets and debt of the VIEs. Debt obligations of the VIEs totaling $2.5 billionand $1.0 billion were recorded in long-term debt at December 31, 2006 and 2005,respectively. Refer to Note 27 of the consolidated financial statements,beginning on page 151 of this Form 10-K, for additional information regardingHUSI's VIE arrangements. Preferred Stock In May 2006, HUSI issued 14,950,000 depositary shares, each representingone-fortieth of a share of 6.50% Non-Cumulative Preferred Stock, Series H($1,000 stated value). Total issue proceeds, net of $9 million of underwritingfees and other expenses, were $365 million. When and if declared by HUSI's boardof directors, dividends of 6.50% per annum on the stated value per share will bepayable quarterly on the first calendar day of January, April, July and Octoberof each year. In April 2005, HUSI issued Floating Rate Non-Cumulative Preferred Stock, SeriesF with a stated value of $25 per share. In October 2005, HUSI issued FloatingRate Non-Cumulative Preferred Stock, Series G with a stated value of $1,000 pershare. Total proceeds of these two issues, net of issuance costs, were $869million. In December 2005, HUSI redeemed all issued shares of $1.8125 CumulativePreferred Stock, Series E at their stated value of $25 per share, resulting intotal cash outlay of $75 million. Refer to Note 18 of the consolidated financial statements, beginning on page 133of this Form 10-K, for information regarding all outstanding preferred shareissues. Capital Resources A summary of changes in common shareholder's equity is presented in thefollowing table. ------------------------------------------------------------------------------- 2006 2005 2004------------------------------------------------------------------------------- (in millions) Balance, January 1 ........................... $ 10,278 $ 10,366 $ 6,962Increase (decrease) due to: Net income ................................ 1,036 976 1,258 Dividends paid to common shareholder ...... (455) (675) (125) Dividends paid to preferred shareholders .. (88) (46) (23) Change in other comprehensive income ...... (202) (43) (97) Capital contributions from parent (1) ..... 15 3 2,411 Reductions of capital surplus ............. (9) (303) (20) Other ..................................... (4) - - -------- -------- -------- Total net increase (decrease) ............. 293 (88) 3,404 -------- -------- --------Balance, December 31 ......................... $ 10,571 $ 10,278 $ 10,366 ======== ======== ======== (1)Capital contributions from parent include amounts related to an HSBC stock option plan in which almost all of HUSI's employees are eligible to participate ($15 million, $3 million, and $11 million for 2006, 2005 and 2004, respectively). 32 HUSI maintains rolling 12 month capital forecasts on a consolidated basis, andfor its banking subsidiaries. Target capital ratios approved by the Board ofDirectors are set above levels established by regulators as "well capitalized",and are partly based on a review of peer banks. Dividends are generally paid byHUSI to its parent company, HSBC North America, Inc. (HNAI), when availablecapital exceeds target levels. Dividends paid to HNAI were significantly reducedin 2004 in order to conserve funds for the December 2004 acquisition of privatelabel receivables and loans from HSBC Finance Corporation. In February 2007,HUSI declared and paid a $305 million dividend to HNAI. Capital contributions from parent in 2004 include $2.4 billion received toprovide additional funding for the private label portfolio acquisition. Effective January 1, 2005, the separate U.S. defined benefit pension plans weremerged into a single defined benefit pension plan which facilitates thedevelopment of a unified employee benefit policy and unified employee benefitplan administration for HSBC affiliates operating in the U.S. As a result,HUSI's prepaid pension asset of $482 million and a related deferred taxliability of $203 million were transferred to HNAH. The net transfer amount of$279 million was recorded as a reduction of capital surplus. HUSI and HBUS are required to meet minimum capital requirements by theirprincipal regulators. Risk-based capital amounts and ratios are presented inNote 19 of the consolidated financial statements, beginning on page 135 of thisForm 10-K. 33 Results of Operations-------------------------------------------------------------------------------- Net Interest Income-------------------------------------------------------------------------------- Net interest income is the total interest income on earning assets less thetotal interest expense on deposits and borrowed funds. In the discussion thatfollows, interest income and rates are presented and analyzed on a taxableequivalent basis to permit comparisons of yields on tax-exempt and taxableassets. An analysis of consolidated average balances and interest rates on ataxable equivalent basis is presented on page 90 of this Form 10-K. The following table presents changes in the components of net interest incomeaccording to "volume" and "rate". -------------------------------------------------------------------------------------------------------------------- 2006 Compared to 2005 2005 Compared to 2004 Increase/(Decrease) Increase/(Decrease)Year Ended December 31 2006 Volume Rate 2005 Volume Rate 2004-------------------------------------------------------------------------------------------------------------------- (in millions)Interest income:Interest bearing deposits with banks .............................. $ 225 $ 37 $ 68 $ 120 $ 24 $ 55 $ 41Federal funds sold and securities purchased under resale agreements .. 526 220 116 190 14 102 74Trading assets ........................ 418 141 2 275 53 57 165Securities ............................ 1,145 158 88 899 38 (24) 885Loans: Commercial ...................... 1,764 217 314 1,233 198 204 831 Consumer: Residential mortgages ........ 2,200 (271) 150 2,321 491 (1) 1,831 Credit cards ................. 1,329 172 345 812 749 (44) 107 Other consumer ............... 279 (17) 32 264 87 34 143 -------- ------- ------ ------------- ------ ------- -------- Total consumer ............... 3,808 (116) 527 3,397 1,327 (11) 2,081Other interest ........................ 91 50 9 32 4 10 18 -------- ------- ------ ------------- ------ ------- --------Total interest income ................. 7,977 707 1,124 6,146 1,658 393 4,095 -------- ------- ------ ------------- ------ ------- --------Interest expense:Deposits in domestic offices: Savings deposits ................ 981 150 513 318 12 127 179 Other time deposits ............. 1,152 14 316 822 255 202 365Deposits in foreign offices: Foreign banks deposits .......... 392 (13) 150 255 20 138 97 Other time and savings .......... 588 (1) 213 376 (7) 199 184Short-term borrowings ................. 300 -- 30 270 33 110 127Long-term debt ........................ 1,457 153 279 1,025 615 25 385 -------- ------- ------ ------------- ------ ------- --------Total interest expense ................ 4,870 303 1,501 3,066 928 801 1,337 -------- ------- ------ ------------- ------ ------- --------Net interest income - taxable equivalent basis ........... 