HSBC Holdings Regulatory News (HSBA)

5 Mar 2007 12:46

HSBC Holdings PLC05 March 2007 Part 4 of 5 Note 22. Stock Option Plans and Restricted Share Plans-------------------------------------------------------------------------------- Options have been granted to employees of HUSI under the HSBC Holdings GroupShare Option Plan (the Group Share Option Plan) and under the HSBC HoldingsSavings-Related Share Option Plan (Sharesave). Since the shares and contributioncommitment have been granted directly by HSBC, the offset to compensationexpense was a credit to capital surplus, representing a contribution of capitalfrom HSBC. The following table presents information for each plan. Descriptions of eachplan follow the table. -----------------------------------------------------------------------------------------------------December 31 2006 2005 2004----------------------------------------------------------------------------------------------------- Restricted Share Plan: Total compensation expense recognized (in millions) .................................... $ 59 $ 44 $ 50 Sharesave (5 year vesting period): Total options granted .............................. 83,000 262,000 207,000 Fair value per option granted ...................... $ 3.49 $ 3.78 $ 3.80 Total compensation expense recognized (in millions) .................................... $ * $ * $ * Significant assumptions used to calculate fair value: Risk free interest rate ...................... 5.0% 4.3% 5.0% Expected life (years) ........................ 5 5 5 Expected volatility .......................... 17% 20% 25% Sharesave (3 year vesting period): Total options granted .............................. 274,000 510,000 407,000 Fair value per option granted ...................... $ 3.42 $ 3.73 $ 3.44 Total compensation expense recognized (in millions) .................................... $ 1 $ 1 $ 1 Significant assumptions used to calculate fair value: Risk free interest rate ...................... 5.0% 4.3% 4.9% Expected life (years) ........................ 3 3 3 Expected volatility .......................... 17% 20% 25% Sharesave (1 year vesting period): Total options granted .............................. 81,000 Fair value per option granted ...................... $ 2.60 Total compensation expense recognized (in millions) .................................... $ * Significant assumptions used to calculate fair value: Risk free interest rate ...................... 5.0% Expected life (years) ........................ 1 Expected volatility .......................... 17% Group Share Option Plan: Total options granted .............................. -- -- 4,574,000 Fair value per option granted ...................... $ -- $ -- $ 2.83 Total compensation expense recognized (in millions) .................................... $ 14 $ 6 $ 10 Significant assumptions used to calculate fair value: Risk free interest rate ...................... --% --% 4.90% Expected life (years) ........................ -- -- 6.9 Expected volatility .......................... --% --% 25% * Less than $500 thousand 140 Restricted Share Plans Awards are granted to key individuals in the form of performance andnon-performance restricted shares. The awards are based on an individual'sdemonstrated performance and future potential. Performance related restrictedshares generally vest after three years from date of grant, based on HSBC'sTotal Shareholder Return (TSR) relative to a benchmark TSR during theperformance period. TSR is defined as the growth in share value and declareddividend income during the period and the benchmark is composed of HSBC's peergroup of financial institutions. If the performance conditions are met, theshares vest and are released to the recipients two years later. Non-performancerestricted shares are released to the recipients based on continued service,typically at the end of a three year vesting period. Sharesave Plans Sharesave is an employee share option plan that enables eligible employees toenter into savings contracts of one, three or five year terms, with the abilityto decide at the end of the contract term to either use their accumulatedsavings to purchase HSBC ordinary shares at a discounted option price or havethe savings plus interest repaid in cash. The one year savings contracts wereoffered to employees for the first time in 2006. Employees can save up to $450per month over all their Sharesave savings contracts. The option price isdetermined at the beginning of the offering period of each plan year andrepresents a 20% discount, for the three and five year savings contracts, and a15% discount for the one year contract, from the average price in London on theHSBC ordinary shares over the five trading days preceding the offering. Oncontracts of three year or five year terms, the options are exercisable at the20% discounted stock option price within six months following the third or fifthanniversary of the beginning of the relevant savings contracts. Upon thecompletion of a one year savings contract, if the share price is higher than theoption price, the option will automatically be exercised and the shares will bepurchased at the 15% discounted stock option price. The shares will then betransferred to a holding account where they will be held for one additionalyear, or until the employee decides to sell the shares. Regardless of the lengthof the savings contract, employees can decide to have their accumulated savingsplus interest refunded to them at the end of the contract period, rather thanchoosing to exercise their purchase option. The fair value of options granted under Sharesave plans is estimated as of thedate of grant using a third party option pricing model. Group Share Option Plan The Group Share Option Plan was a discretionary long-term incentive compensationplan available prior to 2005, to certain HUSI employees based on performancecriteria. Options were granted at market value and are normally exercisablebetween the third and tenth anniversaries of the date of grant, subject tovesting conditions. Fair values of Group Share Option Plan awards made in 2004, measured at the dateof grant, were calculated using a binomial lattice methodology that is based onthe underlying assumptions of the Black-Scholes option pricing model. Whenmodeling options with vesting dependent on attainment of certain performanceconditions over a period of time, these performance targets are incorporatedinto the model using Monte-Carlo simulation. The expected life of optionsdepends on the behavior of option holders, which is incorporated into the optionmodel consistent with historic observable data. The fair values are inherentlysubjective and uncertain due to the assumptions made and the limitations of themodel used. No options were granted under the Group Share Option Plan in 2005 or 2006, sincethe plan was terminated by HSBC in May 2005. In lieu of options, employees nowreceive grants of HSBC Holdings ordinary shares subject to certain vestingconditions (refer to Restricted Share Plans above). All existing stock optiongrants under the Group Share Option Plan remain in effect subject to the sameconditions as before plan termination and compensation expense continues to berecognized over the various grant vesting periods. 141 Note 23. Pension and Other Postretirement Benefits-------------------------------------------------------------------------------- Defined Benefit Pension Plans In November 2004, sponsorship of the defined benefit pension plan of HUSI andthe defined benefit pension plan of HSBC Finance Corporation was transferred toHNAH. Effective January 1, 2005, the two separate plans were combined into asingle HNAH defined benefit pension plan which facilitates the development of aunified employee benefit policy and unified employee benefit plan administrationfor HSBC companies operating in the U.S. As a result, the pension asset relatingto HUSI's defined benefit plan of $279 million, net of tax, was transferred toHNAH as a capital transaction in the first quarter of 2005. In 2006, HUSI adopted SFAS 158 (see New Accounting Pronouncements on page 109 ofthis Form 10-K), which requires balance sheet recognition of the funded statusof pension and other postretirement benefit plans. Since HUSI's main pensionplan was transferred to HNAH in 2005, adoption of SFAS 158 had no significantbalance sheet impact related to pension obligations. The impact of SFAS 158 onother postretirement benefit plans is summarized on page 144 of this Form 10-K. The components of pension expense for the defined benefit plan reflected inHUSI's consolidated statement of income are shown in the table below. Thepension expense for the years ended December 31, 2006 and 2005 reflect theportion of the pension expense of the combined HNAH pension plan which has beenallocated to HUSI. -------------------------------------------------------------------------------------------------------Year Ended December 31 2006 2005 2004------------------------------------------------------------------------------------------------------- (in millions)Service cost-benefits earned during the period ........... $ 30 $ 27 $ 31Interest cost on projected benefit obligation ............ 65 62 69Expected return on assets ................................ (84) (89) (96)Amortization of prior service cost ....................... 1 1 1Recognized losses ........................................ 16 5 26 ------------ ------------ ------------Pension expense .......................................... $ 28 $ 6 $ 31 ============ ============ ============ The information and activity presented in the following tables as of and for theyears ended December 31, 2006 and 2005 relate to the post-merger HNAH definedbenefit pension plan, unless noted otherwise. The information and activitypresented as of and for the year ended December 31, 2004 reflect pre-merger HUSIdefined benefit pension plan balances and activity. The assumptions used in determining pension expense of the defined benefit planare as follows: ------------------------------------------------------------------------------------------------------- 2006 2005 2004------------------------------------------------------------------------------------------------------- Discount rate ............................................ 5.70% 6.00% 6.25%Salary increase assumption ............................... 3.75 3.75 3.75Expected long-term rate of return on plan assets ......... 8.00 8.33 8.00 142 A reconciliation of beginning and ending balances of the fair value of planassets associated with the HNAH defined benefit pension plan is shown below. ---------------------------------------------------------------------------------------------------------Year Ended December 31 2006 2005--------------------------------------------------------------------------------------------------------- (in millions) Fair value of plan assets at beginning of year ..................................... $ 2,383 $ 1,304Transfer of assets from the former HSBC Finance Corporation Plan ................... -- 1,000Actual return on plan assets ....................................................... 246 168Benefits paid ...................................................................... (62) (89) ------- -------Fair value of plan assets at end of year ........................................... $ 2,567 $ 2,383 ======= ======= HUSI does not currently anticipate making employer contributions to the definedbenefit plan in 2007. The allocation of the pension plan assets at December 31, 2006 and 2005 for theHNAH defined benefit pension plan is summarized in the following table: ------------------------------------------------------------------------------------------------------------- Percentage of Plan Assets at December 31, ------------------------- 2006 2005------------------------------------------------------------------------------------------------------------- Equity securities 69% 69%Debt securities 30 31Other 1 -- ------- ----------Total 100% 100% ======= ========== There were no investments in HSBC ordinary shares or American depositary sharesat December 31, 2006 and 2005. The primary objective of the HNAH defined benefit pension plan is to provideeligible employees with regular pension benefits. Since the plans are governedby the Employee Retirement Income Security Act of 1974 (ERISA), ERISAregulations serve as guidance for the management of plan assets. Consistent withprudent standards of preservation of capital and maintenance of liquidity, thegoals of the plans are to earn the highest possible rate of return consistentwith the tolerance for risk as determined by the investment committee in itsrole as a fiduciary. In carrying out these objectives, short-term fluctuationsin the value of plan assets are considered secondary to long-term investmentresults. A third party and an HSBC affiliate are retained by HNAH to provideinvestment consulting services such as recommendations on the type of funds tobe invested in and monitoring the performance of fund managers. In order toachieve the return objectives of the plans, the plans are diversified to ensurethat adverse results from one security or security class will not have an undulydetrimental effect on the entire investment portfolio. Assets are diversified bytype, characteristic and number of investments as well as by investment style ofmanagement organization. Equity securities are invested in large, mid and smallcapitalization domestic stocks as well as international stocks. 143 A reconciliation of beginning and ending balances of the projected benefitobligation of the HNAH defined benefit pension plan is shown in the followingtable. ---------------------------------------------------------------------------Year Ended December 31 2006 2005--------------------------------------------------------------------------- (in millions)Projected benefit obligation at beginning of year ... $ 2,530 $ 1,174Transfer in from the HSBC Finance Corporation Plan .. -- 1,019Service cost ........................................ 102 94Interest cost ....................................... 145 130Actuarial (gains) losses ............................ (17) 203Benefits paid ....................................... (62) (90) -------- -------Projected benefit obligation at end of year ......... $ 2,698 $ 2,530 ======== ======= HUSI's share of the projected benefit obligation of the HNAH defined benefitpension plan at December 31, 2006 is approximately $1.2 billion. The accumulatedbenefit obligation for the HNAH defined benefit pension plan was approximately$2.4 billion and $2 billion at December 31, 2006 and 2005, respectively. HUSI'sshare of the accumulated benefit obligation at December 31, 2006 and 2005 wasapproximately $1.1 billion and $1 billion, respectively. The accumulated benefitobligation for HUSI's pre-merger defined benefit pension plans was approximately$1 billion at December 31, 2004. Estimated future benefit payments for the HNAH defined benefit pension plan andHUSI's share of those estimated payments are summarized in the following table --------------------------------------------------------------------------- HUSI's HNAH Share--------------------------------------------------------------------------- (in millions) 2007 ................................................ $ 122 $ 492008 ................................................ 130 532009 ................................................ 137 562010 ................................................ 144 592011 ................................................ 156 632012-2016 ........................................... 927 388 The assumptions used in determining the projected benefit obligation of thedefined benefit pension plans at December 31 are summarized in the followingtable. -------------------------------------------------------------------------- 2006 2005 2004--------------------------------------------------------------------------Discount rate ................................ 5.90% 5.70% 6.00%Salary increase assumption ................... 3.75 3.75 3.75 Postretirement Plans Other Than Pensions HUSI's employees also participate in several plans which provide medical, dentaland life insurance benefits to retirees and eligible dependents. These planscover substantially all employees who meet certain age and vested servicerequirements. HUSI has instituted dollar limits on payments under the plans tocontrol the cost of future medical benefits. As discussed in Note 2, the adoption of SFAS 158 resulted in additional pensionliability of $31 million, a related deferred tax asset of $13 million, and anoffset to other comprehensive income of $18 million at December 31, 2006. 144 The net postretirement benefit cost included the following components. ------------------------------------------------------------------------------------Year Ended December 31 2006 2005 2004------------------------------------------------------------------------------------ (in millions) Service cost - benefits earned during the period ........ $ 1 $ 2 $ 2Interest cost ........................................... 6 7 7Amortization of transition obligation ................... 3 3 3 ------ ------ -----Net periodic postretirement benefit cost ................ $ 10 $ 12 $ 12 ====== ====== ===== The assumptions used in determining the net periodic postretirement benefit costfor HUSI's postretirement benefit plans are shown in the following table. ------------------------------------------------------------------------------------December 31 2006 2005 2004------------------------------------------------------------------------------------ Discount rate 5.70% 6.00% 5.75%Salary increase assumption 3.75 3.75 3.75 A reconciliation of the beginning and ending balances of the accumulatedpostretirement benefit obligation is shown in the following table. ----------------------------------------------------------------------------Year Ended December 31 2006 2005---------------------------------------------------------------------------- (in millions)Accumulated benefit obligation at beginning of year ..... $ 119 $ 122Service cost ............................................ 1 2Interest cost ........................................... 6 7Participant contributions ............................... 1 1Actuarial gains ......................................... (13) (4)Benefits paid ........................................... (11) (9) ------ ------Accumulated benefit obligation at end of year ........... $ 103 $ 119 ====== ====== HUSI's postretirement benefit plans are funded on a pay-as-you-go basis.Estimated future benefit payments for HUSI's postretirement plans are summarizedin the following table. -------------------------------------------------------------------------------- (in millions)2007 ...................................................... $ 92008 ...................................................... 