HSBC USA Q3 2005 10Q PT.2

HSBC Holdings PLC 14 November 2005 PART 2 o miscellaneous fees have also increased as a direct result of the private label receivable portfolio purchased from HSBC Finance Corporation in December 2004, and from other private label portfolios acquired from unrelated third parties during 2005. Residential Mortgage Banking Revenue The following table presents the components of residential mortgage banking revenue. Net interest income includes interest earned/paid on assets and liabilities of the residential mortgage banking business as well as an allocation of the funding benefit or cost associated with these balances. The net interest income component in the table is included in net interest income in the consolidated statement of income and reflects actual interest earned, net of cost of funds, and adjusted for corporate transfer pricing. Corporate transfer pricing methodology was revised in the first quarter of 2005 resulting in additional internal charges to the residential mortgage banking business from the CIBM segment. Net interest income for the third quarter and the first nine months of 2004 has been adjusted in the table to facilitate comparison. ------------------------------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Net interest income ................................................ $ 103 $ 121 $ (18) (15) ------ ------ ------ ------ Servicing related income (expense): Servicing fee income ......................................... 19 20 (1) (5) MSRs amortization ............................................ (18) (19) 1 5 MSRs temporary impairment (provision) recovery ............... 49 (95) 144 152 Trading - Derivative instruments used to offset changes in value of MSRs .............................................. (14) 33 (47) (142) ------ ------ ------ ------ Total net servicing related income (expense) ................. 36 (61) 97 159 ------ ------ ------ ------ Originations and sales related income (expense): Gains (losses) on sales of mortgages ......................... (12) 1 (13) (1,300) Trading - Forward loan sale commitments ...................... -- (4) 4 100 - Interest rate lock commitments ..................... -- (3) 3 100 - Euro interest rate contracts ....................... 2 -- 2 -- Fair value hedge activity(1) ................................. -- (1) 1 100 ------ ------ ------ ------ Total net originations and sales related income (expense) .... (10) (7) (3) (43) ------ ------ ------ ------ Other mortgage income .............................................. 5 4 1 25 ------ ------ ------ ------ Total residential mortgage banking revenue (expense) included in other revenues ................................................ 31 (64) 95 148 ------ ------ ------ ------ Total residential mortgage banking related revenue ................. $ 134 $ 57 $ 77 135 ====== ====== ====== ====== 40 ------------------------------------------------------------------------------------------------------------------- Increase (Decrease) ------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------------------------------------- (in millions) Nine months ended September 30: Net interest income ................................................ $ 349 $ 342 $ 7 2 ------ ------ ------ ------ Servicing related income (expense): Servicing fee income ......................................... 56 60 (4) (7) MSRs amortization ............................................ (54) (82) 28 34 MSRs temporary impairment (provision) recovery ............... 30 (82) 112 137 Trading - Derivative instruments used to offset changes in value of MSRs .............................................. 5 9 (4) (44) Gains on sales of available for sale securities .............. -- 8 (8) (100) ------ ------ ------ ------ Total net servicing related income (expense) ................. 37 (87) 124 143 ------ ------ ------ ------ Originations and sales related income (expense): Gains (losses) on sales of mortgages ......................... 3 (7) 10 143 Trading - Forward loan sale commitments ...................... (9) (1) (8) (800) - Interest rate lock commitments ..................... (4) (13) 9 69 Fair value hedge activity(1) ................................. -- (2) 2 100 ------ ------ ------ ------ Total net originations and sales related income (expense) .... (10) (23) 13 57 ------ ------ ------ ------ Other mortgage income .............................................. 14 5 9 180 ------ ------ ------ ------ Total residential mortgage banking revenue (expense) included in other revenues ................................................ 41 (105) 146 139 ------ ------ ------ ------ Total residential mortgage banking related revenue ................. $ 390 $ 237 $ 153 65 ====== ====== ====== ====== (1) Includes SFAS 133 qualifying fair value adjustments related to residential mortgage banking warehouse fair value hedging activity. All increases and decreases referenced below for the third quarter and the first nine months of 2005 represent comparisons with the same 2004 periods. Overview Residential mortgage banking related revenue increased $77 million and $153 million for the third quarter and the first nine months of 2005 respectively. Net interest income for the first nine months of 2005 was consistent with 2004 levels. The decrease for the third quarter of 2005 was attributable to a narrowing of interest rate spreads on the core mortgage portfolio. Commentary regarding residential mortgage interest income is presented on pages 35-36 of this Form 10-Q. Servicing Related Income (Expense) Increased net servicing related income (expense) for the third quarter and for the first nine months of 2005 was primarily attributable to recovery of the temporary impairment valuation allowance during 2005 compared with provisions for impairment recorded for 2004, which was partially offset by decreases in income associated with derivative instruments used to offset changes in the economic value of MSRs. The overall increase for the first nine months of 2005 was also partially attributable to decreased MSR amortization expense. The recorded net book value of MSRs and related amortization expense, are directly impacted by interest rate fluctuations, which in turn affect levels of residential mortgage prepayments. During 2005, interest rates generally rose and prepayments of residential mortgages, mostly in the form of loan refinancings, have subsequently decreased in comparison with 2004 levels, resulting in decreased MSR amortization expense compared with amounts recorded in prior periods. Loan refinance activity represented 43% of total originations in the first nine months of 2005, as compared with 52% in the first nine months of 2004. 41 The net servicing related income amounts in the tables do not reflect approximately $4 million of unrealized losses, recorded as other comprehensive income, on available for sale securities used to offset changes in the economic value of MSRs as well as net interest income of $7 million on these securities. Additional commentary regarding risk management associated with the MSRs economic hedging program begins on page 67 of this Form 10-Q. Originations and Sales Related Income (Expense) The increase in originations and sales related income for the first nine months of 2005 was attributable to a higher basis point gain on each individual sale driven by less market volatility as compared with 2004 as well as a higher volume of originated loans sold. During the first nine months of 2005, residential mortgages originated with the intention to sell increased 27% from the same 2004 period. A greater proportion of adjustable rate residential mortgage loans were sold in 2005, which previously would have been held on HUSI's balance sheet. Trading Revenues Trading revenues are generated by HUSI's participation in the foreign exchange, credit derivative and precious metals markets; from trading derivative contracts, including interest rate swaps and options; and from trading securities. Trading revenues related to the mortgage banking business are included in residential mortgage banking revenue. The following table presents trading related revenues by business. The data in the table includes interest income earned on trading instruments, net of allocated funding cost associated with the trading positions. The net interest income component is included in net interest income on the consolidated statement of income. ----------------------------------------------------------------------------------------------- Increase (Decrease) -------------------- 2005 2004 Amount % ----------------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Trading revenues ........................ $ 137 $ 21 $ 116 552 Net interest income ..................... -- 24 (24) (100) ------ ------ ------ ------ Trading related revenues ................ $ 137 $ 45 $ 92 204 ====== ====== ====== ====== Business: Derivative instruments ............ $ 44 $ (3) $ 47 1,567 Treasury (primarily securities) ... 39 5 34 680 Bank notes ........................ 19 16 3 19 Foreign exchange .................. 20 11 9 82 Precious metals ................... 9 11 (2) (18) Other trading ..................... 6 5 1 20 ------ ------ ------ ------ Trading related revenues ................ $ 137 $ 45 $ 92 204 ====== ====== ====== ====== Nine months ended September 30: Trading revenues ........................ $ 268 $ 188 $ 80 43 Net interest income ..................... 21 61 (40) (66) ------ ------ ------ ------ Trading related revenues ................ $ 289 $ 249 $ 40 16 ====== ====== ====== ====== Business: Derivative instruments ............ $ 103 $ 83 $ 20 24 Treasury (primarily securities) ... 42 20 22 110 Bank notes ........................ 49 42 7 17 Foreign exchange .................. 52 48 4 8 Precious metals ................... 35 39 (4) (10) Other trading ..................... 8 17 (9) (53) ------ ------ ------ ------ Trading related revenues ................ $ 289 $ 249 $ 40 16 ====== ====== ====== ====== 42 Improved trading markets during the third quarter of 2005 offset the difficult markets encountered during the first two quarters. Overall, non-interest client and propriety trading revenues increased during the third quarter and the first nine months of 2005 as a result of the following factors: o improved trading markets for the third quarter associated with the credit derivatives trading desk; o successful rollout of a new structured transactions business within the CIBM segment, which has increased derivatives related revenues in the third quarter and the first nine months of 2005; and o increased Treasury related revenues for the third quarter associated with a new whole loan structuring business initiated during 2005. The yield curve continued to flatten during the third quarter, which resulted in significant decreases in quarter and year to date interest rate margins associated with various trading assets. Security Gains, Net The following table presents gains and losses on securities portfolios included in the consolidated statement of income. ------------------------------------------------------------------------------------------------------------------ 2005 2004 ---------------------------------- ---------------------------------- Gross Gross Net Gross Gross Net Realized Realized Realized Realized Realized Realized Gains (Losses) Gains Gains (Losses) Gains ------------------------------------------------------------------------------------------------------------------ (in millions) Three months ended September 30: Net security gains included in: Security gains, net ............ $ 17 $ -- $ 17 $ 19 $ (1) $ 18 ===== ===== ===== ===== ===== ===== Nine months ended September 30: Net security gains included in: Residential mortgage banking related revenue .............. $ -- $ -- $ -- $ 8 $ -- $ 8 Security gains, net ............ 