3,107 $ 404 $ (377) 3,080 $ 730 $ (408) 2,758 ======= ====== ====== =======Tax equivalent adjustment ............. 26 17 17 -------- ------------- --------Net interest income - non taxable equivalent basis ....... $ 3,081 $ 3,063 $ 2,741 ======== ============= ======== 34 Significant components of HUSI's net interest margin are summarized in thefollowing table. -------------------------------------------------------------------------------Year Ended December 31 2006 2005 2004-------------------------------------------------------------------------------Yield on total earning assets ...................... 5.77% 4.96% 4.45%Rate paid on interest bearing liabilities .......... 3.96 2.78 1.64 ----- ------- -----Interest rate spread ............................... 1.81 2.18 2.81Benefit from net non-interest or paying funds ...... .44 .31 .19 ----- ------- -----Net interest margin on average earning assets (1) .. 2.25% 2.49% 3.00% ===== ======= ===== (1) Selected financial ratios are defined in the Glossary of Terms beginning on page 87 of this Form 10-K. Significant trends affecting the comparability of 2005 and 2006 net interestincome and interest rate spread are summarized in the following table. Netinterest income in the table is presented on a taxable equivalent basis (referto pages 90-91 of this Form 10-K). ----------------------------------------------------------------------------------------------------- 2006 2005 2004 ------------------- ------------------ ------------------ Interest Interest Interest Rate Rate RateYear Ended December 31 Amount Spread Amount Spread Amount Spread----------------------------------------------------------------------------------------------------- ($ in millions)Net interest income/interest rate spread from prior year ...... $ 3,080 2.18% $ 2,758 2.81% $ 2,532 3.20% ======== ======== ========Increase (decrease) in net interest income associated with: Trading related activities (1) ............. (71) (61) (5) Balance sheet management activities (2) .. (269) (156) (35) Private label receivable portfolio (3) ... 210 435 -- Other activity ................ 157 104 266 -------- -------- ------- -------- ------- --------Net interest income/interest rate spread for current year ............................. $ 3,107 1.81% $ 3,080 2.18% $ 2,758 2.81% ======== ======== ======= ======== ======= ======== (1) Refer to commentary regarding trading revenues, beginning on page 46 of this Form 10-K. (2) Represents HUSI's activities to manage interest rate risk associated with the repricing characteristics of balance sheet assets and liabilities. Interest rate risk, and HUSI's approach to manage such risk, are described beginning on page 77 of this Form 10-K. (3) Refer to commentary regarding the private label receivable portfolio, beginning on page 52 of this Form 10-K. Net interest income, presented by business segment on a non-taxable equivalentbasis, is summarized in the following table. ----------------------------------------------------------------------------------------------------------------------- 2006 Compared 2005 Compared to 2005 to 2004 Increase/(Decrease) Increase/(Decrease) ---------------------- -------------------Year Ended December 31 2006 2005 2004 Amount % Amount %----------------------------------------------------------------------------------------------------------------------- ($ in millions)Business segment:PFS: Core banking activities ............. $ 985 $ 891 $ 799 $ 94 11 $ 92 12 Residential mortgage loans ......... 247 311 289 (64) (21) 22 8 -------- -------- ------ --------------- ---- -------- -------- Total PFS ........................... 1,232 1,202 1,088 30 2 114 10 -------- -------- ------ --------------- ---- -------- --------CF ..................................... 738 583 182 155 27 401 220CMB .................................... 745 662 586 83 13 76 13CIBM ................................... 181 456 766 (275) (60) (310) (40)PB ..................................... 199 172 130 27 16 42 32Other .................................. (14) (12) (11) (2) * (1) * -------- -------- ------ --------------- ---- -------- --------Total .................................. $ 3,081 $ 3,063 $2,741 $ 18 1 $ 322 12 ======== ======== ====== =============== ==== ======== ======== * Not meaningful. 35 PFS Business Segment 2006 Compared to 2005 Net interest income associated with core banking activities was higher for 2006due primarily to the impact of a growing personal deposit base. Personaldeposits are the primary, and relatively low cost, funding source for the PFSsegment. Customers have migrated to higher yielding deposit products in 2006,such as the internet savings product, leading to a change in product mix andresulting in narrowing of deposit spreads, which partly offset the benefit ofhigher deposit balances. Refer to page 7 of this Form 10-K for commentaryregarding deposit strategy and growth. Lower residential mortgage banking net interest income was mainly due to: o lower residential mortgage loan balances resulting from various balance sheet management initiatives (refer to commentary regarding residential mortgage banking revenue, beginning on page 43 of this Form 10-K); and o interest rate spreads narrowing slightly in 2006 since residential mortgage loans could not be repriced to offset higher funding costs. 2005 Compared to 2004 Higher net interest income for 2005 was due to: o significant growth in consumer loan balances, particularly adjustable rate residential mortgage loans; and o more favorable interest rate spreads on a growing personal deposits base during 2005; partially offset by o $33 million of amortization of premium paid for MasterCard/Visa credit card receivables acquired on a daily basis from HSBC Finance Corporation. 36 CF Business Segment 2006 Compared to 2005 The CF segment includes private label credit card receivables, residentialmortgage loans and other loans acquired from HSBC Finance Corporation. Highernet interest income for 2006 primarily resulted from significantly reducedamortization of the initial premiums paid for the private label credit cardportfolio and other loans acquired in December of 2004. The following tablesummarizes the impact of premium amortization on net interest income for the CFsegment. ------------------------------------------------------------------------------------------------------------------------ 2006 Compared 2005 Compared to 2005 to 2004 Increase/(Decrease) Increase/(Decrease) ---------------------- -------------------- 2006 2005 2004 Amount % Amount %------------------------------------------------------------------------------------------------------------------------ ($ in millions)Net interest income, after premium amortization ................ $ 738 $ 583 $ 182 $ 155 27 $ 401 220 -------- -------- ------ --------------- ---- -------- --------Amortization associated with premiums paid to HSBC Finance Corporation for: Initial purchase of private label credit card receivables (1) ............... 122 432 -- (310) (72) 432 * Ongoing private label credit card receivable purchases (2) ................. 377 283 -- 94 33 283 * Residential mortgage loans (3) ... 45 69 53 (24) (35) 16 30 Other loan purchases (3) ......... 