HSBC
Annual Report 2004

Plain-text annual report

HSBC Holdings plc Annual Report and Accounts H S B C H O L D I N G S P L C Table of Contents Page Page Certain Defined Terms....................................below Board of Directors and Senior Management ... 186 Financial Highlights ............................................... 1 Report of the Directors ...................................... 191 Five-Year Comparison ........................................... 3 Directors’ Remuneration Report ...................... 216 Cautionary Statement regarding Statement of Directors’ Responsibilities in Forward-Looking Statements............................ 5 relation to Financial Statements.................... 234 Information about the Enforceability of Independent Auditors’ Report .......................... 235 Judgements made in the United States ............. 7 Exchange Controls and Other Limitations affecting Equity Security Holders ..................... 7 Financial Statements .......................................... 237 Notes on the Financial Statements .................... 243 Description of Business .......................................... 8 Taxation of Shares and Dividends .................... 357 Governance, Regulation and Supervision........... 20 Shareholder Information ................................... 360 Description of Property........................................ 25 Organisational Structure ................................... 365 Legal Proceedings................................................. 25 Glossary............................................................... 366 Financial Review................................................... 26 Index .................................................................... 370 Other Information .............................................. 179 Certain Defined Terms Unless the context requires otherwise, ‘HSBC Holdings’ means HSBC Holdings plc and ‘HSBC’ or the ‘Group’ means HSBC Holdings together with its subsidiary undertakings. Within this document the Hong Kong Special Administrative Region of the People’s Republic of China is referred to as ‘Hong Kong’. This document comprises the Annual Report and Accounts 2004 for HSBC Holdings plc and its subsidiary and associated undertakings. It contains the Directors’ Report and Financial Statements, together with the Auditors’ Report thereon, as required by the UK Companies Act 1985. The Annual Review 2004 of HSBC Holdings plc is published as a separate document. H S B C H O L D I N G S P L C Financial Highlights HSBC’s Financial Statements and Notes thereon, as set out on pages 237 to 356, are prepared in accordance with UK Generally Accepted Accounting Principles (‘UK GAAP’). HSBC uses the US dollar as its reporting currency because the US dollar and currencies linked to it form the major currency bloc in which HSBC transacts its business. As HSBC is listed on the New York Stock Exchange, it also reconciles certain financial information to US Generally Accepted Accounting Principles (‘US GAAP’), which differ in certain respects from UK GAAP as explained on page 322 and reconciled in Note 49 of the ‘Notes on the Financial Statements’. Unless otherwise stated, the numbers presented in this document have been prepared in accordance with UK GAAP. HSBC judges its own performance by comparing returns before goodwill amortisation on cash invested as HSBC believes this gives an important measure of its underlying performance and facilitates comparison with its peer group. Profit before goodwill amortisation is derived by adjusting reported earnings to eliminate the impact of the amortisation of goodwill arising on acquisitions. The derivation of non-GAAP measures from the equivalent reported measures is explained in the ‘Footnotes to Financial Highlights’ on page 4. For the year (excluding goodwill amortisation) Operating profit before provisions1 ................................................................................................. Profit on ordinary activities before tax2 .......................................................................................... Profit attributable to shareholders2 .................................................................................................. For the year (as reported) Operating profit before provisions .................................................................................................. Profit on ordinary activities before tax ............................................................................................ Profit attributable to shareholders ................................................................................................... Dividends ........................................................................................................................................ At year-end Shareholders’ funds ........................................................................................................................ Capital resources ............................................................................................................................. Customer accounts and deposits by banks ...................................................................................... Total assets ..................................................................................................................................... Risk-weighted assets ....................................................................................................................... Per ordinary share Earnings excluding goodwill amortisation3 .................................................................................... Basic earnings ................................................................................................................................. Diluted earnings .............................................................................................................................. Dividends ........................................................................................................................................ Net asset value at year end .............................................................................................................. Share information US$0.50 ordinary shares in issue (million)...................................................................................... Market capitalisation (billion) ......................................................................................................... Closing market price per ordinary share: – London ......................................................................................................................................... – Hong Kong ................................................................................................................................... Closing market price per American Depositary Share (‘ADS’)4 ...................................................... Total shareholder return to 31 December 20045 – over 1 year6 .................................................................................................................................. For the above footnotes, see ‘Footnotes to Financial Highlights’ on page 4. 2004 US$m 24,712 19,426 13,658 22,898 17,608 11,840 (7,301) 86,623 90,780 777,290 1,276,778 759,210 US$ 1.25 1.09 1.07 0.66 7.75 2003 US$m 19,990 14,401 10,359 18,540 12,816 8,774 (6,532) 74,473 74,042 643,556 1,034,216 618,662 US$ 0.99 0.84 0.83 0.60 6.79 At 31 December 2004 At 31 December 2003 11,172 US$190 £8.79 HK$133.00 US$85.14 10,960 US$172 £8.78 HK$122.50 US$78.82 HSBC Benchmark 105 110 1 H S B C H O L D I N G S P L C Financial Highlights (continued) Capital and performance ratios (annualised) Capital ratios Tier 1 capital ................................................................................................................................... Total capital .................................................................................................................................... Performance ratios (excluding goodwill amortisation) Return on average invested capital7 ................................................................................................ Return on average net tangible equity8,9 .......................................................................................... Post-tax return on average tangible assets9 ...................................................................................... Post-tax return on average risk-weighted assets9 ............................................................................. Performance ratios (as reported) Return on average shareholders’ funds ........................................................................................... Post-tax return on average total assets ............................................................................................ Post-tax return on average risk-weighted assets .............................................................................. Credit coverage ratios Provisions for bad and doubtful debts as a percentage of operating profits before goodwill amortisation and provisions ........................................................................................................ Provisions for bad and doubtful debts as a percentage of average gross customer advances: – in aggregate .................................................................................................................................. – Consumer Finance10 ..................................................................................................................... – other HSBC .................................................................................................................................. Total provisions outstanding as a percentage of non-performing loans at year end: – in aggregate .................................................................................................................................. – Consumer Finance10 ..................................................................................................................... – other HSBC .................................................................................................................................. Efficiency and revenue mix ratios Cost:income ratio (excluding goodwill amortisation)11 .................................................................. – constant currency basis ................................................................................................................ As a percentage of total operating income: – net interest income ....................................................................................................................... – other operating income ................................................................................................................ – net fees and commissions ............................................................................................................ – dealing profits .............................................................................................................................. Constant currency 2004 % 8.9 12.0 15.2 25.4 1.31 2.23 14.4 1.12 1.96 25.7 1.04 4.26 0.19 95.5 102.1 92.5 51.1 51.1 61.3 38.7 25.9 5.1 2003 % 8.9 12.0 13.7 24.7 1.21 2.07 13.0 1.01 1.78 30.5 1.25 5.21 0.38 91.0 110.5 82.1 51.3 51.8 62.3 37.7 25.3 5.3 Constant currency comparatives in respect of 2003 and 2002, used in the 2004 and 2003 commentaries respectively, are computed by retranslating into US dollars: • • the profit and loss accounts for 2003 and 2002 of non-US dollar branches, subsidiary undertakings, joint ventures and associates at the average rates of exchange for 2004 and 2003 respectively; and the balance sheets at 31 December 2003 and 2002 for non-US dollar branches, subsidiary undertakings, joint ventures and associates at the rates of exchange ruling at 31 December 2004 and 2003 respectively. No adjustment is made to the exchange rates used to translate foreign currency denominated assets and liabilities into the functional currency of any HSBC branches, subsidiary undertakings, joint ventures and associates. Operating income and cost growth Net interest income ....................................................... Fees and commissions (net) .......................................... Dealing profits .............................................................. Total operating income ................................................. Administrative expenses (excluding goodwill amortisation) ............................................................. 2004 compared with 2003 2003 compared with 2002 As reported % Constant currency % As reported % Constant currency % 21 26 18 23 23 17 17 12 18 17 66 33 66 54 41 58 24 58 46 32 For the above footnotes, see ‘Footnotes to Financial Highlights’ on page 4. 2 Five-year comparison At year-end Share capital ............................................. Shareholders’ funds .................................. Capital resources12 ..................................... Customer accounts .................................... Undated subordinated loan capital ............ Dated subordinated loan capital ................ Loans and advances to customers13 .......... Total assets ............................................... For the year Net interest income ................................... Other operating income ............................ Operating profit before provisions ............ Provisions for bad and doubtful debts ...... Profit on ordinary activities before tax ...... Profit attributable to shareholders ............. Dividends .................................................. Per ordinary share Earnings excluding goodwill amortisation3 ......................................... Basic earnings ........................................... Diluted earnings ........................................ Dividends .................................................. Net asset value at year end ........................ Share information US$0.50 ordinary shares in 2004 US$m 5,587 86,623 90,780 693,751 3,686 22,800 669,831 1,276,778 31,024 19,563 22,898 (6,357) 17,608 11,840 (7,301) US$ 1.25 1.09 1.07 0.66 7.75 2003 US$m 5,481 74,473 74,042 573,130 3,617 17,580 528,977 1,034,216 25,598 15,474 18,540 (6,093) 12,816 8,774 (6,532) US$ 0.99 0.84 0.83 0.60 6.79 2002 US$m 4,741 51,765 57,430 495,438 3,540 14,831 352,344 758,605 15,460 11,135 10,787 (1,321) 9,650 6,239 (5,001) US$ 0.76 0.67 0.66 0.53 5.46 2001 US$m 4,678 45,688 50,854 449,991 3,479 12,001 308,649 695,545 14,725 11,163 10,484 (2,037) 8,000 4,992 (4,467) US$ 0.63 0.54 0.53 0.48 4.88 2000 US$m 4,634 45,631 50,964 427,069 3,546 12,676 289,837 673,503 13,723 10,850 10,486 (932) 9,775 6,457 (4,010) US$ 0.80 0.74 0.73 0.435 4.92 issue (millions) ...................................... 11,172 10,960 9,481 9,355 9,268 Financial ratios Dividend payout ratio14 ............................. Post-tax return on average total assets ...... Return on average shareholders’ funds ..... Average shareholders’ funds to average total assets ............................... Capital ratios Tier 1 capital ............................................. Total capital .............................................. Foreign exchange translation rates to US$ Closing – US$1:£ ..................................... – US$1:€ ..................................... Average – US$1:£ ..................................... – US$1:€ ..................................... % 52.7 1.12 14.4 7.02 8.9 12.0 0.517 0.733 0.546 0.805 % 60.6 1.01 13.0 7.06 8.9 12.0 0.560 0.793 0.612 0.885 % 69.7 0.97 12.4 6.91 9.0 13.3 0.620 0.953 0.666 1.061 % 76.2 0.86 10.6 6.87 9.0 13.0 0.690 1.130 0.695 1.117 For the above footnotes, see ‘Footnotes to Financial Highlights’ on page 4. % 54.4 1.31 15.8 6.64 9.0 13.3 0.670 1.076 0.660 1.084 3 H S B C H O L D I N G S P L C Financial Highlights (continued) Five-year comparison (continued) Amounts in accordance with US GAAP Income statement for the year Net income available for ordinary shareholders .......................................... Other comprehensive income .................... Dividends .................................................. Balance sheet at 31 December Total assets ............................................... Shareholders’ funds .................................. Per ordinary share Basic earnings ........................................... Diluted earnings ........................................ Dividends .................................................. Net asset value at year end ........................ Footnotes to ‘Financial Highlights’ 2004 US$m 12,506 983 (6,932) 2003 US$m 7,231 7,401 (6,974) 2002 US$m 4,900 5,502 (4,632) 2001 US$m 4,911 (1,439) (4,394) 2000 US$m 6,236 (511) (3,137) 1,266,365 90,082 1,012,023 80,251 763,565 55,831 698,312 48,444 680,076 48,072 US$ 1.15 1.13 0.63 8.06 US$ 0.69 0.69 0.685 7.32 US$ 0.52 0.52 0.495 5.89 US$ 0.53 0.53 0.48 5.18 US$ 0.71 0.70 0.34 5.19 1 Operating profit before provisions and excluding goodwill amortisation can be reconciled to the equivalent reported measure by deducting goodwill amortisation of US$1,814 million (2003: US$1,450 million). 2 The profit on ordinary activities before tax and the profit attributable to shareholders excluding, in each case, goodwill amortisation, can be reconciled to the equivalent reported measures by deducting goodwill amortisation, including that attributable to joint ventures and associates, of US$1,818 million (2003: US$1,585 million). 3 Earnings excluding goodwill amortisation per ordinary share are calculated by dividing profit excluding goodwill amortisation attributable to shareholders (as explained in note 2 above) by the weighted average number of ordinary shares in issue and held outside the Group during the year, which is the same number used in the calculation of basic earnings per share on a reported basis. 4 Each ADS represents five ordinary shares. 5 Total shareholder return (‘TSR’) is defined on page 220. 6 The current TSR peer group benchmark, which is designed to reflect the Group’s geographical profile and business mix, consists of three elements weighted as follows: (i) 50 per cent is applied to a peer group of nine banks weighted by market capitalisation. The nine banks are ABN AMRO Holding N.V., Bank of America Corporation, Citigroup Inc., Deutsche Bank AG, JPMorgan Chase & Co., The Royal Bank of Scotland Group plc, Banco Santander Central Hispano SA, Standard Chartered PLC and UBS AG; (ii) 25 per cent is applied to the five largest banks from each of US, the UK, continental Europe and Asia, other than those included in (i) above, weighted by market capitalisation; (iii) 25 per cent is applied to the banking sector of the Morgan Stanley Capital International World Index (‘MCIWI’), excluding any banks included in (i) and (ii) above, weighted by market capitalisation. 7 The definition of return on invested capital and a reconciliation to the equivalent GAAP measures are set out on page 43. 8 The return on average net tangible equity is defined as attributable profit excluding goodwill amortisation of US$13,658 million (2003: US$10,359 million) divided by average shareholders’ funds after deduction of average purchased goodwill of US$53.9 billion (2003: US$42.0 billion). 9 Average net tangible equity and average tangible assets are calculated by deducting average purchased goodwill net of cumulative amortisation of US$28.2 billion (2003: US$25.4 billion). The calculation of average risk-weighted assets is the same for both the reported basis and that excluding goodwill amortisation. 10 Comprises the consumer finance business of HSBC Finance Corporation (formerly Household International, Inc.) and the US residential mortgages and credit card portfolios acquired by HSBC Bank USA, N.A. (‘HSBC Bank USA’) from HSBC Finance Corporation and its correspondents since December 2003. 11 The cost:income ratio, excluding goodwill amortisation, is defined as operating expenses excluding goodwill amortisation of US$1,814 million (2003: US$1,450 million) divided by operating income. 12 Capital resources are defined on page 174. A detailed computation for 2004 and 2003 is provided on page 177. 13 Net of suspended interest and provisions for bad and doubtful debts. 14 Dividends per share expressed as a percentage of earnings per share (excluding goodwill amortisation). 4 H S B C H O L D I N G S P L C Cautionary Statement regarding Forward-Looking Statements This Annual Report contains certain forward-looking statements with respect to the financial condition, results of operations and business of HSBC. Statements that are not historical facts, including statements about HSBC’s beliefs and expectations, are forward-looking statements. Words such as ‘expects’, ‘anticipates’, ‘intends’, ‘plans’, ‘believes’, ‘seeks’, ‘estimates’, ‘potential’, ‘reasonably possible’ and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are based on current plans, estimates and projections, and therefore undue reliance should not be placed on them. Forward-looking statements speak only as of the date they are made, and it should not be assumed that they have been revised or updated in the light of new information or future events. Written and/or oral forward-looking statements may also be made in the periodic reports to the US Securities and Exchange Commission, summary financial statements to shareholders, proxy statements, offering circulars and prospectuses, press releases and other written materials, and in oral statements made by HSBC’s Directors, officers or employees to third parties, including financial analysts. Forward-looking statements involve inherent risks and uncertainties. Readers are cautioned that a number of factors could cause actual results to differ, in some instances materially, from those anticipated or implied in any forward-looking statement. These factors include, among others: • changes in general economic conditions in the markets in which HSBC operates, such as: – – – – – changes in foreign exchange rates, in both market exchange rates (for example, between the US dollar and the pound sterling) and government-established exchange rates (for example, between the Hong Kong dollar and the US dollar); volatility in interest rates; volatility in equity markets, including in the smaller and less liquid trading markets in Asia and South America; lack of liquidity in wholesale funding markets in periods of economic or political crisis; illiquidity and downward price pressure in national real estate markets, particularly consumer-owned real estate markets; – – – – the impact of lower than expected investment returns on the burden of funding private and public sector defined benefit pensions; the effect of unexpected changes in actuarial assumptions on longevity which would influence the funding of private and public sector defined benefit pensions; continuing or deepening recessions and employment fluctuations; and consumer perception as to the continuing availability of credit, and price competition in the market segments served by HSBC. • changes in governmental policy and regulation, including: – – – – – – – the monetary, interest rate and other policies of central banks and bank and other regulatory authorities, including the UK Financial Services Authority, the Bank of England, the Hong Kong Monetary Authority, the US Federal Reserve, the European Central Bank, the People’s Bank of China and the central banks of other leading economies and markets where HSBC operates; expropriation, nationalisation, confiscation of assets and changes in legislation relating to foreign ownership; initiatives by local, state and national regulatory agencies or legislative bodies to revise the practices, pricing or responsibilities of financial institutions serving their consumer markets; changes in bankruptcy legislation in the principal markets in which HSBC operates and the consequences thereof; general changes in governmental policy that may significantly influence investor decisions in particular markets in which HSBC operates; other unfavourable political or diplomatic developments producing social instability or legal uncertainty which in turn may affect demand for HSBC’s products and services; the costs, effects and outcomes of regulatory reviews, actions or litigation, including any additional compliance requirements; 5 H S B C H O L D I N G S P L C Cautionary Statement regarding Forward-Looking Statements (continued) – – the ability of the Government of Argentina to attract international support for the measures necessary to restructure its debt obligations and create a viable financial system with stability in monetary, fiscal and exchange rate policies; and the effects of competition in the markets where HSBC operates including increased competition resulting from new types of affiliations between banks and financial services companies, including securities firms, particularly in the United States. • transition to International Financial Reporting Standards – the adoption of International Financial Reporting Standards (‘IFRS’) from 1 January 2005 is the most significant accounting development for HSBC. The European Union (‘EU’) requires that listed European companies prepare their 2005 financial statements in accordance with EU-approved IFRS. HSBC’s 2005 interim financial statements will, therefore, be prepared in accordance with IFRS. The European Union endorsement process for IFRS is ongoing but the majority of standards are now endorsed. HSBC has substantially completed its transition to IFRS. The process of refining systems and processes in order to collect data on a fully IFRS-compliant basis for 2005 reporting is well advanced. On 9 December 2004, HSBC filed with the US Securities and Exchange Commission a summary of the applicable significant differences between UK GAAP and IFRS. This should be referred to for details of the major expected IFRS effects on HSBC Group, and is available from http://www.hsbc.com/hsbc/ investor_centre/financial-results, although, as work continues and standards develop other effects may emerge. HSBC currently intends to file 2004 comparative data and the 2005 opening balance sheet on an IFRS basis in the second quarter of 2005. However, HSBC’s results for periods prior to 2004 will not be restated and its results for 2005 and subsequent years will not be comparable to these prior periods. • factors specific to HSBC: – – – the success of HSBC in adequately identifying the risks it faces, such as the incidence of loan losses or delinquency, and managing those risks (through account management, hedging and other techniques). Effective risk management depends on, among other things, HSBC’s ability through stress testing and other techniques to prepare for events that cannot be captured by the statistical models it uses; the success of HSBC in integrating the recently acquired Losango Promotora de Vendas Limitada, The Bank of Bermuda Limited and Marks and Spencer Retail Financial Services Holdings Limited; and the success of HSBC in working with Bank of Communications Limited to generate a satisfactory return from HSBC’s 19.9 per cent equity participation. 6 H S B C H O L D I N G S P L C Information about the Enforceability of Judgements made in the United States HSBC Holdings is a public limited company incorporated in England and Wales. Most of HSBC Holdings’ Directors and executive officers live outside the United States. As a result, it may not be possible to serve process on such persons or HSBC Holdings in the United States or to enforce judgements obtained in US courts against them or HSBC Holdings based on civil liability provisions of the securities laws of the United States. There is doubt as to whether English courts would enforce: • certain civil liabilities under US securities laws in original actions; or • judgements of US courts based upon these civil liability provisions. In addition, awards of punitive damages in actions brought in the United States or elsewhere may be unenforceable in the United Kingdom. The enforceability of any judgement in the United Kingdom will depend on the particular facts of the case as well as the laws and treaties in effect at the time. Exchange Controls and Other Limitations affecting Equity Security Holders There are currently no UK laws, decrees or regulations which would prevent the import or export of capital or remittance of distributable profits by way of dividends and other payments to holders of HSBC Holdings’ equity securities who are not residents of the United Kingdom. There are also no restrictions under the laws of the United Kingdom or the terms of the Memorandum and Articles of Association of HSBC Holdings concerning the right of non-resident or foreign owners to hold HSBC Holdings’ equity securities or, when entitled to vote, to do so. 7 H S B C H O L D I N G S P L C Description of Business Introduction HSBC is one of the largest banking and financial services organisations in the world, with a market capitalisation of US$190 billion at 31 December 2004. Headquartered in London, HSBC operates through long-established businesses and has an international network of over 9,800 offices in 77 countries and territories in five geographical regions: Europe; Hong Kong; the rest of Asia- Pacific, including the Middle East and Africa; North America; and South America. Within these regions, a comprehensive range of financial services is offered to personal, commercial, corporate, institutional, investment and private banking clients. HSBC manages its business through the following customer groups: Personal Financial Services; Commercial Banking; Corporate, Investment Banking and Markets; and Private Banking. Although part of Personal Financial Services, the consumer finance business originated by HSBC Finance Corporation is treated as distinct and has accordingly been separately identified. Services are delivered through businesses which usually operate as domestic banks, typically with large retail deposit bases and strong liquidity and capital ratios. In North America, HSBC Finance Corporation is one of the largest consumer finance companies in the US, and is substantially funded in the wholesale market. The establishment of HSBC and its hexagon symbol as a uniform, consumer brand name has ensured that it has become an increasingly familiar sight across the world. History and development The founding member of HSBC, The Hongkong and Shanghai Banking Corporation Limited (‘The Hongkong and Shanghai Banking Corporation’), was established in Hong Kong and Shanghai in 1865. The bank expanded rapidly, with an emphasis on building up representation in China and the rest of the Asia-Pacific region, while also establishing a presence in the major financial and trading centres in Europe and America. In the mid-1950s, The Hongkong and Shanghai Banking Corporation embarked on a strategy of pursuing profitable growth through acquisition as well as organic development – a combination that has remained a key feature of HSBC’s approach ever since. with its existing businesses with a view to maximising the synergy between the various components. Key to this integration process is the blending of local and international expertise. The most significant developments are described below. Other acquisitions in 2004 are discussed in the ‘Financial Review’ on pages 26 to 178. The Hongkong and Shanghai Banking Corporation purchased The Mercantile Bank of India Limited and The British Bank of the Middle East, now HSBC Bank Middle East Limited (‘HSBC Bank Middle East’) in 1959. In 1965, The Hongkong and Shanghai Banking Corporation acquired a 51 per cent interest (subsequently increased to 62.14 per cent) in Hang Seng Bank Limited (‘Hang Seng Bank’), consolidating its position in Hong Kong. Hang Seng Bank is the second-largest listed bank in Hong Kong by market capitalisation. The Hongkong and Shanghai Banking Corporation entered the US market in 1980 by acquiring a 51 per cent interest in Marine Midland Banks, Inc. now HSBC USA, Inc. The remaining interest was acquired in 1987. In 1981, The Hongkong and Shanghai Banking Corporation incorporated its existing Canadian operations. HSBC Bank Canada has since made numerous acquisitions, expanding rapidly to become the largest foreign-owned bank in Canada and the seventh-largest overall at 31 December 2004. From the early 1980s, The Hongkong and Shanghai Banking Corporation began to focus its acquisition strategy on the UK. In 1987, it purchased a 14.9 per cent interest in Midland Bank plc, now HSBC Bank plc (‘HSBC Bank’), one of the UK’s principal clearing banks. In 1991, HSBC Holdings plc was established as the parent company of the HSBC Group and, in 1992, it purchased the remaining interests in HSBC Bank. In connection with this acquisition, HSBC’s head office was transferred from Hong Kong to London in January 1993. In 1997, HSBC assumed selected assets, liabilities and subsidiaries of Banco Bamerindus do Brasil S.A., now HSBC Bank Brasil S.A.-Banco Múltiplo (‘HSBC Bank Brazil’) following the intervention of the Central Bank of Brazil, and in Argentina completed the acquisition of Grupo Roberts, now part of HSBC Bank Argentina S.A. (‘HSBC Bank Argentina’). As each acquisition has been made, HSBC has focused on integrating its newly acquired operations In December 1999, HSBC acquired Republic New York Corporation, subsequently merged with 8 HSBC USA, Inc., and Safra Republic Holdings S.A. In July 2004, HSBC Bank USA, Inc. merged with HSBC Bank & Trust (Delaware) N.A. to form HSBC Bank USA. To expand its base in the eurozone, in October 2000 HSBC completed its acquisition of 99.99 per cent of the issued share capital of Crédit Commercial de France S.A., now CCF S.A. (‘CCF’), a major French banking group. In 2002, HSBC made further steps in expanding its presence in North America, completing the acquisition of 99.59 per cent of Grupo Financiero Bital, S.A. de C.V. (now Grupo Financiero HSBC, S.A. de C.V. (‘HSBC Mexico’)), the fifth-largest banking group in Mexico measured by assets and the third by customer deposits. Mainland China remains a critical long-term growth area for the Group. In 2002, HSBC completed the acquisition of a 10 per cent equity stake in Ping An Insurance Company of China Limited (‘Ping An Insurance’). Ping An Insurance is the second-largest life insurer and the third-largest property and casualty insurer in mainland China. In June 2004 Ping An Insurance listed its shares through an initial public offering (‘IPO’) in Hong Kong. HSBC invested a further US$168 million, reducing its holding to 9.99 per cent. In March 2003, HSBC acquired Household International, Inc. which, in December 2004, changed its name to HSBC Finance Corporation. HSBC Finance Corporation offers HSBC national coverage in the US for consumer lending, credit cards and credit insurance through various distribution channels. Also in 2003, HSBC acquired assets in Brazil, including all the shares of Banco Lloyds TSB S.A.- Banco Múltiplo and a consumer finance company, Losango Promotora de Vendas Limitada (‘Losango’). In February 2004, the acquisition of The Bank of Bermuda Limited (‘Bank of Bermuda’) was completed for US$1.2 billion, adding a strong position in the local banking market in Bermuda and significant scale and geographical spread to HSBC’s existing international funds administration, private banking, trust and payments and cash management businesses. In May 2004, Hang Seng Bank acquired 15.98 per cent of Industrial Bank Co. Limited (‘Industrial Bank’) for US$208 million. With over 260 outlets in mainland China, Industrial Bank is one of only 10 national joint-stock banks, and had total assets of approximately US$23 billion at 31 December 2003. In June 2004, HSBC acquired 14.62 per cent of UTI Bank in India for US$68 million. With over 250 branches, UTI has the second largest retail banking network amongst Indian private sector banks. In August 2004, HSBC completed the largest single equity investment in a mainland China bank by a foreign bank when it acquired 19.9 per cent of Bank of Communications Limited (‘Bank of Communications’) for US$1,747 million. Bank of Communications is mainland China’s fifth largest bank, with assets of US$112 billion and approximately 2,700 branches in 137 cities in mainland China as at 31 December 2003. In November 2004, HSBC completed the acquisition of 100 per cent of Marks and Spencer Retail Financial Services Holdings Limited, which trades as Marks and Spencer Money (‘M&S Money’) for US$1,044 million, M&S Money is one of the UK’s top 10 credit card providers. Outlook In 2005, the Group expects consumer spending growth to slow across much of the Western world, bringing increased competition and pricing pressure on available business. The slowdown in consumer spending is expected to be reflected in a heightened focus on efficiency and economies of scale in the corporate sector, which may trigger increased merger and acquisition activity, a trend already evident in 2005. The pressure to reinforce personal long-term savings and tighten fiscal discipline, as government responsibility for pension and healthcare programmes is clarified, are likely to contribute to slower consumer spending in the western world. By contrast, in emerging markets such as Brazil, Mexico, India and the Association of South East Asian Nations (‘ASEAN’) countries, relatively stable currencies and historically low interest rates are expected to continue to promote consumer activity, fuelling domestic growth and reducing export dependence. Mainland China is expected to continue to play an increasingly important role, not only through its burgeoning exports, but also as a major and growing market for commodity producing countries and for those developed countries that are supplying the technology, equipment and services to support its economic expansion. The Group is alive to the changing nature of the global economy and the accelerating pace of change, and monitors the impact on sentiment and consumer spending of strong domestic property prices, which in many markets are proving resilient to rising interest rates. While such resilience is understandable in the context of historically low 9 H S B C H O L D I N G S P L C Description of Business (continued) nominal interest rates and a generally limited appetite for alternative investment opportunities, in the long run property prices reflect income growth and, therefore, a correction in some markets cannot be discounted. Against this backdrop, HSBC expects to focus on building its businesses where it has comparative advantage. HSBC also expects its lending to consumers around the world to continue to rise as a proportion of total lending, partly reflecting domestic growth trends and credit demand in emerging markets, but also in response to the introduction of its US consumer finance model, with its emphasis on real estate secured lending and its scale advantages in credit card lending, to new geographical markets. In North America, HSBC expects its business to grow as the US economy demonstrates its flexibility and responds to the lower value of the dollar. Strategy At the end of 2003, HSBC launched ‘Managing for Growth’, a strategic plan that provides HSBC with a blueprint for growth and development during the next five years. The strategy is evolutionary, not revolutionary. It builds on HSBC’s strengths and it addresses the areas where further improvement is considered both desirable and attainable. Management’s vision for the Group remains consistent: HSBC aims to be the world’s leading financial services company. In this context, ‘leading’ means preferred, admired and dynamic, and being recognised for giving the customer a fair deal. HSBC will strive to secure and maintain a leading position within each of its customer groups in selected markets. HSBC will concentrate on growing earnings over the long term at a rate which will place it favourably when compared with its peer group. It will also focus on investing in its delivery platforms, its technology, its people and its brand to support the future value of HSBC as reflected in its comparative stock market rating and total shareholder return (‘TSR’). HSBC remains committed to benchmarking its performance by comparison with a peer group. For full details of the benchmark, see footnote 6 in the ‘Footnotes to Financial Highlights’ on page 4. HSBC’s core values are integral to its strategy, and communicating them to customers, shareholders and employees is intrinsic to the plan. These values comprise an emphasis on long-term, ethical client relationships; high productivity through teamwork; a confident and ambitious sense of excellence; being 10 international in outlook and character; prudence; creativity and customer focused marketing. The plan also reaffirms HSBC’s recognition of its corporate social responsibility (‘CSR’). HSBC has always aspired to the highest standards of conduct, recognises its wider obligations to society and believes there is a strong link between CSR and long-term success. Moreover, the pressures to comply with public expectations across a wide spectrum of social, ethical and environmental issues are growing rapidly. The strategy therefore calls for a renewed emphasis on CSR and for increased external communication of the Group’s CSR policies and performance, particularly on education and the environment, which will remain the principal beneficiaries of HSBC’s philanthropic activities. HSBC’s new plan is led by customer groups, and specific strategies will be implemented for each of them. HSBC believes that by organising its internal and external reporting around customer groups, it reinforces to all its employees the Group’s customer focus. The acquisition of HSBC Finance Corporation in 2003, and subsequent skills sharing and technology transfer, have highlighted the importance within Personal Financial Services of a distinct customer group, Consumer Finance, to augment HSBC’s existing activities. HSBC’s other customer groups are Commercial Banking; Corporate, Investment Banking and Markets; and Private Banking. Key elements in achieving HSBC’s objectives for its customer groups will be accelerating the rate of growth of revenue; developing the brand strategy further; improving productivity; and maintaining the Group’s prudent risk management and strong financial position. Developing the skills of HSBC’s staff will also be critical and it will be necessary to ensure that all employees understand how they can contribute to the successful achievement of the Group’s objectives. Employees who do make such a contribution will be rewarded accordingly. Operational management will continue to be organised geographically under four regional intermediate head offices, with business activities concentrated in locations where growth and critical mass are to be found. The plan contains eight strategic imperatives: • Brand: make HSBC and its hexagon symbol one of the world’s leading brands for customer experience and corporate social responsibility; • Personal Financial Services: drive growth in key markets and through appropriate channels to make HSBC the strongest global player in personal financial services; • Consumer Finance: extend the reach of this business to existing customers through a wider product range and penetrate new markets; • Commercial Banking: make the most of HSBC’s international customer base through effective relationship management and improved product offerings in all the Group’s markets; • Corporate, Investment Banking and Markets: accelerate growth by enhancing capital markets and advisory capabilities focused on client service in defined sectors where HSBC has critical relevance and strength; • Private Banking: serve the Group’s highest value personal clients around the world; • People: attract, develop and motivate HSBC’s people, rewarding success and rejecting mediocrity; and • TSR: fulfil HSBC’s TSR target by achieving strong competitive performances in earnings per share growth and efficiency. Employees and management At 31 December 2004, HSBC’s customers were served by 253,000 employees (including part-time employees) worldwide, compared with 232,000 at 31 December 2003 and 192,000 at 31 December 2002. The main centres of employment are the UK with 56,000 employees, the US 43,000, Brazil 28,000, Hong Kong 26,000, Mexico 20,000 and France 14,000. HSBC negotiates with recognised unions, and estimates that approximately 40 per cent of its employees are unionised. The highest concentrations of union membership are in Brazil, France, India, Malaysia, Malta, Mexico, the Philippines, Singapore and the UK. As a result of well-developed communications and consultation programmes, HSBC has not experienced any material disruptions to its operations from labour disputes during the past five years. In support of its new strategy, HSBC focuses on attracting, developing and motivating the very best individuals, particularly graduates, and on encouraging talent internally. Emphasis is placed on performance management; differentiated rewards; succession planning; diversity; and learning and development, with priority accorded to enhancing sales and relationship management skills. HSBC continues to endeavour to ensure that employees’ engagement with the business is maximised as this is beneficial to shareholders, employees and customers alike. HSBC’s diverse workforce represents a significant competitive advantage. The broad cultural mix and increasing cross-border mobility of its employees enables HSBC to resource operations with individuals who have detailed knowledge of local markets and of HSBC globally. This strengthens international networks and facilitates the sharing of best practices. In addition, a continuing focus on policies that encourage an inclusive working environment and the availability of career opportunities for all is critical to HSBC being an employer of choice. HSBC seeks to maintain an employee profile that reflects its customer base. HSBC operates in a highly competitive and international business environment. Through its network of international operations, it has the advantage of being able to respond to the availability of talented employees wherever they are, in order to enhance customer service and improve productivity. As education levels improve globally and as investments in technology and telecommunications facilitate access at competitive cost to hitherto untapped resources, the balance of employment will change and global resource centres of excellence will emerge. Job losses may arise in some countries, but HSBC has a good record of communicating openly and sensitively in these circumstances, and of reassigning employees and minimising compulsory redundancies wherever possible. HSBC seeks to promote and recruit the most able people and attaches great importance to cultivating its own talent. Resources have been set aside to ensure a supply of talented individuals to meet business succession needs, with support provided for these employees in the form of career enhancement and personal development programmes. In addition, HSBC recognises that there are lessons to be learned from other successful businesses, and will recruit from non-banking industries where appropriate. 11 H S B C H O L D I N G S P L C Description of Business (continued) Customer Groups Profit before tax by customer group (reported basis) Year ended 31 December 2004 6,000 5,000 4,000 3,000 2,000 1,000 0 5,020 4,837 3,895 3,148 384 324 US$ million Personal Financial Services Consumer Finance Commercial Banking Corporate, Investment Banking and Markets Private Banking Other Total assets1 by customer group Year ended 31 December 2004 Corporate, Investment Banking and Markets % 46.1 Personal Financial Services 21.7 Consumer Finance Commercial Banking Private Banking Other 12.9 12.7 4.5 2.1 1 Excludes Hong Kong Government certificates of indebtedness. Personal Financial Services Personal Financial Services provides some 41 million individual and self-employed customers with a wide range of banking and related financial services. The precise nature of the products and services provided is, to some extent, driven by local regulations, market practices, and the market positioning of HSBC’s local business. Typically, products provided include current and savings accounts, mortgages and secured and unsecured personal loans, credit cards, and local payments services. Personal Financial Services customers prefer to conduct their financial business at times convenient to them, using a range of delivery channels. The availability of a number of such channels, including traditional and automated branches and service centres, self-service terminals, call centres and internet capabilities, facilitates the exercise of choice increasingly effectively. Delivering the right products and service 12 propositions for particular target markets is a fundamental requirement in any retail service business, and market research and customer analysis is key to developing an in-depth understanding of significant customer segments and their needs. This understanding of the customer ensures that Customer Relationship Management (‘CRM’) systems are effectively used to identify and fulfil sales opportunities, and to manage the sales process. HSBC Premier is a premium banking proposition for HSBC’s more valuable retail customers. HSBC Premier provides personalised relationship management, 24-hour priority telephone access, global travel assistance and cheque encashment facilities. There are now over one million HSBC Premier customers, who can use more than 250 specially designated Premier branches and centres in 33 countries and territories, either when visiting, or on a more permanent basis if they require a banking relationship in more than one country. Insurance and investment products play an important need in meeting the requirements of customers. Insurance products sold and distributed by HSBC through its branch networks include loan and health protection life, property, casualty and health insurance, and pensions. HSBC acts both as a broker and an underwriter, and sees continuing opportunities to deliver insurance products to its personal customer base. HSBC also makes available a wide range of investment products through its branch networks. Third party funds and proprietary funds are available, and include traditional ‘long only’ equity and bond funds, structured funds that provide capital security as well as an opportunity for enhanced return, and ‘fund of funds’ products which offer customers the ability to diversify their investment across a range of best in class fund managers selected through a rigorous and objective selection process. Comprehensive financial planning services covering customers’ investment; retirement, personal and asset protection needs are offered through specialist financial planning managers. High net worth individuals and their families who choose the differentiated services offered within Private Banking are not included in this customer group. Consumer Finance Within Personal Financial Services, HSBC Finance Corporation’s operations in the US, the UK and Canada make credit available to customer groups not well catered for by traditional banking operations, facilitate point-of-sale credit in support of retail purchases and support major affiliate credit card programmes. At 31 December 2004 HSBC Finance Corporation had over 57 million customers with total gross advances of US$141.9 billion. Consumer Finance products are offered through the following businesses of HSBC Finance Corporation: The consumer lending business is one of the largest sub-prime home equity originators in the US, marketed under the HFC and Beneficial brand names through a network of over 1,300 branches in 46 states, direct mail, telemarketing, strategic alliances and the internet. ‘Sub-prime’ is a US categorisation which describes customers who have limited credit histories, modest incomes, high debt-to-income ratios, high loan-to-value ratios (for real estate secured products) or have experienced credit problems caused by occasional delinquencies, prior charge-offs, bankruptcy or other credit-related actions. Consumer lending products include secured and unsecured loans such as first and second lien closed-end mortgages, open-ended home equity loans, personal loans and retail finance contracts. Consumer lending also offers a near-prime mortgage product which was first introduced in 2003 to broaden the range of customers to which its products are relevant. The mortgage services business purchases first and second lien residential mortgage loans, including open-end home equity loans, from a network of over 200 unaffiliated third party lenders (‘correspondents’) in the US. Purchases are primarily of pools of loans (‘bulk acquisitions’), but also include individual loan portfolios (‘flow acquisitions’), made under predetermined underwriting guidelines. Forward commitments are offered to selected correspondents to strengthen relationships and create a sustainable growth channel for this business. HSBC Finance Corporation, through its subsidiary, Decision One Mortgage Company, also offers mortgage loans referred by mortgage brokers. The retail services business is one of the largest providers of third party private label credit cards (or store cards) in the US based on receivables outstanding, with over 70 merchant relationships and 15.5 million active customer accounts. In addition to originating and refinancing motor vehicle loans, HSBC Finance Corporation’s motor vehicle finance business purchases retail instalment contracts of US customers who do not have access to traditional prime-based lending sources. The loans are largely sourced from a network of approximately 5,200 motor dealers. The credit card services business is the sixth largest issuer of MasterCard®1 and Visa®1 credit cards in the US, and also includes affiliation cards such as the GM Card® and the AFL-CIO Union Plus®2 credit card. Also, credit cards issued in the name of Household Bank and Orchard Bank brands are offered to customers under-served by traditional providers, or are marketed primarily through merchant relationships established by the retail services business. A wide range of insurance services is offered by HSBC Finance Corporation to customers in the US, the UK and Canada who are typically not well served by traditional sources. The taxpayer financial services business accelerates access to funds for US taxpayers who are entitled to tax refunds. The business is seasonal with most revenues generated in the first three months of the year. HSBC Finance Corporation’s business in the UK provides mid-market consumers with mortgages, secured and unsecured loans, insurance products, credit cards and retail finance products. It concentrates on customer service through its 216 HFC Bank and Beneficial branches, and finances consumer electronic goods, through its retail finance operations. In Canada, similar products are offered, and deposits are taken, through HSBC Finance Corporation’s trust operations there. Commercial Banking HSBC is one of the world’s leading banks in the provision of financial services and products to small, medium-sized and middle market businesses, with over two million customers including sole proprietors, partnerships, clubs and associations, incorporated businesses and publicly quoted companies. At 31 December 2004, HSBC had total commercial customer account balances of US$137.8 billion and total commercial customer loans and advances, net of suspended interest and provisions for bad and doubtful debts, of US$129.9 billion. Commercial Banking places particular emphasis on multi-disciplinary and geographical collaboration in meeting its commercial customers’ needs, thereby 1 Visa is a registered trademark of VISA USA, Inc.and MasterCard is a registered trademark of MasterCard International, Incorporated. 2 The Union Plus MasterCard and Visa credit card programme is an affinity arrangement with Union Privilege under which credit cards are offered to members of unions affiliated with the American Federation of Labor and Congress of Industrial Organizations (‘AFL-CIO’). 13 H S B C H O L D I N G S P L C Description of Business (continued) differentiating, broadening and enhancing its offering. The range of products includes: Payments and cash management: HSBC is a leading provider of payments, collections, liquidity management and account services worldwide, enabling commercial customers to manage their cash efficiently on a global basis. HSBC’s extensive network of offices and strong domestic capabilities in many countries, including direct access to local clearing systems, enhance its ability to provide high- quality cash management services. Treasury and capital markets: Commercial Banking customers have long been volume users of the Group’s foreign exchange capabilities. These are now being supplemented with more sophisticated currency and interest rate options. Investment banking: A small number of Commercial Banking customers need occasional investment banking advisory support. Co-operation with Corporate, Investment Banking and Markets ensures that in most key markets such requirements can be serviced internally. Wealth management services: These include advice and products related to savings and investments. They are provided to Commercial Banking customers and their employees through HSBC’s worldwide network of branches and business banking centres. Insurance: HSBC offers insurance protection, employee benefits programmes and pension schemes designed to meet the needs of businesses and their employees, and to help fulfill the applicable statutory obligations of client companies. These products are provided by HSBC either as an intermediary (broker, agent or consultant) or as a supplier of in-house or third party offerings. Products and services include a full range of commercial insurance, including pension schemes; healthcare schemes; ‘key man’ life insurance; car fleet; goods in transit; trade credit protection; risk management and insurance due diligence reviews; and actuarial/employee benefit consultancy. Trade services: HSBC has more than 130 years of experience in trade services. A complete range of traditional documentary credit, collections and financing products is offered, as well as specialised services such as insured export finance, international factoring and forfaiting. HSBC’s expertise is supported by highly automated systems. Leasing, finance and factoring: HSBC provides leasing, finance (including instalment and invoice finance) and domestic factoring services, 14 primarily to commercial customers in the UK, Hong Kong and France. Special divisions have been established to finance vehicles, plant and equipment, materials handling, machinery and large complex leases. Corporate, Investment Banking and Markets HSBC’s Corporate, Investment Banking and Markets business provides tailored financial solutions to major government, corporate and institutional clients worldwide. Managed as a global business, this customer group operates a long-term relationship management approach to build a full understanding of clients’ financial requirements. Sectoral client service teams comprising relationship managers and product specialists develop financial solutions to meet individual client needs. With dedicated offices in over 50 countries and with access to HSBC’s worldwide presence and capabilities, this business serves subsidiaries and offices of its clients on a global basis. Products and services offered include: Global Markets: HSBC’s operations in Global Markets consist of treasury and capital markets services for supranationals, central banks, corporations, institutional and private investors, financial institutions and other market participants. Products include: • • • • • • foreign exchange; currency, interest rate, bond, credit, equity and other specialised derivatives; government and non-government fixed income and money market instruments; precious metals and exchange traded futures; equity services, including research, sales and trading for institutional, corporate and private clients and asset management services, including global investment advisory and fund management services; and distribution of capital markets instruments, including debt, equity and structured products, utilising links with HSBC’s global networks. Global Transaction Banking: This includes international, regional and ‘in-country’ payments and cash management services; trade services, particularly the specialised ‘supply chain’ product; and securities services, where HSBC is one of the world’s leading custodians providing custody and clearing services and funds administration to both domestic and cross-border investors. Factoring and banknotes services are also provided by specialist units. Corporate and Institutional Banking: This includes: • • • • • • • direct lending, including structured finance for complex investment facilities; leasing finance with an emphasis on ‘large ticket’ transactions; and deposit-taking. Global Investment Banking: This comprises: capital raising, both publicly and privately, including debt and equity capital, structured finance and syndicated finance; corporate finance and advisory services for mergers and acquisitions, asset disposals, stock exchange listings, privatisations and capital restructurings; project and export finance services providing non-recourse finance to exporters, importers and financial institutions, and working closely with all major export credit agencies; and financing and risk advisory services. Group Investment Businesses: These comprise asset management products and services for institutional investors, intermediaries and individual investors and their advisers. Private Banking HSBC is one of the world’s leading international private banking groups with total client funds under management of US$178 billion at 31 December 2004. 2004 was the first year in which the name ‘HSBC Private Bank’ was used for worldwide marketing of its principal private banking business. Drawing on the strength of the HSBC Group and utilising the best products from the marketplace, Private Banking works with its clients to offer both traditional and innovative ways to manage and preserve wealth whilst optimising returns. Products and services offered include: Investment services: These comprise both advisory and discretionary investment services. A wide range of investment vehicles is covered, including bonds, equities, derivatives, structured products, mutual funds and hedge funds. Supported by six major advisory centres in Hong Kong, Singapore, Geneva, New York, Paris and London, Private Banking seeks to select the most suitable investments for clients’ needs and investment strategies. Global wealth solutions: These comprise inheritance planning, trustee and other fiduciary services designed to protect existing wealth and create tailored structures to preserve wealth for future generations. Areas of expertise include trusts, foundations, charitable trusts, private investment companies, insurance vehicles and offshore structures. Specialist advisory services: Private Banking offers expertise in several specialist areas of wealth management including tax advisory, family office advisory, charities and foundations, media, diamonds and jewellery, and real estate. Specialist advisers are available to deliver products and services that are tailored to meet the full range of high net worth clients’ individual financial needs. General banking services: These are the ancillary services necessary for the management of clients’ finances. They include treasury and foreign exchange, offshore and onshore deposits, tailor-made loans and internet banking. The skills and products available in HSBC’s other customer groups, such as corporate banking, investment banking and insurance, are also offered to Private Banking clients. Private Banking services are also provided by HSBC Guyerzeller and HSBC Trinkaus & Burkhardt. Geographical Regions Profit before tax split by geographical region (reported basis) Year ended 31 December 2004 6,000 5,000 4,000 3,000 2,000 1,000 0 5,225 4,744 5,419 1,805 US$ million 415 Europe Rest of Asia-Pacific South America Hong Kong North America 15 H S B C H O L D I N G S P L C Description of Business (continued) Total assets1 split by geographical region As at 31 December 2004 Europe Hong Kong Rest of Asia-Pacific North America South America % 42.6 17.2 9.5 29.3 1.4 1 Excludes Hong Kong Government certificates of indebtedness. Additional information regarding business developments in 2004, as well as comparative information relating to developments in 2003, may be found in the ‘Financial Review’ on pages 26 to 178. Europe HSBC’s principal banking operations in Europe are HSBC Bank, CCF and HSBC Private Bank (Suisse). HSBC provides a wide range of banking, treasury and financial services to personal, commercial and corporate customers in the UK, France, and across continental Europe, with strong coverage in Turkey and Malta. HSBC’s strategy is to build long-term relationships, attracting customers through value-for- money products and high-quality service. Hong Kong HSBC’s principal banking subsidiaries in Hong Kong are The Hongkong and Shanghai Banking Corporation and Hang Seng Bank. The Hongkong and Shanghai Banking Corporation is the largest bank incorporated in Hong Kong and is HSBC’s flagship bank in the Asia-Pacific region. It is one of Hong Kong’s three note-issuing banks, accounting for more than 63 per cent by value of banknotes in circulation in 2004. Rest of Asia-Pacific (including the Middle East) The Hongkong and Shanghai Banking Corporation offers personal, commercial, corporate and investment banking and markets services in mainland China. The bank’s network spans 12 major cities, comprising ten branches, three sub-branches and two representative offices. Hang Seng Bank offers personal and commercial banking services and operates five branches, two sub-branches, and two representative offices in seven cities in mainland China. 16 Outside Hong Kong and mainland China, the HSBC Group conducts business in the Asia-Pacific region primarily through branches and subsidiaries of The Hongkong and Shanghai Banking Corporation, with particularly strong coverage in India, Indonesia, Korea, Singapore and Taiwan. HSBC’s presence in the Middle East is led by HSBC Bank Middle East, the largest foreign-owned bank in the region; in Australia by HSBC Bank Australia Limited; and in Malaysia by HSBC Bank Malaysia, which has the second largest presence of any foreign-owned bank in the country. North America HSBC’s North American business covers the United States, Canada, Mexico, Bermuda and Panama. Operations are primarily conducted in the US through HSBC Bank USA in New York State and HSBC Finance Corporation, based outside Chicago. HSBC’s Canadian and Mexican operations are run through HSBC Bank Canada and HSBC Mexico, respectively. South America HSBC’s operations in South America principally comprise HSBC Bank Brazil and HSBC Bank Argentina. HSBC operates the tenth largest insurance business in Brazil, and offers consumer finance products there through its subsidiary, Losango. HSBC also has one of the largest insurance businesses in Argentina, HSBC La Buenos Aires and, through HSBC Máxima and HSBC New York Life, offers pensions and life assurance in Argentina. Competitive environment HSBC faces strong competition in all the markets it serves. It competes with other financial institutions, including commercial banks; consumer finance companies; savings and loan associations; credit unions; retailers; brokerage firms; and investment companies. In investment banking, HSBC faces competition from both investment banks and the investment banking operations of other commercial banks. Global factors Consolidation in the banking industry: Consolidation of banks and financial services companies has been a continuing trend over many years. This trend, at both local and international levels, has created a larger number of banks, financial services companies and mono-line providers capable of competing directly with HSBC across a wide range of services. Limited market growth: In HSBC’s largest markets, the UK, the US and Hong Kong, there is generally limited capacity for market growth in the provision of basic banking services. However, there is potential for growth in the provision of a wider array of financial services to both existing and new customers, and for expansion into new market and customer segments, particularly in the field of consumer finance. Advances in technology: As the internet and related technologies has continued to mature, the delivery of financial services and banking products through both remote and automated delivery channels has introduced both new competitive challenges and opportunities for HSBC. While specialist providers and non-financial organisations can deliver a growing range of services across a wide variety of electronic channels, mainstream banks are also competing fiercely for the growing number of customers who now prefer to use this medium. As these technologies mature, brand differentiation becomes more difficult and costly. HSBC continues to offer customers access to its full range of services in the manner they most prefer. Internet, interactive TV, mobile phone, WAP and telephone banking all complement the more traditional branch network. Regional factors Europe UK While overall market growth has remained relatively limited the continuing demand for consumer credit in the past few years has intensified competition among the established players and attracted a number of new entrants, particularly from non financial services providers. Competition from mono-line providers of both consumer lending and savings products has grown in recent years often through the use of attractive pricing to capture market share. Consolidation in the market for credit and charge cards has increased in recent years as retailers look to outsource their finance company operations to established players rather than running them in- house. This has led to a greater concentration of the industry in the hands of a relatively small number of providers and attracted the attention of the Office of Fair Trading (‘OFT’). In March the OFT referred the supply of store card services to the Competition Commission following a study of the £4.8 billion industry. The study concluded that there were features of the sector, both in the supply of store card credit to consumers and in the supply of store card services, that appeared to prevent, restrict or distort competition. The Competition Commission, which published its initial statement of issues in September, is expected to provide provisional findings in the first quarter of 2005 and publish its final report by early July. In November, the OFT issued a statement of objections against the agreement between Mastercard’s UK members, which includes HSBC Bank, on the multilateral interchange fees charged on credit and charge card transactions in the UK. The statement alleged that parties to the agreement have infringed competition law and invites representations from members before the OFT makes a final decision. In mid December the Department of Trade and Industry announced a new Consumer Credit Bill which seeks to create a clearer and more competitive market for credit by bringing in new rules to give consumers better protection and more rights. France The French government reformed the pension system in France in order to reduce the state’s long- term pension obligations. Retirement ages were increased and pension entitlements lowered. The changes are being introduced over a number of years to allow people to adapt to the new system. To encourage people to save for their retirement, the government has introduced both individual and collective pension plans with tax advantages for scheme members. With clarification of the rules at the start of 2005, these plans are now being marketed by financial institutions in France. HSBC will earn commissions on the sales of the pension plans and earn management fees from managing the funds. The government also created Fonds de Reserve pour les Retraites, a pension body for state employees, and sought tenders for management of €16bn of funds. HSBC Asset Management Europe SA won two of the tenders to manage €1.2 billion of assets for a small caps fund and a bonds fund. Caixa Bank won its case at the European Court of Justice against the French government on the law forbidding banks from paying interest on current accounts. As a result, the law will be withdrawn in 2005, allowing French banks to pay interest on these accounts. Major banks are examining the implications of the ruling. The European Commission is investigating GIE 17 H S B C H O L D I N G S P L C Description of Business (continued) Cartes Bancaire, the partnership operating the credit card system in France, and nine participating banks. Although a member of the GIE, CCF is not currently under investigation. Following a French government review of banking charges, banks adopted a new code of practice whereby they both stopped charging for the closure of accounts and became generally more transparent in the pricing of their services. CCF already notifies customers of its tariffs and the introduction of this code is expected to have little effect. Hong Kong The Hong Kong economy in 2004 continued the strong growth seen in the second half of 2003, driven by regional trade flows, and the strength of the US economic recovery. This resulted in falling unemployment and bankruptcies, and rising property prices, contributing to an increase in private consumption. Other than in the trade sector, however, demand for credit remained muted, with individuals and enterprises slow to increase borrowings, reflecting nervousness about the sustainability of the economic recovery. Interest rates in the economy remained low, as with loan demand subdued, the market was unable to absorb external funds. Against this backdrop, there was fierce competition in traditional core banking products, particularly in the mortgage market, further depressing margins and prices. To address these pressures, banks have sought to diversify revenue streams, and there has been significant growth in the development of wealth management and insurance products. The introduction of a commercial credit reference agency in November 2004, is expected to further intensify competition for quality customers and assets. Hong Kong banks continue to maintain a regular dialogue with Chinese financial institutions as the financial sector continues to liberalise ahead of WTO in 2006. It is expected that this will be a continued source of growth in 2005. Rest of Asia-Pacific (including the Middle East) The competitive environment in the Rest of Asia Pacific varies greatly across the region. Depending 18 on the maturity of the markets, level of regulation and number of financial services providers, HSBC competes with a range of local banks, non-bank financial services companies, and the branches of foreign entities. An emerging trend in recent years has been the growth of pan-regional players, as the larger banks in several countries have expanded through acquisition and organic growth beyond their local markets. These emerging regional banks provide a new level of competition for HSBC as they build critical mass. Competition, therefore, remains intense throughout the region in all the customer groups served by HSBC. However, in many countries the increasing sophistication of the relatively young population continues to provide HSBC with further opportunities for growth. North America In the US, continuing mergers and acquisitions in the banking, insurance and securities industries are bringing consolidation and a blending of services. Consolidation of the banking sector remained an issue throughout 2004, with a greater focus on national networks and retail branch banking. HSBC Bank USA also faced vigorous competition from a large number of non-bank suppliers of financial services, which have found new and effective ways to meet the financial demands of customers. Many of these institutions are not subject to the same laws and regulations imposed on HSBC Bank USA. These continuing trends will increase competitive pressures. HSBC Finance Corporation competes with a wide array of banks, thrifts, insurance companies, credit unions, mortgage lenders and brokers and other providers of consumer credit for consumers who generally do not conform to US banking industry requirements. It competes by expanding its customer base through portfolio acquisitions or alliance and co-branding opportunities, by offering a variety of consumer loan products and by maintaining a strong service orientation. In Canada, the financial services industry continues to be dominated by the five largest banks in the country. However, the market remains highly competitive as other banks, insurance companies and financial institutions offer a range of comparable products and services. While merger activity among the largest banks in Canada remains a possibility, major financial institutions continue to look elsewhere for growth. Consolidation of the banking industry in Mexico has been a significant feature in recent years with over 76 per cent of banking assets and 79 per cent of deposits owned by the subsidiaries of five major foreign banks. However, with a population of approximately 100 million, the majority of whom do not use the banking system, Mexico offers substantial growth opportunities in the retail sector in the medium to long term. HSBC, with its extensive branch network and growing young customer base, is well positioned to take full advantage of this economic and competitive environment. South America The Brazilian banking industry remains dominated by a combination of large state-owned banks, privately-owned local banks, and subsidiaries of foreign institutions, including HSBC. The top ten banking groups account for around two thirds of total financial system assets. Although 2004 saw little consolidation among the larger players, the year was characterised by continued positioning for growth in the consumer finance market. Lending to individuals grew by a third in 2004, and demand is expected to remain strong over the medium term, supported by a more buoyant economy. With a population of 183 million, and over 45 per cent of the economically active population estimated to be ‘unbanked’, banks are looking to increase their capacity to reach non- traditional segments, particularly through partnerships with retailers. HSBC Bank Brazil is at the forefront of this trend. There was strong competition among banks to agree alignments with retail stores, particularly those with their own in-house financing arrangements. HSBC experienced success in this area concluding an agreement with Panashop, a major electronic and white goods supplier. Competition increased in this sector with competitors developing new, individually branded consumer finance propositions. Following the successful integration of Losango, HSBC Bank Brazil continued to expand and develop its leading position in the store and personal loan market through the acquisition of the Valeu and CrediMatone franchises. Following the collapse of a medium sized Brazilian commercial bank, there was a flight to quality and smaller banks experienced increasing difficulties in funding their asset growth. There was a spate of alliances involving small banks, and HSBC boosted its presence in the payroll loan market through a partnership with Banco Schahin, announced in December 2004. Whilst the environment is expected to remain competitive, HSBC’s extensive network of branches and partner stores, and continuous investment in branding and service quality, will ensure that the Group is able to benefit from growth in the demand for financial services. In Argentina, international financial groups provide the greatest competition in core banking services and insurance, with most of the major banks in significant foreign ownership. HSBC, with its branch network, sales force and substantial local insurance business, is one of the few companies capable of providing a comprehensive range of financial services to its clients. Since the crisis in 2001, Argentina’s banking industry has consolidated with some institutions, generally smaller banks, leaving the country and a number of the larger foreign-owned financial institutions re-capitalising their local operations. As confidence has begun to return, the financial sector has seen growth in loans to the private sector and deposits. The insurance industry has also recovered, with a significant increase in premiums that has helped the industry to become profitable for the first time in a number of years. HSBC continues to monitor progress being made with the economic and political reforms necessary to build confidence in Argentina, and evaluates carefully the opportunities and risks within the financial services industry there. 19 H S B C H O L D I N G S P L C Governance, Regulation and Supervision Governance With the listings of its ordinary shares in London, Hong Kong, New York, Paris and Bermuda, HSBC Holdings complies with the relevant requirements for listing and trading on each of these exchanges. In the UK, these are the Listing Rules of the Financial Services Authority; in Hong Kong, The Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited; in the US, where the shares are traded in the form of ADS’s, HSBC Holdings’ shares are registered with the US Securities and Exchange Commission and it is subject to the reporting and other requirements of the US Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and the New York Stock Exchange’s Listed Company Manual, in each case as applied to foreign private issuers. In France and Bermuda HSBC Holdings is subject to the listing rules of Euronext, Paris and the Bermuda Stock Exchange applicable to companies with secondary listings. A statement of HSBC’s compliance with the code provisions of the Combined Code on corporate governance appended to the Listing Rules of the Financial Services Authority and with the provisions of Appendix 14 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited is set out in the Report of the Directors. Regulation and Supervision HSBC’s operations throughout the world are regulated and supervised by approximately 467 different central banks and regulatory authorities in those jurisdictions in which HSBC has offices, branches or subsidiaries. HSBC estimates the cost of this regulation and supervision to be approximately US$500 million in 2004. These authorities impose a variety of requirements and controls covering, inter alia, capital adequacy, depositor protection, market liquidity, governance standards, customer protection (for example, fair lending practices, product design, and marketing and documentation standards), and social responsibility obligations (for example, anti- money laundering and anti-terrorist financing measures). In addition, a number of countries in which HSBC operates impose rules that affect, or place limitations on, foreign or foreign-owned or controlled banks and financial institutions. The rules include restrictions on the opening of local offices, branches or subsidiaries and the types of banking and non-banking activities that may be conducted by those local offices, branches or subsidiaries; restrictions on the acquisition of local banks or regulations requiring a specified percentage of local ownership; and restrictions on investment and other 20 financial flows entering or leaving the country. The supervisory and regulatory regimes of the countries where HSBC operates will determine to some degree HSBC’s ability to expand into new markets, the services and products that HSBC will be able to offer in those markets and how HSBC structures specific operations. The Financial Services Authority (‘FSA’) supervises HSBC on a consolidated basis. In addition, each operating bank, finance company or insurance operation within HSBC is regulated by local supervisors. The primary regulatory authorities are those in the UK, Hong Kong and the US, the Group’s principal areas of operation. In June 2004, the Basel Committee on Banking Supervision issued a new capital adequacy framework to replace the Basel Accord of 1988 in the form of a final Accord (commonly known as ‘Basel II’). Details of how this will affect HSBC are set out on page 175. United Kingdom regulation and supervision UK banking and financial services institutions are subject to multiple regulations. The primary UK statute is the Financial Services and Markets Act 2000 (‘FSMA’). Other UK primary and secondary banking legislation is derived from European Union (‘EU’) directives relating to banking, securities, investment and sales of personal financial services. The FSA is responsible for authorising and supervising UK financial services institutions and regulates all HSBC’s businesses in the UK which require authorisation under FSMA. This ranges from retail life and pensions business to custody, branch share dealing, and treasury and capital markets activity. In addition, from 31 October 2004 and 14 January 2005 respectively, mortgage business and general insurance business became regulated activities. HSBC Bank is HSBC’s principal authorised institution in the UK. FSA rules establish the minimum criteria for authorisation for banks and financial services businesses in the UK. They also set out reporting (and, as applicable, consent) requirements with regard to large individual exposures and large exposures to related borrowers. In its capacity as supervisor of HSBC on a consolidated basis, the FSA receives information on the capital adequacy of, and sets requirements for, HSBC as a whole. Further details on capital measurement are included in ‘Capital Management’ on pages 176 to 177. The FSA has the right to object, on prudential grounds, to persons who hold, or intend to hold, 10 per cent or more of the voting power of a financial institution. The regulatory framework of the UK financial services system has traditionally been based on co-operation between the FSA and authorised institutions. The FSA monitors authorised institutions through ongoing supervision and the review of routine and ad hoc reports relating to financial and prudential matters. The FSA may periodically obtain independent reports, usually from the auditors of the authorised institution, as to the adequacy of internal control procedures and systems as well as procedures and systems governing records and accounting. The FSA meets regularly with HSBC’s senior executives to discuss HSBC’s adherence to the FSA’s prudential guidelines. They also regularly discuss fundamental matters relating to HSBC’s business in the UK and internationally, including areas such as strategic and operating plans, risk control, loan portfolio composition and organisational changes, including succession planning. UK depositors and investors are covered by the Financial Services Compensation Scheme which deals with deposits with authorised institutions in the UK, investment business and contracts of insurance. Institutions authorised to accept deposits and conduct investment business are required to contribute to the funding of the scheme. In the event of the insolvency of an authorised institution, depositors are entitled to receive 100 per cent of the first £2,000 (US$3,900) of a claim plus 90 per cent of any further amount up to £33,000 (US$63,800) (the maximum amount payable being £31,700 (US$61,300)). Payments under the scheme in respect of investment business compensation are limited to 100 per cent of the first £30,000 (US$58,000) of a claim plus 90 per cent of any further amount up to £20,000 (US$38,700) (the maximum amount payable being £48,000 (US$92,800)). The EU reached final agreement on a new directive regarding the taxation of savings income on 3 June 2003. Under the directive, each member state, other than Austria, Belgium, and Luxembourg, will be required, beginning in 2005, to provide the tax authorities of each other member state with details of payments of interest or other similar income paid by a person within its jurisdiction to individuals resident in such other member state. Beginning on the same date, Austria, Belgium, and Luxembourg will impose a withholding tax on such income. The withholding tax rate will initially be 15 per cent, increasing to 20 per cent from 2008 and 35 per cent from 2011. Subject to future conditions being met, Austria, Belgium, and Luxembourg may cease to apply the withholding tax and instead comply with the automatic exchange of information rules applicable to the other member states. Implementation of the directive is dependent upon Switzerland, Liechtenstein, San Marino and Andorra applying equivalent measures. Hong Kong regulation and supervision Banking in Hong Kong is subject to the provisions of the Banking Ordinance of Hong Kong (Chapter 155) (the ‘Banking Ordinance’), and to the powers, functions and duties ascribed by the Banking Ordinance to the Hong Kong Monetary Authority (the ‘Monetary Authority’). The principal function of the Monetary Authority is to promote the general stability and effective working of the banking system in Hong Kong. The Monetary Authority is responsible for supervising compliance with the provisions of the Banking Ordinance. The Banking Ordinance gives power to the Chief Executive of Hong Kong to give directions to the Monetary Authority and the Financial Secretary with respect to the exercise of their respective functions under the Banking Ordinance. The Monetary Authority has responsibility for authorising banks, and has discretion to attach conditions to its authorisation. The Monetary Authority requires that banks or their holding companies file regular prudential returns, and holds regular discussions with the management of the banks to review their operations. The Monetary Authority may also conduct ‘on site’ examinations of banks, and in the case of banks incorporated in Hong Kong, of any local and overseas branches and subsidiaries. The Monetary Authority requires all authorised institutions to have adequate systems of internal control and requires the institutions’ external auditors, upon request, to report on those systems and other matters such as the accuracy of information provided to the Monetary Authority. In addition, the Monetary Authority may from time to time conduct tripartite discussions with banks and their external auditors. The Monetary Authority, which may deny the acquisition of voting power of over 10 per cent in a bank, and may attach conditions to its approval thereof, can effectively control changes in the ownership and control of Hong Kong-incorporated financial institutions. In addition, the Monetary Authority has the power to divest controlling interests in a bank from a person if they are no longer deemed to be fit and proper, if they may otherwise threaten the interests of depositors or potential depositors, or if they have contravened any conditions specified by the Monetary Authority. 21 H S B C H O L D I N G S P L C Governance, Regulation and Supervision (continued) The Monetary Authority may revoke authorisation in the event of an institution's non-compliance with the provisions of the Banking Ordinance. These provisions require, among other things, the furnishing of accurate reports. The Banking Ordinance requires that banks submit to the Monetary Authority certain returns and other information and establishes certain minimum standards and ratios relating to capital adequacy (see below), liquidity, capitalisation, limitations on shareholdings, exposure to any one customer, unsecured advances to persons affiliated with the bank and holdings of interests in land, with which banks must comply. Hong Kong fully implemented the capital adequacy standards established by the Basel Accord in 1989. The Banking Ordinance currently provides that banks incorporated in Hong Kong maintain a capital adequacy ratio (calculated as the ratio, expressed as a percentage, of its capital base to its risk-weighted exposure) of at least 8 per cent. For banks with subsidiaries, the Monetary Authority is empowered to require that the ratio be calculated on a consolidated basis, or on both consolidated and unconsolidated bases. If circumstances require, the Monetary Authority is empowered to increase the minimum capital adequacy ratio (to up to 12 per cent for fully-licensed banks and 16 per cent for deposit-taking companies and restricted-licence banks), after consultation with the bank. The marketing of, dealing in and provision of advice and asset management services in relation to securities in Hong Kong are subject to the provisions of the Securities and Futures Ordinance of Hong Kong (Chapter 571) (the ‘Securities and Futures Ordinance’). Entities engaging in activities regulated by the Securities and Futures Ordinance are required to be licensed. The Monetary Authority is the primary regulator for banks involved in the securities business, while the Securities and Futures Commission is the regulator for non-banking entities. US regulation and supervision HSBC is subject to extensive federal and state supervision and regulation in the US. Banking laws and regulations of the Federal Reserve Board, the Federal Deposit Insurance Corporation (‘FDIC’) and the Office of the Comptroller of Currency (‘OCC’) govern many aspects of HSBC’s US business. HSBC and its US operations are subject to supervision, regulation and examination by the Federal Reserve Board because HSBC is a bank holding company under the US Bank Holding 22 Company Act of 1956 (the ‘BHCA’) as a result of its ownership of HSBC Bank USA. HSBC Bank USA is a nationally-chartered commercial bank and a member of the Federal Reserve System. HSBC Bank USA is the surviving institution of the 1 July 2004 merger of HSBC Bank USA and HSBC Bank & Trust (Delaware) N.A. HSBC also owns Household Bank (SB), N.A. (‘Household Bank’), a nationally chartered ‘credit card bank’ which is also a member of the Federal Reserve System. Both HSBC Bank USA and Household Bank are subject to regulation, supervision and examination by the OCC. The deposits of HSBC Bank USA and Household Bank are insured by the FDIC and both banks are subject to relevant FDIC regulation. On 1 January 2004, HSBC formed a new company to hold all of its North American operations, including these two banks. This company, called HSBC North America Holdings Inc. (‘HNAH’) is also a ‘bank holding company’ under the BHCA, by virtue of its ownership and control of HSBC Bank USA. The BHCA and the International Banking Act of 1978 (‘IBA’) impose certain limits and requirements on the US activities and investments of HSBC, HNAH, and certain companies in which they hold direct or indirect investments. HSBC is also a ‘qualifying foreign banking organisation’ under Federal Reserve Board regulations, and as such, may engage within the United States in certain limited non-banking activities and hold certain investments that would otherwise not be permissible under US law. Prior to 13 March 2000, the BHCA generally prohibited HSBC from acquiring, directly or indirectly, ownership or control of more than 5 per cent of the voting shares of any company engaged in the US in activities other than banking and certain activities closely related to banking. On that date HSBC became a financial holding company (‘FHC’) under the Gramm-Leach-Bliley Act (‘GLBA’) amendments to the BHCA, enabling it to offer a more complete line of financial products and services. Upon its formation, HNSH also registered as an FHC. HSBC and HNAH’s ability to engage in expanded financial activities as FHCs depend upon HSBC and HNAH continuing to meet certain criteria set forth in the BHCA, including requirements that its US depository institution subsidiaries, HSBC Bank USA and Household Bank, be ‘well- capitalised’ and ‘well-managed’, and that such institutions have achieved at least a satisfactory record in meeting community credit needs during their most recent examinations pursuant to the Community Reinvestment Act. These requirements also apply to Wells Fargo HSBC Trade Bank, N.A., in which HSBC and HNAH have a 20 per cent voting interest in equity capital and a 40 per cent economic interest. Each of these depository institutions achieved at least the required rating during their most recent examinations. In general under the BHCA, an FHC would be required, upon notice by the Federal Reserve Board, to enter into an agreement with the Federal Reserve Board to correct any failure to comply with the requirements to maintain FHC status. Until such deficiencies are corrected, the Federal Reserve Board may impose limitations on the US activities of an FHC and depository institutions under its control. If such deficiencies are not corrected, the Federal Reserve Board may require an FHC to divest its control of any subsidiary depository institution or to desist from certain financial activities in the US. HSBC and HNAH are generally prohibited under the BHCA from acquiring, directly or indirectly, ownership or control of more than 5 per cent of any class of voting shares of, or substantially all the assets of, or exercising control over, any US bank or bank holding company without the prior approval of the Federal Reserve Board. The US is party to the 1988 Basel Capital Accord and US banking regulatory authorities have adopted risk-based capital requirements for US banks and bank holding companies that are generally consistent with the Accord. In addition, US regulatory authorities have adopted ‘leverage’ capital requirements that generally require US banks and bank holding companies to maintain a minimum amount of capital in relation to their balance sheet assets (measured on a non-risk weighted basis). The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for extensive regulation of depository institutions (such as HSBC Bank USA, Household Bank and Wells Fargo HSBC Trade Bank, N.A.), including requiring federal banking regulators to take ‘prompt corrective action’ with respect to FDIC-insured banks that do not meet minimum capital requirements. HSBC Bank USA, Household Bank and Wells Fargo HSBC Trade Bank, N.A., like other FDIC-insured banks, may be required to pay assessments to the FDIC for deposit insurance under the FDIC’s Bank Insurance Fund. Under the FDIC’s risk-based system for setting deposit insurance assessments, an institution’s assessments vary according to the level of capital an institution holds, its deposit levels and other factors. At 31 December 2004, HSBC Bank USA, Household Bank and Wells Fargo HSBC Trade Bank, N.A. were each well-capitalised under Federal Reserve Board regulations. The USA Patriot Act (‘Patriot Act’) signed into law in October 2001, imposes significant record keeping and customer identity requirements, expanded the US federal government’s powers to freeze or confiscate assets and increases the available penalties that may be assessed against financial institutions for failure to comply with obligations imposed on such institutions to detect, prevent and report money laundering and terrorist financing. Among other things, the Patriot Act requires the US Treasury Secretary to develop and adopt final regulations with regard to the anti-money laundering compliance obligations of financial institutions (a term which, for this purpose, includes insured US depository institutions, US branches and agencies of foreign banks, US broker-dealers and numerous other entities). The US Treasury Secretary delegated certain authority to a bureau of the US Treasury Department known as the Financial Crimes Enforcement Network (‘FinCEN’). Many of the anti-money laundering compliance requirements of the Patriot Act, as implemented by FinCEN, are generally consistent with the anti- money laundering compliance obligations previously imposed on the then HSBC Bank USA and Household Bank under the Bank Secrecy Act (which was amended in certain respects by the Patriot Act) and applicable regulations. These include requirements to adopt and implement an anti-money laundering programme, report suspicious transactions and implement due diligence procedures for certain correspondent and private banking accounts. Certain other specific requirements under the Patriot Act involve new compliance obligations. The passage of the Patriot Act and other recent events have resulted in heightened scrutiny of the Bank Secrecy Act and anti- money laundering compliance by federal and state bank examiners. On 30 April 2003 the then HSBC Bank USA entered into a written agreement with the Federal Reserve Bank of New York and the New York State Banking Department to enhance its compliance with anti-money laundering requirements. HSBC Bank USA implemented certain improvements in its compliance, reporting, and review systems and procedures to comply with this agreement. When HSBC Bank USA merged with HSBC Bank & Trust (Delaware) N.A. on 1 July 2004, the OCC made the merger conditional on HSBC Bank USA’s continuing compliance with the requirements of the written agreement. HSBC’s US consumer finance operations are also subject to extensive regulation in the US, and to laws relating to consumer protection; (both in general, and in respect of so-called ‘subprime’ lending operations, which have been subject to 23 H S B C H O L D I N G S P L C Governance, Regulation and Supervision (continued) enhanced regulatory scrutiny); discrimination in extending credit; use of credit reports; privacy matters; disclosure of credit terms; and correction of billing errors. They also are subject to regulations and legislation that limit operations in certain jurisdictions. For example, limitations may be placed on the amount of interest or fees that a loan may bear, the amount that may be borrowed, the types of actions that may be taken to collect or foreclose upon delinquent loans or the information about a customer that may be shared. HSBC’s US consumer finance branch lending offices are generally licensed in those jurisdictions in which they operate. Such licences have limited terms but are renewable, and are revocable for cause. Failure to comply with applicable laws and regulations may limit the ability of these licensed lenders to collect or enforce loan agreements made with consumers and may cause the consumer finance lending subsidiary to be liable for damages and penalties. HSBC’s US credit insurance operations are subject to regulatory supervision under the laws of the states in which they operate. Regulations vary from state to state but generally cover licensing of insurance companies; premiums and loss rates; dividend restrictions; types of insurance that may be sold; permissible investments; policy reserve requirements; and insurance marketing practices. Certain US source payments to foreign persons may be subject to US withholding tax unless the foreign person is a qualified intermediary. A qualified intermediary is a financial intermediary which is qualified under the Internal Revenue Code and has completed the Qualified Intermediary Withholding Agreement with the Internal Revenue Service. Various HSBC operations outside the US are qualified intermediaries. 24 H S B C H O L D I N G S P L C Description of Property At 31 December 2004, HSBC had some 9,500 operational properties worldwide, of which approximately 3,200 were located in Europe, 600 in Hong Kong and the rest of Asia Pacific, 3,800 in North America (including 1,600 in Mexico) and 1,700 in Brazil. Additionally, properties with a net book value of US$1,163 million were held for investment purposes. Of the total net book value of HSBC properties, more than 73 per cent were owned or held under long-term leases. Further details are included in Note 24 of the ‘Notes on the Financial Statements’. HSBC values its properties on an annual basis and updates their balance sheet values accordingly. Legal Proceedings HSBC, together with a number of its subsidiary undertakings, is named in and is defending legal actions in various jurisdictions arising out of its normal business operations. None of the above proceedings is regarded as material litigation. 25 H S B C H O L D I N G S P L C Financial Review Summary Net interest income ........................................................................................ Other operating income .................................................................................. Total operating income ................................................................................ Operating expenses excluding goodwill amortisation .................................... Goodwill amortisation ................................................................................... Operating profit before provisions ............................................................. Provisions for bad and doubtful debts ............................................................ Provisions for contingent liabilities and commitments ................................... Amounts written off fixed asset investments . ................................................ Operating profit ........................................................................................... Share of operating profit/(loss) in joint ventures ............................................ Share of operating profit in associates ............................................................ Gains/(losses) on disposal of – investments ............................................................................................. – tangible fixed assets ................................................................................ Profit on ordinary activities before tax ...................................................... Tax on profit on ordinary activities ................................................................ Profit on ordinary activities after tax ......................................................... Minority interests ........................................................................................... Profit attributable to shareholders ............................................................. Profit before tax excluding goodwill amortisation ......................................... Profit attributable to shareholders excluding goodwill amortisation .............. Year ended 31 December 2004 US$m 31,024 19,563 50,587 (25,875) (1,814) 22,898 (6,357) (27) – 16,514 5 287 770 32 17,608 (4,507) 13,101 (1,261) 11,840 19,426 13,658 2003 US$m 25,598 15,474 41,072 (21,082) (1,450) 18,540 (6,093) (44) (106) 12,297 (116) 221 451 (37) 12,816 (3,120) 9,696 (922) 8,774 14,401 10,359 2002 US$m 15,460 11,135 26,595 (14,954) (854) 10,787 (1,321) (107) (324) 9,035 (28) 135 532 (24) 9,650 (2,534) 7,116 (877) 6,239 10,513 7,102 Year ended 31 December 2004 compared with year ended 31 December 2003 ‘HSBC Finance’ is defined for this purpose as HSBC Finance Corporation’s consumer finance, insurance and commercial banking operations together with the US residential mortgages and private label credit cards acquired by HSBC Bank USA from HSBC Finance Corporation and its correspondents since December 2003. Where the word ‘underlying’ is used, disclosures are adjusted for the additional quarter’s contribution from HSBC Finance by deducting HSBC Finance’s results for the first quarter of 2004, and for all other significant acquisitions affecting the comparison of 2004 with 2003 in respect of which the most significant was the Bank of Bermuda, acquired in February 2004. HSBC made a profit on ordinary activities before tax of US$17,608 million, a rise of US$4,792 million, or 37 per cent, on 2003. Of this increase, US$987 million was attributable to an additional quarter’s profit of HSBC Finance in 2004. In the ten months since becoming part of the Group, Bank of Bermuda contributed US$90 million. Excluding goodwill amortisation, HSBC Finance 26 contributed US$1,113 million, and Bank of Bermuda US$118 million to the US$5,025 million, or 35 per cent, rise in profit before tax to US$19,426 million. Of the growth, 4 per cent related to currency movements. On a constant currency basis, underlying growth was 21 per cent, driven by broadly based revenue growth and improved credit conditions which enabled a lower level of new provisions for bad and doubtful debts in both the personal and corporate sectors. Productivity also improved, notwithstanding the planned growth in costs to build broader capabilities within the Corporate, Investment Banking and Markets business. Goodwill amortisation (excluding that in respect of associates) increased by US$364 million to US$1,814 million in 2004, reflecting the additional quarter’s charge in respect of HSBC Finance, the significant acquisitions in 2004 and currency movements. Year ended 31 December 2003 compared with year ended 31 December 2002 In the sections which follow, analysis of these results highlights the contributions from HSBC Finance Corporation, acquired at the end of March 2003, and HSBC Mexico, acquired in November 2002, together with the impact of a weaker US dollar on translating revenues and costs arising in other currencies. These factors are important to an understanding of HSBC’s performance in 2003. It is also important to recognise the structural effect on reported financial performance of the acquisition of HSBC Finance Corporation. HSBC made a profit on ordinary activities before tax of US$12,816 million in 2003, an increase of US$3,166 million, or 33 per cent, compared with 2002. HSBC Finance and HSBC Mexico accounted for over 70 per cent of this increase. HSBC Finance contributed US$1,827 million in its first nine months, while HSBC Mexico contributed US$441 million in its first full year. The shape of the Group’s profit and loss account Excluding goodwill amortisation, HSBC changed as a result of the HSBC Finance Corporation acquisition, reflecting the nature of its business model. HSBC Finance generally serves non-conforming and sub-prime customers who, for a variety of reasons, have a higher delinquency and credit loss probability. These customers are charged a higher rate of interest to compensate for this additional risk of loss. As a consequence, HSBC Finance’s net interest income is a much higher proportion of its total revenues than in the rest of HSBC, and a much higher proportion of HSBC Finance’s pre-provision profitability is absorbed in bad and doubtful debt charges than is normally the case in the rest of HSBC. Net interest income Finance and HSBC Mexico contributed US$2,208 million and US$534 million respectively to profit before tax, which grew by US$3,888 million or 37 per cent to US$14,401 million. Underlying growth, on a constant currency basis, was 7 per cent. Goodwill amortisation increased by US$722 million to US$1,585 million in 2003, reflecting acquisitions, currency movements and the write down of goodwill attributed to a fund management company previously acquired as part of the CCF acquisition. By geographical region Europe..................................................... Hong Kong.............................................. Rest of Asia-Pacific ................................ North America ........................................ South America ........................................ Net interest income ................................. 2004 US$m 9,062 3,639 2,055 14,913 1,355 31,024 % 29.2 11.7 6.6 48.1 4.4 100.0 Year ended 31 December 2003 US$m % 7,540 3,901 1,740 11,777 640 25,598 29.5 15.2 6.8 46.0 2.5 100.0 2002 US$m 6,343 4,133 1,607 2,732 645 % 41.0 26.7 10.4 17.7 4.2 15,460 100.0 Net interest income ........................................................................................ Average interest-earning assets ...................................................................... Gross interest yield (per cent)1 ....................................................................... Net interest spread (per cent)2 ........................................................................ Net interest margin (per cent)3 ....................................................................... Year ended 31 December 2004 US$m 31,024 964,305 5.21 3.01 3.22 2003 US$m 25,598 778,415 5.13 3.06 3.29 2002 US$m 15,460 608,749 4.70 2.27 2.54 1 Gross interest yield is the average interest rate earned on average interest-earning assets (AIEA). 2 Net interest spread is the difference between the average interest rate earned on average interest-earning assets and the average interest rate paid on average interest-bearing funds. 3 Net interest margin is net interest income expressed as a percentage of average interest-earning assets. 27 H S B C H O L D I N G S P L C Financial Review (continued) Year ended 31 December 2004 compared with year ended 31 December 2003 Net interest income was US$5,426 million, or 21 per cent higher than 2003, at US$31,024 million. US$2,745 million of this increase was attributable to an additional quarter of HSBC Finance compared with 2003, while Bank of Bermuda contributed US$154 million in the ten months since acquisition. On an underlying basis and in terms of constant currency, net interest income increased by 5 per cent, as the impact of strong growth in interest-earning assets was partly offset by continuing margin compression in major markets and lower returns on treasury assets. In Europe, net interest income was US$1,522 million, or 20 per cent, higher than in 2003, with US$158 million of the increase coming from an additional quarter of HFC Bank in the UK and US$35 million from the acquisition of M&S Money in November 2004. On an underlying basis and expressed in constant currency, net interest income increased by 6 per cent, reflecting strong growth in mortgages and consumer lending (funded by corresponding growth in lower-costing deposits and current accounts), particularly in the UK. This was partly offset by competitive pricing pressure, particularly in UK mortgages, and the redeployment of liquidity at lower yields as assets matured. In North America, net interest income increased by US$3,136 million, with HSBC Finance contributing US$2,587 million of the increase. On an underlying basis, the rise was US$393 million, or 3 per cent, primarily from a strong performance in Mexico, which benefited from growth in low cost deposits. In the US, an increase in mortgage lending flowed through to net interest income, though the benefit was partly offset by competitive pressure on pricing, a change in asset mix towards lower yielding but higher quality assets, and the effect of funding costs on larger trading positions. In Hong Kong, net interest income declined by 7 per cent, largely due to spread compression on the value of deposits and pressure on lending margins, particularly in mortgages. Foreign funds investing in the buoyant stock market, and inflows from investors anticipating an upward realignment of the currency as US dollar weakened, boosted liquidity in the market, depressing Hong Kong dollar interest rates and reducing spreads on deposits. Net interest income was further reduced by competitive pressure on mortgage yields and corporate spreads, a fall in average mortgage balances and the run-off of higher yielding treasury assets with less attractive reinvestment opportunities, given the flat Hong 28 Kong dollar yield curve. These adverse developments were partly offset by a 10 per cent rise in average interest-earning assets, and continued growth in customer deposits. In the Rest of Asia-Pacific, net interest income increased by 18 per cent. In constant currency terms, the rise was 15 per cent, driven by growth in mortgages, consumer lending and international trade across the region, offset partly by competitive pressure on pricing. In South America, net interest income rose sharply, reflecting the full-year benefit of acquiring Losango in December 2003 and the effect of falls in Brazilian interest rates in the latter part of 2003 and early 2004, which translated into lower funding costs on large fixed rate positions and widening spreads on deposits. The effect was accentuated by strong growth in both personal and commercial lending in Brazil. Argentina similarly benefited from growth in consumer lending as the economy grew and the outcome of the external debt restructuring became increasingly apparent. Overall, average interest-earning assets increased by US$185.9 billion, or 24 per cent, compared with 2003. At constant exchange rates, underlying average interest-earning assets increased by 13 per cent. This growth was driven principally by higher mortgage balances and personal lending in the US, the UK, and across Asia-Pacific. HSBC’s net interest margin was 3.22 per cent in 2004, compared with 3.29 per cent in 2003. Year ended 31 December 2003 compared with year ended 31 December 2002 Net interest income in 2003 was US$10,138 million, or 66 per cent higher than 2002, at US$25,598 million. Of this increase, HSBC Finance contributed US$8,305 million, and HSBC Mexico US$874 million. Excluding these acquisitions, and at constant exchange rates, net interest income was only marginally higher than in 2002, as the impact of growth in interest-earning assets was offset by continuing margin compression from the effect of low interest rates worldwide. This effect was expected to continue in 2004 unless interest rates rose ahead of market expectations. In Europe, net interest income was US$1,197 million, or 19 per cent, higher than in 2002. HFC Bank contributed US$438 million of this increase. Excluding this acquisition and at constant exchange rates, net interest income was slightly higher than in 2002, reflecting strong growth in average interest-earning assets. This was partly offset by the cost of paying interest on small and medium-sized business accounts in the UK and the impact of liquidity being redeployed at lower yields as assets matured. In North America, net interest income increased by US$9,045 million. On an underlying basis, the growth was US$304 million, or 11 per cent, primarily reflecting the benefits of strong growth in mortgage lending and savings products, and good balance sheet management, by which the lending mix was improved by exiting less profitable business. Benefit was also gained from the elimination of funding costs following the closure of certain arbitrage trading activities in the US. In Hong Kong, net interest income declined by 6 per cent, largely due to spread compression on the value of deposits and continued pressure on margins in the mortgage business. Continued pressure on margins depressed mortgage yields in an environment of very low credit demand. This was partly offset by a 7 per cent growth in average interest-earning assets, increased customer deposits and the redeployment of interbank placements in holdings of debt securities. Credit card lending also grew by 6 per cent, improving the mix of assets. In the Rest of Asia-Pacific, net interest income increased by 8 per cent. In constant currency, this increase was 5 per cent, driven by growth in mortgages and credit card lending, and the beneficial effect of the acquisition of the retail deposit and loan business of AMP Bank Limited in the first half of 2003. In South America, net interest income was broadly in line with last year. In constant currency, net interest income grew by 10 per cent. In Brazil, net interest income was marginally higher than in 2002, benefiting from the acquisition of the Brazilian businesses and assets of Lloyds TSB Group plc in December 2003. Excluding this, the favourable effect of higher levels of customer lending and deposits were fully offset by reduced spreads as interest rates fell during the year. Argentina recorded net interest income of US$14 million in 2003 compared with a net interest expense in 2002. As the domestic economy began to recover and the trade surplus grew, interest rates fell. The effect of the continuing reduction in average interest-earning assets was more than offset by the lower cost of funding the non-performing loan portfolio. Overall, average interest-earning assets increased by US$169.7 billion, or 28 per cent, compared with 2002. Of the increase, HSBC Finance contributed US$92.0 billion and HSBC Mexico US$17.8 billion. At constant exchange rates, underlying average interest-earning assets increased by 4 per cent. This growth was driven principally by higher mortgage balances and personal lending in the UK, France, the US, Canada, Malaysia, Australia and Singapore, and an increase in holdings of long-term securities in the US and debt securities in Hong Kong. HSBC’s net interest margin was 3.29 per cent in 2003, compared with 2.54 per cent in 2002. The acquisitions of HSBC Finance Corporation and HSBC Mexico increased net interest margin by 77 and 6 basis points respectively. On an underlying basis, HSBC’s net interest margin fell by 8 basis points to 2.46 per cent. In Europe, the fall in net interest margin was primarily due to a decline in the benefit of net free funds, mainly as a result of paying interest on current account balances belonging to small and medium sized enterprises in the UK. In Hong Kong, HSBC’s net interest margin also declined because of lower spreads on deposits and lower yields on redeployed interbank placements. In Hang Seng Bank, net interest margin narrowed due to lower mortgage yields, narrower spreads on deposits and debt securities, and a lower contribution from net free funds, partly offset by switching liquidity from interbank placements to debt securities. In the rest of Asia-Pacific, net interest margin fell in several countries, mainly from narrower spreads on deposits, lower yields on mortgages, the maturing of higher yielding assets, and a reduced contribution from net free funds. In the US, growth in mortgage balances and a shift in the treasury portfolio to higher yielding fixed rate investments led to an improvement in net interest margin. 29 H S B C H O L D I N G S P L C Financial Review (continued) Other operating income By geographical region Europe .................................................... Hong Kong ............................................. Rest of Asia-Pacific ............................... North America ....................................... South America ....................................... 2004 US$m 9,385 3,156 1,749 5,164 739 % 46.4 15.6 8.7 25.6 3.7 Year ended 31 December 2003 US$m % 7,555 2,331 1,350 3,982 678 47.4 14.7 8.5 25.1 4.3 2002 US$m 6,272 1,917 1,174 1,502 596 % 54.8 16.7 10.2 13.1 5.2 20,193 100.0 15,896 100.0 11,461 100.0 Intra-HSBC elimination ......................... Other operating income .......................... (630) 19,563 (422) 15,474 (326) 11,135 By income category Dividend income ............................................................................................ Fees and commissions (net) ........................................................................... Dealing profits – foreign exchange ........................................................................................ – interest rate derivatives .............................................................................. – debt securities ............................................................................................ – equities and other trading ........................................................................... Operating leased assets rental income ............................................................ General insurance underwriting (net) ............................................................. Increase in value of long-term insurance business ......................................... Income from life assurance and annuities ....................................................... Rental income ................................................................................................ Other .............................................................................................................. Year ended 31 December 2004 US$m 601 13,093 1,806 727 49 (16) 2,566 632 564 235 644 189 1,039 3,303 2003 US$m 222 10,394 1,239 330 251 358 2,178 553 473 206 440 159 849 2,680 2002 US$m 278 7,824 1,167 47 75 24 1,313 490 313 182 85 160 490 1,720 Total other operating income ......................................................................... 19,563 15,474 11,135 Analysis of fees and commissions receivable and payable Year ended 31 December Account services ............................................................................................ Credit facilities ............................................................................................... Remittances ................................................................................................... Cards .............................................................................................................. Imports/exports .............................................................................................. Underwriting .................................................................................................. Insurance ........................................................................................................ Mortgage servicing rights .............................................................................. Trust income .................................................................................................. Broking income ............................................................................................. Global custody ............................................................................................... Maintenance income on operating leases ....................................................... Funds under management .............................................................................. Unit trusts ...................................................................................................... Corporate finance ........................................................................................... Other .............................................................................................................. Total fees and commissions receivable .......................................................... Less: fees payable .......................................................................................... Net fees and commissions .............................................................................. 30 2004 US$m 2,779 1,179 353 3,782 692 234 1,177 80 204 958 564 190 1,498 500 193 1,494 15,877 (2,784) 13,093 2003 US$m 2,317 966 288 2,976 609 175 961 75 145 873 338 171 1,096 358 189 1,023 12,560 (2,166) 10,394 2002 US$m 1,715 752 268 1,242 556 173 775 77 125 773 296 160 1,026 284 122 901 9,245 (1,421) 7,824 Year ended 31 December 2004 compared with year ended 31 December 2003 cardholder spending, and credit card fee income rose by 13 per cent. Other operating income of US$19,563 million, was US$4,089 million, or 26 per cent, higher than in 2003. Of this increase, US$836 million was attributable to an additional quarter from HSBC Finance while Bank of Bermuda contributed US$325 million. On an underlying basis, and at constant exchange rates, growth in other operating income was 12 per cent, driven principally by strong growth in fee and commission income across all operations. Net fees and commissions rose by US$2,699 million, or 26 per cent, with the additional quarter of HSBC Finance and acquisitions accounting for US$1,003 million of this increase. On a constant currency basis, the underlying increase of 10 per cent was underpinned by lending fees from strong growth in consumer lending in the UK and the US, sales of investment products in Asia and a general upturn in funds management income. In Europe, fee income increased by US$1,103 million, or 21 per cent, of which US$107 million came from an extra quarter’s result from HFC Bank and the acquisitions of Bank of Bermuda and M&S Money. At constant currencies, fee income rose by 8 per cent driven by strong growth in funds under management in Private Banking, and by the strength of both mortgage and consumer lending, particularly in the UK where growth in loan fees and cards income was augmented by sales of credit protection products. The increase in loan fee income also reflected strong demand for commercial lending products in the UK. Excluding the US$617 million contribution from an additional quarter of HSBC Finance and US$126 million from Bank Bermuda, fees and commissions in North America increased by US$324 million, or 4 per cent. On a comparable basis, HSBC Finance saw strong growth in fees from loan sales and sales of credit protection policies. In Mexico, strong growth in the Afore pension funds business complemented higher fee income from credit cards, deposit services and international remittances. In Hong Kong, fee income rose strongly as a rise in stock market activity sparked demand for investment products. Unit trust, custody and broking income all benefited from strong customer demand, while strong growth in funds under management was reflected in a sharp rise in discretionary mandate fees. An improvement in consumer confidence in the second half of the year flowed through to a rise in HSBC’s operations in the Rest of Asia-Pacific similarly benefited from an upturn in regional financial markets, with strong sales of investment products reflected in growth in fees from funds under management and global custody. Further growth came from an expansion of HSBC’s credit card base in the region, where cards in issue grew by 929,000 or 25 per cent and from strong growth in trade related income, particularly in the Middle East, where the benefit of higher oil prices boosted local economies. Overall, fee income rose by 26 per cent at constant currencies. In South America, net fees and commissions were 42 per cent higher than in 2003. The bulk of the increase came in Brazil, which benefited both from the integration of Losango, and strong organic growth in consumer and commercial lending. Dealing profits of US$2,566 million were US$388 million, or 18 per cent, higher than in 2003 with US$49 million of the increase coming from acquisitions. Strong growth in foreign exchange and interest rate derivatives trading offset lower income from debt securities, while dealing losses on equity swaps trading were offset by the related dividend income. Customer flows were strongly ahead of 2003, driven largely by the expansion of business capabilities during the year. This was reflected in increases in both foreign exchange trading and derivatives income, particularly in Europe and Hong Kong, while retail sales of structured products further boosted income in Hong Kong and Singapore. However, fixed income revenues fell, particularly in the UK, Brazil, Mexico and the US, as movements in credit spreads adversely affected debt trading income. Other operating income benefited from an expansion of HSBC’s insurance business in the UK and Hong Kong and growth in the asset finance business in the UK. Year ended 31 December 2003 compared with year ended 31 December 2002 Other operating income of US$15,474 million, was US$4,339 million, or 39 per cent, higher than in 2002. Of this increase, HSBC Finance contributed US$1,878 million and HSBC Mexico contributed US$599 million. On an underlying basis, and at constant exchange rates, growth in other operating income was 9 per cent, principally as a result of higher dealing profits throughout HSBC’s operations. 31 H S B C H O L D I N G S P L C Financial Review (continued) The acquisitions of HSBC Finance Corporation and HSBC Mexico reduced the proportion of fee revenues exposed to stock market fluctuations by bringing into the Group significant levels of account service fees (HSBC Mexico) and credit card fee income (HSBC Finance). Fees from credit cards now constitute close to 24 per cent of total fees receivable compared with 13 per cent in 2002. Fee and commission income, excluding HSBC Finance and HSBC Mexico, and at constant exchange rates, increased by 4 per cent compared with 2002. In Europe, fee income increased by US$664 million, or 15 per cent, of which HFC Bank contributed US$49 million. Excluding this acquisition and at constant exchange rates, fee income increased by 2 per cent, mainly from growth in sales of creditor protection insurance, cards transactions and loan fees. Within the UK, personal loan protection premiums grew by 19 per cent, reflecting growth in mortgages and personal loans. However, this was partly offset by a decline in sales of investment and pension products, mainly reflecting uncertainty in the equity markets. In North America, excluding US$1,167 million and US$453 million relating to HSBC Finance and HSBC Mexico respectively, fee income was marginally higher than in 2002. Growth in income from securities advisory services, deposit-related service charges and card fees was partly offset by lower earnings from mortgage servicing. In Hong Kong, fee income increased by US$119 million, primarily due to higher revenues from wealth management services. There was strong growth in fees from sales of unit trusts and capital- guaranteed funds, which increased by US$1.6 billion in 2003. HSBC expanded its range of structured deposit products, further benefiting fee income. Revenues from securities and stockbroking also increased in line with a buoyant stock market in the second half of the year and increased market share. In addition, the insurance business generated strong results reflecting growth in new individual life business written. HSBC’s operations in the rest of Asia-Pacific increased fee income by US$81 million with strong growth in wealth management income, reflecting higher unit trust sales and funds under management. Fee income from credit cards rose in a number of countries. In South America, fee income increased by 10 per cent at constant exchange rates, mainly in Brazil. The increase reflected good growth in credit- related revenue, account service fees and cards. In Argentina a decline in fee income was recorded. Dealing profits of US$2,178 million were US$865 million, or 66 per cent, higher than in 2002 and reflected investment in and refocusing of HSBC’s markets businesses, primarily in the US and in Europe. In Asia, a wider range of structured solutions was offered to customers which boosted revenues. Acquisitions were not significant contributors to growth in this area with HSBC Mexico generating US$103 million. Within dealing profits, there was strong growth in fixed income earnings, predominantly in Europe and Hong Kong, as a result of favourable credit spreads and strong investor demand for yield enhancement products. Foreign exchange revenues increased in both Europe and North America, with volatility in the major currencies driving sales of hedging products and sales activity generally. In Hong Kong, a greater focus on tailored solutions generated a significant increase in corporate sales during the year. Other operating income further benefited from expansion of the insurance businesses in Argentina and Hong Kong and growth in the rail leasing business in the UK. 32 % 51.6 14.0 10.0 17.5 6.9 100.0 76.2 – 3.9 17.1 2.8 100.0 2002 US$m 8,609 1,824 3,331 13,764 1,189 1 854 15,808 % 56.2 Operating expenses By geographical region Europe .................................................... Hong Kong ............................................. Rest of Asia-Pacific ............................... North America ....................................... South America ....................................... Intra-HSBC elimination ......................... Goodwill amortisation Europe .................................................... Hong Kong ............................................. Rest of Asia-Pacific ............................... North America ....................................... South America ....................................... Total operating expenses ........................ 2004 US$m 11,570 2,524 2,080 8,887 1,444 26,505 (630) 25,875 947 9 68 761 29 1,814 27,689 % 43.8 9.5 7.8 33.5 5.4 100.0 52.2 0.5 3.7 42.0 1.6 100.0 Year ended 31 December 2003 US$m % 9,529 2,212 1,741 6,947 1,075 21,504 (422) 21,082 758 3 35 643 11 1,450 22,532 44.3 10.3 8.1 32.3 5.0 100.0 52.3 0.2 2.4 44.3 0.8 100.0 2002 US$m 7,878 2,139 1,528 2,675 1,060 15,280 (326) 14,954 651 – 33 146 24 854 15,808 By expense category Staff costs ...................................................................................................... Premises and equipment (excluding depreciation) ......................................... Other administrative expenses ....................................................................... Administrative expenses ................................................................................ Depreciation and amortisation – tangible fixed assets .................................................................................... – intangible assets .......................................................................................... – goodwill ...................................................................................................... Total operating expenses ................................................................................ Cost:income ratio (excluding goodwill amortisation) .................................... Staff numbers (full-time equivalent) Europe ........................................................................................................... Hong Kong .................................................................................................... Rest of Asia-Pacific ...................................................................................... North America .............................................................................................. South America .............................................................................................. 2004 US$m 14,492 2,726 6,965 24,183 1,664 28 1,814 27,689 % 51.1 2004 74,861 25,552 41,031 69,781 32,108 Total staff numbers ....................................................................................... 243,333 Year ended 31 December 2003 US$m 12,111 2,331 5,243 19,685 1,382 15 1,450 22,532 % 51.3 Year ended 31 December 2003 2002 73,943 23,636 31,827 65,021 28,292 222,719 72,260 23,786 28,630 34,207 25,522 184,405 Year ended 31 December 2004 compared with year ended 31 December 2003 Operating expenses increased by US$5,157 million, or 23 per cent, with an additional quarter’s costs in HSBC Finance accounting for US$1,302 million and acquisitions US$745 million of the increase. Excluding these acquisitions and expressed in terms of constant currency, operating expenses, excluding goodwill amortisation, were 8 per cent higher than in 2003. Staff costs, which, on the same basis, rose by 7 per cent, accounted for less than half of the increase, and largely reflected restructuring and expansion costs in Corporate Investment Banking and Markets, higher performance-related bonuses, and growth in staff numbers in support of rising business volumes. Higher advertising and marketing costs to stimulate product sales, and expenditure on IT infrastructure, largely accounted for the US$1,020 million, or 11 per cent, increase in non- staff costs. HSBC’s cost:income ratio excluding goodwill amortisation fell to 51.1 per cent in 2004 from 51.3 per cent in 2003, reflecting the inclusion 33 H S B C H O L D I N G S P L C Financial Review (continued) of an additional quarter’s result of HSBC Finance Corporation. Excluding this effect, the cost:income ratio increased to 52.5 per cent. In Europe, costs excluding goodwill amortisation increased by US$2,041 million compared with 2003, of which the additional quarter’s costs in HSBC Finance and acquisitions accounted for US$270 million. On an underlying basis and at constant exchange rates, expenses were US$766 million, or 7 per cent, higher than in 2003. Higher marketing and IT infrastructure costs added US$169 million while staff costs rose by US$245 million, reflecting restructuring and incentive compensation within Corporate Investment Banking and Markets, higher performance-related remuneration and staff pay increments. Operating expenses in Hong Kong, excluding goodwill amortisation, rose by US$312 million, 14 per cent higher than in 2003, with US$56 million of the increase attributable to acquisitions. On an underlying basis staff costs rose by 9 per cent, largely due to higher performance-related bonuses, reflecting improved results in a number of businesses, and increased headcount in support of business expansion across a number of business segments. Marketing expenses also rose, particularly in Personal Financial Services, in contrast to the significant cut back in 2003 following the outbreak of SARS. In the Rest of Asia-Pacific, costs excluding goodwill amortisation increased by US$339 million, or 19 per cent, compared with 2003, with acquisitions accounting for US$10 million of the increase. At constant exchange rates, the increase was 15 per cent, as staff were recruited to support business expansion in most business segments across the region and additional marketing costs were incurred to support business growth. Incentive-based staff costs also rose in line with improved business performance. The continued migration of processing activities from other regions to the Group Service Centres meant additional staff and IT infrastructure costs were incurred. In North America, operating expenses, excluding goodwill amortisation, increased by US$1,940 million, or 28 per cent, with acquisitions and an additional quarter’s costs from HSBC Finance contributing US$1,301 million of the increase. The underlying rise of 9 per cent largely reflected a significant expansion in Corporate Investment Banking and Markets in the US, where some 300 staff were added during the year and staff and incentive-based compensation saw significant increases. Investment was also made in a number of 34 related technology projects. Staff were recruited for the branch networks in both Mexico and the US to support business growth, and marketing costs rose by US$93 million in support of a number of personal banking and consumer finance products. In South America, operating expenses, excluding goodwill amortisation, rose by US$369 million, or 34 per cent. US$189 million of this increase related to acquisitions in 2004, and the underlying rise in cost at constant currencies was 12 per cent. Staff costs increased by 2 per cent, with higher levels of performance-related bonuses, particularly in Corporate, Investment Banking and Markets and higher social taxes. Transactional taxes in Brazil increased sharply and additional processing, communications and outsourcing costs were incurred to support business growth. Year ended 31 December 2003 compared with year ended 31 December 2002 Growth in operating expenses of US$6,724 million, or 43 per cent, principally reflected the acquisitions of HSBC Finance Corporation, US$3,787 million, and HSBC Mexico, US$964 million. Excluding the effect of these acquisitions and expressed in terms of constant currency, underlying operating expenses excluding goodwill amortisation were 5 per cent higher than in 2002. Virtually all of this growth was in staff costs, reflecting restructuring costs, higher social taxes and pension costs. In addition, Corporate, Investment Banking and Markets incurred higher costs reflecting expansion of the business and increased profitability. Notwithstanding this growth, the cost:income ratio of Corporate, Investment Banking and Markets improved by 3 per cent to 48.9 per cent. HSBC’s cost:income ratio excluding goodwill amortisation was 51.3 per cent for 2003, compared with 56.2 in 2002. Excluding HSBC Finance, the cost:income ratio was 57.3 per cent. In 2003, HSBC’s Group Service Centre in Malaysia became operational. Overall, the Group Service Centres now employ in excess of 8,000 employees worldwide. In Europe, costs excluding goodwill amortisation increased by US$1,651 million compared with 2002, of which HSBC Finance contributed US$299 million. At constant exchange rates and excluding HSBC Finance and goodwill amortisation, expenses were 5 per cent higher than in 2002. This increase in expenses was primarily due to higher pension provision and employment costs, particularly in the UK, where social taxes were raised. Redundancy and property provisioning costs also increased, as HSBC restructured and relocated positions to the Group Service Centres in order to reduce its long-term staff costs. In addition, higher bonus accruals reflected stronger Global Markets revenues. Operating expenses in Hong Kong, excluding goodwill amortisation, were marginally higher than in 2002. Increased staff costs were mainly attributable to higher performance-related bonuses, reflecting strong Global Markets performance, and provisions for restructuring costs. Marketing expenses also rose in Personal Financial Services as Hong Kong’s economy rebounded after SARS abated. These increases were partly offset by reductions in staff numbers in Hong Kong as HSBC continued its policy of migrating back office processing functions to the Group Service Centres. In the Rest of Asia-Pacific, costs in 2003, excluding goodwill amortisation, increased by US$213 million, or 14 per cent, compared with 2002. At constant exchange rates, the increase was 9 per cent, primarily from recruitment to support business expansion, branch opening costs, acquisitions and provisions for restructuring. In addition, the continued migration of processing activities from other regions to the Group Service Centres in India, Malaysia and mainland China added to costs. In North America, operating expenses, excluding goodwill amortisation, increased by Bad and doubtful debts US$284 million, or 11 per cent, in 2003 excluding HSBC Finance and HSBC Mexico. This increase was largely driven by higher staff costs, namely pension and healthcare provisions, performance- related incentives, and expenses associated with long-term restructuring programmes. In the US during 2003, severance costs of US$47 million were recorded for expense reduction initiatives, global resourcing moves and the integration of HSBC Finance, a US$28 million increase over the previous year. In addition, costs rose from the first full year’s inclusion of HSBC’s high net worth personal tax advisory business. These increases were partly offset by the benefits obtained from discontinuing certain of HSBC’s government and agency securities arbitrage operations in the US, and from business disposals. In South America, operating expenses, excluding goodwill amortisation, were broadly in line with 2002. At constant exchange rates and excluding goodwill amortisation, costs were 6 per cent higher than in 2002. The rise in Brazil was due to higher staff costs, driven by increases in labour claims, together with higher marketing costs and increased transaction taxes on higher operating income as the personal lending portfolio was expanded. In addition, the Group’s newly acquired businesses in Brazil added to cost growth. Costs in Argentina were down on 2002, mainly because of lower severance costs. By geographical region Europe ..................................................... Hong Kong .............................................. Rest of Asia-Pacific ................................. North America ......................................... South America ......................................... – normal .................................................. – additional1 ............................................ 2004 US$m 1,025 (223) 100 5,186 269 – % 16.1 (3.5) 1.6 81.6 4.2 – Year ended 31 December 2003 US$m % 874 400 85 4,676 58 – 14.3 6.6 1.4 76.7 1.0 – Total charge for bad and doubtful debts... 6,357 100.0 6,093 100.0 1 Additional general provisions against Argentine exposures. 2002 US$m 569 246 89 300 313 (196) 1,321 % 43.1 18.6 6.7 22.7 23.7 (14.8) 100.0 35 H S B C H O L D I N G S P L C Financial Review (continued) Specific provisions New provisions .............................................................................................. Release of provisions no longer required ....................................................... Recoveries of amounts previously written off ................................................ General provisions Argentine additional provision ....................................................................... Other .............................................................................................................. Total ............................................................................................................... Customer non-performing loans ..................................................................... Customer bad and doubtful debt provisions ................................................... Year ended 31 December 2004 US$m 8,989 (1,284) (912) 6,793 – (436) (436) 6,357 13,259 12,669 2003 US$m 7,777 (953) (610) 6,214 – (121) (121) 6,093 15,050 13,691 2002 US$m 2,678 (826) (180) 1,672 (196) (155) (351) 1,321 10,523 9,117 Year ended 31 December 2004 compared with year ended 31 December 2003 At 31 December 2004, 78 per cent of customer lending was located in Europe and North America, with 12 per cent in Hong Kong. Personal lending accounted for 57 per cent of the customer loan portfolio, a marginal increase on the position at 31 December 2003. Excluding the effect of foreign exchange translation, over 70 per cent of loan growth in 2004, excluding the financial sector, was generated in personal lending, with particularly strong growth in mortgages and consumer lending. Over 100 per cent of the net charge for bad and doubtful debts in 2004 related to lending to the personal sector, including consumer finance, compared with 90 per cent in 2003. Similarly, some 95 per cent of the charge related to lending in the US and Europe, compared with 88 per cent in 2003. The charge for specific bad and doubtful debts adjusts the specific balance sheet provisions to the level that management deems adequate to absorb actual and inherent losses in the Group’s loan portfolio from homogeneous portfolios of assets and individually identified customer loans. The majority of specific provisions are determined on a portfolio basis employing statistical calculations using roll rate methodology to determine specific provisions for bad and doubtful debts. There were no significant changes to the procedures used by HSBC in determining the various components of the charge for specific bad and doubtful debts during the year. The charge for specific provisions in 2004 was US$6,793 million compared with US$6,214 million in 2003, an increase of US$579 million. With the additional quarter’s charge from HSBC Finance and the acquisitions during the year together adding US$1,433 million to the overall charge, the 36 underlying movement at constant currencies was a decrease of US$979 million. New specific provisions increased by US$1,212 million, reflecting the additional quarter’s charge for HSBC Finance of US$1,367 million and the US$205 million effect of acquisitions during the year. Excluding these and at constant currencies, new specific provisions fell by US$537 million, or 7 per cent, compared with 2003 with lower new provisions in Hong Kong and the US combined with higher releases and recoveries in Europe, North America and South America. General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. In determining the level of general provisions, management takes account of historical loss experience, the estimated period between a loss occurring and that loss being identified, and use their judgement to decide whether current economic conditions are likely to produce credit default rates and loss severity in line with historical precedent. There was a net general provision release of US$436 million in 2004, US$315 million greater than the net release of US$121 million in 2003. Releases increased in all geographical regions except South America. This reflected improved underlying economic conditions, driving lower loss expectations, and progress made with refinancing and restructuring problem credits. The aggregate customer bad and doubtful debt provisions at 31 December 2004 of US$12.7 billion represented 1.98 per cent of gross customer advances (net of suspended interest, reverse repos and settlement accounts) compared with 2.65 per cent at 31 December 2003. As in 2003, HSBC’s cross- border exposures did not necessitate significant provisions. Non-performing loans (net of suspended interest) were US$13.3 billion at 31 December 2004. At constant exchange rates, there was a decrease in the level of non-performing loans (net of suspended interest) in 2004 compared with 2003, with falls in all geographical regions. Hong Kong and North America experienced a substantial fall in the level of loans categorised as non-performing. Year ended 31 December 2003 compared with year ended 31 December 2002 The acquisition of HSBC Finance Corporation significantly affected the geographical and customer segment distribution of the Group’s lending activities and, more markedly, the distribution of its credit costs. At 31 December 2003, 76 per cent of customer lending was located, fairly equally, in Europe and North America, compared with 69 per cent in 2002, with Europe two-thirds of that total. At 31 December 2003, personal lending accounted for 56 per cent of the customer loan portfolio compared with 42 per cent at 31 December 2002. Excluding the effect of foreign exchange translation and the acquisition of HSBC Finance Corporation, over 90 per cent of loan growth in 2003, excluding the financial sector, was generated in personal lending, predominantly mortgages, credit cards and other personal products. Over 90 per cent of the charge for bad and doubtful debts in 2003 related to lending to the personal sector, including consumer finance, compared with 65 per cent in 2002. Similarly, over 88 per cent of the charge related to lending in the US and Europe, compared with 66 per cent in 2002. The charge for specific bad and doubtful debts adjusts the specific balance sheet provisions to a level that management deems adequate to absorb actual and inherent losses in the Group’s loan portfolio from homogeneous portfolios of assets and individually identified customer loans. Following the acquisition of HSBC Finance Corporation, the majority of specific provisions were determined on a portfolio basis. In addition, the acquisition of HSBC Finance Corporation resulted in a significant increase in the extent to which HSBC employed statistical calculations using roll rate methodology to determine specific provisions for bad and doubtful debts. Other than this, there were no significant changes to HSBC’s procedures in determining the various components of the charge for specific bad and doubtful debts. The charge for specific provisions in 2003 was US$6,214 million compared with US$1,672 million in 2002, an increase of US$4,542 million. New specific provisions, which increased by US$5,099 million, principally reflected the acquisitions of HSBC Finance Corporation (US$4,773 million) and HSBC Mexico (US$47 million). Excluding the effect of the acquisitions, new specific provisions rose by US$249 million, or 9 per cent, compared with 2002. General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. In determining the level of general provisions, management takes into account historical loss experience, the estimated period between a loss occurring and that loss being identified and use their judgement to decide whether current economic and credit conditions are likely to increase or reduce the actual level of inherent losses. There was a net general provision release of US$121 million in 2003, US$230 million lower than the net release of US$351 million in 2002. In HSBC Finance and HSBC Mexico, general provisions were augmented by US$191 million due to growth in personal lending. Excluding this, the net release of general provisions of US$312 million was in line with that of 2002. This reflected improved underlying economic conditions, and progress made with refinancing and restructuring problem credits. The aggregate customer bad and doubtful debt provisions at 31 December 2003 of US$13.7 billion represented 2.66 per cent of gross customer advances (net of suspended interest, reverse repos and settlement accounts) compared with 2.68 per cent at 31 December 2002. As in 2003, HSBC’s cross- border exposures did not necessitate significant provisions. Non-performing loans (net of suspended interest) of US$15 billion at 31 December 2003 included US$5 billion relating to HSBC Finance’s loan book. Excluding HSBC Finance, and at constant exchange rates, there was a decrease in the level of non-performing loans (net of suspended interest) in 2003 compared with 2002, mainly as a result of the write-off of loans from the legacy portfolio acquired on the acquisition of HSBC Mexico. 37 H S B C H O L D I N G S P L C Financial Review (continued) Gains on disposal of investments Gains on disposal of: – debt securities ............................................................................................ – equity investments ..................................................................................... – other participating interests ........................................................................ – associates ................................................................................................... – subsidiaries ................................................................................................ – other ........................................................................................................... Year ended 31 December 2004 US$m 2003 US$m 187 300 – 117 22 144 770 161 233 1 1 37 18 451 2002 US$m 170 226 69 47 16 4 532 Year ended 31 December 2004 compared with year ended 31 December 2003 Year ended 31 December 2003 compared with year ended 31 December 2002 During the year, HSBC made 15 business acquisitions and completed 13 business disposals. HSBC’s profit on disposal of investments was US$770 million, US$319 million higher than in 2003. The gain on disposal of associates included a gain on the exchange of HSBC’s interest in World Finance International Limited for a 7 per cent interest in Bergesen Worldwide. The substantial increase in other disposals comprises the sale of venture capital investments in France and the US and the disposal of an investment in NYCE Corporation in the US. Realised gains on the sale of debt and equity investment securities during the year were 24 per cent higher than in 2003. During 2003, HSBC made 26 business acquisitions and completed 14 business disposals. HSBC’s profit on disposal of investments was US$451 million, US$81 million lower than in 2002. The profits in 2002 included gains of US$39 million on the sale of HSBC’s 50 per cent share of Lixxbail to its joint venture partner, and US$38 million on the sale of HSBC’s 6.99 per cent share in Banco Santiago S.A. Realised gains on the sale of debt and equity investment securities during the year were broadly in line with 2002. The reductions in interest rates and improvement in equity markets drove growth of US$59 million in the unrecognised gains on HSBC’s debt and equity investment portfolios. 38 Taxation Current taxation UK corporation tax charge ............................................................................ Overseas taxation ......................................................................................... Joint ventures ................................................................................................ Associates ..................................................................................................... Deferred taxation Origination and reversal of timing differences .............................................. Effect of increased tax rate on opening asset ................................................ Adjustment in respect of prior periods .......................................................... Total charge for taxation ............................................................................... Effective tax rate .......................................................................................... Standard UK corporation tax rate ................................................................. Analysis of overall tax charge Taxation at UK corporation tax rate of 30 per cent (2003 and 2002: 30 per cent) .................................................................... Effect of differently taxed overseas profits in principal locations ................. Tax free gains ............................................................................................... Goodwill amortisation not tax deductible ..................................................... Acquisition accounting adjustments not tax effected .................................... Prior period adjustments ............................................................................... Tax deduction on innovative Tier 1 capital ................................................... Low income housing credits ......................................................................... Other items ................................................................................................... Overall tax charge.......................................................................................... Year ended 31 December 2004 US$m 716 2,856 3 42 3,617 981 (15) (76) 890 4,507 % 25.6 30.0 2003 US$m 547 2,590 1 19 3,157 (5) (7) (25) (37) 3,120 % 24.3 30.0 Year ended 31 December 2004 US$m 5,282 (347) (64) 579 (253) (229) (192) (95) (174) 4,507 2003 US$m 3,845 (366) (17) 476 (331) (230) (117) (72) (68) 3,120 2002 US$m 684 1,217 (6) 17 1,912 615 – 7 622 2,534 % 26.3 30.0 2002 US$m 2,895 (472) (19) 261 – (90) (99) – 58 2,534 Year ended 31 December 2004 compared with year ended 31 December 2003 tax purposes and therefore increases the effective tax rate. HSBC Holdings and its subsidiary undertakings in the UK provided for UK corporation tax at 30 per cent, the rate for the calendar year 2004 (2003: 30 per cent). HSBC’s effective tax rate of 25.6 per cent in 2004 was lower than the corporation tax rate of 30 per cent. The main factors which reduced the rate were: the geographical mix of profits and, in particular, the lower rate of tax on profits generated in Hong Kong; fair value accounting adjustments, which under UK GAAP affect pre-tax profits but are ignored for tax purposes; the tax-deductibility of the cost of servicing the Group’s innovative Tier 1 capital, which under UK GAAP is shown as a minority interest; and prior period adjustments, which by definition are unrelated to earnings in the current year. These were partially offset by the effect of goodwill amortisation, which is also ignored for Overseas tax included Hong Kong profits tax of US$539 million (2003: US$483 million) provided at a rate of 17.5 per cent (2003: 17.5 per cent) on the profits assessable in Hong Kong. Other overseas taxation was provided for in the countries of operation at the appropriate rates. Profits arising in North America represented a higher percentage of HSBC’s profits in 2004 than in 2003, largely because of the effect of an additional quarter’s results of HSBC Finance Corporation. US profits are taxed at a higher rate than the average for the rest of the Group and this change in mix raised the effective tax rate. A number of fair value acquisition accounting adjustments relating to HSBC Finance Corporation and HSBC Mexico resulted in net credits to the profit and loss account with no corresponding tax charge. A more detailed explanation of the 39 H S B C H O L D I N G S P L C Financial Review (continued) acquisition accounting adjustments is disclosed in Note 7 of the ‘Notes on the Financial Statements’. Certain prior period adjustments arose in 2004 which reduced HSBC’s overall tax charge. These related to the recognition of deferred tax assets on losses, which became more likely to be utilised. The Group also reached agreement on a number of settlements in respect of outstanding matters on prior year computations at a lower cost than had originally been estimated in establishing provisions. Goodwill amortisation was higher than in the previous year, mainly due to an additional three months charge for HSBC Finance Corporation. At 31 December 2004, there were potential future tax benefits of US$973 million (2003: US$963 million). The potential benefits are in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowable for tax, and capital losses which have not been recognised because realisation of the benefits is not considered more likely than not. Year ended 31 December 2003 compared with year ended 31 December 2002 HSBC Holdings and its subsidiary undertakings in the UK provided for UK corporation tax at 30 per cent, the rate for the calendar year 2003 (2002: 30 per cent). HSBC’s effective tax rate of 24.3 per cent in 2003 was lower than the corporation tax rate of 30 per cent. The geographic mix of profits; fair value accounting adjustments, which are ignored for tax purposes; and prior period adjustments were the main factors which reduced the rate. These were partially offset by the effect of goodwill amortisation, which is also ignored for tax purposes and which increased the rate. Overseas tax included Hong Kong profits tax of US$483 million (2002: US$408 million) provided at a rate of 17.5 per cent (2002: 16 per cent) on the profits assessable in Hong Kong. Other overseas taxation was provided for in the countries of operation at the appropriate rates of taxation. Profits arising in North America represented a higher percentage of HSBC’s profits in 2003 compared with 2002 largely because of the acquisition of HSBC Finance Corporation. US profits are taxed at a higher rate than the average for the rest of the Group and this change in mix raised the effective tax rate. A number of fair value acquisition accounting adjustments relating to HSBC Finance Corporation and HSBC Mexico resulted in net credits to the profit and loss account with no corresponding tax charge. A more detailed explanation of the acquisition accounting adjustments is disclosed in Note 8 of the ‘Notes on the Financial Statements’ in the 2003 Annual Report and Accounts. Prior period adjustments arose in 2003 which reduced HSBC’s overall tax charge. These related mainly to the recognition of deferred tax assets on losses, which became more likely to be utilised. The Group also reached agreement on a number of settlements in respect of outstanding matters on prior year computations which allowed contingency reserves to be released. Goodwill amortisation was higher than in the previous year, mainly due to the acquisition of HSBC Finance Corporation. At 31 December 2003, there were potential future tax benefits of US$963 million (2002: US$885 million). The potential benefits are in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowable for tax, and capital losses which had not been recognised because realisation of the benefits was not considered more likely than not. 40 Asset deployment Loans and advances to customers ............................................................... Loans and advances to banks ...................................................................... Debt securities ............................................................................................ Treasury bills and other eligible bills .......................................................... Equity shares ............................................................................................... Goodwill and intangible assets .................................................................... Other ........................................................................................................... At 31 December 2004 US$m 669,831 142,712 240,999 30,284 19,319 29,382 132,373 % 52.9 11.3 19.1 2.4 1.5 2.3 10.5 2003 US$m 528,977 117,173 205,722 20,391 12,879 28,640 109,447 % 51.7 11.4 20.1 2.0 1.3 2.8 10.7 1,264,900 100.0 1,023,229 100.0 Hong Kong Government certificates of indebtedness ................................. 11,878 Loans and advances to customers include: – reverse repos ........................................................................................... – settlement accounts ................................................................................. Loans and advances to banks include: – reverse repos ........................................................................................... – settlement accounts ................................................................................. 1,276,778 29,346 13,834 36,543 6,086 10,987 1,034,216 17,777 8,594 23,220 7,039 Year ended 31 December 2004 compared with year ended 31 December 2003 HSBC’s total assets (excluding Hong Kong Government certificates of indebtedness) at 31 December 2004 were US$1,264.9 billion, an increase of US$241.7 billion or 24 per cent since 31 December 2003. At constant exchange rates, total assets grew by US$203.8 billion or 19 per cent. At 31 December 2004, HSBC’s balance sheet remained highly liquid, reflecting strong growth in customer deposits. The proportion of assets deployed in customer advances rose to 53 per cent. Customer advances increased by 27 per cent, marginally higher than the growth in total assets, driven essentially by lending to finance consumer spending and strong growth in mortgage financing, reflecting the buoyant housing markets in the US, the UK and parts of Asia-Pacific. Growth in corporate lending was concentrated in the Commercial Banking customer group, while increased financial lending largely reflected expansion of the euro government bond trading portfolios in France. At constant exchange rates, gross loans and advances to customers (excluding loans to the financial sector) were US$101.4 billion higher than at the end of December 2003. US$50.5 billion of this increase related to mortgages, with strong growth in the US and the UK. At constant exchange rates, other personal lending increased by US$22.9 billion or 17 per cent compared with December 2003, mainly as a result of strong growth in credit card and other unsecured personal lending in all of HSBC’s markets, particularly in the UK. Underlying commercial and corporate lending, excluding lending to governments, grew by 14 per cent, with notable growth in Hong Kong and in the Rest of Asia-Pacific on the back of higher trade volumes. In Europe, growth in assets was driven by increased mortgage and consumer lending in the UK and demand from private banking clients for secured funding to finance investment activity. Lending to small and middle market companies also increased, although lending to major corporate customers remained subdued. In Hong Kong, lending to commercial customers improved as Hong Kong’s economy recovered from the impact of SARS and trade flows with mainland China increased. Competition in the mortgage market remained intense and the portfolio declined slightly. Surplus funds from increased customer deposits were deployed in investment securities to enhance HSBC’s yields. In the Rest of Asia-Pacific, the increase in assets was driven by higher mortgage, consumer lending and strong regional trade flows. The rise in assets in North America was driven substantially by strong growth in mortgage lending and demand for consumer credit. In South America, growth was concentrated in consumer lending in Brazil, which also benefited from an expansion in lending to the Brazilian retail sector. 41 Economic profit HSBC’s internal performance measures include economic profit, a measure which compares the return on the financial capital invested in HSBC by its shareholders with the cost of that capital. HSBC prices its cost of capital internally and the difference between that cost and post-tax profit attributable to ordinary shareholders represents the amount of economic profit generated. Economic profit is used by management as one of the measures to decide where to allocate resources so that they will be most productive. In order to concentrate on external factors rather than measurement bases, HSBC emphasises the trend in economic profit within business units rather than absolute amounts. In light of the current levels of world interest rates, and taking into account the Group’s geographical and customer group diversity, HSBC believes that its true cost of capital on a consolidated basis is approximately 10 per cent. HSBC plans to continue using this cost until the end of the current five year strategic plan, which expires at the end of 2008, in order to ensure consistency and comparability. The cost of capital under the previous strategic plan, which expired at the end of 2003, was 12.5 per cent. On this basis, economic profit increased by US$3,773 million compared with 2003, reflecting both the lower cost of capital rate and improved profitability. H S B C H O L D I N G S P L C Financial Review (continued) At 31 December 2004, assets held by HSBC as custodian amounted to US$2,819 billion. Custody is the safekeeping and administration of securities and financial instruments on behalf of others, and the inclusion of Bank of Bermuda was responsible for much of the increase. Debt securities and equity shares Debt securities held on an accruals basis in the investment book at 31 December 2004 showed an aggregate unrecognised gain, net of off-balance sheet hedges, of US$1,005 million compared with an unrecognised gain of US$1,160 million at 31 December 2003. Equity shares included US$4,709 million held on investment account, compared with US$5,390 million at 31 December 2003, on which there was an unrecognised gain of US$879 million, compared with US$827 million at 31 December 2003. Funds under management Funds under management of US$476 billion were US$57 billion, or 14 per cent, higher than at 30 June 2004 and US$90 billion, or 23 per cent, higher than at the end of 2003. The inclusion of US$22 billion of funds relating to Bank of Bermuda, and continued strong funds inflows from both the asset management and private banking businesses, were responsible for the increase. The weakening of the US dollar benefited the translation of sterling and euro-denominated funds, and contributed to the positive market performance. At 31 December 2004, HSBC’s asset management business, including affiliates, reported funds under management of US$224 billion, and the private banking business reported funds under management of US$178 billion. Funds under management At 1 January ..................................... Net new money ................................ – Bank of Bermuda ........................... – Other ............................................. Value change ................................... Exchange and other .......................... At 31 December ............................... 