106 (1) 105 66 (7) 59 ----- ----- ----- ----- ----- ----- $ 106 $ (1) $ 105 $ 74 $ (7) $ 67 ===== ===== ===== ===== ===== ===== HUSI maintains various securities portfolios as part of its overall liquidity, balance sheet diversification and risk management strategy. During the first nine months of 2005, approximately $33 million of gains were realized on securities sold to address interest rate sensitivity and balance sheet diversification needs, which was consistent with similar gains for the same 2004 period. Also during 2005, HUSI reduced its exposure in Latin American securities, resulting in gains of $20 million, as compared with $27 million for the same 2004 period. In June 2005, HUSI sold shares in a foreign equity fund to an HSBC affiliate for a gain of $48 million. 43 Operating Expenses The following table presents the components of operating expenses. ------------------------------------------------------------------------------------------------------------- Increase (Decrease) -------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Salaries and employee benefits ............................. $ 257 $ 219 $ 38 17 Occupancy expense, net ..................................... 49 42 7 17 Support services from HSBC affiliates: Fees paid to HTSU for technology services ............ 48 42 6 14 Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ......... 102 8 94 1,175 Other fees, primarily treasury and traded markets services ........................................... 63 49 14 29 ------- ------- ------- ------- 213 99 114 115 ------- ------- ------- ------- Other expenses: Equipment and software ............................... 22 26 (4) (15) Marketing ............................................ 22 14 8 57 Outside services ..................................... 29 24 5 21 Professional fees .................................... 15 14 1 7 Telecommunications ................................... 5 4 1 25 Postage, printing and office supplies ................ 6 6 -- -- Insurance business ................................... 6 6 -- -- Other ................................................ 49 26 23 88 ------- ------- ------- ------- Total other expenses ................................. 154 120 34 28 ------- ------- ------- ------- Total operating expenses ................................... $ 673 $ 480 $ 193 40 ======= ======= ======= ======= Personnel - average number ................................. 11,378 11,108 270 2 ------------------------------------------------------------------------------------------------------------- Increase (Decrease) -------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------------------------------- (in millions) Nine months ended September 30: Salaries and employee benefits ............................. $ 778 $ 714 $ 64 9 Occupancy expense, net ..................................... 134 124 10 8 Support services from HSBC affiliates: Fees paid to HTSU for technology services ............ 148 124 24 19 Fees paid to HSBC Finance Corporation for loan servicing and other administrative support ......... 307 19 288 1,516 Other fees, primarily treasury and traded markets services ........................................... 194 148 46 31 ------- ------- ------- ------- 649 291 358 123 ------- ------- ------- ------- Other expenses: Equipment and software ............................... 68 83 (15) (18) Marketing ............................................ 55 34 21 62 Outside services ..................................... 84 74 10 14 Professional fees .................................... 44 35 9 26 Telecommunications ................................... 14 13 1 8 Postage, printing and office supplies ................ 19 18 1 6 Insurance business ................................... 15 17 (2) (12) Other ................................................ 152 86 66 77 ------- ------- ------- ------- Total other expenses ................................. 451 360 91 25 ------- ------- ------- ------- Total operating expenses ................................... $ 2,012 $ 1,489 $ 523 35 ======= ======= ======= ======= Personnel - average number ................................. 11,114 11,634 (520) (4) All increases and decreases referred to for the third quarter and for the first nine months of 2005 represent comparisons with the same 2004 periods. 44 Overview Total operating expenses increased 40% in the third quarter of 2005, and increased 35% in the first nine months of 2005. Increases in various HSBC affiliate charges and in salaries and employee benefits were the primary drivers of increased expenses. Salaries and Employee Benefits Salaries increased $21 million (12%) for the third quarter and increased $26 million (5%) for the first nine months of 2005. During the first half of 2004, HUSI transferred its brokerage subsidiary and most of its branch operations in Panama to other HSBC affiliates, resulting in a significant reduction in average personnel. Excluding these subsidiary transfers, the average number of personnel increased for the third quarter and the first nine months of 2005. Expansion initiatives in various businesses were the primary drivers of increased staff counts and salaries expense. In addition, in March 2005, HSBC transferred a subsidiary to HUSI that provides accounting and valuation services to hedge fund clients, which also increased salaries expense. Employee benefits expenses increased $17 million (43%) in the third quarter and $38 million (22%) in the first nine months of 2005, due to: o increased employer share of payroll taxes and other benefit costs associated with the overall increases noted above for salaries; o HUSI's employer matching of employee retirement savings contributions have increased, due to changes in matching program provisions which took effect during 2004; and o increased staffing levels noted above. Support Services From HSBC Affiliates Fees are charged by various HSBC affiliates for technology services, for underwriting and broker-dealer services, for loan origination and servicing, and for other operational and administrative support functions. Transactions with HSBC affiliates are presented in Note 10 of the consolidated financial statements beginning on page 13 of this Form 10-Q. The overall increases in HSBC affiliate charges are due primarily to the following activity: o fees charged by HSBC Finance Corporation for loan origination and servicing expenses have increased significantly due to increased services related to the private label receivable portfolio and other loans acquired from HSBC Finance Corporation and from their correspondents. Fees charged by HSBC Finance Corporation for various administrative services have also increased as a result of specific initiatives to centralize administrative functions; o fees charged by HTSU for technology services expenses have increased in 2005, as HUSI continued to upgrade its automated technology environment. Equipment and software costs included in other expenses have decreased in 2005, as these costs are now included in the charges by HTSU; and o fees charged by HSBC Markets and other HSBC affiliates for treasury and traded markets services provided to HUSI's CIBM business segment have also increased in 2005 due primarily to business expansion initiatives. Other Expenses Other includes external fraud losses of $4 million in the third quarter of 2005, and $26 million in the first nine months of 2005, which are related primarily to the private label receivable portfolio acquired from HSBC Finance Corporation in December 2004. HUSI maintains a separate reserve for credit risk associated with certain off-balance sheet exposures, including letters of credit, unused commitments to extend credit and financial guarantees. The provision for losses associated with these off-balance sheet exposures increased $9 million in the third quarter of 2005 and $15 million for the first nine months of 2005. Additional analysis of off-balance sheet exposures begins on page 60 of this Form 10-Q. 45 Various business expansion initiatives within the PFS, CMB and CIBM segments have also resulted in general increases in other expenses during 2005. BUSINESS SEGMENTS -------------------------------------------------------------------------------- HUSI has five distinct segments that it utilizes for management reporting and analysis purposes, which are consistent with the line of business groupings used by HSBC. The segments are based upon customer groupings, as well as products and services offered. The segments are described in the following paragraphs. The Personal Financial Services (PFS) Segment This segment provides a broad range of financial products and services including installment and revolving term loans, deposits, branch services, mutual funds, investments and insurance. These products are marketed to individuals primarily through the branch banking network. Residential mortgage lending provides loan financing through direct retail and wholesale origination channels. Mortgage loans are originated through a network of brokers, wholesale agents and retail origination offices. Servicing is performed for the individual mortgage holder or on a contractual basis for mortgages owned by third parties. The PFS segment continues to include MasterCard/Visa credit card receivables acquired on a daily basis, related to account relationships which HUSI sold to HSBC Finance Corporation in 2004. The Consumer Finance (CF) Segment Effective for the first quarter of 2005, HUSI formed a new business segment, Consumer Finance (CF), which was reported as a component of PFS in prior periods. The CF segment includes point of sale and other lending activities primarily to meet the financial needs of individuals. Specifically, operating activity within the CF segment relates to various consumer loans, private label credit card receivables, and retained interests in securitized receivable trusts purchased from HSBC Finance Corporation, as well as consumer loans purchased from originating lenders pursuant to HSBC Finance Corporation correspondent loan programs. Purchases from these correspondents were discontinued effective September 1, 2005 due to HUSI's increasing ability to originate similar products. The Commercial Banking (CMB) Segment This segment provides loan and deposit products to small businesses and middle-market corporations including specialized products such as real estate financing. Various credit and trade related products are also offered such as standby facilities, performance guarantees and acceptances. These products and services are offered through multiple delivery systems, including the branch banking network. The Corporate, Investment Banking and Markets (CIBM) Segment This segment is comprised of Corporate/Institutional Banking (CIB) and Investment Banking and Markets (IBM). CIB provides deposit and lending functionality to large and multi-national corporations and banks. U.S. dollar clearing services are offered for domestic and international wire transfer transactions. Credit and trade related products such as standby facilities, performance guarantees and acceptances are also provided by CIB to large corporate entities. The IBM component includes treasury and traded markets. The treasury function maintains overall responsibility for the investment and borrowing of funds to ensure liquidity, manage interest rate risk and capital at risk. Traded markets encompasses the trading and sale of foreign exchange, banknotes, derivatives, precious metals, securities and emerging markets instruments, both domestically and internationally. The Private Banking (PB) Segment This segment offers a full range of services for high net worth domestic and foreign individuals including deposit, lending, trading, trust, branch services, mutual funds, insurance and investment management. 