6 41 -- (35) (85) 41 * -------- -------- ------ --------------- ---- -------- -------- Total premium amortization ....... 550 825 53 (275) (33) 772 * -------- -------- ------ --------------- ---- -------- --------Net interest income, before premium amortization ................ $ 1,288 $ 1,408 $ 235 $ (120) (9) $ 1,173 499 ======== ======== ====== =============== ==== ======== ======== (1) In December 2004, HUSI acquired private label credit card receivables from HSBC Finance Corporation. The premium paid for these credit card receivables is being amortized against interest income over the estimated life of the related receivables. (2) By agreement, new receivables generated from private label credit card relationships are being acquired from HSBC Finance Corporation on a daily basis, at fair value, resulting in additional premiums, which are amortized over the life of the related receivables. (3) HUSI acquired residential mortgage and other consumer loans from December 2003 until these acquisitions were discontinued in September 2005, due to balance sheet management initiatives to enhance liquidity and to address interest rate risk. * Not meaningful. During 2006, private label credit card receivable balances grew 18% due to theaddition of new customer relationships during 2006 and 2005, and to decreasedfunding requirements of off-balance sheet securitized receivable trusts. Despitehigher receivable balances however, net interest income, excluding the impact ofpremium amortization as reflected in the table above, was lower for 2006. Higherinterest income resulting from growth in receivables was more than offset byhigher interest expense associated with funding the growth in receivables, thelatter being a consequence of higher market driven funding costs. 2005 Compared to 2004 2005 was the first full year of impact for the private label receivableportfolio (the PLRP). During 2005, interest income for the PLRP wassignificantly reduced by amortization of premiums paid for the portfolio, asnoted in the table above. CMB Business Segment Higher net interest income for 2006 and 2005 primarily resulted from strongdeposit growth across all businesses and loan growth within small business andmiddle-market businesses. Resources have been invested in business expansion,including the opening of new regional offices, which resulted in higher actualand average loans and deposits balances for 2006 and 2005. 37 The average yield earned on commercial loans increased for 2006, due toincreases in general market rates and HBUS's prime lending rate. Deposits are the primary funding source for the CMB business segment and asignificant component of CMB's revenue base. Growth in interest free demanddeposits was $541 million and $466 million in 2006 and 2005, respectively.Although the CMB business segment generally earns favorable spreads on thegrowing deposit base, net interest income growth during 2006 and 2005 waspartially offset by narrowing deposit spreads, as customers migrated to higheryielding deposit products. During the second quarter of 2004, HUSI transferred its Panamanian operations,including commercial loans, deposits and related net interest income includedwithin the CMB segment, to an HSBC affiliate, which partially offset the benefitfrom business expansion initiatives noted above. CIBM Business Segment Lower net interest income associated with balance sheet management and tradingactivities for 2006 and 2005 primarily resulted from the cumulative effect ofhigher short-term interest rates in the U.S. which, by flattening the interestrate yield curve, reduced the available opportunities within CIBM to generateadditional net interest income. The compression in the interest rate marginbegan to stabilize in the second half of 2006. Beginning in 2005, the CIBM business segment expanded its operations andproducts offered to clients, which resulted in increased trading activity,higher trading assets and liabilities and improved trading results in 2006 and2005. The resulting increases in trading assets and commercial loans partiallyoffset the negative impact of the rising rate environment and flat yield curve.Refer to pages 31 and 46 of this Form 10-K for additional commentary regardingtrading assets and trading revenues, respectively. PB Business Segment During 2006 and 2005 additional resources have been allocated to expand productsand services provided to high net worth customers served by this businesssegment, resulting in increased loan and deposit balances, and a correspondingincrease in net interest income. Provision for Credit Losses The provision for credit losses associated with various loan portfolios issummarized in the following table. ------------------------------------------------------------------------------------------------------------------------ 2006 Compared 2005 Compared to 2005 to 2004 Increase/(Decrease) Increase/(Decrease) ---------------------- --------------------Year Ended December 31 2006 2005 2004 Amount % Amount %------------------------------------------------------------------------------------------------------------------------ ($ in millions) Commercial ............................. $ 136 $ (15) $ (107) $ 151 * $ 92 * -------- -------- ------ --------------- ---- -------- --------Consumer: Residential mortgages ............... 32 37 21 (5) (14) 16 76 Credit card receivables ............. 592 560 51 32 6 509 * Other consumer ...................... 63 92 18 (29) (32) 74 411 -------- -------- ------ --------------- ---- -------- -------- Total consumer ...................... 687 689 90 (2) * 599 666 -------- -------- ------ --------------- ---- -------- --------Total provision for credit losses ...... $ 823 $ 674 $ (17) $ 149 22 $ 691 * ======== ======== ====== =============== ==== ======== ======== * Not meaningful. 38 Overview HUSI's methodology and accounting policies related to its allowance for creditlosses are presented in Critical Accounting Policies beginning on page 25 and inNote 2 of the consolidated financial statements beginning on page 99 of thisForm 10-K. Additional commentary regarding credit quality begins on page 58 of this Form10-K. HUSI's approach toward credit risk management is summarized on pages 72-74 ofthis Form 10-K. 2006 Compared to 2005 Higher commercial loan provision expense for 2006 resulted from: o higher allowance requirements associated with higher small business and real estate commercial loan portfolio balances in 2006 and 2005; o higher charge offs associated with the growing small business portfolio; o more normalized commercial loan charge off and recovery activity, in comparison with 2005; and o a combination of charge offs and increased allowance for credit losses related to a specific commercial loan relationship within the PB business segment, which resulted in a $29 million provision. Increased provision expense associated with credit card receivables isconsistent with growth in private label credit card receivables during 2006. Lower residential mortgage and other consumer loan balances were the primarydriver for lower allowance requirements and lower provisions associated withthese portfolios. Credit quality associated with HUSI's residential mortgageloan portfolio remained strong in 2006. 