82009 ...................................................... 92010 ...................................................... 92011 ...................................................... 92012-2016 ................................................. 43 145 The assumptions used in determining the benefit obligation of HUSI'spostretirement benefit plans at December 31 are as follows: ---------------------------------------------------------------------------- 2006 2005 2004----------------------------------------------------------------------------Discount rate .................................. 5.90% 5.70% 6.00%Salary increase assumption ..................... 3.75 3.75 3.75 A 10.5 percent annual rate of increase in the gross cost of covered health carebenefits was assumed for 2006. This rate of increase is assumed to declinegradually to 5 percent in 2014. Assumed health care cost trend rates have an effect on the amounts reported forhealth care plans. A one-percentage point change in assumed health care costtrend rates would increase (decrease) service and interest costs and thepostretirement benefit obligation as follows: ----------------------------------------------------------------------------------------- One Percent One Percent Increase Decrease----------------------------------------------------------------------------------------- (in millions) Effect on total of service and interest cost components ..... $ * $ *Effect on postretirement benefit obligation ................. 2 (2) * Less than $500 thousand Other Plans HUSI maintains a 401(k) plan covering substantially all employees. Employercontributions to the plan are based on employee contributions. Total expenserecognized for this plan was approximately $34 million, $33 million and $18million in 2006, 2005 and 2004, respectively. Certain employees are participants in various defined contribution and othernon-qualified supplemental retirement plans. Total expense recognized for theseplans was immaterial in 2006, 2005 and 2004. 146 Note 24. Business Segments-------------------------------------------------------------------------------- HUSI has five distinct segments that it utilizes for management reporting andanalysis purposes. Descriptions of HUSI's business segments are presented onpages 6-7 of this Form 10-K. Results for each segment are summarized in the following tables. Forcomparability purposes, 2005 and 2004 results have been revised to conform with2006 presentation. ----------------------------------------------------------------------------------------------------------------------- PFS CF CMB CIBM PB Other Total----------------------------------------------------------------------------------------------------------------------- (in millions) 2006 Net interest income (1) ........ $ 1,232 $ 738 $ 745 $ 181 $ 199 $ (14) $ 3,081 Other revenues ................. 447 501 274 1,011 305 25 2,563 --------- --------- --------- --------- --------- ------- ---------- Total revenues ................. 1,679 1,239 1,019 1,192 504 11 5,644 Operating expenses (2) ......... 1,192 441 508 803 311 -- 3,255 --------- --------- --------- --------- --------- ------- ---------- 487 798 511 389 193 11 2,389 Provision for credit losses (3) 58 659 62 10 34 -- 823 --------- --------- --------- --------- --------- ------- ---------- Income before income tax expense $ 429 $ 139 $ 449 $ 379 $ 159 $ 11 $ 1,566 ========= ========= ========= ========= ========= ======= ========== Average loans .................. $ 37,242 $ 19,835 $ 14,921 $ 12,399 $ 4,456 $ -- $ 88,853 Average assets ................. 41,685 20,677 17,940 79,882 5,744 350 166,278 Average deposits ............... 33,586 17 15,202 37,617 9,790 -- 96,212 Average liabilities/ equity (4) 48,250 1,657 21,519 82,983 11,869 -- 166,278 Goodwill at December 31, 2006 (5) 1,177 -- 472 636 431 -- 2,716 2005 Net interest income (1) ........ $ 1,202 $ 583 $ 662 $ 456 $ 172 $ (12) $ 3,063 Other revenues ................. 406 356 228 641 257 23 1,911 --------- --------- --------- --------- --------- ------- ---------- Total revenues ................. 1,608 939 890 1,097 429 11 4,974 Operating expenses (2) ......... 1,002 424 410 650 272 -- 2,758 --------- --------- --------- --------- --------- ------- ---------- 606 515 480 447 157 11 2,216 Provision for credit losses (3) 103 599 22 (47) (3) -- 674 --------- --------- --------- --------- --------- ------- ---------- Income before income tax expense $ 503 $ (84) $ 458 $ 494 $ 160 $ 11 $ 1,542 ========= ========= ========= ========= ========= ======= ========== Average loans .................. $ 44,143 $ 18,516 $ 14,001 $ 7,333 $ 3,905 $ -- $ 87,898 Average assets ................. 48,629 19,316 16,272 57,597 5,041 321 147,176 Average deposits ............... 28,436 286 11,745 37,592 7,464 -- 85,523 Average liabilities/ equity (4) 43,114 684 18,046 75,579 9,751 2 147,176 Goodwill at December 31, 2005 (5) 1,167 -- 468 631 428 -- 2,694 147 ---------------------------------------------------------------------------------------------------------------------- PFS CF CMB CIBM PB Other Total---------------------------------------------------------------------------------------------------------------------- (in millions) 2004 Net interest income (1) ........ $ 1,088 $ 182 $ 586 $ 766 $ 130 $ (11) $ 2,741 Other revenues ................. 358 2 200 534 204 21 1,319 --------- --------- --------- --------- --------- ------- ---------- Total revenues ................. 1,446 184 786 1,300 334 10 4,060 Operating expenses (2) ......... 922 17 374 525 263 -- 2,101 --------- --------- --------- --------- --------- ------- ---------- 524 167 412 775 71 10 1,959 Provision for credit losses (3) 81 22 (26) (95) 1 -- (17) --------- --------- --------- --------- --------- ------- ---------- Income before income tax expense $ 443 $ 145 $ 438 $ 870 $ 70 $ 10 $ 1,976 ========= ========= ========= ========= ========= ======= ========== Average loans .................. $ 36,847 $ 4,257 $ 12,287 $ 4,152 $ 2,785 $ -- $ 60,328 Average assets ................. 40,943 4,256 14,009 48,689 4,029 300 112,226 Average deposits ............... 24,145 3,998 9,535 27,508 7,667 -- 72,853 Average liabilities/ equity (4) 34,052 (2) 14,783 54,442 8,951 -- 112,226 Goodwill at December 31, 2004 (5) 1,167 -- 471 631 428 -- 2,697 (1) Net interest income of each segment represents the difference between actual interest earned on assets and interest paid on liabilities of the segment adjusted for a funding charge or credit. Segments are charged a cost to fund assets (e.g. customer loans) and receive a funding credit for funds provided (e.g. customer deposits) based on equivalent market rates. (2) Expenses for the segments include fully apportioned corporate overhead expenses. (3) The provision apportioned to the segments is based on the segments' net charge offs and the change in allowance for credit losses. (4) Common shareholder's equity and earnings on common shareholder's equity are allocated back to the segments based on the percentage of capital assigned to the business. (5) During 2006, a deferred tax asset related to a previous acquisition was adjusted against the related goodwill balance, resulting in a $22 million increase in goodwill (refer to Note 12 on page 125 of this Form 10-K). The reduction in goodwill from December 31, 2004 to December 31, 2005 resulted from the sale of certain branches during 2005. Note 25. Collateral, Commitments and Contingent Liabilities-------------------------------------------------------------------------------- Pledged Assets The following table presents pledged assets included in the consolidated balancesheet. --------------------------------------------------------------------------------December 31 2006 2005-------------------------------------------------------------------------------- (in millions) Interest bearing deposits with banks ................. $ 764 $ 483Trading assets (1) ................................... 2,961 1,452Securities available for sale (2) .................... 6,775 6,369Securities held to maturity .......................... 273 446Loans (3) ............................................ 8,426 7,807Other assets (4) ..................................... 849 687 ---------- ----------Total ................................................ $ 20,048 $ 17,244 ========== ========== (1) Trading assets are primarily pledged against liabilities associated with consolidated variable interest entities (refer to Note 26). (2) Securities available for sale are primarily pledged against various short-term borrowings. (3) Loans are primarily private label credit card receivables pledged against long-term borrowings and residential mortgage loans pledged against long-term borrowings from the Federal Home Loan Bank (refer to Note 14). (4) Other assets represent cash on deposit with non-banks related to derivative collateral support agreements. Debt securities pledged as collateral that can be sold or repledged by thesecured party continue to be reported on the consolidated balance sheet. Thefair value of securities available for sale that can be sold or repledged was$2,289 million and $2,152 million at December 31, 2006 and 2005, respectively. 148 The fair value of collateral accepted by HUSI not reported on the consolidatedbalance sheet that can be sold or repledged was $8,161 million and $5,800million at December 31, 2006 and 2005, respectively. This collateral wasobtained under security resale agreements. Of this collateral, $781 million and$1,158 million has been sold or repledged as collateral under repurchaseagreements or to cover short sales at December 31, 2006 and 2005, respectively. Lease Obligations HUSI and its subsidiaries are obligated under a number of noncancellable leasesfor premises and equipment. Certain leases contain renewal options andescalation clauses. Expected minimum lease payments under noncancellableoperating leases as of December 31, 2006, net of sublease rentals, aresummarized in the following table. -------------------------------------------------------------------------------- (in millions) Expected minimum future payments:2007 .............................................................. $ 812008 .............................................................. 712009 .............................................................. 642010 .............................................................. 562011 .............................................................. 48Thereafter ........................................................ 189 ---------- $ 509 ========== Litigation HUSI is named in and is defending legal actions in various jurisdictions arisingfrom its normal business. None of these proceedings is regarded as materiallitigation. In addition, there are certain proceedings related to the "PrincetonNote Matter" that are described below. In relation to the Princeton Note Matter, as disclosed in HUSI's 2002 AnnualReport on Form 10-K, two of the noteholders were not included in the settlementand their civil suits are continuing. The U.S. Government excluded one of themfrom the restitution order (Yakult Honsha Co., Ltd.) because a senior officer ofthe noteholder was being criminally prosecuted in Japan for his conduct relatingto its Princeton Notes. The senior officer in question was convicted duringSeptember 2002 of various criminal charges related to the sale of the PrincetonNotes. The U.S. Government excluded the other noteholder (Maruzen Company,Limited) because the sum it is likely to recover from the Princeton Receiverexceeds its losses attributable to its funds transfers with Republic New YorkSecurities Corporation, as calculated by the U.S. Government. Both of thesecivil suits seek compensatory, punitive, and treble damages pursuant to RICO andassorted fraud and breach of duty claims arising from unpaid Princeton Noteswith face amounts totaling approximately $125 million. No amount of compensatorydamages is specified in either complaint. These two complaints name HUSI, HBUS,and Republic New York Securities Corporation as defendants. HUSI and HBUS havemoved to dismiss both complaints. The motion is fully briefed and sub judice.Mutual production of documents took place in 2001, but additional discoveryproceedings have been suspended pending the Court's resolution of the motions todismiss. 149 Note 26. Off-Balance Sheet Financial Guarantee Arrangements-------------------------------------------------------------------------------- The following table provides information related to off-balance sheet financialguarantee arrangements. --------------------------------------------------------------------------------December 31 2006 2005-------------------------------------------------------------------------------- (in millions) Standby letters of credit, net of participations (1) .. $ 7,259 $ 6,114Loan sales with recourse (2) .......................... 8 9Credit derivative contracts (3) ....................... 431,631 222,419Securities lending indemnifications ................... - 4,135 ---------- ----------Total ................................................. $ 438,898 $ 232,677 ========== ========== (1) Includes $542 million and $523 million issued for the benefit of HSBC affiliates at December 31, 2006 and 2005, respectively. (2) $7 million of this amount is indemnified by HSBC affiliates at December 31, 2006 and 2005, respectively. (3) Includes $71,908 million and $51,202 million issued for the benefit of HSBC affiliates at December 31, 2006 and 2005, respectively. Standby Letters of Credit HUSI may issue a letter of credit for the benefit of a customer, authorizing athird party to draw on the letter for specified amounts under certain terms andconditions. The issuance of a letter of credit is subject to HUSI's creditapproval process and collateral requirements. A standby letter of credit is issued to third parties for the benefit of acustomer and is essentially a guarantee that the customer will perform, orsatisfy some obligation, under a contract. It irrevocably obligates HUSI to paya third party beneficiary when a customer either: (1) in the case of aperformance standby letter of credit, fails to perform some contractualnon-financial obligation, or (2) in the case of a financial standby letter ofcredit, fails to repay an outstanding loan or debt instrument. Fees are charged for issuing letters of credit commensurate with the customer'scredit evaluation and the nature of any collateral. Included in otherliabilities are deferred fees on standby letters of credit, representing thefair value of the "stand ready obligation to perform" under these guarantees,amounting to $21 million and $19 million at December 31, 2006 and 2005,respectively. Also included in other liabilities is an allowance for creditlosses on unfunded standby letters of credit of $25 million and $20 million atDecember 31, 2006 and 2005, respectively. Loan Sales with Recourse HUSI securitizes and sells assets, generally without recourse. In prior years,HUSI's mortgage banking subsidiary sold residential mortgage loans with recourseupon borrower default, with partial indemnification from third parties. Credit Derivatives HUSI enters into credit derivative contracts primarily to satisfy the needs ofits customers and, in certain cases, for its own benefit. Credit derivatives arearrangements that provide for one party (the "protection buyer") to transfer thecredit risk of a "reference asset" to another party (the "protection seller").Under this arrangement the protection seller assumes the credit risk associatedwith the reference asset without directly purchasing it. The protection buyeragrees to pay a specified fee to the protection seller. In return, theprotection seller agrees to pay the protection buyer an agreed upon amount ifthere is a default during the term of the contract. In accordance with its policy, HUSI offsets most of the risk it assumes inselling credit protection through a credit derivative contract with anothercounterparty. Credit derivatives are recorded at fair value. The commitmentamount included in the table is the maximum amount that HUSI could be requiredto pay, without consideration of the approximately equal amount receivable fromthird parties and any associated collateral. 150 Securities Lending Indemnifications Through December 31, 2005, HUSI occasionally lent securities of customers, on afully collateralized basis, as an agent to third party borrowers. Customers wereindemnified against the risk of loss, and collateral was obtained from theborrower with a market value exceeding the value of the loaned securities.Securities lending activities were terminated during the first quarter of 2006. Note 27. Variable Interest Entities (VIEs)-------------------------------------------------------------------------------- HUSI, in the ordinary course of business, makes use of VIE structures in avariety of business activities, primarily to facilitate client needs. VIEstructures are utilized after careful consideration of the most appropriatestructure needed to achieve HUSI's control and risk management objectives and tohelp ensure an efficient and appropriate structure from a regulatory andtaxation perspective. Consolidated VIEs HUSI entered into a series of transactions with VIEs organized by HSBCaffiliates and unrelated third parties. These VIEs were structured as trusts orcorporations that issue fixed or floating rate instruments backed by the assetsof the issuing entities. HUSI sold trading assets to the VIEs and subsequentlyentered into total return swaps with the VIEs whereby HUSI receives the totalreturn on the transferred assets and, in return, pays a market rate of return toits counterparties. HUSI has determined that it is the primary beneficiary ofthese VIEs under the applicable accounting literature and, accordingly,consolidated $2.6 billion in trading assets at December 31, 2006. These assetsare pledged as collateral for obligations of the VIEs, which are included inlong-term debt (refer to Note 15 on page 126 of this Form 10-K). The holdersof the instruments issued by the VIEs have no recourse to the general credit ofHUSI beyond the assets sold to the VIEs and pledged as collateral. Unconsolidated VIEs HUSI also holds variable interests in various other VIEs which are notconsolidated at December 31, 2006. HUSI is not the primary beneficiary of theseVIE structures. Information for unconsolidated VIEs is presented in thefollowing table and commentary. ----------------------------------------------------------------------------------------------- December 31, 2006 December 31, 2005 ---------------------- -------------------- Maximum Maximum Total Exposure Total Exposure Assets to Loss Assets to Loss----------------------------------------------------------------------------------------------- (in millions) Asset backed commercial paper conduits ........ $ 14,104 $ 8,048 $ 10,183 $ 7,423Securitization vehicles ....................... 2,242 612 1,774 565Investment funds .............................. 200 2 2,513 --Capital funding vehicles ...................... 1,093 32 1,093 32Low income housing tax credits ................ 406 153 1,080 165 ---------- --------- --------- --------Total ......................................... $ 18,045 $ 8,847 $ 16,643 $ 8,185 ========== ========= ========= ======== Asset Backed Commercial Paper Conduits HSBC affiliates support the financing needs of customers by facilitating theiraccess to the commercial paper markets. Specifically, pools of customers'assets, typically trade receivables, are sold to an independently rated,commercial paper financing entity, which in turn issues short-term, asset backedcommercial paper that is collateralized by such assets. Neither the HSBCaffiliates nor HUSI service the assets or transfer their own receivables intothe financing entities. HUSI and other banks provide one year liquidity facilities, in the form ofeither loan or asset purchase commitments, in support of each transaction in thefinancing entity. HUSI does not provide any program wide enhancements to thefinancing entities. In the preceding table, HUSI's maximum exposure to loss isthe total notional amount of the liquidity facilities. 151 In the normal course of business, HUSI provides liquidity facilities to assetbacked commercial paper conduits sponsored by unrelated third parties. HUSI doesnot transfer its own receivables into the financing entity, has no ownershipinterest in, performs no administrative duties for, and does not service anyassets of these conduits. The only interest HUSI has in these entities areliquidity facilities in the amount of approximately $1.5 billion and $1.4billion at December 31, 2006 and 2005, respectively. These facilities areexcluded from the table summarizing HUSI's involvement in VIEs. Credit risk is managed on these commitments by subjecting them to HUSI's normalunderwriting and risk management processes. Securitization Vehicles An HSBC affiliate and third parties organize trusts that are special purposeentities (SPEs) that issue fixed or floating rate debt backed by the assets ofthe trusts. Neither the HSBC affiliate nor HUSI transfer their own assets intothe trusts. HUSI's relationship with the SPEs is primarily as counterparty tothe SPEs' derivative transactions (interest rate, credit default and currencyswaps). HUSI's maximum exposure to loss from the unconsolidated trust entitiesis comprised of investments in the trust and the market risk on the derivativetransactions. Investment Funds HUSI is a derivative counterparty (total return swap) with a hedge fundestablished by an unrelated third party. The total return swap creates avariable interest in the fund for HUSI. HUSI does not hold shares in or have anyother involvement with the fund. As such, HUSI is not the primary beneficiary. HUSI is also an investor in a hedge fund established by an unrelated thirdparty. The shares owned by HUSI do not have voting rights but do participate inprofits and losses based on percentage of share ownership. HUSI does not holdsufficient beneficial interests in the fund to be considered the primarybeneficiary. HUSI is a sub-investment advisor to mutual funds structured as trusts andmanaged by an HSBC affiliate. As sub-investment advisor, HUSI receives avariable fee based on the value of funds. HUSI has no ownership interest in orcredit exposure resulting from its duties as investment advisor. During 2006,the assets of certain of these trusts were liquidated, resulting insignificantly reduced assets to manage. Capital Funding Vehicles Prior to 2005, HUSI established five Capital Trust entities. These trusts issuepreferred securities and common stock. HUSI purchased all of the common equityissued by the trusts, which equates to approximately 3% of the total assets ofthe trusts. HUSI does not own any of the preferred securities issued by thetrusts. It has been determined that the majority of the benefit of profit and/orrisk of loss lies with the preferred security holders. Thus, HUSI is not theprimary beneficiary of the trusts and is not required to consolidate theseentities. Low Income Housing Tax Credits HUSI participates as a limited partner in Low Income Housing Tax CreditPartnerships. These investments are recorded as other assets on the consolidatedbalance sheet using the equity method of accounting. HUSI also receives taxbenefits over a period of time specified in the investment contracts. HUSI'sinvestment is reduced over time for its share of any operating losses incurredby the partnership as well as for any amortization over the time period in whichtax credits are received. Tax credits may be subject to recapture if theunderlying properties do not remain in compliance with certain conditions. Someof these partnerships have been determined to be VIEs. HUSI's maximum exposureto loss shown in the table represents the net assets recorded on the balancesheet, estimated expected reduction of future tax liabilities, and potentialrecapture of tax credits allowed in prior years. 152 Note 28. Fair Value of Financial Instruments-------------------------------------------------------------------------------- HUSI is required to disclose the estimated fair value of its financialinstruments in accordance with Statement of Financial Accounting Standards No.107, Disclosures about Fair Value of Financial Instruments (SFAS 107). Thedisclosures do not attempt to estimate or represent the fair value of HUSI as awhole. The disclosures exclude assets and liabilities that are not financialinstruments, including intangible assets, such as goodwill. The estimationmethods and assumptions used by HUSI to value individual classifications offinancial instruments are described below. Different assumptions couldsignificantly affect the estimates. Accordingly, the net realizable values uponliquidation of the financial instruments could be materially different from theestimates presented. Financial instruments with carrying value equal to fair value - The carryingvalue of certain financial assets and liabilities is considered to be equal tofair value as a result of their short-term nature and interest rates thatapproximate market rates. These items include cash and due from banks, interestbearing deposits with banks, federal funds sold and securities purchased underresale agreements, accrued interest receivable, customers' acceptance liabilityand certain financial liabilities including acceptances outstanding, short-termborrowings and interest, taxes, and other liabilities. Trading account assets and liabilities and derivative instruments included inother assets and other liabilities - Trading account assets and liabilities,including derivative trading accounts (see Note 5 of the consolidated financialstatements), and derivative accounts included in other assets and otherliabilities are recorded at fair value. Fair value is based on current marketquotations, where available. If quoted market prices are not available, fairvalue is estimated based on the quoted price of similar instruments or internalvaluation models that approximate market pricing. Securities - The fair value of securities contracts is based on current marketquotations, where available. If quoted market prices are not available, fairvalue is estimated based on the quoted price of similar instruments or internalvaluation models that approximate market pricing. Available for sale securitiesare recorded at fair value on the consolidated balance sheet, while held tomaturity securities are generally recorded at historical cost. The cost and fairvalues of securities are reported in Note 6 of the consolidated financialstatements. Loans - The fair value of the loan portfolio is determined primarily bycalculating the present value of expected cash flows using discount rates thatapproximate current market rates for similar loans and adjusting for inherentcredit risk. The loans are grouped, to the extent possible, into homogeneouspools, segregated by maturity, weighted average maturity and average couponrate. Depending upon the type of loan involved, maturity assumptions are basedon either the contractual or expected maturity date. Deposits - The fair value of demand, savings and money market depositsapproximate their carrying value. For deposits with fixed maturities, fair valueis estimated using market interest rates currently offered on deposits withsimilar characteristics and maturities. Long-term debt - The fair values of various debt instruments are estimated usingmarket interest rates currently available for borrowings with similarcharacteristics and maturities. 153 The following table includes certain financial instruments where the carryingvalue does not equal or approximate fair value. -------------------------------------------------------------------------------------------- 2006 2005 ----------------------- ----------------------- Carrying Fair Carrying FairDecember 31 Value Value Value Value-------------------------------------------------------------------------------------------- (in millions) Financial assets: Securities held to maturity ......... $ 2,972 $ 3,040 $ 3,171 $ 3,262 Loans, net of allowance ............. 89,340 88,314 89,496 88,467 Financial liabilities: Deposits: Without fixed maturities ......... 88,474 88,474 77,924 77,924 Fixed maturities ................. 16,076 16,060 13,891 13,889 Long-term debt ...................... 29,252 29,525 29,595 30,084 The fair value of commitments to extend credit, standby letters of credit andfinancial guarantees, is not included in the previous table. These instrumentsgenerate fees, which approximate those currently charged to originate similarcommitments. Note 29. Financial Statements of HSBC USA Inc. (Parent)-------------------------------------------------------------------------------- Condensed parent company financial statements follow. ---------------------------------------------------------------------------------------------Balance SheetDecember 31 2006 2005--------------------------------------------------------------------------------------------- (in millions) Assets:Interest bearing deposits with banks ............................. $ 65 $ 65Trading assets ................................................... 1,352 584Securities purchased under resale agreements ..................... 71 6Securities available for sale .................................... 238 157Securities held to maturity (fair value $114 and $136) ........... 108 128Loans (net of allowance for credit losses of $2 and $1) .......... 23 43Receivables from subsidiaries .................................... 4,169 4,832Receivables from other HSBC affiliates ........................... 82 88Investment in subsidiaries at amount of their net assets: Banking ....................................................... 12,258 11,888 Other ......................................................... 501 403Goodwill ......................................................... 604 604Other assets ..................................................... 196 158 ----------- ----------Total assets ..................................................... $ 19,667 $ 18,956 =========== ========== Liabilities:Interest, taxes and other liabilities ............................ $ 192 $ 66Payables due to subsidiaries ..................................... 464 81Short-term borrowings ............................................ 2,414 2,620Long-term debt (1) ............................................... 4,336 4,595 ----------- ----------Total liabilities ................................................ 7,406 7,362Shareholders' equity * ........................................... 12,261 11,594 ----------- ----------Total liabilities and shareholders' equity ....................... $ 19,667 $ 18,956 =========== ========== * See Consolidated Statement of Changes in Shareholders' Equity, page 96. (1) Contractual scheduled maturities for the debt over the next five years are as follows: 2007, $148 million; 2008, $244 million; 2009, $555 million; 2010, $1 million; and 2011, $1,613 million. 154 ----------------------------------------------------------------------------------------------------------Statement of IncomeYear Ended December 31 2006 2005 2004---------------------------------------------------------------------------------------------------------- (in millions) Income: Dividends from banking subsidiaries ................................... $ 855 $ 675 $ 125 Dividends from other subsidiaries ..................................... 2 2 2 Interest from subsidiaries ............................................ 240 168 105 Interest from other HSBC affiliates ................................... 5 16 5 Other interest income ................................................. 26 14 14 Securities transactions ............................................... (1) 13 4 Other income .......................................................... 189 35 91 ------- ------- --------Total income .............................................................. 1,316 923 346 ------- ------- --------Expenses: Interest (including $86 paid to subsidiaries in 2004) ................. 437 350 240 Provision for credit losses ........................................... -- -- 3 Other expenses ........................................................ 17 17 20 ------- ------- --------Total expenses ............................................................ 454 367 263 ------- ------- --------Income before taxes and equity in undistributed income of subsidiaries .... 862 556 83Income tax expense (benefit) .............................................. 10 (40) (21) ------- ------- --------Income before equity in undistributed income of subsidiaries .............. 852 596 104Equity in undistributed income of subsidiaries ............................ 184 380 1,154 ------- ------- --------Net income ................................................................ $ 1,036 $ 976 $ 1,258 ======= ======= ======== ----------------------------------------------------------------------------------------------------------Statement of Cash FlowsYear Ended December 31 2006 2005 2004---------------------------------------------------------------------------------------------------------- (in millions) Cash flows from operating activities: Net income .............................................................. $ 1,036 $ 976 $ 1,258 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and deferred taxes ......................... 2 (3) 13 Provision for credit losses ........................................... -- -- 3 Net change in other accrued accounts .................................. 74 (77) 137 Net change in fair value of non-trading derivatives ................... 39 5 (27) Undistributed income of subsidiaries .................................. (184) (380) (1,154) Other, net ............................................................ (465) (291) (53) ------- ------- -------- Net cash provided by operating activities ........................... 502 230 177 ------- ------- --------Cash flows from investing activities: Net change in interest bearing deposits with banks ...................... 451 (1,930) (738) Purchases of securities ................................................. (85) (174) (11) Sales and maturities of securities ...................................... 19 58 41 Net originations and maturities of loans ................................ 342 414 (435) Net change in investments in and advances to subsidiaries ............... (477) (490) (1,510) Other, net .............................................................. (83) 181 (65) ------- ------- -------- Net cash provided by (used in) investing activities ................. 167 (1,941) (2,718) ------- ------- --------Cash flows from financing activities: Net change in short-term borrowings ..................................... (206) 140 733 Issuance of long-term debt, net of issuance costs ....................... -- 1,497 -- Repayment of long-term debt ............................................. (300) (3) (424) Dividends paid .......................................................... (543) (720) (148) Reductions of capital surplus ........................................... (9) (22) (20) Preferred stock issuance, net of redemptions ............................ 374 816 -- Capital contribution from HNAI .......................................... 15 3 2,400 ------- ------- --------Net cash (used in) provided by financing activities ....................... (669) 1,711 2,541 ------- ------- --------Net change in cash and due from banks ..................................... -- -- --Cash and due from banks at beginning of year .............................. -- -- -- ------- ------- --------Cash and due from banks at end of year .................................... $ -- $ -- $ -- ======= ======= ======== Cash paid for: Interest ................................................................ $ 428 $ 349 $ 237 ======= ======= ======== HBUS is subject to legal restrictions on certain transactions with its nonbankaffiliates in addition to the restrictions on the payment of dividends to HUSI.See Note 18 on page 133 for further discussion. 155 Quarterly Results of Operations (Unaudited)-------------------------------------------------------------------------------- The following table presents a quarterly summary of selected financialinformation. ---------------------------------------------------------------------------------------------------------Quarter Ended December 31 September 30 June 30 March 31--------------------------------------------------------------------------------------------------------- (in millions) 2006Net interest income ................................. $ 794 $ 777 $ 775 $ 735 ----------- ------------ --------- --------Trading revenues .................................... 155 52 269 279Residential mortgage banking revenue ................ 40 6 27 23Securities gains, net ............................... 13 6 6 4Other income ........................................ 410 550 371 352 ----------- ------------ --------- --------Total other revenues ................................ 618 614 673 658 ----------- ------------ --------- --------Operating expenses .................................. 876 819 775 785Provision for credit losses ......................... 237 207 222 157 ----------- ------------ --------- --------Income before income tax expense .................... 299 365 451 451Income tax expense .................................. 101 121 165 143 ----------- ------------ --------- --------Net income .......................................... $ 198 $ 244 $ 286 $ 308 =========== ============ ========= ======== 2005Net interest income ................................. $ 742 $ 761 $ 785 $ 775 ----------- ------------ --------- --------Trading revenues .................................... 