HSBC USA Q4 2005 10-K - Pt 4

HSBC Holdings PLC 06 March 2006 PART 4 128 A reconciliation of beginning and ending balances of the projected benefit obligation of the defined benefit pension plans is shown below. The projected benefit obligation shown for the year ended December 31, 2005 reflects the projected benefit obligation of the merged HNAH plan. -------------------------------------------------------------------------------------------------------------------- Year Ended December 31 2005 2004 -------------------------------------------------------------------------------------------------------------------- (Post-merger) (Pre-merger) (in millions) Projected benefit obligation at beginning of year ............. $ 1,173 $ 1,102 Transfer in from the HSBC Finance Corporation Plan ............ 1,020 -- Service cost .................................................. 94 31 Interest cost ................................................. 130 69 Actuarial gains ............................................... 203 9 Benefits paid ................................................. (90) (38) --------- --------- Projected benefit obligation at end of year ................... $ 2,530 $ 1,173 ========= ========= HUSI's share of the projected benefit obligation at December 31, 2005 is approximately $1 billion. The accumulated benefit obligation for the post-merger HNAH defined benefit pension plans was approximately $2 billion at December 31, 2005. HUSI's share of the accumulated benefit obligation at December 31, 2005 was approximately $1 billion. The accumulated benefit obligation for the pre-merger defined benefit pension plans was approximately $1 billion at December 31, 2004. Estimated future benefit payments for the HNAH defined benefit plan and HUSI's share of those payments are as follows: -------------------------------------------------------------------------------------------------------------------- HUSI's HNAH Share -------------------------------------------------------------------------------------------------------------------- (in millions) 2006 ...................................................................... $ 102 $ 42 2007 ...................................................................... 112 46 2008 ...................................................................... 121 50 2009 ...................................................................... 129 54 2010 ...................................................................... 136 58 2011-2015 ................................................................. 848 366 The assumptions used in determining the projected benefit obligation of the defined benefit plans at December 31 are as follows: -------------------------------------------------------------------------------------------------------------------- 2005 2004 2003 -------------------------------------------------------------------------------------------------------------------- (Post-merger) (Pre-merger) (Pre-merger) Discount rate ......................................... 5.70% 6.00% 6.25% Salary increase assumption ............................ 3.75 3.75 3.75 Postretirement Plans Other Than Pensions HUSI's employees also participate in several plans which provide medical, dental and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. HUSI has instituted dollar limits on payments under the plans to control the cost of future medical benefits. 129 The net postretirement benefit cost included the following: ----------------------------------------------------------------------------------------------------------------- Year Ended December 31 2005 2004 2003 ----------------------------------------------------------------------------------------------------------------- (in millions) Service cost - benefits earned during the period ............... $ 2 $ 2 $ 3 Interest cost .................................................. 7 7 7 Amortization of transition obligation .......................... 3 3 3 ------- -------- -------- Net periodic postretirement benefit cost ....................... $ 12 $ 12 $ 13 ======= ======== ======== The assumptions used in determining the net periodic postretirement benefit cost for HUSI's postretirement benefit plans at December 31 are as follows: ----------------------------------------------------------------------------------------------------------------- 2005 2004 2003 ----------------------------------------------------------------------------------------------------------------- Discount rate .................................................... 6.00% 5.75% 6.25% Salary increase assumption ....................................... 3.75 3.75 3.75 A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is as follows: ----------------------------------------------------------------------------------------------------------------- Year Ended December 31 2005 2004 ----------------------------------------------------------------------------------------------------------------- (in millions) Accumulated benefit obligation at beginning of year ........................ $ 122 $ 124 Service cost ............................................................... 2 2 Interest cost .............................................................. 7 6 Foreign currency exchange rate changes ..................................... 1 1 Actuarial losses ........................................................... (4) -- Benefits paid .............................................................. (9) (11) -------- -------- Accumulated benefit obligation at end of year .............................. $ 119 $ 122 ======== ======== HUSI's postretirement benefit plans are funded on a pay-as-you-go basis. HUSI currently estimates that it will pay benefits of approximately $9 million relating to the postretirement benefit plans in 2006. The components of the accrued postretirement benefit obligation are as follows: ----------------------------------------------------------------------------------------------------------------- December 31 2005 2004 ----------------------------------------------------------------------------------------------------------------- (in millions) Funded status .............................................................. $ (119) $ (122) Unrecognized net actuarial (loss) gain ..................................... 8 12 Unamortized transition obligation .......................................... 21 24 ---------- ---------- Accrued postretirement benefit obligation .................................. $ (90) $ (86) ========== ========== Estimated future benefit payments for HUSI's plans are as follows: ---------------------------------------------------------------------------------------------------------------- (in millions) 2006 ........................................................................................... $ 9 2007 ........................................................................................... 9 2008 ........................................................................................... 9 2009 ........................................................................................... 9 2010 ........................................................................................... 9 2011-2015 ...................................................................................... 49 130 The assumptions used in determining the benefit obligation of HUSI's postretirement benefit plans at December 31 are as follows: ---------------------------------------------------------------------------------------------------------------- 2005 2004 2003 ---------------------------------------------------------------------------------------------------------------- Discount rate ............................................... 5.70% 6.00% 5.75% Salary increase assumption .................................. 3.75 3.75 3.75 A 10.5 percent annual rate of increase in the gross cost of covered health care benefits was assumed for 2006. This rate of increase is assumed to decline gradually to 5 percent in 2014. Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service and interest costs and the postretirement benefit obligation as follows: --------------------------------------------------------------------------------------------------------------- One Percent One Percent Increase Decrease --------------------------------------------------------------------------------------------------------------- (in millions) Effect on total of service and interest cost components ........... $ -- $ -- Effect on postretirement benefit obligation ....................... 1 (2) Other Plans HUSI maintains a 401(k) plan covering substantially all employees. Employer contributions to the plan are based on employee contributions. Total expense recognized for this plan was approximately $33 million, $18 million and $18 million in 2005, 2004 and 2003 respectively. Certain employees are participants in various defined contribution and other non-qualified supplemental retirement plans. Total expense recognized for these plans was immaterial in 2005, 2004 and 2003. 