2005 Compared to 2004 Higher provision expense for credit card receivables directly relates to theprivate label receivable portfolio acquired from HSBC Finance Corporation. 2005was the first full year of activity for this portfolio for HUSI. Provisions for commercial, residential mortgage and other consumer loanportfolios generally increased during 2005 due to allowance requirementsassociated with overall growth within these portfolios. In addition, during2004, exceptionally strong credit quality within the commercial loan portfolioresulted in net recoveries of $6 million and a credit to provision for creditlosses of $107 million for the year. 39 Other Revenues-------------------------------------------------------------------------------- The components of other revenues are summarized in the following table.-------------------------------------------------------------------------------- 2006 Compared to 2005 Compared to 2005 2004 Increase/(Decrease) Increase/(Decrease) ------------------- -------------------Year Ended December 31 2006 2005 2004 Amount % Amount %---------------------------------------------------------------------------------------------------------------------- ($ in millions) Trust income ........................... $ 88 $ 87 $ 95 $ 1 1 $ (8) (8) -------- -------- -------- -------- ------- -------- ------- Service charges (also see HSBC affiliate income below) ............. 204 195 196 9 5 (1) (1) -------- -------- -------- -------- ------- -------- -------Credit card fees: Private label receivables ........... 479 241 3 238 99 238 * MasterCard/Visa receivables ......... 101 82 79 19 23 3 4 -------- -------- -------- -------- ------- -------- ------- 580 323 82 257 80 241 * -------- -------- -------- -------- ------- -------- ------- Other fees and commissions (also see HSBC affiliate income below): Letter of credit fees ............... 74 70 70 4 6 -- -- Wealth and tax advisory services .... 94 60 45 34 57 15 33 Other fee-based income, net of referral fees .................... 233 174 201 59 34 (27) (13) -------- -------- -------- -------- ------- -------- ------- 401 304 316 97 32 (12) (4) -------- -------- -------- -------- ------- -------- ------- Securitization revenue ................. 18 114 -- (96) (84) 114 * -------- -------- -------- -------- ------- -------- ------- HSBC affiliate income: Service charges ..................... 15 15 17 -- -- (2) (12) Other fees and commissions .......... 51 71 27 (20) (28) 44 163 Gain on sale of residential mortgage loans to HMUS ............ 106 18 -- 88 489 18 * Gain on sale of refund anticipation loans to HSBC Finance Corporation ............... 22 19 -- 3 16 19 * Gain on sale of credit card relationships to HSBC Finance Corporation ...................... -- -- 99 -- -- (99) * Other affiliate income .............. 14 7 4 7 100 3 75 -------- -------- -------- -------- ------- -------- ------- 208 130 147 78 60 (17) (12) -------- -------- -------- -------- ------- -------- ------- Other income: Insurance ........................... 47 48 63 (1) (2) (15) (24) Valuation allowance increase for changes in market value of residential mortgage loans held for sale to HMUS ................. (133) (32) -- (101) * (32) * Interest on tax settlement .......... 4 -- 17 4 * (17) * Gains on sale of property and other financial assets .......... 52 67 65 (15) (22) 2 3 Earnings from equity investments .... 110 43 49 67 156 (6) (12) Miscellaneous income ................ 104 67 36 37 55 31 86 -------- -------- -------- -------- ------- -------- ------- 184 193 230 (9) (5) (37) (16) -------- -------- -------- -------- ------- -------- ------- Residential mortgage banking revenue (expense) ........................... 96 64 (120) 32 50 184 *Trading revenues ....................... 755 395 288 360 91 107 37Securities gains, net .................. 29 106 85 (77) (73) 21 25 -------- -------- -------- -------- ------- -------- -------Total other revenues ................... $ 2,563 $ 1,911 $ 1,319 $ 652 34 $ 592 45 ======== ======== ======== ======== ======= ======== ======= * Not meaningful 40 Credit Card Fees Prior to December 2004, credit card fees were primarily associated with HUSI'sMasterCard/Visa credit card portfolio. In December 2004, HUSI acquired privatelabel credit card receivables from HSBC Finance Corporation, which resulted insignificant new credit card fee revenue for 2005 and 2006. Higher private labelcredit card fees in 2006 resulted from the following portfolio activity: o growth in the number of customer accounts and customer transaction activity and receivable balances; and o lower payments to merchant partners due to terminations and revisions to certain merchant agreements. Other Fees and Commissions Increased wealth and tax advisory services revenue in 2006 and 2005 primarilyresulted from expansion of such services within the PB business segment (referto page 57 of this Form 10-K). Higher other fee-based income is partially due to various growth initiativesundertaken in 2005 and 2006, which resulted in general increases in fee incomerecorded within the PFS, CMB and CIBM business segments. In addition, activityfor 2006 reflects one extra quarter of new service fees, recorded within theCIBM business segment, generated by a subsidiary transferred to HUSI from HSBCin March 2005, which provides accounting and valuation services for hedge fundclients. Securitization Revenue Securitization revenue for 2006 and 2005 is comprised of servicing revenue andexcess servicing spread resulting directly from the purchase of residualinterests in securitized private label credit card receivables from HSBC FinanceCorporation in December 2004. During 2006, the balance requirements associatedwith these off-balance sheet securitization trusts decreased significantly,resulting in increased on-balance sheet receivables, increased interest and feeincome and decreased securitization revenue. All collateralized funding transactions have been structured as securedfinancings since the third quarter of 2004. Therefore, there were no newsecuritization transactions during 2006 and 2005. Additional commentary regarding securitization activities is provided in Note 9of the consolidated financial statements beginning on page 121 of this Form10-K. HSBC Affiliate Income In June 2005, HUSI began acquiring residential mortgage loans from unaffiliatedthird parties and subsequently selling these loans to HMUS. During 2006, HUSIalso began acquiring residential mortgage loans from HSBC Finance Corporationunder this program. Higher gains on sales of loans to HMUS in 2006 resulted fromsignificantly increased activity under this program. Refer to other income forcommentary regarding the valuation allowance related to loans held for resaleunder this program. Also, refer to page 9 of this Form 10-K for additionalcommentary and analysis regarding the balance sheet and earnings impacts of thisprogram. Effective October 2004, HBUS became the originating lender for HSBC FinanceCorporation's Taxpayer Financial Services business. During 2006 and 2005, mainlyin the first quarter of the respective years, HUSI recorded gains on the sale ofrefund anticipation loans to HSBC Finance Corporation under this program. In July of 2004, in order to centralize the servicing of credit card receivableswithin a common HSBC affiliate in the United States, certain consumerMasterCard/Visa credit card customer relationships of HUSI were sold to HSBCFinance Corporation. A $99 million gain was recorded in other revenues as aresult of this transaction. 