127 137 35 96Residential mortgage banking revenue (expense) ...... 23 31 (13) 23Securities gains, net ............................... 2 17 64 23Other income ........................................ 362 320 327 337 ----------- ------------ --------- --------Total other revenues ................................ 514 505 413 479 ----------- ------------ --------- --------Operating expenses .................................. 746 673 684 655Provision for credit losses ......................... 198 199 170 107 ----------- ------------ --------- --------Income before income tax expense .................... 312 394 344 492Income tax expense .................................. 116 142 131 177 ----------- ------------ --------- --------Net income .......................................... $ 196 $ 252 $ 213 $ 315 =========== ============ ========= ======== 156 Item 9. Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure-------------------------------------------------------------------------------- There were no disagreements on accounting and financial disclosure mattersbetween HUSI and its independent accountants during 2006. Item 9A. Controls and Procedures-------------------------------------------------------------------------------- HUSI maintains a system of internal and disclosure controls and proceduresdesigned to ensure that information required to be disclosed in reports filed orsubmitted under the Securities Exchange Act of 1934, as amended, (the ExchangeAct), is recorded, processed, summarized and reported on a timely basis. HUSI'sBoard of Directors, operating through its Audit Committee, which is composedentirely of independent outside directors, provides oversight to the financialreporting process. An evaluation was conducted, with the participation of the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of HUSI's disclosurecontrols and procedures as of the end of the period covered by this report.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that HUSI's disclosure controls and procedures were effectiveas of the end of the period covered by this report, so as to alert them in atimely fashion to material information required to be disclosed in reports filedunder the Exchange Act. There have been no significant changes in HUSI's internal controls or in otherfactors that could significantly affect internal and disclosure controlssubsequent to the date that the evaluation was carried out. HUSI continues the process to complete a thorough review of its internalcontrols as part of its preparation for compliance with the requirements ofSection 404 of the Sarbanes-Oxley Act of 2002 (Section 404). Section 404requires management to report on, and external auditors to attest to, theeffectiveness of HUSI's internal controls structure and procedures for financialreporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act,HUSI's first report under Section 404 will be contained in its Form 10-K for theperiod ended December 31, 2007. Item 9B. Other Information-------------------------------------------------------------------------------- None. 157 PART III Item 10. Directors, Executive Officers and Corporate Governance-------------------------------------------------------------------------------- Directors Set forth below is certain biographical information relating to the members ofHUSI's Board of Directors as of February 21, 2007. Each director is electedannually. There are no family relationships among the directors. Salvatore H. Alfiero, age 69, joined the HUSI Board in 2000, the HBUS Board in1996 and the HNAH Board in 2005. Mr. Alfiero has been the Chairman and ChiefExecutive Officer of Protective Industries, LLC since 2001. He is also adirector of Phoenix Companies, Inc., Southwire Company and Fresh Del MonteProduce Company. Mr. Alfiero is Chair of the Audit Committee and a member of the Nominating &Governance Committee. Donald K. Boswell, age 55, joined the HUSI and HBUS Boards in 2002. Mr. Boswellhas been the President and Chief Executive Officer of Western New York PublicBroadcasting Association since 1998, and has been in public broadcasting since1977. Mr. Boswell is a member of the Fiduciary Committee and the Human Resources &Compensation Committee. James H. Cleave, age 64, joined the HUSI and HBUS Boards in 1991. Mr. Cleave wasthe President and Chief Executive Officer of HUSI and HBUS from 1993 through1997. Prior to that, he was President and Chief Executive Officer of HSBC BankCanada and is currently a director and Vice Chairman of HSBC Bank Canada. Mr. Cleave is a member of the Audit Committee and the Executive Committee. Dr. Frances D. Fergusson, age 62, joined the HBUS Board in 1990 and the HUSIBoard in 2000. She is President Emeritus of Vassar College and served asPresident from 1986 to 2006. Prior to that, Dr. Fergusson was Provost and VicePresident for Academic Affairs, Bucknell University. Dr. Fergusson is also adirector of Wyeth Pharmaceuticals and Mattel, Inc., and a member of the Board ofOverseers of Harvard University. Dr. Fergusson is the Chair of the Human Resources & Compensation Committee and amember of the Nominating & Governance Committee and the Executive Committee. Michael F. Geoghegan, age 53, joined the HUSI and HBUS Boards as Chairman inSeptember 2006. He joined HSBC in 1973 and has been an executive director ofHSBC since 2004 and the HSBC Group Chief Executive since May 2006. Mr. Geogheganserved as Chief Executive of HSBC Bank plc from January 2004 to March 2006. Heis a director and Deputy Chairman of HSBC Bank plc and a director of TheHongkong and Shanghai Banking Corporation Limited and HSBC France. Mr. Geogheganis also a non-executive director and Chairman of Young Enterprise UK. Stuart T. Gulliver, age 47, joined the HUSI and HBUS Boards in September 2006.He has been the Chief Executive, CIBM and Group Investment businesses for HSBCsince May 2006. Mr. Gulliver was appointed as a Group Managing Director and tothe Group Management Board in 2004. He served as a Group General Manager from2000 to 2004. Mr. Gulliver joined HSBC in 1980 and has held a number of keyroles in various treasury and capital markets businesses, most recently asCo-Head of Corporate, Investment Banking and Markets from 2003 to 2006 and Headof Global Markets from 2002 to 2003. He is also a director of HSBC Bank plc andThe Hongkong and Shanghai Banking Corporation Limited. 158 Richard A. Jalkut, age 62, joined the HUSI Board in 2000 and the HBUS Board in1992. Mr. Jalkut is the President and Chief Executive Officer of TelepacificCommunications. He was a director of Birch Telecom, Inc. until June 2006.Formerly, he was the President and Chief Executive of Pathnet and, prior tothat, President and Group Executive, NYNEX Telecommunications. Mr. Jalkut isalso a director of IKON Office Solutions and Covad Communications. Mr. Jalkut has been Lead Director of HUSI and HBUS since January 2005. He is thechair of the Executive Committee, the Chair of the Nominating & GovernanceCommittee and a member of the Audit Committee. Peter Kimmelman, age 62, joined the HUSI and HBUS Boards in 2000. Mr. Kimmelmanis a private investor and managing member of Peter Kimmelman Asset Management,LLC, an investment advisory firm registered with the Securities and ExchangeCommission. He was formerly a director of Republic New York Corporation andRepublic National Bank of New York from 1976 until 1999. Mr. Kimmelman is a member of the Audit Committee. Paul J. Lawrence, age 45, joined the HUSI and HBUS Boards and was appointedPresident and Chief Executive Officer of HUSI and HBUS as of February 21, 2007.Mr. Lawrence joined HSBC in 1982 and has held numerous positions in Asia and theUnited Kingdom. He was appointed Head of CIBM, North America for HUSI and HBUSas of October 1, 2006. Mr. Lawrence held the position of Chief ExecutiveOfficer, The Hongkong and Shanghai Banking Corporation Limited, Singapore from2002 through September 2006 and, prior to that, served as Chief ExecutiveOfficer of The Hongkong and Shanghai Banking Corporation Limited, Philippines.Mr. Lawrence has been an HSBC Group General Manager since 2005. Mr. Lawrence is a member of the Executive Committee. Charles G. Meyer, Jr., age 69, joined the HUSI and HBUS Boards in 2000. Mr.Meyer is an architect and former President of Cord Meyer Development Company.Mr. Meyer was formerly a director of Republic National Bank of New York from1987 until 1999. Mr. Meyer is the Chair of the Fiduciary Committee and a member of the Nominating& Governance Committee. James L. Morice, age 69, joined the HUSI and HBUS Boards in 2000. Mr. Morice hasbeen the President and Chief Executive Officer of Morice Consulting, LLC,successor to the JLM Group, LLC, a management consulting firm, since 2006. Hewas previously Executive Vice President and Director of NationsBuildersInsurance Services, Inc. Mr. Morice was a director of Republic New YorkCorporation and Republic National Bank of New York from 1987 until 1999 and amember of the Human Resources Committee of the University of New Haven from 2003through 2005. Mr. Morice is a member of the Fiduciary Committee and the Human Resources &Compensation Committee. 159 Executive Officers-------------------------------------------------------------------------------- Information regarding the executive officers of HUSI as of February 21, 2007 ispresented in the following table. YearName Age Appointed Present Position with HUSI------------------------------------------------------------------------------------------------------------------- Paul J. Lawrence 45 2006 President and Chief Executive OfficerKevin Newman 49 2007 Group General Manager, Personal Financial ServicesJanet L. Burak 51 2004 Senior Executive Vice President, General Counsel and SecretaryRobert M. Butcher 63 1988 Senior Executive Vice President & Chief Risk OfficerChristopher Davies 45 2007 Senior Executive Vice President, Commercial BankingDavid Dew 51 2006 Senior Executive Vice President & Chief Administrative OfficerMark A. Hershey 54 2007 Senior Executive Vice President, Co-Head Chief Credit OfficerDavid C. Kotheimer 49 2007 Senior Executive Vice President, Business PerformanceJohn J. McKenna 47 2005 Senior Executive Vice President & Chief Financial OfficerGeorge T. Wendler 62 2000 Senior Executive Vice President, Co-Head Chief Credit OfficerJeanne G. Ebersole 45 2004 Executive Vice President, Human ResourcesTeresa A. Pesce 47 2005 Executive Vice President & Anti-Money Laundering (AML) DirectorCarolyn M. Wind 53 2005 Executive Vice President, ComplianceMarlon Young 51 2006 Managing Director, Chief Executive Officer Private Bank AmericasClive R. Bucknall 43 2006 Executive Vice President & Controller------------------------------------------------------------------------------------------------------------------- Kevin Newman, Group General Manager, Personal Financial Services since October2006. Mr. Newman served as Senior Executive Vice President, Personal FinancialServices from September 2005 to October 2006 and as Executive Vice President,Personal Financial Services from December 2003 to September 2005. Prior to that,he served as Head of hsbc.com. Janet L. Burak, Senior Executive Vice President, General Counsel and Secretaryfor HUSI and HBUS since April 2004. Ms. Burak served as an attorney with HSBCFinance Corporation for twelve years, most recently as Group General Counsel.Prior to joining HSBC Finance Corporation, she was an associate with Shearman &Sterling and an attorney with Citigroup. Robert M. Butcher, Senior Executive Vice President & Chief Risk Officer for HUSIand HBUS since May 2003. Mr. Butcher was Chief Financial Officer of HUSI andHBUS from 1990 to 2003. Prior to joining HBUS's predecessor, Marine MidlandBank, in 1988, Mr. Butcher was with Citicorp for 15 years where he held varioussenior officer positions in the corporate finance department. Christopher Davies, Senior Executive Vice President, Commercial Banking sinceFebruary 2007. Prior to this appointment, Mr. Davies was Head of Corporate andInstitutional Banking with HSBC Securities (USA) Inc. from 2004 to February2007. From 2003 to 2004, he was Head of Client Service and Marketing, Global CIBwith HSBC Bank plc, and from 2000 to 2003 he was Credit & Banking ServicesDirector with First Direct, Leeds. Mr. Davies has held various senior officerpositions in credit, treasury and retail and commercial banking since joiningMidland Bank plc, now known as HSBC Bank plc, in 1985. David Dew, Senior Executive Vice President & Chief Administrative Officer sinceFebruary 2007. He served as Senior Executive Vice President, Audit for HUSI andHSBC North America Inc. (HNAI) from January 2006 to February 2007. Prior to thisappointment, Mr. Dew served as Chief Auditor, Group Audit, HSBC FinanceCorporation from November 2004 to December 2005. He was Executive Director &Chief Operating Officer, The Saudi British Bank, Riyadh, Saudi Arabia from March2001 to November 2004; Deputy Chief Executive Officer, The Hongkong and ShanghaiBanking Corporation Limited, Singapore from September 1997 to March 2001; andChief Executive Officer, HSBC Bank plc, Milan, Italy from November 1994 toSeptember 1997. Mr. Dew has been an HSBC employee since 1977. 160 Mark A. Hershey, Senior Executive Vice President, Co-Head Chief Credit Officersince February 2007. Prior to this appointment Mr. Hershey was Senior ExecutiveVice President, Commercial Banking since 2005 and Executive Vice President,Commercial Banking from 2000 to 2005. Mr. Hershey was a senior officer ofRepublic National Bank of New York when it was acquired by HSBC in December1999. David C. Kotheimer, Senior Executive Vice President, Business Performance sinceDecember 2006. Mr. Kotheimer served as Senior Executive Vice President,Tri-State, of HBUS from May 2006 to December 2006 and as an Executive VicePresident, Metro New York, of HBUS from November 2000 to May 2006. Since joiningHSBC in 1987, Mr. Kotheimer has held a variety of senior officer positions incommercial banking, human resources and personal financial services. John J. McKenna, Senior Executive Vice President and Chief Financial Officer ofHUSI since October 2005. Prior to this appointment, Mr. McKenna served as ChiefFinancial Officer, HSBC Mexico, S.A. from November 2002 through September 2005.From July 2000 to October 2002, he held the position of Senior Vice Presidentand Director of Financial Management for HUSI. Since joining HSBC in 1986, Mr.McKenna has held a variety of financial management positions focusing onstrategic planning, business controllership and management information. George T. Wendler, Senior Executive Vice President, Co-Head Chief Credit Officerof HUSI since February 2007. Prior to this appointment, Mr. Wendler was ChiefCredit Officer of HUSI from January 2000 to February 2007, and he was ChiefCredit Officer and a member of the Senior Management Committee of Republic NewYork Corporation when it was acquired by HSBC in December 1999. Mr. Wendler wasalso a director and Vice Chairman of Republic New York Corporation from 1997 to1999. Jeanne G. Ebersole, Executive Vice President, Human Resources since May 2004.Prior to this appointment, Ms. Ebersole had overall human resourcesresponsibility for HSBC Finance Corporation's retail services, insuranceservices and refund lending businesses since August 2002. She held a variety ofhuman resources positions after joining HSBC Finance Corporation in 1980. Teresa A. Pesce, Executive Vice President and Anti-Money Laundering (AML)Director since September 2003. In 2004 she was appointed the AML Director forall HSBC businesses in North America. Ms. Pesce joined HUSI from the UnitedStates Attorney's Office, Southern District of New York where she was SeniorTrial Counsel, White Plains Division and previously Chief of the Major CrimesUnit and Deputy Chief of the Criminal Division. From 1992 to 1999 she served asa Line Assistant in the Major Crimes, Narcotics, and General Crimes Units. Carolyn M. Wind, Executive Vice President, Compliance, was the Chief ComplianceOfficer for Republic New York Corporation when it was acquired by HSBC inDecember 1999. Prior to joining Republic New York Corporation, she was a seniornational bank examiner with the Office of the Comptroller of the Currency (OCC). Marlon Young, Managing Director, CEO Private Bank Americas since October 2006.Mr. Young joined HSBC as Managing Director and Head of Domestic Private Bankingfor HBUS in March 2006. He served as Managing Director and Head of PrivateClient Lending for Smith Barney from 2004 through 2006. Prior to that, Mr. Youngheld various positions with Citigroup from 1979, most recently as ManagingDirector and Head of Citigroup Private Bank (Northeast Region) from 2000 through2004. Clive R. Bucknall, Executive Vice President & Controller and Chief AccountingOfficer since March 7, 2006. Prior to this appointment Mr. Bucknall served asSenior Financial Officer, HSBC Singapore from March 2002 through December 2005.He was Senior Financial Officer, HSBC Thailand from September 1998 to March 2002and Senior Area Accounting Manager, HSBC Hong Kong from September 1994 toSeptember 1998. In 1991, Mr. Bucknall joined Midland Bank in London, which wasacquired by HSBC in 1992, as Financial Accounting Manager. 