131 Note 23. Business Segments -------------------------------------------------------------------------------- HUSI reports and manages its business segments consistently with the line of business groupings used by HSBC. HUSI has five distinct segments that it utilizes for management reporting and analysis purposes. Descriptions of HUSI's business segments are presented in Item 1 on pages 4-5 of this Form 10-K. Results for each segment are summarized in the following tables. Prior period disclosures previously reported for 2004 and 2003 have been conformed herein to the presentation of current segments, including methodology changes related to the transfer pricing of assets and liabilities. ------------------------------------------------------------------------------------------------------------------------ PFS CF CMB CIBM PB Other Total ------------------------------------------------------------------------------------------------------------------------ (in millions) 2005 Net interest income (1) $ 1,203 $ 583 $ 661 $ 456 $ 172 $ (12) $ 3,063 Other revenues 442 356 183 641 257 32 1,911 --------- --------- --------- --------- --------- --------- --------- Total revenues 1,645 939 844 1,097 429 20 4,974 Operating expenses (2) 1,033 424 379 650 272 -- 2,758 --------- --------- --------- --------- --------- --------- --------- Working contribution 612 515 465 447 157 20 2,216 Provision for credit losses (3) 103 599 22 (47) (3) -- 674 --------- --------- --------- --------- --------- --------- --------- Income (loss) before income tax expense $ 509 $ (84) $ 443 $ 494 $ 160 $ 20 $ 1,542 ========= ========= ========= ========= ========= ========= ========= Average assets $ 49,084 $ 19,316 $ 15,817 $ 57,597 $ 5,041 $ 321 $ 147,176 Average liabilities/ equity (4) 43,304 684 17,856 75,579 9,751 2 147,176 Goodwill at December 31, 2005 (5) 1,167 -- 468 631 428 -- 2,694 2004 Net interest income (1) $ 1,090 $ 182 $ 584 $ 766 $ 130 $ (11) $ 2,741 Other revenues 381 2 170 534 204 28 1,319 --------- --------- --------- --------- --------- --------- --------- Total revenues 1,471 184 754 1,300 334 17 4,060 Operating expenses (2) 944 17 352 525 263 -- 2,101 --------- --------- --------- --------- --------- --------- --------- Working contribution 527 167 402 775 71 17 1,959 Provision for credit losses (3) 81 22 (26) (95) 1 -- (17) --------- --------- --------- --------- --------- --------- --------- Income before income tax expense $ 446 $ 145 $ 428 $ 870 $ 70 $ 17 $ 1,976 ========= ========= ========= ========= ========= ========= ========= Average assets $ 41,202 $ 4,256 $ 13,750 $ 48,689 $ 4,029 $ 300 $ 112,226 Average liabilities/ equity (4) 34,165 (2) 14,670 54,442 8,951 -- 112,226 Goodwill at December 31, 2004 (5) 1,167 -- 471 631 428 -- 2,697 132 ------------------------------------------------------------------------------------------------------------------------ PFS CF CMB CIBM PB Other Total ------------------------------------------------------------------------------------------------------------------------ (in millions) 2003 Net interest income (1) .. $ 1,081 $ -- $ 592 $ 731 $ 123 $ (17) $ 2,510 Other revenues ........... 250 -- 158 526 195 25 1,154 -------- -------- -------- -------- -------- -------- -------- Total revenues ........... 1,331 -- 750 1,257 318 8 3,664 Operating expenses (2) ... 930 -- 402 442 265 1 2,040 -------- -------- -------- -------- -------- -------- -------- Working contribution ..... 401 -- 348 815 53 7 1,624 Provision for credit losses (3) ............. 68 -- 55 (8) (2) -- 113 -------- -------- -------- -------- -------- -------- -------- Income before income tax expense ............ $ 333 $ -- $ 293 $ 823 $ 55 $ 7 $ 1,511 ======== ======== ======== ======== ======== ======== ======== Average assets ........... $ 28,601 $ -- $ 14,236 $ 45,738 $ 2,936 $ 314 $ 91,825 Average liabilities/ equity (4) ............. 31,066 -- 13,281 38,917 8,561 -- 91,825 Goodwill at December 31, 2003 (5) .... 1,223 -- 495 631 428 -- 2,777 (1) Net interest income of each segment represents the difference between actual interest earned on assets and interest paid on liabilities of the segment adjusted for a funding charge or credit. Segments are charged a cost to fund assets (e.g. customer loans) and receive a funding credit for funds provided (e.g. customer deposits) based on equivalent market rates. (2) Expenses for the segments include fully apportioned corporate overhead expenses. (3) The provision apportioned to the segments is based on the segments' net charge offs and the change in allowance for credit losses. Credit loss reserves are established at a level sufficient to absorb the losses considered to be inherent in the portfolio. (4) Common shareholder's equity and earnings on common shareholder's equity are allocated back to the segments based on the percentage of capital assigned to the business. (5) The reduction in goodwill from December 31, 2004 to December 31, 2005 resulted from the sale of certain branches during 2005. The reduction in goodwill from December 31, 2003 to December 31, 2004 resulted from the sale or transfer of certain domestic and foreign operations during 2004. Note 24. Collateral, Commitments and Contingent Liabilities -------------------------------------------------------------------------------- Pledged Assets The following table presents pledged assets included in the consolidated balance sheet. -------------------------------------------------------------------------------------------------------------------- December 31 2005 2004 -------------------------------------------------------------------------------------------------------------------- (in millions) Interest bearing deposits with banks .................................... $ 1,170 $ 767 Trading assets .......................................................... 1,452 305 Securities available for sale ........................................... 6,369 6,096 Securities held to maturity ............................................. 447 655 Loans ................................................................... 8,204 5,971 ---------- ---------- Total ................................................................... $ 17,642 $ 13,794 ========== ========== Securities available for sale are primarily pledged against various short-term borrowings. Loans are primarily residential mortgage loans pledged against long-term borrowings from the Federal Home Loan Bank and private label credit card receivables pledged against secured long-term borrowings. In accordance with the Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140), debt securities pledged as collateral that can be sold or repledged by the secured party continue to be reported on the consolidated balance sheet. The fair value of securities available for sale that can be sold or repledged at December 31, 2005 and 2004 was approximately $2,152 million and $1,320 million respectively. 133 The fair value of collateral accepted by HUSI not reported on the consolidated balance sheet that can be sold or repledged at December 31, 2005 and 2004 was approximately $5,800 million and $2,834 million respectively. This collateral was obtained under security resale agreements. Of this collateral, approximately $1,158 million at December 31, 2005 has been sold or repledged as collateral under repurchase agreements or to cover short sales compared with $2,081 million at December 31, 2004. The 2004 increase in pledged assets resulted from collateral requirements associated with increased short-term borrowings and with increased derivatives activity. Lease Obligations HUSI and its subsidiaries are obligated under a number of noncancellable leases for premises and equipment. Certain leases contain renewal options and escalation clauses. The following table presents actual and expected minimum lease payments under noncancellable operating leases, net of sublease rentals. -------------------------------------------------------------------------------------------------------------------- December 31 2005 2004 2003 -------------------------------------------------------------------------------------------------------------------- (in millions) Actual annual rental expense .................................. $ 89 $ 82 $ 63 ======= ===== ====== Minimum expected future payments: 2006 .......................................................... $ 79 2007 .......................................................... 72 2008 .......................................................... 61 2009 .......................................................... 54 2010 .......................................................... 46 Thereafter .................................................... 179 ------- $ 491 ======= Litigation HUSI is named in and is defending legal actions in various jurisdictions arising from its normal business. None of these proceedings is regarded as material litigation. In addition, there are certain proceedings related to the "Princeton Note Matter" that are described below. In relation to the Princeton Note Matter, as disclosed in HUSI's 2002 Annual Report on Form 10-K, two of the noteholders were not included in the settlement and their civil suits are continuing. The U.S. Government excluded one of them from the restitution order (Yakult Honsha Co., Ltd.) because a senior officer of the noteholder was being criminally prosecuted in Japan for his conduct relating to its Princeton Notes. The senior officer in question was convicted during September 2002 of various criminal charges related to the sale of the Princeton Notes. The U.S. Government excluded the other noteholder (Maruzen Company, Limited) because the sum it is likely to recover from the Princeton Receiver exceeds its losses attributable to its funds transfers with Republic New York Securities Corporation as calculated by the U.S. Government. Both of these civil suits seek compensatory, punitive, and treble damages pursuant to RICO and assorted fraud and breach of duty claims arising from unpaid Princeton Notes with face amounts totaling approximately $125 million. No amount of compensatory damages is specified in either complaint. These two complaints name HUSI, HBUS, and Republic New York Securities Corporation as defendants. HUSI and HBUS have moved to dismiss both complaints. The motion is fully briefed and sub judice. Mutual production of documents took place in 2001, but additional discovery proceedings have been suspended pending the Court's resolution of the motions to dismiss. 134 Note 25. 