41 Other Income Residential mortgage loans held for resale to HMUS are recorded at the lower ofcost or market value on HUSI's consolidated balance sheet. Changes in thevaluation allowance associated with these loans are recorded as a separatecomponent of other income. Cumulative net valuation losses related to loans heldfor resale to HMUS for 2006 and 2005 are offset by gains on sales of theseloans, as reported in HSBC affiliate income, and by trading related revenuesassociated with hedging the interest rate exposure on these loans. Refer to page9 of this Form 10-K for additional commentary and analysis regarding thebalance sheet and earnings impacts of this program. Gains on sale of property and other financial assets include the followingmaterial transactions: 2006 o $30 million gain on the sale of property in the third quarter; and o $13 million gain from the redemption of Venezuelan Brady Bonds in the second quarter (refer to page 119 of this Form 10-K). 2005 o $17 million gain from the sale of property in the third quarter; and o $26 million gain from the sale of property, as well as additional gains of $7 million from sales of various branches, in the second quarter. 2004 o $45 million gain from the sale of an investment in NYCE Corporation in the third quarter; and o $9 million of combined gains from the sale of branches and other properties. Throughout 2006, HUSI recorded increased earnings from certain equityinvestments, including a $40 million distribution from a foreign equityinvestment in the third quarter of 2006. Refer to page 57 of this Form 10-K foradditional commentary regarding this equity investment, which is reported withinresults for the PB business segment. Business expansion initiatives and balance sheet growth have resulted ingenerally higher revenues recorded as miscellaneous income during 2006 and 2005,particularly within the CIBM business segment. 42 Residential Mortgage Banking Revenue The following table presents the components of residential mortgage bankingrevenue. Net interest income includes interest earned on assets and paid onliabilities of the residential mortgage banking business as well as anallocation of the funding cost or benefit associated with these balances. Thenet interest income component of the table is included in net interest income inthe consolidated statement of income and reflects actual interest earned, net ofinterest expense and corporate transfer pricing. Effective January 2005, HUSI enhanced its funds transfer pricing methodology tobetter approximate current external market pricing and valuation, resulting inadditional internal charges to the residential mortgage banking business. Forcomparability purposes, 2004 amounts in the following table have also beenrestated for this change in methodology, which decreased net interest income for2004 by approximately $206 million.-------------------------------------------------------------------------------- 2006 Compared to 2005 Compared to 2005 2004 Increase/(Decrease) Increase/(Decrease) ------------------- -------------------Year Ended December 31 2006 2005 2004 Amount % Amount %---------------------------------------------------------------------------------------------------------------------- ($ in millions) Net interest income .................... $ 330 $ 447 $ 461 $ (117) (26) $ (14) (3) -------- -------- -------- -------- ------- -------- ------- Servicing related income (expense): Servicing fee income ............. 100 76 78 24 32 (2) (3) Changes in fair value of MSRs due to (1): Changes in valuation inputs or assumptions used in valuation model ............... 44 -- -- 44 * -- -- Realization of cash flows ..... (87) -- -- (87) * -- -- MSRs amortization (2) MSRs temporary impairment ........ -- (73) (101) 73 * 28 * recovery (provision) (2) ....... -- 47 (102) (47) * 149 * Trading - Derivative instruments used to offset changes in value of MSRs .............. (17) 2 8 (19) * (6) (75) (Losses) gains on sales of available for sale securities . -- (11) 8 11 * (19) (238) -------- -------- -------- -------- ------- -------- ------- 40 41 (109) (1) (2) 150 * -------- -------- -------- -------- ------- -------- ------- Originations and sales related income: Gains (losses) on sales of residential mortgages .......... 33 17 (4) 16 94 21 * Trading and hedging activity ..... 1 (13) (17) 14 * 4 * -------- -------- -------- -------- ------- -------- ------- 34 4 (21) 30 750 25 * -------- -------- -------- -------- ------- -------- -------Other mortgage income .................. 22 19 10 3 16 9 90 -------- -------- -------- -------- ------- -------- ------- Total residential mortgage banking revenue (expense) included in other revenues ................... 96 64 (120) 32 50 184 * -------- -------- -------- -------- ------- -------- ------- Total residential mortgage banking related revenue ...................... $ 426 $ 511 $ 341 $ (85) (17) $ 170 50 ======== ======== ======== ======== ======= ======== ======= (1) Based upon adoption of SFAS 156 effective January 1, 2006. Refer to Note 2 of the consolidated financial statements, beginning on page 99 of this Form 10-K for further discussion. (2) Based upon methodology existing prior to adoption of SFAS 156. * Not meaningful. 43 2006 Compared to 2005 As a result of balance sheet management initiatives to enhance liquidity and toaddress interest rate risk, the following strategic decisions were undertaken in2006 and 2005, which affected residential mortgage banking results: o HUSI increased the proportion of loans originated through its retail channels by leveraging the HSBC brand, branch network and customer base; o HUSI opted to decrease the loan volumes generated through HSBC Finance Corporation's network of residential mortgage loan correspondents. Purchases from correspondents were discontinued in September 2005; and o HUSI sold a higher proportion of its own adjustable rate mortgage loan originations in 2006, which previously would have been held on the balance sheet. Net Interest Income As a result of the strategies noted above, average residential mortgage loansrecorded on the consolidated balance sheet decreased 11% during 2006, whichresulted in a corresponding decrease in net interest income. Decreased netinterest income in 2006 was also partially attributable to a narrowing ofinterest rate spreads on the core mortgage portfolio. Overall yields earned onresidential mortgage loans in 2006 were consistent with 2005 levels. Servicing Related Income (Expense) Higher servicing fee income in 2006 resulted primarily from the growth in theportfolio of loans serviced for others, which increased approximately 24% in2006 due to the following factors: o HUSI sold substantially all adjustable rate loans in 2005 and 2006, which previously would have been held on the balance sheet; o in the fourth quarter of 2005, HUSI commenced servicing a