46 Other Segment This segment includes equity investments in Wells Fargo HSBC Trade Bank N.A. and HSBC Republic Bank (Suisse) S.A. The net interest income component in the following tables reflects actual interest earned, net of cost of funds as determined by corporate transfer pricing methodology. Effective January 2005, HUSI enhanced its funds transfer pricing methodology to better approximate current external market pricing and valuation, resulting in additional internal charges to the residential mortgage banking business, included in PFS, from CIBM. For comparability purposes, 2004 segment results were also restated, increasing CIBM revenues by $57 million for the third quarter and $143 million for the first nine months of 2004, with the offsetting decrease to PFS revenues. All increases and decreases referred to on the following pages for the third quarter 2005 and for the first nine months of 2005 represent comparisons with the same 2004 periods. The term "interest rate spread", as used in the following commentary, refers to either: o the percentage difference between the interest rate earned on earning assets, net of amortized premiums and loan fees, and the cost of funds utilized to fund those assets, as calculated using corporate transfer pricing methodology; or o the percentage difference between the interest rate paid on deposits specifically assigned to a business segment and the associated value of funds as calculated using corporate transfer pricing methodology. Personal Financial Services (PFS) Overview Excluding certain one-time transactions that occurred in 2005 and 2004, earnings improved for the PFS segment during the first nine months of 2005. Additional resources and priority have been focused on core retail banking businesses. Investment in the retail branch network continues to be expanded and reallocated to ensure coverage of high potential growth geographic areas. Loan and deposit products offered to individuals have been expanded in conjunction with increased marketing efforts. HUSI has also continued to leverage its relationship with HSBC Finance Corporation to increase consumer loan assets and earnings, to obtain loan origination and servicing, and to reduce overall operating costs of various administrative services. Operating Results The following table summarizes the results for the Personal Financial Services (PFS) segment. ------------------------------------------------------------------------------------ Increase (Decrease) -------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------ (in millions) Three months ended September 30: Net interest income ............... $ 300 $ 274 $ 26 9 Other revenues .................... 124 168 (44) (26) ------- ------- ------- ------- Total revenues .................... 424 442 (18) (4) Operating expenses ................ 257 239 18 8 ------- ------- ------- ------- Working contribution .............. 167 203 (36) (18) Provision for credit losses ....... 23 20 3 15 ------- ------- ------- ------- Income before income tax expense .. $ 144 $ 183 $ (39) (21) ======= ======= ======= ======= Average assets .................... $48,655 $44,731 Average liabilities/equity ........ 42,081 34,072 Goodwill at September 30 .......... 1,164 1,167 47 ------------------------------------------------------------------------------------ Increase (Decrease) -------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------ (in millions) Nine months ended September 30: Net interest income ............... $ 902 $ 803 $ 99 12 Other revenues .................... 339 308 31 10 ------- ------- ------- ------- Total revenues .................... 1,241 1,111 130 12 Operating expenses ................ 757 709 48 7 ------- ------- ------- ------- Working contribution .............. 484 402 82 20 Provision for credit losses ....... 67 63 4 6 ------- ------- ------- ------- Income before income tax expense .. $ 417 $ 339 $ 78 23 ======= ======= ======= ======= Average assets .................... $49,824 $38,877 Average liabilities/equity ........ 43,465 33,063 Increased net interest income for the third quarter and the first nine months of 2005, was due to: o significant growth in average consumer loan balances, particularly adjustable rate residential mortgage loans, partially offset by the lower average yields on the adjustable rate loans; o more favorable interest rate spreads on a growing personal deposits base during 2005; and o offset by $24 million of amortization of premium paid during the first nine months of 2005 for MasterCard/Visa credit card receivables acquired on a daily basis from HSBC Finance Corporation. Other revenues includes the following significant activity for 2005 and 2004, which affects the comparability of reported amounts: 2005 o non-interest residential mortgage banking revenue increased $95 million in the third quarter and increased $146 million in the first nine months of 2005. Commentary regarding residential mortgage banking revenue begins on page 40 of this Form 10-Q; o during 2005, HUSI sold certain properties to unaffiliated third parties. Approximately $26 million of the gains realized on these transactions were recorded in the PFS segment; and o effective in October 2004, HBUS is the originating lender for HSBC Finance Corporation's Taxpayer Financial Services program. Gains recognized for tax refund anticipation loans sold to HSBC Finance Corporation were approximately $19 million in the first nine months of 2005, most of which was recorded in the first quarter of the year. 2004 o during the third quarter of 2004, HUSI recorded a $99 million gain on sale of certain credit card relationships to HSBC Finance Corporation; and o also during the third quarter, HUSI recorded a $45 million gain on sale of an equity investment. Increased operating expenses for the third quarter and the first nine months of 2005, were due to: o increased personnel, marketing and other direct expenses associated with expanded consumer lending and retail banking operations; and o increased fees paid to HTSU, as HUSI has continued to upgrade its technology environment. 48 Consumer Finance (CF) Overview Results of this segment, which was initiated in 2005, have been negatively impacted by significant amortization of premiums paid for private label credit card receivables acquired from HSBC Finance Corporation in 2004 and 2005. Residential mortgage loans and other consumer loans acquired from HSBC Finance Corporation and their correspondents, which began in 2003, have had a positive impact on income before taxes. Operating Results The following table summarizes the results for the Consumer Finance (CF) segment. ------------------------------------------------------------------------------------------------------- Increase (Decrease) ---------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Net interest income ............................ $ 140 $ 49 $ 91 186 Other revenues ................................. 102 -- 102 -- -------- -------- -------- -------- Total revenues ................................. 242 49 193 394 Operating expenses ............................. 101 4 97 2,425 -------- -------- -------- -------- Working contribution ........................... 141 45 96 213 Provision for credit losses .................... 176 3 173 5,767 -------- -------- -------- -------- Income (loss) before income tax expense ........ $ (35) $ 42 $ (77) (183) ======== ======== ======== ======== Average assets ................................. $ 19,764 $ 4,777 Average liabilities/equity ..................... 343 (5) Nine months ended September 30: Net interest income ............................ $ 436 $ 135 $ 301 223 Other revenues ................................. 249 -- 249 -- -------- -------- -------- -------- Total revenues ................................. 685 135 550 407 Operating expenses ............................. 318 10 308 3,080 -------- -------- -------- -------- Working contribution ........................... 367 125 242 194 Provision for credit losses .................... 437 6 431 7,183 -------- -------- -------- -------- Income (loss) before income tax expense ........ $ (70) $ 119 $ (189) (159) ======== ======== ======== ======== Average assets ................................. $ 18,890 $ 3,928 Average liabilities/equity ..................... 506 (3) This segment includes receivables associated with the private label receivable portfolio (the PLRP) acquired in December 2004 from HSBC Finance Corporation and other consumer loans acquired from HSBC Finance Corporation and their correspondents. The following table summarizes the impact of the PLRP on earnings for this segment for the third quarter and first nine months of 2005 in comparison with the other portfolios. -------------------------------------------------------------------------------- PLRP Other Total -------------------------------------------------------------------------------- (in millions) Three months ended September 30, 2005: Net interest income ............................ $ 102 $ 38 $ 140 Other revenues ................................. 102 -- 102 ----- ----- ----- Total revenues ................................. 204 38 242 Operating expenses ............................. 98 3 101 ----- ----- ----- Working contribution ........................... 106 35 141 Provision for credit losses .................... 153 23 176 ----- ----- ----- Income (loss) before income tax expense ........ $ (47) $ 12 $ (35) ===== ===== ===== 49 -------------------------------------------------------------------------------- PLRP Other Total -------------------------------------------------------------------------------- (in millions) Nine months ended September 30, 2005: Net interest income ............................ $ 283 $ 153 $ 436 Other revenues ................................. 249 -- 249 ----- ----- ----- Total revenues ................................. 532 153 685 Operating expenses ............................. 306 12 318 ----- ----- ----- Working contribution ........................... 226 141 367 Provision for credit losses .................... 401 36 437 ----- ----- ----- Income (loss) before income tax expense ........ $(175) $ 105 $ (70) ===== ===== ===== Interest income for the PLRP has been partially offset by approximately $370 million of amortization of the initial premium paid for the portfolio. In addition, amortization of premium paid for additional PLRP receivables acquired from HSBC Finance Corporation during 2005 was $168 million for the first nine months of 2005. Other revenues for the PLRP for the first nine months of 2005 is primarily comprised of the following: o approximately $150 million of credit card and other fees from customers; and o approximately $99 million of securitization revenue from residual interests in securitized private label credit card receivables acquired as part of the PLRP purchase. Operating expenses for the PLRP are primarily fees paid to HSBC Finance Corporation for loan servicing. Additional direct expenses for management of the portfolio, including technology services and fraud losses, have also been incurred. The provision for credit losses includes an incremental provision of $25 million for Hurricane Katrina (see further commentary on page 24 of this Form 10-Q). Excluding this incremental provision, the provision for credit losses for the first nine months of 2005 is consistent with historical experience for this portfolio. Commentary regarding credit quality begins on page 54 of this Form 10-Q. New domestic private label credit card receivable originations are purchased from HSBC Finance Corporation on a daily basis. In accordance with Federal Financial Institutions Examination Council (FFIEC) guidance, in the first quarter of 2006, the required minimum monthly payment amounts for domestic private label credit card accounts will change. Preliminary estimates of the potential impact to the business are based on numerous assumptions and take into account a number of factors, such as changes in customer behavior, which are difficult to predict. The impact of these factors will not be fully known or understood until the changes are fully implemented. It is anticipated that the changes will reduce the premium associated with these daily purchases beginning in 2006. Although these changes are not expected to have a material impact on HUSI's consolidated results, the impact will be material to the CF segment in 2006. Commercial Banking (CMB) Overview Improved results for 2005 resulted from successful rollout of planned expansion initiatives. Loan and deposit products offered to small businesses, and middle-market commercial customers have been expanded, beginning in 2004, in conjunction with increased marketing efforts. HUSI has also leveraged its status as the top ranked small business lender in New York State. 