2004 US$bn 2003 US$bn 386 64 22 42 19 7 476 306 42 – 42 25 13 386 42 Average shareholders’ funds before dividends................................................... Add: dividends declared but not paid ............................................................... Average shareholders’ funds ............................................................................. Add: cumulative goodwill written off and amortised ....................................... Less: property revaluation reserves ................................................................... Average invested capital2 .................................................................................. Profit after tax ................................................................................................... Add: goodwill amortisation .............................................................................. depreciation charged on property revaluations ........................................ Less: equity minority interest ........................................................................... preference dividends ............................................................................... Return on invested capital3 ................................................................................ Benchmark cost of capital ................................................................................. Economic profit/spread ..................................................................................... Year ended 31 December 2004 US$m 80,220 1,888 82,108 9,873 (2,013) 89,968 13,101 1,818 46 (586) (675) 13,704 (8,997) 4,707 %1 14.6 2.0 – (0.7) (0.7) 15.2 (10.0) 5.2 2003 US$m 67,585 1,773 69,358 8,172 (1,824) 75,706 9,696 1,585 38 (487) (435) 10,397 %1 12.8 2.1 – (0.6) (0.6) 13.7 (9,463) (12.5) 934 1.2 1 Expressed as a percentage of average invested capital. 2 Average invested capital is measured as shareholders’ funds after adding back goodwill amortised and goodwill previously written-off directly to reserves and after deducting property revaluation reserves. This measure reflects capital initially invested and subsequent profit (excluding goodwill amortisation). 3 Return on invested capital is based on attributable profit excluding goodwill amortisation adjusted for depreciation attributable to revaluation surpluses. 43 H S B C H O L D I N G S P L C Financial Review (continued) Analysis by Customer Group and by Geographical Region By Customer Group: Profit/(loss) excluding goodwill amortisation Personal Financial Services US$m Consumer Finance4 US$m Total Personal Financial Services US$m Total Year ended 31 December 2004 Corporate, Investment Banking & Markets US$m Commercial Banking US$m Private Banking US$m Net interest income ......... 10,290 11,176 21,466 Dividend income .............. Net fees and commissions Dealing profits ................. Other income .................... Other operating income .... 8 4,568 192 1,011 5,779 9 1,893 – 1,004 2,906 17 6,461 192 2,015 8,685 Operating income ........... 16,069 14,082 30,151 4,884 6 2,742 142 656 3,546 8,430 3,821 565 2,802 1,929 873 6,169 9,990 718 5 962 257 17 1,241 1,959 Inter- segment elimination US$m – – – – (2,378) (2,378) (2,378) Other6 US$m 135 8 126 46 2,120 2,300 2,435 Total US$m 31,024 601 13,093 2,566 3,303 19,563 50,587 (9,601) (4,997) (14,598) (4,107) (5,649) (1,325) (2,574) 2,378 (25,875) 6,468 9,085 15,553 4,323 4,341 634 (139) (1,155) (5,457) (6,612) (227) 473 (80) (2) – – (80) (2) 10 (1) 5,231 3,628 8,859 4,105 – 75 71 – – 39 – 75 110 – 57 7 (38) (11) 4,765 5 96 330 5,377 3,667 9,044 4,169 5,196 % 27.7 59.7 % 18.9 35.5 % 46.6 48.4 % 21.5 48.7 % 26.7 56.5 9 4 (2) 645 – – 48 693 % 3.6 67.6 US$m US$m US$m US$m US$m US$m – 77 16 (46) – 63 307 324 % 1.6 105.7 US$m – – – – – – – – – 24,712 (6,357) (27) – 18,328 5 291 802 19,426 % 100.0 51.1 US$m 233,829 274,995 319,081 137,100 163,420 552 370,929 438,415 319,633 129,939 160,299 137,847 142,160 582,975 177,936 24,463 56,466 57,780 2,340 26,745 555 669,831 1,264,900 693,751 128,001 234,867 79,927 115,668 519 – 519 875 1 876 271 3 274 359 – 359 309 – 309 – – – 1,814 4 1,818 Operating expenses excluding goodwill amortisation1................ Operating profit/(loss) before provisions1 ..... Provisions for bad and doubtful debts ............. Provisions for contingent liabilities and commitments ............... Amounts (written off)/ written back on fixed asset investments Operating profit/(loss)1 .. Share of operating profit in joint ventures .......... Share of operating profit in associates2 .............. Gains on disposal of investments and tangible fixed assets .... Profit on ordinary activities before tax3 .. Share of HSBC’s pre-tax profits3 ........................ Cost:income ratio1 ............ Selected balance sheet data7 Loans and advances to customers (net) ........... Total assets8 ..................... Customer accounts ........... The following assets and liabilities were significant to customer groups as noted: Loans and advances to banks (net) .................. Debt securities, treasury bills and other eligible bills ............................. Deposits by banks ............ Debt securities in issue...... Goodwill amortisation excluded: 1 from (1) above ................. 2 from (2) above ................. 3 from (3) above ................. 356 1 357 For other footnotes, see page 59. 44 Personal Financial Services US$m Consumer Finance5 US$m 8,654 6 3,623 133 834 4,596 8,289 12 1,219 – 674 1,905 Total Personal Financial Services US$m 16,943 18 4,842 133 1,508 6,501 Total Net interest income/(expense) ....... Dividend income .............. Net fees and commissions Dealing profits/(losses) .... Other income9 ................... Other operating income9.... Operating income9........... 13,250 10,194 23,444 Year ended 31 December 2003 Corporate, Investment Banking & Markets US$m Commercial Banking US$m Private Banking US$m 4,196 3 2,256 118 587 2,964 7,160 3,899 161 2,315 1,764 805 5,045 8,944 574 3 822 209 50 1,084 1,658 Inter- segment elimination US$m – – – – (1,208) (1,208) (1,208) Other6 US$m (14) 37 159 (46) 938 1,088 1,074 Total US$m 25,598 222 10,394 2,178 2,680 15,474 41,072 (8,232) (3,397) (11,629) (3,768) (4,373) (1,149) (1,371) 1,208 (21,082) 5,018 6,797 11,815 3,392 4,571 509 (297) doubtful debts ............. (1,058) (4,575) (5,633) (274) (297) Provisions for contingent liabilities and commitments ............... Amounts (written off)/ written back on fixed asset investments (19) (18) – – (19) (18) 14 – (53) (91) Operating profit/(loss)1 .. 3,923 2,222 6,145 3,132 4,130 (2) (2) (3) 502 – – 61 563 % 3.9 69.3 113 16 6 (162) – 74 92 4 % – 127.7 US$m – – – – – – – – – 19,990 (6,093) (44) (106) 13,747 19 221 414 14,401 % 100.0 51.3 US$m 11 47 27 – – 3 11 47 30 – 20 6 8 80 225 4,008 2,225 6,233 3,158 4,443 % 27.8 62.1 % 15.5 33.3 % 43.3 49.6 % 21.9 52.6 % 30.9 48.9 US$m US$m US$m US$m US$m US$m 173,613 206,694 290,540 116,409 145,383 232 290,022 352,077 290,772 103,495 128,086 111,515 115,092 462,995 119,335 18,109 54,510 50,951 2,259 25,561 557 528,977 1,023,229 573,130 Operating expenses excluding goodwill amortisation1,9.............. Operating profit/(loss) before provisions1 ..... Provisions for bad and Share of operating profit in joint ventures2 ......... Share of operating profit in associates2 ............... Gains on disposal of investments and tangible fixed assets .... Profit on ordinary activities before tax3 .. Share of HSBC’s pre-tax profits3 ........................ Cost:income ratio1 ............ Selected balance sheet data7 Loans and advances to customers (net) ........... Total assets8,9 ................... Customer accounts ........... The following assets and liabilities were significant to customer groups as noted: Loans and advances to banks (net) .................. Debt securities, treasury bills and other eligible bills ............................. Deposits by banks ............ Debt securities in issue...... Goodwill amortisation excluded: 1 from (1) above ............. 2 from (2) above ............. 3 from (3) above ............. 249 1 250 For other footnotes, see page 59. 101,277 186,139 65,882 110,905 379 – 379 628 1 629 263 – 263 272 135 407 282 – 282 5 (1) 4 1,450 135 1,585 45 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation (continued) Year ended 31 December 2002 Total Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Net interest income/(expense) ............................... 7,429 3,835 3,700 Dividend income ..................................................... Net fees and commissions ....................................... Dealing profits ........................................................ Other income9 .......................................................... Other operating income9........................................... 6 2,979 50 773 3,808 Operating income9.................................................. 11,237 6 1,934 107 459 2,506 6,341 230 2,164 1,008 609 4,011 7,711 Operating expenses excluding goodwill amortisation1,9 .................................................... (6,958) (3,149) (3,898) Operating profit/(loss) before provisions1............. 4,279 3,192 3,813 Provisions for bad and doubtful debts ..................... Provisions for contingent liabilities and commitments ..................................................... Amounts (written off)/written back on fixed asset investments ........................................................ (857) (269) (184) (42) (2) 19 3 Operating profit/(loss)1 .......................................... 3,378 2,945 Share of operating profit/(loss) in joint ventures2 .... Share of operating profit/(loss) in associates ............ Gains on disposal of investments and tangible fixed assets ........................................................ (23) 17 19 3 15 51 Profit/(loss) on ordinary activities before tax3 ...... 3,391 3,014 Share of HSBC’s pre-tax profits3 ............................. Cost:income ratio1.................................................... % 32.3 61.9 % 28.7 49.7 12 (109) 3,532 2 45 317 3,896 % 37.1 50.6 Private Banking US$m 549 2 623 137 102 864 1,413 (987) 426 (5) (21) (22) 378 (1) (10) 46 413 % 3.8 69.9 Inter- segment elimination US$m Total US$m – 15,460 – – – (1,148) (1,148) (1,148) 278 7,824 1,313 1,720 11,135 26,595 Other6 US$m (53) 34 124 11 925 1,094 1,041 (1,110) 1,148 (14,954) (69) (6) (75) (194) (344) – 68 75 (201) % (1.9) 106.6 – – – – – – – – – 11,641 (1,321) (107) (324) 9,889 (19) 135 508 10,513 % 100.0 56.2 US$m 352,344 749,160 495,438 US$m US$m US$m US$m US$m 143,696 171,478 257,880 90,562 113,520 92,884 101,770 394,540 95,351 14,115 48,346 49,012 2,201 21,276 311 80,870 162,583 48,895 236 8 244 186 – 186 168 – 168 264 – 264 – 1 1 854 9 863 Selected balance sheet data7 Loans and advances to customers (net) ................... Total assets8,9 ........................................................... Customer accounts .................................................. The following assets and liabilities were significant to Corporate, Investment Banking and Markets: Loans and advances banks (net) .............................. Debt securities, treasury bills and other eligible bills .................................................................... Deposits by banks ................................................... Goodwill amortisation excluded: 1 from (1) above .................................................... 2 from (2) above .................................................... 3 from (3) above .................................................... For other footnotes, see page 59. 46 Personal Financial Services Profit excluding goodwill amortisation Business highlights Year ended 31 December 2004 US$m 2003 US$m 2002 US$m Net interest income ............ 10,290 Dividend income .................. Net fees and commissions .... Dealing profits ..................... Other income9 ...................... Other operating income9 ...... 8 4,568 192 1,011 5,779 8,654 6 3,623 133 834 4,596 7,429 6 2,979 50 773 3,808 Operating income9 ............. 16,069 13,250 11,237 Operating expenses excluding goodwill amortisation1,9 ... Operating profit before provisions1 ....................... Provisions for bad and (9,601) (8,232) (6,958) 6,468 5,018 4,279 • doubtful debts .................. (1,155) (1,058) (857) Provisions for contingent liabilities and commitments Amounts written off fixed asset investments ............. (80) (2) (19) (18) (42) • (2) Operating profit1 ................ 5,231 3,923 3,378 Share of operating profit/(loss) in joint ventures ............... Share of operating profit in associates2..................... Gains on disposal of investments and tangible fixed assets ...................... Profit on ordinary activities before tax3 ....................... By geographical region: Europe .................................. Hong Kong ........................... Rest of Asia-Pacific ............. North America ..................... South America ..................... Profit on ordinary activities before tax3........................ Share of HSBC’s pre-tax profits3 ............................. Cost:income ratio1 ................ Selected balance sheet data7 Loans and advances to customers (net) ................ Total assets8,9 ........................ Customer accounts ............... Goodwill amortisation: 1 excluded from (1) above ... 2 excluded from (2) above ... 3 excluded from (3) above ... For other footnotes, see page 59. – 75 71 11 47 27 (23) 17 19 5,377 4,008 3,391 1,719 2,097 350 1,164 47 1,267 1,740 158 870 (27) 987 1,705 127 605 (33) 5,377 4,008 3,391 % 27.7 59.7 % 27.8 62.1 % 32.3 61.9 US$m US$m US$m 233,829 274,995 319,081 173,613 206,694 290,540 143,696 171,478 257,880 356 1 357 249 1 250 186 – 186 General • Pre-tax profit before goodwill amortisation grew by 34 per cent to US$5,377 million. At constant exchange rates and excluding acquisitions, profits increased by 27 per cent. • The one millionth HSBC Premier customer was recruited in May, and by the end of 2004, HSBC had recruited over 1.1 million Premier customers, an increase of 28 per cent compared with the end of 2003. HSBC Premier was launched in Mexico, Bermuda, Greece and Malta during the year. In September 2004, HSBC was voted ‘Global Bank of the Year’ by The Banker magazine for an unprecedented third consecutive year. In November 2004, HSBC was named ‘Best Consumer Bank’ in Global Finance magazine’s listing of the World’s Best Banks 2004. • In December 2004, HSBC was named the ‘International Retail Bank of the Year 2004’ in the Retail Banker International magazine’s annual award. Europe • In December 2004, the three millionth personal internet banking customer was recruited in the UK. • At First Direct, 39 per cent of HSBC’s customers actively used its online banking service and more than 70 per cent of inbound contacts from its customers were over the internet in 2004. • Logons to the CCF.fr website in France almost doubled to 11 million in 2004 and over one million transactions were carried out through the site, an increase of 30 per cent over 2003. • During the Autoroutes Paris Rhin Rhone privatisation, CCF organised the first ever on-line sale of shares to personal customers in France. • In the UK, HSBC’s mortgage products remained highly rated, receiving the ‘Best National Bank’ award over two, five and 10 years from What Mortgage magazine in March 2004. In July 2004, Mortgage Magazine named HSBC as ‘Best First Time Buyer Lender’. HSBC ranked first in the ‘Moneyfacts Top 35 Lenders Survey’ for the amount of interest charged over the 12 months ended 31 December 2004 (£100,000 mortgage at the 47 H S B C H O L D I N G S P L C Financial Review (continued) lender’s standard variable rate). First Direct was awarded ‘Best Internet Lender’ by Mortgage Advisor and Home Buyer magazine for its Offset mortgage. • Following the acquisition of M&S Money and the successful joint management with the John Lewis Partnership of the John Lewis, Peter Jones and Waitrose store card, HSBC became one of the UK’s top credit card issuers. The M&S Money transaction brought an additional 3.5 million customers. Hong Kong • New products, including a range of structured treasury products, capital-guaranteed funds, open-ended funds and certificates of deposit were launched to broaden the range of investment options in Hong Kong. Sales of unit trusts and structured investment products reached record levels. HSBC also recorded growth of 40 per cent in new regular premium life insurance sales, driven by the success of flexible products tailored to customers’ specific needs, such as the Target Protection Plus product. • HSBC maintained its position as the largest credit card issuer in Hong Kong. An attractive rewards programme, customer acquisition, and successful cross-sales to both existing and new customers, helped grow the number of cards in circulation in Hong Kong by 14 per cent and cardholder spending by 32 per cent. • In 2004, renminbi financial services were launched in Hong Kong, offering a comprehensive range of deposits, currency exchange and remittance services. Rest of Asia-Pacific • There are now over 5 million personal customers across the Rest of Asia-Pacific. • HSBC is the leading international unit trust agent in Malaysia. Unit trust sales increased by 22 per cent in 2004. Islamic Banking was launched during the year in UAE, globally branded as HSBC Amanah. HSBC currently offers customers Amanah current accounts, personal finance, vehicle finance and funds. The HSBC Amanah Global Equity Index Fund was also launched. This is the first index tracker fund to invest in the 100 largest Shariah-compliant companies by market capitalisation. Shariah compliant mortgages, • 48 term deposits and savings accounts will be launched in 2005. • In March 2004, India launched “Smart Home” mortgages. The product offers a reduction of interest paid when extra funds are deposited into the Smart Home account and the flexibility to redraw the extra funds paid. Balances of mortgages increased by 112 per cent year on year. North America • Free current account services were successfully launched in the US, which has attracted over 110,000 new customers and added some US$200 million in deposits in the first nine months. • Customer deposits and insurance revenues grew strongly in Mexico, in conjunction with the launch of HSBC Premier. Despite an increasingly competitive marketplace, market share in deposits rose by 60 basis points to 14.4 per cent, leveraging the bank’s extensive branch and ATM network. • On 10 June 2004, HSBC Bank USA successfully launched its first major integrated marketing initiative towards the Hispanic market called ‘¿Quieres un Mejor Banco?’. In addition to building awareness of the bank in the Spanish community, new customer growth increased market penetration by 11 per cent. This campaign attracted over 39,000 new account openings. • The rollout of HSBC Finance Corporation’s proprietary credit card system, WHIRL, will enable HSBC to accelerate the growth in card volumes in a number of countries. Operations in Mexico and the US completed the migration to WHIRL in 2004: the UK transferred in early 2005 and a number of operations in Asia will follow over the next two years. South America • The integration of the Losango business acquired at the end of 2003 progressed well. Good progress was made in delivering anticipated operational synergies and HSBC took a market-leading approach by sharing branches with the Losango franchise. Losango benefited from the acquisition of two additional consumer portfolios, Valeu Promotora de Vendes, in Rio de Janeiro and CrediMatone S.A. in the South of Brazil, increasing the total number of sales outlets by 114 to 288. Consumer Finance Profit excluding goodwill amortisation Business highlights Year ended 31 December 20044 US$m 20035 US$m Net interest income ................................. 11,176 Dividend income ....................................... Net fees and commissions ......................... Other income ............................................ Other operating income ............................. 9 1,893 1,004 2,906 8,289 12 1,219 674 1,905 Operating income .................................... 14,082 10,194 Operating expenses excluding goodwill amortisation1 ......................................... (4,997) (3,397) Operating profit before provisions1 ....... 9,085 6,797 Provisions for bad and doubtful debts ....... (5,457) (4,575) Operating profit1 ..................................... 3,628 2,222 • Gains on disposal of investments and tangible fixed assets .............................. 39 • 3 Profit on ordinary activities before tax1 ............................................ 3,667 2,225 By geographical region: Europe ....................................................... North America .......................................... Profit on ordinary activities 91 3,576 157 2,068 before tax1 ............................................ 3,667 2,225 • Consumer Finance reported a pre-tax profit, before goodwill amortisation, of US$3,667 million, of which US$1,126 million was an additional quarters’ contribution. Excluding this, and at constrant exchange rates, pre-tax profit grew by 13 per cent to US$2,541 million. In September 2004, HSBC extended its brand across a number of its Consumer Finance businesses in the US. In early 2005, the rebranding efforts will continue with the rebranding of HSBC Finance Corporation’s vehicle finance and credit cards businesses. The branch based Consumer Finance business will retain the HFC and Beneficial brands, accompanied by the endorsement signature, ‘Member HSBC Group’. In December 2004, Household International, Inc. merged with its wholly owned subsidiary and changed its name to HSBC Finance Corporation. The name change was a continuation of the rebranding of the Household businesses to the HSBC brand. These actions were taken to establish a single brand in North America to create a stronger platform to advance growth across all HSBC business lines. Share of HSBC’s pre-tax profits1 .............. Cost:income ratio1 ..................................... Selected balance sheet data7 Loans and advances to customers (net) ..... Total assets8 ............................................... Debt securities in issue .............................. % 18.9 35.5 % 15.5 33.3 US$m US$m 137,100 163,420 115,668 116,409 145,383 110,905 Goodwill amortisation: 1 excluded from (1) above ........................ 519 379 For other footnotes, see page 59. • Strong improvement was seen in credit quality, driven by the economic upturn, improved origination quality, growth in the relative proportion of secured receivables, improved collection activity, and the effect on product mix of HSBC Finance Corporation’s move into prime and near-prime markets. Improvements were seen across most products and in a number of key indicators. The rate of improvement began to slow in the second half of the year reflecting the maturing of the portfolio, less robust employment growth and rising energy prices. • Loans and advances to customers grew by 18 per cent to US$137.1 billion, mainly driven by strong organic loan growth in mortgages and vehicle finance. • Expansion into prime and near-prime markets in the US contributed to strong growth in customer loan balances, particularly in the mortgage business. Residential mortgage balances increased from US$46.1 billion at the end of 2003 to US$60.8 billion by the end of 2004. 49 H S B C H O L D I N G S P L C Financial Review (continued) • • In October 2004, Household Mortgage Services was rebranded HSBC Mortgage Services. The launch of a new marketing campaign, new product line and an increase in sales staff resulted in a record number of account acquisitions. Nearly 50 per cent of all mortgage applications were processed on-line in 2004. Greater efficiency was achieved in collections and servicing of mortgages. In December 2004, HSBC Bank USA received regulatory approval to purchase HSBC Finance Corporation’s domestic private label portfolio totalling US$15.6 billion, the transfer was completed on 29 December 2004. HSBC Finance Corporation will continue to maintain the customer account relationships for the assets transferred. • During 2004, retail services in the US launched new financing programmes with high-profile manufacturers and retailers. These include American Suzuki Corporation, Liz Claiborne and Helzberg Diamonds. In addition, HSBC Business Solutions, the business-to-business financial arm of retail services, became the commercial financing partner for Komatsu, Mac Tools and Northern Tool & Equipment Co. • America’s largest labour union, AFL-CIO, and card services, agreed to extend the term of their successful affinity card programme. Card services also added new affinity groups to its partnership programme and rolled out the Cards-in-Branches scheme to HFC and Beneficial branches throughout the US. More than 5.9 million value-added service product memberships are now held by cardholders and HSBC Finance Corporation has expanded into the prime segment of the credit card market under the HSBC brand. • Projected operating synergies were achieved through the integration of HSBC and HBSC Finance Corporation. The merger of the technology services teams of both HSBC and HSBC Finance Corporation in North America was completed; all HSBC’s global credit card technology is now co-ordinated from North America. HSBC Finance Corporation’s use of HSBC’s Group Service Centres was expanded, with over 1,800 employees in the centres now supporting the Consumer Finance business. Purchasing activities in North America were also consolidated, and 45 major vendor relationships renegotiated, with annual savings in excess of US$67 million, US$26 million of such savings directly resulting from the integration of HSBC and HSBC Finance Corporation. • At the end of 2003, the motor vehicle finance businesses of HSBC Finance Corporation and HSBC Bank USA were combined and their product offerings were merged onto a single platform. In January 2004, a new prime financing programme was launched through HSBC Bank USA. Organic growth of US$1.4 billion in motor vehicle finance loans was primarily achieved through the company’s network of 5,200 motor dealers, extensive alliance relationships, and direct sales channels. 50 Commercial Banking Profit excluding goodwill amortisation Business highlights Year ended 31 December 2004 US$m 2003 US$m 2002 US$m Net interest income ............ Dividend income .................. Net fees and commissions .... Dealing profits ..................... Other income9 ...................... Other operating income9 ...... Operating income9 ............. Operating expenses excluding goodwill amortisation1,9 ... Operating profit before provisions1 ....................... Provisions for bad and 4,884 6 2,742 142 656 3,546 8,430 4,196 3 2,256 118 587 2,964 7,160 3,835 6 1,934 107 459 2,506 6,341 (4,107) (3,768) (3,149) 4,323 3,392 3,192 doubtful debts .................. (227) (274) (269) Provisions for contingent liabilities and commitments Amounts (written off)/written back on fixed asset investments ...................... 10 (1) 14 – 19 3 Operating profit1 ................ 4,105 3,132 2,945 Share of operating profit in joint ventures ................... Share of operating profit in associates2......................... Gains on disposal of investments and tangible fixed assets ...................... Profit on ordinary activities before tax3 ....................... By geographical region: Europe .................................. Hong Kong ........................... Rest of Asia-Pacific ............. North America ..................... South America ..................... Profit on ordinary activities before tax3........................ Share of HSBC’s pre-tax profits3 ............................. Cost:income ratio1 ................ Selected balance sheet data7 Loans and advances to customers (net) ................ Total assets8,9 ........................ Customer accounts ............... Goodwill amortisation: 1 excluded from (1) above ... 2 excluded from (2) above ... 3 excluded from (3) above ... For other footnotes, see page 59. – 57 7 – 20 6 3 15 51 4,169 3,158 3,014 1,749 914 496 845 165 1,303 711 450 595 99 1,344 733 423 435 79 4,169 3,158 3,014 % 21.5 48.7 % 21.9 52.6 % 28.7 49.7 US$m US$m US$m 129,939 160,299 137,847 103,495 128,086 111,515 90,562 113,520 92,884 271 3 274 263 – 263 168 – 168 General • Pre-tax profit before goodwill amortisation was 32 per cent higher than last year. At constant exchange rates and excluding acquisitions, profits increased by 24 per cent because of good revenue growth and improving credit quality. • Customer numbers rose by 6 per cent to 2.3 million, while loans and advances to customers increased by 26 per cent and customer accounts by 24 per cent. • • • Sales activity expanded across the segment. Global relationship management was launched in 2004 for well-established relationship with customers with international business dealings. Inward referral champions were appointed in 35 countries to maximise cross border-referral business. Segmentation of the customer base continued in 2004, with the successful approach adopted in UK corporate banking being repeated in other countries for top tier customers. An increase in the number of commercial centres and a change in the focus of their activities, and new packaged products, benefited Smaller and Medium Enterprises (‘SME’). Internet Banking customer numbers increased by 43 per cent. The internet represents a rapidly growing revenue source, generating over US$50 million from transactions, fees and e-sales in 2004. Global e- development resources were rationalised in 2004 to extract cost synergies from utilising common IT platforms. • HSBCnet, the Group’s new ‘e’ banking platform for corporate and mid-market customers, was introduced and now has customers in 30 countries in Asia Pacific, Europe, North America and the Middle East. Services include a range of transaction banking and treasury products. • Major initiatives commenced in the second half of 2004, aimed at significantly increasing the sale of business insurance and commercial wealth management products to relevant customers in a number of selected countries. • In November, HSBC retained the title of ‘Best Clearing Bank for Small Businesses’ awarded by the Forum of Private Business in the UK. It is the fourth consecutive time that HSBC has won the title, which is awarded every two years. 51 H S B C H O L D I N G S P L C Financial Review (continued) • Finance Asia and Global Finance named HSBC ‘Best Trade Finance Bank’ in Asia and in Hong Kong for the eighth and fourth successive years respectively. HSBC was also named ‘Best Foreign Commercial Bank’ in China, India, Indonesia and Malaysia. Europe • • In the UK, the segmentation of customers was refined. 21 corporate banking centres were launched to service top tier customers, a further 209 commercial centres were established to address the banking needs of larger SMEs, while for the rest of the SME market a dedicated outbound contact unit was created. 2004 was a record year for commercial acquisitions, which, coupled with the best customer retention of any UK high street bank, resulted in HSBC reporting a net gain in commercial customers. Over 100,000 start-up business accounts were opened, and HSBC now has a 20 per cent market share. • New products were launched, including business wealth planning, an award-winning flexible commercial mortgage, and HSBCnet. • In France, an exercise was undertaken to segment HSBC’s customer base, creating dedicated regional teams to manage major commercial banking relationships. Some significant early successes in transactional and investment banking mandates and cross border referrals were achieved. Hong Kong • Five business banking centres were established in 2004, serving small commercial customers. Located in key business areas, they offer a one- stop service for account opening, trade services and insurance sales. • HSBC launched the first ever Hong Kong marketing campaign aimed at SME start-up businesses. The start-up segment has experienced sustained growth and new account openings in 2004 increased by 49 per cent. 2004 was a record year for new facilities put in place for Hong Kong and Taiwanese customers in mainland China, which more than doubled on 2003. A first-of-its-kind, co-ordinated advertising campaign in Hong Kong, mainland China and Taiwan was launched in October to further awareness of HSBC’s Greater China capabilities and to promote the Group across the region. The full effect of the campaign is • 52 expected to contribute positively to performance in 2005. Rest of Asia-Pacific • HSBC Middle East launched HSBCnet across 6 countries in the region. Express Cash Service, an offering designed to assist corporate customers with the transportation of large volumes of cash, was launched in the UAE and Qatar. • Islamic business in Commercial Banking experienced strong growth in Malaysia, with customer advances more than doubling and accounting for approximately 80% of the HSBC Bank Malaysia’s Islamic-based customer advances. North America • Business Smart was launched in the US in September. Business Smart is the first product from a major financial institution in New York City to offer commercial customers free checking accounts. 11,000 accounts were opened in the three months following the launch. • The commercial real estate business on the US West coast successfully expanded beyond Los Angeles and San Francisco to other areas in California, including San Diego. • In Mexico, a new product for small businesses, Estímulo, was launched. The product offers an integrated package of financial services, targeting a sector which is currently under- served by banks. South America • In Brazil, HSBC Seguros launched two new insurance products targeted at small and micro- sized enterprises. EmpresaSegura is a property insurance product and VidaProtegida Empresarial is a group life and personal accident policy. • Cross-selling to commercial customers of Losango boosted loan growth in Brazil. Thirty- six per cent of this customer base purchased HSBC products, with more than 5,000 new accounts opened in 2004. Corporate, Investment Banking and Markets Profit excluding goodwill amortisation Business highlights 12 (109) 3,532 2 45 Year ended 31 December 2004 US$m 2003 US$m 2002 US$m Net interest income ............ Dividend income .................. Net fees and commissions .... Dealing profits ..................... Other income9 ...................... Other operating income9 ...... Operating income9 ............. Operating expenses excluding goodwill amortisation1,9 ... Operating profit before provisions1 ....................... Provisions for bad and 3,821 565 2,802 1,929 873 6,169 9,990 3,899 161 2,315 1,764 805 5,045 8,944 3,700 230 2,164 1,008 609 4,011 7,711 (5,649) (4,373) (3,898) 4,341 4,571 3,813 doubtful debts .................. 473 (297) (184) Provisions for contingent liabilities and commitments Amounts written off fixed asset investments ............. (38) (11) (53) (91) Operating profit1 ................ 4,765 4,130 Share of operating profit in joint ventures2 .................. Share of operating profit in associates ......................... Gains on disposal of investments and tangible fixed assets ...................... Profit on ordinary activities before tax3 ....................... By geographical region: Europe .................................. Hong Kong ........................... Rest of Asia-Pacific ............. North America ..................... South America ..................... Profit on ordinary activities before tax3 ....................... Share of HSBC’s pre-tax profits3 ............................. Cost:income ratio1 ................ Selected balance sheet data7 Loans and advances to: – customers (net) .................. – banks (net) ........................ Total assets8,9 ........................ Customer accounts ............... Debt securities, treasury bills and other eligible bills ...... Deposits by banks ................ Goodwill amortisation: 1 excluded from (1) above ... 2 excluded from (2) above ... 3 excluded from (3) above ... For other footnotes, see page 59. 5 96 8 80 330 225 317 5,196 4,443 3,896 1,772 1,584 940 750 150 1,623 1,275 732 837 (24) 1,438 1,226 706 494 32 5,196 4,443 3,896 % 26.7 56.5 % 30.9 48.9 % 37.1 50.6 US$m US$m US$m 142,160 128,001 582,975 177,936 115,092 101,277 462,995 119,335 101,770 80,870 394,540 95,351 234,867 79,927 186,139 65,882 162,583 48,895 359 – 359 272 135 407 236 8 244 • Pre-tax profits, before amortisation of goodwill, increased by 17 per cent, to US$5,196 million. At constant exchange rates and excluding acquisitions, profits rose by 11 per cent. Operating income was 3 per cent higher, reflecting strong growth in foreign exchange and derivatives revenues together with increased fee income from transaction banking services. Operating expenses, excluding goodwill amortisation, grew by 16 per cent as we invested in the people and infrastructure necessary to upgrade our client proposition. A total net release of provisions for bad and doubtful debts compared favourably with a net charge in 2003. In 2004, substantial progress was made in realigning Corporate, Investment Banking and Markets’ businesses, in improving links between client relationship management, product specialists and HSBC’s geographical network, and in establishing multi-disciplinary, global client service teams. Some 2,000 people, including over 100 senior managers, were recruited in a planned restructuring designed to attract the best staff at all levels. At the same time, some 1,500 people departed. In Global Markets, HSBC maintained strong business momentum. Significant revenue gains were made in the areas of foreign exchange, with the rollout of the eFX platform, and derivatives, by developing risk management solutions for clients. These gains reflected the investment made in these areas in the previous year. In 2004, the business continued to invest for growth by strengthening infrastructure and systems, upgrading staff capabilities and improving product and customer delivery. • • • HSBC’s share of the international bond issuance market rose to 4.9 per cent from 4.4 per cent in 2003, raising in excess of US$114 billion, a direct result of the substantial investment in bond origination, trading and sales since 2002. • The restructuring of Global Investment Banking involved the recruitment of an additional 215 staff. HSBC played a leading role in several notable advisory and financing transactions including LNM Holdings’ US$17.0 billion reverse merger with Ispat International to form Mittal Steel; Saudi Arabian Oil Company’s acquisition of a stake in Showa Shell Sekiyu K.K. (Japan) from the Royal Dutch/Shell Group; and Neptune Orient Lines’ US$1.7 billion take-over by Temasek Holding. 53 H S B C H O L D I N G S P L C Financial Review (continued) • HSBC acted as the sole financial advisor to Total SA in the take-over bid launched by its subsidiary, Sanofi-Synthélabo, for Aventis, to create the world’s 3rd largest pharmaceutical group. • HSBC continued to make progress in Europe and the Americas, arranging major financing for clients, including a US$11.8 billion multi- tranche financing for Network Rail. • HSBC debt finance successfully completed a US$2.4 billion syndicated facility for Telefonos de Mexico S.A. de C.V. (Telmex) and acted as a joint lead and bookrunner on a US$1.75 billion bond issue for Petroleos Mexicanos (PEMEX), a pioneering transaction which opened the Asian and retail markets for Latin American credit. HSBC Chile, in conjunction with New York debt capital markets, acted as a joint book- runner in a US$500 million bond issue for Codelco, achieving sub-sovereign pricing and placements with HSBC’s Asian investors. • HSBC acted as advisor on a number of significant transactions in equity capital markets, including Ping An Insurance Company’s US$1.8 billion initial public offering. HSBC also participated in the Hong Kong Government’s US$2.6 billion global bond offering. The French state’s US$1.5 billion issue of equity in Autoroutes Paris-Rhin-Rhone was the second privatisation of France’s motorway networks for which HSBC acted as a joint book- runner and advisor. • HSBC acted as sole bookrunner on Emirates Airlines’ debut US$500 million seven-year Eurobond issue, and was named Best Debt House in the United Arab Emirates in the Euromoney Awards for Excellence. • Within Corporate and Institutional Banking, the corporate loan market remained very competitive during 2004, with many clients taking advantage of low margins and bank demand for assets to refinance on preferential terms. • In the improving economic climate, HSBC achieved substantial recoveries against impaired loans, helped by extensive restructuring and refinancing activity worldwide. 54 • Following a significant development in 2004, HSBCnet provides a single point of entry to a range of sophisticated products and services tailored for corporate, institutional, and mid- market enterprise clients. The service is actively used by HSBC clients in more than 110 countries globally. Functionality includes award-winning economic research, treasury and capital markets cash management, cross-border payments, investment management and foreign exchange tools, in a format that can be personalised to meet clients’ individual needs. • Global research was developed to encompass Corporate, Institutional Banking and Markets’ research across all product areas. • In Global Transaction Banking, the successful integration of Bank of Bermuda contributed to an increase in profitability. In Asia, the payments and cash management product suite was significantly enhanced with the launch of ‘Integrated payables and integrated receivables’ via HSBCnet. • HSBC trade services benefited from increased customer flows. HSBC developed a distinct business line for Supply Chain, experiencing significant early success with a major retailer. • • In securities services, the successful integration of Bank of Bermuda’s alternative funds services, resulted in several new business opportunities. In addition, HSBC agreed a seven year deal with Gartmore to provide back office operations. In Group Investment Businesses, assets under management increased by 9 per cent to US$224.2 billion and included US$11.1 billion of net new client investments. Major successes included the distribution of specialist emerging market mutual funds through HSBC and third- party financial product distributors in Europe and Asia, strong growth in money market investments from corporates in Europe and North America, and flows into an alternative bond investment product marketed to institutions and private banks worldwide. Private Banking Profit excluding goodwill amortisation Business highlights Year ended 31 December 2004 US$m 2003 US$m 2002 US$m 718 5 962 257 17 1,241 1,959 574 3 822 209 50 1,084 1,658 549 2 623 137 102 864 1,413 (1,325) (1,149) (987) 634 509 426 General • Pre-tax profit excluding goodwill amortisation grew by 23 per cent compared with last year. At constant exchange rates and excluding acquisitions, profits increased by 21 per cent, supported by strong growth in funds under management. • At constant exchange rates and excluding the effect of the transfer of a corporate trust business to Corporate, Investment Banking and Markets in Hong Kong, funds under management increased by 24 per cent to US$178.2 billion, including US$13.1 billion of net new money, and US$17.1 billion of funds in Bank of Bermuda. (5) • The acquisition of Bank of Bermuda brought Net interest income ............ Dividend income .................. Net fees and commissions .... Dealing profits ..................... Other income ....................... Other operating income ........ Operating income ............... Operating expenses excluding goodwill amortisation1 ..... Operating profit before provisions1 ....................... Provisions for bad and doubtful debts .................. Provisions for contingent liabilities and commitments Amounts written off fixed asset investments ............. Operating profit1 ................ Share of operating loss in joint ventures2 .......................... Share of operating loss in associates2......................... Gains on disposal of investments and tangible fixed assets ...................... Profit on ordinary activities before tax3 ....................... By geographical region: Europe .................................. Hong Kong ........................... Rest of Asia-Pacific ............. North America ..................... South America ..................... Profit on ordinary activities before tax3........................ Share of HSBC’s pre-tax profits3 ............................. Cost:income ratio1 ................ 9 4 (2) 645 – – 48 693 432 135 59 66 1 693 % 3.6 67.6 (2) (2) (3) 502 – – (21) (22) 378 (1) (10) 61 46 563 413 339 127 36 63 (2) 563 % 3.9 69.3 236 107 25 57 (12) 413 % 3.8 69.9 Selected balance sheet data7 Loans and advances to customers (net) ................ Total assets8 .......................... Customer accounts ............... Goodwill amortisation: 1 excluded from (1) above ... 2 excluded from (2) above ... 3 excluded from (3) above ... For other footnotes, see page 59. US$m US$m US$m 24,463 56,466 57,780 18,109 54,510 50,951 14,115 48,346 49,012 309 – 309 282 – 282 264 – 264 considerable product and service strength to existing trust capabilities, and HSBC now ranks among the largest international private trust banks in the world. • HSBC grew its onshore Private Banking operations, with the addition of Bank of Bermuda’s onshore Bermudan business, and the launch of onshore private banking in Mexico in November, and Malaysia in May. Operations in Europe, Asia, and North America were strengthened through front office recruitment during the year. • The HSBC Private Bank brand was launched globally, supported by a major marketing campaign, bringing a single identity to HSBC’s core operation. Integration of the four French private banks was completed, and Bank of Bermuda’s private client businesses in Hong Kong, Luxembourg and Jersey were fully integrated. • HSBC won a number of awards in the Euromoney second annual private banking survey, including ‘1st private bank for trust services globally’, and ‘1st for Islamic banking in Switzerland, the UK, and Western Europe’. • Work was undertaken to strengthen links between Private Banking and the wider Group. A structure was put in place to facilitate global links and cross- selling activities with HSBC’s Commercial Banking businesses. A cross-referral process was established with Personal Financial Services and, for certain products, with Corporate, Investment Banking and Markets. 55 H S B C H O L D I N G S P L C Financial Review (continued) • Client interest in equity investment opportunities increased as markets continued their late-2003 recovery, and HSBC benefited from this through the launch of new products. Several new funds were introduced during the year, including a global Islamic fund. Banks in Switzerland by net profit, shareholders’ equity and balance sheet. • Internet transaction banking for clients was launched in the UK’s private banking website in December. • HSBC also continued to develop alternative North America investment products. Total client investment in hedge funds reached US$23 billion, following the launch of several new funds, reflecting growth of 40 per cent. • The Strategic Investment Solutions product was launched in the Americas and Channel Islands in March and May respectively, following its success in Geneva and Asia. Global assets under management invested in this product grew by US$0.7 billion to US$1.0 billion. • The lending book grew strongly, as clients sought to leverage their investments in the low interest environments in North America, Europe and Asia. In the UK, lending book growth was buoyed by strong growth in mortgages. Europe • HSBC’s French mutual funds portfolio won four awards for its performance in La Tribune and Standard & Poor’s ‘Victoires des Sicav 2004’. • HSBC was ranked the largest foreign bank in Switzerland by the Association of Foreign • The alignment of HSBC’s international and domestic private banking segments continued, bringing operational cost savings and a more coherent infrastructure. The integration of Wealth and Tax Advisory Services (‘WTAS’), acquired in the second half of 2002, and Bank of Bermuda, acquired in February 2004, including the cross-referral of clients, continued to make progress. • Private Banking and Corporate, Investment Banking and Markets structured products activities were integrated to share expertise and ensure a common approach. Asia • In Asia, HSBC won awards from Euromoney as ‘1st for Family Office Services in Asia’, ‘1st for Inheritance and Succession Planning in Asia’, ‘1st for Trust Services in Asia’, ‘1st in Hong Kong offshore’ and ‘1st in China Offshore’. 56 Other6 Profit excluding goodwill amortisation Business highlights Net interest income/(expense) Dividend income .................. Net fees and commissions .... Dealing profits/(losses) ........ Other income9 ...................... Other operating income9 ...... Operating income9 ............. Operating expenses excluding goodwill amortisation1,9 ... Operating loss before provisions1 ....................... Provisions for bad and doubtful debts .................. Provisions for contingent liabilities and commitments Amounts (written off)/written back on fixed asset investments ...................... Operating loss1 ................... Share of operating profit in associates2......................... Gains on disposal of investments and tangible fixed assets ...................... Profit /(loss) on ordinary activities before tax3 ....... By geographical region: Europe .................................. Hong Kong ........................... Rest of Asia-Pacific ............. North America ..................... South America ..................... Profit /(loss) on ordinary activities before tax3........ Share of HSBC’s pre-tax profits3 ............................. Cost:income ratio1 ................ Year ended 31 December 2004 US$m 2003 US$m 2002 US$m 135 8 126 46 2,120 2,300 2,435 (14) 37 159 (46) 938 1,088 1,074 (53) 34 124 11 925 1,094 1,041 • The Group Service Centres are included in ‘Other’. The creation of the North American technology company brought approximately US$970 million of costs within this category, all of which were recharged. Expansion and greater utilisation of the Group Service Centres outside the US saw their costs rise from US$97 million to US$171 million. As almost all their activity is recharged to HSBC users, their income also increased from US$93 million to US$173 million. (2,574) (1,371) (1,110) • Significant releases of provisions for bad and doubtful debts in Argentina during 2003 were not repeated in 2004. Net releases of provisions for contingent liabilities and commitments increased to US$77 million, largely due to the release of provisions raised in respect of pesification in Argentina. • Gains from disposals in Hong Kong arose from disposals of an associated company, long-term investments and a residential property. In addition, there were gains from the disposal of an insurance company in Europe, and profits from sales of government securities in Argentina. (139) (297) (69) – 77 16 (46) 63 307 324 409 23 32 (221) 81 324 % 1.6 105.7 113 16 (6) (75) 6 (162) (194) (344) 74 92 4 173 (123) 50 (176) 80 4 % 68 75 (201) 155 (61) 12 (207) (100) (201) % – 127.7 (1.9) 106.6 Selected balance sheet data7 Loans and advances to customers (net) ................ Total assets8,9 ........................ Customer accounts ............... Goodwill amortisation: 1 excluded from (1) above ... 2 excluded from (2) above ... 3 excluded from (3) above ... For other footnotes, see page 59. US$m US$m US$m 2,340 26,745 555 2,259 25,561 557 2,201 21,276 311 – – – 5 (1) 4 – 1 1 57 H S B C H O L D I N G S P L C Financial Review (continued) By Geographical Region: In the analysis of profit by geographical region that follows, operating income and operating expenses include intra- HSBC items of US$630 million (2003: US$422 million; 2002: US$326 million). Profit on ordinary activities before tax Europe .................................................. Hong Kong ........................................... Rest of Asia-Pacific ............................. North America ..................................... South America ..................................... 2004 US$m 5,225 4,744 1,805 5,419 415 % 29.6 26.9 10.3 30.8 2.4 Year ended 31 December 2003 US$m % 3,969 3,728 1,391 3,613 115 30.9 29.1 10.9 28.2 0.9 Total ..................................................... 17,608 100.0 12,816 100.0 Profit on ordinary activities before tax excluding goodwill amortisation Europe .................................................. Hong Kong ........................................... Rest of Asia-Pacific ............................. North America ..................................... South America ..................................... 2004 US$m 6,172 4,753 1,877 6,180 444 % 31.7 24.5 9.7 31.8 2.3 Year ended 31 December 2003 US$m % 4,862 3,730 1,426 4,257 126 33.7 25.9 9.9 29.6 0.9 2002 US$m 3,500 3,710 1,260 1,238 (58) 9,650 2002 US$m 4,160 3,710 1,293 1,384 (34) % 36.3 38.4 13.1 12.8 (0.6) 100.0 % 39.5 35.3 12.3 13.2 (0.3) Total ..................................................... 19,426 100.0 14,401 100.0 10,513 100.0 Total assets Europe ....................................................................................................... Hong Kong8 ............................................................................................... Rest of Asia-Pacific .................................................................................. North America .......................................................................................... South America .......................................................................................... At 31 December 2004 US$m 539,116 217,406 120,504 370,477 17,397 % 42.6 17.2 9.5 29.3 1.4 2003 US$m 425,312 197,487 98,081 289,800 12,549 % 41.6 19.3 9.6 28.3 1.2 Total8 ........................................................................................................ 1,264,900 100.0 1,023,229 100.0 For above footnotes, see page 59. Basis of preparation The results are presented in accordance with the accounting policies used in the preparation of HSBC’s consolidated financial statements. HSBC’s operations are closely integrated and, accordingly, the presentation of customer group data includes internal allocations of certain items of income and expense. These allocations include the costs of certain support services and head office functions, to the extent that these can be meaningfully attributed to operational business lines. While such allocations have been made on a systematic and consistent basis, they necessarily involve a degree of subjectivity. Where relevant, income and expense amounts presented include the results of intra-segment funding as well as inter-company and inter-business line transactions. All such transactions are undertaken on arm’s-length terms. Intra-segment funding and placements of surplus funds are generally undertaken at market interest rates. 58 Footnotes to ‘Analysis by customer group and by geographical region’ 1,2,3 Goodwill amortisation excluded from profit/(loss) is disclosed in the tables on pages 44 to 58. 4 Comprises HSBC Finance Corporation’s consumer finance business and the US residential mortgages and credit card portfolios acquired by HSBC Bank USA from HSBC Finance Corporation and its correspondents since December 2003. 5 Comprises HSBC Finance Corporation’s consumer finance activities since the date of acquisition and the US residential mortgages acquired by HSBC Bank USA from HSBC Finance Corporation in December 2003. 6 The main items reported under ‘Other’ are the income and expenses of wholesale insurance operations, certain property activities, unallocated investment activities including hsbc.com, centrally held investment companies and HSBC’s holding company and financing operations. The results include net interest earned on free capital held centrally and operating costs incurred by the head office operations in providing stewardship and central management services to HSBC. Net fees and commissions and other income of the Group’s wholesale insurance operations amounted to US$453 million in 2004 (2003: US$382 million). ‘Other’ also includes the activities of Group Service Centres and Shared Service Organisations (see footnote 9 below). 7 Third party only. 8 Excluding Hong Kong Government certificates of indebtedness. 9 As a result of growth in use of Group Service Centres and Shared Service Organisations, the activities of these centres have been included in the ‘Other’ customer group. Comparatives for the years ended 31 December 2003 and 31 December 2002 are now reported under ‘Other’ where these activities were formerly reported across customer groups. 59 H S B C H O L D I N G S P L C Financial Review (continued) Europe Profit/(loss) before tax excluding goodwill amortisation Year ended 31 December Personal Financial Services ......................................................................... United Kingdom ............................................................................................ France4 ........................................................................................................... Other .............................................................................................................. Consumer Finance2 ...................................................................................... United Kingdom ............................................................................................ Other .............................................................................................................. Total Personal Financial Services ............................................................... United Kingdom ............................................................................................ France4 ........................................................................................................... Other .............................................................................................................. Commercial Banking .................................................................................. United Kingdom ............................................................................................ France4 ........................................................................................................... Other .............................................................................................................. Corporate, Investment Banking and Markets3 .......................................... United Kingdom ............................................................................................ France4 ........................................................................................................... Other .............................................................................................................. Private Banking ............................................................................................ United Kingdom ............................................................................................ France4 ........................................................................................................... Switzerland .................................................................................................... Other .............................................................................................................. Other3 ............................................................................................................ United Kingdom ............................................................................................ France4 ........................................................................................................... Other .............................................................................................................. Total1,3 United Kingdom ............................................................................................ France4 ........................................................................................................... Switzerland .................................................................................................... Other .............................................................................................................. 1 Goodwill amortisation excluded: – arising on subsidiaries ............................................................................ – arising on associates and joint ventures ................................................. – total ......................................................................................................... 2004 US$m 1,719 1,387 230 102 91 100 (9) 1,810 1,487 230 93 1,749 1,337 274 138 1,772 1,112 327 333 432 141 (21) 260 52 409 487 (121) 43 6,172 4,564 689 260 659 947 – 947 2003 US$m 1,267 1,050 165 52 157 157 – 1,424 1,207 165 52 1,303 939 257 107 1,623 1,147 129 347 339 73 21 197 48 173 259 (108) 22 4,862 3,625 464 197 576 758 135 893 2002 US$m 987 826 139 22 – – – 987 826 139 22 1,344 929 325 90 1,438 1,100 165 173 236 88 8 100 40 155 287 (241) 109 4,160 3,230 396 100 434 651 9 660 2 Comprises HSBC Finance Corporation’s consumer finance business since the date of acquisition. 3 Intra-group charges previously netted between countries are reported gross in 2004. Figures for 2003 and 2002 have been restated on a comparable basis. 4 France principally comprises CCF’s domestic operations and the Paris branch of HSBC Bank. 60 Profit before tax Europe Net interest income ...................................................................................... Dividend income ............................................................................................ Net fees and commissions .............................................................................. Dealing profits ............................................................................................... Other income ................................................................................................. Other operating income .................................................................................. 2004 US$m 9,062 545 6,295 953 1,592 9,385 Total operating income ................................................................................ 18,447 Staff costs ...................................................................................................... Premises and equipment ................................................................................. Other .............................................................................................................. Depreciation and intangible asset amortisation .............................................. Goodwill amortisation ................................................................................... Operating expenses ........................................................................................ Operating profit before provisions ............................................................. Provisions for bad and doubtful debts ............................................................ Provisions for contingent liabilities and commitments ................................... Amounts written off fixed asset investments ................................................. Operating profit ........................................................................................... Share of operating profit/(loss) in joint venture ............................................. Share of operating profit in associates ............................................................ Gains on disposal of investments and tangible fixed assets ............................ Profit on ordinary activities before tax ...................................................... Share of HSBC’s pre-tax profits (excluding goodwill amortisation) .............. Share of HSBC’s pre-tax profits .................................................................... Cost:income ratio (excluding goodwill amortisation) .................................... Period-end staff numbers (full-time equivalent) ............................................. Selected balance sheet data1 Loans and advances to customers (net) .......................................................... Loans and advances to banks (net) ................................................................. Debt securities, treasury bills and other eligible bills ..................................... Total assets .................................................................................................... Deposits by banks .......................................................................................... Customer accounts ......................................................................................... 1 Third party only. (6,583) (1,235) (2,743) (1,009) (11,570) (947) (12,517) 5,930 (1,025) (12) (20) 4,873 5 54 293 5,225 % 31.7 29.6 62.7 74,861 US$m 274,160 55,859 112,894 539,116 55,204 292,913 Year ended 31 December 2003 US$m 7,540 150 5,192 960 1,253 7,555 15,095 (5,576) (1,058) (2,068) (827) (9,529) (758) (10,287) 4,808 (874) (33) (64) 3,837 (127) 47 212 3,969 % 33.7 30.9 63.1 73,943 US$m 210,605 51,783 82,656 425,312 47,500 242,724 2002 US$m 6,343 211 4,528 508 1,025 6,272 12,615 (4,425) (966) (1,763) (724) (7,878) (651) (8,529) 4,086 (569) (15) (267) 3,235 (26) 3 288 3,500 % 39.5 36.3 62.4 72,260 US$m 164,701 39,373 71,446 341,569 34,559 197,362 61 H S B C H O L D I N G S P L C Financial Review (continued) Year ended 31 December 2004 compared with year ended 31 December 2003 bond yields fell during 2004 for 10-year bunds from 4.3 per cent to 3.7 per cent. The UK economy expanded by 3.0 per cent during 2004, although after a strong first half, growth decelerated from the third quarter across most sectors. The rate of growth in consumer spending also slowed during the year. Growing uncertainty surrounding the outlook for house prices contributed to a slowdown in housing transactions in the second half of the year and an associated easing in domestic appetite for further credit. However, HSBC expects an increase in real income growth compared with 2003 and stability in levels of employment to continue to provide support for resilient consumer spending in the coming months. In the UK industrial sector, companies were generally cautious about their employment and investment intentions, with some nervousness over the state of the global and domestic recovery and the outlook for oil prices. Although confidence within the industrial sector appeared to be growing, the official data showed that manufacturing activity continued to contract, lagging the global recovery. The eurozone recovery, which got underway in the middle of 2003, continued in the first half of 2004. However, the year-on-year growth rate began to fall in the latter six months of the year from an expected peak of 2.1 per cent in the second quarter to 1.8 per cent in the third quarter. Exports were strong, particularly in the first half of 2004, with year-on-year growth of 7.6 per cent in the second quarter, but export growth slowed in the second half when there was little evidence of benefits feeding through into consumer spending and fixed investment. Companies were reluctant to take on extra workers and, in Germany, concerns about the economic reform process seemed to encourage higher household savings. Companies also appeared reluctant to invest, possibly because of the debt build-up in the late 1990s. Eurozone inflation moved back above the European Central Bank’s (‘ECB’) 2 per cent target in the spring, reaching 2.5 per cent by May and remaining above 2 per cent in the remainder of the year. However, the headline inflation rate was boosted by higher oil prices, health charges and tobacco duties. Excluding these factors, underlying inflation was little changed at around 1.6 per cent. The ECB kept its key interest rate constant at 2 per cent throughout the year. On a trade-weighted basis, the euro fell back in February and March but rose sharply in the autumn, and by December had moved above its January 2004 peak. Also in December, the euro reached record highs against the US dollar since its introduction in 1999. Eurozone 62 European operations reported a pre-tax profit of US$5,225 million, compared with US$3,969 million in 2003. Excluding goodwill amortisation, pre-tax profit was US$6,172 million and represented around 32 per cent of HSBC’s total profit on this basis. The effect of the weakening US dollar was significant in 2004 and the adjustment to prior year figures to provide a like for like basis of comparison added approximately 11 per cent to both reported revenues and costs. At constant exchange rates, the growth in pre- tax profit before goodwill amortisation was 15 per cent, all of which came from existing businesses. The commentary that follows is based on constant exchange rates. Personal Financial Services reported a pre-tax profit, before goodwill amortisation, of US$1,719 million, an increase of 22 per cent compared with 2003. Revenue growth was encouraging, and this, combined with disciplined cost control, increased pre-provision profitability by 37 per cent over 2003. Total operating income grew by 15 per cent compared with cost growth of 5 per cent, of which M&S Money added 1 per cent. The cost:income ratio excluding goodwill, improved by 6.0 percentage points to 62.8 per cent. The UK was the principal driver of increased profitability. Strong growth in UK consumer lending and mortgages was achieved, from brand-led awareness, marketing campaigns and competitive pricing. The same factors also contributed to increased earnings on savings and deposit accounts, and HSBC increased its current account base by 6.5 per cent. Net interest income increased by US$506 million, of which US$35 million was attributable to M&S Money. Personal unsecured lending revenues grew strongly on the back of marketing and price initiatives, and an increase in the average loan size, contributed to growth of 22 per cent in UK personal loans. Market share increased by 66 basis points to 6.92 per cent. The credit cards business continued to expand, due partly to the continued strength of consumer expenditure and to the success of a series of promotional campaigns, pricing initiatives and improved sales. Average card balances grew by 19 per cent to US$5.5 billion, contributing US$17 million to the growth in net interest income. UK average mortgage balances increased by 20 per cent, to US$50.4 billion and gross new lending by 23 per cent to US$24.7 billion as HSBC increased its market share in the buoyant housing market. A number of new products were introduced, including two fixed rate mortgage offers in the first half of the year, contributing to sales of over US$3.5 billion. Mortgage pricing remained competitive and HSBC deferred passing several of the Bank of England’s base rate rises on to its customers during the year. As a consequence, spreads narrowed, offsetting the benefit to net interest income of the growth in mortgage balances although the effect of this was mitigated by an increase in related fee income. The expansion of HSBC’s Premier banking service in the UK increased the number of customers using this service by 29 per cent. A combination of marketing and pricing initiatives, together with enhanced relationship management, contributed to significant growth in Premier savings accounts, and overall UK savings balances grew by 7 per cent to US$41.8 billion. First Direct launched a new on-line e-Savings Account for new and existing customers. Income improvement through growth in savings balances was further enhanced by widening spreads as interest rates rose. Continued strong recruitment of new customers supported growth in UK current account balances of 12 per cent to US$20.1 billion. However, the benefit of higher balances was partly offset by a 14 basis point reduction in spreads. Consumer lending revenues in Turkey grew by 55 per cent following the success of a number of initiatives taken to enhance customer relationship systems and distribution channels in the branch network. Effective marketing initiatives and advertising campaigns contributed to strong recruitment of new customers. Card balances grew by US$0.3 billion and the number of cards in force increased by 33 per cent to 1.7 million. In France, net interest income grew by 6 per cent. CCF continued its record of strong growth in sight deposits in each year since acquisition, with these deposits growing by just under 10 per cent in 2004, and special regulated savings accounts by a further 9 per cent. Driven by strong sales activity, CCF achieved accelerated growth in personal loans and mortgage sales during 2004, with mortgage loans in particular rising by close to 15 per cent. Other operating income rose by 15 per cent, of which M&S Money added 1 per cent. The strong growth in UK personal lending, mortgages and credit cards was reflected in an increase in fee income, and boosted sales of credit protection products by 9 per cent. Similarly, the increased lending activity in Turkey contributed to growth in related fee income. In France, fee income from sales of life protection and assurance products grew by 11 per cent, driven by increased customer lending. Brokerage fees benefited from an increase in privatisation and flotation activity, while sales of investment protection products benefited from a series of marketing campaigns. Operating expenses, excluding goodwill amortisation, increased by 5 per cent. In the UK, operating expenses included US$39 million in respect of the period during which M&S Money was in the Group, and US$89 million of restructuring costs in 2004, compared with US$63 million in 2003. Excluding M&S Money and restructuring costs, operating expenses in the UK were broadly flat. An increase in IT costs reflected development of HSBC Finance Corporation’s WHIRL credit card system for application in the UK, and expenditure on installing HSBC’s universal banking system, HUB, in France. Marketing expenditure increased to support product promotions and expand TV brand advertising. In the UK, ongoing initiatives to simplify product offerings and management structures, along with a greater customer use of direct banking channels and the Group’s Service Centres, led to a reduction in staff numbers. M&S Money added US$61 million to the bad debt charge of US$615 million. The rise in the charge for bad and doubtful debts of US$256 million in the UK unsecured personal lending portfolio was effected by growth in account balances of US$3,370 million, higher levels of UK personal bankruptcies, following legislative changes in 2004, and weakening credit quality as interest rates rose. As part of its commitment to responsible lending practices, HSBC already uses industry-wide positive customer data in some of its UK portfolios and will implement positive data sharing across the remaining UK portfolios from April 2005. This will improve HSBC’s assessment of customer finances. The rise in contingent liability provisions primarily reflects an updated assessment of the likely compensation due to UK customers for shortfalls on certain mortgage endowment policies and investment products. Consumer Finance in Europe contributed a pre-tax profit, before goodwill amortisation, of US$91 million in 2004. Profit was 64 per cent lower than for the comparable period in the previous year, mainly because of an increase in operating expenses, as staff were recruited to support an expansion of telemarketing, and the cost of developing business in the John Lewis Partnership joint venture. The charge 63 H S B C H O L D I N G S P L C Financial Review (continued) for bad debts also increased sharply, reflecting growth in lending balances and a deterioration in credit quality, particularly in the second half of the year, driven by a rise in delinquencies and personal bankruptcies, notably in the credit cards business. Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$1,749 million, an increase of 21 per cent over 2003, driven mainly by strong revenue growth in the UK. Transfer of business from Corporate Banking in Germany to this segment contributed 2 per cent of the growth. In aggregate, revenue grew by 10 per cent and costs by 2 per cent, a marked improvement in productivity which reduced the cost:income ratio by over 4 percentage points. The performance in the UK was even stronger where the cost:income ratio improved by 7 percentage points. Net interest income increased by 8 per cent as new customer acquisition and a growth in demand for credit increased loans and deposits during the year. In the UK, liability growth contributed US$82 million to net interest income. This, in part, reflected the continued popularity of the business money manager product, where deposit balances grew by 16 per cent. Spreads achieved on customer deposits were moderated as customers migrated to this account from current accounts. In order to offset this effect, a number of successful promotions were launched, which increased current account customer numbers in the UK by 8 per cent in 2004. A rise in customer recommendations also contributed to the increase. HSBC attracted over 100,000 new customers in 2004 and now holds just under 20 per cent of start- up business accounts in the UK. In addition to the rise in customer numbers, average current account balances increased by 17 per cent. The UK saw renewed demand for lending products in 2004. Commercial lending grew by 22 per cent to US$21.9 billion, reflecting an increased share of a growing market, although competitive pressure led to narrower spreads as new business margins tightened. As the UK economy improved and customer confidence returned, the commercial mortgage product was updated and relaunched, and HSBC’s return to a market segment it had hitherto downplayed led to an increase in commercial mortgages of 46 per cent. In aggregate, growth in UK commercial lending added US$50 million to the overall increase in net interest income. In France, net interest income fell by 4 per cent, reflecting reduced demand for credit and a resulting decrease in lending balances. In Turkey, net interest 64 income fell by 12 per cent, as a result of lower earnings on free funds, partly offset by liability growth. Other operating income grew by 12 per cent to US$2,062 million. In the UK, increased lending activity, together with some targeted price increases delivered a US$28 million, or 42 per cent, increase in loan fee income. Credit card fee income increased by 26 per cent as a result of a rise in transaction volumes, reflecting higher consumer spending in the UK, a reduction in the interchange rate and recruitment of new merchant customers. Revised fee structures and improved collection processes contributed to a 14 per cent increase in overdraft fees in the UK. A change in strategic focus to concentrate on growing the commercial wealth management business led to the recruitment of a number of independent financial advisors. These advisors, together with an increase in marketing activity, contributed to an 18 per cent increase in income from wealth management products to US$138 million. Operating expenses, excluding goodwill amortisation, increased by 2 per cent. Outside the UK processing and administrative costs rose in line with increased business volumes, and system development costs rose in France, again attributable to the introduction of HUB. Lower costs in the UK reflected headcount reductions in support functions, despite US$55 million of redundancy expenses incurred as part of continuing efficiency improvements. In 2003, redundancy costs were US$21million. UK operating expenses, excluding redundancy costs, decreased by 3 per cent. The charge for bad and doubtful debts, US$305 million, rose by 35 per cent, compared with the modest charge in 2003. Underlying credit quality in the UK was stable and movements in provisions across other European countries were minimal. Contingent liability releases of US$34 million mainly reflected a reduction in provisions against legal claims in France. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,772 million, was broadly in line with 2003. Bank of Bermuda contributed US$17 million to the pre-tax profits. The transfer of certain corporate customers to Commercial Banking referred to above reduced pre-tax profits by 2 per cent. A 29 per cent decrease in operating profit before provisions was driven by a modest fall in revenues coupled with a significant increase in costs as part of the planned programme to upgrade critical infrastructure and staff skills. Net interest income was 16 per cent lower than in 2003, in part reflecting the costs of funding a higher level of equity swaps, the trading impact and dividend benefit from which is reported in other operating income. Global Markets earnings declined as higher yielding assets ran off and were replaced by investments at lower prevailing money market rates. Market concerns over future interest rate increases, oil prices at record highs, and the Iraq crisis all drove down demand for credit. A reduction in the level of customer activity led to a fall in corporate and institutional account balances. In Turkey, significant reductions in local interest rates resulted in lower income streams from net free funds. Other operating income rose by 6 per cent to US$3,210 million of which 2 per cent arose in Bank of Bermuda's European operations. Adjusting for the Bank of Bermuda acquisition, operating income increased by US$76 million or 4 per cent. In the UK, a US$414 million rise in dividends from equity swaps activity reflected an increase in volumes and size of trades, primarily driven by the growth in the equity swaps market. This gain was partly offset by a related decrease in dealing profits and higher fees payable of US$354 million and funding costs of US$38 million, reported under net interest income. Fixed income revenues fell, mainly from lower volatility in credit spreads and a reduced level of corporate debt issuance. Foreign exchange and derivatives revenue increased due to higher customer volumes across a wider range of products, with supplementary gains from the continued weakening of the US dollar. Improved performance in structured derivatives reflected the successful investment in additional execution capabilities, while Global Markets in Turkey experienced a boost in revenues from foreign exchange gains and securities trading following its integration with HSBC’s other dealing rooms in Europe. In Germany, higher fees and commissions were generated from investment banking advisory business and improved volumes on derivatives. Costs increased by 18 per cent, of which 3 per cent represented Bank of Bermuda. The remaining costs reflected the restructuring of the business, with extensive expenditure on systems and people to improve client coverage. Overall, these developments saw the departure of 856 staff and the recruitment of 1,051 during the course of the year, improving levels of proficiency and customer delivery. Key appointments included global sector heads for certain industry teams based in the UK and additional senior hires in investment banking advisory, while staff were also recruited to support the expansion of the cash equities, options, structured products and derivatives businesses. The planned development of global research continued, with the recruitment of people across a variety of sectors and products. The restructuring of regional research franchises into a globally managed business, encompassing all research across all product areas, was completed. Non-staff costs also increased, reflecting the continued investment in technology, including US$19 million for the development of HSBCnet. HSBC Securities Services incurred additional costs to develop insourcing capabilities for third party processing. The net release of provisions for bad and doubtful debts, compared with a net charge in 2003, reflected the benefit of a number of recoveries and releases of certain provisions resulting from successful refinancing during the year. Corporate lending weakness in the power generation sector, which adversely affected 2003, was not repeated. The recoveries included sizeable amounts for a single name in the industrial sector in France. Gains on investment disposals were US$210 million, reflecting the disposal of HSBC’s interest in a number of private equity investments in the UK and France. Private Banking contributed a pre-tax profit, before goodwill amortisation, of US$432 million, an increase of 26 per cent compared with 2003. Growth of 19 per cent in net interest income was driven by a 27 per cent increase in lending balances, predominantly in the UK and Switzerland, where clients leveraged their wealth by borrowing on a secured basis in the low interest environment to reinvest in higher-yielding securities or in alternative investments. Income also benefited from a shift in the profile of investment securities to higher-yielding HSBC Finance Corporation paper. Net fees and commissions increased by 11 per cent to US$658 million. Performance fees included a US$24 million increase in fees from the Hermitage Fund, one of the world’s leading public equity funds dedicated to Russia in which HSBC Private Bank has been invested from its inception. In the UK, commission income in HSBC’s residential property advisory business grew strongly, supported by the generally buoyant housing market, and increased client referrals. Funds under management grew by 13 per cent to US$107.8 billion, as clients moved cash liquidity to higher-yielding investment products in the low 65 H S B C H O L D I N G S P L C Financial Review (continued) interest rate environment, and rising equity markets increased the value of the extant book. Net new money invested was US$8.6 billion. A number of new funds were launched in 2004, including several hedge funds, and the Household European Commercial Paper and Floating Rate Notes programmes attracted over US$2.5 billion of client investments. Higher transaction and portfolio fees, in line with this growth, were partly offset by weaker income in France, where transaction volumes and funds under management both fell during the year. Operating expenses, before goodwill amortisation, increased by 5 per cent, reflecting front office recruitment, the acquisition of Bank of Bermuda, and higher performance-related remuneration. In France, lower costs reflected the merger of HSBC’s four private banks in 2003. A US$33 million net provision for bad debts in France, arising from a small number of specific accounts, was offset by net releases in the UK and Switzerland, following a review of historic loss trends and current economic conditions, which led to release of general provisions. Profits on disposal in 2004 included a gain on sale of a former head office building following the restructuring of HSBC’s four private banks in France. In 2003 there was a gain on a long-term private placement transaction. Included in Other are interest earnings on cash held and interest costs of debt issued by HSBC Holdings, and the effect of corporate items not allocated to customer groups, including gains on the sale of an insurance company and releases of centrally managed litigation provisions. Year ended 31 December 2003 compared with year ended 31 December 2002 The UK economy expanded by 2.3 per cent in 2003. After a slow first six months, growth accelerated in the third quarter and that momentum continued into the final months of the year. Growth in consumer spending slowed during the course of the year but nevertheless remained robust and, in particular, the housing market and household appetite to borrow remained strong. However, low real income growth, together with the expectation of further rises in interest rates, was expected to dampen household activity in the forthcoming months. Elsewhere, there were a few encouraging signs that industrial activity in particular and corporate confidence in general was starting to improve from a low base. Stronger global demand, if maintained, was expected to provide a boost to the corporate sector. 66 Having slipped into recession in the first half of the year, the eurozone economy returned to growth in the second half, expanding by 0.4 per cent quarter-on-quarter in the third quarter and by 0.3 per cent in the fourth quarter. Once again, however, it was stronger exports that drove the third quarter improvement, while the domestic economies remained subdued. Consumer spending was flat and investment contracted for the third consecutive quarter. The pick-up in exports occurred despite the appreciating euro, which rose more than 16 per cent against the US dollar during the course of the year. In the fourth quarter, growth seemed to have been largely the result of inventory build up, with exports falling back after the strength of the third quarter, and with limited growth in consumer spending. Interest rates were cut twice during 2003, with the European Central Bank’s repo rate dropping by 75 basis points to 2 per cent. By contrast, however, longer-term interest rates moved higher, rising by about 80 basis points between June and the end of December, as the bond market anticipated economic recovery. In 2003, personal credit expansion in the UK was the major growth area as consumers took advantage of historically low interest rates, enabling HSBC to generate strong growth in mortgages and consumer lending. Conversely, sales of investment and pension products fell, reflecting a lack of confidence in equity markets. In this environment, HSBC grew its deposit base as customers sought flexibility and security for their savings, notwithstanding the low interest rates available. The low interest rate environment also meant that the value of HSBC’s maturing liquidity reduced as it was redeployed in lower yielding assets. The same factors, low interest rates and weak equity markets, increased the cost of pension provision by US$96 million in the UK. Employment costs also grew, notably in the UK, as social taxes were raised. In order to adjust for this higher cost environment, HSBC took steps to reduce its staff costs, announcing both 1,400 redundancies in the UK and the shift over the next three years of 4,000 positions to the Group Service Centres. In the short term these actions incurred both redundancy and excess property provisioning costs totalling over US$176 million. European operations contributed pre-tax profit of US$3,969 million in 2003 compared with US$3,500 million in 2002. Excluding goodwill amortisation, European operations contributed pre-tax profit of US$4,862 million and represented around one-third of HSBC’s total profit on this basis. At constant exchange rates, and excluding the US$157 million contribution from HFC Bank, which was the only major change in the composition of the Group in Europe, pre-tax profit, excluding goodwill amortisation, was 2 per cent higher than in 2002. Goodwill amortisation of US$893 million increased by US$233 million compared with 2002, mainly reflecting a goodwill write-down in respect of a UK fund management company previously acquired as part of the CCF acquisition, and exchange rate movements. The commentaries that follow are based on constant exchange rates. Pre-tax profit, before goodwill amortisation, of US$1,267 million in Personal Financial Services, excluding Consumer Finance, was 16 per cent higher than in 2002, reflecting strong growth in UK mortgage and consumer lending, and in deposit- taking activities. Net interest income increased by 10 per cent, driven by strong growth in mortgages and personal lending in the UK and, to a lesser extent, in France. The net interest margin fell modestly as rates remained at historically low levels. However, balance sheet growth more than compensated for this. UK mortgage balances increased by 25 per cent to US$37.4 billion, as borrowers continued to take advantage of the low interest rate environment to refinance their mortgages. In France, a similar pattern was seen, and CCF’s mortgage balances increased by 11 per cent over 2002. Gross new mortgage lending in the UK grew by 12 per cent to US$17.9 billion. First Direct contributed to this growth with a US$280 million, or 14 per cent, increase over 2002, reflecting the continuing success of its Offset mortgage product. Both HSBC and First Direct continued to win major awards for their mortgage products in 2003. In the UK, personal lending balances, excluding mortgages and credit cards, grew by 15 per cent, reflecting the success of targeted marketing campaigns and improved utilisation of customer relationship management systems. Card balances grew by 18 per cent to US$4.2 billion, due to strong consumer expenditure and targeted marketing campaigns, resulting in an overall increase in fee income from cards of 13 per cent. HSBC’s Premier service was further enhanced and the number of customers using this service in the UK grew by 57 per cent to over 280,000. Significant growth was achieved in HSBC Premier savings accounts in 2003, which contributed to an overall increase in UK personal savings balances of 20 per cent to US$35.7 billion. UK personal current account balances grew by 13 per cent to US$18.0 billion. Other operating income was broadly in line with 2002. The strong growth in mortgages and personal loans boosted sales of repayment protection products in the UK, producing a 19 per cent increase in personal loan protection premiums. HSBC maintained its position as the leading provider of income protection products in the UK, with a market share of 17 per cent at the end of September 2003. Lack of customer confidence in equity markets led to a decline in sales of investments and pension products. This trend also adversely affected the value of HSBC’s long-term assurance business in the UK. However, weakness in investment product sales reflected market conditions rather than competitive positioning and the bank was awarded the coveted ‘Five Star Award’ from Money Management magazine for its regular premium stakeholder pensions in the UK again in 2003. HSBC Bank A.S. in Turkey benefited from additional card fee income following the acquisition of Benkar in September 2002, contributing to an overall increase in its other operating income of 51 per cent. Operating expenses, excluding goodwill amortisation, increased by 2 per cent. This was largely due to restructuring costs and external factors in the UK, including higher social taxes and the amortisation of the UK pension scheme deficit reported at the end of 2002. The relocation of HSBC Bank’s headquarters to Canary Wharf contributed to higher premises costs, following the upgrade of equipment and infrastructure. Additional costs were also incurred migrating the card issuing business in the UK to the more efficient platform used by HSBC Finance Corporation in the US. Costs in France were largely unchanged compared with 2002. Low interest rates, stable employment and a gradual upturn in economic conditions in the UK provided the environment for continuing low levels of credit charges. The charge for bad and doubtful debts at US$267 million was 14 per cent higher than in 2002, a satisfactory performance in view of the growth of over 20 per cent in UK personal lending. Overall, credit quality improved. In Consumer Finance, HFC Bank, which joined HSBC in the UK in March as part of the HSBC Finance Corporation acquisition, contributed US$157 million to pre-tax profit, before goodwill amortisation, in its first nine months of ownership. Integration with the HSBC Group was running on schedule. 67 H S B C H O L D I N G S P L C Financial Review (continued) In Commercial Banking, pre-tax profits, before amortisation of goodwill, declined by 13 per cent compared with 2002, mainly reflecting lower net interest income and a higher cost base. Net interest income decreased by 3 per cent to US$1,961 million. Following the recommendations of the UK’s Competition Commission, HSBC applied credit interest to all qualifying small and medium-sized customer accounts, increasing interest expense by US$136 million. The move did, however, lead HSBC to strengthen its product proposition within those market segments in the UK, and business current account balances consequently rose by 21 per cent to just over US$10 billion. In addition, HSBC’s popular ‘Start-up Stars’ competition continued to raise the profile of the bank’s small business proposition in the UK and helped to attract over 102,000 new business start-ups and over 23,000 customer transfers. Enhanced customer targeting and the introduction of risk-based relationship pricing improved HSBC’s competitive position in the UK market, increasing lending balances by over US$2.2 billion and net interest income by 10 per cent. Overall, deposit balances in the UK grew by 9 per cent to just over US$9 billion, increasing market share and partly offsetting the effects of reduced deposit book spreads. Balances grew as a consequence of the introduction of the new Business Money Manager account, launched in response to customer demand for flexible savings accounts. The new product attracted an average of 1,700 new accounts per week and generated US$95 million of net interest income. In France, overall net interest income was broadly in line with 2002. The subdued economic climate saw businesses adopt a more conservative investment policy that was reflected in a 3 per cent rise in sight deposits. Short-term higher spread lending fell by 8 per cent, but was partly offset by growth in medium and longer-term lending, which increased by 4 per cent. In the UK, other operating income was marginally higher than 2002. Overdraft fees rose by 12 per cent, or US$19 million, reflecting the further benefit of improved account management initiatives introduced last year, whilst loan fees increased significantly in line with the growth in customer numbers. In France, higher income was generated through a volume-led increase in banking transaction fees and the introduction of a variety of guaranteed investment funds during the year. The former was achieved after specific initiatives directed towards 68 middle market enterprises (‘MMEs’). The successful launch of several structured financial products led to higher trading fees within CCF and the take-up of Asset Management products increased by 9 per cent. Overall, wealth management income declined as continued uncertainty in equity markets led to a fall in sales of savings and investment products. Operating expenses, excluding goodwill amortisation, were 7 per cent higher than last year at US$2,113 million. This was largely due to an increase in staff costs in the UK. Pension costs rose to compensate for the scheme deficit and one-off redundancy costs were incurred as migration was planned to the Group Service Centres’ capabilities. The costs of distributing and supporting business services and products within the UK increased in line with the growth in volumes and continued investment was made in electronic delivery channels across Europe. At US$204 million, the overall charge for bad and doubtful debts was 9 per cent lower than in 2002. In the UK there was a release of general provision which recognised the gradual improvement in the economic outlook for businesses over the year. Offsetting this there was a higher specific charge, reflecting a number of large provisions across various industries. Additionally, the charge in France increased due to lower recoveries in two of the regional banks. Underlying credit quality in France remained stable. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,623 million, an increase of 2 per cent compared with last year. In Global Markets Europe, performance was strong. This reflected income growth in foreign exchange, derivatives and debt securities, partly offset by higher bad debt provisions in Corporate Banking. HSBC also absorbed the costs of restructuring and repositioning the equities and investment banking businesses. In Global Markets UK, earnings from deploying the excess liquidity of the bank declined as long- term assets matured and proceeds were reinvested at lower rates. Overall, net interest income was 5 per cent lower than in 2002. Other operating income increased by 9 per cent, reflecting a substantial growth in dealing profits that more than offset lower fee and commission income. Foreign exchange revenues remained strong as volatility in the major currency pairs prompted customers to hedge their currency exposures. Continued weakening of the US dollar provided a clear trend in the markets for position taking. Fixed income earnings showed a strong year-on-year growth reflecting a combination of tightening credit spreads and strong investor demand for yield in the low interest rate environment, which boosted sales of corporate bonds. In line with a greater business focus on risk management products, revenues from trading increased, reflecting the benefit successful interest rate positioning and continued growth in customer mandates from corporate customers. Additional growth in revenue resulted from a strong presence in each of the euro vanilla and structured derivatives markets. Fees and commission income decreased by 6 per cent. Difficult operating conditions in equity markets resulted in lower commissions and new-issue fees, but these were partly offset by higher fees from merger and advisory business as greater focus was given to HSBC’s core customer sectors and regions. Fees from debt capital markets activities were also strong. Generally, fees benefited from the high level of activity in the primary markets, as customers sought long-term financing at low interest rates. Staff costs rose, with higher bonuses reflecting increased profitability in specific product lines. Restructuring and research costs of US$24 million were also incurred to build and reshape HSBC’s investment banking and equities businesses. Premises and equipment expenses were lower as a result of savings in rental payments from the London office move to Canary Wharf. Credit experience was generally satisfactory although new specific provisions were higher, mainly due to a single name in the engineering sector which was extensively restructured in the second half of the year. Corporate weakness in the power generation sector was also dealt with through raising additional specific provisions, although these were partly offset by recoveries in the transport and telecommunications sectors, as balance sheets were strengthened. Gains on investment disposals were lower than in 2002, mainly due to a reduction in profits from the disposal of venture capital investments in CCF. Against the background of a recovery from recent lows in European stock markets, Private Banking activities continued to grow during 2003. Pre-tax profit, excluding goodwill amortisation, increased by 48 per cent as a result of strong growth in dealing income, lower costs and the non- recurrence of contingencies and write downs in 2002. Net interest income was broadly in line with 2002. A 30 per cent increase in lending balances was driven by clients seeking to maximise the overall earnings potential of their investments by borrowing to reinvest in higher returning securities. These additional earnings were mostly offset by a decline in yield on free funds as lower interest rates prevailed throughout the year. Net fees and commissions increased by 2 per cent to US$556 million. The low interest rate environment improved the attractiveness of investment markets, particularly for sophisticated investors with access to structured products which offered potentially higher returns than from cash deposits. Consequently, funds under management increased by US$20 billion to US$91 billion, with a move by clients away from liquid positions bringing in some US$9 billion of new client funds. A strong rise in discretionary mandates together with client demand for structured products and HSBC Finance Corporation’s commercial paper contributed to the increase. Transaction and safe custody fees rose in line with the growth in client funds while an increased focus on product enrichment produced strong growth in income from structured products. In Germany, fee income was boosted by the placement of two new property funds. However, income in France was weaker as stock market activity remained subdued. Volatility in the major currencies resulted in higher volumes of client transactions in the foreign exchange markets, and combined with proprietary equity gains in 2003, contributed to the 37 per cent improvement in dealing profits to US$94 million. Total operating expenses, before goodwill amortisation, fell by 4 per cent to US$709 million. This was achieved through cost savings realised following the merger of three banks in Switzerland in 2002 and lower property expenses. Provisions for contingent liabilities and commitments were lower than in 2002, which included amounts provided for litigation. Amounts written off fixed asset investments were lower than in 2002 following a specific write down of a debt security in 2002. Gains on disposal of investments and tangible fixed assets increased by 22 per cent to US$61 million, principally reflecting a gain on a long-term private placement transaction. 69 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group Europe Net interest income .......... Dividend income/(expense) Net fees and commissions . Dealing profits .................. Other income ..................... Other operating income ..... Operating income ............ Operating expenses excluding goodwill amortisation1 ................. Operating profit before provisions1 ................... Provisions for bad and Share of operating profit in joint ventures2 .............. Share of operating profit in associates2 .................... Gains on disposal of investments and tangible fixed assets ................... Profit on ordinary activities before tax3 .... Share of HSBC’s pre-tax profits3 .......................... Cost:income ratio1 ............. Selected balance sheet data5 Loans and advances to customers (net) ............. Total assets ....................... Customer accounts ............ The following assets and liabilities were significant to the customer groups noted: Loans and advances to banks (net) .................... Debt securities, treasury bills and other eligible bills .. Deposits by banks ............. Debt securities in issue ...... Goodwill amortisation excluded: Personal Financial Services US$m Consumer Finance4 US$m 3,934 2 2,282 44 172 2,500 6,434 635 – 65 – 239 304 939 Total Personal Financial Services US$m 4,569 2 2,347 44 411 2,804 7,373 Year ended 31 December 2004 Corporate, Investment Banking & Markets US$m Commercial Banking US$m Private Banking US$m Inter- segment elimination US$m Other US$m 2,353 5 1,681 28 348 2,062 4,415 1,402 544 1,293 734 639 3,210 4,612 421 5 658 104 11 778 317 (11) 316 43 350 698 1,199 1,015 – – – – (167) (167) (167) Total US$m 9,062 545 6,295 953 1,592 9,385 18,447 (4,038) (527) (4,565) (2,404) (3,236) (814) (718) 167 (11,570) 2,396 412 2,808 2,011 1,376 385 297 doubtful debts ............... (615) (321) (936) (305) 215 Provisions for contingent liabilities and commitments ................ Amounts written off fixed asset investments .......... (68) (2) Operating profit1 ............. 1,711 – – 91 – – – 91 % 0.5 56.1 (68) (2) 34 (1) (37) (9) 1,802 1,739 1,545 – 7 1 – 8 2 5 12 210 1,810 1,749 1,772 % 9.3 61.9 % 9.0 54.5 % 9.1 70.2 – 7 1 1,719 % 8.8 62.8 2 4 (2) 389 – – 43 432 % 2.2 67.9 (1) 55 (6) 345 – 27 37 409 % 2.1 70.7 – – – – – – – – – 6,877 (1,025) (12) (20) 5,820 5 54 293 6,172 % 31.7 62.7 US$m US$m US$m US$m US$m US$m US$m US$m 108,245 128,691 121,700 10,557 12,787 46 118,802 141,478 121,746 67,234 84,039 57,844 72,446 271,772 78,183 15,676 39,604 35,140 2 2,223 – 274,160 539,116 292,913 47,775 100,901 53,130 1,939 245 1 from (1) above .............. – 2 from (2) above .............. 3 from (3) above .............. 245 4 Comprises HSBC Finance Corporation’s consumer finance business. 5 Third party only. 201 – 201 44 – 44 188 – 188 236 – 236 278 – 278 – – – 947 – 947 70 Personal Financial Services US$m Consumer Finance US$m 4 Total Personal Financial Services US$m Europe Year ended 31 December 2003 Corporate, Investment Banking & Markets US$m Commercial Banking US$m Private Banking US$m Net interest income .......... 3,082 438 – 49 – 149 198 636 3,520 1,961 1,509 4 1,838 37 278 2,157 5,677 2 1,335 16 294 1,647 3,608 138 1,204 839 539 2,720 4,229 334 2 556 94 10 662 996 4 1,789 37 129 1,959 5,041 Inter- segment elimination US$m Other US$m 216 4 259 (26) 371 608 824 – – – – (239) (239) (239) Total US$m 7,540 150 5,192 960 1,253 7,555 15,095 Dividend income ............... Net fees and commissions . Dealing profits/(losses) ..... Other income ..................... Other operating income ..... Operating income ............ Operating expenses excluding goodwill amortisation1 ................ Operating profit before provisions1 ................... Provisions for bad and Provisions for contingent liabilities and commitments ................ Amounts written off fixed asset investments .......... Operating profit1 ............. Share of operating profit in joint ventures2 .............. Share of operating profit in associates ................. Gains/(losses) on disposal of investments and tangible fixed assets ..... Profit on ordinary activities before tax3 ... Share of HSBC’s pre-tax profits3 .......................... Cost:income ratio1 ............. Selected balance sheet data5 Loans and advances to customers (net) ............. Total assets ....................... Customer accounts ............ The following assets and liabilities were significant to the customer groups noted: Loans and advances to banks (net) .............................. Debt securities, treasury bills and other eligible bills .. Deposits by banks ............. Debt securities in issue ...... Goodwill amortisation excluded: doubtful debts ............... (267) (180) (447) (204) (218) (3,471) (299) (3,770) (2,113) (2,471) (709) (705) 239 (9,529) 1,570 337 1,907 1,495 1,758 287 119 (4) (2) (3) (29) (1) – – (29) (1) 10 – (52) (42) 1,273 157 1,430 1,301 1,446 278 – 3 (9) 1,267 % 8.8 68.9 – – – 157 % 1.1 47.0 – 3 – 3 8 13 (9) (1) 156 1,424 1,303 1,623 % 9.9 66.4 % 9.0 58.6 % 11.3 58.4 – – 61 339 % 2.4 71.2 (1) 40 (18) 140 – 28 5 173 % 1.1 85.6 US$m US$m US$m US$m US$m US$m US$m – – – – – – – – – 5,566 (874) (33) (64) 4,595 8 47 212 4,862 % 33.7 63.1 US$m 76,439 92,890 102,192 8,452 10,526 231 84,891 103,416 102,423 52,947 67,107 45,558 61,085 209,885 63,556 11,681 40,964 31,187 1 3,940 – 210,605 425,312 242,724 43,699 67,692 44,261 3,232 192 1 from (1) above .............. 135 2 from (2) above .............. 3 from (3) above .............. 327 4 Comprises HSBC Finance Corporation’s consumer finance business since the date of acquisition. 5 Third party only. 146 – 146 123 – 123 160 – 160 23 – 23 257 – 257 3 – 3 758 135 893 71 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group (continued) Europe Year ended 31 December 2002 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Inter- segment elimination US$m Other US$m Net interest income ....................................... 2,541 1,800 1,444 Dividend income ............................................. Net fees and commissions ............................... Dealing profits ................................................ Other income .................................................. Other operating income ................................... Operating income .......................................... 3 1,570 31 163 1,767 4,308 4 1,128 18 303 1,453 3,253 202 1,137 385 508 2,232 3,676 Operating expenses excluding goodwill amortisation1 ............................................... (3,076) (1,759) (2,197) Operating profit before provisions1 ............. 1,232 1,494 1,479 300 2 471 63 16 552 852 (618) 234 7 (21) (22) 198 – (10) 48 236 % 2.2 72.5 258 – 222 11 316 549 807 (509) 298 (4) 21 (175) 140 – 14 1 155 % 1.4 63.1 Total US$m 6,343 211 4,528 508 1,025 6,272 12,615 – – – – (281) (281) (281) 281 (7,878) – – – – – – – – – 4,737 (569) (15) (267) 3,886 (17) 3 288 4,160 % 39.5 62.4 US$m 164,701 341,569 197,362 (215) (204) (153) (23) (1) 993 (22) (1) 17 987 % 9.4 71.4 11 3 (3) (72) 1,304 1,251 3 (3) 40 1,344 % 12.8 54.1 2 3 182 1,438 % 13.7 59.8 US$m US$m US$m US$m US$m 58,421 72,817 84,486 43,104 56,934 35,614 54,099 172,665 45,818 9,077 35,920 31,444 – 3,233 – 31,402 53,897 31,741 169 8 177 112 – 112 133 – 133 238 – 238 (1) 1 – 651 9 660 Provisions for bad and doubtful debts ............. Provisions for contingent liabilities and commitments ........................................ Amounts written off fixed asset investments .. Operating profit1 ........................................... Share of operating profit/(loss) in joint ventures2 ......................................... Share of operating profit/(loss) in associates ................................................ Gains on disposal of investments and tangible fixed assets ............................. Profit on ordinary activities before tax3 ...... Share of HSBC’s pre-tax profits3 .................... Cost:income ratio1 ........................................... Selected balance sheet data4 Loans and advances to customers (net) ........... Total assets ..................................................... Customer accounts .......................................... The following assets and liabilities were significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) .................. Debt securities, treasury bills and other eligible bills ................................................ Deposits by banks ........................................... Goodwill amortisation excluded: 1 from (1) above ............................................ 2 from (2) above ............................................ 3 from (3) above ............................................ 4 Third party only. 72 Hong Kong Profit/(loss) before tax excluding goodwill amortisation Personal Financial Services ............................................................................ Commercial Banking ..................................................................................... Corporate, Investment Banking and Markets ................................................. Private Banking ............................................................................................. Other .............................................................................................................. Total1 ............................................................................................................. 1 Goodwill amortisation excluded: – arising on subsidiaries ............................................................................ – arising on associates and joint ventures ................................................. – total ......................................................................................................... Profit before tax Hong Kong Net interest income ...................................................................................... Dividend income ............................................................................................ Net fees and commissions .............................................................................. Dealing profits ............................................................................................... Other income ................................................................................................. Other operating income .................................................................................. Total operating income ................................................................................ Staff costs ...................................................................................................... Premises and equipment ................................................................................. Other .............................................................................................................. Depreciation and intangible asset amortisation .............................................. Goodwill amortisation ................................................................................... Operating expenses ........................................................................................ Operating profit before provisions ............................................................. Provisions for bad and doubtful debts ............................................................ Provisions for contingent liabilities and commitments ................................... Amounts written back on/(written off) fixed asset investments ..................... Operating profit ........................................................................................... Share of operating profit in associates ............................................................ Gains on disposal of investments and tangible fixed assets ............................ Profit on ordinary activities before tax ...................................................... Share of HSBC’s pre-tax profits (excluding goodwill amortisation) .............. Share of HSBC’s pre-tax profits .................................................................... Cost:income ratio (excluding goodwill amortisation) .................................... Year ended 31 December 2004 US$m 2,097 914 1,584 135 23 4,753 9 – 9 2003 US$m 1,740 711 1,275 127 (123) 3,730 3 (1) 2 Year ended 31 December 2004 US$m 3,639 19 1,726 630 781 3,156 6,795 (1,415) (256) (653) (200) (2,524) (9) (2,533) 4,262 223 (3) 26 4,508 8 228 4,744 % 24.5 26.9 37.1 2003 US$m 3,901 31 1,383 321 596 2,331 6,232 (1,276) (240) (502) (194) (2,212) (3) (2,215) 4,017 (400) (6) 31 3,642 18 68 3,728 % 25.9 29.1 35.5 2002 US$m 1,705 733 1,226 107 (61) 3,710 – – – 2002 US$m 4,133 25 1,264 133 495 1,917 6,050 (1,249) (233) (459) (198) (2,139) – (2,139) 3,911 (246) (14) (10) 3,641 11 58 3,710 % 35.3 38.4 35.4 Period-end staff numbers (full-time equivalent) ............................................. 25,552 23,636 23,786 73 H S B C H O L D I N G S P L C Financial Review (continued) Selected balance sheet data1 Loans and advances to customers (net) .......................................................... Loans and advances to banks (net) ................................................................. Debt securities, treasury bills and other eligible bills ..................................... Total assets2 ................................................................................................... Deposits by banks .......................................................................................... Customer accounts ......................................................................................... 1 Third party only. 2 Excluding Hong Kong Government certificates of indebtedness. Year ended 31 December 2004 US$m 78,888 45,300 69,464 217,406 4,325 178,368 2003 US$m 73,988 38,640 66,158 197,487 4,777 164,024 2002 US$m 69,948 33,359 60,083 180,433 2,379 148,904 Year ended 31 December 2004 compared with year ended 31 December 2003 resulted in a significant narrowing in the budget deficit in 2004. The Hong Kong economy expanded rapidly in 2004. Despite rising US interest rates and mainland China’s cooling-off measures, Hong Kong continued to benefit from robust re-export trade with mainland China. The positive outlook for Hong Kong, together with the re-emergence of inflation, helped sustain a recovery in local confidence which began in late 2003. Hong Kong’s domestic demand also grew steadily, supported by reviving asset prices and falling unemployment. The continued inflow of liquidity suppressed local interest rates, which in turn encouraged a flow of local funds into asset markets. Rising property prices stimulated private consumption and alleviated past concerns over negative equity in residential mortgages. The unemployment rate fell from 7.3 per cent to 6.5 per cent, with strong growth in the trade and retail sectors helping to sustain consumer spending, though the rate of job creation slowed in the second half of the year as China’s cooling-off measures took effect on the trade sector. Investment revived in the robust tourism industry, which continued to benefit from the liberalisation of regulations governing visits by residents of mainland China. In the second half of 2004, inflation re-emerged in Hong Kong after a nearly six year-long period of deflation. Stimulated by a weak US dollar, recovering property prices and rising local confidence, prices rose from a year ago when the economy was suffering from the effect of the severe acute respiratory syndrome (‘SARS’) epidemic. Significant inflows of liquidity from foreign investors left the Hong Kong market flush with surplus funds. This caused Hong Kong dollar and US dollar interest rates to diverge, with the already cash-rich local economy slow to absorb external funds. Moreover, demand for credit remained muted, other than in the trade sector, with individuals and enterprises slow to increase borrowings, reflecting nervousness regarding the sustainability of the recovery. The improving economy helped to ease concerns over Hong Kong’s fiscal position as it 74 HSBC’s operations in Hong Kong reported a pre-tax profit of US$4,744 million, an increase of US$1,016 million, or 27 per cent, over 2003. Excluding goodwill amortisation, pre-tax profit also grew by 27 per cent to US$4,753 million, representing 24 per cent of HSBC’s total profit on this basis. Personal Financial Services in Hong Kong reported a pre-tax profit, before goodwill amortisation, of US$2,097 million, 21 per cent higher than in 2003. This improvement was largely driven by strong growth in other operating income, within which fee and commission income was 27 per cent higher. This, together with a significant reduction in the net bad debt charge, more than offset an 8 per cent reduction in net interest income. During 2004, the Hong Kong banking sector was characterised by high levels of surplus liquidity as foreign funds entered Hong Kong to invest in the buoyant stock market, and there were inflows from investors anticipating an upward realignment of the currency as the US dollar weakened. This excess liquidity depressed Hong Kong dollar interest rates and so reduced spreads on deposits, as banks were unable to pass on the full effect of the reduction in rates to depositors. The lower Hong Kong dollar interest rates contributed to the overall reduction in net interest income of US$186 million. Net interest income was further reduced by the continued pressure on yields in the mortgage business, where market competition remained intense. Average mortgage balances fell by 2 per cent compared with last year due to a reduction in balances under the Government Home Ownership Scheme (‘GHOS’), which remained suspended during the year. With plenty of low cost funding in the market, and fierce competition for quality mortgage business, the average yield on the mortgage portfolio, excluding GHOS loans, fell by 25 basis points to 202 basis points below HSBC’s best lending rate. HSBC maintained its position as the largest credit card issuer in Hong Kong. An attractive rewards programme, successful cross-sales to both existing and new customers, and customer acquisition, helped grow the number of cards in circulation by 14 per cent to 3.5 million. Cardholder spending increased by 32 per cent compared with 2003, reflecting the successful promotion of credit card internet bill payment services, and promotional campaigns launched in conjunction with retail merchants. Average credit card balances grew by 11 per cent against a backdrop of an overall reduction in outstanding balances in the market. Fee income from credit cards rose by 12 per cent compared with 2003. Other operating income increased by 24 per cent to US$1,466 million, largely driven by the continued strong performance from the insurance and investment businesses. During the year, strong emphasis was placed on growing the insurance business. A series of promotional campaigns was launched, and the number of financial planning managers was increased by 24 per cent to 742. The insurance product range was also enhanced as new products designed to meet customers’ needs were introduced. In 2004, HSBC recorded growth of 40 per cent in new regular premium life sales, driven by the success of flexible products tailored to customers’ specific needs, such as the Target Protection Plus product. Income from the insurance business, including the Mandatory Provident Fund also grew by 31 per cent to US$441 million. Income from sales of unit trusts and structured products grew by 43 per cent to US$183 million, reflecting the successful deployment of customer relationship management systems, an increase in the number of HSBC Premier relationship managers, and a rise in stock market activity. New products, including a range of structured treasury products, capital-guaranteed funds, open-ended funds and certificates of deposit, were launched to broaden the range of investment options. Overall, sales of unit trusts and structured products grew by US$609 million, or 9 per cent, compared with 2003. Higher fee income also came from stockbroking and custody services, which grew by 49 per cent to US$185 million, reflecting increased levels of stock market activity and IPO-related services. Sixty eight per cent of all securities transactions were processed on-line in 2004, 5 percentage points higher than in 2003. Performance-related staff costs increased in line with sales of investment and insurance products and the general improvement in profits. Excluding the impact of incentive payments, staff costs fell by 5 per cent, reflecting greater operational efficiencies and higher utilisation of the Group Service Centres. The various income growth initiatives also involved higher marketing costs, particularly for credit cards, insurance and investment products. Credit conditions improved markedly as the economy recovered, with falling unemployment, lower bankruptcies, higher residential property prices and stronger GDP growth. The charge for bad and doubtful debts fell by US$312 million to US$54 million. New specific provisions declined by over 74 per cent to US$95 million, as provisions for credit card, mortgage and unsecured personal lending portfolios all fell. There was also a US$41 million release of general provisions following a review of historical loss experience and the improved market environment, in particular a reduction in mortgage loans with negative equity. Pre-tax profits, before goodwill amortisation, in Commercial Banking rose by 29 per cent to US$914 million, driven by a 14 per cent rise in operating income and significant releases and recoveries in provisions. Operating income benefited from the success of a series of initiatives designed to enhance the service offered to middle market customers. The introduction of a greater number of experienced relationship managers to service key accounts contributed significantly to income growth, while a number of dedicated business development relationship managers were appointed to focus on new customers, leading to a 3 per cent increase in customer numbers. Small and medium-sized enterprises (‘SME’s) benefited from the opening of five new business banking centres offering a comprehensive range of bespoke services, while an SME start-up marketing campaign, launched in October, promoted these services with specific reference to the BusinessVantage all-in-one account. These initiatives, together with call centre expansion, contributed to an increase in income arising from SME business. Net interest income increased by 13 per cent as strong growth in both lending balances and customer deposits reflected the impact of the relationship managers and business banking centres. Spreads on deposits narrowed during the year in the continued low interest rate environment. Operating expenses, excluding goodwill amortisation, were 4 per cent higher than in 2003. Other operating income rose by 16 per cent to US$525 million due largely to a significant rise in 75 H S B C H O L D I N G S P L C Financial Review (continued) trade finance activity and trade-related income. Economic expansion in mainland China, the consumer spending recovery in the US and an increase in commodity prices contributed to strong regional trade flows. Business activity with mainland China benefited from the secondment of key relationship managers to HSBC offices there, and a regional advertising campaign demonstrating HSBC’s ability to offer integrated solutions across Greater China. Increased lending to middle market customers, together with the launch of several new lending products for SMEs and related marketing campaigns, boosted credit facility fee income. Continued investment in sales resources and training, marketing and incentive campaigns led to higher insurance income. The introduction of income protection, unit trust and structured investment products to HSBC’s range of commercial wealth management products also contributed to the increase in non-funds income, resulting in a 20 per cent rise in investment and protection income. Operating expenses, before goodwill amortisation, were 7 per cent higher than in 2003. The increase reflected growth in headcount, higher recruitment-related costs, and training costs. Marketing spend also rose in support of business development initiatives with mainland China, and to increase sales to existing customers and raise insurance income. Further costs arose from the launch of a number of efficiency initiatives, including a new Customer Relationship Management System, which is expected to lead to both improved sales and cost savings. As part of an ongoing process, credit support and trade services processes were migrated to the Group Service Centre in Shanghai. The net release for bad and doubtful debts increased by US$87 million. There were specific provision releases reflecting the improved economic environment and stronger property market, and a release of general provisions following a review of the impact of the improved economic conditions and historical loan loss experience. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$1,584 million, 24 per cent higher than in 2003, driven by strong growth in dealing profits, a significant increase in fees and commissions and a net release of provisions for bad and doubtful debts. In January, management responsibility for a corporate trust business was transferred from Private Banking, contributing US$18 million to pre-tax profits. While comparative 76 numbers have not been restated, the comments that follow exclude the impact of this business transfer unless stated. Net interest income was 14 per cent lower than in 2003, reflecting continued pressure on corporate spreads and lower treasury income resulting from the run-off of higher yielding assets, coupled with limited reinvestment opportunities against a flat Hong Kong dollar yield curve. This shortfall in revenue was partly mitigated by growth in corporate loan balances and higher deposit balances, driven by the roll-out of an upgraded payments and cash management product set. Other operating income grew by 67 per cent, of which 9 per cent came from the inclusion of Bank of Bermuda’s operations in Hong Kong. Underlying growth reflected a significant increase in fees and commissions and dealing income. Foreign exchange profits increased, benefiting from strong customer flows and growing cross-sales opportunities to corporate clients. These gains were further amplified by the non-recurrence of losses resulting from a strengthening Hong Kong dollar in the latter part of 2003. Derivatives trading reported higher profits as Global Markets provided structured investment solutions to support the growth in the sale of wealth management products to personal and commercial customers. A combination of successful positioning and improved customer flows also contributed to profitability as clients sought to lock in funding requirements at historically low rates. Fee income increased from structured solutions and yield enhancement products, and sales of securities and unit trusts. Structured finance also generated an increased contribution compared with 2003. Equity capital markets benefited from an active IPO market, while private equity revenues were boosted by an improvement in management fees, as the launch of a US$700 million regional fund was completed. In asset management, higher sales of investment products and strong growth in funds under management generated increases in distribution revenues and advisory fees, as customers pursued higher returns in a low interest rate environment. Operating expenses, excluding goodwill amortisation, increased by 36 per cent, of which 10 per cent arose in Bank of Bermuda. Staff costs were 18 per cent higher, driven by the recruitment of additional staff, and higher performance-related incentives in line with strong Global Markets results. In Global Markets, staff were recruited to support the increased product range, while in Global Investment Banking, further expenditure was incurred in recruiting corporate finance executives and a number of senior relationship managers to extend coverage along industry sector lines. Business expansion and new front office initiatives in Global Markets resulted in the recruitment of an additional 45 people. Other general cost increases reflected higher technology expenditure, including a US$10 million charge for the development of HSBCnet and, a rise in travel and communication spending, all driven by business expansion and increased sophistication of the product range. There was a net recovery of bad and doubtful debts, particularly from the property, industrial and telecommunications sectors, following a number of successful restructurings and refinancings, reflecting an improved economic environment in Hong Kong and across the region. Private Banking contributed a pre-tax profit, before goodwill amortisation, of US$135 million, an increase of 6 per cent compared with 2003. A trust business was reclassified as Rest of Asia Pacific during the year, and Corporate, Investment Banking and Markets took over management responsibility for the corporate trust business from Private Banking. These transfers reduced growth in profit before tax by 17 per cent. Excluding the corporate trust transfer mentioned above, funds under management increased by 19 per cent. Growth benefited from the introduction of new products, expansion of the client base, and continued strong growth in Strategic Investment Solutions, which was launched in July 2003 and contributed to a US$2.9 billion inflow in net new funds. The recruitment of front office staff, and a general improvement in market conditions, also contributed to growth in funds under management. Total revenue was 5 per cent higher than last year. Underlying growth of US$57 million, including US$10 million from the Bank of Bermuda, was largely offset by the changes noted above. Recovering equity markets, coupled with historically low interest rates, encouraged a marked increase in client investment activity. Fees and commissions benefited from a higher volume of equity transactions, unit trust sales, and portfolio management fees on increased funds under discretionary management. Higher client volumes also boosted dealing income from foreign exchange, options, and structured products. Revenue from sales of structured products increased by nearly 70 per cent compared with 2003, while commissions on sales of unit trusts rose by over 90 per cent, and from funds under discretionary management by over 120 per cent. Operating expenses, excluding goodwill amortisation, increased by 8 per cent, including 6 per cent growth attributable to Bank of Bermuda and a 25 per cent decrease resulting from the changes noted above. Underlying growth of 27 per cent mainly reflected the recruitment of 49 front office staff. Performance-related remuneration increased as a result of the strong growth in revenue, while a rise in marketing expenditure reflected the new brand advertising campaign. A US$4 million net release of bad debts reflected a release of general provisions, following a review of historical loss trends and current economic conditions. Gains on the exchange of an investment in World Finance International Limited, an associated company, for a 7 per cent stake in Bergesen Worldwide, contributed to an improved performance in Other. Gains on equity sales and profits on the disposal of a residential property also contributed to the increase. Year ended 31 December 2003 compared with year ended 31 December 2002 The Hong Kong economy faced challenging conditions during the first half of 2003. Slower growth in major export markets, rising unemployment and a weak property market dampened consumer demand, whilst the outbreak of the SARS virus had a significant adverse impact on the entertainment, leisure and tourism sectors. However, by the third quarter there was clear evidence of a bounce-back with GDP growing 6.4 per cent quarter-on-quarter, more than reversing the 3.7 per cent dip in the second quarter of 2003. The growth rate benefited significantly from the release of demand deferred during the SARS period. Growth also drew support from stronger export demand and improving sentiment after the central government unveiled a series of economic measures to help Hong Kong, including the relaxation of controls on mainland residents travelling to Hong Kong. Local consumer spending grew for the first time in two years and even more encouraging was a pick-up in investment reflecting an improved business outlook. HSBC’s operations in Hong Kong performed well in these circumstances and reported a pre-tax profit of US$3,728 million, broadly in line with 2002. Excluding goodwill amortisation, profit before tax was US$3,730 million and represented 26 per cent of HSBC’s total profit on that basis. Goodwill amortisation was US$2 million in 2003. Of this growth, just under 4 per cent arose from acquisitions during the period. 77 H S B C H O L D I N G S P L C Financial Review (continued) Personal Financial Services in Hong Kong reported a pre-tax profit, before goodwill amortisation, of US$1,740 million, 2 per cent higher than in 2002. Given the pressure on net interest income as a consequence of muted credit demand and the impact of lower interest rates on the value of deposits, there was continued focus on the insurance business and wealth management. Sales of unit trusts and of capital-guaranteed funds were particularly successful. Net interest income fell by US$161 million or 7 per cent compared with 2002, largely due to a reduction in spreads on the value of deposits taken in the low interest rate environment and continued pressure on yields in the mortgage business, although there was some benefit from lower cost of funds. Partly offsetting the decline in net interest income, other operating income at US$1,182 million was 13 per cent higher than in 2002. HSBC’s position as one of Hong Kong’s leading providers of insurance and wealth management services was sustained amid keen competition. Income from wealth management initiatives, including commissions on sales of unit trust products, funds under management, and securities transactions, grew by 38 per cent to US$408 million. This was achieved by strong growth in sales of unit trusts and capital guaranteed funds, which increased by US$1.6 billion, or 32 per cent, over 2002. Net fee income from credit cards was broadly in line with 2002. Despite fierce competition in the market, HSBC maintained its position as the largest credit card issuer in Hong Kong with some 3.1 million cards in circulation, 9 per cent higher than in 2002. During the year, HSBC continued to place significant emphasis upon the growth and development of its insurance business. HSBC increased sales of regular premium individual life insurance by 59 per cent, growing its market share from 13.9 per cent to 18.6 per cent. Income from the insurance business, including the Mandatory Provident Fund, grew by 53 per cent or US$118 million. Operating expenses, excluding goodwill amortisation, were 5 per cent lower than in 2002, with savings in staff costs partly offset by higher marketing costs. Headcount reduced as HSBC continued to migrate a wide range of back office and call centre functions to the Group Service Centres in Guangzhou and Shanghai. The Group Service Centres in mainland China now provide about half 78 the operational support for credit card operations in Hong Kong. Provisions for bad and doubtful debts were broadly in line with last year. The charge for specific provisions for bad and doubtful debts decreased compared with 2002, mainly due to a reduced charge for unsecured lending (including credit cards), in line with lower personal bankruptcy filings and improved economic conditions in the latter half of the year. This was partly offset by higher provisions against mortgage lending. 2002 benefited from a higher release of general provision. As the economy grows and property prices stop falling the environment for personal credit is expected to improve in 2004. Commercial Banking in Hong Kong contributed a pre-tax profit, before amortisation of goodwill, of US$711 million, a fall of US$22 million, or 3 per cent. Net interest income declined by 7 per cent largely due to lower recoveries of suspended interest and the effect of lower spreads on deposits. There was good volume growth in the loan book, despite the impact of SARS and the war in Iraq. This was offset by narrower spreads caused by limited local investment and market pressure as banks competed for quality business. Loan growth was driven by increased demand for finance to support record trade flows between mainland China and the rest of the world, especially the US. This was particularly evidenced in the manufacturing and transportation sectors. Several new business banking/trade service centres were opened to focus on the business needs of small and medium-sized customers and start-ups. Other operating income rose by US$57 million, or 14 per cent, reflecting growth in cash management and trade services. Both benefited from the increase in trade flows and closer liaison between branches of the bank in Hong Kong and mainland China. This was developed in order to service the growth of investment in the Pearl River delta by Hong Kong-based customers. Additionally, Hang Seng Bank opened its first branch in Macau aimed at assisting customers setting-up offices in the territory. Results of this alignment were particularly successful, with referrals significantly higher than anticipated. Trade finance benefited from a campaign specifically aimed at the increase in export trade business which occurs during the peak summer season. Insurance income rose as a consequence of business expansion, increasing by 36 per cent. Operating expenses were in line with 2002. Staff costs increased marginally as headcount rose to support the insurance business expansion. This was offset by lower legal and professional fees. Overall, credit quality remained stable reflecting improved economic conditions in the latter part of the year. There was a lower release in general provisions in 2003 as last year benefited from a reduction in latent losses. There was a net charge for bad and doubtful debts of US$52 million compared with a release of US$68 million in 2002. This was primarily due to new specific provisions raised against two corporate accounts. Corporate, Investment Banking and Markets HSBC’s Private Banking activities in Hong reported pre-tax profit, before amortisation of goodwill, of US$1,275 million, 4 per cent higher than in 2002. Exceptional Global Markets performance was partly offset by a shift from net recovery to net charge for bad and doubtful debts. Net interest income of US$1,157 million was broadly in line with last year. Reduced corporate lending spreads, which remained under pressure throughout the year, and weak loan demand, were mitigated by a strong Global Markets performance. Global Markets benefited from successful interest rate positioning and an increased value of funds was switched to debt securities from interbank placements in order to enhance yields. Other operating income grew strongly to US$648 million, an increase of US$184 million or 40 per cent. This was achieved through a significant increase in dealing profits to US$205 million. HSBC significantly expanded its derivatives capabilities and higher income was earned from both successful positioning and a growing demand from corporate customers for structured tailored solutions. Increased sales of structured transactions, offering yield enhancement products to retail clients, generated further revenue. Debt securities trading achieved a strong turnaround in income during the year, as losses caused by widening credit spreads in 2002 did not recur. Foreign exchange profits rose compared with 2002, with a significant increase in corporate sales. Trading profits were generated as the bank took advantage of US dollar volatility, and the general weakening of the US dollar during the year. This was partly offset by lower Corporate and Investment Banking fees and commissions, reflecting a decrease in income from credit facilities. Operating expenses, before goodwill amortisation, increased by 5 per cent to US$491 million, with the significant increase in Global Markets’ profitability reflected in higher performance-related staff costs. Kong reported pre-tax profit, before goodwill amortisation, of US$127 million, an increase of 19 per cent over 2002. Funds under management grew by 12 per cent to US$56 billion, benefiting from US$7 billion of net new funds as clients moved away from liquid positions into the investment markets. Net interest income declined by US$7 million, or 8 per cent, to US$84 million. Lower margins from free funds and the investment portfolio reflected falling interest rates while the flattening of the yield curve during the year meant that the significant income earned on longer dated assets in 2002 was not repeated. This more than offset the impact of an increase in lending balances as clients borrowed on margin against their investments to reinvest in higher returning securities. A general improvement in investment markets in the second half of the year saw greater client activity across a range of products. Brokerage, trust services and safekeeping all benefited from the upturn in the markets, and associated fee and commission income increased by 19 per cent to US$87 million. Greater market activity also stimulated higher sales of tailored structured products for clients and higher volumes of debt securities and derivatives transactions, resulting in a 68 per cent increase in dealing profits. Overall, other operating income increased by 31 per cent to US$164 million. Total operating expenses grew by US$9 million or 8 per cent, reflecting a rise in headcount to support increased client activity and the migration of regional support from Singapore to Hong Kong during the year. There was also higher performance- related remuneration in line with increased profits. 79 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group Year ended 31 December 2004 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m 2,017 2 799 46 619 1,466 3,483 679 1 374 35 115 525 1,204 998 2 530 447 106 1,085 2,083 85 – 75 101 (1) 175 260 Inter- segment elimination US$m – – – – (470) (470) (470) Other US$m (140) 14 (52) 1 412 375 235 Total US$m 3,639 19 1,726 630 781 3,156 6,795 (1,336) (399) (668) (128) (463) 470 (2,524) debts .......................................... (54) Provisions for contingent liabilities and commitments ........ Amounts written back on fixed asset investments ....................... – – 2,147 805 109 – – 1,415 132 (228) 164 – – 4 – – – (3) 26 Operating profit/(loss)1 ................ 2,093 914 1,579 136 (205) 4 – 2,097 % 10.8 38.4 – – 914 % 4.7 33.1 – 5 1,584 % 8.2 32.1 – (1) 135 % 0.7 49.2 US$m US$m US$m US$m 33,704 37,986 114,303 17,889 23,579 35,226 22,440 130,300 19,236 2,954 7,733 9,264 4 224 23 % 0.1 197.0 US$m 1,901 17,808 339 – – – – – – – – 4,271 223 (3) 26 4,517 8 228 4,753 % 24.5 37.1 US$m 78,888 217,406 178,368 Hong Kong Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income ................................. Other operating income .................. Operating income ......................... Operating expenses excluding goodwill amortisation1................ Operating profit/(loss) before provisions1 ................................ Provisions for bad and doubtful Share of operating profit in associates2 .................................. Gains/(losses) on disposal of investments and tangible fixed assets .......................................... Profit on ordinary activities before tax3 ................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets5 ................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... 42,515 58,902 4,205 2 – 2 6 – 6 – – – 9 – 9 Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 5 Excluding Hong Kong Government certificates of indebtedness. (1) – (1) 2 – 2 80 Operating profit/(loss)1 ................ 1,733 707 1,267 128 (190) Year ended 31 December 2003 Corporate, Investment Banking & Markets US$m 1,157 3 382 205 58 648 602 1 315 31 107 454 1,056 1,805 Private Banking US$m 84 – 87 74 3 164 248 Inter- segment elimination US$m – – – – (395) (395) (395) Other US$m (145) 25 (31) (29) 313 278 133 Total US$m 3,901 31 1,383 321 596 2,331 6,232 Personal Financial Services US$m Commercial Banking US$m 2,203 2 630 40 510 1,182 3,385 (1,286) (372) (491) (118) (340) 395 (2,212) 2,099 684 1,314 130 (207) (366) – – 22 1 – (52) – 5 (2) – – (2) (7) 26 5 2 1,740 % 12.1 38.0 – 4 711 % 5.0 35.2 1 7 1,275 % 8.9 27.2 – (1) 127 % 0.9 47.6 11 56 (123) % (1.0) 255.6 US$m US$m US$m US$m US$m 33,494 36,410 111,145 12,760 17,783 31,490 23,441 120,890 13,286 2,357 7,555 7,862 1,936 14,849 241 Hong Kong Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income ................................. Other operating income .................. Operating income1 ....................... Operating expenses excluding goodwill amortisation1 ............... Operating profit/(loss) before provisions1 ................................. Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Share of operating profit in associates2 .................................. Gains/(losses) on disposal of investments and tangible fixed assets .......................................... Profit/(loss) on ordinary activities before tax3.................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets5 .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 5 Excluding Hong Kong Government certificates of indebtedness. 2 – 2 – – – 34,165 57,831 4,665 1 – 1 – – – – (1) (1) – – – – – – – – 4,020 (400) (6) 31 3,645 17 68 3,730 % 25.9 35.5 US$m 73,988 197,487 164,024 3 (1) 2 81 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group (continued) Year ended 31 December 2002 Operating profit/(loss)1 ................ 1,699 729 1,220 107 Hong Kong Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income ................................. Other operating income .................. Operating income ......................... Operating expenses excluding goodwill amortisation1 ............... Operating profit/(loss) before provisions1 ................................. Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Share of operating profit in associates2 .................................. Gains on disposal of investments and tangible fixed assets ............ Profit/(loss) on ordinary activities before tax3................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets5 .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m 1,161 3 399 21 41 464 648 2 284 25 86 397 1,045 1,625 Private Banking US$m 91 – 73 44 8 125 216 Inter- segment elimination US$m – – – – (459) (459) (459) Other US$m (131) 17 (35) (2) 362 342 211 Total US$m 4,133 25 1,264 133 495 1,917 6,050 2,364 3 543 45 457 1,048 3,412 (1,351) (371) (469) (109) (298) 459 (2,139) 2,061 674 1,156 107 (87) (362) – – 54 1 – 68 – (4) – – – 3 3 1,705 % 16.2 39.6 – 4 733 % 6.9 35.5 – 6 1,226 % 11.7 28.9 – – 107 % 1.0 50.5 (6) (15) (6) (114) 8 45 (61) % (0.5) 141.2 US$m US$m US$m US$m US$m 34,447 36,369 103,413 10,797 15,097 27,019 20,703 108,063 11,154 1,917 7,346 7,142 2,084 13,558 176 – – – – – – – – 3,911 (246) (14) (10) 3,641 11 58 3,710 % 35.3 35.4 US$m 69,948 180,433 148,904 29,284 53,689 2,170 – – – – – – – – – – – – Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 5 Excluding Hong Kong Government certificates of indebtedness. – – – – – – 82 Rest of Asia-Pacific (including the Middle East) Profit before tax excluding goodwill amortisation Personal Financial Services ............................................................................ Commercial Banking ...................................................................................... Corporate, Investment Banking and Markets ................................................. Private Banking ............................................................................................. Other .............................................................................................................. Year ended 31 December 2004 US$m 350 496 940 59 32 2003 US$m 158 450 732 36 50 2002 US$m 127 423 706 25 12 Total1 ............................................................................................................. 1,877 1,426 1,293 1 Goodwill amortisation excluded: – arising on subsidiaries ............................................................................ – arising on associates and joint ventures ................................................. – total ......................................................................................................... 68 4 72 35 – 35 Year ended 31 December 2004 US$m 2003 US$m Australia and New Zealand ............................................................................ Brunei ............................................................................................................ India ............................................................................................................... Indonesia ........................................................................................................ Japan .............................................................................................................. Mainland China ............................................................................................. Malaysia ........................................................................................................ Middle East (excluding Saudi Arabia) ........................................................... Philippines ..................................................................................................... Saudi Arabia .................................................................................................. Singapore ....................................................................................................... South Korea ................................................................................................... Taiwan ........................................................................................................... Thailand ......................................................................................................... Other .............................................................................................................. 86 33 180 79 50 44 216 295 29 175 274 88 108 59 161 96 28 94 75 39 42 149 236 16 133 198 69 80 54 117 33 – 33 2002 US$m 34 34 85 73 44 50 129 225 32 103 223 60 80 39 82 1,877 1,426 1,293 83 H S B C H O L D I N G S P L C Financial Review (continued) Profit before tax Rest of Asia-Pacific (including the Middle East) Net interest income ...................................................................................... Dividend income ............................................................................................ Net fees and commissions .............................................................................. Dealing profits ............................................................................................... Other income ................................................................................................. Other operating income .................................................................................. Total operating income ................................................................................ Staff costs ...................................................................................................... Premises and equipment ................................................................................. Other .............................................................................................................. Depreciation and intangible asset amortisation .............................................. Goodwill amortisation ................................................................................... Operating expenses ........................................................................................ Operating profit before provisions ............................................................. Provisions for bad and doubtful debts ............................................................ Provisions for contingent liabilities and commitments ................................... Amounts written off fixed asset investments ................................................. Operating profit ........................................................................................... Share of operating profit in associates ............................................................ Gains on disposal of investments and tangible fixed assets ............................ Profit on ordinary activities before tax ...................................................... Share of HSBC’s pre-tax profits (excluding goodwill amortisation) .............. Share of HSBC’s pre-tax profits .................................................................... Cost:income ratio (excluding goodwill amortisation) .................................... Period-end staff numbers (full-time equivalent) ............................................. Selected balance sheet data1 Loans and advances to customers (net) .......................................................... Loans and advances to banks (net) ................................................................. Debt securities, treasury bills and other eligible bills ..................................... Total assets .................................................................................................... Deposits by banks .......................................................................................... Customer accounts ......................................................................................... 1 Third party only. Year ended 31 December 2004 US$m 2,055 3 1,057 494 195 1,749 3,804 (1,104) (183) (689) (104) (2,080) (68) (2,148) 1,656 (100) – – 1,556 232 17 1,805 % 9.7 10.3 54.7 41,031 US$m 60,599 14,780 30,312 120,504 8,046 78,613 2003 US$m 1,740 4 805 421 120 1,350 3,090 (952) (164) (527) (98) (1,741) (35) (1,776) 1,314 (85) (1) (2) 1,226 149 16 1,391 % 9.9 10.9 56.3 31,827 US$m 47,952 12,944 25,980 98,081 6,967 65,441 2002 US$m 1,607 3 724 364 83 1,174 2,781 (826) (156) (454) (92) (1,528) (33) (1,561) 1,220 (89) 18 (2) 1,147 113 – 1,260 % 12.3 13.1 54.9 28,630 US$m 37,078 10,708 21,622 76,635 5,362 54,172 Year ended 31 December 2004 compared with year ended 31 December 2003 Driven primarily by external demand, growth in Asia-Pacific was strong in the first half of 2004 and the positive export performance, in turn, provided the necessary income growth to support consumption demand. However, the surging growth seen in most Asian economies appeared to peak in the middle of 2004 and slow, primarily for two reasons. The first was the erosion of purchasing power from the high level of oil prices, and the second was the start of a policy-induced slowdown in mainland China’s investment demand, designed to slow China’s domestic economy. HSBC estimates that, excluding Japan, Asian economies grew by 7.1 per cent throughout 2004, with growth of 8.3 per cent in the first half down to 6 per cent in the second half of the year. The slowdown is expected to persist in 2005. The mainland China economy dominated economic activity in Asia in 2004, with concerns over whether the authorities would be able to slow growth in a manageable fashion from the unsustainably high levels of 2003 and first half of 2004, and continued speculation regarding a possible 84 revaluation of the renminbi. Evidence to date suggests that the Chinese economy is likely to achieve a soft landing with the investment slowdown being cushioned by strong exports and rising consumption. However, Asian exports to China are being affected by this re-balancing of growth. The Chinese authorities have resisted revaluation speculation and indicated that the status quo will remain in the foreseeable future. Elsewhere, capital flows put Asian currencies under pressure to appreciate in value. In some countries, policy measures were reasonably successful in resisting the pressure, with the result that floating Asian currencies, while gaining on the US dollar, lost ground to the yen and the euro. Inflationary pressures remained modest and Asian central banks did not need to fully match increases in US interest rates during the year. Indeed, the Bank of Korea cut rates by 25 basis points at both its August and November meetings. Energy producing economies in the Middle East continued to benefit from high global oil prices, and the region's current account surplus in 2004 is expected to easily exceed the 2003 surplus of US$52 billion. In the context of relatively low inflation, the Middle East’s strong balance of payments position should ensure that domestic interest rates remain relatively low, which in turn should continue to stimulate domestic demand. Altogether, this means that the GDP growth rate in 2004 in the Middle East should be close to 2003’s 5.4 per cent. The level of public debt relative to GDP remains high in the region compared with other emerging markets, but HSBC considers it unlikely that there will be financing problems there. HSBC’s operations in the rest of the Asia- Pacific region contributed US$1,805 million to HSBC’s pre-tax profit, an increase of US$414 million compared with 2003. Excluding goodwill amortisation, pre-tax profit was US$1,877 million, and represented 10 per cent of HSBC’s total profit on this basis. At constant exchange rates, pre-tax profit before goodwill amortisation increased by 29 per cent over the same period in 2003. Three per cent of this growth arose from acquisitions during the period. The comments which follow are based on constant exchange rates. In Personal Financial Services pre-tax profit, before goodwill amortisation, of US$350 million increased by 117 per cent compared with prior year. Net interest income grew by 22 per cent, reflecting strong asset growth in a number of countries across the region, particularly in the Middle East, Australia, Korea, India, Singapore, Malaysia and Taiwan. Mortgage balances increased by 29 per cent to US$13.6 billion, following strong sales drives and a series of promotional campaigns in a number of countries. Lower pricing to achieve this growth led to lower yields. The cards business continued to expand and a number of new products were introduced. Acquisition strategies, including a wide variety of promotional campaigns and the launch of an enhanced rewards programme in 12 countries across the region, led to a 25 per cent increase in cards in circulation. At the end of 2004, HSBC’s card base in the region exceeded 4.6 million, with particularly strong growth in India, Malaysia, Singapore, the Philippines and the Middle East. Utilisation of this expanded card base contributed to a 21 per cent increase in average credit card balances compared with 2003. Other operating income grew by 27 per cent to US$403 million, driven by sales of investment products across the region. Commissions from sales of unit trusts and funds under management were particularly strong in Taiwan, Korea, India, and Malaysia, where HSBC Bank Malaysia is the leading international institutional unit trust agent. Brokerage and custody fees increased by 143 per cent with particularly strong growth in Australia reflecting increased marketing, buoyant stock market activity and higher stock prices. HSBC continued to grow its insurance business across the region and income grew by 86 per cent as the number of policies in force increased by 25 per cent. Fee income also benefited from the strong growth in the credit card base, increased account service fees and growth in sales of structured products. Operating expenses, excluding goodwill amortisation, of US$947 million increased by 15 per cent, mainly from a 24 per cent increase in other administrative expenses. Significant emphasis was placed on promoting brand awareness in mainland China to generate additional business and to reinforce HSBC’s position as the leading international bank in mainland China. The launch of a number of credit card and mortgage advertising campaigns also fed through to a rise in marketing costs. Investment in systems development across the region was reflected in higher technology costs. In 2004 magnetic stripe cards and ATM cards were replaced by chip based cards in Malaysia. Elsewhere in Asia, progress was made in upgrading point-of-sale terminals and ATM’s to enhance fraud protection and prepare for the eventual pan-regional 85 H S B C H O L D I N G S P L C Financial Review (continued) implementation of chip cards. Other general expenses, including professional fees and communications costs, increased to support business expansion. Within the region HSBC expanded the scale and range of services offered by the Group Service Centres and additional staff were recruited to support increased workflow. As new business and cross-sales across the region grew HSBC increased investment in sales support. At US$117 million, the overall charge for bad and doubtful debts was 21 per cent lower than in 2003. There was a release of general provision in Malaysia which reflected the improvement in economic outlook, and higher releases and recoveries of specific provisions in several countries across the region. New specific provisions raised were 9 per cent higher than in 2003, notably in the Middle East, Indonesia and Australia, reflecting lending growth. Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$496 million for 2004, 9 per cent ahead of 2003. A turnaround in provisions, from a credit of US$52 million to a charge of US$16 million, was more than offset by additional income arising from growth in international trade. Pre-provision profit before tax increased by US$81 million, or 21 per cent. The results also included, for the first time, a contribution of US$24 million from the group’s 19.9 per cent stake in Bank of Communications. Net interest income increased by 11 per cent, compared with 2003, reflecting growth in the Middle East, mainland China, Australia, New Zealand and Singapore. The Middle East benefited from the expansion of international trade, increased lending to infrastructure projects, which took off on the back of strong oil prices, and growth in current accounts. In mainland China, HSBC benefited from increased cross-referrals from Hong Kong, while a Taiwan team seconded to mainland China helped to capture substantial business from Taiwanese customers investing there. The expansion of trade business was also reflected in other operating income, which grew by 18 per cent to US$347 million. Growth was particularly strong in the Middle East, which also benefited from increased fees associated with higher lending, and in mainland China and Malaysia, where dealing profits from foreign currency transactions and trade services fees were both higher. Operating expenses, before amortisation of goodwill, were 6 per cent higher than last year. Additional relationship managers, business development and sales staff, credit analysts and 86 support staff were recruited in the latter part of 2004 in order to benefit from anticipated business opportunities in 2005 arising from strong regional economies. The continued migration of back office work from Singapore, Australia, New Zealand and Taiwan to the Global Service Centres contributed to cost savings. Provisions for bad and doubtful debts were US$16 million, reversing a net release in 2003. New provisions increased in mainland China, largely on a single account and in the Middle East, reflecting growth in lending. There were lower net recoveries in Malaysia, while net recoveries and releases increased in Indonesia and Singapore. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$940 million, an increase of 26 per cent compared with 2003. Net interest income of US$592 million grew by 7 per cent, in part reflecting strong Global Markets performance from increased treasury earnings in India and higher holdings of debt securities in China. Corporate and Institutional Banking benefited from a 55 per cent increase in customer advances in mainland China and a 58 per cent increase in the Middle East. These gains were partly offset by a decline in treasury interest income in Singapore as higher yielding assets matured, and a reduction in interest income in Japan from lower holdings of debt securities. Fees and commissions grew by 24 per cent to US$421 million including a 3 per cent increase resulting from Bank of Bermuda. Corporate and Institutional Banking fee income rose in India, Singapore, Taiwan and Japan, as client demand grew for more sophisticated capital markets and related risk management products. Performance in these countries was improved further as an expansion in business capabilities increased investment banking advisory revenues and boosted Global Transaction Banking volumes. In the Middle East, increases in private equity revenues and corporate finance and advisory fees reflected the expansion of the private equity business and an enhancement of HSBC’s advisory function. In Malaysia, higher fees were attributable to an increase in global custody and transactional fees and an improvement in debt origination and loan syndication activity. The realignment of Corporate and Institutional Banking business with Global Markets capabilities enabled debt finance advisory to double the number of bond and syndicated loan transactions, following effective marketing initiatives and the identification of capital market opportunities. The custody and clearing business benefited from renewed capital inflows, generating higher fees in India, Taiwan and Korea, while improved revenues in institutional funds services reflected the expansion of HSBC’s capabilities into Indonesia, Korea, India and Saudi Arabia. Foreign exchange, derivatives and securities trading income streams were all supported by favourable market opportunities in the region. A 10 per cent increase in dealing income was driven by sales of tailored structured products in Singapore, in part reflecting cross-sales to HSBC’s personal, commercial and corporate customers. In India, higher foreign exchange gains resulted from successful positioning and growing corporate volumes, against a backdrop of an appreciating Indian rupee. The falling interest rate environment in Korea created proprietary trading and cross-currency arbitrage opportunities while interest rate volatility contributed to strong performance in Global Markets Malaysia. In the Middle East, generally volatile market conditions prompted a higher level of hedging activity and an improvement in the volume of customer transactions. Excluding the impact of Bank of Bermuda, operating expenses, excluding goodwill amortisation, increased by 8 per cent, driven primarily by higher performance-related incentives in the Middle East, Korea, Singapore and mainland China. In India, a 20 per cent rise in staff costs, reflecting higher incentives was more than offset by a reduction in restructuring costs compared with 2003. In Singapore, mainland China and the Middle East, an additional 68 people were recruited to upgrade their corporate and support teams, adding to staff costs. There was a higher net release for bad and doubtful debts reflecting the benign credit environment across the region, largely due to releases and recoveries in the chemical and property sectors. Private Banking reported a pre-tax profit, before goodwill amortisation, of US$59 million, an increase of 59 per cent compared with 2003, which reflected the expansion of Private Banking activities in the region, and strong growth in fee income and dealing profits in more positive market conditions. 16 per cent of the growth arose from the transfer of a trust business from Hong Kong during 2004. A 24 per cent increase in net interest income was primarily due to the deployment of liquidity into longer-dated assets, which benefited from the differential between long and short-term interest rates. Customer loans grew in Singapore and Japan, as clients leveraged their wealth to re-invest in higher yielding assets. Deposits grew by over US$1.2 billion in Singapore, as new clients deposited cash for investment. Funds under management grew by 18 per cent, with the introduction of new clients and products contributing to an inflow of US$0.5 billion in net new funds. Other operating income increased by 85 per cent, of which 30 per cent arose from the trust business transfer referred to above. Elsewhere, increased activity in the equity markets and the successful launch of new products boosted fees and commissions. Higher volumes of equity transactions, sales of unit trusts, and portfolio fees on higher funds under discretionary management were all reflected in the rise in fees and commissions income. Dealing income rose by 21 per cent, as a result of higher client transaction volumes in foreign exchange, options, and structured products. Operating expenses, excluding goodwill amortisation, increased by 55 per cent, of which 18 per cent was the trust business transfer referred to above. Higher staff costs reflected the recruitment of 32 additional front office staff in Singapore. Performance-related remuneration increased as a result of the strong growth in profitability, while marketing expenditure increased to support the brand at a time of strong wealth creation across Asia. Year ended 31 December 2003 compared with year ended 31 December 2002 The rest of the Asia-Pacific economies experienced mixed fortunes in the first half of 2003 but performed better in the second half of the year on the back of strong exports (particularly to mainland China), strong commodity prices and improving domestic demand. Inflation and interest rates remained very low and many of the region’s central banks implemented programmes to limit currency appreciation against the US dollar. HSBC’s operations in the rest of Asia-Pacific region reported pre-tax profit of US$1,391 million, an increase of US$131 million, or 10 per cent, over 2002. Excluding goodwill amortisation, pre-tax profit was US$1,426 million and represented 10 per cent of HSBC’s total equivalent profit. At constant exchange rates, pre-tax profit, before goodwill amortisation, increased by 8 per cent over 2002. Goodwill amortisation of US$35 million was marginally higher than last year due to an acquisition in Singapore. 