portfolio of loans previously serviced by a third party; and o also in the fourth quarter of 2005, HUSI completed a sale of loans, which were previously held in portfolio, to a government agency for which it continues to provide servicing. Overall, servicing related income in 2006 was flat in comparison with 2005levels. Higher servicing fee income was offset by reductions in the value ofMSRs, primarily resulting from higher cash flow realization (classified as acomponent of MSR amortization in prior years). The monthly fluctuation of rateswas generally less volatile in 2006 compared to 2005. Under accounting rules in place prior to 2006, there was no direct relationshipbetween the lower of cost or market value (LOCOM) accounting model for valuingMSRs and the fair value model for valuing related derivative instruments used tooffset changes in the economic value of MSRs. Under the guidance outlined inSFAS 156, which became effective January 1, 2006, the accounting model for MSRsnow more closely matches the model for related hedging activity as both are fairvalue models, which has reduced income statement volatility related to thevaluation of MSRs. Additional analysis of MSRs activity is provided in Note 11 of the consolidatedfinancial statements beginning on page 122 of this Form 10-K. Additional commentary regarding risk management associated with the MSRs hedgingprogram is provided on page 82 of this Form 10-K. 44 Origination and Sales Related Income (Expense) HUSI routinely sells residential mortgage loans to government sponsored entitiesand other private investors. The increase in originations and sales relatedincome for 2006 was attributable to a higher basis point gain on each individualloan sale as compared with 2005, partially offset by lower volumes sold in 2006. 2005 Compared to 2004 The following strategic decisions and market factors affected residentialmortgage banking results for 2005: o HUSI increased the proportion of loans originated through its retail channels by leveraging the HSBC brand, branch network and customer base; o as a result of balance sheet management initiatives to enhance liquidity and to address interest rate risk, HUSI opted to decrease the loan volumes generated through HSBC Finance Corporation's network of residential mortgage loan correspondents. Purchases from correspondents were discontinued in September 2005. o HUSI sold a higher proportion of adjustable rate residential mortgage loans in 2005, which previously would have been held on the balance sheet. Residential mortgage loans originated with the intention to sell increased 41% in 2005, as compared with 2004; and o as interest rates rose in 2005, loan originations slowed in comparison to the prior year. Total loan originations declined 50% overall in 2005. Adjustable rate loans originated, as a percentage of all loans originated, fell from 67% in 2004 to 30% in 2005. Net Interest Income As a result of the strategies and market factors noted above, total residentialmortgage loans recorded on the consolidated balance sheet decreased 6% during2005. Despite the decrease in actual balances however, average residentialmortgage loans increased 27% in 2005 due to full year impact of significantportfolio growth in 2004, resulting in a significant increase in interest incomeduring the year. Decreased net interest income in 2005 was attributable to a narrowing ofinterest rate spreads on the core mortgage portfolio. Overall yields earned onresidential mortgage loans in 2005 were consistent with 2004. Servicing Related Income (Expense) Increased net servicing related income (expense) in 2005 was attributable todecreased MSRs amortization expense and to recoveries of temporary impairmentvaluation allowances during 2005, as compared with significant provisions forimpairment recorded in 2004. During 2005, interest rates generally rose and prepayments of residentialmortgages, mostly in the form of loan refinancings, decreased in comparison with2004 levels. Loan refinancing activity represented 44% of total originations in2005, as compared with 50% in 2004. This led to lower amortization charges andthe subsequent release of temporary impairment provision on MSRs. HUSI maintained an available for sale securities portfolio that was used tooffset changes in the economic value of MSRs. Net servicing related incomeamounts in the table do not reflect unrealized losses, reported as a componentof other comprehensive income, or net interest income related to thesesecurities. Origination and Sales Related Income (Expense) HUSI routinely sells residential mortgage loans to government sponsored entitiesand other private investors. The increase in originations and sales relatedincome for 2005 was attributable to a higher basis point gain on each individualloan sale as compared with 2004, as well as a higher volume of originated loansbeing sold during the year. 45 Trading Revenues Trading revenues are generated by HUSI's participation in the foreign exchange,credit derivative and precious metal markets; from trading derivative contracts,including interest rate swaps and options; from trading securities; and as aresult of certain residential mortgage banking activities. The following table presents trading related revenues by business. The data inthe table includes net interest income earned on trading instruments, as well asan allocation of the funding benefit or cost associated with the tradingpositions. The trading related net interest income component is included in netinterest income on the consolidated income statement. Trading revenues relatedto the mortgage banking business are included in residential mortgage bankingrevenue. ----------------------------------------------------------------------------------------------------------------------- 2006 Compared 2005 Compared to 2005 to 2004 Increase/(Decrease) Increase/(Decrease) ----------------------- -----------------------Year Ended December 31 2006 2005 2004 Amount % Amount %----------------------------------------------------------------------------------------------------------------------- ($ in millions) Trading revenues ..................... $ 755 $ 395 $ 288 $ 360 91 $ 107 37Net interest income .................. (56) 15 76 (71) (473) (61) (80) ------ ------- ------- --------------- ----- ----------- ---------Trading related revenues ............. $ 699 $ 410 $ 364 $ 289 70 $ 46 13 ====== ======= ======= =============== ===== =========== ========= Business: Derivatives ....................... $ 283 $ 166 $ 112 $ 117 70 $ 54 48 Economic hedges of loans held for sale to HMUS ........................ 132 36 -- 96 267 36 * Treasury (primarily securities) ... 8 24 37 (16) (67) (13) (35) Foreign exchange and banknotes .... 182 133 143 49 37 (10) (7) Precious metals ................... 87 42 49 45 107 (7) (14) Other trading ..................... 