50 Operating Results The following table summarizes the results for the Commercial Banking (CMB) segment. ----------------------------------------------------------------------------------------- Increase (Decrease) --------------------- 2005 2004 Amount % ----------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Net interest income ................ $ 172 $ 145 $ 27 19 Other revenues ..................... 52 41 11 27 -------- -------- -------- -------- Total revenues ..................... 224 186 38 20 Operating expenses ................. 93 75 18 24 -------- -------- -------- -------- Working contribution ............... 131 111 20 18 Provision for credit losses ........ 7 (5) 12 240 -------- -------- -------- -------- Income before income tax expense ... $ 124 $ 116 $ 8 7 ======== ======== ======== ======== Average assets ..................... $ 16,200 $ 13,783 Average liabilities/equity ......... 18,302 14,180 Goodwill at September 30 ........... 471 473 Nine months ended September 30: Net interest income ................ $ 481 $ 434 $ 47 11 Other revenues ..................... 139 126 13 10 -------- -------- -------- -------- Total revenues ..................... 620 560 60 11 Operating expenses ................. 281 249 32 13 -------- -------- -------- -------- Working contribution ............... 339 311 28 9 Provision for credit losses ........ 6 (8) 14 175 -------- -------- -------- -------- Income before income tax expense ... $ 333 $ 319 $ 14 4 ======== ======== ======== ======== Average assets ..................... $ 15,614 $ 13,504 Average liabilities/equity ......... 17,226 14,131 Increased net interest income and other revenues for the third quarter and the first nine months of 2005 resulted from the successful rollout of planned expansion of various small business, middle-market and real estate commercial lending programs. CMB also benefited from more favorable interest rate spreads on a growing deposit base during 2005. During the second quarter of 2004, HUSI transferred its Panamanian operations to an HSBC affiliate. As a result, commercial loans, deposits and related net interest income, included in the CMB segment, have decreased in 2005, partially offsetting the increases from business expansion initiatives noted above. During 2005, HUSI sold certain properties to unaffiliated third parties. Approximately $14 million of the gains realized on these transactions were recorded in other revenues within the CMB segment. Increased operating expenses resulted from the business expansion initiatives noted above and from increased fees paid to HTSU for technology services as HUSI has continued to upgrade its technology environment. Corporate, Investment Banking and Markets (CIBM) Overview Decreased income for 2005 is primarily the result of significant recent increases in short-term interest rates. While increased short-term rates have a positive impact on interest rate spreads for deposit generating businesses, such as the PFS and CMB segments, they have an adverse impact on CIBM which does not generate significant low cost deposit funding. Improved market conditions resulted in increased trading revenues in the third quarter of 2005, which partially offset difficult markets encountered during the first two quarters of the year. 51 Various treasury and traded markets activities have been expanded in 2005 resulting in increased products offered to customers, increased marketing efforts for those products, increased proprietary activities, and increased infrastructure expenses for the CIBM segment. Operating Results The following table summarizes the results for the Corporate, Investment Banking and Markets (CIBM) segment. ------------------------------------------------------------------------------------------- Increase (Decrease) ---------------------- 2005 2004 Amount % ------------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Net interest income ................ $ 107 $ 200 $ (93) (47) Other revenues ..................... 176 104 72 69 -------- -------- -------- -------- Total revenues ..................... 283 304 (21) (7) Operating expenses ................. 153 106 47 44 -------- -------- -------- -------- Working contribution ............... 130 198 (68) (34) Provision for credit losses ........ (8) 7 (15) (214) -------- -------- -------- -------- Income before income tax expense ... $ 138 $ 191 $ (53) (28) ======== ======== ======== ======== Average assets ..................... $ 58,736 $ 47,342 Average liabilities/equity ......... 78,290 58,229 Goodwill at September 30 ........... 631 631 Nine months ended September 30: Net interest income ................ $ 384 $ 582 $ (198) (34) Other revenues ..................... 441 387 54 14 -------- -------- -------- -------- Total revenues ..................... 825 969 (144) (15) Operating expenses ................. 459 345 114 33 -------- -------- -------- -------- Working contribution ............... 366 624 (258) (41) Provision for credit losses ........ (33) (54) 21 39 -------- -------- -------- -------- Income before income tax expense ... $ 399 $ 678 $ (279) (41) ======== ======== ======== ======== Average assets ..................... $ 55,777 $ 46,510 Average liabilities/equity ......... 74,652 50,806 Decreased net interest income for the third quarter and for the first nine months of 2005 was primarily due to recent increases in short-term interest rates, which have had an adverse impact on CIBM interest rate spreads. Increased other revenues for the third quarter and for the first nine months of 2005 was primarily due to increased trading revenues resulting from more favorable market conditions as compared with previous quarters. Increased fee-based income and increased gains on the sale of securities also contributed to the overall increase in other revenues. Commentary regarding trading revenues and securities gains begins on page 42 of this Form 10-Q. Increased operating expenses resulted from: o increased direct expenses associated with expanded operations in foreign exchange, risk management products, and transaction banking business; o increased expenses associated with development of an infrastructure to support the growing complexity of the CIBM business; o increased fees paid to HTSU for technology services, as CIBM required additional information technology resources to support system conversions and business expansion; and o partially offsetting the above increases was a decrease in incentive compensation expense resulting from a change in the amortization period utilized for share-based compensation. 52 The provision for credit losses increased for the first nine months of 2005 despite a decrease for the third quarter. The net provision credit for the first nine months of 2004 reflected a period of unusually low loan charge offs and relatively high recoveries of amounts previously charged off. The net provision credit for the first nine months of 2005 resulted from continuation of relatively low charge offs, but lower recoveries of amounts previously charged off. Private Banking (PB) Overview During 2005, additional resources have been allocated to expand services provided to high net worth customers served by this segment resulting in increased revenues partially offset by increased expenses. Operating Results The following table summarizes the results for the Private Banking (PB) segment. -------------------------------------------------------------------------------------- Increase (Decrease) -------------------- 2005 2004 Amount % -------------------------------------------------------------------------------------- (in millions) Three months ended September 30: Net interest income ................ $ 45 $ 33 $ 12 36 Other revenues ..................... 45 44 1 2 ------- ------- ------- ------- Total revenues ..................... 90 77 13 17 Operating expenses ................. 69 56 13 23 ------- ------- ------- ------- Working contribution ............... 21 21 -- -- Provision for credit losses ........ 1 2 (1) (50) ------- ------- ------- ------- Income before income tax expense ... $ 20 $ 19 $ 1 5 ======= ======= ======= ======= Average assets ..................... $ 4,999 $ 4,265 Average liabilities/equity ......... 9,674 8,722 Goodwill at September 30 ........... 428 428 Nine months ended September 30: Net interest income ................ $ 127 $ 95 $ 32 34 Other revenues ..................... 206 157 49 31 ------- ------- ------- ------- Total revenues ..................... 333 252 81 32 Operating expenses ................. 197 176 21 12 ------- ------- ------- ------- Working contribution ............... 136 76 60 79 Provision for credit losses ........ (1) -- (1) -- ------- ------- ------- ------- Income before income tax expense ... $ 137 $ 76 $ 61 80 ======= ======= ======= ======= Average assets ..................... $ 4,956 $ 3,899 Average liabilities/equity ......... 9,528 9,019 Increased net interest income for the third quarter and for the first nine months of 2005 resulted from increased average earning assets, primarily loans. Operating expenses have also increased as additional resources have been allocated to this segment to expand the services provided. Other revenues includes the following significant non-recurring transactions which affect comparability of results for 2005 and 2004: o in June 2005, shares in a foreign equity fund were sold to an HSBC affiliate, resulting in a gain of approximately $48 million; o during the first quarter of 2005, HUSI recognized a nominal gain on the sale of a portion of its personal trust business; and o during the first quarter of 2004, HUSI realized higher revenue from a foreign equity investment, as compared with the first quarter of 2005. 53 CREDIT QUALITY -------------------------------------------------------------------------------- HUSI's policies and critical estimates associated with its allowance for credit losses are summarized on pages 15-16, 37-38 and 77-78 of HUSI's 2004 Form 10-K. There have been no material revisions to policies or methodologies in the first nine months of 2005. The following table provides an analysis of changes in the allowance for credit losses and related ratios. ------------------------------------------------------------------------------------------------------------------- September 30, June 30, March 31, December 31, September 30, Quarter ended 2005 2005 2005 2004 2004 ------------------------------------------------------------------------------------------------------------------- (in millions) Balance at beginning of quarter ........... $ 790 $ 773 $ 788 $ 340 $ 347 Allowance related to acquisitions and (dispositions), net ..................... -- -- -- 505 (11) Charge offs: Commercial ....................... 16 17 6 22 18 Consumer: Residential mortgages ......... 6 6 4 5 2 Credit card receivables ....... 154 160 159 17 17 Other consumer loans .......... 26 23 30 6 6 ------- ------- ------- ------- ------- Total consumer loans .......... 186 189 193 28 25 ------- ------- ------- ------- ------- Total charge offs ................ 202 206 199 50 43 ------- ------- ------- ------- ------- Recoveries on loans charged off: Commercial ....................... 26 7 23 12 16 Consumer: Residential mortgages ......... 1 -- -- 1 -- Credit card receivables ....... 30 37 44 2 2 Other consumer loans .......... 8 9 10 2 2 ------- ------- ------- ------- ------- Total consumer loans .......... 39 46 54 5 4 ------- ------- ------- ------- ------- Total recoveries ................ 