161 Corporate Governance-------------------------------------------------------------------------------- Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act, as amended, requires our Directors, executiveofficers and any persons who own more than 10 percent of a registered class ofour equity securities to report their initial ownership and any subsequentchange to the SEC and the New York Stock Exchange ("NYSE"). With respect to theissues of HUSI preferred stock outstanding, we reviewed copies of all reportsfurnished to us and obtained written representations from our Directors andexecutive officers that no other reports were required. Based solely on a reviewof copies of such forms furnished to us and written representations from theDirectors and executive officers, all Section 16(a) filing requirements werecomplied with for the 2006 fiscal year. Board of Directors - Committees and Charters The Board of Directors of HSBC USA Inc. has five standing committees: the AuditCommittee, the Executive Committee, the Fiduciary Committee, the Human Resources& Compensation Committee and the Nominating & Governance Committee. The charterof each of these committees, as well as the HSBC USA Inc. Corporate GovernanceStandards, are available upon written request to HSBC USA Inc., 452 FifthAvenue, New York, New York 10018, Attention: Corporate Secretary. Audit Committee The primary purpose of the Audit Committee is to assist the Board of Directorsin fulfilling its oversight responsibilities relating to HUSI's system ofinternal controls over financial reporting and its accounting, auditing andfinancial reporting practices. The Audit Committee is currently comprised of thefollowing independent directors (as defined by HSBC USA Inc.'s CorporateGovernance Standards, which are based upon the rules of the New York StockExchange): Sal H. Alfiero (Chair), James H. Cleave, Richard A. Jalkut and PeterKimmelman. The Board of Directors has determined that each of these individualsis financially literate. The Board of Directors has also determined that Messrs.Alfiero and Cleave qualify as audit committee financial experts. Executive Committee The Executive Committee may exercise the powers and authority of the Board ofDirectors in the management of HUSI's business and affairs during the intervalsbetween meetings of the Board of Directors. The executive committee is currentlycomprised of the following directors: Richard A. Jalkut (Chair and LeadDirector), James H. Cleave, Dr. Frances D. Fergusson and Paul J. Lawrence. Fiduciary Committee The primary purpose of the Fiduciary Committee is to supervise the fiduciaryactivities of HBUS to ensure the proper exercise of its fiduciary powers inaccordance with 12 U.S.C. Section 92a - Trust Powers of National Banks andrelated regulations promulgated by the Office of the Comptroller of theCurrency. The Fiduciary Committee is currently comprised of the followingdirectors: Charles G. Meyer, Jr. (Chair), Donald K. Boswell and James L. Morice.All members of the Fiduciary Committee are independent directors under HSBC USAInc.'s Corporate Governance Standards. Human Resources & Compensation Committee The primary purpose of the Human Resources & Compensation Committee is to assistthe Board of Directors in discharging its responsibilities related to thecompensation of the Chief Executive Officer, other officers of HUSI holding atitle of executive vice president and above and such other officers as may bedesignated by the Board of Directors. The Human Resources & CompensationCommittee is currently comprised of the following directors: Dr. Frances D.Fergusson (Chair), Donald K. Boswell and James L. Morice. All members of theHuman Resources & Compensation Committee are independent directors under HSBCUSA Inc.'s Corporate Governance Standards. 162 The Charter of the Human Resources & Compensation Committee lists the primaryresponsibilities, powers and authorities of the committee. The listed itemsinclude (i) review and approval of corporate goals and performance objectivesrelevant to the compensation of the Chief Executive Officer and certain otherexecutive officers, evaluate the performance of the Chief Executive Officer andother executive officers in light of those goals and objectives, and review itsfindings with the Board of Directors in executive session, (ii) submitrecommendations concerning base salary, performance-based cash and long-termequity-based incentive awards for the Chief Executive Officer and otherexecutive officers to the Remuneration Committee of HSBC ("REMCO") for approval,(iii) recommend to REMCO equity incentives under HSBC plans to all employees,except those awards that the Chief Executive Officer may determine based upon adelegation of authority by REMCO, (iv) review and approve benefits andperquisites of the Chief Executive Officer and other executive officers to theextent such benefits are not available to all employees, (v) review andrecommend to REMCO any employment and severance arrangements for the ChiefExecutive Officer and other executive officers, as well as any severance payoutsto such officers, (vi) review and consider "best practices" of peer companieswith respect to compensation philosophies, policies and practices, (vii) reviewmanagement's Compensation Discussion and Analysis ("CD&A") to be included inHUSI's Annual Report on Form 10-K, discuss the CD&A's content with management,and prepare the Compensation Committee Report concerning the CD&A and recommendto the Board of Directors that the CD&A be included in the Annual Report on Form10-K, and (viii) engage in an annual self assessment with the goal forcontinuing improvement, and to review and assess the adequacy of this charter atleast annually and recommend any proposed changes to the Board of Directors forapproval. The Human Resources & Compensation Committee may at its discretion retain anddischarge consultants to assist the committee in evaluating Chief ExecutiveOfficer or other executive officer compensation and to determine the appropriateterms of engagement and the fees to be paid to such consultants. The ChiefExecutive Officer is given full authority, which may be delegated, to establishthe compensation and salary ranges for all other employees of HUSI and itssubsidiaries whose salaries are not subject to review by the Human Resources &Compensation Committee and approval by REMCO. For more information about HUSI'scompensation policies and programs, please see Item 11. Executive Compensation -Compensation Discussion and Analysis. Nominating & Governance Committee The primary purpose of the Nominating & Governance Committee is to assist theBoard of Directors of HUSI in discharging its responsibilities related toidentifying and nominating members of the Board of Directors to the Board,recommending to the Board the composition of each committee of the Board and theChair of each committee, establishing and reviewing HUSI's corporate governanceand making recommendations to the Board regarding compensation for service ofthe non-executive Board members. The Nominating & Governance Committee ensuresthat HUSI maintains "best practices" with respect to corporate governance inorder to ensure effective representation of its stakeholders. The Nominating & Governance Committee is currently comprised of the followingdirectors: Richard A. Jalkut (Chair), Sal H. Alfiero, Dr. Frances D. Fergussonand Charles G. Meyer, Jr. All members of the Nominating & Governance Committeeare independent directors under HSBC USA Inc.'s Corporate Governance Standards. Code of Ethics HUSI has adopted a code of ethics that is applicable to its chief executiveofficer, chief financial officer, chief accounting officer and controller, whichis incorporated by reference to Exhibit 14 of this Form 10-K. HUSI also has ageneral code of ethics applicable to all employees that is referred to as itsStatement of Business Principles and Code of Ethics. Both documents areavailable upon written request made to HSBC USA Inc., 452 Fifth Avenue, NewYork, New York 10018, Attention: Corporate Secretary. 163 Item 11. Executive Compensation-------------------------------------------------------------------------------- Compensation Discussion and Analysis The following compensation discussion and analysis (the "2006 CD&A") summarizesthe principles, objectives and factors considered by HUSI in evaluating anddetermining the compensation of executive officers in 2006. Specificcompensation information relating to Sandra L. Derickson, President and ChiefExecutive Officer - Designate (and President and Chief Executive Officer fromJanuary 1 until February 20, 2007); Martin J.G. Glynn, President and ChiefExecutive Officer; John J. McKenna, Senior Executive Vice President and ChiefFinancial Officer; Joseph A. Belfatto, Senior Executive Vice President & Head ofGlobal Markets Americas; Marlon Young, Managing Director, CEO, Private BankAmericas; and Janet L. Burak, Senior Executive Vice President, General Counseland Secretary, is contained in this portion of the Form 10-K. The 2006 CD&A alsoincludes compensation information relating to Brendan McDonagh, Chief OperatingOfficer; and Joseph M. Petri, Senior Executive Vice President, Treasurer andCo-Head, CIBM Americas, both of whom served as an executive officer of HUSIduring part of 2006, but ceased providing services to HUSI prior to December 31,2006. Oversight of Compensation Decisions HUSI is a wholly owned subsidiary of HSBC Holdings plc ("HSBC"). The Board ofDirectors of HSBC has the authority to delegate any of its powers, authoritiesand judgments to any committee consisting of one or more directors, and hasestablished a Remuneration Committee ("REMCO") for the purpose of setting theremuneration policy for HSBC and its subsidiaries and the compensation of seniorexecutives. REMCO's responsibilities include reviewing and approvingperformance-based remuneration by reference to corporate goals and objectivesestablished by the Board of Directors of HSBC from time to time and approvingoverall market positioning of the compensation package, individual base salariesand increases and annual and long-term incentive/bonus arrangements for certainexecutives. In November 2006, REMCO delegated its authority for approval ofsalaries and annual cash incentive awards relating to certain classes ofexecutives to Michael F. Geoghegan, the HSBC Group Chief Executive (the "HSBCCEO"). However, REMCO retained exclusive authority over compensation of the moresenior executives within HSBC and its subsidiaries. As a result, REMCO hadauthority over the compensation of Ms. Derickson and Messrs. Glynn, McDonagh andPetri in 2006. Pursuant to a further delegation of authority from the HSBC CEO,Siddharth N. Mehta, Chief Executive Officer of HNAH until February 15, 2007, hadapproval authority over certain executives within HUSI, including Mr. McKennaand Ms. Burak; Stuart T. Gulliver, HSBC Managing Director and Head of CIBM, hasapproval authority over certain executives within the CIBM businesses; and ChrisM. Meares, Chief Executive Officer, Group Private Banking, has approvalauthority over certain executives within the Private Banking businesses. REMCOhas exclusive authority with respect to all long-term incentive plan awardsinvolving interests in HSBC ordinary shares. The members of REMCO in 2006 were Sir Mark Moody-Stuart (Chairman), W.K.L. Fung,S. Hintze, Sir John Kemp-Welch (until retirement on May 26, 2006) and J.D.Coombe (effective as of June 1, 2006), all of whom were or are non-executivedirectors of HSBC. REMCO has retained the services of Towers Perrin, a humanresource consulting firm, to provide independent advice on executivecompensation issues. REMCO is provided with comparator information from TowersPerrin, which obtains compensation data for executive positions with companiesof similar size and complexity that are subsidiaries of peer financial servicescompanies. In addition, market data has been obtained from American ExpressCompany, Bank of America Corporation, Bank One Corporation, BB&T Corporation,Capital One Corporation, Citigroup, Inc., Countrywide Financial Corporation,FifthThird Bancorp, KeyCorp, LaSalle Bank Corporation, Merrill Lynch & Co.,Inc., National City Corporation, The PNC Financial Services Group Inc., RoyalBank of Canada, State Street Corporation, Sun Trust Banks, Inc., WachoviaCorporation, Washington Mutual Inc. and Wells Fargo & Company. Comparator andmarket data is used by REMCO to evaluate the competitiveness of proposedexecutive compensation. 164 The Human Resources and Compensation Committee of the Board of Directors of HUSI(the "Compensation Committee") seeks to ensure that HUSI's compensation policiesand practices support the objectives of HUSI's compensation program, which isbased upon the compensation objectives established by REMCO. The CompensationCommittee makes advisory recommendations to REMCO for all compensation to bepaid to the HUSI Chief Executive Officer, the HSBC CEO or the Chief ExecutiveOfficer of HNAH, as appropriate, for all executives holding a title of executivevice president or above, other than executive officers in the CIBM and PrivateBanking businesses. Mr. Gulliver makes advisory recommendations to REMCO for allcompensation to be paid to General Managers and certain other senior executiveswithin CIBM. Mr. Meares makes advisory recommendations to REMCO for allcompensation to be paid to Group General Managers and certain other seniorexecutives within Private Banking. HUSI Human Resources executives work with HNAH Human Resources executives toprepare a comprehensive annual compensation package for the Chief ExecutiveOfficer. This package is reviewed by the Chief Executive Officer of HNAH, whoapproves or requests revisions to the compensation package before it issubmitted to the Compensation Committee for review. HUSI Human Resources executives consult with the Chief Executive Officer of HUSIin preparing annual compensation packages for executives holding a title ofexecutive vice president and above (other than the Chief Executive Officer).These compensation packages are also reviewed by the Chief Executive Officer ofHNAH. Any revisions to a compensation package recommended by the Chief ExecutiveOfficer of HNAH are reviewed and considered by the Chief Executive Officer ofHUSI prior to the package being submitted to the Compensation Committee forreview. The Compensation Committee reviews the compensation packages submitted to it,and approves or requests revisions to one or more of the components of annualcompensation. The compensation packages, as approved or modified by theCompensation Committee, are forwarded to HSBC Human Resources management forsubmission to REMCO and the HSBC CEO, as appropriate, or to the Chief ExecutiveOfficer of HNAH in late December or early January, and include advisoryrecommendations for salaries for the ensuing calendar year, preliminaryperformance-based cash awards and equity-based long-term incentive awards. Asthe performance-based cash awards are dependent upon satisfaction of objectivesthat cannot be evaluated until the end of the performance measurement year, thefinal determination of this component of compensation is not made until theCompensation Committee receives reports from management concerning satisfactionof corporate, business unit and individual objectives in January. REMCO or theHSBC CEO, as appropriate, will approve or revise the advisory recommendationsprovided by the Compensation Committee. Within the CIBM and Private Banking businesses, senior executives prepare annualcompensation package recommendations for executive officers within theirbusiness units. Accordingly, the discretion and judgment of senior managementplay a much more significant role in establishing appropriate compensationpackages to be included in advisory recommendations to REMCO or the Head of CIBMor Chief Executive Officer, Group Private Banking, as appropriate. As is thecase for HUSI generally, performance-based cash awards are dependent uponperformance of the individual, the local business unit and the business globallyand, accordingly, cannot be determined until the end of the performancemeasurement year. Within CIBM, compensation recommendations for the Global Markets business areprepared by Mike J. Powell, Group Head of Global Markets, recommendations forthe Global Banking business are prepared by Paul Hand, Co-Head of GlobalBanking, and recommendations for the Group Investment Businesses are prepared byAlain Dromer, Global Chief Executive Officer, Group Investment Businesses. Theserecommendations are submitted to and reviewed by the Head of CIBM. Any revisionsto a compensation package recommended by the Head of CIBM are included in thepackage before it is submitted to REMCO for review. REMCO will approve or reviseto the advisory recommendations provided by the Head of CIBM. 165 For Private Banking, compensation recommendations are prepared by Chris M.Meares, Chief Executive Officer, Group Private Banking, and submitted to andreviewed by the Director of Human Resources, CIBM/INV/GPB/Amanah and the HSBCCEO. Any revisions to a compensation package recommended by the Director ofHuman Resources or the HSBC CEO are included in the package before it issubmitted to REMCO for review. REMCO will approve or revise the advisoryrecommendations provided by the Chief Executive Officer, Group Private Banking. Objectives of HUSI's Compensation Program HUSI's compensation program is designed to support the successful recruitment,development and retention of high performing executive talent and to incentthose executives to achieve HUSI's short-term business objectives and tooptimize its long-term financial returns. We design our compensation program tobe competitive with a comparator group of benchmark financial institutions.HUSI's comparator group is comprised of U.S.-based organizations that competewith us for business, customers and executive talent. HUSI's comparator groupincludes Bank of America Corporation, The Bank of New York Company, Inc., JPMorgan Chase & Co., SunTrust Banks, Inc., Wachovia Corporation and Wells Fargo &Company (collectively, the "Comparator Group"). While these organizations arepublicly-held companies, HUSI's operations are of comparable scale andcomplexity. Accordingly, HUSI's compensation program is designed to provide theflexibility to offer compensation that is competitive with the Comparator Groupso that we may attract and retain the highest performing executives. The philosophy underlying HUSI's executive compensation program, which isdesigned to promote the compensation objectives of our parent, HSBC, isdiscussed below. Across businesses, individual compensation recommendationsreflect HSBC's strong stance with respect to diversity and equal opportunity forall employees within the context of meritocracy and performance. Link to Company Performance We seek to offer competitive base salaries with a significant portion ofvariable compensation components determined by measuring performance of theexecutive, his or her respective business unit, HUSI and HSBC. Theperformance-based cash compensation plans, which are more fully described underElements of Compensation - Annual Performance-Based Awards, emphasize revenueand expense growth, net income, receivable growth, profits and other keyperformance measures. Other considerations taken into account in settingcompensation policies and making compensation decisions include demonstratedleadership, future potential, adherence to HSBC's ethical standards and theability to leverage capabilities across businesses. Corporate, business unitand/or individual goals are established at the beginning of each year. Compensation plans motivate our executives to improve the overall performanceand profitability of HSBC as well as the specific region, unit or function towhich they are assigned. Each executive's individual performance andcontribution is considered in making salary adjustments and determining theamount of annual performance bonus paid and the value of HSBC equity-basedawards granted each year. HUSI has historically used grants of stock options and restricted shares toreward and provide longer term incentives for our executives. In 2005, however,HSBC adopted a new philosophy to provide only restricted shares, called"Achievement Shares," which vest on a specified date if the executive remainsemployed through that date, and "Performance Shares," which require continuedemployment and satisfaction of corporate performance conditions designed toreinforce a long-term focus on HSBC's Managing for Growth strategy anddelivering value to its shareholders. Performance Shares are granted to the mostsenior executives whose business units have the ability to have a direct impacton HSBC's consolidated results. Achievement Share awards are granted to otherhigh performing executives. Within CIBM and Private Banking, restricted sharesare also used as a bonus deferral mechanism for executives within thosebusinesses who receive large bonus awards, as described below. 