7 9 23 (2) (22) (14) (61) ------ ------- ------- --------------- ----- ----------- ---------Trading related revenues ............. $ 699 $ 410 $ 364 $ 289 70 $ 46 13 ====== ======= ======= =============== ===== =========== ========= * Not meaningful 2006 Compared to 2005 During 2006, a wider range of product offerings and enhanced sales capabilitiesdrove significant trading gains across all major client-related activities,primarily during the first half of the year. Derivatives trading revenue washigher due to the success of new product launches, to increased sales ofstructured products that are tailored to specific customer needs, and to therecognition of income during 2006 that was deferred in the previous year, asmarket inputs to valuation models became observable. Gains in the preciousmetals business reflected volume growth driven by a surge in demand arising fromstrong commodities markets. Income streams in the foreign exchange businessremained robust against the backdrop of a weakening U.S. dollar. Effective since the third quarter of 2005, HUSI maintains a portfolio ofderivative instruments that are utilized as economic hedges to offset changes inmarket values of loans held for sale to HMUS. During 2006, HUSI realized $68million of net trading revenues and $64 million of net interest income relatedto this program. Further analysis and commentary regarding these loans and theassociated hedges is provided on page 9 of this Form 10-K. HUSI recognizes gain or loss at the inception of derivative transactions onlywhen the fair value of the transaction can be verified to market transactions orif all significant pricing model assumptions can be verified to observablemarket data. Gain or loss not recognized at inception is recorded in tradingassets and recognized over the term of the derivative contract, or when marketdata becomes observable. During 2006, the availability of observable market dataresulted in recognition of $53 million in trading revenues. 46 Decreased net interest income was primarily due to steadily rising short-terminterest rates during 2005 and 2006, which had an adverse impact on interestrate spreads related to funding of various trading activities. 2005 Compared to 2004 Improved trading markets during the second half of 2005 offset the difficultmarkets encountered during the first half of the year. Overall, client andproprietary trading revenues increased during 2005 as a result of the followingfactors: o improved trading results from an expanded credit derivatives trading desk; o successful rollout of a new structured transactions business within the CIBM segment, which has increased derivatives related revenues in 2005; and o revenues associated with the new business for acquiring residential mortgage loans from unaffiliated third parties with the intent to sell these loans to HMUS, which was initiated during 2005. The yield curve continued to flatten during 2005, which resulted in significantdecreases in interest rate spreads associated with various trading assets. Securities Gains, Net HUSI maintains various securities portfolios as part of its balance sheetdiversification and risk management strategy. The following table summarizes thenet securities gains resulting from various strategies. ----------------------------------------------------------------------------------------------------------------------Year Ended December 31 2006 2005 2004---------------------------------------------------------------------------------------------------------------------- (in millions) Balance sheet diversity and reduction of risk ........................ $ 5 $ 33 $ 45Reduction of Latin and South American exposure ....................... 22 22 30Sale of an equity investment to an HSBC affiliate (1) ................ -- 48 --Other ................................................................ 2 3 10 -------------- ------------- ------------Total securities gains, net .......................................... $ 29 $ 106 $ 85 ============== ============= ============ (1) In June 2005, HUSI sold shares in a foreign equity fund to an HSBC affiliate for a gain of $48 million, which is recorded within the PB segment. Gross realized gains and losses from sales of securities are summarized in Note6 of the consolidated financial statements, which begins on page 112 of thisForm 10-K. 47 Operating Expenses-------------------------------------------------------------------------------- 2006 Compared to 2005 Compared to 2005 2004 Increase/(Decrease) Increase/(Decrease) ------------------- -------------------Year Ended December 31 2006 2005 2004 Amount % Amount %----------------------------------------------------------------------------------------------------------------------- ($ in millions) Salaries and employee benefits: Salaries .............................. $ 916 $ 776 $ 720 $ 140 18 $ 56 8 Employee benefits ..................... 384 276 227 108 39 49 22 -------- -------- -------- --------- ----- --------- ------- 1,300 1,052 947 248 24 105 11Occupancy expense, net ................... 221 182 176 39 21 6 3 Support services from HSBC affiliates: Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ... 452 415 35 37 9 380 1,086 Fees paid to HMUS ..................... 227 162 114 65 40 48 42 Fees paid to HTSU for technology services ........................... 235 216 172 19 9 44 26 Fees paid to other HSBC affiliates .... 162 126 99 36 29 27 27 -------- -------- -------- --------- ----- --------- ------- 1,076 919 420 157 17 499 119 -------- -------- -------- --------- ----- --------- -------Other expenses: Equipment and software ................ 72 91 108 (19) (21) (17) (16) Marketing ............................. 98 79 44 19 24 35 80 Outside services ...................... 125 116 103 9 8 13 13 Professional fees ..................... 78 67 55 11 16 12 22 Telecommunications .................... 21 19 17 2 11 2 12 Postage, printing and office supplies 34 26 25 8 31 1 4 Insurance business .................... 19 19 22 - - (3) (14) Other ................................. 211 188 184 23 12 4 2 -------- -------- -------- --------- ----- --------- ------- Total other expenses .................. 658 605 558 53 9 47 8 -------- -------- -------- --------- ----- --------- -------Total operating expenses ................. $ 3,255 $ 2,758 $ 2,101 $ 497 18 $ 657 31 ======== ======== ======== ========= ===== ========= =======Personnel - average number ............... 12,326 11,275 11,416 1,051 9 (141) (1)Efficiency ratio ......................... 57.66% 55.44% 51.73% Salaries and Employee Benefits 2006 Compared to 2005 Higher salary and benefits expenses for 2006 were primarily due to: o higher staff counts and a changing mix of staffing to support various business growth initiatives within the PFS, CMB, CIBM and PB business segments (refer to commentary regarding Business Segments, beginning on page 50 of this Form 10-K); o higher incentive compensation expenses, largely due to growth in the CIBM and PB segments; o lower deferrals of salary costs within the residential mortgage banking business, included within the PFS business segment, resulting from lower loan originations during 2006; o higher pension expense, resulting from changes in plan assumptions, particularly a lower discount rate, for 2006; and o higher employee welfare costs and payroll related taxes, which relate directly to higher salary costs. In addition, during 2006, HUSI recorded $12 million of increased compensationexpenses related to retirement and other transition of certain HUSI seniorexecutives. 