65 53 77 17 20 ------- ------- ------- ------- ------- Total net charge offs ............... 137 153 122 33 23 ------- ------- ------- ------- ------- Provision charged (credited) to income: Commercial ....................... 5 (1) (25) (45) 3 Consumer: Residential mortgages ......... 12 12 (1) 11 3 Credit card receivables ....... 162 141 108 9 14 Other consumer loans .......... 20 18 25 1 7 ------- ------- ------- ------- ------- Total consumer loans .......... 194 171 132 21 24 ------- ------- ------- ------- ------- Total provision .................. 199 170 107 (24) 27 ------- ------- ------- ------- ------- Balance at end of quarter ........... $ 852 $ 790 $ 773 $ 788 $ 340 ======= ======= ======= ======= ======= Allowance ratios: Annualized net charge offs to average loans .................. .61% .71% .58% .19% .14% Quarter-end allowance to: Quarter-end total loans ....... .95% .90% .90% .93% .51% Quarter-end total nonaccruing loans ........... 362.55% 351.11% 318.11% 298.48% 117.24% 54 The following table provides a summary of credit quality statistics. --------------------------------------------------------------------------------------------------------------------- September 30, June 30, March 31, December 31, September 30, 2005 2005 2005 2004 2004 --------------------------------------------------------------------------------------------------------------------- (in millions) Nonaccruing loans Balance at end of period: Commercial: Construction and other real estate ....................... $ 32 $ 29 $ 28 $ 33 $ 24 Other commercial ............... 77 81 99 117 152 ------- ------- ------- ------- ------- Total commercial ............... 109 110 127 150 176 ------- ------- ------- ------- ------- Consumer: Residential mortgages .......... 126 115 116 113 94 Credit card receivables ........ -- -- -- -- 19 Other consumer loans ........... -- -- -- 1 1 ------- ------- ------- ------- ------- Total consumer loans ........... 126 115 116 114 114 ------- ------- ------- ------- ------- Total nonaccruing loans ................ $ 235 $ 225 $ 243 $ 264 $ 290 ======= ======= ======= ======= ======= As a percent of loans: Commercial: Construction and other real estate .................. .36% .33% .33% .40% .30% Other commercial ............... .48 .53 .66 .80 1.18 ------- ------- ------- ------- ------- Total commercial ............... .43 .46 .54 .65 .84 ------- ------- ------- ------- ------- Consumer: Residential mortgages .......... .27 .24 .24 .24 .22 Credit card receivables ........ -- -- -- -- 1.69 Other consumer loans ........... -- -- -- .03 .05 ------- ------- ------- ------- ------- Total consumer loans ........... .20 .18 .18 .18 .25 ------- ------- ------- ------- ------- Total .................................. .26% .26% .28% .31% .43% ======= ======= ======= ======= ======= Interest income on nonaccruing loans (quarterly total): Amount which would have been recorded had the associated loans been current in accordance with their original terms ................. $ 5 $ 7 $ 5 $ 6 $ 5 Amount actually recorded ............... 3 1 3 5 5 Accruing loans contractually past due 90 days or more as to principal or interest: Total commercial ....................... $ 4 $ 7 $ 13 $ 13 $ 15 ------- ------- ------- ------- ------- Residential mortgages .................. 1 -- 1 1 2 Credit card receivables ................ 237 206 210 223 3 Other consumer loans ................... 15 14 15 22 16 ------- ------- ------- ------- ------- Total consumer loans ............... 253 220 226 246 21 ------- ------- ------- ------- ------- Total accruing loans contractually past due 90 days or more ............. $ 257 $ 227 $ 239 $ 259 $ 36 ======= ======= ======= ======= ======= Criticized assets (balance at end of period): Special mention ........................ $ 735 $ 706 $ 728 $ 784 $ 734 Substandard ............................ 736 761 535 590 383 Doubtful ............................... 29 28 34 46 67 ------- ------- ------- ------- ------- Total .................................. $ 1,500 $ 1,495 $ 1,297 $ 1,420 $ 1,184 ======= ======= ======= ======= ======= Impaired loans: Balance at end of period ............... $ 115 $ 102 $ 119 $ 236 $ 252 Amount with impairment reserve ......... 51 79 96 210 233 Impairment reserve ..................... 8 19 21 18 38 Other real estate and owned assets: Balance at end of period ............... $ 31 $ 25 $ 20 $ 15 $ 14 Ratio of total nonaccruing loans, other real estate and owned assets to total assets ...................... .18% .17% .19% .20% .25% 55 Overview The allowance for credit losses increased $62 million (8%) during the third quarter of 2005 and increased $64 million (8%) during the first nine months of 2005. Total provision for credit losses of $476 million for the first nine months of 2005 was offset by total net charge offs of $412 million. The allowance for credit losses increased $512 million from September 30, 2004 to September 30, 2005, primarily due to the addition of reserves associated with the acquisition of approximately $12 billion of private label receivables from HSBC Finance Corporation in December of 2004. The provision for credit losses for the third quarter of 2005 includes an incremental provision of $26 million for Hurricane Katrina. See discussion of Hurricane Katrina beginning on page 24 of this Form 10-Q. As a result of changes in bankruptcy legislation, consumers nationwide filed bankruptcies in record numbers in recent months. HUSI's provision for the third quarter and allowance for credit losses at September 30, 2005 have not been materially impacted by the changed legislation. Higher levels of personal bankruptcy filings and higher charge offs of private label credit card receivables are expected in the fourth quarter of 2005. Commercial Loan Credit Quality The allowance for credit losses associated with commercial loan portfolios increased $15 million during the third quarter and decreased $4 million during the first nine months of 2005. For the first nine months of 2005, net recoveries of $17 million were offset by a $21 million credit in the provision for credit losses associated with commercial loans. Credit quality was relatively stable during the third quarter of 2005, and has generally improved during the first nine months 2005, as evidenced by decreased nonaccruing loan balances and decreased impaired loans balances. Criticized assets classified as "substandard" have increased $146 million during the first nine months of 2005, primarily due to the addition of non-investment grade securities to the calculation of these assets. Excluding these securities, criticized assets, primarily commercial loans, have declined among all categories during the first nine months of 2005. HUSI expects that a more normalized commercial credit environment for the remainder of 2005 will result in lower recoveries and higher provision expense. Although overall commercial credit quality is expected to remain stable and well controlled, any sudden and/or unexpected adverse economic events or trends could significantly affect credit quality and increase provisions for credit losses. 56 Credit Card Receivable Credit Quality The allowance for credit losses associated with credit card receivables increased $38 million in the third quarter and increased $49 million during the first nine months of 2005. Net charge offs of $362 million in the first nine months of 2005 were more than offset by provision for credit losses of $411 million. The provision for the third quarter of 2005 includes an incremental provision of $23 million for Hurricane Katrina. Excluding the provision for Hurricane Katrina, allowance activity reflects normal portfolio experience for the private label receivables acquired from HSBC Finance Corporation. The following table provides select credit quality data for credit card receivables. Excluding the impact of Hurricane Katrina, credit quality was generally stable in the first nine months of 2005. The September 30, 2004 data pertains to HUSI's credit card portfolio held prior to acquisition of the private label receivable portfolio. ----------------------------------------------------------------------------------------------------------------------- September 30, June 30, December 31, September 30, 2005 2005 2004 2004 ----------------------------------------------------------------------------------------------------------------------- (in millions) Accruing credit card receivables contractually past due 90 days or more: Balance at end of quarter ........................ $ 237 $ 206 $ 223 $ 3 As a percent of total credit card receivables ...................................... 1.66% 1.60% 1.85% .27% Allowance for credit losses associated with credit card receivables: Balance at end of quarter ........................ $ 597 $ 559 $ 548 $ 49 As a percent of total credit card receivables ...................................... 4.18% 4.34% 4.54% 4.35% Net charge offs of credit card receivables: Total for the quarter ended ...................... $ 124 $ 123 $ 15 $ 15 Annualized net charge offs as a percent of average credit card receivables for the quarter .......................................... 3.51% 3.89% 4.05% 5.31% Receivables included in the private label receivable portfolio are generally maintained in accruing status until being charged off six months after delinquency. Other Consumer Loan Credit Quality The allowance for credit losses associated with residential mortgage and other consumer loans increased approximately $9 million in the third quarter and in the first nine months of 2005. Provision for credit losses of $86 million for the first nine months of 2005, primarily associated with various installment lending portfolios, was partially offset by net charge offs of $67 million, also primarily from installment lending portfolios. The provision for the third quarter of 2005 includes an incremental provision of $3 million for Hurricane Katrina, primarily for residential mortgage loans. 57 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES -------------------------------------------------------------------------------- HUSI is party to various derivative financial instruments as an end user, as an international dealer in derivative instruments, and for purely trading purposes in order to realize profits from short-term movements in interest rates, commodity prices, foreign exchange rates and credit spreads. Additional information regarding the use of various derivative instruments is included on pages 79-80 and pages 107-109 of HUSI's 2004 Form 10-K. Credit and Market Risk Associated with Derivative Contracts Credit (or repayment) risk in derivative instruments is minimized by entering into transactions with high quality counterparties including other HSBC group entities. Counterparties include financial institutions, government agencies, both foreign and domestic, corporations, funds (mutual funds, hedge funds, etc.), insurance companies and private clients. These counterparties are subject to regular credit review by the credit risk management department. Most derivative contracts are governed by an International Swaps and Derivatives Association Master Agreement. Depending on the type of counterparty and the level of expected activity, bilateral collateral arrangements may be required as well. The total risk in a derivative contract is a function of a number of variables, such as: o whether counterparties exchange notional principal; o volatility of interest rates, currencies, equity or corporate reference entity used as the basis for determining contract payments; o maturity and liquidity of contracts; o credit worthiness of the counterparties in the transaction; and o existence and value of collateral received from counterparties to secure exposures. The following table presents credit risk exposure and net fair value associated with derivative contracts. In the table, current credit risk exposure is the recorded fair value of derivative receivables, which represents