166 Competitive Compensation Levels and Marketplace Research HUSI endeavors to maintain compensation programs that are competitive with ourComparator Group. We operate in a highly competitive business environment, inwhich our Comparator Group and other financial services companies continuouslylook to gain market share and competitive advantage by hiring top executivetalent. On an annual basis, and as needed when recruiting, we compare thecompensation for our executive officers to that of executives with similarresponsibilities for companies of similar industry, size and complexity. In2006, the Compensation Committee considered comparative data from generalindustry surveys of non-financial services companies and of financial servicescompanies, which included members of our Comparator Group, to help establishcompensation levels for our executives. The Compensation Committee also reviewsthe Towers Perrin data provided to REMCO. We research the types of compensation programs provided by other companies,compensation levels for executives, details of certain compensation programs,historical marketplace compensation trends, marketplace practices regardingcompensation mix, stock vesting terms, equity ownership levels, the amount ofcompensation that is derived from equity incentives and the benefits provided toexecutives. We also research different aspects of performance, including therelationship between performance and compensation, a comparison of HUSI'shistorical performance to our Comparator Group and types of performance measuresthat are used by other companies for their annual and long-term incentiveprograms. Research data is gathered from several different sources, includinggeneral surveys of the marketplace. HUSI's compensation program generally provides executives with the opportunityto earn a base salary that is near the 50th percentile average of our ComparatorGroup. We believe this represents a competitive base salary for meeting generalbusiness objectives. However, total compensation, which includes incentiveawards, is targeted to be in the 75th percentile if HUSI, HSBC and the executivemeet established performance goals. This provides greater incentive to achievehigher performance standards and the specific goals established by theCompensation Committee each year. The level of compensation paid to an executivefrom year to year will differ based on performance. This year-to-year differencestems mainly from HUSI's and/or an individual business unit's performanceresults and, for individuals eligible for performance-based equity awards,awards may vary based upon HSBC's performance results. Compensation levels willalso increase or decrease based on the executive's individual performance andlevel of responsibility. CIBM and Private Banking The philosophies underlying the compensation programs employed in the CIBM andPrivate Banking businesses are consistent with the philosophy described abovefor HUSI generally, but there are some specific variations in the compensationmethodologies that are employed The overall approach for these businesses involves a carefully managed approachto tracking of compensation expense throughout the year in relation to businessperformance and planned overall expenditure on staff costs. This is combinedwith a year-end pay review process that takes careful account of market paymethods, levels and trends, as well as the actual levels of business andindividual performance that are achieved. The year-end pay review process isitself subject to review and approval by HSBC senior management and by REMCO. The approach to regular bonus accrual is agreed with REMCO and updated atintervals to reflect changes in the competitive market. This agreement coversfactors such as the proportion of pre-tax profit that may be allocated to thebonus pool for each business, taking into account aspects such as the maturityand complexity of each business and also considering any appropriategeographical variations. Annual operating plans for each business cover monthlyaccrual of the planned bonus amounts. Development of these accruals against theagreed parameters is reviewed at intervals during each year with the GroupFinance Director. 167 At year end, the compensation levels within each business reflect individualcontribution, business unit performance and the competitive pay market. Inaddition, compensation within CIBM and Private Banking also reflects the overall(i.e., global) results of the respective business. Base salary and incentivecompensation (bonus) are sized within the context of a total compensationpackage that is intended to be appropriately market competitive, but thesebusinesses apply a much less formulaic approach to the use of comparative marketdata than is typical in some other parts of HUSI and HSBC. Compensationproposals are based upon careful benchmarking of individual executives in thecorrect competitive context, making use of independently compiled studies ofmarket pay levels, methods and trends. These studies are conducted by externaladvisors with in-depth knowledge of the business areas concerned and they allowcareful verification against market of the compensation levels and methodologiesfor executives in these businesses. With this information to hand, seniormanagement carefully considers and interprets the performance of each business,and of CIBM or Private Banking globally, relative to the performance of keycompetitors. Individual performance is assessed relative to performance in amarket context to ensure that each executive is correctly positioned againstmarket. Both CIBM and Private Banking target appropriate groups of competitorsfor each business so that the total compensation for each executive can becorrectly positioned within the overall market range, ensuring a high degree ofdifferentiation towards the very best performers. Senior management also usesmarket data in a similar way when designing appropriate recruitment andretention initiatives. The compensation programs within CIBM and Private Banking are designed tosupport the successful recruitment, development and retention of high performingexecutive talent and to incent those executives to maximize the performance oftheir respective businesses. Within the context of the total compensationpackage, performance-related adjustments emphasize variable pay (i.e.,discretionary bonus awards) over fixed pay (i.e., base salary). As describedabove, bonus awards are differentiated significantly towards the very bestperformers and careful attention is also paid to those executives whoseretention is regarded as critical to the business. For those executivesreceiving large bonus awards, a significant portion of the award is paid in theform of restricted shares that vest over three years provided the individualremains employed with HSBC, thus encouraging retention of the best performers.The proportion of bonus that is deferred varies to some extent between specificbusinesses but the typical approach is to apply a 'tax table' so that increasingproportions of a bonus will be deferred above clearly defined hurdles. Themaximum proportion of bonus to be deferred within CIBM and Private Banking isnormally 50 percent. The proportion of bonus to be deferred and the relatedvesting periods are positioned against competitive market practice usinginformation provided by the external advisors referenced above. Elements of Compensation HUSI strives for a compensation mix that reflects our pay for performancephilosophy and results-oriented culture. We attract and retain executives thatare highly motivated to achieve results, and our compensation program supportsthat environment. HUSI's philosophy is to place a significant amount of compensation at risk toensure that company performance objectives are met. In line with this pay forperformance philosophy, on average, approximately 20 percent of executivecompensation is base salary and 80 percent of compensation for top executivesrelates to short-term and long-term incentives where the amount paid is basedupon defined performance goals. Of the 80 percent incentive compensation, onaverage, approximately 45 percent of such compensation relates to long-termincentives, while approximately 35 percent relates to short-term incentives. Theallocation between short-term and long-term incentives is based on HUSI's needto recognize past performance (short-term incentives) in conjunction with theneed to motivate and retain our talent (long-term incentives). We believe theseallocations are competitive within the market and reinforce HUSI'spay-for-performance philosophy, which requires that a greater part ofcompensation is at risk and aligns executives' interests with those of HSBC'sshareholders. 168 The primary elements of executive compensation are base salary, annualnon-equity performance-based awards, and long-term equity-based incentives. Inlimited circumstances, discretionary bonuses may also be awarded. In addition,executives are eligible to receive company funded retirement benefits that areoffered to all employees. Perquisites are not a significant component ofcompensation. In establishing executive compensation packages, the CompensationCommittee provides advisory recommendations and, ultimately, REMCO and/or theHSBC CEO establishes remuneration under each element based on what they believeis an appropriate balance between performance-based compensation and other formsof compensation, the level of responsibility and individual contribution of theexecutive and competitive practice in the marketplace for executives fromcompanies of similar industry, size, and complexity as HUSI. Within the CIBM and Private Banking businesses, the allocation of compensationbetween base salary and incentive compensation, as well as between long-term andshort-term incentives, is recommended by senior management and reviewed andapproved by REMCO and/or the HSBC CEO. As further described below, short-termincentive awards include cash awards under each business's discretionary bonusprogram. Long-term incentives include the deferral of a portion of discretionarybonus awards through HSBC equity-based awards. In establishing executivecompensation packages, remuneration under each element is based on what isbelieved to be an appropriate balance between performance-based compensation andother forms of compensation, the level of responsibility and individualcontribution of the executive, business unit performance and overall CIBM orPrivate Banking results. Base Salary Base salary is reviewed annually and increases, if any, are based on corporateand individual performance. When establishing base salaries for executives,consideration is given to compensation paid for similar positions at companiesincluded in compensation surveys of HUSI's Comparator Group, targeting the 50thpercentile, which the Compensation Committee believes, when combined withsignificant performance-based compensation opportunities, enables HUSI toattract and retain high performing executives. In addition, other factors suchas individual and corporate performance, potential for future advancement,specific job responsibilities, length of time in current position, individualpay history, and comparison to comparable internal positions (internal equity)influences the final base salary recommendations for individual executives. Within the CIBM and Private Banking businesses, annual salary increases must beaccommodated within the annual operating plan for the business globally.Accordingly, salary increases proposed by senior management are prioritizedtowards high performing employees and those who have demonstrated rapiddevelopment. Proposals for salary increases are justified against performanceand with reference to local market rates, where available. While individualperformance is assessed relative to performance in a market context to ensurethat the executive is correctly positioned within the market range, the CIBM andPrivate Banking business generally do not apply formulaic rates in determiningcompensation, but rely more on the discretion and judgment of senior managementin the context of performance relative to key competitors of that business. 169 Annual Performance-Based Awards Annual non-equity performance-based awards are paid in cash upon satisfaction ofindividual, business unit, corporate financial and operational goals. Superiorperformance is encouraged by placing a significant part of the executive's totalcompensation at risk. In the event certain quantitative or qualitativeperformance goals are not met, annual performance awards may be less than themaximum permitted. Performance goals are set based on prior year's performance, expectations forthe upcoming year, HUSI's annual business plan, the HSBC Managing for Growthbusiness strategy, and objectives related to building value for HSBCshareholders. The general concept is if both HUSI and the executive perform wellfor the year, the performance award earned should be at a high level. If eitherHUSI or the executive does not perform well, the award earned should be at a lowlevel. The Management Incentive Program described below implements this approachby defining "target" and "maximum" percentages for annual non-equityperformance-based awards. Target award percentages range form 20 percent to 100percent of base salary and maximum award percentages range from 40 percent to300 percent. The award percentage range assigned to an executive officer will bedetermined on the basis of his or her position and level of responsibilitywithin HUSI. The actual amount of the award within the applicable range will bedetermined on the basis of the performance goals established for HUSI and theindividual each year. In support of our pay-for-performance philosophy, HUSI maintains the ManagementIncentive Program, which is an annual cash incentive plan that uses quantitativeand qualitative goals to motivate HUSI employees who have a significant role inthe corporation and do not participate in another incentive compensation plan.The quantitative objectives may include meeting designated financial performancetargets for the company and/or the executive's respective business unit.Qualitative objectives may include key strategic business initiatives orprojects for the executive's respective business unit. Award opportunity andpayouts are determined as a percentage of base salary and are based oncomparison to other internal comparable positions (internal equity) and externalmarket practices. Cash incentive awards under the Management Incentive Programare paid in February of the year following the measurement year. Ms. Derickson, Messrs. Glynn, McKenna and McDonagh and Ms. Burak participated inthe Management Incentive Program in 2006. A discussion of the quantitative andqualitative objectives for each of these executives and the performance againstthose goals can be found below under the heading Compensation of OfficersReported in the Summary Compensation Table. Within the CIBM and Private Banking businesses, all regular employees areeligible for consideration for a discretionary bonus award. Final bonusrecommendations are determined after full year results are available and areevaluated within the context of the performance of each business unit,including, where relevant, economic profit at the regional and global levels andcompensation proposals for all business units within CIBM or Private Banking, asapplicable. In conjunction with an assessment of the executive's individualperformance, senior management may consult market surveys to assist inidentifying both market pay levels and factors influencing pay (i.e., product,market, length of service, etc.). However, as is the case with other componentsof compensation, we rely more on the discretion and judgment of seniormanagement in the context of performance relative to our key competitors than amechanical application of market rates. Long-term Incentives Long-term incentive compensation is awarded through grants of HSBC equityinstruments. The purpose of equity-based incentives is to help HUSI attract andretain outstanding employees and to promote the growth and success of ourbusiness over a period of time by aligning the financial interests of theseemployees with those of HSBC's shareholders. Historically, equity incentiveswere awarded through stock options and restricted share grants. 