87 H S B C H O L D I N G S P L C Financial Review (continued) The commentaries that follow are based on Net interest income was in line with 2002. There constant exchange rates. In Personal Financial Services pre-tax profit, before goodwill amortisation, of US$158 million, increased by 25 per cent compared with 2002 and was broadly double that achieved in 2001. Net interest income grew by 15 per cent compared with 2002, reflecting strong asset growth in a number of countries across the region. The impact on deposit taking business of lower margins in generally low interest rate environments was more than offset by increased customer deposits and the growth in mortgage lending. The latter increased by 38 per cent mainly due to growth in Korea, Singapore, Malaysia and India. Net interest income also benefited from the acquisition of the mortgage business of AMP Bank Limited in New Zealand in the first half of 2003. Strong growth in card balances contributed to a 34 per cent increase in net interest income in Indonesia. Other operating income grew by 20 per cent to US$314 million. The acquisition of Keppel Insurance, which was renamed HSBC Insurance (Singapore) Pte Ltd, contributed US$17 million to this increase during the year. HSBC continued to expand its wealth management initiatives and a number of structured deposit products were launched across the region. Wealth management income grew by 10 per cent, reflecting strong growth in unit trust sales and funds under management, particularly in Taiwan, Korea, Indonesia and India, while fee income from credit cards rose in a number of markets across the region. At 31 December 2003, the bank’s card base in Asia, outside Hong Kong, exceeded 3.7 million, 20 per cent higher than at the end of 2002. An enhanced credit card processing system was implemented in five countries in the region, applying state-of-the-art technology to risk and fraud management. Operating expenses, excluding goodwill amortisation, of US$804 million were 16 per cent higher than in 2002. This reflected increased costs to support business expansion and provisions for restructuring costs of US$34 million. The acquisition of HSBC Insurance (Singapore) Pte Ltd in the year accounted for US$6 million of the increase. Provisions for bad and doubtful debts were 38 per cent higher than in 2002. Provisions against personal lending increased in Singapore, India, Korea and Australia in line with growth in advances. Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$450 million, an increase of 4 per cent, compared with 2002. 88 were lower margins in most countries across the region, in particular Malaysia, Indonesia and Singapore. Consolidation in the financial services sector increased competition in Singapore, whilst Indonesia was impacted by a lower interest rate environment. In addition, Malaysia suffered lower margins on lending. These effects were offset by increased income in both the Middle East and Australia. In the Middle East an intensive marketing campaign led to an expansion in term lending in addition to a growth in overdraft balances. Net interest income in Australia was boosted by the full year contribution from the acquisition of State Street Bank’s trade finance portfolio in July 2002. Other operating income rose by 10 per cent to US$286 million. HSBC Bank Middle East reported a strong performance despite a subdued first quarter as a result of the war in Iraq. In addition, insurance income in Singapore increased as a result of the acquisition of Keppel Insurance, as detailed previously. Operating expenses increased by 3 per cent to US$324 million, mainly due to restructuring costs in India and Singapore and the impact of the acquisition in Singapore. Credit experience continued to be very good, benefiting from ongoing success in recovering historical troubled debt. The net release of provisions increased 46 per cent to US$52 million in 2003 with higher net releases of specific provisions in Malaysia than last year. This was partly offset by an increase in specific provisions in Indonesia. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$732 million, which was broadly in line with 2002. Net interest income fell by 7 per cent compared with last year, with reductions in Singapore, and to a lesser extent in the Middle East, as higher yielding assets matured and the proceeds were reinvested at lower rates. This was partly offset by an increase in net interest income from corporate banking business in India, Korea and mainland China. Dealing profits increased, primarily in Taiwan, Japan and Thailand, reflecting a broader product offering, more customer-focused sales activity and successful positioning to take advantage of directional trends in the generally more volatile market conditions. Higher fee income was generated from brokerage and corporate finance transactions in the Middle East. Operating expenses, before goodwill amortisation, of US$521 million, increased by 2 per cent, mainly due to restructuring costs in India and Singapore. There was a net release of US$5 million for bad and doubtful debts compared with a net charge of US$26 million in 2002, at constant exchange rates. A specific provision raised against a New Zealand corporate customer in 2002 was recovered during the year. HSBC’s Private Banking activities in the rest of Asia-Pacific reported pre-tax profit, before goodwill amortisation, of US$36 million in 2003, an increase of 46 per cent, compared with 2002. This was achieved through strong growth in dealing profits, which rose by 55 per cent to US$38 million, and more than compensated for a reduction of 7 per cent in net interest income. The fall in net interest income reflected significant income earned in 2002 from the deployment of liquidity into longer dated assets which benefited from the fall in short-term interest rates. With the flattening of the yield curve this was not repeated in 2003. Dealing profits benefited from a higher volume of client transactions in the debt securities and derivatives markets and increased sales of client-tailored structured products. Operating expenses, excluding goodwill amortisation, increased by 25 per cent to US$47 million, primarily to support business growth. 89 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group Year ended 31 December 2004 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Inter- segment elimination US$m Other US$m 946 – 300 44 59 403 472 – 266 59 22 347 819 592 – 421 343 24 788 42 – 41 46 2 89 1,380 131 3 3 29 2 160 194 197 – – – – (72) (72) (72) Total US$m 2,055 3 1,057 494 195 1,749 3,804 (947) (352) (596) (73) (184) 72 (2,080) Operating income ......................... 1,349 – – – – – – – 1,724 (100) – 1,624 236 17 1,877 % 9.7 54.7 US$m 60,599 120,504 78,613 402 (117) – 285 64 1 350 % 1.8 70.2 467 (16) (4) 447 49 – 496 % 2.6 43.0 784 32 17 833 100 7 940 % 4.8 43.2 58 1 – 59 – – 59 % 0.3 55.7 13 – (13) – 23 9 32 % 0.2 93.4 US$m US$m US$m US$m US$m 1,960 4,547 5,543 96 5,209 106 22,819 25,468 28,961 16,446 18,847 15,381 8 1 9 1 3 4 19,278 66,433 28,622 12,118 26,372 7,156 59 – 59 – – – – – – 68 4 72 Rest of Asia-Pacific (including the Middle East) Net interest income ...................... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income ................................. Other operating income .................. Operating expenses excluding goodwill amortisation1 ............... Operating profit before provisions1 ................................ Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Operating profit1 .......................... Share of operating profit in associates2 .................................. Gains on disposal of investments and tangible fixed assets ............ Profit on ordinary activities before tax3 ................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 90 Rest of Asia-Pacific (including the Middle East) Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income5 ................................ Other operating income5 ................ Operating income5 ....................... 1,068 Year ended 31 December 2003 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m 754 – 239 35 40 314 419 – 220 46 20 286 705 541 – 324 301 16 641 1,182 33 – 10 38 - 48 81 Inter- segment elimination US$m – – – – (58) (58) (58) Other US$m (7) 4 12 1 102 119 112 Total US$m 1,740 4 805 421 120 1,350 3,090 Operating expenses excluding goodwill amortisation1,5 ............. Operating profit before provisions1 ................................ Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Operating profit1 .......................... Share of operating profit in associates2 .................................. Gains on disposal of investments and tangible fixed assets ............ Profit on ordinary activities before tax3 ................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets5 ................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... (804) (324) (521) (47) (103) 58 (1,741) 264 381 661 (145) – – 119 39 – 158 % 1.1 75.3 52 (1) – 432 17 1 450 % 3.1 46.0 5 (1) (1) 664 65 3 732 % 5.1 44.1 34 2 – – 36 – – 36 % 0.2 58.0 9 1 1 (1) 10 28 12 50 % 0.4 92.0 US$m US$m US$m US$m US$m 17,848 20,101 26,592 13,383 14,395 13,006 15,129 56,492 22,146 1,481 2,813 3,693 111 4,280 4 – – – – – – – – 1,349 (85) (1) (2) 1,261 149 16 1,426 % 9.9 56.3 US$m 47,952 98,081 65,441 10,452 23,279 6,405 Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 5 Restated to include the activities of the Group Service Centres and Shared Services Organisations in ‘Other’ where these activities were 28 – 28 5 – 5 – – – 1 – 1 1 – 1 35 – 35 formerly reported across customer groups. 91 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group (continued) Year ended 31 December 2002 Rest of Asia-Pacific (including the Middle East) Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits/(losses) .................. Other income5 ................................ Other operating income5 ................ Operating income5 ....................... Operating expenses excluding goodwill amortisation1,5 ............. Operating profit/(loss) before provisions1 ................................ Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Operating profit/(loss)1 ................ Share of operating profit in associates2 .................................. Gains/(losses) on disposal of investments and tangible fixed assets .......................................... Profit on ordinary activities before tax3 ................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets5 ................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m 633 – 211 27 16 254 887 417 – 213 37 5 255 672 561 – 293 278 17 588 1,149 35 – 6 24 – 30 65 (668) (305) (477) (37) 219 (104) – – 115 13 (1) 127 % 1.2 75.3 367 31 5 – 403 18 2 423 % 4.1 45.4 672 (18) 13 (2) 665 42 (1) 706 % 6.7 41.5 28 (3) – – 25 – – 25 % 0.2 56.9 US$m US$m US$m US$m 11,812 13,453 22,613 10,795 11,619 11,600 12,963 46,378 16,506 1,392 2,336 3,413 9,249 19,094 4,830 Inter- segment elimination US$m – – – – (38) (38) (38) Total US$m 1,607 3 724 364 83 1,174 2,781 38 (1,528) – – – – – – – – 1,253 (89) 18 (2) 1,180 113 – 1,293 % 12.3 54.9 US$m 37,078 76,635 54,172 Other US$m (39) 3 1 (2) 83 85 46 (79) (33) 5 – – (28) 40 – 12 % 0.1 171.7 US$m 116 2,849 40 Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 5 Restated to include the activities of the Group Service Centres and Shared Services Organisations in ‘Other’ where these activities were 29 – 29 1 – 1 – – – 3 – 3 – – – 33 – 33 formerly reported across customer groups. 92 North America Profit/(loss) before tax excluding goodwill amortisation Year ended 31 December Personal Financial Services ......................................................................... USA ............................................................................................................... Canada ........................................................................................................... Mexico ........................................................................................................... Other .............................................................................................................. Consumer Finance2 ...................................................................................... USA ............................................................................................................... Canada ........................................................................................................... Total Personal Financial Services ............................................................... USA ............................................................................................................... Canada ........................................................................................................... Mexico ........................................................................................................... Other .............................................................................................................. Commercial Banking ................................................................................... USA ............................................................................................................... Canada ........................................................................................................... Mexico ........................................................................................................... Other .............................................................................................................. Corporate, Investment Banking and Markets ........................................... USA ............................................................................................................... Canada ........................................................................................................... Mexico ........................................................................................................... Other .............................................................................................................. Private Banking ............................................................................................ USA ............................................................................................................... Other .............................................................................................................. Other ............................................................................................................. USA ............................................................................................................... Canada ........................................................................................................... Other .............................................................................................................. Total1 ............................................................................................................. USA ............................................................................................................... Canada ........................................................................................................... Mexico ........................................................................................................... Other .............................................................................................................. 1 Goodwill amortisation excluded: – arising on subsidiaries ............................................................................ – arising on associates and joint ventures ................................................. – total ......................................................................................................... 2004 US$m 1,164 523 54 552 35 3,576 3,479 97 4,740 4,002 151 552 35 845 414 238 140 53 750 512 135 85 18 66 63 3 (221) (229) – 8 6,180 4,762 524 777 117 761 – 761 2003 US$m 870 446 66 345 13 2,068 2,002 66 2,938 2,448 132 345 13 595 292 162 121 20 837 651 121 66 (1) 63 63 – (176) (193) – 17 4,257 3,261 415 532 49 643 1 644 2002 US$m 605 519 59 23 4 – – – 605 519 59 23 4 435 281 162 9 (17) 494 447 47 3 (3) 57 53 4 (207) (209) (1) 3 1,384 1,091 267 35 (9) 146 – 146 2 Comprises HSBC Finance Corporation’s consumer finance business and the US residential mortgages and credit card receivables acquired by HSBC Bank USA from HSBC Finance Corporation and its correspondents since December 2003. 93 H S B C H O L D I N G S P L C Financial Review (continued) Profit before tax North America Net interest income ...................................................................................... Dividend income ............................................................................................ Net fees and commissions .............................................................................. Dealing profits ............................................................................................... Other income ................................................................................................. Other operating income .................................................................................. Total operating income ................................................................................ Staff costs ...................................................................................................... Premises and equipment ................................................................................. Other .............................................................................................................. Depreciation and intangible asset amortisation ............................................... Goodwill amortisation ................................................................................... Operating expenses ........................................................................................ Operating profit before provisions ............................................................. Provisions for bad and doubtful debts ............................................................ Provisions for contingent liabilities and commitments ................................... Amounts written off fixed asset investments ................................................. Operating profit ........................................................................................... Share of operating profit/(loss) in joint ventures ............................................ Share of operating profit/(loss) in associates .................................................. Gains on disposal of investments and tangible fixed assets ............................ Profit on ordinary activities before tax ...................................................... Share of HSBC’s pre-tax profits (excluding goodwill amortisation) .............. Share of HSBC’s pre-tax profits .................................................................... Cost:income ratio (excluding goodwill amortisation) .................................... Period-end staff numbers (full-time equivalent) ............................................. Selected balance sheet data1 Loans and advances to customers (net) .......................................................... Loans and advances to banks (net) ................................................................. Debt securities, treasury bills and other eligible bills ..................................... Total assets .................................................................................................... Deposits by banks .......................................................................................... Customer accounts ......................................................................................... 1 Third party only. Year ended 31 December 2004 US$m 14,913 32 3,535 439 1,158 5,164 20,077 (4,730) (878) (2,961) (318) (8,887) (761) (9,648) 10,429 (5,186) (42) – 5,201 – (8) 226 5,419 % 31.8 30.8 44.3 69,781 US$m 249,251 24,176 54,871 370,477 15,284 132,900 2003 US$m 11,777 34 2,676 340 932 3,982 15,759 (3,723) (745) (2,241) (238) (6,947) (643) (7,590) 8,169 (4,676) 3 (9) 3,487 11 6 109 3,613 % 29.6 28.2 44.1 65,021 US$m 191,450 11,884 49,168 289,800 10,354 93,996 2002 US$m 2,732 24 984 161 333 1,502 4,234 (1,537) (356) (651) (131) (2,675) (146) (2,821) 1,413 (300) 3 (9) 1,107 (2) 8 125 1,238 % 13.2 12.8 63.2 34,207 US$m 77,589 10,391 39,270 142,032 9,972 90,137 Year ended 31 December 2004 compared with year ended 31 December 2003 The expansion of the US economy was robust in early 2004, with GDP growth of 4.5 per cent in the first quarter. The labour market improved significantly in the spring, with nearly 1 million jobs added between March and May, though in the second half of the year, output growth moderated and payroll gains slowed. This was partly due to substantially higher energy prices, which also contributed to an increase in inflation in the first half of 2004. However, by the end of the year the Federal Reserve’s favoured inflation measure, the PCE (personal consumption expenditure) deflator, was well contained at about 1.5 per cent. The Federal Reserve raised its Fed Funds rate from 1 per cent to 2.25 per cent between June and December. After reaching a peak of 4.87 per cent in June, 10-year bond yields declined through most of the third quarter and drifted only slightly higher in the fourth, ending the year at just 4.2 per cent. Equity markets were lacklustre for most of the year prior to a rally in November and December, by the end of which the 94 S&P500 was up about 9 per cent from the beginning of the year. Over approximately the same period, the value of the US dollar fell, reaching US$1.36 to the euro by the end of December. In Canada, annualised GDP growth slowed to 2.7 per cent in the first quarter of 2004 from 3.3 per cent in the final quarter of 2003, largely because of a fall in stockbuilding. Consumer spending and investment growth began the year strongly. However, the Bank of Canada (‘BoC’) cut interest rates three times in the first half of 2004 in response to low inflation and currency appreciation. With the global economy recovering and Canadian GDP growth having rebounded to 3.9 per cent in the second quarter, the BoC started to reverse its policy, raising rates by 25 basis points in both September and October. Growth remained robust in the second half of the year with consumer spending accelerating. Import growth was significant, partly reflecting a very large build-up of inventory in the third quarter, much of it related to the auto sector. Although inflation picked up a little, the BoC kept rates on hold in November and December, because of concerns about the impact of a stronger Canadian dollar. This left the overnight rate at 2.5 per cent, still below the rate at which it started the year. Mexico’s macro-economic fundamentals remained strong in 2004, with year-on-year GDP growth of 4.4 per cent in line with that of the US. At year-end, the fiscal accounts were showing relatively low deficits helped by the windfall of high oil prices. Driven by oil receipts and an unprecedented level of workers´ remittances, the current account deficit shrank to a figure below the level of reinvested earnings from existing foreign direct investment. Inflation increased from 4.0 per cent at the end of 2003 to 5.2 per cent in 2004, as a result of increases in external energy and food prices, but remained manageable. HSBC anticipates that inflation will be reduced in 2005 due to a restrictive monetary policy, and that moderate to strong GDP growth will continue with a mildly appreciating currency. On 1 July 2004, HSBC Bank USA, Inc. consolidated its banking operations under a single national charter, following approval from the Office of Comptroller of Currency. This enabled the newly formed HSBC Bank USA to serve its customers more efficiently and effectively across the US and provide an expanded range of products. It also put HSBC Bank USA on the same footing as other major US banks. HSBC’s operations in North America reported a pre-tax profit of US$5,419 million, compared with US$3,613 million in 2003. Excluding goodwill amortisation, pre-tax profit was US$6,180 million, compared with US$4,257 million in 2003, and represented 32 per cent of HSBC’s total pre-tax profit on this basis. Within these figures HSBC Finance reported a pre-tax profit, before goodwill amortisation, of US$3,576 million in 2004, an increase of US$1,524 million, of which US$1,084 million was an additional quarter’s contribution. Profit was 21 per cent higher than for the comparable period in the prior year. Bank of Bermuda, acquired in February 2004, contributed US$73 million to pre-tax profit, before goodwill amortisation, in the North American segment. At constant exchange rates, and on an underlying basis, HSBC’s pre-tax profit, before goodwill amortisation, was 17 per cent higher than in 2003. The detailed customer group commentary that follows is based on constant exchange rates. Excluding Consumer Finance, Personal Financial Services generated a pre-tax profit, before goodwill amortisation, of US$1,164 million, 35 per cent higher than in 2003. Approximately 22 per cent of this growth arose from the acquisition of Bank of Bermuda and certain insurance interests in Mexico. Growth in net interest income was 19 per cent. This was driven mainly by a 34 per cent increase in Mexico, where growth in low cost deposits and consumer loans, and higher interest income from the insurance business, contributed to the rise. Acquisitions in Mexico accounted for 17 per cent of the overall improvement. HSBC attracted 359,000 net new deposit customers in Mexico during the year, and this contributed to the US$1.6 billion rise in average deposit balances. Despite an increasingly competitive marketplace, market share in deposits rose to 14.4 per cent, driven by the bank’s extensive branch and ATM network. Consumer loan growth was robust in the second half of the year, particularly in pre-approved payroll loans offered through the ATM network, and residential mortgages. Net interest income in the US grew by 10 per cent, reflecting a US$10.9 billion, or 58 per cent, increase in average residential mortgage balances and the widening of spreads on savings and deposits, as interest rates rose. Sales of residential mortgages remained strong following an expansion of the sales force and the development of the correspondent network, competitive pricing and increased marketing. In 2004, customers generally favoured variable rate products over fixed. Several new 95 H S B C H O L D I N G S P L C Financial Review (continued) products, including a range of adjustable rate mortgages, were launched during the year contributing to an overall increase in gross new lending of 3 per cent to US$32.6 billion. The income benefit of this growth, however, was partly offset by pressure on spreads. Competitive pricing in a contracting market forced a general downward trend in mortgage yields in 2004 compared with the levels seen in 2003. Other operating income rose by US$164 million or 20 per cent to US$979 million, of which US$82 million came from acquisitions. Growth was largely attributable to the strong performance in Mexico, where expansion of the pension funds business, acquired in the last quarter of 2003, complemented higher fee income from credit cards, deposit-related services and international remittances. Sales of pension and bancassurance products grew strongly, attracting some 270,000 new customers, following an expansion of the sales force. An enhanced customer relationship management system and the employment of WHIRL helped the number of credit cards in circulation in Mexico to rise by 29 per cent to 568,000. Fee income from credit cards rose by 20 per cent compared with 2003. Operations in Canada benefited from a rise in retail broking volumes, as market activity revived. In the US, a revised fee structure and improved collection processes produced a 9 per cent increase in fee income from cards and deposit-related services. The US mortgage banking business contributed a pre-tax profit of US$270 million, in line with 2003, despite a fall in other operating income. Lower origination and sales-related income in the secondary market was only partly offset by a reduction in net servicing expenses. There was a net loss of US$4 million from sale of mortgage loans in 2004 compared with a net gain of US$117 million in 2003. This was mainly driven by lower gains on sales of mortgages, as narrower spreads combined with a fall in the volume of loans originated for sale. As interest rates increased in 2004 from the historically low levels experienced in 2003, prepayments of residential mortgages, mostly in the form of loan refinancing, reduced significantly and residential mortgages originated for sale declined by 64 per cent compared with 2003, despite an overall increase in mortgage lending. Loan refinancing activity represented 50 per cent of the total loan originations, compared with 74 per cent in 2003. Pricing also fell from the unusually high levels seen in 2003 and, as a result, HSBC earned lower returns on loans sold. The net cost of servicing mortgages fell, improved primarily as a result of lower amortisation 96 expenses on mortgage servicing rights (‘MSR’) and increased income associated with the derivatives used to offset the changes in the economic value of the MSRs. The reduction in amortisation expenses was also partly affected by lower MSR balances in 2004. The cost reduction was partly offset by higher temporary impairment reserves. Operating expenses, excluding goodwill amortisation, were 16 per cent higher than in 2003. This was due mainly to a 15 per cent increase in costs in Mexico, where the expansion of the pension funds business and the inclusion of the insurance business acquired in the last quarter of 2003 contributed to generally higher salaries and performance-related bonuses. Staff numbers increased in the Mexican branch network to support growth in business volumes, improve customer service, and support the rollout of HSBC Premier. The introduction of the WHIRL credit card system in Mexico and the US, at a cost of US$23 million, was completed by the end of October. In the US, expansion in the mortgage sales force and higher performance-related bonuses led to higher staff costs, while the launch of advertising campaigns for mortgages and deposits added to marketing costs. Additional staff were recruited in the branch network to support business expansion and to improve customer service. Costs in Canada increased by 4 per cent, principally due to higher performance-related staff costs in the brokerage business and restructuring expenses arising from the integration of Intesa Bank Canada, acquired in May. The net bad debts charge fell by 29 per cent to US$99 million. Recoveries of amounts previously written-off in Mexico more than offset the US$11 million increase in new specific provisions in the US, predominantly for the credit cards portfolio within HSBC Bank USA. There was also a US$28 million release of general provisions in Mexico following a review of historical loss experience, reflecting a general improvement in the credit quality of consumer loan portfolios, and the improved market environment. Consumer Finance contributed a pre-tax profit, before goodwill amortisation, of US$3,576 million in 2004, an increase of US$1,508 million of which US$1,097 million was an additional quarter’s contribution. On an underlying basis, pre-tax profit, before goodwill amortisation, grew by 20 per cent to US$2,479 million. The integration of HSBC Finance Corporation into HSBC continued to deliver funding benefits in line with those anticipated. Since December 2003, HSBC Finance Corporation has sold US$3.7 billion of residential mortgages and US$15.6 billion of its domestic private label assets to HSBC Bank USA, the latter in December 2004. Under various service level agreements, HSBC Finance Corporation will continue to maintain the related customer account relationships for the assets transferred. By the end of 2004, HSBC had provided a total of US$35.6 billion in direct and client funding to HSBC Finance Corporation, and cash savings realised in 2004 were in excess of US$400 million. Following receipt of regulatory approval for the sale of the private label portfolio, and prior to the sale, HSBC Finance Corporation adopted charge-off and account management policies in accordance with the Uniform Retail Credit Classification and Account Management Policy issued by the Federal Financial Institutions Examination Council (‘FFIEC policies’), for its domestic private label, MasterCard and Visa credit card portfolios. The main effect of this was on the private label credit card portfolio, where the FFIEC policies resulted in accounts being charged- off earlier. Certain pools of accounts were already following FFIEC policies, and so their adoption improved conformity across all relevant portfolios. The FFIEC account management practices change the delinquency and roll rates applicable to these portfolios, and resulted in a one-off charge to pre-tax profit, before goodwill amortisation, of US$154 million, which is expected to be offset by future funding benefits in the region of US$47 million per annum. Net interest income of US$10,541 million was US$2,690 million higher than in 2003, although on an underlying basis adjusting for the additional quarter in 2004, it was only marginally higher. Average customer loan balances increased by 11 per cent to US$120.6 billion. Lower funding costs gave HSBC Finance Corporation the opportunity to expand its prime and near-prime customer base, particularly in the mortgage business. Average mortgage balances grew by 23 per cent to US$54.1 billion. Some US$3.9 billion of gross new lending balances were originated from a single correspondent relationship, while balances of US$1.6 billion were originated following the launch in 2003 of the ‘Secured Plus’ mortgage product. Organic growth of 16 per cent to US$9.6 billion in vehicle finance loans was primarily achieved through a network of 5,200 motor dealers, extensive alliance relationships and direct sales channels. Loans in the MasterCard and Visa credit card portfolios grew by 3 per cent to US$18 billion, driven largely by growth in the sub-prime portfolio. Spreads widened reflecting the change in product mix towards the sub-prime market. The private label business also achieved growth in average loan balances, 5 per cent higher than in 2003, through new and existing merchant agreements. The benefit of strong growth in loan balances was reduced significantly by lower yields. A greater than normal run-off of older, higher-yielding loans, product expansion into near-prime customer segments, and competitive pricing pressures from excess capacity, particularly in the mortgage market, contributed to an overall decline in loan yields. The decline was only partly offset by increased pricing of variable-rate products in line with interest rate movements, and continued growth in sub-prime credit cards. Also, the adoption of the FFIEC policies reduced net interest income by US$57 million. Other operating income rose by US$895 million, or 52 per cent, to US$2,602 million, largely reflecting the additional quarter’s income. On an underlying basis, and excluding the effect of adopting the FFIEC policies, the increase was 10 per cent, predominantly reflecting strong growth in fee income from credit cards, and increased revenue from sales of value added products. Operating expenses, excluding goodwill amortisation, of US$4,470 million were 44 per cent higher than in 2003. On an underlying basis, operating expenses, excluding goodwill amortisation, increased by 10 per cent to US$3,422 million due mainly to increased staff costs and higher IT and marketing expenditure. Additional staff were recruited in the branch network and in the mortgage services business to support growth in volumes and to improve customer service. Increased business volumes also led to higher performance- related bonuses and higher IT costs. Marketing costs increased, largely due to changes in contractual obligations associated with the General Motors co- branded credit card portfolio, but were partly offset by lower account origination costs. Marketing expenses were also incurred in support of income growth initiatives in the sub-prime market. In September 2004, HSBC rebranded a number of its Consumer Finance businesses at a cost of US$8 million. The charge for bad and doubtful debts rose by 17 per cent to US$5,136 million. On an underlying basis and excluding the effect of adopting the FFIEC policies, the charge fell by 12 per cent. This reflected a marked improvement in credit quality, driven by the economic upturn, improved origination, growth in the proportion of secured lending, improved 97 H S B C H O L D I N G S P L C Financial Review (continued) collections, and the move into prime and near-prime markets. Improvements in delinquency were seen across most products and in a number of key indicators, including early stage delinquency, charge- offs and year-on-year bankruptcy filings. The rate of improvement declined in the second half of the year reflecting seasonality, a slowdown in employment growth and rising energy prices. Commercial Banking reported pre-tax profits, before amortisation of goodwill, of US$845 million for 2004, an improvement of 41 per cent over 2003. Net interest income increased by 8 per cent, of which 3 per cent was attributable to the acquisition of Bank of Bermuda. Adjusting for the loss of net interest income following the disposal of the US equipment-leasing portfolio last year, underlying growth was 7 per cent. In the US, the recruitment of 50 additional relationship managers, focusing on the SME market, contributed to a 12 per cent rise in lending balances and a 17 per cent increase in commercial deposits. Improved economic conditions and stronger consumer confidence also led to increased demand for credit, but spreads suffered in the competitive marketplace. Commercial real estate lending increased by 11 per cent, largely as a result of expansion into the US West Coast and Miami. In Canada, net interest income increased by 16 per cent. Growth in lending reflected stronger demand for credit in the low interest rate environment, improved market conditions and additional income following the integration of Intesa Bank. In Mexico, competitors displaying a greater appetite for risk enabled HSBC to selectively reduce loan balances. This, together with the effect of lower interest rates on deposit spreads and a restructuring of prices, which emphasised fees at the expense of margin, led to an 11 per cent reduction in Mexican net interest income. Other operating income was US$13 million or 3 per cent higher than in 2003. Excluding the disposal of the US factoring and equipment leasing businesses, which in 2003 contributed other operating income of US$109 million, the underlying growth was 25 per cent. The impact of acquisitions during 2004 was not material. In Mexico, fees and commissions grew by US$10 million or 11 per cent. Fees earned from payments and cash management and electronic banking both increased. The Mexican authorities changed the tax regulations to require all companies to make tax payments via electronic banking channels from January 2004. HSBC seized the 98 opportunities presented by this change to increase both the number of clients using electronic banking, and the number of transactions and income per client. Earnings from new trade services products and increased loan fees (from the price restructuring) also contributed. Operating expenses declined by 6 per cent compared with 2003 as a result of the disposal of the factoring and equipment leasing businesses in the US. Adjusting for this, there was a 3 per cent rise in expenses reflecting additional costs from the restructuring and integration of Intesa Bank, the inclusion of Bank of Bermuda, and the effect of increased transaction volumes and business flows between Mexico and the US. The charge for bad and doubtful debts fell by 90 per cent to US$13 million, reflecting an improved economic environment and falling corporate default rates. In 2003, the charge included US$33 million in the US factoring and leasing businesses which were sold during that year. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$750 million, 11 per cent lower than in 2003. Net interest income was 11 per cent lower than in 2003, notwithstanding the first contribution from Bank of Bermuda, which added US$31 million, or 4 per cent to the total. In part this reflected the cost of funding trading strategies where the offsetting income arises within dealing revenues. The return on investments held for liquidity fell and the yield on loans dropped as re-financing reached record levels following the reductions in interest rates in the latter part of 2003 and early 2004. The lower interest rates resulted in large early redemptions of mortgage- backed securities. Reinvestment opportunities, however, failed to match the yields given up on these redemptions. In Canada, a combination of interest rate cuts in the early part of 2004 and lower corporate loan balances reduced net interest income. However, in Mexico, investment portfolios profited from having locked into higher long-term interest rate structures. Other operating income improved by 15 per cent, of which 7 per cent was attributable to Bank of Bermuda, which improved its market share in funds administration following its acquisition. A 23 per cent increase in fees and commissions in the US was driven by increased underwriting fees from debt issues and syndication, coupled with higher deal execution revenues. Increased revenues from customers reflected improved client coverage. The growing use of electronic trading by clients resulted in increased commissions from futures transactions, while structured finance and HSBC Amanah benefited from higher transaction fees and new deals. In Global Transaction Banking, higher payment and cash management revenues reflected an increase in volumes. Dealing profits benefited from a reduced level of losses in respect of mortgage hedging activities transacted on behalf of other HSBC customer groups. These transactions resulted in an offsetting reduction in other income. Although credit spread volatility was relatively low, movements in individual corporate spreads, primarily in the industrials sector, adversely affected corporate bond trading revenues. Global Markets continued to benefit from the previous year’s expansion of derivatives capabilities and higher profits from improved marketing and delivery of structured solutions. Proprietary trading revenues increased, mainly through profits on long futures positions and foreign exchange gains which arose from successful positioning against the weakening US dollar. Foreign exchange also benefited from a higher volume of customer transactions. In Mexico, earnings from debt trading fell as interest rates rose during the year, while in Canada, higher fees from securities sales and corporate finance reflected improved market sentiment in local equity markets. Foreign exchange income in Canada grew by 10 per cent in response to the continued volatility of the Canadian and US dollars. Operating expenses, before goodwill amortisation, of US$1,014 million rose by 31 per cent, of which 12 per cent related to costs in Bank of Bermuda. In New York, the significant expansion of the Corporate Investment Banking and Markets’ business resulted in an increase of some 300 in headcount and a corresponding rise in salary costs. Incentive compensation also rose, largely due to the costs of recruiting and retaining the high quality staff needed to deliver the business strategy. Key hires within the expanded complement included the establishment of a mergers and acquisitions and advisory group, and product teams to develop asset- backed and mortgage-backed securitisation and trading. Non-staff costs grew correspondingly and included investment in technology to support the new business streams and the related control environment. A net release of provisions for bad and doubtful debts reflected a significant improvement in credit quality as corporate restructuring and refinancing was facilitated by the better economic conditions. This resulted in releases and recoveries across a number of sectors. Private Banking contributed a pre-tax profit, before goodwill amortisation, of US$66 million, an increase of 6 per cent on the result achieved in 2003. Good progress was made in the integration of Bank of Bermuda’s Private Client Services business, which added an onshore banking capability in Bermuda, and complementary offshore and trust products and services to HSBC’s North American operations. In aggregate, Bank of Bermuda’s North American Private Banking operations added US$2 million to pre-tax profits, before goodwill amortisation, in 2004. Net interest income increased by 37 per cent, due largely to balance sheet growth. Strong growth in customer loans, which were 50 per cent higher than in 2003, reflected the success of the insurance premium financing business, an expanded customer base, and growth in secured borrowing by clients to invest in higher-yielding assets or funds. The larger customer base resulted from an expansion of Private Banking’s geographical presence, and cross-referrals generated through the alignment of Private Banking’s operations with other customer groups. This contributed to an increase in average customer deposits. Other operating income was 4 per cent below that achieved in 2003 but was 23 per cent lower excluding the Bank of Bermuda. The fall in other operating income was mainly driven by client anticipation of interest rate rises, which reduced demand for interest-rate-linked structured products, and sales of fixed interest bonds. WTAS increased revenue despite subdued demand for tax planning services. As a consequence of restrictions placed on the personal tax practices in the major accounting firms engaged in providing audit services, WTAS increased both its customer base and the number of fee-generating staff. Cross-referrals also grew. Operating expenses, before goodwill amortisation and excluding Bank of Bermuda, were broadly flat compared with 2003. Savings were generated from the continuing alignment of international and domestic client servicing units and from operational efficiencies in WTAS. The gain on disposal of investments and tangible fixed assets reflected the sale of seed capital holdings. 99 H S B C H O L D I N G S P L C Financial Review (continued) Year ended 31 December 2003 compared with year ended 31 December 2002 Fuelled by fiscal stimuli and a further interest rate reduction, the US economy steadily gained momentum in 2003. GDP expanded at an annualised rate of 8.2 per cent in the third quarter, the strongest rate since 1984. A strong revival in profits growth boosted investment spending while consumer spending remained strong, supported by tax cuts, a buoyant housing market, and equity releases from refinancing mortgages at record low interest rates. By the end of the year there was some evidence of the long-awaited recovery in the labour market, with the economy adding jobs, albeit modestly. In June the Federal Reserve cut its Fed Funds rate by 25 basis points to 1 per cent. Subsequently, 10-year bond yields rose by 100 basis points from their mid- June low of 3.1 per cent. Equity markets recovered strongly following the end of the Iraq war: by the end of December the S&P 500 had risen by 39 per cent from its March low and was at its highest level since July 2002. This supported consumer confidence. However, with the US current account deficit continuing to deteriorate, the US dollar remained under downward pressure, falling to US$1.26 against the euro by the end of the year. Canada’s central bank was the first of the G7 countries to embark on a policy of raising interest rates in 2003. In response to inflationary pressures in the early part of the year, overnight lending rates were raised on two occasions, by a total of 50 basis points. However, with the Canadian dollar strengthening against the US dollar, inflation worries easing, and concerns about subdued GDP growth, the Central Bank reversed the earlier interest rate rises to take the overnight rate back down to 2.75 per cent in September. Many of the reasons for the disappointing growth were temporary, such as SARS, BSE, forest fires and the Ontario power blackout, and their immediate impact abated. Consumer spending growth remained robust all year, but the ongoing impact of the strong Canadian dollar appeared set to continue, restraining export growth. On 28 March 2003, HSBC completed its acquisition of HSBC Finance Corporation for a consideration of US$14.8 billion, expanding significantly its existing North American business. The addition of HSBC Finance Corporation’s substantial consumer lending portfolio increased the proportion of HSBC’s assets in North America from 19 per cent to 28 per cent of the total Group. The results of HSBC Finance Corporation’s consumer finance business for the period from 29 March to 31 December 2003 are tabulated separately under Consumer Finance in order to highlight their significance to HSBC’s overall performance in North America. HSBC’s results at the pre-tax level and before amortising goodwill also benefited from a US$534 million contribution from HSBC Mexico in its first full year. The integration of both HSBC Finance Corporation and HSBC Mexico progressed well, with synergy benefits and business opportunities generally meeting or exceeding expectations. The following discussion of HSBC’s North American performance highlights the impact of the additions of HSBC Finance Corporation and HSBC Mexico. The phrase ‘on an underlying basis’ is used to describe performance excluding these acquisitions. HSBC’s operations in North America contributed US$3,613 million to HSBC’s profit before tax, an increase of US$2,375 million, compared with 2002. Excluding goodwill amortisation, pre-tax profit was US$4,257 million, compared with US$1,384 million in 2002, which was equivalent to 30 per cent of HSBC’s total pre- tax profit on this basis. On an underlying basis, HSBC’s pre-tax profit, before goodwill amortisation, of US$1,672 million was US$320 million, or 24 per cent, higher than in 2002. Goodwill amortisation was US$644 million in 2003, compared with US$146 million last year, predominantly reflecting the acquisition of HSBC Finance Corporation and, to a lesser extent, HSBC Mexico. The commentaries that follow are based on The Mexican economy continued to lag behind constant exchange rates. the US recovery, largely because, apart from technology, the US manufacturing sector remained subdued. However, the impact of stronger US growth is expected to benefit Mexico in the near term, boosting exports and growth. Meanwhile, political conflicts delayed the passage of critical reform legislation, threatening approval of the 2004 budget. This notwithstanding, a solid macro- economic foundation had been established and was expected to be maintained. Personal Financial Services, excluding Consumer Finance, generated pre-tax profit, before goodwill amortisation, of US$870 million in 2003, 40 per cent higher than last year. HSBC Mexico contributed US$350 million to pre-tax profit for the year. On an underlying basis, pre-tax profit, before goodwill amortisation, was 13 per cent lower than in 2002 mainly due to lower earnings from mortgage servicing and higher staff costs. 100 Net interest income increased by 53 per cent to US$2,116 million mainly as a result of the inclusion of HSBC Mexico. The first full year’s result for HSBC Mexico was strong and ahead of expectations. Growth in Mexico from a relatively weak performance in 2002 reflected an improvement in net interest income driven by a greater level of low cost deposits and an expanding consumer loan portfolio. Interest spreads benefited from a change in asset mix, with over 25 per cent growth in higher yielding assets, including motor vehicle finance, credit cards and payroll loans. On an underlying basis, growth in net interest income of 7 per cent was mainly driven by growth of US$2.5 billion in residential mortgage balances in the US and Canada. In both countries, the low interest rate environment proved attractive to new homebuyers and encouraged existing homeowners to refinance their mortgages. In the US, net interest income further benefited from improved spreads on mortgages and an improved mix of loans and savings deposits. Other operating income of US$825 million was 62 per cent higher than in 2002. Operations in Mexico contributed US$461 million to other operating income in the year. Transaction volumes on core banking related products, such as credit cards, deposit-related services and ATMs, grew significantly. HSBC Mexico led the market with a 34 per cent share in domestic interbank ATM transactions across Mexico, delivering fee revenue of US$92 million. In addition, a growing level of fee income was generated from bancassurance sales and international remittances. On an underlying basis, other operating income fell by 23 per cent. This was primarily caused by a fall in mortgage banking-related income in the US. Total servicing-related income decreased by US$210 million compared with 2002. This decrease was driven by accelerated amortisation and large write-downs of mortgage servicing rights (‘MSRs’) as many customers refinanced mortgages in order to take advantage of the low interest rate environment. MSR income also declined as a result of significant losses on derivative instruments used to protect the economic value of MSRs. In addition, the June/July time period was one of the more difficult periods related to derivative activity. Specifically, in June, positions were taken in derivative instruments to further reduce HSBC’s exposure to these losses as mortgage rates continued to fall. However, in July extreme interest rate volatility ensued and there was a significant rise in interest rates resulting in a substantial loss in the value of the derivative instruments. These losses were only partly offset by subsequent falls in interest rates, and gains from the sale of certain mortgage- backed securities available-for-sale that were used as on-balance sheet economic hedges of the MSRs. While the value of MSRs generally declines in a falling interest rate environment as mortgages are repaid, the effect of this decline is often mitigated by income from refinancing mortgage loans and subsequent sales to mortgage agencies. Total loan volumes sold in 2003 were US$20.1 billion compared with US$12.4 billion in 2002. Market conditions during 2003 permitted favourable pricing which allowed HSBC to earn higher gains on loans sold as well as a higher spread on refinanced loans. As a result, sales-related income for 2003 increased by US$82 million compared with 2002. Overall, the US mortgage banking business contributed US$210 million to pre-tax profit in 2003, compared with US$251 million in 2002. In the US, HSBC generated increases in deposit-related service charges and in card fees, though sales of investment products fell reflecting a lack of confidence in the equity markets. Increased fees in Canada reflected higher insurance sales and increased commissions from retail broking activities as the equity markets rebounded in 2003. Growth in operating expenses, excluding goodwill amortisation, of 65 per cent to US$1,965 million was substantially attributable to the addition of HSBC Mexico, which contributed US$758 million to the overall cost base in 2003. In Mexico, savings in operating expenses were achieved from merging HSBC Mexico with HSBC’s existing operations in the country. These savings funded investment to improve technology support for HSBC Mexico’s branch network. On an underlying basis, operating expenses, excluding goodwill amortisation, increased by 7 per cent. Pension costs rose due to falls in the long-term rates of return on assets, and higher profitability drove increased staff incentive payments. Following the integration with HSBC Finance Corporation, long-term restructuring programmes, including the rationalisation of staff functions, were initiated, adding US$20 million of costs in the year. Operations in Mexico contributed US$67 million to the overall net charge for bad and doubtful debts of US$142 million. On an underlying basis, credit provisions in Personal Financial Services were broadly in line with the prior year, a good performance in view of strong growth in personal lending. Overall credit quality improved, reflecting the improved economic environment. 101 H S B C H O L D I N G S P L C Financial Review (continued) Consumer Finance contributed US$2,068 million to pre-tax profit, before goodwill amortisation, in the nine months since HSBC Finance Corporation became a member of HSBC. The integration of HSBC Finance Corporation into HSBC delivered anticipated benefits in improved funding costs, and technology and administrative cost savings. Significant progress has been made in exporting HSBC Finance Corporation’s core skills, particularly in the areas of credit risk management, sales-focused organisation and customer-centred technology, to other parts of the Group. Further synergies are planned in card processing, IT contingency rationalisation, purchasing, call-centre operations and the shared use of HSBC’s Group Service Centres. HSBC Finance Corporation’s business model is being taken to selected markets overseas and established alongside existing HSBC operations to meet the growing global demand for consumer finance. Net interest margin benefited by US$531 million from purchase accounting adjustments relating to the acquisition of HSBC Finance Corporation in the nine months in which HSBC Finance Corporation was part of the HSBC Group. This comprised of a US$946 million benefit in respect of debt funding, offset by the amortisation of purchase accounting adjustments relating to loans and advances to customers totalling US$415 million. Purchase accounting adjustments restated the book value of debt to fair value at that date and, therefore, reflected the improvement in spread already in the market as well as falling interest rates. They are being amortised in line with the residual maturity of the debt. Assuming credit spreads remain consistent, savings on future debt issues will replace the fair value adjustments relating to credit spreads. Since acquisition, HSBC Finance Corporation’s funding costs on new issues have, in fact, fallen as the credit spreads sought by the market decreased, reflecting the improvement in HSBC Finance Corporation’s credit rating on joining the HSBC Group. During 2003, net interest income benefited by US$124 million as a result of such savings. All consumer portfolios grew during the year, except for personal unsecured loans, with the strongest growth in the real estate secured and private label portfolios. The secured real estate portfolio growth was driven by the correspondent business while the private label portfolio benefited from a number of new relationships added during the year. Growth in MasterCard and Visa loans benefited from portfolio acquisitions made during the year in advantageous circumstances and growth in the General Motors portfolio. The motor vehicle finance 102 business also benefited from new originations from strategic alliances during the year. Included within operating expenses were one- off retention payments arising on the change of control amounting to US$52 million. Headcount increased to support business expansion, particularly in the consumer lending and mortgage services businesses. The charge for bad and doubtful debts in 2003 reflected growth in receivables, increases in personal bankruptcy filings and the weak US economy. However, in the second half of the year credit quality stabilised and improvement was seen in a number of key indicators, including early stage delinquency, charge-offs, bankruptcy filings and collection activities. The improvement reflected resumed domestic economic growth which is forecast to continue into 2004. Commercial Banking in North America reported pre-tax profit, before goodwill amortisation, of US$595 million, an increase of 32 per cent, compared with 2002. On an underlying basis, HSBC generated pre-tax profit, before goodwill amortisation, of US$498 million, 12 per cent higher than last year. Net interest income on an underlying basis was marginally lower than 2002. In Canada, income growth was generated from increased balances on loans and deposits. There were increases in commercial real estate lending where growth in market share was concentrated primarily in New York. Service delivered to SMEs was enhanced as part of the strategy to focus on that market. Notably, the credit application process was re-engineered to make it easier for customers and the number of relationship managers doubled. As a result, lending to SMEs increased by 17 per cent. Net interest income further benefited from steady growth in deposit balances and lower funding costs. Offsetting this was the impact of business disposals as HSBC disposed of its equipment leasing portfolio in the first half of 2003 following a re-evaluation of its core businesses. On an underlying basis, other operating income rose by 20 per cent, reflecting income on the sale of the factoring business and increases in fees related to commercial real estate lending, deposit taking and trade. The inclusion of HSBC Finance Corporation’s commercial portfolio reduced other operating income by US$17 million. These losses were more than offset by tax credits, resulting in an overall benefit to post tax profits of US$40 million. HSBC Mexico contributed US$325 million to total operating income in the Commercial Banking segment in North America, reflecting a strong position in customer deposits. In addition, a growing level of fee income was generated from payments and cash management, loan and credit card fees. Of the total increase in operating expenses, US$163 million was attributable to HSBC Mexico. Underlying operating expenses, excluding goodwill amortisation, increased by 9 per cent to US$614 million. This was driven by higher pension and incentive compensation expenses. In Canada, staff costs increased, primarily due to increased variable incentive payments. Credit quality remained satisfactory. On an underlying basis, provisions for bad and doubtful debts fell by 40 per cent to US$88 million, reflecting the improved credit environment in North America in 2003. Low interest rates, declining credit spreads and positive economic sentiment all contributed to this improvement. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$837 million, an increase of 70 per cent, compared with 2002. On an underlying basis, the Corporate, Investment Banking and Markets business generated pre-tax profit, before amortisation of goodwill, of US$772 million, 58 per cent higher than in 2002. In generally favourable trading conditions, Global Markets achieved higher customer sales from structured finance and hedging products as institutional and corporate borrowers took advantage of low interest rates to raise finance or fix the cost of existing facilities. HSBC’s North American securities trading and debt capital markets business was substantially restructured and refocused towards the end of 2002 and this was reflected positively in its 2003 financial performance. Government and agency securities arbitrage activities were wound down. Corporate bond trading returned to profitability, contrasting with the heavy losses suffered in 2002 as a result of widening credit spreads, particularly in the telecommunications and auto sectors. The turnaround in performance added US$67 million to profit before tax. Investment in relationship management generated new business from major institutional and corporate clients. Global Markets also expanded its structured credit derivatives trading in response to the evolving requirements of its institutional customer base, allowing these clients to risk manage their portfolios more actively, thereby generating fees and trading revenues for HSBC. Underlying net interest income of US$685 million, increased by 28 per cent, compared with 2002. This was partly attributable to the restructuring initiatives in the securities trading and debt capital markets business. As part of this restructuring, large arbitrage trading portfolios, which had historically contributed dealing profits but incurred significant funding costs, were eliminated. Net interest income further benefited from good balance sheet management and effective interest rate positioning in the US and Canada. Underlying total other operating income, at US$738 million improved by 32 per cent. Strong foreign exchange and domestic dollar book trading activity contributed to increased revenues, driven by historically low interest rates and volatile currency markets. Derivatives trading revenues increased, reflecting the growth in demand for the structuring of tailored products for corporate and institutional customers. HSBC Mexico generated other operating income of US$90 million, of which US$64 million was accounted for by dealing profits. Volatility in the Mexican markets enabled the Group to increase trading volumes and capitalise on favourable market movements. These positive market conditions led to increased profits from foreign exchange and fixed income. Underlying operating expenses, before goodwill amortisation, of US$706 million, increased by 9 per cent. Investment in the core business added to the expenditure but was partly funded by lower costs in the securities trading and debt capital markets business, elements of which were wound down. Credit experience on major corporate customers in the US was better in 2003. Many accounts which were potentially problematic at the end of 2002 were successfully refinanced and restructured in the strong debt market at the start of 2003. Elsewhere, credit quality remained satisfactory and consequently, on an underlying basis, there was a net release of US$7 million for bad and doubtful debts. Profits on disposal of investments, on an underlying basis, were US$57 million, a decline of 53 per cent compared with 2002, which included a higher level of securities disposals arising from the restructuring of investment portfolios. HSBC’s Private Banking operations in North America contributed US$63 million to pre-tax profits, before goodwill amortisation, an increase of 11 per cent compared with 2002. During the year the North American business continued its evolution from a deposit-based 103 H S B C H O L D I N G S P L C Financial Review (continued) business to broader wealth advisory service, with a resulting shift from net interest income to fees and commissions. Despite this, net interest income was 3 per cent higher than 2002, reflecting an improved funding environment in 2003. An increase in net fees and commissions and other income of US$52 million, or 37 per cent, mainly reflected the benefit from increased investment activity by clients and a greater emphasis on fee-based non-discretionary advisory and structured products. In addition, WTAS (HSBC’s tax advisory service for high net-worth clients), in its first full year of operation, contributed to this increase. The inclusion of WTAS was the principal contributor to the US$48 million increase in operating expenses, before goodwill amortisation. Cost savings from the alignment of international and domestic client servicing units offset higher staff and restructuring costs. Excluding this operating expenses were essentially flat year-on-year. 104 Profit/(loss) excluding goodwill amortisation by customer group Personal Financial Services US$m Consumer Finance4 US$m Total Personal Financial Services US$m North America Net interest Year ended 31 December 2004 Corporate, Investment Banking & Markets US$m Private Banking US$m Commercial Banking US$m income/(expense) ......... 2,498 10,541 13,039 1,146 Dividend income ............... Net fees and commissions . Dealing profits .................. Other income ..................... Other operating income ..... 4 829 54 92 979 9 1,828 – 765 2,602 13 2,657 54 857 3,581 – 302 15 159 476 664 19 492 364 82 957 Operating income ............ 3,477 13,143 16,620 1,622 1,621 166 – 176 6 4 186 352 Inter- segment elimination US$m Total US$m – 14,913 – – – (1,011) (1,011) (1,011) 32 3,535 439 1,158 5,164 20,077 Other US$m (102) – (92) – 1,067 975 873 (2,270) (4,470) (6,740) (749) (1,014) (294) (1,101) 1,011 (8,887) Operating expenses excluding goodwill amortisation1 ................. Operating profit/(loss) before provisions1 ....... Provisions for bad and Share of operating profit/(loss) in associates2 ................ Gains on disposal of investments and tangible fixed assets ................... Profit/(loss) on ordinary activities before tax3 .... Share of HSBC’s pre-tax profits3 .......................... Cost:income ratio1 ............. Selected balance sheet data5 ............................ Loans and advances to customers (net) ............. Total assets ....................... Customer accounts ............ The following assets and liabilities were also significant to the customer groups noted: Loans and advances to banks (net) .................... Debt securities, treasury bills and other eligible bills .............................. Deposits by banks ............. Debt securities in issue ...... Goodwill amortisation excluded: 1,207 8,673 9,880 873 doubtful debts ............... (99) (5,136) (5,235) (13) Provisions for contingent liabilities and commitments ................ (13) – (13) Operating profit/(loss)1 ... 1,095 3,537 4,632 607 60 (8) 659 (16) 107 750 % 3.9 62.6 58 2 – 60 – 6 66 % 0.3 83.5 (228) – (1) (229) 8 – (221) % (1.1) 126.1 (20) 840 – 5 845 % 4.3 46.2 – – – – – – – 11,190 (5,186) (42) 5,962 (8) 226 6,180 % 31.8 44.3 US$m – 69 – 39 – 108 1,164 3,576 4,740 % 6.0 65.3 % 18.4 34.0 % 24.4 40.6 US$m US$m US$m US$m US$m US$m US$m 65,850 77,054 50,659 126,543 150,633 506 192,393 227,687 51,165 26,844 31,426 27,167 26,142 106,785 46,745 3,871 4,548 7,822 1 31 1 249,251 370,477 132,900 23,814 45,688 14,887 113,729 1 from (1) above .............. 2 from (2) above .............. 3 from (3) above .............. 4 Comprises HSBC Finance Corporation’s consumer finance business and the US residential mortgages and credit card portfolios acquired by HSBC Bank 600 – 600 125 – 125 475 – 475 79 – 79 25 – 25 57 – 57 – – – 761 – 761 USA from HSBC Finance Corporation and its correspondents since December 2003. 5 Third party only. 105 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group (continued) Personal Financial Services US$m Consumer Finance4 US$m Total Personal Financial Services US$m North America Net interest Year ended 31 December 2003 Corporate, Investment Banking & Markets US$m Commercial Banking US$m Private Banking US$m income/(expense) ......... 2,116 7,851 9,967 1,046 Dividend income ............... Net fees and commissions .. Dealing profits .................. Other income ..................... Other operating income ..... – 720 19 86 825 Operating income ............ 2,941 12 1,170 – 525 1,707 9,558 12 1,890 19 611 2,532 – 292 18 152 462 12,499 1,508 1,571 743 20 351 301 156 828 121 1 155 2 36 194 315 Inter- segment elimination US$m Other US$m Total US$m (100) – 11,777 1 (12) – 33 22 (78) – – – (56) (56) (56) 34 2,676 340 932 3,982 15,759 doubtful debts ............... (142) (4,395) (4,537) (133) Operating expenses excluding goodwill amortisation1 ................. Operating profit/(loss) before provisions1 ....... Provisions for bad and Provisions for contingent liabilities and commitments ................ Amounts written off fixed asset investments .......... Operating profit/(loss)1 ... Share of operating profit in joint ventures ............ Share of operating profit in associates2 ................. Gains on disposal of investments and tangible fixed assets ...... Profit/(loss) on ordinary activities before tax3 .... Share of HSBC’s pre-tax profits3 .......................... Cost:income ratio1 ............. Selected balance sheet data5 Loans and advances to customers (net) ............. Total assets ....................... Customer accounts ............ The following assets and liabilities were also significant to the customer groups noted: Loans and advances to banks (net) .................... Debt securities, treasury bills and other eligible bills .............................. Deposits by banks ............. Debt securities in issue....... Goodwill amortisation excluded: (1,965) (3,098) (5,063) (786) (777) (254) (123) 56 (6,947) 976 6,460 7,436 722 794 61 (201) – – – – – – 4 – (6) – (9) 1 – – (1) (1) – 834 2,065 2,899 593 779 62 (203) 11 – 25 870 % 6.0 66.8 – – 3 11 – 28 2,068 2,938 % 14.4 32.4 % 20.4 40.5 – – 2 595 % 4.1 52.1 – – 58 837 % 5.8 49.5 – – 1 63 % 0.4 80.6 – 7 20 (176) % (1.1) (157.7) US$m US$m US$m US$m US$m US$m US$m – – – – – – – – – 8,812 (4,676) 3 (9) 4,130 11 7 109 4,257 % 29.6 44.1 US$m 43,608 53,082 48,576 107,957 134,857 1 151,565 187,939 48,577 23,553 27,444 20,032 13,758 70,223 17,239 2,574 3,108 8,148 – 1,086 – 191,450 289,800 93,996 11,577 36,026 9,958 107,673 1 from (1) above .............. 2 from (2) above .............. 3 from (3) above .............. 4 Comprises HSBC Finance Corporation’s consumer finance business and the US residential mortgages acquired by HSBC Bank USA from HSBC Finance 100 – 100 473 1 474 356 – 356 117 1 118 45 – 45 25 – 25 – – – 643 1 644 Corporation and its correspondents in December 2003. 5 Third party only. 106 Year ended 31 December 2002 North America Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Net interest income/(expense) ...... 1,352 Dividend income ............................ Net fees and commissions .............. Dealing profits/(losses) .................. Other income ................................. Other operating income .................. – 437 (63) 126 500 844 – 222 18 61 301 539 24 268 204 61 557 Operating income ......................... 1,852 1,145 1,096 Private Banking US$m 117 – 61 9 78 148 265 Inter- segment elimination US$m – – – – (22) (22) (22) Other US$m (120) – (4) (7) 29 18 (102) Total US$m 2,732 24 984 161 333 1,502 4,234 (1,172) (567) (649) (206) (103) 22 (2,675) Operating profit/(loss)1 ................ 604 430 Operating expenses excluding goodwill amortisation1 ............... Operating profit/(loss) before provisions1 ................................. Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Share of operating loss in joint ventures2 .................................... Share of operating profit in associates2 .................................. Gains/(losses) on disposal of investments and tangible fixed assets .......................................... Profit/(loss) on ordinary activities before tax3 ................................. Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 680 578 447 (76) (150) – – 2 – (1) 2 – 605 % 5.8 63.3 – – 5 435 % 4.1 49.5 (66) 2 (9) 374 – – 120 494 % 4.7 59.2 59 (2) – – 57 (1) – 1 57 % 0.5 77.7 US$m US$m US$m US$m 37,922 46,777 46,002 25,361 29,166 17,717 12,604 63,161 19,396 1,701 2,707 6,969 (205) (6) (1) – (212) – 6 (1) (207) % (1.9) (101.0) US$m 1 221 53 9,948 34,926 9,545 34 – 34 55 – 55 32 – 32 25 – 25 – – – – – – – – – – – – 1,559 (300) 3 (9) 1,253 (2) 8 125 1,384 % 13.2 63.2 US$m 77,589 142,032 90,137 146 – 146 107 H S B C H O L D I N G S P L C Financial Review (continued) South America Profit/(loss) before tax excluding goodwill amortisation Personal Financial Services ......................................................................... Brazil ............................................................................................................. Argentina ....................................................................................................... Other .............................................................................................................. Commercial Banking .................................................................................. Brazil ............................................................................................................. Argentina ....................................................................................................... Other .............................................................................................................. Corporate, Investment Banking and Markets ........................................... Brazil ............................................................................................................. Argentina ....................................................................................................... Other .............................................................................................................. Private Banking ............................................................................................ Brazil ............................................................................................................. Other .............................................................................................................. Other ............................................................................................................. Brazil ............................................................................................................. Argentina ....................................................................................................... Other .............................................................................................................. Total1 ............................................................................................................. Brazil ............................................................................................................. Argentina ....................................................................................................... Other .............................................................................................................. 1 Goodwill amortisation arising on subsidiaries excluded ........................... Year ended 31 December 2004 US$m 2003 US$m 2002 US$m 47 51 (4) – 165 113 51 1 150 134 8 8 1 1 – 81 (18) 101 (2) 444 281 156 7 29 (27) (31) 3 1 99 65 34 – (24) 49 (72) (1) (2) (1) (1) 80 1 83 (4) 126 83 48 (5) 11 (33) 11 (45) 1 79 54 27 (2) 32 125 (101) 8 (12) (1) (11) (100) (62) (91) 53 (34) 127 (210) 49 24 108 Profit/(loss) before tax Year ended 31 December South America Net interest income ...................................................................................... Dividend income ............................................................................................ Net fees and commissions .............................................................................. Dealing profits ............................................................................................... Other income ................................................................................................. Other operating income .................................................................................. 2004 US$m 1,355 2 480 50 207 739 Total operating income ................................................................................ 2,094 Staff costs ...................................................................................................... Premises and equipment ................................................................................. Other .............................................................................................................. Depreciation and intangible asset amortisation .............................................. Goodwill amortisation ................................................................................... Operating expenses ........................................................................................ Operating profit before provisions ............................................................. Provisions for bad and doubtful debts ............................................................ Provisions for contingent liabilities and commitments ................................... Loss from foreign currency redenomination in Argentina .............................. Amounts written off fixed asset investments ................................................. Operating profit/(loss) ................................................................................. Share of operating profit in associated undertakings ...................................... Gains on disposal of investments and tangible fixed assets ............................ Profit/(loss) on ordinary activities before tax ............................................. Share of HSBC’s pre-tax profits (excluding goodwill amortisation) .............. Share of HSBC’s pre-tax profits .................................................................... Cost:income ratio (excluding goodwill amortisation) .................................... (660) (174) (549) (61) (1,444) (29) (1,473) 621 (269) 30 – (6) 376 1 38 415 % 2.3 2.4 69.0 2003 US$m 640 3 338 136 201 678 1,318 (584) (124) (327) (40) (1,075) (11) (1,086) 232 (58) 2 (9) (62) 105 1 9 115 % 0.9 0.9 81.6 2002 US$m 645 15 324 147 110 596 1,241 (572) (113) (330) (45) (1,060) (24) (1,084) 157 (117) (31) (68) (36) (95) – 37 (58) % (0.3) (0.6) 85.4 Period-end staff numbers (full-time equivalent) ............................................. 32,108 28,292 25,522 Selected balance sheet data1 Loans and advances to customers (net) .......................................................... Loans and advances to banks (net) ................................................................. Debt securities, treasury bills and other eligible bills ..................................... Total assets .................................................................................................... Deposits by banks .......................................................................................... Customer accounts ......................................................................................... 1 Third party only. US$m 6,933 2,597 3,742 17,397 680 10,957 US$m 4,982 1,922 2,151 12,549 828 6,945 US$m 3,028 1,665 1,450 8,491 661 4,863 Year ended 31 December 2004 compared with year ended 31 December 2003 Reaping the rewards of measures taken in 2003 and helped by a buoyant external environment, Brazil enjoyed an outstanding economic performance in 2004. Annualised GDP growth topped 4 per cent in each of the first three quarters of 2004 and, for the year as a whole, HSBC expects growth to exceed 5 per cent, driven by external demand. The 2004 trade surplus reached US$34 billion and the current account surplus US$12 billion. Employment and real wages both expanded in 2004. Faster than anticipated growth and some unexpected consequences of tax changes pushed fiscal revenues to record highs allowing the public sector to produce a consolidated primary surplus in excess of 4 per 109 H S B C H O L D I N G S P L C Financial Review (continued) cent of GDP in 2004. This, together with the growth in the economy and an appreciating currency, reduced the ratio of debt to GDP, ushering in a virtuous circle of declining risk spreads, growing confidence and a return of investment. This was despite the rekindling of inflationary pressures from rising commodity prices early in 2004, adjustments in administered prices and a very rapidly narrowing output gap. Core inflation remained in excess of 7 per cent throughout the year, and the Central Bank raised interest rates and tightened monetary policy in an attempt to avert higher inflation in 2005. The combined effect of the global slowdown and local policy restrictions is slowing the Brazilian economy. Nevertheless, the short-term outlook remains encouragingly positive. In Argentina, the recovery from the crisis of 2001 continued in 2004, helped by the favourable external environment and the absence of effective pressure to improve the exchange offer on defaulted debt. Year-on-year GDP growth was 8.8 per cent. Employment in the formal economy in October was up by 6.8 per cent on the year before, continuing the trend of the past two years. By the end of 2004, the stock market index had surpassed the levels last achieved in August 2001, and stood almost 12 per cent above the minimum reached in September 2002, when the economy began its current expansionary phase. Inflation appeared to be under control and the government, buoyed by revenues from exports, was able to post large fiscal surpluses, with a primary surplus in excess of 5 per cent of GDP. By contrast, the progress on debt restructuring was slow. Though the rate of investment returned to the pre-crisis level of 20 per cent of GDP – arguably, too low to sustain growth in excess of 3 to 4 per cent per annum – it is likely that the re-investment cycle will falter without a workable solution to the debt crisis. To that extent, the outlook for Argentina remains uncertain. HSBC’s operations in South America reported a pre-tax profit of US$415 million, substantially ahead of the US$115 million achieved in 2003. Excluding goodwill amortisation, pre-tax profit was US$444 million compared with US$126 million in 2003, and represented 2 per cent of HSBC’s total pre-tax profit on this basis. The 2004 results include the first full year’s contribution from the Brazilian consumer finance company, Losango, acquired in December 2003, along with contributions from CreditMatone S.A., acquired in November 2004, and Valeu Promotora de Vendas, the consumer finance operations of Indusval Multistock Group, acquired in August 2004. Together, these three businesses contributed US$72 million to pre tax profits before goodwill amortisation, representing 23 per cent of 110 the growth. There were no significant exchange rate impacts in 2004. The commentary that follows is based on constant exchange rates. Personal Financial Services’ pre-tax profit, before goodwill amortisation, of US$47 million predominantly reflected the Losango consumer finance business acquired in December 2003, which contributed US$72 million. It was pleasing to note that, in its first full year in HSBC, Losango’s full- year profitability doubled compared with 2003. Excluding Losango at constant exchange rates, the pre-tax loss before goodwill amortisation improved by 50 per cent on the previous year. The integration of Losango progressed extremely well. There was strong growth across the product portfolios during the period, notably in store loans and personal lending products. Good progress was made in delivering anticipated operational synergies. Plans to embed Losango branches within the HSBC Brazil network are well advanced. In the second half of the year, Losango benefited from the acquisition of the two consumer finance portfolios noted above. Excluding the impact of the acquired businesses, net interest income grew by 15 per cent, reflecting good asset growth in Brazil, partly offset by reduced spreads on credit cards in Argentina. Auto finance loans in Brazil grew by 69 per cent, reflecting the success of a number of initiatives taken to enhance the distribution channels in the branch network, and effective marketing promotions and incentive campaigns. Market share increased from 3.1 per cent to 4.1 per cent. The income benefit arising from the increase in balances was only partly offset by narrower spreads. Competitive pricing was used to grow the cards business to take advantage of strong growth in consumer spending: this generated an 11 per cent increase in balances. Growth in demand deposits was augmented by a widening of spreads. However, the benefit was partly offset by narrower spreads on savings accounts, where rates are set by the Brazilian Government, and on time deposits. Other operating income rose by 32 per cent, of which 17 per cent came from Losango and its consumer lending acquisitions. The remaining 15 per cent arose principally from growth in fee income in Brazil driven by increased lending activity and higher revenues from the life insurance business in Argentina. Excluding Losango, credit-related fee income grew by 44 per cent in Brazil, as a result of growth in customer lending and the introduction of a new pricing structure. Greater use of a new automated collection service and revised fee charging led to a 19 per cent increase in account service fees. Strong growth in the cards business, where cards in circulation rose by 30 per cent, generated a significant increase in fee income of 27 per cent. Higher consumer lending also contributed to an overall increase in brokerage fees from insurance operations. Operating expenses, excluding goodwill amortisation, increased by 38 per cent, of which 25 per cent was attributable to Losango and its acquisitions. Marketing expenditure increased by 58 per cent as HSBC sought to build and reinforce brand awareness in Brazil. Transactional taxes increased by 26 per cent in line with operating income growth. Prices also increased on the renewal of a number of service contracts. Costs in Argentina were 21 per cent higher, largely from increased staff costs, notably pensions and labour claims, together with higher marketing expenditure and regulatory fees. The provision for bad and doubtful debts increased by 88 per cent or US$126 million, of which US$107 million or 75 per cent arose in Losango. The remaining increase was driven by the growth in unsecured lending in Brazil. Credit quality in both Brazil and Argentina was relatively stable throughout 2004 as unemployment and inflation rates declined and domestic economic growth strengthened. Commercial Banking reported pre-tax profits, before goodwill amortisation, of US$165 million, an increase of 62 per cent over 2003, due largely to higher net interest income in Brazil. Net interest income of US$234 million was US$59 million or 34 per cent higher than in 2003. In Brazil, overdraft balances increased by 44 per cent as a result of strong growth in the demand for credit and the introduction of a new pricing structure for SME customers. This led to a 22 per cent increase in income despite a marginal fall in spreads and this, together with strong growth in Giro fácil, a combined loan and overdraft product, contributed US$26 million of additional income. Total commercial lending balances increased by 58 per cent to US$1.4 billion and, following product development expenditure in 2003, lending backed by discounted receivables increased by 81 per cent. Spreads on deposit balances benefited from a reduction in the compulsory deposit rate and lower rural loans, while deposit balances increased by 29 per cent, contributing further to the increase in net interest income. In Argentina, net interest income declined as the low interest rate environment led to reduced spreads on deposits. Other operating income increased by 14 per cent to US$136 million. In Brazil, the growth in lending balances resulted in higher arrangement fee income, while current account fees rose by 15 per cent following the introduction of the new SME pricing structure. Income in Argentina was in line with 2003. Operating expenses of US$203 million were 12 per cent higher than in 2003. In Brazil, growth in staff numbers in support of business expansion and increased transactional tax costs contributed to a 17 per cent rise in costs. Marketing expenses also increased reflecting the SME initiatives taken during the year. In Argentina, cost control initiatives resulted in a 7 per cent reduction in operating expenses. Provisions for bad and doubtful debts were 82 per cent lower than in 2003. Recoveries and releases in Argentina reflected the improved economic conditions. These were partly offset by higher specific provisions raised in Brazil, in line with growth in the small business portfolio. Corporate, Investment Banking and Markets reported pre-tax profit, before amortisation of goodwill, of US$150 million, compared with a small loss in 2003. Net interest income of US$165 million contrasted with a net interest expense in 2003. In Brazil, sharp falls in interest rates in the latter part of 2003 and into early 2004 resulted in lower funding costs, which enabled Global Markets to benefit from large fixed rate positions taken in anticipation of interest rate reductions. Argentina also benefited from a significant decline in interest rates, as a lower interest expense reflected the reduced cost of funding non-performing loans. The more stable political and interest rate environment led to lower volatility in the value of the Brazilian real and interest rates, resulting in fewer opportunities for arbitrage. As a consequence, other operating income declined, mainly through reduced dealing profits in Brazil. Operating expenses, excluding goodwill amortisation, increased as transactional taxes rose in line with improved revenues in Brazil. In addition, bonuses increased in line with significantly higher profits. 111 H S B C H O L D I N G S P L C Financial Review (continued) There was a small net release for bad and doubtful debts compared with a net charge in 2003, mainly due to lower provisions in the consumer brands sector and higher releases in the energy and utilities sector in Brazil. Amounts written-off fixed assets fell, mainly due to lower provisions for certain Argentine government bonds which rose in value as the timing and nature of the external debt exchange offer were clarified. Private Banking reported a pre-tax profit, before goodwill amortisation, of US$1 million, compared with a small loss of US$2 million in 2003. An increase in net interest income was driven by higher time deposits in Brazil, while operating expenses, excluding goodwill amortisation, reduced following a reorganisation of the business. Other includes the ongoing impact of the pesification in Argentina. In 2004, higher earnings from compensation bonds, lower litigation provisions and increased gains on the sale of government securities were largely offset by lower general provision releases. Year ended 31 December 2003 compared with year ended 31 December 2002 2003 was a year of recovery across the region following the economic and political uncertainty experienced during 2002. In Brazil, the turnaround in 2003 was noteworthy. After a difficult start, the new Government demonstrated prudent control of macroeconomic policy including, importantly, inflation. A difficult and costly disinflationary programme was put into effect with the central bank’s reference rate reaching 26.5 per cent in June. The programme was successful within a surprisingly short time horizon. Inflation fell from 17.3 per cent to 9.3 per cent, and reference interest rates ended the year at 16.5 per cent. Actions to reduce Brazil’s two key vulnerabilities, its fiscal and external deficits, were effective. On the fiscal front, Brazil’s Congress approved public sector social security reforms and 2003 was the fifth consecutive year IMF fiscal targets were achieved. On the external front, Brazil is expected to register its first current account surplus in over a decade. Buoyed by a surge in exports and large trade surpluses, the Argentinian economy recovered at a fast pace. Inflation remained under control and the Argentine peso appreciated from 3.60 to the US dollar in May 2002 to 2.93 at December 2003. 112 Unemployment fell and tax revenues and collections increased. Fundamental legal uncertainty persists, particularly regarding the position of pension fund assets following pesification, the ability of utilities to raise prices, and the position of holders of pesified and defaulted government bonds. Although the financial system is emerging slowly from near collapse, questions about the sustainability of the recovery persist and a resolution of the historic sovereign debt default is a pre-condition for stability and sustained new investment. HSBC’s operations in South America reported a pre-tax profit of US$115 million, compared with a loss of US$58 million in 2002. Excluding goodwill amortisation, pre-tax profit was US$126 million, compared with a loss of US$34 million in 2002. Key to this improvement was a turnaround in Argentina, from a loss of US$210 million to a modest profit of US$48 million. This followed the release of part of the general provision previously raised against customer advances, as the economy improved and, in December 2003, compensation bonds with a face value of US$109 million were received from the Argentine government. These have been included at an estimated fair value of US$63 million in the results of the Other segment. Goodwill amortisation at US$11 million was US$13 million lower than in 2002, which included a goodwill write-off relating to the purchase of insurance subsidiaries. The commentaries that follow are based on constant exchange rates. In Personal Financial Services there was a pre- tax loss, before goodwill amortisation, of US$27 million, an improvement against the loss suffered in 2002. The acquisition of Lloyds TSB Group’s businesses and assets in Brazil contributed US$7 million to this overall improvement. Lending growth was stronger in Brazil, while higher bad debt recoveries benefited operations in Argentina. Net interest income was broadly in line with last year. The benefit from higher personal lending balances in Brazil was offset by lower interest income from the insurance businesses in Argentina, largely due to lower CER, an inflation adjustment applied to all pesified loans. Other operating income of US$316 million was 51 per cent higher than in 2002, largely due to a strong performance in Brazil. Growth in customer lending volumes generated an increase in credit- related fee income and account service fees. Following strong marketing support, fee income from cards in Brazil grew by 24 per cent, driven by a 30 per cent increase in cards in circulation to 1.4 million. Other operating income also improved in Argentina, reflecting a strong performance in the insurance business. Operating expenses, excluding goodwill amortisation, were broadly in line with 2002. In Brazil, costs increased by 15 per cent, largely due to higher staff costs, notably labour claims, together with higher costs from marketing initiatives taken in 2003 and an increase in the transactional taxation charge on higher operating income. Costs in Argentina were significantly lower than prior year, mainly due to lower severance costs. The provision for bad and doubtful debts of US$138 million was 50 per cent higher than in 2002. In Brazil, specific provisions increased, predominantly in the first half of 2003, reflecting the prevailing economic conditions. High inflation, interest rates and unemployment reduced customers’ repayment capacity. However, credit quality began to show signs of improvement in the second half of the year. Commercial Banking in South America contributed pre-tax profit, before amortisation of goodwill, of US$99 million, 23 per cent higher than in 2002. Net interest income increased by 39 per cent, to US$168 million. In Argentina, net interest income benefited from lower Argentine peso rates paid on deposits and recoveries of interest suspended on non-performing loans. In Brazil, successful marketing campaigns led to a significant growth in income from overdrafts and working capital products. Other growth areas included discounted receivables and vehicle leasing, supported by the introduction of pre-approved facilities. Other operating income increased by 23 per cent to US$115 million. Credit related fee income in Brazil increased, reflecting the expansion in the current account customer base by 8 per cent. Fees earned on foreign exchange rose from a higher volume of transactions. In response to aggressive pricing by competitors, the introduction of a new fee pricing structure in the first half of 2003 stimulated an increase in the volume of loan fees and funds under management leading to higher fee income. At US$173 million, total operating expenses, before goodwill amortisation, were 25 per cent higher than 2002. The cost increases partly reflected increased business volumes as well as the impact of various initiatives which had been delayed pending evidence of improvement in economic conditions. These included increased advertising, the implementation of a sales structure to support business development, and investment in new products and delivery channels. These were partly funded by the centralisation of support processes which resulted in a reduction of associated costs and reduced the administrative workload for relationship managers, leaving them more time for their customers. Corporate, Investment Banking and Markets reported a loss, before amortisation of goodwill, of US$24 million, broadly in line with 2002, at constant exchange rates. Profit before tax and amortisation of goodwill in Brazil was US$49 million, compared with US$104 million in 2002. Argentina recorded a loss of US$72 million compared with a loss of US$143 million in 2002. Net interest expense was US$51 million, an increase of 16 per cent compared with 2002. In Brazil, net interest income decreased due to lower spreads in Global Markets, partly offset by the impact of downward yield curve movements which allowed the funding of long positions at lower rates. In corporate banking, a lack of attractive risks restricted lending growth. In Argentina, the lower cost of funding non-performing assets and a lower level of suspended interest resulted in a decrease in net interest expense. Dealing profits were broadly in line with 2002. In Brazil, higher dealing profits reflected gains resulting from a fall in interest rates. Brokerage, custody and clearing businesses also grew significantly, taking advantage of market opportunities. These factors were offset in part by lower foreign exchange income in Argentina. Staff costs were higher than in 2002, mainly in Brazil, reflecting improved performance in specific products. Provisions for bad and doubtful debts rose in difficult market conditions. Higher interest rates, currency weakness, and a reduced availability of foreign currency funding all contributed to problems encountered by corporate customers in the first half of 2003 in Brazil. Although the situation improved during the year, new specific provisions were raised against two sizeable corporate accounts as a consequence of business failure in one case and fraud in the other. Private Banking’s pre-tax loss, before goodwill amortisation, of US$2 million compared with a loss of US$12 million in 2002. A lower bad debt charge reflected an improvement in the overall credit quality of the segment. 113 H S B C H O L D I N G S P L C Financial Review (continued) Within the Other customer group, there was a US$113 million release of the special general provision raised in respect of Argentina. This release followed a period of improved market conditions and collections within the lending portfolios. Provisions for contingent liabilities and commitments reflected court decisions (amparos) relating to formally frozen US dollar denominated customer deposits required to be settled at the prevailing market rate. 114 895 – 358 4 69 431 1 – 47 – – 47 % 0.2 76.2 Profit/(loss) excluding goodwill amortisation by customer group Year ended 31 December 2004 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Inter- segment elimination US$m Other US$m South America Net interest income ...................... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income ................................. Other operating income .................. Operating income ......................... 1,326 234 – 119 5 12 136 370 165 – 66 41 22 129 294 4 – 12 – 1 13 17 57 2 (75) – 131 58 115 – – – – (28) (28) (28) Operating expenses excluding goodwill amortisation1 ............... Operating profit before (1,010) (203) (135) (16) (108) 28 (1,444) provisions1 ................................ 316 167 Provisions for bad and doubtful debts .......................................... (270) Provisions for contingent liabilities and commitments ........ Amounts written off fixed asset investments ................................ Operating profit1 .......................... Share of operating profit in associates2 .................................. Gains on disposal of investments and tangible fixed assets ............ Profit on ordinary activities before tax3 ................................ Share of HSBC’s pre-tax profits3 ... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. (2) – – 165 – – 165 % 0.8 54.9 159 2 (10) (2) 149 – 1 150 % 0.8 45.9 1 – – – 1 – – 1 7 1 39 (4) 43 1 37 81 % – 94.1 % 0.5 93.9 2 34 11 340 1,474 109 US$m US$m US$m US$m US$m 3,211 5,796 3,458 1,526 2,408 2,229 23 – 23 1 – 1 1,854 7,685 5,150 1,779 3,004 549 5 – 5 Total US$m 1,355 2 480 50 207 739 2,094 – – – – – – – – 650 (269) 30 (6) 405 1 38 444 % 2.3 69.0 US$m 6,933 17,397 10,957 – – – – – – 29 – 29 115 H S B C H O L D I N G S P L C Financial Review (continued) Profit/(loss) excluding goodwill amortisation by customer group (continued) Year ended 31 December 2003 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Inter- segment elimination US$m Other US$m 499 – 245 2 69 316 815 168 – 94 7 14 115 283 (51) – 54 118 36 208 157 2 – 14 1 1 16 18 22 3 (69) 8 119 61 83 – – – – (38) (38) (38) Total US$m 640 3 338 136 201 678 1,318 (706) (173) (113) (21) (100) 38 (1,075) 109 110 44 (3) (17) (138) (11) 10 (17) (36) – 9 (27) % (0.2) 86.6 – – 99 – – 99 % 0.7 61.1 (26) – (44) (26) 1 1 (24) % (0.2) 72.0 US$m US$m US$m 2,224 4,211 2,035 852 1,357 1,429 4 – 4 – – – 1,679 5,505 3,108 1,384 1,311 593 6 – 6 1 – – (2) – – (2) % 0.0 116.7 US$m 16 70 61 116 (17) (1) 81 – (1) 80 % 0.6 120.5 US$m 211 1,406 312 – – – – – – – – 243 (58) (7) (62) 116 1 9 126 % 0.9 81.6 US$m 4,982 12,549 6,945 – – – 1 – 1 11 – 11 South America Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits ............................... Other income ................................. Other operating income .................. Operating income ......................... Operating expenses excluding goodwill amortisation1................ Operating profit/(loss) before provisions1 ..................... Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Operating profit/(loss)1 ................ Share of operating profit in associates2 .................................. Gains/(losses) on disposal of investments and tangible fixed assets .......................................... Profit/(loss) on ordinary activities before tax3 ................................. Share of HSBC’s pre-tax profits3 .... Cost:income ratio1 .......................... Selected balance sheet data4 Loans and advances to customers (net) .......................... Total assets .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Goodwill amortisation excluded: 1 from (1) above ........................... 2 from (2) above ........................... 3 from (3) above ........................... 4 Third party only. 116 Year ended 31 December 2002 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Inter- segment elimination US$m Other US$m 539 – 218 10 11 239 778 126 – 87 9 4 100 226 (5) 1 67 120 (18) 170 165 6 – 12 (3) – 9 15 (21) 14 (60) 11 135 100 79 – – – – (22) (22) (22) Total US$m 645 15 324 147 110 596 1,241 (691) (147) (106) (17) (121) 22 (1,060) 87 (100) (19) (1) (33) – (33) % (0.3) 88.8 79 – – – 79 – 79 % 0.8 65.0 59 (15) – (22) 22 10 32 % 0.3 64.2 (2) (7) – – (9) (42) 5 (80) (13) (130) (3) 30 (12) % (0.1) 113.3 (100) % (1.0) 153.2 US$m US$m US$m US$m US$m 1,094 2,062 1,366 505 704 934 1,401 4,273 2,477 28 37 44 – 1,415 42 – – – – – – – 181 (117) (99) (36) (71) 37 (34) % (0.3) 85.4 US$m 3,028 8,491 4,863 987 977 609 4 18 – 1 1 24 South America Net interest income/(expense) ...... Dividend income ............................ Net fees and commissions .............. Dealing profits/(losses) .................. Other income/(expenses) ................ Other operating income .................. Operating income ......................... Operating expenses excluding goodwill amortisation1 ............... Operating profit/(loss) before provisions1 ................................. Provisions for bad and doubtful debts .......................................... Provisions for contingent liabilities and commitments ....................... Amounts written off fixed asset investments ................................ Operating profit/(loss)1 ................ Gains/(losses) on disposal of investments and tangible fixed assets .......................................... Profit/(loss) on ordinary activities before tax1 ................................. Share of HSBC’s pre-tax profits1 ... Cost:income ratio1 .......................... Selected balance sheet data2 Loans and advances to customers (net) .......................... Total assets .................................... Customer accounts ......................... The following assets and liabilities were also significant to Corporate, Investment Banking and Markets: Loans and advances to banks (net) . Debt securities, treasury bills and other eligible bills ...................... Deposits by banks .......................... Goodwill amortisation excluded: 1 from (1) above ........................... 2 Third party only. 117 H S B C H O L D I N G S P L C Financial Review (continued) Critical accounting policies Introduction The results of HSBC Holdings are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its consolidated financial statements. The accounting policies used in the preparation of the consolidated financial statements are described in detail in Note 2 in the ‘Notes on the Financial Statements’ on pages 243 to 356. When preparing the financial statements, it is the directors’ responsibility under UK company law to select suitable accounting policies and to make judgements and estimates that are reasonable and prudent. Under UK GAAP, Financial Reporting Standard (‘FRS’) 18 ‘Accounting policies’ requires the Group to adopt the most appropriate accounting policies in order to give a true and fair view. HSBC also provides details of its net income and shareholders’ equity calculated in accordance with US GAAP. US GAAP differs in certain respects from UK GAAP. Details of these differences are set out in Note 49 in the ‘Notes on the Financial Statements’ on pages 322 to 356. The accounting policies that are deemed critical to HSBC’s UK GAAP results and financial position, in terms of materiality and the degree of judgement and estimation involved, are discussed below. Provisions for bad and doubtful debts HSBC’s accounting policy for provisions for bad and doubtful debts on customer loans is described in Note 2(c) in the ‘Notes on the Financial Statements’ on pages 244 to 246. Charges for provisions for bad and doubtful debts are reflected in HSBC’s profit and loss account under the caption ‘Provision for bad and doubtful debts’. Any increase in these provisions has the effect of lowering HSBC’s profit on ordinary activities by a corresponding amount (while any decrease in provisions or release of provisions would have the opposite effect). Specific provisions Specific provisions are established either on a portfolio basis or on a case-by-case basis depending on the nature of the exposure and the manner in which risks inherent in that exposure are managed. In addition, provisions for the sovereign risk inherent in cross-border credit exposures are established for certain countries; this element is not currently significant. 118 When specific provisions are raised on a portfolio basis, the most important factors in calculating the quantum of the required provision are: • • the roll or loss rates set for each category; and the periods embedded in the calculations of roll and loss rates which are designed to reflect fully but not excessively losses inherent at the reporting date and not future losses. The portfolio basis is applied to overdue accounts in HSBC Finance Corporation’s consumer portfolios and to the following portfolios in the rest of HSBC: • • • low value, homogeneous small business accounts in certain jurisdictions; residential mortgages less than 90 days overdue; and credit cards and other unsecured consumer lending products. When establishing specific provisions on a case- by-case basis, the most important factors are: • • • • • • • • • the Group’s aggregate exposure to the customer (including contingent liabilities); the viability of the customer’s business model and capability to trade successfully out of financial difficulties and generate sufficient cash flow to service debt obligations; the likely dividend available on liquidation or bankruptcy; the extent of other creditors’ commitments ranking ahead of, or pari passu with, the Group and the likelihood of other creditors continuing to support the company; the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident; the amount and timing of expected receipts and recoveries; the realisable value of security (or other credit mitigants) and likelihood of successful repossession; the deduction of any costs involved in recovery of amounts outstanding; the ability of the borrower to obtain and make payments in the relevant foreign currency if loans are not in local currency; and, • where available, the secondary market price for the debt. In many cases, the determination of these factors will be judgemental, because either the security may not be readily marketable or the cashflows will require an assessment of the customer’s future performance or the impact of litigation. HSBC’s practice is to make estimates against these factors and to review and update them regularly. If management were to take a more cautious view of the customer’s future cash flows (either by being less optimistic of the ability of the customer to generate profits or general economic conditions) or the availability or value of any security, the provision charge would be higher and HSBC’s profit on ordinary activities would be lower. This method of determining provisions is applied to most corporate loans and, with the exception of HSBC Finance Corporation, which utilises portfolio analysis, to residential mortgages 90 days or more overdue. HSBC has no individual loans where changes in the underlying factors upon which specific bad and doubtful debt provisions have been established could cause a material change to the Group’s reported results. General provisions General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be identified as such until some time in the future. HSBC requires each operating company to maintain a general provision which is determined by taking into account the structure and risk characteristics of each company’s loan portfolios. Provisions held against homogeneous portfolios of assets which are not overdue and which have neither been restructured nor are in bankruptcy are classified as general rather than specific. The most important factors in determining general loan loss provisions are: • • historical loss experience in portfolios of similar risk characteristics, for example, by industry sector, loan grade or product; the estimated period between a loss occurring and that loss being identified and evidenced by the establishment of a specific provision against that loss; and • management’s judgement as to whether the current economic and credit conditions are such that the actual level of inherent losses is likely to be greater or less than that suggested by historical experience. The main areas of judgement are in determining the periods during which latent losses emerge and assessing whether current economic conditions are likely to produce credit default rates and loss severity in line with historical precedent. These factors are kept under review based on an analysis of economic forecasts, industry sector performance, insolvency and bankruptcy statistics, together with details of the rate and nature of losses experienced. If management were to take a more conservative view of economic conditions or increase the loss emergence periods, the provisions charged would increase and HSBC’s profit on ordinary activities would be lower. Goodwill impairment HSBC’s accounting policy for goodwill is described in Note 2(f) in the ‘Notes on the Financial Statements’ on page 247. Amortisation of goodwill is recorded on HSBC’s profit and loss account under the caption ‘Depreciation and Amortisation – Goodwill’. Any impairments or reductions of goodwill are also charged to the profit and loss account (hence reducing HSBC’s operating profit on ordinary activities after tax by a corresponding amount) and also result in a corresponding reduction of ‘Goodwill’ on the balance sheet. In accordance with the requirements of FRS 10 ‘Goodwill and intangible assets’, HSBC reviews goodwill which has arisen on the acquisition of subsidiary undertakings, joint ventures and interests in associates at the end of the first full year after an acquisition, and whenever there is an indication that impairment may have taken place. Impaired goodwill is accounted for in accordance with FRS 11 ‘Impairment of fixed assets and goodwill’. Indications of impairment include any events or changes in circumstance that cast doubt on the recoverability of the carrying amount of goodwill. If management believes that a possible impairment is indicated in respect of a particular entity, the valuations of each of the entity’s relevant ‘Income Generating Units’ (‘IGUs’) are compared with their respective carrying values (including related goodwill). The IGU valuations are derived from discounted cashflow models. Significant management judgement is involved in two elements of the process of identifying and evaluating goodwill impairment. 119 H S B C H O L D I N G S P L C Financial Review (continued) First, the cost of capital assigned to an individual IGU and used to discount its future cash flows can have a significant effect on its valuation. The cost of capital percentage is generally derived from an appropriate capital asset pricing model, which itself depends on a number of financial and economic variables which are established on the basis of management’s judgement. Second, management judgement is required in deriving discounted cash flow valuations of IGUs. These valuations are sensitive to the cash flows in the initial periods for which detailed forecasts are available, and to assumptions regarding the long- term sustainable growth rates of cash flows thereafter. While the acceptable range within which underlying assumptions can be applied is governed by the requirement for resulting forecasts to be compared with actual performance and verifiable economic data in future years, the cash flow forecasts necessarily reflect management’s view of future business prospects. Where management’s judgement is that the expected cash flows of an IGU have declined and/or that its cost of capital has increased, the effect will be to reduce the estimated fair value of the IGU. If this results in an estimated fair value that is lower than the carrying value of the IGU, an impairment of goodwill will be recorded and HSBC’s profit on ordinary activities will be lower. Valuation of securities and derivatives HSBC’s accounting policy for these instruments is described in Note 2 (d) and Note 2 (l) in the ‘Notes on the Financial Statements’ on pages 246 and 248. HSBC carries debt and equity securities and derivatives held for trading purposes at fair or ‘mark- to-market’ value. The mark-to-market of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. For those debt and equity securities not held for trading purposes, and carried in the accounts at amortised historical cost, consideration as to whether any such asset should be written down to reflect impairment takes into account the fair value of the relevant security. Non- trading derivatives (which are primarily interest rate swaps) are accounted for on an accruals basis. Changes in the value of securities and derivatives held for trading purposes are reflected in ‘Dealing profits’ and hence directly impact HSBC’s profit on ordinary activities. Any impairment in the value of debt and equity securities not held for trading purposes is reported in ‘Amounts written of fixed 120 asset investments’ and hence reduces HSBC’s profit on ordinary activities. The majority of the Group’s financial instruments held for trading purposes are valued based on quoted market prices. Where quoted market prices are not available, the fair value reflects management’s assessment of the value of these financial instruments. This assessment may look to a valuation of comparable instruments for which an independent price can be established or use a discounted cash flow model (particularly for debt securities and derivatives) or model the valuation of complex instruments based on a components approach where independent pricing is available for the underlying components, including interest rate yield curves, option volatilities and currency rates. The main factors which management considers when applying a cash flow model are: • • the likelihood and expected timing of future cash flows on the instrument. These cash flows are usually governed by the terms of the instrument, although management judgement may be required in situations where the ability of the counterparty to service the instrument in accordance with its contractual terms is in doubt; and an appropriate discount rate for the instrument. Again, management determines this rate, based on its assessment of the appropriate spread of the rate for the instrument over the risk free rate. When valuing instruments by reference to comparable instruments management takes into account the maturity, structure and rating of the instrument to which the position held is being compared. When valuing instruments on a model basis using the fair value of underlying components, management additionally considers the need for adjustments to take account of counterparty creditworthiness, model uncertainty and the future costs of servicing the portfolio. These adjustments are based on defined policies which are applied consistently across the Group. For derivatives where market observable data are not available, the initial increase in fair value indicated by the valuation model, but based on unobservable inputs, is not recognised immediately in the profit and loss account. This amount is held back and recognised over the life of the transaction in a systematic manner where appropriate, or released to the profit and loss account when the inputs become observable, or, when the transaction matures or is closed out. For securities carried at amortised cost impairment may result from changes in their estimated fair value if management changes its assumptions regarding the above variables. In such circumstances, it will also be necessary for management to exercise judgement as to whether or not the indicative change in estimated fair value arising from revisions to the underlying valuation assumptions are only temporary. The table below summarises HSBC’s trading portfolios by valuation methodology at 31 December 2004: Fair value based on: Quoted market prices .................................................... Internal models with significant observable market parameters ..................................................... Internal models with significant unobservable market parameters ..................................................... Total .............................................................................. Trading assets Trading liabilities Securities purchased % Derivatives % Securities sold % Derivatives % 81.0 18.0 1.0 100.0 6.0 93.0 1.0 100.0 81.0 19.0 – 100.0 6.0 94.0 – 100.0 For a discussion of market risk management, see Market Risk Management on pages 167 to 172. including those relating to the use of the ‘fair value option’ for financial liabilities. UK GAAP compared with US GAAP Net income US GAAP .................... UK GAAP .................... Shareholders’ equity US GAAP .................... UK GAAP .................... 2004 US$m 12,506 11,840 2003 US$m 7,231 8,774 2002 US$m 4,900 6,239 90,082 86,623 80,251 74,473 55,831 51,765 Differences in net income and shareholders’ equity are explained in Note 49 of the ‘Notes on the Financial Statements on pages 322 to 356. Future accounting developments Transition to International Financial Reporting Standards The adoption of International Financial Reporting Standards (‘IFRS’) from 1 January 2005 is the most significant accounting development for HSBC. The European Union (‘EU’) requires that listed European companies prepare their 2005 financial statements in accordance with EU-endorsed IFRS. HSBC’s 2005 interim financial statements will, therefore, be prepared in accordance with IFRS. The European Union endorsement process for IFRS is ongoing but the majority of standards are now endorsed including IAS 32 ‘Financial Instruments: Disclosure and Presentation’ and most of IAS 39 ‘Financial Instruments: Recognition and Measurement’ with the exception of the deletion of a limited number of words and paragraphs in IAS 39 HSBC has substantially completed its transition to IFRS. The process of refining systems and processes in order to collect data on a fully IFRS- compliant basis for 2005 reporting is well advanced. On 9 December 2004, HSBC filed with the US Securities and Exchange Commission a summary of the applicable significant differences between UK GAAP and IFRS. This should be referred to for details of the major IFRS effects on HSBC Group, and is available from http://www.hsbc.com/hsbc/ investor_centre/financial-results. IFRS will also impact HSBC Holdings’ individual accounts. Investments in subsidiary undertakings will be carried at cost rather than net asset value, including attributable goodwill, adjusted for shares held by subsidiaries in HSBC Holdings. Under IFRS, in addition to the balance sheet, HSBC Holdings will publish an income statement and other primary financial statements. HSBC currently intends to file 2004 comparative data and the 2005 opening balance sheet on an IFRS basis in the second quarter of 2005. FRS 27 ‘Life Assurance’ was issued by the UK Accounting Standards Board (‘ASB’) in December 2004. This standard is effective under UK GAAP for 2005 reporting and thus should not ostensibly be applicable to companies adopting IFRS for 2005. However, FRS 27 adds to the requirements of IFRS 4 ‘Insurance contracts’ with regard to further requirements in relation to measurement of realistic liabilities and disclosure of capital position. HSBC continues to assess the likely impact of this accounting standard. 121 H S B C H O L D I N G S P L C Financial Review (continued) US GAAP The Financial Accounting Standards Board (‘FASB’) (US GAAP) has issued the following accounting standards, which become fully effective in future financial statements. In December 2003, the American Institute of Certified Public Accountants (‘AICPA’) released Statement of Position 03-3, ‘Accounting for Certain Loans or Debt Securities Acquired in a Transfer’ (‘SOP 03-3’). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 is effective for loans acquired in fiscal years beginning after 15 December 2004. Adoption is not expected to have a material impact on the US GAAP information in HSBC’s financial statements. In March 2004, the FASB reached a consensus on Emergent Issues Task Force (‘EITF’) 03-1, ‘The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments’. EITF 03-1 provides guidance for determining when an investment is impaired and whether the impairment is other than temporary. EITF 03-1 also incorporates into its consensus the required disclosures about unrealised losses on investments announced by the EITF in late 2003 and adds new disclosure requirements relating to cost-method investments. The new disclosure requirements are effective for annual reporting periods ending after June 15, 2004 and the new impairment accounting guidance was to become effective for reporting periods beginning after June 15, 2004. In September 2004, the FASB delayed the effective date of EITF 03-1 for measurement and recognition of impairment losses until implementation guidance is issued. In December 2004, the FASB decided to reconsider in its entirety all guidance on disclosing, measuring and recognising other-than-temporary impairments of debt and equity securities and requires companies to continue to comply with existing accounting literature. Until the new guidance is finalised, the impact on HSBC’s financial position and results of operations cannot be determined. SFAS 123 (revised 2004) ‘Share-Based Payment’ (‘SFAS 123R’) was issued in December 2004 to replace SFAS 123 ‘Accounting for Stock Based Compensation’ (‘SFAS 123’). SFAS 123R requires a fair value method of accounting for stock- based compensation plans. Under the fair value method, compensation cost is measured at the date of grant based on the value of the award and is recognised over the service period. HSBC had already elected to follow the fair value method encouraged by SFAS 123. Where annual bonuses are awarded in restricted shares, and the employee must remain with HSBC for a fixed period in order to receive the shares, HSBC has, to date, interpreted the service period as being the year to which the bonus relates. HSBC has fully expensed the share award in that year under US GAAP, consistent with the UK GAAP treatment. Under SFAS 123R, the service period is presumed to be the vesting period, i.e. the period the employee must remain with HSBC. Accordingly, for awards granted after the effective date of SFAS 123R, the expense of such awards will be spread forward over the vesting period. HSBC will adopt SFAS 123R from 1 July 2005. The effect of adopting this new accounting treatment will be that 2005 bonuses paid in restricted shares will be excluded from staff costs for 2005 and instead will be expensed over the vesting period with a corresponding increase in net income. The amount of these awards is dependent on 2005 performance. 2004 bonuses that will be paid in restricted shares were approximately US$130 million. 122 Average balance sheet and net interest income Average balances and the related interest are shown for the domestic operations of HSBC’s principal commercial banks by geographic region with all other commercial banking and investment banking balances and transactions included in ‘Other operations’. Additional information on the basis of preparation is set out in the notes on page 130. Other operations .......................................... 11,201 131,006 3,637 Assets Short-term funds and loans to banks Europe Hong Kong Rest of Asia- Pacific HSBC Bank ..................... HSBC Private Banking Holdings (Suisse) ........ CCF .................................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico1 ................. South America Brazilian operations........... HSBC Bank Argentina ..... Loans and advances to customers Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) ........ CCF .................................. HSBC Finance Corporation1 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico1 ................. South America Brazilian operations........... HSBC Bank Argentina ..... Average balance US$m 2004 Interest income Yield % US$m Year ended 31 December 2003 Interest income Yield % US$m Average balance US$m Average balance US$m 2002 Interest income Yield % US$m 24,308 672 2.76 22,534 657 2.92 16,691 595 3.56 2,644 26,008 8,259 89 960 219 3.37 3.69 2.65 3,394 17,519 10,172 75 573 212 2.21 3.27 2.08 5,500 12,650 15,205 144 647 409 2.62 5.11 2.69 28,172 538 1.91 20,735 517 2.49 17,776 496 2.79 9,180 1,348 1,619 2,323 2,162 7,807 3,771 1,954 250 198 36 29 56 45 91 227 237 3 237 2.16 2.67 1.79 2.41 2.08 1.17 6.02 12.13 1.20 2.12 2.78 6,893 693 1,925 1,808 1,711 2,535 4,199 1,237 231 7,206 138 17 29 35 31 20 214 242 2 159 102,792 2,921 2.00 2.45 1.51 1.94 1.81 0.79 5.10 19.56 0.87 2.21 2.84 6,686 547 1,857 2,248 1,291 3,756 421 1,065 164 8,577 187 15 39 63 26 48 32 177 14 328 94,434 3,220 2.80 2.74 2.10 2.80 2.01 1.28 7.60 16.62 8.54 3.82 3.41 168,175 9,298 5.53 130,178 6,739 5.18 105,456 5,865 5.56 4,700 42,149 115 1,892 2.45 4.49 3,385 37,456 79 1,897 2.33 5.06 2,881 29,111 81 1,657 2.81 5.69 9,310 1,055 11.33 5,934 31,234 882 2.82 29,138 671 938 11.31 – – – 3.22 28,820 1,083 3.76 41,906 1,406 3.36 41,517 1,517 3.65 39,040 1,713 4.39 37,068 4,937 7,421 61,659 114,461 22,603 9,170 8,095 4,758 905 1,838 279 418 2,936 13,146 1,099 126 878 1,569 101 864 4.96 5.65 5.63 4.76 11.49 4.86 1.37 10.85 32.98 11.16 4.24 6.44 28,594 4,567 5,725 45,727 81,973 18,791 3,515 9,103 2,930 792 20,284 1,457 266 352 2,256 9,631 982 24 862 1,044 103 627 469,609 29,445 5.10 5.82 6.15 4.93 11.75 5.23 0.68 9.47 35.63 13.01 3.09 6.27 22,898 4,237 5,243 44,130 – 15,631 8,975 913 2,542 889 16,118 1,284 251 366 2,419 – 835 115 102 821 261 671 326,884 17,524 588,951 37,902 Other operations .......................................... 20,400 1 Yields annualised on the basis of the period of ownership in the year of acquisition. 5.61 5.92 6.98 5.48 – 5.34 1.28 11.17 32.30 29.36 4.16 5.36 123 H S B C H O L D I N G S P L C Financial Review (continued) Assets (continued) Trading securities Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... CCF .................................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation ................... The Hongkong and Shanghai Banking Corporation ................... HSBC Bank Malaysia ...... North America HSBC Bank USA ............. HSBC Bank Canada ......... HSBC Markets Inc ............ HSBC Mexico1 .................. South America Brazilian operations .......... HSBC Bank Argentina ...... Average balance US$m 2004 Interest income Yield % US$m Year ended 31 December 2003 Interest income Yield % US$m Average balance US$m Average balance US$m 2002 Interest income Yield % US$m 23,093 13,662 336 846 365 11 3.66 2.67 3.27 24,758 7,043 536 945 236 15 3.82 3.35 2.80 25,104 10,435 569 1,084 235 18 4.32 2.25 3.16 11,209 298 2.66 11,351 334 2.94 11,915 432 3.63 2,487 145 5,447 1,177 11,543 2,957 842 19 101 5 115 25 421 173 129 1 511 4.06 3.45 2.11 2.12 3.65 5.85 15.32 5.26 4.99 3.61 2,823 377 4,236 774 8,837 4,303 – 7 124 11 102 17 303 261 4.39 2.92 2.41 2.20 3.43 6.07 – 1 – 14.29 4,115 138 69,160 2,487 3.35 3.60 2,452 309 4,294 755 16,768 346 34 2 1,818 112 9 140 18 752 27 – – 84 74,801 2,911 4.57 2.91 3.26 2.38 4.48 7.80 – – 4.62 3.89 28,572 1,145 4.01 16,449 659 4.01 13,071 623 4.77 10,828 6,957 55 20,356 303 239 1 479 2.80 3.44 1.82 2.35 14,298 3,365 231 16,458 397 210 2 460 2.78 6.24 0.87 2.79 14,454 2,052 – 503 141 – 3.48 6.87 – 10,629 375 3.53 33,798 779 2.30 31,774 829 2.61 29,945 955 3.19 537 40 27 884 87 65 1 395 301 12 196 3.38 3.46 2.45 4.85 2.09 2.31 5.56 10.33 21.81 7.32 2.01 3.45 13,906 1,101 873 18,753 3,370 2,681 17 2,041 1,323 120 8,056 487 37 24 894 59 75 1 254 250 13 345 134,816 4,996 3.50 3.36 2.75 4.77 1.75 2.80 5.88 12.44 18.90 10.83 4.28 3.71 10,534 981 760 17,795 – 2,440 17 175 1,470 185 7,117 448 34 30 927 – 78 1 14 314 34 323 111,625 4,800 4.25 3.47 3.95 5.21 – 3.20 5.88 8.00 21.36 18.38 4.54 4.30 Other operations .......................................... 10,239 83,156 3,001 Investment securities Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) .......... CCF .................................. HSBC Finance Corporation1 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation ................... The Hongkong and Shanghai Banking Corporation ................... HSBC Bank Malaysia ....... HSBC Bank Middle East .. 15,902 1,156 1,104 North America HSBC Bank USA ............. 18,213 HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ............ HSBC Mexico1 .................. South America Brazilian operations .......... HSBC Bank Argentina ...... Other operations .......................................... 4,153 2,814 18 3,822 1,380 164 9,748 159,040 5,491 1 Yields annualised on the basis of the period of ownership in the year of acquisition. 124 Assets (continued) Other interest-earning assets Europe Hong Kong Rest of Asia- Pacific HSBC Bank ....................... HSBC Private Banking Holdings (Suisse) ........ CCF .................................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico1 ................. South America Brazilian operations .......... HSBC Bank Argentina ..... Average balance US$m 2004 Interest income Yield % US$m Year ended 31 December 2003 Interest income Yield % US$m Average balance US$m Average balance US$m 2002 Interest income Yield % US$m 8,522 7,611 7,534 701 351 4.12 6,190 173 2.79 10,384 198 1.91 146 63 10 1.92 0.84 1.43 5,420 3,276 1,097 102 34 25 1.88 1.04 2.28 3,964 2,701 1,158 119 56 33 3.00 2.07 2.85 16,927 316 1.87 12,680 264 2.08 9,128 238 2.61 5,697 153 200 784 651 234 683 336 284 30 117 1 11 26 63 8 12 5 36 – 2.05 0.65 5.50 3.32 9.68 3.42 1.76 1.49 12.68 – 4,511 22 491 371 484 170 159 74 162 44 81 1 9 17 23 10 4 3 27 2 1.80 4.55 1.83 4.58 4.75 5.88 2.52 4.05 16.67 4.55 4,349 25 744 320 – 1 64 – 196 53 87 1 17 24 2.00 4.00 2.28 7.50 – – 1 100.00 3.13 2 – – 24 6 12.24 11.32 Other operations .......................................... (48,195) (993) (33,113) (656) (32,082) (666) 2,152 172 7.99 2,038 119 5.84 1,005 140 13.93 Total interest-earning assets Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) ......... CCF .................................. HSBC Finance Corporation1 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. 252,670 12,312 4.87 200,109 9,173 4.58 170,706 8,365 4.90 25,783 96,310 653 3,519 2.53 3.65 26,497 68,659 653 2,950 2.46 4.30 26,799 56,949 847 2,736 3.16 4.80 9,365 1,056 11.28 6,165 673 10.92 – – – 60,886 1,601 2.63 57,401 1,650 2.87 56,381 1,918 3.40 132,012 3,337 2.53 118,057 3,461 2.93 107,804 3,834 3.56 North America HSBC Bank USA ............. 88,426 HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico1 ................. South America Brazilian operations .......... HSBC Bank Argentina ..... Other operations .......................................... 119,265 28,990 29,221 18,981 9,218 1,368 3,393 70,334 7,739 10,344 2,791 361 485 4,017 13,296 1,242 651 1,678 2,272 117 3.97 4.66 4.69 4.54 11.15 4.28 2.23 8.84 24.65 8.55 815 24.02 56,727 6,760 9,014 70,895 85,827 24,127 15,063 19,720 5,652 1,194 6,548 2,287 332 414 3,304 9,713 1,115 352 1,594 1,563 121 613 4.03 4.91 4.59 4.66 11.32 4.62 2.34 8.08 27.65 10.13 9.36 5.13 46,919 6,099 8,604 68,787 – 20,118 29,580 1,855 5,307 1,293 1,548 2,118 310 452 3,573 – 958 918 175 4.51 5.08 5.25 5.19 – 4.76 3.10 9.43 1,336 315 25.17 24.36 740 47.80 608,749 28,595 4.70 Summary 964,305 50,203 5.21 778,415 39,968 Total interest-earning assets ........................ Provisions for bad and doubtful debts ......... Non-interest earning assets ......................... 964,305 (12,992) 218,143 50,203 5.21 39,968 5.13 778,415 (12,816) 192,251 28,595 4.70 608,749 (7,809) 132,227 Total assets and interest income .................. 1,169,456 50,203 4.29 957,850 39,968 4.17 733,167 28,595 3.90 1 Yields annualised on the basis of the period of ownership in the year of acquisition. 125 H S B C H O L D I N G S P L C Financial Review (continued) Assets (continued) Distribution of average total assets Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) .......... CCF .................................. HSBC Finance Corporation .................. Hang Seng Bank ................ The Hongkong and Shanghai Banking Corporation ................... The Hongkong and Shanghai Banking Corporation ................... HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Finance Corporation ................... HSBC Bank Canada ......... HSBC Markets Inc ............ HSBC Mexico ................... South America Brazilian operations .......... HSBC Bank Argentina ...... Other operations (including consolidation adjustments) ............................................ 2004 % 27.5 2.4 10.5 1.0 5.6 15.9 6.9 0.7 1.0 9.4 11.6 2.6 3.5 1.8 1.0 0.1 (1.5) 100.0 Year ended 31 December 2003 % 27.8 3.0 9.3 0.7 6.4 16.7 6.8 0.7 1.0 9.6 10.2 2.6 2.6 2.1 0.9 0.1 (0.5) 100.0 2002 % 28.7 3.8 9.7 – 7.9 18.6 7.1 0.8 1.2 11.5 – 2.8 5.3 0.3 1.1 0.2 1.0 100.0 126 Other operations .......................................... 6,201 128 76,829 1,541 Liabilities and shareholders’ funds Deposits by banks1 Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) .......... CCF .................................. HSBC Finance Corporation2 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico2 ................. South America Brazilian operations .......... HSBC Bank Argentina ..... Customer accounts1 Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) ......... CCF .................................. HSBC Finance Corporation2 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico2 ................. South America Brazilian operations .......... HSBC Bank Argentina ..... Average balance US$m 2004 Interest expense US$m Cost % Year ended 31 December 2003 Interest expense US$m Average balance US$m Cost % Average balance US$m 2002 Interest expense US$m Cost % 27,687 415 1.50 19,898 404 2.03 18,259 376 2.06 1,446 22,161 243 685 27 525 2 14 1.87 2.37 0.82 2.04 1,865 12,594 734 161 28 398 31 2 1.50 3.16 4.22 1.24 1,976 13,456 – 83 60 596 – 1 3.04 4.43 – 1.20 3,139 39 1.24 2,358 28 1.19 2,066 35 1.69 3,505 98 1,104 3,833 392 4,367 914 914 140 95 2 23 74 8 76 48 57 8 2.71 2.04 2.08 1.93 2.04 1.74 5.25 6.24 5.71 2.06 2.01 2,599 121 764 3,915 501 2,191 1,039 527 176 5,346 81 3 16 39 11 22 59 93 14 80 54,789 1,309 3.12 2.48 2.09 1.00 2.20 1.00 5.68 17.65 7.95 1.50 2.39 2,683 113 531 4,216 679 3,190 213 693 164 103 3 15 46 26 44 11 79 69 4,772 122 53,094 1,586 3.84 2.65 2.82 1.09 3.83 1.38 5.16 11.40 42.07 2.56 2.99 170,262 4,010 2.36 134,421 2,741 2.04 106,301 2,551 2.40 17,339 22,072 87 50,948 377 575 2 291 2.17 2.61 2.30 0.57 19,238 17,435 412 49,492 401 606 28 289 2.08 3.48 6.80 0.58 20,476 11,841 – 549 593 – 2.68 5.01 – 48,074 448 0.93 92,586 392 0.42 86,836 379 0.44 82,535 616 0.75 42,625 5,744 5,978 52,813 18,192 11,544 11,157 5,786 898 891 151 60 680 351 165 377 842 27 741 2.09 2.63 1.00 1.29 1.93 1.43 3.38 14.55 3.01 1.68 1.80 35,933 4,796 5,863 44,986 15,775 4,915 11,542 3,888 778 29,130 719 142 61 553 326 52 408 755 57 510 465,440 8,027 2.00 2.96 1.04 1.23 2.07 1.06 3.53 19.42 7.33 1.75 1.72 29,965 4,347 6,176 45,438 13,708 6,972 1,032 3,066 757 25,917 705 131 106 860 257 112 51 491 217 653 406,605 8,340 2.35 3.01 1.72 1.89 1.87 1.61 4.94 16.01 28.67 2.52 2.05 Other operations .......................................... 44,054 552,085 9,932 1 Further analysis is given on pages 180 and 181. 2 Costs annualised on the basis of the period of ownership in the year of acquisition. 127 H S B C H O L D I N G S P L C Financial Review (continued) Liabilities and shareholders’ funds (continued) CDs and other money market instruments1 Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... CCF .................................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation ................... The Hongkong and Shanghai Banking Corporation ................... HSBC Bank Malaysia ....... North America HSBC Bank USA ............. HSBC Finance Corporation2 .................. HSBC Bank Canada ......... HSBC Mexico2 ................. South America Brazilian operations .......... HSBC Bank Argentina ...... Average balance US$m 2004 Interest expense US$m 12,427 9,885 1,266 424 214 30 Cost % 3.41 2.16 2.37 Year ended 31 December 2003 Interest expense US$m Average balance US$m Cost % Average balance US$m 2002 Interest expense US$m 5,417 5,739 1,399 151 162 36 2.79 2.82 2.57 2,088 4,856 2,150 83 201 65 Cost % 3.98 4.14 3.02 9,565 357 3.73 8,257 321 3.89 5,331 258 4.84 4,489 261 1,755 11,441 4,028 3,566 102 – 183 8 26 188 89 134 15 – 106 4.08 3.07 1.48 1.64 2.21 3.76 14.71 – 5.22 2.92 3,163 263 1,604 5,522 3,132 4,052 63 – 1,479 121 8 26 60 84 169 12 – 59 40,090 1,209 3.83 3.04 1.62 1.09 2.68 4.17 19.05 – 3.99 3.02 1,659 148 2,286 – 2,168 318 53 105 763 69 7 62 – 56 22 14 7 16 21,925 860 4.16 4.73 2.71 – 2.58 6.92 26.42 6.67 2.10 3.92 Other operations .......................................... 2,029 60,814 1,774 Loan capital Europe HSBC Bank ....................... CCF .................................. HSBC Finance Corporation2 .................. 10,523 6,365 579 219 5.50 3.44 8,790 5,686 466 187 5.30 3.29 7,053 3,941 3,485 161 4.62 2,230 111 4.98 – 463 164 – 6.56 4.16 – Hong Kong The Hongkong and Rest of Asia- Pacific Shanghai Banking Corporation ................... The Hongkong and Shanghai Banking Corporation ................... North America HSBC Bank USA ............. 713 9,370 HSBC Finance Corporation2 .................. HSBC Bank Canada ......... HSBC Mexico2 ................. 101,269 1,967 – South America Brazilian operations .......... HSBC Bank Argentina ...... Other operations .......................................... 258 95 104 1,632 80 4.90 1,796 80 4.45 1,786 83 4.65 42 350 2,751 76 – 5.89 3.74 2.72 3.86 – 49 7 18.99 7.37 270 3,284 71,346 1,288 188 205 353 (22) (21.15) 9,324 17 178 1,779 66 13 46 30 133 6.30 5.42 2.49 5.12 6.91 22.44 8.50 1.43 2.96 151 3,396 – 1,014 19 271 319 12 214 – 65 2 44 62 7,148 167 25,098 1,276 7.95 6.30 – 6.41 10.53 16.24 19.44 2.34 5.08 1 Further analysis is given on page 182. 2 Costs annualised on the basis of the period of ownership in the year of acquisition. 135,781 4,292 3.16 104,760 3,106 128 Liabilities and shareholders’ funds (continued) Other interest bearing liabilities Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) ........ CCF .................................. HSBC Finance Corporation1 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico1 ................. South America Brazilian operations .......... HSBC Bank Argentina ..... Average balance US$m 2004 Interest expense US$m Cost % Year ended 31 December 2003 Interest expense US$m Average balance US$m Cost % Average balance US$m 2002 Interest expense US$m Cost % 24,557 736 3.00 21,502 213 0.99 21,006 253 1.20 2,505 20,118 4,337 1,161 38 602 260 22 1.52 2.99 5.99 1.89 1,509 12,994 1,359 639 26 327 65 15 1.72 2.52 4.78 2.35 1,645 10,725 – 684 37 154 – 19 2.25 1.44 – 2.78 10,495 170 1.62 8,178 136 1.66 7,753 179 2.31 13,175 195 407 12,618 263 937 12,652 195 566 320 227 2 13 324 25 20 460 15 47 4 1.72 1.03 3.19 2.57 9.51 2.13 3.64 7.69 8.30 1.25 10,732 246 335 10,317 2,077 691 7,680 – 296 346 202 3 9 240 7 16 276 – 48 16 1.88 1.22 2.69 2.33 0.34 2.32 3.59 – 16.22 4.62 8,744 51 179 9,545 – 415 19,141 – 467 299 195 1 6 280 – 15 832 – 2.23 1.96 3.35 2.93 – 3.61 4.35 – 79 (5) 16.92 (1.67) Other operations .......................................... (58,260) (1,325) (49,719) (880) (47,127) (972) 46,241 1,640 3.55 29,182 719 2.46 33,527 1,073 3.20 Total interest bearing liabilities Europe Hong Kong Rest of Asia- Pacific HSBC Bank ...................... HSBC Private Banking Holdings (Suisse) ........ CCF .................................. HSBC Finance Corporation1 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation .................. The Hongkong and Shanghai Banking Corporation .................. HSBC Bank Malaysia ....... HSBC Bank Middle East .. North America HSBC Bank USA ............. HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ........... HSBC Mexico1 ................. South America Brazilian operations .......... HSBC Bank Argentina ..... 245,456 6,164 2.51 190,028 3,975 2.09 154,707 3,726 2.41 21,290 80,601 8,152 54,060 442 2,135 425 357 2.08 2.65 5.21 0.66 22,612 54,448 4,735 51,691 455 1,680 235 342 2.01 3.09 4.96 0.66 24,097 44,819 646 1,708 2.68 3.81 – – – 50,991 533 1.05 117,417 1,038 0.88 107,425 944 0.88 99,471 1,171 1.18 64,507 6,298 7,489 80,389 112,973 25,516 28,563 15,832 7,626 1,453 1,438 163 96 1,454 2,964 544 701 574 1,010 46 2.23 2.59 1.28 1.81 2.62 2.13 2.45 3.63 13.24 3.17 52,697 5,426 6,962 64,106 78,945 21,387 14,786 16,821 4,979 1,653 2.16 2.88 1.24 1.62 2.34 2.35 2.37 3.86 19.16 7.08 1,140 156 86 1,036 1,846 503 350 649 954 117 (98) 43,202 4,659 6,886 64,881 – 17,984 29,303 1,582 4,550 1,644 1,084 142 127 1,462 – 419 988 86 707 350 2.51 3.05 1.84 2.25 – 2.33 3.37 5.44 15.54 21.29 (8,527) (14) Other operations........................................... (5,872) (372) (4,440) Summary 871,750 19,179 2.20 694,261 14,370 2.07 540,249 13,135 2.43 Total interest-bearing liabilities .................. Non interest-bearing current accounts ......... Shareholders’ funds & other non interest- 871,750 56,141 bearing liabilities .................................... 241,565 19,179 2.20 694,261 44,233 219,356 14,370 2.07 540,249 40,220 152,698 13,135 2.43 Total liabilities & interest expense .............. 1,169,456 19,179 1.64 957,850 14,370 1.50 733,167 13,135 1.79 1 Costs annualised on the basis of the period of ownership in the year of acquisition. 129 H S B C H O L D I N G S P L C Financial Review (continued) Net interest margin Europe Hong Kong Rest of Asia- Pacific HSBC Bank ....................... HSBC Private Banking Holdings (Suisse) ......... CCF .................................. HSBC Finance Corporation1 .................. Hang Seng Bank ............... The Hongkong and Shanghai Banking Corporation ................... The Hongkong and Shanghai Banking Corporation ................... HSBC Bank Malaysia ....... HSBC Bank Middle East ... North America HSBC Bank USA ............ HSBC Finance Corporation1 .................. HSBC Bank Canada ......... HSBC Markets Inc ............ HSBC Mexico1 .................. South America Brazilian operations .......... HSBC Bank Argentina ...... Other operations2 ......................................... 2004 % 2.43 0.82 1.44 6.74 2.04 1.74 1.92 2.56 3.76 2.90 8.66 2.41 (0.17) 5.82 13.69 5.19 2.20 3.22 Year ended 31 December 2003 % 2.60 0.75 1.85 7.10 2.28 2.13 2.02 2.60 3.64 3.20 9.17 2.54 0.01 4.79 10.77 0.34 1.96 3.29 2002 % 2.72 0.75 1.81 – 2.46 2.47 2.20 2.76 3.78 3.07 – 2.68 (0.24) 4.80 11.85 (2.71) 1.86 2.54 1 Net interest margins annualised on the basis of the period of ownership in the year of acquisition. 2 Excludes eliminations (see note (iii)). Notes (i) Average balances are based on daily averages for the principal areas of HSBC’s banking activities with monthly or less frequent averages used elsewhere. (ii) ‘Loans accounted for on a non-accrual basis’ and ‘Loans on which interest has been accrued but suspended’ have been included in ‘Loans and advances to banks’ and ‘Loans and advances to customers’. Interest income on such loans is included in the consolidated profit and loss account to the extent to which it has been received. (iii) Balances and transactions with fellow subsidiaries are reported gross in the principal commercial banking and consumer finance entities within ‘Other interest-earning assets’ and ‘Other interest-bearing liabilities’ as appropriate and the elimination entries are included within ‘Other operations’ in those two categories. (iv) Other than as noted in (iii) above, ‘Other operations’ comprise the operations of the principal commercial banking and consumer finance entities outside their domestic markets and all other banking operations. (v) Non-equity minority interests are included within shareholders’ funds and other non interest-bearing liabilities and the related coupon payments are included within minority interests in the profit and loss account. 130 Analysis of changes in net interest income The following table allocates changes in net interest income between volume and rate for 2004 compared with 2003, and for 2003 compared with 2002. Changes due to a combination of volume and rate are allocated to rate. Interest income Short-term funds and loans to banks Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ HSBC Private Banking Holdings (Suisse) .................................. CCF ............................................ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation .............. The Hongkong and Shanghai Banking Corporation .............. HSBC Bank Malaysia.................. HSBC Bank Middle East ............ North America HSBC Bank USA ....................... HSBC Bank Canada ................... HSBC Markets Inc ..................... HSBC Mexico ............................ South America Brazilian operations .................... HSBC Bank Argentina ............... Other operations .................................................... Loans and advances to customers Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ HSBC Private Banking Holdings (Suisse) ................................... CCF ............................................ HSBC Finance Corporation ........ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation ................ The Hongkong and Shanghai Banking Corporation ................ HSBC Bank Malaysia.................. HSBC Bank Middle East ............ North America HSBC Bank USA ....................... HSBC Finance Corporation ........ HSBC Bank Canada ................... HSBC Markets Inc ..................... HSBC Mexico ............................ South America Brazilian operations .................... HSBC Bank Argentina .............. Other operations .................................................... 2004 compared with 2003 Increase/(decrease) 2004 Volume Rate US$m US$m US$m 2003 compared with 2002 Increase/(decrease) 2003 Volume US$m US$m Rate US$m 672 89 960 219 538 198 36 29 56 45 91 227 237 3 237 3,637 52 (37) (17) 278 (40) 31 109 47 185 (164) 46 16 (5) 10 8 42 (22) 140 – 88 802 14 3 5 11 6 29 35 (145) 1 (10) (86) 657 75 573 212 517 138 17 29 35 31 20 214 242 2 159 2,921 208 (146) (55) 249 (135) (14) (323) (62) 83 (62) 6 4 1 (12) 8 (16) 287 29 6 (52) 285 (55) (2) (11) (16) (3) (12) (105) 36 (18) (117) (584) 9,298 1,967 592 6,739 1,375 (501) 115 1,892 1,055 882 1,406 1,838 279 418 2,936 13,146 1,099 126 878 1,569 101 864 31 238 382 67 14 432 22 104 786 3,817 199 39 (95) 651 15 4 37,902 7,483 5 (243) 2 (123) (125) (51) (9) (38) (106) (302) (82) 63 111 (126) (17) 233 974 79 1,897 671 938 1,517 1,457 266 352 2,256 9,631 982 24 862 1,044 103 627 14 475 671 12 109 320 20 34 88 9,631 169 (70) 915 125 (28) 173 (16) (235) – (157) (305) (147) (5) (48) (251) – (22) (21) (155) 98 (130) (217) 2002 US$m 595 144 647 409 496 187 15 39 63 26 48 32 177 14 328 3,220 5,865 81 1,657 – 1,083 1,713 1,284 251 366 2,419 – 835 115 102 821 261 671 29,445 13,240 (1,319) 17,524 131 2004 compared with 2003 Increase/(decrease) 2004 Volume Rate US$m US$m US$m 2003 compared with 2002 Increase/(decrease) 2003 Volume US$m US$m Rate US$m 846 365 11 298 101 5 115 25 421 173 129 1 511 3,001 1,145 303 239 1 479 779 537 40 27 884 87 65 1 395 301 12 196 (64) 222 (6) (4) (15) (7) 29 9 93 (82) – 2 205 503 486 (96) 224 (2) 109 53 70 2 6 (26) 14 4 – 222 11 5 72 5,491 898 (35) (93) 2 (32) (8) 1 (16) (1) 25 (6) 129 (2) 168 11 – 2 (195) 1 (90) (103) (20) 1 (3) 16 14 (14) – (81) 40 (6) (221) (403) 945 236 15 334 124 11 102 17 303 261 – 1 (15) (76) (1) (20) 17 2 (2) – (355) 309 – – (124) 77 (2) (78) (5) – (36) (1) (94) (75) – 1 138 106 (52) 659 397 210 2 460 829 487 37 24 894 59 75 1 254 250 13 345 4,996 161 (125) (5) 90 2 206 (101) (21) – (121) 58 (184) (104) (1) (10) (83) – (11) – 91 (33) (9) (21) 143 4 4 50 59 8 – 149 (31) (12) 43 903 2002 US$m 1,084 235 18 432 112 9 140 18 752 27 – – 84 623 503 141 – 375 955 448 34 30 927 – 78 1 14 314 34 323 2,487 (219) (205) 2,911 (707) 4,800 H S B C H O L D I N G S P L C Financial Review (continued) Interest income (continued) Trading securities Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ CCF ............................................ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation .............. The Hongkong and Shanghai Banking Corporation .............. HSBC Bank Malaysia ................. North America HSBC Bank USA. ....................... HSBC Bank Canada ................... HSBC Markets Inc ...................... HSBC Mexico ............................. South America Brazilian operations .................... HSBC Bank Argentina ................ Other operations .................................................... Investment securities Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ HSBC Private Banking Holdings (Suisse) ................................... CCF ............................................ HSBC Finance Corporation ........ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation .............. The Hongkong and Shanghai Banking Corporation .............. HSBC Bank Malaysia ................. HSBC Bank Middle East ............ North America HSBC Bank USA ....................... HSBC Finance Corporation ........ HSBC Bank Canada ................... HSBC Markets Inc ...................... HSBC Mexico ............................. South America Brazilian operations .................... HSBC Bank Argentina ................ Other operations .................................................... 132 Interest expense Deposits by banks Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ HSBC Private Banking Holdings (Suisse) ................................... CCF ............................................ HSBC Finance Corporation ........ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation .............. The Hongkong and Shanghai Banking Corporation .............. HSBC Bank Malaysia ................. HSBC Bank Middle East ............ North America HSBC USA Inc. ......................... HSBC Bank Canada ................... HSBC Markets Inc ..................... HSBC Mexico ............................ South America Brazilian operations .................... HSBC Bank Argentina ............... Other operations .................................................... Customer accounts Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ HSBC Private Banking Holdings (Suisse) ................................... CCF ............................................ HSBC Finance Corporation ........ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation .............. The Hongkong and Shanghai Banking Corporation .............. HSBC Bank Malaysia ................. HSBC Bank Middle East ............ North America HSBC USA Inc. .......................... HSBC Bank Canada ................... HSBC Markets Inc ..................... HSBC Mexico ............................ South America Brazilian operations .................... HSBC Bank Argentina ............... Other operations .................................................... 2004 compared with 2003 Increase/(decrease) 2004 Volume Rate US$m US$m US$m 2003 compared with 2002 Increase/(decrease) 2003 Volume US$m US$m Rate US$m 415 27 525 2 14 39 95 2 23 74 8 76 48 57 8 128 1,541 158 (147) (6) 302 (21) 5 (175) (8) 7 9 28 (1) 7 (1) (2) 22 (7) 68 (3) 13 5 2 (14) – – 36 (1) 32 (4) (104) (3) 35 404 28 398 31 2 28 81 3 16 39 11 22 59 93 14 80 527 (295) 1,309 19 (3) (38) 31 1 5 (3) – 7 (3) (7) (14) 43 (19) 5 15 57 9 (29) (160) – – (12) (19) – (6) (4) (8) (8) 5 33 (60) (57) (334) 2002 US$m 376 60 596 – 1 35 103 3 15 46 26 44 11 79 69 122 1,586 4,010 731 538 2,741 633 (443) 2,551 377 575 2 291 392 891 151 60 680 351 165 377 842 27 741 (40) 161 (22) 9 25 134 28 1 96 50 70 (14) 369 9 261 9,932 1,494 16 (192) (4) (7) (12) 38 (19) (2) 31 (25) 43 (17) (282) (39) (30) 411 401 606 28 289 379 719 142 61 553 326 52 408 755 57 510 (33) 280 28 13 32 140 14 (5) (9) 39 (33) 519 132 6 81 (115) (267) – (172) (269) (126) (3) (40) (298) 30 (27) (162) 132 (166) (224) 549 593 – 448 616 705 131 106 860 257 112 51 491 217 653 8,027 1,202 (1,515) 8,340 133 H S B C H O L D I N G S P L C Financial Review (continued) Interest expense (continued) CDs and other money market instruments Europe Hong Kong Rest of Asia- Pacific HSBC Bank ................................ CCF ............................................ Hang Seng Bank ......................... The Hongkong and Shanghai Banking Corporation .............. The Hongkong and Shanghai Banking Corporation .............. HSBC Bank Malaysia ................. North America HSBC USA Inc ........................... HSBC Finance Corporation ........ HSBC Bank Canada ................... HSBC Mexico ............................. South America Brazilian operations .................... HSBC Bank Argentina ................ Other operations .................................................... Loan capital Europe HSBC Bank ................................ CCF ............................................ HSBC Finance Corporation ........ Hong Kong The Hongkong and Shanghai Banking Corporation .............. Rest of Asia- Pacific The Hongkong and Shanghai Banking Corporation .............. North America HSBC USA Inc ........................... HSBC Finance Corporation ........ HSBC Bank Canada ................... HSBC Mexico ............................. South America Brazilian operations .................... HSBC Bank Argentina ................ 2004 compared with 2003 Increase/(decrease) 2004 Volume Rate US$m US$m US$m 2003 compared with 2002 Increase/(decrease) 2003 Volume US$m US$m Rate US$m 2002 US$m 424 214 30 357 183 8 26 188 89 134 15 – 106 1,774 579 219 161 80 42 350 2,751 76 – 49 7 195 117 (3) 51 51 – 2 64 24 (20) 7 – 22 625 92 22 62 78 (65) (3) (15) 11 – (2) 64 (19) (15) (4) – 25 (60) 21 10 (12) (7) 7 28 330 746 35 (13) 12 (22) (3) (158) 226 (25) – (9) (1) (23) 266 151 162 36 321 121 8 26 60 84 169 12 – 59 1,209 466 187 111 80 17 178 1,779 66 13 46 30 133 132 37 (23) 142 63 5 (18) 60 25 258 3 (7) 15 556 114 73 111 – 9 (7) 1,779 18 18 (11) 7 51 (64) (76) (6) (79) (11) (4) (18) – 3 (111) (5) – 28 (207) (111) (50) – (3) (4) (29) – (17) (7) 13 (39) (85) 83 201 65 258 69 7 62 – 56 22 14 7 16 860 463 164 – 83 12 214 – 65 2 44 62 167 3,106 2,199 (369) 1,276 Other operations .................................................... (22) (132) 4,292 920 134 Risk management All HSBC’s activities involve analysis, evaluation, acceptance and management of some degree of risk or combination of risks. The most important types of risk are credit risk (which includes country and cross-border risk), liquidity risk, market risk, reputational risk and operational risk. Market risk includes foreign exchange, interest rate and equity price risks. HSBC’s risk management policies are designed to identify and analyse these risks, to set appropriate risk limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. HSBC continually modifies and enhances its risk management policies and systems to reflect changes in markets and products and in best practice risk management processes. Training, individual responsibility and accountability, together with a disciplined, conservative and constructive culture of control, lie at the heart of HSBC’s management of risk. The Group Management Board, under authority delegated by the Board of Directors, formulates high level Group risk management policy. A separately constituted Risk Management Meeting monitors risk and receives reports which allow it to review the effectiveness of HSBC’s risk management policies. Credit risk management Credit risk is the risk that financial loss arises from the failure of a customer or counterparty to meet its obligations under a contract. It arises principally from lending, trade finance, treasury and leasing activities. HSBC has dedicated standards, policies and procedures to control and monitor all such risks. Within Group Head Office, a separate function, Group Credit and Risk, is mandated to provide high- level centralised management of credit risk for HSBC worldwide. Group Credit and Risk is headed by a Group General Manager who reports to the Group Chief Executive, and its responsibilities include the following: • Formulating credit policies. These are embodied in HSBC standards with which all HSBC’s operating companies are required to comply in formulating and recording in dedicated manuals their own more detailed credit policies and procedures. All such credit policies and procedures are monitored by Group Credit and Risk. • Establishing and maintaining HSBC’s large credit exposure policy. This policy sets controls • over the maximum level of HSBC’s exposure to customers, customer groups and other risk concentrations in an approach which is designed to be more conservative than internationally accepted regulatory standards. All operating companies within HSBC are required to adopt this approach. Issuing lending guidelines to HSBC’s operating companies on the Group’s attitude towards, and appetite for lending to, inter alia, specified market sectors, industries and products. Each HSBC operating company and major business unit is required to base its own lending guidelines on HSBC’s standards, regularly update them and disseminate them to all credit and marketing executives. • Undertaking an independent review and objective assessment of risk. Group Credit and Risk assesses all commercial non-bank credit facilities originated by HSBC’s operating companies in excess of designated limits, prior to the facilities being committed to customers. Operating companies may not confirm credit approval without this concurrence. Renewals and reviews of commercial non-bank facilities over designated levels are subject to the same process. • Controlling exposures to banks and other financial institutions. HSBC’s credit and settlement risk limits to counterparties in the finance and government sectors are approved centrally to optimise the use of credit availability and avoid excessive risk concentration. A dedicated unit within Group Credit and Risk controls and manages these exposures globally using centralised systems and automated processes. • Controlling cross-border exposures. Country and cross-border risk is managed by a dedicated unit within Group Credit and Risk using centralised systems, through the imposition of country limits with sub-limits by maturity and type of business. Country limits are determined by taking into account economic and political factors, and applying local business knowledge. Transactions with countries deemed to be high risk are considered case-by-case. • Controlling exposures to selected industries. Group Credit and Risk controls HSBC’s exposure to the shipping and aviation sectors, and closely monitors exposures to other industries such as telecommunications, automobiles, insurance and real estate. Where necessary, restrictions are imposed on new 135 H S B C H O L D I N G S P L C Financial Review (continued) business, or exposure within HSBC’s operating companies is capped. • Maintaining and developing HSBC’s facility grading process in order to categorise exposures into meaningful segments and facilitate focused management of the identified risks. Historically, HSBC’s grading framework involved a minimum of seven grades, the first three of which are applied to differing levels of satisfactory risk. Of the four unsatisfactory grades, grades 6 and 7 are non-performing loans. For banks, the grading structure involves ten tiers, six of which cover satisfactory risk. A more sophisticated grading framework, based on default probability and loss estimates and comprising up to 22 categories, is being progressively implemented across the HSBC Group and is already operative in several major business units. This new approach will increasingly allow a more granular analysis of risk trends. Grading methodology is based upon a wide range of financial analytics together with market data-based tools which are core inputs to the assessment of counterparty risk. Although automated grading processes are increasingly in use for the larger facilities, ultimate responsibility for setting facility grades rests with the final approving executive in each case. Facility grades are reviewed frequently and amendments, where necessary, are implemented promptly. • Reviewing the performance and effectiveness of operating companies’ credit approval processes. Regular reports are provided to Group Credit and Risk on the credit quality of local portfolios and corrective action is taken where necessary. • Reporting to certain senior executives on aspects of the HSBC loan portfolio. These executives, as well as the Group Management Board, the Risk Management Meeting, the Group Audit Committee and the Board, receive a variety of regular reports covering: − − − − − risk concentrations and exposure to industry sectors; large customer group exposures; emerging market debt and provisioning; large non-performing accounts and provisions; specific segments of the portfolio: real estate, telecommunications, automobiles, insurance, aviation and shipping, as well as ad hoc reviews; 136 − − country limits and cross-border exposures; and causes of unexpected loss and lessons learned. • Managing and directing credit-related systems initiatives. HSBC has a centralised database of large corporate, sovereign and bank facilities and is constructing a database comprising all Group credit assets. A systems-based credit application process for bank lending is operational in all jurisdictions and a common electronic corporate credit application system is deployed in all of the Group’s major businesses. • Providing advice and guidance to HSBC’s operating companies in order to promote best practice throughout the Group on credit-related matters such as: − − − regulatory developments; implementing environmental and social responsibility policies; scoring and portfolio provisioning; − new products; − − training courses; and credit-related reporting. • Acting on behalf of HSBC Holdings as the primary interface for credit-related issues with external parties including the Bank of England, the UK FSA, rating agencies, corporate analysts, trade associations and counterparts in the world’s major banks and non-bank financial institutions. Each operating company is required to implement credit policies, procedures and lending guidelines which conform to HSBC Group standards, with credit approval authorities delegated from the Board of Directors of HSBC Holdings to the relevant Chief Executive Officer. In each major subsidiary, management includes a Chief Risk Officer (or Chief Credit Officer) who reports to the local Chief Executive Officer on credit-related issues. All Chief Credit/Risk Officers have a functional reporting line to the Group General Manager, Group Credit and Risk. Each operating company is responsible for the quality and performance of its credit portfolios and for monitoring and controlling all credit risks in its portfolios, including those subject to central approval by Group Credit and Risk. This includes managing its own risk concentrations by market sector, geography and product. Local systems are in place throughout the Group to enable operating companies to control and monitor exposures by customer and counterparty. Special attention is paid to problem loans. When appropriate, specialist units are established by HSBC’s operating companies to provide customers with intensive management and control support in order to help them avoid default wherever possible thereby maximising recoveries for HSBC. Regular audits of operating companies’ credit processes are undertaken by HSBC’s Internal Audit function. Audits include consideration of the completeness and adequacy of credit manuals and lending guidelines, an in-depth analysis of a representative sample of accounts, an overview of homogeneous portfolios of similar assets to assess the quality of the loan book and other exposures, and adherence to Group standards and policies in the extension of credit facilities. Individual accounts are reviewed to ensure that facility grades are appropriate, that credit and collection procedures have been properly followed and that, where an account or portfolio evidences deterioration, adequate provisions are raised in accordance with the Group’s established processes. Internal Audit will discuss with management facility gradings they consider to be inappropriate, and their subsequent recommendations for revised grades must then be assigned to the facilities concerned. Provisions for bad and doubtful debts It is HSBC’s policy that each operating company make provision for bad and doubtful debts promptly when required and on a consistent basis in accordance with established Group guidelines. HSBC’s grading process for credit facilities extended by members of the Group is designed to highlight exposures requiring greater management attention based on a higher probability of default and potential loss. Management particularly focuses on facilities to those borrowers and portfolio segments classified below satisfactory grades. Amendments to facility grades, where necessary, are required to be undertaken promptly. Management also regularly evaluates the adequacy of the established provisions for bad and doubtful debts by conducting a detailed review of the loan portfolio, comparing performance and delinquency statistics to historical trends and assessing the impact of current economic conditions. Two types of provision are in place: specific and general. These are discussed below. Specific provisions Specific provisions represent the quantification of actual and inherent losses from homogeneous portfolios of assets and individually identified accounts. In addition, specific provisions for the sovereign risk inherent in cross-border credit exposures are established for certain countries. Specific provisions are deducted from loans and advances in the balance sheet. Portfolios Where homogeneous groups of assets are reviewed on a portfolio basis, for example credit cards, other unsecured consumer lending, motor vehicle financing and residential mortgage loans, two alternative methods are used to calculate specific provisions: • When appropriate empirical information is available, the Group utilises roll rate methodology (a statistical analysis of historical trends of the probability of default and amount of consequential loss, assessed at each time period for which payments are overdue), other historical data and an evaluation of current economic conditions, to calculate an appropriate level of specific provision based on inherent loss. In certain highly developed markets, sophisticated models also take into account behavioural and account management trends such as bankruptcy and restructuring statistics. Roll rates are regularly benchmarked against actual outcomes to ensure that they remain appropriate. • When the portfolio size is less than US$20 million or when information is insufficient or not sufficiently reliable for a roll rate methodology to be adopted, the Group uses a formulaic method which allocates progressively higher loss rates in line with the period of time through which a customer’s loan is overdue. The Group intends to extend the use of the roll rate methodologies to all homogeneous portfolios of assets (for calculating specific provisions) as information becomes available. The portfolio approach is applied to accounts in the following portfolios: • • • low value, homogeneous small business accounts in certain jurisdictions; residential mortgages less than 90 days overdue; and credit cards and other unsecured consumer lending products. 