revaluation gains from the marking to market of derivative contracts held for trading purposes, for all counterparties with an International Swaps and Derivatives Association Master Agreement in place. Future credit risk exposure in the following table is measured using rules contained in the risk-based capital guidelines published by U.S. banking regulatory agencies. The risk exposure calculated in accordance with the risk based capital guidelines potentially overstates actual credit exposure, because: o the risk-based capital guidelines ignore collateral that may have been received from counterparties to secure exposures, and o the risk-based capital guidelines compute exposures over the life of derivative contracts. However, many contracts contain provisions that allow a bank to close out the transaction if the counterparty fails to post required collateral. As a result, these contracts have potential future exposures that are often much smaller that the future exposures derived from the risk-based capital guidelines. The net credit risk exposure amount in the following table does not reflect the impact of bilateral netting (i.e., netting with a single counterparty when a bilateral netting agreement is in place). However, the risk-based capital guidelines recognize that bilateral netting agreements reduce credit risk and therefore allow for reductions of risk-weighted assets when netting requirements have been met. In addition, risk-based capital rules require that netted exposures of various counterparties be assigned risk-weightings, which result in risk-weighted amounts for regulatory capital purposes that are a fraction of the original netted exposures. ------------------------------------------------------------------------------- September 30, December 31, 2005 2004 ------------------------------------------------------------------------------- (in millions) Risk associated with derivative contracts: Current credit risk exposure ................. $ 8,552 $ 9,607 Future credit risk exposure .................. 60,164 29,538 -------- -------- Total risk exposure .......................... 68,716 39,145 Less: collateral held against exposure ....... (2,097) (4,091) -------- -------- Net credit risk exposure ..................... $ 66,619 $ 35,054 ======== ======== 58 Notional Values of Derivative Contracts The notional value of derivative contracts only provides an indicator of the transaction volume in these types of instruments. It does not represent exposure to market or credit risks under these contracts. The following table summarizes the notional values of derivative contracts. -------------------------------------------------------------------------------- September 30, December 31, 2005 2004 -------------------------------------------------------------------------------- (in millions) Interest rate: Futures and forwards ................... $ 128,764 $ 79,830 Swaps .................................. 1,562,785 1,219,657 Options written ........................ 170,839 105,582 Options purchased ...................... 182,777 90,635 ---------- ---------- 2,045,165 1,495,704 ---------- ---------- Foreign exchange: Swaps, futures and forwards ............ 307,098 234,424 Options written ........................ 37,244 42,719 Options purchased ...................... 37,646 43,200 Spot ................................... 41,187 21,927 ---------- ---------- 423,175 342,270 ---------- ---------- Commodities, equities and precious metals: Swaps, futures and forwards ............ 68,933 40,876 Options written ........................ 14,120 10,648 Options purchased ...................... 16,164 11,729 ---------- ---------- 99,217 63,253 ---------- ---------- Credit derivatives ........................... 378,303 135,937 ---------- ---------- Total ........................................ $2,945,860 $2,037,164 ========== ========== At September 30, 2005 and December 31, 2004, the aggregate notional amounts of all derivative contracts with other HSBC affiliates were approximately $479 million and $302 million respectively. 59 OFF-BALANCE SHEET ARRANGEMENTS -------------------------------------------------------------------------------- The following table provides maturity information related to off-balance sheet arrangements and lending and sales commitments. Descriptions of these arrangements are found on pages 43-44 of HUSI's 2004 Form 10-K. --------------------------------------------------------------------------------------------------------------------- One Over One Over Year Through Five September 30, 2005 or Less Five Years Years Total --------------------------------------------------------------------------------------------------------------------- (in millions) Standby letters of credit, net of participations ..... $ 3,795 $ 1,878 $ 78 $ 5,751(1) Commercial letters of credit ......................... 809 35 -- 844 Loan sales with recourse ............................. -- 1 8 9(2) Credit derivative contracts .......................... 2,731 162,037 41,754 206,522(3) Commitments to extend credit: Commercial ..................................... 18,163 27,794 3,004 48,961 Consumer ....................................... 6,885 -- -- 6,885 Commitments to deliver mortgage backed securities .... 3,293 -- -- 3,293 Securities lending indemnifications .................. 3,801 -- -- 3,801 -------- -------- -------- -------- Total ................................................ $ 39,477 $191,745 $ 44,844 $276,066 ======== ======== ======== ======== (1) Includes $526 million issued for the benefit of related parties. (2) $7 million of this amount is indemnified by third parties. (3) Includes $27,408 million issued for the benefit of related parties. --------------------------------------------------------------------------------------------------------------------- One Over One Over Year Through Five December 31, 2004 or Less Five Years Years Total --------------------------------------------------------------------------------------------------------------------- (in millions) Standby letters of credit, net of participations ..... $ 3,564 $ 1,521 $ 110 $ 5,195(1) Commercial letters of credit ......................... 584 200 76 860 Loan sales with recourse ............................. -- 1 9 10(2) Credit derivative contracts .......................... 990 51,435 12,990 65,415(3) Commitments to extend credit: Commercial ..................................... 19,808 18,879 1,944 40,631 Consumer ....................................... 5,582 -- -- 5,582 Commitments to deliver mortgage backed securities .... 1,627 -- -- 1,627 Securities lending indemnifications .................. 4,534 -- -- 4,534 -------- -------- -------- -------- Total ................................................ $ 36,689 $ 72,036 $ 15,129 $123,854 ======== ======== ======== ======== (1) Includes $383 million issued for the benefit of related parties. (2) $8 million of this amount is indemnified by third parties. (3) Includes $9,912 million issued for the benefit of related parties. Letters of Credit Fees are charged for issuing letters of credit commensurate with the customer's credit evaluation and the nature of any collateral. Included in other liabilities are deferred fees on standby letters of credit, representing the fair value of the "stand ready obligation to perform" under these guarantees, amounting to $16 million and $15 million at September 30, 2005 and December 31, 2004 respectively. Also included in other liabilities is an allowance for credit losses on unfunded standby letters of credit of $21 million and $28 million at September 30, 2005 and December 31, 2004 respectively. Credit Derivatives HUSI enters into credit derivative contracts both for its own benefit and to satisfy the needs of its customers. Credit derivatives are arrangements that provide for one party (the "beneficiary") to transfer the credit risk of a "reference asset" to another party (the "guarantor"). Under this arrangement the guarantor assumes the credit risk associated with the reference asset without directly purchasing it. The beneficiary agrees to pay to the guarantor a specified fee. In return, the guarantor agrees to pay the beneficiary an agreed upon amount if there is a default during the term of the contract. 60 In accordance with its policy, HUSI offsets virtually all of the market risk it assumes in selling credit guarantees through a credit derivative contract with another counterparty. Credit derivatives, although having characteristics of a guarantee, are accounted for as derivative instruments and are carried at fair value. The commitment amount included in the table is the maximum amount that HUSI could be required to pay, without consideration of the approximately equal amount receivable from third parties and any associated collateral. Securities Lending Indemnifications HUSI may lend securities of customers, on a fully collateralized basis, as an agent to third party borrowers. Customers are indemnified against the risk of loss, and collateral is obtained from the borrower with a market value exceeding the value of the loaned securities. The fair value of that collateral was approximately $3,887 million and $4,625 million at September 30, 2005 and December 31, 2004 respectively. VARIABLE INTEREST ENTITIES (VIEs) -------------------------------------------------------------------------------- HUSI, in the ordinary course of business, makes use of VIE structures in a variety of business activities, primarily to facilitate client needs. VIE structures are utilized after careful consideration of the most appropriate structure needed to achieve HUSI's control and risk management objectives and to help ensure an efficient structure from a taxation and regulatory perspective. Consolidated VIEs During the third quarter of 2005, HUSI entered into a series of transactions with VIEs organized by HSBC affiliates and unrelated third parties. These VIEs were structured as trusts or corporations that issue fixed or floating rate instruments backed by the assets of the issuing entities. HUSI sold trading assets to the VIEs and subsequently entered into total return swaps with the VIEs whereby HUSI receives the total return on the transferred assets and, in return, pays a market rate of return to its counterparties. HUSI has determined that it is the primary beneficiary of these VIEs under the applicable accounting literature and, accordingly, consolidated $819 million in trading assets at September 30, 2005. These assets are pledged as collateral for obligations of the VIEs. The holders of the instruments issued by the VIEs have no recourse to the general credit of HUSI beyond the assets sold to the VIEs and pledged as collateral. Unconsolidated VIEs HUSI also holds variable interests in various other VIEs which are not consolidated at September 30, 2005. HUSI is not the primary beneficiary of these VIE structures. Information for unconsolidated VIEs is presented in the following table and commentary. Descriptions of these VIE relationships are included in pages 111-112 of HUSI's 2004 Form 10-K. ------------------------------------------------------------------------------------------------ September 30, 2005 December 31, 2004 -------------------- -------------------- Maximum Maximum Total Exposure Total Exposure Assets to Loss Assets to Loss ------------------------------------------------------------------------------------------------ (in millions) Asset backed commercial paper conduits ..... $ 7,858 $ 6,346 $ 5,657 $ 5,867 Securitization vehicles .................... 1,678 549 1,062 552 Investment funds ........................... 2,429 -- 2,832 36 Capital funding vehicles ................... 1,114 32 1,093 32 Low income housing tax credits ............. 