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 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 $1,060 million in trading assets at December 31, 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 December 31, 2005. HUSI is not the primary beneficiary of these VIE structures. Information for unconsolidated VIEs is presented in the following table and commentary. -------------------------------------------------------------------------------------------------------------------- December 31, 2005 December 31, 2004 ------------------------------ ---------------------------- Maximum Maximum Total Exposure Total Exposure Assets to Loss Assets to Loss -------------------------------------------------------------------------------------------------------------------- (in millions) Asset backed commercial paper conduit ......... $ 10,183 $ 7,423 $ 5,657 $ 5,867 Securitization vehicles ....................... 1,774 565 1,062 552 Investment funds . ............................ 2,513 -- 2,832 36 Capital funding vehicles ...................... 1,093 32 1,093 32 Low income housing tax credits ................ 1,080 165 994 88 ---------- --------- --------- -------- Total $ 16,643 $ 8,185 $ 11,638 $ 6,575 ========== ========= ========= ======== 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 preceding table, HUSI's maximum exposure to loss is the total notional amount of the liquidity facilities. 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 $1.4 billion at December 31, 2005. These facilities are excluded from the table summarizing HUSI's involvement in VIEs. 135 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. 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 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. Note 26. Fair Value of Financial Instruments -------------------------------------------------------------------------------- HUSI is required to disclose the estimated fair value of its financial instruments in accordance with Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments (SFAS 107). The disclosures do not attempt to estimate or represent the fair value of HUSI as a whole. The disclosures exclude assets and liabilities that are not financial instruments, including intangible assets, such as goodwill. The estimation methods and assumptions used by HUSI to value individual classifications of financial instruments are described below. Different assumptions could significantly affect the estimates. Accordingly, the net realizable values upon liquidation of the financial instruments could be materially different from the estimates presented. 136 Financial instruments with carrying value equal to fair value - The carrying value of certain financial assets and liabilities is considered to be equal to fair value as a result of their short term nature. These include cash and due from banks, interest bearing deposits with banks, federal funds sold and securities purchased under resale agreements, accrued interest receivable, customers' acceptance liability and certain financial liabilities including acceptances outstanding, short-term borrowings and interest, taxes, and other liabilities. Securities and trading assets and liabilities - The fair value of securities and derivative contracts is based on current market quotations, where available. If quoted market prices are not available, fair value is estimated based on the quoted price of similar instruments or internal valuation models that approximate market pricing. Loans - The fair value of the performing loan portfolio is determined primarily by calculating the present value of expected cash flows using a discount rate as noted below. The loans are grouped, to the extent possible, into homogeneous pools, segregated by maturity, weighted average maturity, and average coupon rate. Depending upon the type of loan involved, maturity assumptions are based on either the contractual or expected maturity date. For commercial loans, the allowance for credit losses is allocated to the expected cash flows to provide for credit risk. A published interest rate that equates closely to a "risk-free" or "low-risk" loan rate is used as the discount rate. The interest rate is adjusted for a liquidity factor, as appropriate. The discount rate used to calculate the fair value of consumer loans is computed using the estimated rate of return an investor would demand for the product without regard to credit risk. The discount rate is formulated by reference to current market rates. The discount rate used to calculate the fair value of residential mortgages is determined by reference to quoted market prices for loans with similar characteristics and maturities. Deposits - The fair value of demand, savings, and money market deposits is equal to the carrying value. For deposits with fixed maturities, fair value is estimated using market interest rates currently offered on deposits with similar characteristics and maturities. Long-term debt - Fair value is estimated using interest rates currently available to HUSI for borrowings with similar characteristics and maturities. The summarized carrying values and estimated fair values of financial instruments as of December 31, 2005 and 2004 follows. ------------------------------------------------------------------------------------------------------------------------ 2005 2004 ---------------------- ---------------------- Carrying Fair Carrying Fair December 31 Value Value Value Value ------------------------------------------------------------------------------------------------------------------------ (in millions) Financial assets: Instruments with carrying value equal to fair value ....... $ 13,385 $ 13,385 $ 9,845 $ 9,845 Trading assets ............................................ 21,220 21,220 19,815 19,815 Securities available for sale ............................. 17,764 17,764 14,655 14,655 Securities held to maturity ............................... 3,171 3,262 3,881 4,042 Loans, net of allowance ................................... 89,496 88,467 84,159 84,216 Derivative instruments included in other assets (1) ....... 305 305 217 217 Financial liabilities: Instruments with carrying value equal to fair value ....... 7,562 7,562 10,200 10,200 Deposits: Without fixed maturities ............................... 77,924 77,924 68,234 68,234 Fixed maturities ....................................... 13,891 13,889 11,747 11,749 Trading account liabilities ............................... 10,710 10,710 12,120 12,120 Long-term debt ............................................ 27,959 28,448 23,839 24,589 Derivative instruments included in other liabilities (1) .. 80 80 176 176 (1) At December 31, 2005 and 2004, the amounts reported relate to derivative contracts that qualify for hedge accounting treatment as defined by SFAS 133. 137 The fair value of commitments to extend credit, standby letters of credit and financial guarantees, is not included in the previous table. These instruments generate fees, which approximate those currently charged to originate similar commitments. Note 27. Financial Statements of HSBC USA Inc. (parent) -------------------------------------------------------------------------------- Condensed parent company financial statements follow. ------------------------------------------------------------------------------------------------------------------------ Balance Sheet December 31 2005 2004 ------------------------------------------------------------------------------------------------------------------------ (in millions) Assets: Cash and due from banks .................................................................... $ -- $ -- Interest bearing deposits with banks (including $3,216 and $1,286 in banking subsidiary) ... 3,281 1,351 Trading assets ............................................................................. 584 279 Securities purchased under resale agreements ............................................... 6 3 Securities available for sale .............................................................. 157 20 Securities held to maturity (fair value $136 and $162) ..................................... 128 151 Loans (net of allowance for credit losses of $1 and $1) .................................... 131 533 Receivables from subsidiaries .............................................................. 1,616 1,766 Investment in subsidiaries at amount of their net assets: Banking .............................................................................. 11,888 11,385 Other ................................................................................ 403 350 Goodwill ................................................................................... 604 604 Other assets ............................................................................... 158 179 --------- --------- Total assets ............................................................................... $ 18,956 $ 16,621 ========= ========= Liabilities: Interest, taxes and other liabilities ...................................................... $ 147 $ 180 Short-term borrowings ...................................................................... 2,620 2,480 Long-term debt (1) ......................................................................... 4,595 3,092 Long-term debt due to subsidiary (1) ....................................................... -- 3 --------- --------- Total liabilities .......................................................................... 7,362 5,755 Shareholders' equity * ..................................................................... 11,594 10,866 --------- --------- Total liabilities and shareholders' equity ................................................. $ 18,956 $ 16,621 ========= ========= * See Consolidated Statement of Changes in Shareholders' Equity, page 85. (1) Contractual scheduled maturities for the debt over the next five years are as follows: $300 million for 2006; 2007, $1,598 million; 2008, $240 million; 2009, $561 million and none in 2010. 138 ------------------------------------------------------------------------------------------------------------------------ Statement of Income Year Ended December 31 2005 2004 2003 ------------------------------------------------------------------------------------------------------------------------ (in millions) Income: Dividends from banking subsidiaries ........................... $ 675 $ 125 $ 690 Dividends from other subsidiaries ............................. 