137 H S B C H O L D I N G S P L C Financial Review (continued) These portfolio provisions are generally reassessed monthly and charges for new provisions, or releases of existing provisions, are calculated for each separately identified portfolio. Individually assessed accounts Specific provisions on individually assessed accounts are determined by an evaluation of the exposures case-by-case. This procedure is applied to all accounts that do not qualify for, or are not subject to, a portfolio-based approach outlined above. In determining such provisions on individually assessed accounts, the following factors are considered: • • • • • • • • • the Group’s aggregate exposure to the customer (including contingent liabilities); the viability of the customer’s business model and capability to trade successfully out of financial difficulties and generate sufficient cash flow to service debt obligations; the likely dividend available on liquidation or bankruptcy; the extent of other creditors’ commitments ranking ahead of, or pari passu with, the Group and the likelihood of other creditors continuing to support the company; the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident; the amount and timing of expected receipts and recoveries; the realisable value of security (or other credit mitigants) and likelihood of successful repossession; the deduction of any costs involved in recovery of amounts outstanding; the ability of the borrower to obtain and make payments in the relevant foreign currency if loans are not in local currency; and, • where available, the secondary market price for the debt. Group policy requires a review of the level of specific provisions on individual facilities above materiality thresholds at least half-yearly, or more regularly where individual circumstances require. This will normally include a review of collateral held (including re-confirmation of its enforceability) and an assessment of actual and anticipated receipts. For significant commercial and corporate debts, specialised loan ‘work-out’ teams with experience in 138 insolvency and specific market sectors are used. This expertise enables likely losses on significant individual exposures to be assessed more accurately. Releases on individually calculated specific provisions are recognised whenever the Group has reasonable evidence that the established estimate of loss has been reduced. Cross-border exposures Specific provisions are established in respect of cross-border exposures to countries assessed by management to be vulnerable to foreign currency payment restrictions. This assessment includes analysis of both economic and political factors. Economic factors include the level of external indebtedness, the debt service burden and access to external sources of funds to meet the debtor country’s financing requirements. Political factors taken into account include the stability of the country and its government, potential threats to security and the quality and independence of the legal system. Provisions are applied to all qualifying exposures within these countries unless these exposures: • • • are performing, trade-related and of less than one year’s maturity; are mitigated by acceptable security cover which is, other than in exceptional cases, held outside the country concerned; or are represented by securities held for trading purposes for which a liquid and active market exists, and which are marked to market daily. General provisions General provisions augment specific provisions and provide cover for loans which are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. HSBC requires each operating company to maintain a general provision which is determined after taking into account: • • historical loss experience in portfolios of similar risk characteristics, for example, by industry sector, loan grade or product; the estimated period between a loss occurring and that loss being identified and evidenced by the establishment of a specific provision against that loss; and • management’s judgement as to whether the current economic and credit conditions are such that the actual level of inherent losses is likely to be greater or less than that suggested by historical experience. is legally sound; or The estimated period between a loss occurring and its identification (as evidenced by the establishment of a specific provision for this loss) is determined by local management for each identified portfolio. In general, the periods used vary between four and twelve months. In normal circumstances, historical experience is the most objective and accurate framework used to assess inherent loss within each portfolio. Historical loss experience is generally benchmarked against the weighted average annual rate of losses over a five- year period. In certain circumstances, economic conditions are such that historical loss experience provides insufficient evidence of the inherent loss in a given portfolio. In such circumstances, management uses its judgement, supported by relevant experience from similar situations, to determine an appropriate general provision. The basis used to establish the general provision within each reporting entity is documented, and is reviewed by senior Group credit management for conformity with Group policy. Suspended and non-accrual interest For individually assessed accounts, loans are designated as non-performing as soon as management has doubts as to the ultimate collectibility of principal or interest, or when contractual payments of principal or interest are 90 days overdue. When a loan is designated as non- performing, interest is not normally credited to the profit and loss account and either interest accruals will cease (‘non-accrual loans’) or interest will be credited to an interest suspense account in the balance sheet which is netted against the relevant loan (‘suspended interest’). Within portfolios of low value, high volume, homogeneous loans, interest will normally be suspended on facilities 90 days or more overdue. In certain operating subsidiaries, interest income on credit cards may continue to be included in earnings after the account is 90 days overdue, provided that a suitable provision is raised against the portion of accrued interest which is considered to be irrecoverable. The designation of a loan as non-performing and the suspension of interest may be deferred for up to 12 months in either of the following situations: • cash collateral is held covering the total of principal and interest due and the right of set-off • the value of any net realisable tangible security is considered more than sufficient to cover the full repayment of all principal and interest due and credit approval has been given to the rolling-up or capitalisation of interest payments. On receipt of cash (other than from the realisation of security), the overall risk is re- evaluated and, if appropriate, suspended or non- accrual interest is recovered and taken to the profit and loss account. Amounts received from the realisation of security are applied first to the repayment of outstanding indebtedness, with any surplus used to recover specific provisions and then suspended interest. Charge-offs Loans (and the related provisions) are normally charged off, either partially or in full, when there is no realistic prospect of recovery of these amounts and when the proceeds from the realisation of security have been received. Unsecured consumer facilities are charged off between 150 and 210 days overdue. In the case of HSBC Finance, this period is generally extended to 300 days overdue (270 days for real estate secured products). There are no cases where the charge-off period exceeds 360 days except for the UK where certain consumer finance accounts are still deemed collectible beyond this point. In the case of bankruptcy, charge-off can occur earlier. US banks typically write off problem lending more quickly than is the practice in the UK. This means that HSBC’s reported levels of credit risk elements and associated provisions are likely to be higher than those of comparable US banks. Restructuring of loans Restructuring activity is designed to manage customer relationships, maximise collection opportunities and avoid foreclosure or repossession, if possible. Following restructuring, an overdue consumer account will normally be reset to current status. Restructuring policies and practices are based on indicators or criteria which, in the judgement of local management, evidence the probability that payment will continue. These policies are continually reviewed and their application varies depending upon the nature of the market, the product and the availability of empirically based data. Where empirical evidence indicates an increased propensity to default on restructured accounts, the use of roll rate methodologies for the calculation of provisions results in the increased default propensity being reflected in provisions. 139 H S B C H O L D I N G S P L C Financial Review (continued) Restructuring activity is used most commonly Assets acquired within consumer finance portfolios. The largest concentration is domiciled in the US in HSBC Finance Corporation. The majority of restructured accounts relate to secured lending. In addition to restructuring, HSBC’s consumer lending businesses, principally HSBC Finance Corporation’s, use other account management techniques on a more limited basis, such as extended payment arrangements, approved external debt management plans, deferring foreclosure, modification, loan rewrites and/or deferral of payments pending a change in circumstances. When using such techniques, accounts may be treated as current, although if payment difficulties are subsequently experienced they will be re-designated as delinquent. At 31 December 2004, the total value of accounts which have been either restructured or subject to other account management techniques in HSBC Finance was US$15 billion, representing 12 per cent of the HSBC Finance loan book, compared with US$18 billion or some 15 per cent at 31 December 2003. Gross loans and advances to customers Assets acquired in exchange for advances in order to achieve an orderly realisation continue to be reported as advances. The asset acquired is recorded at the carrying value of the advance disposed of at the date of the exchange and subsequent provisions are based on any further deterioration in value. Loan portfolio Loans and advances to customers are well spread across the various industrial sectors, as well as geographically. At constant exchange rates, loans and advances to customers (excluding the finance sector and settlement accounts) grew by US$101.4 billion or 20 per cent, during 2004. On the same basis, personal lending comprised 63 per cent of HSBC’s loan portfolio and over 72 per cent of the growth in loans in 2004 related to personal and consumer lending. Overall, including the finance sector and settlement accounts, personal lending represented 57 per cent of total advances to customers at 31 December 2004. Personal Residential mortgages ................................................... Hong Kong Government Home Ownership Scheme ..... Other personal ............................................................... Total personal ............................................................... Corporate and commercial Commercial, industrial and international trade ............. Commercial real estate .................................................. Other property-related ................................................... Government .................................................................. Other commercial1 ........................................................ 2003 US$m 165,464 6,290 134,145 305,899 85,668 35,088 17,140 9,590 44,030 Total corporate and commercial .................................... 191,516 Financial Non-bank financial institutions ..................................... Settlement accounts ...................................................... Total financial ............................................................... 37,091 8,594 45,685 Total gross loans and advances to customers ................ 543,100 Constant currency effect US$m 5,634 (8) 2,935 8,561 4,686 1,596 584 223 2,325 9,414 1,878 267 2,145 20,120 Under- lying change US$m 51,367 (880) 22,926 73,413 10,987 6,699 2,924 400 6,955 27,965 13,271 4,973 18,244 119,622 2004 US$m 222,465 5,402 160,006 387,873 101,341 43,383 20,648 10,213 53,310 228,895 52,240 13,834 66,074 682,842 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. 140 The commentary below is on a constant currency basis. Residential mortgages increased by 28 per cent to US$227.9 billion and comprised 33 per cent of total gross loans to customers at 31 December 2004. Growth was particularly strong in North America where residential mortgages rose by 44 per cent to US$112.9 billion. A combination of low unemployment and low interest rates encouraged both growth in new lending and the refinancing of existing mortgages. HSBC Finance also introduced a number of new products and activated a new correspondent relationship in the first half of the year. Residential mortgages in Europe increased by 26 per cent, predominantly in the UK, reflecting the success of a number of marketing initiatives, competitive pricing and continued buoyancy in the housing market. Mortgage balances in Hong Kong were marginally lower than in 2003 as a 14 per cent fall in GHOS, which remained suspended during the year, offset a small rise in non-scheme mortgages. In the rest of Asia-Pacific, residential mortgages grew by US$2.0 billion, or 16 per cent, with particularly strong growth in China, the Middle East, India, South Korea, Taiwan and Singapore. Other personal lending, which represented 23 per cent of total gross loans to customers at 31 December 2004, increased by 17 per cent to US$160.0 billion. Excluding the impact of the acquisition of M&S Money in the UK in November 2004, the increase was 13 per cent. In Europe, excluding this acquisition, other personal lending grew by 18 per cent as consumer expenditure remained strong, particularly in the UK, while lending to European Private Banking clients rose by 22 per cent as customers took advantage of low interest rates to finance higher returning securities. Hong Kong and the rest of Asia-Pacific also benefited from improved consumer sentiment and other personal lending in Hong Kong increased by 23 per cent. In the rest of Asia-Pacific, an expansion of consumer credit and growth in the credit cards base contributed to a 25 per cent increase in other personal lending while the US benefited from strong growth in both the cards base and balances, and an expansion of auto finance lending. Loans and advances to the large corporate sector remained subdued but commercial lending in Hong Kong and in the rest of Asia-Pacific expanded as regional trade volumes grew. International trade balances in Hong Kong increased by 26 per cent to US$7.8 billion, as economic expansion in mainland China, and buoyant consumer spending in the US encouraged business expansion. Inter-regional trade volumes also grew across the rest of Asia-Pacific and trade finance lending in the region increased by 30 per cent with particularly strong growth in the Middle East, where oil producing countries benefited from high global oil prices, Singapore, Korea and Japan. The following tables analyse loans by industry sector and by the location of the principal operations of the lending subsidiary or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank, HSBC Bank Middle East and HSBC Bank USA, by the location of the lending branch. 141 H S B C H O L D I N G S P L C Financial Review (continued) Customer loans and advances by industry sector At 31 December 2004 Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m Gross loans and advances to customers US$m Gross loans by customer type as a % of total gross loans % 70,552 24,040 14,799 112,866 208 222,465 – 57,920 128,472 54,438 18,827 6,750 3,663 31,626 115,304 30,809 4,491 35,300 5,402 9,104 38,546 14,138 10,391 5,959 615 7,294 38,397 1,932 596 2,528 – 9,075 23,874 19,178 4,232 3,349 1,432 7,023 35,214 2,297 305 2,602 – 80,463 193,329 11,599 9,798 4,518 3,868 6,448 36,231 17,090 8,431 25,521 – 3,444 3,652 1,988 135 72 635 919 3,749 112 11 123 5,402 160,006 387,873 101,341 43,383 20,648 10,213 53,310 228,895 52,240 13,834 66,074 32.6 0.8 23.4 56.8 14.8 6.4 3.0 1.5 7.8 33.5 7.7 2.0 9.7 279,076 79,471 61,690 255,081 7,524 682,842 100.0 40.9% 6,065 11.6% 773 9.0% 1,180 37.4% 4,583 1.1% 658 100.0% 13,259 2.2% 1.0% 1.9% 1.8% 8.7% 1.9% Personal Residential mortgages .................. Hong Kong Government Home Ownership Scheme ................. Other personal ............................. Total personal ............................. Corporate and commercial Commercial, industrial and international trade ................... Commercial real estate ................ Other property-related ................. Government ................................ Other commercial1 ....................... Total corporate and commercial .. Financial Non-bank financial institutions ... Settlement accounts .................... Total financial ............................. Total gross loans and advances to customers2................................ Percentage of Group loans and advances by geographical region....................................... Non-performing loans3,4............... Non-performing loans as a percentage of gross loans and advances to customers3,4 .......... Specific provisions outstanding against loans and advances ..... 4,036 331 791 4,420 522 10,100 Specific provisions outstanding as a percentage of non- performing loans3,4................... 66.5% 42.8% 67.0% 96.4% 79.3% 76.2% 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. 2 Included within this total is credit card lending of US$56,222 million. 3 Net of suspended interest. 4 Included in North America are non-performing loans of US$3,782 million and specific provisions of US$3,443 million in HSBC Finance; excluding HSBC Finance, specific provisions outstanding as a percentage of non-performing loans was 54.6 per cent. Included in gross loans and advances to customers are the following numbers in respect of HSBC Finance, 92 per cent of which relate to North America: Residential mortgages ..................................................................................................................... Motor vehicle finance ..................................................................................................................... MasterCard/Visa credit cards .......................................................................................................... Private label cards ........................................................................................................................... Other unsecured personal lending ................................................................................................... Corporate and commercial lending ................................................................................................. 2004 US$m 60,829 10,237 22,225 15,891 32,677 44 2003 US$m 46,057 8,868 21,207 15,413 30,130 101 Total ................................................................................................................................................ 141,903 121,776 142 At 31 December 2003 Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m Gross loans and advances to customers US$m Gross loans by customer type as a % of total gross loans % 51,721 23,664 12,101 77,754 224 165,464 – 42,041 93,762 49,468 15,517 5,416 2,462 24,239 97,102 21,226 3,068 24,294 6,290 7,420 37,374 10,966 8,548 5,075 927 6,754 32,270 4,921 556 5,477 – 7,135 19,236 14,892 3,149 2,597 1,450 5,735 27,823 2,027 188 2,215 – 75,173 152,927 8,907 7,785 3,994 4,104 6,619 31,409 8,839 4,767 13,606 – 2,376 2,600 1,435 89 58 647 683 2,912 78 15 93 6,290 134,145 305,899 85,668 35,088 17,140 9,590 44,030 191,516 37,091 8,594 45,685 30.3 1.2 24.7 56.2 15.8 6.5 3.2 1.8 8.1 35.4 6.8 1.6 8.4 215,158 75,121 49,274 197,942 5,605 543,100 100.0 Personal Residential mortgages .................. Hong Kong Government Home Ownership Scheme ................. Other personal ............................. Total personal ............................. Corporate and commercial Commercial, industrial and international trade ................... Commercial real estate ................ Other property-related ................. Government ................................ Other commercial1 ....................... Total corporate and commercial .. Financial Non-bank financial institutions ... Settlement accounts .................... Total financial ............................. Total gross loans and advances to customers2................................ Percentage of Group loans and advances by geographical region....................................... Non-performing loans3................. 5,701 1,671 1,538 39.7% 13.8% 9.1% 36.4% 5,4444 1.0% 100.0% 696 15,050 Non-performing loans as a percentage of gross loans and advances to customers3 ............ Specific provisions outstanding 2.6% 2.2% 3.1% 2.8% 12.4% 2.8% against loans and advances ..... 3,554 629 981 5,1844 530 10,878 Specific provisions outstanding as a percentage of non- performing loans3..................... 62.3% 37.6% 63.8% 95.2%4 76.1% 72.3% 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. 2 Included within this total is credit card lending of US$48,634 million. 3 Net of suspended interest. 4 Includes non-performing loans of US$4,380 million and specific provisions of US$4,448 million in HSBC Finance; excluding HSBC Finance, specific provisions outstanding as a percentage of non-performing loans was 69.2 per cent. 143 H S B C H O L D I N G S P L C Financial Review (continued) Customer loans and advances by industry sector (continued) At 31 December 2002 Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m Gross loans and advances to customers US$m Gross loans by customer type as a % of total gross loans % 38,719 23,839 7,507 26,666 253 96,984 – 26,748 65,467 44,424 11,887 3,970 2,164 22,712 85,157 15,221 2,622 17,843 7,255 7,066 38,160 10,173 8,336 4,805 719 6,612 30,645 2,055 347 2,402 – 5,900 13,407 12,582 2,701 2,031 933 5,950 24,197 931 192 1,123 – 7,836 34,502 10,773 6,297 4,515 4,575 4,835 30,995 9,231 5,224 14,455 – 1,012 1,265 1,063 46 26 562 565 2,262 49 – 49 7,255 48,562 152,801 79,015 29,267 15,347 8,953 40,674 173,256 27,487 8,385 35,872 26.9 2.0 13.4 42.3 21.8 8.1 4.2 2.5 11.2 47.8 7.6 2.3 9.9 168,467 71,207 38,727 79,952 3,576 361,929 100.0 46.5% 4,495 19.7% 1,724 10.7% 2,055 22.1% 1,773 1.0% 476 100.0% 10,523 2.7% 2.4% 5.3% 2.2% 13.3% 2.9% Personal Residential mortgages ................. Hong Kong Government Home Ownership Scheme ................. Other personal ............................. Total personal ............................. Corporate and commercial Commercial, industrial and international trade ................... Commercial real estate ................ Other property-related ................. Government ................................ Other commercial1 ....................... Total corporate and commercial .. Financial Non-bank financial institutions ... Settlement accounts .................... Total financial ............................. Total gross loans and advances to customers2 ............................... Percentage of Group loans and advances by geographical region....................................... Non-performing loans3 ................ Non-performing loans as a percentage of gross loans and advances to customers3 ............ Specific provisions outstanding against loans and advances ..... 2,774 688 1,321 1,482 341 6,606 Specific provisions outstanding as a percentage of non- performing loans3 .................... 61.7% 39.9% 64.3% 83.6% 71.6% 62.8% 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. 2 Included within this total is credit card lending of US$9,950 million. 3 Net of suspended interest. 144 At 31 December 2001 Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m Gross loans and advances to customers US$m Gross loans by customer type as a % of total gross loans % 27,282 23,125 5,134 22,126 548 78,215 – 21,065 48,347 38,476 9,475 3,630 2,393 20,510 74,484 11,329 2,361 13,690 8,123 6,227 37,475 9,662 8,474 4,710 543 6,349 29,738 1,546 223 1,769 – 4,616 9,750 11,226 2,395 2,169 900 5,457 22,147 752 189 941 – 6,273 28,399 9,018 5,877 4,011 728 4,230 23,864 12,572 8,984 21,556 – 1,280 1,828 1,720 77 69 775 617 3,258 118 4 122 8,123 39,461 125,799 70,102 26,298 14,589 5,339 37,163 153,491 26,317 11,761 38,078 24.7 2.6 12.3 39.6 22.1 8.3 4.6 1.7 11.7 48.4 8.3 3.7 12.0 136,521 68,982 32,838 73,819 5,208 317,368 100.0 43.0% 3,682 21.7% 2,028 10.3% 2,723 23.3% 672 1.7% 544 100.0% 9,649 2.7% 2.9% 8.3% 0.9% 10.4% 3.0% Personal Residential mortgages ................. Hong Kong Government Home Ownership Scheme ................. Other personal ............................. Total personal ............................. Corporate and commercial Commercial, industrial and international trade ................... Commercial real estate ................ Other property-related ................. Government ................................ Other commercial1 ....................... Total corporate and commercial .. Financial Non-bank financial institutions ... Settlement accounts .................... Total financial ............................. Total gross loans and advances to customers2 ........................... Percentage of Group loans and advances by geographical region....................................... Non-performing loans3 ................ Non-performing loans as a percentage of gross loans and advances to customers3 ............ Specific provisions outstanding against loans and advances ..... 2,204 856 1,786 289 365 5,500 Specific provisions outstanding as a percentage of non- performing loans3 .................... 59.8% 42.2% 65.6% 43.0% 67.1% 57.0% 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. 2 Included within this total is credit card lending of US$8,289 million. 3 Net of suspended interest. 145 H S B C H O L D I N G S P L C Financial Review (continued) Customer loans and advances by industry sector (continued) At 31 December 2000 Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m Gross loans and advances to customers US$m Gross loans by customer type as a % of total gross loans % 24,048 23,121 3,723 19,931 809 71,632 – 20,537 44,585 38,012 10,053 3,121 2,572 19,570 73,328 10,374 3,946 14,320 7,353 4,923 35,397 9,584 8,293 3,850 130 7,459 29,316 1,664 142 1,806 – 4,110 7,833 11,583 2,749 1,815 574 5,406 22,127 629 361 990 – 6,847 26,778 9,274 6,915 4,072 715 3,753 24,729 8,629 2,464 11,093 – 1,364 2,173 2,803 77 156 50 937 4,023 152 41 193 7,353 37,781 116,766 71,256 28,087 13,014 4,041 37,125 153,523 21,448 6,954 28,402 24.0 2.5 12.5 39.0 23.9 9.4 4.4 1.4 12.4 51.5 7.2 2.3 9.5 132,233 66,519 30,950 62,600 6,389 298,691 100.0 44.3% 3,376 22.3% 2,521 10.4% 3,081 20.9% 684 2.1% 710 100.0% 10,372 2.6% 3.8% 9.9% 1.1% 11.1% 3.5% Personal Residential mortgages ................. Hong Kong Government Home Ownership Scheme ................. Other personal ............................. Total personal ............................. Corporate and commercial Commercial, industrial and international trade ................... Commercial real estate ................ Other property-related ................. Government ................................ Other commercial1 ....................... Total corporate and commercial .. Financial Non-bank financial institutions ... Settlement accounts .................... Total financial ............................. Total gross loans and advances to customers2 ........................... Percentage of Group loans and advances by geographical region....................................... Non-performing loans3 ................ Non-performing loans as a percentage of gross loans and advances to customers3 ............ Specific provisions outstanding against loans and advances ..... 2,135 1,241 1,929 278 482 6,065 Specific provisions outstanding as a percentage of non- performing loans3 .................... 63.2% 49.2% 62.6% 40.6% 67.9% 58.5% 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. 2 Included within this total is credit card lending of US$7,604 million. 3 Net of suspended interest. 146 Customer loans and advances by principal area within rest of Asia-Pacific and South America At 31 December 2004 Residential mortgages US$m Other personal US$m Property- related US$m Commercial, international trade and other US$m Loans and advances to customers (gross) Australia and New Zealand .................... India ....................................................... Indonesia ................................................ Japan ...................................................... Mainland China ..................................... Malaysia ................................................ Middle East ............................................ Singapore ............................................... South Korea ........................................... Taiwan ................................................... Thailand ................................................. Other ...................................................... 5,871 778 12 12 256 2,029 129 2,139 1,834 1,509 28 202 Total of rest of Asia-Pacific ................... 14,799 Argentina ............................................... Brazil ..................................................... Other ...................................................... Total of South America .......................... 37 170 1 208 635 371 166 106 10 670 1,976 3,027 189 762 178 985 9,075 69 3,374 1 3,444 2,580 56 9 689 794 407 1,414 1,263 6 – 75 288 7,581 21 158 28 207 3,761 1,440 769 3,532 3,329 2,611 6,326 2,259 1,559 805 1,135 2,709 30,235 1,061 2,433 171 3,665 At 31 December 2003 Residential mortgages US$m Other personal US$m Property- related US$m Commercial, international trade and other US$m Loans and advances to customers (gross) Australia and New Zealand .................... India ....................................................... Indonesia ................................................ Japan ...................................................... Mainland China ..................................... Malaysia ................................................ Middle East ............................................ Singapore ............................................... South Korea ........................................... Taiwan ................................................... Thailand ................................................. Other ...................................................... 5,436 424 13 13 78 1,837 61 1,521 1,430 1,073 32 183 Total of rest of Asia-Pacific ................... 12,101 Argentina ................................................ Brazil ...................................................... Other ...................................................... Total of South America .......................... 47 176 1 224 497 305 135 75 6 518 1,660 2,420 81 506 129 803 7,135 62 2,313 1 2,376 1,835 10 20 613 614 311 923 1,142 – – 82 196 5,746 16 122 9 147 3,460 1,329 670 2,731 1,887 2,591 4,726 2,219 847 852 743 2,237 24,292 975 1,715 168 2,858 Total US$m 12,847 2,645 956 4,339 4,389 5,717 9,845 8,688 3,588 3,076 1,416 4,184 61,690 1,188 6,135 201 7,524 Total US$m 11,228 2,068 838 3,432 2,585 5,257 7,370 7,302 2,358 2,431 986 3,419 49,274 1,100 4,326 179 5,605 147 H S B C H O L D I N G S P L C Financial Review (continued) Analysis of loans and advances to banks by geographical region Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m 55,876 45,300 14,783 24,176 2,597 51,806 38,639 12,948 11,885 1,922 39,398 33,359 10,708 10,391 1,665 40,665 42,516 11,253 7,979 2,252 45,072 57,154 11,197 9,441 3,200 31 December 2004 ..................................... Suspended interest ..................................... Total ........................................................... 31 December 2003 ..................................... Suspended interest ..................................... Total ........................................................... 31 December 2002 ..................................... Suspended interest ..................................... Total ........................................................... 31 December 2001 ..................................... Suspended interest ..................................... Total ........................................................... 31 December 2000 ..................................... Suspended interest ..................................... Total ........................................................... Provisions against total loans and advances Year ended 31 December 2004 Specific US$m General US$m At 1 January 2004 ............................................................................................. Amounts written off .......................................................................................... Recoveries of advances written off in previous years ....................................... Charge/(credit) to profit and loss account ......................................................... Acquisition of subsidiaries ................................................................................ Exchange and other movements ........................................................................ At 31 December 2004 ....................................................................................... – HSBC Finance ............................................................................................. – Rest of HSBC .............................................................................................. Provisions against loans and advances to customers Total provisions to gross lending1 Specific provisions .................................... General provisions Additional general provisions held against Argentine risk ........................... Other ......................................................... Total provisions ........................................ 2004 % 1.58 – 0.40 1.98 2003 % 2.11 – 0.54 2.65 1 Net of suspended interest, reverse repo transactions and settlement accounts. 10,902 (8,896) 912 6,793 219 187 10,117 3,672 6,445 2002 % 1.94 0.04 0.70 2.68 2,813 – – (436) 37 155 2,569 616 1,953 2001 % 1.90 0.21 0.71 2.82 148 Gross loans and advances to banks US$m Provisions for bad and doubtful debts US$m 142,732 (3) 142,729 117,200 (3) 117,197 95,521 (2) 95,519 104,665 (2) 104,663 126,064 (2) 126,062 (17) (24) (23) (22) (30) Total US$m 13,715 (8,896) 912 6,357 256 342 12,686 4,288 8,398 2000 % 2.17 – 0.75 2.92 The following tables show details of the movements in HSBC’s provisions for bad and doubtful debts by location of lending office for each of the past five years. A discussion of the material movements in the charge for provisions by region follows these tables. Year ended 31 December 2004 Europe US$m Provisions at 1 January ....................................... 4,435 Amounts written off: Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. (298) (30) (14) (211) (10) (768) Total amounts written off ................................ (1,331) Recoveries of amounts written off in previous years: Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. 27 3 3 6 1 97 Total recoveries ............................................... 137 Net charge to profit and loss account1: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. General provisions ........................................... Total charge ..................................................... Foreign exchange and other movements ............. Provisions at 31 December .................................. Provisions against banks: Specific provisions .......................................... Provisions against customers: Specific provisions .......................................... General provisions2 ......................................... Provisions at 31 December .................................. Provisions against customers as a percentage of loans and advances to customers: Specific provisions .......................................... General provisions ........................................... Total .................................................................... (7) 181 21 19 (1) (68) 4 1,037 (161) 1,025 547 4,813 14 4,036 763 4,813 % 1.45 0.27 1.72 Hong Kong US$m 1,055 (35) (55) (2) (33) (52) (161) (338) 10 – – 3 12 21 46 – (56) (15) (3) – (29) (12) 116 (224) (223) (7) 533 – 331 202 533 % 0.42 0.25 0.67 Rest of Asia- Pacific US$m 1,181 North America US$m South America US$m 6,461 583 (165) (17) (1) (42) (8) (179) (412) 4 10 – 9 1 41 65 (1) 49 (29) (1) – (18) 4 144 (48) 100 15 949 3 791 155 949 % 1.28 0.25 1.53 (72) (3) (3) (206) (493) (5,640) (6,417) 73 4 – 34 18 455 584 – (44) (1) – 1 (37) 485 4,783 (1) 5,186 (1) 5,813 – 4,420 1,393 5,813 % 1.73 0.55 2.28 (65) (3) – (24) (3) (303) (398) 4 – – 30 – 46 80 (2) 47 1 – – (38) 4 259 (2) 269 44 578 – 522 56 578 % 6.94 0.74 7.68 Total US$m 13,715 (635) (108) (20) (516) (566) (7,051) (8,896) 118 17 3 82 32 660 912 (10) 177 (23) 15 – (190) 485 6,339 (436) 6,357 598 12,686 17 10,100 2,569 12,686 % 1.48 0.38 1.86 1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts’. 2 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of Asia-Pacific, as well as those booked in Hong Kong. 149 H S B C H O L D I N G S P L C Financial Review (continued) Provisions at 1 January ....................................... Amounts written off: Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. Total amounts written off ................................ Recoveries of amounts written off in previous years: Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. Europe US$m 3,668 (338) (31) (3) (1) (54) (4) (471) (902) 25 3 2 – 49 1 62 Total recoveries ............................................... 142 Net charge to profit and loss account1: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. General Provisions .......................................... Total charge ..................................................... Foreign exchange and other movements2 ............ (6) 286 15 (1) – 216 – 482 (118) 874 653 Hong Kong US$m 1,143 (71) (12) (13) – (65) (121) (302) (584) 16 – – – 4 6 16 42 – (3) (18) 1 – 78 102 271 (31) 400 54 Year ended 31 December 2003 Rest of Asia- Pacific US$m 1,496 North America US$m 2,356 South America US$m 477 (201) (18) (21) (1) (42) (16) (146) (445) 18 4 5 – 11 1 35 74 3 (45) (8) (17) 1 (4) 23 116 16 85 (29) (337) (113) (30) – (104) (529) (4,225) (5,338) 20 2 4 – 10 4 295 335 – 78 (1) (5) – 55 421 3,992 136 4,676 4,432 6,461 – 5,184 1,277 6,461 % 2.62 0.65 3.27 (69) (5) – – (30) (5) (78) (187) 3 – – – 7 1 6 17 – 60 1 (1) – (6) 6 122 (124) 58 218 583 – 530 53 583 % 9.46 0.95 10.41 Total US$m 9,140 (1,016) (179) (67) (2) (295) (675) (5,222) (7,456) 82 9 11 – 81 13 414 610 (3) 376 (11) (23) 1 339 552 4,983 (121) 6,093 5,328 13,715 24 10,878 2,813 13,715 % 2.00 0.52 2.52 Provisions at 31 December .................................. 4,435 1,055 1,181 Provisions against banks: Specific provisions .......................................... Provisions against customers: Specific provisions .......................................... General provisions3 ......................................... Provisions at 31 December .................................. Provisions against customers as a percentage of loans and advances to customers: Specific provisions .......................................... General provisions ........................................... Total .................................................................... 20 3,554 861 4,435 % 1.65 0.40 2.05 – 629 426 4 981 196 1,055 1,181 % 0.84 0.57 1.41 % 1.99 0.40 2.39 1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts’. 2 Other movements include amounts of US$129 million in Europe and US$4,524 million in North America transferred in on the acquisition of HSBC Finance Corporation, and of US$116 million in South America transferred in on the acquisition of Lloyds TSB Group’s Brazilian businesses and assets. 3 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of Asia-Pacific, as well as those booked in Hong Kong. 150 Year ended 31 December 2002 North America US$m South America US$m 723 1,033 Provisions at 1 January ........................................ Amounts written off: Banks ............................................................... Commercial, industrial and international trade Real estate ........................................................ Non-bank financial institutions ........................ Governments .................................................... Other commercial ............................................ Residential mortgages ...................................... Other personal .................................................. Total amounts written off ................................. Recoveries of amounts written off in previous years: Banks ............................................................... Commercial, industrial and international trade Real estate ........................................................ Non-bank financial institutions ........................ Governments .................................................... Other commercial ............................................ Residential mortgages ...................................... Other personal .................................................. Total recoveries ................................................ Net charge to profit and loss account1: Banks ............................................................... Commercial, industrial and international trade Real estate ........................................................ Non-bank financial institutions ........................ Governments .................................................... Other commercial ............................................ Residential mortgages ...................................... Other personal .................................................. General Provisions ........................................... Total charge ..................................................... Foreign exchange and other movements2 ............ Hong Kong US$m 1,408 – (59) (18) (11) – (11) (109) (328) (536) 1 – – – 3 7 14 25 – (22) 9 (14) – (22) 70 322 (97) 246 – Rest of Asia- Pacific US$m 1,952 – (255) (88) (2) – (116) (7) (132) (600) 4 2 1 – 14 – 31 52 – 38 (11) (29) – (22) 11 93 9 89 3 Europe US$m 3,067 – (161) (31) (4) (1) (54) (2) (199) (452) 15 6 – – 7 1 29 58 (2) 345 (4) 3 (1) 50 – 243 (65) 569 426 Provisions at 31 December .................................. 3,668 1,143 1,496 – (92) (9) (12) – (149) (2) (96) (360) 6 6 – – 9 – 14 35 – 89 5 18 (5) 116 (4) 66 15 300 1,658 2,356 Provisions against banks: Specific provisions ........................................... Provisions against customers: Specific provisions ........................................... General provisions3 .......................................... Provisions at 31 December .................................. Provisions against customers as a percentage of loans and advances to customers: Specific provisions ........................................... General provisions ........................................... Total .................................................................... 23 2,774 871 3,668 % 1.65 0.52 2.17 – 688 455 1,143 % 0.97 0.64 1.61 – – 1,321 175 1,496 % 3.42 0.45 3.87 1,482 874 2,356 % 1.85 1.09 2.94 Total US$m 8,183 (1) (595) (150) (31) (1) (352) (130) (851) (1) (28) (4) (2) – (22) (10) (96) (163) (2,111) 2 – – – – – 8 28 14 1 – 33 8 96 10 180 – 30 2 11 4 177 10 96 (213) 117 (520) 477 – 341 136 477 % 9.73 3.88 13.61 (2) 480 1 (11) (2) 299 87 820 (351) 1,321 1,567 9,140 23 6,606 2,511 9,140 % 1.83 0.69 2.52 1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts’. 2 Other movements include amounts transferred in on the acquisition of HSBC Mexico of US$1,704 million. 3 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of Asia-Pacific, as well as those booked in Hong Kong. 151 Year ended 31 December 2001 Rest of Asia- Pacific US$m 2,091 North America US$m South America US$m 739 540 H S B C H O L D I N G S P L C Financial Review (continued) Provisions at 1 January ....................................... Amounts written off: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. Total amounts written off ................................ Recoveries of amounts written off in previous years: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. Total recoveries ............................................... Net charge to profit and loss account1: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. General provisions ........................................... Total charge ..................................................... Foreign exchange and other movements ............. Europe US$m 3,025 (5) (123) (27) (5) – (54) (4) (224) (442) 12 1 – – 17 1 34 65 (1) 164 (35) (2) (2) 143 (47) 257 (36) 441 (22) Hong Kong US$m 1,802 – (238) (29) (53) – (34) (121) (155) (630) 1 2 3 – 12 5 8 31 – 15 16 (20) – (84) 111 168 (9) 197 8 – (256) (18) (5) – (48) (7) (93) (427) 11 1 1 – 99 – 26 138 – 157 (6) (14) – (58) 10 82 1 172 (22) Provisions at 31 December .................................. 3,067 1,408 1,952 Provisions against banks: Specific provisions .......................................... Provisions against customers: Specific provisions .......................................... General provisions2 ......................................... Provisions at 31 December .................................. Provisions against customers as a percentage of loans and advances to customers: Specific provisions .......................................... General provisions ........................................... Total .................................................................... 22 2,204 841 3,067 % 1.61 0.62 2.23 – 856 552 1,408 % 1.24 0.80 2.04 – 1,786 166 1,952 % 5.44 0.51 5.95 Total US$m 8,197 (5) (753) (88) (67) – (458) (147) (660) (2,178) 45 4 4 – 140 6 86 285 (1) 484 (16) (34) (5) 242 92 702 573 2,037 (158) 8,183 22 5,500 2,661 8,183 % 1.73 0.84 2.57 – (107) (10) (3) – (107) (2) (93) (322) 18 – – – 11 – 14 43 – 93 2 2 (3) 151 1 70 (16) 300 (37) 723 – 289 434 723 % 0.39 0.59 0.98 – (29) (4) (1) – (215) (13) (95) (357) 3 – – – 1 – 4 8 – 55 7 – – 90 17 125 633 927 (85) 1,033 – 365 668 1,033 % 7.03 12.873 19.90 1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts’. 2 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of Asia-Pacific, as well as those booked in Hong Kong. 3 Includes US$600 million of additional provisions held against Argentine loans. 152 Year ended 31 December 2000 Rest of Asia- Pacific US$m 2,686 North America US$m South America US$m 864 430 Provisions at 1 January ....................................... Amounts written off: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. Total amounts written off ................................ Recoveries of amounts written off in previous years: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. Total recoveries ............................................... Net charge to profit and loss account1: Banks ............................................................... Commercial, industrial and international trade Real estate ....................................................... Non-bank financial institutions ........................ Governments ................................................... Other commercial ............................................ Residential mortgages ..................................... Other personal ................................................. General provisions ........................................... Total charge ..................................................... Foreign exchange and other movements2 ............ Europe US$m 2,153 (9) (154) (27) (2) (37) (68) (5) (181) (483) – 4 7 3 3 4 1 32 54 2 87 (9) 1 (19) (3) 1 245 43 348 953 Hong Kong US$m 1,887 – (202) (9) (8) – (68) (82) (73) (442) – 3 – – – 4 1 8 16 – 81 40 – – (30) 101 55 1 248 93 – (191) (58) (3) – (149) (5) (88) (494) – 3 2 2 – 23 – 19 49 – 107 19 (3) – (18) 5 63 (188) (15) (135) Provisions at 31 December................................... 3,025 1,802 2,091 Provisions against banks: Specific provisions .......................................... Provisions against customers: Specific provisions .......................................... General provisions3 ......................................... Provisions at 31 December .................................. Provisions against customers as a percentage of loans and advances to customers: Specific provisions .......................................... General provisions ........................................... Total .................................................................... 30 2,135 860 3,025 % 1.61 0.65 2.26 – – 1,241 561 1,802 % 1.87 0.84 2.71 1,929 162 2,091 % 6.23 0.53 6.76 Total US$m 8,020 (9) (680) (110) (13) (37) (397) (103) (462) (1,811) – 13 12 6 3 43 3 80 160 2 407 65 (2) (19) 50 128 581 (280) 932 896 8,197 30 6,065 2,102 8,197 % 2.03 0.70 2.73 – (97) (13) – – (97) (4) (90) (301) – 1 3 1 – 11 – 15 31 – 89 10 (2) – 80 9 109 (138) 157 (12) 739 – 278 461 739 % 0.44 0.74 1.18 – (36) (3) – – (15) (7) (30) (91) – 2 – – – 1 1 6 10 – 43 5 2 – 21 12 109 2 194 (3) 540 – 482 58 540 % 7.54 0.91 8.45 1 See table below ‘Net charge to the profit and loss account for bad and doubtful debts’. 2 Other movements include amounts transferred in on the acquisition of CCF of US$882 million. 3 General provisions are allocated to geographical segments based on the location of the office booking the provision. Consequently, the general provision booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in the Rest of Asia-Pacific, as well as those booked in Hong Kong. 153 H S B C H O L D I N G S P L C Financial Review (continued) Net charge to the profit and loss account for bad and doubtful debts The charge for bad and doubtful debts and non-performing customer loans and related customer provisions can be analysed as follows: Specific provisions: New provisions ................................................... HSBC Finance ............................................... Rest of HSBC ................................................. Release of provisions no longer required ............ HSBC Finance ............................................... Rest of HSBC ................................................. Recoveries of amounts previously written off ..... HSBC Finance ............................................... Rest of HSBC ................................................. General provisions: HSBC Finance .................................................... Rest of HSBC ..................................................... Total bad and doubtful debt charge ..................... Bank................................................................ Customer......................................................... Customer bad and doubtful debt charge as a percentage of closing gross loans and advances .................................................. 31 December 2004 Non-performing loans ......................................... HSBC Finance ............................................... Rest of HSBC ................................................. Provisions ........................................................... HSBC Finance ............................................... Rest of HSBC ................................................. Europe US$m Hong Kong US$m Year ended 31 December 2004 Rest of Asia- Pacific US$m North America US$m South America US$m 2,049 382 1,667 (726) – (726) (137) (49) (88) 1,186 (13) (148) (161) 1,025 (7) 1,032 245 – 245 (198) – (198) (46) – (46) 1 – (224) (224) (223) – (223) 418 – 418 (205) – (205) (65) – (65) 148 – (48) (48) 100 (1) 101 5,877 5,549 328 (106) – (106) (584) (428) (156) 400 – 400 (49) – (49) (80) – (80) 5,187 271 6,793 16 (17) (1) 5,186 – 5,186 – (2) (2) 269 (2) 271 3 (439) (436) 6,357 (10) 6,367 0.37% (0.28%) 0.16% 2.03% 3.60% 0.93% US$m US$m US$m US$m US$m US$m 6,065 419 5,646 4,799 207 4,592 773 – 773 533 – 533 1,180 – 1,180 946 – 946 4,583 3,782 801 5,813 4,081 1,732 658 – 658 578 – 578 The total bad and doubtful debt charge for HSBC Finance includes charges for: Year ended 31 December 2004 Residential mortgages ....................................................................................... Credit cards ....................................................................................................... Other personal lending ...................................................................................... Year ended 31 December 2003 Residential mortgages ....................................................................................... Credit cards ....................................................................................................... Other personal lending ...................................................................................... Europe US$m North America US$m 1 66 253 – 59 122 518 2,459 2,160 423 1,740 2,231 154 Total US$m 8,989 5,931 3,058 (1,284) – (1,284) (912) (477) (435) 13,259 4,201 9,058 12,669 4,288 8,381 Total US$m 519 2,525 2,413 423 1,799 2,353 4,540 182 6,214 Specific provisions: New provisions ................................................... HSBC Finance1 .............................................. Rest of HSBC ................................................. Release of provisions no longer required ............ HSBC Finance1 .............................................. Rest of HSBC ................................................. Recoveries of amounts previously written off ..... HSBC Finance1 .............................................. Rest of HSBC ................................................. General provisions: HSBC Finance1 ................................................... Rest of HSBC ..................................................... Total bad and doubtful debt charge ..................... Bank................................................................ Customer......................................................... Customer bad and doubtful debt charge as a percentage of closing gross loans and advances .................................................. 31 December 2003 Non-performing loans ......................................... HSBC Finance ............................................... Rest of HSBC ................................................. Provisions ........................................................... HSBC Finance ............................................... Rest of HSBC ................................................. 1 Since the date of acquisition. Specific provisions: New provisions ................................................... Release of provisions no longer required ............ Recoveries of amounts previously written off ..... General provisions: Argentine additional provision ............................ Other ................................................................... Total bad and doubtful debt charge ..................... Customer bad and doubtful debt charge .............. Customer bad and doubtful debt charge as a percentage of closing gross loans and advances .................................................. 31 December 2002 Non-performing loans ......................................... Provisions ........................................................... Europe US$m Hong Kong US$m Year ended 31 December 2003 Rest of Asia-Pacific US$m North America US$m South America US$m 1,485 193 1,292 (351) – (351) (142) (25) (117) 992 13 (131) (118) 874 (6) 880 0.41% US$m 5,701 326 5,375 4,415 154 4,261 655 – 655 (182) – (182) (42) – (42) 431 – (31) (31) 400 – 400 0.53% US$m 1,671 – 1,671 1,055 – 1,055 412 – 412 (269) – (269) (74) – (74) 69 – 16 16 85 3 82 0.17% US$m 1,538 – 1,538 1,177 – 1,177 4,962 4,580 382 (87) (4) (83) (335) (282) (53) 263 – 263 (64) – (64) (17) – (17) 100 36 136 4,676 – 4,676 2.36% US$m 5,444 4,380 1,064 6,461 5,047 1,414 – (124) (124) 58 – 58 1.03% US$m 696 – 696 583 – 583 Europe US$m Hong Kong US$m Year ended 31 December 2002 Rest of Asia-Pacific US$m North America US$m South America US$m 963 (271) (58) 634 – (65) (65) 569 569 0.34% US$m 4,495 3,645 528 (160) (25) 343 – (97) (97) 246 246 0.35% US$m 1,724 1,143 400 (268) (52) 80 – 9 9 89 89 0.23% US$m 2,055 1,496 399 (79) (35) 285 – 15 15 300 300 0.38% US$m 1,773 2,356 388 (48) (10) 330 (196) (17) (213) 117 117 3.27% US$m 476 477 Total US$m 7,777 4,773 3,004 (953) (4) (949) (610) (307) (303) 113 (234) (121) 6,093 (3) 6,096 1.12% US$m 15,050 4,706 10,344 13,691 5,201 8,490 Total US$m 2,678 (826) (180) 1,672 (196) (155) (351) 1,321 1,321 0.36% US$m 10,523 9,117 155 H S B C H O L D I N G S P L C Financial Review (continued) Net charge to the profit and loss account for bad and doubtful debts (continued) Specific provisions: New provisions ................................................... Release of provisions no longer required ............ Recoveries of amounts previously written off ..... General provisions: Argentine additional provision ............................ Other ................................................................... Total bad and doubtful debt charge ..................... Customer bad and doubtful debt charge .............. Customer bad and doubtful debt charge as a percentage of closing gross loans and advances .................................................. 31 December 2001 Non-performing loans ......................................... Provisions ........................................................... Specific provisions: New provisions ................................................... Release of provisions no longer required ............ Recoveries of amounts previously written off ..... General provisions: Special provision reflecting Asian risk raised in 1997 ........................................................... Other ................................................................... Total bad and doubtful debt charge ..................... Customer bad and doubtful debt charge .............. Customer bad and doubtful debt charge as a percentage of closing gross loans and advances .................................................. 31 December 2000 Non-performing loans ......................................... Provisions ........................................................... Europe US$m Hong Kong US$m Year ended 31 December 2001 Rest of Asia-Pacific US$m North America US$m South America US$m 802 (260) (65) 477 – (36) (36) 441 441 0.32% US$m 3,682 3,045 449 (212) (31) 206 – (9) (9) 197 197 0.29% US$m 2,028 1,408 577 (268) (138) 171 – 1 1 172 172 0.52% US$m 2,723 1,952 392 (42) (43) 307 – (7) (7) 300 300 346 (35) (8) 303 600 24 624 927 927 0.41% US$m 672 723 17.80% US$m 544 1,033 Europe US$m Hong Kong US$m Year ended 31 December 2000 Rest of Asia-Pacific US$m North America US$m South America US$m 609 (248) (56) 305 – 43 43 348 346 454 (192) (15) 247 – 1 1 248 248 0.26% US$m 3,376 2,995 0.37% US$m 2,521 1,802 543 (321) (49) 173 (174) (14) (188) (15) (15) – US$m 3,081 2,091 395 (72) (31) 292 – (135) (135) 157 157 232 (28) (9) 195 – (1) (1) 194 194 0.25% US$m 684 739 3.04% US$m 710 540 Total US$m 2,566 (817) (285) 1,464 600 (27) 573 2,037 2,037 0.64% US$m 9,649 8,161 Total US$m 2,233 (861) (160) 1,212 (174) (106) (280) 932 930 0.31% US$m 10,372 8,167 156 Year ended 31 December 2004 compared with year ended 31 December 2003 This commentary discusses the movements in the numbers reported on pages 142 to 156. In cases where exchange rate changes have contributed significantly to the movements, the exchange rate effect is quantified and the underlying movements are explained in terms of constant currency. The increase in the level of new specific provisions was principally driven by: • New specific provisions in North America, which were US$915 million, or 18 per cent, higher than in 2003, reflected the impact of an additional quarter’s charge for HSBC Finance of US$1,269 million. This was partly offset by a US$323 million reduction in the level of new specific provisions in HSBC Finance in the last nine months of the year compared with the equivalent period in 2003, despite a US$202 million increase resulting from the adoption of FFIEC provisioning policies in December 2004. The majority of HSBC Finance’s customer loans are in the consumer finance sector and are geographically well- spread across the United States, and the decline in new provisions in 2004 reflected the continued improvement in economic conditions, an expansion of near prime lending and the positive impact of tightened underwriting. By 31 December 2004, HSBC Finance’s two- month-and-over consumer delinquency ratio had improved to 4.4 per cent from 5.8 per cent in 2003. The improvement in the US economy was reflected in a fall in new specific provisions for commercial loans in HSBC Bank USA although this was partly offset by a rise in the level of new provisions for personal loans, in line with the growth in the portfolio. Portfolio growth also contributed to a rise in new specific provisions in both Mexico and Canada. • In Europe, new specific provisions were US$564 million, or 38 per cent, higher than in 2003, of which US$140 million or 9 per cent reflected the effects of foreign currency translation. Excluding the currency effect, US$98 million of the increase related to the impact of an additional quarter’s charge for HSBC Finance’s UK consumer finance business and US$61 million was in respect of Marks and Spencer Financial Services, which was acquired in November 2004. Underlying growth in provisions reflected the effect of an increase in unsecured personal lending, where higher levels of personal indebtedness and rising delinquency rates, and higher levels of personal bankruptcies, caused a rise in new specific provisions for unsecured personal lending. As a proportion of lending to the UK personal and consumer finance customer bases, credit costs represented 0.60 per cent and 3.09 per cent of lending respectively, compared with 0.42 per cent and 2.56 per cent in 2003. In the corporate and commercial portfolios, new specific provisions were raised against a small number of accounts in the commercial and industrial sectors although these were offset by a fall in new specific provisions required in the energy and utilities sectors compared with the levels seen in 2003. In France there were higher provisions, raised principally against the personal, financial and industrial sectors. • The US$137 million rise in new specific • provisions in South America came largely from the full year impact of the Losango consumer finance business, acquired in December 2003, and from organic growth in the personal lending portfolios in Brazil as the economy grew. Argentina experienced a lower level of new specific provisions in 2004 than in 2003. In Hong Kong, new specific provisions were US$410 million lower than in 2003. In an environment of falling unemployment, stronger GDP growth and reduced levels of bankruptcies, new specific provisions against unsecured personal lending fell by 51 per cent. The mortgage book benefited from rising property prices and the continued improvement in the economy, and new specific provisions were 79 per cent lower than in 2003. A lower level of new specific provisions was also experienced in the commercial portfolios and the relatively benign credit conditions during the year were particularly reflected in lower provisions in the electronic/electrical and international trade sectors. In 2003, the charge included a significant provision against one borrower in the corporate telecommunications sector. • New specific provisions in the rest of Asia- Pacific increased by US$6 million. At constant exchange rates, new specific provisions were broadly in line with 2003. There was a modest rise in new provisions against the personal sector in a number of countries across the region in line with the growth in personal lending. • In aggregate, specific provision releases and recoveries increased by US$633 million, or 40 per cent, compared with 2003. HSBC Finance contributed US$167 million of the increase due to the inclusion of an additional 157 H S B C H O L D I N G S P L C Financial Review (continued) quarter, improved collections and the sales of charged-off accounts. In Europe, excluding HSBC Finance, releases and recoveries were US$344 million higher, of which US$51 million arose from currency translation effects. At constant currencies, the increase reflected releases of provisions in the energy, utilities and petroleum sectors in the UK and manufacturing and transport equipment sectors in France, while recoveries benefited from the sale in the secondary market of loans to a borrower in the engineering sector. In North America, excluding HSBC Finance, releases and recoveries increased by US$126 million. The improvement reflected an ongoing workout programme to reduce the legacy bad debt portfolio in Mexico, higher repayments of previously non- performing loans in the US and the sale of impaired loans in the US secondary market. In Hong Kong, the benign credit environment and rising house prices contributed to a rise in releases and recoveries for residential mortgages. This offset a general fall in the levels of releases and recoveries in the Hong Kong commercial sector that was also evident across the Rest of Asia-Pacific. The sharp increase in releases and recoveries in South America largely reflected the inclusion of the Losango consumer lending business and organic growth in Brazil, together with successful collections activities in Argentina. • The general provision release of US$436 million in 2004 compared with a release of US$121 million in 2003. In Hong Kong, the net release of US$224 million reflected a reduction in the estimated latent loan losses at 31 December 2004. Estimates of latent losses reflect the historical experience of the rate at which such losses occur and are based on the structure of the credit portfolio and the economic and credit conditions prevailing at the balance sheet date. A similar situation was seen in Malaysia, Singapore and Indonesia where stable economic conditions were reflected in an improvement in credit quality and reduction in latent loan losses. As a result, the net charge for the Rest of Asia-Pacific in 2003 became a net release in 2004. In North America, the small general provision release compared with a charge of US$136 million in 2003 and reflected an improvement in the economic outlook and delinquency roll-rate trends in HSBC Finance Corp, and a smaller charge in Mexico. In Europe, the increase in general provisions required from the growth in lending balances was offset by the impact of the improvement in 158 both historical loss experience and credit conditions in general. The substantial general provision release in South America in 2003 reflecting improved collections and an improvement in the general quality of the loan book in Argentina was not repeated in 2004. Year ended 31 December 2003 compared with year ended 31 December 2002 The increase in the level of new specific provisions was principally driven by: • New provisions in North America, which were US$4,563 million higher than in 2002, essentially reflected the acquisition of HSBC Finance Corporation, which reported US$4,580 million of new provisions. The majority of HSBC Finance’s customer loans are in the consumer finance sector and are geographically well-spread across the United States. During the period since its acquisition, HSBC Finance Corporation’s new provisions reflected the impact of the weak economy, including higher personal bankruptcy filings and a higher level of amounts becoming past due. In the latter part of 2003, there were signs of an improvement in credit quality and delinquency levels stabilised. At 31 December 2003, HSBC Finance’s two-month-and-over consumer contractual delinquency ratio was 5.8 per cent. A charge of US$48 million from HSBC Mexico arose from consumer lending and credit card portfolios, which are provisioned on a portfolio basis. In Canada, new provisions in 2003 were US$66 million lower than in 2002, when significant new provisions for a small number of commercial facilities were necessary, most notably in the telecommunications sector. In Europe, new provisions were US$522 million higher than in 2002 of which US$193 million related to HSBC Finance Corporation’s UK consumer finance business, which is provisioned on a portfolio basis. Elsewhere in the UK, the increase in new provisions in personal lending reflected the growth in loan portfolios. In the corporate and commercial portfolio, new provisions were raised to cover a number of accounts in the energy and manufacturing sectors. In France, there were higher provisions, principally due to the deterioration of a borrower in the engineering sector. • • New provisions in Hong Kong were US$127 million higher than in 2002. Higher levels of new provisions were required in the electronics sector against a small number of customers in niche markets which suffered from a combination of technological developments and excess market capacity. New specific provisions for personal lending (including credit cards) reduced in 2003, reflecting a reduction in bankruptcy filings and improving economic conditions. This more than offsets increased charges in respect of residential mortgages, which reflected the fall in the first half of 2003 in the value of residential property. The second half of 2003 saw property prices stabilise, delinquencies fall and the percentage of the mortgage book with negative equity reduce. • New specific provisions in the rest of Asia- Pacific were broadly in line with 2002, reflecting the relatively stable and improving economic environment across much of the region during 2003. • In South America, new provisions decreased by US$125 million, mainly reflecting an improvement in the economic conditions in Argentina. This was partly offset by increased new provisions in Brazil’s personal lending as a difficult economic environment led to higher levels of delinquencies. There were also higher new specific provisions for corporate customers in the commodities and food sectors as a result of business failure and, in one case, fraud. In aggregate, releases and recoveries increased by US$557 million compared with 2002. HSBC Finance Corp. contributed US$311 million of the increase due to collections and sales of written-off accounts. In Europe, excluding HSBC Finance Corporation’s UK consumer finance business, releases and recoveries were US$139 million higher, mainly the result of a recovery from an exposure in the transport sector and the upgrading of corporate exposures in the telecommunications and retail sectors. There was a net release of general provisions of US$121 million in 2003 compared with a release of US$351 million in 2002. There were general provision charges of US$113 million in HSBC Finance and US$78 million in HSBC Mexico, reflecting growth in lending. In Europe, excluding HSBC Finance Corporation’s UK consumer finance business, a net release of general provision of US$131 million reflected an improved economic outlook and successful restructuring and refinancing activity in industry sectors which had been causing concern. In Argentina, a net release of US$122 million reflected success in collections and the improved environment and hence quality of the remaining loan book. At 31 December 2003, specific and general provisions together covered about 47 per cent of non-government loans (net of suspended interest) in Argentina. 159 H S B C H O L D I N G S P L C Financial Review (continued) Provisions for bad and doubtful debts as a percentage of average gross loans and advances to customers Europe % Hong Kong % Rest of Asia-Pacific % North America % South America % 0.82 (0.35) 0.47 0.41 0.48 0.76 (0.25) 0.51 0.45 0.39 0.62 (0.21) 0.41 0.37 0.25 0.32 (0.32) – (0.29) 0.38 0.89 (0.30) 0.59 0.54 0.73 0.75 (0.26) 0.49 0.35 0.72 0.77 (0.50) 0.27 0.19 0.64 0.96 (0.80) 0.16 0.20 0.86 1.13 (0.90) 0.23 0.25 1.55 2.59 (0.30) 2.29 2.28 2.57 2.91 (0.25) 2.66 2.74 2.93 0.51 (0.15) 0.36 0.38 0.41 6.49 (2.09) 4.40 4.40 5.16 6.09 (1.88) 4.21 1.34 3.94 9.97 (1.48) 8.49 3.01 3.91 Total % 1.46 (0.36) 1.10 1.04 1.30 1.60 (0.32) 1.28 1.25 1.40 0.78 (0.29) 0.49 0.38 0.56 The unsecured element of the portfolio consisted of credit and charge card advances, personal loans, car finance facilities and other varieties of instalment finance. At 31 December 2004, the combined portfolios totalled US$160 billion, or 41 per cent of total lending to the personal sector, compared with US$134 billion, or 44 per cent, at 31 December 2003. Growth in these portfolios reflected continued growth in consumer spending within the main economies in which HSBC operates. Geographically, total lending to personal customers was dominated by the diverse and mature portfolios in the US (US$173 billion), the UK (US$107 billion), and Hong Kong (US$38 billion). Collectively, these books accounted for 82 per cent of total lending to the personal sector, unchanged from the position at 31 December 2003. Account management within HSBC’s personal lending portfolios in both Personal Financial Services and Consumer Finance is supported by sophisticated statistical techniques, which are enhanced by the availability of credit reference data in key local markets. The expansion of an increasingly analytical approach to the management of these portfolios across the Group remains an ongoing objective. Year ended 31 December 2004 New provisions ................................................... Releases and recoveries ....................................... Net charge for specific provisions ....................... Total provisions charged ..................................... Amount written off net of recoveries .................. Year ended 31 December 2003 New provisions ................................................... Releases and recoveries ...................................... Net charge for specific provisions ....................... Total provisions charged ..................................... Amount written off net of recoveries .................. Year ended 31 December 2002 New provisions ................................................... Releases and recoveries ....................................... Net charge for specific provisions ....................... Total provisions charged ..................................... Amount written off net of recoveries .................. Areas of special interest Group advances to personal customers The charge for bad and doubtful debts in 2004 was dominated by the charge relating to the personal sector, this figure representing more than 100 per cent of the Group total after taking account of the Group’s commercial lending activities. Within this total, losses on residential mortgages remained modest. Lending to personal customers has increased substantially in recent years as a result of both organic growth and acquisitions, most notably HSBC Finance Corporation in March 2003. At 31 December 2004, HSBC’s lending to the personal sector amounted to US$388 billion, or 57 per cent of total gross advances to customers, compared with US$306 billion at 31 December 2003. The main attributes of this portfolio and the economic influences affecting it are outlined below. Secured residential mortgages accounted for US$228 billion or 59 per cent of total lending to the personal sector compared with US$172 billion, or 56 per cent, at 31 December 2003. The main areas of growth in 2004 were the US and the UK, which together accounted for US$54 billion of the increase. 160 In view of the high levels of personal indebtedness in many of the world’s leading economies, guidelines for the restructuring of customer facilities in the event of financial difficulty have been reinforced. In the US, the strength of the housing market continued unabated, driven mainly by affordability. Low interest rates, lower transaction costs and increased availability of credit all fuelled the rise in demand. However, recent rises in interest rates are likely to affect growth adversely and add pressure to some borrowers, particularly in certain overpriced locations. The portfolios, however, remain geographically diverse and are secured largely by senior lien positions. Although increased mortgage borrowing has contributed to the record level of consumer debt, levels have largely stabilised and are expected to decline gradually, as incomes rise sufficiently to pay down debt, notwithstanding higher interest rates. Against this background, delinquency rates fell across the majority of portfolios during 2004 and trends in lending quality showed an improvement. Personal lending in the UK also continued to grow strongly, particularly in the mortgage market. This secured portfolio, representing 55 per cent of total lending to personal customers in the UK, continued to suffer negligible delinquency and losses. The unsecured portfolio also continued to expand both through organic growth and with the acquisition of Marks and Spencer Financial Services, which added US$5.3 billion to the portfolio in November 2004. Underwriting criteria were regularly reviewed to ensure that they remained appropriate in prevailing market conditions, which have seen a steady rise in personal bankruptcies and delinquencies over the course of the year. With consumer spending rising in Hong Kong and the levels of bankruptcies and unemployment both falling, the improvement in the personal portfolios, which first became evident during the second half of 2003, continued throughout 2004. With ongoing property price increases a feature of 2004, the most notable trend was the continued reduction in the level of negative equity on mortgage balances, which is now at modest levels. Across the other geographical regions the position remained relatively stable, although HSBC continued to monitor carefully those portfolios that have the greatest potential for future economic stress. Delinquency and loss trends differed across jurisdictions, reflecting these varied conditions. Risk elements in the loan portfolio The following disclosure of credit risk elements reflects US accounting practice and classifications: • • • loans accounted for on a non-accrual basis; accruing loans contractually past due 90 days or more as to interest or principal; and troubled debt restructurings not included in the above. In accordance with UK accounting practice, a number of operating companies suspend interest rather than ceasing to accrue. This additional category is also reported below, as are assets acquired in exchange for advances. Non-performing loans and advances1 Banks ........................................ Customers – HSBC Finance ....................... – Other HSBC............................ At 31 December 2004 US$m 25 4,201 9,058 13,259 2003 US$m 24 4,706 10,344 15,050 Total non-performing loans and advances........................... 13,284 15,074 Total provisions cover as a percentage of non-performing loans and advances ................. 1 Net of suspended interest. 95.5% 91.0% Non-performing customer loans1 and related specific provisions outstanding by geographical segment 2004 2003 Non- performing loans US$m Specific provisions US$m Non- performing loans US$m Specific provisions US$m Europe ...... Hong Kong ...... Rest of Asia- Pacific .... North 6,065 4,036 5,701 3,554 773 331 1,671 629 1,180 791 1,538 981 America . 4,583 4,420 5,444 5,184 South America 658 522 696 530 13,259 10,100 15,050 10,878 1 Net of suspended interest. Total non-performing loans to customers decreased by US$1,791 million during the year. At 31 December 2004, non-performing loans represented 1.9 per cent of total lending compared 161 concessions other than warranted by market conditions due to problems with the borrower. These are classified as ‘troubled debt restructurings’ and are distinct from the normal restructuring activities described above. Disclosure of troubled debt restructurings may be discontinued after the first year if the debt is performing in accordance with the new terms. Troubled debt restructurings decreased significantly in Europe where a number of corporate exposures were regularised, in Hong Kong where balances were repaid on certain restructured borrowings, and in South America. Accruing loans past due 90 days or more Accruing loans past due 90 days decreased as the overall credit environment improved, particularly in Hong Kong and the US. HSBC Finance’s business benefited from a continued improvement in delinquency and default trends as the US economy recovered. In common with other card issuers, including other parts of HSBC, HSBC Finance continues to accrue interest on credit cards past 90 days until charged off at 180 days past due. Appropriate provisions are raised against the proportion judged to be irrecoverable. Potential problem loans Credit risk elements also cover potential problem loans. These are loans where information about borrowers’ possible credit problems causes management serious doubts about the borrowers’ ability to comply with the loan repayment terms. There are no potential problem loans other than those identified in the table of risk elements set out below. Risk elements The following table provides an analysis of risk elements in the loan portfolios at 31 December for the past five years: H S B C H O L D I N G S P L C Financial Review (continued) with 2.8 per cent at 31 December 2003. At constant exchange rates, non-performing loans decreased by US$2.3 billion, or 15 per cent. Improved economic conditions in most geographical regions were the main driver for the fall in non-performing loans. Across Europe, at constant exchange rates, non- performing loans declined marginally with underlying credit quality in the UK and France remaining stable. In the UK, releases and recoveries in the corporate sector, primarily as a result of the restructuring of a number of non-performing loans, were partly offset by a rise in delinquencies across most unsecured personal loan products, in line with the broader target markets now being served. In Hong Kong, non-performing loans decreased by US$0.9 billion, or 54 per cent, during 2004 due to the improved economic climate and rising real estate prices. These factors enabled certain corporate customers to increase repayments through the disposal of assets or improved debt servicing. In the rest of Asia-Pacific, non-performing loans fell by US$0.4 billion, or 23 per cent, during the year, as a general improvement in the economic environment across the region was reflected in a rise in recoveries and releases of provisions. The level of non-performing loans in North America decreased by US$0.9 billion, in line with the continued improvement in economic conditions; HSBC Finance’s business particularly benefited from a continued improvement in delinquencies and default trends. In Mexico, there were further write- offs of US$285 million during 2004 in the commercial and consumer loan books, as management continued to reduce the acquired workout portfolio. South America experienced a modest reduction in non-performing loans in 2004 arising mainly in Argentina as credit quality improved in line with a general upturn in the local economy. Troubled debt restructurings US GAAP requires separate disclosure of any loans where terms have been modified to grant 162 2004 US$m 2003 US$m At 31 December 2002 US$m 2001 US$m 2000 US$m Loans accounted for on a non-accrual basis Europe ....................................................... HSBC Finance ...................................... Other ..................................................... Hong Kong ................................................ Rest of Asia-Pacific .................................. North America .......................................... HSBC Finance ...................................... Other ..................................................... South America .......................................... Total .......................................................... Loans on which interest has been accrued but suspended Europe ....................................................... Hong Kong ................................................ Rest of Asia-Pacific .................................. North America .......................................... South America .......................................... Total .......................................................... Assets acquired in exchange for advances Europe ....................................................... Hong Kong ................................................ Rest of Asia-Pacific .................................. North America .......................................... HSBC Finance ...................................... Other ..................................................... Total .......................................................... 3,498 419 3,079 116 156 3,856 3,138 718 589 8,215 2,555 580 1,016 19 68 4,238 27 75 21 708 644 64 831 3,138 326 2,812 166 168 4,618 3,683 935 601 8,691 2,542 1,504 1,351 33 95 5,525 32 2 30 794 697 97 858 2,393 – 2,393 247 294 1,624 – 1,624 293 4,851 2,086 1,460 1,714 48 183 5,491 26 17 54 101 – 101 198 2,052 – 2,052 213 195 593 – 593 429 3,482 1,553 1,795 2,497 67 115 6,027 84 19 32 14 – 14 149 1,985 – 1,985 236 429 627 – 627 550 3,827 1,389 2,259 2,627 39 160 6,474 25 26 24 19 – 19 94 Total non-performing loans ...................... 13,284 15,074 10,540 9,658 10,395 Troubled debt restructurings Europe ....................................................... HSBC Finance ...................................... Other ..................................................... Hong Kong ................................................ Rest of Asia-Pacific .................................. North America .......................................... HSBC Finance ...................................... Other ..................................................... South America .......................................... Total .......................................................... Accruing loans contractually past due 90 days or more as to principal or interest Europe ....................................................... Hong Kong ................................................ Rest of Asia-Pacific .................................. North America .......................................... HSBC Finance ...................................... Other ..................................................... South America .......................................... Total .......................................................... Total risk elements Europe ....................................................... HSBC Finance ...................................... Other ..................................................... Hong Kong ................................................ Rest of Asia-Pacific .................................. North America .......................................... HSBC Finance ...................................... Other ..................................................... South America .......................................... Total .......................................................... Provisions for bad and doubtful debts as a percentage of total risk elements .......... 34 – 34 436 56 144 2 142 693 1,363 68 67 56 871 607 264 – 1,062 6,182 419 5,763 1,274 1,305 5,598 4,391 1,207 1,350 15,709 80.8% 159 – 159 571 68 210 2 208 837 1,845 34 205 45 1,252 1,215 37 2 1,538 5,905 326 5,579 2,448 1,662 6,907 5,597 1,310 1,535 18,457 41 – 41 396 89 4 – 4 669 1,199 16 193 33 42 – 42 7 291 4,562 – 4,562 2,313 2,184 1,819 – 1,819 1,152 12,030 – – – 381 131 3 – 3 144 659 15 98 38 52 – 52 47 250 3,704 – 3,704 2,506 2,893 729 – 729 735 10,567 – – – 395 231 7 – 7 142 775 11 76 66 64 – 64 82 299 3,410 – 3,410 2,992 3,377 756 – 756 934 11,469 74.3% 76.0% 77.4% 71.5% 163 H S B C H O L D I N G S P L C Financial Review (continued) Interest foregone on non-performing lendings Interest income that would have been recognised under the original terms of the non-accrual, suspended interest and restructured loans amounted to approximately US$300 million in 2004 compared with US$380 million in 2003 and US$406 million in 2002. Interest income of approximately US$184 million from such loans was recorded in 2004, compared with US$230 million in 2003 and US$258 million in 2002. Country distribution of outstandings and cross-border exposures HSBC controls the risks associated with cross-border lending, essentially the risk of foreign currency required for payments not being available to local residents, through a central process of internal country limits which are determined by taking into account both economic and political risks. Exposure to individual countries and cross-border exposure in aggregate is kept under continuous review. The following tables analyse the aggregate of in-country foreign currency and cross-border outstandings by type of borrower to countries which individually represent in excess of 1 per cent of At 31 December 2004 United Kingdom ........................................................... United States ................................................................. Germany ....................................................................... France ........................................................................... Italy ............................................................................... The Netherlands ............................................................ Hong Kong .................................................................... At 31 December 2003 United Kingdom ............................................................ Germany ........................................................................ United States.................................................................. France ............................................................................ The Netherlands............................................................. Hong Kong..................................................................... Canada ........................................................................... Italy................................................................................ At 31 December 2002 United States ................................................................. Germany ....................................................................... France ........................................................................... The Netherlands ............................................................ Hong Kong .................................................................... Canada .......................................................................... Japan ............................................................................. Italy ............................................................................... Australia ....................................................................... 164 HSBC’s total assets. Classification is based upon the country of residence of the borrower but recognises the transfer of country risk in respect of third party guarantees, eligible collateral held or residence of the head office where the borrower is a branch. In accordance with the Bank of England Country Exposure Report (Form CE) guidelines, outstandings comprise loans and advances (excluding settlement accounts), amounts receivable under finance leases, acceptances, commercial bills, certificates of deposit and debt and equity securities (net of short positions), and exclude accrued interest and intra- HSBC exposures. Comparative figures for 2003 and 2002 were calculated under the requirements of the Bank of England’s Form C1, which was replaced by Form CE from 31 December 2004 reporting. The requirements of Form CE differ from those of Form C1 in a number of ways, none of which materially affects the exposures reported below. For 2003, outstandings to counterparties in the UK were collected on a comparable basis to that required for Form C1 for the first time. For 2002, the UK outstandings, which are not recorded on Form C1 because the UK is HSBC’s country of domicile, have not been collected or disclosed. Government and official institutions US$bn Banks US$bn Other US$bn Total US$bn 19.7 9.2 17.8 11.1 5.7 9.1 1.6 14.2 16.0 5.5 9.5 9.0 1.1 6.0 4.4 5.6 16.9 5.8 7.5 0.9 4.8 4.0 4.7 5.8 3.8 13.3 10.4 3.7 9.7 2.2 1.1 3.1 8.0 8.4 2.3 0.6 0.7 3.2 5.2 9.6 2.4 1.7 0.4 0.7 2.9 4.1 2.2 0.5 24.5 14.0 4.0 4.6 2.1 4.2 10.3 20.4 3.7 12.3 5.5 4.6 10.0 1.8 0.8 9.7 2.7 5.0 4.0 9.1 2.4 1.0 1.1 1.6 48.0 36.5 32.2 19.4 17.5 15.5 13.0 37.7 27.7 26.2 17.3 14.2 11.8 11.0 10.4 24.9 22.0 12.5 11.9 10.7 10.1 9.1 8.0 7.9 At 31 December 2004, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Australia and Canada of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross- border outstandings were: Australia: US$12.7 billion; Canada: US$11.8 billion. At 31 December 2003, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Australia and Japan of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross- border outstandings were: Australia: US$9.1 billion; Japan: US$7.9 billion. At 31 December 2002, HSBC had in-country foreign currency and cross-border outstandings to counterparties in Belgium of between 0.75 per cent and 1 per cent of total assets. The aggregate in-country foreign currency and cross-border outstandings were US$5.9 billion. 165 H S B C H O L D I N G S P L C Financial Review (continued) Liquidity and funding management HSBC maintains a diversified and stable funding base of core retail and corporate customer deposits as well as portfolios of highly liquid assets. The objective of HSBC’s liquidity and funding management is to ensure that all foreseeable funding commitments and deposit withdrawals can be met when due. The management of liquidity and funding is primarily carried out locally in the operating companies of HSBC in accordance with practice and limits set by the Group Management Board. These limits vary by local financial unit to take account of the depth and liquidity of the market in which the entity operates. It is HSBC’s general policy that each banking entity should be self-sufficient with regard to funding its own operations. Exceptions are permitted to facilitate the efficient funding of certain short-term treasury requirements and start-up operations or branches which do not have access to local deposit markets, all of which are funded under strict internal and regulatory guidelines and limits from HSBC’s largest banking operations. These internal and regulatory limits and guidelines serve to place formal limitations on the transfer of resources between HSBC entities and are necessary to reflect the broad range of currencies, markets and time zones within which HSBC operates. HSBC requires operating entities to maintain a strong liquidity position and to manage the liquidity profile of their assets, liabilities and commitments so that cash flows are appropriately balanced and all funding obligations are met when due. The Group’s liquidity and funding management process includes: • projecting cash flows by major currency and considering the level of liquid assets necessary in relation thereto; • monitoring balance sheet liquidity ratios against internal and regulatory requirements; • maintaining a diverse range of funding sources with adequate back-up facilities; • managing the concentration and profile of debt maturities; • maintaining debt financing plans; • monitoring depositor concentration in order to avoid undue reliance on large individual depositors and ensure a satisfactory overall funding mix; and • maintaining liquidity and funding contingency plans. These plans identify early indicators of 166 stress conditions and describe actions to be taken in the event of difficulties arising from systemic or other crises while minimising adverse long-term implications for the business. Primary sources of funding Current accounts and savings deposits payable on demand or at short notice form a significant part of HSBC’s funding. HSBC places considerable importance on the stability of these deposits. Stability depends upon maintaining depositor confidence in HSBC’s capital strength and liquidity, and on competitive and transparent deposit-pricing strategies. HSBC actively supports this confidence by consistently reinforcing HSBC’s brand values of trust and solidity across the Group’s geographically diverse retail banking network. HSBC accesses professional markets in order to provide funding for non-banking subsidiaries that do not accept deposits, to maintain a presence in local money markets and to optimise the funding of asset maturities not naturally matched by core deposit funding. In aggregate, HSBC’s banking entities are liquidity providers to the inter-bank market, placing significantly more funds with other banks than they borrow. The main operating subsidiary that does not accept deposits is HSBC Finance Corporation, which funds itself principally through taking term funding in the professional markets and through the securitisation of assets. At 31 December 2004, US$112 billion of HSBC Finance Corporation’s liabilities were drawn from professional markets, utilising a range of products, maturities and currencies to avoid undue reliance on any particular funding source. Since becoming a member of the HSBC Group, HSBC Finance Corporation’s access to funding has improved in respect of both the breadth of available sources and the pricing thereof. Of total liabilities of US$1,277 billion at 31 December 2004, funding from customers amounted to US$694 billion, of which US$671 billion was contractually repayable within one year. However, although the contractual repayments of many customer accounts are on demand or at short notice, in practice short-term deposit balances remain stable as inflows and outflows broadly match. Other liabilities, including deposits by banks and securities in issue, are set forth in the table on page 167. Assets available to meet these liabilities, and to cover outstanding commitments to lend (US$568 billion), included cash, central bank balances, items in the course of collection and treasury and other bills (US$47 billion); loans to banks (US$143 billion, including US$138 billion repayable within one year); and loans to customers (US$670 billion, including US$271 billion repayable within one year). In the normal course of business, a proportion of customer loans contractually repayable within one year will be extended. In addition, HSBC held debt securities marketable at a value of US$242 billion. Of these assets, some US$57 billion of debt securities and treasury and other bills have been pledged to secure liabilities. HSBC would meet unexpected net cash outflows by selling securities and accessing additional funding sources such as interbank markets or securitisations. Although not utilised in the management of HSBC’s liquidity, the consolidated figures shown in the following table provide a useful insight into the structure of the Group’s overall funding position. Debt securities in issue, customer accounts and deposits by banks At 31 December 2004 US$m 99,441 109,152 78,087 5,452 2003 US$m 63,810 89,752 64,678 5,748 397,151 323,250 Debt securities funding due in: – less than one year ................. – one year or over ................... Deposits by banks repayable: – in less than one year ............. – one year or over ................... Customer accounts repayable: – on demand ............................ – with agreed maturity dates but less than one year ...... 273,455 234,778 – with agreed maturity dates one year or over .............. 23,145 15,102 Total ........................................ 985,883 797,118 Debt securities ......................... Deposits by banks ................... Customer accounts .................. % 21.2 8.4 70.4 % 19.3 8.8 71.9 Total ........................................ 100.0 100.0 HSBC Holdings HSBC Holdings’ primary sources of cash are interest and capital receipts from its subsidiaries, which it deploys in short-term bank deposits or liquidity funds. HSBC Holdings’ primary uses of cash are investments in subsidiaries, interest payments to debt holders and dividend payments to shareholders. On an ongoing basis, HSBC Holdings replenishes its liquid resources through the receipt of interest on, and repayment of, intra-group loans, from dividends, and from interest earned on its own liquid funds. The ability of its subsidiaries to pay dividends or advance monies to HSBC Holdings depends, among other things, on their respective regulatory capital requirements, statutory reserves, and financial and operating performance. HSBC actively manages the cash flows from its subsidiaries to optimise the amount of cash held at the holding company level, and expects to continue doing so in the future. The wide range of HSBC’s activities means that HSBC Holdings is not dependent on a single source of profits to fund its dividends. Together with its accumulated liquid assets, HSBC Holdings believes that planned dividends and interest from subsidiaries will enable it to meet anticipated cash obligations. Also, in normal circumstances, HSBC Holdings has full access to capital markets on normal terms. At 31 December 2004, the short-term liabilities of HSBC Holdings totalled US$5.3 billion, including US$1.2 billion in respect of the proposed third interim dividend for 2004 and US$3.0 billion in respect of the proposed fourth interim dividend for 2004. In practice, the full amount of the proposed dividend may not be paid out as shareholders can elect to receive their dividend entitlement in scrip rather than in cash. Short-term assets of US$12.4 billion, consisting mainly of cash at bank and money market deposits of US$7.3 billion and other amounts (including dividends) due from HSBC undertakings of US$5.1 billion, exceeded short-term liabilities. Market risk management The objective of HSBC’s market risk management is to manage and control market risk exposures in order to optimise return on risk while maintaining a market profile consistent with the Group’s status as a premier provider of financial products and services. Market risk is the risk that movements in market rates, including foreign exchange rates, interest rates, credit spreads and equity and commodity prices will reduce HSBC’s income or the value of its portfolios. HSBC separates exposures to market risk into either trading or non-trading portfolios. Trading portfolios include those positions arising from market-making and proprietary position-taking. Non-trading portfolios primarily arise from the management of the commercial banking assets and liabilities. The management of market risk is principally 167 H S B C H O L D I N G S P L C Financial Review (continued) undertaken in Global Markets using risk limits approved by the Group Management Board. Limits are set for each portfolio, product and risk type, with market liquidity being a principal factor in determining the level of limits set. Traded Markets Development and Risk, an independent unit within Corporate, Investment Banking and Markets, develops the Group’s market risk management policies and measurement techniques. Each major operating entity has an independent Market Risk Control function which is responsible for measuring market risk exposures in accordance with the policies defined by Traded Markets Development and Risk, and monitoring and reporting these exposures against the prescribed limits on a daily basis. Each operating entity is required to assess the market risks which arise on each product in its business and to transfer these risks to either its local Global Markets unit for management, or to separate books managed under the auspices of the local Asset and Liability Management Committee (‘ALCO’). The aim is to ensure that all market risks are consolidated within operations which have the necessary skills, tools, management and governance to professionally manage such risks. Fair value and price verification control Where certain financial instruments are carried on the Group’s balance sheet at their mark-to-market values, the mark-to-market valuation and the related price verification processes are subject to careful governance across the Group. Financial instruments which are accounted for on a fair value basis include assets held in the trading portfolio, obligations related to securities sold short and derivative financial instruments (excluding non-trading derivatives accounted for on an accruals basis). The determination of mark-to-market values is therefore a significant element in the reporting of the Group’s Global Markets activities. The responsibility for the determination of accounting policies and procedures governing valuation and validation ultimately rests with the Group Finance and the Corporate, Investment Banking and Markets Finance functions, which report to the Group Finance Director. All significant valuation policies, and any changes thereto, must be approved by senior finance management. HSBC’s governance of financial reporting requires that Financial Control departments across the Group are independent of the risk-taking businesses, with the Finance functions having ultimate responsibility for the determination of fair values included in the 168 financial statements, and for ensuring that the Group’s policies and relevant accounting standards are adhered to. Both senior management and the Group Audit Committee assess the resourcing and expertise of Finance functions within the Group on a regular basis to ensure that the Group’s financial control and price verification processes are properly staffed to support the required control infrastructure. Trading Market risk in trading portfolios is monitored and controlled at both portfolio and position levels using a complementary set of techniques, such as value at risk and present value of a basis point (‘PVBP’), together with stress and sensitivity testing and concentration limits. These techniques quantify the impact on capital of defined market movements. Other controls include restricting individual operations to trading within a list of permissible instruments authorised for each site by Traded Markets Development and Risk, and enforcing rigorous new product approval procedures. In particular, trading in the more complex derivative products is concentrated in offices with appropriate levels of product expertise and robust control systems. Trading value at risk (‘VAR’) One of the principal tools used by HSBC to monitor and limit market risk exposure in its trading portfolios is VAR. VAR is a technique that estimates the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence (for HSBC, 99 per cent). HSBC calculates VAR daily. During the year, HSBC refined its basis of calculating VAR from one predominantly based on variance / co-variance to one predominantly based on historical simulation. This latter calculation was introduced because it better captures the non-linear characteristics of certain market risk positions. Historical simulation uses scenarios derived from historical market rates, and takes account of the relationships between different markets and rates, for example, interest rates and foreign exchange rates. Movements in market prices are calculated by reference to market data from the last two years. Although a valuable guide to risk, VAR should always be viewed in the context of its limitations. For example: • the use of historical data as a proxy for estimating future events may not encompass all potential events, particularly those which are extreme in nature; • • the use of a 10-day holding period assumes that all positions can be liquidated or hedged in 10 days. This may not fully reflect the market risk arising at times of severe illiquidity, when a 10-day holding period may be insufficient to liquidate or hedge all positions fully; the use of a 99 per cent confidence level, by definition, does not take into account losses that might occur beyond this level of confidence; • VAR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect intra-day exposures. HSBC recognises these limitations by augmenting its VAR limits with other position and sensitivity limit structures. Additionally, HSBC applies a wide range of stress testing, both on individual portfolios and on the Group’s consolidated positions. HSBC’s stress-testing regime provides senior management with an assessment of the impact of identified extreme events on the market risk exposures of HSBC. Daily distribution of market risk revenues in 2004 Number of days 70 54 4 1 2 5 80 70 60 50 40 30 20 10 0 19 17 12 10 8 2 0 -8 -4 0 4 8 12 (cid:1)(cid:1)(cid:1)(cid:1) Profit and loss frequency 16 20 Revenues (US$m) 24 28 2 0 0 1 32 36 40 44 48 52 Daily distribution of market risk revenues in 2003 Number of days 80 70 60 50 40 30 20 10 0 0 1 -90 -85 -80 66 49 45 32 7 24 16 0 0 0 2 1 2 5 1 5 1 1 0 0 -40 -35 -30 -25 -20 -15 -10 -5 10 15 20 25 30 35 40 45 50 55 60 0 5 Revenues (US$m) 1 0 85 90 Trading VAR for HSBC is summarised in (cid:1) Profit and loss frequency Note 39(a) in the ‘Notes on the Financial Statements’ on page 308. The daily revenue earned from market risk- related treasury activities includes accrual book net interest income and funding related to dealing positions. The histogram below illustrates the frequency of daily revenue arising from such market risk-related activities. The average daily revenue earned from market risk-related treasury activities in 2004 was US$18.3 million, compared with US$17.1 million for 2003. The standard deviation of these daily revenues was US$8.0 million compared with US$12.5 million for 2003. The standard deviation measures the variation of daily revenues about the mean value of those revenues. An analysis of the frequency distribution of daily revenue shows that there were two days with negative revenues during 2004 compared with 12 days in 2003. The most frequent result was a daily revenue of between US$16 million and US$20 million with 70 occurrences. Non-trading The principal objective of market risk management of non-trading portfolios is to optimise net interest income. Market risk in non-trading portfolios arises principally from mismatches between the future yield on assets and their funding cost as a result of interest rate changes. Analysis of this risk is complicated by having to make assumptions on optionality in certain product areas, for example, mortgage prepayments, and from behavioural assumptions regarding the economic duration of liabilities which are contractually repayable on demand, for example, current accounts. This prospective change in future net interest income from non-trading portfolios will be reflected in the current realisable value of these positions should they be sold or closed prior to maturity. In order to manage this risk optimally, market risk in non- trading portfolios is transferred to Global Markets or to separate books managed under the auspices of the local ALCO. The transfer of market risk to trading books managed by Global Markets or ALCO is usually achieved by a series of internal deals between the business units and these trading books. When the 169 H S B C H O L D I N G S P L C Financial Review (continued) behavioural characteristics of a product differ from its contractual characteristics, the behavioural characteristics are assessed to determine the true underlying interest rate risk. Local ALCOs regularly monitor all such behavioural assumptions and interest rate risk positions, to ensure they comply with interest rate risk limits established by the Group Management Board. As noted above, in certain cases, the non-linear characteristics of products cannot be adequately captured by the risk transfer process. For example, both the flow from customer deposit accounts to more attractive investment products and the precise repayment levels of mortgages will vary at different interest rate levels. In such circumstances simulation modelling is used to identify the impact of varying scenarios on valuations and net interest income. Once market risk has been consolidated in Global Markets or ALCO-managed books, the net exposure is typically managed through the use of interest rate swaps within agreed limits. In the US, market risk arising within HSBC’s residential mortgage business is primarily managed by a specialist function within the mortgage business under guidelines established by HSBC Bank USA’s ALCO. A range of risk management tools is applied to hedge the sensitivity arising from movements in interest rates. A key element of risk management within the US mortgage business is dealing with the sensitivity of Mortgage Servicing Rights (‘MSRs’) to market risks. MSRs represent the economic value of the right to perform specified residential mortgage servicing activities. They are sensitive to interest rates movements, which change the prepayment speed of the underlying mortgages and therefore the value of the MSRs. HSBC uses a combination of interest-rate-sensitive derivative financial instruments and debt securities to help protect the economic value of MSRs. An accounting asymmetry can arise in this area because the derivative instruments used to hedge the economic exposure arising from MSRs are marked to market, but the MSRs themselves are measured for accounting purposes at the lower of cost or market value. It is, therefore, possible for an economically hedged position not to be shown as such in the accounts, when the hedge shows a loss but the MSR cannot be revalued above cost to reflect an associated profit. HSBC’s policy is to hedge the economic risk. VAR limits are set to control the exposure to MSRs and MSR hedges. The VAR on MSRs and MSR hedges at 31 December 2004 was US$10 million. 170 Market risk also arises in the Group’s insurance businesses within their portfolios of investments and policyholder liabilities. The principal market risks are interest rate risk and equity risk which primarily arise where guaranteed investment return policies have been issued. The insurance businesses have a dedicated head office market risk function which oversees management of this risk. Market risk also arises within the Group’s defined benefit pension schemes to the extent that the obligations of the schemes are not fully matched by assets with determinable cash flows. This risk principally derives from the pension schemes holding equities against their future pension obligations. The risk is that market movements in equity prices could result in assets which are insufficient over time to cover the level of projected liabilities. Management and trustees, who act on behalf of the pension scheme beneficiaries, assess the level of this risk using reports prepared by independent external actuaries. The present value of the Group’s defined benefit pension schemes liabilities was US$25.8 billion at 31 December 2004 compared with US$21.7 billion at 31 December 2003. Assets of the defined benefit schemes at 31 December 2004 comprised equity investments 53.3 per cent, debt securities 29.1 per cent and other (including property) 17.6 per cent. Net interest income Future net interest income is affected by movements in interest rates. A principal part of the Group’s management of market risk in non-trading portfolios is to monitor the sensitivity of projected net interest income at varying interest rate scenarios (simulation modelling). HSBC aims, through its management of market risk in non-trading portfolios, to mitigate the impact of prospective interest rate movements which could reduce future net interest income, whilst balancing the cost of such hedging activities on the current net revenue stream. For simulation modelling, businesses use a combination of scenarios relevant to local businesses and local markets as well as standard scenarios required to be used across the Group. The Group standard scenarios are consolidated to illustrate the combined pro-forma impact on Group consolidated portfolio valuations and net interest income. The table below sets out the impact on future net interest income of an immediate hypothetical 100 basis points parallel fall or rise in all yield curves worldwide on 1 January 2005. Assuming no management actions, a 100 basis points parallel fall in all yield curves would increase planned net interest income for the 12 months to 31 December 2005 by US$495 million while a hypothetical 100 basis points parallel rise in all yield curves would decrease planned net interest income by US$908 million. Instead of assuming that all interest rates move together, HSBC groups its interest rate exposures into currency blocs whose interest rates are considered likely to move together. The sensitivity of projected net interest income for 2005, on this basis, is described as follows: US dollar bloc US$m Rest of Americas bloc US$m Hong Kong dollar bloc US$m Rest of Asia bloc US$m Sterling bloc US$m Euro bloc US$m Total US$m Change in 2005 projected net interest income + 100 basis points shift in yield curves ..................................... – 100 basis points shift in yield curves ..................................... Change in 2004 projected net interest income + 100 basis points shift in yield curves ..................................... – 100 basis points shift in yield curves ..................................... (789) 643 98 74 (108) (300) (511) 157 92 (115) (150) (689) (4) (37) (1) (2) (13) 15 (21) (26) (274) (908) 282 495 (228) 212 (819) (463) The interest rate sensitivities set out in the table above are illustrative only and are based on a single simplified scenario. The figures represent the effect of the pro forma movements in net interest income based on the projected yield curve scenarios and the Group’s current interest rate risk profile. This effect, however, does not incorporate actions that could be taken by Global Markets or in the business units to mitigate the impact of this interest rate risk. In reality, Global Markets would seek to proactively change the interest rate risk profile to minimise losses and optimise net revenues. The projections above also assume that rates of all maturities move by the same amount and, therefore, do not reflect the potential impact on net interest income of some rates changing while others remain unchanged. The projections also make other simplifying assumptions, including that all positions run to maturity. The Group’s exposure to changes in its net interest income arising from movements in interest rates falls into three areas: core deposit franchises, HSBC Finance Corporation and Global Markets. • Core deposit franchises: these are exposed to changes in the value of the deposits raised and spreads against wholesale funds; in a low interest rate environment, such as at present, the value of core deposits increases as interest rates rise and decreases as interest rates fall. This risk is, however, asymmetrical as there is limited room to lower deposit pricing in the event of interest rate reductions in a low interest rate environment. Although interest rates have risen over the year, this risk is still particularly acute in the case of Hong Kong dollar deposits. • HSBC Finance Corporation’s net interest income sensitivity is such that it benefits in a falling rate environment and its interest margins decline in a rising rate environment. This arises from having substantially fixed rate real estate secured lending funded to an extent with interest rate-sensitive short-term liabilities. This feature is important from a Group perspective because it provides a natural offset to the effect of interest rate reductions on the core deposit franchises. • Global Markets: the residual interest rate risk is managed within Global Markets. This reflects the Group’s policy of transferring all interest rate risk, other than structural risk, to Global Markets to be managed within defined limits and with flexibility as to the instruments used. The best way of illustrating the active management of this interest rate risk is to highlight the major drivers of the changes shown in the projected effect of interest rate moves in the above table. • In Hong Kong, the rise in interest rates over the year increases the room to lower deposit pricing in the event of falling interest rates. In addition, Global Markets are positioned to increase revenue should rates fall. These two factors have materially reduced the Group’s exposure to falling rates. 171 H S B C H O L D I N G S P L C Financial Review (continued) • Similarly, in the US dollar bloc, the rise in interest rates over the year increases the room to lower deposit pricing in the event of falling interest rates and Global Markets have been able to position themselves to increase revenue if rates fall. In addition, cash balances at the holding company reduced as the Group acquired businesses, principally Bank of Bermuda, M&S Money and the investment in Bank of Communications, increasing the negative impact of rising interest rates. • Global Markets increased its exposure to euro assets, contributing to the increased sensitivity to both rising and falling rates. It can be seen from the above that projecting the movement in net interest income from prospective changes in interest rates is a complex interaction of structural and managed exposures. In a rising rate environment, the most critical exposures are those managed within Global Markets. Structural foreign exchange exposures Structural foreign exchange exposures represent net investments in subsidiaries, branches or associated undertakings, the functional currencies of which are currencies other than US dollars. Revaluation gains and losses on structural exposures are recorded in the statement of total consolidated recognised gains and losses. The main operating (or functional) currencies in which HSBC’s business is transacted are the US dollar, the Hong Kong dollar, sterling, the euro, the Mexican peso, the Brazilian real, and the Chinese renminbi. As the US dollar and currencies linked to it form the dominant currency bloc in which HSBC’s operations transact business, HSBC Holdings prepares its consolidated financial statements in US dollars. HSBC’s consolidated balance sheet is therefore affected by movements in exchange rates between the US dollar and all the non-US dollar functional currencies of underlying subsidiaries. HSBC hedges structural foreign currency exposures only in limited circumstances. HSBC’s structural foreign currency exposures are managed with the primary objective of ensuring, where practical, that HSBC’s consolidated tier 1 ratio and the tier 1 ratios of individual banking subsidiaries are protected from the effect of changes in exchange rates. This is usually achieved by ensuring that, for each subsidiary bank, the ratio of structural exposures in a given currency to risk-weighted assets denominated in that currency is broadly equal to the tier 1 ratio of the subsidiary in question. 172 Selective hedges were in place during 2004. Hedging is undertaken using forward foreign exchange contracts or by financing with borrowings in the same currencies as the functional currencies involved. There was no material effect from foreign currency exchange rate movements on HSBC’s tier 1 capital ratio during the period. Management of insurance and financial risk HSBC’s insurance underwriting operations, inter alia, issue contracts that accept the transfer of insurance risk, or accept financial risk, or both. This section summarises these risks and the way that HSBC manages them. Insurance risk The principal risk that HSBC faces under the insurance risk transfer contracts that it underwrites is that the eventual claims and benefit payments, together with the costs of managing the business and claims handling, exceed the aggregate amount of premia received and investment income earned thereon, pending settlement of claims. HSBC controls this risk by modelling outcomes using statistical techniques and by holding a diversified portfolio of relatively homogeneous contracts which is considered unlikely to be significantly different from the expected outcome. HSBC manages the risk of unexpectedly large underwriting losses through its underwriting strategy, reinsurance arrangements and claims handling. In conjunction with Group Credit and Risk, the central management of HSBC’s insurance operations places reinsurance contracts with the world’s larger reinsurance companies. HSBC assesses the financial strength and creditworthiness of all reinsurers by reviewing publicly available financial information such as credit grades provided by rating agencies. HSBC also takes into account details of recent payment history and the status of any ongoing negotiations between HSBC’s insurance operations and these third parties. Individual operating units maintain records of the payment history of contract holders with whom they conduct regular business. Financial risk HSBC’s insurance operations are also exposed to financial risk in circumstances when the proceeds from financial assets are not sufficient to fund the obligations arising from insurance and investment contracts. The framework for the management of these risks seeks to integrate the financial risks associated with HSBC’s insurance operations with similar risks arising from other financial assets and liabilities not directly associated with insurance and investment liabilities. Investment credit risk is the risk that financial loss arises from the failure of an issuer of an investment product or a counterparty to an investment transaction to meet its obligations. Local management of HSBC’s operating insurance companies are responsible for the quality and performance of their respective investment portfolios. Investment guidelines are set at a Group level and refined by local ALCOs which review, on a quarterly basis, investment management performance and compliance with the guidelines. Assessments of the creditworthiness of issuers and counterparties are based primarily upon rating agency and other publicly available information together with investment concentrations. Investment credit exposures are aggregated and reported to HSBC’s Group Credit and Risk function on a quarterly basis. Operational risk management Operational risk is the risk of loss arising through fraud, unauthorised activities, error, omission, inefficiency, systems failure or from external events. It is inherent to every business organisation and covers a wide spectrum of issues. HSBC manages this risk through a controls- based environment in which processes are documented, authorisation is independent and transactions are reconciled and monitored. This is supported by an independent programme of periodic reviews undertaken by Internal Audit, and by monitoring external operational risk events, which ensure that HSBC stays in line with best practice and takes account of lessons learned from publicised operational failures within the financial services industry. HSBC has codified its operational risk management process by issuing a high level standard. This explains how HSBC manages operational risk by identifying, assessing, monitoring, controlling and mitigating the risk, rectifying operational risk events, and implementing any additional procedures required for compliance with local regulatory requirements. The processes undertaken to manage operational risk are determined by reference to the scale and nature of each HSBC operation. The HSBC standard covers the following: • Operational risk management responsibility is assigned at senior management level within the business operation. • Information systems are used to record the identification and assessment of operational risks and generate appropriate, regular management reporting. • Operational risks are identified by risk assessments covering operational risks facing each business and risks inherent in processes, activities and products. Risk assessment incorporates a regular review of risks identified to monitor significant changes. • Operational risk loss data is collected and reported to senior management. Aggregate operational risk losses are recorded and details of incidents above a materiality threshold are reported to the Group Audit Committee and the Risk Management Meeting. • Risk mitigation, including insurance, is considered where this is cost-effective. In each of HSBC’s subsidiaries, local management is responsible for implementation of the HSBC standard on operational risk throughout their operations and, where deficiencies are evident, these are required to be rectified within a reasonable timeframe. Subsidiaries acquired by HSBC since the standard was issued are required to assess and plan the implementation of the standard’s requirements. HSBC maintains and tests contingency facilities to support operations in the event of disasters. Additional reviews and tests were conducted following the terrorist incidents of 11 September 2001 and, more recently, the two bomb blasts which damaged two of HSBC’s buildings in Istanbul, to incorporate lessons learned in the operational recovery from those circumstances. Reputational risk management The reputation of HSBC is paramount to its success. Reputational risks can arise from social, ethical or environmental issues, or as a consequence of operational risk events. As a banking group, HSBC’s good reputation depends upon the way in which it conducts its business, but it can also be affected by the way in which clients, to whom it provides financial services, conduct themselves. Reputational risks are considered and assessed by the Board, the Group Management Board, the Risk Management Meeting, subsidiary company boards, board committees and/or senior management during the formulation of policy and the establishment of standards. Standards on all major 173 H S B C H O L D I N G S P L C Financial Review (continued) aspects of business are set for HSBC and for individual subsidiaries, businesses and functions. These are communicated through manuals and statements of policy, and promulgated through internal communications and training. The policies set out operational procedures in all areas of reputational risk, including treating customers fairly, conflicts of interest, money laundering deterrence, environmental impact, anti-corruption measures and employee relations. Management in all operating entities is required to establish a strong internal control structure to minimise the risk of operational and financial failure, and to ensure that a full appraisal of reputational implications is made before strategic decisions are taken. The Group internal audit function monitors compliance with policies and standards. Capital management and allocation Capital measurement and allocation The FSA supervises HSBC on a consolidated basis and, as such, receives information on the capital adequacy of, and sets capital requirements for, HSBC as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, which set and monitor their capital adequacy requirements. In some jurisdictions, certain non-banking subsidiaries are subject to the supervision and capital requirements of local regulatory authorities. Since 1988, when the governors of the Group of Ten central banks agreed to guidelines for the international convergence of capital measurement and standards, the banking supervisors of HSBC’s major banking subsidiaries have exercised capital adequacy supervision in a broadly similar framework. The guidelines agreed in 1988, referred to as the Basel Accord, are applied on a consistent basis across the European Union through directives, which are then implemented by member states. In implementing the EU’s Banking Consolidation Directive, the FSA requires each bank and banking group to maintain an individually prescribed ratio of total capital to risk-weighted assets taking into account both balance sheet assets and off-balance sheet transactions. Under the EU’s Amending Directive to the Capital Adequacy Directive, the FSA allows banks to calculate capital requirements for market risk in the trading book using VAR techniques. HSBC’s capital is divided into two tiers: tier 1, comprising shareholders’ funds, innovative tier 1 securities and minority interests in tier 1 capital, but excluding revaluation reserves; and tier 2, 174 comprising general loan loss provisions, revaluation reserves, qualifying subordinated loan capital and minority and other interests in tier 2 capital. The amount of innovative tier 1 securities cannot exceed 15 per cent of overall tier 1 capital, qualifying tier 2 capital cannot exceed tier 1 capital, and qualifying term subordinated loan capital may not exceed 50 per cent of tier 1 capital. There are also limitations on the amount of general provisions which may be included in tier 2 capital. The book values of goodwill, intangible assets and own shares held are deducted in arriving at tier 1 capital. Total capital is calculated by deducting the book values of unconsolidated investments, investments in the capital of banks, and certain regulatory items from the total of tier 1 and tier 2 capital. Banking operations are categorised as either trading book (broadly, marked-to-market activities) or banking book (all other activities) and risk- weighted assets are determined accordingly. Banking book risk-weighted assets are measured by means of a hierarchy of risk weightings classified according to the nature of each asset and counterparty, taking into account any eligible collateral or guarantees. Banking book off-balance-sheet items giving rise to credit, foreign exchange or interest rate risk are assigned weights appropriate to the category of the counterparty, taking into account any eligible collateral or guarantees. Trading book risk-weighted assets are determined by taking into account market- related risks such as foreign exchange, interest rate and equity position risks, and counterparty risk. Future developments In October 2004, the FSA published a consultation paper CP04/17 ‘Implications of a changing accounting framework’. This paper sets out the FSA’s proposed approach to assessing banks’ capital adequacy after implementation of IFRS. In the absence of the FSA’s final rules on capital adequacy reporting under IFRS, which may be different from the proposals set out in CP04/17, HSBC will follow its proposals with effect from 1 January 2005. Under the consultation paper, there will be changes to the measurement of banks’ capital adequacy in a number of ways, the most significant of which for HSBC are set out below. • The capital treatment for collective impairment provisions will be the same as previously for general provisions, i.e. they will be included in tier 2 capital. This is expected to have a positive impact on HSBC’s total capital ratio. • Transitional impacts of IFRS implementation, such as the capitalisation of software costs, are likely to have a positive impact on shareholders’ funds. This is expected to result in increases in the tier 1 and total capital ratios. Under IFRS, dividends will not be recognised on the balance sheet until they are declared. This will give rise to an increase in shareholders’ funds at the year- end which will reverse out when the dividend is declared. Banks will take the benefit of this increase to their regulatory capital until the dividend is declared, in line with the accounting treatment. The remainder of the proposals in CP04/17 will have a smaller impact on HSBC. They include the reversal of the recognition of the assets and liabilities of defined benefit pension schemes. Instead, banks will deduct from capital their best estimate of the funds that will need to be paid into the schemes in addition to normal contributions over the next five years. In June 2004, the Basel Committee on Banking Supervision (‘the Basel Committee’) issued a new capital adequacy framework to replace the Basel Accord of 1988 in the form of a final Accord (commonly known as ‘Basel II’). The new capital framework consists of three ‘pillars’: minimum capital requirements, supervisory review process and market discipline. The supervisory objectives of the Basel Committee are for Basel II to promote safety and soundness in the financial system and, as such, at least maintain the current overall level of capital in the system; to enhance competitive equality; to constitute a more comprehensive approach to addressing risks; and to focus on internationally active banks. With respect to pillar one, Basel II provides three approaches, of increasing sophistication, to the credit risk regulatory capital calculation. The most basic approach is the standardised approach, which uses external credit ratings to determine the risk weighting applied to rated counterparties and groups other counterparties into broad categories and applies standardised risk weightings to these categories. Moving to the internal ratings based foundation approach will allow banks to calculate their credit risk regulatory capital requirement on the basis of their internal assessment of the probability that the counterparty will default. The internal ratings-based advanced approach will allow banks to use their own internal assessment of not only the probability of default, but also the quantification of the exposure to a counterparty and the percentage loss suffered if the counterparty defaults. Pillar one will also introduce capital requirements for operational risk and again three levels of sophistication are available. The capital requirement under the basic indicator approach is a simple percentage of gross revenues; under the standardised approach it is one of three different percentages of gross revenues applicable to each of eight business lines; and under advanced measurement approaches it is an amount determined using banks’ own statistical analysis techniques on operational risk data. In Europe, Basel II will be given effect by applying the ‘re-casting technique’ (Interinstitutional Agreement 2002/C 77/01) enabling substantive amendments to existing legislation without a self- standing amending directive. The proposal for re- casting of the Banking Consolidation Directive and the Capital Adequacy Directive was published in July 2004. It largely incorporates the requirements set out in Basel II, but there are also a number of differences. This proposal will now be subject to a formal EU co-decision legislative process involving the Council of Ministers and the European Parliament, during which further changes may be made. In January 2005, the FSA published a consultation paper CP05/3 ‘Strengthening capital standards’. This paper sets out the FSA’s proposed approach to implementing the requirements of the recast EU directives. The FSA proposes that the new requirements will be applied from 1 January 2007, except that under pillar 1 firms may elect to continue to apply the existing capital adequacy framework until 1 January 2008. HSBC continues to participate actively in the industry consultations surrounding the development and implementation of Basel II and the re-cast EU directives and fully supports a more risk-sensitive regulatory capital framework than the 1988 Basel Accord. The implementation of Basel II across HSBC’s geographically diverse businesses operating in a large number of different regulatory environments represents a significant challenge, and a major programme of projects is in progress. Basel II allows extensive scope for interpretation by regulators and the range of such variation and the interaction of HSBC’s home and host regulators, which is still being developed, will be key factors. In view of this, it is still too early to assess what the impact of Basel II on HSBC’s capital ratios will be. One example of the uncertainty in interpretation by regulators is that the US banking agencies are likely to propose that, in the United States, certain institutions continue to be subject to the 1988 Basel Accord while others be subject to the ‘advanced’ risk and capital methodologies of Basel II. In this latter context, the Federal Reserve Board has determined that HNAH, HSBC’s highest level US bank holding 175 H S B C H O L D I N G S P L C Financial Review (continued) company in the US, which holds all HSBC’s US operating subsidiaries and HSBC Canada, will be expected to qualify for, and comply with, the Federal Reserve Board’s ‘advanced’ risk and capital methodologies of Basel II. These guidelines are still in development and may not be finalised before the second quarter of 2006. Capital management It is HSBC’s policy to maintain a strong capital base to support the development of its business. HSBC seeks to maintain a prudent balance between the different components of its capital and, in HSBC Holdings, between the composition of its capital and that of its investment in subsidiaries. This is achieved by each subsidiary managing its own capital within the context of an approved annual plan which determines the optimal amount and mix of capital required to support planned business growth and meet local regulatory capital requirements and, in the case of HSBC Finance Corporation, its ratings targets. Capital generated in excess of planned requirements is paid up to HSBC Holdings, normally Source and application of tier 1 capital by way of dividends, and represents a source of strength for HSBC. HSBC Holdings is primarily a provider of equity capital to its subsidiaries. These investments are substantially funded by HSBC Holdings’ own equity issuance and profit retentions. Major subsidiaries usually raise their own non-equity tier 1 capital and subordinated debt in accordance with HSBC guidelines regarding market and investor concentration, cost, market conditions, timing and the effect on the composition and maturity profile of HSBC’s capital. The subordinated debt requirements of other HSBC companies are met internally. HSBC recognises the impact on shareholder returns of the level of equity capital employed within HSBC and seeks to maintain a prudent balance between the advantages and flexibility afforded by a strong capital position and the higher returns on equity possible with greater leverage. In the current environment, HSBC uses a benchmark tier 1 capital ratio of 8.25 per cent in considering its long-term capital planning. Movement in tier 1 capital Opening tier 1 capital ...................................................................................................................... Attributable profits .......................................................................................................................... Add back: goodwill amortisation ................................................................................................ Dividends ........................................................................................................................................ Add back: shares issued in lieu of dividends ............................................................................... Increase in goodwill and intangible assets deducted ....................................................................... Merger reserve ................................................................................................................................ Shares issued ................................................................................................................................... Innovative tier 1 capital issued ........................................................................................................ Other (including exchange movements) .......................................................................................... Closing tier 1 capital ....................................................................................................................... Movement in risk-weighted assets Opening risk-weighted assets .......................................................................................................... Movements ..................................................................................................................................... Closing risk-weighted assets ........................................................................................................... 2004 US$m 54,863 11,840 1,818 (7,301) 2,607 (3,088) – 581 1,983 3,956 67,259 618,662 140,548 759,210 2003 US$m 38,949 8,774 1,585 (6,532) 1,423 (13,650) 12,768 1,482 4,263 5,801 54,863 430,551 188,111 618,662 176 Capital structure The table below sets out the analysis of regulatory capital. Composition of capital Tier 1 Shareholders’ funds ........................................................................................................................ Minority interests ............................................................................................................................ Innovative tier 1 securities .............................................................................................................. Less : Property revaluation reserves ...................................................................................................... Goodwill capitalised and intangible assets .................................................................................. Own shares held .......................................................................................................................... Total qualifying tier 1 capital .......................................................................................................... Tier 2 Property revaluation reserves .......................................................................................................... General provisions .......................................................................................................................... Perpetual subordinated debt ............................................................................................................ Term subordinated debt .................................................................................................................. Minority and other interests in tier 2 capital .................................................................................... Total qualifying tier 2 capital .......................................................................................................... Unconsolidated investments ............................................................................................................ Investments in other banks .............................................................................................................. Other deductions ............................................................................................................................. Total capital .................................................................................................................................... Risk-weighted assets Banking book .................................................................................................................................. Trading book ................................................................................................................................... Total ................................................................................................................................................ Capital ratios: Total capital .................................................................................................................................... Tier 1 capital ................................................................................................................................... 2004 US$m 86,623 4,253 10,077 (2,660) (31,190) 156 67,259 2,660 2,624 3,670 21,373 519 30,846 (6,361) (799) (165) 90,780 705,302 53,908 759,210 % 12.0 8.9 2003 US$m 74,473 3,711 8,094 (1,615) (29,920) 120 54,863 1,615 2,868 3,608 15,795 523 24,409 (4,101) (911) (218) 74,042 577,430 41,232 618,662 % 12.0 8.9 The above figures were computed in accordance with the EU Banking Consolidation Directive. Tier 1 capital increased by US$12.4 billion. Retained profits (excluding goodwill amortisation) contributed US$6.4 billion. Shares issued in lieu of dividends and innovative tier 1 securities issued contributed US$2.6 billion and US$2.0 billion, respectively. Exchange movements on reserves and other movements also added US$1.4 billion to tier 1 capital. The increase of US$6.4 billion in tier 2 capital mainly reflects the proceeds of capital issues, net of redemption and regulatory amortisation. Total risk-weighted assets increased by US$141 billion. This increase was driven by significant growth in loans and advances to customers in North America, the UK and Hong Kong. In constant currency, risk-weighted asset growth was 17 per cent. Risk-weighted assets by principal subsidiary In order to give an indication of how HSBC’s capital is deployed, the table below analyses the disposition of risk-weighted assets by principal subsidiary. The risk-weighted assets are calculated using FSA rules and exclude intra-HSBC items. 177 H S B C H O L D I N G S P L C Financial Review (continued) Risk-weighted assets Hang Seng Bank ............................................................................................................................. The Hongkong and Shanghai Banking Corporation and other subsidiaries ..................................... The Hongkong and Shanghai Banking Corporation ........................................................................ HSBC Private Banking Holdings (Suisse) ...................................................................................... CCF ................................................................................................................................................ HSBC Bank and other subsidiaries ................................................................................................. HSBC Bank .................................................................................................................................... HSBC Finance Corporation ............................................................................................................ HSBC Bank Canada ........................................................................................................................ HSBC Bank USA and other subsidiaries ........................................................................................ HSBC North America Holdings Inc. ............................................................................................... HSBC Mexico ................................................................................................................................. HSBC Bank Middle East ................................................................................................................ HSBC Bank Malaysia ..................................................................................................................... HSBC’s South American operations ............................................................................................... Bank of Bermuda ............................................................................................................................ HSBC Holdings sub-group ............................................................................................................. Other ............................................................................................................................................... Total ................................................................................................................................................ 2004 US$m 37,918 119,595 157,513 19,815 54,569 220,824 295,208 110,744 26,127 108,577 245,448 8,750 10,088 5,472 9,743 4,107 1,380 21,501 759,210 2003 US$m 34,972 103,557 138,529 22,245 47,741 167,754 237,740 113,186 20,852 63,234 197,272 7,059 7,379 4,979 6,994 – 2,495 16,215 618,662 178 H S B C H O L D I N G S P L C Other information Loan maturity and interest sensitivity analysis At 31 December 2004, the geographical analysis of loan maturity and interest sensitivity by loan type on a contractual repayment basis was as follows. All amounts are net of suspended interest. Maturity of 1 year or less Loans and advances to banks .............................. Commercial loans to customers Commercial, industrial and international trade Real estate and other property related ............. Non-bank financial institutions ....................... Governments .................................................. Other commercial ........................................... Hong Kong Government Home Ownership Scheme ........................................................... Residential mortgages and other personal loans .. Hong Kong US$m Rest of Asia- Pacific US$m Europe US$m North America US$m South America US$m Total US$m 54,303 45,261 14,074 22,077 2,572 138,287 29,028 10,600 9,675 4,766 26,615 1,328 986 83 22,699 2,431 15,421 3,381 1,930 789 4,518 6,568 5,002 15,993 1,638 13,205 1,610 170 98 98 747 63,227 22,994 45,964 3,594 43,600 89,003 19,208 26,039 42,406 2,723 179,379 – 652 27,587 10,332 – 7,684 – 43,006 – 2,778 652 91,387 Loans and advances to customers ....................... 116,590 30,192 33,723 85,412 5,501 271,418 Total loans maturing in one year or less .............. 170,893 75,453 47,797 107,489 8,073 409,705 Maturity after 1 year but within 5 years Loans and advances to banks .............................. 1,087 39 380 83 25 1,614 Commercial loans to customers Commercial, industrial and international trade Real estate and other property related ............. Non-bank financial institutions ....................... Governments .................................................. Other commercial ........................................... Hong Kong Government Home Ownership Scheme ........................................................... Residential mortgages and other personal loans .. 16,123 3,146 9,686 8,907 2,064 544 629 531 6,344 3,537 3,249 3,324 352 510 1,922 3,927 6,002 841 2,065 1,168 358 34 12 508 173 26,803 27,953 3,813 4,243 13,144 34,846 16,665 9,357 14,003 1,085 75,956 – 1,869 35,874 7,629 – 6,554 – 44,221 – 797 1,869 95,075 Loans and advances to customers ....................... 70,720 26,163 15,911 58,224 1,882 172,900 Total loans maturing after 1 year but within 5 years ............................................................ 71,807 26,202 16,291 58,307 1,907 174,514 Interest rate sensitivity of loans and advances to banks and commercial loans to customers: Fixed interest rate ........................................... Variable interest rate ....................................... Total .................................................................... Maturity after 5 years Loans and advances to banks ............................... Commercial loans to customers Commercial, industrial and international trade Real estate and other property related ............. Non-bank financial institutions ....................... Governments .................................................. Other commercial ........................................... Hong Kong Government Home Ownership Scheme ............................................................ Residential mortgages and other personal loans... 7,783 148 28,150 16,556 2,875 6,862 3,802 10,284 627 483 15,235 62,335 35,933 16,704 9,737 14,086 1,110 77,570 483 – 329 2,016 – 2,828 9,242 366 6,200 2,674 2,127 58 2,048 1 7,057 1,911 421 856 15 132 874 1,098 3,310 255 165 501 14 2 1 29 4 11,141 13,042 2,456 2,375 10,347 26,674 5,010 2,298 5,329 50 39,361 – 2,882 64,975 15,174 – 9,613 – 106,099 – 78 2,882 195,939 Loans and advances to customers ........................ 91,649 23,066 11,911 111,428 128 238,182 Total loans maturing after 5 years........................ 92,132 23,066 12,240 113,444 128 241,010 Interest rate sensitivity of loans and advances to banks and commercial loans to customers Fixed interest rate ............................................ Variable interest rate........................................ 7,517 175 19,640 4,835 988 1,639 1,869 5,476 20 30 10,569 31,620 Total..................................................................... 27,157 5,010 2,627 7,345 50 42,189 179 H S B C H O L D I N G S P L C Other information (continued) Deposits The following table analyses the average amount of bank and customer deposits and certificates of deposit (‘CDs’) and other money market instruments (which are included within ‘debt securities in issue’ in the balance sheet), together with the average interest rates paid thereon for each of the past three years. The geographical analysis of average deposits is based on the location of the office in which the deposits are recorded and excludes balances with HSBC companies. The ‘Other’ category includes securities sold under agreements to repurchase. 2004 Average balance US$m Average rate % Year ended 31 December 2003 Average balance US$m Average rate % 2002 Average balance US$m Average rate % Deposits by banks Europe Demand and other – non-interest bearing ........... Demand – interest bearing .................................. Time ................................................................... Other ................................................................... Total .................................................................... Hong Kong Demand and other – non-interest bearing ........... Demand – interest bearing .................................. Time ................................................................... Other ................................................................... Total .................................................................... Rest of Asia-Pacific Demand and other – non-interest bearing ........... Demand – interest bearing .................................. Time ................................................................... Other ................................................................... Total .................................................................... North America Demand and other – non-interest bearing ........... Demand – interest bearing .................................. Time ................................................................... Other ................................................................... 14,746 9,237 22,746 22,884 69,613 1,723 2,484 1,016 416 5,639 1,641 1,013 4,410 1,146 8,210 1,943 3,098 2,810 4,480 Total .................................................................... 12,331 South America Demand and other – non-interest bearing ........... Demand – interest bearing .................................. Time ................................................................... Other ................................................................... 13 148 238 703 Total .................................................................... 1,102 Total Demand and other – non-interest bearing ........... Demand – interest bearing .................................. Time ................................................................... Other ................................................................... Total .................................................................... 20,066 15,980 31,220 29,629 96,895 – 1.5 2.7 2.5 – 1.2 1.6 1.7 – 2.3 3.1 2.7 – 1.4 3.7 1.8 – 6.8 6.3 5.7 – 1.5 2.9 2.4 9,895 6,418 17,877 13,828 48,018 1,253 2,059 450 110 3,872 1,438 737 3,055 664 5,894 1,442 3,161 3,151 2,526 10,280 17 181 273 299 770 14,045 12,556 24,806 17,427 68,834 – 3.3 1.9 2.5 – 1.0 1.1 5.5 – 1.8 3.6 1.7 – 0.7 2.9 1.2 – 8.3 12.8 19.1 – 2.2 2.3 2.6 7,626 5,282 19,053 12,113 44,074 1,011 1,910 321 39 3,281 898 663 2,804 786 5,151 1,271 3,566 2,205 3,488 10,530 19 385 296 180 880 10,825 11,806 24,679 16,606 63,916 – 3.0 2.8 3.0 – 1.6 2.0 7.0 – 2.4 4.4 4.6 – 1.0 2.4 1.7 – 29.4 5.2 15.0 – 3.0 3.0 2.9 180 2004 Average balance US$m Average rate % Year ended 31 December 2003 Average balance US$m Average rate % 2002 Average balance US$m Average rate % Customer accounts Europe Demand and other – non-interest bearing .. Demand – interest bearing ......................... Savings ...................................................... Time ......................................................... Other .......................................................... Total .......................................................... Hong Kong Demand and other – non-interest bearing .. Demand – interest bearing ......................... Savings ...................................................... Time .......................................................... Other .......................................................... 37,396 128,382 37,846 48,314 15,167 267,105 13,523 94,637 46,817 12,015 106 Total .......................................................... 167,098 Rest of Asia-Pacific Demand and other – non-interest bearing .. Demand – interest bearing ......................... Savings ...................................................... Time .......................................................... Other .......................................................... Total .......................................................... North America Demand and other – non-interest bearing .. Demand – interest bearing ......................... Savings ...................................................... Time .......................................................... Other .......................................................... 8,592 24,480 27,171 7,597 2,866 70,706 21,409 16,394 52,485 13,856 16,988 Total .......................................................... 121,132 South America Demand and other – non-interest bearing .. Demand – interest bearing ......................... Savings ...................................................... Time .......................................................... Other .......................................................... Total .......................................................... Total Demand and other – non-interest bearing .. Demand – interest bearing ......................... Savings ...................................................... Time .......................................................... Other .......................................................... Total .......................................................... CDs and other money market instruments Europe ....................................................... Hong Kong ................................................ Rest of Asia-Pacific ................................... North America ........................................... South America ........................................... Total .......................................................... 1,428 308 5,976 269 411 8,392 82,348 264,201 170,295 82,051 35,538 634,433 22,359 10,830 6,733 20,790 102 60,814 – 2.0 2.5 3.1 2.2 – 0.1 1.0 1.6 4.7 – 1.2 2.9 2.1 1.2 – 1.0 1.3 2.4 2.7 – 1.6 13.5 0.4 16.3 – 1.2 2.2 2.6 2.5 2.9 3.5 4.4 2.1 14.7 2.9 30,667 101,189 33,876 41,010 9,696 216,438 8,829 74,818 58,646 10,101 379 152,773 6,467 18,483 25,685 6,105 2,304 59,044 21,364 11,648 48,295 6,652 11,672 99,631 1,192 207 4,271 157 246 6,073 68,519 206,345 170,773 64,025 24,297 533,959 11,156 9,656 4,906 14,309 63 40,090 – 1.8 2.3 2.8 3.6 – 0.1 0.9 1.4 1.3 – 1.1 2.7 1.6 1.2 – 1.3 1.2 3.3 3.3 – 1.9 18.1 – 18.3 – 1.1 2.0 2.5 3.3 2.8 3.6 4.1 2.4 19.0 3.0 29,109 77,835 23,587 44,745 6,621 181,897 6,743 62,922 65,914 8,630 413 144,622 4,913 13,903 23,711 5,508 1,338 49,373 14,412 7,088 44,913 6,266 10,219 82,898 1,038 606 3,438 11 255 5,348 56,215 162,354 161,563 65,160 18,846 464,138 6,958 7,546 2,418 4,838 165 21,925 – 2.0 2.9 3.1 6.4 – 0.3 1.2 1.9 1.2 – 1.3 3.1 2.0 2.3 – 1.7 1.4 4.9 2.3 – 21.7 17.1 4.2 4.8 – 1.4 2.1 3.0 3.8 4.1 4.0 4.3 3.0 13.8 3.9 181 H S B C H O L D I N G S P L C Other information (continued) Certificates of deposit and other time deposits At 31 December 2004, the maturity analysis of certificates of deposit and other wholesale time deposits, by remaining maturity, was as follows: 3 months or less US$m After 3 months but within 6 months US$m After 6 months but within 12 months US$m After 12 months US$m Europe Certificates of deposit .................................... Time deposits: – banks ........................................................... – customers .................................................... Total .............................................................. Hong Kong Certificates of deposit .................................... Time deposits: – banks ........................................................... – customers .................................................... Total .............................................................. Rest of Asia-Pacific Certificates of deposit .................................... Time deposits: – banks ........................................................... – customers .................................................... 20,645 20,769 49,633 91,047 228 1,061 10,164 11,453 5,405 4,065 7,094 Total .............................................................. 16,564 North America Certificates of deposit .................................... Time deposits: – banks ........................................................... – customers .................................................... Total .............................................................. South America Certificates of deposit .................................... Time deposits: – banks ........................................................... – customers .................................................... Total .............................................................. Total Certificates of deposit .................................... Time deposits: – banks ........................................................... – customers .................................................... Total .............................................................. 3,754 2,383 11,707 17,844 – 113 151 264 30,032 28,391 78,749 137,172 3,722 4,279 2,995 10,996 495 17 477 989 1,042 228 1,020 2,290 40 215 2,871 3,126 – 53 6 59 5,299 4,792 7,369 17,460 200 609 1,305 2,114 1,505 2 262 1,769 273 442 95 810 13 164 149 326 – 48 2 50 1,991 1,265 1,813 5,069 1 1,805 3,863 5,669 9,293 28 1,998 11,319 48 72 712 832 – 228 4,717 4,945 – 27 1 28 9,342 2,160 11,291 22,793 Total US$m 24,568 27,462 57,796 109,826 11,521 1,108 12,901 25,530 6,768 4,807 8,921 20,496 3,807 2,990 19,444 26,241 – 241 160 401 46,664 36,608 99,222 182,494 The geographical analysis of deposits is based on the location of the office in which the deposits are recorded and excludes balances with HSBC companies. The majority of certificates of deposit and time deposits are in amounts of US$100,000 and over or the equivalent in other currencies. 182 Short-term borrowings HSBC includes short-term borrowings within customer accounts, deposits by banks and debt securities in issue and does not show short-term borrowings separately on the balance sheet. Short-term borrowings are defined by the SEC as Federal funds purchased and securities sold under agreements to repurchase, commercial paper and other short-term borrowings. HSBC’s only significant short-term borrowings are securities sold under agreements to repurchase and certain debt securities in issue. Additional information on these is provided in the tables below. Securities sold under agreements to repurchase Outstanding at 31 December ......................................................................... Average amount outstanding during the year ................................................ Maximum quarter-end balance outstanding during the year .......................... Weighted average interest rate during the year ............................................. Weighted average interest rate at the year-end .............................................. Short term bonds Outstanding at 31 December ......................................................................... Average amount outstanding during the year ................................................ Maximum quarter-end balance outstanding during the year .......................... Weighted average interest rate during the year ............................................. Weighted average interest rate at the year-end .............................................. 2004 US$m 43,726 46,229 53,188 2.7% 2.9% 2004 US$m 34,987 28,758 34,987 2.9% 2.5% Year ended 31 December 2003 US$m 27,427 25,883 30,938 2.0% 1.9% Year ended 31 December 2003 US$m 29,979 17,445 29,979 2.5% 2.5% 2002 US$m 21,397 21,089 21,468 4.0% 3.9% 2002 US$m 2,775 3,093 4,422 4.3% 4.7% 183 H S B C H O L D I N G S P L C Other information (continued) Off-balance sheet arrangements HSBC enters into certain off-balance sheet arrangements with customers in the ordinary course of business, as described below. (i) Financial guarantees, letters of credit and similar undertakings Note 38(a) of the ‘Notes on the Financial Statements’ on page 306 describes various types of guarantees and discloses the maximum potential future payments under such arrangements. Credit risk associated with all forms of guarantees is assessed in the same manner as for on-balance sheet credit advances and, where necessary, provisions for assessed impairment are included in ‘provisions for contingent liabilities and commitments’. (ii) Commitments to lend Undrawn credit lines are disclosed in Note 38(a) of the ‘Notes on Financial Statements’ on page 306. The majority by value of undrawn credit lines arises from ‘open to buy’ lines on personal credit cards, whereby cheques are issued to potential customers offering them a pre-approved loan, advised overdraft limits, and mortgage offers awaiting customer acceptance. HSBC generally has the right to change or terminate any conditions of a personal customer’s overdraft, credit card or other credit line upon notification to the customer. In respect of corporate commitments to lend, in most contracts HSBC’s position will be protected through restrictions on access to funding in the event of material adverse change. (iii) Credit derivatives HSBC uses credit derivatives through the dealing operations of certain Group companies, acting as a principal counterparty to a broad range of users, structuring deals to produce risk management products for its customers, or making markets in certain products. Risk is typically controlled through entering into an offsetting credit derivative contract with another counterparty. HSBC also manages its own exposure to industry segments and individual counterparties using credit derivatives. For a more detailed description of credit derivatives and information regarding their carrying amounts in 2004 and 2003, refer to Note 37(a) of the ‘Notes on Financial Statements’ on page 299. (iv) Special purpose and variable interest entities HSBC predominantly uses special purpose entities (‘SPEs’), or variable interest entities (‘VIEs’), to securitise loans and advances it has originated where this source of funding is cost effective. Such loans and advances generally remain on-balance sheet under UK GAAP. HSBC also administers SPEs that have been established for the purpose of providing alternative sources of financing to HSBC’s customers. Such arrangements also enable HSBC to provide tailored investment opportunities for investors. These SPEs, commonly referred to as asset-backed or multi-seller conduits, purchase interests in a diversified pool of receivables from customers or in the market using finance provided by a third party. The cash flows received by the SPE on the pool of receivables are used to service the finance provided by investors. HSBC administers this arrangement, which facilitates diversification of funding sources and the tranching of credit risk. HSBC also typically provides part of the liquidity facilities to the entities, together with secondary credit enhancement. HSBC also has relationships with SPEs which offer management of investment funds, provide finance to public and private sector infrastructure projects, and facilitate capital funding through the issue of preference shares via partnerships. All SPEs used by HSBC are authorised centrally to ensure appropriate purpose and governance, and the activities of SPEs administered by HSBC are closely monitored by senior management. The use of SPEs is not a significant part of HSBC’s activities and HSBC is not reliant on the use of SPEs for any material part of its business operations. For a further discussion of HSBC’s involvement with VIEs and the accounting treatments under UK and US GAAP see Note 49(p) of the ‘Notes on the Financial Statements’ on page 351. 184 Contractual obligations The table below provides details of HSBC’s material contractual obligations as at 31 December 2004. Long-term debt obligations ................................................... Capital (finance) lease obligations ........................................ Operating lease obligations ................................................... Purchase obligations ............................................................. Short positions in debt securities ........................................... Total ...................................................................................... Payments due by period Less than 1 year US$m 1–5 years US$m 100,190 25 638 717 39,882 141,452 88,294 40 1,450 495 – 90,279 More than 5 years US$m 42,909 630 1,099 – – 44,638 Total US$m 231,393 695 3,187 1,212 39,882 276,369 185 H S B C H O L D I N G S P L C Board of Directors and Senior Management Directors Sir John Bond, Group Chairman Age 63. An executive Director since 1990; Group Chief Executive from 1993 to 1998. Joined HSBC in 1961; a non-executive Director of The Hongkong and Shanghai Banking Corporation Limited, having been an executive Director from 1988 to 1992. A Director of HSBC Bank plc from 1993 to 1997 and Chairman from 1998 to 2004. A non-executive director of Ford Motor Company and of Vodafone Group Plc. * The Baroness Dunn, DBE, Deputy Chairman and senior non-executive Director Age 64. An executive Director of John Swire & Sons Limited and a Director of Swire Pacific Limited. A non-executive Director since 1990 and a non-executive Deputy Chairman since 1992. A member of the Nomination Committee. A non-executive Director of The Hongkong and Shanghai Banking Corporation Limited from 1981 to 1996. A former non-executive Director of Marconi p.l.c. and a former Senior Member of the Hong Kong Executive Council and Legislative Council. † Sir Brian Moffat, OBE, Deputy Chairman and senior independent non-executive Director Age 66. Former Chairman of Corus Group plc. A non- executive Director since 1998 and a non-executive Deputy Chairman since 2001. Chairman of the Group Audit Committee and of the Nomination Committee. A member of the Court of the Bank of England. A non- executive Director of Macsteel Global BV. S K Green, Group Chief Executive Age 56. An executive Director since 1998. Executive Director, Corporate, Investment Banking and Markets from 1998 to 2003. Joined HSBC in 1982. Group Treasurer from 1992 to 1998. Chairman of HSBC Bank plc, HSBC Bank Middle East Limited and HSBC Private Banking Holdings (Suisse) S.A. A Director of The Bank of Bermuda Limited, 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. A W Jebson, Group Chief Operating Officer Age 55. An executive Director since 2000. Group IT Director from 2000 to 2003. Group General Manager, Information Technology from 1996 to 2000. Joined HSBC in 1978. A Director of HSBC Finance Corporation. 186 W F Aldinger, Chairman and Chief Executive Officer, HSBC North America Holdings Inc. Age 57. An executive Director since 2003. Joined HSBC Finance Corporation in 1994. Chairman and Chief Executive Officer of HSBC Finance Corporation. Chairman, President and Chief Executive Officer of HSBC North America Inc. Chairman of HSBC Bank USA, N.A. and HSBC USA Inc. A non- executive Director of MasterCard International, Inc., Illinois Tool Works, Inc., AT&T Corp., and the combined board of the Children’s Memorial Medical Center/Children’s Memorial Hospital and the Children’s Memorial Foundation. Former Vice Chairman of Wells Fargo Bank. † The Rt Hon the Lord Butler of Brockwell, KG, GCB, CVO Age 67. Master, University College, Oxford. A non- executive Director since 1998. Chairman of the Corporate Social Responsibility Committee, a member of the Nomination Committee and Chairman of the HSBC Education Trust. A non-executive Director of Imperial Chemical Industries plc. Chaired the UK Government Review of Intelligence on Weapons of Mass Destruction. Secretary of the Cabinet and Head of the Home Civil Service in the United Kingdom from 1988 to 1998. † R K F Ch’ien, CBE Age 53. Executive Chairman of chinadotcom corporation and Chairman of its subsidiary, hongkong.com Corporation. A non-executive Director since 1998. A member of the Group Audit Committee. Non-executive Chairman of HSBC Private Equity (Asia) Limited, and a non-executive Director of The Hongkong and Shanghai Banking Corporation Limited since 1997. Non-executive Chairman of MTR Corporation Limited and a non-executive Director of Convenience Retail Asia Limited, Inchcape plc, VTech Holdings Limited and The Wharf (Holdings) Limited. † J D Coombe Age 59. Executive Director and Chief Financial Officer of GlaxoSmithKline plc, from which he will retire on 31 March 2005. Appointed a non-executive Director with effect from 1 March 2005 and a member of the Group Audit Committee with effect from 1 July 2005. A non-executive Director of the Supervisory Board of Siemens AG and appointed a non-executive Director of GUS plc with effect from 1 April 2005. A member of The Code Committee of the Panel on Takeovers and Mergers. A former Chairman of The Hundred Group of Finance Directors and a former member of the Accounting Standards Board. D G Eldon, Chairman, The Hongkong and Shanghai Banking Corporation Limited Age 59. An executive Director since 1999. Joined HSBC in 1968. Appointed an executive Director of The Hongkong and Shanghai Banking Corporation Limited in 1994, Chief Executive Officer in 1996 and Chairman in 1999. Non-executive Chairman of Hang Seng Bank Limited and a non-executive Director of Swire Pacific Limited and MTR Corporation Limited. † R A Fairhead Age 43. Finance Director of Pearson plc. A non- executive Director since 1 March 2004. A member of the Group Audit Committee. Former Executive Vice President, Strategy and Group Control of Imperial Chemical Industries plc. D J Flint, Group Finance Director Age 49. Joined HSBC as an executive Director in 1995. Director of HSBC Bank Malaysia Berhad. A non-executive Director of BP p.l.c. Chairman of the Financial Reporting Council’s review of the Turnbull Guidance on Internal Control. Served on the Accounting Standards Board and the Standards Advisory Council of the International Accounting Standards Board from 2001 to 2004. A former partner in KPMG. † W K L Fung, OBE Age 56. Group Managing Director of Li & Fung Limited. A non-executive Director since 1998. A member of the Remuneration Committee and of the Corporate Social Responsibility Committee. A non- executive Director of The Hongkong and Shanghai Banking Corporation Limited since 1995. Former Chairman of the Hong Kong General Chamber of Commerce, the Hong Kong Exporters’ Association and the Hong Kong Committee for the Pacific Economic Co-operation Council. M F Geoghegan, CBE, Chief Executive, HSBC Bank plc Age 51. An executive Director since 1 March 2004. Joined HSBC in 1973. Appointed a Director and Chief Executive of HSBC Bank plc in January 2004. A Director of CCF S.A. and HSBC Private Banking Holdings (Suisse) S.A. President of HSBC Bank Brasil S.A. - Banco Múltiplo from 1997 to 2003 and responsible for all of HSBC’s business throughout South America from 2000 to 2003. A non-executive Director and Chairman of Young Enterprise. † S Hintze Age 60. Former Chief Operating Officer of Barilla S.P.A. A non-executive Director since 2001. A member of the Corporate Social Responsibility Committee and of the Remuneration Committee. A non-executive Director of Premier Foods plc and the Society of Genealogists, a registered charity. A former Senior Vice President of Nestlé S.A. With Mars Incorporated from 1972 to 1993, latterly as Executive Vice President of M&M/Mars in New Jersey. A former non-executive Director of Safeway plc. † J W J Hughes-Hallett Age 55. Chairman of John Swire & Sons Limited. Appointed a non-executive Director with effect from 1 March 2005. A non-executive Director of The Hongkong and Shanghai Banking Corporation Limited from 1999 to 2004. A non-executive Director and formerly Chairman of Cathay Pacific Airways Limited and Swire Pacific Limited. † Sir John Kemp-Welch Age 68. Former Joint Senior Partner of Cazenove & Co and former Chairman of the London Stock Exchange. A non-executive Director since 2000. A member of the Remuneration Committee and of the Group Audit Committee. A Deputy Chairman of the Financial Reporting Council and a member of the Panel on Takeovers and Mergers from 1994 to 2000. † Sir Mark Moody-Stuart, KCMG Age 64. Chairman of Anglo American plc. A non- executive Director since 2001. Chairman of the Remuneration Committee. A Director and former Chairman of The ‘Shell’ Transport and Trading Company, plc and former Chairman of the Committee of Managing Directors of the Royal Dutch/Shell Group of Companies. A non-executive Director of Accenture Limited, a Governor of Nuffield Hospitals, President of the Liverpool School of Tropical Medicine and Chairman of the Global Business Coalition on HIV/AIDS. † S W Newton Age 63. Chairman of The Real Return Holdings Company Limited. A non-executive Director since 2002. A Member of the Advisory Board of the East Asia Institute at Cambridge University. Founder of Newton Investment Management, from which he retired in 2002. 187 H S B C H O L D I N G S P L C Board of Directors and Senior Management (continued) * H Sohmen, OBE Group Managing Directors Age 65. Chairman and President of World-Wide Shipping Group Limited and Chairman of Bergesen d.y. ASA and Bergesen Worldwide Limited. A non- executive Director since 1990. A non-executive Director of The Hongkong and Shanghai Banking Corporation Limited since 1984 and Deputy Chairman since 1996. † C S Taylor Age 59. Chair of Canadian Broadcasting Corporation. A non-executive Director since 2002. A member of the Corporate Social Responsibility Committee. Appointed a non-executive Director of HSBC North America Holdings Inc. with effect from 1 March 2005. A former non-executive Director of HSBC Bank Canada, HSBC Bank USA, N.A. and HSBC USA Inc. A non-executive Director of Fairmont Hotels and Resorts from 2001 to February 2005. Chair of Vancouver Board of Trade from 2001 to 2002. † Sir Brian Williamson, CBE Age 60. Chairman of Electra Investment Trust plc and Resolution Life Group Limited. A non-executive Director since 2002. A member of the Nomination Committee. A member of the Supervisory Board of Euronext NV. Senior adviser to Fleming Family and Partners. Former Chairman of London International Financial Futures and Options Exchange and Gerrard Group plc. A former non-executive Director of the Financial Services Authority and of the Court of The Bank of Ireland. * Non-executive Director † Independent non-executive Director Adviser to the Board D J Shaw Age 58. An Adviser to the Board since 1998. Solicitor. A partner in Norton Rose from 1973 to 1998. A Director of The Bank of Bermuda Limited and HSBC Private Banking Holdings (Suisse) S.A. Secretary R G Barber Age 54. Group Company Secretary since 1990. Joined HSBC in 1980; Corporation Secretary of The Hongkong and Shanghai Banking Corporation Limited from 1986 to 1992. Company Secretary of HSBC Bank plc from 1994 to 1996. 188 C-H Filippi Age 52. A Group Managing Director and Chairman and Chief Executive Officer of CCF S.A. since 1 March 2004. A Director of HSBC Bank plc. Joined CCF S.A. in 1987 having previously held senior appointments in the French civil service. Appointed a Group General Manager in 2001 as Global Head of Corporate and Institutional Banking. S T Gulliver Age 45. A Group Managing Director since 1 March 2004. Co-Head Corporate, Investment Banking and Markets since 2003. Joined HSBC in 1980. Appointed a Group General Manager in 2000. Head of Treasury and Capital Markets in Asia-Pacific from 1996 to 2002 and Head of Global Markets from 2002 to 2003. Y A Nasr Age 50. A Group Managing Director since 1 March 2004. President, HSBC Bank Brasil S.A. - Banco Múltiplo since 2003. Joined HSBC in 1976. Appointed a Group General Manager in 1998. President and Chief Executive Officer of HSBC USA Inc. and HSBC Bank USA from 1999 to 2003. President and Chief Executive Officer of HSBC Bank Canada from 1997 to 1999. J J Studzinski Age 48. A Group Managing Director since 1 March 2004. Co-Head Corporate, Investment Banking and Markets since 2003. Joined HSBC in 2003 having previously been with Morgan Stanley from 1980 to 2003, most recently as Deputy Chairman of Morgan Stanley International. Appointed a Group General Manager in 2003. Group General Managers R J Arena Age 56. Group General Manager, Global e-business. Joined HSBC in 1999. Appointed a Group General Manager in 2000. C C R Bannister Age 46. Chief Executive Officer, Group Private Banking. Joined HSBC in 1994. Appointed a Group General Manager in 2001. R E T Bennett D H Hodgkinson Age 53. Group General Manager, Legal and Compliance. Joined HSBC in 1979. Appointed a Group General Manager in 1998. N S K Booker Age 46. Group General Manager and Chief Executive Officer, India. Joined HSBC in 1981. Appointed a Group General Manager in January 2004. G P S Calvert, OBE Age 52. Group General Manager and Managing Director, The Saudi British Bank. Joined HSBC in 1974. Appointed a Group General Manager in June 2004. Age 54. Group General Manager, Chief Executive Officer and Deputy Chairman, HSBC Bank Middle East Limited. Joined HSBC in 1969. Appointed a Group General Manager in 2003. A P Hope Age 58. Group General Manager, Insurance. Joined HSBC in 1971. Appointed a Group General Manager in 1996. D D J John Age 54. Chief Operating Officer and Director, HSBC Bank plc. Joined HSBC Bank plc in 1971. Appointed a Group General Manager in 2000. Z J Cama M J W King Age 57. Deputy Chairman and Chief Executive Officer, HSBC Bank Malaysia Berhad. Joined HSBC in 1968. Appointed a Group General Manager in 2001. Age 48. Group General Manager, Internal Audit. Joined HSBC in 1986. Appointed a Group General Manager in 2002. V H C Cheng, OBE R C F Or Age 56. Executive Director and Chairman designate, The Hongkong and Shanghai Banking Corporation Limited and Chief Executive Officer, Hang Seng Bank Limited. Joined HSBC in 1978. Appointed a Group General Manager in 1995. A A Flockhart Age 53. Group General Manager, Chief Executive Officer and Chairman, Grupo Financiero HSBC, S.A. de C.V. and HSBC México, S.A. Joined HSBC in 1971. Appointed a Group General Manager in 2002. M J G Glynn Age 53. Group General Manager, President and Chief Executive Officer, HSBC Bank USA, N.A. Joined HSBC in 1982. Appointed a Group General Manager in 2001. K M Harvey Age 44. Group General Manager and Group Chief Information Officer. Joined HSBC Finance Corporation in 1989. Appointed a Group General Manager in August 2004. Age 55. Executive Director, The Hongkong and Shanghai Banking Corporation Limited. Joined HSBC in 1972. Appointed a Group General Manager in 2000. K Patel Age 56. Group General Manager and Head of Corporate, Investment Banking and Markets, Emerging Europe & Africa. Joined HSBC in 1984. Appointed a Group General Manager in 2000. R C Picot Age 47. Group Chief Accounting Officer. Joined HSBC in 1993. Appointed a Group General Manager in 2003. J C S Rankin Age 63. Group General Manager, Human Resources. Joined HSBC in 1960. Appointed a Group General Manager in 1990. B Robertson Age 50. Group General Manager, Credit and Risk. Joined HSBC in 1975. Appointed a Group General Manager in 2003. 189 H S B C H O L D I N G S P L C Board of Directors and Senior Management (continued) M R P Smith, OBE Age 48. President and Chief Executive Officer, The Hongkong and Shanghai Banking Corporation Limited. Joined HSBC in 1978. Appointed a Group General Manager in 2000. I A Stewart Age 46. Group General Manager and Head of Transaction Banking, Corporate, Investment Banking and Markets. Joined HSBC in 1980. Appointed a Group General Manager in 2000. P E Stringham Age 55. Group General Manager, Marketing. Joined HSBC in 2001. Appointed a Group General Manager in 2001. P A Thurston Age 51. Group General Manager, Personal Financial Services, Asia-Pacific. Joined HSBC in 1975. Appointed a Group General Manager in 2003. 190 H S B C H O L D I N G S P L C Report of the Directors Results for 2004 HSBC reported operating profit before provisions of US$22,898 million. Profit attributable to shareholders of HSBC Holdings was US$11,840 million, a 14.4 per cent return on shareholders’ funds. The retained profit transferred to reserves was US$4,539 million. First, second and third interim dividends, each of US$0.13 per ordinary share, were paid on 7 July 2004, 6 October 2004 and 20 January 2005 respectively. The Directors have declared a fourth interim dividend of US$0.27 per ordinary share in lieu of a final dividend, making a total distribution for the year of US$7,301 million. The fourth interim dividend will be payable on 4 May 2005 in cash in United States dollars, or in sterling or Hong Kong dollars at exchange rates to be determined on 25 April 2005, with a scrip dividend alternative. The reserves available for distribution before accounting for the third and fourth interim dividends of US$1,444 million and US$2,996 million respectively are US$10,927 million. Further information about the results is given in the consolidated profit and loss account on page 237. Principal activities and business review Through its subsidiary and associated undertakings, HSBC provides a comprehensive range of banking and related financial services. HSBC operates through long-established businesses and has an international network of over 9,800 offices in 77 countries and territories in Europe; the Asia- Pacific region, the Americas, the Middle East and Africa and serves over 110 million customers. Taken together, the five largest customers of HSBC do not account for more than one per cent of HSBC’s income. In February 2004, The Bank of Bermuda Limited was acquired for US$1,224 million. In April 2004, 15.98 per cent of Industrial Bank Co. Limited was acquired by Hang Seng Bank Limited for US$209 million. In May 2004, 100 per cent of Intesa Bank Canada was acquired for US$88 million. In June 2004, 14.62 per cent of UTI Bank Limited was acquired for US$68 million. In August 2004, 19.9 per cent of Bank of Communications Limited was acquired for US$1,747 million. In November 2004, 100 per cent of Marks and Spencer Retail Financial Services Holdings Limited was acquired for US$1,044 million. A review of the development of the business of HSBC undertakings during the year and an indication of likely future developments are given in the 'Description of Business' on pages 8 to 19. Capital and reserves The following events in relation to the HSBC Holdings ordinary shares of US$0.50 each occurred during the year: Scrip dividends 1. 35,092,117 ordinary shares were issued at par on 20 January 2004 to shareholders who elected to receive new shares in lieu of the 2003 second interim dividend. The market value per share used to calculate shareholders’ entitlements to new shares was US$15.1987, being the United States dollar equivalent of £8.838. 2. 22,984,421 ordinary shares were issued at par on 5 May 2004 to shareholders who elected to receive new shares in lieu of the 2003 third interim dividend. The market value per share used to calculate shareholders’ entitlements to new shares was US$15.0552, being the United States dollar equivalent of £8.16. 3. 52,287,747 ordinary shares were issued at par on 7 July 2004 to shareholders who elected to receive new shares in lieu of the 2004 first interim dividend. The market value per share used to calculate shareholders’ entitlements to new shares was US$14.293 being the United States dollar equivalent of £7.926. 4. 49,677,957 ordinary shares were issued at par on 6 October 2004 to shareholders who elected to receive new shares in lieu of the 2004 second interim dividend. The market value per share used to calculate shareholders’ entitlements to new shares was US$15.0141 being the United States dollar equivalent of £8.307. All-Employee share plans 5. 28,472,134 ordinary shares were issued at prices ranging from £5.2212 to £6.7536 per share in connection with the exercise of options under the HSBC Holdings savings-related share option plans. Options over 7,675,359 ordinary shares lapsed. 6. The HSBC Qualifying Employee Share Ownership Trust (‘the QUEST’) was established in 1999 to satisfy options exercised by UK 191 H S B C H O L D I N G S P L C Report of the Directors (continued) participants of the HSBC Holdings Savings- Related Share Option Plan. At 1 January 2004, the QUEST held 514,293 ordinary shares. During 2004, HSBC QUEST Trustee (UK) Limited, the corporate trustee of the QUEST, transferred 1,592,371 ordinary shares from the QUEST to employees who exercised options under the HSBC Holdings Savings-Related Share Option Plan and subscribed for 1,079,099 ordinary shares at market values ranging from £7.84 to £9.38 using subscription moneys received from those employees. At 31 December 2004, the QUEST held 1,021 ordinary shares. 7. 4,216,456 ordinary shares were issued at €9.679 per share in connection with a Plan d’Epargne Entreprise for the benefit of non-UK resident employees of CCF and its subsidiaries. 8. Options over 11,154,679 ordinary shares were awarded at nil consideration on 21 April 2004 and options over 13,885,457 ordinary shares were awarded at nil consideration on 10 May 2004 to over 46,000 HSBC employees resident in more than 56 countries and territories under the HSBC Holdings savings-related share option plans. The options are exercisable within six months following the third or fifth anniversary of the commencement of the relevant savings contracts on 1 August 2004 at a price of £6.472 per share, a 20 per cent discount to the average market value over the five business days immediately preceding the date of the invitation. Discretionary share incentive plans 9. 14,905,692 ordinary shares were issued at prices ranging from £2.1727 to £7.46 per share in connection with the exercise of options under the HSBC Holdings Executive Share Option Scheme. Options over 812,836 ordinary shares lapsed. 10. 1,460,399 ordinary shares were issued at prices ranging from £6.91 to £8.712 per share in connection with the exercise of options under the HSBC Holdings Group Share Option Plan. Options over 5,548,707 ordinary shares lapsed. 11. Options over 63,341,879 ordinary shares were awarded at nil consideration on 30 April 2004 under the HSBC Holdings Group Share Option Plan. The options are normally exercisable between the third and 10th anniversaries of the award at a price of £8.283 per share, the market value of the ordinary shares on the date of award. 192 12. Options over 340,160 ordinary shares were awarded at nil consideration on 27 August 2004 under the HSBC Holdings Group Share Option Plan. The options are normally exercisable between the third and 10th anniversaries of the award at a price of £8.65 per share, the market value of the ordinary shares on the date of award. HSBC Finance Corporation 13. 1,590,319 ordinary shares were issued at US$9.60 in connection with the early settlement of HSBC Finance Corporation 8.875% Adjustable Conversion-Rate Equity Security Units. 14. 293,254 ordinary shares were issued at prices ranging from US$14.11 to US$17.28 in connection with the exercise of options under HSBC Finance Corporation share plans that have been converted into options over HSBC Holdings ordinary shares. Authority to allot shares 15. At the Annual General Meeting in 2004 shareholders renewed the authority for the Directors to allot new shares. The authority was to allot up to 2,199,800,000 ordinary shares, 10,000,000 non-cumulative preference shares of £0.01 each, 10,000,000 non-cumulative preference shares of US$0.01 each and 10,000,000 non-cumulative preference shares of €0.01 each. Other than as described in paragraphs 1. to 14. above, the Directors did not allot any shares during 2004. Authority to repurchase shares 16. At the Annual General Meeting in 2004 shareholders renewed the authority for the Company to make market repurchases of up to 1,099,900,000 ordinary shares. The Directors have not exercised this authority. Employee share option plans In order to align the interests of staff with those of shareholders, share options are awarded to employees under all-employee share plans and discretionary share incentive plans. The following are particulars of outstanding employee share options, including those held by employees working under employment contracts that are regarded as “continuous contracts” for the purposes of the Hong Kong Employment Ordinance. The options were granted at nil consideration. No options have been granted to substantial shareholders, suppliers of goods or services, or in excess of the individual limit for each share plan. No options were cancelled during the year. Under the authority granted by shareholders at the Annual General Meeting in 2000, the maximum number of new HSBC Holdings ordinary shares that may be issued or become issuable under all the share option plans in any ten year period is 848,847,000 HSBC Holdings ordinary shares (approximately 7.6 per cent of HSBC Holdings’ issued ordinary share capital on 28 February 2005). Within this limit not more than 5 per cent of the issued ordinary share capital of HSBC Holdings from time to time may be put under option under the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000 (approximately 560,000,000 HSBC Holdings ordinary shares on 28 February 2005). Under the HSBC Holdings savings-related share option plans, HSBC Holdings Group Share Option Plan, HSBC Holdings Executive Share Option Scheme and the HSBC Holdings Restricted Share Plan 2000 there were options outstanding over 374,369,127 HSBC Holdings ordinary shares at 31 December 2004. Particulars of options over HSBC Holdings shares held by Directors of HSBC Holdings are set out on pages 229 to 233 of the Directors’ Remuneration Report. Following a comprehensive review of share-based remuneration arrangements in 2004, resolutions relating to employee share plans will be submitted to the forthcoming Annual General Meeting. All-Employee share plans The HSBC Holdings Savings-Related Share Option Plan, HSBC Holdings Savings-Related Share Option Plan: Overseas Section, and previously the HSBC Holdings Savings-Related Share Option Scheme: USA Section, are all-employee share plans under which eligible HSBC employees (those with six months continuous service from July to December of the year preceding the date of grant) are granted options to acquire HSBC Holdings ordinary shares. Employees may make overall contributions of up to £250 (or equivalent) each month over a period of three or five years which may be used on the third or fifth anniversary of the commencement of the relevant savings contract, at their election, to exercise the options; alternatively the employee may elect to have the savings (plus interest) repaid in cash. The options are exercisable within six months following the third or fifth anniversary of the commencement of the relevant savings contract. In the case of redundancy, retirement on grounds of injury or ill health, retirement at or after normal retirement age, the transfer of the employing business to another party, or a change of control of the employing company, options may be exercised before completion of the relevant savings contract. Under the HSBC Holdings Savings-Related Share Option Plan and the HSBC Holdings Savings- Related Share Option Plan: Overseas Section the option exercise price is determined by reference to the average market value of the ordinary shares on the five business days immediately preceding the invitation date, then applying a discount of 20 per cent. The all-employee share plans will terminate on 26 May 2010 unless the Directors resolve to terminate the plans at an earlier date. HSBC Holdings Savings-Related Share Option Plan HSBC Holdings ordinary shares of US$0.50 Date of award 6 Apr 1998 1 Apr 1999 10 Apr 2000 11 Apr 2001 11 Apr 2001 2 May 2002 2 May 2002 23 Apr 2003 23 Apr 2003 21 Apr 2004 21 Apr 2004 Exercise price (£) Exercisable from1 Exercisable until2 Options at 1 January 2004 Options awarded during year3 Options exercised during year4 Options lapsed during year Options at 31 December 2004 5.2212 5.3980 6.0299 6.7536 6.7536 6.3224 6.3224 5.3496 5.3496 6.4720 6.4720 1 Aug 2003 1 Aug 2004 1 Aug 2005 1 Aug 2004 1 Aug 2006 1 Aug 2005 1 Aug 2007 1 Aug 2006 1 Aug 2008 1 Aug 2007 1 Aug 2009 31 Jan 2004 31 Jan 2005 31 Jan 2006 31 Jan 2005 31 Jan 2007 31 Jan 2006 31 Jan 2008 31 Jan 2007 31 Jan 2009 31 Jan 2008 31 Jan 2010 186,165 10,598,682 11,163,824 1,870,853 4,171,431 1,741,719 4,636,144 9,056,673 14,074,491 – – – – – – – – – – – 4,556,417 6,534,250 139,268 10,251,424 448,670 1,724,173 103,513 50,624 48,693 101,884 56,157 2,162 411 46,897 147,716 629,718 78,155 339,842 216,124 374,479 1,076,787 968,910 299,055 206,641 – 199,542 10,085,436 68,525 3,728,076 1,474,971 4,212,972 7,878,002 13,049,424 4,255,200 6,327,198 1 May be advanced to an earlier date in certain circumstances, e.g. retirement. 2 May be extended to a later date in certain circumstances, e.g. on the death of a participant the executors may exercise the option up to six months beyond the normal exercise period. 3 The closing price per share on 20 April 2004, the day before the options were awarded, was £8.29. 4 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.37. 193 H S B C H O L D I N G S P L C Report of the Directors (continued) HSBC Holdings Savings-Related Share Option Plan: Overseas Section HSBC Holdings ordinary shares of US$0.50 Date of award 6 Apr 1998 1 Apr 1999 10 Apr 2000 11 Apr 2001 11 Apr 2001 2 May 2002 2 May 2002 23 Apr 2003 23 Apr 2003 8 May 2003 8 May 2003 21 Apr 2004 21 Apr 2004 10 May 2004 10 May 2004 Exercise price (£) Exercisable from1 Exercisable until2 Options at 1 January 2004 Options awarded during year Options exercised during year3 Options lapsed during year Options at 31 December 2004 5.2212 5.3980 6.0299 6.7536 6.7536 6.3224 6.3224 5.3496 5.3496 5.3496 5.3496 6.4720 6.4720 6.4720 6.4720 1 Aug 2003 1 Aug 2004 1 Aug 2005 1 Aug 2004 1 Aug 2006 1 Aug 2005 1 Aug 2007 1 Aug 2006 1 Aug 2008 1 Aug 2006 1 Aug 2008 1 Aug 2007 1 Aug 2009 1 Aug 2007 1 Aug 2009 31 Jan 2004 31 Jan 2005 31 Jan 2006 31 Jan 2005 31 Jan 2007 31 Jan 2006 31 Jan 2008 31 Jan 2007 31 Jan 2009 31 Jan 2007 31 Jan 2009 31 Jan 2008 31 Jan 2010 31 Jan 2008 31 Jan 2010 78,234 10,942,536 16,622,178 5,773,078 1,459,237 3,393,662 1,224,697 10,459 10,488 17,432,578 6,500,298 – – – – – – – – – – – – – – – 49,5244 14,4884 10,550,5505 3,334,9075 39,315 10,673,901 273,551 5,091,195 9,233 19,040 3,949 – – 67,416 9,744 – – 3,358 605 38,919 98,247 661,486 307,840 108,759 310,873 69,419 – – 980,573 224,861 – – 428,360 61,698 – 170,388 15,687,141 374,043 1,341,245 3,063,749 1,151,329 10,459 10,488 16,384,589 6,265,693 49,524 14,488 10,118,832 3,272,604 1 May be advanced to an earlier date in certain circumstances, e.g. retirement. 2 May be extended to a later date in certain circumstances, e.g. on the death of a participant, the executors may exercise the option up to six months beyond the normal exercise period. 3 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.11. 4 The closing price per share on 20 April 2004, the day before the options were awarded, was £8.29. 5 The closing price per share on 9 May 2004, the day before the options were awarded, was £8.12. HSBC Holdings Savings-Related Share Option Scheme: USA Section HSBC Holdings ordinary shares of US$0.50 Date of award Exercise price (£) Exercisable from1 Exercisable until2 Options at 1 January 2004 Options exercised during year3 Options lapsed during year Options at 31 December 2004 10 Aug 1999 6.3078 1 Jul 2004 31 Dec 2004 1,477,642 949,150 – 528,492 1 May be advanced to an earlier date in certain circumstances, e.g. retirement. 2 May be extended to a later date in certain circumstances, e.g. on the death of a participant, the executors may exercise the option up to six months beyond the normal exercise period. 3 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.33. No options were granted during the period. Discretionary share incentive plans The HSBC Holdings Group Share Option Plan, and previously the HSBC Holdings Executive Share Option Scheme, are discretionary share incentive plans under which HSBC employees, based on performance criteria and potential, are granted options to acquire HSBC Holdings ordinary shares. Since 1996 the vesting of these awards has been subject to the attainment of pre-determined performance criteria, except within CCF (which was acquired in 2000) where performance criteria are being phased in. The maximum value of options which may be granted to an employee in any one year (together with any Performance Share awards under the HSBC Holdings Restricted Share Plan 2000) is 150 per cent of the employee’s annual salary at the date of grant plus any bonus paid for the previous year. In exceptional circumstances this could be raised to 225 per cent. Subject to 194 achievement of the performance condition, options are generally exercisable between the third and tenth anniversary of the date of grant. Employees of a subsidiary that is sold or transferred out of HSBC may exercise options awarded under the HSBC Holdings Group Share Option Plan within six months of the sale or transfer regardless of whether the performance condition is met. The terms of the HSBC Holdings Group Share Option Plan were amended in 2001 so that the exercise price of options granted under the Plan in 2002 and beyond would be the higher of the average market value of the ordinary shares on the five business days prior to the grant of the option or the market value of the ordinary shares on the date of grant of the option. The HSBC Holdings Group Share Option Plan will terminate on 26 May 2005 unless the Directors resolve to terminate the plan at an earlier date. HSBC Holdings Executive Share Option Scheme HSBC Holdings ordinary shares of US$0.50 Date of award 8 Mar 1994 7 Mar 1995 1 Apr 1996 24 Mar 1997 12 Aug 1997 16 Mar 1998 29 Mar 1999 10 Aug 1999 31 Aug 1999 3 Apr 2000 Exercise price (£) Exercisable from1 Exercisable until2 2.8376 2.1727 3.3334 5.0160 7.7984 6.2767 6.3754 7.4210 7.8710 7.4600 8 Mar 1997 7 Mar 1998 1 Apr 1999 24 Mar 2000 12 Aug 2000 16 Mar 2001 3 Apr 2002 10 Aug 2002 31 Aug 2002 3 Apr 2003 8 Mar 2004 7 Mar 2005 1 Apr 2006 24 Mar 2007 12 Aug 2007 16 Mar 2008 29 Mar 2009 10 Aug 2009 31 Aug 2009 3 Apr 2010 Options at 1 January 2004 Options exercised during year3 Options lapsed during year Options at 31 December 2004 82,479 234,000 602,019 1,046,174 14,625 1,954,924 32,420,672 193,800 4,000 23,142,646 82,479 133,500 236,349 255,263 – 499,281 8,802,829 43,642 – 4,852,349 – – 15,000 9,000 – 37,500 299,478 7,500 – 444,358 – 100,500 350,670 781,911 14,625 1,418,143 23,318,365 142,658 4,000 17,845,939 1 May be advanced to an earlier date in certain circumstances, e.g. retirement. 2 May be extended to a later date in certain circumstances, e.g. on the death of a participant, the executors may exercise the option up to twelve months beyond the normal exercise period. 3 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.61. The HSBC Holdings Executive Share Option Scheme was replaced by the HSBC Holdings Group Share Option Plan on 26 May 2000. No options have been granted under the Scheme since that date. HSBC Holdings Group Share Option Plan HSBC Holdings ordinary shares of US$0.50 Date of award 4 Oct 2000 23 Apr 2001 30 Aug 2001 7 May 2002 30 Aug 2002 2 May 2003 29 Aug 2003 3 Nov 2003 30 Apr 2004 27 Aug 2004 Exercise price (£) Exercisable from1 Exercisable until2 9.6420 8.7120 8.2280 8.4050 7.4550 6.9100 8.1300 9.1350 8.2830 8.6500 4 Oct 2003 23 Apr 2004 30 Aug 2004 7 May 2005 30 Aug 2005 2 May 2006 29 Aug 2006 3 Nov 2006 30 Apr 2007 27 Aug 2007 4 Oct 2010 23 Apr 2011 30 Aug 2011 7 May 2012 30 Aug 2012 2 May 2013 29 Aug 2013 3 Nov 2013 30 Apr 2014 27 Aug 2014 Options at 1 January 2004 396,235 47,272,814 356,980 54,343,874 452,350 56,527,650 577,270 4,069,800 – – Options awarded during year Options exercised during year3 Options lapsed during year Options at 31 December 2004 – – – – – – – – 63,341,8794 340,1605 – 1,284,499 25,650 71,850 – 78,400 – – – – 6,883 1,182,858 14,100 1,658,549 7,725 1,647,400 8,200 – 1,022,692 300 389,352 44,805,457 317,230 52,613,475 444,625 54,801,850 569,070 4,069,800 62,319,187 339,860 1 May be advanced to an earlier date in certain circumstances, e.g. retirement. 2 May be extended to a later date in certain circumstances, e.g. on the death of a participant, the executors may exercise the option up to twelve months beyond the normal exercise period. 3 The weighted average closing price of the shares immediately before the dates on which options were exercised was £9.05. 4 The closing price per share on 29 April 2004, the day before the options were awarded, was £8.18. 5 The closing price per share on 26 August 2004, the day before the options were awarded, was £8.61. CCF and subsidiary company plans When it was acquired in 2000, CCF and certain of its subsidiary companies operated employee share option plans under which options could be granted over their respective shares. No further options will be granted under any of these subsidiary company plans. The following are outstanding options to acquire shares in CCF and its subsidiaries. 195 H S B C H O L D I N G S P L C Report of the Directors (continued) CCF shares of €5 Date of award 23 Jun 1994 22 Jun 1995 9 May 1996 7 May 1997 29 Apr 1998 7 Apr 1999 12 Apr 2000 Exercise price (€) 32.78 34.00 35.52 37.05 73.50 81.71 142.50 Exercisable from 23 Jun 1996 22 Jun 1997 9 May 1998 7 Jun 2000 7 Jun 2000 7 Jun 2000 1 Jan 2002 Exercisable until 23 Jun 2004 22 Jun 2005 9 May 2006 7 May 2007 29 Apr 2008 7 Apr 2009 12 Apr 2010 Options at 1 January 2004 Options exercised during year1 Options lapsed during year Options at 31 December 20041 10,800 53,130 89,500 282,630 535,400 788,200 856,000 10,000 1,130 25,000 67,070 147,102 199,778 2,000 800 – – – – – – – 52,000 64,500 215,560 388,298 588,422 854,000 1 Following exercise of the options, the CCF shares will be exchanged for HSBC Holdings ordinary shares in the same ratio as for the acquisition of CCF (13 HSBC Holdings ordinary shares for each CCF share). At 31 December 2004, The HSBC Holdings Employee Benefit Trust 2001 (No. 1) held 26,787,515 HSBC Holdings ordinary shares which may be exchanged for CCF shares arising from the exercise of these options. Banque Chaix shares of €16 Date of award 21 Jun 1999 7 Jun 2000 Exercise price (€) 100.31 105.94 Exercisable from Exercisable until 21 Jun 2004 7 Jun 2005 21 Dec 2004 7 Dec 2005 Options at 1 January 2004 10,000 10,000 Options exercised during year Options lapsed during year Options at 31 December 2004 10,000 – – – – 10,000 Banque de Baecque Beau shares of no par value Date of award Exercise price (€) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 22 Dec 2000 61.66 22 Dec 2003 22 Dec 2005 11,500 – – 11,500 Banque de Savoie shares of €16 Date of award 24 Dec 1998 9 Sep 1999 14 Jun 2000 Exercise price (€) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 61.85 64.79 69.52 24 Dec 2003 9 Sep 2004 14 Jun 2005 24 Jun 2004 9 Mar 2005 14 Dec 2005 5,000 5,000 5,100 5,000 – – – – – – 5,000 5,100 Banque Dupuy de Parseval shares of €20 Date of award 1 Jul 1999 3 Apr 2000 8 Jun 2000 Exercise price (€) 34.76 36.36 39.48 Exercisable from 1 Jul 2004 3 Apr 2005 8 Jun 2005 Exercisable until 1 Oct 2004 3 Jul 2005 8 Sep 2005 Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 5,000 5,000 5,000 5,000 – – – – – – 5,000 5,000 196 Crédit Commercial du Sud Ouest shares of €15.25 Date of award 9 Sep 1999 7 Jun 2000 Exercise price (€) 95.89 102.29 Exercisable from 9 Sep 2004 7 Jun 2005 Exercisable until 9 Mar 2005 7 Dec 2005 Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 7,500 7,500 – – – – 7,500 7,500 HSBC Private Bank France shares of €2 Date of award 21 Dec 1999 9 Mar 2000 15 May 2001 7 Sep 2001 1 Oct 2002 Exercise price (€) Exercisable from Exercisable until 10.84 12.44 20.80 15.475 22.22 21 Dec 2000 27 Jun 2004 15 May 2002 7 Sep 2005 2 Oct 2005 21 Dec 2009 31 Dec 2010 15 May 2011 7 Oct 2007 1 Oct 2012 Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 20041 272,250 149,460 258,525 448,500 229,950 101,750 – – – – – – 4,500 117,000 4,500 170,500 149,460 254,025 331,500 225,450 1 Following exercise of the options, the HSBC Private Bank France shares will be exchanged for HSBC Holdings ordinary shares in the ratio of 1.83 HSBC Holdings ordinary shares for each HSBC Private Bank France share. At 31 December 2004, The CCF Employee Benefit Trust 2001 held 2,294,066 HSBC Holdings ordinary shares which may be exchanged for HSBC Private Bank France shares arising from the exercise of these options. Netvalor shares of €415 Date of award 22 Dec 1999 19 Dec 2000 Exercise price (€) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 415 415 22 Dec 2004 19 Dec 2005 22 Dec 2006 19 Dec 2007 2,410 3,340 – – – 70 2,410 3,270 Sinopia Asset Management shares of €0.50 Date of award 22 Mar 1999 15 Oct 1999 18 Feb 2000 Exercise price (€) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 20041 21.85 18.80 18.66 22 Mar 2004 15 Oct 2004 18 Feb 2005 22 Sep 2004 15 Apr 2005 18 Aug 2005 79,000 45,000 97,500 79,000 15,000 – – – 2,000 – 30,000 95,500 1 Following exercise of the options, the Sinopia shares will be exchanged for HSBC Holdings ordinary shares in the ratio of 2.143 HSBC Holdings ordinary shares for each Sinopia share. At 31 December 2004, The CCF Employee Benefit Trust 2001 held 281,814 HSBC Holdings ordinary shares which may be exchanged for Sinopia shares arising from the exercise of these options. Union de Banques à Paris shares of €16 Date of award 25 Nov 1998 22 Nov 1999 12 Jul 2000 Exercise price (€) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 19.97 33.54 47.81 25 Nov 2003 22 Nov 2004 12 Jul 2005 25 May 2004 22 May 2005 12 Jan 2006 27,000 26,200 25,400 27,000 25,400 2,200 – 800 800 – – 22,400 197 H S B C H O L D I N G S P L C Report of the Directors (continued) HSBC Finance Corporation and subsidiary company plans Following the acquisition of HSBC Finance Corporation in 2003, all outstanding options and equity-based awards over HSBC Finance Corporation common shares were converted into rights to receive HSBC Holdings ordinary shares in the same ratio as the share exchange offer for the acquisition of HSBC Finance Corporation (2.675 HSBC Holdings ordinary shares for each HSBC Finance Corporation common share) and the exercise prices per share were adjusted accordingly. No further options will be granted under any of these plans. All outstanding options and other equity-based awards over HSBC Finance Corporation common shares granted before 14 November 2002, being the date the transaction was announced, vested on completion of the acquisition. Options and equity- based awards granted on or after 14 November 2002 will be exercisable on their original terms, save that they have been adjusted to reflect the exchange ratio. At 31 December 2004, the HSBC (Household) Employee Benefit Trust 2003 held 5,645,439 HSBC Holdings ordinary shares and 2,200,000 American Depositary Shares (‘ADSs’), each of which represents five HSBC Holdings ordinary shares, which may be used to satisfy the exercise of employee share options. HSBC Finance Corporation 1984 Long-Term Executive Incentive Compensation Plan HSBC Holdings ordinary shares of US$0.50 Date of award 1 Feb 1994 7 Feb 1995 10 May 1995 17 Jul 1995 13 Nov 1995 Exercise price (US$) Exercisable from Exercisable until 4.16 5.09 5.91 6.42 7.43 1 Feb 1995 7 Feb 1996 10 May 1996 17 Jul 1996 13 Nov 1996 1 Feb 2004 7 Feb 2005 10 May 2005 17 Jul 2005 13 Nov 2005 Options at 1 January 2004 135,627 1,532,234 48,150 40,125 2,056,007 Options exercised during year1 Options lapsed during year Options at 31 December 2004 135,627 1,384,092 48,150 40,125 1,772,876 – – – – – – 148,142 – – 283,131 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.63. HSBC Finance Corporation 1996 Long-Term Executive Incentive Compensation Plan HSBC Holdings ordinary shares of US$0.50 Date of award 11 Nov 1996 14 May 1997 10 Nov 1997 15 Jun 1998 1 Jul 1998 9 Nov 1998 17 May 1999 3 Jun 1999 31 Aug 1999 8 Nov 1999 30 Jun 2000 8 Feb 2000 13 Nov 2000 12 Nov 2001 20 Nov 2002 Exercise price (US$) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year1 Options lapsed during year Options at 31 December 2004 11.43 11.29 14.60 17.08 19.21 13.71 16.99 16.32 13.96 16.96 15.70 13.26 18.40 21.37 10.66 11 Nov 1997 14 May 1998 10 Nov 1998 15 Jun 1999 1 Jul 1999 9 Nov 1999 17 May 2000 3 Jun 2000 31 Aug 2000 8 Nov 2000 30 Jun 2001 8 Feb 2001 13 Nov 2001 12 Nov 2002 20 Nov 20032 11 Nov 2006 14 May 2007 10 Nov 2007 15 Jun 2008 1 Jul 2008 9 Nov 2008 17 May 2009 3 Jun 2009 31 Aug 2009 8 Nov 2009 30 Jun 2010 8 Feb 2010 13 Nov 2010 12 Nov 2011 20 Nov 2012 2,587,394 200,630 4,224,670 802,500 80,250 4,928,354 334,375 200,625 345,077 4,869,841 26,846 66,875 6,379,208 7,571,322 7,315,727 1,580,925 – 208,650 – – 232,725 – – – – – – – – 174,139 – – – – – – – – – – – – – – 30,094 1,006,469 200,630 4,016,020 802,500 80,250 4,695,629 334,375 200,625 345,077 4,869,841 26,846 66,875 6,379,208 7,571,322 7,111,494 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.85. 2 25 per cent of the original award is exercisable on each of the first, second, third and fourth anniversaries of the date of award. May be advanced to an earlier date in certain circumstances, e.g. retirement. 198 HSBC Finance Corporation 1996 Long-Term Executive Incentive Compensation Plan1 HSBC Holdings ordinary shares of US$0.50 Date of award 15 Nov 2002 20 Nov 2002 2 Dec 2002 16 Dec 2002 20 Dec 2002 2 Jan 2003 15 Jan 2003 3 Feb 2003 14 Feb 2003 3 Mar 2003 Exercise price (US$) Exercisable from2 Exercisable until2 nil nil nil nil nil nil nil nil nil nil 15 Nov 2005 20 Nov 2005 2 Dec 2005 16 Dec 2005 20 Dec 2005 2 Jan 2006 15 Jan 2006 3 Feb 2006 14 Feb 2006 3 Mar 2006 15 Nov 2007 20 Nov 2007 2 Dec 2007 16 Dec 2007 20 Dec 2007 2 Jan 2008 15 Jan 2008 3 Feb 2008 14 Feb 2008 3 Mar 2008 Rights at 1 January 2004 7,222 1,961,448 10,701 35,846 180,564 1,338 33,438 11,241 267,768 2,676 Rights exercised during year3 Rights lapsed during year Rights at 31 December 2004 – 84,317 – – 10,700 – – 1,057 80,250 – – 88,047 – – 5,350 – 2,006 549 – 1,338 7,222 1,789,084 10,701 35,846 164,514 1,338 31,432 9,635 187,518 1,338 1 Awards of Restricted Stock Rights which represent a right to receive shares if the employee remains in the employment of HSBC Finance Corporation at the date of vesting. 2 Restricted Stock Rights vest one-third on each of the third, fourth and fifth anniversaries of the date of award. Vesting may be advanced to an earlier date in certain circumstances, e.g. retirement. 3 The weighted average closing price of the shares immediately before the dates on which rights were exercised was £8.57. HSBC Finance Corporation Deferred Fee Plan for Directors Prior to 28 March 2003, HSBC Finance Corporation directors could choose to defer all or a portion of their cash compensation under the Deferred Fee Plan for Directors. At the end of the deferred period selected by the director, all accumulated amounts will be paid in shares in one or more instalments. Following the acquisition of HSBC Finance Corporation the rights to receive HSBC Finance Corporation common shares under the plan were HSBC Holdings ordinary shares of US$0.50 converted into rights to receive HSBC Holdings ordinary shares. No further awards will be granted under this plan. A summary of the rights to receive HSBC Holdings ordinary shares under this plan is set out below. Full details are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Share plans’ or can be obtained upon request from the Group Company Secretary, 8 Canada Square, London E14 5HQ. Dates of deferral Range of prices (US$) Deferral period Rights at 1 January 2004 Rights exercised during year1 Rights lapsed during year2 Rights at 31 December 2004 1 Oct 1995 – 15 Jan 2003 5.42 – 25.40 1 Jan 2000 – 31 Dec 2021 188,406 2,106 186,300 – 1 The weighted average closing price of the shares immediately before the dates on which shares were delivered was £8.57. 2 In May 2004, the rights of participants to receive new HSBC Holdings ordinary shares under the Deferred Fee Plan for Directors were transferred to the HSBC-North America Directors’ Non-Qualified Deferred Compensation Plan. Under this new plan the rights to receive HSBC Holdings ordinary shares must be met through a grantor trust which has acquired, through market purchase, sufficient ADSs to satisfy all the outstanding obligations to deliver HSBC Holdings ordinary shares. All rights to receive HSBC Holdings ordinary shares under the new plan will be met solely from the HSBC Holdings ordinary shares held by the grantor trust. No further rights to receive HSBC Holdings ordinary shares will be granted and no new HSBC Holdings ordinary shares will be issued under this plan. HSBC Finance Corporation Deferred Phantom Stock Plan for Directors In 1995, the HSBC Finance Corporation Directors’ Retirement Income Plan was discontinued and the present value of each director’s accrued benefit was exchanged for a deferred right to receive HSBC Finance Corporation common shares. Following the acquisition of HSBC Finance Corporation the rights to receive HSBC Finance Corporation common shares under the plan were converted into rights to receive HSBC Holdings ordinary shares. When a director dies or leaves the Board due to retirement or resignation, all accumulated amounts will be released in HSBC Holdings ordinary shares in one or more instalments. No further awards will be granted under this plan. A summary of the rights to receive HSBC Holdings ordinary shares under this plan is set out below. Full details are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Share plans’ or can be obtained upon request from the Group Company Secretary, 8 Canada Square, London E14 5HQ. 199 H S B C H O L D I N G S P L C Report of the Directors (continued) HSBC Holdings ordinary shares of US$0.50 Dates of deferral Range of prices (US$) Deferral period 30 Jan 1996 – 15 Jan 2003 7.75 – 25.40 1 Jan 2000 – 31 Dec 2020 Rights at 1 January 2004 102,468 Rights exercised during year1 Rights lapsed during year2 Rights at 31 December 2004 722 101,746 – 1 The weighted average closing price of the shares immediately before the dates on which shares were delivered was £8.45. 2 In May 2004, the rights of participants to receive new HSBC Holdings ordinary shares under the Deferred Phantom Stock Plan for Directors were transferred to the HSBC-North America Directors’ Non-Qualified Deferred Compensation Plan. Under this new plan the rights to receive HSBC Holdings shares must be met through a grantor trust which has acquired, through market purchase, sufficient ADSs to satisfy all the outstanding obligations to deliver HSBC Holdings ordinary shares. All rights to receive HSBC Holdings ordinary shares under the new plan will be met solely from the HSBC shares held by the grantor trust. No further rights to receive HSBC Holdings ordinary shares will be granted and no new HSBC Holdings ordinary shares will be issued under this plan. HSBC Finance Corporation Non-Qualified Deferred Compensation Plan for Restricted Stock Rights HSBC Holdings ordinary shares of US$0.50 Date of award Exercise price (US$) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year1 Options lapsed during year Options at 31 December 2004 10 May 2000 nil 10 May 2002 10 May 2005 294,329 113,204 – 181,125 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.28. HSBC Finance Corporation Non-Qualified Deferred Compensation Plan for Stock Option Exercises HSBC Holdings ordinary shares of US$0.50 Date of award Exercise price (US$) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year Options lapsed during year Options at 31 December 2004 2 Feb 1991 2.48 2 Feb 1992 15 Jul 2005 20,819 – – 20,819 Beneficial Corporation 1990 Non-Qualified Stock Option Plan HSBC Holdings ordinary shares of US$0.50 Date of award 15 Nov 1994 15 Nov 1995 20 Nov 1996 13 Dec 1996 14 Nov 1997 19 Nov 1997 1 Dec 1997 Exercise price (US$) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year1 Options lapsed during year Options at 31 December 2004 4.56 6.00 7.86 7.54 9.20 9.39 9.68 15 Nov 1995 15 Nov 1996 20 Nov 1997 13 Dec 1997 14 Nov 1998 19 Nov 1998 1 Dec 1998 15 Nov 2004 15 Nov 2005 20 Nov 2006 13 Dec 2006 14 Nov 2007 19 Nov 2007 1 Dec 2007 103,682 215,727 313,162 65,624 131,248 429,135 65,624 103,682 38,127 23,458 – – 23,861 – – – – – – – – – 177,600 289,704 65,624 131,248 405,274 65,624 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.57. Beneficial Corporation BenShares Equity Participation Plan HSBC Holdings ordinary shares of US$0.50 Date of award 31 Jan 1997 15 Nov 1997 Exercise price (US$) Exercisable from Exercisable until 9.87 11.04 31 Jan 1998 15 Nov 1998 31 Jan 2007 15 Nov 2007 Options at 1 January 2004 46,243 62,264 Options exercised during year1 Options lapsed during year Options at 31 December 2004 4,926 6,568 – – 41,317 55,696 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.62. 200 Renaissance Holdings, Inc. Amended and Restated 1997 Incentive Plan HSBC Holdings ordinary shares of US$0.50 Date of award 31 Oct 1997 1 Jan 1998 1 Oct 1998 1 Jan 1999 Exercise price (US$) Exercisable from Exercisable until Options at 1 January 2004 Options exercised during year1 Options lapsed during year Options at 31 December 2004 1.25 1.25 1.74 2.24 31 Oct 1998 1 Jan 1999 1 Oct 1999 1 Jan 2000 31 Oct 2007 1 Jan 2008 1 Oct 2008 1 Jan 2009 4,739 3,224 2,810 5,024 – 1,800 1,204 – – – – – 4,739 1,424 1,606 5,024 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.84. Bank of Bermuda plans Following the acquisition of Bank of Bermuda on 18 February 2004, all outstanding options over Bank of Bermuda shares were converted into rights to receive HSBC Holdings ordinary shares based on the consideration of US$40 for each Bank of Bermuda share and the average closing price of HSBC Holdings ordinary shares, derived from the London Stock Exchange Daily Official List, for the five business days preceding the closing date of the Bank of Bermuda Executive Share Option Plan 1997 HSBC Holdings ordinary shares of US$0.50 acquisition. No further options will be granted under any of these plans. All outstanding options over Bank of Bermuda shares vested on completion of the acquisition. At 31 December 2004, the HSBC (Bank of Bermuda) Employee Benefit Trust 2004 held 3,255,273 HSBC Holdings ordinary shares which may be used to satisfy the exercise of these options. Date of award 12 Jun 1997 22 Dec 1997 1 Jul 1998 23 Jul 1998 23 Feb 1999 26 Jul 1999 3 Aug 1999 4 Feb 2000 7 Apr 2000 29 May 2000 1 Jun 2000 31 Jul 2000 19 Sep 2000 11 Jan 2001 Exercise price (US$) Exercisable from Exercisable until Options at 18 February 2004 Options exercised during period1 Options lapsed during period Options at 31 December 2004 3.86 6.33 9.61 8.58 7.40 6.66 7.10 7.21 7.37 7.21 7.04 10.11 11.31 14.27 12 Jun 1998 22 Dec 1998 1 Jul 1999 23 Jul 1999 23 Feb 2000 26 Jul 2000 3 Aug 2000 4 Feb 2001 7 Apr 2001 29 May 2001 1 Jun 2001 31 Jul 2001 19 Sep 2001 11 Jan 2002 12 Jun 2007 22 Dec 2007 1 Jul 2008 23 Jul 2008 23 Feb 2009 26 Jul 2009 3 Aug 2009 4 Feb 2010 7 Apr 2010 29 May 2010 1 Jun 2010 31 Jul 2010 19 Sep 2010 11 Jan 2011 245,196 33,906 67,813 139,019 24,998 159,363 9,331 88,777 385 15,411 61,649 166,454 40,458 161,829 245,196 33,906 – 139,019 6,534 159,363 – 19,266 – – – – – – – – – – – – – 1,586 – – – – – – – – 67,813 – 18,464 – 9,331 67,925 385 15,411 61,649 166,454 40,458 161,829 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.85. 201 H S B C H O L D I N G S P L C Report of the Directors (continued) Bank of Bermuda Share Option Plan 2000 HSBC Holdings ordinary shares of US$0.50 Date of award Exercise price (US$) Exercisable from Exercisable until Options at 18 February 2004 Options exercised during period1 Options lapsed during period Options at 31 December 2004 11 Jan 2001 6 Feb 2001 29 Mar 2001 16 Apr 2001 6 Jun 2001 16 Jul 2001 28 Aug 2001 26 Sep 2001 16 Jan 2002 30 Jan 2002 5 Feb 2002 5 Feb 2002 10 Jul 2002 9 Sep 2002 16 Dec 2002 4 Feb 2003 1 Apr 2003 21 Apr 2003 14.27 16.41 15.39 15.57 18.35 16.87 15.39 12.79 16.11 15.60 16.09 16.41 15.84 12.34 11.27 10.69 11.97 11.85 11 Jan 2002 6 Feb 2002 29 Mar 2002 16 Apr 2002 6 Jun 2002 16 Jul 2002 28 Aug 2002 26 Sep 2002 16 Jan 2003 30 Jan 2003 5 Feb 2003 5 Feb 2003 10 Jul 2003 9 Sep 2003 16 Dec 2003 4 Feb 2004 1 Apr 2004 21 Apr 2004 11 Jan 2011 6 Feb 2011 29 Mar 2011 16 Apr 2011 6 Jun 2011 16 Jul 2011 28 Aug 2011 26 Sep 2011 16 Jan 2012 30 Jan 2012 5 Feb 2012 5 Feb 2012 10 Jul 2012 9 Sep 2012 16 Dec 2012 4 Feb 2013 1 Apr 2013 21 Apr 2013 161,829 1,111,908 540 539 8,091 245,610 13,486 468,611 3,678 1,226 1,483,066 1,383 12,260 61,299 6,130 387,068 28,541 48,853 – 33,733 – – – 20,979 – 6,741 – – 54,204 – – – – 25,786 – – – 10,569 – – – – – 2,219 – – 7,711 – – – – 1,415 – – 161,829 1,067,606 540 539 8,091 224,631 13,486 459,651 3,678 1,226 1,421,151 1,383 12,260 61,299 6,130 359,867 28,541 48,853 1 The weighted average closing price of the shares immediately before the dates on which options were exercised was £8.90. Bank of Bermuda Directors’ Share Option Plan HSBC Holdings ordinary shares of US$0.50 Date of award 22 Sep 1999 20 Sep 2000 28 Mar 2001 3 Apr 2002 30 Apr 2003 Exercise price (US$) Exercisable from Exercisable until Options at 18 February 2004 Options exercised during period Options lapsed during period Options at 31 December 2004 8.02 11.31 15.76 16.01 12.23 22 Sep 2000 20 Sep 2001 28 Mar 2002 3 Apr 2003 30 Apr 2004 22 Sep 2009 20 Sep 2010 28 Mar 2011 3 Apr 2012 30 Apr 2013 7,706 9,440 18,205 34,328 9,808 – – – – – – – – – – 7,706 9,440 18,205 34,328 9,808 Valuation of freehold and leasehold land and buildings HSBC’s freehold and long leasehold properties, together with all leasehold properties in Hong Kong, were revalued in September 2004 in accordance with HSBC’s policy of annual valuation. As a result of this revaluation, the net book value of land and buildings has increased by US$1,246 million. Further details are included in Note 24 of the ‘Notes on the Financial Statements’ on page 275. Corporate Governance Report The information set out on pages 186 to 234 and information incorporated by reference constitutes the Corporate Governance Report of HSBC Holdings. 202 Board of Directors The objectives of the management structures within HSBC, headed by the Board of Directors of HSBC Holdings and led by the Group Chairman, are to deliver sustainable value to shareholders. Implementation of the strategy set by the Board is delegated to the Group Management Board under the leadership of the Group Chief Executive. The Board sets the strategy for HSBC through the five-year strategic plan and approves the annual operating plans presented by management for the achievement of the strategic objectives. The annual operating plans ensure the efficient disposition of HSBC’s resources for the achievement of these objectives. The Board delegates the management and day to day running of HSBC to the Group Management Board but retains to itself approval of certain matters including annual plans and performance targets, procedures for monitoring and control of operations, specified senior appointments, acquisitions and disposals above predetermined thresholds and any substantial change in balance sheet management policy. The Board of Directors meets regularly and Directors receive information between meetings about the activities of committees and developments in HSBC’s business. All Directors have full and timely access to all relevant information and may take independent professional advice if necessary. HSBC Holdings has a unitary Board of Directors. The authority of each Director is exercised in Board Meetings where the Board acts collectively as a unit. At 1 March 2005 the Board will comprise seven executive and 15 non-executive Directors. The roles of Group Chairman and Group Chief Executive are separated and held by experienced executive Directors. The division of responsibilities between the Group Chairman and the Group Chief Executive is clearly established, set out in writing and agreed by the Board. Before assuming the role of Group Chairman in 1998 Sir John Bond had been the Group Chief Executive for five years. The Group Chairman’s knowledge of HSBC’s complex and widespread geographical business from his previous service as Group Chief Executive has been a considerable benefit to HSBC. Executive Directors are employees who carry out executive functions in HSBC in addition to their duties as Directors. Non-executive Directors are not HSBC employees and do not participate in the daily business management of HSBC. Non-executive Directors constructively challenge and help develop proposals on strategy, scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. The roles of non-executive Directors as members of Board committees are set out below. It is estimated that non-executive Directors spend 24 days per annum on HSBC business after an induction phase, with Committee members devoting significant additional time. The names and brief biographical particulars of the Directors are listed on pages 186 to 188. The Board considers all of the non-executive directors to be independent in character and judgement. Baroness Dunn and H Sohmen have served on the Board for more than nine years, however, and in that respect only, do not meet the usual criteria for independence set out in the UK Combined Code on corporate governance. The Board has therefore determined Lord Butler, R K F Ch’ien, J D Coombe, R A Fairhead, W K L Fung, S Hintze, J W J Hughes-Hallett, Sir John Kemp- Welch, Sir Brian Moffat, Sir Mark Moody-Stuart, S W Newton, C S Taylor and Sir Brian Williamson to be independent. In reaching its determination of each non-executive Director’s independence the Board has concluded that there are no relationships or circumstances which are likely to affect the Director’s judgement and any relationships or circumstances which could appear to do so were considered not to be material. In accordance with the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited each non- executive Director determined by the Board to be independent has provided confirmation of his or her independence to HSBC Holdings. The Directors who served during the year were W F Aldinger, Sir John Bond, Lord Butler, R K F Ch’ien, C F W de Croisset, W R P Dalton, Baroness Dunn, D G Eldon, R A Fairhead, D J Flint, W K L Fung, M F Geoghegan, S K Green, S Hintze, A W Jebson, Sir John Kemp-Welch, Lord Marshall, Sir Brian Moffat, Sir Mark Moody-Stuart, S W Newton, H Sohmen, C S Taylor and Sir Brian Williamson. C F W de Croisset retired as a Director on 27 February 2004 and W R P Dalton and Lord Marshall retired as Directors on 28 May 2004. R A Fairhead and M F Geoghegan were appointed Directors with effect from 1 March 2004. J D Coombe and J W J Hughes-Hallett have been appointed Directors with effect from 1 March 2005. Having been appointed since the Annual General Meeting in 2004, they will retire at the forthcoming Annual General Meeting and offer themselves for re-election. W F Aldinger is to retire as a Director on 29 April 2005. Sir John Bond, R K F Ch’ien, Baroness Dunn, D G Eldon, D J Flint, Sir Brian Moffat, S W Newton and H Sohmen will retire by rotation at the forthcoming Annual General Meeting. With the exception of D G Eldon, who is to retire, they will offer themselves for re-election. The Board has undertaken an evaluation of its performance and that of its committees. This evaluation covered board structure; dynamics; capabilities and processes; corporate governance; strategic clarity and alignment; and the performance of individual Directors. In undertaking this review the Group Chairman held structured meetings with each Director using a similar framework to that employed by MWM Consulting, who prepared an independent performance evaluation of the Board and its committees in January 2004. The report on the evaluation of the Board and its committees has been reviewed by the Board and has been used by 203 H S B C H O L D I N G S P L C Report of the Directors (continued) the non-executive Directors, led by Sir Brian Moffat, in their evaluation of the performance of the Group Chairman. The Group Audit Committee, the Remuneration Committee, the Nomination Committee and the Corporate Social Responsibility Committee have also each undertaken a review of their terms of reference and their own effectiveness during 2004. Following this review the Group Chairman has confirmed that the Directors standing for re-election at the Annual General Meeting continue to perform effectively and to demonstrate commitment to their roles. It is the intention of the Board of HSBC Holdings to continue to review its performance and that of its Directors annually. Seven regular Board meetings were held during 2004. W F Aldinger, Sir John Bond, Lord Butler, Baroness Dunn, D G Eldon, D J Flint, W K L Fung, S K Green, S Hintze, A W Jebson, Sir John Kemp- Welch, Sir Brian Moffat, S W Newton, C S Taylor and Sir Brian Williamson attended all of the Board meetings. R K F Ch’ien, Sir Mark Moody-Stuart and H Sohmen attended six of the Board meetings. C F W de Croisset attended the two Board meetings held before his retirement. W R P Dalton attended all four Board meetings held before his retirement and Lord Marshall attended three of the four meetings held before his retirement. R A Fairhead attended four, and M F Geoghegan attended all, of the five Board meetings held following their appointment. During 2004 the non-executive Directors and the Group Chairman met twice to discuss Board performance and succession planning, and the non- executives met once without the Group Chairman to discuss his performance. In addition to the meetings of the principal committees referred to below, 12 other meetings of committees of the Board were held during the year to discharge business delegated by the Board. The Board ensures all Directors, including non- executive Directors, develop an understanding of the views of major shareholders through attendance at analyst meetings following results announcements and other ad hoc meetings with investors and their representative bodies. In April 2004 the Board held an informal meeting with representatives of institutional shareholders to discuss corporate governance matters. An Investor Day, attended by executive and non-executive Directors, was held in September 2004 to articulate HSBC’s Managing for Growth strategy. meetings with institutional investors and report to the Board on those meetings. All Directors attended the 2004 Annual General Meeting. At the Annual General Meeting shareholders may ask questions and are invited to meet with Directors after the conclusion of the Meeting. Sir Brian Moffat, Deputy Chairman and senior independent non-executive Director, is available to shareholders should they have concerns which contact through the normal channels of Group Chairman, Group Chief Executive, Group Finance Director or other executives has failed to resolve or for which such contact would be inappropriate. Sir Brian Moffat may be contacted through the Group Company Secretary at 8 Canada Square, London E14 5HQ. The Group Chairman’s principal commitments outside HSBC are as a non-executive Director of Ford Motor Company and, since January 2005, as a non-executive Director of Vodafone Group plc. During 2004, he ceased to be a member of the Court of the Bank of England. Full, formal and tailored induction programmes are arranged for newly appointed Directors and opportunities to update and develop skills and knowledge are provided to all Directors. The terms and conditions of appointments of non-executive Directors are available for inspection at 8 Canada Square, London E14 5HQ and will be made available for 15 minutes before the Annual General Meeting and during the Meeting itself. The Board of HSBC Holdings has adopted a code of conduct for transactions in Group securities by Directors and their connected persons that complies with The Model Code in the Listing Rules of the Financial Services Authority and, except as noted below, with The Model Code for Securities Transactions by Directors of Listed Issuers (‘Hong Kong Model Code’) set out in the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. The Stock Exchange of Hong Kong has granted certain waivers from strict compliance with the Hong Kong Model Code, largely to take into account accepted practices in the UK, particularly in respect of employee share plans. Following a specific enquiry, each Director has confirmed he or she has complied with the code of conduct for transactions in Group securities throughout the year. None of the Directors had, during the year or at The Group Chairman, Group Chief Executive the end of the year, a material interest, directly or and the Group Finance Director hold regular 204 indirectly, in any contract of significance with HSBC Holdings or any of its subsidiary undertakings. Board committees The Board has appointed a number of committees consisting of certain Directors, Group Managing Directors and, in the case of the Corporate Social Responsibility Committee, certain co-opted non- director members. The following are the principal committees: Group Management Board The Group Management Board meets regularly and operates as a general management committee under the direct authority of the Board. The members of the Group Management Board are S K Green (Chairman), Sir John Bond, W F Aldinger, D G Eldon, D J Flint, M F Geoghegan and A W Jebson, all of whom are executive Directors, and C-H Filippi, S T Gulliver, Y A Nasr and J J Studzinski, all of whom are Group Managing Directors. The Group Management Board exercises the powers, authorities and discretions of the Board in so far as they concern the management and day to day running of HSBC in accordance with such policies and directions as the Board may from time to time determine. Matters reserved for approval by the Board include annual plans and performance targets, procedures for monitoring and control of operations, specified senior appointments, acquisitions and disposals above predetermined thresholds and any substantial change in balance sheet management policy. The Group Management Board sub-delegates credit, investment and capital expenditure authorities to its members. Group Audit Committee The Group Audit Committee meets regularly with HSBC’s senior financial, internal audit, legal and compliance management and the external auditor to consider HSBC Holdings’ financial reporting, the nature and scope of audit reviews and the effectiveness of the systems of internal control and compliance. The members of the Group Audit Committee throughout 2004 were Sir Brian Moffat (Chairman), R K F Ch’ien and Sir John Kemp- Welch. R A Fairhead was appointed a member of the Committee with effect from 1 March 2004 and J D Coombe has been appointed a member of the Committee with effect from 1 July 2005. All members of the Committee are independent non- executive Directors. The Board has determined that Sir Brian Moffat, R A Fairhead and, with effect from 1 July 2005, J D Coombe may be regarded as audit committee financial experts for the purposes of section 407 of the Sarbanes Oxley Act and as having recent and relevant financial experience. Since 2004 appointments to the Committee have been made for periods of up to three years, extendable by no more than two additional three- year periods, so long as members continue to be independent. Formal and tailored induction programmes are held for newly appointed Committee members and appropriate training is provided on an ongoing and timely basis. There were seven meetings of the Group Audit Committee during 2004. Sir John Kemp-Welch and Sir Brian Moffat attended all of the meetings and R K F Ch’ien attended five. R A Fairhead attended each of the five meetings held following her appointment. At the beginning of each meeting the Committee meets with the external auditor, without management present, to facilitate the discussion of any matter relating to its remit and any issue arising from the audit. Similar arrangements have been adopted for the Committee to meet with the internal auditor. The terms of reference of the Committee, which are reviewed annually, are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Board Committees’. The Group Audit Committee is accountable to the Board and assists the Board in meeting its responsibilities in ensuring an effective system of internal control and compliance and for meeting its external financial reporting obligations. The Committee is directly responsible on behalf of the Board for the selection, oversight and remuneration of the external auditor. The Committee receives frequent comprehensive reports from each of the Head of Group Compliance, the Group General Manager Legal and Compliance, the Group General Manager Internal Audit and the Head of Group Security and receives periodic presentations from other functional heads and line management. The Committee monitors the integrity of the financial statements of HSBC Holdings, reviewing significant financial reporting judgements contained in them. During 2004 the Committee reviewed the HSBC Holdings 2003 Results Announcement, the Annual Report and Accounts 2003, the Annual Review 2003, Interim Results 2004 Announcement and the Interim Report 2004 before they were submitted to the Board. 205 H S B C H O L D I N G S P L C Report of the Directors (continued) During 2004 the Committee received presentations on the implications of the introduction of International Financial Reporting Standards and the plans for implementing the standards within HSBC in 2005. In undertaking its annual review of its own effectiveness the Committee discussed with the external auditor the effectiveness of the internal audit function. The Committee also receives summaries of periodic peer reviews of the internal audit functions around HSBC. The Committee undertakes an annual review of the effectiveness of HSBC’s system of internal control, as set out on page 209. The Committee reports on its activities at each Board meeting and, twice annually, produces a written summary of its activities. The Committee has approved procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls and auditing matters, and the confidential and anonymous submission by employees of concerns regarding questionable accounting or auditing matters. The Committee receives regular reports regarding the nature, investigation and resolution of material complaints and concerns from the Head of Group Compliance. The Committee reviews and monitors the external auditor's independence and objectivity and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The Committee receives reports from the external auditor on their own policies and procedures regarding independence and quality control and oversees the appropriate rotation of audit partners with the external auditor. The Group Audit Committee has adopted policies for the pre-approval of specific services that may be provided by the principal auditor, KPMG Audit Plc and its affiliates (‘KPMG’), since 2003. These policies are kept under review and amended as necessary to meet the dual objectives of ensuring that HSBC benefits in a cost effective manner from the cumulative knowledge and experience of its auditor whilst also ensuring that the auditor maintains the necessary degree of independence and objectivity. These pre-approval policies apply to all services where HSBC Holdings or any of its subsidiaries pays for the service, or is a beneficiary or addressee of the service and has selected, or influences the choice of, KPMG. In two instances in 2004, services provided by KPMG were inadvertently not pre-approved individually or 206 entered into pursuant to the pre-approval policies but were subsequently approved by the Group Audit Committee after the services had been rendered. Total fees billed for such services were US$15,000, which represents less than 0.01 per cent of the total non-audit fees billed by KPMG during 2004. All other services entered into with KPMG during 2004 were pre-approved by the Group Audit Committee or were entered into under pre-approval policies established by the Group Audit Committee. The pre-approved services relate to the provision of objective advice, attestation type services or opinions on areas such as controls and are used as an input into management decision making. They fall into the following four categories: Audit services In addition to the statutory audit appointments, which are approved by the Group Audit Committee, this category includes services that are normally provided by the independent auditor in connection with statutory and regulatory filings or engagements, such as reviews of interim financial information, letters to securities underwriters in connection with debt or equity offerings, the inclusion of auditors’ reports in filings with the SEC and certain reports on internal control over financial reporting. Audit-related services These services are those provided by the principal auditor that are reasonably related to the performance of the audit or review of the Group’s financial statements. Examples of such services are due diligence services provided in connection with potential acquisitions, audits or reviews of employee benefit plans, ad hoc attestation or agreed-upon procedures reports (including reports requested by regulators), and accounting and regulatory advice on actual or contemplated transactions. Tax services This category includes both tax advice and compliance services. Examples of such services are advice on national and local income taxation matters, (including assistance in data gathering for preparation, review and submission as agent of tax filings), advice on tax consequences of management- proposed transactions and assistance in responding to tax examinations by governmental authorities. The pre-approved tax services explicitly exclude proposals for tax structures unconnected with a contemplated transaction and whose main motive is to reduce taxation. Other services This category includes various other assurance and advisory services such as training or advice or assurance provided on specific elements of financial data and models, IT security and advice, and providing due diligence on financial reviews of HSBC customers and private equity investments. All services provided by KPMG relating to the implementation of section 404 of the Sarbanes- Oxley Act were specifically pre-approved by the Group Audit Committee. The remuneration paid to KPMG for each of the last three years is disclosed in Note 5(d) on page 258 of the ‘Notes on the Financial Statements’. The Committee has recommended to the Board that KPMG Audit Plc be reappointed as Auditor at the forthcoming Annual General Meeting. Remuneration Committee The role of the Remuneration Committee and its membership are set out in the Directors’ Remuneration Report on page 216. Nomination Committee The Nomination Committee is responsible for leading the process for Board appointments and for identifying and nominating, for approval of the Board, candidates for appointment to the Board. Before recommending an appointment to the Board the Committee evaluates the balance of skills, knowledge and experience on the Board and, in the light of this identifies the role and capabilities required for a particular appointment. Candidates are considered on merit against these criteria. Care is taken to ensure that appointees have enough time to devote to HSBC. All Directors are subject to election by shareholders at the Annual General Meeting following their appointment and to re-election at least every three years. The members of the Nomination Committee throughout 2004 were Sir Brian Moffat (Chairman), Lord Butler and Baroness Dunn. Sir Brian Williamson was appointed a Member of the Committee on 1 October 2004. There were two Nomination Committee meetings during 2004, each of which was attended by Sir Brian Moffat, Lord Butler and Baroness Dunn. There have been no meetings of the Committee since Sir Brian Williamson was appointed a member. Following each meeting the Committee reports to the Board on its activities. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Board Committees’. The appointments of R A Fairhead, J D Coombe and J W J Hughes-Hallett as non-executive Directors and M F Geoghegan as an executive Director were made on the advice and recommendation of the Nomination Committee. An external consultancy was used in connection with the appointments of R A Fairhead, J D Coombe and J W J Hughes- Hallett. The Committee makes recommendations to the Board concerning plans for succession for both executive and non-executive directors; the appointment of any director to executive or other office; suitable candidates for the role of senior independent director; the re-election by shareholders of directors retiring by rotation; the renewal of the terms of office of non-executive directors; membership of Board Committees, in consultation with the Group Chairman and the chairman of such committee as appropriate; any matters relating to the continuation in office of any director at any time; directors’ fees and committee fees for the Company and any of its subsidiaries as appropriate; and appointments and re-appointments to the Boards of Directors of major subsidiary companies as appropriate. The Committee regularly reviews the structure, size and composition of the Board and keeps under review the leadership needs of HSBC with a view to ensuring the continued ability of HSBC to compete effectively in the marketplace. The Nomination Committee regularly reviews the structure, size and composition (including the skills, knowledge and experience) required of the Board and makes recommendations to the Board as appropriate. The Board has satisfied itself that the Nomination Committee has in place appropriate plans for orderly succession to the Board and Senior Management positions as well as procedures to ensure an appropriate balance of skills and experience within HSBC and on the Board. Corporate Social Responsibility Committee The Corporate Social Responsibility Committee is responsible for overseeing Corporate Social Responsibility and Sustainability policies, principally environmental, social and ethical matters and for advising the Board, committees of the Board and executive management on such matters. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘Investor Relations’, 207 H S B C H O L D I N G S P L C Report of the Directors (continued) then ‘Corporate Governance’ then ‘Board Committees’. The members of the Committee throughout 2004 were Lord Butler (Chairman), W K L Fung, S Hintze, C S Taylor, each of whom is an independent non-executive Director, and G V I Davis and Lord May, who are non-Director members of the Committee. Baroness Brigstocke was a non- Director member of the Committee until her untimely death in April 2004. E M Diggory was appointed as a non-Director member of the Committee on 26 November 2004. There were four meetings of the Corporate Social Responsibility Committee during 2004. Following each meeting the Committee reports back to the Board on its activities. Further information is available in HSBC’s Corporate Social Responsibility Report 2004, available in April 2005. Corporate Governance Codes HSBC is committed to high standards of corporate governance. HSBC Holdings complied throughout the year with the code provisions of the Combined Code on corporate governance appended to the Listing Rules of the Financial Services Authority and with the provisions of Appendix 14 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. Appendix 14 to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited was substantially revised during 2004. The new provisions of Appendix 14 will apply for subsequent reporting periods. Differences in HSBC Holdings/New York Stock Exchange corporate governance practices In November 2003, the US Securities and Exchange Commission approved the New York Stock Exchange’s (‘NYSE’) new corporate governance rules for listed companies. Under these new rules, as a NYSE-listed foreign private issuer, HSBC Holdings must disclose any significant ways in which its corporate governance practices differ from those followed by US companies subject to NYSE listing standards. HSBC Holdings believes the following to be the significant differences between its corporate governance practices and NYSE corporate governance rules applicable to US companies. US companies listed on the NYSE are required to adopt and disclose corporate governance guidelines. The Listing Rules of the UK Financial 208 Services Authority require each listed company incorporated in the United Kingdom to include in its Annual Report and Accounts a narrative statement of how it has applied the principles of the Combined Code on Corporate Governance appended to the Listing Rules (‘Combined Code’) and a statement as to whether or not it has complied with the code provisions of the Combined Code throughout the accounting period covered by the Annual Report and Accounts. A company that has not complied with the Code provisions, or complied with only some of the Code provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period covered by the report, must specify the Code provisions with which it has not complied, and (where relevant) for what part of the reporting period such non-compliance continued, and give reasons for any non-compliance. As stated above, HSBC Holdings complied throughout 2004 with the code provisions of the Combined Code. The Combined Code does not require HSBC Holdings to disclose the full range of corporate governance guidelines with which it complies. Under NYSE standards, companies are required to have a nominating/corporate governance committee, composed entirely of independent directors. In addition to identifying individuals qualified to become board members, this committee must develop and recommend to the board a set of corporate governance principles. HSBC’s Nomination Committee, which follows the requirements of the Combined Code, includes a majority of members who are independent. All members of the Committee are non-executive Directors and three of the four members, including the Committee chairman, are independent non- executive Directors. The Committee’s terms of reference do not require the Committee to develop and recommend corporate governance principles for HSBC Holdings. As stated above, HSBC Holdings is subject to the corporate governance principles of the Combined Code. Pursuant to NYSE listing standards, non- management directors must meet on a regular basis without management present and independent directors must meet separately at least once per year. During 2004, HSBC Holdings’ non-executive Directors met twice as a group with the Group Chairman, but with no other executive Directors present, and met once as a group without the Group Chairman or other executive Directors present. HSBC Holdings’ practice, in this regard, complies with the Combined Code. In accordance with the requirements of the Combined Code, HSBC Holdings discloses in its annual report how the Board, its committees and the Directors are evaluated and the results of the evaluation (on pages 203 to 204) and it provides extensive information regarding Directors’ compensation in the Directors’ Remuneration Report (on pages 216 to 233). The terms of reference of HSBC Holdings’ Audit, Nomination and Remuneration Committees are available on www.hsbc.com by selecting ‘Investor Relations’ then ‘Corporate Governance’ then ‘Board Committees’. NYSE listing standards require US companies to adopt a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers. In addition to the Group Business Principles and Values, which apply to the employees of all HSBC companies, pursuant to the requirements of the Sarbanes-Oxley Act the Board of HSBC Holdings has adopted a Code of Ethics applicable to the Group Chairman, the Group Finance Director and Group Chief Accounting Officer. HSBC Holdings’ Code of Ethics is available on www.hsbc.com/codeofethics. If the Board amends or waives the provisions of the Code of Ethics, details of the amendment or waiver will appear at the same website address. During 2004 HSBC Holdings made no amendments to its Code of Ethics and granted no waivers from its provisions. The Group Business Principles and Values is available on www.hsbc.com/businessprinciplesand values. Under NYSE listing rules applicable to US companies, independent directors must comprise a majority of the board of directors. Currently, over half of HSBC Holdings’ Directors are independent. Under the Combined Code the HSBC Holdings Board determines whether a director is independent in character and judgement and whether there are relationships or circumstances which are likely to affect, or could appear to affect, the director’s judgement. Under the NYSE rules a director cannot qualify as independent unless the board affirmatively determines that the director has no material relationship with the listed company; in addition the NYSE rules prescribe a list of circumstances in which a director cannot be independent. The Combined Code requires a company’s board to assess director independence by affirmatively concluding that the director is independent of management and free from any business or other relationship that could materially interfere with the exercise of independent judgement. Lastly, a chief executive officer of a US company listed on the NYSE must annually certify that he or she is not aware of any violation by the company of NYSE corporate governance standards. In accordance with NYSE listing rules applicable to foreign private issuers, HSBC Holdings’ Group Chairman is not required to provide the NYSE with this annual compliance certification. However, in accordance with rules applicable to both US companies and foreign private issuers, the Group Chairman is required promptly to notify the NYSE in writing after any executive officer becomes aware of any material non-compliance with the NYSE corporate governance standards applicable to HSBC Holdings. From July 2005 HSBC Holdings will be required to submit annual and interim written affirmations of compliance with applicable NYSE corporate governance standards, similar to the affirmations required of NYSE listed US companies. Internal control The Directors are responsible for internal control in HSBC and for reviewing its effectiveness. Procedures have been designed for safeguarding assets against unauthorised use or disposition; for maintaining proper accounting records; and for the reliability of financial information used within the business or for publication. Such procedures are designed to manage rather than eliminate the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material errors, losses or fraud. The procedures also enable HSBC Holdings to discharge its obligations under the Handbook of Rules and Guidance issued by the Financial Services Authority, HSBC’s lead regulator. The key procedures that the Directors have established are designed to provide effective internal control within HSBC and accord with the Internal Control Guidance for Directors on the Combined Code issued by the Institute of Chartered Accountants in England and Wales. Such procedures have been in place throughout the year and up to 28 February 2005, the date of approval of the Annual Report and Accounts 2004. In the case of companies acquired during the year, including Bank of Bermuda and Marks and Spencer Retail Financial Services Holdings Limited, the internal controls in place are being reviewed against HSBC’s benchmarks and integrated into HSBC’s systems. 209 H S B C H O L D I N G S P L C Report of the Directors (continued) HSBC’s key internal control procedures include • Responsibilities for financial performance the following: • Authority to operate the various subsidiaries is delegated to their respective chief executive officers within limits set by the Board of Directors of HSBC Holdings or by the Group Management Board under powers delegated by the Board. Sub-delegation of authority from the Group Management Board to individuals requires these individuals, within their respective delegation, to maintain a clear and appropriate apportionment of significant responsibilities and to oversee the establishment and maintenance of systems of controls appropriate to the business. The appointment of executives to the most senior positions within HSBC requires the approval of the Board of Directors of HSBC Holdings. • Functional, operating, financial reporting and certain management reporting standards are established by Group Head Office management for application across the whole of HSBC. These are supplemented by operating standards set by functional and local management as required for the type of business and geographical location of each subsidiary. • Systems and procedures are in place in HSBC to identify, control and report on the major risks including credit, changes in the market prices of financial instruments, liquidity, operational error, breaches of law or regulations, unauthorised activities and fraud. Exposure to these risks is monitored by asset and liability committees and executive committees in subsidiaries and by the Group Management Board for HSBC as a whole. • Customer groups, global product groups, key support functions and certain discrete geographies prepare strategic plans periodically within the framework of the Group Strategic Plan. Operating plans are required to be prepared and adopted by all HSBC members annually, setting out the key business initiatives and the likely financial effects of those initiatives. • Centralised functional control is exercised over all computer system developments and operations. Common systems are employed where possible for similar business processes. Credit and market risks are measured and reported on in subsidiaries and aggregated for review of risk concentrations on a group-wide basis. 210 against plans and for capital expenditure, credit exposures and market risk exposures are delegated with limits to line management in the subsidiaries. In addition, functional management in Group Head Office has been given responsibility to set policies, procedures and standards in the areas of: finance; legal and regulatory compliance; internal audit; human resources; credit; market risk; operational risk; computer systems and operations; property management; and for certain global product lines. • Policies and procedures to guide subsidiary companies and management at all levels in the conduct of business to safeguard the Group’s reputation are established by the Board of HSBC Holdings, the Group Management Board, subsidiary company boards, board committees or senior management. Reputational risks can arise from social, ethical or environmental issues, or as a consequence of operational risk events. As a banking group, HSBC’s good reputation depends upon the way in which it conducts its business but it can also be affected by the way in which clients, to which it provides financial services, conduct their business. • The internal audit function, which is centrally controlled, monitors compliance with policies and standards and the effectiveness of internal control structures across the whole of HSBC. The work of the internal audit function is focused on areas of greatest risk to HSBC as determined by a risk-based approach. The head of this function reports to the Group Chairman and the Group Audit Committee. The Group Audit Committee has kept under review the effectiveness of this system of internal control and has reported regularly to the Board of Directors. The key processes used by the Committee in carrying out its reviews include: regular reports from the heads of key risk functions; the production annually of reviews of the internal control framework applied at Group Head Office and major operating subsidiary level measured against HSBC benchmarks, which cover all internal controls, both financial and non-financial; annual confirmations from chief executives of principal subsidiary companies that there have been no material losses, contingencies or uncertainties caused by weaknesses in internal controls; internal audit reports; external audit reports; prudential reviews; and regulatory reports. The Directors, through the Group Audit Committee, have conducted an annual review of the effectiveness of HSBC’s system of internal control covering all controls, including financial, operational and compliance controls and risk management. Reputational and operational risks HSBC regularly updates its policies and procedures for safeguarding against reputational and operational risks. This is an evolutionary process which takes account of The Association of British Insurers’ guidance on best practice when responding to social, ethical and environmental (‘SEE’) risks. The safeguarding of HSBC’s reputation is of paramount importance to its continued prosperity and is the responsibility of every member of staff. HSBC has always aspired to the highest standards of conduct and, as a matter of routine, takes account of reputational risks to its business. The training of Directors on appointment includes reputational matters. Reputational risks, including SEE matters, are considered and assessed by the Board, the Group Management Board, subsidiary company boards, board committees and/or senior management during the formulation of policy and the establishment of HSBC standards. Standards on all major aspects of business are set for HSBC and for individual subsidiary companies, businesses and functions. These policies, which form an integral part of the internal control systems, are communicated through manuals and statements of policy and are promulgated through internal communications and training. The policies cover SEE issues and set out operational procedures in all areas of reputational risk, including money laundering deterrence, environmental impact, anti-corruption measures and employee relations. The policy manuals address risk issues in detail and co-operation between head office departments and businesses is required to ensure a strong adherence to HSBC’s risk management system and its corporate social responsibility practices. Internal controls are an integral part of how HSBC conducts its business. HSBC’s manuals and statements of policy are the foundation of these internal controls. There is a strong process in place to ensure controls operate effectively. Any significant failings are reported through the control mechanisms, internal audit and compliance functions to subsidiary company audit committees and to the Group Audit Committee, which keeps under review the effectiveness of the system of internal controls and reports regularly to HSBC Holdings’ Board. In addition, all HSBC businesses and major functions are required to review their control procedures and to make regular reports about any losses arising from operational risks. HSBC provides information in its Corporate Social Responsibility Report and website (www.hsbc.com/csr) on the extent to which it has complied with its risk management policies. Aspects covered include: how HSBC is implementing and applying the Equator Principles to manage the environmental and social risks in project finance; employee diversity; environmental management and health and safety. HSBC is using the guidelines of the Global Reporting Initiative in producing its 2004 report. HSBC’s internal risk management procedures are supported by third party scrutiny and assurance. A commentary by The Corporate Citizenship Company in the Corporate Social Responsibility Report and website includes both assurance and forward-looking recommendations on HSBC’s SEE reporting. HSBC also provides external assurance through its participation in the Dow Jones Sustainability Index and Business in the Community’s Environment Index (HSBC’s feedback reports from which are included on our website) and FTSE4Good. Further details are contained in HSBC’s Corporate Social Responsibility Report 2004, available in April 2005. Health and safety The maintenance of appropriate health and safety standards throughout HSBC remains a key responsibility of all managers and HSBC is committed to actively managing all health and safety risks associated with its business. HSBC’s objectives are to identify, remove, reduce or control material risks of fires and of accidents or injuries to employees and visitors. Health and Safety Policies, Group standards and procedures are set by Group Fire and Safety and are implemented by Health, Safety and Fire Co- ordinators based in each country in which HSBC operates. HSBC faces a range of threats from terrorists and criminals across the world. In particular, over recent years the threat from international terrorism has become significant in a number of areas where HSBC operates. This threat has mainly manifested itself in bomb attacks such as the one in Istanbul in 2003 in which HSBC’s Turkish headquarters building was attacked. Despite suffering tragic loss of life and major damage, existing security measures and well-managed contingency procedures ensured 211 H S B C H O L D I N G S P L C Report of the Directors (continued) the business was able to return to normal operations the following day. Group Security provides regular risk assessments in areas of increased risk to assist management in judging the level of terrorist threat. In addition, Regional Security functions conduct regular security reviews to ensure measures to protect HSBC staff, buildings, assets and information are appropriate for the level of threat. Communication with shareholders Communication with shareholders is given high priority. Extensive information about HSBC’s activities is provided in the Annual Report and Accounts, Annual Review and the Interim Report which are sent to shareholders and on www.hsbc.com. There is regular dialogue with institutional investors and enquiries from individuals HSBC Holdings ordinary shares of US$0.50 on matters relating to their shareholdings and the business of HSBC are welcomed and are dealt with in an informative and timely manner. All shareholders are encouraged to attend the Annual General Meeting or the informal meeting of shareholders held in Hong Kong to discuss the progress of HSBC. Directors’ interests According to the registers of Directors’ interests maintained by HSBC Holdings pursuant to section 325 of the Companies Act 1985 and section 352 of the Securities and Futures Ordinance of Hong Kong, the Directors of HSBC Holdings at the year-end had the following interests, all beneficial unless otherwise stated, in the shares and loan capital of HSBC and its associated corporations: At 31 December 2004 Beneficial owner Child under 18 or spouse At 1 January 2004 1,378,974 404,602 45,860 154,362 47,094 51,928 328,000 −4 198,758 2,037 57,794 212,785 385,096 47,796 135,761 – 52,318 328,000 37,795 182,616 2,037 83,628 – 3,604 – – 942 1,953 – – 15,688 – – 5,000 – 411,800 10,746 60,000 – 5,840 5,000 2,941,440 10,000 5,000 5,170 – 9,500 840 – 1,252,274 – W F Aldinger …. Sir John Bond .... R K F Ch’ien ..... Baroness Dunn .. D G Eldon ......... D J Flint ............ W K L Fung ...... M F Geoghegan . S K Green .......... S Hintze ............. A W Jebson ....... Sir John Kemp- Welch . ............ Sir Brian Moffat Sir Mark Moody- Stuart .............. S W Newton ...... H Sohmen ......... C S Taylor ......... Sir Brian Trustee 15,1253 – – – – 27,000 – – – – – 31,8003 – 5,0003 – – – Jointly with another person – 62,831 – – 98,904 – – – 45,355 – – – 11,157 – – – – – Equity derivatives1 Total interests2 Percentage of ordinary shares in issue Other – – – 28,6503 – – – – – – – – – – – 2,017,8735 – 1,363,849 – – – – – – – – – – – – – – – 500 1,591,759 451,531 47,796 164,411 99,846 81,271 328,000 37,795 243,659 2,037 83,628 96,800 11,157 10,840 5,170 3,270,147 10,000 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.03 0.00 0.00 Williamson ..... 15,222 15,865 – – – – 15,865 1 Under the Securities and Futures Ordinance of Hong Kong, interests in listed ADSs are categorised as equity derivatives. 2 Details of executive Directors’ other interests in HSBC Holdings ordinary shares of US$0.50 arising from share option plans and the Restricted Share Plan are set out in the Directors’ Remuneration Report on pages 229 to 233. 3 Non-beneficial. 4 Interests at 1 March 2004 – date of appointment. 5 Interests held by private investment companies. 212 Sir John Bond has an interest as beneficial owner in £290,000 of HSBC Capital Funding (Sterling 1) L.P. 8.208 per cent Non-cumulative Step-up Perpetual Securities, which he held throughout the year. D G Eldon has an interest as beneficial owner in 300 Hang Seng Bank ordinary shares of HK$5.00 each, which he held throughout the year. S K Green has an interest as beneficial owner in €75,000 of HSBC Holdings plc 5½ per cent Subordinated Notes 2009 and in £100,000 of HSBC Bank plc 9 per cent Subordinated Notes 2005, which he held throughout the year. H Sohmen has a corporate interest in £1,200,000 of HSBC Bank plc 9 per cent Subordinated Notes 2005 which he held throughout the year. During the year, his spouse ceased to have an interest in US$3,000,000 of HSBC Bank plc Senior Subordinated Floating Rate Notes 2009. As Directors of CCF, S K Green and M F Geoghegan each have an interest as beneficial owner in one share of €5 in that company, which Mr Green held throughout the year and Mr Geoghegan acquired during the year. The Directors have waived their rights to receive dividends on these shares and have undertaken to transfer these shares to HSBC on ceasing to be Directors of CCF. As Directors of HSBC Private Banking Holdings (Suisse), S K Green and M F Geoghegan each have an interest as beneficial owner in one share of CHF1,000, which Mr Green held throughout the year and Mr Geoghegan acquired during the year. The Directors have waived their HSBC Holdings ordinary shares of US$0.50 rights to receive dividends on these shares and have undertaken to transfer these shares to HSBC on ceasing to be Directors of HSBC Private Banking Holdings (Suisse). At 31 December 2004, the aggregate interests of the executive Directors in HSBC Holdings ordinary shares of US$0.50 (each of which represents less than 0.005 per cent of the shares in issue, unless otherwise stated) under the Securities and Futures Ordinance of Hong Kong, including interests arising through share option plans, the Restricted Share Plan and, in the case of W F Aldinger, through an employee benefit trust as detailed in the Directors' Remuneration Report on pages 216 to 233, are: W F Aldinger – 16,324,412 (0.15 per cent of shares in issue); Sir John Bond – 1,194,046 (0.01 per cent of shares in issue); D G Eldon – 441,417; D J Flint – 511,862; M F Geoghegan – 300,775; S K Green – 771,599 (0.01 per cent of shares in issue); and A W Jebson – 533,659. No directors held any short positions as defined in the Securities and Futures Ordinance of Hong Kong. Save as stated above and in the Directors' Remuneration Report, none of the Directors had an interest in any shares or debentures of any HSBC or associated corporation at the beginning or at the end of the year, and none of the Directors or members of their immediate family was awarded or exercised any right to subscribe for any shares or debentures during the year. Since the end of the year, the interests of each of the following Directors have increased by the number of HSBC Holdings ordinary shares shown against their name: Beneficial owner Child under 18 or spouse Jointly with another person Beneficiary of a trust W F Aldinger ................................................................ Sir John Bond ............................................................... R K F Ch’ien ................................................................. Baroness Dunn............................................................... D G Eldon ..................................................................... D J Flint ........................................................................ M F Geoghegan ............................................................ S K Green ..................................................................... A W Jebson ................................................................... Sir Brian Moffat ............................................................ S W Newton .................................................................. Sir Brian Williamson .................................................... – 652 3655 1,0385 – 4276 2895 337 6405 – 395 1215 – 253 – – 75 143 – 1205 – – – – – – – – 7565 – – – – 855 – – 8,0311 6,4484 – – 2,6101 3,2731 2,0071 4,0131 3,4411 – – – 1 Scrip dividend on awards held under the Restricted Share Plan. 2 Comprises the automatic reinvestment of dividend income by an Individual Savings Account and Personal Equity Plan manager (32 shares), the acquisition of shares in the HSBC Holdings UK Share Ownership Plan through regular monthly contributions (28 shares) and the automatic reinvestment of dividend income on shares held in the plan (5 shares). 213 H S B C H O L D I N G S P L C Report of the Directors (continued) 3 The automatic reinvestment of dividend income by an Individual Savings Account and Personal Equity Plan manager. 4 Comprises scrip dividend on awards held under the Restricted Share Plan (5,658 shares) and on shares held in a Trust (790 shares). 5 Scrip dividend. 6 Comprises scrip dividend on shares held as beneficial owner (360 shares), the acquisition of shares in the HSBC Holdings UK Share Ownership Plan through regular monthly contributions (28 shares), the automatic reinvestment of dividend income on shares held in the plan (5 shares) and the automatic reinvestment of a cash dividend by an Individual Savings Account and Personal Equity Plan manager (34 shares). 7 Comprises the acquisition of shares in the HSBC Holdings UK Share Ownership Plan through normal monthly contributions (28 shares) and the automatic reinvestment of dividend income on shares held in the plan (5 shares). There have been no other changes in Directors’ interests from 31 December 2004 to the date of this Report. Any subsequent changes up to the last practicable date before the publication of the ‘Notice of Annual General Meeting’ will be set out in the notes to that Notice. At 31 December 2004, Directors and Senior Management held, in aggregate, beneficial interests in 24,333,045 HSBC Holdings ordinary shares (0.2 per cent of the issued ordinary shares). Employee involvement HSBC Holdings continues to regard communication with its employees as a key aspect of its policies. Information is given to employees about employment matters and about the financial and economic factors affecting HSBC’s performance through management channels, an intranet site accessible to all HSBC’s employees worldwide, in-house magazines and by way of attendance at internal seminars and training programmes. Employees are encouraged to discuss operational and strategic issues with their line management and to make suggestions aimed at improving performance. The involvement of employees in the performance of HSBC is further encouraged through participation in bonus and share plans as appropriate. About half of all HSBC employees now participate in one or more of HSBC’s employee share plans. Employment of disabled persons HSBC Holdings continues to be committed to providing equal opportunities to employees. The employment of disabled persons is included in this commitment and the recruitment, training, career development and promotion of disabled persons is based on the aptitudes and abilities of the individual. Should employees become disabled during employment, every effort is made to continue their employment and, if necessary, appropriate training is provided. 214 Supplier payment policy HSBC Holdings subscribes to the Better Payment Practice Code for all suppliers, the four principles of which are: to agree payment terms at the outset and stick to them; to explain payment procedures to suppliers; to pay bills in accordance with any contract agreed with the supplier or as required by law; and to tell suppliers without delay when an invoice is contested and settle disputes quickly. Copies of, and information about, the Code are available from: The Department of Trade and Industry, 1 Victoria Street, London SW1H 0ET; and the internet at www.dti.gov.uk/publications. It is HSBC Holdings’ practice to organise payment to its suppliers through a central accounts function operated by its subsidiary undertaking, HSBC Bank. Included in the balance with HSBC Bank is the amount due to trade creditors which, at 31 December 2004, represented 16 days’ average daily purchases of goods and services received from such creditors, calculated in accordance with the Companies Act 1985, as amended by Statutory Instrument 1997/571. Notifiable interests in share capital According to the register maintained under section 211 of the Companies Act 1985, Legal and General Investment Management Limited notified HSBC Holdings on 13 June 2002 that it had an interest on 11 June 2002 in 284,604,788 HSBC Holdings ordinary shares, representing 3.01 per cent of the ordinary shares in issue at that date. Credit Suisse First Boston notified HSBC Holdings on 8 February 2005 that it had an interest on 1 February 2005 in 482,122,209 HSBC Holdings ordinary shares, representing 4.31 per cent of the ordinary shares in issue at that date. No substantial interest, being 5 per cent or more, in any of the equity share capital is recorded in the register maintained under section 336 of the Securities and Futures Ordinance of Hong Kong. In compliance with the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited at least 25 per cent of the total issued share capital of HSBC Holdings has been held by the public at all times during 2004 and up to the date of this Report. Dealings in HSBC Holdings shares Except for the dealings as intermediaries by HSBC Bank, HSBC CCF Financial Products (France) SNC and The Hongkong and Shanghai Banking Corporation, which are members of a European Economic Area exchange in market-making and other dealing activities, neither HSBC Holdings nor any subsidiary undertaking has bought, sold or redeemed any securities of HSBC Holdings during the year ended 31 December 2004. Donations During the year, HSBC made charitable donations totalling US$69.2 million. Of this amount, US$21.1 million was given for charitable purposes in the United Kingdom. No political donations were made during the year. At the Annual General Meeting in 2003 shareholders gave authority for HSBC Holdings and HSBC Bank to make EU political donations and incur EU political expenditure up to a maximum aggregate sum of £250,000 and £50,000 respectively over a four-year period as a precautionary measure in light of the wide definitions in The Political Parties, Elections and Referendums Act 2000. These authorities have not been used. Annual General Meeting The Annual General Meeting of HSBC Holdings will be held at the Barbican Hall, Barbican Centre, London EC2 on Friday 27 May 2005 at 11.00 am. An informal meeting of shareholders will be held at Level 28, 1 Queen’s Road Central, Hong Kong on Tuesday 24 May 2005 at 4.30pm. A live webcast of the Annual General Meeting will be available on www.hsbc.com. From shortly after the conclusion of the Meeting until 30 June 2005 a recording of the proceedings will be available on www.hsbc.com. Auditor KPMG Audit Plc has expressed its willingness to continue in office. The Group Audit Committee and the Board recommend that it be reappointed. A resolution proposing the reappointment of KPMG Audit Plc as auditor of HSBC Holdings and giving authority to the Group Audit Committee to determine its remuneration will be submitted to the forthcoming Annual General Meeting. On behalf of the Board R G Barber, Secretary 28 February 2005 215 H S B C H O L D I N G S P L C Directors’ Remuneration Report Remuneration Committee The Remuneration Committee meets regularly to consider human resource issues, particularly terms and conditions of employment, remuneration, retirement benefits, development of high potential employees and key succession planning. The Remuneration Committee seeks to respond to the variety of environments and circumstances which are faced by different businesses in different markets at different times and has in place appropriate policies and procedures to monitor the size of the potential remuneration awards. The members of the Remuneration Committee throughout 2004 were Sir Mark Moody-Stuart (Chairman), W K L Fung and Sir John Kemp-Welch. S Hintze was appointed a member of the Committee on 30 January 2004. There were seven meetings of the Remuneration Committee during 2004. Sir Mark Moody-Stuart and Sir John Kemp-Welch attended all of these meetings, W K L Fung attended five meetings and S Hintze attended five of the six meetings following her appointment. Following each meeting the Committee reports back to the Board on its activities. The terms of reference of the Committee are available on www.hsbc.com by selecting ‘Investor Relations’, then ‘Corporate Governance’, then ‘Board Committees’. Towers Perrin, a firm of specialist human resources consultants, has been appointed by the Committee to provide independent advice on executive remuneration issues. As a global firm, Towers Perrin also provides other remuneration, actuarial and retirement consulting services to various parts of HSBC. Other than the provision of expert advice in these areas to the Remuneration Committee and to HSBC, Towers Perrin have no connection with HSBC. Other consultants are used from time to time to validate their findings. The Remuneration Committee also receives advice from the Group General Manager, Human Resources, J C S Rankin, and the Senior Executive, Group Reward Management, P M Wood. General Policy on Employees As with most businesses, HSBC’s performance depends on the quality and commitment of its people. Accordingly, the Board’s stated strategy is to attract, retain and motivate the very best people. In a business that is based on trust and relationships, HSBC’s broad policy is to look for people who want to make a long-term career with the organisation since trust and relationships are built over time. 216 Remuneration is an important component in people’s decisions on which company to join, but it is not the only one; it is HSBC’s experience that people are attracted to an organisation with good values, fairness, the potential for success and the scope to develop a broad, interesting career. Within the authority delegated by the Board of Directors, the Remuneration Committee is responsible for determining the remuneration policy of HSBC including the terms of bonus plans, share plans and other long-term incentive plans, and for agreeing the individual remuneration packages of executive Directors and other senior Group employees. No Directors are involved in deciding their own remuneration. The Remuneration Committee applies the following key principles: • • • • • • to ensure that the total remuneration package (salary, bonus, long-term incentive awards and other benefits) is competitive in relation to comparable organisations in each of the countries or regions in which HSBC operates; to offer fair and realistic salaries with an important element of variable pay, differentiated by performance; through awards of shares (and in limited circumstances, share options) to recognise high performance and retain key talent; and since 1996, to follow a policy of moving progressively from defined benefit to defined contribution Group pension schemes for new employees only. In line with these principles: employees’ salaries are reviewed annually in the context of individual and business performance, market practice, internal relativities and competitive market pressures. Allowances and benefits are largely determined by local market practice; employees participate in various bonus arrangements. The level of performance-related variable pay depends upon the performance of constituent businesses and the individual concerned. During 2004 variable bonus plans were reviewed to give greater emphasis to revenue growth whilst retaining a strong link to expense control; other key measures taken into account in determining individual bonus levels include customer relationships; full utilisation of professional skills; adherence to HSBC’s ethical standards, internal controls and procedures. Bonus ranges are reviewed in the context of prevailing market practice; and • HSBC has a long history of paying close attention to its customers in order to provide value for shareholders. This has been achieved by ensuring that the interests of HSBC and its employees are aligned with those of its shareholders and that HSBC’s approach to risk management serves the interests of all. Accordingly, employees are encouraged to participate in the success they help to create, through participating in the HSBC Holdings savings-related share option plans and in local share ownership and profit sharing arrangements. During 2004, a comprehensive review of share- based remuneration arrangements was conducted. This review was undertaken in light of changing business needs, taking into account HSBC’s expansion in certain markets and an evolving external environment. Approval for The HSBC Share Plan will be sought at the forthcoming Annual General Meeting. The proposed arrangements for the most senior executives of HSBC are described under ‘Long-term incentive plan’ on page 219. Shareholders and their representatives were consulted and the proposed arrangements reflect feedback that has been received. Below the senior executive level and in the context of an employee’s total remuneration package, the practice of awarding share options at all levels within HSBC has been reconsidered. In future and commencing with awards to be made in 2005, restricted shares will be granted to a substantially smaller number of executives than those who previously received share options, with awards focused on those individuals who bring key talents and high levels of performance to the Group. These awards will normally vest after three years, subject to the individual remaining in employment. Awards of share options will only be granted in limited circumstances. For those who will normally no longer be eligible to receive awards of shares or share options, variable bonus arrangements have been reviewed and enhanced, as appropriate, taking account of local markets. Such changes may include an element of deferral. To encourage greater participation in the HSBC Holdings Savings-Related Share Option Plan: (International), two amendments to existing arrangements will be proposed for approval at the forthcoming Annual General Meeting. The first is the introduction of the facility to save in US dollars, Hong Kong dollars and euros as well as in pounds sterling. The maximum savings limit of £250 per month will continue to apply but be converted to the other currencies on a consistent and appropriate date. The second proposal is to offer individuals the choice of options over one year in addition to the existing three and five year terms. This change will carry tax advantages in certain jurisdictions. The impact on existing equity of granting share options which are to be satisfied by the issue of new shares is shown in diluted earnings per share on the face of the consolidated profit and loss account, with further details disclosed in Note 10 of the ‘Notes on the Financial Statements’ on page 261. The effect on basic earnings per share of exercising all outstanding share options would be to dilute it by 0.6 per cent. At the Annual General Meeting in 2000, shareholders approved a limit of 848,847,000 ordinary shares (approximately 10 per cent of the ordinary shares then in issue), which may be issued or become issuable under all employee share plans in any ten year period. Within this limit, not more than 5 per cent of the ordinary shares in issue from time to time (approximately 560,000,000 ordinary shares at 28 February 2005) may be put under option under the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000. In the ten year period to 31 December 2004, less than 650 million ordinary shares had been issued or could become issuable under all employee share plans and less than 350 million ordinary shares had been issued or could become issuable under discretionary employee share plans, including the HSBC Holdings Group Share Option Plan and the HSBC Holdings Restricted Share Plan 2000. At the forthcoming Annual General Meeting, revised limits on the number of shares that may be issued or become issuable under employee share plans will be proposed to reflect the increase in share capital since 2000. Directors and Senior Management HSBC’s operations are substantial, diverse and international; for example, over 73 per cent of profit before tax is derived from outside the United Kingdom. With effect from 1 March 2005 the HSBC Holdings’ Board will comprise 15 non-executive Directors and seven executive Directors. With businesses in 77 countries and territories, HSBC aims to attract Directors with a variety of experience, both in its key areas of activity and internationally. The Board currently includes nationals of five different countries. The seven executive Directors, four Group Managing Directors and 23 Group 217 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) General Managers have in total more than 793 years of service with HSBC. • • long-term incentives; and pension. Directors’ fees Directors’ fees are regularly reviewed and compared with other large international companies. The current fee, which was approved by shareholders in 2004, is £55,000 per annum. With effect from 1 January 2005 Sir John Bond, D J Flint, M F Geoghegan, S K Green and A W Jebson waived their rights to receive a Director’s fee from HSBC Holdings: an appropriate adjustment has been made to their basic salaries which, when taken with the consequent impact on bonuses, long-term incentive awards and pension benefits, will deliver a similar value to the fee that has been waived. W F Aldinger and D G Eldon had previously elected to waive any fees payable by HSBC Holdings. In addition, non-executive Directors receive the following fees: Chairman, Audit Committee Member, Audit Committee £40,000 p.a. £15,000 p.a. During 2004, seven Audit Committee meetings were held. A Director’s commitment to each meeting, including preparatory reading and review, can be 15 hours or more. Chairman, Remuneration Committee Member, Remuneration Committee £20,000 p.a. £15,000 p.a. During 2004, seven meetings of the Remuneration Committee were held. Chairman, Nomination Committee Member, Nomination Committee £20,000 p.a. £15,000 p.a. During 2004, two meetings of the Nomination Committee were held. Chairman, Corporate Social Responsibility Committee Member, Corporate Social Responsibility Committee £20,000 p.a. £15,000 p.a. During 2004, four meetings of the Corporate Social Responsibility Committee were held. Executive Directors The executive Directors are experienced executives with detailed knowledge of the financial services business in various countries. In most cases there has been a need to attract them from abroad to work in the United Kingdom. Consistent with the principles applied by the Committee to employees generally, there are four key components to the executive Directors’ remuneration: salary; annual cash bonus; • • 218 To ensure that the executive Directors’ remuneration packages are competitive having regard to the broad international nature of the Group, each year the Remuneration Committee considers market data on senior executive remuneration arrangements within primarily: • European banks with significant domestic and/or global operations/influences; these banks include Barclays PLC, Standard Chartered PLC, The Royal Bank of Scotland Group plc, ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria, S.A., Banco Santander Central Hispano, S.A., BNP PARIBAS S.A., Commerzbank AG and Deutsche Bank AG; and • other global UK-based organisations with significant exposure to US markets and competitors, including BP p.l.c., Diageo plc, GlaxoSmithKline plc, Unilever PLC, Vodafone Group plc. The level of awards available to the executive Directors under the annual cash bonus scheme and as Performance Shares is entirely dependent on performance. Remuneration policy for executive Directors is intended to provide competitive rates of base salary but with the potential for the majority of the value of the remuneration package to be delivered in the form of both short and long-term incentives. This typically results in base salary comprising around 30 per cent of total direct pay and the remaining 70 per cent split between annual bonus and the expected value of Performance Share awards. The remuneration package of W F Aldinger has a smaller proportion of fixed salary and a higher proportion of annual bonus and Restricted Share awards. The awards are in accordance with the minimum level of awards set out under his employment agreement entered into on 14 November 2002 at the time of the acquisition of HSBC Finance Corporation (‘the 2002 employment agreement’). It was noted by the Committee that the three- year term, and certain other terms, of the 2002 employment agreement represented an exception to HSBC’s normal policy for executive Directors’ service contracts, but that the background and reasons for this were explained in detail at the time of the acquisition and that the terms of the 2002 employment agreement were consistent with practice in the United States. Since 31 December 2004, the Remuneration Committee has reviewed the financial and other terms proposed in connection with W F Aldinger’s retirement on 29 April 2005 which are reflected in the amendment agreement dated 26 February 2005 between HSBC Finance Corporation and Mr Aldinger, details of which are summarised below. The Committee, having reviewed the relevant factors and circumstances, considered that these financial and other terms were appropriate and in order and in the best interests of the Group. Each component of executive Directors’ remuneration is explained in detail below. Salary The Committee reviews salary levels for executive Directors each year in the same context as other employees. With reference to market practice and taking account of the international nature of the Group, the Committee benchmarks the salary of each Director and member of Senior Management against those of comparable executives in large, diverse companies. Base salaries with effect from January 2005 will be: W F Aldinger .............................................. Sir John Bond ............................................. D G Eldon ................................................... D J Flint ...................................................... M F Geoghegan .......................................... S K Green ................................................... A W Jebson ................................................. US$1,000,000 £1,276,300 US$425,503 £500,000 £632,500 £770,000 £535,000 Excluding the effect of adjustments to salaries following the waivers by Sir John Bond, D J Flint, M F Geoghegan, S K Green and A W Jebson of their HSBC Holdings Director’s fee, this represents an average increase from 2004 of 5.02 per cent. As an International Manager, D G Eldon’s current base salary, shown above, is calculated on a net basis. Annual cash bonus Cash bonuses for executive Directors are based on two key factors: individual performance, taking into account, as appropriate, results against plan of the business unit or performance of the support function for which the individual is responsible; and Group performance, measured by comparing operating profit before tax with plan. The Remuneration Committee has discretion to eliminate extraordinary items when assessing bonuses, if the main cause did not arise during the current bonus year. Measurement against these key performance factors may result in discretionary cash bonuses of up to 250 per cent of basic salary for executive Directors. Long-term incentive plan Long-term incentive plans are designed to reward the delivery of sustained financial growth of HSBC. So as to align the interests of the Directors and senior employees more closely with those of shareholders, the vesting of Performance Share awards is subject to the attainment of predetermined performance criteria. The Remuneration Committee has generally provided, on a discretionary basis and reflective of individual performance, long-term share incentives to executive Directors and members of Senior Management through conditional awards of Performance Shares under the HSBC Holdings Restricted Share Plan 2000, rather than through the HSBC Holdings Group Share Option Plan. As part of a comprehensive review of share- based remuneration, the Remuneration Committee considered whether the continued use of Performance Shares was appropriate. The Committee considered several other types of arrangement but concluded that Performance Shares remain the most appropriate vehicle for HSBC’s executive Directors and Senior Management. However, the Committee recognised that there were a number of aspects to the current plan that could be improved to ensure the plan encouraged and rewarded growth and outperformance. Accordingly, the adoption of The HSBC Share Plan, to replace the HSBC Holdings Restricted Share Plan 2000 and the HSBC Holdings Group Share Option Plan, will be proposed at the forthcoming Annual General Meeting. For executive Directors and members of Senior Management The HSBC Share Plan will: • • introduce absolute growth in earnings per share as a performance measure in addition to relative Total Shareholder Return; and require higher levels of performance for full vesting of the conditional awards. The effect of these proposals is that the vesting of Performance Share awards will be more challenging and highly geared to performance than under the previous arrangements. To maintain the same approximate expected value (which takes into account factors such as the probability of vesting and risk of forfeiture for early departure) of Performance Share awards under The HSBC Share Plan as previously made under the HSBC Holdings Restricted Share Plan 2000, the face value of conditional awards under The HSBC Share Plan will be greater (as shown under ‘2005 Awards’ below) than those previously made under the HSBC 219 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) Holdings Restricted Share Plan 2000. It is proposed that awards under The HSBC Share Plan will be up to a maximum of seven times salary. Whilst having flexibility to make awards at this level in certain exceptional circumstances, the Remuneration Committee does not intend seven times salary to be the normal level of award. The average face value of the awards proposed for executive Directors is just over three times base salary; proposed individual awards are set out in the table below. Awards proposed for 2005 for Group Managing Directors and Group General Managers will generally be below two times salary. Further details of the performance conditions and vesting arrangements for The HSBC Share Plan are set out below. A summary of the arrangements relevant to previous awards of Performance Shares under The HSBC Holdings Restricted Share Plan 2000 is also given. Subject to approval at the forthcoming Annual General Meeting, all future awards of Performance Shares, including the 2005 awards, will be made under The HSBC Share Plan. 2005 Awards The Remuneration Committee is proposing that the conditional awards shown in the table below should be made to executive Directors in 2005. The table shows the face value of the full conditional awards and their approximate expected value. Sir John Bond .......................... D J Flint ................................... M F Geoghegan ....................... S K Green ................................ A W Jebson .............................. Face Value £000 4,000 1,500 2,000 2,500 1,415 Total ......................................... 11,415 Expected Value £000 1,760 660 880 1,100 622 5,022 As set out above, the higher face value of these awards than in previous years is balanced by the significantly more challenging vesting schedule of The HSBC Share Plan where maximum value will only be released to the individual if Group performance is at a very high level. The Trustee to the Plan will be provided with funds to acquire HSBC Holdings ordinary shares at an appropriate time after the announcement of the annual results. Under the terms of the 2002 employment agreement entered into at the time of the acquisition of HSBC Finance Corporation, W F Aldinger is entitled to receive an award of US$5.5 million which was to be used to purchase Restricted Shares in 220 HSBC Holdings. However, as referred to below, Mr Aldinger is to retire on 29 April 2005 and it has been agreed that this award will not be made. C F W de Croisset and W R P Dalton, who retired during 2004, did not receive a long-term incentive award in 2004. D G Eldon, who is to retire at the forthcoming Annual General Meeting, will not receive a long- term incentive award in 2005. Performance conditions Subject to approval of The HSBC Share Plan at the forthcoming Annual General Meeting, awards of Performance Shares, commencing in 2005, will be divided into two equal parts to be subject to separate performance conditions measured over a three-year performance period: • • ‘The Total Shareholder Return (TSR) award’: one half of the award will be subject to a relative TSR measure. TSR is defined as the growth in share value and declared dividend income, measured in sterling, during the relevant period. In calculating TSR, dividend income is assumed to be reinvested in the underlying shares; and ‘The earnings per share (‘EPS’) award’: the other half of the award will be based upon the absolute growth in EPS achieved by HSBC Holdings over the three-year performance period. The TSR element of the award will be based on HSBC’s ranking against a comparator group of 28 major banks. The comparator group will generally comprise the largest banks in the world measured in terms of market capitalisation, having regard to the geographic spread and the nature of the activities of each bank. The Remuneration Committee will use this criteria in selecting any replacements to the comparator group that may be necessary during the performance period, for example because a bank ceases to exist or to be quoted or if its relevance to HSBC as a comparator significantly diminishes. The comparator group at 28 February 2005 comprises ABN AMRO Holding N.V., Banco Bilbao Vizcaya Argentaria S.A, Banco Santander Central Hispano S.A., Bank of America Corporation, The Bank of New York Company, Inc., Barclays PLC, BNP PARIBAS S.A., Citigroup Inc., Credit Agricole S.A., Credit Suisse Group, Deutsche Bank AG, HBOS plc, JPMorgan Chase & Co., Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group, Inc., Mizuho Financial Group, Inc., Morgan Stanley, National Australia Bank Limited, Royal Bank of Canada, The Royal Bank of Scotland Group plc, Société Générale, Standard Chartered PLC, UBS AG, UniCredit S.p.A., US Bancorp, Wachovia Corporation, Wells Fargo & Company and Westpac Banking Corporation. The extent to which awards will vest will be determined by reference to HSBC Holdings’ TSR measured against the comparator TSR. The calculation of the share price component within HSBC Holdings’ TSR will be the average market price over the 20 trading days commencing on the day when the annual results are announced, which in 2005 is 28 February. The starting point will be, therefore, the average over the period 28 February to 29 March inclusive. TSR for comparator group constituents will be calculated on the same basis. For TSR performance in line with the bank ranked 14th, only 30 per cent of the conditional award will vest; if HSBC’s performance is in line with or above the bank ranked 7th in the ranked list all of the TSR award shares will vest. Vesting between the 14th and 7th ranked banks will be based on HSBC’s position against the ranked list. In simple terms, the percentage vesting will rise in 10 per cent increments for each position that HSBC achieves higher than the 14th bank in the ranked list until full vesting is achieved for TSR performance equal to or greater than the 7th bank in the ranked list. Where HSBC’s performance falls between these incremental steps, account will be taken of how far above or below the next ranked bank HSBC’s TSR performance is positioned. For example, if HSBC’s TSR falls half way between the bank ranked 12th (where, a release of 50 per cent of the award would occur) and the bank ranked 13th (where a release of 40 per cent of the award would occur), then the actual award released would be 45 per cent, i.e. half way between 40 per cent and 50 per cent. For the EPS element of the award, the base measure shall be EPS for the financial year preceding that in which the award is made (‘the base year’). Absolute growth in EPS will then be compared with the base year over three consecutive financial years commencing with the year in which the award is made. The EPS growth element will be the absolute level of EPS achieved during the three- year performance period. For this purpose, EPS means the profit attributable to the shareholders (expressed in US dollars), excluding goodwill amortisation, divided by the weighted average number of ordinary shares in issue and held outside the Group during the year in question. In the event that the 2004 published EPS is restated to adjust for accounting standards changes during the performance period, the restated published EPS will be used for the EPS performance condition for awards made in 2005 under The HSBC Share Plan. The percentage of the conditional award vesting will depend upon the absolute growth in EPS achieved over the three years (‘the performance period’). 30 per cent of the conditional shares will vest if the incremental EPS over the performance period is 24 per cent or more of EPS in the base year. The percentage of shares vesting will rise on a straight line proportionate basis to 100 per cent if HSBC’s incremental EPS over the performance period is 52 per cent or more of EPS in the base year. No element of the ‘TSR award’ will vest if HSBC’s performance is below that of the bank ranked 14th in the ranked list and no element of the ‘EPS award’ will vest if HSBC’s incremental EPS over the performance period is less than 24 per cent of EPS achieved in the base year. To the extent that the performance conditions have not been met at the third anniversary, the shares will be forfeited. In addition, awards will only vest if the Remuneration Committee is satisfied that HSBC Holdings’ financial performance has shown a sustained improvement in the period since the date of grant. In determining whether HSBC has achieved a sustained improvement in performance the Remuneration Committee will take account of, among other factors, the comparison against history and the peer group in the following areas: 1. 2. 3. 4. 5. revenue growth; revenue mix; cost efficiency; credit performance as measured by risk-adjusted revenues; and cash return on cash invested, dividend performance and total shareholder return. Following the three-year performance period, awards of Performance Shares under The HSBC Share Plan will be tested and vesting will take place shortly afterwards. Where events occur which cause the Remuneration Committee to consider that the performance condition has become unfair or impractical, the right is reserved to the Remuneration Committee to make such adjustments as in its absolute discretion it deems appropriate to make. 221 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) Awards will vest immediately in cases of death. In the event of redundancy, retirement on grounds of injury or ill health, early retirement, normal retirement and where a participant ceases to be employed by HSBC due to a company ceasing to be part of HSBC, awards will normally vest at the end of the vesting period on a time-apportioned basis to the extent that performance conditions have been satisfied. Awards will normally be forfeited if the participant is dismissed or resigns from HSBC. In all of these circumstances the Committee retains discretion to ensure fair and reasonable treatment. Arrangements from 1999-2004 From 1999 to 2004, the vesting of awards was linked to the attainment of predetermined TSR targets over a three-year period from date of grant as set out below. The TSR performance condition for awards of Performance Shares remained the same from 1999 to 2003. For awards made in 2004, changes were made to the peer group and re-testing provisions were eliminated such that awards will lapse if the performance condition is not satisfied after the initial three-year performance period. A benchmark for HSBC Holdings’ TSR, weighted by market capitalisation, was established which takes account of the TSR performance of: 1. a peer group of nine banks weighted by market capitalisation which were considered most relevant to HSBC in terms of size and international scope. For performance periods up to and including the one beginning in 2003, this group comprised ABN AMRO Holding N.V., The Bank of East Asia, Limited, Citigroup Inc., Deutsche Bank AG, JPMorgan Chase & Co., Lloyds TSB Group plc, Mitsubishi Tokyo Financial Group Inc., Oversea-Chinese Banking Corporation Limited and Standard Chartered PLC. To be more relevant to HSBC in terms of size and international scope, this peer group was amended for conditional awards made in 2004 and onwards by the replacement of Lloyds TSB Group plc, Oversea-Chinese Banking Corporation Ltd., Mitsubishi Tokyo Financial Group Inc. and The Bank of East Asia, Limited with Bank of America Corporation, The Royal Bank of Scotland Group plc, Banco Santander Central Hispano S.A. and UBS AG; 2. the five largest banks from each of the US, the UK, continental Europe and the Far East, other than any within paragraph 1 above, weighted by market capitalisation; and 222 3. the banking sector of the Morgan Stanley Capital International World Index, excluding any within paragraph 1 and paragraph 2 above, weighted by market capitalisation. By combining the weighted average TSR for each of the above three groups and weighting that average so that 50 per cent is applied to paragraph 1, 25 per cent is applied to paragraph 2 and 25 per cent is applied to paragraph 3, a single TSR benchmark for market comparison was determined. The extent to which each award will vest will be determined by reference to HSBC Holdings’ TSR measured against the TSR benchmark. For each award the calculation of the share price component within HSBC Holdings’ TSR was the average market price over the 20 trading days commencing on the day when the annual results were announced. TSR for the benchmark constituents was based on their published share prices on the 20th trading day after the annual results were announced. If HSBC Holdings’ TSR over the performance period exceeds the benchmark TSR, awards with a value, at the date of grant, of up to 100 per cent of the individual’s earnings, will vest. For higher value awards, the greater of 50 per cent of the award or the number of shares equating at the date of grant to 100 per cent of the individual’s earnings (base salary and bonus in respect of the previous performance year), will vest at this level of performance. If HSBC Holdings’ TSR over the performance period places it within the upper quartile in the ranked list against the benchmark, these higher value awards will vest in full. For performance between the median and the upper quartile, vesting will be on a straight-line basis. For awards made in 2004, if the upper quartile performance target is achieved then, as before, an additional award equal to 20 per cent of the initial Performance Share award will be made and will vest at the same time as the original award to which it relates. However, regardless of whether the upper quartile is achieved, full vesting and transfer of the shares will not generally occur until the fifth anniversary of the date of grant. If the performance test is not passed at the third anniversary, the shares will be forfeited. In addition to these performance conditions, none of the outstanding awards will vest unless the Remuneration Committee is satisfied that, during the performance period, HSBC has achieved a sustained improvement in performance. The Remuneration Committee retains discretion to recommend early release of shares awarded in certain circumstances, for example, redundancy and ill health. The Performance Shares awarded in 2000 passed their three-year TSR performance condition in March 2003 and will vest on the fifth anniversary of the award, 10 March 2005. Total Shareholder Return The graphs below show HSBC Holdings’ TSR performance against the benchmark TSR (graph 1), the Financial Times-Stock Exchange (‘FTSE’) 100 Index (graph 2), the Morgan Stanley Capital International (‘MSCI’) World Index (graph 3) and MSCI Financials Index (graph 4) over the three-year period to March 2004. These measures have been chosen as they are the main published indices against which HSBC monitors its performance. Graph 1: HSBC TSR and Benchmark TSR 140% 130% 120% 110% 100% 90% 80% 70% M ar 2001 M ar 2002 M ar 2003 M ar 2004 HSBC TSR TSR Benchmark Graph 2: HSBC TSR and FTSE 100 Index 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% Mar 2001 Mar 2002 Mar 2003 Mar 2004 HSBC TSR FTSE 100 Graph 3: HSBC TSR and MSCI World Index 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% Mar 2001 Mar 2002 Mar 2003 Mar 2004 HSBC TSR MSCI World Index Graph 4: HSBC TSR and MSCI Financials Index 140% 130% 120% 110% 100% 90% 80% 70% 60% Mar 2001 Mar 2002 Mar 2003 Mar 2004 HSBC TSR MSCI Financials Pursuant to the Directors’ Remuneration Report Regulations 2002, graph 5 below shows HSBC Holdings’ TSR performance against a broad equity market index, the Financial Times-Stock Exchange (‘FTSE’) 100 Index, for the five-year period ended 31 December 2004. Graph 5: HS BC TS R and FTS E 100 In de x 150 % 14 0 % 13 0 % 12 0 % 110 % 10 0 % 9 0 % 8 0 % 70 % 6 0 % 50 % Dec 19 9 9 Dec 2 0 0 0 Dec 2 0 0 1 Dec 2 0 0 2 Dec 2 0 0 3 Dec 2 0 0 4 HS B C TS R F TS E 100 Source: Datastream Pensions The pension entitlements earned by the executive Directors during the year are set out on pages 228 and 229. Service contracts and terms of appointment HSBC’s policy is to employ executive Directors on one-year rolling contracts although, on recruitment, longer initial terms may be approved by the Remuneration Committee. The Remuneration Committee will, consistent with the best interests of the Group, seek to minimise termination payments. No executive Director has a service contract with HSBC Holdings or any of its subsidiaries with a notice period in excess of one year or with provisions for predetermined compensation on termination which exceeds one year’s salary and benefits in kind, save as referred to below. There are 223 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) no provisions for compensation upon early termination of executive Directors’ service contracts save for W F Aldinger, details of which are set out below. As referred to above, Mr Aldinger entered into a new employment agreement with HSBC Finance Corporation on 14 November 2002 for a term of three years, such term to commence on the effective date of the acquisition of HSBC Finance Corporation by HSBC. Full details of the agreement were set out in the Discloseable Transaction Circular relating to the acquisition of HSBC Finance Corporation sent to shareholders on 26 February 2003 in advance of the Extraordinary General Meeting to approve the acquisition. The effective date of the acquisition, and commencement date of the 2002 employment agreement, was 28 March 2003. The terms of the 2002 employment agreement, were amended by an agreement (‘amendment agreement’) entered into between HSBC Finance Corporation and Mr Aldinger, as referred to below. During the term of the 2002 employment agreement Mr Aldinger is entitled to be paid an annual base salary equal to his annual base salary as at the date of the merger agreement between HSBC Finance Corporation and HSBC (US$1 million) and an annual bonus in an amount at least equal to the annual average of Mr Aldinger’s bonuses earned with respect to the three-year period ended 2001 (pro rated for any partial year) (US$4 million). Within 30 days of the effective date of the acquisition, Mr Aldinger received a one-time special retention grant of HSBC Holdings ordinary shares under the HSBC Holdings Restricted Share Plan 2000 with a value equal to US$10 million on terms that these Restricted Shares will vest in three equal instalments on each of the first three anniversaries of the effective date, as set out on page 232. After each of the first and second anniversaries of the effective date, subject to the approval of the Trustee of the HSBC Holdings Restricted Share Plan 2000, Mr Aldinger is entitled to receive an additional grant of HSBC Holdings ordinary shares with a value equal to at least US$5.5 million. The purpose of these arrangements was to retain the services of Mr Aldinger through the initial integration of HSBC Finance Corporation. HSBC considered it essential that the experience, knowledge and skills of Mr Aldinger be retained for the benefit of HSBC shareholders. Under the 2002 employment agreement, if Mr Aldinger’s employment is terminated by him during its term for ‘good reason’, or by HSBC 224 Finance Corporation for reasons other than ‘cause’ or disability, he is entitled to: a pro rata target annual bonus for the financial year of the date of termination; a payment equal to his annual base salary, plus the average of his annual bonuses with respect to the three-year period ended 2001, times the number of full and partial months from the date of termination until the third anniversary of the effective date, divided by 12; the immediate vesting and exercisability of each stock option, restricted stock award and other equity-based award or performance award (or cash equivalent) that is outstanding as at the date of termination and treatment as retirement eligible for purposes of exercising any such award; for the remainder of his life and that of his current spouse, continued medical and dental benefits at HSBC Finance Corporation’s cost; and his retirement benefits (as set out on page 228) in a lump sum. Following discussion with Mr Aldinger, it has been agreed that Mr Aldinger will retire as Chairman and Chief Executive of HSBC Finance Corporation and HSBC North America Holdings Inc on 29 April 2005 and will retire as a director of HSBC Holdings on the same date and resign from his directorships and other appointments with Group companies. As indicated above, the original purpose of the 2002 employment agreement was to retain the services of Mr Aldinger before the initial integration of HSBC Finance Corporation with the Group’s other North American businesses. The discussions with Mr Aldinger about his retirement before the expiry of the three-year term took into account that the integration process has now been completed successfully and faster than expected. Under the amendment agreement, Mr Aldinger will be entitled to receive, on termination of the 2002 employment agreement on 29 April 2005, the same terms and benefits (summarised above) as if his employment had been terminated by him for ‘good reason’ or by HSBC Finance Corporation for reasons other than ‘cause’ or disability, except that he will not be entitled to receive the 2005 restricted share award (or cash equivalent) with a value to at least US$5.5 million that he would have been entitled to receive on or before 28 April 2005. Mr Aldinger will, however, receive a payment of US$4.6 million in lieu of salary and bonus in respect of the remainder of the three-year period. The amendment agreement also provides that the ‘non-competition’ provision in the 2002 employment agreement for a period of one year after termination of his employment, and certain other restrictions, will continue to apply. Under this provision he may not become associated with certain competitive entities that are actively engaged in the consumer lending business (including mortgage and credit card lending). Sir John Bond, who is to stand for re-election at the forthcoming Annual General Meeting, is employed on a rolling contract dated 14 July 1994 which requires 12 months’ notice to be given by either party. W R P Dalton, who retired as a Director on 28 May 2004, was employed on a rolling contract dated 5 January 1998 that required 12 months’ notice to be given by either party. D G Eldon is employed on a rolling contract dated 1 January 1968 which requires three months’ notice to be given by either party. D G Eldon will retire as a Director at the conclusion of the forthcoming Annual General Meeting. D J Flint, who is to stand for re-election at the forthcoming Annual General Meeting, is employed on a rolling contract dated 29 September 1995 which requires 12 months’ notice to be given by the Company and nine months’ notice to be given by Mr Flint. M F Geoghegan is employed on a rolling contract dated 25 May 2004 which requires 12 months’ notice to be given by either party. S K Green is employed on a rolling contract dated 9 March 1998 which requires 12 months’ notice to be given by either party. A W Jebson is employed on a rolling contract dated 14 January 2000 which requires 12 months’ notice to be given by either party. Members of Senior Management are employed on service contracts which generally provide for a term of service expiring at the end of a period of up to two years, or the individual’s sixtieth birthday, whichever is earlier. Non-executive Directors are appointed for fixed terms not exceeding three years, subject to their re-election by shareholders at subsequent Annual General Meetings. Non-executive Directors have no service contract and are not eligible to participate in HSBC’s share plans. Non-executive Directors’ terms of appointment will expire as follows: in 2006, Baroness Dunn, Sir John Kemp- Welch, S W Newton, H Sohmen, C S Taylor and Sir Brian Williamson; in 2007, Lord Butler, R K F Ch’ien, R A Fairhead, W K L Fung, S Hintze, Sir Brian Moffat and Sir Mark Moody-Stuart; and (assuming re-election at the 2005 Annual General Meeting) in 2008, J D Coombe and J W J Hughes- Hallett. Other directorships Executive Directors, if so authorised by either the Nomination Committee or the Board, may accept appointments as non-executive Directors of suitable companies which are not part of HSBC. Approval will not be given for executive Directors to accept a non-executive directorship of more than one FTSE 100 company. When considering a non- executive appointment, the Nomination Committee or Board will take into account the expected time commitment of such appointment. The time commitment for executive Directors’ external appointments will be reviewed as part of the annual Board review. Any remuneration receivable in respect of an external appointment is normally paid to the HSBC company by which the executive Director is employed, unless otherwise approved by the Remuneration Committee. Sir John Bond retains his fees as a non- executive director of the Ford Motor Company, which are provided partly in the form of restricted shares, which become unrestricted over a period of five years. During 2004 the fees received were US$82,500 in cash and US$77,500 deferred into Ford common stock units. In addition, Ford provides US$200,000 of life assurance and US$500,000 of accidental death or dismemberment insurance. The life assurance can be continued after retirement from the Board or Sir John Bond could elect to have it reduced to US$100,000 and receive US$15,000 a year for life. The accidental death or dismemberment insurance ends upon retirement from the Board. W F Aldinger retains his fees as a non- executive director of Illinois Tool Works, Inc. and as a non-executive director of AT&T Corp. During 2004 the fee received from Illinois Tool Works, Inc. was US$67,000 in the form of deferred stock and the fee received from AT&T Corp. was US$84,500 in cash and US$7,785 in cash instead of dividend due on deferred shares. In addition, AT&T Corp. provide travel accident insurance when on AT&T Corp. company business and US$100,000 of life assurance. 225 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) Employees’ emoluments Set out below is information in respect of the five individuals who are not Directors of HSBC Holdings whose emoluments (excluding commissions or bonuses related to the revenue or profits generated by employees individually or collectively with others engaged in similar activities) were the highest in HSBC for the year ended 31 December 2004. Basic salaries, allowances and benefits in kind ......................................................... Pension contributions .................................. Bonuses paid or receivable .......................... Inducements to join paid or receivable......... Compensation for loss of office – contractual .............................................. – other ........................................................ Total ............................................................ Total (US$000) ........................................... £000 976 90 34,038 820 – – 35,924 65,803 Their emoluments are within the following bands: £4,600,001 – £4,700,000 ............................ £5,200,001 – £5,300,000 ............................ £7,300,001 – £7,400,000 ............................ £13,500,001 – £13,600,000 ........................ Number of Employees 1 2 1 1 The basic salaries of Group Managing Directors and Group General Managers are within the following bands: Number of Group Managing Directors and Group General Managers £150,001 – £250,000 ........................ £250,001 – £350,000 ........................ £350,001 – £450,000 ........................ £450,001 – £550,000 ........................ 6 17 4 1 The aggregate remuneration of Directors and Senior Management for the year ended 31 December 2004 was US$118,290,000. The aggregate amount set aside or accrued to provide pension, retirement or similar benefits for Directors and Senior Management for the year ended 31 December 2004 was US$6,261,000. At 31 December 2004, executive Directors and Senior Management held, in aggregate, options to subscribe for 11,398,184 HSBC Holdings ordinary shares under the HSBC Holdings Executive Share Option Scheme, HSBC Holdings Group Share Option Plan and HSBC Holdings savings-related share option plans. These options are exercisable between 2005 and 2014 at prices ranging from £3.3334 to £8.2830. 226 Audited Information Directors’ emoluments The emoluments of the Directors of HSBC Holdings for 2004 were as follows: Salary and other remuneration £000 Fees £000 Benefits in kind1 £000 Bonuses £000 –2 55 9 23 31 55 46 55 55 90 18611 70 58 11712 85 85 23 115 75 55 3913 9514 59 559 1,183 71 246 395 6038 486 695 521 – – – – – – – – – – – – – – 79 5 – – 435 8 14 7 – – – – – – – – – – – – – – – 2,1843 2,4064 2,1165 3264 4564 5004 –10 1,0004 4504 – – – – – – – – – – – – – – Total 2004 £000 2,822 3,649 2,196 595 1,317 1,166 546 1,757 1,026 90 186 70 58 117 85 85 23 115 75 55 39 95 59 Total 2003 £000 2,157 2,147 1,334 631 1,180 1,057 – 1,237 958 45 159 35 – 65 35 55 35 50 50 35 25 64 35 Executive Directors W F Aldinger .............................. Sir John Bond ............................. C F W de Croisset5 ...................... W R P Dalton6 ............................. D G Eldon7 .................................. D J Flint ...................................... M F Geoghegan9 ......................... S K Green ................................... AW Jebson .................................. Non-executive Directors Lord Butler ................................. R K F Ch’ien ............................... Baroness Dunn ............................ R A Fairhead9 .............................. W K L Fung ................................ S Hintze ...................................... Sir John Kemp-Welch ................. Lord Marshall ............................. Sir Brian Moffat .......................... Sir Mark Moody-Stuart ............... S W Newton ................................ H Sohmen ................................... C S Taylor.................................... Sir Brian Williamson .................. Total ............................................ Total (US$000) ........................... 1,481 2,713 4,759 8,717 548 1,004 9,438 17,288 16,226 29,722 12,27215 20,052 1 Benefits in kind for executive Directors include provision of company car, medical insurance, other insurance cover and travel assistance. 2 W F Aldinger has elected to waive any fees payable to him by HSBC Holdings (2004: £55,000; 2003: £23,300). 3 Under the terms of his employment contract dated 14 November 2002, W F Aldinger is entitled to a bonus of US$4,000,000 in respect of 2004, which will be paid in 2005. 4 These discretionary bonuses are in respect of 2004 and will be paid in 2005. 5 Retired as a Director on 27 February 2004. He had a contract of employment dated 7 January 1980 that was in force before he joined the Board of CCF. The contract had no set term but provided for three months’ notice to be given by either party. Under the terms of the contract, Mr de Croisset would be entitled to receive one month's salary for each year of service with CCF on termination of his employment with CCF. In accordance with French legal requirements and practice, this contract was suspended while he served as an executive Director of CCF. In consideration of Mr de Croisset's early retirement from the Group and in light of French legal requirements, a review of market practice was undertaken and a one-off payment of €2,633,742 was made to Mr de Croisset, which was considered to be appropriate in all the circumstances. 6 Retired as a Director on 28 May 2004. 7 The emoluments of D G Eldon include a fee from The Hongkong and Shanghai Banking Corporation and housing and other expatriate benefits in kind that are normal within the location in which he is employed. Mr Eldon has elected to waive any fees payable to him by HSBC Holdings (2004: £55,000; 2003: £35,000). 8 Includes an executive allowance of £137,100 (2003: £96,863) paid to fund personal pension arrangements. 9 Appointed a Director on 1 March 2004. 10 In return for the prior waiver of bonus, the employer contribution into the pension scheme has been increased by the amount of £1,200,000 (2003: nil) which would otherwise have been paid. 11 Includes fees as non-executive Chairman of HSBC Private Equity (Asia) Limited and as a non-executive Director of The Hongkong and Shanghai Banking Corporation. 12 Includes fee as a non-executive Director of The Hongkong and Shanghai Banking Corporation. 13 Fees as a non-executive Director and member of the Audit Committee of The Hongkong and Shanghai Banking Corporation. H Sohmen has elected to waive any fees payable to him by HSBC Holdings (2004: £55,000; 2003: £35,000). 14 Includes fees as a non-executive Director of HSBC Bank USA and HSBC USA Inc. 15 Includes the emoluments of a Director who retired in 2003. 227 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) Pensions There are separate schemes for UK-based and overseas-based employees: the UK scheme has a normal retirement age of 60; retirement ages for overseas schemes vary in accordance with local legislation and practice. Save as stated below no other Director participated in any HSBC pension schemes, none of the Directors participating in HSBC’s UK ‘approved’ pension schemes is subject to the earnings cap introduced by the 1989 Finance Act and only basic salary is pensionable. With two exceptions (see paragraphs below on W F Aldinger and D J Flint), the current executive Directors are members of defined benefit pension schemes, having joined HSBC at a time when these were the norm. Before commencement of the 2002 employment agreement on 28 March 2003, W F Aldinger participated in HSBC Finance Corporation’s ‘qualified’ and ‘non-qualified’ defined benefit pension plans. The annual pension benefit under these arrangements was a function of service and a percentage of Final Average Earnings (which included bonus). The ‘non-qualified plans’ were enhanced before commencement of the 2002 employment agreement. The benefits under the ‘qualified’ and ‘non-qualified’ defined benefit pension plans were then frozen and will be payable in a lump sum on the earlier of the termination of Mr Aldinger’s employment or on Mr Aldinger’s retirement (these benefits will be payable in a lump sum following Mr Aldinger’s retirement on 29 April 2005, referred to above). No further benefits have accrued under these arrangements since 28 March 2003. Since commencement of the 2002 employment agreement on 28 March 2003, Mr Aldinger has continued to participate in the HSBC Finance Corporation Tax Reduction Investment Plan (‘TRIP’), which is a ‘qualified’ funded deferred profit-sharing and savings plan for eligible employees. Employer contributions of US$10,250 were made to this plan on behalf of Mr Aldinger in 2004 (2003: Nil). On 1 January 2005 the plan name was changed to HSBC-North America (U.S.) Tax Reduction Investment Plan (TRIP). Mr Aldinger also participated in Supplemental TRIP (a ‘non-qualified’ plan), which is an unfunded arrangement under which additional employer provision of US$289,749 has been made for 2004 (2003: US$41,539). The pension arrangements for Sir John Bond, S K Green and A W Jebson to contractual retirement age of 60 are provided under the HSBC Bank (UK) Pension Scheme. The pensions accrue at a rate of 228 one-thirtieth of pensionable salary per year of pensionable service in the UK. Until his retirement from CCF on 29 February 2004, C F W de Croisset was eligible for pension benefits which were supplementary to those accrued under the French State and Compulsory arrangements. The amount of this supplementary pension, payable from age 60, accrued at the rate of €6,098 per annum for each year of service (maximum 18 years) as an executive Director of CCF. Consequent upon Mr de Croisset’s early retirement from CCF and following a review of market practice, it was agreed to provide a total pension of €341,467 per annum (equivalent to 32.5 per cent of his average total cash compensation over a three-year period) payable from 1 March 2004. In 2004, CCF paid €213,003 to Mr de Croisset under this arrangement. The pension arrangements for W R P Dalton to contractual retirement age of 60 were provided on a defined benefit basis (details of which are set out in the table below) under the HSBC Canada Pension Plan A, at an accrual rate of one-thirtieth of pensionable salary per year of pensionable service until his transfer to the UK in 1998. On taking up his appointment in the UK, he joined the HSBC Holdings Overseas (No.1) Pension Plan on a defined contribution basis, with an employer contribution in respect of 2004 of £129,000 (2003: £1,379,000 inclusive of a bonus waiver of £1,250,000). The pension arrangements for D J Flint to contractual retirement age of 60 are provided through an executive allowance paid to fund personal pension arrangements set at 30 per cent of basic salary. This is supplemented through the HSBC Holdings plc Funded Unapproved Retirement Benefits Scheme on a defined contribution basis with an employer contribution during 2004 of £86,013 (2003: £81,943). The intention of these arrangements is to provide benefits broadly comparable to an accrual rate of one-thirtieth of pensionable salary for each year of pensionable service. The pension arrangements for D G Eldon and M F Geoghegan are provided under the HSBC International Staff Retirement Benefits Scheme. The pensions accrue at a rate of one twenty-seventh of pensionable salary per year of pensionable service. In addition, Mr Geoghegan has joined the HSBC Asia Holdings Pension Plan, on a defined contribution basis, with an employer contribution in respect of 2004 of £1,200,000, arising entirely from a bonus sacrifice. There were no other employer contributions made to this plan. Audited Information Accrued annual pension at 31 December 2004 £000 Increase in accrued pension during 2004 £000 Increase in accrued pension during 2004, excluding any increase for inflation £000 Transfer value of accrued pension at 1 January 2004 £0001 Transfer value of accrued pension at 31 December 2004 £0001 Increase of transfer value of accrued pension (less personal contributions) in 2004 £0001 Transfer value (less personal contributions) at 31 December 2004 relating to increase in accrued pensions during 2004, excluding any increase for inflation £0001 Sir John Bond2 .... C F W de Croisset3 W R P Dalton4 ..... D G Eldon5 .......... M F Geoghegan7 .. S K Green ........... A W Jebson ......... 481 193 13 278 185 288 182 57 128 3 27 34 110 41 44 128 (3) 18 29 105 37 7,924 860 4,258 5,045 3,652 2,367 1,769 9,230 2,623 4,562 5,275 4,042 4,401 2,612 1,306 1,763 304 3286 6208 2,034 843 840 1,747 226 2156 3768 1,599 529 1 The transfer value represents a liability of HSBC’s pension funds and not a sum paid or due to the individual; it cannot therefore meaningfully be added to annual remuneration. 2 On attaining age 60, Sir John Bond has been able, under the terms of the scheme, to retire at any time with an immediate pension equal to his accrued pension which, at 31 December 2004, is shown above. 3 Retired as a Director on 27 February 2004. 4 W R P Dalton retired from HSBC with effect from 31 May 2004 with a gross pension of £277,000 per annum. Mr Dalton elected to commute part of this pension for a lump sum payment of £4,256,000, leaving a residual pension of £13,000 per annum. As a result the pension in payment at 31 December 2004 is lower than the accrued pension at 1 January 2004. The increase in accrued pension during 2004 reflects the gross pension before commutation. The transfer value of benefits at 31 December 2004 reflects both the pension in payment and the commutation lump sum, increased with interest. 5 On attaining age 53, D G Eldon has been able, under the terms of the scheme, to retire at any time with an immediate pension equal to his accrued pension which, at 31 December 2004, is shown above. 6 D G Eldon made personal contributions towards his pension of £15,445 in respect of 2004. 7 Appointed as a Director on 1 March 2004. 8 M F Geoghegan made personal contributions towards his pension of £14,182 in respect of 2004. In addition to the unfunded pension payments as from 1 March 2004 to C F W de Croisset referred to above, the following unfunded pension payments, in respect of which provision has been made, were made during 2004 to four former Directors of HSBC Holdings: B H Asher ....................... R Delbridge ...................... Sir Brian Pearse ................ Sir William Purves ........... 2004 £ 85,443 122,891 51,246 90,453 350,033 2003 £ 83,277 119,777 49,947 88,158 341,159 The payments in respect of R Delbridge and Sir Brian Pearse were made by HSBC Bank plc as former Directors of the bank. Share options At 31 December 2004, the undernamed Directors held options to acquire the number of HSBC Holdings ordinary shares set against their respective names. The options were awarded for nil consideration at exercise prices equivalent to the market value at the date of award, except that options awarded under the HSBC Holdings savings- related share option plans before 2001 are exercisable at a 15 per cent discount to the market value at the date of award and those awarded since 2001 at a 20 per cent discount. Under the Securities and Futures Ordinance of Hong Kong the options are categorised as unlisted physically settled equity derivatives. Except as otherwise indicated, no options were exercised or lapsed during the year and there are no remaining performance criteria conditional upon which the outstanding options are exercisable. The market value of the ordinary shares at 31 December 2004 was £8.79. The highest and lowest market values during the year were £9.535 and £7.84. Market value is the mid-market price derived from the London Stock Exchange Daily Official List on the relevant date. 229 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) Audited Information Options held at 1 January 2004 Options awarded during year Options exercised during year Sir John Bond ........ 