1,406 200 994 88 ------- ------- ------- ------- Total ...................................... $14,485 $ 7,127 $11,638 $ 6,575 ======= ======= ======= ======= 61 Asset Backed Commercial Paper Conduits HSBC affiliates support the financing needs of customers by facilitating their access 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 backed commercial paper that is collateralized by such assets. Neither the HSBC affiliates nor HUSI service the assets or transfer their own receivables into the financing entities. HUSI and other banks provide one year liquidity facilities, in the form of either loan or asset purchase commitments, in support of each transaction in the financing entity. HUSI does not provide any program wide enhancements to the financing entities. In the table on the preceding page, the total notional amount of the liquidity facilities represents HUSI's maximum exposure to loss. In the normal course of business, HUSI provides liquidity facilities to asset backed commercial paper conduits sponsored by unrelated third parties. HUSI does not transfer their own receivables into the financing entity, has no ownership interest in, no administrative duties, and does not service any assets of these conduits. The only interest HUSI has in these entities are liquidity facilities in the amount of approximately $1.7 billion at September 30, 2005. These facilities are excluded from the table summarizing HUSI's involvement in VIEs. Credit risk is managed on these commitments by subjecting them to HUSI's normal underwriting and risk management processes. Securitization Vehicles An HSBC affiliate and third parties organize trusts that are special purpose entities (SPEs) that issue fixed or floating rate debt backed by the assets of the trusts. Neither the HSBC affiliate nor HUSI transfer their own assets into the trusts. HUSI's relationship with the SPEs is primarily as counterparty to the SPE's derivative transactions (interest rate, credit default and currency swaps). HUSI's maximum exposure to loss from the unconsolidated trust entities is comprised of investments in the trust and the market risk on the derivative transactions. Investment Funds HUSI is a derivative counterparty (total return swap) with a hedge fund established by an unrelated third party. The total return swap creates a variable interest in the fund for HUSI. HUSI does not hold shares in or have any other 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 third party. The shares owned by HUSI do not have voting rights but do participate in profits and losses based on percentage of share ownership. HUSI does not hold sufficient beneficial interests in the fund to be considered the primary beneficiary. HUSI is a sub-investment advisor to mutual funds structured as trusts and managed by an HSBC affiliate. As sub-investment advisor, HUSI receives a variable fee based on the value of funds. HUSI has no ownership interest in or credit exposure resulting from its duties as investment advisor. Capital Funding Vehicles Prior to 2005, HUSI established five Capital Trust entities. These trusts issue preferred securities and common stock. HUSI purchased all of the common equity issued by the trusts, which equates to approximately 3% of the total assets of the trusts. HUSI does not own any of the preferred securities issued by the trusts. It has been determined that the majority of the benefit of profit and/or risk of loss lies with the preferred security holders. Thus, HUSI is not the primary beneficiary of the trusts and is not required to consolidate these entities. 62 Low Income Housing Tax Credits HUSI participates as a limited partner in Low Income Housing Tax Credit Partnerships. These investments are recorded as other assets on the consolidated balance sheet using the equity method of accounting. HUSI also receives tax benefits over a period of time specified in the investment contracts. HUSI's investment is reduced over time for its share of any operating losses incurred by the partnership as well as for any amortization over the time period in which tax credits are received. Tax credits may be subject to recapture if the underlying properties do not remain in compliance with certain conditions. Some of these partnerships have been determined to be VIEs. HUSI's maximum exposure to loss shown in the table above represents the net assets recorded on the balance sheet, estimated expected reduction of future tax liabilities, and potential recapture of tax credits allowed in prior years. CAPITAL -------------------------------------------------------------------------------- The following table presents the capital ratios of HUSI and HBUS calculated in accordance with banking regulations. To be categorized as "well-capitalized" under the Federal Reserve Board and Federal Deposit Insurance Corporation guidelines, a banking institution must have the minimum ratios reflected in the table, and must not be subject to a directive, order, or written agreement to meet and maintain specific capital levels. ------------------------------------------------------------------------------------------------------------- "Well-Capitalized" September 30, December 31, Minimum 2005 2004 ------------------------------------------------------------------------------------------------------------- Total capital (to risk weighted assets) HUSI ............................................ 10.00% 12.88% 12.53% HBUS ............................................ 10.00 12.89 12.46 Tier 1 capital (to risk weighted assets) HUSI ............................................ 6.00 8.48 8.34 HBUS ............................................ 6.00 8.74 8.66 Tier 1 capital (to average assets) HUSI ............................................ 3.00 6.85 7.20 HBUS ............................................ 5.00 7.12 7.51 Tangible common equity (to risk weighted assets) HUSI ............................................ 6.87 7.07 HBUS ............................................ 8.77 8.69 RISK MANAGEMENT -------------------------------------------------------------------------------- Overview Some degree of risk is inherent in virtually all of HUSI's activities. For the principal activities undertaken by HUSI, the most important types of risks are considered to be credit, interest rate, market, liquidity, operational, fiduciary and reputational. Market risk broadly refers to price risk inherent in mark to market positions taken on trading and non-trading instruments. Operational risk technically includes legal and compliance risk. However, since compliance risk, including anti-money laundering (AML) risk, has such broad scope within HUSI's businesses, it is addressed as a separate functional discipline. During the first nine months of 2005, there have been no significant changes in policies or approach for managing various types of risk. 63 Liquidity Management HUSI's approach to address liquidity risk is summarized on pages 49-50 of HUSI's 2004 Form 10-K. HUSI's ability to regularly attract wholesale funds at a competitive cost is enhanced by strong ratings from the major credit rating agencies. At September 30, 2005, HUSI and HBUS maintained the following debt and preferred stock ratings. -------------------------------------------------------------------------------- At September 30, 2005 Moody's S&P Fitch -------------------------------------------------------------------------------- HUSI: Short-term borrowings ........................ P-1 A-1 F1+ Long-term debt ............................... Aa3 A+ AA Preferred stock .............................. A2 A- AA- HBUS: Short-term borrowings ........................ P-1 A-1+ F1+ Long-term debt ............................... Aa2 AA- AA HUSI periodically issues capital instruments to fund balance sheet growth, to meet cash and capital needs, or to fund investments in subsidiaries. In October 2005, HUSI issued 373,750 shares of Floating Rate Non-Cumulative Perpetual Preferred Stock represented by 14,950,000 depositary shares. Total proceeds, net of issuance costs, were approximately $365 million. Commentary regarding growth and composition of the consolidated balance sheet is provided on pages 24-25 of this Form 10-Q. Interest Rate Risk Management Various techniques are utilized to quantify and monitor risks associated with the repricing characteristics of HUSI's assets, liabilities, and derivative contracts. The approach toward managing interest rate risk is summarized on pages 51-56 of HUSI's 2004 Form 10-K. During the first nine months of 2005, there were no significant changes in policies or approach for managing interest rate risk. Present Value of a Basis Point (PVBP) Analysis PVBP is the change in value of the balance sheet for a one basis point upward movement in all interest rates. In June 2005, HUSI's institutional PVBP movement limit was increased from $6.5 million to $7.5 million. The following table reflects the PVBP position at September 30, 2005. -------------------------------------------------------------------------------- September 30, 2005 -------------------------------------------------------------------------------- (in millions) Institutional PVBP movement limit ......................... $7.5 PVBP position at period end ............................... 2.6 Capital at Risk Capital at risk is the change in base case valuation of the balance sheet for either a 200 basis point gradual rate increase or a 100 basis point gradual rate decrease. The projected changes in valuation are reflected on an after tax basis. The following table reflects the capital at risk position at September 30, 2005. -------------------------------------------------------------------------------------------------------------------- September 30, 2005 -------------------------------------------------------------------------------------------------------------------- Institutional capital at risk movement limit ................................................... +/- 10% Projected change in value resulting from a gradual 200 basis point increase in interest rates .. (2) Projected change in value resulting from a gradual 100 basis point decrease in interest rates .. (3) 64 The projected drop in value for a 100 basis point gradual decrease in rates is primarily related to the anticipated acceleration of prepayments for the held mortgage and mortgage backed securities portfolios in this lower rate environment. This assumes that no management actions are taken to manage exposures to the changing interest rate environment. Capital at risk valuations are currently calculated using discounted cash flows anticipated for specific rate environments. A market based calculation, which relies less on discounted cash flows in favor of actual market valuations, is currently under development. Dynamic Simulation Modeling Various modeling techniques are utilized to monitor a number of interest rate scenarios for their impact on net interest income. These techniques include both rate shock scenarios which assume immediate market rate movements of 200 basis points, as well as scenarios in which rates rise or fall by as much as 200 basis points over a twelve month period. The following table reflects the impact on net interest income of the scenarios utilized by these modeling techniques. --------------------------------------------------------------------------------------------------------------------- September 30, 2005 ------------------ Amount % --------------------------------------------------------------------------------------------------------------------- (in millions) Projected change in net interest income (reflects projected rate movements on October 1, 2005): Institutional base earnings movement limit ......................................... (10) Change resulting from a gradual 200 basis point increase in the yield curve ........ $(170) (5) Change resulting from a gradual 200 basis point decrease in the yield curve ........ 372 12 Change resulting from a gradual 100 basis point increase in the yield curve ........ (43) Change resulting from a gradual 100 basis point decrease in the yield curve ........ 251 Other significant scenarios monitored (reflects projected rate movements on October 1, 2005): Change resulting from an immediate 100 basis point increase in the yield curve ..... (132) Change resulting from an immediate 100 basis point decrease in the yield curve ..... 