2 2 34 Interest from banking subsidiaries ............................ 167 104 99 Interest from other subsidiaries .............................. 1 1 1 Other interest income ......................................... 30 19 16 Securities transactions ....................................... 13 4 (2) Other income .................................................. 35 91 49 ---------- ---------- ---------- Total income ........................................................ 923 346 887 ---------- ---------- ---------- Expenses: Interest (including $-, $86 and $64 paid to subsidiaries) ..... 350 240 229 Provision for credit losses ................................... -- 3 36 Other expenses ................................................ 17 20 24 ---------- ---------- ---------- Total expenses ...................................................... 367 263 289 ---------- ---------- ---------- Income before taxes and equity in undistributed income of subsidiaries 556 83 598 Income tax benefit .................................................. (40) (21) (64) ---------- ---------- ---------- Income before equity in undistributed income of subsidiaries ........ 596 104 662 Equity in undistributed income of subsidiaries ...................... 380 1,154 279 ---------- ---------- ---------- Net income .......................................................... $ 976 $ 1,258 $ 941 ========== ========== ========== 139 ------------------------------------------------------------------------------------------------------------------------ Statement of Cash Flows Year Ended December 31 2005 2004 2003 ------------------------------------------------------------------------------------------------------------------------ (in millions) Cash flows from operating activities: Net income ....................................................... $ 976 $ 1,258 $ 941 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and deferred taxes ................. (3) 13 13 Provision for credit losses ................................... -- 3 36 Net change in other accrued accounts .......................... (77) 137 25 Undistributed income of subsidiaries .......................... (380) (1,154) (279) Other, net .................................................... (286) (80) (63) ---------- ---------- ---------- Net cash provided by operating activities .................. 230 177 673 ---------- ---------- ---------- Cash flows from investing activities: Net change in interest bearing deposits with banks ............... (1,930) (738) 306 Purchases of securities .......................................... (174) (11) (1) Sales and maturities of securities ............................... 58 41 31 Net originations and maturities of loans ......................... 414 (435) (32) Net change in investments in and advances to subsidiaries ........ (490) (1,510) (539) Other, net ....................................................... 172 (65) 56 ---------- ---------- ---------- Net cash used in investing activities ...................... (1,950) (2,718) (179) ---------- ---------- ---------- Cash flows from financing activities: Net change in short-term borrowings .............................. 140 733 261 Issuance of long-term debt, net of issuance costs ................ 1,497 -- -- Repayment of long-term debt ...................................... (3) (424) -- Dividends paid ................................................... (711) (148) (712) Reductions of capital surplus .................................... (22) (20) (44) Preferred stock issuance, net of redemptions ..................... 816 -- -- Capital contribution from HNAI ................................... 3 2,400 -- ---------- ---------- ---------- Net cash provided by (used in) financing activities .................... 1,720 2,541 (495) ---------- ---------- ---------- Net change in cash and due from banks .................................. -- -- (1) Cash and due from banks at beginning of year ........................... -- -- 1 ---------- ---------- ---------- Cash and due from banks at end of year ................................. $ -- $ -- $ -- ========== ========== ========== Cash paid for: Interest ......................................................... $ 349 $ 237 $ 228 ========== ========== ========== HBUS is subject to legal restrictions on certain transactions with its nonbank affiliates in addition to the restrictions on the payment of dividends to HUSI. See Note 18 on page 119 for further discussion. 140 Quarterly Results of Operations (Unaudited) -------------------------------------------------------------------------------- The following table presents a quarterly summary of selected financial information. ------------------------------------------------------------------------------------------------------------------------ Quarter Ended December 31 September 30 June 30 March 31 ------------------------------------------------------------------------------------------------------------------------ (in millions) 2005 Net interest income .................................... $ 742 $ 761 $ 785 $ 775 ------- ------- ------- ------- Trading revenues ....................................... 127 137 35 96 Residential mortgage banking revenue (expense) ......... 23 31 (13) 23 Securities gains, net .................................. 2 17 64 23 Other income ........................................... 362 320 327 337 ------- ------- ------- ------- Total other revenues ................................... 514 505 413 479 ------- ------- ------- ------- Operating expenses ..................................... 746 673 684 655 Provision for credit losses ............................ 198 199 170 107 ------- ------- ------- ------- Income before income tax expense ....................... 312 394 344 492 Income tax expense ..................................... 116 142 131 177 ------- ------- ------- ------- Net income ............................................. $ 196 $ 252 $ 213 $ 315 ======= ======= ======= ======= 2004 Net interest income .................................... $ 700 $ 698 $ 689 $ 654 ------- ------- ------- ------- Trading revenues ....................................... 99 21 78 90 Residential mortgage banking revenue (expense) ......... (14) (65) (17) (24) Securities gains, net .................................. 26 18 3 38 Other income ........................................... 214 388 234 230 ------- ------- ------- ------- Total other revenues ................................... 325 362 298 334 ------- ------- ------- ------- Operating expenses ..................................... 613 480 520 488 Provision (credit) for credit losses ................... (24) 27 6 (26) ------- ------- ------- ------- Income before income tax expense ....................... 436 553 461 526 Income tax expense ..................................... 167 214 130 207 ------- ------- ------- ------- Net income ............................................. $ 269 $ 339 $ 331 $ 319 ======= ======= ======= ======= 141 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure -------------------------------------------------------------------------------- There were no disagreements on accounting and financial disclosure matters between HUSI and its independent accountants during 2005. Item 9A. Controls and Procedures -------------------------------------------------------------------------------- HUSI maintains a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, as amended, (the Exchange Act), is recorded, processed, summarized and reported on a timely basis. HUSI's Board of Directors, operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight to the financial reporting process. 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. 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. There have been no significant changes in HUSI's internal controls or in other factors that could significantly affect internal and disclosure controls subsequent to the date that the evaluation was carried out. HUSI continues the process to complete a thorough review of its internal controls as part of its preparation for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404). Section 404 requires management to report on, and external auditors to attest to, the effectiveness of HUSI's internal controls structure and procedures for financial reporting. As a non-accelerated filer under Rule 12b-2 of the Exchange Act, HUSI's first report under Section 404 will be contained in its Form 10-K for the period ended December 31, 2007. 