170 Prior to 2005, options on HSBC ordinary shares were granted to certainexecutives and restricted shares to others. Awarded options have an exerciseprice equal to the greater of the average market value of HSBC ordinary shareson the five business days prior to the grant of the option and the market valueof HSBC ordinary shares on the grant date. The options typically vest in three,four or five equal installments, subject to continued employment, and expire tenyears from the grant date. However, certain options awarded to key executiveshad a "total shareholder return" performance vesting condition and only vest ifand when the condition is satisfied. No stock options were granted to executiveofficers in 2005 or 2006 in conjunction with HSBC's philosophical shift on theform of equity based compensation. Awards of restricted shares is another form of long-term incentive compensationutilized to compensate and incent our employees. When restricted shares aregranted to an executive officer, the underlying shares are held in a trust forthe benefit of the employee and are released only after the defined vestingconditions are met at the end of the holding period. While in such trust,dividend equivalents are paid on all underlying shares of restricted stock atthe same rate paid to ordinary shareholders. The dividend equivalents are paidin the form of additional shares for awards made after 2004 and in cash paid tothe executive for all prior awards. There are three types of restricted shares used by HSBC: those with a timevesting condition awarded to recognize significant contribution to HUSI("Achievement Shares"), those with time and performance-based vesting conditions("Performance Shares") and those with a time vesting condition for retentionpurposes ("Retention Awards"). Achievement Shares are awarded to key executivesas part of the annual pay review process in recognition of past performance andto further motivate and retain executives. The amount granted is based ongeneral guidelines established by REMCO, which include a percentage of base pay,position within HUSI and potential for growth. Performance Shares are awarded tokey executives whose performance can have a direct impact on HSBC's consolidatedresults and, in 2006, within HUSI, only Mr. Glynn and Mr. McDonagh received suchawards. Retention Awards have typically not been granted on an annual basis butrather have been granted on an as needed basis. No Retention Awards were grantedto executive officers in 2006. As described above, Performance Shares are awarded to an executive and vestingof those shares is based on achievement of defined levels of future performanceof HSBC. Performance Shares are divided into two equal parts subject to distinctperformance conditions measured over a three year period. A total shareholderreturn award, which accounts for 50 percent of each Performance Share award,will vest in whole or in part (based on a sliding scale of 0 percent to 100percent) depending upon how the growth in HSBC's share value, plus declareddividends, compares to the average shareholder return of a defined competitorgroup which for 2006 grants was comprised of 28 major banking institutionsincluding: ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria, S.A., BancoSantander Central Hispano S.A., Bank of America Corporation, The Bank of NewYork Company, Inc., Barclays PLC, BNP Paribas S.A., Citigroup, Inc., CreditAgricole SA, Credit Suisse Group, Deutsche Bank AG, HBOS plc, JP Morgan Chase,Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group Inc., Mizuho FinancialGroup Inc., Morgan Stanley, National Australia Bank Limited, Royal Bank ofCanada, The Royal Bank of Scotland Group plc, Societe Generale, StandardChartered PLC, UBS AG, Unicredito Italiano, US Bancorp, Wachovia Corporation,Wells Fargo & Company and Westpac Banking Corporation. The earnings per share award accounts for 50 percent of each Performance Shareaward and is measured using a defined formula based on HSBC's earnings per sharegrowth over the three-year period as compared to the base-year earnings pershare, which is earnings per share for the year prior to the year thePerformance Shares are granted. None of the earnings per share PerformanceShares will vest unless a minimum earnings per share is reached at the end ofthree years. REMCO maintains discretion to determine that a Performance Share award will notvest unless REMCO is satisfied that HSBC's financial performance has shownsustained improvement since the date of the award. REMCO may also waive, amendor relax performance conditions if it believes the performance conditions havebecome unfair or impractical and believes it appropriate to do so. Due to theprobability of one or both of the performance conditions not being met in partor in full, grants of Performance Shares are for a greater number of shares thanAchievement Share grants. The expected value of Performance Shares is equal to44 percent of the face value. Additional information concerning the conditionsto vesting of Performance Share awards is contained in Footnote 2 to the Grantsof Plan Based Awards table on page 184. 171 Within the CIBM and Private Banking businesses, a portion of each discretionarybonus award is paid in restricted shares. The minimum deferral threshold, or theportion of each bonus award paid in restricted shares, and vesting schedules mayvary by business unit within the parameters set by CIBM and Private Banking, asapplicable, for their businesses. Repricing of Stock Options and Timing of Option Grants For HSBC discretionary option plans, the exercise price of awards made in 2003and 2004 was the higher of the average market value for HSBC ordinary shares onthe five business days preceding the grant date or the market value on the dateof the grant. HSBC also offers all employees a plan in which options to acquire HSBC ordinaryshares are awarded when an employee commits to contribute up to 250 GBP (or theequivalent) each month for one, three or five years. At the end of the term, theaccumulated amount, plus interest, may be used to purchase shares under theoption, if the employee chooses to do so. The exercise price for such options isthe average market value of HSBC ordinary shares on the five business dayspreceding the date of the invitation to participate, less a 15 to 20 percentdiscount (depending on the term). HUSI does not, and our parent, HSBC, does not, reprice stock option grants. Inaddition, neither HUSI nor HSBC has ever engaged in the practice known as"back-dating" of stock option grants, nor have we attempted to time the grantingof historical stock options in order to gain a lower exercise price. Dilution from Equity-Based Compensation While dilution is not a primary factor in determining award amounts, there arelimits to the number of shares that can be issued under HSBC equity-basedcompensation programs. These limits were established by vote of HSBC'sshareholders in 2005. Perquisites HUSI's philosophy is to provide perquisites that are intended to help executivesbe more productive and efficient or to protect HUSI and its executives fromcertain business risks and potential threats. Our review of competitive marketdata indicates that the perquisites provided to executives are reasonable andwithin market practice. See the "Summary Compensation Table" below for furtherinformation on perquisites awarded to HUSI executives. Retirement Benefits HNAH offers a pension retirement plan in which HUSI executives may participatethat provides a benefit equal to that provided to all employees of HUSI.However, both qualified and non-qualified defined benefit plans are maintainedso that this level of pension benefit can be continued without regard to certainInternal Revenue Service limits. Executives and other highly compensatedemployees can elect to participate in a nonqualified deferred compensation plan,where such employees can elect to defer the receipt of earned compensation to afuture date. We also maintain a qualified 401(k) plan with company matchingcontributions. Ms. Derickson and Ms Burak, as former executives of HSBC FinanceCorporation, also participate in a nonqualified deferred compensation plan thatprovides executives and other highly compensated employees with a companymatching contribution based on the level of the deferral of the employee'searned compensation to the qualified 401(k) plan to the extent that such companycontributions cannot be allocated to the 401(k) plan because of certain InternalRevenue Service limits. HUSI does not pay any above-market or preferentialinterest in connection with deferred amounts. 172 Employment Contracts and Severance Protection Ms. Derickson entered into an employment agreement with HSBC FinanceCorporation, an affiliate of HUSI, on November 14, 2002, which was amended andrestated on May 17, 2005. As of December 31, 2006, Ms. Derickson's employmentremained subject to the terms of that agreement, the main purpose of which wasto protect HSBC Finance Corporation and its affiliates (including HUSI) fromcertain business risks (threats from competitors, loss of confidentiality ortrade secrets, solicitation of customers and employees) and to define HSBCFinance Corporation's right to terminate the employment relationship. Theemployment agreement also protected Ms. Derickson from certain risks, such as achange in control, death or disability. The terms of Ms. Derickson's employmentagreement are summarized in the description of her compensation under theheading Compensation of Officers Reported in the Summary Compensation Table. In connection with his employment March 2006, HBUS extended an offer letter toMr. Young dated February 17, 2006. The primary purpose of the offer letter wasto define Mr. Young's terms of employment, compensation and the rights of theparties in the event of Mr. Young's resignation or termination. The terms of Mr.Young's offer letter are summarized in the description of his compensation underthe heading Compensation of Officers Reported in the Summary Compensation Table. In connection with his retirement on December 31, 2006, Mr. Glynn entered intoan agreement with HNAH dated June 30, 2006. The primary purpose of the agreementwas to define the rights of the parties prior to and upon Mr. Glynn'sretirement. The terms of Mr. Glynn's agreement are summarized in the descriptionof his compensation under the heading Compensation of Officers Reported in theSummary Compensation Table. Prior to his retirement on August 5, 2006, Mr. Petri entered into a separationagreement with HBUS dated August 1, 2006. The primary purpose of the agreementwas to define the rights of the parties prior to and upon Mr. Petri'sretirement. The terms of Mr. Petri's agreement are summarized in thedescriptions of his compensation under the heading Compensation of OfficersReported in the Summary Compensation Table. Accounting Considerations We adopted the fair value method of accounting under Statement of FinancialAccounting Standards No. 123 (revised 2004), "Share Based Payment" (SFAS 123(R))effective January 1, 2006. SFAS 123(R) applies to all equity instruments grantedto employees beginning January 1, 2006 and does not apply to awards granted inprior periods before the effective date, except to the extent that priorperiods' awards are modified, repurchased or cancelled after the requiredeffective date. Prior to 2006, we adopted the fair value method of accountingprospectively in 2002 for all new equity instruments granted to employees asprovided under Statement of Financial Accounting Standards No. 148, "Accountingfor Stock-Based Compensation - Transition and Disclosure (an amendment of FASBStatement No. 123)." The Board of Directors believes that this treatmentreflects greater accuracy and transparency of the cost of these incentives andpromotes better corporate governance. Tax Considerations Limitations on the deductibility of compensation paid to executive officersunder Section 162(m) of the Internal Revenue Code is not applicable to HUSI, asit is not a public corporation as defined by Section 162(m). As such, allcompensation to our executive officers is deductible for federal income taxpurposes, unless there are excess golden parachute payments under Section 4999of the Internal Revenue Code following a change in control. Compensation of Officers Reported in the Summary Compensation Table Below is a summary of the factors that affected the compensation earned in 2006by the executive officers listed in the Summary Compensation Table. Inrecommending compensation for each of our executives, management and theCompensation Committee evaluated competitive levels of compensation forexecutives managing operations or functions of similar size and complexity andthe importance of retaining executives with the strategic, leadership andfinancial skills to ensure HUSI's continued growth and success and theirpotential for assumption of additional responsibilities. 173 Chief Executive Officer Compensation - Ms. Derickson Sandra L. Derickson was appointed President and Chief Executive Officer -Designate of HUSI as of September 1, 2006 and succeeded Mr. Glynn as Presidentand Chief Executive Officer as of January 1, 2007. She resigned as President andChief Executive Officer on February 20, 2007. Until that time, Ms. Dericksonparticipated in the same programs and generally received compensation based onthe same factors as HUSI's other executive officers. However, Ms. Derickson'soverall compensation level reflected her greater degree of policy anddecision-making authority, her higher level of responsibility with respect tothe strategic direction of HUSI, and her ultimate responsibility for HUSI'sfinancial and operational results. In connection with her appointment as of September 1, 2006, the CompensationCommittee set Ms. Derickson's base salary at an annualized level of $700,000 for2006. In establishing Ms. Derickson's initial base salary, the CompensationCommittee sought to align Ms. Derickson's compensation level with that of herpredecessor, Mr. Glynn, which placed Ms. Derickson's compensation level at the50th percentile among similarly-placed executives within the Comparator Group.As Ms. Derickson's initial base salary with HUSI did not represent an increaseover her base salary for HSBC Finance Corporation, no further approvals weresought or obtained. Because she served as President & Chief Executive Officer - Designate for only aportion of the year, Ms. Derickson did not receive an equity-based award withrespect to her service to HUSI in 2006. In January 2006, REMCO met andconsidered the proposed equity-based awards for all HSBC executives and awardedMs. Derickson Performance Shares with a grant date value of $2,500,003 withrespect to Ms. Derickson's services as an executive officer of HSBC FinanceCorporation. In making the award, REMCO considered internal equity ofcompensation paid to management peers within HSBC and its subsidiaries andexternal benchmarking, as described above. Under the Management Incentive Program, Ms. Derickson's 2006 target annualincentive bonus opportunity was 100 percent of her base salary at December 31,2006 and her maximum opportunity was 300 percent. In addition, pursuant to heremployment agreement, described below, Ms. Derickson was entitled to a bonusguaranteed to be not less than $1,275,000. However, due to the disappointingresults in the HSBC Finance Corporation Mortgage Services business, Ms.Derickson voluntarily waived her right to a guaranteed bonus under heremployment agreement. Other compensation paid to Ms. Derickson in 2006, including perquisites, such aslife insurance premiums and social club membership fees, was consistent withperquisites paid to similarly-placed executive officers within and outside ofHSBC. Ms. Derickson had an employment agreement with HSBC Finance Corporation, whichwas to expire on March 28, 2008. Pursuant to her agreement, Ms. Derickson servedas President and Chief Executive Officer of HUSI. The terms of that agreementare summarized below. As stated above, Ms. Derickson resigned as of February 20,2007. The terms of the severance arrangements agreed with Ms. Derickson will bedescribed in HUSI's Annual Report on Form 10-K for the year ending December 31,2007. During the term of the employment agreement, Ms. Derickson was entitled toreceive an annual base salary (which as of January 1, 2006 was increased to$700,000), and an annual bonus of at least $1,275,000 (75 percent of the annualaverage of her bonus earned in 2003, 2004 and 2005). During the term of theagreement, Ms. Derickson was be eligible to participate in any equity-basedincentive compensation plan or program of HSBC as in effect from time to timefor similarly situated senior executives of HSBC Finance Corporation, asapproved by REMCO. In addition, during the term of the agreement, Ms. Dericksonwas eligible to participate in the various retirement, medical, disability andlife insurance plans, programs and arrangements in accordance with the terms ofHSBC Finance Corporation's benefit plans. 174 Under the terms of the employment agreement, if Ms. Derickson's employment wasterminated during the term of the agreement other than for "cause" ordisability, or she resigned for "good reason," subject to her execution of ageneral release in favor of HSBC Finance Corporation and its affiliates, Ms.Derickson was to continue to receive her base salary and annual bonus describedabove as if she had remained employed until March 28, 2008. In addition, to theextent permitted under the terms of the applicable plans, Ms. Derickson'swelfare benefits, umbrella liability insurance and automobile and financialcounseling allowances would continue until March 28, 2008, unless she becameeligible to participate in similar plans of another employer prior to that date. In 2003 and 2005, Ms. Derickson was awarded Retention Awards of HSBC restrictedshares with values of $3.75 and $6 million, respectively, in each case based onthe closing price of HSBC ordinary shares as of the date of the grant. The 2003award was to vest in five equal installments on March 28 of each year through2008. The 2005 was to vest in five equal installments on March 26 of each yearthrough 2010. Each award was to vest in full upon termination of Ms. Derickson'semployment other than for cause or, with respect to the 2003 award, by Ms.Derickson due to a material breach by HUSI of Ms. Derickson's employmentagreement, or with respect to the 2005 award, by Ms. Derickson for good reason. Chief Executive Officer Compensation - Mr. Glynn Martin J.G. Glynn retired as President and Chief Executive Officer as ofDecember 31, 2006. Prior to his retirement, Mr. Glynn participated in the sameprograms and generally received compensation based on the same factors as theother executive officers. However, Mr. Glynn's overall compensation levelreflected his greater degree of policy and decision-making authority, his higherlevel of responsibility with respect to the strategic direction of HUSI, and hisultimate responsibility for HUSI's financial and operational results. For 2006,Mr. Glynn's compensation was comprised of base salary, non-equity incentivecompensation (bonus), an additional cash payment in lieu of stock awards, anadditional cash payment triggered by his retirement and perquisites. In 2006, Mr. Glynn's base salary remained at $700,000, the same as for 2005. For2006, the Compensation Committee reviewed competitive compensation levels andfound Mr. Glynn's then current cash compensation level was in line with the 50thpercentile among similarly-placed executives in our Comparator Group. In keepingwith the goal of maintaining executive base salaries in the 50th percentile, itdid not make an advisory recommendation to increase his salary. In January 2006, REMCO approved the Compensation Committee's advisoryrecommendation that Mr. Glynn receive a Performance Share award with a grantdate value of $1,400,000. The award is subject to three-year performance vestingconditions. The vesting criteria of the Performance Shares are set out inFootnote 2 to the Grants of Plan-Based Awards Table on page 184. The grantreflected the view of the Compensation Committee and REMCO of the value of Mr.Glynn's contribution to and leadership of HUSI and HSBC's desire to incentoutstanding performance. Mr. Glynn's cash incentive under the Management Incentive Program is determinedbased upon satisfaction of quantitative and qualitative objectives that providefor a target cash award equal to 100 percent of his base salary, up to a maximumof 300 percent of base salary. Mr. Glynn's cash incentive compensation requiredsatisfaction of objectives that included business goals related to HUSI's profitbefore tax and initiates promoting diversity in employment, managingreputational risk and improving HUSI's compliance environment. Managementassessed Mr. Glynn's and HUSI's performance against the objectives and foundthat there was complete or substantial satisfaction of each objective. Mr. Glynnwas awarded cash incentive compensation of $1,600,000, or approximately 230percent of his base salary, which was paid to him in February 2007. This amountwas consistent with the guaranteed cash incentive award provided for in Mr.Glynn's agreement, as described below. Other compensation paid to Mr. Glynn including perquisites, such as rentallowance, car allowance and related tax gross-ups, is consistent withperquisites paid to similarly-placed executive officers within and outside ofHSBC. 