172 Change resulting from an immediate 200 basis point increase in the yield curve ..... (345) Change resulting from an immediate 200 basis point decrease in the yield curve ..... 291 Change resulting from an immediate 100 basis point increase in short-term rates .... (190) The projections do not take into consideration possible complicating factors such as the effect of changes in interest rates on the credit quality, size and composition of the balance sheet. Therefore, although this provides a reasonable estimate of interest rate sensitivity, actual results will vary from these estimates, possibly by significant amounts. Capital Risk/Sensitivity of Other Comprehensive Income Large movements of interest rates could directly affect reported capital and some capital ratios. The mark to market valuation of available for sale securities is credited on a tax effected basis through other comprehensive income in the consolidated statement of changes in shareholders' equity. This valuation mark is excluded from Tier 1 and Tier 2 capital ratios but it would be included in the ratio of total shareholders' equity to total assets. As of September 30, 2005, HUSI had an available for sale securities portfolio of approximately $16 billion with a net negative mark to market of $202 million included in total equity of $12 billion. An increase of 25 basis points in interest rates of all maturities of available for sale securities would lower the mark to market by approximately $158 million to a net pre-tax loss of $360 million with the following effect on the total equity to total assets ratio. ----------------------------------------------------------------------------------------------- Proforma - Reflecting 25 Basis Points September 30, 2005 Actual Increase in Rates ----------------------------------------------------------------------------------------------- Total shareholders' equity to total assets ............ 7.95% 7.89% 65 Value at Risk (VAR) VAR analysis is also used to measure interest rate risk and to calculate the economic capital required to cover potential losses due to interest risk. The approach toward using VAR to measure interest rate risk is summarized on pages 53-54 of HUSI's 2004 Form 10-K. Trading Activities Trading portfolios reside primarily in the CIBM and residential mortgage banking areas and include foreign exchange, derivatives, precious metals (gold, silver, platinum), commodities, equities and money market instruments. The trading portfolios have defined limits pertaining to items such as permissible investments, risk exposures, loss review, balance sheet size and product concentrations. Loss review refers to the maximum amount of loss that may be incurred before senior management intervention is required. Trading Activities - Treasury Value at Risk The following table summarizes trading VAR, assuming a 99% confidence level for a two year observation period and a 10 day holding period. ---------------------------------------------------------------------------------------------------- Three Months Ended September 30, 2005 September 30, ------------------------------------- December 31, 2005 Minimum Maximum Average 2004 ---------------------------------------------------------------------------------------------------- (in millions) Total trading ........... $50 $17 $53 $27 $41 Commodities ............. 7 1 9 4 11 Credit derivatives ...... 24 14 25 17 9 Equities ................ -- -- 2 -- 1 Foreign exchange ........ 7 1 14 5 1 Interest rate ........... 62 17 62 30 27 Trading Volatility The following tables summarize the frequency distribution of daily market risk-related revenues for Treasury trading activities. Market risk-related Treasury trading revenues include realized and unrealized gains (losses) related to Treasury trading activities, but exclude the related net interest income. Analysis of gain (loss) data for the first nine months of 2005 shows that the largest daily gain was $13 million and the largest daily loss was $9 million. ----------------------------------------------------------------------------------------------------------------------- Three months ended September 30, 2005 ----------------------------------------------------------------------------------------------------------------------- Ranges of daily Treasury trading revenue earned from market risk-related activities Below $(2) to $0 to $2 to $4 to Over (in millions) $(2) $0 $2 $4 $6 $6 Number of trading days market risk-related revenue was within the stated range ........... 3 9 21 16 8 7 ----------------------------------------------------------------------------------------------------------------------- Nine months ended September 30, 2005 ----------------------------------------------------------------------------------------------------------------------- Ranges of daily Treasury trading revenue earned from market risk-related activities Below $(2) to $0 to $2 to $4 to Over (in millions) $(2) $0 $2 $4 $6 $6 Number of trading days market risk-related revenue was within the stated range ........... 14 32 58 45 24 16 66 Trading Activities - Mortgage Banking HUSI's MSRs hedging program is designed to minimize long-term economic volatility as opposed to short-term earnings volatility. The program is actively monitored to ensure that it supports anticipated business growth while at the same time limiting economic volatility in the mortgage banking results. The economic value of the net hedged MSRs portfolio is monitored on a daily basis for interest rate sensitivity. If the economic value declines by more than established limits for one day or one month, various levels of management review, intervention and/or corrective actions are required. Rate Shock Analysis Modeling techniques are used to monitor certain interest rate scenarios for their impact on the economic value of net hedged MSRs, as reflected in the following table. --------------------------------------------------------------------------------------------------------- September 30, 2005 Values --------------------------------------------------------------------------------------------------------- (in millions) Projected change in net market value of hedged MSRs portfolio (reflects projected rate movements on October 1, 2005): Value of hedged MSRs portfolio ..................................................... $ 342 Change resulting from an immediate 50 basis point decrease in the yield curve: Change limit (no worse than) ................................................... (16) Calculated change in net market value .......................................... (3) Change resulting from an immediate 50 basis point increase in the yield curve: Change limit (no worse than) ................................................... (8) Calculated change in net market value .......................................... 5 Change resulting from an immediate 100 basis point increase in the yield curve: Change limit (no worse than) ................................................... (12) Calculated change in net market value .......................................... 9 Hedge Volatility The following tables summarize the frequency distribution of the weekly economic value of the MSR asset, net of changes in the market value of the related hedge positions. ------------------------------------------------------------------------------------------------------------ Three months ended September 30, 2005 ------------------------------------------------------------------------------------------------------------ Ranges of mortgage trading revenue earned from market risk-related activities Below $(2) to $0 to $2 to Over (in millions) $(2) $0 $2 $4 $4 Number of trading weeks market risk-related revenue was within the stated range ............ 1 1 5 4 2 ------------------------------------------------------------------------------------------------------------ Nine months ended September 30, 2005 ------------------------------------------------------------------------------------------------------------ Ranges of mortgage trading revenue earned from market risk-related activities Below $(2) to $0 to $2 to Over (in millions) $(2) $0 $2 $4 $4 Number of trading weeks market risk-related revenue was within the stated range ............ 6 7 14 8 4 67 Item 3. Quantitative and Qualitative Disclosures About Market Risk -------------------------------------------------------------------------------- Refer to Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, under the captions "Interest Rate Risk Management" and "Trading Activities", beginning on page 64 of this Form 10-Q. Item 4. Controls and Procedures -------------------------------------------------------------------------------- Disclosure Controls An evaluation was conducted, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of HUSI's disclosure controls and procedures as of the end of the period covered by this report. HUSI's disclosure controls and procedures are designed to ensure that information required to be disclosed by HUSI in the reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported on a timely basis. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that HUSI's disclosure controls and procedures were effective as of the end of the period covered by this report so as to alert them in a timely fashion to material information required to be disclosed in reports filed under the Exchange Act. Internal Controls There have not been any changes in HUSI's internal controls over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, HUSI's internal controls over financial reporting. Sarbanes-Oxley Section 404 Compliance As an SEC registrant of public debt and preferred shares, HUSI is required to comply with the Sarbanes-Oxley Act of 2002 (the Act). Section 404 of the Act (Section 404) requires registrants and their auditors to assess and report on internal controls over financial reporting on an annual basis. As a foreign registrant, HSBC is required to comply with Section 404 of the Act beginning in the fiscal year ending December 31, 2006. As a subsidiary of a foreign registrant, HUSI will support HSBC with its Section 404 compliance. Under the SEC's current rules for non-accelerated filers, HUSI will be required to comply with Section 404 of the Act for the fiscal year ending December 31, 2007. 68 Part II - OTHER INFORMATION -------------------------------------------------------------------------------- Item 6 - Exhibits 3(i) Registrant's Articles of Incorporation and amendments and supplements thereto (incorporated by reference to Exhibit 3.3 to HUSI's Annual Report on Form 10-K for the year ended December 31, 1999, filed with the Securities and Exchange Commission on March 30, 2000, Exhibit 3 to HUSI's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, filed with the Securities and Exchange Commission on November 9, 2000, Exhibits 3.2 and 3.3 to HUSI's Current Report on Form 8-K dated March 30, 2005, filed with the Securities and Exchange Commission on April 4, 2005, and Exhibit 3.2 to HUSI's Current Report on Form 8-K dated October 11, 2005 and filed with the Securities and Exchange Commission on October 14, 2005). (ii) Registrant's By-Laws (incorporated by reference to Exhibit 3(ii) to HUSI's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, filed with the Securities and Exchange Commission on May 16, 2005). 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.0 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 69 SIGNATURE -------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HSBC USA Inc. ------------- (Registrant) Date: November 14, 2005 /s/ Joseph R. Simpson ---------------------------------------- Joseph R. Simpson Chief Accounting Officer (On behalf of Registrant) 70 This information is provided by RNS The company news service from the London Stock Exchange

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