142 PART III Item 10. Directors and Executive Officers of the Registrant -------------------------------------------------------------------------------- Directors Set forth below is certain biographical information relating to the members of HUSI's Board of Directors. The members of the HUSI Board of Directors also comprise the HBUS Board of Directors. Each director is elected annually. There are no family relationships among the directors. Salvatore H. Alfiero, age 68, Chairman and Chief Executive Officer, Protective Industries, LLC. since May 2001. He is also a director of Phoenix Companies, Inc., Southwire Company, Fresh Del Monte Produce Company and National Health Care Affiliates. He has been a director of HBUS since 1996, a director of HUSI since 2000 and a director of HNAH since 2005. Donald K. Boswell, age 54, President and Chief Executive Officer, Western New York Public Broadcasting Association since 1998. Mr. Boswell has been in public broadcasting since 1977. He has been a director of HBUS and HUSI since 2002. James H. Cleave, age 63, formerly President and Chief Executive Officer of HUSI and HBUS from 1993 through 1997. Prior to that Mr. Cleave was President and Chief Executive Officer of HSBC Bank Canada and he is currently a director and Vice Chairman of HSBC Bank Canada. He has been a director of HBUS and HUSI since 1991. Frances D. Fergusson, age 61, President, Vassar College since 1986. Dr. Fergusson was formerly Provost and Vice President for Academic Affairs, Bucknell University. Dr. Fergusson is also director of Wyeth Pharmaceuticals and a member of the Board of Overseers of Harvard University. She has been a director of HBUS since 1990 and a director of HUSI since 2000. Martin J. G. Glynn, age 54, President and Chief Executive Officer of HUSI and HBUS since 2003. Mr. Glynn also has been a Group General Manager for HSBC since 2001 and Chairman of HSBC Bank Canada since 2004. He has been a director of HSBC Bank Canada since 1999 and was formerly President and Chief Executive Officer of HSBC Bank Canada from 1999 to 2003. He is also a director of AEA Investors LLC and Husky Energy Inc. He has been a director of HUSI and HBUS since 2000. Stephen K. Green, age 57, Chairman of HUSI and HBUS since April 2005. Mr. Green is HSBC Group Chairman (designate) and has been Group Chief Executive, HSBC since 2003 and an Executive Director of HSBC since 1998. Mr. Green joined HSBC in 1982 and more recently served as Executive Director, Corporate, Investment Banking and Markets from 1998 to 2003 and as Group Treasurer from 1992 to 1998. Mr. Green is also Chairman of HSBC Bank plc, HSBC Bank Middle East Limited, HSBC Group Investment Businesses Limited and HSBC Private Banking Holdings (Suisse) S.A. He is a director of The Bank of Bermuda Limited, HSBC France S.A. (formerly CCF S.A.), The Hongkong and Shanghai Banking Corporation Limited, Grupo Financiero HSBC, S.A. de C.V., HSBC North America Holdings Inc. and HSBC Trinkaus & Burkhardt KGaA. He was previously a director of HBUS and HUSI from 2000 to 2004 and re-elected in 2005. Richard A. Jalkut, age 61, Lead Director of HUSI and HBUS since January 2005. Mr. Jalkut is President and Chief Executive Officer, Telepacific Communications and Chairman of Birch Telecom, Inc. Formerly President and Chief Executive of Pathnet and previously President and Group Executive, NYNEX Telecommunications. Mr. Jalkut is also a director of IKON Office Solutions and Covad Communications. He has been a director of HBUS since 1992 and a director of HUSI since 2000. Peter Kimmelman, age 61, private investor and managing member of Peter Kimmelman Asset Management LLC, an investment advisory firm registered with the Securities and Exchange Commission. Mr. Kimmelman was formerly a director of Republic New York Corporation and Republic National Bank of New York from 1976 until 1999. He has been a director of HBUS and HUSI since 2000. 143 Charles G. Meyer, Jr., age 68, Director and former President of Cord Meyer Development Company. Mr. Meyer was formerly a director of Republic National Bank of New York from 1987 until 1999. He has been a director of HBUS and HUSI since 2000. James L. Morice, age 68, President and Chief Executive Officer since January 1, 2006 of Morice Consulting, LLC, successor to the JLM Group LLC, a management consulting firm. Mr. Morice was previously Executive Vice President and Director of NationsBuilders Insurance Services, Inc. He was formerly a director of Republic New York Corporation and Republic National Bank of New York from 1987 until 1999 and a member of the Human Resources Committee of the University of New Haven from 2003 through 2005. He has been a director of HBUS and HUSI since 2000. Executive Officers -------------------------------------------------------------------------------- Information regarding the executive officers of HUSI as of March 6, 2006 is presented in the following table. ------------------------------------------------------------------------------------------------------------------- Year Name Age Appointed Present Position with HUSI ------------------------------------------------------------------------------------------------------------------- Martin J. G. Glynn 54 2003 President and Chief Executive Officer Brendan McDonagh 47 2002 Chief Operating Officer Gerard Aquilina 54 2002 Senior Executive Vice President, Private Banking and Wealth Management Janet L. Burak 50 2004 Senior Executive Vice President, General Counsel and Secretary Robert M. Butcher 62 1988 Senior Executive Vice President and Chief Risk Officer David Dew 50 2006 Senior Executive Vice President and Group Audit Executive, USA John J. McKenna 46 2005 Senior Executive Vice President and Chief Financial Officer Joseph M. Petri 53 2001 Senior Executive Vice President, Treasurer and Co-Head, CIBM Americas George T. Wendler 61 2000 Senior Executive Vice President and Chief Credit Officer Anthony J. Murphy 46 2005 Co-Head, CIBM Americas Paulette M. Crooke 52 2004 Executive Vice President, Operations Jeanne G. Ebersole 44 2004 Executive Vice President, Human Resources Seamus McMahon 46 2004 Executive Vice President and Regional President, Atlantic Region Teresa A. Pesce 46 2005 Executive Vice President, AML Compliance Carolyn M. Wind 52 2005 Executive Vice President, Compliance Michael P. Ebbs 46 2005 Managing Director, Chief Information Officer Joseph R. Simpson 44 2003 Chief Accounting Officer Clive R. Bucknall 42 2006 Chief Accounting Officer (Designate) ------------------------------------------------------------------------------------------------------------------- Martin J. G. Glynn was appointed President and Chief Executive Officer of HUSI and HBUS in October 2003. Prior to joining HUSI, he was President and Chief Executive Officer of HSBC Bank Canada from 1999 to 2003. Mr. Glynn was appointed a Group General Manager in 2001 and has been with the HSBC Group since 1982. Brendan McDonagh was appointed Chief Operating Officer, HBUS in October 2004. Mr. McDonagh is an HSBC International Manager who has been with the HSBC Group for over twenty five years and was appointed a Group General Manager effective August 1, 2005. He is Chairman of HSBC Investments (USA) Inc., a wholly owned subsidiary of HBUS. Mr. McDonagh has extensive commercial and retail management experience and prior to joining HUSI in 2002 as Senior Executive Vice President, Retail and Commercial Banking, he served as Senior Executive, Strategy Implementation, at HSBC Group headquarters. Gerard Aquilina assumed responsibilities for Private Banking and Wealth Management Services for HSBC in North America in 2003. Mr. Aquilina joined HSBC in June 2002 as Chief Executive Officer, International Private Banking, Americas. He previously held various management positions with Merrill Lynch from 1984 to 2002, including Global Head of Marketing and Wealth Management for their International Private Client Group. Janet L. Burak was appointed General Counsel and Secretary for HUSI and HBUS in April 2004. Ms. Burak had served as an attorney with HSBC Finance Corporation for twelve years and most recently as their Group General Counsel. Prior to joining HSBC Finance Corporation, she was an associate with Shearman & Sterling and an attorney with Citigroup. 144 Robert M. Butcher was appointed Chief Risk Officer for HUSI and HBUS in May 2003. Mr. Butcher was Chief Financial Officer of HUSI and HBUS from 1990 to 2003. Prior to joining HBUS's predecessor, Marine Midland Bank in 1988, Mr. Butcher was with Citicorp for 15 years where he held various senior officer positions in the corporate finance department. David Dew was appointed Senior Executive Vice President, Audit, HSBC North America Inc. (HNAI) effective January 1, 2006. Prior to this appointment Mr. Dew served as Chief Auditor, Group Audit, HSBC Finance Corporation from November 2004 to December 2005. He was Executive Director & Chief Operating Officer, The Saudi British Bank, Riyadh, Saudi Arabia from March 2001 to November 2004; Deputy Chief Executive Officer, The Hongkong and Shanghai Banking Corporation Limited, Singapore from September 1997 to March 2001; and Chief Executive Officer, HSBC Bank plc, Milan, Italy from November 1994 to September 1997. Mr. Dew has been an HSBC employee since 1977. John J. McKenna was appointed Senior Executive Vice President and Chief Financial Officer of HUSI effective October 3, 2005. Prior to this appointment, Mr. McKenna served as Chief Financial Officer, HSBC Mexico, S.A. from November 2002 through September 2005. From July 2000 to October 2002, he held the position of Senior Vice President and Director of Financial Management for HUSI. Since joining HSBC in 1986, Mr. McKenna has held a variety of financial management positions focusing on strategic planning, business controllership and management information. Joseph M. Petri was appointed Co-Head of Corporate, Investment Banking and Markets (CIBM) Americas in November 2004. Mr. Petri had been Head of Global Markets, Americas. He joined HUSI in April 2000 as Executive Managing Director and head of sales for HSBC's Investment Banking and Markets, Americas division. From 1995 to 1998, he was President and Senior Partner of Summit Capital Advisors LLC, a New Jersey based hedge fund. Prior to that, Mr. Petri held a variety of management positions with Merrill Lynch. George T. Wendler was appointed Chief Credit Officer of HUSI in 2000. Mr. Wendler was Chief Credit Officer and a member of the Senior Management Committee of Republic New York Corporation when it was acquired by HSBC in December 1999. He was also a director and Vice Chairman of Republic New York Corporation from 1997 to 1999. Anthony J. Murphy, Chief Executive Officer, HSBC Securities (USA) Inc., was appointed Co-Head, CIBM Americas in November 2004. Mr. Murphy has been with the HSBC Group since 1990. Prior to his appointment as Chief Executive Officer, HSBC Securities (USA) Inc. in April 2003, Mr. Murphy served as Chief Strategic Officer, CIBM Americas from 2000. Prior to that assignment, he was Head of Market Risk Management for HSBC Bank plc and HSBC Investment Bank in London from 1996. Paulette M. Crooke was appointed Executive Vice President, Operations for HUSI and HBUS in July 2004. Ms. Crooke has previously held various management positions within the HBUS Human Resources Division, as well as various retail banking positions, most recently directing PFS activities in Manhattan. She has been with HBUS for over thirty years. Jeanne G. Ebersole joined HUSI from HSBC Finance Corporation in May 2004 as Executive Vice President, Human Resources. Prior to this appointment, Ms. Ebersole had overall human resources responsibility for HSBC Finance Corporation's retail services, insurance services and refund lending businesses since August 2002. She held a variety of human resources positions since joining HSBC Finance Corporation in 1980. Seamus McMahon was appointed Executive Vice President in charge of strategic planning, corporate development and acquisitions, and ongoing integration initiatives in May 2004. In October 2004, Mr. McMahon was appointed HBUS Regional President, Atlantic Region. Mr. McMahon has more than twenty years of experience in the financial services industry. Prior to joining HUSI, Mr. McMahon served as President and Chief Executive Officer of TD Bank, USA, a wholly owned subsidiary of Toronto Dominion Bank. He also led the retail financial services practices at First Manhattan Consulting Group and Booz Allen & Hamilton, and worked for Chase Manhattan in New York and Accenture (then Andersen Consulting) in Europe. 