175 In connection with his retirement, Mr. Glynn entered into an agreement with HNAHon June 30, 2006. Pursuant to the terms of this agreement, Mr. Glynn receivedhis regular base salary and benefits through his retirement on December 31,2006. Mr. Glynn also received a full incentive bonus of $1,600,000 for 2006,which was paid in February 2007. He is also entitled to an additional cashpayment of $616,000 in lieu of any equity-based award for 2006 and continuedvesting of his outstanding equity-based awards as reflected in the OutstandingEquity Awards at Fiscal Year-End Table. Finally, Mr. Glynn received a lump sumpayment of $6,600,000 for general employment benefits that would otherwise haveaccrued had he retired two years after December 31, 2006. Chief Financial Officer Compensation The Senior Executive Vice President & Chief Financial Officer of HUSI, John J.McKenna, participates in general benefits available to executives of HUSI andthe Management Incentive Program. His cash compensation for 2006 was determinedby Mr. Mehta, the HNAH Chief Executive Officer, upon recommendation of theCompensation Committee in consultation with HUSI Human Resources executives andthe Chief Financial Officer of HNAH. As with all HUSI executives, REMCO hasauthority over Mr. McKenna's Achievement Share awards. For 2006, Mr. McKenna'scompensation was comprised of base salary, non-equity incentive compensation(bonus), stock awards and perquisites. Mr. McKenna's base salary increased by $25,050 in February 2006, bringing hisbase salary to $325,050. In recommending Mr. McKenna's base salary, theCompensation Committee and HUSI senior executives reviewed competitivecompensation levels and found Mr. McKenna's current compensation level was onlyslightly below the 50th percentile among similarly-placed executives at HUSI'sComparator Group. The recommendation also reflected the company's view of Mr.McKenna's performance in 2005. The HNAH Chief Executive Officer agreed with therecommendation and approved the increase in Mr. McKenna's base salary. In March 2006, Mr. McKenna was granted Achievement Shares with a grant datevalue of $400,000, which vest in three years and have no performance conditions.This reflected management's recognition of the value of Mr. McKenna'scontribution to and leadership of HUSI and HSBC's desire to retain Mr. McKennaand to incent outstanding performance. Mr. McKenna's cash incentive under the Management Incentive Program isdetermined based upon satisfaction of quantitative and qualitative objectivesthat provide for a target cash award equal to 75 percent of his base salary, upto a maximum of 150 percent of base salary. Mr. McKenna's cash incentivecompensation required satisfaction of the quantitative and qualitativeobjectives described above for Mr. Glynn. Management assessed Mr. McKenna's andHUSI's performance against the objectives and found that there was complete orsubstantial satisfaction of each objective. Mr. McKenna was awarded cashincentive compensation of $381,934, or approximately 119 percent of his basesalary, which was paid to him in February 2007. Other compensation paid to Mr. McKenna, including perquisites such as lifeinsurance premiums, is consistent with perquisites paid to similarly-placedexecutive officers within and outside of HSBC. Joseph A. Belfatto Compensation The Senior Executive Vice President and Head of Global Markets Americas, JosephA. Belfatto, participates in general benefits available to executives of HUSIand the CIBM business. For 2006, Mr. Belfatto's compensation was comprisedprimarily of base salary, non-equity incentive compensation (discretionary bonusaward) and stock awards. Mr. Belfatto's total compensation increased by $20,000 in 2006, bringing histotal compensation to $3,750,000. In recommending Mr. Belfatto's compensationpackage to the Group Head of CIBM, CIBM senior management considered theperformance of the CIBM business locally and globally and its judgment ofcompetitive compensation levels within the relevant markets. The recommendationalso reflected CIBM senior management's view of Mr. Belfatto's contribution tothe business's performance in 2005 and the desire to retain Mr. Belfatto withinthe CIBM business. The Head of CIBM agreed with senior management'srecommendation and approved the increase in Mr. Belfatto's total compensationpackage. 176 As described above, the allocation of compensation between base salary andincentive compensation within CIBM, as well as between long-term and short-termincentives, is recommended by senior management in its discretion and reviewedand approved by REMCO and/or the HSBC CEO. For 2006, Mr. Belfatto's compensationpackage consisted of $250,000, or approximately seven percent of his totalcompensation, in base salary and $3,500,000, or approximately 93 percent, as adiscretionary bonus award. Of the discretionary bonus award, Mr. Belfattoreceived $1,960,000 in cash and the balance will be deferred through a grant ofrestricted shares in March 2007 with a grant date value of $1,540,000. One-thirdof the shares vest on each of the first three anniversaries of the grant andhave no performance conditions. Other compensation paid to Mr. Belfatto, including perquisites, is consistentwith perquisites paid to similarly-placed executive officers within and outsideof HSBC. Marlon Young Compensation The Managing Director, Chief Executive Officer, Private Bank Americas, MarlonYoung, participates in general benefits available to executives of HUSI and thePrivate Banking business. For 2006, Mr. Young's compensation was comprisedprimarily of base salary, non-equity incentive compensation (discretionary bonusaward) and stock awards. Mr. Young was appointed Managing Director, Chief Executive Officer, Private BankAmericas, in March 2006. His total compensation for 2006 was $1,875,000, whichincluded a $75,000 increase to his base salary in September 2006. Inrecommending Mr. Young's compensation package, Group Private Banking seniormanagement considered the performance of the Private Banking business locallyand globally and the competitive compensation levels within the relevantmarkets. The recommendation also reflected management's view of Mr. Young'spotential contribution to the business's performance and HSBC's desire to retainMr. Young within Private Banking. The Chief Executive Officer, Group PrivateBanking agreed with senior management's assessment and approved Mr. Young'scompensation package. As described above, the allocation of compensation between base salary andincentive compensation within Private Banking, as well as between long-term andshort-term incentives, is recommended by senior management in its discretion andreviewed and approved by REMCO. For 2006, Mr. Young's compensation packageconsisted of $375,000, or 20 percent of his total compensation, in base salaryand $1,500,000, or 80 percent, as a discretionary bonus award. Of thediscretionary bonus award, Mr. Young received $750,000 in cash and the balancewill be deferred through a grant of restricted shares in March 2007 with a grantdate value of $750,000. One-third of the shares vest on each of the first threeanniversaries of the grant and have no performance conditions. These amountswere consistent with the guaranteed cash incentive award provided for in Mr.Young's offer letter, as described below. Other compensation paid to Mr. Young, including perquisites, is consistent withperquisites paid to similarly-placed executive officers within and outside ofHSBC. In connection with his employment by HUSI in March 2006, HBUS extended an offerletter to Mr. Young defining the terms of his employment. Pursuant to the offerletter, Mr. Young is entitled to an annual salary of $300,000 and a guaranteedbonus of $1,000,000 for each of the 2006 and 2007 performance years, 50 percentof which is to be deferred through a grant of restricted shares. The offerletter also provided for additional annual bonuses to be awarded in the solediscretion of the company, subject to deferral pursuant to the Private Bankingdiscretionary bonus program. The offer letter also defined the rights of theparties upon Mr. Young's resignation or termination, which are described underbelow under Potential Payments upon Termination or Change-in-Control. Janet L. Burak Compensation The Senior Executive Vice President, General Counsel and Secretary of HUSI,Janet L. Burak, participates in general benefits available to executives of HUSIand the Management Incentive Program. Her cash compensation for 2006 wasdetermined by Mr. Mehta, the HNAH Chief Executive Officer, upon recommendationof the Compensation Committee in consultation with HUSI Human Resourcesexecutives. As with all HUSI executives, REMCO has authority over Ms. Burak'sAchievement Share awards. For 2006, Ms. Burak's compensation was comprised ofbase salary, non-equity incentive compensation (bonus), stock awards andperquisites. 177 Ms. Burak's base salary increased by $32,708 in February 2006, bringing her basesalary to $400,208. In recommending Ms. Burak's base salary, the CompensationCommittee and HUSI senior executives reviewed competitive compensation levelsand found Ms. Burak's current compensation level was in line with the 50thpercentile among similarly-placed executives at HUSI's Comparator Group. Therecommendation also reflected the company's view of Ms. Burak's performance in2005. The HNAH Chief Executive Officer agreed with the recommendation andapproved the increase in Ms. Burak's base salary. In March 2006, Ms. Burak was granted Achievement Shares with a grant date valueof $500,000, which vest in three years and have no performance conditions. Thisreflected management's recognition of the value of Ms. Burak's expectedlong-term contribution to and leadership of HUSI and HNAH, and HSBC's desire toretain Ms. Burak and to incent outstanding performance. Ms. Burak's cash incentive under the Management Incentive Program is determinedbased upon satisfaction of quantitative and qualitative objectives that providefor a target cash award equal to 100 percent of her base salary, up to a maximumof 200 percent of base salary. Ms. Burak's cash incentive compensation requiredsatisfaction of the quantitative and qualitative objectives described above forMr. Glynn. Management assessed Ms. Burak's and HUSI's performance against theobjectives and found that there was complete or substantial satisfaction of eachobjective. Ms. Burak was awarded cash incentive compensation of $735,383, orapproximately 186 percent of her base salary, which was paid to her in February2007. Other compensation paid to Ms. Burak including perquisites, such as lifeinsurance premiums, is consistent with perquisites paid to similarly-placedexecutive officers within and outside of HSBC. Brendan McDonagh Compensation Mr. McDonagh served as Chief Operating Officer of HUSI until December 1, 2006.For that portion of 2006, Mr. McDonagh participated in general benefitsavailable to executives of HUSI and the Management Incentive Program and certainadditional benefits available to HSBC's international staff executives. As anHSBC Group General Manager, Mr. McDonagh's cash compensation for 2006 wasdetermined by REMCO upon advisory recommendation of the Compensation Committeein consultation with HSBC Human Resources executives. As with all HUSIexecutives, REMCO has authority over Mr. McDonagh's equity-based awards. For2006, Mr. McDonagh's compensation was comprised of base salary, non-equityincentive compensation (bonus), stock awards and perquisites. Mr. McDonagh's base salary for 2006 was $676,553. In recommending Mr. McDonagh'sbase salary to the Compensation Committee, HUSI and HNAH senior executivesreviewed competitive compensation levels and found Mr. McDonagh's currentcompensation level was below the 50th percentile among similarly-placedexecutives at HUSI's Comparator Group. The recommendation also reflected thecompany's view of Mr. McDonagh's performance in 2005. The Compensation Committeeagreed with management's recommendation and made an advisory recommendation toREMCO. REMCO concurred with the Compensation Committee's assessment and, as aresult, Mr. McDonagh's base salary was increased. In January 2006, REMCO approved the Compensation Committee's advisoryrecommendation that Mr. McDonagh receive a Performance Share award with a grantdate value of $635,000. The award is subject to three-year performance vestingconditions. The vesting criteria of the Performance Shares are set out inFootnote 2 to the Grants of Plan-Based Awards Table on page 184. The grantreflects REMCO's view of the value of Mr. McDonagh's long-term contribution toand leadership of HSBC, including HUSI and HNAH, and HSBC's desire to retain Mr.McDonagh and to incent exceptional performance. 178 Under the Management Incentive Program, Mr. McDonagh's 2006 target annualincentive bonus opportunity was 100 percent of his base salary at December 31,2006 and his maximum opportunity was 200 percent. Mr. McDonagh's cash incentivecompensation was determined upon satisfaction of the quantitative andqualitative objectives described above for Mr. Glynn. Management assessed Mr.McDonagh's and HUSI's performance against the objectives and recommended a cashincentive compensation award equal to $720,000, or approximately 106 percent ofhis base salary, which was paid in February 2007. The Compensation Committeeagreed with management's assessment and made an advisory recommendation to REMCOthat Mr. McDonagh receive this amount. REMCO concurred with the assessment andadvisory recommendation of the Compensation Committee and approved the cashincentive compensation. Mr. McDonagh received other compensation in 2006, including perquisites relatingto housing, education, travel and tax equalization, that was significant whencompared to other compensation received by other executive officers within HUSI.These amounts are consistent, however, with perquisites paid to similarly-placedHSBC international staff executives, who are subject to appointment to HSBClocations globally as deemed appropriate by HSBC senior management. Theadditional perquisites and benefits available to HSBC international staffexecutives, as described below in the Summary Compensation Table, are intendedto compensate executives for the significant cost and expense incurred inconnection with global postings. Joseph M. Petri Compensation Mr. Petri served as Senior Executive Vice President, Treasurer and Co-Head, CIBMAmericas until August 5, 2006. For that portion of 2006, Mr. Petri participatedin general benefits available to executives of HUSI and the CIBM business. For2006, Mr. Petri's compensation was comprised primarily of base salary,non-equity incentive compensation (discretionary bonus award) and a cash paymenttriggered by his retirement. In 2006, Mr. Petri's total compensation remained at $7,825,000, the same as for2005. In recommending Mr. Petri's compensation package to the Group Head ofCIBM, CIBM senior management considered the performance of the CIBM businesslocally and globally and its judgment of competitive compensation levels withinthe relevant markets. The recommendation also reflected CIBM senior management'sview of Mr. Petri's contribution to the business's performance in 2005 and thedesire to retain Mr. Petri within the CIBM business. The Head of CIBM agreedwith senior management's recommendation and made an advisory recommendation toREMCO to approve his compensation. REMCO concurred with the assessment andrecommendation of CIBM management and approved Mr. Petri's total compensationpackage. Mr. Petri entered into a separation agreement with HBUS on August 1, 2006.Pursuant to the terms of his separation agreement, Mr. Petri received hisregular base salary and benefits through his retirement on August 4, 2006. Mr.Petri received a lump sum payment of $146,339 as payment of the base salary thatwould have accrued for continued employment through December 31, 2006. He alsoreceived a lump sum payment of $3,960,000 in February 2007 in payment of theportion Mr. Petri's minimum guaranteed bonus for 2006 not subject to deferral,and is entitled to receive the balance of his guaranteed bonus amount for 2006through a grant of restricted shares with a grant date value of $3,540,000. Inconnection with Mr. Petri's retirement, REMCO also approved the continuedvesting of all outstanding restricted shares that have not yet vested, subjectto any existing performance conditions. Other compensation paid to Mr. Petri, including perquisites, is consistent withperquisites paid to similarly-placed executive officers within and outside ofHSBC. 179 Compensation Committee Interlocks and Insider Participation The primary purpose of the Compensation Committee is to assist the Board ofDirectors in discharging its responsibilities related to the compensation of theChief Executive Officer, other officers of HUSI holding a title of executivevice president and above and such other officers as may be designated by theBoard of Directors. The Compensation Committee is comprised of the followingdirectors: Dr. Frances D. Fergusson (Chair), Donald K. Boswell and James L.Morice. During 2006, with the exception of Mr. Glynn, the Compensation Committeewas comprised of independent directors, as defined under HUSI's CorporateGovernance Standards. HUSI's present intention is to maintain a CompensationCommittee that consists entirely of independent directors. Additional information with regard to the Compensation Committee, including adescription of the committee's responsibilities under its charter, is containedin the section of this Form 10-K entitled Item 10. Directors, Executive Officersand Corporate Governance - Board of Directors - Committees and Charters. Compensation Committee Report We, the Human Resources & Compensation Committee of the Board of Directors ofHSBC USA Inc., have reviewed and discussed the Compensation Discussion andAnalysis ("2006 CD&A") set forth above with management and, based on such reviewand discussion, have recommended to the Board of Directors that the 2006 CD&A beincluded in this Annual Report on Form 10-K. Human Resources & Compensation Committee Dr. Frances D. Fergusson (Chair) Donald K. Boswell James L. Morice 180 This information is provided by RNS The company news service from the London Stock Exchange More to Follow