2,798 C F W de Croisset3. 206,000 206,000 206,000 W R P Dalton6 ....... 2,7982 D J Flint ................. M F Geoghegan .... S K Green .............. A W Jebson............ 27,000 2,617 1,2482,9 5599 5732,9 3,070 1,4342 – – – – – – – – – – – – – – – – – 27,0008 – 1,24810 – 57310 – 1,43411 Options held at 31 December 2004 2,7982 206,0004 206,0004 206,0005 2,7987 – 2,6172 – 5592 – 3,0702 Exercise price (£) Date of award Exercisable from1 Exercisable until 6.0299 10 Apr 2000 1 Aug 2005 31 Jan 2006 8.7120 23 Apr 2001 23 Apr 2004 23 Apr 2011 7 May 2012 8.4050 1 May 2013 6.9100 7 May 2005 2 May 2006 7 May 2002 2 May 2003 6.0299 10 Apr 2000 1 Aug 2005 31 Jan 2006 3.3334 6.3224 1 Apr 1996 2 May 2002 1 Apr 1999 1 Aug 2007 1 Apr 2006 31 Jan 2008 5.3980 1 Apr 1999 6.0299 10 Apr 2000 6.7536 11 Apr 2001 1 Aug 2004 1 Aug 2005 1 Aug 2004 31 Jan 2005 31 Jan 2006 31 Jan 2005 5.3496 23 Apr 2003 1 Aug 2008 31 Jan 2009 – 6.7536 11 Apr 2001 1 Aug 2004 31 Jan 2005 1 May be advanced to an earlier date in certain circumstances, e.g. retirement. 2 Options awarded under the HSBC Holdings Savings-Related Share Option Plan. 3 Retired as a Director on 27 February 2004. 4 Options held under the HSBC Holdings Group Share Option Plan at date of retirement as a Director (27 February 2004). In accordance with the transitional arrangements agreed with CCF in 2000 the awards were not subject to performance conditions. 5 Options held under the HSBC Holdings Group Share Option Plan at date of retirement as a Director (27 February 2004). In accordance with the transitional arrangements agreed with CCF in 2000, vesting of 50 per cent of the award is subject to the performance tests set out in the section headed ‘Arrangements from 1999-2004’ on pages 222 to 223. 6 Retired as a Director on 28 May 2004. 7 Options held at date of retirement as a Director (28 May 2004). On 11 November 2004, in accordance with the rules of the Plan, the option was exercised in respect of 2,070 ordinary shares and options over 728 shares lapsed. At the date of exercise the market value per share was £9.38. 8 At the date of exercise, 4 March 2004, the market value per share was £ 8.515. The exercise of these options was conditional upon the growth in earnings per share over a three-year period being equal to or greater than a composite rate of inflation (comprising 50 per cent of the Hong Kong Composite Consumer Price Index, 35 per cent of the UK Retail Price Index and 15 per cent of the USA All Urban Consumer Price Index) plus 2 per cent per annum. This condition has been satisfied. 9 Interests at date of appointment as a Director (1 March 2004). 10 At the date of exercise, 16 August 2004, the market value per share was £8.265. 11 At the date of exercise, 2 August 2004, the market value per share was £8.335. At 27 February 2004, the date he retired as a Director, C F W de Croisset held the following options to acquire CCF shares of €5 each. On exercise of these options each CCF share will be exchanged for 13 HSBC Holdings ordinary shares. The options were granted by CCF for nil consideration at a 5 per cent discount to the market value at the date of award. There are no remaining performance criteria conditional upon which the outstanding options are exercisable. Save as indicated in the following table no options over CCF shares were awarded to or exercised by Mr de Croisset during 2004. 230 Audited Information CCF shares of €5 Options held at 1 January 2004 10,000 30,000 30,000 30,000 30,000 28,000 28,000 Exercise price per share (€) Options held at 27 February 2004 32.78 34.00 35.52 37.05 73.50 81.71 142.50 10,0001 30,000 30,000 30,000 30,000 28,000 28,000 Equivalent HSBC Holdings ordinary shares at 27 February 2004 130,000 390,000 390,000 390,000 390,000 364,000 364,000 Date of award 23 Jun 1994 22 Jun 1995 9 May 1996 7 May 1997 29 Apr 1998 7 Apr 1999 12 Apr 2000 Exercisable from 23 Jun 1996 22 Jun 1997 9 May 1998 7 Jun 2000 7 Jun 2000 7 Jun 2000 1 Jan 2002 Exercisable until 23 Jun 2004 22 Jun 2005 9 May 2006 7 May 2007 29 Apr 2008 7 Apr 2009 12 Apr 2010 1 Options exercised on 24 March 2004. At the date of exercise the market value per HSBC Holdings ordinary share was £8.21. At 31 December 2004, W F Aldinger held options to acquire HSBC Holdings ordinary shares as set out in the table below. These options arise from options he held over shares of Household International (now HSBC Finance Corporation) before its acquisition, which were converted into options over HSBC Holdings ordinary shares in the same ratio as the offer for HSBC Finance Corporation (2.675 HSBC HSBC Holdings ordinary shares of US$0.50 Holdings ordinary shares for each HSBC Finance Corporation common share) and the exercise prices per share adjusted accordingly. The HSBC Finance Corporation options were granted at nil consideration. No options over HSBC Holdings ordinary shares were awarded to Mr Aldinger during 2004. Options held at 1 January 2004 971,025 1,003,125 1,203,750 1,337,500 1,230,500 1,605,000 2,140,000 2,140,000 Exercise price per share (US$) Options exercised during year Options held at 31 December 2004 7.43 11.43 14.60 13.72 16.96 18.40 21.37 10.66 971,0251 1,003,1252 – – – – – – – – 1,203,750 1,337,500 1,230,500 1,605,000 2,140,000 2,140,000 Date of award 13 Nov 1995 11 Nov 1996 10 Nov 1997 9 Nov 1998 8 Nov 1999 13 Nov 2000 12 Nov 2001 20 Nov 2002 Exercisable from 13 Nov 1996 11 Nov 1997 10 Nov 1998 9 Nov 1999 8 Nov 2000 13 Nov 2001 12 Nov 2002 20 Nov 20033 Exercisable until 13 Nov 2005 11 Nov 2006 10 Nov 2007 9 Nov 2008 8 Nov 2009 13 Nov 2010 12 Nov 2011 20 Nov 2012 1 At the date of exercise, 2 September 2004, the market value per share was £8.755. 2 At the date of exercise, 7 December 2004, the market value per share was £8.855. 3 535,000 options are exercisable on each of the first, second, third and fourth anniversaries of the date of award. May be advanced, under the terms of the HSBC Finance Corporation stock option plan, to an earlier date in certain circumstances e.g. retirement. 1,070,000 options remaining unvested will therefore vest on Mr Aldinger’s retirement on 29 April 2005. Based on the market price of HSBC Holdings shares on 24 February 2005 and after deduction of the option subscription price these options have a value of approximately £3,512,000. As a beneficiary of an employee benefit trust W F Aldinger has an interest in the HSBC Holdings ordinary shares held by the trust which may be used to satisfy exercises of his share options. Under the Securities and Futures Ordinance of Hong Kong, the interest is categorised as a ‘beneficiary of a trust’. At 31 December 2004, the trust held 1,525,850 HSBC Holdings ordinary shares and 500,000 ADSs. Save as stated above, none of the Directors, or members of their immediate families, were awarded or exercised any right to subscribe for any shares or debentures during the year. 231 H S B C H O L D I N G S P L C Directors’ Remuneration Report (continued) Audited Information Restricted Share Plan HSBC Holdings ordinary shares of US$0.50 Awards held at 1 January 2004 Awards made during the year Monetary value of awards made during the year £000 W F Aldinger ..... Sir John Bond ... W R P Dalton..... D G Eldon ......... D J Flint ............ M F Geoghegan S K Green ......... A W Jebson ....... 960,662 – 71,386 89,621 83,988 125,767 167,843 – 41,643 40,738 47,994 79,432 114,438 41,643 40,738 47,994 7,072 52,955 9,806 76,292 13,329 – 41,643 36,663 59,992 79,432 114,438 – 35,97511 32,84611 36,28011 40,03011 53,82711 – 41,643 40,738 83,988 99,290 114,438 – 35,693 32,589 71,990 92,671 114,438 – – 372,5874 – – – – – 244,4457 – – – – – – – – – – – – – 87,3027 – – – – – 121,0587 – – – – – 90,7947 – – – – – 166,4557 – – – – – 121,0587 – 3,068 – – – – – 2,100 – – – – – – – – – – – – – 750 – – – – – 1,040 – – – – – 780 – – – – – 1,430 – – – – – 1,040 Awards vested during the year1 319,5212 – 71,9486 – – – – – 41,9696 41,7148 49,1458 – – 41,9696 – – 7,24010 – – – – – 41,9696 – – – – – 35,9746 – – – – – 41,9696 – – – – – 35,9746 – – – – – Monetary value of awards vested during the year £000 Awards held at 31 December 20041 Year in which awards may vest Date of award 2,585 – 670,821 379,232 15 Apr 2003 10 May 2004 2005 to 20063 2005 to 20075 613 – – – – – 357 342 403 – – 357 – – 58 – – – – – 357 – – – – – 306 – – – – – 357 – – – – – 306 – – – – – – 93,405 87,535 131,077 174,929 252,771 – – – 81,3359 117,1809 – 42,458 50,021 – 55,191 10,220 79,513 13,892 90,276 – 38,211 62,525 82,786 119,270 125,182 – 33,965 37,515 41,393 55,661 93,887 – 42,458 87,535 103,482 119,270 172,125 – 33,965 75,030 96,584 119,270 125,182 4 Mar 1999 10 Mar 2000 12 Mar 2001 8 Mar 2002 5 Mar 2003 4 Mar 2004 4 Mar 1999 10 Mar 2000 12 Mar 2001 8 Mar 2002 5 Mar 2003 4 Mar 1999 10 Mar 2000 12 Mar 2001 30 Apr 2001 8 Mar 2002 15 May 2002 5 Mar 2003 12 May 2003 4 Mar 2004 4 Mar 1999 10 Mar 2000 12 Mar 2001 8 Mar 2002 5 Mar 2003 4 Mar 2004 4 Mar 1999 10 Mar 2000 12 Mar 2001 8 Mar 2002 5 Mar 2003 4 Mar 2004 4 Mar 1999 10 Mar 2000 12 Mar 2001 8 Mar 2002 5 Mar 2003 4 Mar 2004 4 Mar 1999 10 Mar 2000 12 Mar 2001 8 Mar 2002 5 Mar 2003 4 Mar 2004 2004 2005 2006 2007 2008 2009 2004 2005 2006 2007 2008 2004 2005 2006 2004 2007 2005 2008 2006 2009 2004 2005 2006 2007 2008 2009 2004 2005 2006 2007 2008 2009 2004 2005 2006 2007 2008 2009 2004 2005 2006 2007 2008 2009 Unless otherwise indicated, vesting of these shares is subject to the performance tests set out in the section headed ‘Arrangements from 1999-2004’ on pages 222 to 223. 232 Audited information 1 Includes additional shares arising from scrip dividends. 2 At the date of vesting, 31 March 2004, the market value per share was £8.09. At the date of award, 15 April 2003, the market value per share was £6.81. 3 Under the terms of this award the shares will vest in three instalments on each of the first three anniversaries of 28 March 2003 so long as Mr Aldinger remains employed on the relevant vesting date, subject to accelerated vesting upon a termination of cause, or by Mr Aldinger for good reason or due to his death or disability. Pursuant to the amendment agreement referred to above the 337,976 shares (having a value of approximately £2,994,000 based on the market price on 24 February 2005) not vested at retirement will vest on Mr Aldinger’s retirement on 29 April 2005. 4 At the date of the award, 10 May 2004, the market value per share was £7.94. The shares acquired by the Trustee of the Plan were purchased at an average price of £8.235. 5 Under the terms of this award the shares will vest in three instalments on each of 31 March 2005, 2006 and 2007 so long as Mr Aldinger remains employed on the relevant vesting date, subject to accelerated vesting upon a termination of cause, or by Mr Aldinger for good reason or due to his death or disability. Pursuant to the amendment agreement referred to above the 254,755 shares (having a value of approximately £2,257,000 based on the market price on 24 February 2005) not vested at retirement will vest on Mr Aldinger’s retirement on 29 April 2005. 6 The performance tests described in the 'Report of the Directors' in the Annual Report and Accounts 1998 and set out in the section headed ‘Arrangements from 1999-2004’ on pages 222 to 223 have been met and the shares have vested. At the date of vesting, 4 March 2004, the market value per share was £8.515. The market value per share (adjusted for the share capital reorganisation implemented on 2 July 1999) at the date of the award, 4 March 1999, was £5.92. 7 At the date of the award, 4 March 2004, the market value per share was £8.515. The shares acquired by the Trustee of the Plan were purchased at an average price of £8.5909. 8 Retired as a Director on 28 May 2004. The awards held at the date of retirement that had passed the performance tests set out in the section headed ‘Arrangements from 1999-2004’ on pages 222 to 223 (the awards made in 2000 and 2001) were released to Mr Dalton on 30 June 2004. At 30 June 2004 the market value per share was £8.20. The market values per share at the dates of the awards, 10 March 2000 and 12 March 2001, were £7.09 and £8.62 respectively. 9 Interests at date of retirement as a Director (28 May 2004). 10 50 per cent of D G Eldon’s discretionary bonus in respect of 2000, 2001 and 2002 respectively was awarded in Restricted Shares with a three-year restricted period. 11 Interests at date of appointment (1 March 2004). On behalf of the Board 28 February 2005 Sir Mark Moody-Stuart, Chairman of Remuneration Committee 233 H S B C H O L D I N G S P L C Statement of Directors’ Responsibilities in Relation to Financial Statements The following statement, which should be read in conjunction with the Auditors’ statement of their responsibilities set out in their report on pages 235 and 236, is made with a view to distinguishing for shareholders the respective responsibilities of the Directors and of the Auditors in relation to the financial statements. The Directors are required by the Companies Act 1985 to prepare financial statements for each financial year which give a true and fair view of the state of affairs of HSBC Holdings plc together with its subsidiary undertakings as at the end of the financial year and of the profit or loss for the financial year. They are also required to present additional information for US shareholders. Accordingly, these financial statements are framed to meet both UK and US requirements to give a consistent view to all shareholders. The Directors are required to prepare these financial statements on the going concern basis unless it is not appropriate. Since the Directors are satisfied that HSBC has the resources to continue in business for the foreseeable future, the financial statements continue to be prepared on the going concern basis. The Directors consider that in preparing the financial statements on pages 237 to 356, HSBC Holdings has used appropriate accounting policies, consistently applied, save as disclosed in the ‘Notes on the Financial Statements’, and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider to be applicable have been followed. The Directors have responsibility for ensuring that HSBC Holdings keeps accounting records which disclose with reasonable accuracy at any time the financial position of HSBC Holdings and which enable them to ensure that the financial statements comply with the Companies Act 1985. The Directors have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of HSBC and to prevent and detect fraud and other irregularities. On behalf of the Board R G Barber, Secretary 28 February 2005 234 H S B C H O L D I N G S P L C Independent auditors’ report to the Members of HSBC Holdings plc We have audited the financial statements on pages 237 to 356. We have also audited the information in the directors’ remuneration report that is described as having been audited. This report is made solely to the members of HSBC Holdings plc (‘HSBC Holdings’), as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the members of HSBC Holdings those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than HSBC Holdings and the members of HSBC Holdings as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors The Directors are responsible for preparing the Annual Report and the Directors’ remuneration report. As described on page 234, this includes responsibility for preparing the financial statements in accordance with applicable United Kingdom law and accounting standards. Our responsibilities, as independent auditors, are established in the United Kingdom by statute, the Auditing Practices Board, the Listing Rules of the Financial Services Authority, and by our profession’s ethical guidance. We report to you our opinion as to whether the financial statements give a true and fair view and whether the financial statements and the part of the Directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985. We also report to you if, in our opinion, the Directors’ report is not consistent with the financial statements, if HSBC Holdings has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding Directors’ remuneration and transactions with HSBC Holdings together with its subsidiary undertakings (together ‘HSBC’) is not disclosed. We review whether the corporate governance statement on pages 208 to 209 reflects HSBC Holdings’ compliance with the nine provisions of the 2003 Financial Reporting Council Code specified for our review by the Listing Rules, and we report if it does not. We are not required to consider whether the board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of HSBC’s corporate governance procedures or its risk and control procedures. We read the other information contained in the Annual Report, including the corporate governance statement and the unaudited part of the Directors’ remuneration report, and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Basis of audit opinion We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the Directors’ remuneration report to be audited. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to HSBC’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements and the part of the Directors’ remuneration report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements and the part of the Directors’ remuneration report to be audited. 235 H S B C H O L D I N G S P L C Independent auditors’ report to the Members of HSBC Holdings plc (continued) Opinion In our opinion: • the financial statements give a true and fair view of the state of affairs of HSBC Holdings and HSBC as at 31 December 2004 and of the profit of HSBC for the year then ended; and • the financial statements and the part of the Directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985. KPMG Audit Plc Chartered Accountants and Registered Auditor 28 February 2005 236 H S B C H O L D I N G S P L C Financial Statements Consolidated profit and loss account for the year ended 31 December 2004 Notes 2004 US$m 2003 US$m 2002 US$m Interest receivable – interest receivable and similar income arising from debt securities ............................................................................... – other interest receivable and similar income ................................ Interest payable ................................................................................ Net interest income ........................................................................ Dividend income .............................................................................. Fees and commissions receivable ..................................................... Fees and commissions payable ........................................................ Dealing profits ................................................................................. Other operating income .................................................................... Operating income............................................................................ Administrative expenses .................................................................. Depreciation and amortisation – tangible fixed assets...................................................................... – intangible assets............................................................................ – goodwill........................................................................................ Operating profit before provisions ............................................... Provisions for bad and doubtful debts .............................................. Provisions for contingent liabilities and commitments ..................... Amounts written off fixed asset investments ................................... Operating profit ............................................................................. Share of operating profit/(loss) in joint ventures .............................. Share of operating profit in associates ............................................. Gains/(losses) on disposal of – investments .................................................................................. – tangible fixed assets ..................................................................... Profit on ordinary activities before tax ........................................ Tax on profit on ordinary activities .................................................. Profit on ordinary activities after tax ........................................... Minority interests – equity ........................................................................................... – non-equity .................................................................................... Profit attributable to shareholders ............................................... 3 4 6 5,6 24 23 23 16 31 6 7 Dividends ......................................................................................... 9 Retained profit for the year............................................................ Basic earnings per ordinary share .................................................... Diluted earnings per ordinary share ................................................. Dividends per ordinary share ........................................................... 10 10 9 Movements in reserves are set out in Note 35. The accompanying notes are an integral part of the Consolidated Financial Statements. All results are from continuing operations. 7,845 42,358 (19,179) 31,024 601 15,877 (2,784) 2,566 3,303 50,587 (24,183) (1,664) (28) (1,814) 22,898 (6,357) (27) – 16,514 5 287 770 32 17,608 (4,507) 13,101 (586) (675) 11,840 (7,301) 4,539 US$ 1.09 1.07 0.66 6,947 33,021 (14,370) 25,598 222 12,560 (2,166) 2,178 2,680 41,072 (19,685) (1,382) (15) (1,450) 18,540 (6,093) (44) (106) 12,297 (116) 221 451 (37) 12,816 (3,120) 9,696 (487) (435) 8,774 (6,532) 2,242 US$ 0.84 0.83 0.60 7,253 21,342 (13,135) 15,460 278 9,245 (1,421) 1,313 1,720 26,595 (13,764) (1,190) – (854) 10,787 (1,321) (107) (324) 9,035 (28) 135 532 (24) 9,650 (2,534) 7,116 (505) (372) 6,239 (5,001) 1,238 US$ 0.67 0.66 0.53 237 H S B C H O L D I N G S P L C Financial Statements (continued) Consolidated balance sheet at 31 December 2004 Notes 2004 US$m 2003 US$m ASSETS Cash and balances at central banks .................................................................................... Items in the course of collection from other banks ............................................................ Treasury bills and other eligible bills ................................................................................ Hong Kong Government certificates of indebtedness ....................................................... Loans and advances to banks ............................................................................................ Loans and advances to customers ...................................................................................... Debt securities ................................................................................................................... Equity shares ..................................................................................................................... Interests in joint ventures: gross assets .............................................................................. gross liabilities ........................................................................ Interests in associates ........................................................................................................ Other participating interests .............................................................................................. Goodwill and intangible assets .......................................................................................... Tangible fixed assets ......................................................................................................... Other assets ....................................................................................................................... Prepayments and accrued income ...................................................................................... 11 12 14 15 18 19 20 21 22 23 24 26 9,872 6,352 30,284 11,878 142,712 669,831 240,999 19,319 110 (98) 12 3,440 881 29,382 18,829 73,498 19,489 7,661 6,628 20,391 10,987 117,173 528,977 205,722 12,879 87 (77) 10 1,263 690 28,640 15,748 63,128 14,319 Total assets ........................................................................................................................ 1,276,778 1,034,216 238 Notes 2004 US$m 2003 US$m LIABILITIES Hong Kong currency notes in circulation .......................................................................... Deposits by banks ............................................................................................................. Customer accounts ............................................................................................................ Items in the course of transmission to other banks ............................................................ Debt securities in issue ...................................................................................................... Other liabilities .................................................................................................................. Accruals and deferred income ........................................................................................... Provisions for liabilities and charges – deferred taxation ........................................................................................................... – other provisions ............................................................................................................. Subordinated liabilities – undated loan capital ...................................................................................................... – dated loan capital .......................................................................................................... Minority interests – equity ............................................................................................................................ – non-equity ..................................................................................................................... Called up share capital ...................................................................................................... Share premium account ..................................................................................................... Other reserves ................................................................................................................... Revaluation reserves ......................................................................................................... Profit and loss account ...................................................................................................... Shareholders’ funds ........................................................................................................... 12 27 28 29 30 31 32 33 34 35 35 35 35 11,878 83,539 693,751 5,301 208,593 123,315 16,500 2,066 5,532 3,686 22,800 2,476 10,718 5,587 4,881 21,457 2,660 52,038 86,623 10,987 70,426 573,130 4,383 153,562 94,669 13,760 1,670 5,078 3,617 17,580 2,162 8,719 5,481 4,406 21,543 1,615 41,428 74,473 Total liabilities .................................................................................................................. 1,276,778 1,034,216 MEMORANDUM ITEMS Contingent liabilities ......................................................................................................... – acceptances and endorsements ....................................................................................... – guarantees and assets pledged as collateral security ....................................................... – other contingent liabilities .............................................................................................. 38 7,214 64,921 57 72,192 5,412 54,439 29 59,880 Commitments .................................................................................................................... 38 567,696 428,764 Sir John Bond, Group Chairman The accompanying notes are an integral part of the Consolidated Financial Statements. 239 H S B C H O L D I N G S P L C Financial Statements (continued) HSBC Holdings balance sheet at 31 December 2004 FIXED ASSETS Tangible assets .................................................................................................................. Investments – shares in HSBC undertakings ........................................................................................ – loans to HSBC undertakings .......................................................................................... – debt securities of HSBC undertakings ........................................................................... – other investments other than loans ................................................................................. CURRENT ASSETS Debtors – money market deposits with HSBC undertakings........................................................... – other amounts owed by HSBC undertakings .................................................................. – amounts owed by HSBC undertakings (falling due after more than 1 year).................... – other debtors ................................................................................................................... Cash at bank and in hand – balances with HSBC undertakings ................................................................................. CREDITORS: amounts falling due within 1 year Amounts owed to HSBC undertakings............................................................................... Other creditors ................................................................................................................... Dividends declared............................................................................................................. NET CURRENT ASSETS .............................................................................................. TOTAL ASSETS LESS CURRENT LIABILITIES ..................................................... CREDITORS: amounts falling due after more than 1 year Subordinated liabilities – owed to third parties ...................................................................................................... – owed to HSBC undertakings........................................................................................... Amounts owed to HSBC undertakings .............................................................................. PROVISIONS FOR LIABILITIES AND CHARGES Notes 24 25 9 32 Deferred taxation ............................................................................................................... 31 NET ASSETS .................................................................................................................. CAPITAL AND RESERVES Called up share capital ...................................................................................................... Share premium account ..................................................................................................... Revaluation reserve ........................................................................................................... Reserve in respect of obligations under subsidiary share options ...................................... Profit and loss account ...................................................................................................... 34 35 35 35 35 2004 US$m 2 94,885 4,712 1,885 581 102,065 7,036 5,131 1,680 100 13,947 246 14,193 (858) (191) (4,205) (5,254) 8,939 111,004 (9,669) (8,143) (6,494) (75) 86,623 5,587 4,881 68,963 399 6,793 86,623 2003 US$m 2 79,326 3,788 1,175 537 84,828 6,995 2,526 2,412 95 12,028 901 12,929 (700) (261) (3,936) (4,897) 8,032 92,860 (5,970) (6,845) (5,479) (93) 74,473 5,481 4,406 57,041 485 7,060 74,473 Sir John Bond, Group Chairman The accompanying notes are an integral part of the Consolidated Financial Statements. 240 Statement of total consolidated recognised gains and losses for the year ended 31 December 2004 Profit for the financial year attributable to shareholders ................................. Unrealised surplus/(deficit) on revaluation of investment properties: Subsidiaries ................................................................................................ Associates .................................................................................................. Unrealised surplus/(deficit) on revaluation of land and buildings (excluding investment properties): Subsidiaries ................................................................................................ Exchange and other movements ..................................................................... Total recognised gains and losses for the year ............................................... 2004 US$m 11,840 52 12 1,093 3,404 16,401 2003 US$m 8,774 (28) (10) (292) 5,318 13,762 2002 US$m 6,239 (22) (1) (297) 3,781 9,700 Reconciliation of movements in consolidated shareholders’ funds for the year ended 31 December 2004 Profit for the period attributable to shareholders ............................................ Dividends ....................................................................................................... Other recognised gains and losses relating to the year ................................... New share capital subscribed, net of costs ..................................................... Purchases of own shares to meet share awards and share option awards ....... Own shares released on vesting of share awards and exercise of options ....... Amortisation of shares in restricted share plan................................................ Net purchases and sales of own shares for market making purposes1 ............ Total net change in shareholders’ funds arising from own shares adjustments ................................................................................................ Reserve in respect of obligations under CCF share options ........................... Net reserve in respect of obligations under the Bank of Bermuda share options ....................................................................................................... New share capital issued in connection with the acquisition of HSBC Finance Corporation ................................................................... Reserve in respect of obligations under HSBC Finance Corporation share options .............................................................................................. Reserve in respect of the equity component of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units ............................................................................................ Amounts arising on shares issued in lieu of dividends ................................... Net addition to shareholders’ funds ................................................................ Shareholders’ funds at 1 January .................................................................... Shareholders’ funds at 31 December .............................................................. 2004 US$m 11,840 (7,301) 4,539 4,561 581 (345) 159 36 98 (52) (81) 15 – (19) (1) 2,607 12,150 74,473 86,623 2003 US$m 8,774 (6,532) 2,242 4,988 862 (301) 162 19 (138) (258) (41) – 13,405 84 3 1,423 22,708 51,765 74,473 2002 US$m 6,239 (5,001) 1,238 3,461 337 (5) 45 19 – 59 (41) – – – – 1,023 6,077 45,688 51,765 No note of historical cost profits and losses has been presented as there is no material difference between HSBC’s results as disclosed in the consolidated profit and loss account and the results on an unmodified historical cost basis. The accompanying notes are an integral part of the Consolidated Financial Statements. 1 The net purchases and sales for market making purposes relate to long positions. Short positions arising in market making activities are included within ‘Other liabilities’. In 2004, total purchases and sales for market making purposes (including those related to short positions) each amounted to about US$5.9 billion. 241 H S B C H O L D I N G S P L C Financial Statements (continued) Consolidated cash flow statement for the year ended 31 December 2004 Net cash inflow from operating activities ......................................... 40 Notes Dividends received from associated undertakings ............................ Returns on investments and servicing of finance Interest paid on finance leases and similar hire purchase contracts Interest paid on subordinated loan capital ..................................... Dividends paid to minority interests – equity .......................................................................................... – non-equity .................................................................................. Net cash outflow from returns on investments and servicing of finance ......................................................................................... Taxation paid ................................................................................... Capital expenditure and financial investments Purchase of investment securities .................................................. Proceeds from sale and maturities of investment securities ........... Purchase of tangible fixed assets ................................................... Proceeds from sale of tangible fixed assets ................................... Purchase of intangible assets ......................................................... Net cash outflow from capital expenditure and financial 2004 US$m 37,209 127 (45) (915) (664) (548) (2,172) (3,797) (330,917) 315,437 (2,830) 371 (108) 2003 US$m 22,675 108 (37) (882) (514) (392) (1,825) (2,631) (218,196) 206,099 (1,981) 346 (87) 2002 US$m 16,426 114 (29) (870) (480) (357) (1,736) (1,371) (130,166) 122,495 (1,723) 328 – investments ................................................................................. (18,047) (13,819) (9,066) 25 Acquisitions and disposals Net cash (outflow)/inflow from acquisition of and increase in stake in subsidiary undertakings ................................................. Net cash inflow from disposal of subsidiary undertakings ............. Purchase of interests in associated undertakings and other participating interests .................................................................. Proceeds from disposal of associated undertakings and other participating interests .................................................................. Net cash outflow from acquisitions and disposals ........................ Equity dividends paid ....................................................................... Net cash inflow/(outflow) before financing ................................... Financing Issue of ordinary share capital ....................................................... Net purchases and sales of own shares for market making purposes Purchases of own shares to meet share awards and share option awards ........................................................................................ Own shares released on vesting of share awards and exercise of options ........................................................................................ Increase of non equity minority interests ....................................... Decrease of non equity minority interests ..................................... Subordinated loan capital issued ................................................... Subordinated loan capital repaid ................................................... Net cash inflow from financing ...................................................... Increase in cash .............................................................................. 41 42 The accompanying notes are an integral part of the Consolidated Financial Statements. (2,431) 27 (2,301) 204 (4,501) (4,425) 4,394 581 98 (345) 159 1,480 – 6,021 (1,740) 6,254 10,648 (2,137) 556 (47) 3 (1,625) (4,242) (1,359) 845 (138) (301) 181 4,104 (206) 2,358 (1,464) 5,379 4,020 264 – (649) 341 (44) (3,609) 714 337 – (5) 64 – (50) 4,105 (1,923) 2,528 3,242 242 H S B C H O L D I N G S P L C Notes on the Financial Statements 1 Basis of preparation (a) The financial statements have been prepared under the historical cost convention, as modified by the revaluation of certain investments and land and buildings, and in accordance with applicable accounting standards. The consolidated financial statements are prepared in accordance with the special provisions of Part VII Chapter II of the UK Companies Act 1985 (‘the Act’) relating to banking groups. The consolidated financial statements comply with Schedule 9 and the financial statements of HSBC Holdings comply with Schedule 4 to the Act. As permitted by Section 230 of the Act, no profit and loss account is presented for HSBC Holdings. The accounts have been prepared in accordance with the Statements of Recommended Accounting Practice (‘SORPs’) issued by the British Bankers’ Association (‘BBA’) and Irish Bankers’ Federation and with the SORP ‘Accounting issues in the asset finance and leasing industry’ issued by the Finance & Leasing Association. The SORP issued by the Association of British Insurers ‘Accounting for insurance business’ contains recommendations on accounting for insurance business for insurance companies and insurance groups. HSBC is primarily a banking group, rather than an insurance group, and, consistent with previously established practice for such groups preparing consolidated financial statements complying with Schedule 9 to the Act, places a value on its long-term assurance businesses using a valuation of the discounted future earnings expected to emerge from business currently in force, taking into account factors such as recent experience and general economic conditions, together with the surplus retained in the long-term assurance funds. (b) The preparation of financial information requires the use of estimates and assumptions about future conditions. In this connection, management believes that the critical accounting policies where management judgement is necessarily applied are those in relation to provisions for bad and doubtful debts, goodwill impairment, and the valuation of securities and derivatives. Application of these policies and the key estimates and assumptions used are described in the Financial Review section on pages 118 to 121 under the heading ‘Critical Accounting Policies’. (c) The consolidated financial statements of HSBC comprise the financial statements of HSBC Holdings and its subsidiary undertakings. Financial statements of subsidiary undertakings are made up to 31 December, with the exception of the banking and insurance subsidiaries of HSBC Bank Argentina, whose financial statements are made up to 30 June annually to comply with local regulations. Accordingly HSBC uses interim financial statements for its principal banking and insurance subsidiaries in Argentina, drawn up to 31 December annually, and these interim financial statements are audited. The consolidated financial statements include the attributable share of the results and reserves of joint ventures and associates, based on financial statements made up to dates not earlier than six months prior to 31 December. All significant intra-HSBC transactions are eliminated on consolidation. (d) HSBC’s financial statements are prepared in accordance with UK generally accepted accounting principles (‘UK GAAP’), which differs in certain respects from Hong Kong and US generally accepted accounting principles (‘Hong Kong GAAP’ and ‘US GAAP’). A discussion of the significant differences between UK GAAP and Hong Kong GAAP is contained in note 48. A discussion of the significant differences between UK GAAP and US GAAP and a reconciliation to US GAAP of certain amounts is contained in Note 49. The Notes on the Financial Statements, taken together with the Financial Review, include the aggregate of all disclosures necessary to satisfy both UK and US reporting requirements. 2 Principal accounting policies (a) Income recognition Interest income is recognised in the profit and loss account as it accrues, except in the case of doubtful debts (Note 2 (c) below). Fee and commission income is accounted for in the period when receivable, except where it is charged to cover the costs of a continuing service to, or risk borne for, the customer, or is interest in nature. In these cases, it is recognised on an appropriate basis over the relevant period. 243 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (b) Interest on debt issuance Premiums and discounts on the issue of debt and fair value adjustments to debt arising on acquisitions are amortised to interest payable so as to give a consistent rate over the life of the debt. Where debt is callable, either by HSBC or the holder, the premium or discount is amortised over the period to the earliest call date. (c) Loans and advances and doubtful debts It is HSBC’s policy that each operating company will make provisions for bad and doubtful debts promptly where required and on a consistent basis in accordance with established Group guidelines. There are two basic types of provision, specific and general, each of which is considered in terms of the charge and the amount outstanding. Specific provisions Specific provisions represent the quantification of actual and inherent losses from homogeneous portfolios of assets and individually identified accounts. Specific provisions are deducted from loans and advances in the balance sheet. The majority of specific provisions are determined on a portfolio basis. Portfolios Where homogeneous groups of assets are reviewed on a portfolio basis, two alternative methods are used to calculate specific provisions: – When appropriate empirical information is available, the Group utilises roll rate methodology (a statistical analysis of historical trends of the probability of default and amount of consequential loss, assessed at each time period for which payments are overdue), other historical data and an evaluation of current economic conditions to calculate an appropriate level of specific provision based on inherent loss. Additionally, in certain highly developed markets, sophisticated models also take into account behavioural and account management trends such as bankruptcy and rescheduling statistics. Roll rates are regularly benchmarked against actual outcomes to ensure they remain appropriate. – In other cases, when information is insufficient or not sufficiently reliable to adopt a roll rate methodology, the Group adopts a formulaic approach which allocates progressively higher loss rates in line with the period of time for which a customer’s loan is overdue. Individually assessed accounts Specific provisions on individually assessed accounts are determined by an evaluation of the exposures on a case-by-case basis. This procedure is applied to all accounts that do not qualify for, or are not subject to, a portfolio based approach. In determining such provisions on individually assessed accounts, the following factors are considered: the Group’s aggregate exposure to the customer (including contingent liabilities); the viability of the customer’s business model and the capability to trade successfully out of financial difficulties and generate sufficient cash flow to service their debt obligations; the likely dividend available on liquidation or bankruptcy; the extent of other creditors’ commitments ranking ahead of, or pari passu with, the Group and the likelihood of other creditors continuing to support the company; the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident; the amount and timing of expected receipts and recoveries; the realisable value of security (or other credit mitigants) and likelihood of successful repossession; the deduction of any costs involved in recovery of amounts outstanding; the ability of the borrower to obtain and make payments in the relevant foreign currency if loans are not in local currency; and – – – – – – – – – 244 – where available, the secondary market price for the debt. Releases on individually calculated specific provisions are recognised whenever the Group has reasonable evidence that the established estimate of loss has been reduced. Cross-border exposures Specific provisions are established in respect of cross-border exposures to countries assessed by management to be vulnerable to foreign currency payment restrictions. This assessment includes analysis of both economic and political factors. Provisions are applied to all qualifying exposures within these countries unless these exposures: – – – are performing, trade related and of less than one year’s maturity; are mitigated by acceptable security cover which is, other than in exceptional cases, held outside the country concerned; or are represented by securities held for trading purposes for which a liquid and active market exists, and which are marked to market daily. General provisions General provisions augment specific provisions and provide cover for loans that are impaired at the balance sheet date but which will not be individually identified as such until some time in the future. HSBC requires operating companies to maintain a general provision, which is determined after taking into account: – – historical loss experience in portfolios of similar risk characteristics (for example, by industry sector, loan grade or product); the estimated period between a loss occurring and that loss being identified and evidenced by the establishment of a specific provision against that loss; and – management’s judgement as to whether the current economic and credit conditions are such that the actual level of inherent losses is likely to be greater or less than that suggested by historical experience. The estimated period between a loss occurring and its identification (as evidenced by the establishment of a specific provision for that loss) is determined by local management for each identified portfolio. Loans on which interest is being suspended and non-accrual loans Loans are designated as non-performing as soon as management has doubts as to the ultimate collectibility of principal or interest or when contractual payments of principal or interest are 90 days overdue. When a loan is designated as non-performing, interest is not normally credited to the profit and loss account and either interest accruals will cease (‘non-accrual loans’) or interest will be credited to an interest suspense account in the balance sheet which is netted against the relevant loan (‘suspended interest’). Within portfolios of low value, high volume, homogeneous loans, interest will normally be suspended on facilities 90 days or more overdue. In certain operating subsidiaries, interest income on credit cards may continue to be included in earnings after the account is 90 days overdue, provided that a suitable provision is raised against the portion of accrued interest which is considered to be irrecoverable. The designation of a loan as non-performing and the suspension of interest may be deferred for up to 12 months in either of the following situations: – – cash collateral is held covering the total of principal and interest due and the right of set-off is legally sound; or the value of any net realisable tangible security is considered more than sufficient to cover the full repayment of all principal and interest due and credit approval has been given to the rolling-up or capitalisation of interest payments. In certain subsidiaries, principally those in the UK and Hong Kong, provided that there is a realistic prospect of interest being paid at some future date, interest on non-performing loans is charged to the customer’s account. However, the interest is not credited to the profit and loss account but to an interest suspense account in the 245 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) balance sheet, which is netted against the relevant loan. In other subsidiaries and in any event where the probability of receiving interest payments is remote, interest is no longer accrued and any suspended interest balance is written off. On receipt of cash (other than from the realisation of security), the overall risk is re-evaluated and, if appropriate, suspended or non-accrual interest is recovered and taken to the profit and loss account. A specific provision of the same amount as the interest receipt is then raised against the principal balance. Amounts received from the realisation of security are applied to the repayment of outstanding indebtedness, with any surplus used to recover any specific provisions and then suspended interest. Loans are not reclassified as accruing until interest and principal payments are up-to-date and future payments are reasonably assured. Loan write-offs Loans (and the related provisions) are normally written off, either partially or in full, when there is no realistic prospect of recovery of these amounts and when the proceeds from the realisation of security have been received. Assets acquired in exchange for advances Assets acquired in exchange for advances in order to achieve an orderly realisation continue to be reported as advances. The asset acquired is recorded at the carrying value of the advance disposed of at the date of the exchange and subsequent provisions are based on any further deterioration in value. (d) Treasury bills, debt securities and equity shares Treasury bills, debt securities and equity shares intended to be held on a continuing basis are disclosed as investment securities and are included in the balance sheet at cost less provision for any permanent diminution in value. Where dated investment securities have been purchased at a premium or discount, these premiums and discounts are amortised through the profit and loss account over the period from the date of purchase to the date of maturity so as to give a constant rate of return. If the maturity is at the borrowers’ option within a specified range of years, the earliest maturity is adopted. These securities are included in the balance sheet at cost adjusted for the amortisation of premiums and discounts arising on acquisition. The amortisation of premiums and discounts is included in ‘Interest receivable’. Any profit or loss on realisation of these securities is recognised in the profit and loss account as it arises and included in ‘Gains on disposal of investments’. Other treasury bills, debt securities, equity shares and short positions in securities are included in the balance sheet at market value. Changes in the market value of such assets and liabilities are recognised in the profit and loss account as ‘Dealing profits’ as they arise. For liquid portfolios market values are determined by reference to independently sourced mid-market prices. In certain less liquid portfolios securities are valued by reference to bid or offer prices as appropriate. Where independent prices are not available, market values may be determined by discounting the expected future cash flows using an appropriate interest rate adjusted for the credit risk of the counterparty. Where securities are sold subject to a commitment to repurchase them at a predetermined price, they remain on the balance sheet and a liability is recorded in respect of the consideration received. Conversely, securities purchased under analogous commitments to resell are not recognised on the balance sheet and the consideration paid is recorded in ‘Loans and advances to banks’ or ‘Loans and advances to customers’. (e) Subsidiary undertakings, joint ventures, associates and other participating interests (i) HSBC Holdings’ investments in subsidiary undertakings are stated at net asset values, including attributable goodwill, adjusted for shares held by subsidiaries in HSBC Holdings. Changes in the value of subsidiary undertakings are accounted for as movements in the revaluation reserve. (ii) Interests in joint ventures are stated at HSBC’s share of gross assets, including attributable goodwill, less HSBC’s share of gross liabilities. 246 (iii) Interests in associates are stated at HSBC’s share of net assets, including attributable goodwill. (iv) Other participating interests are investments in the shares of undertakings which are held on a long-term basis for the purpose of securing a contribution to HSBC’s business, other than subsidiary undertakings, joint ventures or associates. Other participating interests are stated at cost less any permanent diminution in value. (f) Goodwill and intangible assets (i) Goodwill arises on the acquisition of subsidiary undertakings, joint ventures or associates when the cost of acquisition exceeds the fair value of HSBC’s share of separable net assets acquired. Negative goodwill arises on the acquisition of subsidiary undertakings, joint ventures and associates when the fair value of HSBC’s share of separable net assets acquired exceeds the cost of acquisition. For acquisitions made on or after 1 January 1998, goodwill is included in the balance sheet in ‘Goodwill and intangible assets’ in respect of subsidiary undertakings, in ‘Interests in joint ventures’ in respect of joint ventures and in ‘Interests in associates’ in respect of associates. Capitalised goodwill is amortised over its estimated life on a straight- line basis. Capitalised goodwill is tested for impairment when necessary by comparing the present value of the expected future cash flows from an entity with the carrying value of its net assets, including attributable goodwill. Negative goodwill is credited to the profit and loss account in the periods expected to be benefited. For acquisitions prior to 1 January 1998, goodwill was charged against reserves in the year of acquisition. At the date of disposal of subsidiary undertakings, joint ventures or associates, any unamortised goodwill or goodwill previously charged directly to reserves is included in HSBC’s share of net assets of the undertaking in the calculation of the gain or loss on disposal of the undertaking. (ii) Intangible assets represent contracts with retailers and other organisations to originate and promote HSBC products such as credit cards, store cards and retail loans. They are stated at their cost less amortisation to write off the assets over the contract lives. Intangible assets are subject to impairment review if there are events or changes in circumstances that indicate that the carrying amount may not be recoverable. (g) Tangible fixed assets (i) Land and buildings are stated at valuation or cost less depreciation calculated to write off the assets over their estimated useful lives as follows: – – – freehold land and land held on leases with more than 50 years to expiry are not depreciated; land held on leases with 50 years or less to expiry is depreciated over the unexpired terms of the leases; and buildings and improvements thereto are depreciated on cost or valuation at the greater of 2 per cent per annum on the straight-line basis or over the unexpired terms of the leases or over the remaining useful lives. (ii) Equipment, fixtures and fittings are stated at cost less depreciation calculated on the straight-line basis to write off the assets over their estimated useful lives, which are generally between 5 years and 20 years. (iii) HSBC holds certain properties as investments. No depreciation is provided in respect of such properties other than leaseholds with 20 years or less to expiry. Investment properties are included in the balance sheet at their open market value and the aggregate surplus or deficit, where material, is transferred to the investment property revaluation reserve. (h) Finance and operating leases (i) Assets leased to customers under agreements which transfer substantially all the risks and rewards associated with ownership, other than legal title, are classified as finance leases. Where HSBC is a lessor under finance leases the amounts due under the leases, after deduction of unearned charges, are included in ‘Loans and advances to banks’ or ‘Loans and advances to customers’. Finance charges receivable are recognised over the periods of the leases so as to give a constant rate of return on the net cash investment in the leases, taking into account tax payments and receipts associated with the leases. 247 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (ii) Where HSBC is a lessee under finance leases the leased assets are capitalised and included in ‘Equipment, fixtures and fittings’ and the corresponding liability to the lessor is included in ‘Other liabilities’. Finance charges payable are recognised over the periods of the leases based on the interest rates implicit in the leases. (iii) All other leases are classified as operating leases and, where HSBC is the lessor, are included in ‘Tangible fixed assets’. Provision is made to the extent that the carrying value of equipment is impaired through residual values not being fully recoverable. Rentals payable and receivable under operating leases are accounted for on the straight-line basis over the periods of the leases and are included in ‘Administrative expenses’ and ‘Other operating income’ respectively. (i) Deferred taxation Deferred tax is recognised in full on timing differences between the accounting and taxation treatment of income and expenditure, subject to assessment of the recoverability of deferred tax assets. Deferred tax assets are regarded as recoverable to the extent that it is more likely than not there will suitable taxable profits from which the future reversal of the underlying timing differences can be deducted. Deferred tax balances are not discounted. (j) Pension and other post-retirement benefits HSBC operates a number of pension and other post-retirement benefit schemes throughout the world. For UK defined benefit schemes annual contributions are made, on the advice of qualified actuaries, for funding of retirement benefits in order to build up reserves for each scheme member during the employee’s working life and used to pay a pension to the employee or dependant after retirement. The costs of providing these benefits are charged to the profit and loss account on a systematic basis. Arrangements for staff retirement benefits in overseas locations vary from country to country and are made in accordance with local regulations and custom. The pension cost of the major overseas schemes is assessed in accordance with the advice of qualified actuaries so as to recognise the cost of pensions on a systematic basis over employees’ service lives. Since 1 January 1993, the cost of providing post-retirement health-care benefits, which is assessed in accordance with the advice of qualified actuaries, has been recognised on a systematic basis over employees’ service lives. At 1 January 1993, there was an accumulated obligation in respect of these benefits relating to current and retired employees which is being charged to the profit and loss account in equal instalments over 20 years. (k) Foreign currencies (i) Assets and liabilities denominated in foreign currencies are translated into US dollars at the rates of exchange ruling at the year-end. The results of branches, subsidiary undertakings, joint ventures and associates not reporting in US dollars are translated into US dollars at the average rates of exchange for the year. (ii) Exchange differences arising from the retranslation of opening foreign currency net investments and the related cost of hedging and exchange differences arising from retranslation of the result for the year from the average rate to the exchange rate ruling at the year-end are accounted for in reserves. (iii) Other exchange differences are recognised in the profit and loss account. (l) Off-balance-sheet financial instruments Off-balance-sheet financial instruments comprise futures, forward, swap and option transactions undertaken by HSBC in the foreign exchange, interest rate, equity, credit derivative, and commodity markets. Netting is applied where a legal right of set-off exists. Accounting for these instruments is dependent upon whether the transactions are undertaken for trading or non- trading purposes. 248 Trading transactions Trading transactions include transactions undertaken for market-making, to service customers’ needs and for proprietary purposes, as well as any related hedges. Transactions undertaken for trading purposes are marked-to-market and the net present value of any gain or loss arising is recognised in the profit and loss account as ‘Dealing profits’, after appropriate deferrals for unearned credit margin and future servicing costs. Off-balance sheet trading transactions are valued by reference to an independent liquid price where this is available. For those transactions where there are no readily quoted prices, which predominantly relates to over the counter transactions, market values are determined by reference to independently sourced rates, using valuation models. If market observable data are not available, the initial increase in fair value indicated by the valuation model, but based on unobservable inputs, is not recognised immediately in the profit and loss account. This amount is held back and recognised over the life of the transaction where appropriate, or released to the profit and loss account when the inputs become observable, or, when the transaction matures or is closed out. Adjustments are made for illiquid positions where appropriate. Assets, including gains, resulting from off-balance sheet exchange rate, interest rate, equities, credit derivative and commodity contracts which are marked-to-market are included in ‘Other assets’. Liabilities, including losses, resulting from such contracts, are included in ‘Other liabilities’. Non-trading transactions Non-trading transactions are those which are held for hedging purposes as part of HSBC’s risk management strategy against cashflows, assets, liabilities or positions measured on an accruals basis. Non-trading transactions include qualifying hedges and positions that synthetically alter the characteristics of specified financial instruments. Non-trading transactions are accounted for on an equivalent basis to the underlying assets, liabilities or net positions. Any gain or loss arising is recognised on the same basis as that arising from the related assets, liabilities or positions. To qualify as a hedge, a derivative must effectively reduce the price, foreign exchange or interest rate risk of the asset, liability or anticipated transaction to which it is linked and be designated as a hedge at inception of the derivative contract. Accordingly, changes in the market value of the derivative must be highly correlated with changes in the market value of the underlying hedged item at inception of the hedge and over the life of the hedge contract. If these criteria are met, the derivative is accounted for on the same basis as the underlying hedged item. Derivatives used for hedging purposes include swaps, forwards and futures. Interest rate swaps are also used to alter synthetically the interest rate characteristics of financial instruments. In order to qualify for synthetic alteration, a derivative instrument must be linked to specific individual, or pools of similar, assets or liabilities by the notional principal and interest rate risks of the associated instruments, and must achieve a result that is consistent with defined risk management objectives. If these criteria are met, accruals based accounting is applied, i.e. income or expense is recognised and accrued to the next settlement date in accordance with the contractual terms of the agreement. Any gain or loss arising on the termination of a qualifying derivative is deferred and amortised to earnings over the original life of the terminated contract. Where the underlying asset, liability or position is sold or terminated, the qualifying derivative is immediately marked-to-market and any gain or loss arising is taken to the profit and loss account. (m) Long-term assurance business The value placed on HSBC’s interest in long-term assurance business includes a valuation of the discounted future earnings expected to emerge from business currently in force, using appropriate assumptions in assessing factors such as recent experience and general economic conditions, together with the surplus retained in the long-term assurance funds. These are determined annually, in consultation with external actuaries, and included in ‘Other assets’. Changes in the value placed on HSBC’s interest in long-term assurance business are calculated on a post-tax basis and reported gross in the profit and loss account as part of ‘Other operating income’ after adjusting for taxation. 249 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Long-term assurance assets excluding own shares held (see note 26) and liabilities attributable to policyholders are recognised in HSBC’s accounts in ‘Other assets’ and ‘Other liabilities’. (n) Share awards No costs are recognised for options granted under share option schemes at market price at the date of grant or, for save-as-you-earn schemes, at the approved discount to such market price. Shares awarded to employees in respect of annual bonuses are charged to the profit and loss account in the relevant performance year. Shares awarded to employees in respect of joining incentives are charged to the profit and loss account over any minimum contract period. The intrinsic value of shares conditionally awarded under restricted share award schemes is charged to compensation cost over the period in respect of which performance conditions apply. The compensation cost is adjusted in line with any adjustment to the awards due to lapses or application of the performance conditions. 3 Dividend income Income from equity shares ............................................................................. Income from participating interests other than joint ventures and associates ............................................................................................ 4 Analysis of income from dealing in financial instruments 2004 US$m 588 13 601 2003 US$m 213 9 222 2004 Dividend and net interest income US$m 34 (95) 305 375 619 Total US$m 1,840 632 354 359 3,185 2003 Dividend and net interest income US$m 31 16 460 198 705 Dealing profits US$m 1,239 330 251 358 2,178 Total US$m 1,270 346 711 556 2,883 2002 Dividend and net interest income US$m 43 (7) 259 186 481 Dealing profits US$m 1,167 47 75 24 1,313 Dealing profits US$m 1,806 727 49 Foreign exchange .......... Interest rate derivatives .. Debt securities ............... Equities and other trading ....................... (16) 2,566 5 Administrative expenses (a) 2004 US$m 12,606 970 916 14,492 2,726 6,965 24,183 2003 US$m 10,434 809 868 12,111 2,331 5,243 19,685 Staff costs – wages and salaries ............................................................................. – social security costs ........................................................................... – retirement benefits (Note 5(b) below) ................................................ Premises and equipment (excluding depreciation) ................................. Other administrative expenses ............................................................... 250 2002 US$m 274 4 278 Total US$m 1,210 40 334 210 1,794 2002 US$m 7,367 630 612 8,609 1,824 3,331 13,764 The average number of persons employed by HSBC during the year was made up as follows: Europe ................................................................................................... Hong Kong ............................................................................................ Rest of Asia-Pacific ............................................................................... North America ....................................................................................... South America ...................................................................................... 2004 80,930 25,070 37,211 70,041 31,475 2003 80,541 23,871 30,247 58,964 25,663 2002 76,924 24,452 27,584 22,262 26,253 244,727 219,286 177,475 (b) Retirement benefits HSBC has continued to account for pensions in accordance with Statement of Standard Accounting Practice (‘SSAP’) 24 ‘Accounting for pension costs’ and the disclosures given in (i) are those required by that standard. FRS 17 ‘Retirement benefits’ was issued in November 2000. Phased transitional disclosures are required from 31 December 2001. These disclosures, to the extent not given in (i), are set out in (ii). (i) HSBC Pension Schemes HSBC operates some 168 pension schemes throughout the world, covering 85 per cent of HSBC’s employees, with a total pension cost of US$810 million (2003: US$814 million, 2002: US$558 million), of which US$389 million (2003: US$443 million, 2002: US$316 million) relates to overseas schemes. Of the overseas schemes, US$119 million (2003: US$146 million, 2002: US$43 million) has been determined in accordance with best practice and regulations in the United States and Canada. Progressively HSBC has been moving to defined contribution schemes for all new employees. The majority of the extant schemes are funded defined benefit schemes, which cover 50 per cent of HSBC’s employees, with assets, in the case of most of the larger schemes, held in trust or similar funds separate from HSBC. The pension cost relating to these schemes was US$620 million (2003: US$649 million, 2002: US$406 million) which is assessed in accordance with the advice of qualified actuaries. The schemes are reviewed at least on a triennial basis or in accordance with local practice and regulations. The actuarial assumptions used to calculate the projected benefit obligations of HSBC’s pension schemes vary according to the economic conditions of the countries in which they are situated. Included in the above figures is the pension cost relating to the HSBC Bank (UK) Pension Scheme. This comprises: Regular cost ...................................................................................................................................................... Amortisation of deficit ...................................................................................................................................... Total cost for the year........................................................................................................................................ 2004 US$m 223 86 309 In the United Kingdom, the HSBC Bank (UK) Pension Scheme covers employees of HSBC Bank plc and certain other employees of HSBC. This scheme comprises a funded defined benefit scheme (‘the principal scheme’) which is closed and a defined contribution scheme which was established on 1 July 1996 for new employees. The latest valuation of the principal scheme was made at 31 December 2002 by C G Singer, Fellow of the Institute of Actuaries, of Watson Wyatt LLP. At that date, the market value of the principal scheme’s assets was US$9,302 million. The actuarial value of the assets represented 88 per cent of the benefits accrued to members, after allowing for expected future increases in earnings, and the resulting deficit amounted to US$1,270 million. The method adopted for this valuation was the projected unit method and the main assumptions used were a long-term investment return of 6.85 per cent per annum, salary increases of 3.0 per cent per annum, and post-retirement pension increases of 2.5 per cent per annum. In anticipation of the above valuation result, HSBC made a payment into the scheme in February 2003 amounting to US$817 million. In addition, following receipt of the valuation results, a further payment of US$137 million was made into the scheme. HSBC has decided to continue ongoing contributions to the 251 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) scheme at the rate of 20 per cent of pensionable salaries until completion of the next actuarial valuation, due as at 31 December 2005. The deficit as at 31 December 2002 is being amortised over a thirteen year period, the average remaining service life of the existing employed members. The amortisation is net of the interest benefit from the payments of US$817 million in February and US$137 million in August 2003. In Hong Kong, the HSBC Group Hong Kong Local Staff Retirement Benefit Scheme covers employees of The Hongkong and Shanghai Banking Corporation and certain other employees of HSBC. The scheme comprises a funded defined benefit scheme (which is a lump sum scheme) and a defined contribution scheme. The latter was established on 1 January 1999 for new employees. The latest valuation of the defined benefit scheme was made at 31 December 2004 and was performed by E Chiu, Fellow of the Society of Actuaries of the United States of America, of HSBC Life (International) Limited, a subsidiary of HSBC Holdings. At that date, the market value of the defined benefit scheme’s assets was US$942 million. On an ongoing basis, the actuarial value of the scheme’s assets represented 115 per cent of the benefits accrued to members, after allowing for expected future increases in salaries, and the resulting surplus amounted to US$121 million. On a wind-up basis, the actuarial value of the scheme’s assets represents 128 per cent of the members’ vested benefits, based on current salaries, and the resulting surplus amounted to US$206 million. The actuarial method used was the projected unit credit method and the main assumptions used in this valuation were a discount rate of 4.0 per cent per annum and long-term salary increases of 3.0 per cent per annum (with short-term deviation from 2005 to 2008). HSBC has decided to continue ongoing contributions to the scheme at the rate of 14.4 per cent of pensionable salaries until completion of the next valuation, due as at 31 December 2005. In the United States, the HSBC Bank USA Pension Plan (the ‘US principal scheme’) covers employees of HSBC Bank USA and certain other employees of HSBC. The latest valuation of the US principal scheme was made at 1 January 2004 by R G Gendron and K G Leister, Fellows of the Society of Actuaries, of Hewitt Associates LLC. At that date, the market value of the scheme’s assets was US$1,222 million. The actuarial value of the assets represented 122 per cent of the benefits accrued to members, after allowing for expected future increases in earnings, and the resulting surplus amounted to US$191 million. The method employed for this valuation was the projected unit credit method and the main assumptions used were a discount rate of 8.0 per cent per annum and average salary increases of 5.0 per cent per annum. HSBC has decided not to pay contributions to the scheme until completion of the next valuation, due as at 31 December 2005. Also in the United States, the HSBC Finance Corporation Retirement Income Plan, which covers employees of the HSBC Finance Corporation and certain other employees of HSBC, comprises a funded defined benefit scheme (the ‘HSBC Finance Corporation principal scheme’) which is closed and a cash balance plan which was established on 1 January 2000. HSBC has decided not to pay contributions to the scheme until completion of the next valuation, due as at 31 December 2005. The last reported actuarial valuation was made as at 1 July 2004. At that date, the market value of the HSBC Finance Corporation principal scheme’s assets was US$956 million, representing 129 per cent of the benefits accrued to members, after allowing for future increases in earnings. The resulting surplus amounted to US$213 million. The method employed for this valuation was the projected unit credit method and the main assumptions used were a discount rate of 8.0 per cent per annum and average salary increases of 3.75 per cent per annum. Effective close of business on 31 December 2004, the HSBC Bank USA Pension Plan and the HSBC Finance Corporation Retirement Income Plan merged, to form the HSBC North America (U.S.) Retirement Income Plan, with all new employees participating in the cash balance plan. The HSBC Bank (UK) Pension Scheme, The HSBC Group Hong Kong Local Staff Retirement Benefits Scheme, the HSBC Bank USA Pension Plan and the HSBC Finance Corporation Retirement Income Plan cover 40 per cent (2003: 41 per cent, 2002: 37 per cent) of HSBC’s employees. The pension cost for defined contribution schemes, which cover 34 per cent (2003: 34 per cent, 2002: 38 per cent) of HSBC’s employees, was US$190 million (2003: US$165 million, 2002: US$152 million). 252 (ii) FRS 17 Retirement Benefits At 31 December 2004 the assumptions used to calculate scheme liabilities for HSBC’s main defined benefit pension schemes under FRS 17 are: Discount rate % 5.3 4.0 6.0 5.3 10.75 11.75 4.5 3.25-6.0 Inflation assumption % 2.7 n/a 2.5 2.7 5.0 5.0 2.0 1.5-2.5 Rate of increase for pensions in payment and deferred pension % 2.7 n/a n/a 2.7 5.0 5.0 2.0 0-1.5 Rate of pay increase % 3.2 5.0 3.75 4.45 6.50 5.0 3.5 2.25-3.0 United Kingdom ........................................... Hong Kong ................................................... United States ................................................ Jersey ............................................................ Mexico .......................................................... Brazil ............................................................ France ........................................................... Other ............................................................ The variation in discount rates between countries reflects the impact of local economic conditions. At 31 December 2003 the assumptions used to calculate scheme liabilities for HSBC’s main defined benefit pension schemes under FRS 17 were: Rate of increase for pensions in payment and deferred pension % 2.5 n/a n/a 2.5 5.0 5.0 2.0 0-1.5 Inflation assumption % 2.5 n/a 2.5 2.5 5.0 5.0 2.0 1.5-2.0 Rate of pay increase % 3.0 4.5 3.75 4.25 7.5 5.11 3.5 2.5-3.0 Discount rate % 5.5 5.5 6.25 5.5 10.75 11.30 5.25 3.5-6.25 United Kingdom ........................................... Hong Kong ................................................... United States ................................................ Jersey ............................................................ Mexico ......................................................... Brazil ............................................................ France ........................................................... Other ............................................................ At 31 December 2002 the assumptions used to calculate scheme liabilities for HSBC’s main defined benefit pension schemes under FRS 17 were: Rate of increase for pensions in payment and deferred pension % 2.25 n/a n/a 2.25 5.0 5.0 2.0 0-1.5 Inflation assumption % 2.25 n/a 2.5 2.25 5.0 5.0 2.0 1.5-2.0 Discount rate % 5.6 5.5 6.75 5.6 10.78 10.25 5.5 3.75-6.75 United Kingdom ........................................... Hong Kong ................................................... United States ................................................ Jersey ............................................................ Mexico ......................................................... Brazil ............................................................ France ........................................................... Other ............................................................ Rate of pay Increase % 2.75 4.5 3.75 4.0 7.62 6.05 3.5 2.5-3.0 253 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) The assets in the defined benefit schemes and the expected rates of returns are: At 31 December 2004 HSBC Bank (UK) Pension Scheme Other schemes Expected rate of return % 8.1 4.7 6.5 3.6 Expected rate of return % 9.5 5.5 6.5 4.5 Value US$m 8,728 4,108 1,536 750 15,122 (19,501) (4,379) 1,314 (3,065) Value US$m 2,639 2,037 68 1,058 5,802 (6,362) (560)1 128 (432) 433 1 Equities ............................................................. Bonds ................................................................ Property ............................................................. Other .................................................................. Total market value of assets .............................. Present value of scheme liabilities ..................... Deficit in the schemes ....................................... Related deferred tax asset .................................. Net pension liability .......................................... Net amounts provided in the balance sheet for unfunded schemes ...................................... Net pension asset ............................................... 1 Of the deficit in other schemes, US$887 million related to schemes in deficit and US$327 million related to schemes in surplus. Of the schemes in deficit, US$622 million related to unfunded pension schemes in respect of which a provision, net of deferred tax, of US$433 million has been made. In relation to main schemes, there was a surplus of US$121 million in the HSBC Group Hong Kong Local Staff Retirement Benefit Scheme, a surplus of US$131 million in the HSBC Bank USA Pension Plan, and a deficit of US$19 million in the HSBC Finance Corporation Retirement Income Plan. HSBC Bank (UK) Pension Scheme Other schemes At 31 December 2003 Expected rate of return % 8.5 5.0 7.0 4.0 Expected rate of return % 9.3 5.6 7.0 3.1 Value US$m 7,232 3,544 1,167 917 12,860 (16,232) (3,372) 1,012 (2,360) Value US$m 2,740 2,124 26 372 5,262 (5,514) (252)1 45 (207) 388 181 Equities ............................................................. Bonds ................................................................ Property ............................................................. Other .................................................................. Total market value of assets .............................. Present value of scheme liabilities ..................... Deficit in the schemes ....................................... Related deferred tax asset .................................. Net pension liability .......................................... Net amounts provided in the balance sheet for unfunded schemes .......................................... Net pension asset................................................ 1 Of the deficit in other schemes, US$679 million relates to schemes in deficit and US$427 million relates to schemes in surplus. Of the schemes in deficit, US$514 million relates to unfunded pension schemes in respect of which a provision, net of deferred tax, of US$388 million has been made. In relation to main schemes, there is a surplus of US$156 million in the HSBC Group Hong Kong Local Staff Retirement Benefit Scheme, a surplus of US$112 million in the HSBC Bank USA Pension Plan, and a surplus of US$71 million in the HSBC Finance Corporation Retirement Income Plan. The net pension liability would have a consequent effect on reserves if recognised. The defined benefit section of the HSBC Bank (UK) Pension Scheme, the HSBC Group Hong Kong Local Staff Retirement Benefit Scheme and the HSBC Finance Corporation Retirement Income Plan are closed to new entrants. For these schemes the current service cost will increase under the projected unit credit method as the members of the scheme approach retirement. 254 HSBC Bank (UK) Pension Scheme Other schemes At 31 December 2002 Expected rate of return % 8.5 5.0 7.0 3.75 Expected rate of return % 10.75 6.3 – 3.1 Value US$m 5,682 2,032 1,139 415 9,268 (12,094) (2,826) 848 (1,978) Value US$m 1,491 1,418 – 402 3,311 (4,030) (719)1 150 (569) 402 (167) Equities ............................................................. Bonds ................................................................ Property ............................................................. Other ................................................................. Total market value of assets .............................. Present value of scheme liabilities ..................... Deficit in the schemes ....................................... Related deferred tax asset .................................. Net pension liability .......................................... Net amounts provided in the balance sheet for unfunded schemes ......................................... Net unprovided pension liability ....................... 1 Of the deficit in other schemes, US$832 million related to schemes in deficit and US$113 million related to schemes in surplus. Of the schemes in deficit, US$442 million related to unfunded pension schemes in respect of which a provision, net of deferred tax, of US$402 million was made. In relation to main schemes, there was a surplus of US$86 million in the HSBC Group Hong Kong Local Staff Retirement Benefit Scheme and a deficit of US$79 million in the HSBC Bank USA Pension Plan. The following amounts would be reflected in the profit and loss account and statement of total consolidated recognised gains and losses, if FRS 17 were implemented in full. Year ended 31 December 2004 2003 HSBC Bank (UK) Pension Scheme US$m Other schemes US$m HSBC Bank (UK) Pension Scheme US$m Other schemes US$m Amount that would be charged to operating profit Current service cost ........................................... Past service cost ................................................ (Gains) on any settlements or curtailments ....... Total operating charge ....................................... Amount that would be credited to other finance income Expected return on pension scheme assets ........ Interest on pension scheme liabilities ................ Net return .......................................................... Amount that would be recognised in the statement of total consolidated recognised gains and losses Actual return less expected return on pension scheme assets ................................................. Experience gains and losses arising on the scheme liabilities............................................ Changes in assumptions underlying the present value of the scheme liabilities ........... Actuarial (loss)/gain .......................................... 377 – – 377 927 (901) 26 498 1981 (1,323) (627) 253 16 (9) 260 381 (324) 57 68 (37) (293) (262) 277 – – 277 728 (675) 53 987 (195) (1,978) (1,186) 215 28 – 243 304 (277) 27 442 19 (184) 277 255 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Year ended 31 December 2004 2003 HSBC Bank (UK) Pension Scheme US$m Other schemes US$m HSBC Bank (UK) Pension Scheme US$m Movement in deficit in the pension schemes during the year Deficit in the pension schemes at 1 January ...... Movement in the year: Total operating charge ....................................... Contributions ..................................................... Other finance income ........................................ Actuarial (loss)/gain .......................................... Acquisition of subsidiary undertaking ............... Exchange and other movements ........................ (3,372) (377) 289 26 (627) – (318) Deficit in the pension schemes at 31 December (4,379) (252) (260) 224 57 (262) (12) (55) (560) (2,826) (277) 1,189 53 (1,186) – (325) (3,372) Other schemes US$m (719) (243) 548 27 277 (106) (36) (252) 1 Includes US$193 million increase in pension liability relating to termination benefits attributable to members of the HSBC Bank (UK) Pension Scheme. If FRS 17 were implemented this amount would be recognised in the profit and loss account, but not as part of pension costs. A further amount of US$63 million attributable to members scheduled to cease employment in 2005 is not included in the liability for this scheme as at 31 December 2004. 2004 HSBC Bank (UK) Pension Scheme US$m Year ended 31 December 2003 HSBC Bank (UK) Pension Scheme US$m Other schemes US$m Other schemes US$m 2002 HSBC Bank (UK) Pension Scheme US$m Other schemes US$m History of experience gains and losses Difference between expected and actual return on scheme assets: – amount ....................................... – percentage of scheme assets ....... Experience gains and losses arising on scheme liabilities: – amount ....................................... – percentage of the present value of the scheme liabilities .............. Total amount recognised in the statement of total consolidated gains and losses: – amount ....................................... – percentage of the present value of the scheme liabilities .............. 498 3% 198 1% (627) (3%) 68 1% (37) (1%) (262) (4%) 987 8% (195) (1%) 442 8% (1,825) (20%) (510) (15%) 19 (18) 0.4% (0.1%) (1,186) (7%) 277 5% (1,441) (12%) 95 2% (356) (9%) Most of the employees of HSBC Holdings are members of the HSBC Bank (UK) Pension Scheme. HSBC Holdings is unable to identify the share of the underlying assets and liabilities of this scheme which are attributable to its employees and is therefore accounting for the scheme as if it were a defined contribution scheme. (iii) Post-retirement healthcare benefits HSBC also provides post-retirement healthcare benefits under schemes, mainly in the United Kingdom and also in the United States, Canada, Mexico, France and Brazil. The charge relating to these schemes is US$106 million for the year (2003: US$54 million, 2002: US$54 million). The schemes are unfunded, except for the scheme in Mexico which had assets of US$79 million at 31 December 2004 (2003: US$68 million; 2002: US$13 million) comprising US$61 million in equities (2003: nil; 2002: US$2 million), US$18 million in bonds (2003: US$52 million; 2002: US$6 million) and US$nil in cash (2003: US$16 million; 2002: US$5 million). The latest full actuarial valuations of the liability were carried 256 out at dates between 31 December 1999 and 31 December 2004 by independent qualified actuaries and have been updated to 31 December 2004 as necessary. These latest actuarial reviews (in accordance with FRS 17) estimated the present value of the accumulated post-retirement benefit obligation at US$1,013 million (2003: US$850 million, 2002: US$491 million), of which US$726 million (2003: US$656 million, 2002: US$366 million) has been provided and US$79 million (2003: US$68 million; 2002: US$13 million) is held in assets in the funded scheme in Mexico. Of the year-end obligation, US$36 million arose on the acquisition of Bank of Bermuda. The actuarial assumptions used to estimate this obligation vary according to the claims experience and economic conditions of the countries in which the schemes are situated. For the UK schemes, the main financial assumptions used at 31 December 2004 were price inflation of 2.7 per cent per annum (2003: 2.5 per cent, 2002: 2.5 per cent), health-care claims cost escalation of 7.7 per cent per annum (2003: 7.5 per cent, 2002: 7.5 per cent) and a discount rate of 5.3 per cent per annum (2003: 5.3 per cent, 2002: 5.6 per cent). For the US schemes, the main financial assumptions used at 31 December 2004 were price inflation of 2.5 per cent per annum (2003: 2.5 per cent, 2002: 2.5 per cent), health-care claims cost escalation of 9 per cent per annum (2003: 12.9 per cent, 2002: 7 per cent) and a discount rate of 6 per cent (2003: 6.25 per cent, 2002: 6.75 per cent). Under FRS 17, the deferred tax asset related to the unprovided liability of US$208 million (2003: US$126 million, 2002: US$112 million) would be US$75 million (2003: US$46 million, 2002: US$38 million). The movement in the FRS 17 liability is as follows: Deficit at 1 January ........................................................................................................ Current service cost ........................................................................................................ Contributions ................................................................................................................. Interest cost on liabilities ................................................................................................ Expected return on scheme assets .................................................................................. Experience gains and losses arising on liabilities ........................................................... Change in assumptions underlying the present value of scheme liabilities ..................... Actual return less expected return on scheme assets ...................................................... Acquisition of subsidiary undertaking ........................................................................... Exchange and other movements ..................................................................................... Deficit at 31 December ................................................................................................... Amounts provided in the balance sheet for unfunded liabilities...................................... Unprovided liability at 31 December ............................................................................. Related deferred tax asset ............................................................................................... Net unprovided liability at 31 December ....................................................................... Year ended 31 December 2004 US$m 2003 US$m (782) (18) 52 (61) 6 3 (58) (4) (36) (36) (934) 726 (208) 75 (133) (478) (11) 81 (49) 1 32 (67) (3) (251) (37) (782) 656 (126) 46 (80) (c) Directors’ emoluments The aggregate emoluments of the Directors of HSBC Holdings, computed in accordance with Part I of Schedule 6 of the Act were: Fees ........................................................................................................ Salaries and other emoluments .............................................................. Bonuses ................................................................................................. Gains on the exercise of share options ................................................... Vesting of Restricted Share Plan awards ............................................... 2004 US$000 2,713 9,721 17,288 29,722 14,078 9,598 2003 US$000 1,525 8,712 9,856 20,093 17,602 1,728 2002 US$000 1,338 7,605 5,636 14,579 514 – In addition, there were payments under retirement benefit agreements with former Directors of US$906,000 (2003: US$557,000). The provision as at 31 December 2004 in respect of unfunded pension obligations to former Directors amounted to US$17,016,000 (2003: US$7,273,000). During the year, aggregate contributions to pension schemes in respect of Directors were US$4,423,122 (2003: US$3,337,433), including US$2,198,072 (2003: US$2,042,469) arising from a Director’s waiver of bonus. 257 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Discretionary bonuses for Directors are based on a combination of individual and corporate performance and are determined by the Remuneration Committee. The cost of the conditional awards under the Restricted Share Plan is recognised through an annual charge based on the original cost and the likely level of vesting of shares, apportioned over the period of service to which the award relates. Details of Directors’ remuneration, share options and conditional awards under the Restricted Share Plan are included in the ‘Directors’ Remuneration Report’ on pages 216 to 233. (d) Auditors’ remuneration Auditors’ remuneration in relation to statutory audit amounted to US$41.7 million (2003: US$31.7 million, 2002: US$24.8 million). The following remuneration was paid by HSBC companies to HSBC’s principal auditor, KPMG Audit Plc and its affiliated firms (‘KPMG’): Audit services – Statutory audit ................................................................................... – Audit-related regulatory reporting .................................................... Total audit services ................................................................................ Further assurance services ..................................................................... Tax services ........................................................................................... Other services – Financial information technology ...................................................... – Other services .................................................................................... Total other services ................................................................................ Total fees paid to KPMG ....................................................................... 2004 US$m 2003 US$m 2002 US$m 39.6 9.3 48.9 7.0 6.2 – 3.4 3.4 65.5 30.2 6.1 36.3 6.8 3.3 – 2.5 2.5 48.9 23.5 5.6 29.1 1.3 3.3 0.1 3.5 3.6 37.3 Of fees paid to auditors for non-audit work, US$0.4 million were capitalised (2003: US$2.1 million, 2002: US$0.4 million). Included in ‘Further assurance services’ above are fees paid to KPMG in respect of work relating to the implementation of Sarbanes-Oxley Act Section 404 of US$4.1 million. Other accounting firms have been paid a total of US$6.6 million for work on this project to date. The following is a description of the type of services included within the categories listed above: – Audit-related regulatory reporting services include services for assurance and other services that are reasonably related to the performance of the audit or review of financial statements, including comfort letters and interim reviews. – Further assurance services include services for advice on accounting matters, reporting on internal controls not connected with the financial statements, due diligence work and environmental audits. – Tax services include services for tax compliance and tax advice. – Other services include other assurance and advisory services such as translation services, review of financial models and advice on IT security. In addition to the above, KPMG estimate they have been paid fees of US$16 million (2003: US$12 million) by parties other than HSBC but where HSBC is connected with the contracting party. These fees arise principally in respect of services such as the audits of mutual funds managed by HSBC and reviews of the financial position of corporate borrowers where HSBC is a lender. 258 6 Profit on ordinary activities before tax Profit on ordinary activities before tax is stated after: Income Aggregate rentals receivable under – finance leases and hire purchase contracts ................................................. – operating leases .......................................................................................... Income from listed investments ..................................................................... Profits less losses on debt securities and equities dealing .............................. Gains on disposal of investment securities .................................................... Charges Charges incurred with respect to subordinated liabilities .............................. Finance charges in respect of finance leases and similar hire purchase contracts .................................................................................................... Hire of plant and machinery .......................................................................... Rentals payable on premises held under operating leases .............................. 2004 US$m 4,560 632 5,073 87 528 1,052 42 160 847 2003 US$m 3,279 553 4,276 294 396 958 38 110 773 Gains on the disposal of investments and tangible fixed assets attracted a tax charge of US$160 million (2003: US$84 million, 2002: US$86 million). Of the after-tax amount, US$28 million (2003: US$23 million, 2002: US$23 million) is attributable to minority interests. 7 Tax on profit on ordinary activities The charge for taxation comprises: Current taxation United Kingdom corporation tax charge – current year ................................. United Kingdom corporation tax charge – adjustment in respect of prior years .................................................................................................. Relief for overseas taxation ............................................................................ Overseas taxation – current year .................................................................... Overseas taxation – adjustment in respect of prior years ............................... Joint ventures ................................................................................................. Associates ...................................................................................................... Deferred taxation Origination and reversal of timing differences ............................................... Effect of change in tax rate on opening asset ................................................. Adjustment in respect of previous periods ..................................................... Total charge for taxation ................................................................................ HSBC Holdings and subsidiaries tax charge ................................................. Joint ventures tax charge ................................................................................ Associates tax charge ..................................................................................... 2004 US$m 1,570 (132) (722) 716 2,877 (21) 3 42 3,617 981 (15) (76) 890 4,507 4,462 3 42 4,507 2003 US$m 1,819 (149) (1,123) 547 2,646 (56) 1 19 3,157 (5) (7) (25) (37) 3,120 3,100 1 19 3,120 2002 US$m 2,502 490 4,361 19 405 862 36 81 548 2002 US$m 1,096 (68) (344)1 684 1,246 (29) (6) 17 1,912 615 – 7 622 2,534 2,523 (6) 17 2,534 HSBC Holdings and its subsidiary undertakings in the United Kingdom provide for UK corporation tax at 30 per cent (2003 and 2002: 30 per cent). Overseas tax includes Hong Kong profits tax of US$539 million (2003: US$483 million, 2002: US$408 million). Subsidiary undertakings in Hong Kong provide for Hong Kong profits tax at the rate of 17.5 per cent (2003: 17.5 per cent, 2002: 16 per cent) on the profits for the year assessable in Hong Kong. Other overseas subsidiary undertakings and overseas branches provide for taxation at the appropriate rates in the countries in which they operate. 259 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Analysis of overall tax charge Taxation at UK corporate tax rate of 30 per cent (2003 and 2002: 30 per cent) ..................................................................... Effect of overseas profits in principal locations taxed at different rates1 ....... Tax free gains ................................................................................................. Goodwill amortisation not tax deductible ..................................................... Acquisition accounting adjustments not tax effected2 .................................... Adjustments in respect of prior period liabilities ........................................... Tax deduction on innovative tier 1 capital ..................................................... Low income housing credits3 ......................................................................... Other items ..................................................................................................... Overall tax charge .......................................................................................... Timing differences deferring tax payable/(charging tax previously deferred) Accelerated capital allowances ....................................................................... Timing differences on lease income ............................................................... Provision for bad and doubtful debts ............................................................. Relief for losses brought forward ................................................................... Provision for Princeton Note settlement ......................................................... Other short-term timing differences ............................................................... Deferred tax charge/(credit) ........................................................................... 2004 US$m 5,282 (347) (64) 579 (253) (229) (192) (95) (174) 4,507 (2) (212) (392) (116) – (168) (890) 2003 US$m 3,845 (366) (17) 476 (331) (230) (117) (72) (68) 3,120 (1) (187) 356 52 – (183) 37 2002 US$m 2,895 (472) (19) 261 – (90) (99) – 58 2,534 23 (90) (29) (125) (221) (180) (622) Current tax charge .......................................................................................... 3,617 3,157 1,912 1 Overseas profits taxed at different rates to that which applies in the UK contributed to a reduction in the effective tax rate of 2.0 per cent (2003: 2.9 per cent). The reduction in the effective tax rate was less in 2004 than in 2003 because of the greater proportion of Group profits arising in the US, where they are subject to a higher rate of tax than in the UK, in 2004. 2 In 2003 and 2004 significant acquisition adjustments arose in respect of certain assets and liabilities which were revalued to their fair value on the purchase of HSBC Finance Corporation and HSBC Mexico. The difference between the ‘fair value’ of assets and liabilities, which is included in the accounts, and the previous book value is amortised to the profit and loss account over the life of the relevant assets and liabilities. However, there is no adjustment to the related tax basis of the assets and liabilities. The amortisation resulted in a credit to the profit and loss account of US$728 million (2003: US$957 million) and as there is no tax associated with this adjustment to net income, this reduces the effective tax rate for the year. 3 Low income housing tax credits available in the United States which are designed to encourage the provision of rental housing targeted at low income households. 8 Profit of HSBC Holdings Profit on ordinary activities before tax ........................................................... Tax credit on profit on ordinary activities ...................................................... Profit for the financial year attributable to shareholders ................................ 2004 US$m 4,401 117 4,518 2003 US$m 6,097 116 6,213 2002 US$m 5,185 82 5,267 Profit on ordinary activities before tax includes dividend income from subsidiary undertakings for the years ended 31 December as follows: Bank ............................................................................................................... Non-bank ....................................................................................................... 2004 US$m 2,700 2,277 2003 US$m 2,409 3,933 2002 US$m 1,715 3,745 260 9 Dividends First interim ................................................. Second interim ............................................. Third interim ................................................ Fourth interim .............................................. 2004 US$ per share 0.130 0.130 0.130 0.270 0.660 US$m 1,425 1,436 1,444 2,996 7,301 2003 US$ per share 0.240 0.120 0.240 – 0.600 US$m 2,596 1,309 2,627 – 6,532 2002 US$ per share 0.205 0.325 – – 0.530 US$m 1,932 3,069 – – 5,001 Of the first, second and third interim dividends for 2004, US$747 million, US$746 million and US$255 million respectively (2003: US$979 million, 2002: US$166 million) were settled by the issue of shares. Of the second and third interim dividends for 2003, US$533 million and US$346 million respectively (2002: US$444 million, 2001: US$857 million) were settled by the issue of shares in 2004. 10 Earnings per ordinary share Basic earnings per ordinary share was calculated by dividing the earnings of US$11,840 million (2003: US$8,774 million, 2002: US$6,239 million) by the weighted average number of ordinary shares, excluding own shares held, outstanding in 2004 of 10,907 million (2003: 10,421 million, 2002: 9,339 million). Diluted earnings per share was calculated by dividing the basic earnings, which require no adjustment for the effects of dilutive potential ordinary shares, by the weighted average number of ordinary shares outstanding, excluding own shares held, plus the weighted average number of ordinary shares that would be issued on ordinary conversion of dilutive potential ordinary shares (being share options outstanding not yet exercised) in 2004 of 11,054 million (2003: 10,539 million, 2002: 9,436 million). The effect of dilutive share options on the weighted average number of ordinary shares in issue is as follows: Average number of shares in issue ................................................................. Savings-related Share Option Plan ................................................................. Executive Share Option Scheme .................................................................... Group Share Option Plan ............................................................................... Restricted Share Plan ..................................................................................... CCF share options .......................................................................................... HSBC Finance Corporation share options ..................................................... Average number of shares in issue assuming dilution ................................... Number of shares (millions) 2004 10,907 38 12 13 63 13 8 11,054 2003 10,421 30 8 4 56 14 6 10,539 2002 9,339 30 11 – 38 18 – 9,436 Of the total number of employee share options existing at 31 December 2004, 70 million were antidilutive (2003: 130 million, 2002: nil). 11 Treasury bills and other eligible bills Treasury bills and similar securities ............................................................... Other eligible bills ......................................................................................... 2004 US$m 29,194 1,090 30,284 2003 US$m 19,193 1,198 20,391 2002 US$m 16,759 1,382 18,141 Of the total treasury bills and other eligible bills, US$25,666 million (2003: US$15,799 million, 2002: US$12,902 million) are non-trading book investment securities. These are mainly short-term in maturity and are analysed below. 261 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) At 1 January 2004 ............................................................................................................................................................... Additions ............................................................................................................................................................................. Disposals and amounts repaid ............................................................................................................................................. Amortisation of discounts and premiums ............................................................................................................................ Exchange and other movements .......................................................................................................................................... At 31 December 2004 ......................................................................................................................................................... Cost and book value US$m 15,799 78,751 (70,221) 317 1,020 25,666 Non-trading book treasury bills and other eligible bills are all available-for-sale. Their book value, analysed by type of borrower, is as follows: US Treasury and Government agencies ......................................................... UK Government ............................................................................................. Hong Kong Government ................................................................................ Other governments ......................................................................................... Corporate debt and other securities ................................................................ 2004 US$m 5,514 7,099 2,778 8,756 1,519 25,666 2003 US$m 4,624 955 2,450 6,891 879 15,799 2002 US$m 2,888 740 2,898 5,344 1,032 12,902 The following tables provide an analysis of gross unrealised gains and losses on treasury bills and other eligible bills: Carrying value US$m Gross unrealised gains US$m Gross unrealised losses US$m Market valuation US$m 31 December 2004 US Treasury and Government agencies ....................... UK Government ........................................................... Hong Kong Government .............................................. Other governments ....................................................... Corporate debt and other securities .............................. At 31 December 2003 US Treasury and Government agencies ....................... UK Government ........................................................... Hong Kong Government .............................................. Other governments ....................................................... Corporate debt and other securities .............................. At 31 December 2002 US Treasury and Government agencies ....................... UK Government ........................................................... Hong Kong Government .............................................. Other governments ....................................................... Corporate debt and other securities .............................. 5,514 7,099 2,778 8,756 1,519 25,666 4,624 955 2,450 6,891 879 15,799 2,888 740 2,898 5,344 1,032 12,902 1 1 3 15 – 20 2 – 2 10 – 14 3 – 2 8 – 13 (4) – – (13) (3) (20) – – – (5) – (5) – – – (1) – (1) 5,511 7,100 2,781 8,758 1,516 25,666 4,626 955 2,452 6,896 879 15,808 2,891 740 2,900 5,351 1,032 12,914 The amounts shown under ‘other governments’ in the above table includes securities with a book and market value of US$1,122 million (2003: book and market value US$711 million) issued by the Government of Japan. 262 The maturities of available-for-sale treasury bills and other eligible bills at 31 December 2004 are analysed as follows: 1 year or less ................................................................................................................................... 5 years or less but over 1 year ......................................................................................................... 10 years or less but over 5 years ...................................................................................................... Carrying value US$m 25,018 593 55 25,666 Market valuation US$m 25,009 596 61 25,666 The following table provides an analysis of contractual maturities and weighted average yields of available-for-sale treasury bills and other eligible bills as at 31 December 2004. US Treasury and Government agencies .................................... UK Government ........................................................................ Hong Kong Government ........................................................... Other governments .................................................................... Corporate debt and other securities ........................................... Within one year Amount Yield % US$m 2.0 4.2 0.6 2.5 1.2 5,502 6,852 2,778 8,386 1,500 25,018 After one year but within five years Amount Yield % US$m After five years but within ten years Amount Yield % US$m 5.6 4.9 – 4.6 2.2 12 247 – 315 19 593 – – – 4.2 – – – – 55 – 55 12 Hong Kong currency notes in circulation The Hong Kong currency notes in circulation are secured by the deposit of funds in respect of which the Government of Hong Kong certificates of indebtedness are held. 13 Credit risk management HSBC’s credit risk management process is discussed in the ‘Financial Review’ in the section headed ‘Credit risk management’ on pages 135 to 137, ending with the sentence ‘Internal audit will discuss with management … assigned to the facilities concerned’. 14 Loans and advances to banks Remaining maturity: Repayable on demand ................................................................................................................. 3 months or less but not repayable on demand ............................................................................ 1 year or less but over 3 months ................................................................................................. 5 years or less but over 1 year ..................................................................................................... Over 5 years ................................................................................................................................ Specific bad and doubtful debt provisions (Note 16) ...................................................................... 2004 US$m 34,842 95,386 8,059 1,614 2,828 (17) 2003 US$m 25,289 77,188 10,879 1,454 2,387 (24) 142,712 117,173 Amounts include: Due from associates – unsubordinated ......................................................................................................................... 164 21 263 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 15 Loans and advances to customers Remaining maturity: Repayable on demand or at short notice ...................................................................................... 3 months or less but not repayable on demand or at short notice ................................................ 1 year or less but over 3 months .................................................................................................. 5 years or less but over 1 year ..................................................................................................... Over 5 years ................................................................................................................................ General and specific bad and doubtful debt provisions (Note 16) ................................................... Amounts include: Subordinated advances ................................................................................................................ Securitised advances not qualifying for linked presentation under FRS 5 (‘Reporting the substance of transactions’) ............................................................................. Due from joint ventures Unsubordinated ........................................................................................................................... Due from associates Subordinated ............................................................................................................................... Unsubordinated ........................................................................................................................... 2004 US$m 70,452 124,893 76,073 172,900 238,182 (12,669) 669,831 218 18,463 71 38 931 2003 US$m 60,331 94,001 63,648 142,814 181,874 (13,691) 528,977 202 26,640 65 35 464 Loans and advances to customers included US$793 million (2003: US$824 million) of repossessed real estate and other assets. Securitisation transactions Loans and advances to customers include balances that have been securitised. Certain of these balances meet the requirements for linked presentation under FRS 5 ‘Reporting the substance of transactions’. The non-recourse finance has been netted against customer loans as follows: Customer loans ................................................................................................................................ Non-recourse finance ...................................................................................................................... Funding provided by HSBC ............................................................................................................ Clover Funding Securitisation 2004 US$m 1,456 (1,251) 205 2003 US$m 2,555 (2,291) 264 HSBC has securitised a designated portion of its corporate loan portfolio. The transaction was effected through a declaration of trust in favour of Clover Securitisation Limited. Clover Securitisation Limited holds its beneficial interest in the trust for Clover Funding No. 1 plc, Clover Funding No. 3 plc, Clover Funding No. 4 plc (collectively ‘Clover Funding’) and HSBC. To fund the acquisition of this beneficial interest, Clover Funding has issued US$2,010 million (2003: US$2,541 million) floating rate notes (‘FRNs’). Clover Funding No.2 plc is in scheduled accumulation and has collected US$702 million (2003: US$395 million) to repay its outstanding Notes in April 2005. The offering circulars for the FRNs stated that they are the obligations of Clover Funding only and are not guaranteed by, or the responsibility of, any other party. Non-returnable proceeds of US$1,102 million (2003: US$1,882 million) received by HSBC from Clover Funding have been deducted from ‘Loans and advances to customers’. Clover Securitisation Limited has entered into swap agreements with HSBC under which Clover Securitisation Limited pays the floating rate of interest on the loans and receives interest linked to three-month London Interbank Offered Rate (‘LIBOR’). The proceeds generated from the loans are used in priority to meet the claims of the FRN holders, and amounts payable in respect of the interest rate swap arrangements after the payment of trustee and administration expenses. There is no provision whatsoever, either in the financing arrangements or otherwise, whereby HSBC has a right or obligation either to keep the loans and advances on repayment of the finance or to repurchase them at any time other than in certain circumstances where HSBC is in breach of warranty. 264 HSBC is not obliged to support any losses that may be suffered by the FRN holders and does not intend to provide such support. HSBC has taken up US$58 million (2003: US$73 million) of subordinated FRNs that are repayable after payments in respect of senior FRNs. HSBC has made subordinated loans of US$37 million (2003: US$46 million) to Clover Funding that are repayable after all other payments. Interest is payable on the subordinated FRNs and subordinated loans conditional upon Clover Funding having funds available. Clover Securitisation Limited’s entire share capital is held by Clover Holdings Limited. Clover Funding’s entire share capital is held by Clover Holdings Limited. Clover Holdings Limited’s entire share capital is held by trustees under the terms of a trust for charitable purposes. HSBC recognised net income of US$8 million (2003: US$7 million) which comprised US$114 million (2003: US$108 million) of interest receivable by Clover Funding less US$106 million (2003: US$101 million) of interest on FRNs and other third party expenses payable by Clover Funding. HFC Bank Limited Securitisations HSBC, through its wholly-owned subsidiary company, HFC Bank, has securitised certain amounts of its personal loan portfolios. The transactions were effected through equitable assignment of those loans to receivables trusts, beneficial interests in which were purchased by several special purpose companies. To fund the acquisition of these beneficial interests, the special purpose companies have issued asset backed notes, discounted notes, and subordinated loans, or have received funds on-lent by other companies that have issued such securities and loans for this purpose. Certain of the notes issued were credit enhanced by a third party to provide the required ratings at the time of issue. The securitisation documentation sets out the acknowledgement by the special purpose companies that they will seek to repay their financing only to the extent that repayment is funded by the proceeds generated by the securitised personal loans, and that they will not seek recourse in any other form from HFC Bank. As at 31 December 2004 non-returnable proceeds of US$149 million (2003: US$409 million) received by HFC Bank from the receivables trusts have been deducted from ‘Loans and advances to customers’. Certain of the special purpose companies have entered into swap agreements with HFC Bank (via a third party swap provider) under which the special purpose companies pay the fixed rate of interest on the personal loans and receive a floating interest rate. The proceeds generated from the loans are used in priority to meet the claims of the note holders and other lenders, and amounts payable in respect of the interest rate swap arrangements after the payment of trustee and administration expenses. HFC Bank is entitled to any residual income from the personal loans after the claims of the note-holders, other lenders and swap counterparties are met. Under the terms of the securitisation agreements, during the initial periods of the securitisations, HFC Bank was able to substitute securitised loans that were prepaid or expired with further loans that met the same criteria as those originally securitised. In 2004, the special purpose companies acquired no qualifying personal loans from HFC Bank under these arrangements (2003, in the period since the acquisition of HFC Bank by HSBC: US$94 million). The initial periods have now expired, and further substitutions are no longer possible. There is no provision whatsoever, either in the financing arrangements or otherwise, whereby HFC Bank has a right or obligation either to keep the loans and advances on repayment of the finance or to repurchase them at any time other than in certain circumstances where HFC Bank is in breach of warranty. HFC Bank is not obliged to support any losses that may be suffered by the note-holders and does not intend to provide such support. The entire share capital of the special purpose companies is indirectly held by trustees under the terms of a trust for charitable purposes. In 2004, HFC Bank recognised net income of US$9 million (2003, in the period since the acquisition of HFC Bank by HSBC: US$33 million) from these personal loan securitisations. 265 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 16 Provisions for bad and doubtful debts Provisions against advances At 1 January 2004 ...................................................... Amounts written off ..................................................... Recoveries of advances written off ............................... Charge/(credit) to profit and loss account .................... Interest suspended during the year ............................... Suspended interest recovered ....................................... Acquisition of subsidiaries ........................................... Exchange and other movements ................................... At 31 December 2004 ................................................. Included in: Loans and advances to banks (Note 14) ................... Loans and advances to customers (Note 15) ............ At 1 January 2003 ........................................................ Amounts written off ..................................................... Recoveries of advances written off .............................. Charge/(credit) to profit and loss account .................... Interest suspended during the year ............................... Suspended interest recovered ....................................... Acquisition of subsidiaries ........................................... Exchange and other movements ................................... At 31 December 2003 .................................................. Included in: Loans and advances to banks (Note 14) ................... Loans and advances to customers (Note 15) ............ At 1 January 2002 ........................................................ Amounts written off ..................................................... Recoveries of advances written off .............................. Charge/(credit) to profit and loss account .................... Interest suspended during the year ............................... Suspended interest recovered ....................................... Acquisition of subsidiaries ........................................... Exchange and other movements ................................... At 31 December 2002 .................................................. Included in: Loans and advances to banks ................................... Loans and advances to customers ............................ Specific US$m 10,902 (8,896) 912 6,793 – – 219 187 10,117 6,629 (7,456) 610 6,214 – – 4,269 636 10,902 5,522 (2,111) 180 1,672 – – 1,278 88 6,629 General US$m 2,813 – – (436) – – 37 155 2,569 2,511 – – (121) – – 500 (77) 2,813 2,661 – – (351) – – 426 (225) 2,511 Suspended interest US$m 610 (246) – – 184 (131) 17 (6) 428 566 (147) – – 240 (182) – 133 610 861 (327) – – 426 (214) – (180) 566 Total US$m 13,715 (8,896) 912 6,357 – – 256 342 12,686 17 12,669 12,686 9,140 (7,456) 610 6,093 – – 4,769 559 13,715 24 13,691 13,715 8,183 (2,111) 180 1,321 – – 1,704 (137) 9,140 23 9,117 9,140 The total of customer advances, net of suspended interest, on which interest is being placed in suspense, is as follows: Gross ............................................................................................................... Net of specific provisions................................................................................ 2004 US$m 4,229 1,823 2003 US$m 5,513 2,673 2002 US$m 5,485 2,780 266 17 Concentrations of exposure HSBC has the following concentrations of gross loans and advances to customers: Total gross loans and advances to customers Residential mortgages ............................... Hong Kong Government Home Ownership Scheme ............................... Other personal ........................................... – 57,920 Total personal ........................................... 128,472 Commercial, industrial and international trade ...................................................... Commercial real estate .............................. Other property related ............................... Government .............................................. Other commercial1 ..................................... 54,438 18,827 6,750 3,663 31,626 Total corporate and commercial ................ 115,304 Non-bank financial institutions ................. Settlement accounts .................................. Total financial ........................................... 30,809 4,491 35,300 Europe US$m Hong Kong US$m Rest of Asia- Pacific US$m North America US$m South America US$m Total US$m 70,552 24,040 14,799 112,866 208 222,465 5,402 9,104 38,546 14,138 10,391 5,959 615 7,294 38,397 1,932 596 2,528 – 9,075 – 80,463 23,874 193,329 19,178 4,232 3,349 1,432 7,023 35,214 2,297 305 2,602 11,599 9,798 4,518 3,868 6,448 36,231 17,090 8,431 25,521 – 3,444 3,652 1,988 135 72 635 919 3,749 112 11 123 5,402 160,006 387,873 101,341 43,383 20,648 10,213 53,310 228,895 52,240 13,834 66,074 At 31 December 2004 .............................. 279,076 79,471 61,690 255,081 7,524 682,842 Residential mortgages ............................... Hong Kong Government Home Ownership Scheme ............................... Other personal ........................................... Total personal ........................................... Commercial, industrial and international trade ...................................................... Commercial real estate .............................. Other property related ............................... Government .............................................. Other commercial1 ..................................... Total corporate and commercial ................ Non-bank financial institutions ................. Settlement accounts .................................. Total financial ........................................... 51,721 23,664 12,101 77,754 224 165,464 – 42,041 93,762 49,468 15,517 5,416 2,462 24,239 97,102 21,226 3,068 24,294 6,290 7,420 37,374 10,966 8,548 5,075 927 6,754 32,270 4,921 556 5,477 – 7,135 – 75,173 19,236 152,927 14,892 3,149 2,597 1,450 5,735 27,823 2,027 188 2,215 8,907 7,785 3,994 4,104 6,619 31,409 8,839 4,767 13,606 – 2,376 2,600 1,435 89 58 647 683 2,912 78 15 93 6,290 134,145 305,899 85,668 35,088 17,140 9,590 44,030 191,516 37,091 8,594 45,685 At 31 December 2003 ............................... 215,158 75,121 49,274 197,942 5,605 543,100 1 Other commercial includes advances in respect of agriculture, transport, energy and utilities. The geographical information shown above has been classified by the location of the principal operations of the subsidiary undertaking, or in the case of The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, HSBC Bank Middle East Limited and HSBC Bank USA, N.A., by location of the branch responsible for advancing the funds. 267 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 18 Debt securities 2004 Book value US$m Market valuation US$m 2003 Book value US$m Market valuation US$m 2002 Book value US$m Market valuation US$m Issued by public bodies Investment securities: Government securities and US Government agencies ............................ Other public sector securities ................ Other securities: Government securities and US Government agencies ............................ Other public sector securities ................ Issued by other bodies Investment securities: Bank and building society certificates of deposit .......................................... Other debt securities ............................. Other securities: Bank and building society certificates of deposit .......................................... Other debt securities ............................. 56,885 7,591 64,476 8,283 77,736 86,019 56,410 7,338 63,748 43,642 1,440 108,830 8,279 77,178 85,457 9,016 37,696 132,169 Total ........................................................ 240,999 Due within 1 year ..................................... Due 1 year and over ................................. Amounts include: Subordinated debt securities ................. Unamortised net premium on investment securities ............................. Listing of securities Investment securities 78,754 162,245 240,999 730 573 – listed on a recognised UK exchange .. – listed in Hong Kong .......................... – listed elsewhere ................................. – unlisted .............................................. 21,635 2,216 53,513 71,841 22,247 2,328 53,869 72,051 51,215 6,087 57,302 32,848 1,504 91,654 6,468 67,146 73,614 8,411 32,043 114,068 205,722 62,047 143,675 205,722 276 485 18,852 1,601 54,435 56,028 51,822 6,385 58,207 6,502 67,885 74,387 19,315 1,710 55,166 56,403 42,706 5,369 48,075 27,664 1,095 76,834 6,097 53,753 59,850 11,309 27,737 98,896 175,730 56,052 119,678 175,730 311 594 17,651 1,530 50,221 38,523 43,591 5,670 49,261 6,142 54,494 60,636 18,082 1,640 51,354 38,821 149,205 150,495 130,916 132,594 107,925 109,897 Other securities – listed on a recognised UK exchange .. – listed in Hong Kong .......................... – listed elsewhere ................................. – unlisted .............................................. 12,760 2,302 49,843 26,889 240,999 9,442 2,503 39,850 23,011 205,722 9,158 2,397 29,434 26,816 175,730 Where securities are carried at market value, and the market value is higher than cost, the difference between cost and market value is not disclosed as it cannot be determined without unreasonable expense. The above market valuations do not take account of transactions entered into to hedge the value of HSBC’s investment securities. If the market value of such hedges was included, the effective value of investment securities would be US$150,210 million (2003: US$132,076 million, 2002: US$109,204 million). 268 At 1 January 2004 .......................................................................................... Additions ....................................................................................................... Acquisition of subsidiaries ............................................................................. Disposals and amounts repaid ........................................................................ Provisions released.......................................................................................... Amortisation of discounts and premiums ....................................................... Exchange and other movements ..................................................................... At 31 December 2004 ................................................................................... Cost US$m 131,037 247,778 5,731 (239,877) – (99) 4,756 149,326 The book value of investment securities, analysed by type of borrower, is as follows: Available-for-sale US Treasury and Government agencies ......................................................... UK Government ............................................................................................. Hong Kong Government ................................................................................ Other governments ......................................................................................... Asset-backed securities .................................................................................. Corporate debt and other securities ................................................................ Held-to-maturity US Treasury and Government agencies ......................................................... Obligations of US state and political sub-divisions......................................... Corporate debt and other securities ................................................................. Investment securities Provisions US$m Book value US$m (121) – – (26) 20 – 6 (121) 2003 US$m 19,215 554 1,124 26,685 7,200 71,626 130,916 247,778 5,731 (239,903) 20 (99) 4,762 149,205 2002 US$m 18,574 1,064 1,042 18,067 3,697 60,852 145,324 126,404 103,296 3,040 465 376 3,881 3,637 573 302 4,512 3,918 673 38 4,629 The following table provides an analysis of gross unrealised gains and losses for investment securities by instrument type as at 31 December for the past three years: At 31 December 2004 US Treasury and Government agencies ........................ UK Government ............................................................ Hong Kong Government ............................................... Other governments ........................................................ Asset-backed securities ................................................. Corporate debt and other securities ............................... At 31 December 2003 US Treasury and Government agencies ........................ UK Government ............................................................ Hong Kong Government ............................................... Other governments ........................................................ Asset-backed securities ................................................. Corporate debt and other securities ............................... Available-for-sale Gross unrealised gains US$m Gross unrealised losses US$m Carrying value US$m 18,999 4,411 2,464 27,496 13,296 78,658 145,324 1,633 19,215 554 1,124 26,685 7,200 71,626 126,404 224 – 65 427 131 1,007 1,854 (145) (2) – (227) (6) (124) (504) (155) (1) – (34) (9) (113) (312) 2004 US$m 18,999 4,411 2,464 27,496 13,296 78,658 116 – 82 532 28 875 Market valuation US$m 18,970 4,409 2,546 27,801 13,318 79,409 146,453 19,284 553 1,189 27,078 7,322 72,520 127,946 269 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) At 31 December 2002 US Treasury and Government agencies ....................... UK Government ........................................................... Hong Kong Government .............................................. Other governments ....................................................... Asset-backed securities ................................................ Corporate debt and other securities .............................. Carrying value US$m 18,574 1,064 1,042 18,067 3,697 60,852 103,296 Available-for-sale Gross unrealised gains US$m Gross unrealised losses US$m 445 4 70 370 25 1,146 2,060 (7) – (2) (228) (7) (121) (365) Market valuation US$m 19,012 1,068 1,110 18,209 3,715 61,877 104,991 The amounts shown under other governments in the above table include securities with a book value of US$2,653 million (2003: US$5,847 million) and a market value of US$2,657 million (2003: US$5,853 million) issued by the Government of Japan. Carrying value US$m Held-to-maturity Gross unrealised gains US$m Gross unrealised losses US$m Market valuation US$m At 31 December 2004 US Treasury and Government agencies ....................... Obligations of US state and political sub-divisions ...... Corporate debt and other securities .............................. At 31 December 2003 US Treasury and Government agencies ....................... Obligations of US state and political sub-divisions ...... Corporate debt and other securities ............................... At 31 December 2002 US Treasury and Government agencies ....................... Obligations of US state and political sub-divisions ...... Corporate debt and other securities .............................. 3,040 465 376 3,881 3,637 573 302 4,512 3,918 673 38 4,629 132 37 6 175 121 – 57 178 234 44 1 279 The maturities of investment securities at 31 December 2004 are analysed as follows: Available-for-sale 1 year or less ................................................................................................................................... 5 years or less but over 1 year ......................................................................................................... 10 years or less but over 5 years ...................................................................................................... Over 10 years .................................................................................................................................. Held-to-maturity 1 year or less ................................................................................................................................... 5 years or less but over 1 year ......................................................................................................... 10 years or less but over 5 years ...................................................................................................... Over 10 years .................................................................................................................................. (13) – (1) (14) (40) – (2) (42) (1) (1) – (2) Book value US$m 43,627 64,435 11,137 26,125 145,324 276 139 255 3,211 3,881 3,159 502 381 4,042 3,718 573 357 4,648 4,151 716 39 4,906 Market valuation US$m 43,712 64,849 11,572 26,320 146,453 277 145 275 3,345 4,042 270 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) The following table provides an analysis of contractual maturities and weighted average yields of investment debt securities as at 31 December 2004: Within one year Amount US$m Yield % After one year but within five years Amount US$m Yield % After five years but within ten years Amount US$m Yield % After ten years Amount US$m Yield % Available-for-sale US Treasury and Goverment agencies .. UK Government ............ Hong Kong Government Other governments ........ Asset-backed securities . Corporate debt and other securities ........... Held-to-maturity US Treasury and Government agencies Obligations of US state and political sub- divisions .................... Corporate debt and other securities ........... 4,284 – 401 9,515 69 29,358 43,627 2.50 – 2.74 3.03 1.45 2.91 122 1.66 6.85 2.49 9 145 276 1,724 4,411 1,722 13,901 937 41,740 64,435 90 49 – 139 3.11 4.40 3.19 4.66 1.81 3.37 7.14 6.26 – 1,114 – 341 3,738 1,860 4,084 11,137 4.48 – 4.99 4.33 0.91 4.98 11,877 – – 342 10,430 3,476 26,125 4.10 – – 5.85 0.57 2.19 169 6.53 2,659 6.34 5.55 – 86 – 255 321 231 3,211 5.31 5.93 The maturity distributions of asset-backed securities are presented in the above table based upon contractual maturity dates. The weighted average yield for each range of maturities in the above table is calculated by dividing the annualised interest income for the year ended 31 December 2004 by the book amount of available-for-sale debt securities at that date. The yields do not include the effect of related derivatives. Proceeds from the sale and redemption of investment securities were US$240,064 million (2003: US$153,910 million, 2002: US$77,105 million). Gross realised gains of US$215 million (2003: US$182 million, 2002: US$247 million) and gross realised losses of US$28 million (2003: US$21 million, 2002: US$77 million) were recorded on those sales. All gains and losses arose on sales of securities from the available-for-sale portfolio. Realised gains and losses are computed using the weighted average cost method. There were no gains recorded on securities transferred from the investment book to the trading book. The cost of investment securities purchased during the year ended 31 December 2004 was US$247,778 million (2003: US$164,817 million, 2002: US$85,837 million). 19 Equity shares 2004 2003 2002 Carrying value US$m Market valuation US$m Carrying value US$m Market valuation US$m Carrying value US$m Market valuation US$m Investment securities: – listed on a recognised UK exchange . – listed in Hong Kong .......................... – listed elsewhere ................................. – unlisted ............................................. Other securities: – listed on a recognised UK exchange . – listed in Hong Kong .......................... – listed elsewhere ................................. – unlisted ............................................. 65 379 1,757 4,016 6,217 35 86 1,493 3,095 4,709 645 129 12,914 922 19,319 54 207 1,805 3,522 5,588 44 238 1,531 3,577 5,390 129 20 7,303 37 12,879 14 241 1,163 2,866 4,284 670 9 2,576 125 7,664 23 400 1,207 3,127 4,757 271 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Where securities are carried at market value, and the market value is higher than cost, the difference between cost and market value is not disclosed as it cannot be determined without unreasonable expense. At 1 January 2004 .......................................................................................... Additions ........................................................................................................ Acquisition of subsidiaries ............................................................................. Disposals ........................................................................................................ Provisions released ......................................................................................... Provisions written off ..................................................................................... Exchange and other movements ..................................................................... At 31 December 2004 ................................................................................... Investment securities Provisions US$m Book value US$m (348) – – 26 72 19 50 (181) 5,390 4,388 39 (4,682) 72 – (498) 4,709 Cost US$m 5,738 4,388 39 (4,708) – (19) (548) 4,890 The following table provides an analysis of gross unrealised gains and losses as at 31 December for the past three years: 31 December 2004 ...................................................... 31 December 2003 ....................................................... 31 December 2002 ....................................................... Carrying value US$m 4,709 5,390 4,284 Gross unrealised gains US$m 891 858 603 Gross unrealised losses US$m (12) (31) (130) Market valuation US$m 5,588 6,217 4,757 Equity investment securities include interests in money market mutual funds primarily held by HSBC Finance Corporation for liquidity management. Proceeds from the sale of investment securities were US$5,008 million (2003: US$6,117 million; 2002: US$1,980 million). Gross realised gains of US$365 million (2003: US$281 million; 2002: US$215 million) and gross realised losses of US$65 million (2003: US$43 million; 2002: US$9 million) were recorded on those sales. Realised gains and losses are computed using the weighted average cost method. There were no gains recorded on securities transferred from the investment book to the trading book. The cost of investment securities purchased during the year ended 31 December 2004 was US$4,388 million (2003: US$5,692 million; 2002: US$1,748 million). 20 Interests in joint ventures At 1 January 2004 ............................................................................................................................................................. Retained profits and losses ................................................................................................................................................ At 31 December 2004 ...................................................................................................................................................... (a) Shares in non-banks ...................................................................................................................... 2004 US$m 12 2004 US$m 10 2 12 2003 US$m 10 All shares are unlisted. (b) HSBC’s joint venture at 31 December 2004 is: Country of incorporation Framlington Group Limited .................................. England Principal activity Asset management HSBC’s interest in equity capital Issued equity capital 51% £3m Framlington Group Limited is owned by a subsidiary of HSBC Holdings and makes its financial statements up to 31 December. Its principal country of operation is England. 272 Although HSBC owns more than 50 per cent of the equity capital of Framlington Group Limited, the agreement with the other shareholder means that there are severe long-term restrictions which substantially hinder HSBC’s rights over the assets and management of the entity. HSBC does however continue to exercise significant influence and together with the other shareholder controls the entity. (c) HSBC’s share of total operating income in the joint venture is US$44 million (2003: US$36 million). 21 Interests in associates At 1 January 2004 ................................................................................................................................................................ Additions ............................................................................................................................................................................. Amortisation of goodwill ..................................................................................................................................................... Disposals .............................................................................................................................................................................. Retained profits and losses (Note 35) ................................................................................................................................... Exchange and other movements ........................................................................................................................................... At 31 December 2004 ......................................................................................................................................................... 2004 US$m 1,263 2,117 (4) (98) 122 40 3,440 Included within additions is US$566 million of goodwill which has been determined on a provisional basis. There is no goodwill included in the interests in associates at 31 December 2003. (a) Shares in banks ........................................................................................................................ Other ........................................................................................................................................ Listed shares (all listed outside the United Kingdom and Hong Kong) .................................... Unlisted shares ......................................................................................................................... 2004 US$m 2,879 561 3,440 681 2,759 3,440 (b) The principal associates of HSBC are: Financial statements made up to Country of incorporation Principal activity HSBC’s interest in equity capital 2003 US$m 777 486 1,263 367 896 1,263 Issued equity capital Banking 19.9% RMB39,070m Bank of Communications Limited ........................... 30.09.04 Industrial Bank Company Limited ........................... The Saudi British Bank ....... The Cyprus Popular Bank Limited2........................... British Arab Commercial Bank Limited .................. Erisa ................................... Wells Fargo HSBC Trade Bank, N.A ...................... AEA Investors LP................ 30.09.04 31.12.04 31.12.04 31.12.04 31.12.04 31.12.04 31.12.04 People’s Republic of China People’s Republic of China Saudi Arabia Banking Banking Cyprus Banking England France Banking Insurance United States United States Trade finance Private equity investment fund Property investment Barrowgate Limited ............ 31.12.04 Hong Kong 1 Issued equity capital is less than HK$1 million. 2 Trading as Laiki Group. 3 Issued equity capital is less than US$1 million. 4 Limited partnership. All the above interests in associates are owned by subsidiaries of HSBC Holdings. 15.98% 40% 21.39% 46.51% 49.99% 20% 79.87% 24.64% RMB3,999m SR2,500m C£152m US$81m £32m fully paid £5m nil paid €65m –3 –4 –1 273 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) The principal countries of operation are the same as the countries of incorporation except for British Arab Commercial Bank Limited which operates in the Middle East. In May 2004, Hang Seng Bank Limited acquired a 15.98 per cent stake in Industrial Bank Co. Ltd, and in August, 2004, The Hongkong and Shanghai Banking Corporation Limited acquired a 19.9 per cent interest in Bank of Communications Limited. These companies are accounted for as associated companies, as HSBC has representation on the Board of Directors of each bank, and in accordance with the Technical Support and Assistance Agreements, is assisting in the development of financial and operating policies. In respect of Bank of Communications Limited, a number of staff have been seconded to assist in this process. In respect of Industrial Bank Co. Ltd., Hang Seng Bank Limited also has representation on the executive committee, whilst for Bank of Communications Limited, The Hongkong and Shanghai Banking Corporation Limited has representation on the senior executives’ remuneration and audit committees. For Industrial Bank Company Limited and Bank of Communications Limited, the attributable share of results comprises 4 months for the former and 1 month for the latter, being amounts from their respective dates of acquisition to 30 September 2004. HSBC is accounting for its share of the results of these associates on the basis of a 3 month time lag in order to facilitate the production of the necessary information. (c) HSBC has no interest in the loan capital of the associates listed above, except for British Arab Commercial Bank Limited which has issued US$44.5 million of subordinated unsecured loan stock in which HSBC has a 34.66 per cent interest; Barrowgate Limited which has HK$945 million of loan capital in which HSBC has a 24.64 per cent interest; Erisa which has in issue €55.2 million of subordinated debt in which HSBC has a 50 per cent interest; and The Cyprus Popular Bank Limited which has in issue C£8.8 million of debentures in which HSBC has a 74 per cent interest. HSBC also has a 100 per cent interest in the issued preferred stock (less than US$1 million) of Wells Fargo HSBC Trade Bank, N.A. HSBC has a 40 per cent economic interest in Wells Fargo HSBC Trade Bank, N.A. by virtue of the joint agreement under which HSBC’s equity capital and preferred stock interests are held. 22 Other participating interests Listed in Hong Kong ....................................................................................................................... Listed other than on a recognised UK exchange or in Hong Kong .................................................. Unlisted ........................................................................................................................................... Market value of listed securities ...................................................................................................... Other participating interests in banks .............................................................................................. 2004 US$m 781 1 99 881 1,079 6 At 1 January 2004 .......................................................................................... Additions ........................................................................................................ Exchange and other movements ..................................................................... At 31 December 2004 ................................................................................... 23 Goodwill and intangible assets Cost US$m 722 184 8 914 Provisions US$m (32) – (1) (33) 2003 US$m – 4 686 690 29 1 Carrying value US$m 690 184 7 881 The net book value of goodwill at 31 December 2004 is stated net of negative goodwill of US$19 million (2003: US$15 million). The charge to the profit and loss account in respect of goodwill amortisation is net of a credit relating to negative goodwill of US$27 million (2003: US$50 million). Included in ‘Additions and acquisition of subsidiaries’ is goodwill arising on the acquisition of businesses and increases of holdings in subsidiaries during 2004. Positive goodwill is amortised over periods of up to 20 years. Negative goodwill is credited to the profit and loss account over periods of up to 5 years. 274 Goodwill US$m Intangible assets US$m Cost at 1 January 2004 ................................................................................... Additions and acquisitions of subsidiaries (note 25) ...................................... Exchange and other movements ..................................................................... Cost at 31 December 2004 ........................................................................... Accumulated amortisation at 1 January 2004 ................................................. Charge to the profit and loss account ............................................................. Exchange and other movements ..................................................................... Accumulated amortisation at 31 December 2004 ...................................... Net book value at 31 December 2004 .......................................................... Net book value at 31 December 2003 ............................................................ 32,674 1,223 1,535 35,432 (4,196) (1,814) (300) (6,310) 29,122 28,478 178 111 16 305 (16) (28) (1) (45) 260 162 24 Tangible fixed assets (a) HSBC Freehold land and buildings US$m Long leasehold land and buildings US$m Short leasehold land and buildings US$m Equipment, fixtures and fittings US$m Equipment on operating leases US$m 3,647 522 169 (138) (14) 159 188 2,789 1 – (27) (51) 530 61 2,830 62 – (34) (62) 557 16 8,212 1,243 52 (441) – – 538 5,095 1,002 – (430) – – 450 Cost or valuation at 1 January 2004 Additions ..................................... Acquisition of subsidiaries ........... Disposals ..................................... Transfer of accumulated depreciation arising on revaluation ............................... Surplus on revaluation ................. Exchange and other movements .. Cost or valuation at Total US$m 32,852 1,334 1,551 35,737 (4,212) (1,842) (301) (6,355) 29,382 28,640 Total1 US$m 22,573 2,830 221 (1,070) (127) 1,246 1,253 31 December 2004 .................. 4,533 3,303 3,369 9,604 6,117 26,926 Accumulated depreciation at 1 January 2004 ........................ Disposals ..................................... Transfer of accumulated depreciation arising on revaluation ............................... Charge to the profit and loss account .................................... Exchange and other movements .. Accumulated depreciation at (115) 16 14 (81) (14) 31 December 2004 .................. (180) (8) – 51 (59) 6 (10) (512) 16 62 (126) (3) (5,143) 417 – (1,084) (370) (1,047) 282 – (314) (85) (6,825) 731 127 (1,664) (466) (563) (6,180) (1,164) (8,097) Net book value at 31 December 2004 ......................................... Net book value at 31 December 4,353 3,293 2,806 3,424 4,953 18,829 2003 ......................................... 3,532 2,781 2,318 3,069 4,048 15,748 1 Included in the above are assets held on finance leases with a net book value of US$370 million (2003: US$284 million), on which the depreciation charge for the year to 31 December 2004 was US$10 million (2003: US$8 million). 275 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (b) HSBC Holdings Cost or valuation at 1 January 2004 ......................................................................................................................... Additions ................................................................................................................................................................. Disposals .................................................................................................................................................................. Cost or valuation at 31 December 2004 ................................................................................................................ Accumulated depreciation at 1 January 2004 ........................................................................................................... Charge to the profit and loss account ....................................................................................................................... Disposals .................................................................................................................................................................. Accumulated depreciation at 31 December 2004 ................................................................................................. Net book value at 31 December 2004 .................................................................................................................... Net book value at 31 December 2003 ...................................................................................................................... (c) Non-investment properties Cost or valuation of freehold and long and short leasehold land and buildings (excluding investment properties): At 2004 valuation (2003: at 2003 valuation) ....................................................................... At cost ................................................................................................................................ On the historical cost basis, freehold and long and short leasehold land and buildings would have been included as follows (excluding investment properties): Cost .................................................................................................................................... Accumulated depreciation .................................................................................................. HSBC 2004 US$m 8,759 1,283 10,042 8,881 (2,205) 6,676 Equipment, fixtures and fittings US$m 4 1 (1) 4 (2) (1) 1 (2) 2 2 2003 US$m 7,473 1,078 8,551 8,285 (1,930) 6,355 HSBC values its non-investment properties on an annual basis. In September 2004, except as noted below, HSBC’s freehold and long leasehold properties, together with all leasehold properties in Hong Kong, were revalued on an existing use basis or open market value as appropriate or, in the case of a few specialised properties, at depreciated replacement cost. The properties were valued either by professional external valuers or by professionally qualified staff and updated for any material changes at 31 December 2004. As a result of the revaluation, the net book value of land and buildings (excluding investment properties) increased by US$1,151 million (2003: decrease US$311 million). A surplus of US$1,093 million (2003: deficit of US$292 million), net of minority interest of US$58 million (2003: US$19 million) was credited to reserves at 31 December 2004. Included within ‘Short leasehold land and buildings’ are the following amounts in respect of assets classed as improvements to buildings, which are carried at depreciated historical cost: Cost US$m Accumulated depreciation US$m At 1 January 2004 ................................................................................................................... Additions ................................................................................................................................ Disposals ................................................................................................................................. Charge for the year ................................................................................................................. Exchange and other movements .............................................................................................. At 31 December 2004 ............................................................................................................ Net book value at 31 December 2004 ................................................................................... Net book value at 31 December 2003 ..................................................................................... 942 60 (25) – 17 994 647 619 (323) – 5 (26) (3) (347) 276 (d) Investment properties The valuation at which investment properties are included in tangible fixed assets, together with the net book value of these properties calculated under the historical cost basis, is as follows: Freehold land and buildings .................................. Short and long leasehold land and buildings ......... 2004 At valuation US$m 2003 At cost US$m At valuation US$m 704 459 1,163 676 142 818 310 405 715 At cost US$m 315 144 459 Investment properties are valued on an open market value basis at 31 December annually by professional valuers. Investment properties in Hong Kong, the Macau Special Administrative Region and mainland China, which represent 40 per cent by value of HSBC’s investment properties subject to revaluation, were valued by DTZ, which is a member of the Hong Kong Institute of Surveyors. As a result of the revaluation, the net book value of investment properties has increased by US$95 million (2003: deficit of US$41 million). A surplus of US$52 million (2003: deficit of US28 million), net of minority interests of US$43 million (2003: US$13 million), has been credited to reserves at 31 December 2004. HSBC Holdings had no investment properties at 31 December 2004 or 2003. (e) HSBC properties leased to customers HSBC properties leased to customers, none of which was held by HSBC Holdings, included US$559 million at 31 December 2004 (2003: US$499 million) let under operating leases, net of accumulated depreciation of US$59 million (2003: US$52 million). (f) Land and buildings occupied for own activities Net book value ........................................................................................................................ 2004 US$m 9,136 (g) Residual values of equipment on operating leases Included in the net book value of equipment on operating leases are projected residual values at the end of current lease terms, which will be recovered through re-letting or disposal in the following periods: Within 1 year .......................................................................................................................... Between 1-2 years .................................................................................................................. Between 2-5 years .................................................................................................................. More than 5 years ................................................................................................................... Total exposure ........................................................................................................................ 2004 US$m 173 484 1,042 2,073 3,772 2003 US$m 7,902 2003 US$m 1,262 121 691 1,164 3,238 Residual value risk arises in relation to operating lease transactions to the extent that the values of the leased assets at the end of the lease terms (the residual values) actually recovered through disposing of or re-letting the assets at that time, could be different from that projected at the inception of the respective lease. Residual value exposure is regularly monitored by the business through reviewing the recoverability of the residual value projected at lease inception. This entails considering the re-lettability and projected disposal proceeds of operating lease assets at the end of their lease terms. Provision is made to the extent that the carrying values of leased assets are impaired through residual values not being fully recoverable. 277 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 25 Investments (a) HSBC Holdings Shares in HSBC undertakings US$m Loans to HSBC undertakings US$m Debt securities of HSBC undertakings US$m Other investments other than loans US$m At 1 January 2004 ....................... Reclassification ........................... Additions .................................... Repayments and redemptions ..... Impairment provisions ................ Write-up of subsidiaries (Note 35) ................................ Other movements ........................ At 31 December 2004 ................ 80,501 (1,175) 3,696 – (92) 11,955 – 94,885 3,788 – 924 – – – – 4,712 – 1,175 710 – – – – 1,885 537 – 387 (365) – – 22 581 Total US$m 84,826 – 5,717 (365) (92) 11,955 22 102,063 ‘Loans to HSBC undertakings’ includes qualifying or regulatory capital and similar financing which can only be repaid by the relevant HSBC undertaking with the consent of its local regulatory authority. On the historical cost basis, shares in HSBC undertakings would have been included as follows: Cost less provisions of US$283 million (2003: US$191 million) ........................................... (b) The principal subsidiary undertakings of HSBC Holdings are: 2004 US$m 29,842 2003 US$m 26,224 Country of incorporation or registration Principal activity Issued equity capital Europe CCF S.A. (99.99% owned) ............................................... HFC Bank Limited ........................................................... HSBC Asset Management (Europe) Limited .................... HSBC Asset Finance (UK) Limited .................................. HSBC Bank A.S. .............................................................. HSBC Bank Malta p.l.c. (70.03% owned) ........................ HSBC Bank Middle East Limited...................................... HSBC Bank plc (directly owned) ...................................... HSBC Guyerzeller Bank AG ............................................ HSBC Insurance Brokers Limited ..................................... HSBC Life (UK) Limited ................................................. HSBC Private Bank (Guernsey) Limited .......................... HSBC Private Bank (Suisse) S.A. ..................................... HSBC Private Bank (UK) Limited France England England England Turkey Malta Jersey England Switzerland England England Guernsey Switzerland Banking Financial services Investment banking Finance Banking Banking Banking Banking Private banking Insurance Insurance Private banking Private banking (formerly HSBC Republic Bank (UK) Limited) ........... England Private banking HSBC Trinkaus & Burkhardt KGaA (partnership limited by shares, 73.47% owned) ............ Germany Banking €372m £109m £142m £265m TRL277bn Lm9m US$331m £797m SFr95m £2.8m £94m US$5m1 SFr683m £152m €70m Hong Kong Hang Seng Bank Limited (62.14% owned) ....................... HSBC Insurance (Asia) Limited ....................................... HSBC Life (International) Limited ................................... The Hongkong and Shanghai Banking Corporation Hong Kong Hong Kong Bermuda Banking Insurance Retirement benefits and life assurance HK$9,559m HK$125m HK$327m Limited ......................................................................... Hong Kong Banking H HK$22,494m Rest of Asia-Pacific HSBC Bank Australia Limited .......................................... HSBC Bank Egypt S.A.E. (94.53% owned) ...................... HSBC Asset Management (Taiwan) Ltd ........................... HSBC Bank Malaysia Berhad ........................................... Australia Egypt Taiwan Malaysia Banking Banking Investment banking Banking A$811m E£500m TWD788m RM$114m 278 Country of incorporation or registration Principal activity Issued equity capital North America The Bank of Bermuda Limited .......................................... HSBC Bank Canada ......................................................... HSBC Bank USA, N.A. .................................................... HSBC Finance Corporation .............................................. HSBC Mexico S.A. (99.74% owned) ................................ HSBC Securities (USA) Inc. ............................................. HSBC Technology & Services (USA) Inc. ....................... South America HSBC Bank Argentina S.A. (99.99% owned) ................... HSBC Bank Brasil S.A. – Banco Múltiplo ....................... HSBC La Buenos Aires Seguros S.A. (99.52% owned) .... HSBC Seguros (Brasil) S.A. (97.90% owned) .................. Bermuda Canada United States United States Mexico United States United States Argentina Brazil Argentina Brazil Máxima S.A. AFJP (59.99% owned) ................................ Argentina Financial services Banking Banking Financial services Banking Investment Banking Technology Banking Banking Insurance Insurance Pension fund management 1 HSBC also owns 100% of the issued redeemable preference share capital of US$17 million. 2 Issued equity capital is less than US$1 million. All the above subsidiaries are included in the consolidation. US$30m C$1,125m US$2m US$1,100m MXP3,399m –2 –2 ARS1,110m BRL1,761m ARS44m BRL194m ARS84m Details of all HSBC companies will be annexed to the next Annual Return of HSBC Holdings filed with the UK Registrar of Companies. Except where indicated otherwise, the issued equity capital of the above undertakings is wholly-owned by HSBC and is held by subsidiaries of HSBC Holdings. All the above make their financial statements up to 31 December except for HSBC Bank Argentina S.A., HSBC La Buenos Aires Seguros S.A. and Máxima S.A. AFJP, whose financial statements are made up to 30 June annually. The principal countries of operation are the same as the countries of incorporation except for HSBC Bank Middle East Limited which operates mainly in the Middle East, and HSBC Life (International) Limited which operates mainly in Hong Kong. (c) Acquisitions HSBC made the following acquisitions of subsidiary undertakings or business operations in 2004, which were accounted for on an acquisition basis: (i) On 18 February 2004, HSBC acquired the entire share capital of the Bank of Bermuda for a cash consideration of US$1,224 million. Goodwill of US$651 million arose from this acquisition. (ii) On 31 May 2004, HSBC Bank Canada, a wholly-owned subsidiary of HSBC, acquired Intesa Bank Canada for a cash consideration of US$88 million. No goodwill arose from this acquisition. (iii) On 22 December 2004, Grupo Financiero HSBC S. A. de C. V., a subsidiary of HSBC, acquired Allianz Rentas Vitalicias for a cash consideration of US$30 million. Negative goodwill of US$7 million arose from this acquisition. (iv) On 9 November 2004, HSBC Bank plc, a wholly-owned subsidiary of HSBC, acquired 100 per cent of Marks and Spencer Retail Financial Services Holdings Ltd and subsidiary companies for a cash consideration of US$1,044 million. Goodwill of US$509 million arose from the acquisition. (v) On 19 August 2004, HSBC Bank Brasil S. A. – Banco Múltiplo, a wholly-owned subsidiary of HSBC, acquired the consumer finance operations of Indusval Multistock Group for a cash consideration of US$126 million. Goodwill of US$50 million arose from this acquisition. (vi) On 22 September 2004, The Bank of Bermuda Limited, a wholly-owned subsidiary of HSBC, acquired the entire share capital of BoE International Fund Services Limited and BoE International Fund Managers Limited for a cash consideration of US$5 million. Goodwill of US$4 million arose from this acquisition. (vii) On 29 November 2004, HSBC Bank Brasil S. A. – Banco Múltiplo, a wholly-owned subsidiary of HSBC, acquired CrediMatone S. A. for a cash consideration of US$11 million. Goodwill of US$11 million arose from this acquisition. 279 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (viii) Increase in stake in an existing subsidiary is excluded from the table below. On 20 April 2004, HSBC increased its stake in HSBC Guyerzeller Bank AG from 93.51 per cent to 100 per cent for a cash consideration of US$17 million. Goodwill of US$5 million arose from this acquisition. The assets and liabilities at the dates of acquisition and the total consideration paid are set out in the following table. The adjustments in the table below primarily represent revaluations reflecting the recognition of the fair value of financial instruments and tangible fixed assets acquired, and adjustments to provisions and other liabilities. The fair value of the assets and liabilities acquired have been determined on a provisional basis pending completion of the fair value appraisal process. Accounting policy alignments US$m Revaluations US$m – – – – – – – 6 – – – – – 6 – – – 51 11 5 76 (4) – (90) 10 (29) (61) (31) 2004 US$m 3,180 32,188 219 2,581 19,618 15,712 73,498 Fair value US$m 74 23 6,020 7,780 5,731 39 221 1,243 (1,429) (15,166) (859) (83) (2,284) 1,310 1,218 2,528 2003 US$m 2,230 27,652 190 2,942 15,634 14,480 63,128 Book value US$m 74 23 6,020 7,729 5,720 34 145 1,241 (1,429) (15,076) (869) (54) (2,223) 1,335 At date of acquisition Cash and balances at central banks ...................... Items in the course of collection from other banks Loans and advances to banks1 .............................. Loans and advances to customers ........................ Debt securities ..................................................... Equity shares ........................................................ Tangible fixed assets ............................................ Other asset categories .......................................... Deposits by banks ................................................ Customer accounts ............................................... Debt securities in issue ......................................... Provisions for liabilities and charges .................... Other liability categories ...................................... Net assets acquired ............................................... Goodwill attributable: Subsidiaries (Note 23) ..................................... Total consideration including costs of acquisition 1 Includes cash equivalent balances of US$40 million. 26 Other assets Bullion ............................................................................................................................................ Assets, including gains, resulting from off-balance-sheet interest rate, exchange rate and equities contracts which are marked to market ..................................................................... Current taxation recoverable ........................................................................................................... Deferred taxation (Note 31a) ........................................................................................................... Long-term assurance assets attributable to policyholders ................................................................ Other accounts ................................................................................................................................ 280 The composition of the net tangible assets relating to long-term assurance and retirement funds is as follows: Loans and advances to banks – with HSBC companies .................................................................. Debt securities ................................................................................................................................ Equity shares ................................................................................................................................... Other assets ..................................................................................................................................... Prepayments and accrued income ................................................................................................... Other liabilities ............................................................................................................................... Own shares held .............................................................................................................................. Total (Note 30) ............................................................................................................................... 2004 US$m 376 9,772 6,483 3,371 109 (493) 19,618 157 19,775 2003 US$m 299 8,070 5,301 2,157 93 (286) 15,634 140 15,774 Own shares held are deducted from retained profits (see note 35). They have been included above to reconcile to the long-term assurance liabilities attributable to policyholders in Note 30. 27 Deposits by banks Repayable on demand ..................................................................................................................... With agreed maturity dates or periods of notice, by remaining maturity – 3 months or less but not repayable on demand ....................................................................... – 1 year or less but over 3 months ............................................................................................. – 5 years or less but over 1 year ................................................................................................. – over 5 years ............................................................................................................................ Amounts include: Due to associates ........................................................................................................................ The composition of deposits by banks on a geographical basis is set out below: Europe .................................................. Hong Kong ........................................... Rest of Asia-Pacific ............................. North America ..................................... South America ..................................... 2004 Non interest- bearing US$m 3,792 1,161 1,398 1,567 102 8,020 Interest- bearing US$m 51,412 3,164 6,648 13,717 578 75,519 Total US$m 55,204 4,325 8,046 15,284 680 83,539 Interest- bearing US$m 42,697 3,716 5,700 9,564 812 62,489 2004 US$m 25,420 45,723 6,944 3,509 1,943 83,539 80 2003 Non interest- bearing US$m 4,803 1,061 1,267 790 16 7,937 The geographical analysis of deposits is based on the location of the office in which the deposits are recorded. 28 Customer accounts Repayable on demand ..................................................................................................................... With agreed maturity dates or periods of notice, by remaining maturity – 3 months or less but not repayable on demand ....................................................................... – 1 year or less but over 3 months ............................................................................................. – 5 years or less but over 1 year ................................................................................................. – over 5 years ............................................................................................................................ Amounts include: Due to joint ventures ................................................................................................................... Due to associates ........................................................................................................................ 2004 US$m 397,151 242,630 30,825 18,954 4,191 693,751 16 965 2003 US$m 25,066 34,313 5,299 4,192 1,556 70,426 28 Total US$m 47,500 4,777 6,967 10,354 828 70,426 2003 US$m 323,250 210,717 24,061 13,183 1,919 573,130 25 439 281 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) The composition of customer accounts on a geographical basis is set out below: Europe ................................................. Hong Kong .......................................... Rest of Asia-Pacific ............................ North America .................................... South America .................................... 2004 Non interest- bearing US$m 31,803 14,699 10,752 21,574 1,940 80,768 Interest- bearing US$m 261,110 163,669 67,861 111,326 9,017 612,983 Total US$m 292,913 178,368 78,613 132,900 10,957 693,751 Interest- bearing US$m 215,356 152,505 58,651 79,112 5,533 511,157 2003 Non interest- bearing US$m 27,368 11,519 6,790 14,884 1,412 61,973 The geographical analysis of customer accounts is based on the locations of the offices in which the customer accounts are recorded. 29 Debt securities in issue Bonds and medium-term notes, by remaining maturity – within 1 year ........................................................................................................................... – between 1 and 2 years ............................................................................................................. – between 2 and 5 years ............................................................................................................. – over 5 years ............................................................................................................................. Other debt securities in issue, by remaining maturity – 3 months or less ...................................................................................................................... – 1 year or less but over 3 months .............................................................................................. – 5 years or less but over 1 year ................................................................................................. – over 5 years ............................................................................................................................. 2004 US$m 34,987 25,808 49,985 23,318 134,098 54,402 10,052 8,753 1,288 208,593 The following table analyses bond and medium-term notes with original maturities greater than one year: Fixed rate: 8.875% Adjustable Conversion-Rate Equity Security Units ........................................................... 8.375% debentures; due 2007 ......................................................................................................... Federal Home Loan Bank of New York (‘FHLB’) advances – 2.01% to 7.24%; due 2005 to 2033 3.99% senior debt; due 2044 ........................................................................................................... Secured financing: 1.14% to 3.99%; due 2005 to 2008 ............................................................................................. 4.00% to 4.99%; due 2005 to 2006 ............................................................................................. 5.00% to 5.49%; due 2005 to 2007 ............................................................................................. 5.50% to 5.99%; due 2005 .......................................................................................................... 7.00% to 7.49%; due 2005 .......................................................................................................... 7.50% to 7.99%; due 2005 .......................................................................................................... 8.00% to 8.99%; due 2005 .......................................................................................................... Other fixed rate senior debt: 2.15% to 3.99%; due 2005 to 2010 ............................................................................................. 4.00% to 4.99%; due 2005 to 2023 ............................................................................................. 5.00% to 5.49%; due 2005 to 2023 ............................................................................................. 5.50% to 5.99%; due 2005 to 2024 ............................................................................................. 6.00% to 6.49%; due 2005 to 2033 ............................................................................................. 6.50% to 6.99%; due 2005 to 2033 ............................................................................................. 7.00% to 7.49%; due 2005 to 2032 ............................................................................................. 7.50% to 7.99%; due 2005 to 2032 ............................................................................................. 8.00% to 9.25%; due 2005 to 2012 ............................................................................................. 2004 US$m 594 100 13 557 2,805 401 533 105 206 11 12 8,378 11,685 5,358 7,495 9,074 9,779 6,876 8,002 3,694 75,678 Total US$m 242,724 164,024 65,441 93,996 6,945 573,130 2003 US$m 29,979 16,950 33,578 30,081 110,588 30,115 3,716 8,726 417 153,562 2003 US$m 609 102 17 – 3,665 445 555 411 665 17 18 4,014 8,373 5,052 6,375 9,834 9,442 6,917 7,968 3,636 68,115 282 Fixed rate Variable interest rate: Secured financings – 2.52% to 5.15%; due 2005 to 2010 ............................................................... Other variable interest rate senior debt – 2.16% to 6.07%; due 2005 to 2018 ................................. Secured financings – 0.96% to 2.61%; due 2006 to 2036 ............................................................... FHLB advances – 2.02% to 3.99%; due 2006 to 2008 .................................................................... 7.97% Securitisation; due 2005 to 2009 .......................................................................................... Other variable interest rate senior debt – 2.20% to 2.60%; due 2005 to 2040 ................................. Others ............................................................................................................................................. 2004 US$m 75,678 19,743 10,571 10,291 5,000 3,327 890 8,598 2003 US$m 68,115 26,363 8,506 30 – – 175 7,399 134,098 110,588 30 Other liabilities Short positions in securities Debt securities: Government securities ............................................................................................................ Other public sector securities .................................................................................................. Other debt securities ............................................................................................................... Treasury bills and other eligible bills .......................................................................................... Equity shares .............................................................................................................................. Liabilities, including losses, resulting from off-balance sheet interest rate, exchange rate and equities contracts which are marked-to-market ............................................. Current taxation .............................................................................................................................. Obligations under finance leases ..................................................................................................... Dividend payable by HSBC Holdings ............................................................................................. Long-term assurance liabilities attributable to policyholders (Note 26) .......................................... Other liabilities ............................................................................................................................... Short positions in debt securities are in respect of securities – due within 1 year .................................................................................................................... – due 1 year and over ................................................................................................................. – listed ....................................................................................................................................... – unlisted ................................................................................................................................... Obligations under finance leases fall due – within 1 year ........................................................................................................................... – between 1 and 5 years ............................................................................................................. – over 5 years ............................................................................................................................ 31 Provisions for liabilities and charges (a) Deferred taxation At 1 January 2004 ...................................................................................................................... Charge/(release) to profit and loss account (Note 7) .................................................................. Movements arising from acquisitions and disposals .................................................................. Exchange and other movements ................................................................................................ At 31 December 2004 ............................................................................................................... 2004 US$m 33,278 – 6,604 39,882 3,980 2,598 46,460 35,394 1,654 695 4,205 19,775 15,132 123,315 1,316 38,566 39,882 36,972 2,910 39,882 25 40 630 695 HSBC US$m (1,272) 890 (32) (101) (515) 2003 US$m 23,881 27 3,856 27,764 935 1,428 30,127 28,534 2,069 585 3,936 15,774 13,644 94,669 1,317 26,447 27,764 23,986 3,778 27,764 25 20 540 585 HSBC Holdings US$m 93 (18) – – 75 283 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Included in ‘Provisions for liabilities and charges’ Included in ‘Other assets’ (Note 26) ................... Net deferred taxation (asset)/provision ............... Comprising: Accelerated capital allowances ....................... Timing differences on lease income ............... Provision for bad and doubtful debts .............. Relief for losses brought forward .................... Other short-term timing differences ................ HSBC 2004 US$m 2,066 (2,581) (515) 88 1,921 (2,407) (115) (2) (515) 2003 US$m 1,670 (2,942) (1,272) 116 1,586 (2,828) (231) 85 (1,272) HSBC Holdings 2004 US$m 2003 US$m 75 – 75 – – – – 75 75 93 – 93 – – – – 93 93 There is no material deferred taxation liability not provided for. At 31 December 2004, there were potential future tax benefits of approximately US$973 million (2003: US$963 million) in respect of trading losses, allowable expenditure charged to the profit and loss account but not yet allowed for tax, and capital losses which have not been recognised because recoverability of the potential benefits is not considered likely. (b) Other provisions for liabilities and charges Provisions for pension and other post- retirement obligations US$m Provisions for contingent liabilities and commitments US$m Insurance provisions US$m Other provisions US$m At 1 January 2004 ............... Additional provisions /increase in provisions1 ... Acquisition of subsidiaries .. Provisions utilised ............... Exchange and other movements ...................... At 31 December 2004 ........ 1,382 147 46 (68) 230 1,737 735 27 20 (119) 128 791 2,159 812 – (603) (162) 2,206 802 258 16 (333) 55 798 Total US$m 5,078 1,244 82 (1,123) 251 5,532 1 The increase in ‘other provisions’ includes unwinding of discounts of US$12 million (2003: US$9 million) in relation to vacant space provisions and US$19 million (2003: US$18 million) in relation to Brazilian labour claims provisions. Included within ‘Provisions for contingent liabilities and commitments’ are provisions for the costs of possible redress relating to the sales of certain personal pension plans of US$54 million (2003: US$16 million). This is the result of an actuarial calculation extrapolated from a sample of cases and the timing of the expenditure depends on settlement of the individual claims. Included within ‘Other provisions’ are: (i) Provisions for onerous property contracts of US$202 million (2003: US$203 million), of which US$66 million (2003: US$72 million) relates to discounted future costs associated with leasehold properties that became vacant as a consequence of HSBC’s move to Canary Wharf in 2002. The provisions cover rent voids whilst finding new tenants, shortfalls in expected rent receivable compared to rent payable and costs of refurbishing the buildings to attract tenants. Uncertainties relate to movements in market rents, the delay in finding new tenants and the timing of rental reviews. (ii) Labour, civil and fiscal litigation provisions in HSBC Brazilian operations of US$231 million (2003: US$286 million). This relates to labour and overtime litigation claims brought by employees after leaving the bank. The provision is based on the expected number of departing employees, their individual salaries and historical trends. The timing of settlement of these potential claims is uncertain. 284 32 Subordinated liabilities Undated subordinated loan capital: Other HSBC ................................................................................................................................ Dated subordinated loan capital: HSBC Holdings .......................................................................................................................... Other HSBC ................................................................................................................................ Total subordinated liabilities: HSBC Holdings .......................................................................................................................... Other HSBC ................................................................................................................................ Dated subordinated loan capital is repayable – within 1 year ........................................................................................................................... – between 1 and 2 years ............................................................................................................. – between 2 and 5 years ............................................................................................................. – over 5 years ............................................................................................................................ The total subordinated borrowings of HSBC Holdings were as follows: Amounts owed to third parties Amounts falling due after more than 1 year: €2,000m Callable subordinated floating rate notes 2014 1 .................................................. US$1,400m 5.25% subordinated notes 2012 .......................................................................... €1,000m 5.375% subordinated notes 2012 ......................................................................... £650m 5.75% subordinated notes 2027 ........................................................................... US$1,000m 7.5% subordinated notes 2009 ............................................................................ US$488m 7.625% subordinated notes 2032 ......................................................................... £250m 9.875% subordinated bonds 20182 ....................................................................... €300m 5.5% subordinated notes 2009 ............................................................................. US$350m Subordinated step-up coupon floating rate notes 20101 ....................................... US$222m 7.35% subordinated notes 2032 .......................................................................... 2004 US$m 3,686 9,669 13,131 22,800 9,669 16,817 26,486 749 807 2,941 18,303 22,800 2004 US$m 2,730 1,394 1,360 1,250 999 481 478 409 350 218 9,669 2003 US$m 3,617 5,970 11,610 17,580 5,970 15,227 21,197 858 718 1,863 14,141 17,580 2003 US$m – 1,394 1,257 1,153 999 – 440 378 349 – 5,970 285 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Amounts owed to HSBC undertakings Amounts falling due after more than 1 year: €1,400m 5.3687% fixed/floating subordinated notes 2043 – HSBC Capital Funding (Euro 2) LP .................................................................... US$1,350m 9.547% subordinated step-up cumulative notes 2040 – HSBC Capital Funding (Dollar 1) LP................................................................... US$1,250m 4.61% fixed/floating subordinated notes 2043 – HSBC Capital Funding (Dollar 2) LP................................................................... €750m 5.13% fixed/floating subordinated notes 2044 – HSBC Capital Funding (Euro 3) LP. .................................................................... £500m 8.208% subordinated step-up cumulative notes 2040 – HSBC Capital Funding (Sterling 1) LP ............................................................... US$900m 10.176% subordinated step-up cumulative notes 2040 – HSBC Capital Funding (Dollar 1) LP .................................................................. €600m 8.03% subordinated step-up cumulative notes 2040 – HSBC Capital Funding (Euro 1) LP. .................................................................... HSBC Holdings’ dated subordinated loan capital is repayable – between 2 and 5 years ............................................................................................................. – over 5 years ............................................................................................................................. 2004 US$m 1,894 1,338 1,238 1,012 958 891 812 8,143 17,812 2004 US$m 1,408 16,404 17,812 2003 US$m 1,748 1,338 1,237 – 884 889 749 6,845 12,815 2003 US$m – 12,815 12,815 1 The interest margins on the callable subordinated floating rate notes 2014 and the subordinated step-up coupon floating rate notes 2010 increase by 0.5 per cent from September 2009 and April 2005, respectively. The notes are repayable from their step up date at the option of the borrower, subject to the prior consent of the Financial Services Authority. 2 The interest rate on the 9.875 per cent subordinated bonds 2018 changes in April 2013 to become the higher of (i) 9.875 per cent or (ii) the sum of the yield on the relevant benchmark treasury stock plus 2.5 per cent. The bonds may be redeemed in April 2013 at par and redemption has also been allowed from April 1998, subject to the prior consent of the Financial Services Authority, for an amount based on the redemption yields of the relevant benchmark treasury stocks. 286 At 31 December 2004, the other HSBC subordinated borrowings were as follows: US$1,200m US$1,000m US$1,000m £500m €600m US$750m £350m £350m £350m £300m US$500m US$500m US$400m £225m US$375m £200m US$300m US$300m US$300m US$300m US$300m £150m £150m US$250m JP¥24,800m US$250m US$200m US$200m BRL608m US$200m US$200m US$200m Primary capital subordinated undated floating rate notes .................................... 4.625% subordinated notes 2014 ......................................................................... 5.875% subordinated notes 2034 ......................................................................... 5.375% subordinated notes 2033 ......................................................................... 4.25% Callable subordinated notes 2016 1 ............................................................ Undated floating rate primary capital notes ......................................................... 5.375% Callable subordinated step-up notes 20302 ............................................. Callable subordinated variable coupon notes 20173 ............................................. 5% Callable subordinated notes 20234 ................................................................. 6.5% subordinated notes 2023 ............................................................................. Undated floating rate primary capital notes ......................................................... 7.625% subordinated notes 2006 ......................................................................... 8.625% subordinated notes 2004 ......................................................................... 6.25% subordinated notes 2041 ........................................................................... Subordinated step-up coupon floating rate notes 20095 ....................................... 9% subordinated notes 2005 ................................................................................ 10% trust preferred securities 2030 .................................................................... Undated floating rate primary capital notes (Series 3) ......................................... 6.95% subordinated notes 2011 ........................................................................... 7.65% subordinated notes 20258 .......................................................................... 7% subordinated notes 2006 ................................................................................ 9.25% step-up undated subordinated notes6 ......................................................... 8.625% step-up undated subordinated notes7 ....................................................... 5.875% subordinated notes 2008 ......................................................................... Fixed rate (5.0% to 5.5%) Subordinated Loans 2004 ........................................... 7.20% subordinated debentures 2097 .................................................................. 8.25% trust preferred securities 2031 .................................................................. 7.50% trust preferred securities 2031 .................................................................. Subordinated debentures 2008 ............................................................................ 6.625% subordinated notes 2009 ......................................................................... 7.808% capital securities 2026 ............................................................................ 8.38% capital securities 2027 .............................................................................. Other subordinated liabilities less than US$200m ............................................... 2004 US$m 2003 US$m 1,200 997 993 964 819 750 677 677 676 577 500 500 – 432 – 385 306 300 300 300 300 290 290 237 – 216 204 203 229 200 200 200 2,895 1,200 – – 893 756 750 – 625 625 532 500 500 400 399 375 357 329 300 300 299 299 268 268 233 232 216 209 207 210 200 200 200 3,345 16,817 15,227 Subordinated loan capital is repayable at par on maturity, but some is repayable prior to maturity at the option of the borrower, generally with the consent of the Financial Services Authority, in certain cases at a premium over par. Interest rates on the floating rate loan capital are related to interbank offered rates. On the remaining subordinated loan capital, interest is payable at fixed rates up to 9.25 per cent. 1 The interest rate on the 4.25 per cent Callable subordinated notes changes in March 2011 to three-month EURIBOR plus 1.05 per cent. 2 The interest rate on the 5.375 per cent Callable subordinated step-up notes 2030 changes in November 2025 to three month sterling LIBOR plus 1.50 per cent. 3 The interest rate on the Callable subordinated variable coupon notes is fixed at 5.75 per cent until June 2012. Thereafter, the rate per annum is the sum of the gross redemption yield of the then prevailing five-year UK gilt plus 1.70 per cent. 4 The interest on the 5 per cent Callable subordinated notes changes in March 2018 to become the rate per annum which is the sum of the gross redemption yield of the prevailing five-year UK gilt plus 1.80 per cent. 5 The subordinated step-up coupon floating rate notes 2009 were called and repaid by the borrower in August 2004. 6 The interest rate on the 9.25 per cent step-up undated subordinated notes changes in December 2006 to become, for each successive five year period, the rate per annum which is the sum of the yield on the then five year benchmark UK gilt plus 2.15 per cent. 7 The interest rate on the 8.625 per cent step-up undated subordinated notes changes in December 2007 to become, for each successive five year period, the rate per annum which is the sum of the yield on the then five year benchmark UK gilt plus 1.87 per cent. 8 The 7.65 per cent Subordinated notes are repayable at the option of each of the holders in May 2007. Footnotes 1 to 7 all relate to notes that are repayable at the option of the borrower on the date of the change of the interest rate, and at subsequent interest rate reset dates and interest payment dates in some cases, subject to the prior consent of the Financial Services Authority. 287 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 33 Minority interests – non-equity Preference shares issued by subsidiaries: €1,400m £700m US$1,350m US$1,250m €750m £500m US$900m €600m £300m US$150m US$150m US$125m CAD125m US$75m 5.3687% Non-cumulative Step-up Perpetual Preferred Securities 1 ...................... 5.844% Non-cumulative Step-up Perpetual Preferred Securities2 ........................ 9.547% Non-cumulative Step-up Perpetual Preferred Securities, Series 11 ......... 4.61% Non-cumulative Step-up Perpetual Preferred Securities1 .......................... 5.13% Non-cumulative Step-up Perpetual Preferred Securities 1 .......................... 8.208% Non-cumulative Step-up Perpetual Preferred Securities1 ........................ 10.176% Non-cumulative Step-up Perpetual Preferred Securities, Series 21 ....... 8.03% Non-cumulative Step-up Perpetual Preferred Securities 1 .......................... 5.862% Non-cumulative Step-up Perpetual Preferred Securities2 ........................ Depositary shares each representing 25% interest in a share of adjustable rate cumulative preferred stock, Series D3 ...................................... Cumulative preferred stock4 ................................................................................. Dutch auction rate transferable securities preferred stock, Series A and B5.......... Non-cumulative redeemable class 1 preferred shares, Series A ........................... Cumulative preferred stock ................................................................................. 2004 US$m 1,908 1,354 1,338 1,250 1,025 958 889 812 580 150 150 125 104 75 2003 US$m 1,763 1,250 1,338 1,250 – 884 889 749 – 150 150 125 96 75 10,718 8,719 1 See Step-up Perpetual Preferred Securities, note (a) Guaranteed by HSBC Holdings. 2 See Step-up Perpetual Preferred Securities, note (b) Guaranteed by HSBC Bank. 3 The preferred stock has been redeemable, at the option of HSBC USA Inc., in whole or in part from 1 July 1999 at par. 4 The preferred stock is redeemable at the option of HSBC USA Inc., in whole or in part, at any time on or after 1 October 2007 at par. 5 The preferred stock of each series is redeemable at the option of HSBC USA Inc., in whole or in part, on any dividend payment date at par. The redemption of all preference shares is subject to the prior consent of the Financial Services Authority and, where relevant, the local banking regulator. Step-up Perpetual Preferred Securities (a) Guaranteed by HSBC Holdings The seven issues of Non-cumulative Step-up Perpetual Preferred Securities (footnote 1) were made by Jersey limited partnerships and are guaranteed, on a subordinated basis, by HSBC Holdings. The proceeds of the issues were on-lent to HSBC Holdings by the limited partnerships by issue of subordinated notes. The Preferred Securities qualify as innovative tier 1 capital for HSBC. The Preferred Securities, together with the guarantee, are intended to provide investors with rights to income and capital distributions and distributions upon liquidation of HSBC Holdings that are equivalent to the rights that they would have had if they had purchased non-cumulative perpetual preference shares of HSBC Holdings. The Preferred Securities are perpetual, but redeemable in 2014, 2010, 2013, 2016, 2030, 2015 and 2012 respectively at the option of the general partner of the limited partnerships. If not redeemed the distributions payable step-up and become floating rate or, for the sterling issue, for each successive five-year period, the sum of the then five-year benchmark UK gilt plus a margin. There are limitations on the payment of distributions if prohibited under UK banking regulations or other requirements, if a payment would cause a breach of HSBC’s capital adequacy requirements, or if HSBC Holdings has insufficient distributable reserves (as defined). HSBC Holdings has covenanted that if it is prevented under certain circumstances from paying distributions on the Preferred Securities in full, it will not pay dividends or other distributions in respect of its ordinary shares, or effect repurchase or redemption of its ordinary shares, until after a distribution has been paid in full. If (i) HSBC’s total capital ratio falls below the regulatory minimum ratio required, or (ii) the Directors expect that, in view of the deteriorating financial condition of HSBC Holdings, (i) will occur in the near term, then the Preferred Securities will be substituted by Preference Shares of HSBC Holdings having economic terms which are in all material respects equivalent to those of the Preferred Securities and the guarantee taken together. 288 (b) Guaranteed by HSBC Bank The two issues of Non-cumulative Step-up Perpetual Preferred Securities (footnote 2) were made by Jersey limited partnerships and are guaranteed, on a subordinated basis, by HSBC Bank. The proceeds of the issues were on-lent to HSBC Bank by the limited partnerships by issue of subordinated notes. The Preferred Securities qualify as innovative tier 1 capital for HSBC and for HSBC Bank on a solo and consolidated basis and, together with the guarantee, are intended to provide investors with rights to income and capital distributions and distributions upon liquidation of HSBC Bank that are equivalent to the rights they would have had if they had purchased non-cumulative perpetual preference shares of HSBC Bank. The Preferred Securities are perpetual, but redeemable in 2031 and 2020, respectively, at the option of the general partner of the limited partnerships. If not redeemed the distributions payable step-up and become floating rate. The same limitations on the payment of distributions applies to HSBC Bank, as to HSBC, as above, and HSBC Bank has provided a similar covenant to that provided by HSBC Holdings, also as above. If (i) any Preferred Securities are outstanding in November 2048 or April 2049, respectively, or (ii) the total capital ratio of HSBC Bank on a solo and consolidated basis falls below the regulatory minimum ratio required, or (iii) in view of the deteriorating financial condition of HSBC Bank, the Directors expect (ii) to occur in the near term, then the Preferred Securities will be substituted by Preference Shares of HSBC Bank having economic terms which are in all material respects equivalent to those of the Preferred Securities and the guarantee taken together. 34 Called up share capital Authorised The authorised ordinary share capital of HSBC Holdings at 31 December 2004, 2003 and 2002 was US$7,500 million divided into 15,000 million ordinary shares of US$0.50 each, and £301,500 divided into 301,500 non-voting deferred shares of £1 each. At 31 December 2004, 2003 and 2002, the authorised preference share capital of HSBC Holdings was 10 million non-cumulative preference shares of £0.01 each, 10 million non-cumulative preference shares of US$0.01 each, and 10 million non-cumulative preference shares of €0.01 each. Issued At 1 January 2004 ........................................................................................................................... Shares issued in connection with the early settlement of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units ............................................. Shares issued under HSBC Finance Corporation share plans .......................................................... Shares issued to QUEST ................................................................................................................. Shares issued under other employee share plans ............................................................................. Shares issued in lieu of dividends ................................................................................................... Number of HSBC Holdings ordinary shares 10,960,018,480 1,590,319 293,254 1,079,099 49,052,156 160,042,242 At 31 December 2004 .................................................................................................................... 11,172,075,550 At 1 January 2003 ........................................................................................................................... Shares issued on acquisition of HSBC Finance Corporation ........................................................... Shares issued in connection with the early settlement of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units ............................................. Shares issued under HSBC Finance Corporation share plans .......................................................... Shares issued to QUEST ................................................................................................................. Shares issued under other employee share plans ............................................................................. Shares issued in lieu of dividends ................................................................................................... 9,480,820,796 1,273,297,057 51,072,691 26,576 2,200,630 33,858,455 118,742,275 US$m 5,481 1 – – 25 80 5,587 4,741 637 26 – 1 17 59 At 31 December 2003 ..................................................................................................................... 10,960,018,480 5,481 289 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) At 1 January 2002 ........................................................................................................................... Shares issued to QUEST ................................................................................................................. Shares issued under other employee share plans ............................................................................. Shares issued in lieu of dividends ................................................................................................... 9,354,627,521 6,147,311 30,460,369 89,585,595 At 31 December 2002 ..................................................................................................................... 9,480,820,796 Number of HSBC Holdings ordinary shares US$m 4,678 3 15 45 4,741 The 301,500 non-voting deferred shares were in issue throughout 2002, 2003 and 2004 and are held by a subsidiary undertaking of HSBC Holdings. Options outstanding to subscribe for HSBC Holdings ordinary shares under the HSBC Holdings Group Share Option Plan, HSBC Holdings Executive Share Option Scheme, and HSBC Holdings savings-related share option plans are as follows: 31 December 2004 .............................................. 31 December 2003 ............................................... 31 December 2002 ............................................... Number of HSBC Holdings ordinary shares 374,369,127 347,007,843 307,522,913 Period of exercise Exercise price 2005 to 2014 2004 to 2013 2003 to 2012 £2.1727 – £9.642 £2.1727 – £9.642 £2.1727 – £9.642 Following the acquisition of CCF in 2000, outstanding employee share options over CCF shares vested. On exercise of the options, the CCF shares are exchangeable for HSBC Holdings ordinary shares in the same ratio as for the acquisition of CCF (13 HSBC Holdings ordinary shares for each CCF share). During 2004, 451,080 (2003: 226,000; 2002: 229,066) CCF shares were issued following the exercise of employee share options and exchanged for 5,864,040 HSBC Holdings ordinary shares (2003: 2,938,000; 2002: 2,977,858) and 1,000 (2003: 7,000) CCF shares were issued following the exercise of employee share options and will be exchanged for 13,000 (2003: 91,000) HSBC Holdings ordinary shares on the fifth anniversary of the award. During 2004, options over 800 (2003: 100; 2002: nil) CCF shares lapsed. During 2004, 9,500 (2003: 2,500; 2002: 5,000) CCF shares previously issued following the exercise of employee share options were exchanged for 123,500 (2003: 32,500; 2002: 65,000) HSBC Holdings ordinary shares. At 31 December 2004, 1,500 (2003: 10,000; 2002: 5,500) CCF shares were in issue and will be exchanged for HSBC Holdings ordinary shares on the fifth anniversary of the award of the options. There were 2,162,780 CCF employee share options exchangeable for HSBC Holdings ordinary shares outstanding at 31 December 2004 (2003: 2,615,660; 2002: 2,848,760). At 31 December 2004, The HSBC Holdings Employee Benefit Trust 2001 (No. 1) held 26,787,515 (2003: 32,775,055; 2002: 35,745,555) HSBC Holdings ordinary shares which may be exchanged for CCF shares arising from the exercise of options. CCF options (including shares issued but not exchanged) effectively outstanding over HSBC Holdings ordinary shares under this arrangement are as follows: Number of CCF shares exchangeable for HSBC Holdings ordinary shares Period of exercise Exercise price 31 December 2004 .............................................. 31 December 2003 ............................................... 31 December 2002 ............................................... 2,164,280 2,625,660 2,854,260 2005 to 2010 2004 to 2010 2003 to 2010 €32.78 – €142.5 €32.78 – €142.5 €32.78 – €142.5 There also exist outstanding options over the shares of various CCF subsidiaries which are exchangeable for HSBC Holdings ordinary shares, the details of which are set out in the Directors’ Report on pages 196 to 197 and summarised below. On exercise of options over shares of Sinopia Asset Management (‘Sinopia’) the Sinopia shares are exchangeable for HSBC Holdings ordinary shares in the ratio of 2.143 HSBC Holdings ordinary shares for each Sinopia share. During 2004, 94,000 (2003: 94,400; 2002: 91,200) Sinopia shares were issued following the exercise of employee share options and exchanged for 201,439 (2003: 202,296; 2002: 195,439) HSBC Holdings ordinary shares. During 2004, options over 2,000 (2003: nil; 2002: 25,000) Sinopia shares lapsed. At 31 December 2004, The CCF Employee Benefit Trust 2001 held 281,814 (2003; 483,253; 2002: 685,549) HSBC Holdings ordinary shares which may be exchanged for Sinopia shares arising from the exercise of options. 290 Sinopia options effectively outstanding over HSBC Holdings ordinary shares under this arrangement are as follows: Number of Sinopia shares exchangeable for HSBC Holdings ordinary shares Period of exercise Exercise price 31 December 2004 .............................................. 31 December 2003 ............................................... 31 December 2002 ............................................... 125,500 221,500 315,900 2005 2004 to 2005 2003 to 2005 €18.66 – €18.80 €8.61 – €21.85 €8.61 – €21.85 Since 2003, on exercise of options over shares of HSBC Private Bank France, the HSBC Private Bank France shares are exchangeable for HSBC Holdings ordinary shares in the ratio of 1.83 HSBC Holdings shares for each HSBC Private Bank France share. During 2004, 101,750 HSBC Private Bank France shares were issued following the exercise of employee share options and exchanged for 184,093 HSBC Holdings ordinary shares. During 2004, options over 126,000 (2003: 293,500) HSBC Private Bank France shares lapsed. At 31 December 2004, 1,125 HSBC Private Bank France shares were in issue and will be exchanged for HSBC Holdings ordinary shares on the fourth anniversary of the awards of the options. At 31 December 2004, The CCF Employee Benefit Trust 2001 held 2,294,066 (2003: 1,900,000) HSBC Holdings ordinary shares which may be exchanged for HSBC Private Bank France shares arising from the exercise of options. HSBC Private Bank France options effectively outstanding over HSBC Holdings ordinary shares under this arrangement are as follows: Number of HSBC Private Bank France shares exchangeable for HSBC Holdings ordinary shares Period of exercise Exercise price 31 December 2004 ............................................... 31 December 2003 ............................................... 1,132,060 1,359,810 2005 to 2012 2004 to 2012 €10.84 – €22.22 €10.84 – €22.22 On the acquisition of Banque Hervet in 2001, Banque Hervet shares were held in a Plan d’Epargne Entreprise on behalf of Banque Hervet employees to vest and be released to employees over a 5 year period. It was agreed to exchange these Banque Hervet shares, on vesting, for HSBC Holdings ordinary shares in the ratio of 3.46 HSBC Holdings ordinary shares for each Banque Hervet share. During 2004, 44,870 (2003: 8,303; 2002: nil) Banque Hervet shares were released in connection with the vesting of interests in the Plan d’Epargne Entreprise and exchanged for 155,219 (2003: 28,729; 2002: nil) HSBC Holdings ordinary shares. At 31 December 2004, The CCF Employee Benefit Trust 2001 held 612,752 (2003: 767,971; 2002: 796,700) HSBC Holdings ordinary shares which may be exchanged for Banque Hervet shares from the vesting of interests. Banque Hervet shares to be exchanged for HSBC Holdings ordinary shares under this arrangement are as follows: 31 December 2004 ............................................................................................... 31 December 2003 ............................................................................................... 31 December 2002 ................................................................................................ Number of Banque Hervet shares exchangeable for HSBC Holdings ordinary shares 177,086 221,956 230,259 Period of vesting 2005 – 2006 2004 – 2006 2003 – 2006 Following the acquisition of HSBC Finance Corporation in 2003, all outstanding options and equity-based awards over HSBC Finance Corporation common shares were converted into rights to receive HSBC Holdings ordinary shares in the same ratio as the share exchange offer for HSBC Finance Corporation (2.675 HSBC Holdings ordinary shares for each HSBC Finance Corporation common share) and the exercise prices per share adjusted accordingly. During 2004, options over 6,073,291 (2003: 4,755,951) HSBC Holdings ordinary shares were exercised and 5,771,110 (2003: 4,755,951) HSBC Holdings ordinary shares were delivered from The HSBC (Household) Employee Benefit Trust 2003 to satisfy the exercise of these options. During 2004, options over 415,430 (2003: 1,495,103) HSBC Holdings ordinary shares lapsed. At 31 December 2004, The HSBC (Household) Employee Benefit Trust 2003 held 5,645,439 (2003: 12,444,049) HSBC Holdings ordinary shares and 2,200,000 (2003: nil) 291 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) ADSs which may be used to satisfy the exercise of these options and equity-based awards under the HSBC Finance Corporation share plans. Options and equity-based awards outstanding over HSBC Holdings ordinary shares under the HSBC Finance Corporation share plans are as follows: 31 December 2004 .............................................. 31 December 2003 ............................................... Number of HSBC Holdings ordinary shares 41,823,886 48,312,607 Period of exercise Exercise price 2005 to 2021 2004 to 2021 nil – US$25.40 nil – US$25.40 Prior to its acquisition by HSBC Holdings, HSBC Finance Corporation issued 8.875 per cent Adjustable Conversion- Rate Equity Security Units (‘Units’) consisting of a contract under which the holder agreed to purchase, for US$25 each, HSBC Finance Corporation common shares on 15 February 2006, with an option for early settlement. The Units which remained outstanding following the acquisition of HSBC Finance Corporation were converted into contracts to purchase HSBC Holdings ordinary shares. If a holder of Units elects to settle early, the holder will receive 2.6041 HSBC Holdings ordinary shares per Unit. Units exercised at maturity, 15 February 2006, will entitle the holder to receive a number of shares based on the market value of HSBC Holdings ordinary shares at the time, up to a maximum of 3.1249 HSBC Holdings ordinary shares for each Unit. During 2004, 1,590,319 (2003: 51,072,691) HSBC Holdings ordinary shares were issued in connection with the early settlement of 610,700 (2003: 19,612,420) Units. The maximum number of Units outstanding over HSBC Holdings ordinary shares are as follows: Number of Units exchangeable for HSBC Holdings ordinary shares Period of exercise Exercise price 31 December 2004 .............................................. 31 December 2003 ............................................... 1,439,840 2,050,540 2005 to 2006 2004 to 2006 US$8.00 – US$9.60 US$8.00 – US$9.60 Prior to its acquisition by HSBC Holdings, HSBC Finance Corporation issued US$1,220,793,000 Zero Coupon Convertible Senior Debentures due 2021. The debentures which remained outstanding following the acquisition of HSBC Finance Corporation were converted into rights to receive HSBC Holdings ordinary shares. Upon the occurrence of certain events, a holder could have elected to exchange these debentures and would have received 24.13385 HSBC Holdings ordinary shares per US$1,000 principal amount of debentures. During 2004, nil (2003: nil) HSBC Holdings ordinary shares were issued in connection with the conversion of these debentures and in August 2004, the entire outstanding principal amount of US$8,000 was repurchased. The principal amount of these debentures outstanding over HSBC Holdings ordinary shares are as follows: Principal amount of debentures exchangeable for HSBC Holdings ordinary shares Period of exercise Conversion value 31 December 2004 .............................................. 31 December 2003 ............................................... – US$8,000 – 2004 to 2021 – US$41.44 Following the acquisition of Bank of Bermuda on 18 February 2004, all outstanding employee share options over Bank of Bermuda shares were converted into rights to receive HSBC Holdings ordinary shares based on the consideration of US$40 for each Bank of Bermuda share and the average closing price of HSBC Holdings ordinary shares, derived from the London Stock Exchange Daily Official List, for the five business days preceding the closing date of the acquisition. During 2004, options over 744,727 HSBC Holdings ordinary shares were exercised and 744,727 HSBC Holdings ordinary shares delivered from the HSBC (Bank of Bermuda) Employee Benefit Trust 2004 to satisfy the exercise of these options. During 2004, options over 23,500 HSBC Holdings ordinary shares lapsed. At 31 December 2004, the HSBC (Bank of Bermuda) Employee Benefit Trust 2004 held 3,255,273 HSBC Holdings ordinary shares which may be used to satisfy the exercise of options. 292 Options outstanding over HSBC Holdings ordinary shares under the Bank of Bermuda share plans are as follows: Number of HSBC Holdings ordinary shares Period of exercise Exercise price 31 December 2004 .............................................. 4,569,967 2005 to 2013 US$3.86 – US$18.35 The total obligation at 31 December 2004 to deliver HSBC Holdings ordinary shares under all of the above arrangements and under the HSBC Holdings Restricted Share Plan was 514,846,111 (2003: 496,414,669). The total number of shares at 31 December 2004 held by employee benefit trusts that may be used to satisfy such obligations to deliver HSBC Holdings ordinary shares is 123,108,967 (2003: 110,770,974). 35 Reserves Share premium account At 1 January 2004 ...................................................................................... Shares issued to QUEST ............................................................................ Shares issued under other employee option schemes ................................. Shares issued in lieu of dividends .............................................................. On redemption of the equity component of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units ........ Scrip dividend expenses ............................................................................. At 31 December 2004 ............................................................................... Other reserves Reserve in respect of obligations under subsidiary share options: At 1 January 2004 .................................................................................. Reserve in respect of obligations under Bank of Bermuda share options On exercise of CCF share options ......................................................... On exercise of HSBC Finance Corporation share options ..................... On exercise of Bank of Bermuda share options ..................................... On redemption of the equity component of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units .... At 31 December 2004 ........................................................................... Merger reserve: At 1 January 2004 and 31 December 2004 ............................................. Total other reserves ........................................................................................ Revaluation reserves Investment property revaluation reserve: At 1 January 2004 .................................................................................. Unrealised surplus on revaluation of land and buildings ....................... Transfer to revaluation reserve .............................................................. Realisation on disposal of properties ..................................................... Exchange and other movements ............................................................ At 31 December 2004 ........................................................................... Revaluation reserve: At 1 January 2004 .................................................................................. Realisation on disposal of properties ..................................................... Transfer from investment property revaluation reserve ......................... Unrealised surplus on revaluation of properties ..................................... Transfer of depreciation from profit and loss account reserve ............... Net increase in attributable net assets of subsidiary undertakings (Note 25 (a))....................................................................................... Exchange and other movements ............................................................ At 31 December 2004 ........................................................................... Total revaluation reserves .......................................................................... HSBC US$m 4,406 17 525 (80) 15 (2) 4,881 485 22 (81) (19) (7) (1) 399 21,058 21,457 207 64 11 (11) 2 273 1,408 (75) (11) 1,093 (42) – 14 2,387 2,660 HSBC Holdings US$m Associates US$m 4,406 17 525 (80) 15 (2) 4,881 485 22 (81) (19) (7) (1) 399 – 399 – – – – – – 57,041 – – – – 11,955 (33) 68,963 68,963 – – – – – – – – – – – – – – – – 34 12 – – – 46 8 – – – – – 1 9 55 293 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Profit and loss account At 1 January 20041 ..................................................................................... Retained profit/(loss) for the year .............................................................. Revaluation reserve realised on disposal of properties ............................... Arising on shares issued in lieu of dividends ............................................. Transfer of depreciation to revaluation reserve .......................................... Amortisation of shares in restricted share plans ......................................... Own shares acquired to meet share awards and share option awards ......... Own shares released on vesting of share awards and exercise of options ... Net purchases and sales of own shares for market making purposes .......... Exchange and other movements ................................................................. At 31 December 20041 .............................................................................. HSBC US$m 41,428 4,539 86 2,607 42 36 (345) 159 98 3,388 52,038 HSBC Holdings US$m Associates US$m 7,060 (2,803) – 2,627 – 14 (261) 151 – 5 6,793 324 122 – – – – – – – – 446 1 Includes the balance relating to own shares held. In the 2003 Annual Report and Accounts, the balance relating to own shares held was reported separately together with movements in the year. Included within the HSBC profit and loss account reserve at 31 December 2004 are retained losses of US$116 million (2003: US$118 million; 2002: US$136 million) attributable to interests in joint ventures. Share premium account At 1 January 2003 ...................................................................................... Shares issued to QUEST ............................................................................ Shares issued under other employee option schemes ................................. Shares issued in lieu of dividends .............................................................. On redemption of the equity component of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units ........ Scrip dividend expenses ............................................................................. At 31 December 2003 ............................................................................... Other reserves Reserve in respect of obligations under subsidiary share options: At 1 January 2003 .................................................................................. Reserve in respect of obligations under HSBC Finance Corporation share options ...................................................................................... Reserve in respect of obligations under the equity component of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units ............................................. On exercise of CCF share options .......................................................... On exercise of HSBC Finance Corporation share options ...................... On redemption of the equity component of HSBC Finance Corporation 8.875 per cent Adjustable Conversion-Rate Equity Security Units .... At 31 December 2003 ........................................................................... Merger reserve: At 1 January 2003 .................................................................................. On acquisition of HSBC Finance Corporation ....................................... At 31 December 2003 ........................................................................... Total other reserves ........................................................................................ HSBC US$m 3,647 26 311 (59) 482 (1) 4,406 439 112 21 (41) (28) (18) 485 8,290 12,768 21,058 21,543 HSBC Holdings US$m Associates US$m 3,647 26 311 (59) 482 (1) 4,406 439 112 21 (41) (28) (18) 485 – – – 485 – – – – – – – – – – – – – – – – – – 294 Revaluation reserves Investment property revaluation reserve: At 1 January 2003 .................................................................................. Unrealised deficit on revaluation of land and buildings ......................... Transfer to revaluation reserve .............................................................. Realisation on disposal of properties ..................................................... Exchange and other movements ............................................................ At 31 December 2003 ........................................................................... Revaluation reserve: At 1 January 2003 .................................................................................. Realisation on disposal of properties ..................................................... Transfer from investment property revaluation reserve ......................... Unrealised deficit on revaluation of properties ...................................... Transfer of depreciation from profit and loss account reserve ............... Net increase in attributable net assets of subsidiary undertakings (Note 25 (a))....................................................................................... Exchange and other movements ............................................................ At 31 December 2003 ........................................................................... Total revaluation reserves .......................................................................... Profit and loss account At 1 January 20031 ..................................................................................... Retained profit/(loss) for the year .............................................................. Revaluation reserve realised on disposal of properties ............................... Arising on shares issued in lieu of dividends ............................................. Transfer of depreciation to revaluation reserve .......................................... Amortisation of shares in restricted share plans ......................................... Own shares acquired to meet share awards and share option awards ......... Own shares released on vesting of share awards and exercise of options .. Net purchases and sales of own shares for market making purposes ......... Exchange and other movements ................................................................. At 31 December 20031 .............................................................................. HSBC US$m 247 (38) (1) (2) 1 207 1,707 (28) 1 (292) (29) – 49 1,408 1,615 32,694 2,242 30 1,423 29 19 (301) 162 (138) 5,268 41,428 HSBC Holdings US$m Associates US$m – – – – – – 36,883 – – – – 20,195 (37) 57,041 57,041 6,055 (319) – 1,423 – 14 (266) 153 – – 7,060 44 (10) – – – 34 6 – – – – – 2 8 42 243 80 – – – – – – – 1 324 1 Includes the balance relating to own shares held. In the 2003 Annual Report and Accounts, the balance relating to own shares held was reported separately together with movements in the year. Share premium account At 1 January 2002 ...................................................................................... Shares issued to QUEST ............................................................................ Shares issued under other employee option schemes ................................. Shares issued in lieu of dividends .............................................................. At 31 December 2002 ................................................................................ Other reserves Reserve in respect of obligations under subsidiary share options: At 1 January 2002 .................................................................................. On exercise of CCF share options ......................................................... At 31 December 2002 ............................................................................ Merger reserve: At 1 January and 31 December 2002 ..................................................... Total other reserves ........................................................................................ HSBC US$m 3,373 65 254 (45) 3,647 480 (41) 439 8,290 8,729 HSBC Holdings US$m 3,373 65 254 (45) 3,647 480 (41) 439 – 439 Associates US$m – – – – – – – – – – 295 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Revaluation reserves Investment property revaluation reserve: At 1 January 2002 .................................................................................. Unrealised deficit on revaluation of land and buildings ......................... Transfer of depreciation from profit and loss account reserve ................ Realisation on disposal of properties ..................................................... Exchange and other movements ............................................................. At 31 December 2002 ............................................................................ Revaluation reserve: At 1 January 2002 .................................................................................. Realisation on disposal of properties ..................................................... Unrealised deficit on revaluation of properties ...................................... Transfer of depreciation from profit and loss account reserve ............... Net increase in attributable net assets of subsidiary undertakings .......... Exchange and other movements ............................................................. At 31 December 2002 ............................................................................ Total revaluation reserves .............................................................................. Profit and loss account At 1 January 20021 ..................................................................................... Retained profit for the year ........................................................................ Revaluation reserve realised on disposal of properties ............................... Depreciation realised on disposal of properties .......................................... Arising on shares issued in lieu of dividends ............................................. Transfer of depreciation to revaluation reserve .......................................... Amortisation of shares in restricted share plans ......................................... Own shares acquired to meet share awards and share option awards ......... Own shares released on vesting of share awards and exercise of options ... Exchange and other movements ................................................................. At 31 December 20021 ............................................................................... HSBC US$m 269 (23) 7 (4) (2) 247 2,002 (29) (297) (37) – 68 1,707 1,954 26,596 1,238 33 37 1,023 (7) 19 (5) 45 3,715 32,694 HSBC Holdings US$m Associates US$m – – – – – – 32,436 (4) – – 4,553 (102) 36,883 36,883 4,721 266 4 – 1,023 – 10 (11) 42 – 6,055 46 (1) – – (1) 44 6 – – – – – 6 50 255 (11) – – – – – – – (1) 243 1 Includes the balance relating to own shares held. In the 2003 Annual Report and Accounts, the balance relating to own shares held was reported separately together with movements in the year. The accumulated foreign exchange translation adjustment as at 31 December 2004 increased HSBC’s reserves by US$9,134million (2003: increased by US$5,729 million; 2002: increased by US$411 million). Cumulative goodwill amounting to US$5,138 million (2003: US$5,138 million; 2002: US$5,138 million) has been charged against reserves in respect of acquisitions of subsidiary undertakings prior to 1 January 1998. Statutory share premium relief under Section 131 of the Companies Act 1985 was taken in respect of the acquisition of CCF in 2000 and HSBC Finance Corporation in 2003 and the shares issued were recorded at their nominal value only. In HSBC’s consolidated accounts the fair value difference of US$8,290 million in respect of CCF and US$12,768 million in respect of HSBC Finance Corporation was transferred to a merger reserve. Many of HSBC’s banking subsidiary undertakings, joint ventures and associates operate under local regulatory jurisdictions which could potentially restrict the amount of reserves which can be remitted to HSBC Holdings plc in order to maintain local regulatory capital ratios. In addition, the remittance of reserves may result in further taxation liabilities. The HSBC Qualifying Employee Share Ownership Trust was established in 1999 to satisfy options exercised by UK participants of the HSBC Holdings Savings-Related Share Option Plan. During 2004, HSBC QUEST Trustee (UK) Limited, the corporate trustee of the QUEST, subscribed at market value for 1,079,099 ordinary shares at a total cost of US$17 million (2003: US$27 million; 2002: US$68 million). HSBC provided US$nil (2003: US$nil; 2002: US$nil) for this purpose. During 2004, 1,592,371 (2003: 3,175,232; 2002: 9,564,355) ordinary shares were transferred from the QUEST to employees who exercised under the HSBC Holdings Savings-Related Share Option Plan. US$17 million (2003: US$27 million; 2002: US$68 million) was received from the share option plan participants. The price paid by option 296 holders ranged from £5.2212 to £6.7536 (2003: £4.5206 to £6.7536; 2002: £3.059 to £6.7536) per ordinary share of US$0.50. At 31 December 2004, the trust held 1,021 (2003: 514,293; 2002: 1,488,895) ordinary shares of US$0.50 with a market value of US$17,357 (2003 US$8,062,509; 2002: US$16,474,634) in respect of these options. Dividends on these shares are waived by the QUEST. HSBC has taken advantage of the exemptions applicable to Inland Revenue approved SAYE share option schemes and equivalent overseas schemes under UITF Abstract 17 (revised 2000) ‘Employee share schemes’. HSBC Own shares held Deducted from retained profits are: (a) US$39 million (2003: US$33 million; 2002: US$29 million) of shares held by HSBC Life International. (b) US$84 million (2003: US$134 million; 2002: US$nil) of shares held by subsidiary companies for market making and trading activities. (c) US$749 million (2003: US$653 million; 2002: US$540 million) of shares held by HSBC Holdings as explained below. (d) US$175 million (2003: US$58 million; 2002: US$56 million) of ordinary shares held in trusts established by subsidiary companies for the purposes of conditional awards under the Restricted Share Plan, details of which are provided in the Directors’ Remuneration Report on pages 216 to 233. At 31 December 2004, such trusts held 14,177,399 (2003: 7,562,628; 2002: 5,029,157) ordinary shares with a market value at that date of US$241,014,365 (2003: US$118,550,244; 2002: US$55,688,358) in respect of these conditional awards. (e) US$54 million (2003: US$45 million; 2002: US$21 million) of ordinary shares held in trusts established by subsidiary companies which may be used in respect of the exercise of share options or for the purposes of share awards as detailed in Note 34. At 31 December 2004, such trusts held 3,188,632 (2003: 3,251,780; 2002: 1,482,249) ordinary shares. HSBC Holdings Own shares held Deducted from retained profits are: (a) US$100 million (2003: US$64 million; 2002: US$43 million) of HSBC Holdings’ own shares held in trust for the purposes of conditional awards under the Restricted Share Plan, details of which are provided in the Directors’ Remuneration Report on pages 216 to 233. At 31 December 2004, the trust held 8,163,554 (2003: 6,391,497; 2002: 4,664,315) ordinary shares with a market value at that date of US$138,779,602 (2003: US$100,191,651; 2002: US$51,610,678) in respect of these conditional awards. (b) US$372 million (2003: US$455 million; 2002: US$497 million) of HSBC Holdings’ own shares held in trust which may be used in respect of the exercise of CCF share options as detailed in Note 34. At 31 December 2004, the trust held 26,787,515 (2003: 32,775,055; 2002: 35,745,555) ordinary shares with a market value of US$455,385,076 (2003: US$513,774,295; 2002: US$395,524,816) in respect of these option holders. (c) US$220 million (2003: US$134 million; 2002: US$nil) of HSBC Holdings’ own shares held in trust which may be used in respect of the exercise of HSBC Finance Corporation share options as detailed in Note 34. At 31 December 2004, the trust held 16,645,439 (2003: 12,444,049; 2002: nil) ordinary shares with a market value of US$282,970,798 (2003: US$195,070,109; 2002: nil) in respect of these option holders. (d) US$57 million (2003: US$nil; 2002: nil) of HSBC Holdings’ own shares held in trust which may be used in respect of the exercise of Bank of Bermuda share options as detailed in Note 34. At 31 December 2004, the trust held 3,255,273 (2003: nil; 2002: nil) ordinary shares with a market value of US$55,339,315 (2003: US$nil ; 2002: US$nil) in respect of these option holders. 297 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 36 Analyses of assets and liabilities (a) Assets subject to sale and repurchase transactions Total assets subject to sale and repurchase transactions .......................................................... (b) Assets leased to customers Loans and advances to customers ............................................................................................ Tangible fixed assets – equipment on operating leases (Note 24 (a)) ...................................... 2004 US$m 39,944 2004 US$m 13,750 4,953 18,703 2003 US$m 22,299 2003 US$m 10,519 4,048 14,567 The cost of assets acquired during 2004 for letting to customers under finance leases and hire purchase contracts by HSBC amounted to US$7,753 million (2003: US$4,370 million). (c) Assets charged as security for liabilities HSBC has pledged assets as security for liabilities included under the following headings: Deposits by banks ................................................................................................................... Customer accounts .................................................................................................................. Debt securities in issue ............................................................................................................ Other liabilities ....................................................................................................................... Amount of liability secured 2004 US$m 2,303 4,189 27,793 5,178 39,463 2003 US$m 1,487 3,709 33,584 3,122 41,902 The amount of assets pledged to secure these liabilities is included under the following headings: Amount of assets pledged Treasury bills & other eligible securities ................................................................................. Loans and advances to customers ........................................................................................... Debt securities ........................................................................................................................ Other ....................................................................................................................................... 2004 US$m 3,152 34,992 53,837 1,438 93,419 (d) HSBC Holdings HSBC Holdings’ investment in and indebtedness of and to subsidiary undertakings was as follows: Investments in subsidiary undertakings1 .. Amounts owed by HSBC undertakings ... Subordinated liabilities to HSBC undertakings ....................................... Other amounts owed to HSBC undertakings ....................................... Bank US$m 71,303 14,655 – 677 2004 Non-bank US$m 23,582 6,035 8,143 6,675 Total US$m 94,885 20,690 8,143 7,352 Bank US$m 54,336 11,883 – 1,603 2003 Non-bank US$m 26,165 4,739 6,845 4,576 2003 US$m 1,489 37,441 71,690 828 111,448 Total US$m 80,501 16,622 6,845 6,179 1 Investments in subsidiary undertakings have been analysed on the basis of the business of the principal operating sub-group, i.e. banking sub-groups which include insurance companies have been categorised as banks. 298 37 Financial instruments (a) Derivatives Derivatives are financial instruments that derive their value from the price of an underlying item such as equities, bonds, interest rates, foreign exchange, credit spreads, commodities or equity and other indices. (i) Types of derivatives Derivative instruments are classified as being for either trading or hedging purposes. The following outlines the nature and terms of the most common types of derivatives used by HSBC. Currency forwards represent commitments to purchase foreign or domestic currency at a future date. Forward rate agreements are individually negotiated interest rate futures that call for a cash settlement at a future date for the difference between a contractual rate or agreed rate of interest, and the current market rate, based on a notional principal amount. Currency and interest rate swaps are commitments to exchange one set of cash flows for another. Swaps result in an economic exchange of currencies or interest rates (for example, fixed rate for floating rate) or a combination of both of these (i.e. cross-currency interest rate swaps). Except for certain currency swaps, no exchange of principal takes place. Equity swaps are bilateral agreements to transfer the risk and returns on an equity in exchange for a stream of payments, typically interest. Foreign currency, equity and interest rate options are contractual agreements under which the seller (writer) grants the purchaser (holder) the right, but not the obligation, either to buy (a call option) or sell (a put option) at or by a set date or during a set period, a specific amount of a foreign currency or a financial instrument at a predetermined price. In consideration for the assumption of foreign exchange, equity, or interest rate risk, the seller receives a premium from the purchaser. Options may be either exchange-traded or negotiated between the Group and a customer on an over the counter basis. Futures are exchange-traded agreements to buy or sell a standard quantity of a specified fixed income security, time deposit, equity or currency at a future date, at a price decided at the time the contract is made. Equity futures may be settled in cash or through delivery. Credit default swaps are bilateral agreements to transfer credit risks between counterparties. Under the agreement, the party buying protection makes one or more payments to the party selling protection during the life of the swap in exchange for an undertaking by the seller to make a payment to the buyer following a specified credit event. Credit default swaps may be on a single name (counterparty) or may be on multiple names (counterparties). Commodity derivatives include exchange traded and over the counter contracts involving commodities and base metals. (ii) Use of derivatives Commercially HSBC transacts in derivatives for three primary purposes – to create risk management solutions for clients, for proprietary trading purposes, and to manage and hedge HSBC’s own risks. For accounting purposes, derivative instruments are classified as either trading or hedging. Trading Derivatives Most of the Group’s derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or expected risks. Trading activities in derivatives are entered into principally for the purpose of generating profits from short-term fluctuations in price or margin. Positions may be traded actively or be held over a period of time, to benefit from expected changes in currency rates, interest rates, equity prices or other market parameters. Trading includes market-making, positioning and arbitrage activities: market- making involves quoting bid and offer prices to other market participants with the intention of generating revenues based on spread and volume; positioning means managing market risk positions with the 299 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) expectation of profiting from favourable movements in prices, rates or indices; arbitrage activities involve identifying and profiting from price differentials between markets and products. The following tables summarise the contract amount, replacement cost, mark-to-market values and average mark-to-market values of third party and internal trading derivatives by product type. The replacement cost shown is the positive mark-to-market value and represents the accounting loss HSBC would incur if the counterparty to a derivative contract failed to perform according to the terms of the contract and the collateral, if any, for the amount due proved to be of no value. Because all derivative instruments used for trading purposes are marked to market, carrying values are equal to mark-to-market values. The notional or contractual amounts of certain types of financial instruments provide a basis for comparison with instruments recognised on the balance sheet but do not necessarily indicate the amounts of future cash flows involved or the current fair value of the instruments and, therefore, do not indicate the Group’s exposure to credit or price risks. The derivative instruments become favourable (assets) or unfavourable (liabilities) as a result of market changes or movements relative to their terms. The aggregate contractual or notional amount of derivative financial instruments, the extent to which instruments are favourable or unfavourable and, thus the aggregate fair values of derivative financial assets and liabilities can fluctuate significantly over the reporting period. Trading derivatives are valued at mark-to-market based on quoted market prices or on internally developed models that are based on independently sourced market parameters, including interest rate yield curves, option volatilities and currency rates. If market observable data are not available, the initial increase in fair value indicated by the valuation model, but based on unobservable inputs, is not recognised immediately in the profit and loss account. This amount is held back and recognised over the life of the transaction where appropriate, or released to the profit and loss account when the inputs become observable, or, when the transaction matures or is closed out. 2004 2003 Spot and forward foreign exchange ............. Currency swaps, futures and options purchased ................................................ Currency options written ............................. Other contracts ............................................ Contract amount US$m 1,044,148 404,172 138,035 29,151 Total exchange rate contracts ...................... 1,615,506 Interest rate swaps ....................................... Interest rate futures, forward rate agreements, and options purchased ......... Interest rate options written ......................... 3,335,145 861,448 374,058 Total interest rate contracts .......................... 4,570,651 Equities, futures and options purchased ....... Equities options written ............................... Other contracts ............................................ Total equities contracts ................................ 20,806 15,192 19,060 55,058 Credit derivatives ........................................ 195,603 Netting ......................................................... Total ............................................................ 6,436,818 1 Third party contracts only. Replacement cost1 US$m 16,546 13,219 – 1,259 31,024 31,364 4,659 – 36,023 2,037 – 744 2,781 1,338 (41,568) 29,598 Contract amount US$m 792,845 286,283 94,623 14,209 1,187,960 2,170,050 717,114 267,294 3,154,458 24,721 15,171 10,950 50,842 49,613 4,442,873 Replacement cost1 US$m 14,813 8,822 – 668 24,303 21,364 3,654 – 25,018 1,927 – 1,319 3,246 622 (28,578) 24,611 300 2004 2003 Mark-to- market values at year end US$m Average mark-to- market values for the year US$m Mark-to- market values at year end US$m Average mark-to- market values for the year US$m Exchange rate Interest rate Equities Credit derivatives Total assets .................. liabilities ............. assets .................. liabilities ............. assets .................. liabilities ............. assets .................. liabilities ............. assets .................. liabilities ............. Netting ......................................................... 33,590 (35,414) 36,041 (36,874) 2,784 (3,280) 1,341 (1,394) 73,756 (76,962) 41,568 28,765 (30,000) 33,861 (32,848) 3,197 (3,029) 948 (888) 66,771 (66,765) 29,926 26,961 (27,226) 25,394 (26,824) 3,252 (2,503) 623 (559) 56,230 (57,112) 28,578 20,893 (22,033) 33,913 (32,622) 2,405 (2,802) 409 (346) 57,620 (57,803) 26,146 The above amounts are stated after deducting cash collateral meeting the offset criteria of FRS 5 ‘Reporting the substance of transactions’ as follows: Offset against assets ..................................... Offset against liabilities ................................ 4,891 1,806 3,454 1,221 Hedging derivatives HSBC uses derivatives (principally interest rate swaps) for hedging purposes in the management of its own asset and liability portfolios and structural positions. This enables HSBC to optimise the all-in cost to the Group of accessing debt capital markets and to mitigate market risk which would otherwise arise from structural imbalances between the profile of its assets and liabilities. The following table summarises the contract amount and replacement cost of derivatives used for risk management purposes by product type. The replacement cost represents the accounting loss HSBC would incur if the counterparty to a derivative contract failed to perform according to the terms of the contract and the collateral, if any, for the amount due proved to be of no value. 2004 2003 Contract amount US$m 69,421 40,344 109,765 426,081 10,734 436,815 44 50 94 Replacement cost1 US$m 111 810 921 1,070 1 1,071 – – – Contract amount US$m 67,370 40,130 107,500 358,491 27,288 385,779 91 71 162 Spot and forward foreign exchange .............. Currency swaps, futures and options purchased ................................................. Total exchange rate contracts ....................... Interest rate swaps ........................................ Interest rate futures, forward rate agreements and options purchased .............................. Total interest rate contracts .......................... Equities, futures and options purchased ....... Other contracts ............................................. Total equities contracts ................................. 1 Third party contracts only. Replacement cost1 US$m 142 1,342 1,484 906 3 909 59 – 59 301 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) The table below summarises the carrying value and mark-to-market value of derivative contracts held for risk management purposes. Mark-to-market values for assets and liabilities arising from derivatives held for non-trading purposes are determined in the same way as those set out for trading derivatives above, including internal positions. 2004 Carrying value US$m Mark-to- market values US$m 2003 Carrying value US$m Mark-to- market values US$m 6,282 (3,488) 2,335 (2,525) – 6,366 (3,204) 4,638 (3,117) – 3,658 (3,147) 1,824 (2,312) 4 4,297 (3,495) 5,814 (4,136) 59 Exchange rate Interest rate Equities assets ..................... liabilities................ assets ..................... liabilities................ assets ..................... (iii) Risks associated with derivatives Derivative instruments are subject to both market risk and credit risk. Market risk The Group takes on exposure to market risk. Market risk arises from open positions in interest rate, currency and equity products, all of which are exposed to general and specific market movements. The Group applies a ‘value at risk’ methodology to calculate the market risk of positions held and the maximum losses expected, based upon a number of assumptions for various changes in market conditions. The market risk associated with derivatives can be significant since large positions can be accumulated with a substantially smaller initial outlay than required in cash markets. Recognising this, only certain offices within major subsidiaries with sufficient derivative product expertise and appropriate control systems are authorised to trade derivative products. Market risk arising from derivatives business, as well as the market risk arising from on-balance-sheet instruments is monitored by Traded Markets Development and Risk, an independent unit within the Corporate, Investment Banking and Markets operation. Credit risk Unlike assets recorded on the balance sheet, where the credit risk is typically the full amount of the principal value, together with any unrealised interest accrued or mark-to-market gain, the credit risk of a derivative is principally the replacement cost of any contract with a positive mark-to-market gain and an estimate of the potential future change in value, reflecting the volatilities affecting the contract. The credit risk on contracts having a negative mark-to-market value is restricted to the potential future change in value. Credit risk on derivatives is, therefore, small in relation to an equivalent on-balance sheet risk. In addition, credit exposure with individual counterparties can be reduced by the receipt of collateral and close-out netting agreements which allow for positive and negative mark-to-market values on different transactions to be offset and settled by a single payment in the event of default by either party. Such agreements are enforceable in the jurisdictions of the major markets in which the Group operates and HSBC has executed closeout netting agreements with the majority of its significant counterparties. Furthermore HSBC transacts derivatives with only creditworthy counterparties. The credit risk profile generated by the use of credit derivatives has an additional dimension. Where HSBC purchases protection, credit risk arises through the cost of replacing the contract as set out above and it is managed and reduced in the same way as for other derivative contracts. Selling protection through credit derivatives gives rise to additional credit risk. This credit risk arises as a direct consequence of the obligation of HSBC as the protection seller to make a payment to the protection buyer following a credit event on a reference name. HSBC manages the credit risk with regard to reference names by including any such exposures arising from credit derivatives within its overall credit limits structure. In addition the trading of credit derivatives is restricted to a small number of offices within the major centres which in management’s view have the control infrastructure and market skills to manage effectively the credit risk inherent in the products. 302 Concentrations of credit risk Concentrations of credit risk exist if a number of counterparties are engaged in similar activities or activities in the same region, or have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The following table analyses the replacement cost of all third party exchange rate, interest rate, equity and credit derivative contracts with positive mark-to-market gains by category of counterparty and by maturity, including netting where available at 31 December 2004 and 31 December 2003. The table shows that the replacement cost of derivatives is predominantly with banks and under five years. Less than 1 year US$m 23 15,280 1,077 3,604 2,806 22,790 19,562 1-5 years US$m 122 19,907 311 3,833 1,965 26,138 23,254 Residual maturity Over 5 years US$m Netting US$m 394 17,250 23 5,407 1,156 24,230 12,825 (49) (34,594) (3) (5,204) (1,718) (41,568) (28,578) 2004 Total US$m 490 17,843 1,408 7,640 4,209 31,590 2003 Total US$m 116 16,085 798 5,643 4,421 27,063 Governments ....................... Banks .................................. Non-bank financial institutions: Exchanges1 ...................... Other ............................... Other sectors ....................... Total 2004 .......................... Total 2003 ........................... 1 Exchanges with margining requirements. The following table shows the maturity profile of the notional principal values of third party derivatives contracts outstanding as at 31 December 2004 and 31 December 2003. Exchange rate, interest rate, equities and credit derivative contracts: Exchanges1 ............................... Other contracts ......................... Less than 1 year US$m 565,193 2,344,065 Total 2004 ................................... 2,909,258 Residual maturity Over 5 years US$m 87,049 1,087,501 1,174,550 1-5 years US$m 212,467 1,986,385 2,198,852 2004 Total US$m 864,709 5,417,951 6,282,660 Total 2003 .................................... 2,215,501 1,359,029 604,778 2003 Total US$m 503,215 3,676,093 4,179,308 1 Exchanges with margining requirements. (iv) Credit derivatives Use of credit derivatives Credit derivatives can be used for either trading activity, or for the portfolio management of the credit risk on the Group’s loan portfolio. Currently HSBC does not use credit derivatives in any significant manner for the portfolio management of the credit risk on its own loan portfolio. The following table presents the notional amounts of credit derivatives protection bought and sold at 31 December 2004 and 2003: At 31 December 2004 ................................................................................................... At 31 December 2003 .................................................................................................... Credit derivative positions Notional amount of protection Sold US$m Bought US$m 93,750 25,322 102,321 24,807 HSBC has limited counterparty exposure as a result of credit derivatives transactions. 303 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Of the US$29.6 billion of total derivative receivables at 31 December 2004, approximately US$1.3 billion, or 4 per cent, was associated with credit derivatives, before the benefit of collateral. The use of credit derivatives to manage exposures does not reduce the reported level of assets on the balance sheet or the level of reported off–balance sheet commitments. HSBC’s trading activity in credit derivatives is primarily client driven. The business acts as a market-maker in single-name credit derivatives. It also structures more complex transactions for clients’ investment or risk management purposes. The credit derivatives trading function operates within the same framework as other market-making desks. Risk limits are established and closely monitored. As at 31 December 2004, the total notional amounts of protection purchased and sold were US$93.8 billion and US$102.3 billion, respectively. The mismatch between these notional amounts is attributable to HSBC selling protection on large, diversified, predominantly investment-grade portfolios (including the most senior tranches) and then hedging these positions by buying protection on the more subordinated tranches of the same portfolios. In addition, HSBC uses securities to hedge certain derivative positions. Consequently, while there is a mismatch in notional amounts of credit derivatives, the risk positions are largely matched. (b) Other financial instruments (i) Financial instruments held for trading purposes: Assets Treasury bills and other eligible bills ........................................................................... Loans and advances to banks and customers ............................................................... Debt securities ............................................................................................................. Equity shares ............................................................................................................... Liabilities Short positions in securities ......................................................................................... Debt securities in issue ................................................................................................ Deposits by banks and customer accounts ................................................................... Mark-to-market values 2004 US$m 4,618 81,716 91,794 14,610 2003 US$m 4,592 57,448 74,806 7,489 192,738 144,335 46,460 7,825 69,588 123,873 30,127 3,881 46,167 80,175 The net trading assets above are funded by liabilities whose fair value is not materially different from their carrying value. (ii) Financial instruments not held for trading purposes and for which a liquid and active market exists: Assets Treasury bills and other eligible bills............ Debt securities .............................................. Equity shares ................................................ Liabilities Debt securities in issue ................................. Subordinated liabilities ................................. Non-equity minority interests ....................... 2004 Carrying value US$m Mark-to- market values US$m 25,613 149,152 4,709 179,474 155,480 25,521 10,718 191,719 25,611 150,437 5,588 181,636 154,318 27,313 10,711 192,342 2003 Mark-to- market values US$m 15,794 132,421 6,217 154,432 131,430 20,219 8,715 160,364 Carrying value US$m 15,781 130,761 5,390 151,932 130,510 19,825 8,719 159,054 Where possible, mark-to-market values have been estimated using market prices for these financial instruments. Where market prices are not available, values have been estimated using quoted prices for financial instruments with similar characteristics, or otherwise using a suitable valuation technique where practicable to do so. 304 The techniques used in the two tables above are: Treasury bills and other eligible bills Mark-to-market value approximates to carrying value because these are mainly short-term in maturity with a carrying value not materially different from mark-to-market value. Loans and advances to banks and customers For variable rate loans and advances with no significant change in credit risk, the carrying value is considered to represent mark-to-market value. The mark-to-market values of other loans and advances are estimated by discounting future cash flows using market interest rates. Debt securities and equity shares Listed securities are valued at middle-market prices and unlisted securities at management’s valuation which takes into consideration future earnings streams, valuations of equivalent quoted securities and other relevant techniques. Debt securities in issue, short positions in securities, subordinated liabilities and non-equity minority interests Mark-to-market values are estimated using quoted market prices at the balance sheet date. Deposits by banks and customer accounts Deposits by banks and customer accounts which mature or reprice after six months are grouped by residual maturity. Fair value is estimated using discounted cash flows, applying either market rates, where applicable, or current rates offered for deposits of similar repricing maturities. (c) Gains and losses on hedges Unrecognised gains and losses Gains and losses on instruments used for hedging are recognised in line with the underlying items which are being hedged. The unrecognised gains on instruments used for hedging as at 31 December 2004 were US$12,792 million (2003: US$7,669 million) and the unrecognised losses were US$10,713 million (2003: US$5,157 million). Unrecognised gains of US$6,440 million and unrecognised losses of US$5,055 million are expected to be recognised in 2005. Of the gains and losses included in the profit and loss account in 2004, US$4,767 million of gains and US$2,713 million of losses were unrecognised at 1 January 2004. (d) Liquidity management HSBC’s liquidity management process is discussed in the ‘Financial Review’ section on page 166 from the paragraph under the heading ‘Liquidity and funding management’ to the bullet point ‘maintaining liquidity and funding contingency plans’. 305 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 38 Memorandum items (a) HSBC Contingent liabilities and commitments Contingent liabilities Acceptances and endorsements ................. Guarantees and assets pledged as collateral security: guarantees and irrevocable letters of credit ..................................................... Other contingent liabilities ........................ Commitments Documentary credits and short-term trade-related transactions ...................... Forward asset purchases and forward forward deposits placed ........................ Undrawn note issuing and revolving underwriting facilities ........................... Undrawn formal standby facilities, credit lines and other commitments to lend – over 1 year ......................................... – 1 year and under ................................ 2004 Credit equivalent amount US$m Risk- weighted amount US$m Contract amount US$m 2003 Credit equivalent amount US$m Risk- weighted amount US$m Contract amount US$m 7,214 4,280 4,070 5,412 3,327 3,194 64,921 57 72,192 7,788 2,689 601 92,077 464,541 567,696 51,201 57 55,538 2,982 2,689 565 46,038 – 52,274 37,138 56 41,264 1,660 1,449 36 44,396 – 47,541 54,439 29 59,880 7,511 1,437 671 56,252 362,893 428,764 42,792 29 46,148 2,750 1,437 605 28,126 – 32,918 31,110 28 34,332 1,616 618 66 27,461 – 29,761 The table above gives the nominal principal amounts, credit equivalent amounts and risk-weighted amounts of off-balance-sheet transactions. The credit equivalent amounts are calculated for the purposes of deriving the risk- weighted amounts. These are assessed in accordance with the Financial Services Authority’s guidelines which implement the 1988 Basel Capital Accord on capital adequacy and depend on the status of the counterparty and the maturity characteristics. Contingent liabilities and commitments are credit-related instruments which include acceptances, letters of credit, guarantees and commitments to extend credit. Where irrevocable offers to extend credit are made in customer mailing programs, commitments are calculated using management’s best estimate of response rates incorporating appropriate historical experience. The contractual amounts represent the amounts at risk should a contract be fully drawn upon and the client default. Since a significant portion of guarantees and commitments are expected to expire without being drawn upon, the total of the contract amounts is not representative of future liquidity requirements. Guarantees HSBC provides guarantees and similar undertakings on behalf of both third party customers and other entities within the HSBC Group. These guarantees are generally provided in the normal course of HSBC’s banking business. 306 The principal types of guarantees provided, and the maximum potential amount of future payments which HSBC could be required to make, at 31 December 2004 were as follows: At 31 December 2004 At 31 December 2003 Guarantees by HSBC Holdings in favour of other HSBC Group entities US$m – 54,387 – – – – – – – 54,387 Guarantees in favour of third parties US$m 7,214 27,031 3,108 7,322 4,910 382 5,322 16,824 79 72,192 Guarantees in favour of third parties US$m 5,412 21,573 2,371 7,188 4,780 290 4,345 13,881 40 59,880 Guarantees by HSBC Holdings in favour of other HSBC Group entities US$m – 41,775 – – – – – – – 41,775 Guarantee type Acceptances and endorsements1 ........................... Financial guarantees2 ............................................ Standby letters of credit which are financial guarantees3 ....................................................... Other direct credit substitutes4 .............................. Performance bonds5 .............................................. Bid bonds5 ............................................................ Standby letters of credit related to particular transactions5 ..................................................... Other transaction-related guarantees5 .................... Other items ........................................................... Balance as at 31 December ................................... 1 Acceptances and endorsements arise where HSBC agrees to guarantee payment on a negotiable instrument drawn up by a customer. The accepted instrument is then sold into the market on a discounted basis. 2 Financial guarantees include undertakings to stand behind the obligations of customers or other HSBC entities and to undertake these obligations if the other entity fails to do so. Intra-group items of this type will also include guarantees of a capital nature, given to another HSBC entity and intended to be considered as capital support by the relevant regulatory authority. 3 Standby letters of credit which are financial guarantees are irrevocable obligations to pay a third party where a customer fails to repay an outstanding commitment. 4 Other direct credit substitutes include re-insurance letters of credit and trade-related letters of credit which have been issued without provision for the issuing entity to retain title to the underlying shipment. 5 Performance bonds, bid bonds, standby letters of credit and other transaction-related guarantees are undertakings whereby the requirement to make payment under the guarantee depends on the outcome of a future event which is independent of the creditworthiness of the customer. The above maximum amounts payable reflect HSBC’s maximum exposure under a large number of individual guarantee undertakings. The risks and exposures arising from guarantees are captured and managed in accordance with HSBC’s overall credit risk management policies and procedures. Approximately one half of the above guarantees have a term of less than one year. Guarantees with a term of more than one year are subject to HSBC’s annual credit review process. When HSBC has given a guarantee on behalf of a customer, it will have the right to recover from that customer any amounts paid under the guarantee. A provision is recognised only where HSBC considers that it is more likely than not that an obligation exists under the guarantees. At 31 December 2004, HSBC had established the following provisions in respect of its obligations under outstanding guarantees: Acceptances and endorsements ............................................................................................... Guarantees and items pledged as collateral security ............................................................... Other items ............................................................................................................................. 2004 US$m 88 77 28 2003 US$m 92 82 25 HSBC believes that the amortised fair value of its liabilities under other guarantees for which no provision has been established is broadly equivalent to the amount of deferred income received but not yet recognised for such guarantees, which at 31 December 2004 amounted to US$38 million (2003: US$32 million) 307 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (b) Geographical concentration of contingent liabilities and commitments HSBC has the following geographic concentrations of exposure to contingent liabilities and commitments. These are allocated on the basis set out in Note 46: Contract amounts Contingent liabilities 2004 ............................................ 2003 ............................................ Commitments Europe US$m 31,915 27,460 2004 ............................................ 2003 ............................................ 202,976 133,475 Hong Kong US$m 18,844 16,036 69,945 58,098 Rest of Asia- Pacific US$m 10,621 7,686 50,934 40,029 North America US$m South America US$m 10,275 8,302 237,172 192,779 537 396 6,669 4,383 Total US$m 72,192 59,880 567,696 428,764 39 Market risk management HSBC’s market risk management process is discussed in the ‘Financial Review’ section on pages 167 to 169 from the paragraph under the heading ‘Market risk management’ to the paragraph ended ‘impact of extreme events on the market risk exposures of HSBC’. (a) Trading VAR VAR is a technique that estimates the potential losses that could occur on risk positions taken due to movements in market rates and prices over a specified time horizon and to a given level of confidence. The methodology for calculating VAR was enhanced from Variance Co-Variance (‘VCV’) to Historical Simulation (‘HS’) on 1 November 2004. The HS methodology incorporates non-linear risks associated with the planned expansion of HSBC’s derivatives business into the trading VAR calculation using a full valuation approach. Previously, any non-linear risk was incorporated using a conservative non-linear adjustment consistent with the level of non-linear risk taken. Consequently, the trading VAR for 2004, shown below, is based on 10 months VCV and 2 months HS. By way of comparison, average trading VAR for the six month period to 31 December 2004 under HS (US$114.7 million) was 0.7 per cent more than that under VCV (US$113.8 million). At 31 December 2004 the trading VAR under HS (US$119.1 million) was 4.5 per cent more than that under VCV (US$114.0 million). Trading VAR for HSBC for 2004 was: Foreign exchange trading positions Interest rate trading positions Equities trading positions US$m US$m US$m 31 December 2004 30 June 2004 ......... 31 December 2003 Averages: Full year 2004 ...... First half of 2004 .. Full year 2003 ....... 39.3 40.7 52.8 38.6 42.2 48.7 97.7 89.5 64.9 91.7 89.0 70.0 15.3 16.1 15.9 16.6 16.2 16.9 Combined positions US$m 119.1 112.2 101.0 112.5 111.7 102.4 Minimum Maximum US$m US$m Minimum Maximum US$m US$m Minimum Maximum US$m US$m Minimum Maximum US$m US$m Full year 2004 ...... First half of 2004 .. Full year 2003 ....... 20.1 24.1 1.2 55.6 55.6 184.4 59.0 59.0 43.1 134.4 130.4 124.7 10.9 12.4 10.9 28.1 23.7 23.1 82.3 82.3 48.7 152.4 151.7 234.1 (b) Interest rate sensitivity gap table In accordance with FRS 13 ‘Derivatives and other financial instruments: disclosure’, the table below discloses the mismatch of the dates on which interest receivable on assets and interest payable on liabilities are next reset 308 to market rate on a contractual basis or, if earlier, the dates on which the instruments mature. Actual reset dates may differ from contractual dates owing to prepayments and the exercise of options. In addition, contractual terms may not be representative of the behaviour of assets and liabilities. For these reasons, HSBC manages its interest rate risk on a different basis from that presented below, taking into account the behavioural characteristics of the relevant assets and liabilities. At 31 December 2004 More than three months but not more than six months US$m More than six months but not more than one year US$m More than one year but not more than five years US$m Not more than three months US$m More than five years US$m Non- interest bearing US$m Banking book total US$m Trading book total US$m Total US$m Assets Treasury bills and other eligible bills ........ Loans and advances to banks .............. Loans and advances to customers ....... Debt securities and equity shares ....... Other assets ........... 18,534 2,138 4,172 94,401 4,452 1,528 778 526 44 454 – 25,666 4,618 30,284 3,319 104,680 38,032 142,712 428,431 30,789 24,407 88,198 42,679 11,643 626,147 43,684 669,831 62,902 1,102 10,306 – 14,165 – 42,178 – 19,582 – 4,781 136,024 153,914 137,126 106,404 36,507 260,318 173,633 Total assets ............ 605,370 47,685 44,272 131,680 62,759 155,767 1,047,533 229,245 1,276,778 Liabilities Deposits by banks .. Customer accounts . Debt securities in issue ............... Other liabilities Loan capital and other subordinated liabilities ............ Minority interests and shareholders’ funds .................. Internal funding of (54,121) (526,220) (4,327) (14,589) (1,345) (12,228) (2,618) (12,224) (666) (1,963) (4,686) (72,715) (67,763) (639,939) (15,776) (53,812) (83,539) (693,751) (176,179) (334) (5,437) (2) (3,028) (6) (14,653) (309) (1,461) (44) (10) (81,548) (200,768) (82,243) (7,825) (82,349) (208,593) (164,592) (7,785) (612) (198) (3,894) (13,994) (3) (26,486) – (26,486) the trading book . 65,575 1,485 1,015 – – – – 463 – (97,942) (97,942) (1,875) (99,817) (92) (838) 67,608 (67,608) – Total liabilities ....... (699,064) (23,482) (15,790) (33,235) (18,220) (257,742) (1,047,533) (229,245) (1,276,778) Off-balance-sheet items ................... (52,320) (14,739) 7,898 58,337 824 – Interest rate sensitivity gap .... Cumulative interest rate sensitivity gap ..................... (146,014) 9,464 36,380 156,782 45,363 (101,975) (146,014) (136,550) (100,170) 56,612 101,975 – – – – – – – – – – A positive interest rate sensitivity gap exists where more assets than liabilities re-price during a given period. Although a positive gap position tends to benefit net interest income in a rising interest rate environment, the actual effect will depend on a number of factors, including the extent to which repayments are made earlier or later than the contracted date and variations in interest rates within re-pricing periods and among currencies. Similarly, a negative interest rate sensitivity gap exists where more liabilities than assets re-price during a given period. In this case, a negative gap position tends to benefit net interest income in a declining interest rate environment, but again the actual effect will depend on the same factors as for positive interest rate gaps, as described above. 309 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) At 31 December 2003 More than three months but not more than six months US$m More than six months but not more than one year US$m More than one year but not more than five years US$m Not more than three months US$m More than five years US$m Non- interest bearing US$m Banking book total US$m Trading book total US$m Total US$m Assets Treasury bills and other eligible bills . 11,447 2,275 1,383 Loans and advances to banks ................ 76,899 5,291 4,377 694 425 Loans and advances – – 15,799 4,592 20,391 427 2,954 90,373 26,800 117,173 to customers ......... 357,183 24,249 19,006 61,618 26,804 9,469 498,329 30,648 528,977 Debt securities and equity shares ......... Other assets .............. 53,442 962 8,489 – 12,751 – 40,477 – 15,722 – 5,425 117,092 136,306 118,054 82,295 31,020 218,601 149,074 Total assets .............. 499,933 40,304 37,517 103,214 42,953 134,940 858,861 175,355 1,034,216 Liabilities Deposits by banks .... Customer accounts ... Debt securities in issue ..................... Other liabilities ........ Loan capital and other subordinated liabilities ............... Minority interests and shareholders’ funds ..................... Internal funding of (40,448) (455,677) (3,159) (12,275) (1,190) (9,022) (3,510) (9,168) (1,126) (1,398) (5,474) (54,942) (54,907) (542,482) (15,519) (30,648) (70,426) (573,130) (124,552) (243) (5,406) (6) (3,683) (10) (14,379) (280) (1,653) (46) (8) (70,802) (149,681) (71,387) (3,881) (59,160) (153,562) (130,547) (4,916) (1,487) (678) (1,871) (12,245) – (21,197) – (21,197) – – – – – (83,531) (83,531) (1,823) (85,354) the trading book .... 59,643 1,387 2,392 1,346 (22) (422) 64,324 (64,324) – Total liabilities ......... (566,193) (20,946) (12,191) (27,862) (16,490) (215,179) (858,861) (175,355) (1,034,216) Off-balance-sheet items ..................... (41,162) (9,525) 15,536 27,430 7,721 – Interest rate sensitivity gap ....... (107,422) 9,833 40,862 102,782 34,184 (80,239) Cumulative interest rate sensitivity gap ........................ (107,422) (97,589) (56,727) 46,055 80,239 – (c) Assets and liabilities denominated in foreign currency Assets Denominated in US dollars ..................................................................................................... Denominated in currencies other than US dollars ................................................................... – – – 2004 US$m 480,072 796,706 – – – – – – 2003 US$m 390,911 643,305 Total assets ............................................................................................................................. 1,276,778 1,034,216 Liabilities Denominated in US dollars ..................................................................................................... Denominated in currencies other than US dollars ................................................................... 502,116 774,662 386,418 647,798 Total liabilities ........................................................................................................................ 1,276,778 1,034,216 (d) Structural currency exposures HSBC’s structural foreign currency exposure is represented by the net asset value of its foreign currency equity and subordinated debt investments in subsidiary undertakings, branches, joint ventures and associates. Gains or losses on structural foreign currency exposures are taken to reserves. 310 HSBC’s management of structural foreign currency exposures is discussed in the ‘Financial Review’ section on page 172. HSBC’s structural currency exposures as at the year-end were as follows: Net structural currency exposures Currency of structural exposure Euros ...................................................................................................................................... Sterling ................................................................................................................................... Hong Kong dollars .................................................................................................................. Chinese renminbi .................................................................................................................... Mexican pesos ........................................................................................................................ Canadian dollars ..................................................................................................................... Swiss francs1 ........................................................................................................................... Brazilian reais ......................................................................................................................... UAE dirham ........................................................................................................................... Indian rupees .......................................................................................................................... Turkish lira .............................................................................................................................. Australian dollars .................................................................................................................... Malaysian ringgit .................................................................................................................... Korean won ............................................................................................................................. Singapore dollars .................................................................................................................... Taiwanese dollars .................................................................................................................... Maltese lira .............................................................................................................................. Japanese Yen ........................................................................................................................... Thai baht ................................................................................................................................. Egyptian pounds ..................................................................................................................... Chilean pesos .......................................................................................................................... Indonesia rupiah ..................................................................................................................... Saudi riyals2 ............................................................................................................................ Argentine pesos3 ..................................................................................................................... Others, less than US$100 million ........................................................................................... Total ....................................................................................................................................... 2004 US$m 19,054 17,749 12,693 3,105 2,907 2,250 1,921 1,498 760 745 705 703 605 420 401 326 278 225 203 181 175 155 107 (76) 746 67,836 2003 US$m 17,785 15,249 11,881 813 1,536 1,743 1,548 1,106 520 498 547 407 521 307 440 272 254 129 173 143 153 180 516 (297) 579 57,003 1 After deducting Swiss Franc borrowings of US$810 million (2003: US$741 million) taken out in order to hedge the net investments. 2 After deducting sales of Saudi Riyals amounting to US$480 million (2003: US$ nil) in order to hedge the net investments. 3 The negative net investment in Argentine pesos reflects the deficiency in domestic net assets following the pesification of certain balances formerly denominated in US dollars. 311 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 40 Reconciliation of operating profit to net cash flow from operating activities Operating profit .............................................................................................. Change in prepayments and accrued income .................................................. Change in accruals and deferred income ........................................................ Interest on finance leases and similar hire purchase contracts ........................ Interest on subordinated loan capital .............................................................. Depreciation and amortisation......................................................................... Accretion of discounts and amortisation of premiums ................................... Provisions for bad and doubtful debts ............................................................ Loans written off net of recoveries ................................................................. Provisions for liabilities and charges .............................................................. Provisions utilised .......................................................................................... Amounts written off fixed asset investments .................................................. Net cash inflow from trading activities .......................................................... Change in items in the course of collection from other banks ........................ Change in treasury bills and other eligible bills .............................................. Change in loans and advances to banks .......................................................... Change in loans and advances to customers ................................................... Change in other securities .............................................................................. Change in other assets .................................................................................... Change in deposits by banks .......................................................................... Change in customer accounts ......................................................................... Change in items in the course of transmission to other banks ........................ Change in debt securities in issue ................................................................... Change in other liabilities .............................................................................. Elimination of exchange differences1 ............................................................. Net cash inflow from operating activities ....................................................... 2004 US$m 16,514 (4,969) 2,492 42 1,052 3,506 (218) 6,357 (7,984) 1,244 (1,123) (99) 16,814 299 (26) (9,957) (132,052) (24,107) (9,657) 11,684 105,454 909 54,172 26,783 (3,107) 37,209 2003 US$m 12,297 (6,825) 6,015 38 958 2,847 338 6,093 (6,846) 759 (781) 66 14,959 (135) 650 (14,537) (77,614) (10,518) (4,302) 14,628 76,085 (251) 13,976 14,443 (4,709) 22,675 2002 US$m 9,035 355 190 36 862 2,044 (8) 1,321 (1,931) 879 (1,331) 324 11,776 124 715 16,550 (35,332) 2,543 (7,055) (3,505) 31,161 716 2,935 (1,580) (2,622) 16,426 1 Adjustment to bring changes between opening and closing balance sheet amounts to average rates. This is not done on a line-by-line basis, as details cannot be determined without unreasonable expense 41 Changes in financing during the year Subordinated loan capital US$m Preference shares1 US$m Ordinary Shares US$m Share premium US$m Own shares held US$m Balance at 1 January 2004 ........... Shares issued in lieu of dividends Acquisition of subsidiaries .......... Issued during the year ................. Repaid during the year ................ Net purchases and sales of own shares during the year ............. Net cash inflow/(outflow) from financing ................................. Exchange and other movements .. Balance at 31 December 2004 ... 21,197 – 218 6,021 (1,740) – 4,281 790 26,486 8,719 – – 1,480 – – 1,480 519 10,718 5,481 80 – 26 – – 26 – 5,587 4,406 (80) – 555 – – 555 – 4,881 (923) – – – – (88) (88) (90) (1,101) 312 Subordinated loan capital US$m Preference shares1 US$m Ordinary shares US$m Share premium US$m Own shares held US$m Balance at 1 January 2003 ........... Shares issued in lieu of dividends Acquisition of subsidiaries........... Issued during the year ................. Repaid during the year ................ Net purchases and sales of own shares during the year ............. Net cash inflow/(outflow) from financing ................................. Exchange and other movements... 18,371 – 1,192 2,358 (1,464) – 894 740 Balance at 31 December 2003 ..... 21,197 Balance at 1 January 2002 .......... Shares issued in lieu of dividends Acquisition of subsidiaries .......... Issued during the year ................. Repaid during the year ................ Net purchases and sales of own shares during the year ............. Net cash inflow/(outflow) from financing ................................. Exchange and other movements .. Balance at 31 December 2002 ..... 15,480 – 214 4,105 (1,923) – 2,182 495 18,371 4,431 – – 4,104 (206) – 3,898 390 8,719 4,291 – – – (50) – (50) 190 4,431 4,741 59 637 44 – – 44 – 5,481 4,678 45 – 18 – – 18 – 4,741 1 Preference shares in issue are in subsidiary undertakings (Note 33). 42 Analysis of cash 3,647 (59) – 801 – – 801 17 4,406 3,373 (45) – 319 – – 319 – 3,647 (646) – – – – (258) (258) (19) (923) (686) – – – – 59 59 (19) (646) HSBC is required to maintain deposits with central banks as a result of government regulations in the territories in which it operates. At 31 December 2004, these amounted to US$6,338 million (2003: US$2,765 million; 2002: US$2,154 million). (a) Changes in cash during the year Balance at 1 January .............................................................................. Net cash inflow before the effect of foreign exchange movements ........ Effect of foreign exchange movements .................................................. Balance at 31 December ........................................................................ 2004 US$m 32,950 10,648 1,116 44,714 (b) Analysis of the balances of cash as classified in the consolidated balance sheet Cash and balances at central banks ........................................................ Loans and advances to banks ................................................................. 2004 US$m 9,872 34,842 44,714 2003 US$m 26,870 4,020 2,060 32,950 2003 US$m 7,661 25,289 32,950 43 Litigation HSBC, through a number of its subsidiary undertakings, is named in and is defending legal actions in various jurisdictions arising from its normal business. None of these proceedings is regarded as material litigation. 2002 US$m 22,224 3,242 1,404 26,870 2002 US$m 7,659 19,211 26,870 313 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 44 Capital commitments Expenditure contracted for ........................................................................................................... Expenditure authorised by Directors but not contracted for ......................................................... 45 Lease commitments At the year-end, annual commitments under non-cancellable operating leases were: Leasehold land and buildings: Operating leases which expire – within 1 year ............................................................................................................................ – between 1 and 5 years .............................................................................................................. – over 5 years.............................................................................................................................. Equipment: Operating leases which expire – within 1 year ............................................................................................................................ – between 1 and 5 years .............................................................................................................. 2004 US$m 1,212 311 1,523 2003 US$m 1,551 680 2,231 2004 US$m 2003 US$m 79 305 225 609 4 25 29 109 360 223 692 21 14 35 46 Segmental analysis As HSBC is not required to disclose turnover, no segmental analysis of turnover is included. Turnover of non- banking businesses is included in other operating income. The allocation of earnings reflects the benefit of shareholders’ funds to the extent that these are actually allocated to businesses in the segment by way of intra-HSBC capital and funding structures. Common costs are included in segments on the basis of the actual recharges made. (a) By geographical region Geographical information has been classified by the location of the principal operations of the subsidiary undertaking, or in the case of The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, HSBC Bank Middle East Limited, HSBC Finance Corporation and HSBC Bank USA, N.A. operations, by the location of the branch responsible for reporting the results or for advancing the funds. Due to the nature of HSBC’s structure, the analysis of profits and net assets shown below includes intra-HSBC items between geographical regions. The ‘Rest of Asia-Pacific’ geographical segment includes the Middle East, India and Australasia. Total assets: Europe ........................................ Hong Kong ................................. Rest of Asia-Pacific .................... North America ............................ South America ............................ At 31 December 2004 At 31 December 2003 At 31 December 2002 US$m 539,116 217,406 120,504 370,477 17,397 % 42.6 17.2 9.5 29.3 1.4 US$m 425,312 197,487 98,081 289,800 12,549 % 41.6 19.3 9.6 28.3 1.2 1,264,900 100.0 1,023,229 100.0 % 45.6 24.1 10.2 19.0 1.1 100.0 US$m 341,569 180,433 76,635 142,032 8,491 749,160 9,445 758,605 Add: Hong Kong Government certificates of indebtedness ..... 11,878 Total assets ................................. 1,276,778 10,987 1,034,216 314 Net assets: At 31 December 2004 At 31 December 2003 At 31 December 2002 Europe ......................................... Hong Kong .................................. Rest of Asia-Pacific ..................... North America ............................. South America ............................. Total net assets ............................ US$m 36,136 15,706 6,375 26,883 1,523 86,623 Profit on ordinary activities before tax: Year ended 31 December 2004 Interest receivable ................................... Interest payable ....................................... Net interest income ................................. Dividend income .................................... Fees and commissions receivable ........... Fees and commissions payable ............... Dealing profits ........................................ Other operating income .......................... Operating income ................................... Operating expenses (excluding goodwill amortisation) ........................ Goodwill amortisation ............................ Operating expenses ................................. Operating profit before provisions .......... Provisions for bad and doubtful debts ..... Provisions for contingent liabilities and commitments ............................... Amounts (written off)/written back on fixed asset investments ....................... Operating profit ...................................... Share of operating profit in joint ventures ...................................... Share of operating profit/(loss) in associates ........................................ Gains on disposal of investments and tangible fixed assets ............................ Profit on ordinary activities before tax .... % 41.7 18.1 7.4 31.0 1.8 100.0 Hong Kong US$m 5,167 (1,528) 3,639 19 1,986 (260) 630 781 6,795 (2,524) (9) (2,533) 4,262 223 (3) 26 Europe US$m 18,096 (9,034) 9,062 545 7,724 (1,429) 953 1,592 18,447 (11,570) (947) (12,517) 5,930 (1,025) (12) (20) US$m 35,102 11,302 5,145 22,044 880 74,473 % 47.1 15.2 6.9 29.6 1.2 100.0 US$m 30,681 9,682 3,811 7,613 (22) 51,765 Rest of Asia- Pacific US$m North America US$m South America US$m Intra- HSBC items US$m 4,146 (2,091) 2,055 3 1,303 (246) 494 195 3,804 (2,080) (68) (2,148) 1,656 (100) – – 21,201 (6,288) 14,913 32 4,520 (985) 439 1,158 20,077 (8,887) (761) (9,648) 10,429 (5,186) (42) – 2,421 (1,066) 1,355 2 580 (100) 50 207 2,094 (1,444) (29) (1,473) 621 (269) 30 (6) 376 – 1 38 415 (828) 828 – – (236) 236 – (630) (630) 630 – 630 – – – – – – – – – 4,873 4,508 1,556 5,201 5 54 293 5,225 – 8 228 4,744 – 232 17 1,805 – (8) 226 5,419 % 59.3 18.7 7.3 14.7 – 100.0 Total US$m 50,203 (19,179) 31,024 601 15,877 (2,784) 2,566 3,303 50,587 (25,875) (1,814) (27,689) 22,898 (6,357) (27) – 16,514 5 287 802 17,608 315 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) North America US$m South America US$m Intra- HSBC items US$m Total US$m 39,968 (14,370) 25,598 222 12,560 (2,166) 2,178 2,680 41,072 (21,082) (1,450) (22,532) 18,540 (6,093) (44) (106) 12,297 (116) 221 414 12,816 28,595 (13,135) 15,460 278 9,245 (1,421) 1,313 1,720 26,595 (14,954) (854) (15,808) 10,787 (1,321) (107) (324) 9,035 (28) 135 508 9,650 1,716 (1,076) 640 3 435 (97) 136 201 1,318 (1,075) (11) (1,086) 232 (58) (7) (62) 105 – 1 9 115 1,751 (1,106) 645 15 417 (93) 147 110 1,241 (1,060) (24) (1,084) 157 (117) (99) (36) (95) – – 37 (58) (712) 712 – – (141) 141 – (422) (422) 422 – 422 – – – – – – – – – (740) 740 – – (120) 120 – (326) (326) 326 – 326 – – – – – – – – – 3,837 3,642 1,226 3,487 Hong Kong US$m 5,293 (1,392) 3,901 31 1,584 (201) 321 596 6,232 (2,212) (3) (2,215) 4,017 (400) (6) 31 Rest of Asia- Pacific US$m 3,363 (1,623) 1,740 4 1,006 (201) 421 120 3,090 (1,741) (35) (1,776) 1,314 (85) (1) (2) Europe US$m 14,023 (6,483) 7,540 150 6,242 (1,050) 960 1,253 15,095 (9,529) (758) (10,287) 4,808 (874) (33) (64) (127) 47 212 3,969 12,646 (6,303) 6,343 211 5,397 (869) 508 1,025 12,615 (7,878) (651) (8,529) 4,086 (569) (15) (267) 3,235 (26) 3 288 – 18 68 – 149 16 3,728 1,391 3,174 (1,567) 1,607 3 897 (173) 364 83 2,781 (1,528) (33) (1,561) 1,220 (89) 18 (2) 1,147 – 113 5,968 (1,835) 4,133 25 1,449 (185) 133 495 6,050 (2,139) – (2,139) 3,911 (246) (14) (10) 3,641 – 11 58 16,285 (4,508) 11,777 34 3,434 (758) 340 932 15,759 (6,947) (643) (7,590) 8,169 (4,676) 3 (9) 11 6 109 3,613 5,796 (3,064) 2,732 24 1,205 (221) 161 333 4,234 (2,675) (146) (2,821) 1,413 (300) 3 (9) 1,107 (2) 8 Year ended 31 December 2003 Interest receivable ................................... Interest payable ....................................... Net interest income ................................. Dividend income ..................................... Fees and commissions receivable ........... Fees and commissions payable ............... Dealing profits ........................................ Other operating income ........................... Operating income .................................... Operating expenses (excluding goodwill amortisation) ........................ Goodwill amortisation ............................ Operating expenses ................................. Operating profit before provisions .......... Provisions for bad and doubtful debts ..... Provisions for contingent liabilities and commitments ................................ Amounts (written off)/written back on fixed asset investments ....................... Operating profit ...................................... Share of operating (loss)/profit in joint ventures .............................................. Share of operating profit in associates .... Gains on disposal of investments and tangible fixed assets ............................ Profit on ordinary activities before tax .... Year ended 31 December 2002 Interest receivable .................................... Interest payable........................................ Net interest income .................................. Dividend income...................................... Fees and commissions receivable ............ Fees and commissions payable ................ Dealing profits ......................................... Other operating income............................ Operating income..................................... Operating expenses (excluding goodwill amortisation)......................... Goodwill amortisation ............................ Operating expenses ................................. Operating profit before provisions ........... Provisions for bad and doubtful debts...... Provisions for contingent liabilities and commitments................................. Amounts written off fixed asset investments.......................................... Operating profit/(loss).............................. Share of operating loss in joint ventures . Share of operating profit in associates ..... Gains on disposal of investments and tangible fixed assets............................. Profit/(loss) on ordinary activities – 125 before tax............................................. 3,500 3,710 1,260 1,238 316 (b) By Customer Groups HSBC’s operations include a number of support services and head office functions. The costs of these functions are allocated to business lines, where it is appropriate, on a systematic and consistent basis. In addition, there are a number of income and expense items between customer group and the following profits analysis includes amounts within each customer group and then eliminates any duplication in a separate column. As a result of growth in use of Group Service Centres and Shared Service Organisations, the activities of these centres have been included in the ‘Other’ customer group. Comparatives for the years ended 31 December 2003 and 31 December 2002 are not reported under ‘Other’ where these activities were formerly reported across customer groups. Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m 21,466 17 6,461 192 2,015 30,151 4,884 6 2,742 142 656 8,430 3,821 565 2,802 1,929 873 9,990 718 5 962 257 17 1,959 Intra- HSBC items US$m – – – – (2,378) (2,378) Total US$m 31,024 601 13,093 2,566 3,303 50,587 Other US$m 135 8 126 46 2,120 2,435 Year ended 31 December 2004 Net interest income ............. Dividend income ................ Net fees and commissions .. Dealing profits .................... Other operating income ..... Operating income ............... Operating expenses ............. (15,473) (4,378) (6,008) (1,634) (2,574) 2,378 (27,689) Operating profit/(loss) before provisions ............. 14,678 4,052 3,982 325 (139) Provisions for bad and doubtful debts .................. (6,612) (227) 473 (80) (2) 10 (1) 7,984 3,834 – 74 110 – 54 7 (38) (11) 4,406 5 96 330 8,168 3,895 4,837 9 4 (2) 336 – – 48 384 – 77 16 (46) – 63 307 324 438,415 160,299 582,975 56,466 26,745 Provisions for contingent liabilities and commitments ................... Amounts (written off)/written back on fixed asset investments ..................... Operating profit/(loss) ........ Share of operating profit in joint ventures ............... Share of operating profit in associates ........................ Gains on disposal of investments and tangible fixed assets....................... Profit on ordinary activities before tax ........................ Segment total assets ............ Hong Kong Government certificates of indebtedness .................... Total assets ......................... Net assets ............................ 34,659 13,924 24,362 9,726 3,952 – – – – – – – – – 22,898 (6,357) (27) – 16,514 5 287 802 17,608 1,264,900 11,878 1,276,778 86,623 317 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Total Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Other US$m Year ended 31 December 2003 Net interest income ............. Dividend income ................. Net fees and commissions ... Dealing profits .................... Other operating income ....... Operating income ................ 16,943 18 4,842 133 1,508 23,444 4,196 3 2,256 118 587 7,160 3,899 161 2,315 1,764 805 8,944 574 3 822 209 50 (14) 37 159 (46) 938 1,658 1,074 Intra- HSBC items US$m – – – – (1,208) (1,208) Total US$m 25,598 222 10,394 2,178 2,680 41,072 Operating expenses ............. (12,257) (4,031) (4,645) (1,431) (1,376) 1,208 (22,532) Operating profit/(loss) before provisions ............ 11,187 3,129 4,299 227 Provisions for bad and doubtful debts ................. (5,633) (274) (297) Provisions for contingent liabilities and commitments .................. Amounts (written off)/ written back on fixed asset investments ............ Operating profit/(loss) ......... Share of operating profit/ (loss) in joint ventures .... Share of operating profit in associates .................... Gains on disposal of investments and tangible fixed assets ..................... Profit on ordinary activities (19) (18) 5,517 11 46 30 14 – 2,869 – 20 6 (53) (91) 3,858 (127) 80 225 before tax ........................ 5,604 2,895 4,036 (2) (2) (3) 220 – – 61 281 (302) 113 16 6 (167) – 75 92 – – – – – – – – – – 18,540 (6,093) (44) (106) 12,297 (116) 221 414 12,816 352,077 128,086 462,995 54,510 25,561 1,023,229 10,987 1,034,216 74,473 Segment total assets ............ Hong Kong Government certificates of indebtedness ................... Total assets ......................... Net assets ............................ 30,092 11,268 19,529 8,098 5,486 318 Personal Financial Services US$m Commercial Banking US$m Corporate, Investment Banking & Markets US$m Private Banking US$m Other US$m Year ended 31 December 2002 Net interest income ............. Dividend income ................ Net fees and commissions .. Dealing profits .................... Other operating income ...... 7,429 6 2,979 50 773 Operating income ............... 11,237 3,835 6 1,934 107 459 6,341 3,700 230 2,164 1,008 609 7,711 549 2 623 137 102 (53) 34 124 11 925 1,413 1,041 Intra- HSBC items US$m – – – – (1,148) (1,148) Total US$m 15,460 278 7,824 1,313 1,720 26,595 Operating expenses ............. (7,144) (3,317) (4,134) (1,251) (1,110) 1,148 (15,808) Operating profit/(loss) before provisions ............ 4,093 3,024 3,577 Provisions for bad and doubtful debts ................. (857) (269) (184) 162 (5) (69) (6) Provisions for contingent liabilities and commitments .................. Amounts (written off)/ written back on fixed asset investments ............ Operating profit/(loss) ........ Share of operating profit/ (loss) in joint ventures .... Share of operating profit/ (loss) in associates .......... Gains on disposal of investments and tangible fixed assets ..................... Profit/(loss) on ordinary (42) (2) 19 3 3,192 2,777 (23) 17 19 3 15 51 activities before tax ........ 3,205 2,846 3,652 12 (21) (75) (109) 3,296 (7) 46 317 (22) 114 (1) (10) 46 149 (194) (344) – 67 75 (202) 171,478 113,520 394,540 48,346 21,276 749,160 Segment total assets ............ Hong Kong Government certificates of indebtedness ................... Total assets ......................... Net assets ............................ 12,101 10,290 16,852 7,366 5,156 (c) By country of domicile HSBC Holdings is registered and domiciled in the United Kingdom. (i) Profit on ordinary activities before tax in the United Kingdom Operating income ........................................................................... Profit on ordinary activities before tax ........................................... 2004 US$m 13,665 4,506 2003 US$m 10,969 3,474 Operating income includes intra-HSBC income of US$328 million (2003: US$359 million; 2002: US$418 million). Profit on ordinary activities before tax includes profit arising on intra-HSBC transactions of US$303 million (2003: US$376 million; 2002: US$406 million). 319 – – – – – – – – – 10,787 (1,321) (107) (324) 9,035 (28) 135 508 9,650 9,445 758,605 51,765 2002 US$m 9,504 3,239 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (ii) Geographical analysis of tangible fixed assets United Kingdom ............................................................................. Other............................................................................................... Total ............................................................................................... 2004 US$m 8,436 10,393 18,829 2003 US$m 7,213 8,535 15,748 2002 US$m 6,240 7,941 14,181 Other includes assets held in Hong Kong amounting to US$4,817 million (2003: US$3,877 million; 2002: US$4,180 million). 47 Related party transactions (a) Transactions, arrangements and agreements involving Directors and others Particulars of transactions, arrangements and agreements entered into by subsidiary undertakings of HSBC Holdings with Directors and connected persons and companies controlled by them and with officers of HSBC Holdings disclosed pursuant to section 232 of the Companies Act 1985 are as follows: 2004 2003 Number US$m Number US$m Directors and connected persons and companies controlled by them Loans and credit card transactions (including US$324,171 in credit card transactions (2003: US$274,198) and US$21,627,562 in guarantees (2003: US$25,776,133)) ................................. Officers Loans and credit card transactions (including US$394,532 in credit card transactions (2003: US$377,611) and US$167,993 in guarantees (2003: US$224,769)) .......................................... 82 34 332 48 82 32 353 38 Particulars of Directors’ transactions are recorded in a register held at the Registered Office of HSBC Holdings which is available for inspection by members for 15 days prior to the HSBC Holdings Annual General Meeting and at the Annual General Meeting itself. The transactions were made in the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with persons of a similar standing or, where applicable, with other employees. The transactions did not involve more than the normal risk of repayment or present other unfavourable features. (b) Transactions with other related parties of HSBC Joint ventures Information relating to joint ventures can be found in the ‘Notes on the Financial Statements’ where the following are disclosed: − Note 15: amounts due from joint ventures; − Note 20: interests in joint ventures and principal joint ventures; and − Note 28: amounts due to joint ventures. Associates Information relating to associates can be found in the ‘Notes on the Financial Statements’ where the following are disclosed: − Notes 14 and 15: amounts due from associates; − Note 21: interests in associates; principal associates and interests in loan capital; and − Notes 27 and 28: amounts due to associates. Pension funds At 31 December 2004, US$19.3 billion (2003: US$14.7 billion) of HSBC pension fund assets were under management by HSBC companies of which US$1,432 million (2003: US$1,315 million) of ‘Long-term assurance assets attributable to policyholders’ were included in HSBC’s balance sheet under ‘Other assets’. Fees 320 of US$35 million (2003: US$23 million) were earned by HSBC companies for these management services. HSBC’s pension funds had placed deposits of US$268 million (2003: US$211 million) with its banking subsidiaries. 48 UK and Hong Kong accounting requirements The financial statements have been prepared in accordance with UK accounting requirements. There would be no material differences had they been prepared in accordance with Hong Kong Accounting Standards, except as set out below. The presentation of the cash flow statement is in accordance with Financial Reporting Standard 1 (revised 1996) ‘Cash Flow Statements’ rather than Hong Kong Statement of Standard Accounting Practice 15 ‘Cash Flow Statements’. In accordance with Financial Reporting Standard 11 ‘Impairment of Fixed Assets and Goodwill’, no charge has been made in the profit and loss account in respect of those decreases in the valuation of HSBC properties that do not represent impairments. If HSBC had prepared its financial statements under Hong Kong Statement of Standard Accounting Practice 17 ‘Property, plant and equipment’, there would have been a net charge to the profit and loss account of US$13 million (2003: US$154 million) in respect of valuations below depreciated historical cost (of which a credit of US$1 million (2003: US$4 million) relates to minority interests). In accordance with Financial Reporting Standard 19 ‘Deferred Tax’, HSBC has recognised deferred tax in full on timing differences between the accounting and taxation treatment of income and expenditure, subject to recoverability of deferred tax assets. If HSBC had prepared its financial statements in accordance with Hong Kong Statement of Standard Accounting Practice 12 ‘Income Taxes’ (revised August 2002) it would have recognised additional deferred tax assets and liabilities, resulting in an increase in reserves at 31 December 2004 of US$622 million (2003: US$174 million). The increase in the charge to the profit and loss account in respect of tax on profit on ordinary activities would have been US$216 million (2003: US$nil). If HSBC had prepared its financial statements under Hong Kong Statement of Standard Accounting Practice 24 ‘Accounting for Investments in Securities’, US$1,567 million (2003: US$1,746 million) would have been credited to reserves in respect of changes in the fair value of its investment securities. In accordance with UK Statement of Standard Accounting Practice 17 ‘Post balance sheet events’, HSBC has recorded dividends declared after the period end in the period to which they relate. If HSBC had prepared its financial statements in accordance with Hong Kong Statement of Standard Accounting Practice 9 ‘Events after the balance sheet date’, dividends would be recorded in the period in which they are declared and there would have been an increase in reserves at 31 December 2004 of US$2,996 million (2003: US$2,627 million). HSBC Holdings has recorded its investment in HSBC undertakings at net asset value, including attributable goodwill, adjusted for shares held by subsidiaries in HSBC Holdings plc. If HSBC Holdings had prepared its individual financial statements in accordance with Hong Kong Statement of Standard Accounting Practice 32 ‘Consolidated Financial Statements and Accounting for Investments in Subsidiaries’ and elected to record its investment in HSBC undertakings at cost, less provisions for any impairment, there would have been a reduction in the reserves of HSBC Holdings at 31 December 2004 of US$65,043 million (2003: US$53,102 million). There would have been no impact on the consolidated financial statements of HSBC. HSBC applies UK Statement of Standard Accounting Practice 24 ‘Accounting for pension costs’ to defined benefit schemes, which requires that the cost of providing pensions be recognised on a systematic and rational basis over the period during which benefit is gained from the employees’ services. If HSBC had prepared its financial statements under Hong Kong Statement of Standard Accounting Practice 34 ‘Employee benefits’ a defined benefit pension liability of US$5,873 million would have been recognised in the balance sheet at 31 December 2004 (2003: US$4,406 million). There would have been an additional credit to the profit and loss account in 2004 of US$99 million (2003: US$206 million). 321 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 49 Differences between UK GAAP and US GAAP The consolidated financial statements of HSBC are prepared in accordance with UK GAAP which differs in certain significant respects from US GAAP. The following is a summary of the significant differences applicable to HSBC: Leasing UK GAAP • Finance lease income is recognised so as to give a constant rate of return on the net cash investment in the lease, taking into account tax payments and receipts associated with the lease. • Leases are categorised as finance leases when the substance of the agreement is that of a financing transaction and the lessee assumes substantially all of the risks and benefits relating to the asset. All other leases are categorised as operating leases. • Operating leased assets are depreciated over their useful lives so that, for each asset, rentals less depreciation are recognised at a constant periodic rate of return on the net cash invested in that asset. Rentals receivable under operating leases are accounted for on a straight-line basis over the lease term. US GAAP • Unearned income on finance leases is taken to income at a rate calculated to give a constant rate of return on the investment in the lease, but generally no account is taken of the tax flows generated by the lease. • Leases are classified as capital leases when any of the criteria outlined under Statement of Financial Accounting Standards (‘SFAS’) 13 ‘Accounting for leases’ are met. • Operating leased assets are depreciated so that in each period the depreciation charge is at least equal to that which would have arisen on a straight-line basis. Shareholders’ interest in the long-term assurance fund UK GAAP • The value placed on HSBC’s interest in long-term assurance business includes a valuation of the discounted future earnings expected to emerge from business currently in force, taking into account factors such as recent experience and general economic conditions, together with the surplus retained in the long-term assurance funds. These are determined annually in consultation with external actuaries and are included in ‘Other assets’. • Changes in the value of HSBC’s interest in long-term assurance business are calculated on a post-tax basis and are reported in the profit and loss account as part of ‘Other operating income’ after adjusting for taxation. US GAAP • The net present value of these profits is not recognised. Acquisition costs and fees are deferred and amortised in accordance with SFAS 97 ‘Accounting and reporting by insurance enterprises for certain long-duration contracts and for realised gains and losses from the sale of investments’. Long-term assurance assets and liabilities UK GAAP • Long-term assurance fund assets, excluding own shares held, and liabilities attributable to policyholders are recognised at fair value in ‘Other assets’ and ‘Other liabilities’ as summary amounts ‘Long-term assurance assets/liabilities attributable to policyholders’. US GAAP • Under the Statement of Position issued by the American Institute of Certified Public Accountants (‘AICPA SOP’) 03-1, ‘Accounting and reporting by Insurance Enterprises for certain Non-traditional and Long-duration Contracts and for Separate Accounts’, which became fully effective in 2004, where assets qualify for separate accounting they should be measured at fair value and be reported in the financial statements as a summary total, with an equivalent summary total for related liabilities, consistent with the UK GAAP presentations. Otherwise, assets representing policyholders funds under the arrangements should be accounted for and recognised as 322 general account assets, i.e. consistent with other HSBC holdings of similar assets. Any related liability should be accounted for as a general account liability. Share compensation schemes UK GAAP • Options granted under executive share option schemes are granted at market price and no compensation costs are recognised under the ‘intrinsic value method’. • Employees in save-as-you-earn schemes are granted shares at a 20 per cent discount to market price at the date of grant. No compensation cost is recognised for such awards. • The fair value of shares awarded under longer term and other restricted share award schemes is charged to compensation cost over the period in respect of which performance conditions apply. To the extent the award is adjusted by virtue of performance conditions being met or not, the compensation cost is adjusted in line. US GAAP • SFAS 123 ‘Accounting for Stock Based Compensation’ encourages a fair value method of accounting for stock- based compensation plans. HSBC follows this fair value method. Under the fair value method, compensation cost is measured at the date of grant based on the value of the award and is recognised over the service period, which is usually the vesting period. • Where options lapse, because an employee ceases to be employed by HSBC before their entitlement to the options vest, any costs previously recognised relating to lapsed options are written back. From 2004, estimates of such future employee departures are taken into account when accruing the cost during the service period and revised and trued-up over this period. • Where the number of option awards that vest is contingent on HSBC meeting certain performance targets of Total Shareholder Return, this uncertainty is factored into the calculation of the fair value of the award at grant date. Costs of software for internal use UK GAAP • HSBC generally expenses costs of software developed for internal use. If it can be shown that conditions for capitalisation are met under FRS 10 ‘Goodwill and intangible assets’ or FRS 15 ‘Tangible fixed assets’, the software is capitalised and amortised over its useful life. • Website design and content development costs are capitalised only to the extent that they lead to the creation of an enduring asset delivering benefits at least as great as the amount capitalised. US GAAP • AICPA SOP 98-1 ‘Accounting for the costs of computer software developed or obtained for internal use’ requires that all costs incurred in the preliminary project and post implementation stages of internal software development be expensed. Costs incurred in the application development stage must be capitalised and amortised over their estimated useful life. Website design costs are capitalised and website content development costs are expensed as they are incurred. Goodwill UK GAAP • Goodwill arising on acquisitions of subsidiary undertakings, associates or joint ventures prior to 1998 was charged against reserves in the year of acquisition. • For acquisitions made on or after 1 January 1998, goodwill is included in the balance sheet and amortised over its estimated useful life on a straight-line basis. UK GAAP allows goodwill previously eliminated against reserves to be reinstated, but does not require it. In common with many other UK companies, HSBC elected not to reinstate such goodwill on the grounds that it would not materially assist the understanding of readers of its accounts who were already familiar with UK GAAP. 323 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) • Goodwill included in the balance sheet is tested for impairment when necessary by comparing the recoverable amount of an entity with the carrying value of its net assets, including attributable goodwill. The recoverable amount of an entity is the higher of its value in use, generally the present value of the expected future cash flows from the entity, and its net realisable value. • At the date of disposal of subsidiaries, associates or joint ventures, any unamortised goodwill or goodwill charged directly against reserves is included in HSBC’s share of the undertakings’ total net assets in the calculation of the gain or loss on disposal. • Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair value of those securities for the purpose of determining the cost of acquisition is the market price at the date of completion. US GAAP • Goodwill acquired up to 30 June 2001 was capitalised and amortised over its useful life but not more than 25 years. The amortisation of previously acquired goodwill ceased from 31 December 2001. • SFAS 142 ‘Goodwill and Other Intangible Assets’ requires that goodwill should not be amortised but should be tested for impairment annually at the reporting unit level by applying a fair-value-based test. • The goodwill of a reporting unit should be tested for impairment between annual tests in response to events or changes in circumstance which could result in an impairment. • Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair value of those securities for the purpose of determining the cost of acquisition is the average market price of the securities for a reasonable period before and after the date that the terms of the acquisition are agreed and announced. Intangible assets UK GAAP • An intangible asset is recognised separately from goodwill where it is identifiable and controlled. It is identifiable only if it can be disposed of or settled separately without disposing of the whole business. Control requires legal rights or custody over the item. • An intangible asset purchased as part of a business combination is capitalised at fair value based on its replacement cost, which is normally its estimated market value. US GAAP • An intangible asset is recognised separately from goodwill when it arises from contractual or other legal rights or if it is separable, i.e. it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged in combination with a related contract, asset or liability. The effect of this is that certain intangible assets such as trademarks and customer relationships are recognised under US GAAP, although such assets will not be recognised under UK GAAP. • Intangible assets are initially recognised at fair value. An intangible asset with a finite useful life is amortised on a straight-line basis over the period for which it contributes to the future cash flows of the entity. An intangible asset with an indefinite useful life is not amortised but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Property UK GAAP • HSBC values its properties on an annual basis and adjustments arising from such revaluations are taken to reserves. HSBC depreciates non-investment properties based on their cost or revalued amounts. No depreciation is charged on investment properties other than leaseholds with 20 years or less to expiry. US GAAP • US GAAP does not permit revaluations of property, although it requires recognition of asset impairment. Any realised surplus or deficit is, therefore, reflected in income on disposal of the property. Depreciation is charged on all properties based on cost. 324 Derivatives UK GAAP • Non-trading derivatives are those which are held for hedging purposes as part of HSBC’s risk management strategy against cash flows, assets, liabilities, or positions measured on an accruals basis. Non-trading transactions include qualifying hedges and positions that synthetically alter the characteristics of specified financial instruments. • Non-trading derivatives are accounted for on an equivalent basis to the underlying assets, liabilities or net positions. Any profit or loss arising is recognised on the same basis as that arising from the related assets, liabilities or positions. • To qualify as a hedge, a derivative must effectively reduce the price, foreign exchange or interest rate risk of the asset, liability or anticipated transaction to which it is linked and be designated as a hedge at inception of the derivative contract. Accordingly, changes in the market value of the derivative must be highly correlated with changes in the market value of the underlying hedged item at inception of the hedge and over the life of the hedge contract. If these criteria are met, the derivative is accounted for on the same basis as the underlying hedged item. Derivatives used for hedging purposes include swaps, forwards and futures. • Interest rate swaps are also used to alter synthetically the interest rate characteristics of financial instruments. In order to qualify for synthetic alteration, a derivative instrument must be linked to specific individual, or pools of similar, assets or liabilities by the notional principal and interest rate risk of the associated instruments, and must achieve a result that is consistent with defined risk management objectives. If these criteria are met, accrual based accounting is applied, i.e. income or expense is recognised and accrued to the next settlement date in accordance with the contractual terms of the agreement. • Any gain or loss arising on the termination of a qualifying derivative is deferred and amortised to earnings over the original life of the terminated contract. Where the underlying asset, liability or position is sold or terminated, the qualifying derivative is immediately marked-to-market through the profit and loss account. • Derivatives that do not qualify as hedges or synthetic alterations at inception are marked-to-market through the profit and loss account, with gains and losses included within ‘Dealing profits’. US GAAP • All derivatives must be recognised as either assets or liabilities in the balance sheet and be measured at fair value (SFAS 133 ‘Accounting for Derivative Instruments and Hedging Activities’). • The accounting for changes in the fair value of a derivative (i.e. gains and losses) depends on the intended use of the derivative and the resulting designation as described below: – For a derivative designated as hedging exposure to changes in the fair value of a recognised asset or liability or a firm commitment, the gain or loss is recognised in earnings in the period of change together with the associated loss or gain on the hedged item attributable to the risk being hedged. Any resulting net gain or loss represents the ineffective portion of the hedge. – For a derivative designated as hedging exposure to variable cash flows of a recognised asset or liability, or of a forecast transaction, the derivative’s gain or loss associated with the effective portion of the hedge is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecast transaction affects earnings. The ineffective portion is reported in earnings immediately. – For net investment hedges in which derivatives hedge the foreign currency exposure of a net investment in a foreign operation, the change in fair value of the derivative associated with the effective portion of the hedge is included as a component of other comprehensive income (‘OCI’), together with the associated loss or gain on the hedged item. The ineffective portion is reported in earnings immediately. – In order to apply hedge accounting it is necessary to comply with documentation requirements and to demonstrate the effectiveness of the hedge on a retrospective and prospective basis. – For a derivative not designated as a hedging instrument, the gain or loss is recognised in earnings in the period of change in fair value. 