145 Teresa A. Pesce joined HUSI in September 2003 as Executive Vice President and Anti-Money Laundering (AML) Director. In 2004 she was appointed the AML Director for all HSBC businesses in North America. Ms. Pesce joined HUSI from the United States Attorney's Office, Southern District of New York where she was Senior Trial Counsel, White Plains Division and previously Chief of the Major Crimes Unit and Deputy Chief of the Criminal Division. From 1992 to 1999 she served as a Line Assistant in the Major Crimes, Narcotics, and General Crimes Units. Carolyn M. Wind, Executive Vice President, Compliance, was the Chief Compliance Officer for Republic New York Corporation when it was acquired by HSBC in December 1999. Prior to joining Republic New York Corporation, she was a senior national bank examiner with the Office of the Comptroller of the Currency (OCC). Michael P. Ebbs was appointed Managing Director and Chief Information Officer - HBUS Banking Systems in January 2005. Mr. Ebbs was Head of Information Technology at The Bank of Bermuda Limited when it was acquired by HSBC in February 2004. Prior to his thirteen years at The Bank of Bermuda Limited, Mr. Ebbs held senior technology positions at The Putnam Companies and the Bank of New England. Joseph R. Simpson was appointed Controller and Chief Accounting Officer for HUSI and HBUS in 2003. Prior to that appointment, he held the position of Manager of External Financial Reporting and previous to that, Manager of Accounting Policy. Mr. Simpson has been with HUSI for over fifteen years. Clive R. Bucknall was appointed Controller and Chief Accounting Officer, HUSI effective March 7, 2006. Prior to this appointment Mr. Bucknall served as Senior Financial Officer, HSBC Singapore from March 2002 through December 2005. He was Senior Financial Officer, HSBC Thailand from September 1998 to March 2002 and Senior Area Accounting Manager, HSBC Hong Kong from September 1994 to September 1998. In 1991, Mr. Bucknall joined Midland Bank in London, which was acquired by HSBC in 1992, as Financial Accounting Manager. Audit Committee -------------------------------------------------------------------------------- The Audit Committee of HUSI's Board of Directors is comprised of Messrs.: Alfiero (Chairman), Cleave, Jalkut and Kimmelman. Messrs. Alfiero and Cleave have been determined by HUSI's Board of Directors to be audit committee financial experts, each having the attributes prescribed by the SEC, and are independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act. Code of Ethics -------------------------------------------------------------------------------- HUSI has adopted a code of ethics applicable to its chief executive officer, its chief financial officer, and its chief accounting officer and is included herein as Exhibit 14. 146 Item 11. Executive Compensation -------------------------------------------------------------------------------- The following table presents the compensation earned for the three years ending December 31, 2005 by the President and Chief Executive Officer of HUSI and HBUS and by the four most highly compensated Executive Officers of HUSI and HBUS, who were serving as such on December 31, 2005 (the named executive officers). Principal position indicates capacity served in 2005. Summary Compensation Table ------------------------------------------------------------------------------------------------------------------------ Long Term Annual Compensation Compensation ---------------------------------------- ------------- Restricted All Other Name and Principal Position Year Salary Bonus Other Stock Awards(6) Compensation ------------------------------------------------------------------------------------------------------------------------ Martin J. G. Glynn (1) 2005 $ 707,692 $1,650,000 $ 295,235(2) $1,200,000 $ 10,500(5) President and 2004 600,000 1,500,000 299,312(2) 526,693 7,738 Chief Executive Officer 2003 103,846 1,000,000 70,449(2) 278,758 1,846 Joseph M. Petri 2005 325,000 3,960,000 -- 2,790,000 10,500(5) Senior Executive Vice President, 2004 325,000 3,210,000 69,355(3) 3,879,045 7,175 Treasurer and Co-Head, Corporate, 2003 325,000 3,750,000 246,553(3) 2,794,674 7,000 Investment Banking and Markets, Americas Gerard Aquilina 2005 500,000 1,050,000 -- 775,000 10,500(5) Senior Executive Vice President, 2004 490,173 875,000 -- 700,000 6,384 Private Banking and Wealth 2003 465,000 750,000 -- 412,000 781 Management Brendan McDonagh 2005 636,960 789,000 477,756(4) 376,000 156,265(5) Senior Executive Vice President 2004 529,796 475,500 401,871(4) 228,000 164,041 and Chief Operating Officer 2003 470,333 219,598 464,264(4) 150,000 93,174 George T. Wendler 2005 566,500 747,780 -- 150,000 12,600(5) Senior Executive Vice President 2004 566,500 700,194 -- -- -- and Chief Credit Officer 2003 566,500 475,000 -- 56,000 -- (1) Mr. Glynn was appointed President and Chief Executive Officer of HUSI and HBUS effective October 22, 2003. His 2003 salary figure represents the salary earned and paid by HUSI from October 22, 2003 to December 31, 2003. Prior to joining HUSI, Mr. Glynn was President and Chief Executive Officer of HSBC Bank Canada. (2) Mr. Glynn's Other Annual Compensation represents perquisites and other personal benefits. The amount reported for 2005, 2004 and 2003 includes reimbursements and tax gross-ups related to rental expenses of $259,285, $272,115 and $69,222 respectively. (3) Mr. Petri's Other Annual Compensation for 2004 and 2003 principally represents imputed interest income from the investment of deferred bonus amounts from previous years. (4) Mr. McDonagh's Other Annual Compensation includes perquisites and other personal benefits of $452,232, $366,984 and $424,964 for 2005, 2004 and 2003 respectively. Total perquisites and personal benefits for 2005 include reimbursements and tax gross-ups related to rental expenses of $172,645 and children's educational expenses of $130,858. Perquisites and personal benefits for 2004 include reimbursements and tax gross-ups related to rental expenses of $135,501 and children's educational expenses of $103,205. Perquisites and personal benefits for 2003 include reimbursements and tax gross-ups related to rental expenses of $169,283 and children's educational expenses of $124,149. (5) All Other Compensation in 2005 for each of the named executive officers, except Mr. McDonagh, represents HUSI's matching 401(k) plan contribution. Mr. McDonagh's 2005 All Other Compensation represents pension contributions made by HSBC on his behalf. (6) Restricted stock awards granted in the past three fiscal years include performance and non-performance based awards. 147 The restricted stock awards included in the Summary Compensation Table represent the monetary value on the date of grant of awards received during the years indicated. Dividends are paid on all restricted shares and are reinvested in additional restricted shares. The following table presents the number and value of the aggregate restricted stock holdings at December 31, 2005 for each named executive officer. ----------------------------------------------------------------------------------------------------------------------- Number of December 31, 2005 Shares Value ----------------------------------------------------------------------------------------------------------------------- Martin J. G. Glynn .................................................................... 177,208 $ 2,845,664 Joseph M. Petri (1) ................................................................... 475,924 7,642,537 Gerard Aquilina ....................................................................... 139,696 2,243,280 Brendan McDonagh ...................................................................... 81,987 1,316,567 George T. Wendler ..................................................................... 