48 2005 Compared to 2004 During the first half of 2004, HUSI transferred its brokerage subsidiary andmost of its branch operations in Panama to other HSBC affiliates, resulting in asignificant reduction in staffing levels and salaries. Excluding thesesubsidiary transfers, the average number of personnel and associated salariesfrom HUSI's remaining operations increased for 2005. Business expansioninitiatives in various business segments were the primary drivers of increasedstaff counts and salaries expense. In addition, in March 2005, HSBC transferreda subsidiary to HUSI that provides accounting and valuation services to hedgefund clients, which also increased staff counts and salaries expense within theCIBM business segment. Higher employee benefits expenses in 2005 was primarily due to: o increased employer share of payroll taxes and other benefit costs associated with the overall staffing and salaries increases noted above; and o an increase in HUSI's employer matching of employee retirement savings contributions due to changes in matching program provisions which took effect during 2004. Occupancy Expense, Net Expansion of the core banking network has been a key component of HUSI'sbusiness expansion initiatives during 2006 and 2005. New branches have beenopened and lending operations have been expanded, which have resulted in higherrental, depreciation of leasehold improvements, utilities and other occupancyexpenses during both years, but particularly during 2006. Support Services from HSBC Affiliates Fees are charged by various HSBC affiliates for technology services, forunderwriting and broker-dealer services, for loan origination and servicing, andfor other operational and administrative support functions. Transactions withHSBC affiliates are further described and summarized in Note 21 of theconsolidated financial statements beginning on page 137 of this Form 10-K. Higher fees charged by HSBC Finance Corporation in 2006 and 2005 resulted fromthe following: o Loan origination and servicing fees - higher fees for 2006 and 2005 resulted from an increased number of accounts and increased balances associated with various credit card receivable and consumer loan portfolios serviced by HSBC Finance Corporation on behalf of HUSI. o Various administrative services - higher administrative fees for 2006 and 2005 resulted from specific initiatives to centralize administrative functions. Higher fees charged by HMUS for treasury and traded markets services resultedprimarily from business expansion initiatives within the CIBM segment, whichhave resulted in higher trading revenues (refer to page 46 of this Form 10-K)and higher other revenues for 2006 and 2005. Additional commentary regardingexpansion initiatives for the CIBM segment is provided on pages 55 of this Form10-K. Fees charged by HTSU for technology services expenses increased in 2006 and2005, due to continued initiatives by HUSI to upgrade its technologyenvironment. Equipment and software costs included in other expenses havedecreased in 2006 and 2005, as these costs are now included in the fees chargedby HTSU. Higher fees charged by other HSBC affiliates in 2006 and 2005 primarily resultedfrom treasury and traded markets services provided to support business expansioninitiatives within the CIBM segment, as well as higher data processing and othercharges related to expanded global outsourcing services. 49 Other Expenses Business expansion initiatives within PFS, CMB, CIBM and PB business segmentshave resulted in general increases in outside services and various other expensecategories, particularly during 2006. Increased marketing and promotional expenses for 2006 and 2005 primarilyresulted from investment in HSBC brand activities, promotion of the internetsavings account and marketing support for branch expansion initiatives. Efficiency Ratio The higher efficiency ratios for 2006 and 2005 resulted primarily from higheroperating expenses related to various business expansion initiatives, which werepartially offset by higher revenues associated with these initiatives, as wellas improved results for the private label receivable portfolio. As expectedduring the build out phase, expense growth associated with expansion initiativeshas outpaced related core banking revenue growth. Income Taxes-------------------------------------------------------------------------------- Income tax expense decreased $36 million (6%) in 2006, primarily resulting froma lower effective tax rate compared with 2005. The lower effective tax rate for2006 reflects higher revenues from operations in states with lower tax rates andan increase in low income housing tax credits. Income tax expense decreased $152 million (21%) in 2005 due principally to adecrease in pretax income combined with an adjustment of prior years' state andlocal tax provisions to reflect the actual tax liabilities per the returns filedand a higher level of low income housing tax credits. Refer to Note 17 of the consolidated financial statements on page 131 ofthis Form 10-K for additional information regarding income taxes. Business Segments-------------------------------------------------------------------------------- HUSI's business segments are described on pages 50-58 of this Form 10-K. Resultsfor each segment are summarized in the following tables and commentary. Priorperiod disclosures previously reported for 2005 and 2004 have been conformedherein to the presentation of current segments. Effective January 1, 2006, activity related to certain commercial bankingrelationships, which was previously reported in the PFS segment, was transferredto the CMB segment. In addition, also effective January 1, 2006, the CMB segmentalso includes activity related to an equity investment in Wells Fargo HSBC TradeBank N.A., which was previously reported in the Other segment. For comparabilitypurposes, 2005 and 2004 results for these segments have been revised to reflectthese changes. Personal Financial Services (PFS) Lower overall results for the PFS segment in 2006 were primarily due to reducedincome before income tax expense for the residential mortgage banking businessand, to a lesser extent, to lower results for other core PFS businesses. Lower residential mortgage related results were driven by strategic balancesheet initiatives to decrease the residential mortgage loan portfolio, and bytightening interest rate spreads. As a result, net interest income associatedwith residential mortgage banking activities declined $117 million in 2006.Operating expenses for the residential mortgage banking business increased in2006, partly due to reduced cost deferrals related to a reduced volume of loanoriginations. 50 This information is provided by RNS The company news service from the London Stock Exchange More to Follow
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HSBC Holdings Information
Share Price Information for HSBC Holdings (HSBA)
Share Price is delayed by 15 minutes
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Share Price:
676.80
Bid:
678.10
Ask:
678.30
Change:
3.60 (0.53%)
Spread:
0.20 (0.029%)
Open:
678.60
High:
679.40
Low:
670.30
Prev. Close:
673.20
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