325 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Investment securities UK GAAP • Debt securities and equity shares intended to be held on a continuing basis are disclosed as investment securities and are included in the balance sheet at cost less provision for any permanent diminution in value. Other participating interests are accounted for on the same basis. Premiums or discounts on dated investment securities purchased at other than face value are amortised through the profit and loss account over the period from date of purchase to date of maturity and are included in ‘interest income’. Any gain or loss on realisation of these securities is recognised in the profit and loss account as it arises and included in ‘Gains on disposal of investment securities’. • SSAP 20 ‘Foreign currency translation’ requires foreign currency exchange differences on foreign currency- denominated monetary items, including securities, to be recognised in the profit and loss account. • Other debt securities and equity shares held for trading purposes are included in the balance sheet at market value. Changes in the market value of such assets are recognised in the profit and loss account as ‘Dealing profits’. US GAAP • All debt securities and equity shares are classified and disclosed within one of the following three categories: held-to-maturity; available-for-sale; or trading (SFAS 115 ‘Accounting for Certain Investments in Debt and Equity Securities’). • Held-to-maturity debt securities are measured at amortised cost. • Available-for-sale securities are measured at fair value with unrealised holding gains and losses excluded from earnings and reported net of applicable taxes and minority interests in a separate component of shareholders’ funds. Foreign exchange gains or losses on foreign currency denominated available-for-sale securities are also excluded from earnings and recorded as part of the same separate component of shareholders’ funds. • A decline considered other than temporary in fair value below cost of an available-for-sale or held-to-maturity security is treated as a realised loss and included in earnings. This lower fair value is then treated as the cost basis for the security. A decline in fair value is generally considered other than temporary where management does not have the ability and intent to hold the investment for a reasonable period of time sufficient for the fair value to recover back up to the cost of the investment. • Trading securities are measured at fair value with unrealised holding gains and losses included in earnings. Foreign currency UK GAAP • A company’s local currency is the currency of the primary economic environment in which it operates and generates net cash flows. Foreign exchange differences arising when translating non-local currency assets and liabilities into the local currency are reported in the profit and loss account (SSAP 20 ‘Foreign currency translation’). US GAAP • An entity’s functional currency is the currency of the primary economic environment in which it operates. An entity operating in a single economic environment may have only one functional currency. Foreign exchange differences arising when translating non-functional currency assets and liabilities into the functional currency are reported in the profit and loss account (SFAS 52 ‘Foreign Currency Translation’). Own shares held UK GAAP • HSBC Holdings’ shares are deducted from shareholders’ funds (including those HSBC Holdings shares held within ‘Long-term assurance assets attributable to policyholders’). No profits or losses are recognised on own shares held. 326 US GAAP • AICPA Accounting Research Bulletin 43 ‘Restatement and Revision of Accounting Research Bulletins’ requires a reduction in shareholders’ equity for own shares held. However, HSBC shares held within ‘Long-term assurance assets attributable to policyholders’ remain classified as an asset where the criteria for classification as ‘separate accounts’ are met. Dividends payable UK GAAP • Dividends declared after the period end are recorded in the period to which they relate. US GAAP • Dividends are recorded in the period in which they are declared. Deferred taxation UK GAAP • Deferred tax is generally provided in the accounts for all timing differences subject to exceptions in FRS 19 and the assessment of the recoverability of deferred tax assets. • Fair value adjustments on acquisition are treated as if they were timing differences arising in the acquired entity’s own accounts. Deferred tax is recognised on fair value adjustments where they give rise to deferral or acceleration of taxable cash flows. US GAAP • Deferred tax liabilities and assets are recognised in respect of all temporary differences. A valuation allowance is raised against any deferred tax asset where it is more likely than not that the asset, or a part thereof, will not be realised (SFAS 109 ‘Accounting for Income Taxes’). • The deferred taxation impact of all temporary differences arising from fair value adjustments on acquisition is recognised as part of the purchase accounting adjustment. Sale and repurchase transactions (‘repos’) and reverse repos UK GAAP • Repos and reverse repos are accounted for as if the collateral involved remains with the transferor. On the balance sheet, repos are included within ‘Deposits by banks’ or ‘Customer accounts’ and reverse repos are included within ‘Loans and advances to banks’ or ‘Loans and advances to customers’. US GAAP • Repos and reverse repos transacted under agreements that give the transferee the right by contract or custom to sell or repledge collateral give rise to the following adjustments and disclosures (SFAS 140 ‘Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities’): – For repos, where the transferee has the right to sell or repledge the collateral, the transferor reports the securities separately in the financial statements from other securities not so encumbered. – For reverse repos, where the transferee has the right to sell or repledge the collateral, the transferee does not recognise the pledged asset but discloses the fair value of the collateral. If the transferee sells collateral pledged to it, the proceeds from the sale and the transferee’s obligation to return the collateral are recognised. Loan origination UK GAAP • Fee and commission income is accounted for in the period when receivable, except when it is charged to cover the costs of a continuing service to, or risk borne for, the customer, or is interest in nature. In these cases, it is recognised on an appropriate basis over the relevant period. 327 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) • Loan origination costs are generally expensed as incurred. As permitted by UK GAAP, HSBC applies a restricted definition of the incremental, directly attributable origination expenses that are deferred and subsequently amortised over the life of the loans. US GAAP • Certain loan fee income and direct loan origination costs are amortised to the profit and loss account, on a straight-line basis, over the life of the loan as an adjustment to interest income (SFAS 91 ‘Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases’). Prepayment and delinquency estimates are regularly monitored and fee and cost amortisation rates adjusted accordingly. • Credit card annual fees are netted with direct lending costs, deferred, and amortised on a straight-line basis over one year. Pension costs UK GAAP • Pension costs, based on actuarial assumptions and methods, are charged so as to allocate the cost of providing benefits over the average remaining service lives of employees. US GAAP • SFAS 87 ‘Employers’ Accounting for Pensions’ prescribes a similar method of actuarial valuation but requires assets to be assessed at fair value and the assessment of liabilities to be based on current settlement rates. • When the accumulated benefit obligation on a pension plan (the value of the benefits accrued based on employee service up to the balance sheet date) exceeds the fair value of plan assets, the employer recognises a minimum pension liability equal to this excess, so long as the excess is greater than any accrual which has already been established for unfunded pension costs. • Where unrecognised net actuarial gains/losses are in excess of 10 per cent of the greater of the projected benefit obligation and the plan assets, the excess is amortised to net income in equal amounts over the average remaining service lives of current employees. Securitisations UK GAAP • FRS 5 ‘Reporting the substance of transactions’ requires that the accounting for securitised receivables is governed by whether the originator has access to the benefits of the securitised assets and exposure to the risks inherent in those benefits and whether the originator has a liability to repay the proceeds of the note issue: – The securitised assets should be derecognised in their entirety and a gain or loss on sale recorded where the originator retains no significant benefits and no significant risks relating to those securitised assets. – The securitised assets and the related finance should be consolidated under a linked presentation where the originator retains significant benefits and significant risks relating to those securitised assets but where the downside exposure is limited to a fixed monetary amount and certain other conditions are met. – The securitised assets and the related finance should be consolidated on a gross basis where the originator retains significant benefits and significant risks relating to those securitised assets and does not meet the conditions required for linked presentation. US GAAP • SFAS 140 ‘Accounting for Transfers and Servicing of Finance Assets and Extinguishments of Liabilities’ requires that receivables that are sold to a special purpose entity and securitised can only be derecognised and a gain or loss on sale recognised if the originator has surrendered control over those securitised assets. • Control has been surrendered over transferred assets if and only if all of the following conditions are met: – The transferred assets have been put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. 328 – Each holder of interests in the transferee (i.e. holder of issued notes) has the right to pledge or exchange their beneficial interests, and no condition constrains this right and provides more than a trivial benefit to the transferor. – The transferor does not maintain effective control over the assets through either an agreement that obligates the transferor to repurchase or to redeem them before their maturity or through the ability to unilaterally cause the holder to return specific assets, other than through a clean-up call. – If these conditions are not met the securitised assets should continue to be consolidated. • Where HSBC retains an interest in the securitised assets, such as a servicing right or the right to residual cash flows from the special purpose entity, HSBC recognises this interest at fair value on sale of the assets. • There are no provisions for linked presentation of securitised assets and the related finance. Consolidation of Variable Interest Entities UK GAAP • In accordance with FRS 5, entities that fall within the definition of quasi-subsidiaries are consolidated. A quasi- subsidiary is defined as an entity that is directly or indirectly controlled by HSBC and gives rise to benefits that are in substance no different from those that would arise were the vehicle a subsidiary. FRS 5 states that this will arise where HSBC receives the benefits of the net assets of the entity and is exposed to the risks inherent in those net assets. US GAAP • FASB Interpretation 46 (revised December 2003) ‘Consolidation of Variable Interest Entities’(‘FIN 46R’), which became fully effective for HSBC from 1 January 2004, requires consolidation of Variable Interest Entities (‘VIEs’) in which HSBC is the primary beneficiary and disclosures in respect of all other VIEs in which it has a significant variable interest. • A VIE is an entity in which equity investors do not hold an investment with the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities. HSBC is the primary beneficiary of a VIE if its variable interests absorb a majority of the entity’s expected losses. Variable interests are contractual, ownership or other pecuniary interests in an entity that change with changes in the fair value of an entity’s net assets exclusive of variable interests. If no party absorbs a majority of the entity’s expected losses, HSBC consolidates the VIE if it receives a majority of the expected residual returns of the entity. Restructuring provisions UK GAAP • • In accordance with FRS 12 ‘Provisions, contingent liabilities and contingent assets’, provisions are made for any direct costs and net future operating losses arising from a business that management is committed to restructure, sell or terminate, has a detailed formal plan to exit, and has raised a valid expectation of carrying out that plan. In accordance with SSAP 24 ‘Accounting for pension costs’, the cost of additional pension benefits that accrue to employees made redundant are spread over the remaining service lives of existing employees in line with other actuarial adjustments. US GAAP • SFAS 146 ‘Accounting for Costs Associated with Exit or Disposal Activities’, requires that the fair value of a liability for a cost associated with an exit or disposal activity be recognised when the liability is incurred. Accordingly, provisions are recognised upon the implementation of the restructuring plan. • SFAS 88 ‘Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits’ requires that the present value of expected employee termination benefits payable pursuant to a contractual or legal obligation be recognised when it is probable that employees will be entitled to benefits and the amounts can be reasonably estimated. Generally, this would be when management commits to a plan of termination that identifies the number of employees to be terminated, their job classification or functions 329 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) and locations and the expected completion date of the plan, and actions required to complete the plan indicate that it is unlikely that significant changes will be made or the plan will be withdrawn. Acceptances UK GAAP • Acceptances outstanding are not included in the consolidated balance sheet. US GAAP • Acceptances outstanding and matching customer liabilities are included in the consolidated balance sheet. Profit and loss presentation UK GAAP • The following items are separately disclosed in the profit and loss account: – Provisions for contingent liabilities and commitments. – Amounts written off fixed asset investments. – Gains on disposal of investments and tangible fixed assets. US GAAP • The above items are disclosed as follows: – Provisions for contingent liabilities and commitments are classified as ‘Operating expenses’. – Amounts written off fixed asset investments and gains on disposal of investments and tangible fixed assets are classified as ‘Other operating expense’ and ‘Other operating income’ respectively. – Gains on disposal of investments and tangible fixed assets are classified as ‘Other operating income’. The following tables summarise the significant adjustments to consolidated net income and shareholders’ equity which would result from the application of US GAAP: Year ended 31 December Net income Attributable profit of HSBC (UK GAAP) ........................................ Lease financing ................................................................................ Shareholders’ interest in long-term assurance fund .......................... Pension costs .................................................................................... Stock-based compensation ............................................................... Goodwill .......................................................................................... Internal software costs ...................................................................... Revaluation of property .................................................................... Purchase accounting adjustments ..................................................... Intangibles ........................................................................................ Derivatives ....................................................................................... Own shares held ................................................................................ Foreign exchange losses/(gains) on available-for-sale securities ...... Loan origination................................................................................ Securitisations ................................................................................... Restructuring provisions ................................................................... Other-than-temporary decline in value of available-for-sale securities ..................................................................................... Foreign exchange losses on Argentine overseas funding .................. Taxation : US GAAP....................................................................... on reconciling items ...................................................... Minority interest in reconciling items .............................................. Note a b c d f g h I r j k l 2004 US$m 11,840 (90) (102) (244) (234) 1,845 55 139 (233) (390) 244 17 1,069 119 (1,097) (120) 36 – (216) (95) (311) (37) 2003 US$m 8,774 (114) (394) 266 (190) 1,500 13 62 (1,018) (289) (613) 42 (2,283) 217 683 96 43 26 – 223 223 187 Net income (US GAAP) ................................................................... 12,506 7,231 2002 US$m 6,239 (68) (6) (62) (240) 845 66 76 15 – 221 – (2,197) – – – (122) (390) (30) 475 445 78 4,900 330 Year ended 31 December Per share amounts (US GAAP) Basic earnings per ordinary share .................................................... Diluted earnings per ordinary share ................................................. Note o o 2004 US$ 1.15 1.13 Note Shareholders’ equity Shareholders’ funds (UK GAAP) ....................................................................................... Lease financing .................................................................................................................. Shareholders’ interest in long-term assurance fund ............................................................ Pension costs ...................................................................................................................... Goodwill ............................................................................................................................ Internal software costs ....................................................................................................... Revaluation of property ..................................................................................................... Purchase accounting adjustments ....................................................................................... Intangibles ......................................................................................................................... Derivatives ......................................................................................................................... Fair value adjustment for securities available-for-sale ....................................................... Own shares held ................................................................................................................. Dividend payable ............................................................................................................... Loan origination ................................................................................................................. Securitisations .................................................................................................................... Restructuring provisions .................................................................................................... Taxation : US GAAP ......................................................................................................... on reconciling items ......................................................................................... Minority interest in reconciling items ................................................................................ Shareholders’ equity (US GAAP) ...................................................................................... Movement in shareholders’ equity (US GAAP) Balance brought forward .................................................................. Net income ....................................................................................... Dividends ......................................................................................... Stock based compensation ............................................................... Shares issued in lieu of dividends .................................................... Equity issued on acquisition of HSBC Finance Corporation under US GAAP .......................................................................... New share capital subscribed net of costs ........................................ Other, including movements in own shares held............................... Net change in net unrealised gains/(losses) on securities available-for-sale, net of tax effect ............................................... Net change in net unrealised gains on derivatives classified as cash flow hedges, net of tax effect ............................................... Minimum pension liability adjustment, net of tax effect .................. Exchange and other movements ....................................................... Total Other Comprehensive Income ................................................. Balance carried forward .................................................................. Note c b a b d f g h j r l 2004 US$m 80,251 12,506 (6,932) 234 2,607 – 581 (148) (837) (349) (195) 2,364 983 90,082 2003 US$ 0.69 0.69 2004 US$m 86,623 (718) (1,600) (4,776) 2,706 760 (3,040) 1,142 3,218 356 1,969 147 2,996 317 (358) (19) (72) 367 295 64 90,082 2003 US$m 55,831 7,231 (6,974) 190 1,423 14,366 862 (79) 1,676 367 (1,127) 6,485 7,401 80,251 2002 US$ 0.52 0.52 2003 US$m 74,473 (575) (1,532) (3,122) 1,072 718 (1,949) 1,352 3,028 702 2,046 140 2,627 217 739 96 173 (144) 29 190 80,251 2002 US$m 48,444 4,900 (4,632) 240 1,023 – 337 17 2,253 86 (824) 3,987 5,502 55,831 331 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) The following table provides an estimated summarised balance sheet for HSBC, which incorporates the adjustments arising from the application of US GAAP: Assets Cash and balances at central banks .................................................................................................. Items in the course of collection from other banks .......................................................................... Treasury bills and other eligible bills .............................................................................................. Hong Kong Government certificates of indebtedness ..................................................................... Loans and advances to banks .......................................................................................................... Loans and advances to customers .................................................................................................... Debt securities and equity shares .................................................................................................... Interests in associated undertakings and other participating interests .............................................. Intangible and tangible fixed assets ................................................................................................. Due from customers on acceptances ............................................................................................... Other assets (including prepayments and accrued income) ............................................................. 2004 US$m 9,893 6,352 30,284 11,878 143,077 653,279 275,304 4,621 51,962 7,214 72,501 2003 US$m 7,661 6,628 20,391 10,987 117,173 505,152 220,579 1,973 47,133 5,411 68,935 Total assets ...................................................................................................................................... 1,266,365 1,012,023 Liabilities Hong Kong currency notes in circulation ........................................................................................ Deposits by banks ........................................................................................................................... Customer accounts .......................................................................................................................... Items in the course of transmission to other banks .......................................................................... Debt securities in issue .................................................................................................................... Acceptances outstanding ................................................................................................................. Other liabilities (including accruals and deferred income) .............................................................. Provisions for liabilities and charges – deferred taxation ...................................................................................................................... – other provisions for liabilities and charges ............................................................................... Subordinated liabilities .................................................................................................................... Minority interests ............................................................................................................................ Shareholders’ equity ........................................................................................................................ 11,878 83,539 693,734 5,301 190,766 7,214 131,826 2,754 9,339 37,685 2,247 90,082 10,987 70,426 573,132 4,383 127,555 5,411 98,696 1,368 8,134 25,462 6,218 80,251 Total liabilities ................................................................................................................................ 1,266,365 1,012,023 Net assets arising due to reverse repo transactions of US$36,543 million (2003: US$23,220 million) and US$29,346 million (2003: US$17,777 million) are included in ‘Loans and advances to banks’ and ‘Loans and advances to customers’ respectively. Net liabilities arising due to repo transactions of US$11,590 million (2003: US$12,226 million) and US$32,137 million (2003: US$15,201 million) are included in ‘Deposits by banks’ and ‘Customer accounts’ respectively. Average repo liabilities during the year were US$46,229 million (2003: US$25,883 million). The maximum quarter- end repo liability outstanding during the year was US$53,188 million (2003: US$30,938 million). HSBC enters into repo and reverse repo transactions which are accounted for as secured borrowings. Under SFAS 140, securities pledged as collateral, where the counterparty has the right to sell or repledge the collateral, would be reclassified within ‘Debt securities and equity shares’ and ‘Treasury bills and other eligible bills’ as encumbered. As at 31 December 2004, the impact on ‘Debt securities and equity shares’ and ‘Treasury bills and other eligible bills’ would be to reclassify securities amounting to US$39,999 million as encumbered (2003: US$22,292 million). At 31 December 2004, collateral received under reverse repo transactions where HSBC had the right to sell or repledge the security obtained amounted to US$84,767 million gross (2003: US$45,319 million). Approximately US$36 billion (2003: approximately US$26 billion) of the collateral obtained from reverse repo transactions had been sold or pledged by HSBC in connection with repo transactions and securities sold not yet purchased. HSBC also enters into stock lending and borrowing transactions by which either cash or other securities may be received in exchange for stock. At 31 December 2004, stock lending transactions where the securities lent were subject to sale or repledge amounted to US$7,169 million (2003: US$7,062 million). At 31 December 2004, stock borrowing transactions where the securities borrowed were subject to sale or repledge amounted to US$28,354 million (2003: US$11,428 million). 332 (a) Shareholders’ interest in long-term assurance fund Under UK GAAP, the value of the shareholders’ interest in the in-force life assurance and fund pensions policies of the long-term assurance fund are valued at the net present value of the profits inherent in such policies. The net present value of such profits is not recognised under US GAAP. US GAAP requires the application of different accounting treatments in a number of areas of accounting for the long-term assurance fund. In particular, the definition and amortisation of deferred acquisition costs and the methodology for determining actuarial reserves vary between US and UK GAAP. Net pre-tax income under US GAAP would have been US$102 million lower than under UK GAAP, as a result of differences in accounting for the shareholder’s interest in the long-term assurance fund. The reduction in income is greater than in the previous year, because of an increase in the net present value of in force policies in the UK in 2003, due in part to a reduction in the risk discount rate, and certain refinements to the models underlying the US GAAP calculation in the previous year. (b) Pension and post-retirement costs (i) Pensions For the purpose of the above reconciliations, the provisions of SFAS 87 ‘Employers’ Accounting for Pensions’ have been applied to HSBC’s main defined benefit pension plans, which make up approximately 97 per cent of all HSBC’s schemes by plan assets. For non-US schemes, HSBC has applied SFAS 87 with effect from 30 June 1992 as it was not feasible to apply it as at 1 January 1989, the date specified in the standard. When the accumulated benefit obligation on a pension plan (the value of the benefits accrued based on employee service up to the balance sheet date) exceeds the fair value of plan assets, the employer recognises an additional minimum pension liability equal to this excess, so long as the excess is greater than any accrual which has already been established for unfunded pension costs. At the same time, an intangible asset is established equal to the lower of the liability recognised for the unfunded benefit obligation or the amount of any unrecognised prior service cost. At 31 December 2004, HSBC recognised an additional minimum pension liability of US$3,261 million (2003: US$2,789 million) in respect of its unfunded accumulated benefit obligations. This liability is partially offset by an intangible asset of US$12 million (2003: US$14 million). The net impact of these items, after taking account of relevant tax assets of US$968 million (2003: US$824 million), would be to reduce the Group’s shareholders’ equity under US GAAP by US$2,281 million (2003: US$1,951 million). Estimated pension costs for these plans computed under SFAS 87 are as follows: Components of net periodic benefit cost Service cost ...................................................................................... Interest cost ...................................................................................... Expected return on plan assets ......................................................... Amortisation of prior service cost .................................................... Amortisation of unrecognised net liability at 30 June 1992 .............. Amortisation of recognised net actuarial loss ................................... Net periodic pension cost ................................................................. 2004 US$m 743 1,209 (1,278) 7 – 142 823 2003 US$m 429 915 (992) 5 6 74 437 2002 US$m 438 862 (885) 4 6 14 439 The US GAAP pension cost of US$823 million (2003: US$437 million; 2002 US$439 million) compares with US$579 million for these plans under UK GAAP (2003: US$703 million; 2002: US$377 million) for the schemes included in the SFAS 87 calculation. 333 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Change in projected benefit obligation Projected benefit obligation as at 1 January ................................................................. Service cost ................................................................................................................. Interest cost ................................................................................................................. Employee contributions ............................................................................................... Net actuarial loss .......................................................................................................... Acquisition of subsidiary ............................................................................................. Plan amendment .......................................................................................................... Benefits paid ................................................................................................................ Transfers ...................................................................................................................... Exchange movements .................................................................................................. Projected benefit obligation as at 31 December ........................................................... Change in plan assets Plan assets at fair value as at 1 January ........................................................................ Actual return on plan assets ......................................................................................... Acquisition of subsidiary ............................................................................................. Employer contributions ............................................................................................... Employee contributions ............................................................................................... Benefits paid ................................................................................................................ Transfers ...................................................................................................................... Exchange movements .................................................................................................. Plan assets at fair value as at 31 December .................................................................. Funded status ............................................................................................................... Unrecognised net actuarial loss ................................................................................... Unrecognised prior service cost ................................................................................... Accrued pension cost ................................................................................................... Additional minimum liability ...................................................................................... Intangible assets .......................................................................................................... Net amount recognised ................................................................................................. Amounts recognised under US GAAP in the balance sheet consist of: Prepaid benefit cost ..................................................................................................... Accrued benefit liability .............................................................................................. Additional minimum liability ...................................................................................... Intangible assets .......................................................................................................... US GAAP adjustment Amount recognised under US GAAP .......................................................................... Amounts recognised for these schemes under UK GAAP ........................................... 2004 US$m 21,085 743 1,209 21 1,244 – – (845) 417 1,632 25,506 17,344 1,828 – 431 21 (845) 264 1,235 20,278 (5,228) 4,526 49 (653) (3,261) 12 (3,902) 783 (1,436) (3,261) 12 (3,902) (3,902) (874) (4,776) 2003 US$m 15,463 429 915 4 2,306 897 6 (714) – 1,779 21,085 11,786 2,399 832 1,653 4 (714) – 1,384 17,344 (3,741) 3,558 42 (141) (2,789) 14 (2,916) 833 (974) (2,789) 14 (2,916) (2,916) (206) (3,122) In 2004, plans with an aggregate accumulated benefit obligation of U$20,566 million (2003: US$17,332 million) and assets with an aggregate fair value of US$16,128 million (2003: US$13,739 million) had an accumulated benefit obligation in excess of plan assets. Plans with an aggregate projected benefit obligation of US$22,914 million (2003: US$17,841 million) and assets with an aggregate fair value of US$17,422 million (2003: US$13,739 million) had a projected benefit obligation in excess of plan assets. Plan assets are invested primarily in equities, fixed interest securities and property. Included within plan assets at 31 December 2004 are direct holdings of 4,797,952 HSBC Holdings shares with a market value of US$82 million (2003:760,690 shares; US$12 million). Plan asset valuations are as at 31 December. The projected benefit obligations at 31 December 2004 and 2003 for HSBC’s main pension plans have been calculated using the following financial assumptions on a weighted average basis: 334 Discount rate Return on assets Rate of pay increase United Kingdom ................................................................... Hong Kong ........................................................................... Jersey .................................................................................... Brazil .................................................................................... United States ........................................................................ France ................................................................................... Mexico .................................................................................. Other ..................................................................................... United Kingdom ................................................................... Hong Kong ........................................................................... Jersey .................................................................................... Brazil..................................................................................... United States ........................................................................ France.................................................................................... Mexico .................................................................................. Other ..................................................................................... United Kingdom ................................................................... Hong Kong ........................................................................... Jersey .................................................................................... Brazil .................................................................................... United States ........................................................................ France ................................................................................... Mexico .................................................................................. Other ..................................................................................... 2004 % per annum 2003 % per annum 5.3 4.0 5.3 11.75 6.0 4.5 10.75 3.25 – 4.5 6.8 6.0 5.5 12.35 8.75 5.4 12.5 4.6 3.2 4.0 4.45 5.0 3.75 3.5 6.5 2.25 – 2.5 5.5 5.5 5.5 11.3 6.25 5.25 10.75 3.5 – 5.25 7.1 6.0 6.8 11.3 8.4 5.4 7.0 4.7 3.0 4.5 4.25 5.11 3.75 3.5 7.5 2.5 In accordance with SFAS 132 (revised) ‘Employers’ Disclosures about Pensions and other Post-retirement Benefits’, the following disclosures are required in respect of HSBC’s pension schemes: Plan assets Asset category Equity shares Real estate .... Debt securities Other ............ HSBC Bank (UK) Pension Scheme Expected return on assets 2005 % 8.1 6.5 4.7 3.6 Target allocation 2005 % 53.0 10.0 36.0 1.0 Percentage of plan assets at 31 December 2003 % 56.2 9.1 27.6 7.1 2004 % 57.7 10.2 27.1 5.0 Expected return on assets 2005 % 8.1 1.0 5.5 3.2 Other schemes Target allocation 2005 % 46.5 1.9 44.6 7.0 Percentage of plan assets at 31 December 2003 % 53.1 0.6 40.7 5.6 2004 % 45.7 1.3 34.9 18.1 Total ............. 6.8 100.0 100.0 100.0 7.2 100.0 100.0 100.0 HSBC determines the expected return on plan assets in consultation with its actuary based upon historical market returns, adjusted for additional factors such as the current rate of inflation and interest rates. Plan objectives The Trustees’ long-term investment objectives are to: • Limit the risk of the assets failing to meet the liability of the Schemes over the long-term; and • Maximise returns consistent with an acceptable level of risk so as to control the long-term costs of the Defined Benefit Schemes. The Trustees consider that the investment policy is consistent with meeting their overall long-term investment objectives. In pursuit of these long-term objectives, the Trustees establish an overall benchmark for the allocation of the Defined Benefit Schemes’ assets between asset categories. In addition each permitted asset class has its own benchmarks, such as stock market or property valuation indices and desired levels of out performance where relevant. This is intended to be reviewed at least triennially within 18 months of the date at which the actual valuation is made, or more frequently if circumstances require it. The process involves an extensive asset and liability review. 335 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Pension assumptions The measurement date for the major pension plans is 31 December. The assumptions used to determine the projected benefit obligation of the defined benefit plans are as follows: HSBC Bank (UK) Pension Scheme 2004 % Discount rate ....................................... Rate of compensation increase ............ Inflation ............................................... 5.3 3.2 2.7 2003 % 5.5 3.0 2.5 Other schemes 2004 % 5.5 3.5 2.0 2003 % 6.0 4.0 2.0 HSBC determines discount rates in consultation with its actuary based upon the current average yield of high quality (AA rated) debt instruments, with maturities consistent with that of the pension obligation. The accumulated benefit obligation in respect of the above schemes was: HSBC Bank (UK) Pension Scheme ........................................................................ Other schemes ......................................................................................................... 2004 US$m 19,063 4,829 2003 US$m 16,165 4,464 The weighted average assumptions used in determining the net periodic costs are as follows: HSBC Bank (UK) Pension Scheme 2004 % Discount rate ....................................... Rate of compensation increase ............ Expected return on assets .................... 5.5 3.0 7.1 2003 % 5.6 2.75 7.3 Other schemes 2004 % 6.0 4.0 7.0 2003 % 5.6 3.7 6.5 For the year 2005, HSBC expects to contribute US$251 million for the HSBC Bank (UK) Pension Scheme and US$142 million for the other schemes. Benefits expected to be paid over each of the next five years and in aggregate for the five years thereafter are: HSBC Bank (UK) Pension Scheme ............................. Other schemes ....................... (ii) Post-retirement benefits 2005 US$m 644 260 2006 US$m 658 267 2007 US$m 677 282 2008 US$m 696 296 2009 US$m 2010 - 2015 US$m 716 316 3,868 1,866 The components of post-retirement expense for HSBC’s principal schemes, which make up approximately 80 per cent of all HSBC’s schemes by benefit obligation, are as follows: Components of net periodic post-retirement benefit cost Service cost .................................................................................................................... Interest cost .................................................................................................................... Amortisation of transition obligation .............................................................................. Net periodic post-retirement benefit cost ........................................................................ 2004 US$m 10 45 12 67 2003 US$m 5 27 12 44 For measurement purposes, the calculation assumes a 9.3 per cent annual rate of increase in the weighted average per capita cost of covered medical benefits. The measurement date for the plans is 31 December. 336 Change in accumulated post-retirement benefit obligation Accumulated post-retirement benefit obligation as at 1 January .................................... Service cost .................................................................................................................... Interest cost .................................................................................................................... Net actuarial loss/(gain) .................................................................................................. Acquisition of subsidiary ................................................................................................ Benefits paid .................................................................................................................. Transfers ........................................................................................................................ Exchange and other movements ..................................................................................... Accumulated post-retirement benefit obligation as at 31 December ............................... Change in plan assets Fair value of plan assets at 1 January ............................................................................. Employer contributions .................................................................................................. Investment returns .......................................................................................................... Benefits paid .................................................................................................................. Transfers ........................................................................................................................ Exchange and other movements ..................................................................................... Funded status of plan Funded status at 31 December ........................................................................................ Unrecognised net actuarial (gain)/loss ............................................................................ Unrecognised net transition obligation ........................................................................... Accrued post-retirement benefit obligation .................................................................... 2004 US$m 2003 US$m 598 10 45 43 – (41) 137 20 812 – 50 2 (41) 73 (5) 79 (733) (4) 32 (705) 326 5 27 (5) 251 (27) – 21 598 – 27 – (27) – – – (598) 15 45 (538) Benefits expected to be paid over each of the next five years and in aggregate for the five years thereafter are: UK post-retirement scheme .. Other schemes ....................... 2005 US$m 12 34 2006 US$m 12 36 2007 US$m 14 37 2008 US$m 15 38 2009 US$m 2010 - 2015 US$m 15 38 99 191 Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one percentage point change in assumed health care cost trend rates would increase/(decrease) service and interest costs and the post-retirement benefit obligation as follows: One per cent increase US$m One per cent decrease US$m Effect on total of service and interest cost components .................................................. Effect on post-retirement benefit obligation ................................................................... 5.9 63.6 (5.0) (58.2) In accordance with US GAAP, the accounting for the post-retirement benefit charge assumed a discount rate of 5.3 per cent (2003: 5.3 per cent) for UK benefits and 7.1 per cent (2003: 6.01 per cent) for non-domestic benefits, on a weighted average basis. HSBC intends to contribute US$11 million to its principal UK post- retirement health care scheme and US$47 million to other schemes in 2005. There is no material difference between the amounts disclosed above and amounts provided for under UK GAAP. Further details of the UK post-retirement health care expenses under UK GAAP are given in Note 5. (c) Stock-based compensation HSBC has adopted SFAS 123 and accounts for share compensation schemes based on their estimated fair values at date of grant. The SFAS 123 charge for the fair value of options granted since 1 January 1997 is US$234 million (2003: US$190 million; 2002: US$240 million). The Executive Share Option Scheme, Group Share Option Plan, Savings-Related Share Option Plan and Restricted Share Plan fall within the scope of SFAS 123. The disclosures of options outstanding only relate to those granted from 1995 onwards. An analysis of the movement in the 337 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) number and weighted average exercise price of options is set out below. Calculation of fair values Fair values of share options/awards made in 2004, measured at the date of grant of the option/award, are calculated using a binomial lattice methodology that is based on the underlying assumptions of the Black- Scholes model. When modelling options/awards with vesting dependent on HSBC's Total Shareholder Return over a period, these performance targets are incorporated into the model using Monte-Carlo simulation. The expected life of options depends on the behaviour of option holders, which is incorporated into the option model consistent with historic observable data. Prior to 2004, options were valued using a simpler methodology also based on the Black-Scholes model. The fair values calculated are inherently subjective and uncertain due to the assumptions made and the limitations of the model used. The significant assumptions used to estimate the fair value of the options granted in 2004 are as follows: Risk-free interest rate (%) ............................ Expected life (years) 1 .................................. Expected volatility (%) ................................ Group Share Option Plan 4.9 – 5.0 6.9 25.0 3 year Savings- Related Share Option Schemes 5 year Savings- Related Share Option Schemes 4.7 – 4.9 3 25.0 4.9 – 5.0 5 25.0 1 Expected life is not a single input parameter but a function of various behavioural assumptions. The risk-free rate was determined from the UK gilts zero-coupon yield curve. Expected volatility is estimated by considering both historic average share price volatility and implied volatility for traded options over HSBC shares of similar maturity to those of the employee options. Expected dividend yield was based on historic levels of dividend growth denominated in sterling. Executive Share Option Scheme The Executive Share Option Scheme is a long-term incentive scheme available to certain HSBC employees with grants usually made each year. The aim of the plan is to align the interest of those employees assessed as higher performing to the creation of shareholder value. This is achieved by setting certain Total Shareholder Return targets which must normally be attained in order for the awards to vest. Options are granted at market value and are normally exercisable between the third and tenth anniversaries of the date of grant, subject to vesting conditions. No further grants will be made under the Scheme following the adoption of the Group Share Option Plan in 2000. 2004 2003 2002 Outstanding at 1 January ......................... Exercised in the year ............................... Forfeited in the year ................................ Number (000’s) 59,613 (14,823) (813) Outstanding at 31 December ................... 43,977 Weighted average exercise price £ 6.73 6.62 6.90 6.76 Weighted average exercise price £ 6.68 6.50 7.07 6.73 Number (000’s) 79,645 (18,205) (1,827) 59,613 Weighted average exercise price £ 6.60 6.26 6.91 6.68 Number (000’s) 102,710 (20,982) (2,083) 79,645 The weighted average fair value of options as at the last date of grant during 2000 was US$5.26. The number of options, weighted average exercise price and the weighted average remaining contractual life for options outstanding at the balance sheet date, analysed by exercise price range, are as follows: 338 Exercise price range (£) ............. 2.17 – 6.00 6.01 – 7.87 2.17 – 6.00 6.01 – 7.87 2.17 – 6.00 6.01 – 7.87 2004 2003 2002 Number (000’s) ......................... Weighted average exercise price (£) ................................. Weighted average remaining contractual life (years) ........... Of which exercisable: Number (000’s) ..................... Weighted average exercise price (£) ............................. Group Share Option Plan 1,233 42,744 1,882 57,731 3,094 76,551 4.31 1.78 6.83 4.63 4.12 2.66 6.81 5.61 4.01 3.59 6.79 6.59 1,233 42,744 1,882 57,731 3,094 47,344 4.31 6.83 4.12 6.81 4.01 6.38 The Group Share Option Plan is a long-term incentive plan available to certain HSBC employees that was adopted by HSBC during 2000. The aim of the plan is to align the interest of those employees assessed as higher performing to the creation of shareholder value. This is achieved by setting certain Total Shareholder Return targets which must normally be attained in order for the awards to vest. Options are granted at market value and are normally exercisable between the third and tenth anniversaries of the date of grant, subject to vesting conditions. 2004 2003 2002 Outstanding at 1 January ............ Granted in the year .................... Exercised in the year .................. Forfeited in the year ................... Number (000’s) 163,997 63,682 (1,460) (5,549) Outstanding at 31 December....... 220,670 Weighted average exercise price £ 8.00 8.28 8.59 8.00 8.07 Weighted average exercise price £ 8.55 7.07 8.52 8.19 8.00 Number (000’s) 106,164 62,118 (2) (4,283) 163,997 Weighted average exercise price £ 8.72 8.40 – 8.62 8.55 Number (000’s) 50,825 57,236 – (1,897) 106,164 The weighted average fair value of options granted in the year as at the date of grant was US$2.96 (2003: US$3.13; 2002: US$2.33) The number of options, weighted average exercise price, and the weighted average remaining contractual life for options outstanding at the balance sheet date, analysed by exercise price range, are set out below: 2004 2003 2002 Exercise price range (£) ............. 6.00 – 8.00 8.01 – 10.00 6.00 – 8.00 8.01 – 10.00 6.00 – 8.00 8.01 – 10.00 Number (000’s) ......................... Weighted average exercise price (£) ................................. Weighted average remaining contractual life (years) ........... Of which exercisable: Number (000’s) ..................... Weighted average exercise price (£) ............................. 55,246 165,243 56,980 107,017 6.91 6.46 – – 8.46 7.86 45,463 8.72 6.91 9.33 – – 8.57 7.66 396 9.64 469 7.46 9.66 – – 105,695 8.55 8.83 – – Savings-Related Share Option Plans The Savings-Related Share Option Plans invite eligible employees to enter into savings contracts to save up to £250 per month, with the option to use the savings to acquire shares. The aim of the plan is to align the interests of all employees to the creation of shareholder value. The options are exercisable within six months following either the third or the fifth anniversary of the commencement of the savings contract depending on conditions set at grant. The exercise price is at a 20 per cent (2003 and 2002: 20 per cent) discount to the market value at the date of grant. The employee has the right to withdraw their accumulated savings and withdraw from the plan at any time. Upon voluntary withdrawal, any remaining unamortised compensation expense is recognised in the current period. 339 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) 2004 2003 2002 Outstanding at 1 January ............ Granted in the year ..................... Exercised in the year .................. Forfeited in the year ................... Number (000’s) 123,316 25,040 (30,068) (8,566) Outstanding at 31 December ...... 109,722 Weighted average exercise price £ 5.75 6.47 5.76 5.67 5.92 Weighted average exercise price £ 5.97 5.35 5.13 6.29 5.75 Number (000’s) 121,520 48,313 (14,630) (31,887) 123,316 Weighted average exercise price £ 5.76 6.32 4.73 5.90 5.97 Number (000’s) 130,450 19,828 (16,455) (12,303) 121,520 The maximum term of options granted in the year is 51/2 years from the date of grant (2003 and 2002: 51/2 years). The weighted average fair value of options granted in the year as at the date of grant was US$3.75 (2003: US$3.09; 2002: US$3.58). The number of options, weighted average exercise price, and the weighted average remaining contractual life for options outstanding at the balance sheet date, analysed by exercise price range, are as follows: 2004 2003 2002 Exercise price range (£) ............. 1.81 – 4.00 4.01 – 6.75 1.81 – 4.00 4.01 – 6.75 1.81 – 4.00 4.01 – 6.75 Number (000’s) .......................... Weighted average exercise price (£) ................................. Weighted average remaining contractual life (years) ........... Of which exercisable: Number (000’s) ..................... Weighted average exercise price (£) ............................. – – – – – 109,722 5.92 1.82 1,341 6.20 891 3.78 0.16 891 3.78 122,425 2,382 119,138 5.76 1.91 264 5.22 3.78 0.65 – – 6.02 2.02 312 4.52 CCF and Subsidiary Company Plans CCF granted share purchase and subscription offers to certain executives of CCF, directors and officers, as well as to certain senior executives of subsidiaries. Options granted between 1994 and 1999 vested upon announcement of HSBC’s intent to acquire CCF and were therefore included in the valuation of CCF. CCF granted 909,000 options in 2000 after the public announcement of the acquisition and these options did not vest as a result of the change in control. The options were subject to continued employment and vested on 1 January 2002. The CCF shares obtained on exercise of the options are exchangeable for HSBC’s ordinary shares of US$0.50 each in the same ratio as the Exchange Offer for Crédit Commercial de France shares (13 ordinary shares of US$0.50 for each CCF share). Options are granted at market value and are exercisable within 10 years of the vesting date. 2004 2003 2002 Weighted average exercise price 142.50 142.50 142.50 Number (000’s) 856 (2) 854 Weighted average exercise price 142.50 142.50 142.50 Number (000’s) 857 (1) 856 Weighted average exercise price 142.50 142.50 142.50 Number (000’s) 861 (4) 857 Outstanding at 1 January ............ Exercised in the year .................. Outstanding at 31 December ...... The weighted average remaining contractual life for options outstanding at the balance sheet date was 7 years. When it was acquired in 2000, certain of CCF’s subsidiary companies also operated employee share option plans under which options could be granted over their respective shares. Following exercise of certain of these options, the subsidiary shares may be exchanged for HSBC ordinary shares. The total number of HSBC shares 340 € € € exchangeable under such arrangements was less than 2 million shares during the year. HSBC Finance Corporation Options granted under HSBC Finance Corporation’s own share option schemes prior to the announcement of the acquisition by HSBC in November 2002 vested upon acquisition by HSBC. Options granted after the announcement of the acquisition in November 2002 but prior to 28 March 2003 were granted at market value, and generally vest equally over 4 years and expire 10 years from the date of grant. Upon acquisition, HSBC Finance Corporation share options previously granted were converted to share options over HSBC ordinary shares of US$0.50 each at a rate of 2.675 HSBC share options (the same ratio as the Exchange Offer for HSBC Finance Corporation) for each HSBC Finance Corporation share option. Information with respect to share options granted under the former HSBC Finance Corporation schemes is as follows: HSBC Finance Corporation share options outstanding at 28 March 2003 .......................... HSBC share options at 1 January or conversion ... Exercised in the year ............................................. Forfeited in the year .............................................. Outstanding at end of year .................................... Of which exercisable ............................................ 2004 2003 Number (000’s) – 7,316 (174) (30) 7,112 4,228 Weighted average price US$ – 10.66 10.66 10.66 10.66 10.66 Number (000’s) 2,784 7,446 (23) (107) 7,316 1,812 Weighted average price US$ 28.52 10.66 10.66 10.66 10.66 10.66 The weighted average contractual life for options outstanding at the balance sheet date was 8 years. Restricted Share Plan Conditional awards under the Restricted Share Plan Conditional awards under the Restricted Share Plan have been in operation since 1996. The aim of the plan is to align the interests of executives to the creation of shareholder value. This is achieved by setting certain Total Shareholder Return targets which must normally be attained in order for the awards to vest. Outstanding at 1 January ........................................................................ Additions during the year ...................................................................... Released in the year ............................................................................... Forfeited in the year ............................................................................... Outstanding at 31 December .................................................................. 2004 Number (000’s) 13,669 5,727 (2,352) – 17,044 2003 Number (000’s) 9,540 5,074 (945) – 13,669 2002 Number (000’s) 6,197 3,667 (261) (63) 9,540 The weighted average purchase price for shares purchased by HSBC for conditional awards under the Restricted Share Plan in 2004 was US$16.55 (2003: US$10.89; 2002: US$12.08). The weighted average remaining vesting period as at 31 December 2004 was 2.52 years (2003: 2.82 years; 2002: 2.98 years). The 2005 conditional awards proposed to be made to Executive Directors and certain other senior employees from the Restricted Share Plan in respect of 2004, will have an aggregate face value at the date of award of US$52.1 million (2004 awards in respect of 2003: US$31.6 million) and an aggregate expected value of US$22.9 million. Other awards made under the Restricted Share Plan Other awards are made under the Restricted Share Plan as part deferral of annual bonus. Awards are also made for recruitment and retention purposes. The awards generally vest from one to three years from the date of award. 341 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Outstanding at 1 January ........................................................................ Additions during the year ....................................................................... Released in the year ............................................................................... Forfeited in the year ............................................................................... Outstanding at 31 December .................................................................. 2004 Number (000’s) 43,153 18,813 (15,945) – 46,021 2003 Number (000’s) 36,172 20,974 (13,993) – 43,153 2002 Number (000’s) 29,049 21,292 (12,262) (1,907) 36,172 The weighted average purchase price for shares purchased by HSBC for other awards under the Restricted Share Plan in 2004 was US$16.43 (2003: US$11.39; 2002: US$12.04). The weighted average remaining vesting period as at 31 December 2004 was 1.47 years (2003: 1.23 years; 2002: 1.41 years). (d) Goodwill Goodwill arises on the acquisition of subsidiary or associated undertakings when the cost of acquisition exceeds the fair value of HSBC’s share of separable net assets acquired. Under UK GAAP, for acquisitions made on or after 1 January 1998, goodwill is included in the balance sheet in ‘Intangible assets’ in respect of subsidiary undertakings, in ‘Interests in associates’ in respect of associates and in ‘Interests in joint ventures’ in respect of joint ventures. Capitalised goodwill is amortised over its estimated life on a straight-line basis. For acquisitions prior to 1 January 1998, goodwill was charged against reserves in the year of acquisition. Under US GAAP, goodwill on acquisitions made before 1 July 2001, including those made before 1 January 1998, would have been capitalised and amortised over its useful economic life. Goodwill on acquisitions made after 1 July 2001 is capitalised but not amortised, and is subject to annual impairment testing. Goodwill on acquisitions made before 1 July 2001 ceased to be amortised on 1 January 2002 and is subject to annual impairment testing. At 31 December 2004, the cost of goodwill arising on the acquisition of subsidiary undertakings on a US GAAP basis was US$36,084 million (2003: US$33,581 million; 2002: US$23,613 million) and accumulated amortisation of goodwill was US$4,385 million (2003: US$4,016 million; 2002: US$3,630 million). The following table shows changes in the carrying value of goodwill arising on the acquisition of subsidiary undertakings during the year: Europe Hong Kong US$m US$m Rest of Asia-Pacific US$m North America US$m South America US$m At 1 January 2004 ................................ Additions ............................................. Exchange and other movements ........... At 31 December 2004 ......................... At 1 January 2003 ................................ Additions ............................................. Exchange and other movements ........... At 31 December 2003 .......................... 17,977 246 1,081 19,304 14,901 492 2,584 17,977 18 14 43 75 18 – – 18 429 – (56) 373 380 38 11 429 10,685 412 345 11,442 4,552 6,353 (220) 10,685 456 6 43 505 132 287 37 456 Total US$m 29,565 678 1,456 31,699 19,983 7,170 2,412 29,565 (e) Intangible assets The following intangible assets were recognised under US GAAP: 342 Balance brought forward at 1 January .................................................................................... Additions ................................................................................................................................ On acquisition of subsidiaries ................................................................................................. Amortisation charge ............................................................................................................... Provision for impairment ........................................................................................................ Exchange and other movements ............................................................................................. Balance carried forward at 31 December ................................................................................ 2004 US$m 3,703 167 572 (526) (102) 34 3,848 2003 US$m 620 419 3,158 (462) (27) (5) 3,703 Provision for impairment relates to the write-down of mortgage servicing rights, as a low interest rate environment has encouraged consumers to refinance mortgages at a faster rate than initially expected. Weighted average amortisation period Months At 31 December 2004 Accumulated amortisation US$m Cost US$m Carrying value US$m Intangible assets subject to amortisation Purchased credit card relationships and related programmes ...................................................... Retail Services merchant relationship ................... Other loan related relationships ............................ Mortgage servicing rights ..................................... Technology, customer lists and other contracts .... Core deposit relationships ..................................... Other ..................................................................... Intangible assets not subject to amortisation Trade name ........................................................... 83 89 110 60 83 229 109 92 1,755 529 326 889 452 228 91 4,270 887 5,157 The intangible asset amortisation expense for the next five years is estimated to be: Amortisation charge ............ 2005 US$m 534 2006 US$m 504 2007 US$m 470 (358) (99) (71) (580) (103) (92) (6) (1,309) – (1,309) 2008 US$m 358 1,397 430 255 309 349 136 85 2,961 887 3,848 2009 US$m 232 Mortgage servicing rights are included in the UK GAAP balance sheet as ‘Other assets’ and related amortisation and provisions for impairment are included as a reduction of other operating income. The remaining intangibles not recognised under UK GAAP were acquired as part of business combinations. (f) Internal software costs Under UK GAAP, costs of software developed for internal use are generally expensed as they are incurred. Under US GAAP, costs incurred in the application development stage of internal software must be capitalised as part of intangible assets and amortised over their estimated useful life. HSBC recognises an adjustment in calculating its US GAAP net income, reflecting the impact of current year software development costs capitalised under US GAAP, offset by the US GAAP amortisation of these and previous years’ costs and by any provisions for impairment of these capitalised costs. The following table shows changes in the carrying value of software during the year: At 1 January ............................................................................................................................ Additions ................................................................................................................................ Amortisation............................................................................................................................ Impairment .............................................................................................................................. Exchange and other movements ............................................................................................. At 31 December ...................................................................................................................... 2004 US$m 718 365 (310) – (13) 760 2003 US$m 669 397 (341) (43) 36 718 343 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) hsbc.com, Inc., has been engaged in development activities to provide a global website and web hosting services to HSBC companies. The provisions for impairment against the US GAAP capitalised amount of development costs disclosed above arise largely on this project. At 31 December 2004, capitalised amounts in respect of hsbc.com, Inc., totalled US$72 million (2003: US$150 million). (g) Purchase accounting adjustments The reconciling item ‘Purchase accounting adjustments’ predominantly reflects: • • • the measurement of equity consideration at the date the terms of acquisition are agreed and announced under US GAAP; under UK GAAP equity consideration is measured at the date of acquisition; recognition of deferred tax on all fair value adjustments under US GAAP, and corresponding amortisation post-acquisition; and non-recognition of residual interests in securitisation vehicles existing at acquisition under UK GAAP. Instead, the assets and liabilities of the securitisation vehicles are recognised on the UK GAAP balance sheet, and credit provisions are established against the loans and advances. This GAAP adjustment existing at acquisition unwinds over the life of the securitisation vehicles. (h) Derivatives Under UK GAAP, internal derivatives used to hedge banking book transactions may be accruals accounted but, under US GAAP, all derivatives are held at fair value. With the exception of certain subsidiaries in North America, HSBC has not elected to satisfy the more prescriptive hedge documentation requirements of SFAS 133 in respect of external derivative contracts. Internal derivative contracts are not recognised for hedge accounting purposes under US GAAP. During the latter part of 2004, as part of its preparation for the transition from UK GAAP to IFRS, HSBC undertook a review of its hedging activities in order to confirm which transactions would comply with the hedge accounting requirements of IFRS. As a result of this review, the management of HSBC Finance Corporation concluded that there were some deficiencies in the documentation designed to re-establish hedge accounting under SFAS 133 following the acquisition by HSBC. As a result of these deficiencies, it was determined by HSBC Finance Corporation management that hedge accounting should not have been applied in these circumstances. The cumulative effect of the loss of hedge accounting has been reported as part of US GAAP net income in 2004 and the element attributable to 2003 was not material to HSBC’s reported US GAAP net income for that year. Fair value hedges HSBC’s North American operating subsidiaries designate certain derivative financial instruments as qualifying fair value hedges of certain fixed rate assets and liabilities under SFAS 133. Where the critical terms of the hedge instrument are identical to the hedged item at the hedge inception date, the short-cut method of accounting is utilised for these hedging relationships. As a result, no retrospective or prospective assessment of effectiveness is required and no hedge ineffectiveness is recognised. For a small number of fair value hedges of fixed rate liabilities, the short-cut method of accounting cannot be utilised. Ineffectiveness of such fair value hedges recognised in US GAAP reported net income was a gain of US$1 million (2003: loss of US$0.4 million; 2002: nil). Additionally, since 2002, HSBC’s US mortgage bank has hedged fixed rate closed residential mortgage loans held for sale with forward sale commitments. In order to satisfy the retrospective and prospective assessment of effectiveness for SFAS 133, the cumulative dollar offset method is utilised. Ineffectiveness is recognised in the income statement on a monthly basis. Ineffectiveness on these hedging activities recognised in US GAAP reported net income was a gain of US$2 million (2003: US$0.2 million; 2002: US$8 million). Cash flow hedges HSBC’s North American operating subsidiaries designate certain derivative financial instruments, including interest rate swaps and future contracts, as qualifying cash flow hedges under SFAS 133 of the forecast repricing of certain deposit liabilities, issues of debt and variable rate commercial loans. In order to initially qualify, 344 assessment of hedge effectiveness is demonstrated on a prospective basis utilising both statistical regression analysis and the cumulative dollar offset method. In order to satisfy the retrospective assessment of effectiveness for SFAS 133, the cumulative dollar offset method is utilised and ineffectiveness is recognised in the income statement on a monthly basis. The time value component of the derivative contracts is excluded from the assessment of hedge effectiveness. Ineffectiveness of cash flow hedging activities recognised in US GAAP reported net income was a loss of US$1 million (2003: gain of US$4 million; 2002: gain of US$13 million). The adjustment to US GAAP reported equity of such hedges at 31 December 2004 was to increase equity by US$133 million (2003: US$409 million). Trading derivatives All other UK GAAP hedging derivatives have been marked to market for US GAAP purposes with the gain or loss recognised in net income for the period. This has given rise to the increase in US reported net income of US$210 million (2003: US$613 million; 2002: US$221 million). The principal impact of applying SFAS 133 is to reduce other assets by US$5,487 million (2003: US$6,545 million) and reduce other liabilities by US$5,754 million (2003: US$7,491 million). Under UK GAAP, internal derivatives used to hedge banking book transactions may be accruals accounted but, under US GAAP, all derivatives are held at fair value. (i) Foreign exchange gains on available-for-sale securities Within individual legal entities HSBC holds securities in a number of different currencies which are classified as available-for-sale. For example, within the private bank in Switzerland, which has the US dollar as its reporting currency, the Group holds euro-denominated bonds which are funded in euros and Swiss franc securities funded in Swiss francs. No foreign exchange exposure arises from this because, although the value of the assets in US dollar terms changes according to the exchange rate, there is an identical offsetting change in the US dollar value of the related funding. Under UK GAAP both the assets and the liabilities are translated at closing exchange rates and the differences between historical book value and current value are reflected in foreign exchange dealing profits. This reflects the economic substance of holding currency assets financed by currency liabilities. However, under US accounting rules, SFAS 115 and Emerging Issues Task Force (‘EITF’) Abstract 96-15 ‘Accounting for the Effects of Changes in Foreign Currency Exchange Rates on Foreign-Currency-Denominated Available-for-Sale Debt Securities’ the change in value of the investments classified as available-for-sale is taken directly to reserves whereas the offsetting change in US dollar terms of the borrowing is taken to earnings. This leads to an accounting result which, although in compliance with US GAAP, does not necessarily reflect either the underlying risk position or the economics of the transactions. It is also a situation that will reverse on maturity of the asset or earlier sale. A similar difference arises where foreign currency exposure on foreign currency assets is covered using forward contracts, but where HSBC does not manage these hedges to conform with the detailed US hedge designation requirements of SFAS 133. The result of this is that for 2004, US GAAP profits were increased by US$1,069 million (2003: decreased by US$2,283 million; 2002: decreased by US$2,197 million) compared to UK GAAP profits. There is no difference in shareholders’ equity between UK GAAP and US GAAP as a result of this reconciling item. The adjustment for 2004 largely reflects the reversal of adjustments in prior periods on the maturity or disposal of securities. This was offset by the impact of a weakening of the US dollar against the principal currencies in which HSBC held ‘available for sale’ securities, which also gave rise to the adjustments in prior periods. (j) Investment securities Under UK GAAP, debt securities and equity shares intended to be held on a continuing basis are classified as investment securities and are included in the balance sheet at cost less provision for any permanent diminution in value. Other participating interests are accounted for on the same basis. Where dated investment securities have been purchased at a premium or discount, these premiums and discounts are amortised through the profit and loss account over the period from the date of purchase to the date of maturity and included in ‘interest income’. These securities are included in the balance sheet at cost adjusted for the amortisation of premium and discounts arising on acquisition. Any gain or loss on realisation of these securities is recognised in the profit and loss account as it arises and included in ‘Gains on disposal of investments’. Other debt securities and equity shares are included in the balance sheet at market value. Changes in the market 345 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) value of such assets are recognised in the profit and loss account as ‘Dealing profits’ as they arise. Debt securities and listed equity shares acquired in exchange for advances in order to achieve an orderly realisation, continue to be reported as advances under UK GAAP. Under SFAS 115 ‘Accounting for certain investments in debt and equity securities’, all the above debt securities and equity shares, with the exception of equity investments without a readily determinable market value, are classified and disclosed within one of the following three categories: held-to-maturity; available-for-sale; or trading. Held-to-maturity securities are measured at amortised cost less provision for any other-than-temporary declines in value. Available-for-sale securities are measured at fair value with unrealised holding gains and losses excluded from earnings and reported net of applicable taxes and minority interests in a separate component of shareholders’ funds. Provisions for other-than-temporary declines in the fair value of available- for-sale securities are recognised in earnings. Trading securities are measured at fair value with unrealised holding gains and losses included in earnings. Under US GAAP, HSBC’s investment securities, other participating interests and debt securities and equity shares with a readily determinable market value acquired in exchange for advances are classified as available- for-sale securities, except for certain securities held by Republic New York Corporation at acquisition, which were classified as held-to-maturity. All other debt and equity shares are categorised as trading securities. The US GAAP book and market values of these debt securities and equity shares with a readily determinable market value are analysed as follows: Trading ................................................................ Available-for-sale ................................................ Held-to-maturity .................................................. 2004 2003 Book value US$m 111,022 175,634 3,881 Market valuation US$m 111,022 175,634 4,042 Book value US$m 86,887 146,934 4,512 Market valuation US$m 86,887 146,934 4,648 The US GAAP amortised cost of ‘available-for-sale’ investment securities subject to the provisions of SFAS 115 is US$173,607 million (2003: US$144,807 million). During the year, excluding the effects of foreign exchange, US$376 million (2003: US$376 million; 2002: US$1,229 million) of net unrealised gains on available-for-sale securities were included in OCI. US$476 million (2003: US$401 million; 2002: US$393 million) of net gains were reclassified out of OCI and recognised as part of income for the year. During 2004, HSBC recorded net losses under US GAAP of US$127 million (2003: US$24 million; 2002: US$308 million) in respect of impairments of available-for-sale securities which were considered to be other than temporary. These losses were treated as realised items and included in net income. Trading assets The following table provides an analysis of trading assets, which are valued at market value and the net gains/(losses) resulting from trading activities: US Treasury and Government agencies ............... UK Government ................................................... Hong Kong Government ...................................... Other government ................................................ Asset-backed securities ........................................ Corporate debt and other securities ...................... Equities ................................................................ 2004 Market valuation US$m 8,198 6,032 5,189 29,201 2,161 45,632 14,609 111,022 Gains/ (losses) US$m 109 164 12 (17) 2 (221) 38 87 2003 Market valuation US$m Gains/ (losses) US$m 7,079 1,969 4,284 24,684 2,476 38,906 7,489 86,887 115 12 (1) 127 1 (3) 43 294 Trading assets are marked to market and all gains and losses are deemed realised. 346 Available-for-sale The following table provides an analysis of available-for-sale securities under US GAAP. The principal impact of the adjustment described below is to increase the carrying value of investment securities under US GAAP by US$1,653 million in 2004 (2003: US$2,053 million): Book value US$m Market Valuation US$m Gross SFAS 115 adjustment US$m Tax and minority interests US$m Net SFAS 115 adjustment US$m At 31 December 2004 Investment securities (excluding investments with no readily determinable market value) ....... Other participating interests ........... Brady bonds ................................... Other debt securities and equity shares acquired in exchange for advances .................................... Securities available-for-sale at 172,541 881 177 174,188 1,255 176 8 15 31 December 2004 .................... 173,607 175,634 Securities available-for-sale at 31 December 2003 ..................... 144,807 146,934 Movement in the year ended 31 December 2004 .................... 1,647 374 (1) 7 2,027 2,127 (100) (517) (107) – (2) (626) (645) 19 1,130 267 (1) 5 1,401 1,482 (81) The book value above includes securities denominated in foreign currencies which have been translated at closing rates. Foreign exchange movements between historic rates and closing rates are reflected in OCI. Unrealised losses on investment securities The following investment securities, that have unrealised losses at 31 December 2004, are not considered ‘Other- than-temporary’ impaired under US GAAP: Period investment has been in an unrealised loss position Less than one year Fair value US$m Unrealised losses US$m Greater than or equal to one year Fair value US$m Unrealised losses US$m Total Fair value US$m Unrealised losses US$m US Treasury and Government agencies UK Government ......... Other government ....... Asset-backed securities Corporate debt and other securities ......... Debt securities ............. Equity shares ............... Total 8,704 4,040 4,185 934 21,253 39,116 157 39,273 (70) (2) (221) (3) (84) (380) (12) (392) 2,510 2 1,779 178 5,373 9,842 – 9,842 (88) – (6) (3) (41) (138) – (138) 11,214 4,042 5,964 1,112 26,626 48,958 157 49,115 (158) (2) (227) (6) (125) (518) (12) (530) Under US GAAP, 2,653 debt security investments and 61 investments in equity shares had unrealised losses at 31 December 2004. Under US GAAP, HSBC recognises an ‘other-than-temporary’ impairment in the income statement for any investment security whose market value has been significantly below its carrying value for a period exceeding six months. The only exception to this policy is in respect of debt securities where their decline in market value is due solely to an increase in underlying rates of interest and where HSBC has the ability to hold these securities until maturity. None of the securities disclosed in the table above are considered ‘Other-than-temporarily’ impaired at 31 December 2004. 347 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (k) Foreign exchange losses on Argentine funding The mandatory and asymmetrical conversion of onshore US dollar denominated assets and liabilities in Argentina (‘pesification’) caused significant erosion of the capital base of HSBC Argentina, in part because of the asymmetry of the conversion and in part through the creation of a structural foreign exchange mismatch to the extent of residual external US dollar liabilities which were no longer matched with US dollar assets. HSBC recognised these losses through its income statement in 2001; these amounted to US$520 million. Following pesification, HSBC Argentina’s balance sheet primarily reflected Argentine peso assets more than fully funded by Argentine peso liabilities and this represents HSBC’s ongoing business in Argentina. On top of this HSBC Argentina had residual external US dollar liabilities which essentially represented a portion of the loss recognised in 2001. Under UK GAAP these US dollar liabilities, as they were no longer funding the ongoing business, were treated as a separate operation with the US dollar as the unit of account. These liabilities were settled as they fell due by the Group outside Argentina. As HSBC prepares its accounts in US dollars no further translation effect arose. Under US GAAP this accounting treatment was not possible and the external US dollar liabilities were treated as part of the Argentine operation which accounts in Argentine pesos. As a result, when the Argentine peso weakened the US dollar denominated liabilities generated a substantial loss in Argentine pesos which was reflected in US GAAP income. However, as HSBC accounts in US dollars and economically there was no change in the amount of US dollars owing, an exactly offsetting gain was reflected in the US GAAP accounts in other comprehensive income. There was no net effect on US GAAP shareholders’ equity. In addition, as these liabilities are settled by the Group, the resultant intra-Group Funding was treated for US GAAP purposes as part of the permanent investment in the Argentine operation. As all such liabilities have now been settled in this way, there in no further difference to be recorded in 2004 or subsequent years. (l) Taxation The components of the net deferred tax liability calculated under SFAS 109 ‘Accounting for Income Taxes’, are as follows: Deferred tax liabilities Leasing transactions ................................................................................................................ Capital allowances .................................................................................................................. Provision for additional UK tax on overseas dividends .......................................................... Reconciling items ................................................................................................................... Other ....................................................................................................................................... Total deferred tax liabilities .................................................................................................... Deferred tax assets Provisions for bad and doubtful debts ..................................................................................... Tax losses ............................................................................................................................... Reconciling items ................................................................................................................... Other ....................................................................................................................................... Total deferred tax assets before valuation allowance .............................................................. Less: valuation allowance ....................................................................................................... Deferred tax assets less valuation allowance ........................................................................... Net deferred tax asset under SFAS 109 ................................................................................... Included within ‘other assets’ under US GAAP ...................................................................... Included within ‘deferred tax liabilities’ under US GAAP ...................................................... 2004 US$m 1,924 280 107 2,661 1,101 6,073 2,530 827 3,066 2,254 8,677 (1,062) 7,615 1,542 3,272 (1,730) 2003 US$m 1,587 293 61 2,417 1,076 5,434 3,122 972 2,273 1,332 7,699 (964) 6,735 1,301 2,669 (1,368) The valuation allowance against deferred tax assets principally relates to trading and capital losses carried forward, which have not been recognised due to uncertainty over their utilisation. A valuation allowance is established to reduce deferred tax assets if, based on available evidence, it is considered more likely than not that any of the deferred tax assets will not be realised. At 31 December 2004, HSBC has recognised deferred tax assets in respect of tax losses (net of valuation 348 allowances) totalling US$115 million (2003: US$231 million), of which, US$7 million (2003: US$49 million) expire within two to five years and US$108 million (2003: US$182 million) expire in 5 years or more. (m) Loans and advances SFAS 114 ‘Accounting by creditors for impairment of a loan’ was amended by SFAS 118 ‘Accounting by creditors for impairment of a loan – income recognition and disclosures’. SFAS 114 addresses accounting by creditors for impairment of a loan by specifying how allowances for credit losses for certain loans should be determined. A loan is impaired when it is probable that the creditor will be unable to collect all amounts in accordance with the contractual terms of the loan agreement. Impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective rate or, as an expedient, at the fair value of the loan’s collateral. Leases, smaller-balance homogeneous loans and debt securities are excluded from the scope of SFAS 114. At 31 December 2004, HSBC estimated that the difference between the carrying value of its loan portfolio on the basis of SFAS 114 and its value in HSBC’s UK GAAP financial statements was such that no adjustment to net income or shareholders’ equity was required. Impaired loans are those reported by HSBC as non-performing. The value of such loans at 31 December 2004 was US$13,284 million (2003: US$15,074 million). Of this total, loans which were included within the scope of SFAS 114 and for which a provision has been established amounted to US$6,780 million (2003: US$8,810 million). The impairment reserve in respect of these loans estimated in accordance with the provisions of SFAS 114 was US$3,981 million (2003: US$4,709 million). During the year ended 31 December 2004, impaired loans, including those excluded from the scope of SFAS 114, averaged US$13,739 million (2003: US$12,215 million) and interest income recognised on these loans was US$184 million (2003: US$230 million; 2002: US$258 million). (n) Fair value of financial instruments SFAS 107 ‘Disclosures about fair value of financial instruments’ requires disclosure of the estimated fair values of certain financial instruments, both on-balance-sheet and off-balance-sheet, where it is practicable to do so. Where possible, fair values have been estimated using market prices for the financial instruments. Where market prices are not available, fair values have been estimated using quoted prices for financial instruments with similar characteristics, or otherwise using a suitable valuation technique where practicable to do so. The fair value information presented represents HSBC’s best estimate of these values and may be subject to certain assumptions and limitations. The fair values presented in the table on page 351 are at a specific date and may be significantly different from the amounts which will actually be paid or received on the maturity or settlement dates. In many cases, the estimated fair values could not be realised immediately and accordingly do not represent the value of these financial instruments to HSBC as a going concern. HSBC has excluded the fair value of intangible assets, such as values placed on its portfolio of core deposits, credit card relationships and customer goodwill, as these are not considered to constitute financial instruments for the purposes of SFAS 107. HSBC believes such items to be significant and essential to the overall evaluation of HSBC’s worth. In view of the above, comparisons of fair values between financial institutions may not be meaningful and users are advised to exercise caution when using this data. Financial instruments for which fair value is equal to carrying value The following table lists those financial instruments, within the scope of SFAS 107, where carrying value is an approximation of fair value because they are either (i) carried at market value or (ii) short term in nature or reprice frequently. By definition, the fair value of trading account assets and liabilities, including derivative instruments, equals carrying value. Carrying values of these instruments are presented on the balance sheets and related notes on pages 238 to 356. 349 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) Assets Cash and balances at central banks Liabilities Deposits by banks repayable on demand or that mature / reprice within six months Items in the course of collection Customer accounts repayable on demand or that mature / reprice Hong Kong Government certificates of indebtedness Trading debt securities and equity shares Treasury bills and other eligible bills Other assets Prepayments and accrued income Off-balance-sheet trading instruments within six months Hong Kong Government currency notes in circulation Short positions in treasury bills, debt securities and equity shares Items in the course of transmission Other liabilities Accruals and deferred income Provisions for liabilities and charges Off-balance-sheet trading instruments In addition, the fair value of non-derivative off-balance-sheet financial instruments is the same as their carrying value under US GAAP. Other financial instruments The fair value of other financial instruments within the scope of SFAS 107 is set out in the table below. The valuation technique adopted for each major category is discussed below: (i) Loans and advances to banks and customers For personal and commercial loans and advances which mature or reprice after six months, fair value is principally estimated by discounting anticipated cash flows (including interest at contractual rates). Performing loans are grouped, to the extent possible, into homogenous pools segregated by maturity and the coupon rates of the loans within each pool. In general, cash flows are discounted using current market rates for instruments with similar maturity, repricing and credit risk characteristics. The fair value for conforming residential mortgages in the United States are treated differently where there is an established market value for asset-backed securities. In such situations, the fair value is estimated by reference to quoted market prices for loans with similar characteristics and maturities. For non-performing uncollateralised commercial loans, an estimate is made of the time period to realise these cash flows and the fair value is estimated by discounting these cash flows at a risk-free rate of interest. For non-performing commercial loans where collateral exists, the fair value is the lesser of the carrying value of the loans, net of specific provisions, or the fair value of the collateral, discounted where appropriate. General provisions are deducted from the fair values of these non-performing loans. (ii) Debt securities and equity shares held for investment purposes, and other participating interests Listed investment securities are valued at middle market prices and unlisted investment securities at management’s valuation which takes into consideration future earnings streams, valuations of equivalent quoted securities and other relevant techniques. (iii) Deposits by banks and customer accounts Deposits by banks and customer accounts which mature or reprice after six months are grouped by residual maturity. Fair value is estimated using discounted cash flows, applying either market rates, where applicable, or current rates offered for deposits of similar remaining maturities. (iv) Debt securities in issue and subordinated liabilities Fair value is estimated using quoted market prices at the balance sheet date. The following table presents the carrying value and fair value for those financial instruments whose fair value is derived using these various estimation techniques: 350 Assets Loans and advances to banks and customers .............................................. Debt securities – non-trading ..................... Equity shares – non-trading ....................... Other participating interests ...................... Liabilities Deposits by banks and customer accounts . Debt securities in issue .............................. Subordinated liabilities .............................. Non-equity minority interests .................... 2004 Carrying value US$m 796,350 149,199 4,681 881 777,296 189,930 37,688 102 Fair value US$m 798,165 150,496 5,613 1,255 775,190 192,861 39,561 95 2003 Carrying value US$m 622,325 130,922 5,304 690 643,558 127,555 25,462 4,604 Fair value US$m 624,969 132,594 6,217 764 643,611 128,359 26,889 4,600 The fair value of derivative financial instruments is the same as their carrying value under US GAAP. (o) Earnings per share Basic earnings per share under US GAAP, SFAS 128 ‘Earnings per share’, is calculated by dividing net income of US$12,506 million (2003: US$7,231 million; 2002: US$4,900 million) by the weighted average number of ordinary shares in issue in 2004 of 10,916 million (2003: 10,429 million; 2002: 9,339 million). Diluted earnings per share under US GAAP is calculated by dividing net income, which requires no adjustment for the effects of dilutive ordinary potential shares, by the weighted average number of shares outstanding plus the weighted average number of ordinary shares that would be issued on conversion of all the dilutive potential ordinary shares in 2004 of 11,063 million (2003: 10,547 million; 2002: 9,436 million). (p) Variable interest entities (‘VIEs’) Nature, purpose and activities of VIEs with which HSBC is involved HSBC, in the ordinary course of business, makes use of VIE structures in a variety of business activities outlined below. The use by HSBC of a VIE structure in a business transaction is primarily to facilitate client needs and is thus commercially driven. Utilisation of a VIE occurs after careful consideration has been given to the most appropriate structure needed to achieve HSBC’s control and risk allocation objectives and to help ensure an efficient structure from a taxation and regulatory perspective. The main VIEs are discussed below. (i) Asset-backed conduits (‘ABCs’) and securitisation vehicles ABCs and securitisation vehicles are structures in which interests in consumer and commercial receivables are sold to investors. ABCs generally consist of entities which purchase assets from clients to meet their financing needs, while securitisation vehicles generally acquire assets originated by HSBC itself and provide HSBC a cost-effective source of financing. Both types of vehicles issue interests, such as commercial paper, notes, or equity interests to investors to fund the purchase of the receivables. Cash flows received by the vehicles on the pool of the receivables are used to service the finance provided by investors. In certain instances, HSBC receives fees for providing liquidity facility commitments and for acting as administrator of the vehicle. HSBC’s exposure to loss generally arises through back-up liquidity facility commitments to the vehicles, interest-rate swaps for which HSBC is the counterparty, retained or acquired interests in the receivables sold, or through acquired interests in the vehicles themselves. In certain vehicles, the risk of loss to HSBC is reduced by credit enhancement provided by the originator of the receivables or other parties. In addition to securitisation vehicles disclosed here, HSBC (primarily through its North American subsidiaries) also securitises assets through entities that are not considered VIEs, including government- sponsored financing vehicles and vehicles considered qualifying special-purpose entities under US GAAP. These entities are not consolidated under US GAAP although certain of them are consolidated under UK GAAP. 351 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (ii) Infrastructure projects and funds HSBC acts as an arranger for both public and private infrastructure projects and funds. The use of VIE structures in such projects is common as a method of attracting a wider class of investor by tranching the risk associated with such projects. HSBC’s exposure to loss generally arises through the provision of subordinated or mezzanine debt finance to projects, either directly, or via a consolidated investment fund investing in infrastructure projects. HSBC is deemed to be the primary beneficiary of an infrastructure project or fund where its investment in the equity and subordinated or mezzanine debt of a project, or its interest in a fund is at a level where it absorbs the majority of the expected losses or residual returns of the project/fund. Application of FIN 46R FIN 46R requires consolidation of VIEs in which HSBC is the primary beneficiary, and disclosures in respect of other VIEs in which it has a significant variable interest. Under UK GAAP, HSBC consolidates entities in which it has a controlling interest. As UK GAAP normally requires a risk and rewards approach to consolidation, HSBC’s interests in entities deemed to be VIEs may result in differences in accounting and disclosure treatment under US GAAP. The following table analyses HSBC’s total consolidated VIE assets in a US GAAP balance sheet: Classification Loans and advances to customers ............................................................................................................................. Debt securities and equity shares .............................................................................................................................. Tangible fixed assets................................................................................................................................................. Other assets............................................................................................................................................................... At 31 December 2004 US$m 12,256 1,996 1,865 599 16,716 For the year ended 31 December 2003, HSBC was not required to consolidate VIEs created before 1 February 2003 of which it was the primary beneficiary, under the transition rules of FIN46R. The total assets consolidated under US GAAP at 31 December 2003 were US$94 million. Of the 2004 total, US$12,256 million represents asset-backed commercial paper conduits and securitisation vehicles, and US$1,612 million represents infrastructure projects and funds. The remaining balance consists of guaranteed pension funds, investment funds, and other entities. Certain of these entities with assets of approximately US$9,338 million at 31 December 2004 are consolidated by HSBC in its UK GAAP financial statements. There was no significant impact on US GAAP net income for the year ended 31 December 2004 as a result of consolidating these VIEs. HSBC also has significant involvement in, but is not the primary beneficiary of, VIEs with total assets of approximately US$32.8 billion, including asset-backed commercial paper conduits and securitisation vehicles with assets of approximately US$15.8 billion (2003: US$7.3 billion), and infrastructure projects and funds of approximately US$4.5 billion, as well as interests in investment funds, low income housing tax credit partnerships, guaranteed pension funds, government debt restructuring programmes and other entities. HSBC’s maximum exposure to loss in relation to these entities is estimated at US$10.7 billion (2003: US$7.2 billion) which arises from guarantees, retained interests and recourse liabilities. HSBC is also involved in other investment funds and similar entities that are considered VIEs for which its involvement is limited to that of administrator, investment adviser, or other service provider. In addition, HSBC has an interest in certain capital funding vehicles that are consolidated under UK GAAP. However, under US GAAP, these vehicles are not recognised on HSBC’s balance sheet because it is not the primary beneficiary. HSBC’s deconsolidation of these vehicles results in non-equity minority interests under UK GAAP of US$10,114 million being reclassified as subordinated liabilities under US GAAP. (q) Consolidated cash flow statement HSBC prepares its cash flow statement in accordance with the UK Financial Reporting Standard 1 (Revised 1996) ‘Cash flow statements’. Its objectives and principles are similar to those set out in SFAS 95 ‘Statement of 352 cash flows’, as amended by SFAS 104 ‘Statement of cash flows – Net reporting of certain cash receipts and cash payments and classification of cash flows from hedging transactions’. FRS 1 (Revised) defines ‘Cash’ as ‘Cash and balances at central banks’ and ‘Advances to banks payable on demand’. Under US GAAP, ‘Cash equivalents’ are defined as ‘Short-term highly liquid investments’ that are both: − − convertible to known amounts of cash; and so near their maturity that they present insignificant risk of changes in value because of fluctuations in interest rates. The other principal differences between US and UK GAAP are in respect of classification. Under UK GAAP, HSBC presents its cash flows by: (a) Operating activities; (b) Dividends received from associates; (c) Returns on investments and servicing of finance; (d) Taxation; (e) Capital expenditure and financial investments; (f) Acquisitions and disposals; (g) Equity dividends paid; and (h) Financing. Under US GAAP, only three categories are required, (a) Operating; (b) Investing; and (c) Financing. Cash Flow Taxation Dividends received from associates Equity dividends paid Non-equity dividends paid and dividends to minority interests Capital expenditure and financial investments Transfers of subsidiary undertakings, joint ventures and associates Net changes in loans and advances including finance lease payables Net changes in deposits Classification under FRS 1 (Revised) Taxation Dividends received from associates Equity dividends paid Returns on investments and servicing of finance Capital expenditure and financial investments Classification under SFAS 95/104 Operating activities Operating activities Financing activities Financing activities Investing activities Acquisitions and disposals Investing activities Operating activities Operating activities Investing activities Financing activities Under FRS 1 (Revised), hedges are reported under the same heading as the related assets or liabilities. For the purposes of the following table, HSBC has defined ‘Cash’ and ‘Cash equivalents’ as the sum of the following balance sheet categories: Cash and balances at central banks ........................................................ Items in the course of collection from other banks ................................ Loans and advances to banks repayable on demand .............................. Less: Items in the course of transmission to other banks ....................... 2004 US$m 9,872 6,352 34,842 (5,301) 45,765 2003 US$m 7,661 6,628 25,289 (4,383) 35,195 Set out below is a summary combined statement of cash flows under US GAAP. Cash flows from operating activities ..................................................... Cash flows from investing activities ...................................................... Cash flows from financing activities ..................................................... Effect of exchange rate changes on cash and cash equivalents .............. Net movement in cash and cash equivalents under US GAAP .............. Cash and cash equivalents at beginning of year ..................................... Cash and cash equivalents at end of year ............................................... Year ended 31 December 2004 US$m 26,217 (188,690) 171,927 1,116 10,570 35,195 45,765 2003 US$m 17,791 (117,463) 104,920 2,060 7,308 27,887 35,195 The total interest paid by HSBC during the year was US$19,038 million (2003: US$14,437 million; 2002: US$13,761 million). 2002 US$m 7,659 5,651 19,211 (4,634) 27,887 2002 US$m (1,757) (24,575) 28,614 1,404 3,686 24,201 27,887 353 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) (r) Securitisations Following the acquisition of HSBC Finance Corporation in 2003, HSBC increased its securitisation activity and the following discussion relates only to HSBC Finance Corporation’s securitisation activities including securitised credit card receivables transferred to HSBC Bank USA. In other HSBC entities such activities do not represent a significant part of HSBC’s business and retained interests in securitisations are not significant. Details of securitisations presented under a linked presentation for UK GAAP purposes are shown in note 15. HSBC has sold MasterCard and Visa, private label, personal non-credit card and auto finance loans in various securitisation transactions during the year. HSBC continues to service and receive servicing fees on the outstanding balance of these securitised loans and retains rights to future cash flows arising from the loans after the investors receive their contractual return. HSBC has also, in certain cases, retained other subordinated interests in these securitisations. These transactions result in the recording of an interest-only strip receivable under US GAAP which represents the value of the future residual cash flows from securitised loans. The investors and the securitisation trusts have only limited recourse to HSBC assets for failure of debtors to pay. That recourse is limited to HSBC’s rights to future cash flows and any subordinated interest retained. Servicing assets and liabilities are not recognised in conjunction with securitisations since HSBC receives adequate compensation relative to current market rates to service the loans sold. Securitisation revenue includes income associated with the current and prior period securitisation of loans with limited recourse structured as sales under US GAAP. Such income includes gains on sales, net of the estimate of probable credit losses under the recourse provisions, servicing income and excess spread relating to those loans. Net initial gains ....................................................................................................................... Net replenishment gains from revolving securitisations .......................................................... Servicing revenue and excess spread ...................................................................................... Total securitisation revenue .................................................................................................... 2004 US$m 25 414 569 1,008 2003 US$m 135 412 461 1,008 Interest-only strip receivables, net of the related losses and excluding the mark-to-market adjustment recorded in accumulated other comprehensive income decreased by US$466 million in 2004 (2003: US$415 million). Net initial gains, which represent gross initial gains net of management’s estimate of probable credit losses under the recourse provisions, and the key economic assumptions used in measuring the net initial gains from securitisations were as follows: 2004 Net initial gains (US$millions) ...... Key economic assumptions1 Weighted average life (in years) Payment speed ........................... Expected credit losses (annual rate) ....................................... Discount rate on cash flows ....... Cost of funds ............................. 2003 Net initial gains (US$millions) ...... Key economic assumptions1 Weighted average life (in years) Payment speed ........................... Expected credit losses (annual rate) ....................................... Discount rate on cash flows ....... Cost of funds ............................. Auto Finance MasterCard/ Visa 6 2.1 35.0% 5.7% 10.0% 3.0% 40 2.1 35.4% 6.1% 10.0% 2.2% 14 0.3 93.5% 4.9% 9.0% 1.5% 13 0.4 93.3% 5.1% 9.0% 1.8% Private Label 5 0.4 93.5% 4.8% 10.0% 1.4% 44 0.7 74.5% 5.7% 10.0% 1.8% Personal Non-Credit Card – – – – – – 38 1.7 43.3% 12.0% 11.0% 2.1% Total 25 135 1 Weighted-average rates for securitisations entered into during the year for securitisations of loans with similar characteristics. Certain revolving securitisation trusts, such as credit cards, are established at fixed levels and require frequent sales of new loan balances into the trust to replace loans as they run-off. These replenishments totalled 354 US$30.3 billion in 2004 (2003: US$25.0 billion). Net gains (gross gains less estimated credit losses under the recourse provisions) related to these replenishments were calculated using weighted-average assumptions consistent with those used for calculating gains on initial securitisations and totalled US$414 million in 2004 (2003: US$412 million). Cash flows received from securitisation trusts were as follows: 2004 Proceeds from initial securitisations ...................... Servicing fees received ............ Other cash flow received on retained interests1 ................ 2003 Proceeds from initial securitisations ...................... Servicing fees received ............ Other cash flow received on retained interests1 ................ Real Estate Secured US$m Auto Finance US$m MasterCard/ Visa US$m Private Label US$m Personal Non-Credit Card US$m – 1 4 – 2 8 – 86 (9) 1,158 86 50 550 185 705 350 149 635 190 93 252 1,050 65 193 – 161 80 2,810 100 132 Total US$m 740 526 1,032 5,368 402 1,018 1 Other cash flows included all cash flows from interest-only strip receivables, excluding servicing fees. At 31 December 2004, the sensitivity of the current fair value of the interest-only strip receivables to an immediate 10 per cent and 20 per cent unfavourable change in assumptions are presented in the table below. These sensitivities are based on assumptions used to value interest-only strip receivables at 31 December 2004. Carrying value (fair value) of interest- only strip receivables (US$ millions) ............................. Weighted-average life (in years) ......................... Payment speed assumption (annual rate) ............. Impact on fair value of 10% adverse change (US$ millions) ............................................ Impact on fair value of 20% adverse change (US$ millions) ............................................ Expected credit losses (annual rate) .................... Impact on fair value of 10% adverse change (US$ millions) ............................................ Impact on fair value of 20% adverse change (US$ millions) ............................................ Discount rate on residual cash flows (annual rate) ................................................................. Impact on fair value of 10% adverse change (US$ millions) ............................................ Impact on fair value of 20% adverse change (US$ millions) ............................................ Variable returns to investors (annual rate) ........... Impact on fair value of 10% adverse change (US$ millions) ............................................ Impact on fair value of 20% adverse change (US$ millions)............................................. Real Estate Secured Auto Finance MasterCard/ Visa Private Label Personal Non-Credit Card 1 0.3 36 1.6 162 0.5 50 0.5 124 0.9 21.5% 44.7% 81.4% 79.0% 69.9% – – (16) (33) (13) (24) (3) (5) (8) (15) 1.8% 8.2% 5.2% 5.7% 10.1% – – (30) (59) (14) (28) (8) (17) (30) (61) 13.0% 10.0% 9.0% 10.0% 11.0% – – 1.7% – – (4) (9) – – – (1) (2) – – (1) (2) 1.9% 3.1% 3.3% (6) (13) (5) (10) (10) (20) These sensitivities are hypothetical and should not be considered to be predictive of future performance. As the figures indicate, the change in fair value based on a 10 per cent variation in assumptions cannot necessarily be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the residual cash flow is calculated independently from any change in another assumption. In reality, changes in one factor may 355 H S B C H O L D I N G S P L C Notes on the Financial Statements (continued) contribute to changes in another (for example, increases in market interest rates may result in lower prepayments) which might magnify or counteract the sensitivities. Furthermore, the estimated fair values as disclosed should not be considered indicative of future earnings on these assets. Static pool credit losses are calculated by summing actual and projected future credit losses and dividing them by the original balance of each pool of asset. Due to the short term revolving nature of MasterCard and Visa, and private label loan balances, the weighted-average percentage of static pool credit losses is not considered to be materially different from the weighted-average charge-off assumptions used in determining the fair value of interest-only strip receivables in the table above. At 31 December 2004, static pool credit losses for auto finance loans securitised in 2003 were estimated to be 10.2 per cent and for auto finance loans securitised in 2002 were estimated to be 14.7 per cent (2003: 11.5 per cent). 50 Approval of accounts These accounts were approved by the Board of Directors on 28 February 2005. 356 H S B C H O L D I N G S P L C Taxation of Shares and Dividends Taxation The following is a summary, under current law, of the principal UK tax considerations that are likely to be material to the ownership and disposition of shares. The summary does not purport to be a comprehensive description of all the tax considerations that may be relevant to a holder of shares. In particular, the summary deals principally with shareholders who are resident in the United Kingdom for UK tax purposes and only with holders who hold the shares as investments and who are the beneficial owners of the shares, and does not address the tax treatment of certain classes of holders such as dealers in securities. Holders and prospective purchasers should consult their own advisers regarding the tax consequences of an investment in shares in light of their particular circumstances, including the effect of any national, state or local laws. Taxation of dividends Currently no tax is withheld from dividends paid by HSBC Holdings. However, dividends are paid with an associated tax credit which is available for set-off by certain shareholders against any liability they may have to UK income tax. Currently, the associated tax credit is equivalent to 10 per cent of the combined cash dividend and tax credit, i.e. one- ninth of the cash dividend. For individual shareholders who are resident in the United Kingdom for taxation purposes and liable to UK income tax at the basic rate, no further UK income tax liability arises on the receipt of a dividend from HSBC Holdings. Individual shareholders who are liable to UK income tax at the higher rate on UK dividend income (currently 32.5 per cent) are taxed on the combined amount of the dividend and the tax credit. The tax credit is available for set-off against the higher rate liability, leaving net higher rate tax to pay equal to 25 per cent of the cash dividend. Individual UK resident shareholders are not entitled to any tax credit repayment, unless the dividend income arises in a Personal Equity Plan (PEP) or Individual Savings Account (ISA), and then only for a five-year period to 5 April 2004. Although non-UK-resident shareholders are generally not entitled to any repayment of the tax credit in respect of any UK dividend received, some such shareholders may be so entitled under the provisions of a double taxation agreement between their country of residence and the United Kingdom. However, in most cases no amount of the tax credit is, in practice, repayable. Information on the taxation consequences of the HSBC Holdings scrip dividends offered in lieu of the 2003 third interim dividend and the first, second and third interim dividends for 2004 was set out in the Secretary’s letters to shareholders of 30 March, 2 June, 1 September and 7 December 2004. In each case, the market value of the scrip dividend was not substantially different from the dividend forgone and, accordingly, the price of HSBC Holdings US$0.50 ordinary shares (the ‘shares’) for UK tax purposes for the dividends was the cash dividend foregone. Taxation of capital gains The computation of the capital gains tax liability arising on disposals of shares in HSBC Holdings by shareholders subject to UK capital gains tax can be complex, partly depending on whether, for example, the shares were purchased since April 1991, acquired in 1991 in exchange for shares in The Hongkong and Shanghai Banking Corporation Limited, or acquired subsequent to 1991 in exchange for shares in other companies. For capital gains tax purposes, the acquisition cost for ordinary shares is adjusted to take account of subsequent rights and capitalisation issues. Further adjustments apply where an individual shareholder has chosen to receive shares instead of cash dividends, subject to scrip issues made since 6 April 1998 being treated for tax as separate holdings. Any capital gain arising on a disposal may also be adjusted to take account of indexation allowance and, in the case of individuals, taper relief. Except for gains made by a company chargeable to UK corporation tax, any such indexation allowance is calculated up to 5 April 1998 only. If in doubt, shareholders are recommended to consult their professional advisers. Shares or ADSs held by an individual whose domicile is determined to be the United States for the purposes of the United States-United Kingdom Double Taxation Convention relating to estate and gift taxes (the “Estate Tax Treaty”) and who is not for such purposes a national of the United Kingdom will not, provided any US Federal estate or gift tax chargeable has been paid, be subject to UK inheritance tax on the individual’s death or on a lifetime transfer of shares or ADSs except in certain cases where the shares or ADSs (i) are comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the United Kingdom), (ii) is part of the business property of a UK permanent establishment of an enterprise, or (iii) pertains to a 357 H S B C H O L D I N G S P L C Taxation of Shares and Dividends (continued) UK fixed base of an individual used for the performance of independent personal services. In such cases, the Estate Tax Treaty generally provides a credit against US Federal tax liability for the amount of any tax paid in the United Kingdom in a case where the shares or ADSs are subject to both UK inheritance tax and to US Federal estate or gift tax. Stamp duty and stamp duty reserve tax Transfers of shares by a written instrument of transfer generally will be subject to UK stamp duty at the rate of 0.5 per cent of the consideration paid for the transfer, and such stamp duty is generally payable by the transferee. An agreement to transfer shares, or any interest therein, normally will give rise to a charge to stamp duty reserve tax at the rate of 0.5 per cent of the consideration. However, provided an instrument of transfer of the shares is executed pursuant to the agreement and duly stamped before the date on which the stamp duty reserve tax becomes payable, under current UK Inland Revenue practice it will not be necessary to pay the stamp duty reserve tax, nor to apply for such tax to be cancelled. Stamp duty reserve tax generally is payable by the transferee. Paperless transfers of shares within CREST, the United Kingdom’s paperless share transfer system, are liable to stamp duty reserve tax at the rate of 0.5 per cent of the consideration. In CREST transactions, the tax is calculated and payment made automatically. Deposits of shares into CREST generally will not be subject to stamp duty reserve tax, unless the transfer into CREST is itself for consideration. Taxation – US residents The following is a summary, under current law, of the principal UK tax and US Federal tax considerations that are likely to be material to the ownership and disposition of shares or ADSs by a holder that is a resident of the United States for the purposes of the income tax convention between the United States and the United Kingdom (the ‘Treaty’), and is fully eligible for benefits under the Treaty (an ‘eligible US holder’). The summary does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a holder of shares or ADSs. In particular, the summary deals only with eligible US holders that hold shares or ADSs as capital assets, and does not address the tax treatment of holders that are subject to special tax rules, such as banks, tax-exempt entities, insurance companies, dealers in securities or 358 currencies, persons that hold shares or ADSs as part of an integrated investment (including a ‘straddle’) comprised of a share or ADS and one or more other positions, and persons that own, directly or indirectly, 10 per cent or more of the voting stock of HSBC Holdings. This discussion is based on laws, treaties, judicial decisions and regulatory interpretations in effect on the date hereof, all of which are subject to change. A new income tax treaty (the ‘new Treaty’) between the United Kingdom and the United States entered into effect on 1 May 2003 with respect to withholding taxes on dividends superseding the previous tax treaty (the ‘old Treaty’). Following entry into effect of the new Treaty, eligible US holders are no longer entitled to claim a special foreign tax credit in respect of dividends that was available under the terms of the old Treaty, except for a limited period of time during which such holders may have elected to apply the old Treaty in its entirety in preference to the new Treaty. Holders and prospective purchasers should consult their own advisers regarding the tax consequences of an investment in shares or ADSs in light of their particular circumstances, including the effect of any national, state or local laws. In general, the beneficial owner of a share or ADS will be entitled to benefits under the new Treaty (and, therefore, will be an eligible US holder) if it is (i) an individual resident of the United States, a US corporation meeting ownership criteria specified in the new Treaty or other entity meeting criteria specified in the new Treaty; and (ii) not also resident in the United Kingdom for UK tax purposes. Special rules, including a limitation of benefits provision, may apply. The Treaty benefits discussed below generally are not available to US holders that hold shares or ADSs in connection with the conduct of a business through a permanent establishment, or the performance of personal services through a fixed base, in the United Kingdom. Taxation of dividends An eligible US holder must include cash dividends paid on the shares or ADSs in ordinary income on the date that such holder or the ADS depositary receive them, translating dividends paid in UK pounds sterling into US dollars using the exchange rate in effect on the date of receipt. Subject to certain exceptions for positions that are hedged or held for less than 61 days, an individual eligible US holder generally will be subject to US taxation at a maximum rate of 15 per cent in respect of dividends received before 2009 if the dividends are “qualified dividends”. Dividends paid on the shares or ADSs will be treated as qualified dividends if (i) HSBC Holdings was not, in the year prior to the year in which the dividend was paid and is not in the year in which the dividend is paid, a passive foreign investment company (‘PFIC’), and (ii) for dividends paid in the 2004 taxable year, HSBC Holdings was not a foreign personal holding company (‘FPHC’) or foreign investment company (‘FIC’) with respect to its 2003 or 2004 taxable year. Based on the company’s audited financial statements and relevant market and shareholder data, HSBC Holdings believes that it was not treated as a PFIC, FPHC or FIC for US Federal income tax purposes with respect to its 2003 or 2004 taxable year. In addition, based on the company’s audited financial statements and current expectations regarding the value and nature of its assets, the sources and nature of its income, and relevant market data, HSBC Holdings does not anticipate becoming a PFIC for its 2005 taxable year. Taxation of capital gains Gains realised by an eligible US holder on the sale or other disposition of shares or ADSs normally will not be subject to UK taxation unless at the time of the sale or other disposition the holder carries on a trade, profession or vocation in the United Kingdom through a branch or agency or permanent establishment and the shares or ADSs are or have been used, held or acquired for the purposes of such trade, profession, vocation, branch or agency or permanent establishment. Such gains will be included in income for US tax purposes, and will be long-term capital gains if the shares or ADSs were held for more than one year. A long-term capital gain realised by an individual holder generally is subject to US tax at a maximum rate of 5 or 15 per cent. Stamp duty and stamp duty reserve tax – ADSs If shares are transferred into a clearance service or depository receipt arrangement (which will include a transfer of shares to the Depository) UK stamp duty and/or stamp duty reserve tax will be payable. The stamp duty or stamp duty reserve tax is generally payable on the consideration for the transfer and is payable at the aggregate rate of 1.5 per cent. The amount of stamp duty reserve tax payable on such a transfer will be reduced by any stamp duty paid in connection with the same transfer. No stamp duty will be payable on the transfer of, or agreement to transfer, an ADS, provided that the ADR and any separate instrument of transfer or written agreement to transfer remain at all times outside the United Kingdom, and provided further that any such transfer or written agreement to transfer is not executed in the United Kingdom. No stamp duty reserve tax will be payable on a transfer of, or agreement to transfer, an ADS effected by the transfer of an ADR. On a transfer of shares from the Depository to a registered holder of an ADS upon cancellation of the ADS, a fixed stamp duty of £5 per instrument of transfer will be payable by the registered holder of the ADR cancelled. US backup withholding tax and information reporting Distributions made on shares and proceeds from the sale of shares or ADSs that are paid within the United States, or through certain financial intermediaries to US holders, are subject to information reporting and may be subject to a US ‘backup’ withholding tax unless, in general, the US holder complies with certain certification procedures or is a corporation or other person exempt from such withholding. Holders that are not US persons generally are not subject to information reporting or backup withholding tax, but may be required to comply with applicable certification procedures to establish that they are not US persons in order to avoid the application of such information reporting requirements or backup withholding tax to payments received within the United States or through certain financial intermediaries. 359 H S B C H O L D I N G S P L C Shareholder Information Fourth Interim Dividend for 2004 The Directors have declared a fourth interim dividend of US$0.27 per ordinary share (in lieu of a final dividend) which, together with the first, second and third interim dividends, each of US$0.13, already paid, will make a total distribution for the year of US$0.66 per share, an increase of 10 per cent on 2003. Information on the scrip dividend scheme and currencies in which shareholders may elect to have the cash dividend paid will be sent to shareholders on or about 31 March 2005. The timetable for the dividend is: Shares quoted ex-dividend in London, Hong Kong and Bermuda; ADSs quoted ex-dividend in New York .................... Record date and closure of Hong Kong Overseas Branch Register of shareholders for one day ........................................ Shares quoted ex-dividend in Paris .................................................................................................................................... Mailing of Annual Report and Accounts 2004 and/or Annual Review 2004, Notice of Annual General Meeting and dividend documentation ................................................................................................................................................ Final date for receipt by registrars of forms of election and revocations of standing instructions for scrip dividends ....... Exchange rate determined for payment of dividends in sterling and Hong Kong dollars .................................................. 2005 16 March 18 March 21 March 31 March 21 April 25 April Payment date: dividend warrants, new share certificates or transaction advices and notional tax vouchers mailed and shares credited to stock accounts in CREST ................................................................................................................. 4 May Annual General Meeting The 2005 Annual General Meeting will be held at the Barbican Hall, Barbican Centre, London EC2 on 27 May 2005 at 11am. The results of the polls on the resolutions considered at the 2004 Annual General Meeting were: Resolution 1. To receive the Report and Accounts for 2003 .................................................... 2. To re-elect the following as Directors: (i) The Lord Butler ......................................................................................... (ii) The Baroness Dunn ................................................................................... (iii) R A Fairhead ............................................................................................ (iv) W K L Fung ............................................................................................... (v) M F Geoghegan ......................................................................................... (vi) S Hintze ..................................................................................................... (vii) Sir John Kemp-Welch ................................................................................ (viii) Sir Mark Moody-Stuart .............................................................................. (ix) H Sohmen .................................................................................................. 3. To reappoint the Auditor .................................................................................... 4. To approve the Directors' Remuneration Report for 2003 .................................. 5. To authorise the Company to purchase its own Ordinary Shares ....................... 6. To authorise the Directors to allot shares ........................................................... 7. To disapply pre-emption rights .......................................................................... 8. To increase the fees payable to each Director to £55,000 per annum ................. Total votes For1 Against Abstain 4,534,048,124 30,738,011 100,222,400 4,584,223,431 4,492,829,647 4,580,638,229 4,563,806,817 4,521,685,013 4,586,866,409 4,568,924,728 4,585,915,338 4,550,012,643 4,535,270,802 4,300,843,761 4,598,522,244 4,589,969,856 4,522,023,920 4,582,085,323 39,229,528 69,944,841 42,918,568 36,436,808 41,362,809 36,801,910 37,774,400 37,302,195 56,244,926 49,114,012 231,541,059 7,185,058 29,699,300 116,714,723 38,135,193 41,811,813 102,488,373 41,666,160 65,024,000 102,176,346 41,585,070 58,556,934 42,021,810 58,774,190 79,985,778 149,917,043 38,983,604 41,332,269 23,172,113 41,346,918 1 Includes discretionary votes Interim Results The interim results for the six months to 30 June 2005 will be announced on Monday 1 August 2005. 360 Interim Dividends for 2005 The Board has adopted a policy of paying quarterly dividends. Under this policy it is intended to have a pattern of three equal interim dividends with a variable fourth interim dividend. It is envisaged that the first interim dividend in respect of 2005 will be US$0.14 per share. The proposed timetables for the dividends in respect of 2005 are: Interim dividends for 2005 First Second Third Fourth Announcement ........................................................ 3 May 2005 1 August 2005 7 November 2005 6 March 2006 ADSs quoted ex-dividend in New York .................. 18 May 2005 17 August 2005 22 November 2005 22 March 2006 Shares quoted ex-dividend in London, Hong Kong and Bermuda ....................................................... 18 May 2005 17 August 2005 23 November 2005 22 March 2006 Record date and closure of Hong Kong Overseas Branch Register of shareholders for one day ...... 20 May 2005 19 August 2005 25 November 2005 24 March 2006 Shares quoted ex-dividend in Paris ......................... 23 May 2005 22 August 2005 28 November 2005 27 March 2006 Payment date ........................................................... 6 July 2005 5 October 2005 19 January 2006 11 May 2006 Shareholder Enquiries and Communications Enquiries Any enquiries relating to your shareholding, for example transfers of shares, change of name or address, lost share certificates or dividend cheques, should be sent to the Registrars: Principal Register Hong Kong Overseas Branch Register: Bermuda Overseas Branch Register: Computershare Investor Services PLC PO Box 1064, The Pavilions Bridgwater Road Bristol BS99 3FA UK Computershare Hong Kong Investor Services Limited Hopewell Centre, 46th Floor 183 Queen’s Road East Wan Chai Hong Kong Corporate Shareholder Services Limited The Bank of Bermuda Limited 6 Front Street Hamilton HM 11 Bermuda Any enquiries relating to ADSs should be sent to the Depositary: The Bank of New York 101 Barclay Street Floor 22W New York, NY 10286 USA Any enquiries relating to shares held through Euroclear France, the settlement and central depositary system for Euronext Paris, should be sent to the paying agent: CCF S.A. 103, avenue des Champs Elysées 75008, Paris France Further copies of this Annual Report and Accounts 2004 may be obtained by writing to the following departments. For those in Europe, the Middle East and Africa For those in Asia-Pacific: For those in the Americas: Group Corporate Affairs HSBC Holdings plc 8 Canada Square London E14 5HQ UK Group Public Affairs The Hongkong and Shanghai Banking Corporation Limited 1 Queen’s Road Central Hong Kong Employee Communications HSBC-North America 2700 Sanders Road Prospect Heights Illinois 60070 USA 361 H S B C H O L D I N G S P L C Shareholder Information (continued) Electronic communications Shareholders may at any time choose to receive corporate communications in printed form or electronically. To register online to receive electronic communications, or revoke or amend an instruction to receive electronic communications, go to www.hsbc.com/ecomms. If you received this document electronically and would like to receive a printed copy or would like to receive future shareholder communications in printed form, please write to the appropriate Registrars at the address given above. Printed copies will be provided without charge. Chinese translation A Chinese translation is available on request after 31 March 2005 from the Registrars: Computershare Hong Kong Investor Services Limited Hopewell Centre, 46th Floor 183 Queen’s Road East Wan Chai Hong Kong Computershare Investor Services PLC PO Box 1064, The Pavilions Bridgwater Road Bristol BS99 3FA UK Please also contact the Registrars if you wish to receive Chinese translations of future documents or if you have received a Chinese translation of this document and do not wish to receive such translations in future. Investor Relations Enquiries relating to HSBC’s strategy or operations may be directed to: Senior Manager Investor Relations HSBC Holdings plc 8 Canada Square London E14 5HQ UK Telephone: +44 (0)20 7991 8041 Facsimile: +44 (0)20 7991 4663 E-mail: investorrelations@hsbc.com Director – Corporate Finance and Senior Manager External Investor Relations HSBC Finance Corporation 2700 Sanders Road Prospect Heights, IL 60070 USA +1 847 564 6478 +1 847 205 7538 investor.relations@us.hsbc.com Relations The Hongkong and Shanghai Banking Corporation Limited 1 Queen’s Road Central Hong Kong +852 2822 4929 +852 2845 0113 investorrelations@hsbc.com.hk Where more information about HSBC is available This Annual Report and Accounts 2004, and other information on HSBC, may be viewed on our web site: www.hsbc.com. US Investors may read and copy the reports, statements or information that HSBC Holdings files with the Securities Exchange Commission at its public reference room in Washington D.C., which is located at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. These documents will also be available at the Commission’s regional offices located at The Woolworth Building, 233 Broadway, New York, NY 10279 and at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, IL 60661. Investors should call the Commission at 1- 800-SEC-0330 for further information on the operation of the public reference rooms. Investors can request copies of these documents upon payment of a duplicating fee, by writing to the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Investors may also obtain the reports and other information HSBC Holdings files at the offices of the New York Stock Exchange, Inc., 20 Broad Street, New York, NY 10005. 362 Dividends on the ordinary shares of HSBC Holdings HSBC Holdings has paid dividends on its ordinary shares every year without interruption since it became the HSBC Group holding company by a scheme of arrangement in 1991. The dividends declared, per ordinary share, for each of the last five years were: First interim Second interim 20041 2003 2002 2001 2000 US$ ...................................... £ ........................................... HK$ ..................................... US$ ...................................... £ ........................................... HK$ ..................................... US$ ...................................... £ ........................................... HK$ ..................................... US$ ...................................... £ ........................................... HK$ ..................................... US$ ...................................... £ ........................................... HK$ ..................................... 0.130 0.071 1.013 0.240 0.146 1.860 0.205 0.130 1.600 0.190 0.129 1.482 0.150 0.103 1.170 0.130 0.072 1.014 0.120 0.065 0.931 0.325 0.202 2.534 0.290 0.200 2.261 0.285 0.191 2.223 Third interim 0.130 0.069 1.013 0.240 0.134 1.863 – – – – – – – – – Fourth interim 0.270 0.140 2.100 – – – – – – – – – – – – Total 0.660 0.352 5.139 0.600 0.345 4.654 0.530 0.332 4.134 0.480 0.329 3.743 0.435 0.294 3.393 1 The fourth interim dividend for 2004 of US$0.27 per share has been translated into pounds sterling and Hong Kong dollars at the closing rate on 31 December 2004. The dividend will be paid on 4 May 2005. Dividends are declared in US dollars and, at the election of the shareholder, paid in cash in one of, or in a combination of, US dollars, sterling and Hong Kong dollars, or satisfied in whole or in part by the issue of new shares in lieu of a cash dividend. Nature of trading market HSBC Holdings has listings on the London Stock Exchange, HKSE, Euronext Paris, NYSE and the Bermuda Stock Exchange. HSBC Holdings maintains its principal share register in London and overseas branch share registers in Hong Kong and Bermuda (collectively, the ‘share register’). As at 31 December 2004, there were a total of 208,105 holders of record of HSBC Holdings ordinary shares. As at 31 December 2004, a total of 13,528,484 of the HSBC Holdings ordinary shares were registered in the HSBC Holdings share register in the name of 8,610 holders of record with addresses in the United States. These shares represented 0.12 per cent of the total HSBC Holdings ordinary shares in issue. As at 18 February 2005, there were 12,141 holders of record of ADSs holding approximately 104.56 million ADSs, representing approximately 522.80 million HSBC Holdings ordinary shares. 11,900 of these holders had addresses in the United States, holding approximately 104.48 million ADSs, representing 522.41 million HSBC Holdings ordinary shares. As at 18 February 2005, approximately 4.67 per cent of the HSBC Holdings ordinary shares were represented by ADSs held by holders of record with addresses in the United States. The following table shows, for the years, calendar quarters and months indicated, the highest and lowest prices for the HSBC Holdings ordinary shares and ADSs. These are based on mid-market prices at close of business on the London Stock Exchange, HKSE, Euronext Paris, NYSE and the Bermuda Stock Exchange. Past share price performance should not be regarded as a guide to future performance. 363 H S B C H O L D I N G S P L C Shareholder Information (continued) High and low mid-market closing prices 2004 ......................... 2003 ….. ................... 2002 ......................... 2001 ......................... 2000 ......................... London US$0.50 shares High pence 954 914 866 1092 1046 Low pence 784 631 643 608 682 Hong Kong US$0.50 shares High HK$ 136.5 122.5 97.5 121.5 117.5 Low HK$ 109.5 80.3 78.8 68.5 82.8 London US$0.50 shares High pence Low pence Hong Kong US$0.50 shares High HK$ Low HK$ 2004 4th Quarter .............. 3rd Quarter .............. 2nd Quarter ............. 1st Quarter .............. 2003 4th Quarter ................ 3rd Quarter ................ 2nd Quarter ................ 1st Quarter ................. 954 888 836 893 914 828 743 709 860 784 789 802 810 700 650 631 London US$0.50 shares High pence Low pence 900 895 954 909 888 866 814 868 860 891 873 871 821 784 2005 January ..................... 2004 December ................. November ................. October .................... September ................ August ...................... July ........................... Notes 136.5 124.0 118.5 128.5 122.5 105.0 97.0 89.0 124.5 114.5 109.5 115.5 104.0 91.8 80.3 80.3 Hong Kong US$0.50 shares High HK$ Low HK$ 132.5 127.0 134.5 136.5 126.0 124.0 121.5 117.5 130.0 126.5 124.5 122.0 115.0 114.5 New York ADSs1 High US$ 87.8 78.8 64.4 79.7 76.6 New York ADSs High US$ 87.8 79.8 76.5 82.5 78.8 67.3 62.5 57.3 New York ADSs High US$ 84.7 86.7 87.8 81.0 79.8 77.9 74.4 Low US$ 70.0 51.1 50.3 44.8 54.3 Low US$ 79.8 72.7 70.0 73.5 68.0 58.6 51.6 51.1 Low US$ 81.3 83.6 81.8 79.8 78.3 75.3 72.7 Paris2 US$0.50 shares High euro 13.6 13.4 13.9 17.3 17.6 Low euro 11.8 9.3 10.2 9.5 14.2 Bermuda3 US$0.50 shares High US$ 17.3 – – – – Low US$ 14.5 – – – – Paris US$0.50 shares High euro Low euro Bermuda US$0.50 shares High US$ Low US$ 13.6 13.1 12.6 13.2 13.4 12.0 10.7 10.9 12.4 11.8 11.8 12.0 11.5 10.1 9.4 9.3 17.3 15.9 15.3 16.5 – – – – 16.0 14.6 14.5 14.7 – – – – Paris US$0.50 shares High euro Low euro Bermuda US$0.50 shares High US$ Low US$ 12.7 13.0 13.6 13.1 13.1 13.0 12.3 12.4 12.4 12.8 12.6 12.8 12.2 11.8 16.5 17.1 17.3 16.3 15.9 15.3 15.2 16.5 16.7 16.6 16.0 15.6 15.0 14.6 1 In New York each ADS represents 5 underlying ordinary shares. 2 Shares were not listed on the Paris Bourse (now Euronext Paris) prior to 28 July 2000. 3 Shares were not listed on the Bermuda Stock Exchange prior to 18 February 2004. 364 H S B C H O L D I N G S P L C Organisational Structure ) C B S H o c u b a c a h C s e n o i s r e v n I . A S . o p u r G o r e i c n a n i F e d . A S . , C B S H ) . V C . % 8 . 9 9 ( o c i x e M C B S H . A S . % 8 . 9 9 ( C B S H a n i t n e g r A . A S s g n i d l o H n i t a L C B S H a c i r e m A ) K U ( s g n i d l o H d e t i m L i C B S H n i t a L a c i r e m A V B ) % 5 4 . 0 1 ( k n a B C B S H – o l p i t l u M o c n a B . . A S l i s a r B . . A S ) l i s a r B ( ) % 0 9 . 7 9 ( C B S H s o r u g e S a L C B S H s e r i A s o n e u B A S s o r u g e S ) % 6 3 . 9 9 ( k n a B C B S H . . A S a n i t n e g r A ) % 7 9 . 9 9 ( ) % 3 5 . 9 8 ( ) % 9 9 . 9 ( ) % 9 9 . 6 1 ( ) % 9 9 . 2 3 ( A S a m i x a M ) P J F A % 9 . 9 5 ( k n a B C B S H t s a E e l d d i M d e t i m L i b a r A h s i t i r B l a i c r e m m o C d e t i i m L k n a B ) % 1 5 . 6 4 ( C B S H e c n a r u s n I s g n i d l o H d e t i m L i C B S H e c n a r u s n I s r e k o r B d e t i m L i k n a B C B S H E A S t p y g E ) % 3 5 . 4 9 ( f o k n a B s n o i t a c i n u m m o C d e t i m L i ) % 9 . 9 1 ( i d u a S e h T h s i t i r B k n a B ) % 0 4 ( C B S H e c n a r u s n I ) c i f i c a P - a i s A ( s g n i d l o H d e t i m L i C B S H e c n a r u s n I ) a i s A ( d e t i m L i e h T g n o k g n o H i a h g n a h S d n a g n i k n a B n o i t a r o p r o C d e t i m L i k n a B C B S H a i l a r t s u A d e t i m L i ) % 1 3 . 5 1 ( d e t i m L i e t a g w o r r a B d e t i i m L k n a B ) % 4 1 . 2 6 ( ) % 4 6 . 4 2 ( g n e S g n a H k n a B C B S H a i s y a l a M d a h r e B f o k n a B e h T a d u m r e B d e t i m L i C B S H t n e m t s e v n I c l p k n a B s g n i d l o H t e s s A C B S H t n e m e g a n a M ) e p o r u E ( d e t i m L i t e s s A C B S H t n e m e g a n a M ) n a w i a T ( d e t i m L i ) % 4 9 . 9 9 ( C B S H e c n a n i F ) s d n a l r e h t e N ( h t r o N C B S H a c i r e m A . c n I s g n i d l o H C B S H s g n i d l o H c l p p u o r G C B S H e h T i s e n a p m o C g n i t a r e p O l i a p c n i r P f o e r u t c u r t S 5 0 0 2 y r a u n a J t a ) % 9 3 . 1 2 ( k n a B C F H d e t i m L i o g r a F s l l e W e d a r T C B S H . A N . , k n a B ) % 0 2 ( k n a B C B S H c n I . A N . , A S U e h T s u r p y C k n a B r a l u p o P d e t i m L i C B S H V B s g n i d l o H e c n a n i F n o i t a r o p r o C s e i t i r u c e S . c n I ) A S U ( C B S H C B S H A S U C B S H . c n I C B S H & y g o l o n h c e T ) A S U ( s e c i v r e S C B S H c i l b u p e R s g n i d l o H ) g r u o b m e x u L ( . A S . C B S H & s u a k n i r T t d r a h k r u B A a G K ) % 7 4 3 7 ( . t e s s A C B S H k n a B C B S H c l p e c n a n i F ) K U ( d e t i m L i ) % 7 3 . 7 9 ( k n a B C B S H . . S A . . A S F C C ) % 9 9 . 9 9 ( d e t i i m L ) K U e f i L C B S H ) % 3 6 2 ( . k n a B C B S H a d a n a C C B S H e p o r u E V B ) % 6 5 2 1 ( . a s i r E ) % 9 9 . 9 4 ( ) % 5 . 5 ( ) % 5 . 4 9 ( ) % 2 9 ( k n a B C B S H . c . l . p a t l a M ) % 3 0 0 7 ( . ) % 4 4 7 8 ( . C B S H e t a v i r P g n i k n a B s g n i d l o H A S ) e s s i u S ( C B S H e t a v i r P ) e s s i u S ( k n a B . A S . C B S H k n a B e t a v i r P d e t i i m L ) K U ( C B S H k n a B e t a v i r P ) y e s n r e u G ( d e t i m L i n o t g n i l m a r F p u o r G d e t i m L i ) % 1 5 ( C B S H r e l l e z r e y u G G A k n a B ) % 8 ( e f i L C B S H ) l a n o i t a n r e t n I ( d e t i m L i n w o h s e r a s e i n a p m o c g n i d l o h e t a i d e m r e t n i l l a t o n ; y l n o m a r g a i d p i h s r e n w o d e i f i l p m i s a s i t r a h c s i h T d e n w o e g a t n e c r e p e t a m i t l u e h t s e t a c i d n i x o b e m a n y n a p m o c a e d i s n i s t e k c a r b n i e r u g i f e g a t n e c r e p A . ' s t n e m e t a t S l a i c n a n i F e h t n o s e t o N ' e h t f o 5 2 d n a 1 2 , 0 2 s e t o N n i n w o h s e r a n o i t a r o p r o c n i f o s e c a l P . d e n w o y l l o h w s i y n a p m o c e h t s r a e p p a e r u g i f o n e r e h W p u o r G C B S H e h t n i h t i w y n a p m o c t a h t f o ) 1 ) 2 ) 3 ) 4 S E T O N ( 365 H S B C H O L D I N G S P L C Glossary Glossary of Accounting Terms and Abbreviations Accounting terms used US equivalent or brief description Financial Statements Issued Bylaws Long-term equity investments accounted for by the equity method Net income Statement of financial position Notes Ordinary shares, issued and fully paid Tax depreciation allowances Payables Trading Receivables Deferred income tax Process by which a mutual society is converted into a public limited company Amortisation Fees and commissions expense Fees and commissions income Capital lease Ownership with absolute rights in perpetuity Interest expense Interest income Long-term equity investments accounted for by the equity method Lendings Long-term debt Contingencies and commitments; off-balance-sheet items Par value Non-recurring Common stock Long-term equity investments accounted for by the cost method A line of credit, contractually repayable on demand unless a fixed-term has been agreed, established through a customer’s current account Preferred stock Real estate Income statement Retained earnings Allowances Increase or temporary decrease in the valuation of certain assets as compared with historical cost Ordinary shares or common stock issued and fully paid Stockholders’ equity Additional paid-in capital Shares outstanding Property and equipment Restricted surplus Charge-offs Accounts Allotted Articles of Association Associates Attributable profit Balance sheet Bills Called-up share capital Capital allowances Creditors Dealing Debtors Deferred tax De-mutualising Depreciation Fees and commissions payable Fees and commissions receivable Finance lease Freehold Interest payable Interest receivable Interests in associated undertakings Loans and advances Loan capital Memorandum items Nominal value One-off Ordinary shares Other participating interests Overdraft Preference shares Premises Profit & loss account Profit & loss account reserve Provisions Revaluation reserve Share capital Shareholders’ funds Share premium account Shares in issue Tangible fixed assets Undistributable reserves Write-offs 366 Abbreviations used Brief description ABC ADS AICPA AIEA ALCO Amparos ASB Banking Ordinance Bank of Bermuda Bank of Communications Basel Committee Basel II BBA BHCA BOC Brazilian operations CCF CD Combined Code Consumer Finance CPI CRM CSR ECB EITF EU FASB FDIC FFIEC policies FHC FIC FIN FinCEN FPHC FRN FRS FSA FSMA FTE FTSE GAAP GDP GHOS Asset-backed conduits American depositary share The American Institute of Certified Public Accountants Average interest-earning assets Asset and liability management committee Argentinian judicial orders that allow certain depositors relief from the pesification rules and recovery of their historical US dollar deposits at current exchange rates. Accounting Standards Board (UK) The Banking Ordinance of Hong Kong (Chapter 155) The Bank of Bermuda Limited, which was acquired in February 2004 Bank of Communications Limited, mainland China’s fifth largest bank in which HSBC acquired a 19.9% investment in August 2004. The Basel Committee on Banking Supervision The Final Accord of the Basel Committee on proposals for a new capital adequacy framework British Bankers Association Bank Holdings Company Act of 1956 (US) The Bank of Canada HSBC Bank Brazil and subsidiaries, plus Banco Lloyds TSB S.A. and Losango Promotora de Vendas Limitada. CCF S.A., HSBC’s French banking subsidiary Certificate of deposit Combined Code on Corporate Governance appended to the Listing Rules HSBC’s Consumer Finance customer group, comprising HSBC Finance Corporation’s consumer finance business and the US residential mortgages and credit card portfolios acquired by HSBC Bank USA from HSBC Finance Corporation and its correspondents since December 2003 Consumer price index Customer relationship management Corporate social responsibility European Central Bank Emerging Issues Task Force (US) European Union Financial Accounting Standards Board (US) Federal Deposit Insurance Corporation (US) Uniform Retail Credit Classification and Account Management Policy issued by the Federal Financial Institutions Examination Council (US) Financial holding company, as defined under the Gramm-Leach-Bliley Act amendments to the BHCA Foreign investment company FASB Interpretation (US) The Financial Crimes Enforcement Network, a bureau of the US Treasury Department Foreign personal holding company (US) Floating rate note Financial Reporting Standard (UK) Financial Services Authority (UK) Financial Services and Markets Act 2000 (UK) Full-time equivalent staff numbers Financial Times – Stock Exchange index Generally Accepted Accounting Principles Gross domestic product Hong Kong Government Home Ownership Scheme 367 H S B C H O L D I N G S P L C Glossary (continued) Abbreviations used Global Markets Group Hang Seng Bank HFC Bank HK Model Code HKSE Hong Kong Hong Kong GAAP Household Bank HNAH HS HSBC HSBC Bank HSBC Bank Argentina HSBC Bank Brazil HSBC Bank Malaysia HSBC Bank Middle East Brief description HSBC’s treasury and capital markets services in Corporate, Investment Banking and Markets HSBC Holdings together with its subsidiary undertakings Hang Seng Bank Limited, the second largest bank in Hong Kong by market capitalisation HFC Bank Limited, the UK-based consumer finance business acquired through the acquisition by HSBC of HSBC Finance Corporation Rules governing the listing of securities on the HKSE The Stock Exchange of Hong Kong Limited The Hong Kong Special Administrative Region of the People’s Republic of China Hong Kong Generally Accepted Accounting Principles Household Bank (SB), N.A. a national chartered ‘credit card bank’ in the US which is a subsidiary of HSBC Finance Corporation HSBC North America Holdings Inc, the bank holding company formed on 1 January 2004 to hold all of HSBC’s North America operations Historic simulation methodology for calculating trading VAR. HSBC Holdings together with it subsidiary undertakings HSBC Bank plc, formerly Midland Bank plc HSBC Bank Argentina S.A. HSBC Bank Brasil S.A.-Banco Múltiplo, HSBC’s retail banking operation in Brazil, formerly Banco Bamerindus do Brasil S.A. HSBC Bank Malaysia Berhad HSBC Bank Middle East Limited, formerly The British Bank of the Middle East HSBC Bank USA HSBC’s retail bank in the US. From 1 July 2004, HSBC Bank USA, N.A. HSBC Finance Consumer Finance plus the insurance and commercial banking operations HSBC Finance Corporation The US consumer finance company acquired in March 2003 (formerly of HSBC Finance Corporation (formerly HSBC Bank USA, Inc,) HSBC Holdings HSBC Mexico HSBC Private Bank (Suisse) IAS IBA IFRS IGU Industrial Bank IPO IT KPMG LIBOR Losango Mainland China M&S Money MMEs Monetary Authority MSCI MSRs 368 Household International, Inc.) HSBC Holdings plc, the parent company of HSBC Grupo Financiero HSBC, S.A. de C.V. (formerly Grupo Financiero Bital, S.A. de C.V.), the fifth-largest bank in Mexico by deposits and assets HSBC Private Bank (Suisse) S.A., HSBC’s private bank in Switzerland (formerly HSBC Republic Bank (Suisse) S.A.) International Accounting Standard International Banking Act of 1978 (US) International Financial Reporting Standard Income generating unit Industrial Bank Co. Limited, a national joint-stock bank in China of which Hang Seng owns 15.98 per cent. Initial public offering Information technology KPMG Audit plc and its affiliates London interbank offered rate Losango Promotora de Vendas Limitada, the Brazilian consumer finance company acquired in December 2003 The People’s Republic of China excluding Hong Kong Marks and Spencer Retail Financial Services Holdings Limited, acquired by HSBC in November 2004. Middle market enterprises The Hong Kong Monetary Authority Morgan Stanley Capital International index Mortgage servicing rights Abbreviations used Brief description NYSE OCC OCI Patriot Act Pesification PFIC PFS Ping An Insurance PVBP QUEST Repos SARS SAYE SEC SEE SFAS Sinopia SME SOP SORP New York Stock Exchange Office of the Comptroller of the Currency (US) Other comprehensive income The USA Patriot Act of October 2001 The mandatory and asymmetrical conversion of onshore US dollar denominated assets and liabilities in Argentina Passive foreign investment company HSBC’s Personal Financial Services customer group Ping An Insurance Company of China Limited, the second-largest life insurer in the PRC, in which HSBC holds a 10 per cent stake Present value of a basis point HSBC’s Qualifying Employee Share Ownership Trust Sale and repurchase transactions Severe acute respiratory syndrome Save As You Earn Securities and Exchange Commission (US) Social, ethical and environmental Statement of Financial Accounting Standards (US) Sinopia Asset Management Small to medium-sized enterprise Statement of Position issued by the AICPA (US) Statement of Recommended Accounting Practice issued by the BBA (UK) SPE SSAP The Act The Hongkong and Shanghai Banking Special purpose entity Statement of Standard Accounting Practice (UK) The Companies Act 1985 (UK) The Hongkong and Shanghai Banking Corporation Limited, the founding Corporation member of the HSBC Group The Securities and Futures Ordinance TRIP TSR UITF UK UK GAAP Units The Securities and Futures Ordinance of Hong Kong (Chapter 571) Tax Reduction Investment Plan Total shareholder return Urgent Issues Task Force (UK) United Kingdom UK Generally Accepted Accounting Principles 8.875 per cent adjustable convertible rate equity security units issued by US US GAAP VAR VCV VIEs WHIRL WTAS HSBC Finance Corporation United States of America US Generally Accepted Accounting Principles Value at risk Variance co-variance methodology for computing trading VAR. Variable interest entities Worldwide Household International Revolving Lending system Wealth and Tax Advisory Services 369 H S B C H O L D I N G S P L C lndex Acceptances (UK/US GAAP differences) 330 Accounting developments (future) 121 policies (principal) 243 requirements in UK and Hong Kong 321 Accounts (approval) 356 Administrative expenses 250 Annual General Meeting 215, 360 Assets analysis 298 by customer group 12 by geographical region 15, 58, (total and net) 314 deployment 41 other 280 Associates 273 Assurance fund (UK/US GAAP differences) 322 Audit committee (Group) 205 Auditor 215 report 235 Available for sale securities 347 Bad and doubtful debts 35 credit risk management 135 net charge to profit and loss account 154 provisions 118, 137, 138, 142, 152 suspended and non-accrual interest 139 Balance sheet average 123 – 130 consolidated 238 – 239 HSBC Holdings 240 Basis of preparation of accounts 243 Business highlights 47 Calendar (financial) 360 Capital commitments 314 events 191 future developments 174 management and allocation 174 structure 177 Cash flow analysis of cash 313 consolidated statement 242, 352 reconciliation to operating profit 312 Cautionary statement regarding forward-looking statements 5 Certificates of deposit and other time deposits (maturity analysis) 182 Commercial banking business highlights 51 performance in Europe 64, 68 performance in Hong Kong 75, 78 performance in Rest of Asia Pacific 86 performance in North America 98,102 performance in South America 111,113 product offering 13 Committees (board) 205 Communication with shareholders 212 Competitive environment 16 global factors 16 regional factors 17 Constant currency 2 370 Consumer finance business highlights 49 performance in Europe 63, 67 performance in North America 96, 102 product offering 12 Contents frontispiece Contingent liabilities and commitments 306 Contractual obligations 185 Corporate governance 202 HSBC Holdings/New York Stock Exchange corporate governance differences 208 Corporate, Investment Banking & Markets business highlights 53 performance in Europe 64, 68 performance in Hong Kong 76, 79 performance in Rest of Asia Pacific 86, 88 performance in North America 98, 103 performance in South America 110, 113 product offering 14 Corporate social responsibility (CSR) committee 207 Credit risk management 135 – 137, 263 Critical accounting policies 118 – 121 Customer groups 12, 62 – 117 Customer accounts 281 Dealings in HSBC Holdings plc shares 215 Debt securities 268 held in accrual books 42 in issue 282 Deferred taxation UK/US GAAP differences 327, 348 Defined terms frontispiece Deposits average balances and average rates 180 by banks 281 Derivatives (accruals accounted) UK/US GAAP differences 325, 344 Directors Biographies 186 board of directors 202, 217 Emoluments 226 Interests 212 Remuneration 216 responsibilities (statement of) 234 service contracts and terms of appointment 223 Dividend income 250 Dividends 261, 360, 363 UK/US GAAP differences 327 Donations 215 Earnings per ordinary share 261, 351 Economic background Europe 62, 66 Hong Kong 74, 77 Rest of Asia Pacific 84, 87 North America 94, 100 South America 109, 112 Economic profit 42 Employees 11 remuneration policy 216 disabled 214 involvement 214 Enforceability of judgements made in the US 7 Enquiries (from shareholders) 361 Europe competitive environment 17 economic background 62, 66 profit/(loss) 60 regulation and supervision 20 Equity shares 271 Exchange controls and other limitations affecting security holders 7 Fair value and price verification control 168 Fees and commissions 30 Financial highlights 1 Financial instruments 299 fair value 349 Financing changes 312 Five-year comparison 3 Fixed assets intangible 274 tangible 275 Foreign currency Denomination losses in Argentina 348 UK/US GAAP differences 326 Funds under management 42 Gains on disposal of investments 38 Goodwill impairment 119 UK/US GAAP differences 323, 342 Group Management Board 205 Health and safety 211 Hong Kong competitive environment 18 currency notes in circulation 263 economic background 74, 77 profit/(loss) 73 regulation and supervision 21 HSBC Holdings plc availability of information 362 balance sheet 240 funding 167 history and development 8 profit 260 Income from dealing in financial instruments 250 Intangible assets UK/US GAAP differences 324, 342 Interest rate exposures 171 Internal control 209 Insurance and financial risk (management of) 172 International Financial Reporting Standards (transition) 121 Investments 278 Investment securities UK/US GAAP differences 326, 345 Investor relations 362 Joint ventures 272 Lease commitments 314 UK/US GAAP differences 322 Legal proceedings 25, (litigation) 313 Liabilities analysis 298 other 283 provisions 283 subordinated 285 Liquidity and funding management 166 primary sources 166 Loans and advances maturity and interest sensitivity 179 UK/US GAAP differences 327, 349 to banks 148, 263, 350, to customers 140, 264, 350 Market risk management 167, 308 Memorandum items 306 Minority interests 288 Net interest income 27 average balance sheet 123 analysis of changes 131 simulation modelling 170 Nomination committee 207 North America competitive environment 18 economic background 94, 100 profit/(loss) 93 regulation and supervision 22 Off-balance sheet arrangements 184 Other operating income 30 Operating expenses 33 Operational risk management 173 Organisational structure chart 365 Outlook 9 Own shares held UK/US GAAP differences 326 Participating interests (other) 274 Pensions for directors 228 UK/US GAAP differences 328, 333 Personal financial services business highlights 47 performance in Europe 62, 67 performance in Hong Kong 74, 78 performance in Rest of Asia Pacific 85, 88 performance in North America 95, 100 performance in South America 110, 112 product offering 12 Principal activities and business review 191 Private Banking business highlights 55 performance in Europe 65, 69 performance in Hong Kong 77, 79 performance in Rest of Asia Pacific 87, 89 performance in North America 99, 103 performance in South America 112, 113 product offering 15 Profit/(loss) excluding goodwill amortisation by customer group 12,44-46, 70-72, 80-82, 90- 92, 105-107, 115-117 Profit/(loss) on ordinary activities before tax after including 259 by geographical region 58 consolidated 237 UK/US GAAP differences 330 Property 371 H S B C H O L D I N G S P L C lndex (continued) description 25 UK/US GAAP differences 324 valuation of land and buildings 202 Purchase accounting adjustments 344 Ratios – capital and performance 2 Recognised gains and losses for year (statement of total consolidated) 241 Regulation and supervision 20 – 24 Related party transactions 320 Remuneration Committee 216 Reputational risk 173 Reserves 191, 293 Rest of Asia Pacific competitive environment 18 economic background 84, 88 profit/(loss) 83 Restructuring provisions UK/US GAAP differences 329 Risk elements in loan portfolio 161 Risk credit 135, 263 reputational and operational 211 Risk-weighted assets (by principal subsidiary) 178 Sale and repurchase transactions UK/US GAAP differences 327 Securitisations UK/US GAAP differences 328, 354 Segmental analysis 314 Senior management biographies 186 remuneration 216 Share capital 289 notifiable interests 214 Share option plans CCF and subsidiary plans 196 discretionary plans 194 for directors 229 for employees 192 HSBC Finance Corporation and subsidiary plans 198 restricted share plan 219, 232 UK/US GAAP differences 323 Shareholders’ funds for year (reconciliation of movements in consolidated) 241 Short-term borrowings (analysis) 183 Software costs UK/US GAAP differences 323, 343 South America competitive environment 19 economic background 109, 112 profit/(loss) 108 Strategy 10 Structural foreign exchange exposure 172 Supplier payment policy 214 Taxation 39, 259, 348, 357, 358 (US residents) Total shareholder return 10, 11, 220 Trading market (nature of) 363 Treasury bills and other eligible bills 261 UK GAAP differences from US GAAP 322 – 356 US GAAP differences from UK GAAP 322 – 356 selected financial data 4 Value at risk 168 Variable interest entities UK/US GAAP differences 329, 351 372 HSBC HOLDINGS PLC Incorporated in England with limited liability under the UK Companies Act 1985. Registered in England: number 617987 REGISTERED OFFICE AND GROUP HEAD OFFICE 8 Canada Square London E14 5HQ United Kingdom Telephone:44 (0) 20 7991 8888 Facsimile: 44 (0) 20 7992 4880 Web: www.hsbc.com STOCKBROKERS Goldman Sachs Peterborough Court 133 Fleet Street London EC4A 2BB United Kingdom HSBC Bank plc 8 Canada Square London E14 5HQ United Kingdom REGISTRARS Principal Register Computershare Investor Services PLC PO Box 1064, The Pavilions Bridgwater Road Bristol BS99 3FA United Kingdom Telephone: 44 (0) 870 702 0137 Hong Kong Overseas Branch Register Computershare Hong Kong Investor Services Limited 46th floor, Hopewell Centre 183 Queen’s Road East Hong Kong Telephone: 852 2862 8628 Bermuda Overseas Branch Register Corporate Shareholder Services The Bank of Bermuda Limited 6 Front Street Hamilton HM11 Bermuda Telephone: 1 441 299 6737 ADR Depositary The Bank of New York 101 Barclay Street Floor 22W New York, NY 10286 Telephone: 1 888 269 2377 Paying Agent (France) CCF 103 avenue des Champs Elysées 75008 Paris Telephone: 33 1 40 70 22 56 373 374 © Copyright HSBC Holdings plc 2005 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC Holdings plc. Published by Group Finances, HSBC Holdings plc, London Designed by Group Public Affairs, The Hongkong and Shanghai Banking Corporation Limited, Hong Kong Printed by St Ives Direct Romford Limited, Romford, United Kingdom, on Revive Special Silk paper using vegetable oil-based inks. Made in Spain, the paper comprises 30% virgin fibre from Forest Stewardship Council-certified forests, 30% de-inked post-consumer waste, 10% mill broke and 30% virgin fibre. Pulps used are elemental chlorine-free. FSC Trademark © 1996 Forest Stewardship Council A.C. SGS-COC-0912 HSBC Holdings plc 8 Canada Square London E14 5HQ United Kingdom Telephone: 44 020 7991 8888 Facsimile: 44 020 7992 4880 Web: www.hsbc.com 

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