34,372 551,953 (1) Mr. Petri's restricted share holdings at December 31, 2005 include 96,332 shares representing the balance of shares originally granted in March 2003, two thirds of which vested equally in 2004 and 2005 and the balance of which will vest in 2006 on the date HSBC publishes its 2005 annual results. Restricted share holdings at December 31, 2005 also include 170,109 shares representing the balance of shares originally granted in March 2004, one third of which vested in 2005 and two thirds of which will vest equally in 2006 and 2007 on the date HSBC publishes its annual results. Also included in Mr. Petri's total restricted share holdings are 174,548 shares representing the accumulated balance of shares originally granted in February 2005. These shares will vest in equal increments on the date HSBC publishes its annual results in 2006, 2007 and 2008. No stock options on HSBC Holdings plc common stock were granted during 2005 to any of the named executive officers and none of the named executive officers exercised any previously awarded stock options during 2005. The only named executive officer with any unexercised stock options on HSBC Holdings plc common stock is Mr. McDonagh. His options were granted under the HSBC Holdings Executive Share Option Scheme for performance years 1996 through 1998 while employed by other HSBC entities. The number of Mr. McDonagh's options and their value at December 31, 2005 are presented in the following table. -------------------------------------------------------------------------------------------------------------------- Aggregated Stock Options Exercised in 2005 and Option Values as of Year End 2005 Number of Securities Value of Unexercised Underlying Unexercised Options In-the-Money Options Shares as of December 31, 2005 as of December 31, 2005 (2) Acquired on Value ------------------------------- ---------------------------- Name Exercise (#) Realized ($) Exercisable(1) Unexercisable Exercisable Unexercisable -------------------------------------------------------------------------------------------------------------------- Martin J. G. Glynn -- $ -- -- -- $ -- $ -- Joseph M. Petri -- -- -- -- -- -- Gerard Aquilina -- -- -- -- -- -- Brendan McDonagh -- -- 33,900 -- 187,959 -- George T. Wendler -- -- -- -- -- -- (1) Although the performance conditions have been met on the above unexercised options, HSBC Staff Dealing Rules prohibit the exercise of these options until the 2005 financial results of HSBC have been publicly announced. (2) The value of unexercised in-the-money options is based on the December 31, 2005 closing price per share of 9.330 GBP for HSBC Holdings plc common stock and a U.S. dollar exchange rate of 1.72115 per GBP. 148 Pension Benefits for the Named Executive Officers -------------------------------------------------------------------------------- Mr. Glynn's pension benefits will be provided pursuant to the terms of the qualified and non-qualified supplemental pension plan of HSBC Bank Canada. HSBC Bank Canada's qualified pension plan is a defined benefit plan under which benefits are determined primarily by final average earnings, years of service and a plan formula. Benefits payable under this plan are limited to the maximum allowed by Canada Revenue Agency (CRA). For example, in year 2005 the limit was $2,000 and in year 2006, the limit is $2,111.11 per year of pensionable service. The following table, which is presented in Canadian currency, indicates the maximum pension benefits allowed by law for plan participants in the specified compensation and years of service classifications for year 2006. The table assumes payments in the form of a life annuity, guaranteed for ten years. -------------------------------------------------------------------------------------------------------------------- Compensation 15 20 25 30 -------------------------------------------------------------------------------------------------------------------- $ 500,000 $ 31,666 $ 42,222 $ 52,777 $ 63,333 600,000 31,666 42,222 52,777 63,333 700,000 31,666 42,222 52,777 63,333 800,000 31,666 42,222 52,777 63,333 900,000 31,666 42,222 52,777 63,333 1,000,000 31,666 42,222 52,777 63,333 -------------------------------------------------------------------------------------------------------------------- The pension benefit for plan participants in the compensation levels presented above is capped for all participants having the number of years of credited service indicated. The compensation covered by the plan is limited to straight salary. At the plan's normal retirement date of age 60, Mr. Glynn will have 28.75 years of credited service. In addition to the pension benefit available from the HSBC Bank Canada qualified plan, Mr. Glynn is entitled to receive an annual pension benefit during his lifetime pursuant to a non-qualified supplemental retirement agreement with HSBC Bank Canada. Under the terms of this agreement, the supplemental allowance is forfeited if Mr. Glynn ceases employment with HSBC before age 55 and goes to work for a competitor within two years. The supplemental allowance is calculated based on Mr. Glynn's highest three years average base salary, excluding all bonuses. The supplemental pension agreement formula is 2.5% of final average earnings, times years of pensionable service. Mr. Glynn's earnings under this formula are converted into Canadian currency by multiplying his current earnings in U.S. currency by 1.3333. Based on an annual salary of $933,310 in Canadian currency, the estimated annual total pension benefit at the normal retirement age of 60 for Mr. Glynn is $670,815. Of this amount, $60,694 is payable from the HSBC Bank Canada qualified plan and $610,121 from the non-qualified supplemental retirement agreement. In U.S. currency, these pension benefits amount to $45,522 from the qualified plan and $457,602 from the non-qualified plan. The pension benefits for Joseph M. Petri, Gerard Aquilina and George T. Wendler will be provided pursuant to the terms of the HSBC - North America (USA) Retirement Income Plan, a non-contributory defined benefit pension plan under which HBUS and other participating subsidiaries of HNAH make contributions in actuarially determined amounts. The pension benefits under the Retirement Income Plan for employees hired before January 1, 2000 are determined primarily by compensation and years of service. The following table shows the estimated annual retirement benefit payable upon normal retirement on a straight life annuity basis to participating employees, including officers, in the compensation and years of service classifications indicated under the Retirement Income Plan and non-qualified supplemental benefit plans. The amounts shown are before application of social security reductions. Years of service for benefit purposes is limited to 30 years in the aggregate. 149 -------------------------------------------------------------------------------------------------------------------- Five Year Average Compensation 15 20 25 30 35 -------------------------------------------------------------------------------------------------------------------- $ 300,000 $ 87,750 $ 117,450 $ 147,450 $ 177,450 $ 178,200 400,000 117,000 156,600 196,600 236,600 237,600 500,000 146,250 195,750 245,750 295,750 297,000 600,000 175,500 234,900 294,900 354,900 356,400 700,000 204,750 274,050 344,050 414,050 415,800 800,000 234,000 313,200 393,200 473,200 475,200 900,000 263,250 352,350 442,350 532,350 534,600 1,000,000 292,500 391,500 491,500 591,500 594,000 -------------------------------------------------------------------------------------------------------------------- Compensation covered by the Retirement Income Plan in the above table includes regular basic earnings (including salary reduction contributions to the 401(k) plan), but not incentive awards, bonuses, special payments or deferred salary. HNAH maintains supplemental benefit plans which provide for the difference between the benefits actually payable under the Retirement Income Plan and those that would have been payable if certain other awards, special payments and deferred salaries were taken into account and if compensation in excess of the limitations set by the Internal Revenue Code could be counted. Payments under these plans are unfunded and will be made out of the general funds of HBUS or other participating subsidiaries. The calculation of retirement benefits is based on the highest five-consecutive year compensation. Mr. Wendler is the only named executive officer participating in the Retirement Income Plan who was hired before January 1, 2000. He is also a member of the Senior Management Committee of HBUS. Individuals who were members of the Senior Management Committee prior to July 1, 2004, and who participate in the Retirement Income Plan receive two times their normal credited service for each year and fraction thereof served as a committee member in determining pension and severance benefits to a maximum of 30 years of credited service in total. This additional service accrual is unfunded and payments will be made from the general funds of HBUS or other subsidiaries. As of December 31, 2005, Mr. Wendler had 23.76 total years of credited service in determining benefits payable under the Retirement Income Plan and other non-qualified supplemental benefit plans. The pension benefits for Joseph M. Petri and Gerard Aquilina under the HSBC - North America (USA) Retirement Income Plan are based on the formula applicable to employees hired on or after January 1, 2000. Under this formula, benefits are calculated at 2% of pensionable pay for each year of service, credited with interest at the end of the year at a rate equal to the lesser of the average of the 10-year treasury rates or the average of the 30-year treasury rates for the September of the preceding year. Under certain circumstances, this benefit may be reduced due to federal regulations. Pensionable pay is defined as base pay plus overtime, bonuses and commissions paid in that calendar year. Employee pre-tax contributions to any benefit plan maintained by HNAH are also included in pensionable pay. Deferred compensation is not included. The estimated pension benefit available for Mr. Petri at age 65, the normal retirement age, is a one time only, lump sum benefit of $67,652.83. The estimated age 65 benefit available for Mr. Aquilina is a one time only, lump sum benefit of $59,585.58. Since Brendan McDonagh is an HSBC International Manager, he participates in the HSBC International Staff Retirement Benefits Scheme (ISRBS), a defined benefit plan. Based on a benefit formula that approximates 85% of his Sterling Basic Salary of 161,310.60 GBP and a normal retirement date of July 31, 2011, at age 53 and over 30 years of service, Mr. McDonagh's pension benefit is 136,357.87 GBP per annum. At a U.S. dollar exchange rate of 1.72115 per GBP at December 31, 2005, this benefit equates to $234,692.35 in U.S. currency. Mr. McDonagh makes ISRBS contributions at the current rate of 6.67% of Sterling Basic Salary and HSBC makes contributions on his behalf at the current rate of 57.5% of Sterling Basic Salary. 150 Directors' Compensation -------------------------------------------------------------------------------- Directors who are employees of HSBC or other Group Affiliates, including HUSI and HBUS, do not receive annual retainers or fees. For their services as directors of both HUSI and HBUS, all nonemployee directors, including the Chairman of the Board but excluding the Lead Director, receive an annual retainer of $50,000. The Lead Director receives an annual retainer of $75,000. Committee chairmen receive an additional annual fee of $2,500 for acting in that capacity. Members of the Audit Committee receive an annual fee which is $10,000 for the chairman and $6,000 for the other members. Directors are reimbursed for their expenses incurred in attending meetings. HUSI and HBUS have standard arrangements pursuant to which directors elected prior to June 1999 may defer all or part of their fees. Employment Contracts -------------------------------------------------------------------------------- Mr. Joseph M. Petri has an agreement with HUSI whereby he will give six months notice before leaving and sign a non-compete agreement in order to receive all restricted stock granted to him at that time. There are no other employment contracts between HUSI and any of its other named executive officers. Compensation Committee Interlocks and Insider Participation -------------------------------------------------------------------------------- The current members of the Human Resources and Compensation Committee of HUSI's Board of Directors are: nonemployee director Dr. Frances D. Fergusson, Chair; Mr. Martin J. G. Glynn, President and Chief Executive Officer of HUSI and HBUS; nonemployee director Mr. James L. Morice and nonemployee director Mr. Donald K. Boswell. There are no interlocking relationships. 151 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Matters -------------------------------------------------------------------------------- Security Ownership of Certain Beneficial Owners HUSI's common stock is 100% owned by HSBC North America Inc. (HNAI). HNAI is an indirect wholly owned subsidiary of HSBC. Security Ownership by Management The following table shows the beneficial ownership of HSBC $0.50 ordinary shares as of December 31, 2005 by each of HUSI's directors, the named executive officers in the Summary Compensation Table on page 147 and by all of HUSI's directors and executive officers as a group. Each of the individuals listed below and all directors and executive officers as a group own less than 1% of the outstanding shares of stock. -------------------------------------------------------------------------------------------------------------------- Shares That Shares May be Acquired Total Beneficially Within 60 Days by Beneficially Directors Owned (1) Exercise of Options (2) Owned Shares -------------------------------------------------------------------------------------------------------------------- Salvatore H. Alfiero 259,000 -- 259,000 Donald K. Boswell 220 -- 220 James H. Cleave 218,578 -- 218,578 Frances D. Fergusson 100 -- 100 Martin J. G. Glynn (3) 219,968 -- 219,968 Stephen K. Green 1,094,648 -- 1,094,648 Richard A. Jalkut 250 -- 250 Peter Kimmelman 17,035 -- 17,035 Charles G. Meyer, Jr. 500 -- 500 James L. Morice 613 -- 613 -------------------------------------------------------------------------------------------------------------------- Named executive officers -------------------------------------------------------------------------------------------------------------------- Joseph M. Petri 477,281 -- 477,281 Gerard Aquilina 139,696 -- 139,696 Brendan McDonagh 109,937 33,900 143,837 George T. Wendler 34,372 -- 34,372 -------------------------------------------------------------------------------------------------------------------- All directors and executive officers as a group 3,129,096 247,031 3,376,127 -------------------------------------------------------------------------------------------------------------------- (1) Beneficially owned shares include restricted stock awards which do not carry voting rights. (2) HSBC Staff Dealing Rules prohibit the exercise of these options until the 2005 financial results of HSBC have been publicly announced. (3) As the President and Chief Executive Officer of HUSI and HBUS, Mr. Glynn is also one of the named executive officers. No director or executive officer of HUSI owned any of HUSI's outstanding preferred stock at December 31, 2005. 152 Item 13. Certain Relationships and Related Transactions -------------------------------------------------------------------------------- None. Item 14. Principal Accounting Fees and Services -------------------------------------------------------------------------------- Fees billed to HUSI by its auditing firm, KPMG LLP, were as follows. ------------------------------------------------------------------------------------------------------------------------ Year Ended December 31 2005 2004 ------------------------------------------------------------------------------------------------------------------------ (in thousands) Audit fees: Auditing of financial statements, quarterly reviews, statutory audits, preparation of comfort letters, consents and review of registration statements .............................. $ 5,137 $ 4,310 Audit related fees: Employee benefit plan audits, due diligence assistance, internal control review assistance, and audit or attestation services not required by statute or regulation .............. 870 1,478 Tax fees: Tax related research, general tax services in connection with transactions and legislation, and review of federal and state tax accounts for possible over-assessment of interest and/or penalties ..................................................................... 51 1,762 All other fees ............................................................................... -- 46 -------- -------- Total KPMG LLP fees .......................................................................... $ 6,058 $ 7,596 ======== ======== Audit Committee Pre-approval Policies and Procedures It is the practice of the Audit Committee of HUSI's Board of Directors to approve the annual audit fees, including those covering audit services beyond HUSI's financial statements, before any audit procedures are undertaken. Prior to 2003, management had the implicit pre-approval of the Audit Committee to engage KPMG LLP, or any other professional service firm, to perform tax and other services. Any such services provided by KPMG LLP were reported to the Audit Committee after the fact. Beginning in 2003, the Audit Committee assumed responsibility for pre-approving all auditing services and permitted non-auditing services, including the related fees and terms thereof. 153 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K -------------------------------------------------------------------------------- (a) (1) Financial Statements HSBC USA Inc.: Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders' Equity Consolidated Statement of Cash Flows HSBC Bank USA, National Association: Consolidated Balance Sheet Notes to Financial Statements (2) Not applicable (3) Exhibits 3(i) Articles of Incorporation and amendments and supplements thereto (incorporated by reference to Exhibit 3(a) 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). 3(ii) By-Laws dated April 21, 2005. 4(i) Senior Indenture, dated as of October 24, 1996, by and between HUSI and Bankers Trust Company, as trustee, as amended and supplemented (incorporated by reference to Exhibits 4.1 and 4.2 to Post-Effective Amendment No. 1 to HUSI's registration statement on Form S-3, Registration No. 333-42421, filed with the Securities and Exchange Commission on April 3, 2002, and Exhibit 4.1 to HUSI's Current Report on Form 8-K dated November 21, 2005 and filed with the Securities and Exchange Commission on November 28, 2005). 4(ii) Subordinated Indenture, dated as of October 24, 1996, by and HUSI and Bankers Trust Company, as trustee, as amended and supplemented (incorporated by reference to Exhibits 4.3, 4.4, 4.5 and 4.6 to Post-Effective Amendment No. 1 to HUSI's registration statement on Form S-3, Registration No. 333-42421, filed with the Securities and Exchange Commission on April 3, 2002. 12.01 Computation of Ratio of Earnings to Fixed Charges 12.02 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends 14 Code of Ethics for Senior Financial Officers 21 Subsidiaries of HSBC USA Inc. 23 Consent of Independent Registered Public Accounting Firm 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 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 154 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 --------------------------------------- /s/ Janet L. Burak --------------------------------------- Janet L. Burak Senior Executive Vice President, General Counsel and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 6, 2006 by the following persons on behalf of the registrant and in the capacities indicated: /s/ John J. McKenna Stephen K. Green* -------------------------------------- Chairman of the Board John J. McKenna Salvatore H. Alfiero* Director Senior Executive Vice President and Donald K. Boswell* Director Chief Financial Officer James H. Cleave* Director (Principal Financial Officer) Frances D. Fergusson* Director Martin J. G. Glynn* Director, President and Chief Executive Officer Richard A. Jalkut* Director Peter Kimmelman* Director /s/ Joseph R. Simpson Charles G. Meyer, Jr.* Director -------------------------------------- James L. Morice* Director Joseph R. Simpson Chief Accounting Officer (Principal Accounting Officer) * /s/ Janet L. Burak ------------------------------------------------ Janet L. Burak Attorney-in-fact 155 This information is provided by RNS The company news service from the London Stock Exchange

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